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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Three Months Ended:
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March 31, 1998
Commission File Number:
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33-27139
FEDERAL TRUST CORPORATION
(Exact name of registrant as specified in its charter)
Florida
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(State or other jurisdiction
of incorporation)
59-2935028
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(I.R.S. Employer
Identification No.)
1211 Orange Avenue
Winter Park, Florida 32789
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(Address of principal executive offices)
Registrant's telephone number: (407) 645-1201
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FEDTRUST CORPORATION
(Former name of registrant)
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 quarterly reports), and (2) has been subject to such
filing requirements for the past 90 days:
YES X NO
Indicate the number of shares outstanding of
each of the issuer's classes of
common stock, as of the last
practicable date:
Common Stock, par value $.01 per share 4,941,547
- -------------------------------------- --------------------------------------
(class) Outstanding at March 31,1998
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FEDERAL TRUST CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Page
Consolidated Condensed Balance Sheets (unaudited)
March 31, 1998 and December 31, 1997......................... 3
Consolidated Condensed Statements of Operations for the
Three months ended March 31, 1998 and 1997 (unaudited)....... 4
Consolidated Condensed Statements of Cash Flows for the
Three months ended March 31, 1998 and 1997 (unaudited)....... 5
Notes to Consolidated Condensed Financial Statements (unaudited)..6 - 11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................12 - 18
PART II. OTHER INFORMATION
Signatures........................................................... 19
2
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
March 31, 1998 December 31, 1997
-------------- -----------------
Assets (unaudited)
Cash $ 424,242 446,134
Interest bearing deposits 2,520,162 3,555,916
Investment securities available for sale 3,322,781 3,301,844
Investment securities held to maturity 6,392,895 6,368,111
Loans receivable, net (net of allowance for loan losses of
$1,146,160 in 1998 and $1,110,521 in 1997) 128,097,403 121,908,816
Accrued interest receivable - Loans 893,759 846,396
Accrued interest receivable - Securities 58,698 157,155
Notes Receivable 75,000 75,000
Federal Home Loan Bank of Atlanta stock, at cost 1,427,500 1,427,500
Real Estate owned, net 1,532,741 1,389,900
Property and equipment, net 798,754 814,325
Prepaid expenses and other assets 321,269 417,015
Executive supplemental income plan-cash surrender
value life insurance policies 1,201,646 1,071,443
Deferred income taxes 748,477 803,977
------------- -----------
Total $ 147,815,327 142,583,532
============= ===========
Liabilities and Stockholders' Equity
Deposit accounts $ 107,231,264 104,890,163
Official Checks 1,137,972 1,208,607
Federal Home Loan Bank advances 25,550,000 23,000,000
Advance payments for taxes and insurance 677,913 336,406
Accrued expenses and other liabilities 527,437 577,694
------------- -----------
Total Liabilities $ 135,124,586 130,012,870
------------- -----------
Stockholders' equity
Commonstock, $.01 par value, 5,000,000 shares authorized
4,941,547 shares issued and outstanding at March 31,1998
and December 31, 1997 49,416 49,416
Additional paid-in capital 15,857,532 15,857,532
Accumulated deficit (2,820,580) (2,912,142)
Accumulated other comprehensive income (395,627) (424,144)
------------- -----------
Total Stockholders' Equity $ 12,690,741 12,570,662
------------- -----------
Total Liabilities and Stockholders' Equity $ 147,815,327 142,583,532
============= ===========
See accompanying Notes to Consolidated Condensed Financial Statements.
3
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
For Three Months Ended March 31, 1998 and 1997
(Unaudited)
Three Months
Ended March 31,
1998 1997
---- ----
Interest income:
Loans $2,401,931 2,335,042
Securities 81,699 167,450
Interest-bearing deposits and other 71,254 47,567
---------- ----------
Total interest income 2,554,884 2,550,059
---------- ----------
Interest expense:
Deposit accounts 1,426,197 1,384,785
Federal Home Loan Bank advances & other
borrowings 337,768 338,741
---------- ----------
Total interest expense 1,763,965 1,723,526
---------- ----------
Net interest income 790,919 826,533
Provision for loan losses 30,000 (3,000)
---------- ----------
Net interest income after provision 760,919 829,533
---------- ----------
Other income:
Fees and service charges 33,536 25,835
Rents -- 13,673
Gain on sale of assets 10,260 49,819
Other miscellaneous 80,571 15,541
---------- ----------
Total other income 124,367 104,868
---------- ----------
Other expenses:
Employee compensation & benefits 347,896 325,867
Occupancy and equipment 137,970 131,813
Data processing expense 23,025 20,831
Professional fees 40,491 79,664
FDIC Insurance 80,624 61,952
Other miscellaneous 109,252 137,085
---------- ----------
Total other expense 739,258 757,212
---------- ----------
Net income before income tax 146,028 177,189
Income tax expense 54,465 76,300
---------- ----------
Net income $ 91,563 100,889
========== ==========
Per share amounts:
Earnings per share .02 .04
Cash dividends per share 0.00 0.00
Weighted average number of shares outstanding 4,941,547 2,256,505
See accompanying Notes to Consolidated Financial Statements.
4
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
For the Three Months Ended March 31, 1998 and 1997
(Unaudited)
1998 1997
------------ ------------
Cash flows from operating activities:
Net income (loss) $ 91,563 100,889
Adjustments to reconcile net income to net cash flows from operations:
Depreciation & amortization of property & equipment 33,361 39,878
Amort. (net) of premiums, fees & disc. on loans & securities 104,530 51,803
Provision for allowance on real estate owned -- 33,000
Provision for loan losses 30,000 (3,000)
Gain on sale of assets (10,260) --
Deferred Income Taxes 55,500 76,300
Executive supplemental income plan (130,203) --
Cash provided by (used for) changes in:
Accrued interest receivable 51,094 94,738
Prepaid expenses & other assets 95,746 57,257
Official checks (70,635) (137,906)
Accrued expenses & other liabilities (50,257) (1,183)
------------ ------------
Net cash provided by operating activities 200,439 311,776
------------ ------------
Cash flows from investing activities:
Acquisition of office properties and equipment (17,790) (9,446)
Purchase of Federal Home Loan Bank of Atlanta stock -- (174,300)
Proceeds collected from loan sales 1,125,328 699,248
Reimbursement of real estate owned costs 16,668 --
Proceeds form the sale of real estate owned -- 212,774
Principal collected on securities held to maturity -- 4,880
Principal collected on loans 7,657,653 4,398,391
Loans originated or purchased (15,272,552) (8,163,721)
------------ ------------
Net cash provided by (used in) investing activities (6,490,693) (3,032,174)
------------ ------------
Cash flows from financing activities:
Increase (decrease) in deposits, net 2,341,101 (2,392,859)
Increase (decrease) in Federal Home Loan Bank advances 2,550,000 2,450,000
Net increase in advance payments by borrowers for taxes & insurance 341,507 332,847
------------ ------------
Net cash provided by financing activities 5,232,608 389,988
------------ ------------
(Decrease) increase in cash and cash equivalents (1,057,646) (2,330,410)
Cash and cash equivalents at beginning of period 4,002,050 5,465,762
------------ ------------
Cash and cash equivalents at end of period $ 2,944,404 3,135,352
============ ============
See accompanying Notes to Consolidated Condensed Financial Statements.
5
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
1. General
Federal Trust Corporation ("Company" or "Holding Company") is a unitary savings
and loan holding company for a federally-chartered stock savings bank known as
Federal Trust Bank ("Bank"). The Bank and the Company are headquartered in
Winter Park, Florida. The Company is currently conducting business as a unitary
savings and loan holding company, and its principal asset is all of the capital
stock of the Bank. As a unitary holding company, the Company has greater
flexibility than the Bank to diversify and expand its business activities,
either through newly formed subsidiaries or through acquisitions.
The Holding Company's primary investment is the ownership of the Bank. The Bank
is primarily engaged in the business of attracting deposits from the general
public and using these funds with Federal Home Loan Bank ("FHLB") advances to
originate one-to-four family residential mortgage loans, residential consumer
loans, multi-family loans, and to a lesser extent, commercial real estate
related SBA loans and consumer loans, and also fund bulk purchases of
one-to-four family residential mortgage loans
The consolidated condensed balance sheets as of March 31, 1998 and December 31,
1997, and the consolidated condensed statements of operations for the three
month periods ended March 31, 1998 and 1997, and the cash flows for the three
month periods ended March 31, 1998 and 1997, include the accounts and operations
of the Company and all subsidiaries. All material intercompany accounts and
transactions have been eliminated.
In the opinion of management of the Company, the accompanying consolidated
condensed financial statements contain all adjustments (principally consisting
of normal recurring accruals) necessary to present fairly the financial position
as of March 31, 1998, the results of operations for the three month periods
ended March 31, 1998 and 1997, and cash flows for the three month periods ended
March 31, 1998 and 1997. The results of operations for the three month period
ended March 31, 1998 are not necessarily indicative of the results to be
expected for the full year. These statements should be read in conjunction with
the consolidated financial statements included in the Company's Annual Report on
Form 10 - K for the year ended December 31, 1997.
2. Summary of Significant Accounting Policies
Comprehensive Income:
In June 1997, the Financial Accounting Standards Board established Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income."
This Statement establishes standards for reporting and display of comprehensive
income and its components in a full set of financial statements. This Statement
requires that an enterprise classify items or other comprehensive income by
nature in a financial statement, and display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a balance sheet. The Company adopted this
Statement effective January 1, 1998. The Company's other comprehensive income is
the unrealized gain/(loss) on investment securities available for sale.
Real Estate:
Real estate acquired through foreclosure is recorded at the lower of cost
(unpaid loan balance plus costs of obtaining title and possession) or estimated
(continued)
6
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
fair value at the time of acquisition. Subsequently, such real estate is carried
at the lower of cost or fair value less estimated costs to sell. Costs relating
to development and improvement of the property are capitalized, whereas those
relating to holding the property are charged to operations.
3. Loans
The Bank's policy is to classify all loans 90 days or more past due as
non-performing and not accrue interest on these loans and reverse all accrued
and unpaid interest, however, a non-performing loan is not considered impaired
if all amounts due including contractual interest are expected to be collected.
When the ultimate collectibility of an impaired loan's principal is in doubt,
wholly or partially, all cash receipts are applied to principal. When this doubt
does not exist, cash receipts are applied under the contractual terms of the
loan agreement first to interest income and then to principal. Once the recorded
principal balance has been reduced to zero, future cash receipts are applied to
interest income, to the extent that any interest has been forgone. Further cash
receipts are recorded as recoveries of any amounts previously charged off.
At March 31, 1998, impaired loans amounted to $2.2 million as compared to $1.4
million at March 31, 1997. Included in the allowance for loan losses is $311
thousand related to the impaired loans as compared to $477 thousand at March 31,
1997. The Bank measures impairment on collateralized loans using the fair value
of the collateral, and on unsecured loans using the present value of expected
future cash flows discounted at the loan's effective interest rate.
In the first three months of 1998, the average recorded investment in impaired
loans was $2.0 million and $13.2 thousand of interest income was recognized on
loans while they were impaired. All of this income was recognized using a cash
basis method of accounting.
4. Allowance for Losses
Allowance for Loan Losses: The following is an analysis of the activity in the
allowance for loan losses for the periods presented:
Three Months
Ended March 31,
---------------
1998 1997
------------- -------------
Balance at beginning of period $ 1,110,521 1,533,003
Provision for loan losses 30,000 (3,000)
Less Charge-offs -- (340,335)
Plus recoveries 5,639 3,066
------------- -------------
Balance at end of period $ 1,146,160 1,192,734
============= =============
Loans Outstanding $ 128,097,403 $ 113,214,544
Ratio of charge-offs to Loans Outstanding - 0 -% .30%
Ratio of allowance to Loans Outstanding .89% 1.05%
A provision for loan losses is generally charged to operations based upon
management's evaluation of the potential losses in its loan portfolio. During
the quarter ended March 31, 1998, management made a provision of $30,000 based
on its evaluation of the loan portfolio, as compared to the negative provision
of $3,000 made in the quarter ended March 31, 1997. The overall provision for
loans and real estate owned was unchanged, however, in 1997 the $30,000 was
charged to the provision for real estate owned and $3,000 was transferred from
the provision for loans and used to write down foreclosed real estate. Although
(continued)
7
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
the amount of loans outstanding increased, the level of the allowance for losses
decreased slightly, primarily as a result of the improving quality of the loans
in the portfolio.
5. Supplemental Disclosure of Cash Flow and Non-Cash Investing and Financing
Activities
Three Months Ended March 31,
1998 1997
---- ----
Cash paid during the period for:
Interest expense $ 822,541 803,481
Income taxes $ -- --
Supplemental disclosure of non-cash transactions:
Real Estate Acquired in Settlement of Loans $ 159,509 2,350,000
Market Value adjustment - investment securities
available for sale:
Market value adjustment - investments $ (27,219) (326,297)
Deferred income tax asset $ (10,243) (122,361)
---------- ----------
Unrealized loss on investment securities
available for sale, net $ (16,976) (203,936)
Unrealized loss on investment securities transferred
from available for sale to held to maturity $ (607,105) (693,642)
Deferred income tax asset $ (228,454) (260,116)
---------- ----------
Unrealized loss on investment securities transferred
from available for sale to held to maturity $ (378,651) (433,526)
========== ==========
6. Real Estate Owned, Net
Real Estate Acquired through Foreclosure, Other Repossessed Assets: The
following is an analysis of the activity in real estate acquired through
foreclosure and other repossessed assets for the periods ended:
Three Months
Ended March 31,
---------------
1998 1997
---- ----
Balance at beginning of period $ 1,389,900 1,508,166
Acquired through foreclosure 159,509 2,350,000
Add: Capitalized costs (16,668) (9,463)
Less: Sale of real estate -- (203,311)
Less: Charge-offs -- (33,000)
Less: Allowance for losses -- --
----------- -----------
Balance at end of period $ 1,532,741 3,612,392
=========== ===========
(continued)
8
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
7. Investment Securities
At March 31, 1998
Book Value Market Value
---------- ------------
Held to maturity:
FHLB Floating Rate Note, 2.575% due 7/30/03 $ 6,392,895 6,485,937
========= =========
Available for sale:
FHLB Floating Rate Note, 3.934% due 7/28/98 3,322,781 3,222,781
========= =========
The Bank's investment in obligations of U.S. government agencies consists of
dual indexed bonds issued by the Federal Home Loan Bank. At March 31, 1998, the
bonds had a market value of $9,708,718 and gross unrealized pretax losses of
$641,282. The bonds have a par value of $10,350,000 and pay interest based on
the difference between two indices. All of the bonds at March 31, 1998, pay
interest at the 10-year constant maturity treasury ("CMT") rate less the 3 month
or 6 month LIBOR rate plus a contractual amount ranging from 2.75% to 4.0%.
During the quarter ended March 31, 1998, the Bank did not buy or sell any bonds.
8. Advances from Federal Home Loan Bank
The following is an analysis of the advances from the Federal Home Loan Bank:
Amounts Outstanding at March 31, 1998:
Maturity Date Rate Amount Type
- ------------- ---- ------ ----
06/30/98 6.00% $ 5,000,000 Fixed rate
09/15/98 6.12% 5,000,000 Fixed rate
10/16/98 5.88% 5,000,000 Fixed rate
12/02/98 6.23% 5,550,000 Variable rate
03/05/01 5.96% 5,000,000 Fixed rate
Total 6.04% $25,550,000
==== ===========
Variable rate advances reprice daily and may be repaid at any time without
penalty. Fixed rate advances incur a prepayment penalty if repaid prior to
maturity, and the interest rate is fixed for the term of the advance.
Amounts Outstanding at:
Month-end Rate Amount
--------- ---- ------
1/31/98 5.94% $ 23,000,000
2/28/98 5.97% 21,500,000
3/31/98 6.04% 25,550,000
The maximum amount of borrowings outstanding at any month end during the three
period ended March 31, 1998 was $25,550,000. During the three period ended March
31, 1998, average advances outstanding totaled $22.9 million at an average rates
of 5.91%.
Advances from the FHLB are collateralized by loans and securities that totaled
approximately $28.8 million and $5.9 million, respectively.
(continued)
9
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
9. Supervision
Federal Trust and the Bank are subject to extensive regulation, supervision and
examination by the OTS, their primary federal regulator, by the FDIC with regard
to the insurance of deposit accounts and, to a lesser extent, the Federal
Reserve. Such regulation and supervision establishes a comprehensive framework
of activities in which a savings and loan holding company and its financial
institution subsidiary may engage and is intended primarily for the protection
of the Savings Association Insurance Fund administered by the FDIC and
depositors.
On October 3, 1994, Federal Trust and the Bank voluntarily entered into
individual Cease and Desist Orders (collectively, the "Orders") with the OTS.
The Bank Order superseded a prior Supervisory Agreement with the Bank. Under the
Holding Company's Order, Federal Trust (i) could not request dividends from the
Bank without written permission from the OTS; (ii) was required to reimburse the
Bank for the Holding Company's expenses; (iii) had to develop a Management
Services Agreement with the Bank which provides for the reimbursement for
employees who work for both the Bank and the Holding Company; (iv) had to
appoint a Compliance Committee to report to the Board of Directors as to the
Holding Company's compliance with the Order; and (v) was required to report to
the OTS on a quarterly basis the Holding Company's compliance with the Order.
The Bank's initial Order required the Board of Directors to: (i) develop, adopt
and adhere to policies and procedures to strengthen the Bank's underwriting,
administration, collection and foreclosure efforts with regard to loans; (ii)
review and revise underwriting policies and procedures to comply with regulatory
requirements; (iii) record minutes of the loan committee and grant loans only on
procedures which comply with regulatory requirements; (iv) record minutes of the
loan committee and grant loans only on terms approved by the loan committee; (v)
develop and implement a written plan to collect, strengthen and reduce the risk
of loss for all real estate owned and for certain loans at risk and secured by
real estate; (vi) comply with policies and procedures requiring written
inspection of development and construction loans; (vii) pay no more than market
rate, determined by a rent study approved by the OTS for lease of the Bank's
offices; (viii) make no payment of taxes owned by a person affiliated with the
Bank; (ix) seek reimbursement for work performed for the Holding Company by Bank
employees; (x) develop and submit for approval a three year business plan; (xi)
comply with loans to one borrower policy; (xii) make no capital distribution to
the Holding Company without the consent of the OTS; (xiii) appoint a compliance
committee; and (xiv) refrain from purchasing additional dual indexed bonds.
The respective Compliance Committees meet monthly to review, in detail, the
terms of the Orders to ensure that the Holding Company and the Bank are in
compliance with their Orders. The Bank also contracted with a company
specializing in the review of internal controls and operating procedures of
financial institutions, including compliance with internal policies and
procedures. In the 1996 examinations of Federal Trust and the Bank the OTS found
the companies to be in compliance with the Orders and upgraded the supervisory
rating of Federal Trust to an acceptable level. In light of the improvement in
the Bank's operations, the OTS reduced the number of provisions in the Bank's
Order from 27 to 23.
In connection with the Rights and Community Offering ("Offering"), management
requested that the OTS perform an examination on the Bank's loan underwriting,
loan classifications, and allocation for loan losses. The OTS did not take
exception to the Bank's classifications or its allocation for loan losses. This
portion of the examination was completed in the first week of August 1997. In
October 1997, the OTS undertook the second phase of the examination which was
directed at the Bank's operation which included a separate examination of the
Holding Company. The OTS was satisfied with the steps taken by the Holding
(continued)
10
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (unaudited)
Company in its restructuring of the Board of Directors and the completion of the
Offering which resulted in an infusion of $3.7 million dollars in capital to the
Bank.
With regard to the Bank, the OTS noted improvement in the Bank's overall
operations, including loan underwriting procedures, documentation, significant
disposition of problem assets which included a $2.5 million dollar apartment
project in Amelia Island, Florida, the elimination of the bank's dependency on
wholesale funds, as well as continued reduction in operation expenses. As a
result, the Bank's CAMELS rating was upgraded, which should have a positive
effect on the Bank's insurance of deposit premium for the second half of 1998.
In December 1997, the Bank formally requested that the OTS remove the growth
restrictions which it has been operating under since the entry of the Bank's
Order. In January 1998, management followed up with a request that the OTS
rescind the Holding Company Order and the Bank's Order.
On March 13, 1998, the OTS officially rescinded the growth restrictions. The OTS
has also advised that it is considering the removal of the Orders against the
Holding Company and the Bank, provided certain commitments are received from the
Board of Directors in the form of a Board resolution. The contents and specific
wording of the resolution are currently being discussed. While no assurances are
given, management believes that the Bank and the OTS will be able to agree to
the language in the Board resolution and that the respective Orders will be
rescinded in the second quarter of 1998.
10. Stock Options
Stock Options for Stock Sales. In connection with the 1993 Private Placement
Offering and the 1990 Public Offering, the Holding Company issued stock options
to certain sales representatives for their commitment to sell common stock in
the respective offerings. The options have a strike price of $5.63 per share and
will expire on October 26, 1999. At September 30, 1997 none of the stock options
for 58,453 shares had been exercised. The stock options have an anti-dilutive
provision which adjusts the strike price in the event of a stock split or a
stock sale wherein the purchase price is less than the strike price.
11. Year 2000 Considerations
The Company has formulated a Year 2000 Action Plan which has been presented to,
and approved by, the Board of Directors. Management believes that all affected
systems have been identified and plans have been made to ensure that all
necessary changes are accomplished in a timely manner. An OTS off-site
examination was performed on the Year 2000 plan in September 1997 and certain
changes were made to the plan as a result. Implementation of the plan is
progressing and the Board of Directors receives quarterly reports regarding the
progress made. Management has concluded that the additional costs for Year 2000
compliance will be approximately $50,000 in addition to already budgeted
purchases of new equipment and software.
(THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK)
11
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
Overview
The Company's net earnings were negatively affected by the increase in its
interest expense during the first quarter of 1998. Although interest rates
declined very slightly from the first quarter of 1997, the Bank has had to pay
higher rates on deposits due to an intense level of competition in the local
market over the past several months as many banks in the area have increased
their interest rates in an attempt to attract customers. It is the opinion of
management that much of this increased competition is the result of the Barnett
Bank merger into Nationsbank and the efforts by many of the banks in the area to
entice Barnett customers to switch to another bank. As a result of the higher
rates being paid in the Orlando market the Bank has had to pay higher rates to
keep its existing customers and attract new money in its effort to increase the
Bank's assets. The Bank continues to have a negative GAP position as its
liabilities reprice sooner than, and in greater amounts than, its assets, but
the GAP position did improve significantly in 1997. However, should interest
rates increase the Bank's earnings would be adversely affected as the
adjustments on the ARM loans in the Bank's portfolio lag the movement in
interest rates by approximately two months.
The decline in long term interest rates during the first quarter has also
resulted in a lower level of mortgage loan rates which has resulted in an
increase in the number of loans at the Bank that are prepaying as individuals
refinance to take advantage of the lower rates. This has increased the write-off
of the premiums that the Bank has paid in the past when purchasing loans, which
results in a lower yield on the loan portfolio. As long as this continues the
Bank's earning will be adversely affected to some degree.
The Bank has been able to decrease its additions to the loss reserves in 1997
and 1998 as a result of a lower level of non-performing loans. Although
management believes that the level of non-performing assets should decease
somewhat in future periods, unforeseen economic conditions and other
circumstances beyond the Bank's control could result in material additions to
the loss reserves in future periods if the level of non-performing assets
increases. The Bank does anticipate additions to the loss reserves in future
periods as part of the normal course of business, as the Bank's assets,
consisting primarily of loans, are continually evaluated and the loss allowances
are adjusted to reflect the potential losses in the portfolio on an ongoing
basis. During the quarter ended March 31, 1998, the bank did make an addition to
its loan loss reserves based on its evaluation of the loan portfolio.
During the quarter ended March 31, 1997, the Bank sold a participation interest
in a loan originated in March, 1996 in conjunction with the sale of a previously
foreclosed property, which resulted in the realization of $122,007 in interest
income and $30,993 in profit that had been deferred since the loan was
originated in 1996 in accordance with Statement of Accounting Standards ("SFAS")
No.66 which requires the income on the loan and profit on the sale be deferred
until such time as the loan balance is reduced to a certain level, in this case
85%, when the buyer does not make a cash down payment. Of the $122,007 in
interest income taken into income on this loan during the quarter ended March
31, 1997, $85,463 was attributable to the year 1996 and $36,544 was attributable
to the quarter ended March 31, 1997.
The Company has projected an operating profit for the full year of 1998, as a
result of the decrease in non-performing loans at the Bank, the reduction in
expenses, resulting from the corporate reorganization of the Company in 1996 and
the additional capital raised during the fourth quarter of 1997 which will give
the Company the capital resources it needs to grow now that the regulatory
growth restriction has been removed. However, should interest rates rise during
the remainder of the year or non-performing assets increase due to unforeseen
circumstances, the Company earnings could be adversely affected.
(continued)
12
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
General
Federal Trust Corporation ("Company" or "Holding Company"), is a unitary savings
and loan holding company for a federally-chartered savings bank known as Federal
Trust Bank. The Holding Company acquired all outstanding common stock of the
Bank on February 28, 1989 pursuant to an agreement and plan of reorganization
whereby five shares of the Company's common stock were exchanged for each four
shares of the Bank's common stock on that date. The Bank is currently the only
subsidiary of the Company and began operations on May 3, 1988.
The Company's expenses have been reduced to minimal levels, as there are no
longer any salaried employees in the Company and its offices have been sublet.
Employees of the Bank perform all necessary functions needed by the Company, and
the Company reimburses the Bank for the time they spend on Company business.
Asset/Liability Management
The operating results of the Company depend primarily on the Bank's net interest
income, which is the difference between interest income on interest-earning
assets, primarily single-family residential loans, and interest expense on
interest-bearing liabilities, consisting of deposits, FHLB advances, and other
borrowings. Net interest income is determined by (i) the difference between
yields earned on interest-earning assets and rates paid on interest-bearing
liabilities ("interest rate spread") and (ii) the relative amounts of
interest-earning assets and interest-bearing liabilities. The Bank's interest
rate spread is affected by regulatory, economic and competitive factors that
influence interest rates, loan demand and deposit flows. In addition, the
Company's net earnings are also affected by the level of non-performing loans
and real estate owned, as well as the level of its non-interest income,
including loan related fees, and its non-interest expenses, such as salaries and
employee benefits, occupancy and equipment costs and provisions for losses on
real estate owned and income taxes.
The Bank's one year GAP position at December 31, 1997, the most recent report
available, was -1%, as compared to -13% at December 31, 1996. The primary reason
for the decrease in the one year GAP has been the ability of the Bank to extend
the maturities of its liabilities and the sale of a portion of the dual-indexed
bonds from the Bank's investment portfolio in 1997. In addition, the Bank sold
fixed rate loans during 1997 which it replaced with adjustable rate loans as
part of its efforts to continue improving its GAP position. As interest rates
rose slightly in 1997 the Bank's net interest spread decreased only slightly as
a result of the increased amount of adjustable rate loans in the portfolio and
the decrease in non-performing loans. The Bank's net interest spread has been
adversely affected in the first quarter of 1998 as a result of the increase in
prepayments on mortgage loans resulting from lower mortgage rates which has
increased the amount of the write-off of the premiums that the Bank has paid in
the past when purchasing loans, which results in a lower yield on the loan
portfolio
In order to minimize the potential for adverse effects of material and prolonged
increases in interest rates on the Company's results of operations, the Bank has
an Interest Rate Risk Management Policy, which is reviewed and approved by the
Board of Directors on an annual basis. The policy provides (i) for management to
manage the assets and liabilities of the Bank to protect earnings over the
interest rate cycle; (ii) the maximum allowable percentage changes in net
interest income and net portfolio value over eight interest rate scenarios
(+100, +200, +300, +400 and -100, -200, -300, -400 basis points); (iii) for the
Asset/Liability Management Committee ("ALCO"); and (iv) for quarterly reporting
(continued)
13
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
to the Board of Directors. The ALCO monitors the Bank's interest rate risk
position and manages the asset and liability mix in order to better match the
maturities and repricing terms of the Bank's interest-earning assets and
interest-bearing liabilities. Since the latter half of 1993 the ALCO has focused
primarily on (i) emphasizing the origination and purchase of single-family
residential adjustable-rate mortgage loans ("ARMs"); (ii) extending the term of
the Bank's deposits and borrowings; and (iii) maintaining an adequate amount of
liquid assets (cash and interest-earning assets). As a result, the Bank has
continued to originate and purchase ARM loans throughout this period and has
extended deposits and borrowings to longer terms whenever possible through its
pricing practices.
The following table sets forth information about rates and yields:
Yields and Rates at
March 31, December 31, March 31,
1998 1997 1997
---- ---- ----
Yields on:
Loan portfolio 7.82% 8.20% 8.24%
Other interest-earning assets 4.09% 4.69% 4.65%
---- ---- ----
Interest-earning assets 7.42% 7.71% 7.74%
Cost of:
Deposits 5.42% 5.49% 5.30%
FHLB advances and other interest-bearing liabilities 5.91% 6.04% 5.94%
---- ---- ----
Interest-bearing liabilities 5.50% 5.59% 5.42%
Interest rate spread 1.92% 2.12% 2.32%
==== ==== ====
Liquidity and Capital Resources
General
Like other financial institutions, the Bank must ensure that sufficient funds
are available to meet deposit withdrawals, loan commitments, investment needs
and expenses. Control of the Bank's cash flow requires the anticipation of
deposit flows and loan payments. The Bank's primary sources of funds are deposit
accounts, FHLB advances, and principal and interest payments on loans.
The Bank requires funds in the short-term to finance ongoing operating expenses,
pay liquidating deposits, purchase temporary investments in securities and
invest in loans. The Bank funds short-term requirements through short-term
advances from the FHLB, the sale of temporary investments, deposit growth and
loan principal payments. The Bank requires funds in the long-term to invest in
loans for its portfolio, purchase fixed assets and provide for the liquidation
of deposits maturing in the future. The Bank funds its long-term requirements
with proceeds from maturing loans, the sale of loans, the sale of investments
securities available for sale, deposits, long-term advances from the FHLB and
the sale of real estate. Management has no plans to significantly change
long-term funding requirements.
During the three-month period ended March 31, 1998, the Company used funds
primarily from principal collected on loans, $7,657,653; proceeds from loan
sales, $1,125,328; increases in net deposits, $2,341,101; an increase in FHLB
advances, $2,550,000; advance payments by borrowers, $341,507; and a decrease in
cash, $1,057,646; to fund the origination and purchase of loans, $15,272,552. As
of March 31, 1998, the Bank had outstanding FHLB advances of $25,550,000.
Management believes that in the future funds will be obtained from the above
sources.
(continued)
14
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
At March 31, 1998, loans-in-process, or closed loans scheduled to be funded over
a future period of time, totaled $3,711,349. Loans committed including loans to
be purchased, but not closed, totaled $7,109,352 and available lines of credit
totaled $418,196. During the three-month period ended March 31, 1998, the Bank
acquired $11.0 million in primarily domestic residential mortgage loans. The
Company anticipates that other loan acquisitions will occur in the future.
Funding for these amounts is expected to be provided by the sources described
above.
The Company last declared a dividend to its stockholders on September 30, 1994,
which was paid on November 14, 1994. As a result of the net losses that were
incurred by the Company in 1995 and 1996, no additional dividends have been
declared. The Board of Directors decided to suspend the payment of dividends for
calendar years 1995, 1996 and 1997, and does not anticipate the payment of
dividends during 1998. Although the Company and the Bank were recapitalized in
the fourth quarter of 1997 and are profitable, earnings are being reinvested to
provide for additional growth of the Company. In addition, although the Company
does not require OTS approval for the granting of dividends, the Bank is
prohibited from granting dividends without OTS approval and Bank does not
anticipate the payment of dividends to the Company for calendar year 1998. The
payment of dividends in subsequent years will depend on general economic
conditions, the overall performance of the Company, and the capital needs of the
Company and the Bank.
Liquidity
OTS regulations require the Bank to maintain a daily average balance of liquid
assets equal to a specified percentage (currently 4%) of net withdrawable
deposit accounts and borrowings payable in one year or less. Generally, the
Bank's management seeks to maintain its liquid assets at comfortable levels
above the minimum requirements imposed by the OTS. At March 31, 1998, average
liquidity was 6.06%.
The Asset/Liability Management Committee of the Bank meets regularly and, in
part, reviews liquidity levels to ensure that funds are available as needed.
Credit Risk
The Bank's primary business is the origination and acquisition of loans to
families and small businesses. This activity entails potential credit losses,
the magnitude of which depends on a variety of economic factors affecting
borrowers which are beyond the control of the Bank. While the Bank has
instituted guidelines and credit review procedures to protect it from avoidable
credit losses, some losses may inevitably occur.
Short-term balloon mortgage loans are sometimes used to allow borrowers the
option of waiting until interest rates are more favorable for a long term fixed
rate loan. If interest rates rise, these loans may require renewals if borrowers
fail to qualify for a long term fixed rate loan at maturity and there is no
assurance that a borrower's income will be sufficient to service the renewal.
Management recognizes the risks associated with this type of lending and
believes that the policies and procedures it applies to such loans lowers the
general risk.
Regulatory Enforcement Action
Federal Trust and the Bank are currently operating under individual cease and
desist orders (collectively, the "Orders") with the OTS which were voluntarily
entered into in 1994. The Bank Order superseded a prior Supervisory Agreement
with the Bank. See Item 9 of Notes to Consolidated Condensed Financial
Statements for a full discussion of the Orders. In addition to the Orders, the
Bank was placed under growth restrictions.
(continued)
15
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
In the 1996 and 1997 examination of Federal Trust and the Bank, the OTS found
that both companies were in compliance with their respective Orders.
On December 4, 1997, Federal Trust successfully completed its Rights and
Community Offering. The Holding Company, in turn, infused $3.7 million in
capital to the Bank. As a result, the Bank is again considered to be "well
capitalized" under regulations of the Federal Deposit Insurance Corporation.
In December 1997, the Bank formally requested that the OTS remove the growth
restrictions. In January 1998, management followed up with a request that the
OTS rescind the Orders against the Holding Company and the Bank. On March 13,
1998, the OTS officially rescinded the growth restrictions against the Bank.
The OTS is currently considering the removal of the Orders against the Holding
Company and the Bank, provided certain commitments are received from the Board
of Directors in the form of a Board resolution. While no assurances can be
given, management believes that the Bank and the OTS will be able to agree to
the language in the Board resolution and that the respective Orders will be
rescinded in the second quarter of 1998.
Capital Requirements
The Bank is required to meet certain minimum regulatory capital requirements.
The following table presents a summary of the capital requirements for
adequately capitalized banks, the Bank's capital and the amounts in excess as of
September 30, 1997:
At March 31, 1998
-----------------
Tangible Core Risk-Based
-------- ---- ----------
(Dollars in Thousands)
Percent Percent Percent
Amount of Assets Amount of Assets Amount of Assets
------ --------- ------ --------- ------ ---------
Regulatory Capital $11,305 7.65% $11,305 7.65% $12,357 14.69%
Requirement 2,217 1.50% 4,434 3.00% 6,729 8.00%
----- ----- ------ ----- ------ -----
Excess $9,088 6.15% $ 6,871 4.65% $ 5,628 6.69%
===== ===== ====== ===== ====== =====
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in
accordance with Generally Accepted Accounting Principles ("GAAP"), which require
the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services, since such prices are affected by inflation to
a larger extent than interest rates.
Impact of Accounting Requirements
(continued)
16
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
In June 1997 the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information." This
statement establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. The statement is
required for fiscal years beginning after December 15, 1997. The Company does
not anticipate adoption of this standard will have a significant impact on its
consolidated financial statements upon adoption.
Results of Operations
Comparison of the Three-Month Periods Ended March 31, 1998 and 1997
General. The Company had a net profit for the three-month period ended March 31,
1998 of $91,563 or $.02 per share, compared to a net profit of $100,889 or $.04
per share for the same period in 1997. The decrease in the net profit was due
primarily to a decrease in net interest income, and an increase in the provision
for loan losses, offset partially by increased other income and decreased other
expense.
Interest Income and Expense. Interest income increased by $4,825 to $2,554,884
for the three-month period ended March 31, 1998 from $2,550,059 for the same
period in 1997. Interest income on loans increased to $2,401,931 in 1998 from
$2,335,042 in 1997, primarily as a result of an increase in the average amount
of loans outstanding, offset partially by a decrease in the average yield earned
on loans. The decrease in the average yield earned on loans is the result of
higher prepayments on mortgage loans resulting in the expensing of premiums paid
on many of the loans when purchased. In addition, during the quarter ended March
31, 1997, the Bank sold a participation interest in a loan orginated in March,
1996 in conjunction with the sale of a previously forecolosed property,
whichresulted in the realization of $122,007 in interest incomeand $30,993 in
profit that had been deferred since the loan was originated in 1996 in
accordance with Statement of Accounting Standards ("SFAS") No. 66 which requires
the income on the loan and profit on the sale be deferred until such time as the
loan balance is reduced to a certain level, in this case 85%, when the buyer
does not make a cash down payment. Of the $122,007 in interest income taken into
income on this loan during the quarter ended March 31, 1997, $85,463 was
attributable to the year 1996 and $36,544 was attributable to the quarter ended
March 31, 1997. Interest income on the securities portfolio decreased by $85,751
for the three-month period ended March 31, 1998 over the same period in 1997, as
a result of a decrease in the amount of securities owned. Other interest and
dividends increased $23,687 during the same three-month period in 1998 from 1997
as a result of an increase in the average volume of other interest-bearing
assets. Management expects the rates earned on the portfolio to fluctuate with
general market conditions.
Interest expense increased to $1,763,965 during the three-month period ended
March 31, 1998 from $1,723,526 for the same period in 1997 due to an increase in
the amount of deposits and an increase in the rates paid. Interest on deposits
increased to $1,426,197 in 1998 from $1,384,785 in 1997 as a result of an
increase in the amount of deposits and in the rates paid on deposits, and
interest on FHLB Advances decreased to $337,768 in 1998 from $338,741 in 1997 as
a result of a decrease in the rates paid on advances even though the average
amount of advances outstanding increased slightly. Management expects to
continue to use FHLB advances as a liability management tool.
Provisions for Loan Losses. A provision for loan losses is generally charged to
operations based upon management's evaluation of the potential losses in its
loan portfolio. During the quarter, management made a provision for loan losses
of $30,000 based on its evaluation of the loan portfolio, which was an increase
of $33,000 from the same period in 1997, when the Bank had a negative provision
for loan losses of $3,000. The negative provision for loan losses was the result
of the quarterly provision being used to write down real estate owned. There
were net recoveries of $5,639 during the three-month period ended March 31, 1998
as compared to net recoveries of $3,066 during the three-month period ended
March 31, 1997. Total non-performing loans at March 31, 1998 were $1,767,936
compared to $1,323,551 at March 31, 1997. The allowance for loan losses at March
(continued)
17
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operation
31, 1998 was $1,146,160 or 65% of non-performing loans and .89% of net loans
outstanding, versus $1,192,734 at March 31, 1997 or 90% of non-performing loans
and 1.05% of net loans outstanding.
Total Other Income. Other income increased from $104,868 for the three-month
period ended March 31, 1997 to $124,367 for the same period in 1998. The
increase in other income was due to an increase of $7,701 in fees and service
charges, an increase of $65,030 in other miscellaneous income, offset partially
by a decrease in gains on the sale of assets of $39,559, and a decrease of
$13,673 in rental income. Fees and service charges increased primarily because
of an increase in late charges earned by the Bank on past due loans. Other
miscellaneous income increased for the three-month period ended March 31, 1998
due primarily to increased other loan income, resulting from increased
originations of loans. Gains on the sale of assets decreased as a result of a
decrease in the amount of loans sold by the Bank. Rental income decreased as a
result of the sale of the other real estate owned that was generating rental
income.
Total Other Expense. Other expense decreased to $739,258 for the three-month
period ended March 31, 1998 from $757,212 for the same period in 1997.
Compensation and benefits increased to $347,896 in 1998 from $325,867 in 1997 as
a result of an increase in staff, and the implementation of a 401k savings plan
for the employees in the second quarter of 1997. Occupancy and equipment expense
increased by $6,157 in 1998 to $137,970 due to increases in office building rent
and maintenance expenses. Data Processing expense increased by $2,194 due to an
increase in the number of accounts at the Bank. Professional fees decreased by
$39,173 primarily as a result of decreased legal costs associated with
non-performing loans. FDIC Insurance expense increased by $18,672 as a result of
the an increase in the premium rate charged by the FDIC and an increase in the
amount of deposits in the Bank. The FDIC insurance premium is calculated on a
six month lagging basis and during 1997, prior to the public offering by the
Company, the capital ratio in the Bank declined below 5% for one quarter which
caused an increase in the premium rate. The Bank's capital ratio is now in
excess of 7% which along with its improved examination rating will result in a
significant reduction in the Bank's FDIC insurance premium beginning in the
third quarter of 1998. Other miscellaneous expense decreased by $27,833 due
primarily to decreases in REO expenses.
18
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused the report to be signed on its behalf by the
undersigned thereunto duly authorized.
FEDERAL TRUST CORPORATION
(Registrant)
Date: May 1 , 1998 By: /s/ Aubrey H. Wright, Jr.
- ---------------------- -------------------------
Aubrey H. Wright, Jr.
Chief Financial Officer
and duly authorized
Officer of the Registrant
19