Century Bancorp Inc.
Annual Report 2008

Plain-text annual report

Cove:Layout 1 2/27/09 4:28 PM Page 1 annual report 2008 years of family values Cove:Layout 1 2/27/09 4:28 PM Page 2 $1.8 FROM OUR CHAIRMAN: billion in assets By building on the strength of our relationships with small and medium-sized businesses, retail customers, and local governments and institutions, we increased our total assets 7.2% to $1.8 billion in 2008. When I founded Century 40 years ago in an office trailer on Fellsway West in Somerville, I never dreamed that we would grow to be the largest family controlled bank in New England, and in 2008, one of the very few banks in the nation with a solid balance sheet and increasing earnings. Marshall M. Sloane As we approach our anniversary celebration in May, there are so many memories of loyal customers and Century Associates, deals done, and most of all, people helped and communities that prospered. It seems like not that long ago that I cut the first ribbon on opening day, May 1, 1969, and I’ve been blessed to cut many more new office ribbons in the years that followed. I note with sadness the passing in 2008 of our Founding Director, Henry L. Foster, DVM. I am grateful for his 39 years of devoted service and wisdom. My father landed in Boston from Russia 100 years ago next March. He had a strong conviction that success in America was only limited by one's work ethic and values. He instilled in me a strict moral compass and the values of honesty, integrity and good character. He would be proud, but not too surprised, by what Century has become. I give much of the credit for our success to what we call our “family values”: hard work, unwavering focus, patient expectations, ethical behavior, and a lifelong commitment to our home communities. I am proud that my three children, and the entire Century family, will carry on these values as they build Century for the future. I’ve been a banker for over 50 years. I thought I’d seen it all, but many of the events of the past couple of months have left me astounded: monumental write-offs, absurd executive compensation, bank failures, huge forced mergers, frauds, depositor panics, and now the deepest recession since the Great Depression. Over the years, I have lost plenty of sleep worrying about events like these to ensure Century would survive and prosper. In the 90’s, I told my family that sound management principles are as important during a recession as when times are prosperous. I am proud to say we are sound, profitable, and growing. Century has always been a culture based on risk management. We are spending more time than ever on loan portfolio quality and underwriting standards. I feel confident that by maintaining our centralized control of lending in local markets, we’ll be fine. Most of all, I have faith in the United States, the economy of Massachusetts, and the core Greater Boston communities we serve. I’m proud of the skills and commitment of our management team, and take great pride in our 40 years of achievement. I’m already making plans for our next 40 years. Sincerely, Marshall M. Sloane Founder & Chairman About Century Century Bancorp, Inc. is a $1.8 billion banking and financial services company headquartered in Medford, Massachusetts. The Company operates 22 banking offices in 17 cities and towns in Massachusetts and provides a full range of business, personal, and institutional services. The Company’s common stock is listed on the NASDAQ Market under the symbol: “CNBKA.” 491070.Text.QX7:Layout 1 2/20/09 3:57 PM Page 1 DEAR FELLOW SHAREHOLDERS: 2008 was a strong and positive year for Century Bancorp. Our earnings, assets, capital, and branch footprint all grew meaningfully. Despite the most challenging business environment in a generation, each of our business units exceeded their goals. Here are some highlights: Net income for the year ended December 31, 2008 increased 15% to $9,046,000, or $1.63 per diluted share, compared to $7,864,000, or $1.42 per diluted share for 2007. Total assets increased 7.2% from $1.7 billion at December 31, 2007 to $1.8 billion at December 31, 2008. Net interest income increased 14.2% due to an improvement of 35 basis points in the net interest margin to 3.00%. Total stockholders’ equity increased from $118.8 million at year-end 2007 to $120.5 million at year-end 2008. Book value per share increased to $21.76. Total loans increased by 15.1% from year-end 2007 to $836 million at year-end 2008, including a 20.5% increase in commercial and industrial loans. Jonathan G. Sloane and Barry R. Sloane Total deposits grew $135 million from year-end 2007 to 2008, or 12%. The efficiency ratio, a key measure of operating effectiveness, improved (declined) from 77.5% to 70.6% from 2007 to 2008. We opened two new branches: Main Street in Winchester and Riverside Avenue in Medford; and repositioned our Medford Square branch to the very center of the Square. Each location has accomplished significant deposit growth, further increasing our market share and our commitment to the communities we serve. Institutional Services increased its lockbox and related cash management fees by 9% and grew deposit balances by 22% in 2008. 15% increase in net income Despite the challenging economic climate, we grew our net income by staying true to our core values and focused on our communities. 491070.Text.QX7:Layout 1 2/20/09 3:57 PM Page 2 22branch locations Continually seeking ways to improve service and lower costs, we optimized and expanded our branch network to 22 offices in 17 Massachusetts cities and towns. Century was founded 40 years ago on the philosophy of careful risk management and centralized in-market lending, long before these imperatives were cited as absent in the recent analysis of troubled banks. A year ago, we perceived a significant deterioration in national credit quality, so we fortified our loan approval mechanism. The improved process requires daily Executive review and approval on all bank lending. Our nonperforming assets (“NPA”) increased from $1.8 million at year-end 2007 to $3.7 million at year-end 2008. The NPAs represent a small percentage of our loan portfolio, less than half of 1%, and the Bank has no foreclosed real estate owned. Regardless, we remain relentlessly devoted to proactively managing the credit quality of our portfolio. Independent thinking. The troubles of the giant, multinational banks have further distracted their management’s attention from their communities and clients. Some years ago, we wrote of our concern about “living in the land of the giants.” The “giants” appear less formidable today. Clients and bankers have moved to Century as a refuge from the “management by headline” that defines those multinational banks. To seize this opportunity, we recognize how critical it is that we remain focused on strengthening our local ties. It is a relief to be fortunate to spend our days on constructive business building initiatives, rather than on lobbying for federal assistance. We did receive preliminary approval in December for $30 million of the Capital Purchase Program (“CPP”) preferred capital stock investment from the U.S. Treasury's Troubled Asset Relief Program (“TARP”). However, in early February 2009, we cancelled our scheduled closing. We simply felt that the relatively high percentage coupon, 10-year stock warrants, and the almost daily announcements of proposed restrictions on dividends and acquisitions did not justify the “insurance” value of the additional and, in our case, unneeded capital. Total Assets (in thousands) , 6 6 5 1 0 8 1 $ , , 1 8 2 0 8 6 1 $ , , 0 9 2 4 4 6 1 $ , 06 07 08 Net Income (in thousands) 6 4 0 9 $ , 4 6 8 7 $ , 8 8 6 4 $ , 06 07 08 Earnings per Share, Diluted . 3 6 1 $ 2 4 1 $ . 4 8 0 $ . 06 07 08 491070.Text.QX7:Layout 1 2/24/09 10:50 PM Page 3 Looking ahead. There is no doubt of the severity of this recession, but conservative economic forecasts foreshadow a leveling of GDP in late 2009, followed by modest growth in 2010. We feel comfortable that we can manage our way through this economic contraction without the TARP/CPP money and its burdens. There is no doubt that we are living through a deleveraging of American consumers and corporations. While less debt will restrain spending and GDP growth in the short term, less high-rate debt is a good and productive development for America. We acknowledge recessions are painful for our communities and clients, but we are certain they will emerge stronger at the conclusion of this challenging period. As we mark our 40th anniversary, we are confident that, with the continued support and commitment of our 400 Associates, Century will continue to prosper in the years ahead. Thank you for your business, your share ownership, and your confidence in our leadership. Sincerely, Barry R. Sloane Co-CEO & Co-President Jonathan G. Sloane Co-CEO & Co-President Management Committee members, from left: Brian J. Feeney, David B. Woonton, William P. Hornby, Linda Sloane Kay, and Paul A. Evangelista 491070.Text.QX7:Layout 1 2/20/09 3:57 PM Page 4 40 years of giving and guidance Providing financial and leadership support to charitable organizations throughout our communities is a proud family tradition that goes back to our founding. In 2008, we continued to invest in our communities, supporting 170 organizations. Charitable Donations – 2008 Adopt-A-Student Foundation Allston Village Main Streets American Heart Association American Red Cross of Massachusetts Bay American Stroke Association Anti-Defamation League Associazione Gizio Autism Speaks Bay State Chapter Freedoms Foundation Beacon Academy Boston Harbor Association Boston Minuteman Council, Boy Scouts of America Boston University Boys & Girls Club of Lynn Boys & Girls Club of Middlesex County Braintree Police Superior Officers’ Union Bread of Life Brendan M. Curtin Sponsorship Fund Bridge Over Troubled Waters Brighton Board of Trade Brookline Music School Burlington Community Scholarship Foundation/ Dollars for Scholars Burlington Education Foundation Burlington High School Scholarship Fund Burlington Recreation Department Burlington Rotary Club Business Advancement & Social Entrepreneurs, Inc. (BASE) Cambridge & Somerville Program for Alcoholism and Drug Abuse Rehabilitation (CASPAR) Casa Monte Casino Catholic Charities of Boston Catholic University Center for Women & Enterprise Chicopee Chamber of Commerce City of Malden City of Medford City of Quincy City of Somerville City of Waltham Combined Jewish Philanthropies Congregation of Holy Cross Congregation Shaarei Tefillah Current Trends in Autism 2008/ Friends of LADDERS Dana-Farber Cancer Institute Digital Credit Union for Kids Dimock Community Health Centers Discover Quincy Don Guanella Center Dormition of the Virgin Mary Greek Orthodox Church of Somerville Eleanora Duse Italian American Theatre, LLC Elizabeth Peabody House Endicott College Essex National Heritage Commission Everett Chamber of Commerce Everett Kiwanis Club Federated Dorchester Neighborhood First Candle/Marley Jaye Cherella Memorial Fund Fishermen's Feast of Boston Fontbonne Academy Foundation for Faces of Children Fourth Presbyterian Church of South Boston Georgetown Light Department Greenlight Fund - Raising A Reader Harry Langburd Scholarship Fund Hebrew Senior Life Housing Families Inner City 100 Interfaithfamily.com International Union of Elevator Constructors Irish Chamber of Commerce USA Italia Unita Jewish Cemetery Association of Massachusetts Jewish Family Services of the North Shore Katz Silver Lung Cancer Research Kids Clothes Club Little League of Somerville Little Sisters of the Poor Lupus Foundation of America Lynn Area Chamber of Commerce Lynn Housing Authority & Neighborhood Development Lynn Lions Club Lynn Rotary Club Maimonides School Malden Beautification Program Malden Chamber of Commerce Malden Rotary Club Malden YMCA Massachusetts Affordable Housing Alliance Medford Firefighters Union Medford High School Medford Historical Society Medford Jingle Bell Festival Medford Police Association Medford Rotary Club Medford Senior Football Associates Medford Vocational Tech High School Medical Academic & Scientific Community Organization Mental Health Programs, Inc. (MHPI) MetroCast Foundation MetroWest Jewish Day School Middlesex County Deputy Sheriff’s Association Middlesex County Sheriff’s Department Milton Hospital Muscular Dystrophy Association Mystic Learning Centers Nazzaro Recreation Center NEMLEC Police Foundation Neponset Valley Philharmonic Orchestra Neurofibromatosis of New England New England Aquarium New England Athletes for Academic Excellence New England Conservatory New England Province of Jesuits New England Shelter for Homeless Veterans Newburyport Yankee Homecoming Newmarket Business Association North Bennet Street School North Cambridge Senior Center North End Christmas Fund North Shore Medical Center Cancer Walk Ocular Immunology and Uveitis Foundation Operation A.B.L.E. of Greater Boston Our Lady of Nazareth Academy Pan-Mass Challenge Peabody Chamber of Commerce Peabody High School Hockey Boosters Pope John XXIII High School Prospect Hill Academy Charter School Rashi School Regis College Rodman Ride for Kids Run for Wednesday's Child Sacred Heart Parish of Lynn Saint John School Salem Little League Salem State College Shakespeare & Company Societa di San Giuseppe Solomon Schechter Day School Somerville Chamber of Commerce Somerville Community Corporation Somerville Housing Authority Somerville Lions Club Somerville Mental Health Somerville Police Relief Association Somerville Veterans' Services Sons of Italy Sportsmen's Tennis Club Springstep St. Leonard’s Parish of Boston Synagogue Council of Massachusetts Taste of the North End Temple Israel of Boston Templeton Municipal Light and Water The Brotherhood Fund The Genesis Fund The Wellness Community Torah Academy Town of Burlington Town of Swampscott Town of Weymouth Toys for Tots Ward 7 Improvement Association Wheelock College Winchester Historical Society Winchester Veterans’ Honor Roll Committee World Unity YMCAs of Greater Boston Young Israel of Brookline 491070.Financial.QX7.qxd:CA14518_Financials 2/25/09 7:18 PM Page 1 CENTURY BANCORP, INC. DIRECTORS George R. Baldwin 1,4,6* President & CEO Baldwin & Company Roger S. Berkowitz 2,5,7* President & CEO Legal Sea Foods, Inc. Marshall I. Goldman 3*,5** Professor Emeritus Wellesley College Russell B. Higley, Esq.6,7 Attorney Higley & Higley Jackie Jenkins-Scott 4,5 President Wheelock College Linda Sloane Kay 7 Senior Vice President Century Bank and Trust Company Fraser Lemley 2*,4,5 Chairman & CEO Sentry Auto Group Joseph J. Senna, Esq.1*,4 Attorney Jonathan G. Sloane 4,5,6,7 Co-President & Co-CEO Century Bank and Trust Company Barry R. Sloane 4,5,6,7 Co-President & Co-CEO Century Bank and Trust Company Marshall M. Sloane 4,5 Chairman of the Board Century Bank and Trust Company Stephanie Sonnabend 1,3,5* CEO & President Sonesta International Hotels Corporation George F. Swansburg 4*,5 Jon Westling 1,2,3 President Emeritus Boston University OFFICERS Marshall M. Sloane Founder & Chairman Jonathan G. Sloane Co-President & Co-CEO Barry R. Sloane Co-President & Co-CEO William P. Hornby, CPA Chief Financial Officer & Treasurer Rosalie A. Cunio Clerk Paula A. Grimaldi Assistant Clerk CENTURY BANK AND TRUST COMPANY OFFICERS MANAGEMENT COMMITTEE Marshall M. Sloane Chairman of the Board Jonathan G. Sloane Co-President & Co-CEO Barry R. Sloane Co-President & Co-CEO William P. Hornby, CPA Chief Financial Officer & Treasurer Paul A. Evangelista Executive Vice President Brian J. Feeney Executive Vice President Linda Sloane Kay Senior Vice President David B. Woonton Executive Vice President SENIOR VICE PRESIDENTS Gerald S. Algere Richard L. Billig Janice A. Brandano Bradford J. Buckley Peter R. Castiglia James M. Flynn, Jr. William J. Gambon, Jr. Timothy L. Glynn Anthony C. LaRosa, CPA Nancy Lindstrom Jason J. Melius Deborah R. Rush Kenneth A. Samuelian Yasmin D. Whipple FIRST VICE PRESIDENTS Susan B. Delahunt Phillip A. Gallagher Shipley C. Mason Joanne C. McNamara, CISA VICE PRESIDENTS Michael D. Ballard Jean P. Belcher-Scarpa Robert A. Bennett Gerald Bovardi Joseph B. Chapman Gracine Copithorne Rosalie A. Cunio Barbara J. Cunningham Sandra R. Edey Michele English Judith A. Fallon Jonathan S. Gilbert Howard N. Gold T. Daniel Kausel Kathleen A. Kelly Michael F. Long Nancy M. Marsh Karen M. Martin Carl M. Mattos Thomas E. Piemontese Cornelius C. Prioleau Andrew J. Santos, Jr. Bernice A. Shuman Janice D. Taylor David J. Waryas A SSISTANT VICE PRESIDENTS John S. Bosco, Jr. Pasqualina Buttiri Frank A. Call Toni M. Chardo Cynthia A. Davidson Laura A. DiFava John R. Ferguson Thatcher L. Freeborn Anna M. Gorska Lisa Gosling Daniel F. Griffin Janice D. Hallinan Kristine M. Holopainen James J. Jordan Malcolm I. Maloon Ann E. Mannion Kathleen McGillicuddy Carol A. Melisi Richard D. Murray Sarah A. O’Toole Karen J. Pessia Elizabeth M. Pinault Laurie A. Rizzo William F. Shutt, Jr. Richard A. Thimble Tuesday N. Thomas Lawrence H. Tsoi Jose I. Umana Christina Welch-Matthews OFFICERS John J. Ferren Marissa L. Fitzgerald Janet Garcia Sara A. Gaudet Paula A. Grimaldi Amelia N. Iocco Brian Kelly Brandon N. Letellier Robson G. Miguel Scott M. Rembis Judith A. Shannon Krzysztof A. Sikorski Nikole A. Solomon Elizabeth A. Theriault Jeanne A. Wood 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 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 2 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 3 Century Bancorp, Inc. AR ’08 F I N A N C I A L S TAT E M E N T S 1 3 19 20 21 22 23 44 46 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 in Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Reports of Independent Registered Public Accounting Firm Management’s Report on Internal Control Over Financial Reporting 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 1 2008 2007 2006 2005 2004 $ 80,693 35,914 44,779 4,425 40,354 13,975 43,028 11,301 2,255 $ 83,008 43,805 39,203 1,500 37,703 13,948 40,255 11,396 3,532 $ 9,046 $ 7,864 5,541,983 5,543,702 5,538,407 5,542,461 5,546,707 5,543,804 $ $ 1.63 1.63 24.0 % $ $ 1.42 1.42 27.6 % $ $ $ $ 80,707 43,944 36,763 825 35,938 11,365 40,196 7,107 2,419 4,688 5,540,966 5,550,722 5,541,188 $ 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 $ 6,880 $ 8,881 5,535,202 5,553,009 5,535,422 5,526,202 5,553,197 5,534,088 0.85 0.84 46.2 % $ $ 1.24 1.24 31.3 % $ $ 1.61 1.60 24.2 % $ 1,801,566 836,065 1,265,527 120,503 21.76 $ $ 1,680,281 726,251 1,130,061 118,806 21.43 $ $ 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 $ 0.54 % 7.43 % 3.00 % 0.38 % 7.23 % 70.6 % 0.49 % 7.05 % 2.65 % 0.22 % 6.97 % 77.5 % 0.28 % 4.45 % 2.40 % 0.06 % 6.39 % 83.5 % 0.41 % 6.57 % 2.58 % 0.04 % 6.31 % 79.1 % 0.55 % 8.61 % 2.75 % 0.01 % 6.38 % 72.7 % Financial Highlights Century Bancorp, Inc. AR ’08 (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 charge-offs as a percent of average loans Average stockholders’ equity to average assets Efficiency ratio 1 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 2 Per Share Data 2008, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 2007, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B Financial Highlights Century Bancorp, Inc. AR ’08 December 31, September 30, June 30, March 31, $ 18.00 11.50 0.12 0.06 $ 20.51 12.76 0.12 0.06 $ 21.62 17.00 0.12 0.06 $ 22.48 18.25 0.12 0.06 December 31, September 30, June 30, March 31, $ 25.49 19.80 0.12 0.06 $ 22.67 19.26 0.12 0.06 $ 26.55 21.27 0.12 0.06 $ 28.25 26.00 0.12 0.06 The stock performance graph below compares the cumulative total shareholder return of the Company’s Common Stock from December 31, 2003 to December 31, 2008 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 $175 $150 $125 $100 $75 $50 $25 $0 NASDAQ Banks NASDAQ U.S. Century Bancorp, Inc. 2003 2004 2005 2006 2007 2008 Value of $100 Invested on December 31, 2003 at: Century Bancorp, Inc. NASDAQ Banks NASDAQ U.S. 2004 $ 84.46 114.44 108.84 2005 2006 $ 85.16 111.80 111.16 $ 80.87 125.47 122.11 2007 $ 61.03 99.45 132.42 2008 $ 49.02 72.51 63.80 *Assumes that the value of the investment in the Company’s Common Stock and each index was $100 on December 31, 2003 and that all dividends were reinvested. 2 491070.Financial.QX7.qxd:CA14518_Financials 2/25/09 7:21 PM Page 3 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets, and the availability of and costs associated with sources of liquidity. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward- looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. RECENT MARKET DEVELOPMENTS The financial services industry is facing unprecedented challenges in the face of the current economic crisis. The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market, and increased foreclosure levels and unemployment rates, have resulted in significant writedowns of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These writedowns, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital; to merge with larger and stronger institutions; and, in some cases, to fail. The Company is fortunate that the markets it serves have been impacted to a lesser extent than many areas around the country. In response to the financial crises affecting the banking system and financial markets, there have been several recent announcements of federal programs designed to purchase assets from, provide equity capital to, and guarantee the liquidity of the industry. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. The EESA authorizes the U.S. Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities, and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The Company does not expect to participate in the sale of any of its assets into these programs. EESA also immediately increased the FDIC deposit insurance limit from $100,000 to $250,000 through December 31, 2009. On October 14, 2008, the U.S. Treasury announced that it will purchase equity stakes in a wide variety of banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), the U.S. Treasury has made approximately $250 billion of capital available (from the $750 billion authorized by the EESA) to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the U.S. Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the U.S. Treasury’s 3 standards for executive compensation, dividend restrictions and corporate governance for the period during which the U.S. Treasury holds equity issued under the TARP Capital Purchase Program. The U.S. Treasury also announced that nine large financial institutions had already agreed to participate in the TARP Capital Purchase Program. Subsequently, a number of smaller institutions have participated in the TARP Capital Purchase Program. On December 18, 2008, the Company announced, in a press release, it had received preliminary approval from the U.S. Treasury to participate in the TARP Capital Purchase Program, in an amount up to $30 million in the form of Century Bancorp, Inc. preferred stock and warrants to purchase Class A common stock. In light of uncertainty surrounding additional restrictions that may be imposed on participants under pending legislation, the Company, on January 14, 2009, informed the U.S. Treasury that it would not be closing on the transaction on January 16, 2009, as originally scheduled. The Company will monitor developments and may decide to close on the transaction once uncertainties are resolved if it is in the best interest of the Company to do so, though the U.S. Treasury did not commit to close at a future date. On October 14, 2008, the U.S. Treasury and the FDIC jointly announced a new program, known as the Temporary Liquidity Guarantee Program (“TLGP”), to strengthen confidence and encourage liquidity in the nation’s banking system. The TLGP consists of two programs: the Debt Guarantee Program (“DGP”) and the Transaction Account Guarantee Program (“TAGP”). Under the DGP, the FDIC will guarantee certain newly issued senior unsecured debt of participating banks, thrifts and certain holding companies issued from October 14, 2008 through June 30, 2009, which debt matures on or prior to June 30, 2012, up to a fixed maximum amount per participant. In addition, under the TAGP, the FDIC will fully guarantee deposits in noninterest bearing transaction accounts without dollar limitation through December 31, 2009. Institutions opting to participate in the DGP will be charged a 50-, 75- or 100-basis point fee (depending on maturity) for the guarantee of eligible debt, and a 10-basis point assessment will be applicable to deposits in noninterest bearing transaction accounts at institutions participating in the TAGP that exceed the existing deposit insurance limit of $250,000. The Company opted to participate in both the DGP and the TAGP. 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. At December 31, 2008, the Company had total assets of $1.8 billion. Currently, the Company operates 22 banking offices in 17 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 the interest paid on deposits and borrowings. The results of operations are also affected by the level of income/fees from loans and 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, nonprofit 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 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:34 PM Page 4 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 services to the municipal market. Also, the Company provides full-service securities brokerage services through a program called Investment Services at Century Bank which is supported by Linsco/Private Ledger Corp., a full-service securities brokerage business. 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. The Company is also a provider of financial services, including cash management, transaction processing and short-term financing, to municipalities in Massachusetts and Rhode Island. The Company has deposit relationships with approximately 43% of the 351 cities and towns in Massachusetts. The Company had net income of $9,046,000 for the year ended December 31, 2008, compared with net income of $7,864,000 for the year ended December 31, 2007 and net income of $4,688,000 for the year ended December 31, 2006. Diluted earnings per share were $1.63 in 2008, compared to $1.42 in 2007 and $0.84 in 2006. Included in income for 2007 is a $1,321,000 pre-tax gain on the sale of the building that houses the Company’s Medford Square branch. Included in income for 2006 is a pre-tax gain of $600,000 from the sale of the Company’s rights to future royalty payments for a portion of its Merchant Credit Card customer base. Throughout 2007 and 2008, the Company has seen improvement in its net interest margin as illustrated in the graph below: Net Interest Margin 2.64% 2.77% 2.79% 2.41% 2.82% 2.86% 3.14% 3.16% 3.60 % 3.20 % 2.80 % 2.40 % 2.00 % 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 2008 2007 2007 2007 2007 2008 2008 2008 The primary factors accounting for the increase in net interest margin are: • a continuing decline in the cost of funds as a result of increased pricing discipline related to deposits, • an increase in average loans outstanding during 2008, • the maturity of lower-yielding investment securities, • an increase in the slope of the yield curve, During 2008, the U.S. economy has experienced a lower rate environment along with a steepening of the yield curve, which means that the spread between the long-term and short-term yields has increased. This has positively impacted the net interest margin. During 2007, rates fell and the yield curve steepened somewhat. This positively impacted the net interest margin. During 2006, the Company’s earnings were negatively impacted primarily by a decrease in net interest income. This decrease was primarily due to the inverted yield curve during 2006 as well as increased funding costs. Total assets were $1,801,566,000 at December 31, 2008, an increase of 7.2% from total assets of $1,680,281,000 on December 31, 2007. On December 31, 2008, stockholders’ equity totaled $120,503,000, compared with $118,806,000 on December 31, 2007. Book value per share increased to $21.76 at December 31, 2008 from $21.43 on December 31, 2007. On August 17, 2007, the Company sold the building that houses one of its branches located at 55 High Street, Medford, Massachusetts, for $1.5 million at market terms. The Bank relocated this branch to 1 Salem Street (formerly 3 Salem Street), Medford, Massachusetts. This sale resulted in a pre-tax gain of $1,321,000. The branch opened on May 5, 2008. On April 14, 2008, the Company opened a branch located on Riverside Avenue in Medford, Massachusetts. On November 17, 2008, the Company opened a branch located on Main Street in Winchester, Massachusetts. During October 2008, the Company received regulatory approval to close a branch on Albany Street in Boston, Massachusetts. This branch closed during the first quarter of 2009. During the fourth quarter of 2007, the Company sold the assets associated with the Sherman Union branch located on Commonwealth Avenue in Boston, Massachusetts, as well as automated teller machines (“ATMs”) located at or near Boston University. The buyer assumed the leases for the branch and ATMs. The deposits associated with the Sherman Union branch were transferred to Century’s Hotel Commonwealth branch located at 512 Commonwealth Avenue in Boston, Massachusetts. This resulted in a gain of $115,000. • an increase in the loan yield due to an increase in prepayment fees, particularly in the second quarter of 2007, and • an increase in investment yields due, in part, to taking advantage of elevated yields in the municipal auction rate securities market, particularly in the third quarter of 2008. 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. While management will continue its efforts to improve the net interest margin, there can be no assurance that certain factors beyond its control, such as prepayments of loans and changes in market interest rates, will continue to positively impact the net interest margin. Historical U.S. Treasury Yield Curve 6.00 % 5.00 % 4.00 % 3.00 % 2.00 % 1.00 % 0.00 % 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. 3 Month 6 Month 2 Year 3 Year 5 Year 10 Year 30 Year U.S. Treasury Yield Curve 12/31/2006 U.S. Treasury Yield Curve 12/31/2007 U.S. Treasury Yield Curve 12/31/2008 4 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:34 PM Page 5 Management’s Discussion and Analysis of Results of Operations and Financial Condition Impaired Investment Securities If a 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 writedown 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 hinders its ability to make future scheduled interest and principal payments on a timely basis or whether there was a downgrade in ratings by rating agencies. The Company has the ability and intent to hold all securities with an unrealized loss until recovery of fair value, which may be maturity. 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 Enterprise mortgage-backed securities; state, county and municipal securities; foreign debt securities and other marketable equities. 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, 2008 totaled $495,585,000 and includes gross unrealized gains of $4,783,000 and gross unrealized losses of $5,244,000. A year earlier, securities available-for-sale were $388,104,000 including gross unrealized gains of $1,728,000 and unrealized losses of $2,077,000. In 2008, the Company recognized gross gains of $251,000 and gross losses of $2,000 on the sale of available-for-sale securities. The Company also recognized $76,000 in realized losses on the writedown of two stocks. In 2007, the Company recognized gross gains of $153,000 on the sale of one stock. 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, 2008 are carried at their amortized cost of $184,047,000 and exclude gross unrealized gains of $1,820,000 and gross unrealized losses of $434,000. A year earlier, securities held-to-maturity totaled $183,710,000 excluding gross unrealized gains of $131,000 and gross unrealized losses of $2,137,000. Century Bancorp, Inc. AR ’08 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 and specific allowances for identified problem loans. 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 net loss experience and qualitative adjustments. For the residential real estate and consumer loan portfolios, the reserves are calculated by applying historical charge-off and recovery experience and qualitative adjustments to the current outstanding balance in each loan category. Loss factors are based on the Company’s historical net loss experience, as well as regulatory guidelines. Specific allowances for loan losses entail 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 nonaccrual 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 formula allowance and specific allowances also include management’s evaluation of various conditions, including business and economic conditions, delinquency trends, charge-off experience and other quality factors. 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 of 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. 5 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 6 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 The following table sets forth the fair value and percentage distribution of securities available-for-sale (“AFS”) at the dates indicated. Fair Value of Securities Available-for-Sale At December 31, (dollars in thousands) U.S. Treasury U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities Privately Issued Mortgage-Backed Securities Obligations of States and Political Subdivisions Other Total 2008 2007 2006 Amount Percent Amount Percent Amount Percent $ 2,028 161,292 260,132 9,026 60,259 2,848 0.4 % 32.5 % 52.5 % 1.8 % 12.2 % 0.6 % $ 2,036 218,729 145,638 16,524 1,678 3,499 0.5 % 56.4 % 37.5 % 4.3 % 0.4 % 0.9 % $ 1,991 221,037 148,134 30,942 — 3,554 0.5 % 54.5 % 36.5 % 7.6 % 0 % 0.9 % $ 495,585 100.0 % $ 388,104 100.0 % $ 405,658 100.0 % Included in Obligations Issued by States and Political Subdivisions as of December 31, 2008, are $33,300,000 of auction rate municipal obligations (“ARSs”) and $20,000,000 of variable rate demand notes (“VRDNs”) with unrealized losses of $1,254,000 for ARSs. VRDNs’ market value equals the carrying value. These debt securities were issued by governmental entities, but are not necessarily debt obligations of the issuing entity. Of the total of $53,300,000 of ARSs and VRDNs, $25,000,000 are obligations of governmental entities and the remainder are obligations of large nonprofit entities. These obligations are variable rate securities with long-term maturities whose interest rates are set periodically through an auction process for ARSs and by prevailing market rates for VRDNs. Should the auction not attract sufficient bidders, the interest rate adjusts to the default rate defined in each obligation’s underlying documents. The Company increased its holdings in these types of securities during the second and third quarters of 2008 to take advantage of yields available due to market disruption. Although many of these issuers have bond insurance, the Company purchased the securities based on the creditworthiness of the underlying obligor. In the case of a failed auction, the Company may not have access to funds as only a limited market exists for failed ARSs. As of December 31, 2008, three of the Company’s ARSs were purchased subsequent to their failure with a fair value of $12,000,000 and an amortized cost of $13,300,000. Three securities issued by governmental entities were purchased prior to their failure with a fair value and amortized cost of $10,000,000. The remaining securities were issued by governmental entities, and large nonprofit entities, and are the debt of nonprofit organizations which the Company believes to be creditworthy. As of December 31, 2008, the weighted average taxable equivalent yield on these securities was 5.69%. The majority of the Company’s securities AFS are classified as Level 2, as defined in footnote 1 of the “Notes to Consolidated Financial Statements.” The fair values of these securities are obtained from a pricing service, which provides the Company with a description of the inputs generally utilized for each type of security. These inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Market indicators and industry and economic events are also monitored. The decline in fair value of $460,000 from amortized cost for available-for-sale securities is attributable to changes in interest rates and not credit quality. 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, 2008. Securities available-for-sale totaling $3,470,000, or 0.19% of assets, are classified as Level 3, as defined in footnote 1 of the “Notes to Consolidated Financial Statements.” These securities are generally equity investments or municipal securities with no readily determinable fair value. The securities are carried at fair value with periodic review of underlying financial statements and credit ratings to assess the appropriateness of these valuations. Debt securities of Government Sponsored Enterprises primarily refer to debt securities of Fannie Mae and Freddie Mac. Control of these enterprises was directly taken over by the U.S. Government in the third quarter of 2008. 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) 2008 2007 2006 Amount Percent Amount Percent Amount Percent U.S. Government Sponsored Enterprise $ 44,000 23.9 % $ 94,987 51.7 % $ 159,969 60.2 % U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities 140,047 76.1 % 88,723 48.3 % 105,743 39.8 % Total $ 184,047 100.0 % $ 183,710 100.0 % $ 265,712 100.0 % For all years presented, all mortgage-backed securities are obligations of U.S. Government Sponsored Enterprises. 6 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 7 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 The following two tables set forth contractual maturities of the Bank’s securities portfolio at December 31, 2008. 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 % of Total Average Yield to Five Years % of Total Average Yield to Ten Years % of Total Weighted Average Yield Over Ten Years Weighted Average Yield % of Total (dollars in thousands) U.S. Treasury U.S. Government $ 2,028 0.4 % 4.60 % $ — 0.0 % — $ — 0.0 % — $ — 0.0 % Sponsored Enterprise 15,006 3.0 % 3.00 % 108,576 21.9 % 4.40 % 37,710 7.6 % 4.47 % — 0.0 % — — U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities 68,401 13.8 % 4.21 % 183,468 37.0% 4.10 % Privately Issued Mortgage- Backed Securities Obligations of States and Political Subdivisions 3,368 0.7 % 3.28 % 5,658 1.1 % 3.49 % — — 0.0 % 0.0 % — — 8,263 1.7 % 5.79 % — — — and other Total 4,715 1.0 % $ 93,518 18.9 % 3.38 % 3.95 % 3,809 0.8 % $301,511 60.8 % 4.13 % 4.20 % 8,233 $ 45,943 1.7 % 9.3 % 4.24 % 44,202 8.9 % 3.47 % 4.43 % $ 52,465 10.6 % 3.84 % Non- Maturing % of Total Weighted Average Yield Total Weighted Average Yield % of Total $ — — — — 2,148 $ 2,148 0.0 % 0.0 % 0.0 % 0.0 % 0.4 % 0.4 % — — — — $ 2,028 0.4 % 161,292 32.5 % 4.60 % 4.28 % 260,132 52.5 % 4.18 % 9,026 1.8 % 3.43 % 4.11 % 63,107 12.8 % 4.11 % $ 495,585 100.0 % 3.64 % 4.13 % (dollars in thousands) U.S. Treasury U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities Privately Issued Mortgage-Backed Securities Obligations of States and Political Subdivisions and other Total Amortized Cost of Securities Held-to-Maturity Amounts Maturing Within One Year Weighted One Year Weighted Five Years % of Total Average Yield to Five Years % of Total Average Yield to Ten Years % of Total Weighted Average Yield Total Weighted Average Yield % of Total (dollars in thousands) U.S. Government Sponsored Enterprise $ 25,000 13.6 % 3.92 % $ — — — $ 19,000 10.3 % 4.16 % $ 44,000 23.9 % 4.02 % Mortgage-Backed Securities Total 2,022 1.1 % 3.90 % 136,869 74.4 % 4.34 % 1,156 0.6 % 4.68 % 140,047 76.1 % 4.34 % $ 27,022 14.7 % 3.92 % $ 136,869 74.4 % 4.34 % $ 20,156 10.9 % 4.19 % $ 184,047 100.0 % 4.26 % 7 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 8 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 At December 31, 2008 and 2007, the Bank had no investments in obligations of individual states, counties, municipalities or nongovernment corporate entities which exceeded 10% of stockholders’ equity. Additionally, in 2008, there were sales totaling $123,704,000 in gross proceeds in state, county or municipal securities resulting in gross gains of $46,000 and gross losses of $0. There were no sales of state, county or municipal securities in 2007. In 2008, sales of securities totaling $238,894,000 in gross proceeds resulted in a net realized gain of $249,000. One equity security was sold during 2007 with gross proceeds of $336,000 resulting in a gain of $153,000. The book value of two equity securities was written down $76,000 during 2008. Debt securities of Government Sponsored Enterprises primarily refer to debt securities of Fannie Mae and Freddie Mac. Control of these enterprises was directly taken over by the U.S. Government in the third quarter of 2008. Management reviews the investment portfolio for other-than-temporary impairment of individual securities on a regular basis. The results of such analysis are dependent upon general market conditions and specific conditions related to the issuers of our securities. 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 are generally dependent on the health of the real estate market in the borrowers’ geographic areas and of the general economy. The following summary shows the composition of the loan portfolio at the dates indicated. December 31, 2008 2007 2006 2005 2004 Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total (dollars in thousands) Construction and land development $ 59,511 7.1 % $ 62,412 8.6 % $ 49,709 6.7 % $ 58,846 8.5 % $ 51,918 9.0 % Commercial and industrial Commercial real estate Residential real estate Consumer Home equity Overdrafts Total 141,373 332,325 194,644 8,246 98,954 1,012 16.9 % 39.8 % 23.3 % 1.0 % 11.8 % 0.1 % 117,332 299,920 168,204 8,359 68,585 1,439 16.2 % 41.3 % 23.2 % 1.1 % 9.4 % 0.2 % 117,497 327,040 167,946 7,104 66,157 1,320 15.9 % 44.4 % 22.8 % 1.0 % 9.0 % 0.2 % 94,139 13.7 % 71,962 12.4 % 302,279 43.8 % 258,524 44.6 % 146,355 21.2 % 118,223 20.4 % 8,318 1.2 % 7,653 1.3 % 78,369 11.4 % 70,911 12.2 % 1,339 0.2 % 812 0.1 % $ 836,065 100.0 % $ 726,251 100.0 % $ 736,773 100.0 % $ 689,645 100.0 % $ 580,003 100.0 % At December 31, 2008, 2007, 2006, 2005 and 2004, loans were carried net of discounts of $2,000, $3,000, $3,000, $4,000 and $4,000, respectively. Net deferred loan fees of $81,000, $38,000, $183,000, $482,000 and $485,000 were carried in 2008, 2007, 2006, 2005 and 2004, respectively. The following table summarizes the remaining maturity distribution of certain components of the Company’s loan portfolio on December 31, 2008. The table excludes loans secured by 1-4 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, 2008 One Year or Less One to Five Years Over Five Years Total $ 23,004 74,570 135,178 $232,752 $ 4,637 38,235 50,213 $93,085 $ 31,870 28,568 146,934 $ 207,372 $ 59,511 141,373 332,325 $ 533,209 The following table indicates the rate variability of the above loans due after one year. December 31, 2008 (dollars in thousands) Predetermined interest rates Floating or adjustable interest rates Total One to Five Years Over Five Years Total $ 26,069 67,016 $ 93,085 $ 14,759 192,613 $ 40,828 259,629 $ 207,372 $ 300,457 8 491070.Financial.QX7.qxd:CA14518_Financials 2/25/09 7:23 PM Page 9 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 regional economic strength or weakness impacts the relative risks in this loan catgory. 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 rewrite or otherwise extend the loan at prevailing interest rates. During recent years, the Bank has emphasized nonresidential-type owner-occupied properties. This complements our C&I emphasis placed on the operating business entities and will continue. The regional economic environment affects the risk of both nonresidential and residential mortgages. Residential real estate (1-4 family) includes two categories of loans. Included in residential real estate are approximately $8,498,000 of C&I type loans secured by 1-4 family real estate. Primarily, these are small businesses with modest capital or shorter operating histories where the collateral mitigates some risk. This category of loans shares similar risk characteristics with the C&I loans, notwithstanding the collateral position. The other category of residential real estate loans is 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%. 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, 2008, the Company was obligated to advance a total of $16,642,000 to complete projects under construction. The composition of nonperforming assets is as follows: December 31, (dollars in thousands) Total nonperforming loans/loans on nonaccrual Other real estate owned Total nonperforming assets Restructured loans Loans past due 90 and still accruing 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 Commercial real estate Construction and land development Commercial and industrial Total impaired loans $ 3,661 — $ 3,661 $— 89 0.44 % 0.20 % 2008 $ 194 1,175 — 1,329 $ 2,698 2008 2007 2006 2005 2004 $ 1,312 452 $ 1,764 $— 122 0.18 % 0.10 % 2007 $ — —— — 196 $ 135 — $ 135 $ — 789 0.02 % 0.01 % 2006 $ — — 16 16 $ $ $ $ $ 949 — 949 — — 0.14 % 0.05 % $ $ $ 628 — 628 — 160 0.11 % 0.03 % 2005 2004 — — 675 211 886 $ 512 — — 452 $ 964 $ 196 $ At December 31, 2008 and December 31, 2007, impaired loans had specific reserves of $600,000 and $75,000, respectively. There were no impaired loans with specific reserves from December 31, 2004 through December 31, 2006. The Company was servicing mortgage loans sold to others without recourse of approximately $768,000, $559,000, $798,000, $1,078,000 and $1,538,000 at December 31, 2008, 2007, 2006, 2005 and 2004, respectively. Additionally, the Company services mortgage loans sold to others with limited recourse. The outstanding balance of these loans with limited recourse was approximately $56,000, $65,000, $72,000, $80,000 and $86,000 at December 31, 2008, 2007, 2006, 2005 and 2004, respectively. 9 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 10 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 nonaccrual 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 Bank. Nonaccrual loans increased from 2007 to 2008 primarily as a result of eight consumer mortgages totaling $1,649,000. Nonaccrual loans increased from 2006 to 2007 primarily as a result of three consumer mortgages totaling $938,000. The relatively low level of nonperforming assets of $135,000 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 $21,807,000 and $14,117,000 at December 31, 2008 and 2007, 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, 2008, although such values may fluctuate with changes in the economy and the real estate market. 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 2008 2007 2006 2005 2004 (net of unearned discount and deferred loan fees) $ 836,065 $ 726,251 $ 736,773 $ 689,645 $ 580,003 Average loans outstanding (net of unearned discount and deferred loan fees) $ 775,337 $ 725,903 $ 723,825 $ 641,103 $ 546,147 Balance of allowance for loan losses at the beginning of year Loans charged-off: Commercial Construction 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 Additions to allowance charged to operating expense $ 9,633 $ 9,713 $ 9,340 $ 9,001 $ 8,769 2,869 15 — 489 3,373 159 5 270 434 2,939 4,425 1,828 — — 311 2,139 268 149 142 559 1,580 1,500 386 — — 322 708 96 49 111 256 452 825 366 — — 324 690 75 235 119 429 261 600 1 — 194 113 308 117 103 20 240 68 300 Balance at end of year $ 11,119 $ 9,633 $ 9,713 $ 9,340 $ 9,001 Ratio of net charge-offs during the year to average loans outstanding Ratio of allowance for loan losses to loans outstanding 0.38 % 1.33 % 0.22 % 1.33 % 0.06 % 1.32 % 0.04 % 1.35 % 0.01 % 1.55 % 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. Charge-offs increased during 2007 and 2008 due to an increase in commercial loan charge-offs as a result of the weakening of the overall economy. 10 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:34 PM Page 11 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 experience and current economic conditions. Although the allowance is allocated between categories, the entire allowance is available to absorb losses attributable to all loan categories. At December 31 of each year listed below, the allowance was comprised of the following: 2008 2007 2006 2005 2004 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 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 $ 679 7.1 % $ 592 8.6 % $ 849 6.7 % $ 1,014 8.5 % $ 806 9.0 % Commercial and industrial Commercial real estate Residential real estate Consumer and other Home equity Unallocated Total 5,148 2,632 782 344 16.9 39.8 23.3 1.1 1,534 11.8 —— 4,714 2,584 647 407 689 16.2 41.3 23.2 1.3 9.4 15.9 44.4 22.8 1.2 9.0 1,916 4,502 512 135 219 1,580 13.7 43.8 21.2 1.4 11.4 1,575 4,131 778 148 625 1,069 12.4 44.6 20.4 1.4 12.2 1,232 3,626 628 130 560 2,019 $11,119 100.0 % $ 9,633 100.0 % $ 9,713 100.0 % $ 9,340 100.0 % $ 9,001 100.0 % The shift in the allocations of the allowance for loan losses in 2007 is the result of the implementation of guidance issued by the FDIC. The current allocation is based on historical charge-off rates with additional allocations based on risk factors for each category and general economic factors. Prior to 2007, the allowance related to general economic factors was included solely in the unallocated category. Deposits The Company offers savings accounts, NOW accounts, demand deposits, time deposits and money market accounts. Additionally, the Company offers cash management accounts which provide either automatic transfer of funds above a specified level from the customer’s checking account to a money market account or short-term borrowings. Also, an account reconciliation service is offered whereby the Company provides a computerized report balancing the customer’s checking account. Interest rates on deposits are set bi-monthly by the Bank’s rate-setting committee, based on factors including loan demand, maturities and a review of competing interest rates offered. Interest rate policies are reviewed periodically by the Executive Management Committee. The following table sets forth the average balances of the Bank’s deposits for the periods indicated. 2008 2007 2006 Amount Percent Amount Percent Amount Percent (dollars in thousands) Demand Deposits $ 267,966 Savings and Interest Checking Money Market Time Certificates of Deposit 369,687 308,432 273,925 22.0 % 30.3 % 25.3 % 22.4 % $ 278,402 314,961 277,482 335,972 23.1 % 26.1 % 23.0 % 27.8 % $ 284,295 22.6 % 290,172 23.0 % 327,203 26.0 % 359,045 28.4 % Total $1,220,010 100.0 % $1,206,817 100.0 % $1,260,715 100.0 % Time Deposits of $100,000 or more as of December 31 are as follows: 2008 $ 56,982 44,491 49,302 31,919 $ 182,694 (dollars in thousands) Three months or less Three months through six months Six months through 12 months Over 12 months 11 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 12 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 borrowings from the FHLB totaled $237,000,000, a decrease of $52,250,000 from the prior year. The Bank’s remaining term borrowing capacity at the FHLB at December 31, 2008 was approximately $194,415,000. In addition, the Bank has a $14,500,000 line of credit with the FHLB. See Note 12, “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 Securities with a liquidation value of $10 per share. These securities pay dividends at an annualized rate of 8.30%. The Company redeemed through its subsidiary, Century Bancorp Capital Trust, 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 Capital Trust II. Century Bancorp Capital Trust II then issued 35,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $1,000 per share. These securities pay dividends at an annualized rate of 6.65% for the first ten years and then convert to the three-month LIBOR rate plus 1.87% for the remaining 20 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 $112,510,000, an increase of $26,520,000 from the prior year. See Note 11, “Securities Sold Under Agreements to Repurchase,” for a schedule, including their interest rates and other information. 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 increased 18.9% in 2008 to $46,750,000, compared with $39,313,000 in 2007. The increase in net interest income for 2008 was mainly due to a 13.2% or a 35 basis point increase 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 increased to 3.00% in 2008 from 2.65% in 2007, and from 2.40% in 2006. Additional information about the increased net interest margin is contained in the “Overview” section of this report. Also, there can be no assurance that certain factors beyond its control, such as the prepayment of loans and changes in market interest rates, will continue to positively impact the net interest margin. Management believes that the current yield curve environment will continue to present challenges as deposit and borrowing costs may have the potential to increase at a faster rate than corresponding asset categories. 12 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:35 PM Page 13 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 2008 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2007 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2006 Interest Income/ Expense(1) Rate Earned/ Paid(1) Average Balance Average Balance Average Balance $ 775,337 $ 50,199 6.47 % $ 725,903 $ 52,902 7.29 % $ 723,825 $ 51,466 7.11 % 411,938 61,406 18,183 3,204 193,584 99,784 8,265 2,442 4.41 5.24 4.27 2.45 372,878 330 14,466 17 248,338 131,737 9,065 6,661 3.88 5.21 3.65 5.06 497,113 354 17,182 18 275,897 10,112 37,511 1,955 3.46 5.02 3.67 5.21 14,478 371 2.56 163 7 4.29 217 9 4.15 Total interest-earning assets 1,556,527 82,664 5.31 % 1,479,349 83,118 5.62 % 1,534,917 80,742 5.26 % Noninterest-earning assets Allowance for loan losses Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Interest-bearing deposits: NOW accounts Savings accounts Money market accounts Time deposits 136,830 (9,997) $ 1,683,360 130,652 (9,719) $ 1,600,282 123,601 (9,608) $ 1,648,910 $ 203,678 166,009 308,432 273,925 $ 3,076 2,929 7,260 9,744 1.51 % 1.76 2.35 3.56 $ 202,761 112,200 277,482 335,972 $ 4,235 2,477 8,901 15,640 2.09 % 2.21 3.21 4.66 $ 205,645 84,527 327,203 359,045 $ 3,936 1,013 9,804 16,026 1.91 % 1.20 3.00 4.46 Total interest-bearing deposits 952,044 23,009 2.42 928,415 31,253 3.37 976,420 30,779 3.15 Securities sold under agreements to repurchase 94,526 1,393 1.47 89,815 3,193 3.56 70,862 2,681 3.78 Other borrowed funds and subordinated debentures 225,743 11,512 5.10 168,535 9,359 5.55 192,143 10,484 5.46 Total interest-bearing liabilities 1,272,313 35,914 2.82 % 1,186,765 43,805 3.69 % 1,239,425 43,944 3.55 % Noninterest-bearing liabilities Demand deposits Other liabilities Total liabilities Stockholders’ equity Total liabilities and 267,966 21,363 1,561,642 121,718 278,402 23,565 1,488,732 111,550 284,295 19,801 1,543,521 105,389 stockholders’ equity $ 1,683,360 $ 1,600,282 $ 1,648,910 Net interest income on a fully taxable equivalent basis Less taxable equivalent adjustment Net interest income Net interest spread Net interest margin $ 46,750 (1,971) $ 44,779 $ 39,313 (110) $ 39,203 $ 36,798 (35) $ 36,763 2.49 % 3.00 % 1.93 % 2.65 % 1.71 % 2.40 % (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. 13 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 14 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 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 2008 Compared with 2007 Increase/(Decrease) Due to Change in 2007 Compared with 2006 Increase/(Decrease) Due to Change in Volume Rate Total Volume Rate Total $ 3,450 $ (6,153) $(2,703) $ 148 $ 1,288 $ 1,436 1,606 3,187 (2,190) (1,349) 368 5,072 19 1,020 915 (2,589) (635) 159 2,968 2,492 2,111 — 1,390 (2,870) (4) (5,526) (1,178) (568) (2,556) (3,307) (7,609) (1,959) (815) (10,383) 3,717 3,187 (800) (4,219) 364 (454) (1,159) 452 (1,641) (5,896) (8,244) (1,800) 2,153 (7,891) (4,647) (1) (1,006) 4,766 (2) (742) (56) 410 (1,562) (1,056) (2,264) 682 (1,308) (2,890) 1,931 — (41) (60) — 3,118 355 1,054 659 670 2,738 (170) 183 2,751 (2,716) (1) (1,047) 4,706 (2) 2,376 299 1,464 (903) (386) 474 512 (1,125) (139) $ 2,580 $ 4,857 $ 7,437 $ 2,148 $ 367 $ 2,515 Average earning assets were $1,556,527,000 in 2008, an increase of $77,178,000 or 5.2% from the average in 2007, which was 3.6% lower than the average in 2006. Total average securities, including securities available-for-sale and securities held-to-maturity, were $666,928,000, an increase of 7.3% from the average in 2007. The increase in securities volume was mainly attributable to an increase in tax-exempt securities. Investments in tax-exempt securities increased to take advantage of increased yields in this market. An increase in securities balances resulted in higher securities income, which increased 25.9% to $29,652,000 on a fully tax equivalent basis. Total average loans increased 6.8% to $775,337,000 after increasing $2,078,000 in 2007. The primary reason for the increase in loans was due in large part to an increase in residential first and second mortgage lending as well as an increase in commercial real estate lending. The increase in loan volume partially offset by decreases in loan rates resulted in lower loan income, which decreased by 5.1% or $2,703,000 to $50,199,000. Total loan income was $51,466,000 in 2006. The Company’s sources of funds include deposits and borrowed funds. On average, deposits showed an increase of 1.1% or $13,193,000 in 2008 after decreasing by 4.3% or $53,898,000 in 2007. Deposits increased in 2008 primarily as a result of increases in savings and money market accounts, which increased by 21.8% or $84,759,000, somewhat offset by decreases in time deposits, which decreased by 18.5% or $62,047,000. During 2007, deposits decreased primarily as a result of decreases in money market accounts, which decreased by 15.2% or $49,721,000 and time deposits, which decreased by 6.4% or $23,073,000. Borrowed funds and subordinated debentures increased by 33.9% in 2008 following a decrease of 12.3% in 2007. The majority of the Company’s borrowed funds are borrowings from the FHLB and retail repurchase agreements. Borrowings from the FHLB increased by approximately $57,208,000, and retail repurchase agreements increased by $4,711,000. Interest expense totaled $35,914,000 in 2008, a decrease of $7,891,000 or 18.0% from 2007 when interest expense decreased 0.3% from 2006. The decrease in interest expense is primarily due to market decreases in deposit rates and continued deposit pricing discipline. Provision for Loan Losses The provision for loan losses was $4,425,000 in 2008, compared with $1,500,000 in 2007 and $825,000 in 2006. These provisions are the result of management’s evaluation of the amounts and quality of the loan portfolio considering such factors as loan status, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The provision increased during 2008 primarily as a result of growth in the loan portfolio, nonperforming loans and an increase in net charge-offs during the year as well as management’s quantitative analysis of the loan portfolio. The allowance for loan losses was $11,119,000 at December 31, 2008, compared with $9,633,000 at December 31, 2007. Expressed as a percentage of outstanding loans at year-end, the allowance was 1.33% in 2008 and 2007. This ratio remained stable as a result of management’s evaluation of the loan portfolio. Nonperforming loans, which include all nonaccruing loans, totaled $3,661,000 on December 31, 2008, compared with $1,312,000 on December 31, 2007. Nonperforming loans increased primarily as a result of an increase in both nonperforming consumer mortgages and commercial loans. 14 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 15 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 Other Operating Income During 2008, 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 Linsco/Private Ledger Corp. (“LPL”), an unaffiliated registered securities broker-dealer and investment advisor. Under the lockbox program, which is not tied to extensions of credit by the Company, the Company’s customers arrange for payments of their 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 that 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 LPL, a full-service securities brokerage business. Registered representatives employed by LPL offer limited investment advice, execute transactions and assist customers in financial and retirement planning. LPL provides research to and supervises its representatives. The Bank receives a share in the commission revenues. Total other operating income in 2008 was $13,975,000, an increase of $27,000 or 0.2% compared to 2007. This increase followed an increase of $2,583,000 or 22.7% in 2007, compared to 2006. Included in 2007 is the $1,321,000 pre-tax gain on the sale of the building that houses the Company’s Medford Square branch. Service charge income, which continues to be a major area of other operating income totaling $8,190,000 in 2008, increased $611,000 compared to 2007. This followed an increase of $877,000 compared to 2006. Service charges on deposit accounts increased mainly because of increases in fees. Lockbox revenues totaled $2,953,000, down $3,000 in 2008 following an increase of $184,000 in 2007. Other income totaled $2,479,000, up $792,000 in 2007 following a decrease of $55,000 in 2007. The increase in 2008 was mainly attributable to an increase of $420,000 in the growth of cash surrender values on life insurance policies which was attributable to higher returns on life insurance policies, an increase of $143,000 in foreign ATM surcharges and an increase of $138,000 in royalty payments on the merchant and credit card customer base. The decrease in 2007 was mainly attributable to an increase of $217,000 in foreign ATM surcharges and an increase of $183,000 in the growth of cash surrender values on life insurance policies that was attributable to higher returns on life insurance policies 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 Credit Card customer base during 2006. Foreign ATM surcharges increased because of an increase in rates charged and the addition of ATMs. Operating Expenses Total operating expenses were $43,028,000 in 2008, compared to $40,255,000 in 2007 and $40,196,000 in 2006. Salaries and employee benefits expenses increased by $1,072,000 or 4.4% in 2008, after increasing by 3.1% in 2007. The increase in 2008 and 2007 was mainly attributable to an increase in staff levels, merit increases in salaries and increases in health insurance costs. Pension expense for 2009 is expected to increase. Occupancy expense increased by $394,000 or 10.2% in 2008, following a decrease of $55,000 or 1.4% in 2007. The increase in 2008 was primarily attributable to an increase in rent expense associated with general rent escalations as well as retail branch expansion, depreciation and real estate taxes. The decrease in 2007 was primarily attributable to an increase in rental income. 15 Equipment expense decreased by $83,000 or 2.8% in 2008, following a decrease of $86,000 or 2.8% in 2007. The decrease in 2008 and 2007 was primarily attributable to a decrease in depreciation expense. Other operating expenses increased by $1,390,000 in 2008, which followed a $528,000 decrease in 2007. The increase in 2008 was primarily attributable to an increase in FDIC assessments, legal expense, consulting expense and contributions to charitable organizations. The decrease in 2007 was primarily attributable to a decrease in bank processing charges and legal expense. Currently, the Company pays approximately 5.3 basis points for FDIC deposit insurance. Under a proposal by the FDIC, the assessment rate schedule would be raised uniformly by 7 basis points (annualized) beginning on January 1, 2009. Beginning with the second quarter of 2009, changes would be made to the deposit insurance assessment system to make the increase in assessments fairer by requiring riskier institutions to pay a larger share. As discussed in the “Recent Market Developments” section, the Company has elected to participate in the TAGP. The annual impact to the Company of raising the deposit insurance rate by seven basis points and participating in the TAGP will be approximately $1.2 million in FDIC insurance premiums. Provision for Income Taxes Income tax expense was $2,255,000 in 2008, $3,532,000 in 2007 and $2,419,000 in 2006. The effective tax rate was 20.0% in 2008, 31.0% in 2007 and 34.0% in 2006. The decrease in the effective tax rate for 2008 and 2007 was mainly attributable to an increase in tax-exempt interest income as a percentage of taxable income. The federal tax rate was 34% in 2008, 2007 and 2006. On July 3, 2008, the Commonwealth of Massachusetts enacted a law that included reducing the tax rates on net income applicable to financial institutions. The rate drops from the current rate of 10.5% to 10% for tax years beginning on or after January 1, 2010; to 9.5% for tax years beginning on or after January 1, 2011; and to 9% for tax years beginning on or after January 1, 2012 and thereafter. The Company has analyzed the impact of this law and as a result of revaluing its net deferred tax assets, we calculated the impact to be additional tax expense of approximately $80,000. This charge was recognized during the third quarter of 2008. 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. 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 change 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 exposure to differential changes in interest rates between assets and liabilities is an interest rate risk management test. 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 16 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 –300 (2.0) % (1.8) % (1.2) % 1.5 % 3.1 % (5.9) % (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 $199,982,000 on December 31, 2008, compared with $299,901,000 on December 31, 2007. In each of these two years, deposit and borrowing activity has generally been adequate to support asset activity. Century Bancorp, Inc. AR ’08 The source of funds for dividends paid by the Company is dividends received from the Bank. The Company and the Bank are regulated enterprises and their abilities to pay dividends are subject to regulatory review and restriction. Certain regulatory and statutory restrictions exist regarding dividends, loans and advances from the Bank to the Company. Generally, the Bank has the ability to pay dividends to the Company subject to minimum regulatory capital requirements. Capital Adequacy Total stockholders’ equity was $120,503,000 at December 31, 2008, compared with $118,806,000 at December 31, 2007. The increase in 2008 was primarily the result of earnings offset by an increase in accumulated other comprehensive loss, net of taxes and dividends paid. The increase in accumulated other comprehensive loss was mainly attributable to an increase of $4,723,000 in the pension liability, net of taxes, and an increase of $81,000 in the net unrealized loss on the Company’s available-for-sale portfolio, net of taxes. 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 15.30% and 12.10%, respectively, and total capital-to-risk assets ratio of 16.38% and 13.19%, respectively, at December 31, 2008. 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, 2008, the Company and the Bank exceeded this requirement with leverage ratios of 9.05% and 7.15%, 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, 2008. Contractual Obligations and Commitments by Maturity (dollars in thousands) CONTRACTUAL OBLIGATIONS FHLB advances Subordinated debentures Retirement benefit obligations Lease obligations Other Treasury, tax and loan Customer repurchase agreements Total $237,000 36,083 21,622 5,601 1,413 112,510 Payments Due — By Period Less Than One Year $ 104,500 — 1,754 1,439 1,413 112,510 One to Three Years $ 70,000 — 3,617 2,069 — — Three to Five Years $ 20,500 — 3,940 618 — — After Five Years $ 42,000 36,083 12,311 1,475 — — Total contractual cash obligations $414,229 $ 221,616 $ 75,686 $ 25,058 $ 91,869 OTHER COMMITMENTS Lines of credit Standby and commercial letters of credit Other commitments Total commitments Amount of Commitment Expiring — By Period Total $144,653 14,225 24,425 $183,303 Less Than One Year $ 82,296 12,248 7,063 $ 101,607 One to Three Years $ 5,412 1,727 12,646 $ 19,785 Three to Five Years $ 4,564 250 903 $ 5,717 After Five Years $ 52,381 — 3,813 $ 56,194 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. 16 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:35 PM Page 17 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 The Company’s exposure to credit loss in the event of nonperformance 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 2008 2007 (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 $ 1,225 14,225 144,653 16,642 6,558 $ 2,442 13,498 155,378 27,294 8,746 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 creditworthiness 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. The fair market value of standby letters of credit was $117,000 and $109,000 for 2008 and 2007, respectively. Recent Accounting Developments Statement of Financial Accounting Standard No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities.” In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS 159, which gives entities the option to measure eligible financial assets, and financial liabilities at fair value on an instrument by instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability. Subsequent changes in fair value must be recorded in earnings. This statement is effective as of the beginning of a company’s first fiscal year after November 15, 2007. The Company adopted SFAS 159 on January 1, 2008 and did not elect to apply the fair value to any existing financial instruments. 17 Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS 160”). In December 2007, the FASB issued SFAS 141R and SFAS 160. These statements require significant changes in the accounting and reporting for business acquisitions and the reporting of noncontrolling interests in subsidiaries. Among many changes under SFAS 141R, an acquirer will record 100% of all assets and liabilities at fair value for partial acquisitions, contingent consideration will be recognized at fair value at the acquisition date with changes possibly recognized in earnings, and acquisition related costs will be expensed rather than capitalized. SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary. Key changes under the standard are that noncontrolling interests in a subsidiary will be reported as part of equity, losses allocated to a noncontrolling interest can result in a deficit balance, and changes in ownership interests that do not result in a change of control are accounted for as equity transactions and, upon a loss of control, gain or loss is recognized and the remaining interest is remeasured at fair value on the date control is lost. SFAS 141R applies prospectively to business combinations for which the acquisition is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The effective date for applying SFAS 160 is also the first annual reporting period beginning on or after December 15, 2008. Adoption of these statements will affect the Company’s accounting for any business acquisitions occurring after the effective date and the reporting of any noncontrolling interests in subsidiaries existing on or after the effective date. SFAS No. 162 (“SFAS 162”), “The Hierarchy of Generally Accepted Accounting Principles.” In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (“the GAAP hierarchy”). This Statement shall be effective 60 days following the Security and Exchange Commission’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company has not yet determined the impact of the adoption of SFAS 162 to the Company’s statement of financial position or results of operations. FASB Staff Position FAS 142-3 (“FSP FAS 142-3”), “Determination of the Useful Life of Intangible Assets.” In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007) (“SFAS 141R”), “Business Combinations,” and other U.S. generally accepted accounting principles (“GAAP”). This Statement is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those years. Early application is not permitted. The Company has not yet determined the impact of the adoption of FSP FAS 142-3 to the Company’s statement of financial position or results of operations. 491070.Financial.QX7.qxd:CA14518_Financials 2/25/09 7:41 PM Page 18 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ’08 FSP EITF 03-6-01, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128 (“SFAS 128”), “Earnings per Share.” The guidance in this FSP applies to the calculation of EPS under SFAS 128 for share-based payment awards with rights to dividends or dividend equivalents. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This Statement is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. The Company has determined that the impact of the adoption of FSP EITF 03-6-1 to the Company’s statement of financial position or results of operations is immaterial. FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” The FSP requires disclosure of additional information about investment allocation, fair values of major asset categories of assets, the development of fair value measurements, and concentrations of risk. The FSP is effective for fiscal years ending after December 15, 2009; however, earlier application is permitted. The Company will adopt the FSP upon its effective date and will report the required disclosures in our Form 10-K for the period ending December 31, 2009. 18 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 19 Consolidated Balance Sheets Century Bancorp, Inc. AR ’08 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 Short-term investments Securities available-for-sale, amortized cost $496,046 in 2008 and $388,453 in 2007 (Notes 3 and 9) Securities held-to-maturity, fair value $185,433 in 2008 and $181,704 in 2007 (Notes 4 and 11) Federal Home Loan Bank of Boston, stock at cost Loans, net (Note 5) Less: allowance for loan losses (Note 6) Net loans Bank premises and equipment (Note 7) Accrued interest receivable Other assets (Notes 8 and 14) Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Demand deposits Savings and NOW deposits Money market accounts Time deposits (Note 10) Total deposits Securities sold under agreements to repurchase (Note 11) Other borrowed funds (Note 12) Subordinated debentures (Note 12) Other liabilities Total liabilities Commitments and contingencies (Notes 7, 16 and 17) Stockholders’ equity (Note 13): Common stock, Class A, $1.00 par value per share; authorized 10,000,000 shares; issued 3,511,307 shares in 2008 and 3,516,704 shares in 2007 Common stock, Class B, $1.00 par value per share; authorized 5,000,000 shares; issued 2,027,100 shares in 2008 and 2,027,100 shares in 2007 Additional paid-in capital Retained earnings Unrealized losses on securities available-for-sale, net of taxes Pension liability, net of taxes Total accumulated other comprehensive loss, net of taxes (Notes 3 and 13) Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying “Notes to Consolidated Financial Statements.” 19 2008 2007 $ 61,195 94,973 156,168 43,814 495,585 184,047 15,531 836,065 11,119 824,946 22,054 6,723 52,698 $ 66,974 232,927 299,901 — 388,104 183,710 15,531 726,251 9,633 716,618 21,985 6,590 47,842 $ 1,801,566 $ 1,680,281 $ 277,217 353,261 308,177 326,872 $ 289,526 310,858 234,099 295,578 1,265,527 1,130,061 112,510 238,558 36,083 28,385 85,990 289,885 36,083 19,456 1,681,063 1,561,475 3,511 3,517 2,027 11,475 112,135 129,148 (292) (8,353) (8,645) 120,503 2,027 11,553 105,550 122,647 (211) (3,630) (3,841) 118,806 $ 1,801,566 $ 1,680,281 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 20 Year Ended December 31, (dollars in thousands except share data) INTEREST INCOME Loans, taxable Loans, non-taxable Securities available-for-sale, taxable Securities available-for-sale, non-taxable Federal Home Loan Bank of Boston dividends Securities held-to-maturity Federal funds sold, interest-bearing deposits in other banks and short-term investments Total interest income INTEREST EXPENSE Savings and NOW deposits Money market accounts Time deposits (Note 8) Securities sold under agreements to repurchase Other borrowed funds and subordinated debentures Total interest expense Net interest income Provision for loan losses (Note 6) Net interest income after provision for loan losses OTHER OPERATING INCOME Service charges on deposit accounts Lockbox fees Brokerage commissions Net gains on sales of securities Writedown of certain investments to fair value (Note 3) Net gains on sales of fixed assets Other income Total other operating income OPERATING EXPENSES Salaries and employee benefits (Note 15) Occupancy Equipment Other (Note 18) Total operating expenses Income before income taxes Provision for income taxes (Note 14) Net income SHARE DATA (Note 13) 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.” Consolidated Statements of Income Century Bancorp, Inc. AR ’08 2008 2007 2006 $ $ $ 47,521 1,782 17,680 2,101 531 8,265 2,813 80,693 6,005 7,260 9,744 1,393 11,512 35,914 44,779 4,425 40,354 8,190 2,953 180 249 (76) — 2,479 13,975 25,615 4,246 2,874 10,293 43,028 11,301 2,255 9,046 5,541,983 5,543,702 1.63 1.63 $ $ $ 52,589 207 13,815 12 651 9,065 6,669 83,008 6,712 8,901 15,640 3,191 9,361 43,805 39,203 1,500 37,703 7,579 2,956 135 153 —— 1,438 1,687 13,948 24,543 3,852 2,957 8,903 40,255 11,396 3,532 7,864 5,542,461 5,546,707 1.42 1.42 $ $ $ 51,332 105 16,449 12 733 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 20 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 21 Consolidated Statements of Changes in Stockholders’ Equity Century Bancorp, Inc. AR ’08 Class A Common Stock Class B Common Stock Additional Paid-in Capital Accumulated Other Total Retained Earnings Comprehensive Stockholders’ Loss Equity (dollars in thousands except share data) BALANCE, DECEMBER 31, 2005 $ 3,453 $ 2,082 $ 11,416 $ 97,338 $ (11,088) $ 103,201 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 $1,421 in taxes 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 — 4,688 — 3,159 3,159 — — — (1,674) (493) (2,158) — — — — 7,847 (2,158) — 95 (1,674) (493) BALANCE, DECEMBER 31, 2006 $ 3,499 $ 2,042 $ 11,505 $ 99,859 $ (10,087) $ 106,818 Net income Other comprehensive income, net of tax: Unrealized holding gains arising during period, net of $2,977 in taxes Pension liability adjustment, net of $934 in taxes Comprehensive income Conversion of Class B Common Stock to Class A Common Stock, 15,350 shares Stock options exercised, 2,616 shares Cash dividends, Class A Common Stock, $0.48 per share Cash dividends, Class B Common Stock, $0.24 per share — — — 15 3 — — — — — (15) — — — — — — — 48 — — 7,864 — 7,864 — — 4,900 1,346 — — (1,685) (488) — — — — 4,900 1,346 14,110 — 51 (1,685) (488) BALANCE, DECEMBER 31, 2007 $ 3,517 $ 2,027 $ 11,553 $ 105,550 $ (3,841) $ 118,806 Net income Other comprehensive income, net of tax: Unrealized holding losses arising during period, net of $32 in taxes Pension liability adjustment, net of $3,054 in taxes Comprehensive income Effects of changing pension plans’ measurement date pursuant to SFAS 158, net of $177 in taxes Stock repurchased, 5,397 shares Cash dividends, Class A Common Stock, $0.48 per share Cash dividends, Class B Common Stock, $0.24 per share — — — — (6) — — — — — — — — — 9,046 — 9,046 — — — — — (81) (4,754) — (78) — — (287) — (1,687) (487) 31 — — — (81) (4,754) 4,211 (256) (84) (1,687) (487) BALANCE, DECEMBER 31, 2008 $ 3,511 $ 2,027 $ 11,475 $ 112,135 $ (8,645) $ 120,503 See accompanying “Notes to Consolidated Financial Statements.” 21 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 22 Consolidated Statements of Cash Flows Century Bancorp, Inc. AR ’08 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: 2008 2007 2006 $ 9,046 $ 7,864 $ 4,688 Mortgage loans originated for sales Proceeds from mortgage loans sold Gain on sale of loans Gain on sale of building Gain on sale of fixed assets Gain on sales of securities Writedown of certain investments to fair value Provision for loan losses Deferred tax (benefit) expense Net depreciation and amortization (Increase) decrease in accrued interest receivable Loss on sales of other real estate owned Writedown of other real estate owned Increase in other assets Increase (decrease) in other liabilities Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of short-term investments Purchase of short-term investments 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 Loan acquired, net of discount Net (increase) decrease in loans Proceeds from sales of other real estate owned Proceeds from sale of building Proceeds from sales of fixed assets Capital expenditures Net cash (used in) provided by investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in time deposit accounts Net increase (decrease) in demand, savings, money market and NOW deposits Net payments for the repurchase of stock 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 Net cash provided by (used in) financing activities Net (decrease) increase 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 losses on securities available-for-sale, net of taxes Pension liability adjustment, net of taxes Effects of changing pension plans’ measurement date pursuant to SFAS 158, net of taxes Transfer of loans to other real estate owned See accompanying “Notes to Consolidated Financial Statements.” (512) 515 (3) — — (249) 76 4,425 (1,094) 3,229 (133) 33 77 (1,415) 737 14,732 3,717 (47,531) 282,705 238,894 (593,958) 56,123 (91,431) (4,099) (108,950) 673 — — (3,009) (266,866) 31,294 104,172 (84) — (2,174) 26,520 (51,327) 108,401 (143,733) 299,901 $ 156,168 $ 35,997 2,750 (81) (4,754) $ (256) 330 —— —— —— (1,321) (117) (153) —— 1,500 111 3,443 782 —— —— (5,809) (656) 5,644 —— —— 197,322 160 (177,870) 82,074 —— —— 8,489 —— 1,500 300 (2,252) 109,723 (114,519) (24,385) —— 51 (2,173) (970) 166,862 24,866 140,233 159,668 — — — 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 $ 299,901 $ 159,668 $ $ 44,787 3,942 4,900 1,346 —— 453 $ 42,887 2,713 3,159 (2,158) $ — 22 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 23 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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, and 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 inter- est 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 judgments about information available to them at the time of their examination. Certain reclassifications are made to prior-year amounts whenever necessary to conform with the current-year presentation. FAIR VALUE MEASUREMENTS In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS 157, “Fair Value Measurements,” which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007. FASB Staff Position 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008. 23 SFAS 157 establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The three broad levels defined by the SFAS 157 hierarchy are as follows: Level I – Quoted prices are available in active markets for identical assets or liabilities as of the reported date. The type of financial instruments included in Level I are highly liquid cash instruments with quoted prices such as G-7 government, agency securities, listed equities and money market securities, as well as listed derivative instruments. Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these financial instruments includes cash instruments for which quoted prices are available but traded less frequently, derivative instruments whose fair value has been derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed. Instruments which are generally included in this category are corporate bonds and loans, mortgage whole loans, municipal bonds and OTC derivatives. Level III – Instruments that have little to no pricing observability as of the reported date. These financial instruments do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. Instruments that are included in this category generally include certain commercial mortgage loans, certain private equity investments, distressed debt, noninvestment grade residual interests in securitizations, as well as certain highly structured OTC derivative contracts. In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” FSP No. FAS 157-3 clarifies the application of SFAS No. 157 in an inactive market, without changing its existing principles. The FSP was effective immediately upon issuance. The adoption of FSP No. FAS 157-3 did not have an effect on our financial condition, results of operations or cash flows. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash equivalents include highly liquid assets with an original maturity of three months or less. Highly liquid assets include cash and due from banks, federal funds sold and certificates of deposit. SHORT-TERM INVESTMENTS As of December 31, 2008, short-term investments include highly liquid certificates of deposit with original maturities of greater than 90 days but less than one year. 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 writedown is included as a charge to earnings. Gains and losses on the sale of investment securities are recognized on the trade date on a specific identification basis. 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 24 The Company owns Federal Home Loan Bank (“FHLB”) stock which is considered a restricted equity security. As a voluntary member of the FHLB, the Company is required to invest in stock of the FHLB in an amount equal to 4.5% of its outstanding advances from the FHLB. Stock is purchased at par value. As and when such stock is redeemed, the Company would receive from the FHLB an amount equal to the par value of the stock. At its discretion, the FHLB may declare dividends on the stock. During the fourth quarter, the Company received notice that the FHLB has placed a moratorium on all excess stock repurchases and has placed limitations on quarterly dividend payouts. 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 nonaccrual loans. When a loan is placed on nonaccrual, all income which has been accrued but remains unpaid is reversed against current period income, and all amortization of deferred loan costs and fees is discontinued. Nonaccrual 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 nonaccrual 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. Prepayments are not initially considered when amortizing premiums and discounts. The Bank accounts for impaired loans 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 such as residential real estate and consumer 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. ACQUIRED LOANS In accordance with Statement of Position (“SOP”) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” the Company reviews acquired loans for differences between contractual cash flows and cash flows expected to be collected from the Company’s initial investment in the acquired loans to determine if those differences are attributable, at least in part, to credit quality. If those differences are attributable to credit quality, the loan’s contractually required payments received in excess of the amount of its cash flows expected at acquisition, or nonaccretable discount, is not accreted into income. SOP No. 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the Company’s initial investment in the loan as interest income using the interest method over the term of the loan. This excess is referred to as accretable discount and is recorded as a reduction of the loan balance. Loans which, at acquisition, do not have evidence of deterioration of credit quality since origination are outside the scope of SOP No. 03-3. For such loans, Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 the discount, if any, representing the excess of the amount of reasonably estimable and probable discounted future cash collections over the purchase price, is accreted into interest income using the interest method over the term of the loan. Prepayments are not considered in the calculation of accretion income. Additionally, discount is not accreted on nonperforming loans. When a loan is paid off, the excess of any cash received over the net investment is recorded as interest income. In addition to the amount of purchase discount that is recognized at that time, income may also include interest owed by the borrower prior to the Company’s acquisition of the loan, interest collected if on nonperforming status, prepayment fees and other loan fees. NONPERFORMING ASSETS In addition to nonperforming loans, nonperforming assets include other real estate owned. Other real estate owned is comprised of properties acquired through foreclosure or acceptance of a deed in lieu of foreclosure. Other real estate owned is recorded initially at estimated fair value less costs to sell. When such assets are acquired, the excess of the loan balance over the estimated fair value of the asset is charged to the allowance for loan losses. An allowance for losses on other real estate owned is established by a charge to earnings when, upon periodic evaluation by management, further declines in the estimated fair value of properties have occurred. Such evaluations are based on an analysis of individual properties as well as a general assessment of current real estate market conditions. Holding costs and rental income on properties are included in current operations, while certain costs to improve such properties are capitalized. Gains and losses from the sale of other real estate owned are reflected in earnings when realized. 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. GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is not subject to amortization. Identifiable intangible assets consist of core deposit intangibles and are assets resulting from acquisitions that are being amortized over their estimated useful lives. Goodwill and identifiable intangible assets are included in other assets on the consolidated balance sheets. The Company tests goodwill for impairment on an 24 491070.Financial.QX7.qxd:CA14518_Financials 2/24/09 10:28 PM Page 25 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 annual basis, or more often if events or circumstances indicate there may be impairment. Goodwill impairment testing is performed at the segment (or “reporting unit”) level. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or organically grown, are available to support the value of the goodwill. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit’s fair value to its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is considered not to be impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to measure the amount of impairment. STOCK OPTION ACCOUNTING The Company follows the fair value recognition provisions of SFAS 123R for all share-based payments, using the modified-prospective transition method. The Company’s method of valuation for share-based awards granted utilizes 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 nonqualified 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 nonqualified 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 81,037 shares of Class A common stock exercisable at December 31, 2008. 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. 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 estimates that, as a result of this accelerated vesting, approximately $190,000 of 2006 noncash compensation expense was eliminated that would otherwise have been recognized in the Company’s earnings. The Company decided to accelerate the vesting of certain stock options primarily to reduce the noncash 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. 25 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 2008. 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. In July 2006, the 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. The Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s results of operations or its financial position. The Company classifies interest resulting from underpayment of income taxes as income tax expense in the first period the interest would begin accruing according to the provisions of the relevant tax law. The Company classifies penalties resulting from underpayment of income taxes as income tax expense in the period for which the Company claims or expects to claim an uncertain tax position or in the period in which the Company’s judgment changes regarding an uncertain tax position. 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. 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 of 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. 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 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 26 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 required the Company to measure plan assets and benefit obligations as of December 31, 2008, the date of the Company’s fiscal year-end. RECENT ACCOUNTING DEVELOPMENTS Statement of Financial Accounting Standard No. 159 ("SFAS 159"), “The Fair Value Option for Financial Assets and Financial Liabilities.” In February 2007, the FASB issued SFAS 159, which gives entities the option to measure eligible financial assets, and financial liabilities at fair value on an instrument by instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability. Subsequent changes in fair value must be recorded in earnings. This statement is effective as of the beginning of a company's first fiscal year after November 15, 2007. The Company adopted SFAS 159 on January 1, 2008 and did not elect to apply the fair value to any existing financial instruments. SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS 160”). In December 2007, the FASB issued SFAS 141R and SFAS 160. These statements require significant changes in the accounting and reporting for business acquisitions and the reporting of non- controlling interests in subsidiaries. Among many changes under SFAS 141R, an acquirer will record 100% of all assets and liabilities at fair value for partial acquisitions, contingent consideration will be recognized at fair value at the acquisition date with changes possibly recognized in earnings, and acquisition- related costs will be expensed rather than capitalized. SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary. Key changes under the standard are that noncontrolling interests in a subsidiary will be reported as part of equity, losses allocated to a noncontrolling interest can result in a deficit balance, and changes in ownership interests that do not result in a change of control are accounted for as equity transactions and, upon a loss of control, gain or loss is recognized and the remaining interest is remeasured at fair value on the date control is lost. SFAS 141R applies prospectively to business combinations for which the acquisition is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The effective date for applying SFAS 160 is also the first annual reporting period beginning on or after December 15, 2008. Adoption of these statements will affect the Company’s accounting for any business acquisitions occurring after the effective date and the reporting of any noncontrolling interests in subsidiaries existing on or after the effective date. SFAS No. 162 (“SFAS 162”), “The Hierarchy of Generally Accepted Accounting Principles.” In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (“the GAAP hierarchy”). This Statement shall be effective 60 days following the Security and Exchange Commission’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company has not yet determined the impact of the adoption of SFAS 162 to the Company’s statement of financial position or results of operations. FASB Staff Position FAS 142-3 (“FSP FAS 142-3”), “Determination of the Useful Life of Intangible Assets.” In April 2008, the FASB issued FSP FAS 142-3, Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007) (“SFAS 141R”), “Business Combinations,” and other U.S. generally accepted accounting principles (“GAAP”). This Statement is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those years. Early application is not permitted. The Company has not yet determined the impact of the adoption of FSP FAS 142-3 to the Company’s statement of financial position or results of operations. FSP EITF 03-6-01, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share- Based Payment Transactions Are Participating Securities.” This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128 (“SFAS 128”), “Earnings per Share.” The guidance in this FSP applies to the calculation of EPS under SFAS 128 for share-based payment awards with rights to dividends or dividend equivalents. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This Statement is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings and selected financial data) to conform with the provisions of this FSP. Early applica- tion is not permitted. The Company has determined that the impact of the adoption of FSP EITF 03-6-1 to the Company’s statement of financial position or results of operations is immaterial. FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” The FSP requires disclosure of additional information about investment allocation, fair values of major asset categories of assets, the development of fair value measurements, and concentrations of risk. The FSP is effective for fiscal years ending after December 15, 2009; however, earlier application is permitted. The Company will adopt the FSP upon its effective date and will report the required disclosures in our Form 10-K for the period ending December 31, 2009. 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 $1,020,000 at December 31, 2008 and $1,909,000 at December 31, 2007. 26 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 27 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 3. Securities Available-for-Sale December 31, 2008 Gross Unrealized Losses Gross Unrealized Gains Estimated Fair Value Amortized Cost* December 31, 2007 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost $ 1,999 159,100 $ 29 2,216 $ — 24 $ 2,028 161,292 $ 1,997 218,168 $ 39 982 259,264 10,972 2,427 — 61,532 3,179 38 73 1,559 1,946 1,311 404 260,132 9,026 60,259 2,848 146,630 16,693 1,678 3,287 400 2 — 305 $ — $ 421 1,392 171 — 93 2,036 218,729 145,638 16,524 1,678 3,499 $ 496,046 $ 4,783 $ 5,244 $ 495,585 $ 388,453 $ 1,728 $ 2,077 $ 388,104 (dollars in thousands) U.S. Treasury U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities Privately Issued Mortgage-Backed Securities Obligations of States and Political Subdivisions Other Total *Amortized cost is net of impairment writedown. Included in U.S. Government Sponsored Enterprise Securities and U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities are securities at fair value pledged to secure public deposits and repurchase agreements amounting to $113,259,000 and $80,260,000 at December 31, 2008 and 2007, respectively. Also included in securities available-for-sale at fair value are securities pledged for borrowing at the Federal Home Loan Bank amounting to $244,409,000 and $233,544,000 at December 31, 2008 and 2007, respectively. The Company realized gross gains of $251,000 and gross losses of $2,000 from the proceeds of $238,894,000 from the sales of available-for-sale securities for the year ended December 31, 2008. The Company realized gross gains of $153,000 in 2007 from gross proceeds of $336,000 on the sale of one stock. The Company did not realize any gains or losses in 2006. Debt securities of Government Sponsored Enterprises primarily refer to debt securities of Fannie Mae and Freddie Mac. Control of these enterprises was directly taken over by the U.S. Government in the third quarter of 2008. The following table shows the estimated maturity distribution of the Company’s securities available-for-sale at December 31, 2008. (dollars in thousands) Within one year After one but within five years After five but within ten years More than ten years Nonmaturing Total *Amortized cost is net of impairment writedown. Amortized Cost* Fair Value $ 93,598 $ 93,518 301,511 45,943 52,465 2,148 300,874 45,397 53,698 2,479 $ 496,046 $ 495,585 The weighted average remaining life of investment securities available-for-sale at December 31, 2008 and 2007 was 4.8 and 2.2 years, respectively. Excluding auction rate municipal obligations (“ARSs”) and variable rate demand notes (“VRDNs”), which have maturities up to 30 years, but reprice more frequently, the estimated average remaining life is 2.9 years for 2008. ARSs and VRDNs are included in Obligations of States and Political Subdivisions above. There were no holdings of ARSs and VRDNs during 2007. Included in the weighted average remaining life calculation at December 31, 2008 and 2007 were $126,145,000 and $113,160,000, respectively, of U.S. Government Sponsored Enterprise obligations that are callable at the discretion of the issuer. These call dates were not utilized in computing the weighted average remaining life. The contractual maturities, which were used in the table above, of mortgage-backed securities will differ from the actual 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, 2008. This table shows the unrealized 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 44 and 17 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively, out of a total of 260 holdings at December 31, 2008. As of December 31, 2008, management has concluded that the unrealized losses below its investment securities are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for the time necessary to recover its cost which for debt securities may be at maturity. In making its other-than-temporary impairment evaluation, the Company considered the fact that the principal and interest on these securities are from issuers that are investment grade. The change in the unrealized losses on the state and municipal securities and the nonagency mortgage- backed securities were caused by changes in credit spreads and liquidity issues in the marketplace. In evaluating the underlying credit quality of a security, management considers several factors such as the credit notary of the obliger and the issuer, if applicable. Internal reviews of issuer financial statements are performed as deemed necessary. In the case of privately issued mortgage-backed securities, the performance of the underlying loans is analyzed as deemed necessary. 27 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 28 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 Temporarily Impaired Investments* December 31, 2008 (dollars in thousands) U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities Privately Issued Mortgage-Backed Securities Obligations of States and Political Subdivisions Other Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 4,976 $ 24 $ — $ — $ 4,976 $ 24 80,873 1,716 13,645 482 1,351 569 1,311 266 15,793 7,310 — 1,569 208 1,377 — 125 96,666 9,026 13,645 2,051 1,559 1,946 1,311 391 Total temporarily impaired securities $ 101,692 $ 3,521 $ 24,672 $ 1,710 $ 126,364 $ 5,231 *The decline in fair value is attributable to change 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, 2008. Excluded from the table above are two stocks that were written down by $76,000. The current fair value is $96,000 with an unrealized loss of $13,000. These stocks were deemed to be impaired based on the extent of the decline in value and the length of time the stocks had been trading below cost. The following table shows the temporarily impaired securities of the Company’s available-for-sale portfolio at December 31, 2007. 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 5 and 63 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively, out of a total of 174 holdings at December 31, 2007. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2007 (dollars in thousands) U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities Privately Issued Mortgage-Backed Securities Other 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 $ — $ 7,186 3,218 198 — 24 58 28 $ 89,570 $ 421 $ 89,570 $ 421 83,553 12,560 1,985 1,368 113 65 90,739 15,778 2,183 1,392 171 93 $ 10,602 $ 110 $ 187,668 $ 1,967 $ 198,270 $ 2,077 *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, 2007. 4. Investment Securities Held-to-Maturity December 31, 2008 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost December 31, 2007 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost (dollars in thousands) U.S. Government Sponsored Enterprise $ 44,000 $ 506 $ — $ 44,506 $ 94,987 $ 59 $ 251 $ 94,795 U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities 140,047 1,314 434 140,927 88,723 72 1,886 86,909 Total $ 184,047 $ 1,820 $ 434 $ 185,433 $ 183,710 $ 131 $ 2,137 $ 181,704 Included in U.S. Government and Agency Securities are securities pledged to secure public deposits and repurchase agreements at fair value amounting to $35,000,000 and $93,000,000 at December 31, 2008 and 2007, respectively. Also included are securities pledged for borrowing at the Federal Home Loan Bank at fair value amounting to $114,103,000 and $86,987,000 at December 31, 2008 and 2007, respectively. At December 31, 2008 and 2007, all mortgage-backed securities are obligations of U.S. Government Sponsored Enterprises. Government Sponsored Enterprises primarily refer to debt securities of Fannie Mae and Freddie Mac. Control of these enterprises was directly taken over by the U.S. Government in the third quarter of 2008. 28 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 29 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 The following table shows the maturity distribution of the Company’s securities held-to-maturity at December 31, 2008. (dollars in thousands) Within one year After one but within five years After five but within ten years Total Amortized Cost Fair Value $ 27,022 136,869 20,156 $ 27,245 137,745 20,443 $ 184,047 $ 185,433 The weighted average remaining life of investment securities held-to-maturity at December 31, 2008 and 2007 was 2.4 and 1.8 years, respectively. Included in the weighted average remaining life calculation at December 31, 2008 were $19,000,000 of U.S. Government Sponsored Enterprise obligations that are callable at the discretion of the issuer. The contractual maturities, which were used in the table above, of mortgage-backed securities will differ from the actual 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, 2008. 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 9 and 12 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively, out of a total of 80 holdings at December 31, 2008. As of December 31, 2008, management has concluded that the unrealized losses below its investment securities are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for the time necessary to recover its cost which for debt securities may be at maturity. In making its other-than-temporary impairment evaluation, the Company considered the fact that the principal and interest on these securities are from issuers that are investment grade. In evaluating the underlying credit quality of a security, management considers several factors such as the credit notary of the obliger and the issuer, if applicable. Internal reviews of issuer financial statements are performed as deemed necessary. Temporarily Impaired Investments* December 31, 2008 (dollars in thousands) U.S. Government Agency and Sponsored Enterprise 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 $ 12,995 $ 12,995 $ $ 111 111 $ 19,821 $ 19,821 $ $ 323 323 $ 32,816 $ 32,816 $ $ 434 434 *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, 2008. The following table shows the temporarily impaired securities of the Company’s held-to-maturity portfolio at December 31, 2007. 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 63 securities that are temporarily impaired for 12 months or longer, out of a total of 78 holdings at December 31, 2007. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2007 (dollars in thousands) U.S. Government Sponsored Enterprise U.S. Government Agency and Sponsored Enterprise 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 $ $ — — — $ $ — — — $ 74,737 $ 251 $ 74,737 $ 251 82,667 1,886 82,667 1,886 $ 157,404 $ 2,137 $ 157,404 $ 2,137 *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, 2007. 29 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 30 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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, 2008 2007 (dollars in thousands) Construction and land development $ 59,511 $ 62,412 Commercial and industrial Commercial real estate Residential real estate Consumer Home equity Overdrafts Total 141,373 332,325 194,644 8,246 98,954 1,012 117,332 299,920 168,204 8,359 68,585 1,439 $ 836,065 $ 726,251 Net deferred fees included in loans at December 31, 2008 and December 31, 2007 were $81,000 and $38,000, respectively. The Company was servicing mortgage loans sold to others without recourse of approximately $768,000 and $559,000 at December 31, 2008 and December 31, 2007, 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 $56,000 and $65,000 at December 31, 2008 and at December 31, 2007, respectively. As of December 31, 2008 and 2007, the Bank recorded investment in impaired loans was $2,698,000 and $196,000, respectively. At December 31, 2008, there were $1,460,000 of impaired loans with a specific reserve of $600,000. At December 31, 2007, there were $75,000 of impaired loans with a specific reserve of $75,000. The composition of nonaccrual loans and impaired loans is as follows: December 31, (dollars in thousands) Loans on nonaccrual Loans 90 days past due and still accruing Impaired loans on nonaccrual included above Total recorded investment in impaired loans Average recorded value of impaired loans Interest income on nonaccrual loans according to their original terms Interest income on nonaccrual loans actually recorded Interest income recognized on impaired loans 2008 2007 2006 $ 3,661 89 1,511 2,698 1,194 121 — 24 $ 1,312 122 196 196 332 52 —— —— $ 135 789 16 16 278 3 During the first quarter of 2008, the Company purchased a loan for $4,823,000 with a discount of $724,000. The entire discount is classified as an accretable discount. The Company accreted $34,000 of the discount during 2008. Directors and officers of the Company and their associates are customers of, and have other transactions with, the Company in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features. The following table shows the aggregate amount of loans to directors and officers of the Company and their associates during 2008. Balance at December 31, 2007 (dollars in thousands) Additions Repayments and Deletions Balance at December 31, 2008 $ 2,396 $ 303 $ 127 $ 2,572 30 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 31 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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, 2008, 2007 and 2006 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 2008 2007 2006 $ 9,633 (3,373) 434 (2,939) 4,425 $ 9,713 (2,139) 559 (1,580) 1,500 $ 9,340 (708) 256 (452) 825 $ 11,119 $ 9,633 $ 9,713 2008 2007 Estimated Useful Life $ 3,478 17,846 25,357 6,558 53,239 (31,185) $ 3,478 17,710 23,889 5,114 50,191 (28,206) — 30 –39 years 3–10 years 30 –39 years or lease term Total $ 22,054 $ 21,985 During 2007, the Company sold the building which houses one of its branches located at 55 High Street, Medford, Massachusetts, for $1,500,000 at market terms. This property was sold to an entity affiliated with a director of the Company. The Bank financed $1,000,000 of this purchase at market terms. This sale resulted in a pre-tax gain of $1,321,000. The Bank relocated this branch to 1 Salem Street (formerly 3 Salem Street), Medford, Massachusetts. This property is leased from an entity affiliated with Marshall M. Sloane, Chairman of the Board of the Company. The lease is for a period of 15 years. The annual base rent amount is $28,500 with annual increases based on the consumer price index. The Company is also required to pay 25% of all real estate taxes and operating costs. The lease contains options to extend the lease for three additional five-year periods. The lease was effective on September 1, 2007. The terms of the lease were based on an independent appraisal of the property and are considered to be market terms. The branch opened on May 5, 2008. 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 $1,533,000, $1,349,000 and $1,113,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Rental income approximated $399,000, $351,000 and $69,000 in 2008, 2007 and 2006, respectively. Future minimum rental commitments for noncancelable operating leases with initial or remaining terms of one year or more at December 31, 2008 were as follows: Year Amount 2009 2010 2011 2012 2013 Thereafter $ 1,439 1,179 890 323 295 1,475 $ 5,601 (dollars in thousands) 31 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 32 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 8. Goodwill and Identifiable Intangible Assets Historically, the Company has determined fair values of reporting units based on stock prices, market earnings and tangible book value multiples of peer companies for the reporting unit. During the third quarter of 2008, management determined that the Company’s goodwill should be tested for impairment as the Company’s Class A common stock had been trading below book value per share. In the third quarter of 2008, management enhanced the valuation methodology with discounted cash flow analysis. During the fourth quarter of 2008, management reviewed the assumptions used during the third quarter and concluded that the assumptions continued to be appropriate. Based on management’s assessment of the reporting unit’s fair value, goodwill is not considered to be impaired at December 31, 2008. The changes in goodwill and identifiable intangible assets for the years ended December 31, 2008 and 2007 are shown in the table below. Carrying Amount of Goodwill and Intangibles Goodwill Core Deposit Intangibles Total (dollars in thousands) Balance at December 31, 2006 Amortization Expense Balance at December 31, 2007 Amortization Expense Balance at December 31, 2008 $ 2,714 — 2,714 — $ 2,059 (388) 1,671 (388) $ 4,773 (388) 4,385 (388) $ 2,714 $ 1,283 $ 3,997 The following table sets forth the estimated annual amortization expense of the identifiable intangible assets. Core Deposit Intangibles (dollars in thousands) Year Amount 2009 2010 2011 2012 $ 388 388 388 119 $ 1,283 32 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 33 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 9. Fair Value Measurements The Company has evaluated SFAS 157, and the results of the fair value hierarchy required by SFAS 157 as of December 31, 2008 are as follows: Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Other Unobservable Inputs (Level 3) Carrying Value (dollars in thousands) Financial Instruments Measured at Fair Value on a Recurring Basis: Securities AFS $ 495,585 $ 578 $ 491,537 $ 3,470 Financial Instruments Measured at Fair Value on a Nonrecurring Basis: Impaired Loans $ 1,460 $ — $ 1,460 $ — Impaired loan balances in the table above represent those collateral-dependent loans where management has estimated the credit loss by comparing the loan’s carrying value against the expected realizable fair value of the collateral, in accordance with SFAS 114 (as amended). Specific provisions related to impaired loans recognized for 2008 for credit losses amounted to $2,519,000. There were purchases of $13,367,000 and maturities of $9,897,000 for a net increase of $3,470,000 in the fair value of available-for-sale securities valued using significant unobservable inputs (Level 3), between January 1, 2008 and December 31, 2008. The increase was attributable to an increase in certain municipal securities without readily available fair values. The securities in this category are generally equity investments or municipal securities with no readily determinable fair value. In the judgment of management, the fair value of these securities was considered to approximate their carrying value because they were deemed to be fully collectible and the rates paid on the securities were at least equal to rates paid on securities with similar maturities. 10. Deposits The following is a summary of original maturities or repricing of time deposits as of December 31, (dollars in thousands) Within one year Over one year to two years Over two years to three years Over three years to five years Total 2008 Percent 2007 Percent $ 254,314 23,517 36,576 12,465 $ 326,872 78 % 7 % 11 % 4 % $ 255,983 27,945 5,849 5,801 87 % 9 % 2 % 2 % 100 % $ 295,578 100 % Time deposits of $100,000 or more totaled $182,694,000 and $172,592,000 in 2008 and 2007, respectively. 11. Securities Sold Under Agreements to Repurchase The following is a summary of securities sold under agreements to repurchase as of December 31, (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 2008 2007 2006 $ 112,510 $ 85,990 $ 86,960 1.08 % 2.95 % 3.71 % $ 112,510 $ 94,526 $102,110 $ 89,815 $ 139,460 $ 70,862 1.47 % 3.56 % 3.78 % Amounts outstanding at December 31, 2008, 2007 and 2006 carried maturity dates of the next business day. U.S. Government Sponsored Enterprise securities with a total amortized cost of $112,072,000, $86,760,000 and $89,114,000 were pledged as collateral and held by custodians to secure the agreements at December 31, 2008, 2007 and 2006, respectively. The approximate fair value of the collateral at those dates was $112,990,000, $86,692,000 and $87,249,000, respectively. 33 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 34 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 12. Other Borrowed Funds and Subordinated Debentures The following is a summary of other borrowed funds and subordinated debentures as of December 31, (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 2008 2007 2006 $ 274,641 $ 325,968 $ 159,106 4.22 % 4.94 % 5.54 % $ 293,668 $ 225,743 $ 325,968 $ 168,535 $ 339,858 $ 192,143 5.10 % 5.55 % 5.46 % 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 remaining term borrowing capacity at the FHLB at December 31, 2008 was approximately $194,415,000. 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, 2008 2007 2006 (dollars in thousands) Within one year Over one year to two years Over two years to three years Over three years to five years Over five years Total Amount $ 104,500 59,000 11,000 20,500 42,000 $ 237,000 Weighted Average Rate 2.80 % 5.17 % 4.05 % 4.18 % 4.55 % 3.88 % Amount $ 124,750 54,500 59,000 9,000 42,000 $ 289,250 Weighted Average Rate 4.65 % 4.67 % 5.17 % 4.14 % 4.53 % 4.73 % 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 % SUBORDINATED DEBENTURES Subordinated debentures totaled $36,083,000 at December 31, 2008 and 2007. In May 1998, the Company consummated the sale of a trust preferred securities offering, in which it issued $29,639,000 of subordinated debt securities due 2029 to its newly formed unconsolidated subsidiary Century Bancorp Capital Trust. Century Bancorp Capital Trust then issued 2,875,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $10 per share. These securities pay dividends at an annualized rate of 8.30%. The Company redeemed through its subsidiary, Century Bancorp Capital Trust, its 8.30% Trust Preferred Securities on January 10, 2005. In December 2004, the Company consummated the sale of a trust preferred securities offering, in which it issued $36,083,000 of subordinated debt securities due 2034 to its newly formed unconsolidated subsidiary Century Bancorp Capital Trust II. Century Bancorp Capital Trust II then issued 35,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $1,000 per share. These securities pay dividends at an annualized rate of 6.65% for the first ten years and then convert to the three-month LIBOR rate plus 1.87% for the remaining 20 years. OTHER BORROWED FUNDS There were no overnight federal funds purchased at December 31, 2008 and 2007. The Bank serves as a Treasury Tax and Loan depository under a note option with the Federal Reserve Bank of Boston. This open-ended interest-bearing borrowing carries an interest rate equal to the daily federal funds rate less 0.25%. This amount totaled $1,413,000 and $489,000 at December 31, 2008 and 2007, respectively. The Bank also has an outstanding loan in the amount of $145,000 and $146,000 at December 31, 2008 and 2007, respectively, borrowed against the cash value of a whole life insurance policy for a key executive of the Bank. 34 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 35 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 13. 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 per 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 2008, 2007 and 2006 was an increase of 1,719, 4,246 and 9,756 shares, respectively. STOCK OPTION PLAN During 2000 and 2004, common stockholders of the Company approved stock option plans (the “Option Plans”) that provide 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 nonqualified 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 nonqualified 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 81,037 options exercisable at December 31, 2008. Stock option activity under the plan is as follows: Shares under option: Outstanding at beginning of year Granted Forfeitured Exercised Outstanding at end of year Exercisable at end of year Available to be granted at end of year December 31, 2008 December 31, 2007 December 31, 2006 Weighted Average Exercise Price Weighted Average Exercise Price Amount Amount 94,787 $ 27.66 122,737 $ 27.20 —— (13,750) 29.07 —— 81,037 81,037 190,509 $ $ 27.42 27.42 —— (25,334) (2,616) 94,787 94,787 176,759 26.32 19.20 27.66 27.66 $ $ 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 At December 31, 2008, 2007 and 2006, the options outstanding have exercise prices between $15,063 and $35,010, and a weighted average remaining contractual life of four years for 2008, four years for 2007 and five years for 2006. The weighted average intrinsic value of options exercised for the period ended December 31, 2007 and 2006 was $4.90 and $10.76 per share with an aggregate value of $61,805 and $16,857, respectively. The average intrinsic value of options exercisable at December 31, 2008, 2007 and 2006 had an aggregate value of $7,331, $54,805 and $271,511, respectively. 35 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 36 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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 effect 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 judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2008, that the Bank and the Company meet all capital adequacy requirements to which they are subject. As of December 31, 2008, 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 below. 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, 2008 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, 2007 Total Capital (to Risk-Weighted Assets) Tier 1 Capital (to Risk-Weighted Assets) Tier 1 Capital (to 4th Qtr. Average Assets) Actual Amount $ 134,990 123,871 123,871 $ 128,405 118,772 118,772 Ratio 13.19 % 12.10 % 7.15 % 14.08 % 13.02 % 7.56 % The Company’s actual capital amounts and ratios are presented in the following table: As of December 31, 2008 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, 2007 Total Capital (to Risk-Weighted Assets) Tier 1 Capital (to Risk-Weighted Assets) Tier 1 Capital (to 4th Qtr. Average Assets) Actual Amount $ 168,121 157,002 157,002 $ 160,076 150,443 150,443 Ratio 16.38 % 15.30 % 9.05 % 17.51 % 16.46 % 9.56 % For Capital Adequacy Purposes Amount Ratio $ 81,904 40,952 69,264 $ 72,960 36,480 62,846 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % For Capital Adequacy Purposes Amount Ratio $ 82,114 41,057 69,404 $ 73,130 36,565 62,966 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio $ 102,380 10.00 % 61,428 86,580 6.00 % 5.00 % $ 91,200 10.00 % 54,720 78,557 6.00 % 5.00 % To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio $ 102,643 10.00 % 61,586 86,755 6.00 % 5.00 % $ 91,413 10.00 % 54,848 78,708 6.00 % 5.00 % 14. 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 2008 2007 2006 $ 3,117 232 3,349 $ 3,137 284 3,421 $ 2,968 164 3,132 (954) (140) (1,094) 50 61 111 (592) (121) (713) $ 2,255 $ 3,532 $ 2,419 Included in income tax expense for the year ended December 31, 2008, 2007, and 2006 is interest of $0, $0 and $24,000, respectively. There were no penalties during these periods. 36 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:36 PM Page 37 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 Income tax accounts included in other assets/liabilities at December 31 are as follows: (dollars in thousands) Currently (payable) receivable Deferred income tax asset, net Total 2008 2007 $ (9) 12,822 $ 12,813 $ $ 589 8,465 9,054 Differences between income tax expense at the statutory federal income tax rate and total income tax expense are summarized as follows: (dollars in thousands) Federal income tax expense at statutory rates State income tax, net of federal income tax benefit Insurance income Effect of tax-exempt interest Other Total Effective tax rate 2008 2007 2006 $ 3,842 62 (353) (1,307) 11 $ 3,875 225 (210) (105) (253) $ 2,417 108 (109) (4) 7 $ 2,255 $ 3,532 $ 2,419 20.0 % 31.0 % 34.0 % The following table sets forth the Company’s gross deferred income tax assets and gross deferred income tax liabilities at December 31: The Company and its subsidiaries file a consolidated federal tax return and separate state income tax return. For years before 2005, the Company is no longer subject to federal or state income tax examinations. (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 Depreciation Investments writedown Deferred gain Other Gross deferred income tax asset Deferred income tax liabilities: Depreciation Limited partnerships Other Gross deferred income tax liability Deferred income tax asset net 2008 2007 15. $ 4,495 4,151 $ 3,943 4,132 169 5,745 519 64 27 91 65 137 2,514 515 — 27 112 2 15,326 11,382 — (2,401) (103) (360) (2,415) (142) (2,504) (2,917) $ 12,822 $ 8,465 Based on the Company’s historical and current pre-tax earnings, management believes it is more likely than not that the Company will realize the deferred income tax asset existing at December 31, 2008. Management believes that existing net deductible temporary differences which give rise to the deferred tax asset will reverse during periods in which the Company generates net taxable income. In addition, gross deductible temporary differences are expected to reverse in periods during which offsetting gross taxable temporary differences are expected to reverse. Factors beyond management’s control, such as the general state of the economy and real estate values, can affect 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. 37 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 then began maintaining the Qualified 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 and performance measurement and to assist with manager searches. The target allocation mix calls for an equity-based investment deployment range from 55% to 75% of total portfolio assets. The remainder of the portfolio is allocated to fixed income. 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. Prior to 2008, the measurement date for the Plan was September 30 for each year. Beginning in 2008, the measurement date was changed to December 31 in accordance with SFAS No. 158. The benefits expected to be paid in each year from 2009 to 2013 are $720,000, $752,000, $774,000, $910,000 and $934,000, respectively. The aggregate benefits expected to be paid in the five years from 2014 to 2018 are $5,830,000. The Company plans to contribute $1,275,000 to the Plan in 2009. The weighted-average asset allocation of pension benefit assets was: Asset Category Fixed income Domestic equity International equity Total December 31, 2008 September 30, 2007 35 % 53 % 12 % 38 % 46 % 16 % 100 % 100 % The performance of the plan assets is dependent upon general market conditions and specific conditions related to the issuers of the underlying securities. 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 38 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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. 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. Prior to 2008, the measurement date for the Supplemental Plan was September 30 for each year. Beginning in 2008, the measurement date was changed to December 31 in accordance with SFAS No. 158. The benefits expected to be paid in each year from 2009 to 2013 are $1,034,000, $1,042,000, $1,049,000, $1,051,000 and $1,045,000, respectively. The aggregate benefits expected to be paid in the five years from 2014 to 2018 are $6,481,000. (dollars in thousands) Change projected 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 2008 2007 2008 2007 $ 19,139 1,026 1,436 459 (647) $ 18,795 867 1,081 (1,116) (488) $ 13,462 336 1,008 2,255 (1,293) $ 13,740 107 758 (111) (1,032) Projected benefit obligation at end of year $ 21,413 $ 19,139 $ 15,768 $ 13,462 Change in plan assets Fair value of plan assets at beginning of year Actual (loss) return on plan assets Employer contributions Benefits paid Fair value of plan assets at end of year (Unfunded) Funded status Accumulated benefit obligation Weighted-average assumptions as of December 31 Discount rate — Liability Discount rate — Expense Expected return on plan assets Rate of compensation increase Components of net periodic benefit cost Service cost Interest cost Expected return on plan assets Recognized prior service cost Recognized net losses Net periodic cost Other changes in plan assets and benefit obligations recognized in other comprehensive income Amortization of prior service cost Net (gain) loss Total recognized in other comprehensive income Total recognized in net periodic benefit cost and other comprehensive income $ $ $ $ $ 13,873 1,735 1,540 (488) 16,660 (2,479) 17,375 6.00 % 5.75 % 8.00 % 4.00 % 867 1,081 (1,110) (116) 398 $ $ (15,768) 14,165 $ $ (13,462) 12,584 5.75 % 6.00 % NA 4.00 % 308 814 — 108 49 $ 6.00 % 5.75 % NA 4.00 % 107 758 — 64 81 $ $ 1,120 $ 1,279 $ 1,010 $ $ $ $ $ $ $ 16,660 (3,731) 1,777 (647) 14,059 (7,534) 19,468 5.75 % 6.00 % 8.00 % 4.00 % 821 1,148 (1,333) (116) 211 731 116 5,623 5,739 $ 116 (2,140) (2,024) $ (108) 2,177 2,069 $ 6,470 $ (904) $ 3,348 $ $ (64) (192) (256) 754 38 491070.RevFinancial.QX7.qxd:CA14518_Financials 2/24/09 10:36 PM Page 39 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 The following table summarizes amounts recognized in Accumulated Other Comprehensive Loss as of: Prior service cost Net actuarial loss Total December 31, 2008 Supplemental Plan Total $ (1,513) (3,666) $ (468) (13,483) Plan 1,045 (9,817) (8,772) $ (5,179) $ (13,951) $ $ December 31, 2007 Supplemental Plan $ (964) (2,146) Plan 1,190 (4,225) (3,035) $ (3,110) Total 226 (6,371) (6,145) $ $ $ $ The following table summarizes the amounts included in Accumulated Other Comprehensive Loss at December 31, 2008 expected to be recognized as components of net periodic benefit cost in the next year: Amortization of prior service cost to be recognized in 2009 Amortization of loss to be recognized in 2009 Plan $ (116) 684 Supplemental Plan $ 110 139 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 performs 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 performs 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 $265,000 for 2008, $229,000 for 2007 and $210,000 for 2006. Administrative costs associated with the plan are absorbed by the Company. The Company has a cash incentive plan that is designed to reward our executives and officers for the achievement of annual financial performance goals of the Company as well as business line, department and individual performance. The plan supports the philosophy that management be measured for their performance as a team in the attainment of these goals. There were no payments under this plan for 2006, 2007 and 2008. Discretionary bonus expense amounted to $348,000, $154,000, and $0, in 2008, 2007, and 2006, respectively. The Company does not offer any postretirement programs other than pensions. 39 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 40 16. Commitments and Contingencies A number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 2008. 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 operations. 17. 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 nonperformance 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 2008 2007 $ 1,225 14,225 144,653 $ 2,442 13,498 155,378 16,642 27,294 6,558 8,746 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 creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 18. Other Operating Expenses Year ended December 31, 2008 2007 2006 (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 $ 1,482 921 994 922 807 698 832 626 388 322 229 613 12 1,447 $ 1,540 876 776 867 721 759 639 546 388 380 232 148 12 1,019 $ 1,515 1,326 894 849 717 684 642 524 388 368 219 154 12 1,139 $ 10,293 $ 8,903 $ 9,431 19. 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 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. SHORT-TERM INVESTMENTS The fair value of short-term investments is estimated using the discounted value of contractual cash flows. The discount rate used is estimated based on the rates currently offered for short-term investments of similar remaining maturities. SECURITIES HELD-TO-MATURITY AND SECURITIES AVAILABLE-FOR-SALE The fair value of these securities is estimated based on prices published in financial newspapers or received from pricing services, or bid quotations received from securities dealers. LOANS For variable-rate loans, which 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. 40 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 41 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 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 offered 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: 2008 2007 Carrying Amounts Fair Value Carrying Amounts Fair Value (dollars in thousands) Financial assets: Cash and cash equivalents Short-term investments 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 $ 299,901 $ 299,901 $ 156,168 43,814 495,585 184,047 824,946 6,723 1,265,527 351,068 36,083 1,488 $ 156,168 43,978 495,585 185,433 837,064 6,723 1,271,404 357,927 41,908 1,488 —— 388,104 183,710 716,618 6,590 1,130,061 375,875 36,083 1,678 — 117 — 388,104 181,704 711,611 6,590 1,131,503 379,229 36,694 1,678 109 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 judgments 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 judgment 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. 41 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 42 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 20. Quarterly Results of Operations (unaudited) 2008 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 2007 Quarters (in thousands, except share data) Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other operating income Operating expenses Income before income taxes Provision for income taxes Net income Share data: Average shares outstanding, basic Average shares outstanding, diluted Earnings per share, basic Earnings per share, diluted Fourth Third Second First $ 20,570 8,638 11,932 1,450 10,482 3,499 10,850 3,131 320 $ 2,811 $ $ $ 5,539,043 5,539,092 0.51 0.51 Fourth 20,481 10,378 10,103 600 9,503 3,591 9,765 3,329 955 $ 2,374 5,543,804 5,547,234 $ $ 0.43 0.43 $ $ $ $ $ $ $ $ 20,891 8,932 11,959 1,350 10,609 3,577 11,051 3,135 576 2,559 5,541,345 5,542,404 0.46 0.46 Third 20,944 10,835 10,109 300 9,809 4,416 9,940 4,285 1,421 2,864 5,542,483 5,545,915 0.52 0.52 $ $ $ $ $ $ $ $ 19,470 8,814 10,656 925 9,731 3,477 10,743 2,465 589 1,876 5,543,781 5,546,128 0.34 0.34 $ 19,762 9,530 10,232 700 9,532 3,422 10,384 2,570 770 $ 1,800 5,543,804 5,546,700 $ $ 0.32 0.32 Second First 20,837 11,048 9,789 300 9,489 3,092 10,247 2,334 711 1,623 5,542,304 5,548,105 0.29 0.29 $ 20,746 11,544 9,202 300 8,902 2,849 10,302 1,449 445 $ 1,004 5,541,225 5,550,653 $ $ 0.18 0.18 42 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 43 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ’08 21. Parent Company Financial Statements The balance sheets of Century Bancorp, Inc. (“Parent Company”) as of December 31, 2008 and 2007 and the statements of income and cash flows for each of the years in the three-year period ended December 31, 2008 are presented below. The statements of changes in stockholders’ equity are identical to the consolidated statements of changes in stockholders’ equity and are therefore not presented here. BALANCE SHEETS December 31, (dollars in thousands) ASSETS: Cash Investment in subsidiary, at equity Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY: Liabilities Subordinated debentures Stockholders’ equity Total liabilities and stockholders’ equity STATEMENTS OF INCOME 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 2008 2007 $ 31,588 122,324 2,786 $ 156,698 $ 112 36,083 120,503 $ 156,698 $ 30,399 122,085 2,512 $ 154,996 $ 107 36,083 118,806 $ 154,996 2008 2007 2006 $ 4,778 884 72 5,734 2,400 165 3,169 (547) 3,716 5,330 $ 3,611 1,442 72 5,125 2,400 130 2,595 (345) 2,940 4,924 $ 2,891 1,381 72 4,344 2,400 158 1,786 (375) 2,161 2,527 Net income $ 9,046 $ 7,864 $ 4,688 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: 2008 2007 2006 $ 9,046 $ 7,864 $ 4,688 Undistributed income of subsidiary Depreciation and amortization Increase in other assets Increase (decrease) in liabilities Net cash provided by operating activities CASH FLOWS FROM FINANCING ACTIVITIES: Stock repurchases Net proceeds from the exercise of stock options Cash dividends paid Net cash used in financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year 43 (5,330) 12 (286) 5 3,447 (84) — (2,174) (2,258) 1,189 30,399 (4,924) 12 (495) (39) 2,418 —— 51 (2,173) (2,122) 296 30,103 (2,527) 12 (490) 34 1,717 95 (2,167) (2,072) (355) 30,458 $ 31,588 $ 30,399 $ 30,103 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 44 Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ’08 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 its subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. 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 its subsidiary as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, 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), Century Bancorp, Inc.’s internal control over financial reporting as of December 31, 2008, 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 24, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Boston, Massachusetts February 24, 2009 44 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 45 Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ’08 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 Century Bancorp, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Century Bancorp, Inc.’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, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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, Century Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, 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. as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated February 24, 2009 expressed an unqualified opinion on those consolidated financial statements. Boston, Massachusetts February 24, 2009 45 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 46 Management’s Report on Internal Control Over Financial Reporting Century Bancorp, Inc. AR ’08 CENTURY BANCORP, INC. 400 Mystic Avenue Medford, Massachusetts 02155 We, together with the other members of Century Bancorp, Inc. and our 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, 2008. 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, 2008, 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 the effectiveness of the Company’s internal control over financial reporting. Their report appears on page 45. Marshall M. Sloane Chairman of the Board Jonathan G. Sloane Co-President & Co-CEO Barry R. Sloane Co-President & Co-CEO William P. Hornby, CPA Chief Financial Officer & Treasurer February 24, 2009 46 491070.Financial.QX7.qxd:CA14518_Financials 2/20/09 6:54 PM Page 47 Notes Century Bancorp, Inc. AR ’08 47 Cove:Layout 1 2/27/09 4:28 PM Page 3 Stockholder Information CORPORATE HEADQUA RTERS Century Bank 400 Mystic Avenue Medford, MA 02155-6316 TEL (866) 8.CENTURY or (866) 823.6887 AskCentury.com TRANSFER AG ENT AND REGISTRAR Computershare Trust Company, N.A. P.O. Box 43078 Providence, RI 02940-3078 TEL (781) 575.3400 Computershare.com ANNUAL MEETING The annual meeting of stockholders will be held on Tuesday, April 14, 2009, at 10:00 a.m. The meeting will take place at Century Bank, 400 Mystic Avenue, Medford, MA. STOCK LISTING Century Bancorp, Inc. became a public company in 1987. Century’s Class A Common Stock is listed on the NASDAQ national market and is traded under the symbol “CNBKA.” 10-K REPORT 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 or online at http://www.century-bank.com/about/investorrelations.cfm. Century Bank Locations OFFICES Allston Beverly Boston Boston Boston Boston Braintree Brookline Burlington Cambridge Everett Lynn Malden Medford Medford Medford Newton Peabody Quincy Salem Somerville Winchester 300 Western Avenue, Allston, MA 02134 428 Rantoul Street, Beverly, MA 01915 512 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 1 Salem Street, Medford, MA 02155 400 Mystic Avenue, Medford, MA 02155 503 Riverside Avenue, Fellsway Plaza, Medford, MA 02155 31 Boylston Street/Rt 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 522 Main Street, Winchester, MA 01890 FREE-STANDING CASH DISPENSERS Boston Cambridge Cambridge Medford Milton Weston The Hotel Commonwealth, 500 Commonwealth Avenue, Boston, MA 02215 CambridgeSide Galleria, 100 CambridgeSide Place, Cambridge, MA 02141 One Kendall Square, Building #100, Cambridge, MA 02139 Sloane Square, 110 Medford Street, Medford, MA 02155 Milton Hospital, 199 Reedsdale Road, Milton, MA 02186 College Hall, Regis College, 235 Wellesley Street, Weston, MA 02493 (617) 562.1700 (978) 921.2300 (617) 424.1644 (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) 391.9830 (781) 393.4160 (781) 393.6520 (617) 582.0920 (978) 977.4900 (617) 376.8100 (978) 740.6900 (617) 629.0929 (781) 756.3480 Cove:Layout 1 2/27/09 4:28 PM Page 4 400 Mystic Avenue Medford, MA 02155 (866) 8.CENTURY or (866) 823.6887 AskCentury.com Equal Housing Lender / Member FDIC c 2009 Century Bancorp, Inc. All rights reserved. 002-CS17893 

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