SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934, as amended
For the fiscal year ended December 31, 1999
Commission File No.: 0-29770
WEST ESSEX BANCORP, INC.
(exact name of registrant as specified in its charter)
UNITED STATES 22-3597632
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
417 Bloomfield Avenue, Caldwell, New Jersey 07006
(Address of principal executive offices)
Registrant's telephone number, including area code: (973) 226-7911
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
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 reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. Yes X No
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than the directors and executive officers
of the registrant, was $12,516,894 based upon the last sales price of $9.00 as
listed on The Nasdaq National Market for March 20, 2000. Solely for purposes of
this calculation, the shares held by West Essex Bancorp, M.H.C. and the
directors and officers of the registrant are deemed to be shares held by
affiliates.
The number of shares of Common Stock outstanding as of March 20, 2000
is: 4,038,357.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 1999 Annual Report to Shareholders and the definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on April 27,
2000 are incorporated herein by reference to Parts II and III, respectively, of
this Form 10-K.
INDEX
PAGE
PART I
Item 1. Business...................................................... 1
Item 2. Properties.................................................... 36
Item 3. Legal Proceedings............................................. 36
Item 4. Submission of Matters to a Vote of Security Holders........... 37
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................... 37
Item 6. Selected Financial Data....................................... 37
Item 7. Management's Discussion and Analysis of Financial ............ 37
Condition and Results of Operations........................... 37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 37
Item 8. Financial Statements and Supplementary Data................... 37
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure........................ 37
PART III
Item 10. Directors and Executive Officers of the Registrant............ 38
Item 11. Executive Compensation........................................ 38
Item 12. Security Ownership of Certain Beneficial Owners
and Management................................................ 38
Item 13. Certain Relationships and Related Transactions................ 38
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K................................................... 38
SIGNATURES
Item 1. Business.
- - ------------------
General
West Essex Bancorp, Inc. (the "Company") became the federally chartered
stock holding company for West Essex Bank (the "Bank"), a federally chartered
stock savings bank on October 2, 1998 in connection with the conversion of the
Bank from the mutual to stock form and reorganization of the Bank into a mutual
holding company structure ("Reorganization"). In connection with the
Reorganization, West Essex Bancorp, M.H.C. (the "MHC") was organized and became
a majority holder of the Company's outstanding common stock. The Company, the
Bank and the MHC are regulated by the Office of Thrift Supervision (the "OTS").
The Bank is a federally chartered savings bank and is wholly-owned by the
Company. The Company is a savings and loan holding company and is subject to
regulation by the OTS, the Federal Deposit Insurance Corporation ("FDIC") and
the Securities and Exchange Commission ("SEC"). Currently, other than investing
in various securities, the Company does not directly transact any material
business other than through the Bank. Accordingly, the discussion herein
addresses the operations of the Company as they are conducted through the Bank.
At December 31, 1999, the Company had total assets of $348.3 million, total
deposits of $235.0 million and total stockholders' equity of $47.1 million.
The Bank was originally organized in 1915 as a New Jersey chartered
building and loan association and, in 1995, became a federally chartered savings
bank. The Bank is a community-oriented savings institution whose business
primarily consists of accepting deposits from customers and investing those
funds primarily in mortgage-backed securities and mortgage loans secured by one-
to four-family residences located in the Bank's primary market area. To a
significantly lesser extent, the Bank invests in commercial real estate loans,
multi-family loans, construction and land development loans and home equity
loans as well as consumer loans and obligations of the federal government and
federal agencies as well as states and municipalities. The Bank generally
retains for its portfolio all one- to four-family mortgage loans which it
originates.
The Company's and Bank's executive offices are located at 417
Bloomfield Avenue, Caldwell, New Jersey 07006. The telephone number is (973)
226-7911.
Market Area and Competition
The Bank conducts its business through its administrative and branch
office located in Caldwell, New Jersey, and seven other full service branch
offices located in West Orange, Franklin Lakes, River Vale, Pine Brook, Old
Tappan and Northvale, all of which are located in the Northern New Jersey
counties of Essex, Morris and Bergen. The Bank's deposit gathering base is
concentrated in the communities surrounding its offices. While its lending area
extends throughout New Jersey, most of the Bank's mortgage loans are secured by
properties located in Essex, Morris and Bergen Counties in Northern New Jersey.
The economy in the Bank's primary market area is based upon a mixture
of service and retail trade. Other employment is provided by a variety of
wholesale trade, manufacturing, federal, state and local government, hospitals
and utilities. The area is also home to commuters working in the greater New
York City metropolitan area. Certain communities in Bergen, Essex and Morris
Counties are among the highest per capita income in the country. Essex County
contains many older residential commuter towns which function partially as
business and service centers. Morris County was once predominantly a rural
farming area. It has experienced rapid growth in the residential, commercial and
industrial sectors. Bergen County has benefitted from its geographical proximity
to New York City. Originally an agricultural region, the county shifted toward
manufacturing and service industries and many foreign firms have set up their
American headquarters in this County.
The Bank faces significant competition both in making loans and in
attracting deposits. The State of New Jersey has a high density of financial
institutions, many of which are branches of significantly larger institutions
which have greater financial resources than the Bank, all of which are
competitors of the Bank to varying degrees. The Bank's competition for loans
comes principally from commercial banks, savings banks, savings and loan
associations, credit unions, mortgage banking companies and insurance companies.
These companies compete aggressively through advertising and by cutting interest
rates on loans. The Bank has sought to compete for loans by advertising in local
papers, developing contacts with local real estate brokers, and providing cash
incentives to its retail and mortgage origination staff to attract loans to the
Bank. In addition, the Bank is affiliated with several mortgage brokers who, for
a fee, provide the Bank with loans. The Bank does not attempt to compete by
offering interest rates below those offered by its competitors, but does
endeavor to keep its interest rates competitive in that the Bank's rates are
neither higher nor lower than rates generally available from the Bank's
competitors in its market area. Its most direct competition for deposits has
historically come from commercial banks, savings banks, savings and loan
associations and credit unions. The Bank faces additional competition for
deposits from short-term money market funds, common stock, other corporate and
government securities funds and from other financial service institutions such
as brokerage firms and insurance companies.
Lending Activities
Loan Portfolio Composition. The Bank's loan portfolio consists
primarily of first mortgage loans secured by one- to four-family residences. At
December 31, 1999, the Bank had total loans receivable of $156.2 million, of
which $122.7 million were one- to four-family, residential mortgage loans,
equalling 78.5% of the Bank's total loans receivable. At such date, the
remainder of the Bank's loan portfolio consisted primarily of: $13.0 million of
commercial real estate loans or 8.3% of total loans receivable; $14.4 million of
home equity loans and lines of credit, or 9.2% of total loans receivable; $1.7
million of multi-family residential loans, or 1.1% of total loans receivable;
$3.8 million of construction and development loans, or 2.4% of total loans
receivable; and $617,000 of consumer loans, or 0.4% of total loans receivable,
consisting primarily of loans on passbook deposit accounts and automobile loans.
The types of loans that the Bank may originate are subject to federal
and state laws and regulations. Interest rates charged by the Bank on loans are
affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board, and legislative tax
policies. In recent years, the Bank has aggressively sought to increase its
originations of mortgage loans and has sought to purchase loans and loan
participations. This has resulted in total loans increasing from $116.1 million
at December 31, 1997 to $143.0 million at December 31, 1998 and $156.2 million
at December 31, 1999.
2
The following table sets forth the composition of the Bank's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
At December 31,
-------------------------------------------------------------------------------------
1999 1998 1997 1996
--------------------- -------------------- -------------------- --------------------
Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ -------- ------ --------
Mortgage Loans:
Residential:
One- to four-family...................... $122,680 78.54% $114,690 80.20% $87,489 75.34% $60,741 71.88%
Multi-family............................. 1,693 1.08 1,943 1.36 2,004 1.73 2,068 2.45
Home equity loans and lines(1)........... 14,382 9.21 9,631 6.73 8,554 7.37 6,653 7.87
Commercial real estate................... 12,965 8.30 11,589 8.11 10,695 9.21 12,275 14.53
Construction and development............. 3,819 2.45 4,394 3.07 6,485 5.58 2,080 2.46
-------- ----- -------- ----- ------- ----- ------- -----
Total mortgage loans.................. 155,539 99.58 142,247 99.47 115,227 99.23 83,817 99.19
-------- ----- -------- ----- ------- ----- ------- -----
Commercial loans............................ 40 0.02 49 0.04 59 0.05 87 0.10
-------- ----- -------- ----- ------- ----- ------- -----
Consumer Loans:
Passbook or certificate................. 341 0.22 401 0.28 550 0.47 427 0.51
Other.................................... 276 0.18 305 0.21 291 0.25 168 0.20
-------- ----- -------- ----- ------- ----- ------- -----
Total consumer loans.................. 617 0.40 706 0.49 841 0.72 595 0.71
-------- ----- -------- ----- ------- ----- ------- -----
Total loans receivable.................... 156,196 100.00% 143,002 100.00% 116,127 100.00% 84,499 100.00%
====== ====== ====== ======
Less:
Construction loans in process........... (1,886) (1,311) (1,437) (440)
Allowance for loan losses............... (1,400) (1,717) (1,885) (1,564)
Deferred loan fees, net................. 366 298 (70) (361)
-------- --------- ------- -------
Loans receivable, net..................... $153,276 $140,272 $112,735 $82,134
======== ======== ======== =======
1996
--------------------
Percent
Amount of Total
------ --------
Mortgage Loans:
Residential:
One- to four-family...................... $65,002 74.50%
Multi-family............................. 1,115 1.28
Home equity loans and lines(1)........... 4,388 5.03
Commercial real estate................... 12,707 14.56
Construction and development............. 3,032 3.47
------- -----
Total mortgage loans.................. 86,244 98.84
------- -----
Commercial loans............................ 234 0.27
------- -----
Consumer Loans:
Passbook or certificate................. 543 0.62
Other.................................... 234 0.27
------- -----
Total consumer loans.................. 777 0.89
------- -----
Total loans receivable.................... 87,255 100.00%
======
Less:
Construction loans in process........... (592)
Allowance for loan losses............... (1,200)
Deferred loan fees, net................. (432)
-------
Loans receivable, net................... $85,031
=======
(1) Includes second mortgage loans other than home equity loans of $-0-, $-0-,
$63,000, $74,000 and $91,000 at December 31, 1999, 1998, 1997, 1996 and
1995.
3
Loan Maturity. The following table shows the remaining contractual
maturity of the Bank's loans at December 31, 1999. The table does not include
the effect of future principal repayments or prepayments.
At December 31, 1999
-------------------------------------------------------------------------
One- to Equity Construction
Four- Multi- Loans and Commercial and
Family Family Lines Real Estate Development Commercial
------ ------ ----- ----------- ----------- ----------
(In thousands)
Amounts due:
One year or less........................... $ 398 $ -- $ 151 $ -- $ 3,259 $-
-------- ------ ------- ------- ------- ---
After one year:
More than one year to three years....... 893 38 163 333 490 --
More than three years to five years..... 1,279 267 1,412 1,084 -- 2
More than five years to ten years....... 8,413 -- 3,537 2,273 30 38
More than 10 years to 20 years.......... 26,550 1,204 8,348 8,307 -- --
More than 20 years..................... 85,147 184 771 968 40 --
-------- ------ ------- ------- ------- ---
Total due after one year................... 122,282 1,693 14,231 12,965 560 40
-------- ------ ------- ------- ------- ---
Total due.................................. 122,680 1,693 14,382 12,965 3,819 40
Less:
Loans in process................. -- -- -- -- (1,886) --
Deferred loan (fees) costs....... 340 5 -- 36 (15) --
Allowance for loan losses........ (927) (29) (198) (180) (58) --
-------- ------ ------- ------- ------- ---
Loans receivable, net................... $122,093 $1,669 $14,184 $12,821 $ 1,860 $40
======== ====== ======= ======= ======= ===
-----------------
Total
Consumer Loans
-------- -----
Amounts due:
One year or less........................... $356 $ 4,164
---- -------
After one year:
More than one year to three years....... 123 2,040
More than three years to five years..... 138 4,182
More than five years to ten years....... -- 14,291
More than 10 years to 20 years.......... -- 44,409
More than 20 years...................... -- 87,110
--- -------
Total due after one year................... 261 152,032
--- -------
Total due.................................. 617 156,196
Less:
Loans in process................. -- (1,886)
Deferred loan (fees) costs....... -- 366
Allowance for loan losses........ (8) (1,400)
--- ------
Loans receivable, net................... $609 $153,276
==== ========
4
The following table sets forth, at December 31, 1999, the dollar amount
of loans contractually due after December 31, 2000, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2000
-------------------------------------------------------
Fixed Adjustable Total
-------- ------- --------
(In thousands)
Mortgage loans:
One- to four-family...................... $85,773 $36,509 $122,282
Multi-family............................. 1,693 -- 1,693
Equity loans and lines................... 10,077 4,154 14,231
Commercial real estate................... 11,467 1,498 12,965
Construction and development............. 290 270 560
-------- ------- --------
Total mortgage loans................... 109,300 42,431 151,731
Commercial loans............................ 40 -- 40
Consumer loans.............................. 227 34 261
-------- ------- --------
Total loans ......................... $109,567 $42,465 $152,032
======== ======= ========
Origination, Purchase and Servicing of Loans. The Bank's mortgage
lending activities are conducted primarily by its loan personnel operating in
all of the Bank's branch offices. All loans originated by the Bank, either
through internal sources or through loan brokers, are underwritten by the Bank
pursuant to the Bank's policies and procedures. The Bank's underwriting
policies, guidelines and procedures are modeled after those of FNMA and FHLMC.
The Bank originates both adjustable-rate and fixed-rate loans. The Bank's
ability to originate fixed- or adjustable-rate loans is dependent upon the
relative customer demand for such loans, which is affected by the current and
expected future level of interest rates. It is the general policy of the Bank to
retain all loans originated in its portfolio. The Bank currently retains the
servicing for all loans originated in its portfolio. The Bank has faced
significant competition for loans in its market area. Until 1996, the Bank had
relied solely upon its own mortgage staff to originate loans and depended
primarily upon getting loans from the Bank's customer base. The Bank did not
aggressively advertise, nor did it pay brokers to introduce loans to the Bank.
Since 1996, the Bank has sought to compete more aggressively for loans. To that
end, the Bank began paying its retail and mortgage loan origination staff cash
incentives based upon loan originations and has significantly increased its
advertising in its local market area. The Bank has also begun working with
mortgage brokers and paying them fees in return for referring loan applicants to
the Bank. The Bank's efforts have enabled it to substantially increase loan
originations since 1996. Specifically, the Bank originated $42.2 million in
mortgage loans in 1999, $50.5 million in 1998 and $46.4 million in 1997.
During the years ended December 31, 1999 and December 31, 1998, the
Bank originated $34.5 million and $45.8 million of one- to four-family loans,
respectively, including home equity loans and lines of credit. Based upon the
Bank's investment needs and market opportunities, the Bank has, on occasion,
purchased loans, primarily one- to four-family loans, or participated in loans,
primarily multi-family loans through the Thrift Institutions Community
Investment Corporation of New Jersey ("TICIC"). At December 31, 1999, the Bank
had nine loan participations through TICIC totalling $2.0 million. The Bank has
in its loan portfolio loans generated by third-party mortgage companies which
were underwritten pursuant to the Bank's policies, and closed in the name of the
Bank.
5
The following table sets forth the Bank's loan originations, purchases,
and principal repayments for the periods indicated. The Bank sold no loans
during the periods indicated.
For the Years Ended
December 31,
---------------------------------
1999 1998 1997
-------- -------- --------
Beginning balance............................................................. $143,002 $116,127 $ 84,499
-------- -------- --------
Purchases--Multi-family mortgage loans....................................... 970 281 --
-------- -------- --------
Loans originated:
Mortgage loans:
One- to four-family.................................................... 25,440 41,194 35,017
Multi-family........................................................... 455 -- --
Home equity lines...................................................... 9,022 4,644 4,330
Commercial real estate................................................. 2,485 2,310 1,436
Construction and land development...................................... 4,803 2,317 5,610
-------- -------- --------
Total mortgage loans............................................... 42,205 50,465 46,393
-------- -------- --------
Consumer loans:
Passbook loans......................................................... 725 371 477
Automobile............................................................. 116 167 222
Credit lines(1)........................................................ 141 3 28
------- -------- --------
Total consumer loans............................................... 982 541 727
-------- -------- --------
Loans made to facilitate the sale of
real estate owned....................................................... -- -- --
-------- -------- --------
Total originations................................................. 43,187 51,006 47,120
-------- -------- --------
Loans transferred to real estate owned...................................... (309) -- (680)
-------- -------- --------
Principal repayments and other, net....................................... (30,654) (24,412) (14,812)
-------- -------- --------
Ending balance................................................................ $156,196 $143,002 $116,127
======== ======== ========
One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate
and adjustable-rate mortgage loans ("ARM") secured by one- to four-family
residences with maturities of up to 30 years. Loan originations are generally
obtained from the Bank's retail and loan origination staff, from local real
estate agents, from wholesale brokers and their contacts in the Bank's local
real estate industry, from existing or past customers and through referrals from
members of the local communities and advertising. One- to four-family mortgage
loans are generally underwritten in accordance with FHLMC/FNMA standards. At
December 31, 1999, one- to four-family mortgage loans totalled $122.7 million,
or 78.5% of the Bank's total loans receivable. Of the Bank's mortgage loans
secured by one- to four-family residences, $86.2 million, or 70.2%, were
fixed-rate loans and $36.5 million or 29.8% were ARM loans.
6
The Bank currently offers fixed-rate mortgage loans with terms from 10
to 30 years. The Bank generally retains for its portfolio all loans it
originates. The Bank also offers ARM loan programs made for terms of 30 years
with interest rates which adjust periodically. The Bank's ARM loans generally
provide for periodic (not more than 2.0% over the existing interest rate) and
overall (not more than 6.0%) caps on the increase or decrease in the interest
rate at any adjustment date and over the life of the loan. The interest rate
adjustment on these loans is indexed to the one-year U.S. Treasury CMT Index
with a repricing margin of 2.75% above the index.
The origination of adjustable-rate residential mortgage loans, as
opposed to fixed-rate residential mortgage loans, helps reduce the Bank's
interest rate exposure to increases in interest rates. However, adjustable-rate
loans generally pose credit risks not inherent in fixed-rate loans, primarily
because as interest rates rise, the underlying payments of the borrower rise,
thereby increasing the potential for default. Periodic and lifetime caps on
interest rate increases help to reduce the credit risk associated with the
Bank's adjustable-rate loans but also limit the interest rate sensitivity of its
adjustable-rate mortgage loans.
The Bank's policy generally is to originate one- to four-family
residential mortgage loans in amounts up to 90% of the lower of the appraised
value or the selling price of the property securing the loan, but generally
requires private mortgage insurance if the loan is in an amount in excess of 80%
of the lower of the appraised value or selling price. Mortgage loans originated
by the Bank include due-on-sale clauses which provide the Bank with the
contractual right to deem the loan immediately due and payable in the event the
borrower transfers ownership of the property without the Bank's consent.
Due-on-sale clauses are an important means of adjusting the rates on the Bank's
fixed-rate mortgage loan portfolio and the Bank has generally exercised its
rights under these clauses. The Bank requires fire, casualty, title and, in
certain cases, flood insurance on all properties securing real estate loans made
by the Bank.
In an effort to provide financing for first-time home buyers, the Bank
offers a first-time home buyers program. This program offers one- to four-family
residential mortgage loans to qualified individuals. These loans are originated
using the Bank's standard underwriting guidelines. With respect to loans granted
under this program, the Bank originates these loans in amounts up to 95% of the
lower of the appraised value or selling price of the property securing the loan.
In addition, the Bank also participates in the First Home Club Program through
the FHLB-NY, which benefits low income first time homebuyers.
Home Equity Loans. The Bank offers fixed-rate home equity loans and
floating rate home equity lines of credit in amounts of up to $150,000. Loans in
excess of $150,000 may be made with Board approval. Home equity loans have fixed
rates of interest with terms of up to 20 years. Interest rates on such loans
will vary depending on the amortization period chosen by the borrowers. Home
equity lines of credit have adjustable-rates of interest, which may adjust on a
monthly basis. The adjustable-rate of interest charged on such loans is indexed
to the prime rate as published in The Wall Street Journal. Currently, home
equity lines of credit originated at this time bear a maximum lifetime interest
rate cap of 14.0%. The maximum combined loan-to-value ("LTV") ratio on home
equity loans and equity lines of credit is 70%; however, this policy provides
that management has the discretion to make such real estate loans in excess of
70%. At December 31, 1999, the Bank had in its loan portfolio an aggregate of
$19.4 million of home equity loans and equity lines of credit, of which $10.3
million were fixed-rate home equity loans and $9.1 million were equity lines of
credit. Of the $9.1 million equity lines of credit, $5.0 million was drawn upon
such loans at December 31, 1999. The underwriting standards employed by the Bank
for home equity loans and lines of credit include a determination of the
applicant's credit history and an assessment of the applicant's ability to meet
existing obligations and payments on the proposed loan and the value of the
collateral securing the loan. The stability of the applicant's monthly income
may be determined by verification of gross monthly income from primary
employment and, additionally, from any verifiable secondary income.
Creditworthiness of the applicant is of
7
primary consideration. The Bank's home equity loans and lines of credit are
secured by first or second liens on one- to four-family residences and
condominiums located in the Bank's primary market area.
Commercial Real Estate and Multi-Family Lending. The Bank also
originates multi-family and commercial real estate loans that are generally
secured by five or more unit apartment buildings and properties used for
business purposes such as small shopping centers located in northern New Jersey.
The Bank's multi-family and commercial real estate underwriting policy provides
that such real estate loans may be made in amounts up to 65% of the appraised
value of the property; however, this policy provides that management has the
discretion to make such real estate loans in excess of 65% of the appraised
value of the property. The Bank's multi-family and commercial real estate
lending is limited by the regulatory loans-to-one borrower limit which at
December 31, 1999 was $5.7 million. The Bank currently originates multi-family
and commercial real estate loans, generally with terms of up to 20 years and has
developed a variety of programs, including balloon-type and adjustable
mortgages, indexed to the FHLB advance rate, the Prime Rate and the U.S.
Treasury Bill rate. The Bank's multi-family and commercial real estate loans
have fixed or adjustable rates of interest that adjust periodically and are
indexed to either the prime rate as published in The Wall Street Journal or the
U.S. Treasury Bill. In reaching its decision on whether to make a multi-family
or commercial real estate loan, the Bank considers the net operating income of
the property, the borrower's expertise, credit history and profitability and the
value of the underlying property. The Bank has generally required that the
properties securing these real estate loans have debt service coverage ratios
(the ratio of earnings before debt service to debt service) of at least 1.15. In
addition, environmental impact surveys may be required for multi-family and
commercial real estate loans. Generally, multi-family and commercial real estate
loans made to corporations, partnerships and other business entities require
personal guarantees by the principals. The Bank may not require a personal
guarantee on such loans depending on the creditworthiness of the borrower and
the amount of the downpayment and other mitigating circumstances. The Bank's
multi-family real estate loan portfolio at December 31, 1999 was $1.7 million,
or 1.1%, of total loans receivable and the Bank's commercial real estate loan
portfolio at such date was $13.0 million, or 8.3%, of total loans receivable.
Loans secured by multi-family and commercial real estate properties are
generally larger and involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
and commercial real estate properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to the then prevailing conditions in the real estate
market or the economy. The Bank seeks to minimize these risks through its
underwriting standards.
Construction and Development Lending. The Bank originates construction
and development loans for the development of one- to four-family residences.
Such loans are made principally to licensed and experienced developers known to
the Bank in its primary market area for the construction of single-family
developments. The Bank also originates construction and development loans for
the development of commercial properties. The Bank generally does not originate
loans secured by unimproved land. Construction loans are originated in amounts
up to 70% of the lesser of the appraised value of the property, as improved, or
the sales price. Such loans are offered for up to two year terms and adjustable
interest rates which may adjust monthly and float at margins which are generally
indexed to the Prime Rate of interest as reported in The Wall Street Journal.
Proceeds of construction loans are disbursed as phases of the construction are
completed. Generally, if the borrower is a corporation, partnership or other
business entity, personal guarantees by the principals are required. At December
31, 1999, the Bank had $3.8 million of construction loans which amounted to 2.4%
of the Bank's total loans receivable.
Construction and development financing is generally considered to
involve a higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan
8
is dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development compared to the estimated
cost (including interest) of construction and other assumptions, including the
estimated time to sell residential properties. If the estimate of value proves
to be inaccurate, the Bank may be confronted with a project, when completed,
having a value which is insufficient to assure full repayment.
Consumer Lending. Consumer loans at December 31, 1999 amounted to
$617,000, or 0.4% of the Bank's total loans receivable, and consisted primarily
of $341,000 in loans secured by deposit accounts and $243,000 in automobile
loans. Such loans are generally originated in the Bank's primary market area.
These loans are generally shorter term and have higher interest rates than one-
to four-family mortgage loans.
Loans secured by rapidly depreciable assets such as automobiles or that
are unsecured entail greater risks than one- to four-family mortgage loans. In
such cases, repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding loan balance, since there is a
greater likelihood of damage, loss or depreciation of the underlying collateral.
Further, consumer loan collections on these loans are dependent on the
borrower's continuing financial stability and, therefore, are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default.
Commercial Lending. At December 31, 1999, the Bank had $40,000 in
commercial loans, which the Bank originated through FHLB program over ten years
ago. The Bank currently anticipates that commercial lending activity will
increase in the immediate future.
Loan Approval Procedures and Authority. The Board of Directors
establishes the lending policies and loan approval limits of the Bank. All loans
originated by the Bank with principal amounts in excess of $1.0 million require
the approval of the Board of Directors. All loans originated by the Bank with
principal amounts above $350,000, but less than or equal to $1.0 million require
the approval of the Lending Committee. All other loans may be approved by the
Bank's Chief Lending Officer. Pursuant to OTS regulations, loans to one borrower
cannot exceed 15% of the Bank's unimpaired capital and surplus. The Bank will
not make loans to one borrower that are in excess of the regulatory limits.
Underwriting. With respect to all loans originated by the Bank, it is
the general policy of the Bank to retain all such loans in its portfolio. The
Bank usually underwrites loans in accordance with FNMA or FHLMC guidelines. Upon
receipt of a completed loan application from a prospective borrower, a credit
report is ordered and certain other information is verified by an independent
credit agency. If necessary, additional financial information may be required.
An appraisal of real estate intended to secure a proposed loan generally is
required to be performed by outside appraisers approved by the Bank. The Board
annually approves independent appraisers used by the Bank and approves the
Bank's appraisal policy. The Bank's policy is to obtain title and hazard
insurance on all mortgage loans and flood insurance when necessary and the Bank
generally requires borrowers to make payments to a mortgage escrow account for
the payment of property taxes. No title or flood insurance is required, however,
for home equity loans.
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquencies and Classified Assets. Reports listing all delinquent
accounts are generated and reviewed by management at least once a month and the
Board of Directors performs a monthly review of all loans or lending
relationships delinquent 60 days or more and all real estate owned ("REO"). The
procedures taken by the Bank with respect to delinquencies vary depending on the
nature of the loan, period and cause
9
of delinquency and whether the borrower is habitually delinquent. When a
borrower fails to make a required payment on a loan, the Bank takes a number of
steps to have the borrower cure the delinquency and restore the loan to current
status. The Bank generally sends the borrower a written notice of non-payment
after the loan is first past due. The Bank's guidelines provide that telephone,
written correspondence and/or face-to-face contact will be attempted to
ascertain the reasons for delinquency and the prospects of repayment. When
contact is made with the borrower at any time prior to foreclosure, the Bank
will attempt to obtain full payment, offer to work out a repayment schedule with
the borrower to avoid foreclosure or, in some instances, accept a deed in lieu
of foreclosure. In the event payment is not then received or the loan not
otherwise satisfied, additional letters and telephone calls generally are made.
If the loan is still not brought current or satisfied and it becomes necessary
for the Bank to take legal action, which typically occurs after a loan is 90
days or more delinquent, the Bank will commence foreclosure proceedings against
any real property that secures the loan. If a foreclosure action is instituted
and the loan is not brought current, paid in full, or refinanced before the
foreclosure sale, the property securing the loan generally is sold at
foreclosure and, if purchased by the Bank, becomes real estate owned.
Federal regulations and the Bank's Asset Classification Policy require
that the Bank utilize an internal asset classification system as a means of
reporting problem and potential problem assets. The Bank has incorporated the
OTS internal asset classifications as a part of its credit monitoring system.
The Bank currently classifies problem and potential problem assets as
"Substandard," "Doubtful" or "Loss" assets. An asset is considered "Substandard"
if it is inadequately protected by the current net worth and paying capacity of
the obligor or of the collateral pledged, if any. "Substandard" assets include
those characterized by the "distinct possibility" that the insured institution
will sustain "some loss" if the deficiencies are not corrected. Assets
classified as "Doubtful" have all of the weaknesses inherent in those classified
"Substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets classified
as "Loss" are those considered "uncollectible" and of such little value that
their continuance as assets without the establishment of a specific loss reserve
is not warranted.
Management of the Bank, in determining the allowance for loan losses,
considers the risks inherent in its loan portfolio and changes in the nature and
volume of its loan activities, along with the general economic and real estate
market conditions. The Bank utilizes a two tier approach: (i) identification of
impaired loans and the establishment of specific loss allowances on such loans;
and (2) establishment of general valuation allowances on the remainder of its
loan portfolio. The Bank maintains a loan review system which allows for a
periodic review of its loan portfolio and the early identification of potential
impaired loans. Such system takes into consideration, among other things,
delinquency status, size of loans, type and estimated fair value of collateral
and financial condition of the borrowers. Specific loan loss allowances are
established for identified loans based on a review of such information. General
loan loss allowances are based upon a combination of factors including, but not
limited to, actual loan loss experience, composition of the loan portfolio,
current economic conditions and management's judgment. Although management
believes that adequate loan loss allowances are established, actual losses are
dependent upon future events and, as such, further additions to the level of the
allowance for loan losses may be necessary.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and
10
controls to identify, monitor and address asset quality problems; that
management has analyzed all significant factors that affect the collectibility
of the portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth in
the policy statement. Although management believes that, based on information
currently available to it at this time, its allowance for loan losses is
adequate, actual losses are dependent upon future events and, as such, further
additions to the level of allowances for loan losses may become necessary.
The Board reviews classified assets reports prepared by management and
classifies its assets on a quarterly basis. The Bank classifies assets in
accordance with the management guidelines described above. At December 31, 1999,
the Bank had $1.2 million, or 0.36% of total assets, of assets designated as
"Substandard," consisting of five one- to four-family mortgage loans, totalling
$553,000, and real estate owned totalling $691,000. At December 31, 1999, the
largest loan designated as "Substandard" had a carrying balance of $189,000, and
was a single-family mortgage loan. At December 31, 1999, no assets were
designated as "Doubtful" or "Loss."
11
The following table sets forth delinquencies in the Bank's
loan portfolio as of the dates indicated.
At December 31, 1999 At December 31, 1998
------------------------------------------------- ----------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
--------------------- ----------------------- --------------------- -----------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- -------- -------- --------
Loans: .................. (Dollars in thousands)
Residential Mortgage . 7 $ 369 11 $ 792 1 $ 15 14 $1,201
Commercial Mortgage .. -- -- -- -- -- -- 1 158
Construction and land -- -- -- -- -- -- 2 725
development
---- ---- ---- ---- ---- ---- ---- ----
Total loans ........ 7 $ 369 11 $ 792 1 $ 15 17 $2,084
==== ==== ==== ==== ==== ==== ==== ====
Delinquent loans to total
loans ............... 0.51% 0.24% 0.79% 0.51% 0.01% 0.01% 1.25% 1.46%
==== ==== ==== ==== ==== ==== ==== ====
At December 31, 1997
-----------------------------------------------------
60-89 Days 90 Days or More
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
-------- -------- -------- --------
Loans: (Dollars in thousands)
Residential Mortgage......... 10 $528 19 $1,652
Commercial Mortgage.......... -- -- 1 119
Construction and land -- -- 2 718
development............... ---- ---- ---- ------
Total loans................ 10 $528 22 $2,489
==== ==== ==== ======
Delinquent loans to total
loans......................... 0.72% 0.45% 1.59% 2.14%
==== ==== ==== ======
12
Non-Performing Assets and Impaired Loans. The following table sets
forth information regarding nonaccrual loans and REO. At December 31, 1999, REO
totalled $900,000 and consisted of nine properties. It is the policy of the Bank
to cease accruing interest on loans 90 days or more past due and to fully
reserve for all previously accrued interest. For the years ended December 31,
1999 and 1998, the amount of additional interest income that would have been
recognized on non-accrual loans if such loans had continued to perform in
accordance with their contractual terms was $23,000 and $162,000, respectively.
On January 1, 1995, the Bank adopted SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118. At December 31, 1999 and
1998, total impaired loans were $189,000 and $1.46 million, respectively. All
impaired loans are residential real estate mortgage loans which have been
measured for impairment using the fair value of the collateral method. During
the year ended December 31, 1999, the average recorded value of impaired loans
was $647,000. For these loans, interest income of $147,000 was recognized during
1999.
At December 31,
--------------------------------------------------
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
Nonaccrual loans:
Residential Mortgages.................................. $ 792 $1,201 $1,576 $1,733 $931
Commercial Mortgages................................... -- 158 119 431 380
Construction and land development...................... -- 725 718 705 734
------ ------ ------ ------ ------
Total nonaccrual loans............................... 792 2,084 2,413 2,869 2,045
Restructured loans:
Residential Mortgages.................................. 92 94 94 99 104
------ ------ ------ ------ ------
Total non-performing loans........................... 884 2,188 2,507 2,968 2,149
Real estate owned, net(1)................................. 900 582 1,215 1,394 1,352
------ ------ ------ ------ ------
Total non-performing assets.......................... $1,784 $2,770 $3,722 $4,362 $3,501
====== ====== ====== ====== ======
Non-performing loans as a
percent of total loans(2).............................. 0.57% 1.46% 2.16% 3.51% 2.46%
====== ====== ====== ====== ======
Non-performing assets as
a percent of total assets(3)........................... 0.51% 0.84% 1.24% 1.85% 1.57%
====== ====== ====== ====== ======
(1) REO balances are shown net of related valuation allowances. REO includes
$209,000 of property that is not considered substandard.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by the Bank as presenting
uncertainty with respect to the collectibility of interest or principal.
(3) Non-performing assets consist of non-performing loans and REO.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses in loans receivable which are deemed probable and estimable
based on information currently known to management. The allowance is based upon
a number of factors, including current economic conditions, actual loss
experience and industry trends. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to make additional
provisions for estimated loan losses based upon judgments different from those
of management. As of December 31, 1999 and 1998, the Bank's allowance for loan
losses was 0.90% and 1.20%, respectively, of total loans receivable and 176.8%
and 82.4%, respectively, of nonaccrual loans. The Bank had non-accrual loans of
$792,000 and $2.1 million at December 31, 1999 and 1998, respectively. The Bank
will continue to monitor and modify its allowances for loan losses as conditions
dictate. While management believes the Bank's allowance for loan losses is
sufficient to cover losses inherent in its loan portfolio at this
13
time, no assurances can be given that the Bank's level of allowance for loan
losses will be sufficient to cover future loan losses incurred by the Bank or
that future adjustments to the allowance for loan losses will not be necessary
if economic and other conditions differ substantially from the economic and
other conditions used by management to determine the current level of the
allowance for loan losses.
The Bank has established a standardized process to assess the adequacy
of the allowance for loan losses and to identify the risks inherent in the loan
portfolio. The process incorporates credit reviews and gives consideration to
areas of exposure such as concentrations of credit, local economic conditions,
trends in delinquencies, collateral coverage, the composition of the performing
and non-performing loan portfolios, and other risks inherent in the loan
portfolio.
Specific allocations of the allowance for loan losses are identified by
individual loan based upon a detailed credit review of each such loan. General
loan loss allowances are allocated to pools of loans categorized by type and
assigned allowance percentages which take into effect past charge-off history,
industry averages and current trends and risks. Finally, an unallocated portion
of the allowance is maintained to account for the general inherent risk in the
loan portfolio, known circumstances which are not addressed in the allocated
portion of the allowance (such as the increased dependence on outside mortgage
brokers for originations), and the necessary imprecision in the determination of
the allocation portion of the allowance.
Among the more significant situations and circumstances which are
considered within the unallocated portion of the allowance is that the Bank
began aggressively competing in the market for loan originations in early 1997
via various means not previously utilized, such as the use of outside mortgage
brokers and paying bonuses to inside loan origination personnel. In addition,
the Bank increased its advertising efforts and expanded its product line to
include product types with more risk, such as a first-time homeowner loan which
allows for higher than normal loan to collateral ratios. The loan portfolio grew
by $13.2 million or 9.2% in 1999, by $26.9 million or 23.1% in 1998 and by $31.6
million, or 37.4%, in 1997, due to these factors after declining in 1996 and
1995. The increased inherent risk associated with the aforementioned
circumstances are elements within the unallocated allowance. Finally, the
determination of the allocated portion of the allowance is highly subjective and
requires significant reliance on estimates, assumptions and judgments. Specific
allowances are typically based upon the appraised value of the underlying
collateral, which can vary based upon the particular appraiser involved, and
management's estimates of property disposal costs. General allowances are based
upon loss percentages applied to delineated loan categories. The loss
percentages are a particularly inexact science. As such, management has deemed
it prudent to recognize the inherent imprecision of the process by maintaining
what it believes to be a conservative, but appropriate level of unallocated
reserves.
The following table sets forth activity in the Bank's allowance for
loan losses for the periods set forth in the following table.
At or For the Years Ended December 31,
----------------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(Dollars in thousands)
Balance at beginning of period ......... $ 1,717 $ 1,885 $ 1,564 $ 1,200 $ 1,236
------- ------- ------- ------- -------
Provision for (recapture of) loan losses -- (131) 487 232 510
------- ------- ------- ------- -------
Charge-offs:
Mortgage loans:
One- to four-family .............. -- 37 60 -- --
Multi-family ..................... -- -- -- -- 56
Commercial real estate .............. -- -- 106 -- --
Construction and land development ... 317 -- -- -- 490
------- ------- ------- ------- -------
Total mortgage loans ............. 317 37 166 -- 546
------- ------- ------- ------- -------
Recoveries:
Construction and land development ... -- -- -- 132 --
------- ------- ------- ------- -------
Balance at end of period ............... $ 1,400 $ 1,717 $ 1,885 $ 1,564 $ 1,200
======= ======= ======= ======= =======
Ratio of net charge-offs during
the period to average gross loans
during the period ................... 0.21% 0.03% 0.17% (0.15)% 0.63%
======= ======= ======= ======= =======
Allowance for loan losses as a
percent of total loans .............. 0.90% 1.20% 1.62% 1.85% 1.38%
======= ======= ======= ======= =======
Allowance for loan losses as a
percent of non-performing loans ..... 158.37% 78.47% 75.19% 52.70% 55.84%
======= ======= ======= ======= =======
15
The following tables set forth the Bank's percent of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
At December 31, 1999
-------------------------------------
Percent of
Loans in
Percent of Each
Allowance Category
to Total to Total
Amount Allowance Loans
------ --------- -----
(Dollars in thousands)
Mortgage loans:
Residential .................................... $ 735 52.50% 88.83%
Commercial real estate ......................... 141 10.07 8.30
Construction and land development .............. 46 3.29 2.45
------ ------ ------
Total mortgage loans ......................... 922 65.86 99.58
Commercial loans ................................. -- -- 0.02
Consumer loans ................................... 6 0.43 0.40
------ ------ ------
928 66.29 100.00%
Unallocated ...................................... 472 33.71 ======
------ ------
Total allowance for loan losses .............. $1,400 100.00%
====== ======
At December 31,
-------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995
-------------------------- -------------------------- ------------------------- --------------------------
(Dollars in thousands)
Percent Percent Percent Percent
of Loans of Loans of Loans of Loans
Percent of in Each Percent of in Each Percent of in Each Percent of in Each
Allowance Category Allowance Category Allowance Category Allowance Category
to Total to Total to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------ --------- ----- ------ --------- ----- ------ --------- ----- ------ --------- -----
Mortgage loans:
Residential....... $ 763 44.44% 88.29% $621 32.94% 84.44% $511 32.67% 82.20% $413 34.42% 80.81%
Commercial real
estate.......... 122 7.11 8.11 112 5.94 9.21 184 11.77 14.53 190 15.83 14.56
Construction and
land
development..... 418 24.34 3.07 628 33.32 5.58 349 22.31 2.46 141 11.75 3.47
----- ----- ------ ---- ----- ---- --- ----- ---- --- ----- ----
Total mortgage 1,303 75.89 99.47 1,361 72.20 99.23 1,044 66.75 99.19 744 62.00 98.84
loans........
Commercial loans..... -- -- 0.04 -- -- 0.05 -- -- 0.10 1 0.08 0.27
Consumer loans....... 6 0.35 0.49 6 0.32 0.72 4 0.26 0.71 6 0.50 0.89
----- ----- ------ ---- ----- ---- ----- ----- ---- --- ----- ----
1,309 76.24 100.00% 1,367 72.52 100.00% 1,048 67.01 100.00% 751 62.58 100.00%
====== ====== ====== ======
Unallocated.......... 408 23.76 518 27.48 516 32.99 449 37.42
------ ----- --- ----- --- ----- --- -----
Total............. $1,717 100.00% $1,885 100.00% $1,564 100.00% $1,200 100.00%
====== ====== ====== ====== ====== ====== ====== ======
16
Real Estate Owned. At December 31, 1999, the Company and the Bank had
$900,000 of real estate owned consisting of nine properties, of which seven were
acquired through foreclosure. When a property is acquired through foreclosure or
deed in lieu of foreclosure, it is initially recorded at the lower of the
recorded investment in the corresponding loan or the fair value of the related
assets at the date of foreclosure, less costs to sell. Thereafter, if there is a
further deterioration in value, a specific valuation allowance is provided via a
charge to operations for the diminution in value. It is the policy of the
Company and the Bank to have obtained an appraisal on all real estate subject to
foreclosure proceedings prior to the time of foreclosure, to require appraisals
on a periodic basis on foreclosed properties and to conduct inspections on
foreclosed properties.
Investment Activities
The Company can invest in common and preferred stocks, limited
partnerships and all investments in which the Bank is permitted to invest.
Anything else requires the Board of Director's approval. Federally chartered
savings institutions have the authority to invest in various types of liquid
assets, including United States Treasury obligations, securities of various
federal agencies, certificates of deposit of insured banks and savings
institutions, bankers' acceptances, repurchase agreements and federal funds.
Subject to various restrictions, federally chartered savings institutions may
also invest their assets in commercial paper, investment-grade corporate debt
securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly. Additionally, the Bank must maintain minimum levels of investments
that qualify as liquid assets under OTS regulations. Historically, the Bank has
maintained liquid assets above the minimum OTS requirements and at a level
considered to be adequate to meet its normal daily activities.
The Bank's current policies generally limit securities investments to
U.S. Government and agency securities, municipal bonds and corporate debt
obligations and corporate equities. In addition, the Bank's policies permit
investments in mortgage-backed securities, including securities issued and
guaranteed by FNMA, FHLMC and GNMA. The Bank's current securities investment
strategy is to continue to emphasize the purchase of mortgage-backed securities
and U.S. Government and agency obligations as well as state and municipal
obligations for purposes of interest rate risk management.
At December 31, 1999, the Company had $165.7 million in securities,
consisting primarily of mortgage-backed securities, U.S. Government and agency
obligations, trust preferred securities and municipal obligations. SFAS No. 115
requires the Company to designate its securities as held-to-maturity,
available-for-sale or trading depending on the Company's intent regarding its
investments. The Company does not currently maintain a trading portfolio of
securities. At December 31, 1999, all of the Company's mortgage-backed
securities were classified as held-to-maturity. Also at that date, 6.6% of the
Company's investment securities were classified as available-for-sale and 93.4%
were classified as held-to-maturity. Of the Company's total investment
securities and mortgage-backed securities portfolio, the Company's securities
classified as held-to-maturity had an aggregate market value of $157.7 million
and an amortized cost of $162.8 million. The Company's securities classified as
available-for-sale had an aggregate market value of $2.9 million and an
amortized cost of $3.0 million at December 31, 1999.
Mortgage-Backed Securities. The Bank purchases mortgage-backed
securities in order to: (i) generate positive interest rate spreads with minimal
administrative expense; (ii) reduce its credit risk as a result of the guarantee
provided by FHLMC, FNMA and GNMA; (iii) utilize these securities as collateral
for borrowings; and (iv) increase the liquidity of the Bank. The Bank has
primarily invested in mortgage-backed securities issued or sponsored by FNMA,
FHLMC and GNMA and private issuers. At December 31, 1999, mortgage-backed
securities totalled $121.2 million, or 34.8% of total assets and 36.8% of total
interest-earning
17
assets, and all were classified as held-to-maturity. At December 31, 1999, 49.2%
of the mortgage-backed securities were adjustable-rate and 50.8% were
fixed-rate. The mortgage-backed securities portfolio had coupon rates ranging
from 4.97% to 15.00% and had a weighted average yield of 6.55% at December 31,
1999. The estimated fair value of the Bank's mortgage-backed securities held to
maturity at December 31, 1999, was $118.8 million, which is $2.4 million less
than the amortized cost of $121.2 million.
Mortgage-backed securities are created by the pooling of mortgages and
issuance of a security with an interest rate which is less than the interest
rate on the underlying mortgage. Mortgage-backed securities typically represent
a participation interest in a pool of single-family or multi-family mortgages,
although the Bank focuses its investments on mortgage-backed securities backed
by single-family mortgages. The issuers of such securities (generally U.S.
Government agencies and government sponsored enterprises, including FNMA, FHLMC
and GNMA) pool and resell the participation interests in the form of securities
to investors such as the Bank and guarantee the payment of principal and
interest to investors. Mortgage-backed securities generally yield less than the
loans that underlie such securities because of the cost of loan servicing and
payment guarantees. In addition, mortgage-backed securities are usually more
liquid than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Bank. Investments in mortgage-backed
securities involve a risk that actual prepayments will differ from estimated
prepayments used in pricing the security at the time of purchase, which may
require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby changing the net yield on such
securities. There is also reinvestment risk associated with the cash flows from
such securities on in the event such securities are redeemed by the issuer. In
addition, the market value of such securities may be adversely affected by
changes in interest rates. The Bank estimates prepayments for its
mortgage-backed securities at purchase to ensure that prepayment assumptions are
reasonable considering the underlying collateral for the mortgage-backed
securities at issue and current mortgage interest rates and to determine the
yield and estimated maturity of its mortgage-backed security portfolio. Of the
Bank's $121.2 million mortgage-backed securities portfolio at December 31, 1999,
$2.5 million with a weighted average yield of 6.64% had contractual maturities
within five years and $118.7 million with a weighted average yield of 6.55% had
contractual maturities over five years. However, the actual maturity of a
mortgage-backed security may be less than its stated maturity due to prepayments
of the underlying mortgages. Prepayments that are faster than anticipated may
shorten the life of the security and may result in a loss of any premiums paid
and thereby reduce the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, the difference between the interest
rates on the underlying mortgages and the prevailing mortgage interest rates
generally is the most significant determinant of the rate of prepayments. During
periods of declining mortgage interest rates, refinancing generally increases
and accelerates the prepayment of the underlying mortgages and the related
security. Under such circumstances, the Bank may be subject to reinvestment risk
because, to the extent that the Bank's mortgage-backed securities prepay faster
than anticipated, the Bank may not be able to reinvest the proceeds of such
repayments and prepayments at a comparable rate.
U.S. Government and Agency Obligations and Obligations of States and
Municipalities. At December 31, 1999, the U.S. Government and Agency securities
portfolio totalled $33.8 million, or 9.7% of total assets, $30.9 million of
which were classified as held-to-maturity. In addition, the Bank held $733,000
in obligations of a New Jersey municipal subdivision.
Trust Preferred Securities. At December 31, 1999, the investment
portfolio included $10.0 million, or 2.9% of total assets, in trust preferred
securities, all of which were purchased in 1998. Trust preferred securities are
non-perpetual cumulative preferred stock issued by a wholly owned subsidiary of
a bank and are classified as debt securities under generally accepted accounting
principles. Securities of this nature are permissible investments for banks and
thrifts provided they are of investment grade quality and are rated as such by
any of the top rating services. Before purchasing these investments, the Bank
researched extensively
18
the permissibility and suitability of these investments and whether they had a
place on the balance sheet of the Bank. The Bank's policy as approved by the
Board of Directors allows for the purchase of investments which are considered
investment grade and are permissible investments under OTS regulations.
Securities considered investment grade must be rated in one of the four highest
categories by a nationally recognized statistical rating agency. Additionally,
the Board's policy limits these type of investments to a maximum aggregate
dollar amount of $10,000,000. The Bank's conclusion was that these investments
had a place on the balance sheet and, during 1998, $10.0 million of trust
preferred security investments in five of the most well known large commercial
banks in the eastern United States was made. In addition to $8.9 million of such
securities owned by the Bank, the Company owns one trust preferred security
which is carried at $1.1 million.
During 1999, the OTS reviewed these securities and concluded that, in
its opinion, three of the five investments were not of a type suitable for the
Bank. Accordingly, the OTS mandated that the Bank liquidate these issues as soon
as possible without incurring a loss. The Company determined that these three
securities should be retained and thus the Bank may transfer them to the Company
over a period of time. One of the three issues was transferred during the fourth
quarter of 1999.
The $10.0 million in trust preferred securities is a combination of
$6.8 million in floating rate (spread to Libor) investments and $3.2 million in
fixed rate investments. The adjustable investments offer quarterly interest
adjustments, uncapped coupons and call protection unavailable in most other
types of adjustable investments. The fixed rate investments offer yield for the
balance sheet and presented a cost of funds spread which was unavailable in
other types of alternative investments. These investments present the normal
type of risk to the Company and the Bank that is associated with other forms of
marketable debt securities. These include credit risk, which is associated with
the underlying creditworthiness of the issuer, liquidity risk, which is
associated with the ability to dispose of a security in a reasonable time period
at a reasonable price, and call risk, which is associated with these securities
having call provisions after 10 years.
19
The following table sets forth certain information regarding the
amortized cost and fair value of securities at the dates indicated.
At December 31,
-------------------------------------------------------------------------
1999 1998 1997
------------------- ------------------- ----------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(In thousands)
Investment securities
available-for-sale(1):
U.S. Government and Agency
obligations ....................... $ 2,998 $ 2,924 $ 7,983 $ 8,282 $ 6,980 $ 7,081
Investment securities held-to-maturity (1):
U.S. Government and
Agency obligations ................... 30,856 28,904 25,582 25,884 22,929 23,339
Trust preferred securities ............. 9,993 9,286 10,903 10,619 -- --
Obligations of states and
municipal subdivisions ............... 733 679 388 388 -- --
------- ------- ------- ------- ------- -------
41,582 38,869 36,873 36,891 22,929 23,339
------- ------- ------- ------- ------- -------
Federal Home Loan Bank of
New York stock (2) ..................... 3,273 3,273 2,607 2,607 2,184 2,184
------- ------- ------- ------- ------- -------
Total ................................ $47,853 $45,066 $47,463 $47,780 $32,093 $32,604
======= ======= ======= ======= ======= =======
(1) Available-for-sale securities are carried at fair value while
held-to-maturity securities are carried at amortized cost.
(2) Investment is required by regulation. As the security is not readily
marketable, its cost approximates fair value.
The following table sets forth investment securities activities for the
periods indicated.
At December 31,
--------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Investment securities:
Investment securities, beginning of period(1) $ 45,156 $ 30,009 $ 24,124
-------- -------- --------
Purchases:
Investment securities--held-to-maturity .. 21,045 23,640 10,400
Investment securities--available-for-sale -- 1,000 7,034
Calls:
Investment securities--held-to-maturity .. (14,550) (7,740) (10,000)
Investment securities--available-for-sale -- -- --
Maturities:
Investment securities--held-to-maturity .. (1,150) (2,150) --
Investment securities--available-for-sale -- -- (115)
Sales:
Investment securities--held-to-maturity .. (908) -- --
Investment securities--available-for-sale (4,987) -- (1,608)
Amortization of premiums and discounts ...... 274 199 52
Unrealized gain (loss) ...................... (374) 198 122
-------- -------- --------
Net increase in investment securities ... (650) 15,147 5,885
-------- -------- --------
Investment securities, end of period ........ $ 44,506 $ 45,156 $ 30,009
======== ======== ========
(1) Includes investment securities available-for-sale.
20
The following table sets forth certain information regarding the
amortized cost and fair values of the Bank's mortgage-backed securities, all of
which are held-to-maturity, at the dates indicated.
At December 31,
----------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ----------------------------
Percent Percent Percent
Amortized of Fair Amortized of Fair Amortized of Fair
Cost Total(1) Value Cost Total(1) Value Cost Total(1) Value
---- -------- ----- ---- -------- ----- ---- -------- -----
(Dollars in thousands)
By Issuer:
GNMA...................... $51,616 42.58% $51,762 $58,816 53.29% $59,500 $ 78,657 60.42% $ 79,775
FHLMC..................... 18,781 15.49 18,576 26,699 24.19 27,019 26,551 20.40 26,749
FNMA...................... 16,894 13.94 16,787 20,101 18.21 20,267 24,959 19.17 25,150
Other..................... 33,932 27.99 31,682 4,760 4.31 4,727 7 0.01 7
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed
securities (1)(2)... $121,223 100.00% $118,807 $110,376 100.00% $111,513 $130,174 100.00% $131,681
======== ====== ======== ======== ====== ======== ======== ====== ========
By Coupon Type:
Adjustable-rate........... $59,667 49.22% $59,764 $70,919 64.25% $71,390 $ 82,938 63.71% $ 83,740
Fixed-rate................ 61,556 50.78 59,043 39,457 35.75 40,123 47,236 36.29 47,941
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed
securities (1)(2)... $121,223 100.00% $118,807 $110,376 100.00% $111,513 $130,174 100.00% $131,681
======== ====== ======== ======== ====== ======== ======== ====== ========
(1) Based on amortized cost.
(2) Includes net unamortized (discount) premiums of $(37), $206 and $243 at
December 31, 1999, 1998 and 1997, respectively.
The following table sets forth the Bank's mortgage-backed securities
activities for the periods indicated.
For the Years
Ended December 31,
--------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Beginning balance ............................. $110,376 $130,174 $113,254
Purchases................................... 46,531 21,892 37,026
Principal repayments........................ (35,580) (41,587) (20,084)
Net amortization and accretion of
discounts and premiums................... (104) (103) (22)
-------- -------- --------
Ending balance................................. $121,223 $110,376 $130,174
======== ======== ========
21
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of investment securities
available-for-sale and held-to-maturity and mortgage-backed securities
held-to-maturity as of December 31, 1999.
At December 31, 1999
--------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years More than Ten Years
-------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- -----
(Dollars in thousands)
Investment securities available-for-sale:
U.S. Treasury and Government
agency obligations.................. $ -- --% $2,015 6.67% $ -- --% $ 909 7.00%
===== ====== ====== =======
Investment securities held-to-maturity:
U.S. Treasury and Government
agency obligations.................. $ -- -- $-- -- $8,000 6.83 $22,856 6.84
Municipal obligations.................. 150 3.65 -- -- -- -- 583 4.47
Trust preferred securities............. -- -- -- -- -- -- 9,993 7.02
----- ------ ------ -------
Total investment securities held
to maturity....................... $150 3.65 $-- -- $8,000 6.83 $33,432 6.85
===== ====== ====== =======
Mortgage-backed securities held-to-maturity:
Adjustable-rate:
GNMA................................ $ -- -- $-- -- $ -- -- $44,060 6.21
FHLMC............................... -- -- -- -- 547 6.63 3,684 6.82
FNMA................................ -- -- -- -- -- -- 11,376 6.24
----- ------ ------ -------
Total........................ -- -- -- -- 547 6.63 59,120 6.25
----- ------ ------ -------
Fixed-rate:
GNMA................................ -- -- 2 8.00 6,073 7.38 1,481 8.43
FHLMC............................... -- -- 2,528 6.64 6,145 6.72 5,877 7.17
FNMA................................ -- -- -- -- 511 7.00 5,007 7.05
Other............................... -- -- -- -- -- -- 33,932 6.61
----- ------ ------ -------
Total........................ -- -- 2,530 6.64 12,729 7.05 46,297 6.79
----- ------ ------ -------
Total mortgage-backed securities
held-to-maturity....................... $ -- -- $2,530 6.64 $13,276 7.03 $105,417 6.49
===== ====== ====== =======
-------------------
Total
------------------
Weighted
Carrying Average
Value Yield
----- -----
Investment securities available-for-sale:
U.S. Treasury and Government
agency obligations.................. $ 2,924 6.78%
=======
Investment securities held-to-maturity:
U.S. Treasury and Government
agency obligations.................. $30,856 6.83
Municipal obligations.................. 733 4.30
Trust preferred securities............. 9,993 7.02
-------
Total investment securities held
to maturity....................... $41,582 6.83
=======
Mortgage-backed securities held-to-maturity:
Adjustable-rate:
GNMA................................ $44,060 6.21
FHLMC............................... 4,231 6.80
FNMA................................ 11,376 6.24
-------
Total........................ 59,667 6.26
-------
Fixed-rate:
GNMA................................ 7,556 7.59
FHLMC............................... 14,550 6.89
FNMA................................ 5,518 7.04
Other............................... 33,932 6.61
-------
Total........................ 61,556 6.84
-------
Total mortgage-backed securities
held-to-maturity....................... $121,223 6.55
========
22
Sources of Funds
General. Deposits, loan repayments and prepayments, security
maturities, cash flows generated from operations and FHLB borrowings are the
primary sources of the Bank's funds for use in lending, investing and for other
general purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. The Bank's deposits consist of savings, checking
accounts, NOW accounts, money market and club accounts, certificate of deposit
accounts and Individual Retirement Accounts. For the year ended December 31,
1999, average core deposits, which include all non-certificate deposits,
represented 40.2% of total average deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates,
prevailing interest rates and competition. The Bank's deposits are obtained
predominantly from the areas in which its branch offices are located. The Bank
has historically relied primarily on customer service and long-standing
relationships with customers to attract and retain these deposits; however,
market interest rates and rates offered by competing financial institutions
significantly affect the Bank's ability to attract and retain deposits. The Bank
uses traditional means of advertising its deposit products through print media
and generally does not solicit deposits from outside its market area. The Bank
does not actively solicit certificate accounts in excess of $100,000 or use
brokers to obtain deposits. At December 31, 1999, 79.8% of the Bank's
certificate of deposit accounts had terms of less than twelve months.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Years Ended December 31,
-----------------------------------------
1999 1998 1997
--------- --------- ---------
(In thousands)
Beginning balance .................................. $ 238,313 $ 238,192 $ 179,946
--------- --------- ---------
Purchase of deposits from another ............... -- -- 51,007
institution
Net deposits (withdrawals) ...................... (11,919) (9,626) (850)
Interest credited ............................... 8,584 9,747 8,089
--------- --------- ---------
Increase in deposit accounts ....................... (3,335) 121 58,246
--------- --------- ---------
Ending balance ..................................... $ 234,978 $ 238,313 $ 238,192
========= ========= =========
At December 31, 1999, the Bank had $18.2 million in certificate
accounts in amounts of $100,000 or more maturing as follows.
Weighted
Maturity Period Amount Average Rate
- - --------------- -------- ------------
(Dollars in thousands)
Three months or less $6,330 5.11%
Over 3 through 6 months 3,344 5.19
Over 6 through 12 months 5,849 5.21
Over 12 months. 2,633 5.60
-------
Total.......... $18,156 5.23%
=======
23
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. Averages for the periods presented
utilize month-end balances.
For the Years Ended December 31,
-------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------- ----------------------------- -----------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
Demand accounts..................... $36,308 15.35% 0.78% $33,631 14.10% 1.01% $ 24,863 12.60% 1.18%
Savings and Club accounts........... 58,727 24.84 2.06 62,120 26.05 2.69 53,221 26.97 2.55
Certificates of deposit............. 141,432 59.81 5.01 142,714 59,85 5.42 119,272 60.43 5.40
-------- ------ -------- ------ -------- ------
Total...................... $236,467 100.00% 3.98 $238,465 100.00% 4.09% $197,356 100.00% 4.10%
======== ====== ======== ====== ======== ======
Certificate accounts(1):
Less than six months............. $71,619 51.11% 4.84% $70,208 49.74% 5.15% $ 70,186 49.32% 5.24%
Over six through 12 months....... 40,181 28.67 5.11 48,109 34.08 5.32 44,047 30.95 5.59
Over 12 months through 36 months. 24,400 17.41 5.49 19,572 13.86 5.46 25,309 17.78 5.96
Over 36 months................... 3,940 2.81 5.81 3,280 2.32 5.75 2,782 1.95 6.96
-------- ------ -------- ------ -------- ------
Total certificate accounts. $140,140 100.00% 5.05 $141,169 100.00% 5.26 $142,324 100.00% 5.51%
======== ====== ======== ====== ======== ======
(1) Based on remaining maturity of certificates calculated as of the end of the
period.
24
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1999.
Period to Maturity from December 31, 1999
-----------------------------------------------------------------------
Less than One to Two to Three to Four to After
One Year Two years Three years Four years Five years Five Years
-------- --------- ----------- ---------- ---------- ----------
(In thousands)
Certificate accounts:
4.00% and below............. $ 2,808 $ -- $ -- $ -- $ -- $ --
4.01 to 5.00%............... 59,560 5,153 851 143 177 165
5.01 to 6.00%............... 42,420 13,756 1,967 1,108 981 50
6.01 to 7.00%............... 6,314 1,942 731 276 890 150
7.01 to 8.00%............... 424 -- -- -- -- --
Over 9.00%.................. 21 -- -- -- -- --
-------- ------- ------- ------- ------- -------
$111,547 $20,851 $3,549 $1,527 $2,048 $ 365
======== ======= ====== ====== ====== =====
Accrued interest payable.......
Total.......................
December 31,
----------------------------------
1999 1998 1997
-------- -------- -------
Certificate accounts:
4.00% and below............. $ 2,808 $ 4,851 $ 2,538
4.01 to 5.00%............... 66,049 45,485 33,593
5.01 to 6.00%............... 60,282 77,729 88,877
6.01 to 7.00%............... 10,303 10,741 14,451
7.01 to 8.00%............... 424 2,129 2,069
Over 9.00%.................. 21 -- 536
------- -------- -------
139,887 140,935 142,064
Accrued interest payable....... 253 234 260
------- -------- -------
Total....................... $140,140 $141,169 $142,324
======== ======== ========
25
Borrowings. The Bank utilizes borrowings from the FHLB as an
alternative to retail deposits to fund its operations as part of its operating
strategy. These FHLB borrowings are collateralized primarily by certain of the
Bank's mortgage-related securities and secondarily by the Bank's investment in
capital stock of the FHLB. FHLB borrowings are made pursuant to several
different credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time to time in accordance
with the policies of the FHLB. See "Regulation and Supervision--Federal Home
Loan Bank System." At December 31, 1999, the Bank had $64.3 million in
outstanding FHLB borrowings, compared to $42.0 million at December 31, 1998.
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated.
At or For the Years
Ended December 31,
---------------------------------
1999 1998 1997
------- ------- -------
(Dollars in thousands)
Average balance outstanding.................... $57,756 $42,364 $26,223
Maximum amount outstanding at any
month-end during the period................ 65,453 52,145 43,675
Balance outstanding at end of period........... 64,340 42,010 30,300
Weighted average interest rate
during the period........................... 5.67% 5.83% 5.97%
Weighted average interest rate at
end of period............................... 5.66% 5.69% 6.08%
Subsidiary Activities
The Company is the parent corporation of two wholly owned subsidiaries,
the Bank and West Essex Property Company ("West Essex Property"). West Essex
Property was formed in April 1999 to purchase a parcel of land located in Sussex
County, New Jersey from the Company. Upon the purchase of this parcel of land,
West Essex Property was to have entered into an arrangement to lease the
property to a restaurant chain. As of December 31, 1999, West Essex Property has
neither purchased the parcel of land nor entered into a lease arrangement. As of
December 31, 1999 and for the year then ended, West Essex Property had no
operations, assets, liabilities or equity. In addition, the Bank is the parent
corporation of one wholly owned subsidiary corporation, West Essex Insurance
Agency ("WEIA"). WEIA was formed in December 1982 to offer insurance products
and tax-deferred annuities through an agent. Originally, these products were
sold at one of the Bank's branches. Commencing in 1993, customers have been
referred to Anthony R. Davis Agency at an off-site location. WEIA receives a fee
for each customer referral resulting in the purchase of an insurance and/or
annuity product. Sales of annuity products totalled $612,894 for the year ended
December 31, 1999. WEIA's earnings are at a nominal level since management
decided in early 1994 to de-emphasize this activity due to the lack of demand
and controversial publicity associated with uninsured annuity products.
Personnel
As of December 31, 1999, the Company had 49 authorized full-time
employee positions and three authorized part-time employee positions. The
employees are not represented by a collective bargaining unit and the Bank
considers its relationship with its employees to be good.
26
REGULATION AND SUPERVISION
General
The Bank is subject to extensive regulation, examination and
supervision by the OTS, as its chartering agency, and the FDIC, as the deposit
insurer. The Bank is a member of the FHLB System. The Bank's deposit accounts
are insured up to applicable limits by the Savings Association Insurance Fund
("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the
FDIC concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to test the Bank's compliance with various
regulatory requirements. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the MHC and the Bank and their
operations. The MHC, as a federal mutual holding company and the Company, as a
federal corporation, will also be required to file certain reports with, and
otherwise comply with the rules and regulations of the OTS.
The following summary of the regulation and supervision of savings
associations and their holding companies does not purport to be a complete
description of the applicable statutes and regulations and is qualified in its
entirety by reference to such statutes and regulations.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are
governed by the Home Owners Loan Act (the "HOLA") and, in certain respects, the
Federal Deposit Insurance Act (the "FDI Act") and the regulations issued by the
agencies to implement these statutes. These laws and regulations delineate the
nature and extent of the activities in which federal associations may engage. In
particular, many types of lending authority for federal associations, e.g.,
commercial, non-residential real property loans and consumer loans, are limited
to a specified percentage of the institution's capital or assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are
generally subject to the national bank limit on loans-to-one borrower.
Generally, this limit is 15% of the Bank's unimpaired capital and surplus, plus
an additional 10% of unimpaired capital and surplus, if such loan is secured by
readily-marketable collateral, which is defined to include certain financial
instruments and bullion. At December 31, 1999, the Bank's regulatory limit on
loans-to-one borrower was $5.7 million. At December 31, 1999, the Bank's largest
aggregate amount of loans-to-one borrower was $1.6 million, consisting of two
commercial real estate loans.
QTL Test. The HOLA requires savings institutions to meet a qualified
thrift lender ("QTL") test. Under the QTL test, a savings association is
required to qualify as a "domestic building and loan association" as that term
is defined in the Code or maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed and related
securities) in at least nine months out of each 12 month period. A savings
association that fails the QTL test must either convert to a bank charter or
operate under certain restrictions. As of December 31, 1999, the Bank maintained
81.5% of its portfolio assets in qualified thrift investments and, therefore,
met the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by a savings institution, including cash
dividends, payments to repurchase its shares and payments to shareholders of
another institution in a cash-out merger. The rule effective through the first
quarter of 1999 established three tiers of
27
institutions based primarily on an institution's capital level. An institution
that exceeded all capital requirements before and after a proposed capital
distribution ("Tier 1 Association") and had not been advised by the OTS that it
was in need of more than normal supervision, could, after prior notice but
without obtaining approval of the OTS, make capital distributions during the
calendar year equal to the greater of (i) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by one-half the
excess capital over its capital requirements at the beginning of the calendar
year or (ii) 75% of its net income for the previous four quarters. Any
additional capital distributions required prior regulatory approval. At December
31, 1999, the Bank was a Tier 1 Association.
Effective April 1, 1999, the OTS's capital distribution regulation
changed. Under the new regulation, an application to and the prior approval of
the OTS is required prior to any capital distribution if the institution does
not meet the criteria for "expedited treatment" of applications under OTS
regulations (i.e., generally, examination ratings in the two top categories),
the total capital distributions for the calendar year exceed net income for that
year plus the amount of retained net income for the preceding two years, the
institution would be undercapitalized following the distribution or the
distribution would otherwise be contrary to a statute, regulation or agreement
with OTS. If an application is not required, the institution must still provide
prior notice to OTS of the capital distribution. In the event the Bank's capital
fell below its regulatory requirements or the OTS notified it that it was in
need of more than normal supervision, the Bank's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus
short-term borrowings. Monetary penalties may be imposed for failure to meet
these liquidity requirements. The Bank's average liquidity ratio for December
31, 1999 was 25.4%, which exceeded the applicable requirements. The Bank has
never been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general assessment,
paid on a semi-annual basis, is based upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the Bank's latest
quarterly Thrift Financial Report. The assessments paid by the Bank for the year
ended December 31, 1999 totaled $74,000.
Branching. OTS regulations permit federally chartered savings
associations to branch nationwide under certain conditions. Generally, federal
savings associations may establish interstate networks and geographically
diversify their loan portfolios and lines of business. The OTS authority
preempts any state law purporting to regulate branching by federal savings
associations.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Company
and any non-savings institution subsidiaries that the Company may establish) is
limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A
restricts the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and also
limits the aggregate amount of transactions with all affiliates to 20% of the
savings institution's capital and surplus. Certain transactions with affiliates
are required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B generally requires that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies. A savings association
also is prohibited from extending credit to any affiliate engaged in activities
not permitted for a bank holding company and may not purchase the securities of
an affiliate (other than a subsidiary).
28
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders ("insiders"), as well as entities such persons control, is
also governed by federal law. Such loans are required to be made on terms
substantially the same as those offered to unaffiliated individuals and not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to have an adverse effect on an insured institution.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1.0 million per
day in especially egregious cases. Under the FDI Act, the FDIC has the authority
to recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal and state law also establishes criminal penalties for
certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. If the appropriate federal
banking agency determines that an institution fails to meet any standard
prescribed by the Guidelines, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard, as
required by the FDI Act. The final regulations establish deadlines for the
submission and review of such safety and soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage ratio and an 8% risk-based capital ratio. Effective April
1, 1999, however, the minimum leverage ratio increased to 4% for all
institutions except those with the highest rating on the CAMELS financial
institution rating system. In addition, the prompt corrective action standards
discussed below also establish, in effect, a minimum 2% tangible capital
standard, a 4% leverage ratio (3% for institutions receiving the highest rating
on the CAMEL financial institution rating system), and, together with the
risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The
OTS regulations also require that, in meeting the tangible, leverage and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
29
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
The capital regulations also incorporate an interest rate risk
component. Savings institutions with "above normal" interest rate risk exposure
are subject to a deduction from total capital for purposes of calculating their
risk-based capital requirements. For the present time, the OTS has deferred
implementation of the interest rate risk component. At December 31, 1999, the
Bank met each of its capital requirements.
The following table presents the Bank's capital position at December
31, 1999.
Capital
-------------------------
Actual Required Excess Actual Required
Capital Capital Amount Percent Percent
------- ------- ------ ------- -------
(Dollars in thousands)
Tangible............ $36,592 $5,135 $31,457 10.69% 1.5%
Core (Leverage)..... 36,592 13,693 22,899 10.69% 4.0%
Risk-based.......... 37,992 10,645 27,347 28.55% 8.0%
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of capitalization. Generally, a savings institution that
has a total risk-based capital of less than 8% or a leverage ratio or a Tier 1
capital ratio that is less than 4% is considered to be undercapitalized. A
savings institution that has a total risk-based capital less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the banking regulator is required to appoint a receiver or conservator for an
institution that is critically undercapitalized. The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date an association receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions may become immediately applicable to the
institution depending upon its category, including, but not limited to,
increased monitoring by regulators, restrictions on growth, and capital
distributions and limitations on expansion. The OTS could also take any one of a
number of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The Bank is a member of the SAIF. The
FDIC maintains a risk-based assessment system by which institutions are assigned
to one of three categories based on their capitalization and one of three
subcategories based on examination ratings and other supervisory information. An
institution's assessment rate depends upon the categories to which it is
assigned. Assessment rates for SAIF member institutions are determined
semiannually by the FDIC and currently range from zero basis points for the
healthiest institutions to 27 basis points for the riskiest.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 1999,
FICO payments for SAIF members approximated six basis points, while Bank
Insurance Fund ("BIF") members paid
30
approximately one basis point. By law, there was equal sharing of FICO payments
between SAIF and BIF members on January 1, 2000.
The Bank's assessment rate for fiscal 1999 was zero basis points and no
premium was paid for this period. Payments toward the FICO bonds amounted to
$142,000. The FDIC has authority to increase insurance assessments. A
significant increase in SAIF insurance premiums would likely have an adverse
effect on the operating expenses and results of operations of the Association.
Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that
the institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Community Reinvestment Act. Under the Community Reinvestment Act, as
amended ("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA requires the OTS, in connection with its examination of a savings
institution, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications by such institution. The FIRREA amended the CRA to require the OTS
to provide a written evaluation of an institution's CRA performance utilizing a
four-tiered descriptive rating system, which replaced the five-tiered numerical
rating system. The Bank's latest CRA rating received from the OTS was
"Satisfactory."
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB of New York, is required to
acquire and hold shares of capital stock in the FHLB in an amount at least equal
to 1% of the aggregate principal amount of its unpaid residential mortgage loans
and similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at December 31, 1999 of
$3.3 million. FHLB borrowings must be secured by specified types of collateral
and all long-term borrowings may only be obtained for the purpose of providing
funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended December 31, 1999, 1998 and 1997,
dividends from the FHLB to the Bank amounted to approximately $207,000, $180,000
and $126,000, respectively. If dividends were reduced, the Bank's net interest
income would likely also be reduced. Further, there can be no assurance that the
impact of recent or future legislation on the FHLBs will not also cause a
decrease in the value of FHLB stock held by the Bank, if any.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be maintained
31
against aggregate transaction accounts as follows: for accounts aggregating
$44.3 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $44.3 million, the
reserve requirement is $1.329 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $44.3 million. The first $5.0 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained in
the form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
Holding Company Regulation
General. The Company is a federal savings and loan holding company
within the meaning of the HOLA. As such, the Company is registered with the OTS
and is subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the OTS has enforcement authority over the Company
and its non-savings institution subsidiaries. Among other things, this authority
permits the OTS to restrict or prohibit activities that are determined to be a
serious risk to the subsidiary savings institution. The Bank must notify the OTS
30 days before declaring any dividend to the Company.
Restrictions Applicable to Mutual Holding Companies. Pursuant to
Section 10(o) of the HOLA and the Regulations, a mutual holding company, such as
the MHC, may engage in the following activities: (i) investing in the stock of a
savings association; (ii) acquiring a mutual association through the merger of
such association into a savings association subsidiary of such holding company
or an interim savings association subsidiary of such holding company; (iii)
merging with or acquiring another holding company, one of whose subsidiaries is
a savings association; (iv) investing in a corporation, the capital stock of
which is available for purchase by a savings association under federal law or
under the law of any state where the subsidiary savings association or
associations share their home offices; (v) furnishing or performing management
services for a savings association subsidiary of such company; (vi) holding,
managing or liquidating assets owned or acquired from a savings subsidiary of
such company; (vii) holding or managing properties used or occupied by a savings
association subsidiary of such company properties used or occupied by a savings
association subsidiary of such company; (viii) acting as trustee under deeds of
trust; (ix) any other activity (A) that the Federal Reserve Board, by
regulation, has determined to be permissible for bank holding companies under
Section 4(c) of the Bank Holding Company Act (the "BHC Act"), unless the
Director, by regulation, prohibits or limits any such activity for savings and
loan holding companies; or (B) in which multiple savings and loan holding
companies were authorized (by regulation) to directly engage on March 5, 1987;
and (x) purchasing, holding, or disposing of stock acquired in connection with a
qualified stock issuance if the purchase of such stock by such savings and loan
holding company is approved by the Director.
Financial Institution Modernization Legislation. Recently enacted
federal legislation designed to modernize the regulation of the financial
services industry expands the ability of bank holding companies to affiliate
with other types of financial services companies such as insurance companies and
investment banking companies. The legislation also expanded the activities
permitted for mutual savings and loan holding companies to also include any
activity permitted a "financial holding company" under the legislation,
including a broad array of insurance and securities activities.
The HOLA prohibits a savings and loan holding company, including a
federal mutual holding company, directly or indirectly, or through one or more
subsidiaries, from acquiring more than 5% of the voting stock of another savings
institution, or holding company thereof, without prior written approval of the
OTS; from acquiring or retaining, with certain exceptions, more than 5% of a
non-subsidiary holding company or savings association. The HOLA also prohibits a
savings and loan holding company from acquiring more than 5% of a company
engaged in activities other
32
than those authorized for savings and loan holding companies by the HOLA; or
acquiring or retaining control of a depository institution that is not insured
by the FDIC. In evaluating applications by holding companies to acquire savings
institutions, the OTS must consider the financial and managerial resources and
future prospects of the company and institution involved, the effect of the
acquisition on the risk to the insurance funds, the convenience and needs of the
community and competitive factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
If the savings institution subsidiary of a savings and loan holding
company fails to meet the QTL test set forth in Section 10(m) of the HOLA and
the regulations of the OTS, the holding company must register with the Federal
Reserve Board as a Bank Holding Company within one year of the savings
institution's failure to so qualify.
Stock Holding Company Subsidiary Regulation. The OTS has adopted
regulations governing the two-tier mutual holding company form of organization
and mid-tier stock holding companies that are controlled by mutual holding
companies. Under these rules, the stock holding company subsidiary holds all the
shares of the mutual holding company's savings association subsidiary and issues
the majority of its own shares to the mutual holding company parent. In
addition, the stock holding company subsidiary is permitted to engage in
activities that are permitted for its mutual holding company parent and to have
the same indemnification and employment contract restrictions imposed that are
on the mutual holding company parent. Finally, OTS regulations maintain that the
stock holding company subsidiary must be federally chartered for supervisory
controls.
33
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Bank, the Company and the MHC will report their income on
a calendar year basis using the accrual method of accounting and will be subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary and
does not purport to be a comprehensive description of the tax rules applicable
to the Bank, the Company and the MHC.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Bank's deductions with respect
to "qualifying real property loans," which are generally loans secured by
certain interest in real property, were computed using an amount based on the
Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable
income, computed with certain modifications and reduced by the amount of any
permitted addition to the non-qualifying reserve. Due to the Bank's loss
experience, the Bank generally recognized a bad debt deduction equal to 8% of
taxable income.
In August 1996, the provisions repealing the above thrift bad debt
rules were passed by Congress as part of "The Small Business Job Protection Act
of 1996." The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(last taxable year beginning before January 1, 1988). The Bank has previously
recorded a deferred tax liability equal to the bad debt recapture and as such,
the new rules will have no effect on net income or federal income tax expense.
For taxable years beginning after December 31, 1995, the Bank's bad debt
deduction will be equal to net charge-offs. The new rules allow an institution
to suspend the bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years is equal to or greater than the
institution's average mortgage lending activity for the six taxable years
preceding 1996. For this purpose, only home purchase and home improvement loans
are included and the institution can elect to have the tax years with the
highest and lowest lending activity removed from the average calculation. If an
institution is permitted to postpone the reserve recapture, it must begin its
six year recapture no later than the 1998 tax year. The unrecaptured base year
reserves will not be subject to recapture as long as the institution continues
to carry on the business of banking. In addition, the balance of the pre-1988
bad debt reserves continue to be subject to a provision of present law referred
to below that require recapture in the case of certain excess distributions to
shareholders.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method, or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock, and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not be
considered to result in a distribution from the Bank's bad debt reserve. Thus,
any dividends to the Company that would reduce amounts appropriated to the
Bank's bad debt reserve and deducted for federal income tax purposes would
create a tax liability for the Bank. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution.
34
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers. AMTI is increased by an amount equal to 75% of the amount by
which the Bank's adjusted current earnings exceeds its AMTI (determined without
regard to this preference and prior to reduction for net operating losses).
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 80% of dividends received from the Bank as long as it maintains
ownership in the Bank of at least 20%.
Audits. The Bank was last audited by the IRS in 1995 and has not been
audited by the New Jersey Department of Revenue ("DOR") in the past five years.
State and Local Taxation
State of New Jersey. The Bank, the Company and the MHC file New Jersey
income tax returns. For New Jersey income tax purposes, savings institutions are
presently taxed at a rate equal to 3% of taxable income. For this purpose,
"taxable income" generally means federal taxable income, subject to certain
adjustments (including addition of interest income on state and municipal
obligations). For New Jersey tax purposes, regular corporations are presently
taxed at a rate equal to 9% of taxable income.
35
Item 2. Properties.
- - --------------------
The Bank currently conducts its business through an administrative and
full service branch office located in Caldwell, New Jersey and seven other full
service branch offices located in West Orange, Franklin Lakes, River Vale, Pine
Brook, Old Tappan and Northvale, New Jersey. Management believes that the Bank's
facilities are adequate to meet the present and immediately foreseeable needs of
the Bank and the Company.
Original Net Book Value
Year of Property or
Leased Leased Leasehold
or or Improvements at
Location Owned Acquired December 31, 1999
- - -------- ------ -------- -----------------
(In thousands)
Administrative/Corporate/
Branch Office:
417 Bloomfield Avenue Owned 1962 $370
Caldwell, NJ 07006
Branch Offices:
216 Main Street Owned 1987 142
West Orange, NJ 07052
487 Pleasant Valley Way Owned 1987 206
West Orange, NJ 07052
574 Franklin Avenue Leased 1978 1
Franklin Lakes, NJ 07417
653 Westwood Avenue Owned 1997 469
River Vale, NJ 07675
267 Changebridge Road Owned 1974 236
Pine Brook, NJ 07058
207 Old Tappan Road Owned 1997 480
Old Tappan, NJ 07675
119 Paris Avenue Owned 1997 314
Northvale, NJ 07647
Item 3. Legal Proceedings.
- - ----------------------------
The Company is not a party to any pending legal proceedings.
Periodically, there have been various claims and lawsuits involving the Bank,
such as claims to enforce liens, condemnation proceedings on properties in which
the Bank holds security interests, claims involving the making and servicing of
real property loans and other issues incident to the Bank's business. The Bank
is not a party to any pending legal proceedings that it believes would have a
material adverse effect on the financial condition or operations of the Bank.
36
Item 4. Submission of Matters to a Vote of Security Holders.
- - -------------------------------------------------------------
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
- - -------------------------------------------------------------------------------
Information regarding the market for the Company's common equity and
related stockholder matters appears on the inside back cover of the 1999 Annual
Report under the caption "Investor and Corporate Information" and is
incorporated herein by reference.
Item 6. Selected Financial Data.
- - ----------------------------------
Information regarding selected financial data appears on pages 4 and 5
of the 1999 Annual Report under the caption "Selected Consolidated Financial and
Other Data" and is incorporated herein by this reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- - ------------------------------------------------------------------------
Information regarding management's discussion and analysis of financial
condition and results of operations appears on pages 6 through 19 of the 1999
Annual Report under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and is incorporated herein by
this reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- - --------------------------------------------------------------------
Information regarding qualitative and quantitative disclosures about
market risk are contained in the section captioned "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Management of Interest
Rate Risk and Market Risk Analysis" in the 1999 Annual Report and is
incorporated herein by this reference.
Item 8. Financial Statements and Supplementary Data
- - ----------------------------------------------------
Information regarding the financial statements and the Independent
Auditors' Report appears on pages 20 through 59 of the 1999 Annual Report and is
incorporated herein by this reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- - -------------------------------------------------------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- - ------------------------------------------------------------
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the 2000 Annual Meeting of Stockholders to be held on April 27,
2000, at pages 4 through 7.
37
Item 11. Executive Compensation.
- - --------------------------------
The information relating to directors' compensation and executives'
compensation is incorporated herein by reference to the Registrant's Proxy
Statement for the 2000 Annual Meeting of Stockholders to be held on April 27,
2000, at pages 7 through 16 and 18 (excluding the Executive Compensation
Committee Report and Stock Performance Graph).
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- - ------------------------------------------------------------------------
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the 2000 Annual Meeting of Stockholders to be held on April
27, 2000, at pages 3 and 4.
Item 13. Certain Relationships and Related Transactions.
- - ---------------------------------------------------------
The information relating to certain relationships and related
transactions is incorporated herein by reference to the Registrant's Proxy
Statement for the 2000 Annual Meeting of Stockholders to be held on April 27,
2000, at pages 17 through 18.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- - --------------------------------------------------------------------------
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are incorporated by
reference to the following indicated pages of the 1999 Annual Report to
Stockholders.
Page
Report of Independent Auditors.......................................21
Consolidated Statements of Financial Condition as of
December 31, 1999 and 1998........................................22
Consolidated Statements of Income for the
Years Ended December 31, 1999, 1998 and 1997......................23
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1999, 1998 and 1997..................................24
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1999, 1998 and 1997..............25
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1999, 1998 and 1997......................26
Notes to Consolidated Financial Statements for the
Years Ended December 31, 1999, 1998 and 1997......................28
38
The remaining information appearing in the 1999 Annual Report to
Stockholders is not deemed to be filed as part of this report, except as
expressly provided herein.
(2) All schedules are omitted because they are not required or applicable,
or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Federal MHC Subsidiary Holding Company Charter of West Essex Bancorp, Inc.*
3.2 Bylaws of West Essex Bancorp, Inc.*
4.0 Draft Stock Certificate of West Essex Bancorp, Inc.*
10.1 West Essex Bank Employee Stock Ownership Plan**
10.2 West Essex Bank Employee Stock Ownership Plan Trust**
10.3 ESOP Loan Commitment Letter**
10.4 West Essex Bank Employee Stock Ownership Trust Loan and Security Agreement**
10.5 Employment Agreement between West Essex Bank and Leopold W. Montanaro**
10.6 Employment Agreement between West Essex Bancorp, Inc. and Leopold W. Montanaro**
10.7 Three Year Change in Control Agreement between West Essex Bank and Dennis A. Petrello**
10.8 Three Year Change in Control Agreement between West Essex Bank and Charles E. Filippo**
10.9 Three Year Change in Control Agreement between West Essex Bank and Craig L. Montanaro**
10.10 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Dennis A. Petrello**
10.11 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Charles E. Filippo**
10.12 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Craig L. Montanaro**
10.13 West Essex Bank Employee Severance Compensation Plan**
10.14 West Essex Bank Supplemental Executive Retirement Plan**
10.15 West Essex Bank Management Supplemental Executive Retirement Plan**
10.16 Restated Executive Supplemental Retirement Income Agreement for Leopold W. Montanaro*
10.17 Restated Executive Supplemental Retirement Income Agreement for Charles E. Filippo*
10.18 West Essex Bancorp, Inc. 1999 Stock-Based Incentive Plan
11.0 Computation of Earnings Per Share
13.0 Portions of the 1999 Annual Report to Shareholders
21.0 Subsidiary information is incorporated herein by reference to "Part I-Business-Subsidiary Activities"
23.0 Consent of Radics & Co., LLC
27.0 Financial Data Schedule
(b) Reports on Form 8-K
None.
----------------------------------
* Incorporated herein by reference into this document from
the Exhibits to Form S-1, Registration Statement, filed on
June 12, 1998, as amended, Registration No. 333-56729.
** Incorporated herein by reference into this document from
the Exhibits to the Form 10-K, filed on March 31, 1999.
*** Incorporated herein by reference into this document from
the Proxy Statement dated March 17, 2000
39
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.
WEST ESSEX BANCORP, INC.
By: /s/ Leopold W. Montanaro
------------------------
Leopold W. Montanaro
President, Chief Executive
Officer and Director
Date: March 29, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
Name Title Date
- - ---- ----- ----
/s/ Leopold W. Montanaro President, Chief Executive March 29, 2000
- - ------------------------ Officer and Director
Leopold W. Montanaro (principal executive officer)
/s/ Dennis A. Petrello Executive Vice President March 29, 2000
- - ---------------------- and Chief Financial Officer
Dennis A. Petrello (principal accounting and
financial officer)
/s/ William J. Foody Chairman of the Board March 29, 2000
- - ---------------------
William J. Foody
/s/ David F. Brandley Director March 29, 2000
- - ----------------------
David F. Brandley
/s/ Everett N. Leonard Director March 29, 2000
- - ----------------------
Everett N. Leonard
/s/ James P. Vreeland Director March 29, 2000
- - ---------------------
James P. Vreeland
/s/ John J. Burke Director March 29, 2000
- - -----------------
John J. Burke