SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For Quarter Ended June 30, 1996
Commission File Number 0-16329
First State Financial Services, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
22-2823506
(I.R.S. Employer Identification Number)
1120 Bloomfield Avenue, CN 2449, West Caldwell, New Jersey 07007-2449
(Address of principal executive offices)
(201) 575-5800
(Registrant's telephone number, including area code)
N/A
Former name, former address, and former fiscal year, if changed
since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's class of
common stock at
June 30, 1996:
3,938,815 shares of common stock, par value $.01.
FIRST STATE FINANCIAL SERVICES, INC.
INDEX
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets,
June 30, 1996 and
September 30, 1995 3
Consolidated Statements of Income,
three and nine months ended June 30,
1996 and 1995 4
Consolidated Statements of Cash Flows,
nine months ended June 30, 1996
and 1995 5
Notes to Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 7
PART II. OTHER INFORMATION 19
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Balance Sheets
(unaudited)
June 30 September 30,
1996 1995
---------- ----------
(in thousands)
ASSETS
Cash on hand and in banks $ 13,874 $ 11,792
Investment securities available for sale 17,604 11,799
Investment securities, at cost 22,309 20,889
Federal Home Loan Bank stock, at cost 3,715 3,715
Loans receivable, net 525,997 461,648
Mortgage loans held for resale 10,854 67,219
Mortgage-backed securities, at cost 31,616 18,961
Accrued interest receivable 4,311 4,046
Office properties and equipment, net 10,442 10,523
Real estate owned 5,192 8,564
Cost in excess of fair value of
net assets acquired 2,199 2,349
Other assets 17,824 15,515
---------- ----------
$ 665,937 $ 637,020
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 589,509 $ 567,710
Borrowed money 32,629 23,105
Advance payments by borrowers for
taxes and insurance 2,475 3,253
Accrued expenses and other liabilities 1,369 1,360
---------- ----------
Total liabilities 625,982 595,428
---------- ----------
Stockholders' Equity:
Preferred stock, $.01 par value,
2 million shares authorized;none issued - -
Common stock, $.01 par value,
8 million shares authorized;
3,938,815 issued;
3,929,455 outstanding at 6/30/96; 39
3,883,765 issued;
3,874,405 outstanding at 9/30/95; 39
Paid-in capital 21,242 20,949
Net unrealized loss on investment
securities available for sale (379) (89)
Retained income 19,053 20,693
---------- ----------
Total stockholders' equity 39,955 41,592
---------- ----------
$ 665,937 $ 637,020
========== ==========
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Income
(in thousands, except per share data)
Three months ended Nine months ended
June 30, June 30,
(unaudited) (unaudited)
1996 1995 1996 1995
--------- -------- --------- ---------
Interest income:
Interest on mortgage loans $ 7,975 $ 8,504 $ 23,870 $ 24,034
Interest on consumer and
commercial loans 3,925 2,090 9,447 5,890
Interest on mortgage-
backed securities 536 297 1,413 927
Interest on investments
available for sale 250 134 681 358
Interest on investment
securities 364 425 1,083 1,298
--------- -------- --------- ---------
Total interest income 13,050 11,450 36,494 32,507
--------- -------- --------- ---------
Interest expense:
Interest on deposits 5,734 5,472 17,036 14,769
Interest on borrowed money 388 254 744 776
--------- -------- --------- ---------
Total interest expense 6,122 5,726 17,780 15,545
--------- -------- --------- ---------
Net interest income 6,928 5,724 18,714 16,962
Provision for loan losses 4,400 600 5,600 1,100
--------- -------- --------- ---------
Net interest income after
provision for loan losses 2,528 5,124 13,114 15,862
--------- -------- --------- ---------
Other income:
Loan fees and other loan
charges 4,007 1,019 8,973 2,543
Service charges on
deposit accounts 498 459 1,385 1,321
Net gain on sales of loans 13 36 1,067 42
Net gain (loss) on sales
of investments 4 11 140 (144)
Other 583 297 901 781
--------- -------- --------- ---------
Total other income 5,105 1,822 12,466 4,543
--------- -------- --------- ---------
Operating expenses:
Compensation and employee
benefits 2,118 1,866 6,134 5,492
Premises and occupancy
costs, net 569 471 1,744 1,506
Amortization of intangible
assets 50 110 150 378
Loan processing expenses 5,503 1,233 11,708 3,061
Data processing 304 271 916 824
Advertising and promotion 205 201 610 603
Federal insurance premiums 311 322 939 929
Problem asset expenses, inclusive of
real estate owned write-downs 1,451 354 2,164 981
Other expenses 625 786 2,016 2,335
--------- -------- --------- ---------
Total operating expenses 11,136 5,614 26,381 16,109
--------- -------- --------- ---------
Income (loss) before income
tax expense (benefit) (3,503) 1,332 (801) 4,296
Income tax expense (benefit) (694) 374 195 1,389
--------- -------- --------- ---------
Net income (loss) $ (2,809) $ 958 $ (996) $ 2,907
========= ======== ========= =========
Primary earnings (loss) per
share of common stock $ (.69) $ .24 $ (.25) $ .75
========= ======== ========= =========
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Cash Flows
(in thousands)
Nine months ended
June 30,
(unaudited)
1996 1995
---------- ----------
OPERATING ACTIVITIES
Net income (loss) $ (996) $ 2,907
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of intangible assets 150 378
Depreciation 919 723
Net accretion of loan fees and discounts (181) (182)
Net amortization and (accretion) of
investment premium and discount 23 (50)
Net amortization of MBS premium and
discount 50 58
Increase in interest receivable (265) (1,661)
Proceeds from loan sales 76,636 3,638
Origination of loans held for resale (19,204) (2,693)
Recovery on sale of real estate owned (261) -
Net gain on sale of loans (1,067) (42)
Net (gain) loss on sales of investments (140) 144
Provisions for losses on loans 5,600 1,100
Provision for write-downs of real
estate owned 1,700 300
Increase in other assets (2,309) (477)
Increase in other liabilities 9 1,812
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 60,664 5,955
---------- ----------
INVESTING ACTIVITIES
Net increase in loans, receivable (71,078) (63,216)
Purchase of mortgage-backed securities (15,337) (2,325)
Principal payments on mortgage-backed
securities 2,659 3,382
Proceeds from dispositions of real
estate owned 3,243 2,457
Office properties and equipment
expenditures (838) (681)
Purchase of investment securities (11,711) (7,655)
Purchase of investment securities
available for sale (30,017) (4,677)
Proceeds from sale of investment securities
available for sale 31,419 10,021
Purchase of Federal Home Loan Bank stock - (710)
Proceeds from maturities of investment
securities 2,884 6,340
---------- ----------
NET CASH USED BY INVESTING ACTIVITIES (88,776) (57,064)
---------- ----------
FINANCING ACTIVITIES
Net increase in deposits 21,799 55,097
Dividends paid on common stock (644) (545)
Additional borrowings 9,524 -
Principal repayments of borrowings - (4,008)
Net (decrease) increase in advance payment
by borrowers for taxes and insurance (778) 622
Common stock issued 293 189
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 30,194 51,355
---------- ----------
Increase in cash and cash equivalents 2,082 246
CASH AND CASH EQUIVALENTS AT BEGINNING 11,792 14,137
OF PERIOD ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,874 $ 14,383
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest $ 17,836 $ 15,521
Income taxes $ 50 $ 2,213
NON-CASH TRANSFERS:
Loans classified as Real Estate Owned $ 1,310 $ 1,740
Transfer of Investment securities to
Investment securities available for sale $ 7,357 $ 2,300
Reclassification of Mortgage loans held
for resale to Loans receivable, net $ - $ 758
FIRST STATE FINANCIAL SERVICES, INC.
Notes to Consolidated Financial Statements
1. Presentation of Statements
In the opinion of management the accompanying unaudited
consolidated financial statements contain all
adjustments (all which were normal recurring accruals)
necessary for a fair presentation. The results of
operations for the interim period are not necessarily
indicative of the results which may be expected for the
entire year.
First State Financial Services, Inc. is the holding
company for First DeWitt Bank, its principal wholly-
owned subsidiary. Audited consolidated financial
statements for the year ended September 30, 1995 were
filed with the Securities and Exchange Commission.
2. Earnings Per Share
Earnings per share was calculated for each period by
dividing the net income for the period by the average
number of primary shares outstanding over the period.
The actual average primary shares outstanding were
4,046,706 and 4,030,960 for the three and nine months
ended June 30, 1996, respectively; and 3,995,225 and
3,894,013 for the three and nine months ended June 30,
1995, respectively.
FIRST STATE FINANCIAL SERVICES, INC.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Condition
On June 26, 1996, First State Financial Services, Inc. (First
State), entered into an Agreement and Plan of Merger with
Sovereign Bancorp, Inc. (Sovereign) providing for the merger of
First State into Sovereign. Sovereign is to exchange $14.75 in
Sovereign common stock for each outstanding share of First State
common stock. The price is fixed to First State shareholders,
subject to adjustment if the average price of Sovereign common
stock, as defined in the Agreement, falls outside a specified
range. First State has the ability to terminate the transaction
if the average price of Sovereign common stock is less than $8.00
per share, unless Sovereign elects to increase the exchange
ratio. Sovereign may terminate the transaction at any time if
certain specified asset quality measures are triggered at First
State, or if the reported losses on asset sales exceed certain
levels. In this regard, First State had previously announced a
strategic restructuring, pursuant to which, among other things,
it intended to liquidate substantially all of its problem assets
and in connection therewith indicated that it intended to make
significant additional provisions for loan losses in the third
quarter of fiscal 1996. The Agreement may be terminated by
Sovereign if First State records additional provisions for loan
losses in excess of $5.75 million prior to the consummation of
the merger. The merger is subject to approval by various
regulatory agencies and the shareholders of First State. It is
anticipated that the transaction will close early in the 1st
quarter (calendar) of 1997.
Total assets of First State Financial Services, Inc. were $665.9
million at June 30, 1996. This is a net increase of $28.9
million, or 4.54%, in total assets from September 30, 1995. The
increase in total assets was mainly due to increases in loans
receivable of $64.3 million, in mortgage-backed securities of
$12.7 million, in investment securities and investment securities
available for sale of $7.2 million, in cash on hand and in banks
of $2.1 million, and an increase in other assets of $2.3 million.
Regarding the increase in loans receivable, First DeWitt Bank
("the Bank") continues to market a number of competitive loan
products. The Bank originated $169.9 million in loans since
September 30, 1995. The increases in the mortgage-backed
securities portfolio, investment securities portfolio, and
investment securities available for sale were mainly because of
outright purchases of such securities. The increase in cash on
hand and in banks was mainly due to the increase in volume of
check clearances. Nationar, a former correspondent institution
clearing checks for the Bank, was taken over by the Acting
Superintendent of Banks of the State of New York on February 6,
1995 for purposes of an orderly liquidation of their affairs.
Nationar was in process of clearing $7.7 million of the Bank's
checks at time of takeover. First DeWitt had received $4.7
million from Nationar for check clearances in 1995 and received
the remaining $3.0 million balance in June of 1996. The increase
in other assets was mainly due to an increase in the cash
surrender value of insurance policy investments held in
connection with executive supplemental retirement plans, deferred
servicing premiums acquired with the sale of mortgage loans, and
other receivables including income tax receivables. The
significant decreases in assets were in loans held for resale of
$56.4 and in real estate owned of $3.4 million. In the December
quarter, the Bank sold $67.7 million of mortgage loans from its
mortgage loans held for resale accounts. The cash generated from
the sale was used to repay brokered certificates of deposit, to
fund loans, and to fund the purchase of investment securities.
The decrease in real estate owned is elaborated on below.
Total liabilities were $626.0 million at June 30, 1996. This is
an increase of $30.6 million, or 5.13%, in total liabilities from
September 30, 1995. The increase was mainly due to an increase
in deposits of $21.8 million and an increase in borrowings of
$9.5 million. The increase in deposits was mainly due to the
continued aggressive marketing of the Banks deposit products and
also to the opening of two new branch offices. A branch office
was opened in a mall in a retirement community near Toms River,
New Jersey in October of 1995 and an office was opened in Wall
Township, New Jersey in April of 1996. The deposits in both
offices were in excess of $16.0 million at June 30, 1996. The
increase in borrowings was primarily used to fund the increase in
loans.
Nonperforming assets, including current restructured loans, were
$28.3 million at June 30, 1996 compared to $31.2 million at March
31, 1996, and $30.5 million at September 30, 1995. The table
below details the composition of these assets.
6/30/96 3/31/96 9/30/95
--------- --------- ---------
(in thousands)
Nonaccrual loans $ 21,504 $ 23,134 $ 18,503
Real estate owned 5,192 6,513 8,564
Current restructured loans 1,569 1,575 3,476
--------- --------- ---------
Total nonperforming assets $ 28,265 $ 31,222 $ 30,543
========= ========= =========
The decrease at June 30, 1996 was mainly attributable to charge-
offs and also due to disposals. When a loan becomes 90 days or
more past due or the collection of interest becomes uncertain,
the accrual of income is discontinued. These loans are classified
as nonaccrual and interest income is only recognized subsequently
in the period collected. Loans are returned to an accrual status
when all past due amounts have been collected and factors
indicating doubtful collectibility on a timely basis no longer
exist. If nonaccrual loans had been current in accordance with
their original terms, the Bank would have realized additional
interest income of approximately $394,000 for the quarter ended
June 30, 1996 and $1.2 million for the period from September 30,
1995 to June 30, 1996.
The allowance for loan losses totaled $9.1 million at June 30,
1996. An analysis of the allowance for loan losses follows:
Balance at September 30, 1995 $ 6,081,000
Charge-offs:
Consumer loans 617,000
Mortgage loans 1,809,000
Commercial loans 252,000
Recoveries:
Mortgage loans 83,000
Consumer loans 18,000
------------
Net charge-offs 2,577,000
Additions charged to operations 5,600,000
------------
Balance at June 30, 1996 $ 9,104,000
============
Management closely monitors the loan portfolio and is
concentrating on workouts with the Bank's troubled loans and real
estate owned properties. The Bank's loan review committee
analyzes the loan portfolio on a quarterly basis for
classification of problem and potentially problem loans. The
loan review committee also reviews the allocation of loss
reserves to loans. Management believes that the present
allowance for loan losses is adequate in light of management's
assessment of the risk inherent in the portfolio. However, while
management uses its best judgment in providing for possible loan
losses, management recognizes that additional problems could
develop and that future adjustments may be necessary. The Board
of Directors of First State previously announced a strategic
restructuring, pursuant to which, among other things, it intended
to liquidate substantially all of its problem assets and, in
connection therewith, indicated that it intended to make
significant additional provisions for loan losses this quarter.
The provision for loan losses of $4.4 million recognized this
quarter is reflective of this strategic restructuring.
Subsequently, First State entered into a merger agreement with
Sovereign Bancorp, Inc. One of the conditions in the merger
agreement is that the merger agreement may be terminated by
Sovereign if First State records additional provisions for loan
losses in excess of $5.75 million during the period between the
signing of the merger agreement and the consummation of the
merger. It is anticipated that the transaction will close early
in the 1st quarter of 1997.
In May 1993 the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No.
114, "Accounting by Creditors for the Impairment of a Loan."
SFAS No. 114 was amended by SFAS No. 118 in October 1994. SFAS
No. 114, as amended, prescribes the recognition criteria for loan
impairment and the measurement methods for certain impaired loans
whose terms are modified in troubled debt restructurings. The
Bank adopted SFAS No. 114, as amended, effective October 1, 1995,
and the adoption has not had a material impact on the
consolidated financial statements. As a result of the adoption of
SFAS 114, as amended, the Bank had a recorded investment of
$14.0 million in loans defined as impaired at June 30, 1996. The
total allowance associated with these loans totaled $5.1 million
at June 30, 1996. The loans classified as impaired in accordance
with SFAS 114 were classified as such due to management's belief
that it was probable that all amounts due according to the
contractual terms of the loans would not be collected in full.
In conjunction with the adoption, the Bank chose to not to
recognize interest income on impaired loans and instead recognize
the net entire change in net present value of impaired loans as
bad-debt expense.
Real estate owned totaled $5.2 million at June 30, 1996 compared
to $6.5 million at March 31, 1996, and $8.6 million at September
30, 1995. The decrease was due to the sale of foreclosed
properties as well as writedowns. The Bank has contracted the
services of an experienced problem asset disposition expert to
assist in the disposition of the Bank's problem assets. Real
estate owned is carried on the Bank's books at fair value less
estimated costs to sell the property. Management recognizes that
future adjustments may be necessary if the real estate values
decline.
First State had previously announced a strategic restructuring,
pursuant to which, among other things, it intended to liquidate
substantially all of its problem assets. Additional write-downs,
depending upon the availability of interested purchasers and the
speed with which a sale can be consummated, will be made as
considered necessary to dispose of the problem assets.
Liquidity and Capital Resources
First State's principal sources of funds are funds provided from
operations and dividends received from subsidiaries. The Bank's
principal sources of funds are deposits; scheduled loan
amortization payments; sales and prepayments of loan principal;
sales and repayments of mortgage-backed securities, sales and
maturities of investment securities and short-term investments;
borrowings and funds provided from operations.
The financing activities section of the Consolidated Statement of
Cash Flows reflects a net increase in deposits of $21.8 million
during the nine month period ended June 30, 1996. The increase
consisted of $4.8 million in net deposits along with $17.0
million in interest credited to deposit accounts. The opening of
two new branch offices contributed to the increase in deposits.
See the "Financial Condition" section of this report for
additional information. Deposits increased $55.1 million during
the same 1995 period. The increase consisted of $40.3 million in
net deposits along with $14.8 million in interest credited to
deposit accounts. The Bank had a special promotion program to
attract certificates of deposit in the 1995 period. Borrowings
were increased by $9.5 million in the 1996 period compared to the
net repayment of $4.0 million in borrowings in the 1995 period.
The increased borrowings were mainly used to fund loans.
Cash provided by operating activities amounted to $60.7 million
in the nine month period ended June 30, 1996 compared to $6.0
million in the 1995 period. The 1996 activity was mainly
attributable to the sale of mortgage loans from the Bank's
mortgage loans held for resale accounts. The proceeds from the
sales were primarily used to fund loans and to fund the purchase
of securities. Loans originated for resale totaled $19.2 million
in the 1996 period compared to $2.7 million in the 1995 period.
In the investing activities section of the Statement of Cash
Flows, a net increase in loans receivable of $71.1 million is
reported for the nine months ended June 30, 1996 compared to a
net increase of $63.2 million for the same 1995 period. Loans
originated totaled $169.9 million and $130.8 million in the 1996
and 1995 periods, respectively. The Bank actively markets
several competitive loan programs and has successfully utilized
the services of loan solicitors for the origination of mortgage
loans. Cash generated from sale of investment securities totaled
$31.4 million. Principal repayments of mortgage-backed
securities amounted to $2.7 million. These funds along with
funds from other sources were utilized to purchase $15.3 million
in mortgage-backed securities and $41.7 million in investment
securities, primarily securities held for resale. See the
"Financial Condition" section of this report for additional
information. In the 1995 period, the Bank received $5.3 million
in cash from activities in its investments held for sale accounts
and $6.3 million from maturities of investments. The cash
proceeds were mainly reinvested in short term notes of local
municipalities. Cash funds received from the disposition of real
estate owned properties amounted to $3.2 million in the nine
month period ended June 30, 1996 compared to $2.5 million in the
same 1995 period.
At June 30, 1996 First State's liquid assets consisted of $13.9
million in cash on hand and in banks and $17.4 million in
securities which qualify as liquid assets for Office of Thrift
Supervision (OTS) regulatory requirements. The cash balances
will be used in normal operations. The Bank is required to
maintain minimum levels of liquid assets as defined by the OTS
regulations, such as United States Government and federal agency
securities. This requirement, which may be varied by the OTS, is
based upon a percentage of deposits and short-term borrowings.
The required ratio is currently 5.00%. The Bank's ratio was 5.29%
at June 30, 1996. The Bank anticipates maintaining its liquidity
at or above the level required by regulatory agencies.
First DeWitt had $27.6 million in outstanding commitments to
originate loans, $3.3 million in commitments to sell loans, and
$51.6 million in unused lines of credit primarily available under
home equity credit and credit card lines at June 30, 1996. The
Bank had no material commitments for capital expenditures at that
date. Management intends to fund the loan commitments from
internal operations and available liquid assets. Any shortfall in
obtaining the funds internally will be satisfied by additional
borrowings. As a member of the Federal Home Loan Bank (FHLB)
system, the Bank may borrow from the FHLB of New York. The Bank
maintains a $60.4 million line of credit with the FHLB. The Bank
had $22.8 million in borrowings against the line of credit at
June 30, 1996.
The Bank's capital exceeds all regulatory requirements and is
categorized as "well capitalized" under the Federal Deposit
Insurance Corporation Improvement Act of 1991 definitions. The
regulatory capital requirements and First DeWitt Bank's capital
position as of June 30, 1996 are as follows:
Capital
Capital Requirement Excess
Amount % Amount % Amount %
---------- ---- --------- ---- --------- ----
(dollars in thousands)
Tangible Capital $ 36,506 5.5% $ 10,005 1.5% $ 26,501 4.0%
Core Capital 36,506 5.5% 20,010 3.0 16,496 2.5
Risk-based Capital 42,023 9.6% 35,134 8.0 6,888 1.6
The OTS has proposed an increase in the core capital requirement
from the current 3% to a level that is expected to be between 4%
and 5%.
The deposits of the Bank are insured by the FDIC primarily
through the Savings Association Insurance Fund ("SAIF"), with
$67.3 million of deposits at June 30, 1996 insured through the
Bank Insurance Fund (the "BIF"), the deposit insurance fund that
insures most commercial bank deposits.
The FDIC Board has reduced the insurance premium assessed on
deposits insured by the Bank Insurance Fund ("BIF"). The FDIC
reduced the BIF premiums from a range of 23 to 31 basis points,
which is the range of premiums currently paid on deposits insured
by the Savings Association Insurance Fund ("SAIF"), to a range of
0 to 31 basis points. The FDIC estimated that in excess of 90%
of the banks whose deposits are insured through the BIF would be
assessed at the lowest premium rate. Due to the reserve levels
of the SAIF, the FDIC has not proposed a reduction in the SAIF
insurance premiums, and it is not expected that, absent
legislative developments, the insurance premiums assessed on SAIF
deposits could be reduced until the end of the decade. The
deposits held by the Bank are primarily insured through the SAIF
and the reduction in BIF premiums, without a similar reduction in
SAIF premiums, places the Bank at a competitive disadvantage,
since BIF-insured institutions can either: (1) pass through to
depositors in the form of higher rates the reduction in deposit
premiums, which would cause the Bank to increase rates on its
deposits without an offsetting reduction in premium expense; (2)
increase BIF-insured institutions' profitability, which may not
be available to the Bank; or (3) a combination of both.
Management continues to monitor the situation and is working with
the various trade associations the Bank is affiliated with to
achieve equality in the insurance premium assessment.
Legislation has been proposed in Congress to recapitalize the
SAIF fund and possibly consolidate the BIF and SAIF funds. One
feature of this proposal calls for a special one-time assessment
on all SAIF-insured institutions of up to 80 basis points to
bring the SAIF fund up to its required level of capitalization.
It is assumed that after this assessment takes place, the on-
going level of insurance premium assessments for the SAIF-insured
institutions would be reduced to the same range as that of the
BIF-insured institutions. Based upon the Bank's deposit base at
June 30, 1996, the special assessment could cause a charge to
earnings of approximately $4.4 million, or $2.8 million net of
income taxes, while a reduction in the insurance premium
assessment rate from 23 basis points to 3 basis points would
reduce annual premium expenses by approximately $1.2 million, or
$762,000 net of income taxes. It is not known at this time when
and if this legislation will be approved and implemented.
Results of Operations
Comparison of Three Months Ended June 30, 1996 and June 30, 1995
First State recorded a net loss of $2.8 million, or $.69 per
share, for the quarter ended June 30, 1996 compared to a net
income of $958,000, or $.24 per share, for the same quarter in
1995. The most significant factor contributing to the decrease
in net income during the 1996 quarter was the posting of loan
loss provisions. Loan loss provisions in the 1996 quarter were
$4.4 million compared to $600,000 in the comparable 1995 quarter.
Total interest income increased $1.6 million during the quarter
ended June 30, 1996 compared to the same period in 1995. The
increase in interest income was primarily due to the $1.8 million
increase in interest on consumer and commercial loans and the
$239,000 increase in interest on mortgage-backed securities. The
increases were mainly attributable to the increased average
balance of the loan and mortgage-backed security portfolios
outstanding. The average balance of consumer and commercial
loans outstanding was $119.0 million in the 1996 quarter compared
to $79.5 million in the 1995 quarter. The average balance of the
mortgage-backed security portfolio was $32.4 during the 1996
quarter compared to $17.7 million in the comparable 1995 quarter.
A serviced credit card portfolio, which is included in the
consumer loan category, is described and elaborated upon in the
"operating expenses" section of this report. The decrease of
$529,000 in interest on mortgage loans was mainly attributable to
the sale of $67.7 million of such loans from the Bank's loans
held for sale accounts in the December 1995 quarter. The Bank
primarily invests its funds in loans and intends to continue to
be active in originating loans both for its own portfolio and
also for sale to others. The Bank originated $27.9 million in
mortgage loans during the quarter. Long-term, fixed-rate loans
are mainly originated with the intent of selling the loans to
others. Adjustable-rate and shorter term fixed-rate loans are
mainly originated for the loan portfolio. The yield on all loan
portfolios was 9.12% at June 30, 1996 compared to 8.25% at June
30, 1995. Interest income from the investment securities and the
investment securities available for sale portfolios increased
$55,000 during the 1996 quarter. If nonaccrual loans of $21.5
million at June 30, 1996 had been current in accordance with
their original terms, the Bank would have realized additional
interest income of approximately $394,000 during the quarter
ended June 30, 1996. The average yield on loans and investments
was 8.77% at June 30, 1996.
Total interest expense increased $396,000 in the quarter ended
June 30, 1996, compared to the same period in 1995. The increase
was due to the $262,000 increase in interest on deposits and the
$134,000 increase in interest on borrowings. Average deposits
outstanding during the 1996 period were $574.3 million compared
to $546.5 million during the 1995 period. The average cost of
deposits increased to 4.26% at June 30, 1996 from 4.07% at June
30, 1995. The Bank will continue to offer deposit programs that
are competitively priced to attract new deposits as well as
retain savings of existing depositors. The average interest rate
on deposits and borrowed money was 4.33% at June 30, 1996.
Net interest income increased $1.2 million during the quarter
ended June 30, 1996 compared to the same period in 1995. The
interest income and interest expense elements of the changes in
net interest income are described above.
Provisions for loan losses totaled $4.4 million in the quarter
ended June 30, 1996 compared to $600,000 in the same 1995
quarter. The related allowance for loan losses totaled $9.1
million at June 30, 1996. Substantially all of the nonaccrual
loans are secured by first mortgage liens on real property. See
"Financial Condition" section for additional information and
information regarding factors which influence management's
judgment in determining the amount of additions to the loan loss
allowance. Although management considers the allowance for loan
losses to be adequate, management recognizes that additional
problems could develop and lead to additional loss provisions and
asset write-downs.
Total other income increased $3.3 million in the quarter ended
June 30, 1996. The increased income is mainly attributable to a
$3.0 million increase in loan fees and other loan charges and a
$286,000 increase in the "other Income" category. The $3.0
million increase in loan fees and other loan charges is directly
attributable to the credit card portfolio. First State obtained
a serviced credit card portfolio through the merger with Ocean
Independent Bank in October, 1994. The effect of the accounting
for the credit card portfolio has caused increases in the areas
of consumer loan interest, loan fees and other loan charges, and
loan processing expenses. Details regarding First State's
serviced credit card portfolio are discussed below. The increase
in the "other" category of other income was mainly due to the
recognition of income from a non refundable deposit that was
placed with the Bank and forfeited when related proposed deal was
not consummated.
Total operating expenses increased $5.5 million in the quarter
ended June 30, 1996 and was mainly attributable to an increase
in loan processing expenses of $4.3 million, an increase in
problem asset expenses, inclusive of real estate owned
writedowns, of $1.1 million, and an increase in compensation and
employee benefits of $252,000. Substantially all of the increase
in loan processing expenses was due to the accounting for credit
card expenses. Details regarding First State's serviced credit
card portfolio are discussed separately below. The $1.1 million
increase in problem asset expenses, inclusive of real estate
owned writedowns was mainly due to writedowns of $1.3 million.
The writedowns are in accordance with the Bank's announced intent
to liquidate substantially all of its problem assets. The
$252,000 increase in compensation and employee benefits was
mainly due to continually rising cost of employee benefits,
living increase, and the employment of personnel to staff the new
branch office opened in April, 1996.
The Corporation acquired a serviced credit card portfolio through
the acquisition of Ocean Independent Bank in October, 1994. The
arrangement with the servicer of the portfolio, Applied Card
Systems (ACS) of Wilmington, Delaware, provides the Corporation
with a guaranteed net return based on the outstanding receivables
associated with the serviced portfolio. The return that is
guaranteed to the Corporation is net of all costs, including
credit loss and cost of funds. First State records all interest
income associated with the portfolio in the "Interest on consumer
and commercial loans" caption and all fees associated with
portfolio are recorded in the "Loan fees and other loan charges"
caption. The difference between the amounts received for the two
captions above and the net return guaranteed to the Corporation
is considered "credit card expenses" that represent the fees paid
to ACS for their servicing of the portfolio. This amount is
recorded in the "Loan processing expenses" caption. The
Corporation's business with ACS has expanded and this growth has
caused an increase in all three income statement captions. The
detail effects of the serviced credit card portfolio on the
income statement for the quarter ended June 30, 1996, and for the
nine-month period ended June 30, 1996, are presented below.
3 Months 9 Months
Ended Ended
Income Statement Caption 3/30/96 6/30/96
---------- ---------
(in thousands)
Interest on consumer and commercial loans $ 2,094 $ 4,330
Loan fees and other loan charges 3,755 8,285
---------- ---------
Total credit card income 5,849 12,615
Loan processing expenses 5,376 11,641
---------- ---------
Net credit card income (pre tax) $ 473 $ 974
========== =========
Net credit card income (after tax) $ 289 $ 594
========== ==========
The total credit card receivables outstanding that were serviced
by ACS totaled $62.6 million at June 30, 1996 and $36.7 million
at March 31, 1996.
The Income tax benefit of $694,000 incurred in the quarter ended
June 30, 1996 was mainly due to a pre-tax loss of $3.5 million.
The loan loss provision of $4.4 million recognized during the
quarter was not entirely deductible for income tax purposes.
Income tax expense of $374,000 incurred in the quarter ended June
30, 1995 was due to the generation of taxable income.
Comparison of Nine Months Ended June 30, 1996 and June 30, 1995
First State recorded a net loss of $996,000, or $.25 per share,
for the nine month period ended June 30, 1996 compared to net
income of $2.9 million, or $.75, per share, for the same period
in 1995. The loss in the 1996 period was mainly attributable to
the $4.4 million in provisions for loan losses recorded in the
quarter ended June 30, 1996.
Interest income increased $4.0 million during the nine month
period ended June 30, 1996 compared to the same period in 1995.
The increase in interest income was primarily due to the $3.6
million increase in interest income on consumer and commercial
loans and was mainly attributable to the increased average
balances of the portfolios. The average balances totaled $103.4
million in the 1996 period compared to $76.6 million in the 1995
period. A serviced credit card portfolio, which is included in
the consumer loan category, is described and elaborated upon in
the "Comparison of Three Months Ended June 30, 1996--Results of
Operations" section of this report. The Bank primarily invests
its funds in loans and intends to continue to be active in
originating loans both for its own portfolio and also for sale to
others. The Bank originated $169.9 million in loans during the
nine month period ended June 30, 1996. Long-term, fixed-rate
loans are mainly originated with the intent of selling the loans
to others. Adjustable-rate and shorter term fixed-rate loans are
mainly originated for the loan portfolio. The yield on all loan
portfolios was 9.12% at June 30, 1996 compared to 8.25% at June
30, 1995. Interest income from mortgage-backed securities
increased $486,000 and was mainly attributable to the increase in
the average balance of the mortgage-backed security portfolio.
The average balance of the portfolio was $28.5 million during the
1996 period compared to $17.9 million in the comparable 1995
period. The Bank's investment securities available for sale
portfolio, which totaled $17.6 million at June 30, 1996,
generated an increase in interest income of $323,000 over the
1995 period. If nonaccrual loans of $21.5 million at June 30,
1996 had been current in accordance with their original terms,
the Bank would have realized additional interest income of
approximately $1.2 million during the nine months ended June 30,
1996. The average yield on loans and investments was 8.77% at
June 30, 1996.
Total interest expense increased $2.2 million in the nine month
period ended June 30, 1996, compared to the same period in 1995.
The increase was due to the increase in interest expense on
deposits and was mainly attributable to the increased deposits
outstanding in the 1996 period. Average deposits outstanding
during the 1996 period were $555.8 million compared to $524.1
million during the 1995 period. The average cost of deposits
increased to 4.26% at June 30, 1996 from 4.07% at June 30, 1995.
The Bank will continue to offer deposit programs that are
competitively priced to attract new deposits as well as retain
savings of existing depositors. Interest on borrowed money
decreased $32,000 in the 1996 period. The average interest rate
on deposits and borrowed money was 4.33% at June 30, 1996.
Net interest income increased $1.8 million during the nine month
period ended June 30, 1996 compared to the same period in 1995.
The interest income and interest expense elements of the changes
in net interest income are described above.
Provisions for loan losses totaled $5.6 million in the nine-month
period ended June 30, 1996 compared to $1.1 million in the same
1995 quarter. The related allowance for loan losses totaled $9.1
million at June 30, 1996. Substantially all of the nonaccrual
loans are secured by first mortgage liens on real property. See
"Financial Condition" section for information regarding factors
which influence management's judgment in determining the amount
of additions to the loan loss allowance. Although management
considers the allowance for loan losses to be adequate,
management recognizes that additional problems could develop and
lead to additional loss provisions and asset write-downs.
Total other income increased $7.9 million in the nine month
period ended June 30, 1996. The increased income was primarily
due to the $6.4 million increase in loan fees and other loan
charges, the $1.0 million net gain on the sales of loans, and the
net gain on the sales of investments of $284,000. The increase
in loan fees and other loan charges was mainly attributable to
the credit card portfolio. First State obtained a serviced
credit card portfolio through the merger with Ocean Independent
Bank in October, 1994. The effect of the accounting for the
credit card portfolio has caused increases in the areas of
consumer loan interest, loan fees and other loan charges, and
loan processing expenses. Details regarding First State's
serviced credit card portfolio were previously discussed in the
"Comparison of Three Months Ended June 30, 1996 --Results of
Operations" section of this report. The sale of $75.4 million of
mortgage loans from the available for sale portfolio generated a
net gain on sales of loans of $1.0 million. Net gains on the
sales of investments totaled $284,000 in the 1996 period. First
State maintains an investment securities available for sale
portfolio and anticipates periodic gains on the sales of such
securities.
Total operating expenses increased $10.3 million in the nine
month period ended June 30, 1996. The increase was mainly
attributable to the $8.6 million increase in loan processing
expenses, the $642,000 increase in compensation and employee
benefits expense, and to the $1.2 million increase in problem
asset expenses, inclusive of real estate owned writedowns.
Substantially all of the increase in loan processing expenses was
attributable to the accounting for credit card expenses. Details
regarding First State's serviced credit card portfolio are
discussed In the "Comparison of Three Months Ended June 30, 1996-
- -Results of Operations " section of this report. The $642,000
increase in compensation and employee benefits was mainly due to
continually rising cost of employee benefits, a cost of living
increase, and the employment of personnel to staff the two new
branch offices opened during the period. The increase in problem
asset expenses was mainly due to write-downs of the carrying
values of properties.
Income tax expense of $195,000 was incurred in the nine month
period ended June 30, 1996 despite a pre tax loss of $801,000.
The loan loss provisions of $5.6 million recognized during the
period were not entirely deductible for income tax purposes.
First State therefore generated taxable income over the period.
Income tax expense of $1.4 million incurred in the nine month
period ended June 30, 1995 was due to the generation of taxable
income.
PART II. OTHER INFORMATION
FIRST STATE FINANCIAL SERVICES, INC.
Item 1. Legal Proceedings
The company is not engaged in any legal
proceedings of a material nature at the present time.
From time to time, First DeWitt is a party to legal
proceedings within the normal course of business.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) None
(b) A report on form 8-K dated June 25,1996 and a report
filed on form 8A dated July 17, 1996 had been filed
during the quarter. Both reports provided disclosure,
pursuant to Item 1(b) thereof, relating to an agreement
entered into between First State Financial Services, Inc.
(First State), and Sovereign Bancorp, Inc. (Sovereign),
pursuant to which Sovereign will acquire First State
through the merger of First State into Sovereign. Sovereign
will issue shares of its common stock to the shareholders of
First State as a result of the merger.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
First State Financial Services, Inc.
Dated: 08/14/96 By: /s/Michael J. Quigley, III
--------------------------
Michael J. Quigley, III
Chairman, President and
Chief Executive Officer
Dated: 08/14/96 By: /s/Emil J. Butchko
--------------------------
Emil J. Butchko
Senior Vice President
and Treasurer