Century Bancorp Inc.
Annual Report 2006

Plain-text annual report

170680.BCFC.qxd 2/27/07 7:59 PM Page 1 400 Mystic Avenue Medford, MA 02155 (866) 823.6887 www.century-bank.com A N N U A L R E P O R T 2 0 0 6 F A M I L Y - F O C U S E D IT IS WHAT SETS US APART Equal Housing Lender / Member FDIC 002CS-13055 170680.BCFC.qxd 2/27/07 8:00 PM Page 2 A WORD FROM MARSHALL SLOANE 2006 has been a busy year at Century Bank. In April, I proudly turned over the CEO position to my sons, Barry and Jonathan. As Co-CEOs, they have assumed these responsibilities during one of the most challenging periods for bank fundamentals since the early 1990s. With their leadership and our strong financial position, I am confident they will strive to carry on the family tradition of a strong work ethic and sound values. Although these challenging times have lowered net earnings, our balance sheet is rock solid. Additionally, increased loan outstandings, sizable branch deposit growth, and stable overhead point toward a recovery in 2007. While I have abdicated my CEO responsibilities, I expect to continue my tenure as Chairman of the Board well into the future. I wish to commend my two colleagues who have also enjoyed a long and successful tenure with Century Bank: Paul V. Cusick, Jr. who retires as Century’s CFO after 18 years of service; and John C. Lavallee, the 33-year veteran head of our Institutional Services Group, who is working part-time in retirement as a senior consultant for Century. I am grateful to them, our loyal shareholders, associates, and clients, who have all played a strong role in the growth of Century. I look forward to prospering together in 2007 and the years ahead. Sincerely, Marshall M. Sloane Founder and Chairman 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) 823.6887 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 43078 Providence, RI 02940-3078 TEL (781) 575.3400 computershare.com A N N UA L M E E T I N G The annual meeting of stockholders will be held on Tuesday, April 10, 2007, 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 CentBcp A 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 Braintree Brookline Burlington Cambridge Everett Lynn Malden Medford Medford Square Newton Peabody Quincy Salem Somerville 300 Western Avenue, Allston, MA 02134 428 Rantoul Street, Beverly, MA 01915 710 Albany Street, Boston, MA 02118 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 (617) 562.1700 (978) 921.2300 (617) 578.9250 (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 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 Weston 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 Sloane Square, 110 Medford Street, Medford, MA 02155 College Hall, Regis College, 235 Wellesley Street, Weston, MA 02493 170680.P.qxd 2/27/07 8:03 PM Page 1 DEAR FELLOW SHAREHOLDERS, Family. Spouses. Parents. Children. Grandchildren. For most of us, family defines our life, motivates our work, inspires our legacy, and sets the tone for the way we live. Family values are the Century difference. As one of the 16 remaining family controlled banks (over $1 billion in assets) in the US, and the last one in Massachusetts; family is our defining competitive differentiator. We passionately believe that the closely controlled nature of our enterprise has important benefits to all four of our core constituencies now and in the years to come: For our shareholders, the economic interest of senior management through its “B” shares is fully aligned with our public “A” shareholders. Our family’s ownership stake is of such significant size there is no doubt we are focused on the strategic issues facing our company with the long-term view of all equity owners. For our clients, it means that we take a personal interest in their relationship, making client contact a constant theme of our management style. Our focus on serving the total needs of our clients is more than a slogan; it is how we run our business. It also means that superior product and service execution is a way of life for us. For our associates, it is the assurance that we will not announce a round of layoffs just to meet analyst expectations. While we function from a lean and proven expense base, officer and staff can make a career at Century, and not use their time with us as a professional interlude en route to another job. Century’s low level of staff turnover and historically high job satisfaction is testimony to the success of our human resource policy. For the 17 communities in Massachusetts where we operate 22 offices, it is the banking, lending, and philanthropic dedication to these cities and towns that distinguish our commitment from all four of Massachusetts’ “giant” banks, which are owned and controlled from outside the state. Our financial performance was below our plans and expectations in 2006. Our balance sheet, however, in terms of both loans and securities, remains strong. Century is profitable, though like our competitors, our earnings have been adversely affected by the following elements: The flat to inverted yield curve that has plagued the bond market has consumed over 1.6% of our historical net interest margin. We have managed our asset/liability process more closely than ever, resulting in the planned contraction of our total assets by some $84 million. All bankers have experienced the depression of margins to record low levels. We will not attempt to predict when the yield curve will “rationalize,” but we will stay the course in what is admittedly a cyclical business. 170680.P.qxd 2/27/07 7:11 AM Page 2 Barry and Jonathan Sloane Our securities portfolio has proven to be of a shorter duration, at 1.7 years, than we would have optimally wanted. To improve earnings in 2007, we are allowing our securities portfolio to shrink through scheduled maturities, and redeploying the resources in loans and short-term investments. The intensity of retail branch competition in Greater Boston has continued its escalation. In response, we repositioned our 22-branch network and consolidated our Atlantic Avenue location into our new and highly efficient State Street office. With all of 2006’s challenges, we are proud of the following achievements: Our loan portfolio grew 6.8%, including the addition of some 430 new small business loans, representing over $37 million of our $110 million of total loan growth. The deposits of our branch system grew by 14.8%, nearly $119 million. We attribute much of this growth to the premier level of service provided by our branch managers and their associates; and the consistent “best in class” programs of our marketing department, despite a flat non-interest expense base. We have undertaken a significant project to analyze and improve the margins in our Institutional Services Group. Comprised of government banking, lockbox, and cash management services, the Group processes more than 43 million items annually. We have installed new management and believe we can improve the earnings of our Institutional Services business, which is now the third largest lockbox provider in New England. 170680.P.qxd 2/27/07 8:03 PM Page 3 We have increased our fee income by nearly $1 million, a significant portion of which is due to our expanded products and services for money service businesses throughout New England. We continued our long tradition of “best practices” in client related technology by introducing Century Remote Deposit. This enables commercial clients to deposit electronically from their facilities, discontinuing the need to use deposit couriers, often at our expense. In the area of energy conservation, Century shined, receiving the Osram Sylvania Ecologic and Energy Saver Certificates, and the National Grid Environmental Protection Award. Additionally, Medford Mayor McGlynn proclaimed January 31, 2007, "Century Bank Energy Efficiency Day" in the city. Finally, we continue to be proud of our A– Quality Ranking by Standard and Poor’s (1/07) on our Class A shares. There is no question that these are complex and difficult times for financial institutions, but our outlook is positive and the state of Century and our management partnership is strong and upbeat. We believe the marketplace recognizes and will reward us for our client centricity and family business values. We are grateful for your business, your loyalty, and your faith in our franchise. Sincerely, Barry R. Sloane Co-CEO and Co-President Century Bancorp, Inc. and Century Bank Jonathan G. Sloane Co-CEO and Co-President Century Bancorp, Inc. and Century Bank Management Committee members, from left: David B. Woonton, Brian J. Feeney, Paul A. Evangelista, and Paul V. Cusick, Jr. 170680.P.qxd 2/27/07 8:04 PM Page 4 Adopt-A-Student Foundation Allston-Brighton Community Development Corporation American Cancer Society American Heart Association American Ireland Fund American Lung Association of Massachusetts American Red Cross American Skin Association Anna Jacques Community Health Foundation of Newburyport Anti-Defamation League of New England Art Street Association for Retarded Citizens of Eastern Middlesex Bay State Chapter Freedoms Foundation Beth Israel Deaconess Medical Center Big Brothers Big Sisters Bishop Fenwick High School Boston Area Reform Jewish Day School Boston Inner-City Scholarship Fund Boston Police Athletic League Boston University Boston Ward 7 Improvement Committee Boy Scouts of America Brendan M. Curtin Memorial Fund Brian D. Silber Memorial Fund Brookline Music School Brookline Summer Concert Series Burlington Dollars for Scholars Burlington High School Scholarship Fund Cambridge and Somerville Program for Alcoholism and Drug Abuse Rehabilitation Cambridge Family and Children's Services Caritas Holy Family Hospital Caritas Por Cristo Caritas St. Elizabeth's Hospital Catholic Charities of Greater Boston Catholic Foundation of the Archdiocese of Boston Children's Hospital Trust Community Action Agency of Somerville Congregation of the Holy Cross Dana Farber Marathon Challenge Dimock Community Health Center Dreams for Youth Foundation Easter Seals of Massachusetts Economic Education Foundation for Massachusetts Elizabeth Peabody House of Somerville Everett Chamber of Commerce Everett High School Everett Kiwanis Club Everett Lions Club Everett Mayor's Art & Entertainment Concert Fisher Center for Alzheimer's Research Foundation Foundation for Racial, Ethnic and Religious Harmony Fourth Presbyterian Church of South Boston Gann Academy Girl Scouts of the USA Greater Boston Chamber of Commerce Greater Medford Visiting Nurses Association Hallmark Health Visiting Nurses Association Hebrew College Hebrew Senior Life Home for Little Wanderers India Association of Greater Boston J. F. Kennedy School of Government, Harvard University Jewish Big Brothers Big Sisters Jewish Cemetery Association of Massachusetts Jewish Family Services of the North Shore Jimmy Fund Jules Sabatinelli Fund Justice Louis Brandeis Film Documentary Lawrence Boys and Girls Club Little Sisters of the Poor CENTURY BANK CONTINUED OUR PROUD FAMILY TRADITION OF COMMUNITY SERVICE BY PROVIDING FINANCIAL AND LEADERSHIP SUPPORT TO THESE CHARITABLE AND CIVIC ORGANIZATIONS IN 2006 Lowell General Hospital Lupus Foundation of America Lynn Housing Authority & Neighborhood Development Lynn Rotary Club Maimonides School Malden Beautification Program Malden Bread of Life Malden Chamber of Commerce Malden Lions Club Malden Pop Warner Malden Rotary Club Malden Summer Concert Series Malden YMCA Massachusetts Affordable Housing Alliance Massachusetts Bankers Association Charitable Foundation Massachusetts General Hospital Massachusetts MainSpring Coalition for the Homeless Massachusetts Society of CPAs Medford Chamber of Commerce Medford Police Patrolman's Association Medford Police Relief Association Medford Public Library Medford Senior Football Association MetroWest Jewish Day School Milton Hospital Muscular Dystrophy Association Mystic River Watershed Association National Center for Family Homelessness New England Aquarium New England Baptist Hospital Newburyport Maritime Society Newton – Needham Chamber of Commerce North Cambridge Little League Baseball North End Against Drugs North End Music & Performing Arts North Shore Women in Business Northeast Health Foundation Officer Harold L. Vitale Memorial Fund One Family Scholars of Boston Our Lady of Nazareth Academy Outdoor Explorations Pan Mass Challenge Partners Health Care System Peabody Brooksby Farm Peabody Chamber of Commerce Peabody High School Hockey Boosters Perkins School for the Blind Perry S. Levy Fellow Fund at Dana Farber Cancer Institute Pine Street Inn Regis College Rental Housing Association of Boston Ribbie Millis Memorial Fund Rivers School Rodman Ride for Kids Run for Wednesday's Child Sacred Heart School of Lynn Salem 4th of July Celebration Salem Chamber of Commerce Salem New Main Streets Downtown Initiative Salem State College Salem Street Business Association Shakespeare & Co. Small Business Association of New England Solomon Schechter Day School of Greater Boston Somerville Chamber of Commerce Somerville Community Youth Program Somerville Council on Aging Somerville High School Hockey Somerville Historic Preservation Commission Somerville Housing Authority Somerville Little League Somerville Police Relief Association Somerville Pop Warner Somerville Veteran's Services Springstep St. Clement Elementary School of Medford St. John's School of Boston St. Joseph's of Medford St. Leonard Parish of Boston St. Mary's Parish of Lynn St. Peter School of Cambridge Storer Trust Synagogue Council of Massachusetts Taste of the North End Temple Beth Elohim of Wellesley Temple Israel Boston Temple Ohabei Shalom of Brookline Temple Shalom of West Newton Temple Tifereth Israel of Malden Tufts University United Way of Massachusetts Bay US Marines’ Toys for Tots USS Intrepid Museum Foundation USS Massachusetts Memorial Foundation Visiting Nurses Association of Massachusetts Weymouth Annual Fund Raiser Woburn Council for Social Concern Work, Inc. of Massachusetts World Unity YMCA of Greater Boston Young Israel of Brookline Youth Education in the Arts ASSISTANT VICE PRESIDENTS Michael D. Ballard John S. Bosco, Jr. Gerald Bovardi Pasqualina Buttiri Toni M. Chardo Debra J. Cloutier Cynthia A. Davidson Laura A. DiFava John R. Ferguson Thatcher Freeborn Lisa Gosling Daniel F. Griffin Janice D. Hallinan Roland E. Harvey Kristine M. Holopainen Sandy J. Jackson James J. Jordan Kathleen A. Kelly Ann E. Mannion Carol A. Melisi Cornelius C. Prioleau William F. Shutt, Jr. John C. Stanton Richard A. Thimble Tuesday N. Thomas Jose I. Umana Christina Welch-Matthews OFFICERS Marianne Cacciola Madeline Connor Kimberly A. Dziadyk Janet Garcia Paula A. Grimaldi Amelia N. Iocco Aslihan Kendircioglu Brandon N. Letellier Malcolm I. Maloon Kathleen McGillicuddy Jonathan J. Moschilli Sarah A. O’Toole David C. Pennybaker, Jr. Karen Pessia Bruce A. Priestley Judith A. Shannon Elizabeth A. Theriault Jason H. Truong 170680.FIN.P.qxd 3/1/07 4:23 PM Page I CENTURY BANCORP, INC. DIRECTORS CENTURY BANK AND TRUST COMPANY OFFICERS George R. Baldwin1,4,6 President & CEO Baldwin & Company Roger S. Berkowitz2,5,7 President & CEO Legal Sea Foods, Inc. 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*,7 Attorney Higley & Higley Jackie Jenkins-Scott5,6 President Wheelock College Linda Sloane Kay7 Vice President Century Bank Fraser Lemley2,4,5 Chairman & CEO Sentry Auto Group Joseph J. Senna, Esq.1*,4 Attorney Barry R. Sloane4,5,6,7 Co-President & Co-CEO Century Bank and Trust Company Jonathan G. Sloane4,5,6,7 Co-President & Co-CEO Century Bank and Trust Company Marshall M. Sloane4,5 Chairman of the Board Century Bank and Trust Company Stephanie Sonnabend1,3,5* President and CEO Sonesta International Hotels Corporation George F. Swansburg4*,5 Jon Westling1,2*,3 President Emeritus Boston University OFFICERS Marshall M. Sloane Founder and Chairman Jonathan G. Sloane Co-President & Co-CEO Barry R. Sloane Co-President & Co-CEO Paul V. Cusick, Jr.5,6 Vice President and Treasurer Rosalie A. Cunio Clerk Paula A. Grimaldi Assistant Clerk 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 Brian J. Feeney Executive Vice President David B. Woonton Executive Vice President SENIOR VICE PRESIDENTS Gerald S. Algere Richard L. Billig Janice A. Brandano Bradford J. Buckley Diana L. Carito, CIA, CRP Peter R. Castiglia James M. Flynn, Jr. William J. Gambon, Jr. Anthony C. LaRosa, CPA Nancy Lindstrom John McKenna Jason J. Melius Deborah R. Rush FIRST VICE PRESIDENTS Timothy L. Glynn Shipley C. Mason Kenneth A. Samuelian Yasmin D. Whipple VICE PRESIDENTS Robert A. Bennett Vincent C. Bertrand Joseph B. Chapman Jennifer L. Conrad Gracine Copithorne Rosalie A. Cunio Barbara J. Cunningham Sylvia Daikos Susan B. Delahunt Anthony J. DiGuilio Sandra R. Edey Stuart J. Erbstein Judith A. Fallon Phillip A. Gallagher Howard N. Gold Ann J. Hollup T. Daniel Kausel Linda Sloane Kay Nancy M. Marsh Karen Martin Carl M. Mattos Joanne C. McNamara, CISA Andrew J. Santos, Jr. Bernice A. Shuman Janice D. Taylor David J. Waryas 1 Audit Committee, 2 Compensation Committee, 3 Nominating Committee, 4 Executive Committee, 5 Asset Liability Committee, 6 Non-deposit Investment and Insurance Products Committee, 7 Trust Committee, * Committee Chairperson, ** Vice Chairperson 170680.FIN.P.qxd 3/1/07 4:23 PM Page III Century Bancorp, Inc. AR ‘06 F I N A N C I A L S TAT E M E N T S 1 3 16 17 18 19 20 37 39 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 170680.FIN.P.qxd 3/1/07 4:23 PM Page 1 2006 2005 2004 2003 2002 $ $ $ $ 80,707 43,944 36,763 825 35,938 11,365 40,196 7,107 2,419 4,688 $ 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 $ 6,880 $ 8,881 $ 11,680 $ 13,504 5,540,966 5,550,722 5,541,188 5,535,202 5,553,009 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 0.85 0.84 46.2 % $ $ 1.24 1.24 31.3 % $ $ 1.61 1.60 24.2 % $ $ 2.12 2.11 17.2 % $ $ 2.45 2.44 13.9 % $ 1,644,290 736,773 1,268,965 106,818 19.28 $ $ 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 $ .28 % 4.45 % 2.40 % 0.06 % 6.39 % 83.5 % .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 % Financial Highlights Century Bancorp, Inc. AR ‘06 (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 Net income 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 01 170680.FIN.P.qxd 3/1/07 4:23 PM Page 2 Per Share Data 2006, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 2005, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B Financial Highlights Century Bancorp, Inc. AR ‘06 December 31, September 30, June 30, March 31, $ 29.48 25.77 0.12 0.06 $ 27.24 24.05 0.12 0.06 $ 29.10 24.01 0.12 0.06 $ 30.00 27.29 0.12 0.06 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 The stock performance graph below compares the cumulative total shareholder return of the Company’s Common Stock from December 31, 2001 to December 31, 2006 with the cumulative total return of the NASDAQ Market Index (U.S. Companies) and the NASDAQ Bank Stock index. The lines in the table below represent monthly index levels derived from compounded daily returns that include all dividends. If the monthly interval, based on the fiscal year end was not a trading day, the preceding trading day was used. Comparison of Five-Year Cumulative Total Return* $200 $150 $100 $50 Century NASDAQ Bank Stocks NASDAQ U.S. 2001 2002 2003 2004 2005 2006 Value of $100 Invested on December 31, 2001 at: Century Nasdaq Banks Nasdaq U.S. 2002 2003 2004 2005 2006 $ 134.77 102.37 69.13 $ 182.81 131.69 103.36 $ 154.40 150.71 112.49 $ 155.67 147.23 114.88 $ 147.83 165.21 126.21 * Assumes that the value of the investment in the Company's Common Stock and each index was $100 on December 31, 2001 and that all dividends were reinvested. 02 170680.FIN.P.qxd 3/1/07 4:23 PM Page 3 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 FORWARD-LOOKING STATEMENTS Certain statements contained herein are not based on historical facts and are “forward-looking statements” within the meaning of Section 21A of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions (some of which are beyond the Company’s control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue” or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary polices of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. 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 $1.6 billion on December 31, 2006. The Company presently operates 22 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, and 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 a program called Investment Services at Century Bank supported by Independent Financial Marketing Group, Inc. (IFMG), 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 03 Massachusetts and Rhode Island. The Company has deposit relationships with approximately 30% of the 351 cities and towns in Massachusetts. The Company had net income of $4,688,000 for the year ended December 31, 2006, compared with net income of $6,880,000 for year ended December 31, 2005 and net income of $8,881,000 for the year ended December 31, 2004. Basic earnings per share were $0.85 in 2006, compared to $1.24 in 2005 and $1.61 in 2004. Diluted earnings per share were $0.84 in 2006, compared to $1.24 in 2005 and $1.60 in 2004. The Company’s earnings in 2006 were negatively impacted mainly by a decrease in net interest income. The Company believes that the net interest margin will continue to be challenged in this current inverted yield curve environment. This is mainly the result of deposit and borrowing pricing that has the potential to increase faster than corresponding asset categories. During 2005, the Company’s earnings were also 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 imaging system. Historical U.S. Treasury Yield Curve 6.00 % 5.00 % 4.00 % 3.00 % 2.00 % 1.00 % 0.00 % 3 month 6 Month 2 Year 3 Year 5 Year 10 Year 30 Year Treasury Yield Curve 12/31/2006 Treasury Yield Curve 12/31/2005 Treasury Yield Curve 12/31/2004 A yield curve is a line that typically plots the interest rates of U.S. Treasury Debt, which have different maturity dates, but the same credit quality, at a specific point in time. The three main types of yield curve shapes are normal, inverted and flat. Over the past three years, the U.S. economy has experienced a flattening and subsequent inversion of the yield curve, which means that the spread between the long-term and short-term yields has decreased or inverted. Total assets were $1,644,290,000 at December 31, 2006, a decrease of 4.9% from total assets of $1,728,769,000 on December 31, 2005. On December 31, 2006, stockholders equity totaled $106,818,000, compared with $103,201,000 on December 31, 2005. Book value per share increased to $19.28 at December 31, 2006 from $18.64 on December 31, 2005. On February 7, 2006 the Company announced that it had renewed its contract with NOVA Information Systems, a wholly owned subsidiary of U.S. Bancorp, and had also sold its rights to future royalty payments for a portion of its Merchant Credit Card customer base for $600,000, which the Bank has included as other income. During the third quarter of 2006, 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 12, 2007. 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. 170680.FIN.P.qxd 3/1/07 4:23 PM Page 4 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 its 8.30% Trust Preferred Securities, with a redemption date of January 10, 2005. The total amount of this redemption was $29,639,000. 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 $1,010,000 for 2006 and $960,000 for 2005 as a result of the addition. 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 similar 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 Century Bancorp, Inc. AR ‘06 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 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, occurrence 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.) present value of anticipated future cash flows, (b.) the loan’s observable fair market price or (c.) fair value of collateral, if the loan is collateral dependent. 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 characteristics 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 intent to hold these investments until recovery of fair value, which may be maturity. 04 170680.FIN.P.qxd 3/1/07 4:23 PM Page 5 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 FINANCIAL CONDITION Investment Securities The Company’s securities portfolio consists of securities available-for-sale and securities held-to-maturity. Securities available-for-sale consist of certain U.S. Treasury and U.S. Government Sponsored Enterprises, mortgage-backed securities, state, county, municipal securities, foreign debt securities, other marketable equities and Federal Home Loan Bank (“FHLB”) stock. These securities are carried at fair value and unrealized gains and losses, net of applicable income taxes, are recognized as a separate component of stockholders’ equity. The fair value of securities available-for-sale at December 31, 2006 totaled $415,481,000 and include gross unrealized gains of $221,000 and gross unrealized losses of $8,447,000. A year earlier, securities available for sale were $532,982,000 including gross unrealized gains of $70,000 and unrealized losses of $13,612,000. In 2006 and 2005, the Company recognized no net gains or losses on the sale of available-for-sale securities. Securities which management intends to hold until maturity consist of U.S. Government Sponsored Enterprises and mortgage-backed securities. Securities held-to-maturity as of December 31, 2006 are carried at their amortized cost of $265,712,000 and exclude gross unrealized gains of $76,000 and gross unrealized losses of $7,368,000. A year earlier, securities held to maturity totaled $286,578,000 excluding gross unrealized gains of $109,000 and gross unrealized losses of $8,918,000. The following table sets forth the fair value and percentage distribution of securities available for sale at the dates indicated. Fair Value of Securities Available-for-Sale At December 31, (dollars in thousands) U.S. Treasury and U.S. Government Sponsored Enterprises Mortgage-backed securities Obligations of states and political subdivisions FHLB Stock Other Total 2006 2005 2004 Amount Percent Amount Percent Amount Percent $ 223,028 179,076 — 9,823 3,554 53.7 % 43.1 % 0 % 2.4 % 0.8 % $ 294,132 218,552 807 16,312 3,179 55.1 % 41.0 % 0.2 % 3.1 % 0.6 % $ 380,862 185,758 499 13,895 28,792 62.4 % 30.4 % 0.1 % 2.3 % 4.8 % $ 415,481 100.0 % $ 532,982 100.0 % $ 609,806 100.0 % The following table sets forth the amortized cost and percentage distribution of securities held to maturity at the dates indicated. Amortized Cost of Securities Held-to-Maturity At December 31, (dollars in thousands) 2006 2005 2004 Amount Percent Amount Percent Amount Percent U.S. Government and U.S. Government Sponsored Enterprises Mortgage-backed securities Total $ 159,969 105,743 60.2 % 39.8 % $ 159,952 126,626 55.8 % 44.2 % $ 186,324 159,045 53.9 % 46.1 % $ 265,712 100.0 % $ 286,578 100.0 % $ 345,369 100.0 % 05 170680.FIN.P.qxd 3/1/07 4:23 PM Page 6 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 The following two tables set forth contractual maturities of the Bank’s securities portfolio at December 31, 2006. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair Value of Securities Available-for-Sale Amounts Maturing Within One Year Weighted One Year Weighted Five Years Weighted Weighted Weighted % of Average to Five Total Yield Years % of Total Average to Ten % of Average Non- % of Average % of Average Yield Years Total Yield Maturing Total Yield Total Total Yield (dollars in thousands) U.S. Treasury and U.S. Government Sponsored Enterprises Mortgage-backed $ 110,925 26.7 % 2.68 % $ 112,103 27.0 % 3.43 % $ — 0.0 % 0.0 % $ — 0.0 % 0.0 % $ 223,028 53.7 % 3.06 % securities 10,354 2.5 % 3.59 % 145,771 35.1 % 3.91 % 22,952 5.5 % 4.21 % — 0.0 % 0.0 % 179,076 43.1 % 3.93 % Obligations of state and political subdivisions and other 50 0.0 % 5.3 % 739 0.2 % 4.84 % — 0.0 % 0.0 % 12,588 3.0 % 5.25 % 13,377 3.2 % 5.23 % Total $ 121,329 29.2 % 2.76 % $ 258,612 62.3 % 3.70 % $ 22,952 5.5 % 4.21 % $ 12,588 3.0 % 5.25 % $ 415,481 100.0 % 3.5 % Amortized Cost of Securities Held-to-Maturity Amounts Maturing Within One Year Weighted One Year Weighted Five Years Weighted Over Weighted Weighted % of Average to Five % of Average to Ten % of Average Ten % of Average % of Average Total Yield Years Total Yield Years Total Yield Years Total Yield Total Total Yield (dollars in thousands) U.S. Government Sponsored Enterprises Mortgage-backed securities $ 64,998 24.5 % 2.99 % $ 94,971 35.7 % 3.47 % $ — 0.0 % — — 0.0 % 0.0 % $ 159,969 60.2 % 3.27 % 115 0.0 % 6.01 % 103,049 38.8 % 4.17 % 2,579 1.0 % 4.62 % — 0.0 % 0.0 % 105,743 39.8 % 4.18 % Total $ 65,113 24.5 % 3.0 % $ 198,020 74.5 % 3.83 % $ 2,579 1.0 % 4.62 % $ — 0.0 % 0.0 % $ 265,712 100.0 % 3.63 % At December 31, 2006 and 2005, the Bank had no investments in obligations of individual states, counties or municipalities which exceeded 10 % of stockholders’ equity. In addition, there were no sales of state, county or municipal securities in 2006 or 2005. Loans The Company’s lending activities are conducted principally in Massachusetts. The Company grants single and multi-family residential loans, commercial and commercial real estate loans, and a variety of consumer loans. To a lesser extent, the Company grants loans for the construction of residential homes, multi-family properties, commercial real estate properties, and land development. Most loans granted by the Company are secured by real estate collateral. The ability and willingness of commercial real estate, commercial, construction, residential and consumer loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate market in the borrowers’ geographic areas and the general economy. 06 170680.FIN.P.qxd 3/1/07 4:23 PM Page 7 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 The following summary shows the composition of the loan portfolio at the dates indicated. December 31, 2006 2005 2004 2003 2002 Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Construction and land development $ 49,709 6.7 % $ 58,846 8.5 % $ 51,918 9.0 % $ 34,121 6.7 % $ 33,155 Commercial and industrial Revenue bonds Commercial real estate Residential real estate Consumer Home Equity Overdrafts Total 71,962 12.4 % 39,742 7.8 % 0.0 % 46,044 — — 6.4 % 9.0 % 0.0 % 117,497 3,340 323,700 167,946 9,881 63,380 1,320 16.0 % 0.5 % 44.0 % 22.8 % 1.3 % 8.5 % 0.2 % 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 % — 258,524 118,223 8,607 0.0 % 44.6 % 20.4 % 1.5 % 69,957 12.0 % 812 0.1 % 293,781 57.3 % 291,598 56.7 % 86,780 16.9 % 92,291 17.9 % 8,025 49,382 483 1.6 % 9.6 % 0.1 % 8,169 41,527 1,465 1.6 % 8.1 % 0.3 % $ 736,773 100.0 % $ 689,645 100.0 % $ 580,003 100.0 % $ 512,314 100.0 % $ 514,249 100.0 % At December 31, 2006, 2005, 2004, 2003 and 2002 loans were carried net of discounts of $3,000, $4,000, $20,000, $138,000 and $492,000 respectively. Included in these amounts at December 31, 2006, 2005, 2004, 2003 and 2002, residential real estate loans were carried net of discounts of $0, $0, $16,000, $133,000 and $487,000 respectively, associated with the acquisition of loans from another financial institution. Net deferred loan fees of $183,000, $482,000, $485,000, $389,000 and $315,000 were carried in 2006, 2005, 2004, 2003 and 2002 respectively. The following table summarizes the remaining maturity distribution of certain components of the Company’s loan portfolio on December 31, 2006. 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, 2006 One Year or Less One to Five Years Over Five Years Total $ 34,040 66,797 34,760 $135,597 $ 13,838 43,074 116,634 $ 173,546 $ 1,831 7,626 172,306 $ 181,763 $ 49,709 117,497 323,700 $ 490,906 The following table indicates the rate variability of the above loans due after one year. December 31, 2006 (dollars in thousands) Predetermined interest rates Floating or adjustable interest rates Total One to Five Years Over Five Years Total $ 112,571 60,975 $ 173,546 $ 31,570 150,193 $ 181,763 $ 144,141 211,168 $ 355,309 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 continue. 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 $10,993,000 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 07 170680.FIN.P.qxd 3/1/07 4:23 PM Page 8 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 loans shares similar risk characteristics with the C&I loans, notwithstanding the collateral position. The other category of residential real estate loans are mostly 1-4 family residential properties located in the Bank’s market area. General underwriting criteria are largely the same as those used by Fannie Mae but normally only one or three year adjustable interest rates are used. The Bank utilizes mortgage insurance to provide lower down payment products and has provided a “First Time Homebuyer” product to encourage new home ownership. Residential real estate loan volume has increased and remains a core consumer product. The economic environment impacts the risks associated with this category. 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, 2006, the Company was obligated to advance a total of $16,793,000 to complete projects under construction. The composition of nonperforming assets is as follows: December 31, (dollars in thousands) Loans past due 90 and still accruing Loans on non-accrual Total nonperforming loans Other real estate owned Total nonperforming assets Restructured loans Nonperforming loans as a percent of gross loans Nonperforming assets as a percent of total assets 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 2006 2005 2004 2003 2002 $ $ 789 135 924 — $ 924 — 0.13 % 0.06 % 2006 $ — — — 16 $ 16 $ — 949 $ 949 — $ 949 $ — 0.14 % 0.05 % 2005 $ — 675 — 211 $ 886 $ 160 628 $ 788 — $ 788 $ — 0.14 % 0.04 % 2004 $ 512 — — 452 $ 964 $ $ $ $ — 511 511 — 511 — 0.10 % 0.03 % $ — 1,175 $ 1,175 — $ 1,175 — 0.23 % 0.07 % $ $ 2003 2002 541 — — 1,077 $ 629 — 487 — $ 1,618 $ 1,116 There were no impaired loans with specific reserves from December 31, 2002 through December 31, 2006 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 $798,000, $1,078,000, $1,538,000, $2,397,000 and $4,444,000 at December 31, 2006, 2005, 2004, 2003 and at December 31, 2002 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 $72,000, $80,000, $86,000, $183,000 and $194,000 at December 31, 2006, 2005, 2004, 2003 and at December 31, 2002 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. 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 $924,000 in 2006 and $949,000 in 2005 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, the Company continues to monitor closely $20,779,000 and $14,077,000 at December 31, 2006 and 2005, respectively, 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, 2006, although such values can fluctuate with changes in the economy and the real estate market. 08 170680.FIN.P.qxd 3/1/07 4:23 PM Page 9 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 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 2006 2005 2004 2003 2002 (net of unearned discount and deferred loan fees) $ 736,773 $ 689,645 $ 580,003 $ 512,314 $ 514,249 Average loans outstanding (net of unearned discount and deferred loan fees) $ 723,825 $ 641,103 $ 546,147 $ 500,723 $ 488,465 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 $ $ 9,340 386 — — 322 708 96 49 112 256 452 825 $ $ 9,001 366 — — 324 690 75 235 119 429 261 600 $ $ 8,769 1 — 194 113 308 117 103 20 240 68 300 $ $ 8,506 240 — — 125 365 127 29 22 178 187 450 $ $ 7,112 — 58 — 87 145 276 — 63 339 (194) 1,200 Balance at end of year $ 9,713 $ 9,340 $ 9,001 $ 8,769 $ 8,506 Ratio of net charge-offs during the year to average loans outstanding Ratio of allowance for loan losses to loans outstanding 0.06 % 1.32 % 0.04 % 1.35 % 0.01 % 1.55 % 0.04 % 1.71 % (0.04) % 1.65 % These provisions are the result of management’s evaluation of the quality of the loan portfolio considering such factors as loan status, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The pace of the charge-offs depends on many factors including the national and regional economy. Cyclical lagging factors may result in charge-offs being higher than historical levels. The allowance for loan losses is an estimate of the amount needed for an adequate reserve to absorb losses in the existing loan portfolio. This amount is determined by an evaluation of the loan portfolio including input from an independent organization engaged to review selected larger loans, a review of loan loss experience and current economic conditions. At December 31 of each year listed below, the allowance was comprised of the following: 2006 2005 2004 2003 2002 Percent of Loans in Each Category to Total Loans Amount Percent of Loans in Each Category to Total Loans Amount Percent of Loans in Each Category to Total Loans Amount Percent of Loans in Each Category to Total Loans Percent of Loans in Each Category to Total Loans Amount Amount (dollars in thousands) Construction and land development $ 849 6.8 % $ 1,014 8.5 % $ 806 9.0 % $ 563 6.7 % $ 303 6.4 % Commercial and industrial Commercial real estate Residential real estate Consumer and other Home equity Unallocated Total 09 15.9 43.9 22.8 2.0 8.6 1,916 4,460 512 220 176 1,580 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 $ 9,713 100.0 % $ 9,340 100.0 % $ 9,001 100.0 % $ 8,769 100.0 % $ 8,506 100.0 % 170680.FIN.P.qxd 3/1/07 4:23 PM Page 10 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 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. As of December 31, 2006, deposits of $1,269,000,000 were $52,000,000, or 4.3%, higher than the prior year end. 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. The following table sets forth the average balances of the Bank’s deposits for the periods indicated. 2006 2005 2004 Amount Percent Amount Percent Amount Percent (dollars in thousands) Demand deposits $ 284,295 Savings and interest checking Money market Time certificates of deposit 290,172 327,203 359,045 22.6 % 23.0 % 26.0 % 28.4 % $ 283,876 313,146 366,623 265,310 23.1 % 25.5 % 29.8 % 21.6 % $ 279,361 22.1 % 329,261 26.1 % 412,220 32.6 % 242,791 19.2 % Total $1,260,715 100.0 % $1,228,955 100.0 % $1,263,633 100.0 % 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 2006 $ 104,759 78,659 28,317 17,841 $ 229,576 Borrowings The Bank’s borrowings consisted primarily of FHLB borrowings collateralized by a blanket pledge agreement on the Bank’s FHLB stock, certain qualified investment securities, deposits at the FHLB and residential mortgages held in the Bank’s portfolios. The Bank’s borrowing totaled $121,750,000 a decrease of $176,906,000 from the prior year. The Bank’s borrowing capacity at the FHLB at December 31, 2006 was approximately $142,435,000 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. See note 10 “Other Borrowed Funds and Subordinated Debentures” for a schedule, their interest rates and other information. Subordinated Debentures 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 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, its 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 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. Securities Sold Under Agreements to Repurchase The Bank’s remaining borrowings consist primarily of securities sold under agreements to repurchase. Securities sold under agreements to repurchase totaled $86,960,000, an increase of $36,950,000 from the prior year. See note 9 “Securities sold under agreements to repurchase” for a schedule, their interest rates and other information. 10 170680.FIN.P.qxd 3/1/07 4:23 PM Page 11 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 RESULTS OF OPERATIONS Net Interest Income The Company’s operating results depend primarily on net interest income and fees received for providing services. Net interest income on a fully taxable equivalent basis decreased 8.1% in 2006 to $36,763,000, compared with $39,991,000 in 2005. The decrease in net interest income for 2006 was mainly due to a 7.0% or a eighteen 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 2.40% in 2006 from 2.58% in 2005, which had decreased from 2.75% in 2004. The Company believes that the net interest margin will continue to be challenged in this current inverted yield curve environment. This is mainly the result of deposit and borrowing pricing that has the potential to increase faster than corresponding asset categories. 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:(3) Taxable Tax-exempt Securities held-to-maturity: Taxable Federal funds sold Interest-bearing deposits in other banks 2006 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2005 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2004 Interest Income/ Expense(1) Rate Earned/ Paid(1) Average Balance Average Balance Average Balance $ 723,825 $ 51,437 7.11 % $ 641,103 $ 41,274 6.44 % $ 546,147 $ 33,384 6.11 % 497,113 354 17,182 12 275,897 10,112 37,511 1,955 3.46 5.02 3.67 5.21 580,129 878 19,518 22 311,738 11,635 15,847 362 3.36 3.85 3.73 2.28 570,935 61 18,528 1 319,860 12,296 69,461 824 3.25 3.04 3.84 1.19 217 9 4.15 50 — 0.64 251 — 0.13 Total interest-earning assets 1,534,917 80,707 5.26 % 1,549,745 72,811 4.70 % 1,506,715 65,033 4.32 Non interest-earning assets Allowance for loan losses Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Interest-bearing deposits: NOW accounts Savings accounts Money market accounts Time deposits 123,601 (9,608) $ 1,648,910 118,325 (9,353) $ 1,658,717 120,306 (8,813) $ 1,618,208 $ 205,645 84,527 327,203 359,045 $ 3,936 1,013 9,804 16,026 1.91 % 1.20 3.00 4.46 $ 237,016 76,130 366,623 265,310 $ 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 Total interest-bearing deposits 976,420 30,779 3.15 945,079 19,405 2.05 984,272 14,111 1.43 Securities sold under agreements to repurchase 70,862 2,681 3.78 39,746 813 2.05 40,937 331 0.81 Other borrowed funds and subordinated debentures 192,143 10,484 5.46 268,878 12,602 4.69 194,932 9,204 4.72 Total interest-bearing liabilities 1,239,425 43,944 3.55 % 1,253,703 32,820 2.62 % 1,220,141 23,646 1.94 % Non interest-bearing liabilities Demand deposits Other liabilities Total liabilities Stockholders’ equity Total liabilities & 284,295 19,801 1,543,521 105,389 283,876 16,463 1,554,042 104,675 279,361 15,511 1,515,013 103,195 stockholders’ equity $ 1,648,910 $ 1,658,717 $ 1,618,208 Net interest income(1) Net interest spread Net interest margin $ 36,763 $ 39,991 $ 41,387 1.71 % 2.40 % 2.08 % 2.58 % 2.38 % 2.75 % (1) On a fully taxable equivalent basis calculated using a federal tax rate of 34%. (2) Nonaccrual loans are included in average amounts outstanding. (3) At amortized cost. 11 170680.FIN.P.qxd 3/1/07 4:23 PM Page 12 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 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 2006 Compared with 2005 Increase/(Decrease) Due to Change in 2005 Compared with 2004 Increase/(Decrease) Due to Change in Volume Rate Total Volume Rate Total $ 5,632 $ 4,531 $ 10,163 $ 6,041 $ 1,849 $ 7,890 (2,857) (16) (1,317) 822 3 521 6 (206) 771 6 (2,336) (10) (1,523) 1,593 9 2,267 5,629 7,896 (475) 35 (823) 3,663 2,400 896 (3,971) 1,146 691 3,609 3,528 8,974 972 1,853 671 726 2,786 7,191 11,374 1,868 (2,118) (675) 11,799 11,124 302 20 (308) (903) — 5,152 (109) (11) (606) 673 (53) (10) 3,466 3,403 688 1 (353) 441 — 2,626 1,408 (4) 2,614 1,329 5,347 492 (68) 5,771 990 21 (661) (462) — 7,778 1,299 (15) 2,008 2,002 5,294 482 3,398 9,174 $ 2,942 $ (6,170) $ (3,228) $ 1,749 $ (3,145) $ (1,396) Average earning assets were $1,534,917,000 in 2006, a decrease of $14,828,000 or 1.0% from the average in 2005, which was 2.9% higher than the average in 2004. Total average securities, including securities available-for-sale and securities held-to-maturity were $773,364,000, a decrease of 13.4% from the average in 2005. The decrease in securities volume was mainly attributable to a continued shift in asset concentration to loans. A decrease in securities rates resulted in lower securities income, which decreased 12.4% to $27,306,000. Total average loans increased 12.9% to $723,825,000 after increasing $94,956,000 in 2005. The primary reason for the increase in loans was due in large part to an increase in residential and small business lending. The increase in loan volume and increases in loan rates resulted in higher loan income, which increased by 24.6% or $10,163,000 to $51,437,000. Total loan income was $41,274,000 in 2004. The Company’s sources of funds include deposits and borrowed funds. On average, deposits showed an increase of 2.60% or $31,760,000 in 2006 after decreasing by 2.7% or $34,678,000 in 2005. Deposits increased in 2006 primarily as a result of an increase in time deposits, which increased by 35.3% or $93,734,000. Borrowed funds and subordinated debentures decreased by 14.8% in 2006 following an increase of 30.8% in 2005. The majority of the Company’s borrowed funds are borrowings from the FHLB and retail repurchase agreements. Borrowings from the FHLB decreased by approximately $76,445,000 and retail repurchase agreements increased by $31,116,000. Interest expense totaled $43,944,000 in 2006, an increase of $11,124,000 or 33.9% from 2005 when interest expense increased 38.8% from 2004. The increase in interest expense is mainly due to increases in interest rates. 12 170680.FIN.P.qxd 3/1/07 4:23 PM Page 13 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 Provision for Loan Loss The provision for loan losses was $825,000 in 2006, compared with $600,000 in 2005 and $300,000 in 2004. 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 $9,713,000 at December 31, 2006, compared with $9,340,000 at December 31, 2005. Expressed as a percentage of outstanding loans at year-end, the allowance was 1.32% in 2006 and 1.35% in 2005. 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 $924,000 on December 31, 2006, compared with $949,000 on December 31, 2005. Other Operating Income During 2006, 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 IFMG, 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 a program called Investment Services at Century Bank, the Bank provides full service securities brokerage services supported by IFMG, a full service securities brokerage business. Registered representatives employed by IFMG offer limited investment advice, execute transactions and assist customers in financial and retirement planning. IFMG provides research to and supervises its representatives. The Bank receives a share in the commission revenues. Total other operating income in 2006 was $11,365,000, an increase of $392,000 or 3.6% compared to 2005. This increase followed an increase of $542,000 or 5.2% in 2005, compared to 2004. Service charge income, which continues to be a major area of other operating income with $6,702,000 in 2006, saw an increase of $856,000 compared to 2005. This follows an increase of $575,000 compared to 2004. Service charges on deposit accounts increased mainly because of increases in fees and an increase in overdraft charges associated with an overdraft protection program. Lockbox revenues totaled $2,772,000, down $35,000 in 2006 and a decrease of $143,000 in 2005. This decrease was mainly attributable to competitive pricing pressures. Through IFMG, brokerage commissions decreased to $149,000 in 2006, from $462,000 in 2005, primarily as a result of decreased transaction volume. Brokerage commissions decreased in 2005 by $208,000 mainly as a result of decreased transaction volume. Other income totaled $1,742,000, down $116,000 in 2006 and an increase of $227,000 in 2005. The decrease in 2006 was mainly attributable to a decrease in the growth of cash surrender values by $697,000 offset by a pre-tax gain of $600,000 from the sale of rights to future royalty payments for a portion of the Company’s Merchant 13 Credit Card customer base. The decrease in the growth of cash surrender values was mainly attributable to lower returns on life insurance policies. The increase in 2005 was mainly attributable to an increase in the growth of cash surrender values that was attributable to higher returns on life insurance policies. Operating Expenses Total operating expenses were $40,196,000 in 2006, compared to $40,318,000 in 2005 and $37,663,000 in 2004. Salaries and employee benefits expenses decreased by $382,000 or 1.6% in 2006, after increasing by 4.0% in 2005. The decrease in 2006 was mainly attributable to the retirement of the Chief Executive Officer offset somewhat by an increase in pension expense and health insurance costs. The increase in 2005 was mainly attributable to an increase in staff levels and merit increases in salaries. Occupancy expense increased by $109,000 or 2.9% in 2006, this followed an increase of $801,000 or 26.7% in 2005. The increase in 2006 was mainly attributable to an increase in utility rates. 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. Equipment expense increased by $56,000 or 1.9% in 2006, this followed an increase of $607,000 or 25.5% in 2005. The increase in 2006 was mainly attributable to depreciation associated with the addition of capital expenditures. 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. Other operating expenses increased by $95,000 in 2006, which followed a $316,000 increase in 2005. The increase in 2006 was mainly attributable to an increase in contributions. 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 on January 31, 2006. Provision for Income Taxes Income tax expense was $2,419,000 in 2006, $3,166,000 in 2005 and $4,974,000 in 2004. The effective tax rate was 34.0% in 2006, 31.5% in 2005 and 35.9% in 2004. The increase in the effective tax rate for 2006 was mainly the result of a decrease in the growth of the cash surrender values. The decrease in the effective tax rate for 2005 was mainly attributable to a higher proportion of non-taxable income. The federal tax rate was 34% in 2006 and 2005 and 35% in 2004. 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. 170680.FIN.P.qxd 3/1/07 4:23 PM Page 14 Management’s Discussion and Analysis of Results of Operations and Financial Condition This test measures the impact on net interest income of an immediate change in interest rates in 100 basis point increments as set forth in the following table: Change in Interest Rates (in Basis Points) Percentage Change in Net Interest Income(1) +300 +200 +100 –100 –200 (14.4)% (9.6)% (4.9)% 0.2 % 2.0 % (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 $159,668,000 on December 31, 2006, compared with $152,679,000 on December 31, 2005. In each of these two years, deposit and borrowing activity has generally been adequate to support asset activity. The source of funds for dividends paid by the Company is dividends received from the Bank. The Company and the Bank are regulated enterprises and their abilities Century Bancorp, Inc. AR ‘06 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. Capital Adequacy Total stockholders’ equity was $106,818,000 at December 31, 2006, compared with $103,201,000 at December 31, 2005. The increase in 2006 was primarily the result of earnings less dividends paid plus a decrease in accumulated other comprehensive loss. The decrease in accumulated other comprehensive loss was mainly attributable to an improvement of $3,159,000 in the net unrealized loss on the Company’s available-for-sale portfolio, partially offset by a $2,158,000 net pension liability adjustment from the previously announced adoption of SFAS 158. The decrease in 2005 was primarily the result of an increase in accumulated other comprehensive loss 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 15.93% and 12.55%, respectively, and total capital-to-risk assets ratio of 17.00% and 13.62%, respectively, at December 31, 2006. 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, 2006, the Company and the Bank exceeded this requirement with leverage ratios of 8.58% and 6.76%, 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, 2006. 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 and federal funds purchased Payments Due — by Period Total $121,750 36,083 19,138 4,973 856 Less than One Year $ 2,750 — 1,619 1,197 856 87,230 87,230 One to Three Years $ 51,500 — 3,317 1,999 — — Three to Five Years $ 40,500 — 3,578 1,316 — — After Five Years $ 27,000 36,083 10,624 461 — — Total contractual cash obligations $ 270,030 $ 93,652 $ 56,816 $ 45,394 $ 74,168 OTHER COMMITMENTS Lines of credit Standby and commercial letters of credit Other commitments Total commitments Amount of Commitment Expiring — by Period Total $ 168,289 10,397 25,073 Less than One Year $ 55,847 9,626 11,270 $ 203,759 $ 76,743 One to Three Years $ 12,576 521 5,952 $ 19,049 Three to Five Years $ 1,276 — 2,054 $ 3,330 After Five Years $ 98,590 250 5,797 $104,637 14 170680.FIN.P.qxd 3/1/07 4:23 PM Page 15 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘06 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 2006 2005 (dollars in thousands) Financial instruments whose contract amount represents credit risk: Commitments to originate 1-4 family mortgages Standby and commercial letters of credit Unused lines of credit Unadvanced portions of construction loans Unadvanced portions of other loans $ 2,305 10,397 168,290 16,793 5,975 $ 1,814 10,272 143,533 52,469 7,934 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 In July, 2006 the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company’s financial position. In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 158 (SFAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS 158 requires the net amount by which the defined-benefit-postretirement obligation is over or under funded to be reported on the balance sheet. The Company recorded an additional $2,158,000 net pension liability adjustment, through stockholders’ equity, as a result of the adoption of SFAS 158. On September 13, 2006, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements,” expressing the SEC staff’s views regarding the process of quantifying financial statement misstatements. This SAB is addressing diversity in practice in quantifying financial statement misstatements and the build up of amounts on the balance sheet. The cumulative amounts, while not considered material in the individual years in which the build up occurred may be considered material in a subsequent year if a Company were to correct those amounts through current period earnings. Initial application of SAB No. 108 allows registrants to elect not to restate prior periods but to reflect the initial application in their annual financial statements covering the first fiscal year ending November 15, 2006. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year, and the offsetting adjustment, net of tax, should be made to the opening balance of equity for that year. The adoption of SAB No. 108 did not have a material impact on the Company’s financial position. 15 170680.FIN.P.qxd 3/1/07 4:23 PM Page 16 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 $423,707 in 2006 and $546,524 in 2005 (note 3) Securities held-to-maturity, fair value $258,420 in 2006 and $277,769 in 2005 (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 3,498,738 shares in 2006 and 3,453,202 shares in 2005 Common stock, Class B, $1.00 par value per share; authorized 5,000,000 shares; issued 2,042,450 shares in 2006 and 2,082,240 shares in 2005 Additional paid-in-capital Retained earnings Unrealized loses on securities available-for-sale, net of taxes Additional pension liability, net of taxes Total accumulated other comprehensive loss, 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 ‘06 2006 2005 $ 60,465 99,203 159,668 $ 47,626 105,053 152,679 415,481 265,712 736,773 9,713 727,060 22,955 7,372 46,042 532,982 286,578 689,645 9,340 680,305 25,228 7,127 43,870 $ 1,644,290 $ 1,728,769 $ 283,449 274,231 301,188 410,097 $ 296,696 239,326 279,245 401,773 1,268,965 1,217,040 86,960 123,023 36,083 22,441 50,010 304,722 36,083 17,713 1,537,472 1,625,568 3,499 3,453 2,042 11,505 99,859 116,905 (5,111) (4,976) (10,087) 106,818 2,082 11,416 97,338 114,289 (8,270) (2,818) (11,088) 103,201 $ 1,644,290 $ 1,728,769 16 170680.FIN.P.qxd 3/1/07 4:23 PM Page 17 Consolidated Statements of Income Century Bancorp, Inc. AR ‘06 Year Ended December 31, (dollars in thousands except share data) INTEREST INCOME Loans Securities available-for-sale Securities held-to-maturity Federal funds sold and interest-bearing deposits in other banks Total interest income INTEREST EXPENSE Savings and NOW deposits Money market accounts Time deposits (note 8) Securities sold under agreements to repurchase Other borrowed funds and long term debt Total interest expense Net interest income Provision for loan losses (note 6) Net interest income after provision for loan losses OTHER OPERATING INCOME Service charges on deposit accounts Lockbox fees Brokerage commissions Net (losses) gains on sales of securities Other income Total other operating income OPERATING EXPENSES Salaries and employee benefits (note 13) Occupancy Equipment Other (note 16) Total operating expenses Income before income taxes Provision for income taxes (note 12) 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. 17 2006 2005 2004 $ $ $ 51,437 17,194 10,112 1,964 80,707 4,950 9,804 16,026 2,681 10,483 43,944 36,763 825 35,938 6,702 2,772 149 — 1,742 11,365 23,815 3,907 3,043 9,431 40,196 7,107 2,419 4,688 5,540,966 5,550,722 0.85 0.84 $ $ $ 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 6,880 5,535,202 5,553,009 1.24 1.24 $ $ $ 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 8,881 5,526,202 5,553,197 1.61 1.60 170680.FIN.P.qxd 3/1/07 4:23 PM Page 18 Consolidated Statements of Changes of 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 ‘06 Accumulated Other Total Comprehensive Stockholders' Income (Loss) Equity (dollars in thousands except share data) 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, net of tax 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, net of tax 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 Net income Other comprehensive income, net of tax: Unrealized holding gains arising during period, net of $2,156 in taxes Comprehensive income Adjustment to initially apply SFAS 158, net of tax Conversion of Class B Common Stock to Class A Common Stock, 39,790 shares Stock options exercised, 5,746 shares Cash dividends, Class A Common Stock, $0.48 per share Cash dividends, Class B Common Stock, $0.24 per share — — — 40 6 — — — — — (40) — — — — — — — 89 — — 4,688 — — — — (1,674) (493) BALANCE, DECEMBER 31, 2006 $ 3,499 $ 2,042 $ 11,505 $ 99,859 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 — 4,688 3,159 3,159 7,847 (2,158) (2,158) — — — — — 95 (1,674) (493) $ (10,087) $ 106,818 18 170680.FIN.P.qxd 3/1/07 4:23 PM Page 19 Consolidated Statements of Cash Flows Century Bancorp, Inc. AR ‘06 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 Loss on sales of securities available-for-sale Increase 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 in investments purchased payable Net increase in loans Capital expenditures Net cash provided by (used in) investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in time deposit accounts Net increase (decrease) 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 (decrease) increase in other borrowed funds (Retirement) issuance of subordinated debentures Net cash (used in) provided by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 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 Change in additional pension liability, net of taxes See accompanying Notes to Consolidated Financial Statements. 19 2006 2005 2004 $ 4,688 $ 6,880 $ 8,881 825 (713) 3,595 (245) (2,644) — 1,202 6,708 123,013 — (498) 20,965 — — (47,580) (723) 95,177 8,324 43,601 95 (2,167) 36,950 (181,699) — (94,896) 6,989 152,679 600 128 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 $ 159,668 $ 152,679 $ 42,887 2,713 3,159 (2,158) $ $ $ 33,369 3,050 (5,261) (1,061) 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 $ 238,235 $ 23,165 4,600 (4,109) (1,757) $ 170680.FIN.P.qxd 3/1/07 4:23 PM Page 20 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 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 whenever necessary to conform with the current year presentation. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 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 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, by either the present value of the expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. 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 and 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 not probable. In addition, criteria for classification of a loan as in-substance foreclosure has been modified so that such classification need be made only when a lender is in possession of the collateral. The Bank measures the impairment of troubled debt restructurings using the pre-modification rate of interest. 20 170680.FIN.P.qxd 3/1/07 4:23 PM Page 21 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is based on management’s evaluation of the quality of the loan portfolio and is used to provide for losses resulting from loans which ultimately prove uncollectible. In determining the level of the allowance, periodic evaluations are made of the loan portfolio which take into account such factors as the character of the loans, loan status, financial posture of the borrowers, value of collateral securing the loans and other relevant information sufficient to reach an informed judgment. 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, if appropriate, 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 Prior to January 1, 2006, the Company accounted for its stock-based plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). No compensation cost was recognized for stock options in the Consolidated Statement of Income for the periods ended on or prior to December 31, 2005, as options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of the grant. Effective January 1, 2006 the Company adopted the fair value recognition provisions of SFAS 123R for all share-based payments, using the modified-prospective transition method. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. Upon adoption of SFAS 123R, the Company elected to retain its method of valuation for share-based awards granted using the Black-Scholes option-pricing model which was also previously used for the Company’s pro forma information required under SFAS 123. The Company will recognize compensation expense for its awards on a straight-line basis over the requisite service period for the entire award (straight-line attribution method), ensuring that the amount of compensation cost recognized at any date at least equals the portion of the grant-date fair value of the award that is vested at that time. During 2000 and 2004, common stockholders of the Company approved stock option plans (the “Option Plans”) that provide for granting of options to purchase up to 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 21 or 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 options to purchase an aggregate of 123,237 shares of Class A common stock exercisable at September 30, 2006. On December 30, 2005 the Board of Directors approved the acceleration and immediate vesting of all unvested options with an exercise price of $31.60 or greater per share. As a consequence, options to purchase 23,950 shares of Class A common stock became exercisable immediately. The average of the high and low price at which the Class A common stock traded on December 30, 2005, the date of the acceleration and vesting, 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 was eliminated that would otherwise have been recognized in the Company’s earnings. 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. SFAS 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123R 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 period which is usually the vesting period. SFAS 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The Company accelerated the vesting of certain unvested “out-of-the-money” stock options awarded to Bank employees pursuant to the Option Plans so that they immediately vested as of December 30, 2005. In connection with this acceleration the Board of Directors approved a technical amendment to each of the Option 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. Effective as of January 1, 2006 the Company adopted SFAS 123R for all share based payments. 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. There was no earnings impact for 2006 due to the Company’s adoption of SFAS 123R. 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 in the following table: 170680.FIN.P.qxd 3/1/07 4:23 PM Page 22 December 31, (dollars in thousands) Net income: As reported Less: Pro forma stock based compensation cost (net of tax): Pro forma net income Basic earning per share As reported Pro forma Diluted earnings per share As reported Pro forma 2005 2004 $ 6,880 $8,881 $ 282 $ 151 $ 6,598 $8,730 $ 1.24 $ 1.19 $ 1.61 $ 1.58 $ 1.24 $ 1.19 $ 1.60 $ 1.57 In determining the pro forma amounts, the fair value of each option grant was estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: Dividend yield Expected life Expected volatility Risk-free interest rate 1.59 % 9 years 28 % 3.95 % The Company uses the fair value method to account for stock options. All of the Company’s stock options are vested and there were no options granted during 2006. INCOME TAXES The Company uses the asset and liability method in 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 reacquired 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 Company 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. The Company also has a Supplemental Executive Insurance/Retirement Plan (the Supplemental Plan) which is limited to certain officers and employees of the Company. The Supplemental Plan is accrued on a current basis and recognizes costs over the estimated employee service period. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Executive officers of the Company or its subsidiaries who have at least one year of service may participate in the Supplemental Plan. The Supplemental Plan is voluntary and participants are required to contribute to its cost. Individual life insurance policies, which are owned by the Company, are purchased covering the lives of each participant. Effective December 31, 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires the Company to recognize the overfunded or underfunded status of a single employer defined benefit pension or postretirement plan as an asset or liability on its balance sheet and to recognize changes in the funded status in comprehensive income in the year in which the change occurred. However, gains or losses, prior service costs or credits, and transition assets or obligations that have not yet been included in net periodic benefit cost as of the end of 2006, the fiscal year in which the Statement is initially applied are to be recognized as components of the ending balance of accumulated other comprehensive income, net of tax. The Company recorded an additional $2,158,000 pension liability adjustment, net of tax, through stockholders’ equity, as a result of the adoption of SFAS 158. SFAS 158 also requires the Company to measure plan assets and benefit obligations as of the date of the Company’s fiscal year end effective for fiscal years ending after December 15, 2008. RECENT ACCOUNTING DEVELOPMENTS In July, 2006 the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company’s financial position. On September 13, 2006, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin (SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements,” expressing the SEC staff’s views regarding the process of quantifying financial statement misstatements. This SAB is addressing diversity in practice in quantifying financial statement misstatements and the build up of amounts on the balance sheet. The cumulative amounts, while not considered material in the individual years in which the build up occurred may be considered material in a subsequent year if a Company were to correct those amounts through current period earnings. Initial application of SAB No. 108 allows registrants to elect not to restate prior periods but to reflect the initial application in their annual financial statements covering the first fiscal year ending November 15, 2006. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year, and the offsetting adjustment, net of tax, should be made to the opening balance of equity for that year. The adoption of SAB No. 108 did not have a material impact on the Company’s financial position. 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 $805,000 at December 31, 2006 and $746,000 at December 31, 2005. 22 170680.FIN.P.qxd 3/1/07 4:23 PM Page 23 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 3. Securities Available-for-Sale (dollars in thousands) U.S. Government and U.S. Government Sponsored Enterprises Mortgage-backed securities Obligations of states and political subdivisions FHLB stock Other Total December 31, 2006 Gross Unrealized Losses Gross Unrealized Gains Estimated Fair Value Amortized Cost December 31, 2005 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost $ 226,960 183,458 800 9,823 2,666 — 56 — — 165 $ 3,932 4,438 $ 223,028 179,076 $ 301,914 224,256 11 — 66 789 9,823 2,765 807 16,312 3,235 — 24 — — 46 $ 7,782 5,728 $ 294,132 218,552 — — 102 807 16,312 3,179 $ 423,707 $ 221 $ 8,447 $ 415,481 $ 546,524 $ 70 $ 13,612 $ 532,982 Included in U.S. Government and U.S. Government Sponsored Enterprises securities are securities pledged to secure public deposits and repurchase agreements amounting to $91,510,000 and $53,774,000 at December 31, 2006 and 2005, respectively. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $190,961,000 and $262,051,000 at December 31, 2006 and 2005, respectively. Also included in U.S. Government and U.S. Government Sponsored Enterprises is one U.S. Government security totaling $2,000,000 for both 2006 and 2005. The Company did not realize any gains or losses in 2006 and 2005. The Company realized gross gains of $693,000 and gross losses of $784,000 in 2004. The following table shows the maturity distribution of the Company's securities available-for-sale at December 31, 2006. (dollars in thousands) Within one year After one but within five years After five but within ten years More than ten years Non-maturing December 31, 2006 Fair Value Amortized Cost $ 122,551 $ 121,329 265,356 23,311 — 12,489 258,612 22,952 — 12,588 Total $ 423,707 $415,481 The weighted average remaining life of investment securities available-for-sale at December 31, 2006 and 2005 was 2.1and 2.3 years, respectively. The weighted average life of mortgage-backed securities was computed based on contracted maturities. Included in the weighted average remaining life calculation at December 31, 2006 and 2005 were $10,000,000 and $15,000,000 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 actual maturities, which were used in the table above, of mortgage-backed securities will differ from the contractual maturities, due to the ability of the issuers to prepay underlying obligations. The following table shows the temporarily impaired securities of the Company's available-for-sale portfolio at December 31, 2006. 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 2 and 101 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively out of a total of 161 holdings at December 31, 2006. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2006 Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (dollars in thousands) U.S. Government and U.S. Government Sponsored Enterprises Mortgage-backed securities Other Total temporarily impaired securities $ $ — — 82 82 $ $ — — 1 1 $ 218,028 170,828 2,037 $ 3,932 4,438 76 $ 218,028 170,828 2,119 $ 3,932 4,438 77 $ 390,893 $ 8,446 $ 390,975 $ 8,447 * 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, 2006. 23 170680.FIN.P.qxd 3/1/07 4:23 PM Page 24 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Temporarily Impaired Investments* December 31, 2005 Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (dollars in thousands) U.S. Government and U.S. Government Sponsored Enterprises Mortgage-backed securities Other $ 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. 4. Investment Securities Held-to-Maturity December 31, 2006 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost December 31, 2005 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost (dollars in thousands) U.S. Government Sponsored Enterprises $ 159,969 Mortgage-backed securities Total 105,743 $ 265,712 $ $ — 76 76 $ 3,406 $ 156,563 3,962 101,857 $ 7,368 $ 258,420 $ 159,952 126,626 $ 286,578 $ $ — 109 109 $ 4,770 $ 155,182 4,148 122,587 $ 8,918 $ 277,769 Included in U.S. Government and Agency securities are securities pledged to secure public deposits amounting to $130,949,000 and $6,000,000 at December 31, 2006 and 2005, respectively. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $103,971,000 and $124,632,000 at December 31, 2006 and 2005, respectively. The following table shows the maturity distribution of the Company's securities held-to-maturity at December 31, 2006. (dollars in thousands) Within one year After one but within five years After five but within ten years Total December 31, 2006 Fair Value Amortized Cost $ 65,113 $63,894 198,020 2,579 192,031 2,495 $ 265,712 $258,420 The weighted average remaining life of investment securities held-to-maturity at December 31, 2006 and 2005 was 2.3 and 3.0 years, respectively. Included in the weighted average remaining life calculation at December 31, 2006 and 2005 were $0 and $5,000,000 respectively of U.S. Government Sponsored Enterprises obligations that are callable at the discretion of the issuer. These call dates were not utilized in computing the weighted average remaining life. The actual maturities, which were used in the table above, of mortgage-backed securities will differ from the contractual maturities, due to the ability of the issuers to prepay underlying obligations. The following table shows the temporarily impaired securities of the Company's held-to-maturity portfolio at December 31, 2006. 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 0 and 84 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, 2006. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2006 (dollars in thousands) U.S. Government Sponsored Enterprises Mortgage-backed securities Total temporarily impaired securities Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ $ — — — $ $ — — — $ 156,563 98,937 $ 3,406 3,962 $ 156,563 98,937 $ 3,406 3,962 $ 255,500 $ 7,368 $ 255,500 $ 7,368 * 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, 2006. 24 170680.FIN.P.qxd 3/1/07 4:23 PM Page 25 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Temporarily Impaired Investments* December 31, 2005 (dollars in thousands) U.S. Government Sponsored Enterprises Mortgage-backed securities Total temporarily impaired securities Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 19,561 29,740 $ 407 624 $ 135,621 89,038 $ 4,363 3,524 $ 155,182 118,778 $ 4,770 4,148 $ 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. 5. Loans The majority of the Bank's lending activities are conducted in the Commonwealth of Massachusetts. The Bank originates construction, commercial and residential real estate loans, commercial and industrial loans, consumer, home equity and other loans for its portfolio. The following summary shows the composition of the loan portfolio at the dates indicated. December 31, (dollars in thousands) Construction and land development Commercial and industrial Revenue bonds Commercial real estate Residential real estate Consumer Home equity Overdrafts Total 2006 Amount 2005 Amount $ 49,709 117,497 3,340 323,700 167,946 9,881 63,380 1,320 $ 58,846 94,139 — 302,279 146,355 9,977 76,710 1,339 $ 736,773 $ 689,645 Net deferred fees included in loans at December 31, 2006 and December 31, 2005 were $183,000 and $482,000, respectively. The Company was servicing mortgage loans sold to others without recourse of approximately $798,000 and $1,078,000 at December 31, 2006 and December 31, 2005, 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 $72,000 and $80,000 at December 31, 2006,and at December 31, 2005, respectively. As of December 31, 2006 and 2005 the bank recorded investment in impaired loans was $16,000 and $886,000, respectively. There were no impaired loans with specific reserves on December 31, 2006 and December 31, 2005. 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 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 2006 2005 2004 $ 135 16 $ $ 16 $ 278 3 $ $ — 31 $ $ 949 $ 886 $ 886 $ 1,384 77 $ $ — $ 202 628 $ 452 $ $ 964 $ 1,156 67 $ — $ 105 $ 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. 25 170680.FIN.P.qxd 3/1/07 4:23 PM Page 26 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 The following table shows the aggregate amount of loans to directors and officers of the Company and their associates during 2006. Balance at December 31, 2005 (dollars in thousands) Additions Repayments and Deletions Balance at December 31, 2006 $ 1,936 $ 1,059 $ 1,052 $ 1,943 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. An analysis of the total allowances for loan losses for each of the three years ending December 31, 2006, 2005, and 2004 are as follows: (dollars in thousands) Allowance for loan losses, beginning of year Loans charged off Recoveries on loans previously charged-off Net charge-offs Provision charged to expense Allowance for loan losses, end of year 7. Bank Premises and Equipment December 31, (dollars in thousands) Land Bank premises Furniture and equipment Leasehold improvements Accumulated depreciation and amortization 2006 2005 2004 $ 9,340 (708) 256 (452) 825 $ 9,001 (690) 429 (261) 600 $ 8,769 (308) 240 (68) 300 $ 9,713 $ 9,340 $ 9,001 2006 2005 Estimated Useful Life $ 3,650 17,146 22,952 5,310 49,058 (26,103) $ 3,650 16,916 22,726 5,102 48,394 (23,166) — 30-39 years 3-10 years 30-39 years or lease term Total $ 22,955 $ 25,228 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 $1,113,000, $1,076,000 and $1,084,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Rental income approximated $69,000, $61,000 and $69,000 in 2006, 2005 and 2004, respectively. Future minimum rental commitments for noncancelable operating leases with initial or remaining terms of one year or more at December 31, 2006 were as follows: (dollars in thousands) Year Amount 2007 2008 2009 2010 2011 Thereafter $ 1,197 1,100 899 755 561 461 $ 4,973 26 170680.FIN.P.qxd 3/1/07 4:23 PM Page 27 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 8. Deposits The following is a summary of original maturities or repricing of time deposits as of December 31, (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 2006 Percent 2005 Percent $ 361,825 37,719 9,109 1,444 — $ 410,097 88% 9% 2% 1% 0% $ 312,797 74,291 3,053 11,632 — 78% 18% 1% 3% 0% 100% $ 401,773 100% Time deposits of $100,000 or more totaled $229,576,000 and $259,301,000 in 2006 and 2005, respectively. 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 2006 2005 2004 $ 86,960 $ 50,010 $ 38,650 3.71 % 3.05 % 0.97 % $ 139,460 $ 70,862 $ 52,680 $ 39,746 $ 49,700 $ 40,937 3.78 % 2.05 % 0.81 % Amounts outstanding at December 31, 2006, 2005, and 2004 carried maturity dates of the next business day. U.S. Government Sponsored Enterprises securities with a total book value of $89,114,000, $52,009,000, and $39,460,000 were pledged as collateral and held by custodians to secure the agreements at December 31, 2006, 2005, and 2004, respectively. The approximate market value of the collateral at those dates was $87,249,000, $50,328,000, and $38,989,000, 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 2006 2005 2004 $ 159,106 $ 340,805 $ 280,628 5.54 % 4.79 % 4.62 % $ 339,858 $ 192,143 $ 393,734 $ 268,878 $ 280,628 $ 194,932 5.46 % 4.69 % 4.72 % 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 FHLB and residential mortgages held in the Bank’s portfolios. The Bank’s borrowing capacity at the FHLB at December 31, 2006 was approximately $142,435,000 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, 2006 2005 2004 (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 Amount $ 2,750 19,500 32,000 40,500 27,000 $ 121,750 Weighted Average Rate 3.80 % 5.38 % 5.17 % 5.80 % 4.44 % 5.22 % 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 % Amount $ 105,000 1,120 — 51,500 55,500 $ 213,120 Weighted Average Rate 2.22 % 7.20 % 0.00 % 5.25 % 5.32 % 3.79 % SUBORDINATED DEBENTURES Subordinated debentures totaled $36,083,000 at December 31, 2006 and 2005. 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. 27 170680.FIN.P.qxd 3/1/07 4:23 PM Page 28 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Century Bancorp Capital Trust then issued 2,875,000 shares of Cumulative Trust Preferred 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, its 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 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 20 years. The Company is using the proceeds primarily for general business purposes. OTHER BORROWED FUNDS The Bank had $270,000 and $4,500,000 of overnight federal funds purchased on December 31, 2006 and 2005, respectively. The borrowings carried interest rates of 5.00% and 4.00% for 2006 and 2005, respectively. 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 $856,000 and $1,418,000 at December 31, 2006 and 2005, respectively. The Bank also has an outstanding loan in the amount of $147,000 and $148,000 at December 31, 2006 and 2005, respectively, borrowed against the cash value of a whole life insurance policy for a key executive of the Bank. 11. 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 common stock may vote in the election of directors. Class A common stockholders are entitled to receive dividends per share equal to at least 200% per share of that paid, if any, on each share of Class B common stock. Class A common stock is publicly traded. Class B common stock is not publicly traded, however, it can be converted on a share for share basis to Class A common stock at any time at the option of the holder. Dividend payments by the Company are dependent in part on the dividends it receives from the Bank, which are subject to certain regulatory restrictions. EARNINGS PER SHARE (EPS) Diluted EPS includes the dilutive effect of common stock equivalents; basic EPS excludes all common stock equivalents. The only common stock equivalents for the Company are the stock options discussed below. The dilutive effect of these stock options for 2006, 2005 and 2004 was an increase of 9,756, 17,807 and 26,995 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 122,737 options exercisable at December 31, 2006. 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, 2006 December 31, 2005 December 31, 2004 Weighted Average Exercise Price $ 26.74 28.05 16.54 27.20 27.20 $ $ Amount 130,133 — (1,650) (5,746) 122,737 122,737 151,425 NA Weighted Average Exercise Price $ $ $ 26.65 — 28.56 16.82 26.74 26.74 Amount 131,787 — (300) (1,354) 130,133 130,133 149,775 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 NA $ 10.69 At December 31, 2006, 2005 and 2004 the options outstanding have exercise prices between $15.063 and $35.010, and a weighted average remaining contractual life of five years for 2006, six years 2005 and seven years for 2004. The weighted average intrinsic value of options exercised for the period ended December 31, 2006, 2005 and 2004 was $10.76, $12.45 and $11.19 per share with an aggregate value of $61,805, $16,857 and $107,984, respectively. The average intrinsic value of options exercisable at December 31, 2006, 2005 and 2004 had an aggregate value of $271,511, $487,075 and $491,179, respectively. 28 170680.FIN.P.qxd 3/1/07 4:23 PM Page 29 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 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 Company's financial statements. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Bank and Company must meet specific capital guidelines that involve quantitative measures of the Bank and Company's assets and liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank and Company's capital amounts and classification are also subject to qualitative judgements 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, 2006, that the Bank and the Company meets all capital adequacy requirements to which it is subject. As of December 31, 2006 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, 2006 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, 2005 Total Capital (to Risk-Weighted Assets) Tier 1 Capital (to Risk-Weighted Assets) Tier 1 Capital (to 4th Qtr. Average Assets) Actual Amount $ 123,173 113,460 113,460 119,838 110,499 110,499 Ratio 13.62 % 12.55 % 6.76 % 13.13 % 12.11 % 6.72 % The Company’s actual capital amounts and ratios are presented in the following table. As of December 31, 2006 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, 2005 Total Capital (to Risk-Weighted Assets) Tier 1 Capital (to Risk-Weighted Assets) Tier 1 Capital (to 4th Qtr. Average Assets) Actual Amount $ 154,027 144,314 144,314 150,603 141,263 141,263 Ratio 17.00 % 15.93 % 8.58 % 16.48 % 15.46 % 8.58 % For Capital Adequacy Purposes Amount Ratio $ 72,352 36,176 67,174 73,001 36,500 65,729 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % For Capital Adequacy Purposes Amount Ratio $ 72,488 36,244 67,282 73,108 36,544 65,821 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio $ 90,440 10.00 % 54,264 83,968 91,251 54,751 82,162 6.00 % 5.00 % 10.00 % 6.00 % 5.00 % To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio $ 90,609 10.00 % 54,366 84,103 91,385 54,831 82,276 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 29 2006 2005 2004 $ 2,968 164 3,132 $ 2,842 196 3,038 $ 4,277 227 4,504 (592) (121) (713) 117 11 128 427 43 470 $ 2,419 $ 3,166 $ 4,974 170680.FIN.P.qxd 3/1/07 4:23 PM Page 30 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Income tax accounts included in other assets at December 31 are as follows: (dollars in thousands) Currently receivable Deferred income tax asset, net Total (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 Total Effective tax rate 2006 2005 $ 67 12,487 $ 486 12,509 $ 12,554 $ 12,995 2006 2005 2004 $ 2,417 108 (109) (4) 7 $ 3,516 135 (356) (8) (121) $ 4,849 176 (260) — 209 $ 2,419 $ 3,166 $ 4,974 34.0 % 31.5 % 35.9 % 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 Pension and 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 2006 2005 $ 3,975 4,141 $ 3,907 4,136 3,115 3,447 502 27 132 33 5,271 2,026 380 33 156 1 15,372 15,910 — (733) (2,048) (104) (70) (1,191) (2,048) (92) (2,885) (3,401) $ 12,487 $ 12,509 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 had been offered to all employees reaching minimum age and service requirements. In 2006 the bank became a member of the Savings Bank Employees Retirement Association (“SBERA”) within which it maintains a Defined Benefit pension plan. SBERA offers a common and collective trust as the underlying investment structure for pension plans participating in SBERA. The Trustees of SBERA, through SBERA’s Investment Committee, select investment managers for the common and collective trust portfolio. A professional advisory firm is retained by the Investment committee to provide allocation analysis, performance measurement and to assist with manager searches. The overall investment objective is to diversify equity investments across a spectrum of investment types (e.g. small cap, large cap, international, etc.) and styles (e.g., growth, value, etc.) The Company closed the plan to employees hired after March 31, 2006. The measurement date for the Plan is September 30 for each year. The benefits expected to be paid in each year from 2007-2011 are $589,000, $602,000, $665,000, $732,000 and $784,000. The aggregate benefits expected to be paid in the five years from 2012-2016 are $5,269,000. The Company plans to contribute $1,560,000 to the Plan in 2007. The weighted-average asset allocation of pension benefit assets at September 30, were: 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, 2006. 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 Asset Category Fixed income Domestic equity International equity Other Total 2006 2005 36 % 49 % 15 % — 73 % 14 % — 13 % 100 % 100 % 30 170680.FIN.P.qxd 3/1/07 4:23 PM Page 31 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 The Company has a Supplemental Executive 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. An increase in recognized net losses resulted in an increase in the cost of the Supplemental Plan in 2006. Effective December 31, 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statements No. 87, 88, 106 and 132(R).” The Company recorded an additional $2,158,000 net pension liability adjustment, through stockholders’ equity, as a result of this adoption. The measurement date for the Supplemental Plan is September 30 for each year. The benefits expected to be paid in each year from 2007-2011 are $1,030,000, $1,027,000, $1,023,000, $1,025,000 and $1,037,000. The aggregate benefits expected to be paid in the five years from 2012-2016 are $5,355,000. (dollars in thousands) Change in benefit obligation Benefit obligation at beginning of year Service cost Interest cost Actuarial (gain)/loss Benefits paid Defined Benefit Pension Plan Supplemental Insurance/ Retirement Plan 2006 2005 2006 2005 $ 18,339 882 997 (1,039) (384) $ 14,076 760 914 2,869 (280) $ 14,130 106 766 (613) (649) $ 11,857 128 746 1,676 (277) Benefit obligation at end of year $ 18,795 $ 18,339 $ 13,740 $ 14,130 $ $ $ $ $ $ $ 12,194 645 1,418 (384) 13,873 (4,922) — — (4,922) NA NA 5.75 % 5.50 % 8.00 % 4.00 % 882 997 (1,015) (116) 371 $ $ $ $ $ $ $ 10,803 282 1,389 (280) 12,194 (6,145) 1,420 (7,401) (164) 16,680 3,135 5.50 % 6.00 % 8.00 % 4.00 % 760 914 (854) (20) 256 $ (13,740) $ (14,130) $ $ $ $ — — (13,740) NA NA 5.75 % 5.50 % NA 4.00 % 106 766 — 64 110 (1,091) (3,062) (9,977) 13,291 1,708 5.50 % 6.00 % NA 4.00 % 128 746 — 64 51 989 $ $ $ $ $ $ 1,119 $ 1,056 $ 1,046 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 cost Unrecognized net actuarial loss (Accrued) benefit cost Accumulated benefit obligation Additional minimum pension liability 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 31 170680.FIN.P.qxd 3/1/07 4:23 PM Page 32 Effective December 31, 2006 the Company adopted SFAS 158. The incremental effect of applying this Statement on individual line items in the consolidated Balance Sheet at December 31, 2006 follows: Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 Before Adoption of SFAS 158 Adjustments After Adoption of SFAS 158 Deferred tax assets, net $ 11,066 $ 1,421 $ 12,487 Total assets $ 1,642,869 $ 1,421 $ 1,644,290 Liability for plan benefits Liability for supplemental plan benefits $ 3,000 12,083 $ 1,922 1,657 $ 4,922 13,740 Total liabilities $ 1,533,893 $ 3,579 $ 1,537,472 Accumulated other comprehensive loss Total stockholders’ equity $ $ (7,929) $ (2,158) 108,976 $ (2,158) $ $ (10,087) 106,818 Amounts recognized in Accumulated Other Comprehensive Loss, which have not yet been recognized as components of net periodic benefit cost as of December 31, 2006: Prior service cost Net actuarial loss Total Plan 771 (3,759) (2,988) $ $ Supplemental Plan $ (607) (1,381) $ (1,988) $ $ Total 164 (5,140) (4,976) The following table summarizes the amounts included in accumulated other comprehensive income (loss) at December 31, 2006 expected to be recognized as components of net periodic benefit cost in the next year. Amortization of prior service cost to be recognized in 2007 Amortization of loss to be recognized in 2007 Plan $(116) 398 Supplemental Plan $64 81 Assumptions for the 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 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. The Company offers a 401(k) defined contribution plan for all employees reaching minimum age and service requirements. The plan is voluntary and employee contributions are matched by the Company at a rate of 33.3% for the first 6% of compensation contributed by each employee. The Company's match totaled $210,000 for 2006 $217,000 for 2005 and $211,000 for 2004. Administrative costs associated with the plan are absorbed by the Company. The Company does not offer any post retirement programs other than pensions. 32 170680.FIN.P.qxd 3/1/07 4:23 PM Page 33 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 14. Commitments and Contingencies A number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 2006. 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 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 (dollars in thousands) Financial instruments whose contract amount represents credit risk: Commitments to originate 1-4 family mortgages Standby and commercial letters of credit Unused lines of credit Unadvanced portions of construction loans Unadvanced portions of other loans 2006 2005 $ 2,305 10,397 168,290 $ 1,814 10,272 143,533 16,793 52,469 5,975 7,934 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. 33 16. Other Operating Expenses Year ended December 31, 2006 2005 2004 (dollars in thousands) Marketing Processing services Legal and audit Postage and delivery Software maintenance/amortization Supplies Consulting Telephone Core deposit tangible amortization Insurance Director’s fees FDIC assessment Capital expense amortization Other Total $ 1,515 1,326 894 849 717 684 642 524 388 368 219 154 12 1,139 $ 1,478 1,281 881 820 876 605 616 489 388 370 200 186 9 1,137 $ 1,403 1,379 812 826 653 728 316 583 388 316 258 198 — 1,160 $ 9,431 $ 9,336 $ 9,020 17. Fair Values of Financial Instruments The following methods and assumptions were used by the Company in estimating fair values of its financial instruments. Excluded from this disclosure are certain financial instruments for which it is not practical to estimate their value and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. CASH AND CASH EQUIVALENTS The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair values of these assets because of the short-term nature of these financial instruments. SECURITIES HELD-TO-MATURITY AND SECURITIES AVAILABLE-FOR-SALE The fair value of these securities, excluding certain state and municipal securities whose fair value is estimated at book value because they are not readily marketable, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. LOANS For variable-rate loans, that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair value of other loans is estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Incremental credit risk for nonperforming loans has been considered. 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. 170680.FIN.P.qxd 3/1/07 4:23 PM Page 34 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 DEPOSITS The fair value of deposits, with no stated maturity, is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on the deposit products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding (“deposit base intangibles”). REPURCHASE AGREEMENTS AND OTHER BORROWED FUNDS The fair value of repurchase agreements and other borrowed funds is based on the discounted value of contractual cash flows. The discount rate used is estimated based on the rates currently offered for other borrowed funds of similar remaining maturities. SUBORDINATED DEBENTURES The fair value of subordinated debentures is based on the discounted value of contractual cash flows. The discount rate used is estimated based on the rates currently for other subordinated debentures of similar remaining maturities. OFF-BALANCE SHEET INSTRUMENTS The fair values of the Company’s unused lines of credit and unadvanced portions of construction loans, commitments to originate and sell loans and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The carrying amounts and fair values of the Company’s financial instruments at December 31 are as follows: (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 2006 2005 Carrying Amounts Fair Value Carrying Amounts Fair Value $ 159,668 415,481 265,712 727,060 7,372 1,268,965 209,983 36,083 2,947 $ 159,668 415,481 258,420 713,889 7,372 1,268,500 211,931 34,948 2,947 $ 152,679 532,982 286,578 680,305 7,127 1,217,040 354,732 36,083 1,891 — 96 — $ 152,679 532,982 277,769 665,515 7,127 1,216,610 358,263 35,769 1,891 118 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. 34 170680.FIN.P.qxd 3/1/07 4:23 PM Page 35 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 18. Quarterly Results of Operations (unaudited) 2006 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 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 35 Fourth Third Second First $ 21,246 12,258 $ 8,988 225 8,763 2,736 9,850 1,649 561 20,541 11,170 9,371 225 9,146 2,729 10,056 1,819 622 $ 19,733 10,656 9,077 225 8,852 2,773 10,125 1,500 527 $ 19,187 9,860 9,327 150 9,177 3,127 10,165 2,139 709 $ 1,088 $ 1,197 $ 973 $ 1,430 $ $ $ 5,541,156 5,550,796 0.20 0.20 Fourth 18,788 9,421 9,367 150 9,217 2,633 10,100 1,750 478 $ $ $ 5,541,088 5,548,842 0.22 0.22 Third 18,289 8,533 9,756 150 9,606 2,720 10,067 2,259 727 $ $ $ 5,541,088 5,550,784 0.18 0.18 Second 18,082 7,745 10,337 150 10,187 2,937 10,116 3,008 973 5,540,523 5,553,351 $ $ $ 0.26 0.26 First 17,652 7,121 10,531 150 10,381 2,683 10,035 3,029 988 $ 1,272 $ 1,532 $ 2,035 $ 2,041 5,535,442 5,548,548 $ $ 0.23 0.23 5,535,388 5,553,751 $ $ 0.28 0.28 5,535,317 5,548,674 $ $ 0.37 0.37 5,534,651 5,550,263 $ $ 0.37 0.37 170680.FIN.P.qxd 3/1/07 4:23 PM Page 36 19. Parent Company Financial Statements The balance sheets of Century Bancorp, Inc. (“Parent Company”) as of December 31, 2006 and 2005 and the statements of income and cash flows for each of the years in the three-year period ended December 31, 2006 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. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘06 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 Year Ended 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 Benefit from income taxes Income before equity in undistributed income of subsidiary Equity in undistributed income of subsidiary 2006 2005 $ 30,103 110,915 2,029 $ 143,047 $ 146 36,083 106,818 $ 143,047 $ 30,458 107,388 1,550 $ 139,396 $ 112 36,083 103,201 $ 139,396 2006 2005 2004 $ 2,891 1,381 72 4,344 2,400 158 1,786 (375) 2,161 2,527 $ 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 Net income $ 4,688 $ 6,880 $ 8,881 STATEMENTS OF CASH FLOWS December 31, (dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating activities: 2006 2005 2004 $ 4,688 $ 6,880 $ 8,881 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) Stock options exercised Cash dividends paid Net cash (used in) provided by financing activities Net (decrease) increase in cash Cash at beginning of year Cash at end of year (2,527) 12 (490) 34 1,717 — 95 (2,167) (2,072) (355) 30,458 (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 $ 30,103 $ 30,458 $ 58,704 36 170680.FIN.P.qxd 3/1/07 4:23 PM Page 37 Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ‘06 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, 2006 and 2005, 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, 2006. 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, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, 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, 2006, 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 28, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. Boston, Massachusetts February 28, 2007 37 170680.FIN.P.qxd 3/1/07 4:23 PM Page 38 KPMG LLP Independent Registered Public Accounting Firm 99 High Street Boston, Massachusetts 02110 The Board of Directors and Stockholders Century Bancorp, Inc.: Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ‘06 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, 2006, 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, 2006, 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, 2006, 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, 2006 and 2005, 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, 2006, and our report dated February 28, 2007 expressed an unqualified opinion on those consolidated financial statements. Boston, Massachusetts February 28, 2007 38 170680.FIN.P.qxd 3/1/07 4:23 PM Page 39 Management’s Report on Internal Control Over Financial Reporting Century Bancorp, Inc. AR ‘06 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, 2006. 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, 2006, 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 38. Marshall M. Sloane Chairman February 28, 2007 Jonathan G. Sloane Co-President and Co-CEO Barry R. Sloane Co-President and Co-CEO Paul V. Cusick, Jr. Vice President and Treasurer 39 170680.FIN.P.qxd 3/1/07 4:23 PM Page 40 Notes Century Bancorp, Inc. AR ‘06 40 170680.FIN.P.qxd 3/1/07 4:23 PM Page 41 Notes Century Bancorp, Inc. AR ‘06 41 170680.BCFC.qxd 2/27/07 8:00 PM Page 2 A WORD FROM MARSHALL SLOANE 2006 has been a busy year at Century Bank. In April, I proudly turned over the CEO position to my sons, Barry and Jonathan. As Co-CEOs, they have assumed these responsibilities during one of the most challenging periods for bank fundamentals since the early 1990s. With their leadership and our strong financial position, I am confident they will strive to carry on the family tradition of a strong work ethic and sound values. Although these challenging times have lowered net earnings, our balance sheet is rock solid. Additionally, increased loan outstandings, sizable branch deposit growth, and stable overhead point toward a recovery in 2007. While I have abdicated my CEO responsibilities, I expect to continue my tenure as Chairman of the Board well into the future. I wish to commend my two colleagues who have also enjoyed a long and successful tenure with Century Bank: Paul V. Cusick, Jr. who retires as Century’s CFO after 18 years of service; and John C. Lavallee, the 33-year veteran head of our Institutional Services Group, who is working part-time in retirement as a senior consultant for Century. I am grateful to them, our loyal shareholders, associates, and clients, who have all played a strong role in the growth of Century. I look forward to prospering together in 2007 and the years ahead. Sincerely, Marshall M. Sloane Founder and Chairman 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) 823.6887 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 43078 Providence, RI 02940-3078 TEL (781) 575.3400 computershare.com A N N UA L M E E T I N G The annual meeting of stockholders will be held on Tuesday, April 10, 2007, 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 CentBcp A 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 Braintree Brookline Burlington Cambridge Everett Lynn Malden Medford Medford Square Newton Peabody Quincy Salem Somerville 300 Western Avenue, Allston, MA 02134 428 Rantoul Street, Beverly, MA 01915 710 Albany Street, Boston, MA 02118 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 (617) 562.1700 (978) 921.2300 (617) 578.9250 (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 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 Weston 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 Sloane Square, 110 Medford Street, Medford, MA 02155 College Hall, Regis College, 235 Wellesley Street, Weston, MA 02493 170680.BCFC.qxd 2/27/07 7:59 PM Page 1 400 Mystic Avenue Medford, MA 02155 (866) 823.6887 www.century-bank.com A N N U A L R E P O R T 2 0 0 6 F A M I L Y - F O C U S E D IT IS WHAT SETS US APART Equal Housing Lender / Member FDIC 002CS-13055 

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