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, 1997
Commission File No.: 0-27428
OCEAN FINANCIAL CORP.
(exact name of registrant as specified in its charter)
DELAWARE 22-3412577
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
975 HOOPER AVENUE, TOMS RIVER, NEW JERSEY 08753
(Address of principal executive offices)
Registrant's telephone number, including area code: (732) 240-4500
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. [X]
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 $261,336,000, based upon the last sales price as quoted on The
Nasdaq Stock Market for March 18, 1998.
The number of shares of Common Stock outstanding as of March 18, 1998 is
7,767,067.
DOCUMENTS INCORPORATED BY REFERENCE
THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1997, IS
INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K.
THE PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF SHAREHOLDERS IS
INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K.
INDEX
PAGE
PART I
Item 1. Business.................................................. 1
Item 2. Properties................................................ 28
Item 3. Legal Proceedings......................................... 28
Item 4. Submission of Matters to a Vote of Security Holders....... 28
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 28
Item 6. Selected Financial Data................................... 28
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 28
Item 8. Financial Statements and Supplementary Data............... 28
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant........ 29
Item 11. Executive Compensation.................................... 29
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................ 29
Item 13. Certain Relationships and Related Transactions............ 29
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 29
SIGNATURES
PART I
ITEM 1. BUSINESS
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GENERAL
Ocean Financial Corp. (the "Company") was organized by the Board of Directors of
Ocean Federal Savings Bank (the "Bank") for the purpose of acquiring all of the
capital stock of the Bank issued in connection with the Bank's conversion from
mutual to stock form, which was completed on July 2, 1996. At December 31, 1997,
the Company had consolidated total assets of $1,510.9 million and total equity
of $215.5 million. The Company was incorporated under Delaware law and is a
savings and loan holding company subject to regulation by the Office of Thrift
Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the
Securities and Exchange Commission ("SEC"). Currently, the Company does not
transact any material business other than through its subsidiary, the Bank.
The Bank was originally founded as a state-chartered building and loan
association in 1902, and converted to a federal savings and loan association in
1945. The Bank became a federally chartered mutual savings bank in 1989. The
Bank's principal business has been and continues to be attracting retail
deposits from the general public in the communities surrounding its branch
offices and investing those deposits, together with funds generated from
operations and borrowings, primarily in single-family, owner-occupied
residential mortgage loans within its market area. To a significantly lesser
extent, the Bank invests in commercial real estate, multi-family, construction,
consumer and commercial loans. The Bank also invests in mortgage-backed
securities, securities issued by the U.S. Government and agencies thereof, and
other investments permitted by applicable law and regulations. The Bank may
periodically sell newly originated 30-year, fixed-rate mortgage loans to the
secondary market. Loan sales come from loans held in the Bank's portfolio
designated as being held for sale or originated during the period and being so
designated. The Bank retains all of the servicing rights of loans sold. The
Bank's revenues are derived principally from interest on its mortgage loans, and
to a lesser extent, interest on its investment and mortgage-backed securities
and income from loan servicing. The Bank's primary sources of funds are
deposits, principal and interest payments on loans, Federal Home Loan Bank
("FHLB") and other borrowings and to a lesser extent, investment maturities and
proceeds from the sale of loans.
In addition to historical information, this Form 10-K may include certain
forward looking statements based on current management expectations. The
Company's actual results could differ materially from those management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of
federal and state tax authorities, changes in interest rates, deposit flows, the
cost of funds, demand for loan products, demand for financial services,
competition, changes in the quality or composition of the Bank's loan and
investment portfolios, changes in accounting principles, policies or guidelines,
and other economic, competitive, governmental and technological factors
affecting the Company's operations, markets, products, services and prices.
Further description of the risks and uncertainties to the business are included
in detail herein and in the Company's Annual Report to Stockholders.
MARKET AREA AND COMPETITION
The Bank is a community-oriented financial institution, offering a wide variety
of financial services to meet the needs of the communities it serves. The Bank
conducts its business through an administrative and branch office located in
Toms River, Ocean County, New Jersey, and nine additional branch offices, eight
of which are located in Ocean County and one of which is located in Middlesex
County, New Jersey. 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 Ocean County and Southern Monmouth County.
The Bank is the oldest and largest community-based financial institution
headquartered in Ocean County, New Jersey, which is located along the central
New Jersey shore. Ocean County is among the fastest
growing population areas in New Jersey and has a significant number of retired
residents who have traditionally provided the Bank with a stable source of
deposit funds. 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 New
Jersey suburban areas around New York and Philadelphia.
In the late 1980's and early 1990's, due in part to the effects of a prolonged
decline in the national and regional economy, layoffs in the financial services
industry and corporate relocations, New Jersey experienced reduced levels of
employment. These events, in conjunction with a surplus of available commercial
and residential properties, resulted in an overall decline during this period in
the underlying values of properties located in New Jersey. However, New Jersey's
real estate market has stabilized in recent years. Whether such stabilization
will continue is dependent, in large part, upon the general economic health of
the United States and New Jersey, and other factors beyond the Bank's control
and, therefore, cannot be estimated.
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. 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, 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
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conventional first mortgage loans secured by one- to four-family residences. At
December 31, 1997, the Bank had total loans outstanding of $794.3 million, of
which $711.6 million or 89.57 % of total loans, were one- to four-family,
residential mortgage loans. The remainder of the portfolio consisted of $45.4
million of consumer loans, primarily home equity loans and lines of credit,
equaling 5.72% of total loans; $25.7 million of commercial real estate, multi-
family and land loans, or 3.24% of total loans; $8.7 million of real estate
construction loans, or 1.10% of total loans; and $2.9 million of commercial
loans, or .37% of total loans. The Bank had no loans held for sale at December
31, 1997. At that same date, 59.87% of the Bank's total loans had adjustable
interest rates.
The types of loans that the Bank may originate are subject to federal and state
law 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.
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,
-------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Real estate:
One- to four-family........... $711,548 89.57% $628,525 91.05% $575,010 92.01% $552,401 91.63% $505,984 91.66%
Commercial real estate,
multi-family and land.... 25,699 3.24 15,634 2.26 14,939 2.39 13,885
Construction.................. 8,748 1.10 9,287 1.35 8,153 1.30 10,474 1.74 8,123 1.47
Consumer (1)................... 45,417 5.72 36,860 5.34 26,867 4.30 26,100 4.33 26,427 4.79
Commercial loans............... 2,904 .37 - - - - - - - -
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............... 794,316 100.00% 690,306 100.00% 624,969 100.00% 602,860 100.00% 552,006 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan funds........ 2,867 3,517 2,687 2,661 2,341
Unamortized discounts, net.... 9 11 12 13 27
Deferred loan fees............ 1,133 1,302 1,679 2,263 3,286
Allowance for loan losses..... 6,612 6,021 6,001 5,608 5,504
-------- -------- -------- -------- --------
Total loans, net.......... 783,695 679,455 614,590 592,315 540,848
Less:
Mortgage loans held for sale.. - 727 1,894 - 963
-------- -------- -------- -------- --------
Loans receivable, net......... $783,695 $678,728 $612,696 $592,315 $539,885
======== ======== ======== ======== ========
Total loans:
Adjustable rate............... $475,533 59.87% $437,706 63.41% $405,485 64.88% $386,424 64.10% $332,487 60.23%
Fixed rate.................... 318,783 40.13 252,600 36.59 219,484 35.12 216,436 35.90 219,519 39.77
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............... $794,316 100.00% $690,306 100.00% $624,969 100.00% $602,860 100.00% $552,006 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
___________________________
(1) Consists primarily of home equity loans and lines of credit, and to a lesser
extent, loans on savings accounts, automobile and student loans.
3
Loan Maturity. The following table shows the contractual maturity of the Bank's
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total loans at December 31, 1997. There were no loans held for sale at
December 31, 1997. The table does not include principal repayments. Principal
repayments, including prepayments, on total loans was $120.9 million, $103.5
million and $89.6 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
AT DECEMBER 31, 1997
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COMMERCIAL
ONE- TO REAL ESTATE, TOTAL
FOUR- MULTI-FAMILY COMMERCIAL LOANS
FAMILY AND LAND CONSTRUCTION CONSUMER LOANS RECEIVABLE
---------------------------------------------------------------------------
(IN THOUSANDS)
One year or less........................ $ 23,692 $ 6,526 $8,748 $ 5,309 $1,099 $ 45,374
-------- ------- ------ ------- ------ --------
After one year:
More than one year to three years..... 51,973 763 - 8,304 290 61,330
More than three years to five years... 56,870 6,290 - 7,821 1,324 72,305
More than five years to 10 years...... 134,274 1,628 - 16,304 191 152,397
More than 10 years to 20 years........ 235,045 6,569 - 7,679 - 249,293
More than 20 years.................... 209,694 3,923 - - - 213,617
-------- ------- ------ ------- ------ --------
Total due after December 31, 1998..... 687,856 19,173 - 40,108 1,805 748,942
-------- ------- ------ ------- ------ --------
Total amount due...................... $711,548 $25,699 $8,748 $45,417 $2,904 794,316
======== ======= ====== ======= ======
Less:
Undisbursed loan funds............ 2,867
Unamortized discounts, net........ 9
Deferred loan fees................ 1,133
Allowance for loan losses......... 6,612
--------
Total loans, net...................... 783,695
Less: Mortgage loans held for sale..... -
--------
Loans receivable, net................... $783,695
========
4
The following table sets forth at December 31, 1997, the dollar amount of total
loans receivable contractually due after December 31, 1998, and whether such
loans have fixed interest rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 1998
-----------------------------------------------
Fixed ADJUSTABLE Total
-------------- ---------------- ----------
(In thousands)
Real estate loans:
One- to four-family.................. $266,606 $421,250 $687,856
Commercial real estate,
multi-family and land............. 9,763 9,410 19,173
Consumer............................... 15,775 24,333 40,108
Commercial loans....................... 1,697 108 1,805
-------- -------- --------
Total loans receivable.............. $293,841 $455,101 $748,942
======== ======== ========
Origination, Sale, Servicing and Purchase of Loans. The Bank's residential
- --------------------------------------------------
mortgage lending activities are conducted primarily by commissioned loan
representatives in the exclusive employment of the Bank and through the Bank's
branch offices. The Bank originates both adjustable-rate and fixed-rate
mortgage loans. The Bank's ability to originate loans is dependent upon the
relative customer demand for fixed-rate or adjustable-rate mortgage loans, which
is affected by the current and expected future level of interest rates. The
Bank may periodically sell part of the 30-year, fixed-rate mortgage loans that
it originates and retain for portfolio ARM loans and shorter term fixed-rate
loans with maturities of 15 years or less. The Bank retains all servicing of
the loans sold. See "- Loan Servicing." At December 31, 1997 there were no
loans categorized as held for sale. In the past, the Bank has also originated
loans through commitments negotiated with correspondent mortgage origination
firms.
The following tables set forth the Bank's loan originations, purchases, sales,
principal repayments and loan activity for the periods indicated.
FOR THE YEAR DECEMBER 31,
-------------------------------------------------------
1997 1996 1995
-------------- ------------- ----------
(IN THOUSANDS)
Total loans:
Beginning balance.......................... $690,306 $624,969 $602,860
-------- -------- --------
Loans originated:
One- to four-family................... 182,519 170,381 112,283
Commercial real estate,
multi-family and land............. 16,709 2,031 4,058
Construction.......................... 4,743 1,537 6,010
Consumer.............................. 22,982 21,829 11,007
Commercial ........................... 3,177 - -
-------- -------- --------
Total loans originated.......... 230,130 195,778 133,358
-------- -------- --------
Total........................... 920,436 820,747 736,218
Less:
Principal repayments..................... 120,905 103,546 89,596
Sales of loans........................... 2,752 24,711 18,861
Transfer to REO.......................... 2,463 2,184 2,792
-------- -------- --------
Total loans................................ $794,316 $690,306 $624,969
======== ======== ========
One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate and
- ------------------------------------
adjustable-rate mortgage loans secured by one- to four-family residences with
maturities up to 30 years. Substantially all of such loans are secured by
property located in the Bank's primary market area. Loan originations are
generally obtained from the Bank's existing or past customers, members of the
local communities and commissioned loan representatives and their contacts with
the local real estate industry. In the past, the Bank has also originated loans
through commitments negotiated with correspondent mortgage origination firms.
5
At December 31, 1997, the Bank's total loans outstanding were $794.3 million, of
which $711.6 million, or 89.57%, were one- to four-family residential mortgage
loans, primarily single-family and owner-occupied. To a lesser extent, the Bank
also makes mortgage loans secured by seasonal second homes. The average size of
the Bank's one- to four-family mortgage loan was approximately $82,000 at
December 31, 1997. The Bank currently offers a number of ARM loan programs with
interest rates which adjust every one-, three-, or five-years. The Bank's ARM
loans generally provide for periodic (not less than 2%) and overall (not more
than 6%) caps on the increase or decrease in the interest rate at any adjustment
date and over the life of the loan. The interest rate on these loans is indexed
to the applicable one-, three-, five- or ten-year U.S. Treasury constant
maturity yield, with a repricing margin which ranges generally from 2.75% to
3.25% above the index. The Bank also offers three-, five-, and seven-year ARM
loans which operate as fixed-rate loans for three, five or seven years and then
convert to one-year ARM loans for the remainder of the term. The ARM loans are
then indexed to a margin of generally 2.75% to 3.25% above the one-year U.S.
Treasury constant maturity yield.
Generally, ARM loans pose credit risks different than risks inherent in fixed-
rate loans, primarily because as interest rates rise, the payments of the
borrower rise, thereby increasing the potential for delinquency and default. At
the same time, the marketability of the underlying property may be adversely
affected by higher interest rates. In order to minimize risks, borrowers of one-
year ARM loans with a loan-to-value ratio of 75% or less are qualified at the
fully-indexed rate (the applicable U.S. Treasury index plus the margin, rounded
to the nearest one-eighth of one percent), and borrowers of one-year ARM loans
with a loan-to-value ratio over 75% are qualified at the higher of the fully
indexed rate or the initial rate plus the 2% annual interest rate cap. The Bank
does not originate ARM loans which provide for negative amortization.
The Bank's fixed-rate mortgage loans currently are made for terms from 10 to 30
years. At December 31, 1997, the Bank had commitments for the origination of
fixed-rate mortgage loans totaling $24.5 million. The normal terms for such
commitments provide for a maximum of 90 days rate lock upon receipt of a 1.0%
fee charged on the mortgage amount. The Bank may periodically sell part of the
30-year, fixed-rate residential mortgage loans that it originates. The Bank
retains the servicing on all loans sold. The Bank generally retains for its
portfolio shorter term, fixed-rate loans with maturities of 15 years or less,
and certain longer term fixed-rate loans, generally consisting of loans to
facilitate the sale of REO, loans to officers, directors or employees of the
Bank and "jumbo", non-conforming loans as determined by applicable FNMA and
FHLMC guidelines. The Bank may retain all or most of its longer term fixed rate
loans after considering volume and yield and after evaluating interest rate risk
and capital management considerations.
The Bank's policy is to originate one- to four-family residential mortgage loans
in amounts up to 80% of the lower of the appraised value or the selling price of
the property securing the loan and up to 95% of the appraised value or selling
price if private mortgage insurance is obtained. 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.
Commercial Real Estate, Multi-Family and Land Lending. The Bank originates
- -----------------------------------------------------
commercial real estate loans that are secured by properties generally used for
business purposes such as small office buildings or retail facilities located in
the Bank's primary market area. The Bank's underwriting procedures provide that
commercial real estate loans may be made in amounts up to 80% of the appraised
value of the property. The Bank currently originates commercial real estate
loans with terms of up to twenty five years with fixed or adjustable rates which
are indexed to a margin above the one-, three-, or five-year U.S. Treasury
constant maturity yield. In reaching its decision on whether to make a
commercial real estate loan, the Bank considers the net operating income of the
property and the borrower's expertise, credit history, profitability and the
term and quantity of leases. The Bank has generally required that the properties
securing commercial real estate loans have debt service coverage ratios of at
least 120%. Generally, properties securing a loan are appraised by an
independent appraiser and title insurance is required on all first mortgage
loans. The Bank typically requires the personal guarantee of the principal
borrowers for all commercial real estate loans. The Bank's commercial real
estate loan portfolio at
6
December 31, 1997 was $21.5 million, or 2.71% of total loans. The largest
commercial real estate loan in the Bank's portfolio at December 31, 1997 was a
performing loan for which the Bank had an outstanding carrying balance of $2.7
million, which was secured by a first mortgage on an owner-occupied 38,000
square foot commercial building.
The Bank originates multi-family mortgage loans generally secured by buildings
with five or more housing units located in the Bank's primary market area. As a
result of market conditions in its primary market area, the Bank currently
originates multi-family loans on a limited and highly selective basis. In
reaching its decision on whether to make a multi-family loan, the Bank considers
the qualifications of the borrower as well as the underlying property. Some of
the factors to be considered are: the net operating income of the mortgaged
premises before debt service and depreciation; the debt service ratio; and the
ratio of loan amount to appraised value. Pursuant to the Bank's current
underwriting policies, a multi-family adjustable-rate mortgage loan may only be
made in an amount up to 75% of the appraised value of the underlying property to
a maximum amount of generally $4 million. In addition, the Bank generally
requires a debt service ratio of 120%. Properties securing a loan are appraised
by an independent appraiser and title insurance is required on all loans. The
Bank's multi-family loan portfolio at December 31, 1997, totaled $4.0 million.
The Bank's largest multi-family loan at December 31, 1997, had an outstanding
balance of $2.2 million and was secured by a 125-unit affordable-housing
apartment complex located in Toms River, New Jersey. To a significantly lesser
extent, the Bank also originates land loans. Such loans totaled $153,000 at
December 31, 1997.
Loans secured by commercial real estate and multi-family residential 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 properties are often dependent on successful operation or management of
the properties, repayment of such loans may be subject to a greater extent to
adverse conditions in the real estate market or the economy. The Bank seeks to
minimize these risks through its underwriting policies, which require such loans
to be qualified at origination on the basis of the property's income and debt
coverage ratio.
Construction Lending. At December 31, 1997, construction loans totaled $8.7
- --------------------
million, or 1.10%, of the Bank's total loans outstanding. The Bank originates
single-family construction loans primarily on a construction/permanent basis
with such loans converting to an amortizing loan following the completion of the
construction phase. Most of the Bank's construction loans are made to
individuals building their primary residence, while, to a lesser extent, loans
are made to developers known to the Bank in order to build single-family houses
under contract for sale, which loans become due and payable over terms not
exceeding 18 months. The current policy of the Bank is to charge interest rates
on its construction loans which float at margins which are generally 2.0% above
the prime rate (as published in the Wall Street Journal). The Bank's
construction loans increase the interest rate sensitivity of its earning assets.
At December 31, 1997, the Bank had 44 construction loans, with the largest loan
balance being approximately $825,000. At December 31, 1997, all of the Bank's
construction lending portfolio consisted of loans secured by property located in
the State of New Jersey, for the purpose of constructing one- to four-family
homes. The Bank may originate construction loans to individuals and contractors
on approved building lots in amounts up to 75% of the appraised value of the
land and the building. The terms to maturity of the Bank's
construction/permanent loans are similar to the Bank's other one- to four-family
mortgage products. The Bank requires an appraisal of the property, credit
reports, and financial statements on all principals and guarantors, among other
items, for all construction loans.
Construction lending, by its nature, entails additional risks compared to one-to
four-family mortgage lending, attributable primarily to the fact that funds are
advanced upon the security of the project under construction prior to its
completion. As a result, construction lending often involves the disbursement of
substantial funds with repayment dependent on the success of the ultimate
project and the ability of the borrower or guarantor to repay the loan. Because
of these factors, the analysis of prospective construction loan projects
requires an expertise that is different in significant respects from that which
is required for residential mortgage lending. The Bank has attempted to address
these risks through its underwriting procedures.
Consumer Loans. The Bank also offers consumer loans. At December 31, 1997, the
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Bank's consumer
7
loans totaled $45.4 million, or 5.72% of the Bank's total loan portfolio. Of
that amount, home equity loans comprised $23.1 million, or 50.9%; home equity
lines of credit comprised $18.7 million, or 41.2%; loans on savings accounts
totaled $1.6 million, or 3.5%; and automobile and student loans totaled $2.0
million, or 4.4%.
The Bank originates home equity loans secured by one- to four-family residences.
These loans are originated as either adjustable-rate or fixed-rate loans with
terms ranging from 10 to 20 years. Home equity loans are typically made on
owner-occupied, one- to four-family residences and generally to the Bank's first
mortgage customers. These loans are subject to a 80% loan-to-value limitation,
including any other outstanding mortgages or liens.
The Bank also offers a variable rate home equity line of credit which extends a
credit line based on the applicant's income and equity in the home. Generally,
the credit line, when combined with the balance of the first mortgage lien, may
not exceed 80% of the appraised value of the property at the time of the loan
commitment. Home equity lines of credit are secured by a mortgage on the
underlying real estate. The Bank presently charges no origination fees for these
loans, but may in the future charge origination fees for its home equity lines
of credit. A borrower is required to make monthly payments of principal and
interest, at a minimum of $50, based upon a 10 or 15 year amortization period.
Generally, the adjustable rate of interest charged is the prime rate of interest
(as published in the Wall Street Journal) plus a range of 0.0% to 1.25%. The
loans have an 18% lifetime cap on interest rate adjustments. The Bank's home
equity lines of credit outstanding at December 31, 1997 totaled $18.7 million.
Commercial Lending. At December 31, 1997, commercial loans totaled $2.9
- ------------------
million, or .37% of the Bank's total loans outstanding. During 1996, a
Commercial Lending group was established within the Bank. The group's primary
function is to service the business communities' banking and financing needs in
the Bank's primary market area. The Commercial Lending group originates both
commercial loans (including loans for working capital; fixed asset purchases;
and acquisition, receivable and inventory financing) and commercial mortgage
loans (including acquisition, construction, expansion and refinancing of owner
occupied and investment properties). Credit facilities such as lines of credit
and term loans will be used to facilitate these requests. In all cases, the Bank
will review and analyze financial history and capacity, collateral value,
strength and character of the principals, and general payment history of the
borrower and principals in coming to a credit decision.
A well-defined credit policy has been approved by the Bank's Board of Directors.
This policy discourages high risk credits, while focusing on quality
underwriting, sound financial strength, and close management and Board
monitoring. Commercial business lending, both secured and unsecured, is
generally considered to involve a higher degree of risk than secured residential
real estate lending. Risk of loss on a commercial business loan is dependent
largely on the borrower's ability to remain financially able to repay the loan
out of ongoing operations. If the Bank's estimate of the borrower's financial
ability is inaccurate, the Bank may be confronted with a loss of principal on
the loan.
Loan Approval Procedures and Authority. The Board of Directors establishes the
- --------------------------------------
loan approval policies of the Bank. The Board of Directors has authorized the
approval of loans secured by real estate up to $1 million and unsecured loans up
to $500,000 by various employees of the Bank, on a scale which requires approval
by personnel with progressively higher levels of responsibility as the loan
amount increases. A minimum of two employees' signatures are required to approve
residential loans over $150,000. Loans secured by real estate in amounts over $1
million and unsecured loans over $500,000 require approval by the Loan Committee
of the Board of Directors. Loans in excess of $2 million require approval by the
Board of Directors. Pursuant to OTS regulations, loans to one borrower generally
cannot exceed 15% of the Bank's unimpaired capital, which at December 31, 1997
amounted to $26.8 million. At December 31, 1997, the Bank's maximum loan
exposure to a single borrower was $4.4 million.
Loan Servicing. Loan servicing includes collecting and remitting loan payments,
- --------------
accounting for principal and interest, making inspections as required of
mortgaged premises, contacting delinquent mortgagors, supervising foreclosures
and property dispositions in the event of unremedied defaults, making certain
insurance and tax payments on behalf of the borrowers and generally
administering the loans. The Bank also services mortgage loans for others. All
of the loans currently being serviced for
8
others are loans which have been sold by the Bank. At December 31, 1997, the
Bank was servicing $144.2 million of loans for others. For the years ended
December 31, 1997, 1996 and 1995, loan servicing fees totaled $529,000, $543,000
and $522,000, respectively.
Delinquencies and Classified Assets. The Board of Directors performs a monthly
- -----------------------------------
review of all delinquent loan totals which includes loans sixty days or more
past due, and the detail of each loan thirty days or more past due that were
originated within the past year. In addition, management prepares a quarterly
list of all classified loans and a narrative report of classified commercial,
commercial real estate, multi-family, land and construction loans. The
procedures taken by the Bank with respect to delinquencies vary depending on the
nature of the loan and period of delinquency. 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. In the event payment is not then received, additional letters
and phone calls generally are made. If the loan is still not brought current and
it becomes necessary for the Bank to take legal action, which typically occurs
after a loan is delinquent at least 90 days or more, 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 an acceptable workout accommodation is not agreed upon before the
foreclosure sale, the real property securing the loan generally is sold at
foreclosure.
The Bank's Internal Asset Classification Committee, which is chaired by an
officer who reports directly to the Audit Committee of the Board of Directors,
reviews and classifies the Bank's assets quarterly and reports the results of
its review to the Board of Directors. The Bank classifies assets in accordance
with certain regulatory guidelines established by the OTS which are applicable
to all savings associations. At December 31, 1997, the Bank had $7.0 million of
assets, including all REO, classified as Substandard, $3,000 of assets
classified as Doubtful and no assets classified as Loss. Loans and other assets
may also be placed on a watch list as "Special Mention" assets. Assets which do
not currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are required to be designated "Special Mention." Special Mention assets totaled
$3.6 million at December 31, 1997, and consisted primarily of loans secured by
single-family, owner-occupied residences. These loans are classified as Special
Mention due to past delinquencies or other identifiable weaknesses. At December
31, 1997, the largest loan classified as Special Mention had a balance of
$552,000 and the largest loan classified as Substandard had a balance of
$250,000.
Non-Accrual Loans and REO
- -------------------------
The following table sets forth information regarding non-accrual loans and REO.
The Bank had no troubled-debt restructured loans within the meaning of SFAS 114,
and 16 REO properties at December 31, 1997. It is the policy of the Bank to
cease accruing interest on loans 90 days or more past due or in the process of
foreclosure. For the years ended December 31, 1997, 1996, 1995, 1994 and 1993,
respectively, the amount of interest income that would have been recognized on
nonaccrual loans if such loans had continued to perform in accordance with their
contractual terms was $278,000, $345,000, $428,000, $607,000 and $642,000 none
of which was recognized.
9
December 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------- ---------- ---------- ----------- --------------
Non-accrual loans:
Real estate:
One- to four-family.................. $ 5,062 $7,148 $ 8,296 $10,280 $ 9,705
Commercial real estate,
multi-family and land............... 382 122 154 96 315
Construction......................... - 314 -- 265 250
Consumer................................. 110 113 221 298 224
------- ------ ------- ------- -------
Total............................. 5,554 7,697 8,671 10,939 10,494
REO, net(1)................................ 1,198 1,555 1,367 1,580 3,056
------- ------ ------- ------- -------
Total non-performing assets............. $ 6,752 $9,252 $10,038 $12,519 $13,550
======= ====== ======= ======= =======
Allowance for loan losses as a
percent of total loans receivable (2).. .83% .88% .97% .94% 1.01%
Allowance for loan losses as a
percent of total non-performing
loans (3).............................. 119.03 78.23 69.21 51.27 52.45
Non-performing loans as a percent of
total loans receivable(2)(3)........... .70 1.12 1.40 1.83 1.92
Non-performing assets
as a percent of total assets(3)........ .45 .71 .97 1.29 1.45
- ----------------------------
(1) REO balances are shown net of related loss allowances.
(2) Total loans includes loans receivable and mortgage loans held for sale, less
undisbursed loan funds, deferred loan fees and unamortized premiums and
discounts.
(3) Non-performing assets consist of non-performing loans and REO. Non-
performing loans consist of all loans 90 days or more past due and other loans
in the process of foreclosure.
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 sufficient to provide for
estimated losses based on evaluating known and inherent risks in the loan
portfolio based upon management's continuing analysis of the factors underlying
the quality of the loan portfolio. These factors include changes in the size
and composition of the loan portfolio, actual loan loss experience, current and
anticipated economic conditions, detailed analysis of individual loans for which
full collectibility may not be assured, and the determination of the existence
and realizable value of the collateral and guarantees securing the loan.
Additions to the allowance are charged to earnings. 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 loan losses based upon
information available to them at the time of their examination. Although
management uses the best information available, future adjustments to the
allowance may be necessary due to economic, operating, regulatory and other
conditions beyond the Company's control. As of December 31, 1997 and 1996, the
Bank's allowance for loan losses was .83% and .88%, respectively, of total
loans. The Bank had non-accrual loans of $5.6 million and $7.7 million at
December 31, 1997 and 1996, respectively. The Bank will continue to monitor and
modify its allowances for loan losses as conditions dictate.
10
PAGE>
The following table sets forth activity in the Bank's allowance for estimated
loan losses for the periods set forth in the table.
AT OR FOR THE YEAR ENDED
------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- --------- --------
(IN THOUSANDS)
Balance at beginning of year.................... $6,021 $6,001 $5,608 $5,504 $5,737
------ ------ ------ ------ ------
Charge-offs:
Real Estate:
One- to four-family.......................... 328 599 510 907 1,080
Commercial real estate,
multi-family and land.................... -- 30 28 141 334
Construction................................. -- -- -- -- 11
Consumer....................................... 9 63 30 5 122
------ ------ ------ ------ ------
Total...................................... 337 692 568 1,053 1,547
Recoveries...................................... 28 12 11 28 14
------ ------ ------ ------ ------
Net charge-offs.............................. 309 680 557 1,025 1,533
------ ------ ------ ------ ------
Provision for loan losses....................... 900 700 950 1,129 1,300
------ ------ ------ ------ ------
Balance at end of year.......................... $6,612 $6,021 $6,001 $5,608 $5,504
====== ====== ====== ====== ======
Ratio of net charge-offs during the year
to average net loans outstanding during
the year...................................... .05% .11% .09% .18% .29%
====== ====== ====== ====== ======
11
The following tables set forth the Bank's percent of allowance for loan losses
to total allowance and the percent of loans to total loans in each of the
categories listed at the dates indicated.
At December 31,
---------------------------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Percent of Each Percent of Each Percent of Each
Allowance to Category Allowance to Category Allowance to Category
Total to Total Total to Total Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
---------------------------------------------------------------------------------------------------------------
One- to
four-family $2,485 37.58% 89.57% $2,659 44.16% 91.05% $2,790 46.49% 92.01%
Commercial real
estate, multi-
family and land 591 8.94 3.24 330 5.48 2.26 556 9.27 2.39
Construction 44 .67 1.10 75 1.25 1.35 41 .68 1.30
Consumer 471 7.12 5.72 324 5.38 5.34 273 4.55 4.30
Commercial 58 .88 .37 -- -- -- -- -- --
Unallocated 2,963 44.81 - 2,633 43.73 -- 2,341 39.01 --
------ ------ ------ ------ ------ ------ ------ ------ ------
Total $6,612 100.00% 100.00% $6,021 100.00% 100.00% $6,001 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
At December 31,
--------------------------------------------------------------------------
1994 1993
--------------------------------------------------------------------------
Percent of Percent of
Loans in Loans in
Percent of Each Percent of Each
Allowance to Category Allowance to Category
Total to Total Total to Total
Amount Allowance Loans Amount Allowance Loans
--------------------------------------------------------------------------
One- to
four-family $2,809 50.09% 91.63% $2,941 53.43% 91.66%
Commercial real
estate, multi-
family and land 483 8.61 2.30 506 9.19 2.08
Construction 79 1.41 1.74 49 .89 1.47
Consumer 268 4.78 4.33 275 5.00 4.79
Commercial -- -- -- -- -- --
Unallocated 1,969 35.11 -- 1,733 31.49 --
------ ------ ------ ------ ------ ------
Total $5,608 100.00% 100.00% $5,504 100.00% 100.00%
====== ====== ====== ====== ====== ======
12
INVESTMENT ACTIVITIES
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. See "Regulation and
Supervision - Federal Savings Institution Regulation -Liquidity." 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 investment policy of the Bank as established by the Board of Directors
attempts to provide and maintain liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk, and
complement the Bank's lending activities. Specifically, the Bank's policies
generally limit investments to government and federal agency-backed securities
and other non-government guaranteed securities, including corporate debt
obligations, that are investment grade. The Bank's policies provide that all
investment purchases must be approved by two officers (either the Senior Vice
President/Treasurer, Executive Vice President/Chief Financial Officer or the
President and Chief Executive Officer) and be ratified by the Board of
Directors. In December 1995, the Bank reassessed its investment portfolio and
reclassified all of its investment and mortgage-backed securities, totaling in
the aggregate $382.7 million, from held-to-maturity to available for sale.
Mortgage-backed Securities. Mortgage-backed securities represent a
- --------------------------
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which, in general, are passed from the
mortgage originators, through intermediaries that pool and repackage the
participation interests in the form of securities, to investors such as the
Bank. Such intermediaries may be private issuers, or agencies including FHLMC,
FNMA and GNMA that guarantee the payment of principal and interest to investors.
Mortgage-backed securities typically are issued with stated principal amounts,
and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed- or ARM loans.
The actual maturity of a mortgage-backed security varies, depending on when the
mortgagors repay or prepay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the security, thereby affecting its
yield to maturity and the related market value of the mortgage-backed security.
The prepayments of the underlying mortgages depend on many factors, including
the type of mortgages, the coupon rates, the age of mortgages, the geographical
location of the underlying real estate collateralizing the mortgages, general
levels of market interest rates, and general economic conditions. GNMA mortgage-
backed securities that are backed by assumable Federal Housing Authority ("FHA")
or the Department of Veterans Affairs ("VA") loans generally have a longer life
than conventional non-assumable loans underlying FHLMC and FNMA mortgage-backed
securities. During periods of falling mortgage interest rates, prepayments
generally increase, as opposed to periods of increasing interest rates when
prepayments generally decrease. If the interest rate of underlying mortgages
significantly exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages. Prepayment experience is more difficult to estimate for
adjustable-rate mortgage-backed securities.
The Bank has significant investments in mortgage-backed securities and has
utilized such investments to complement its mortgage lending activities. At
December 31, 1997, mortgage-backed securities totaled $457.1 million, or 30.2%
of total assets, all of which were classified as available for sale. The Bank
invests in a large variety of mortgage-backed securities, including ARM, balloon
and fixed-rate mortgage-backed securities, the majority of which are directly
insured or guaranteed by FHLMC, GNMA and FNMA. At such date, the mortgage-backed
securities portfolio had a weighted average interest rate of 6.73%.
The Bank generally purchases short-term, straight sequential or planned
amortization class collateralized
13
mortgage obligations ("CMOs"). CMOs are securities created by segregating or
portioning cash flows from mortgage pass-through securities or from pools of
mortgage loans. CMOs provide a broad range of mortgage investment vehicles by
tailoring cash flows from mortgages to meet the varied risk and return
preferences of investors. These securities enable the issuer to "carve up" the
cash flows from the underlying securities and thereby create multiple classes of
securities with different maturity and risk characteristics. The Bank invests in
U.S. Government and agency-backed CMOs and, to a lesser extent, privately issued
CMOs, all of which have agency-backed collateral. All of the Bank's CMOs and
mortgage-backed securities are currently rated "AAA". Prior to purchasing
mortgage-backed securities, each security is tested for Federal Financial
Institutions Examination Council ("FFIEC") qualification. At December 31, 1997,
the Bank's investment in CMOs had an amortized cost of $3.4 million, and a
market value of $3.4 million.
The following table sets forth the Bank's mortgage-backed securities activities
for the periods indicated.
FOR THE YEAR
ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995
----------------- ------------------ ---------------
(IN THOUSANDS)
Beginning balance...................................... $ 395,542 $ 265,113 $224,569
Mortgage-backed securities
purchased........................................... 248,917 251,004 88,490
Less: Principal repayments........................... (164,291) (117,048) (50,193)
Mortgage-backed securities sold................... (19,149) - -
(Amortization of
premium)....................................... (3,504) (1,804) (612)
Change in net unrealized gain
(loss) on mortgage-backed
securities available for sale................... (367) (1,723) 2,859
--------- --------- --------
Ending balance......................................... $ 457,148 $ 395,542 $265,113
========= ========= ========
14
The following table sets forth certain information regarding the amortized cost
and market value of the Bank's mortgage-backed securities at the dates
indicated.
At December 31,
-------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- -------------------------- --------------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
------------ ----------- ------------ ----------- ------------ -----------
(IN THOUSANDS)
Mortgage-backed
securities:
FHLMC.................. $245,414 $245,559 $316,773 $317,735 $221,822 $223,884
FNMA................... 109,873 109,991 69,190 69,108 27,307 27,624
GNMA................... 97,714 98,172 2,800 2,931 3,561 3,763
3,378 3,426 5,643 5,768 9,564 9,842
-------- -------- -------- -------- -------- --------
Total mortgage-backed
securities............. $456,379 $457,148 $394,406 $395,542 $262,254 $265,113
======== ======== ======== ======== ======== ========
Investment Securities. Investment securities identified as held to maturity are
- ---------------------
carried at cost, adjusted for amortization of premium and accretion of discount,
which are recognized as adjustments to interest income. Management determines
the appropriate classification of securities at the time of purchase. If
management has the intent and the Bank has the ability at the time of purchase
to hold securities until maturity, they are classified as held to maturity.
Debt securities to be held for indefinite periods of time and not intended to be
held to maturity are classified as available for sale. Securities available for
sale include securities that management intends to use as part of its
asset/liability management strategy. Such securities are carried at fair value
and unrealized gains and losses, net of related tax effect, are excluded from
earnings, but are included as a separate component of stockholders' equity. At
December 31, 1997, the Bank had investment securities with an amortized cost of
$206.6 million, and a market value of $207.4 million, all of which were
classified as available for sale.
The following table sets forth certain information regarding the amortized cost
and market values of the Bank's investment securities at the dates indicated.
AT DECEMBER 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- ---------------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
------------ ------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
Investment securities:
U.S. Government and
agency obligations..... $204,992 $205,648 $175,003 $173,327 $112,956 $113,302
State and municipal
obligations............ 393 400 693 701 1,549 1,579
Equity
investments............ 1,170 1,309 --- --- --- ---
-------- -------- -------- -------- -------- --------
Total investment
securities............. $206,555 $207,357 $175,696 $174,028 $114,505 $114,881
======== ======== ======== ======== ======== ========
15
The table below sets forth certain information regarding the amortized cost,
weighted average yields and contractual maturities of the Bank's investment and
mortgage-backed securities as of December 31, 1997.
AT DECEMBER 31, 1997
-----------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEAR TO TEN YEARS MORE THAN TEN YEARS
--------------------- -------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD
--------- -------- --------- -------- --------- -------- --------- --------
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. Government and
agency obligations.............. $ 5,000 5.75% $ 85,000 6.31% $ 114,992 7.10% $ --- ---%
State and municipal
obligations (1)................. 60 9.66 197 9.27 136 8.71 --- ---
Equity investments............... 1,170 --- --- --- --- --- --- ---
--------- --------- --------- ---------
Total investment
securities....................... $ 6,230 4.71 $ 85,197 6.32 $ 115,128 7.10 $ --- ---
========= ========= ========= =========
Mortgage-backed
securities:
FHLMC........................... 12,898 5.55 29,428 6.42 40,823 6.76 162,265 6.52
FNMA............................ 836 8.66 4,016 6.31 52,326 6.61 52,695 6.21
GNMA............................ --- --- 205 8.00 1,433 8.96 96,076 7.62
CMOs............................ 519 6.27 2,227 8.98 632 6.28 --- ---
--------- --------- --------- ---------
Total mortgage-backed
securities....................... $ 14,253 5.76 $ 35,876 6.58 $ 95,214 6.71 $ 311,036 6.81
========= ========= ========= =========
AT DECEMBER 31, 1997
---------------------------------
WEIGHTED
AMORTIZED MARKET AVERAGE
COST VALUE YIELD
--------- --------- --------
(DOLLARS IN THOUSANDS)
Investment securities:
U.S. Government and
agency obligations.............. $ 204,992 $ 205,648 6.74%
State and municipal
obligations (1)................. 393 400 9.14
Equity investments............... 1,170 1,309 ---
--------- ---------
Total investment
securities....................... $ 206,555 $ 207,357 6.70
========= =========
Mortgage-backed
securities:
FHLMC........................... 245,414 245,559 6.50
FNMA............................ 109,873 109,991 6.42
GNMA............................ 97,714 98,172 7.64
CMOs............................ 3,378 3,426 8.06
--------- ---------
Total mortgage-backed
securities....................... $ 456,379 $ 457,148 6.73
========= =========
__________________________
(1) Tax equivalent yield.
16
SOURCES OF FUNDS
General. Deposits, loan repayments and prepayments, proceeds from sales of
- -------
loans, investment maturities, cash flows generated from operations and FHLB and
other 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 accounts, NOW
accounts, money market accounts and time deposits. For the year ended December
31, 1997, time deposits constituted 66.3% 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 relies 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. Time
deposits in excess of $100,000 are not actively solicited by the Bank, nor does
the Bank use brokers to obtain deposits.
The following table presents the deposit activity of the Bank for the periods
indicated:
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
------------- ------------- -------------
(IN THOUSANDS)
Net deposits (withdrawals)................................ $ 2,946 $(29,111) $23,097
Interest credited on deposit accounts..................... 39,088 37,283 36,041
------- -------- -------
Total increase in deposit accounts........................ $42,034 $ 8,172 $59,138
======= ======== =======
At December 31, 1997, the Bank had $59.5 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
WEIGHTED
AVERAGE
MATURITY PERIOD AMOUNT RATE
- ------------------------------------------------------- --------------- ------------
(DOLLARS IN THOUSANDS)
Three months or less................................... $21,158 5.48%
Over three through six months.......................... 6,633 5.55
Over six through 12 months............................. 12,538 5.73
Over 12 months......................................... 19,175 6.20
-------
Total.................................................. $59,504 5.77%
=======
17
The following table sets forth the distribution of the Bank's average deposit
accounts for the periods indicated and the weighted average interest rates at
the end of each period, on each category of deposits presented.
AT OR FOR THE YEARS ENDED 31,
--------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------- ------------------------------
PERCENT PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD
--------- -------- -------- --------- -------- -------- --------- --------- --------
(DOLLARS IN THOUSANDS)
Money market deposit accounts.. $ 68,972 7.18% 2.94% $ 70,209 7.52% 2.90% $ 68,987 7.71% 2.93%
Savings accounts............... 168,733 17.56 2.30 175,060 18.75 2.28 178,973 20.00 2.53
NOW accounts................... 77,785 8.09 1.78 72,265 7.74 1.84 69,330 7.74 2.14
Non-interest-bearing accounts.. 8,115 .84 - 6,425 .69 -- 2,902 .32 --
-------- ------ -------- ------ -------- ------
Total......................... 323,605 33.67 2.25 323,959 34.70 2.27 320,192 35.77 2.49
-------- ------ -------- ------ -------- ------
Time deposits:
Six months or less............ 78,724 8.19 5.32 71,353 7.64 4.95 78,455 8.77 4.84
Over Six through 12 months.... 146,951 15.29 5.37 151,485 16.23 5.23 131,795 14.73 5.44
Over 12 through 24 months..... 178,440 18.57 5.55 150,085 16.08 5.49 123,825 13.83 5.59
Over 24 months................ 120,709 12.56 5.92 124,056 13.29 6.09 127,205 14.21 6.19
IRA/KEOGH..................... 112,602 11.72 5.84 112,641 12.06 5.86 113,564 12.69 6.39
-------- ------ -------- ------ -------- ------
Total time deposits.......... 637,425 66.33 5.60 609,620 65.30 5.55 574,844 64.23 5.70
-------- ------ -------- ------ -------- ------
Total average deposits...... $961,030 100.00% 4.47% $933,579 100.00% 4.44% $895,036 100.00% 4.59%
======== ====== ======== ====== ======== ======
18
Borrowings
- ----------
From time to time the Bank has obtained advances from the FHLB as an alternative
to retail deposit funds and may do so in the future as part of its operating
strategy. FHLB advances may also be used to acquire certain other assets as may
be deemed appropriate for investment purposes. These advances are collateralized
primarily by certain of the Bank's mortgage loans and mortgage-backed securities
and secondarily by the Bank's investment in capital stock of the FHLB. The Bank
has an available overnight line of credit with the FHLB-NY for $50.0 million
which expires November 25, 1998. When utilized, the line bears a floating
interest rate of 1/8% over the current federal funds rate and is secured by the
Bank's mortgage loans, mortgage-backed securities and U.S. Government
securities. 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 OTS and the FHLB. At December 31, 1997, the Bank had
borrowed $20.4 million against the FHLB line of credit.
The Bank also borrows funds using securities sold under agreements to
repurchase. Under this form of borrowing specific U.S. Government agency and/or
mortgage-backed securities are pledged as collateral to secure the borrowing.
These securities are not under the Bank's control. At December 31, 1997, the
Bank had borrowed $288.2 million through securities sold under agreements to
repurchase. (See note 11 to the consolidated financial statements in the 1997
Annual Report to Stockholders.)
SUBSIDIARY ACTIVITIES
The Bank owns two subsidiaries - Ocean Investment Services Corp. (formerly Dome
Financial Services, Inc.) and Ocean Federal Realty Inc.
Ocean Investment Services Corp. was originally organized in 1982 to engage in
the sale of all-savers life insurance. For the past several years the subsidiary
has been inactive, however, beginning in 1998, the Bank plans to sell non-
deposit investment products (annuities and mutual funds) to Bank customers
through this subsidiary, recognizing fee income from such sales.
Ocean Federal Realty Inc. was established in 1997 and is intended to qualify as
a real estate investment trust, which may, among other things, be utilized by
the Company to raise capital in the future. Upon formation of Ocean Federal
Realty Inc., the Bank transferred $668 million of mortgage loans to this
subsidiary.
PERSONNEL
As of December 31, 1997, the Bank had 210 full-time employees and 47 part-time
employees. The employees are not represented by a collective bargaining unit and
the Bank considers its relationship with its employees to be good.
REGULATION AND SUPERVISION
GENERAL
The Company, as a savings and loan holding company, is required to file certain
reports with, and otherwise comply with the rules and regulations of the Office
of Thrift Supervision ("OTS") under the Home Owners' Loan Act, as amended (the
"HOLA"). In addition, the activities of savings institutions, such as the Bank,
are governed by the HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by the
OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The
Bank is a member of the Federal Home Loan Bank ("FHLB") System and its 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 savings institutions. The OTS
and/or the FDIC conduct periodic examinations to test the Bank's safety and
soundness and 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
19
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 regulatory
requirements and policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements applicable to the Bank and to the Company
are referred to below or elsewhere herein. The description of statutory
provisions and regulations applicable to savings institutions and their holding
companies set forth in this Form 10-K does not purport to be a complete
description of such statutes and regulations and their effects on the Bank and
the Company.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As a unitary savings and loan holding company, the
Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Bank continues to
be a qualified thrift lender ("QTL"). See "Federal Savings Institution
Regulation - QTL Test." Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the QTL test and is
deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and certain activities authorized by
OTS regulation, and no multiple savings and loan holding company may acquire
more than 5% of the voting stock of a company engaged in impermissible
activities.
The HOLA prohibits a savings and loan 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; 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, subject to two exceptions: (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.
Although savings and loan holding companies are not subject to specific capital
requirements or specific restrictions on the payment of dividends or other
capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
FEDERAL SAVINGS INSTITUTION REGULATION
Capital Requirements. The OTS capital regulations require savings institutions
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to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3%
leverage (core) capital ratio and an 8% risk-based capital ratio. In addition,
the prompt corrective action standards discussed below also establish, in
effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
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 I risk-based capital standard. Core 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
20
other than certain purchased mortgage servicing rights and credit card
relationships. The OTS regulations also require that, in meeting the tangible,
leverage (core) and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 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%,
as assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term 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 OTS regulatory capital requirements 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. A savings institution's interest rate risk is
measured by the decline in the net portfolio value of its assets (i.e., the
difference between incoming and outgoing discounted cash flows from assets,
liabilities and off-balance sheet contracts) that would result from a
hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At December 31, 1997, the
Bank met each of its capital requirements, in each case on a fully phased-in
basis. Although the Bank may be subject to the interest rate risk component, the
effect on the Bank's capital compliance is not expected to be significant.
The following table presents the Bank's capital position at December 31, 1997
relative to fully phased-in regulatory requirements.
EXCESS CAPITAL
-------------------------------
ACTUAL REQUIRED (DEFICIENCY) ACTUAL REQUIRED
CAPITAL CAPITAL AMOUNT PERCENT PERCENT
------------------ --------------- ------------------- ------------- -----------
(Dollars in thousands)
Tangible.............. $178,592 $22,491 $156,101 11.91% 1.50%
Core (Leverage)....... 178,592 44,982 133,610 11.91% 3.00%
Risk-based............ 184,970 49,525 135,445 29.88% 8.00%
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
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regulations, the OTS is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMEL rating). A savings institution that has a
ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier
I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
21
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 a
savings institution 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 become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
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. Deposits of the Bank are presently insured by
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the SAIF. Both the SAIF and the Bank Insurance Fund ("BIF"), (the deposit
insurance fund that covers most commercial bank deposits), are statutorily
required to be recapitalized to a 1.25% of insured reserve deposits ratio. Until
recently, members of the SAIF and BIF were paying average deposit insurance
premiums of between 24 and 25 basis points. The BIF met the required reserve in
1995, whereas the SAIF was not expected to meet or exceed the required level
until 2002 at the earliest. This situation was primarily due to the statutory
requirement that SAIF members make payments on bonds issued in the late 1980s by
the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted a
new assessment rate schedule of from 0 to 27 basis points under which 92% of BIF
members paid an annual premium of only $2,000. With respect to SAIF member
institutions, the FDIC adopted a final rule retaining the previously existing
assessment rate schedule applicable to SAIF member institutions of 23 to 31
basis points. As long as the premium differential continued, it may have had
adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as the Bank could have been placed at a substantial competitive
disadvantage to BIF members with respect to pricing of loans and deposits and
the ability to achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance Funds
Act of 1996 (the "Funds Act") which, among other things, imposed a special one-
time assessment on SAIF member institutions, including the Bank, to recapitalize
the SAIF. As required by the Funds Act, the FDIC imposed a special assessment of
65.7 basis points on SAIF assessable deposits held as of March 31, 1995, payable
November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special Assessment
was recognized by the Bank as an expense in the quarter ended September 30, 1996
and is generally tax deductible. The SAIF Special Assessment recorded by the
Bank amounted to $5.7 million on a pre-tax basis and $3.6 million on an after-
tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds across
all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits will be
assessed for FICO payment of 1.3 basis points, while SAIF deposits will pay
approximately 6.5 basis points. Full pro rata sharing of the FICO payments
between BIF and SAIF members will occur on the earlier of January 1, 2000 or the
date the BIF and SAIF are merged. The Funds Act specifies that the BIF and SAIF
will be merged on January 1, 1999, provided no savings associations remain as of
that time.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. However, SAIF members will continue to make the FICO
payments described above. The FDIC also lowered the SAIF assessment schedule for
the fourth quarter of 1996 to 18 to 27 basis points. Management cannot predict
the level of FDIC insurance assessments on an on-going basis, whether the
savings association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for fiscal 1997 was 6.5 basis points and the premium
paid for this period was $482,000. A significant increase in SAIF insurance
premiums would likely have an adverse effect on the operating expenses and
results of operations of the Bank.
22
Under the FDI Act, 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.
Thrift Rechartering Legislation. The Funds Act provides that the BIF and SAIF
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will merge on January 1, 1999, if there are no more savings associations as of
that date. Various proposals to eliminate the federal thrift charter, create a
uniform financial institutions charter and abolish the OTS have been introduced
in Congress. Some bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date or they would
automatically become national banks. Under some proposals, converted federal
thrifts would generally be required to conform their activities to those
permitted for the charter selected and divestiture of nonconforming assets would
be required over a two year period, subject to two possible one year extensions.
State chartered thrifts would become subject to the same federal regulation as
applies to state commercial banks. A more recent bill passed by the House
Banking Committee would allow savings institutions to continue to exercise
activities being conducted when they convert to a bank regardless of whether a
national bank could engage in the activity. Holding companies for savings
institutions would become subject to the same regulation as holding companies
that control commercial banks, with a limited grandfather provision for unitary
savings and loan holding company activities. The grandfathering would be lost
under certain circumstances such as a change in control of the Company. The Bank
is unable to predict whether such legislation would be enacted or the extent to
which legislation would restrict or disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally
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subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 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,
1997, the Bank's limit on loans to one borrower as provided under the HOLA was
$26.8 million. At December 31, 1997, the Bank's largest aggregate outstanding
balance of loans to one borrower was $4.4 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the
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QTL test, a savings and loan association is required to 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 securities) in at least 9 months out of each 12 month period.
A savings institution that fails the QTL test is subject to certain operating
restrictions and may be required to convert to a bank charter. As of December
31, 1997, the Bank maintained 95% of its portfolio assets in qualified thrift
investments and, therefore, met the QTL test. Recent legislation has expanded
the extent to which education loans, credit card loans and small business loans
may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
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all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in
need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a 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 its "surplus capital ratio"
(the excess capital over its fully phased-in 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 would require prior
regulatory approval. 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
23
determines that such distribution would constitute an unsafe or unsound
practice. In December 1994, the OTS proposed amendments to its capital
distribution regulation that would generally authorize the payment of capital
distributions without OTS approval provided that the payment does not cause the
institution to be undercapitalized within the meaning of the prompt corrective
action regulation. However, institutions in a holding company structure would
still have a prior notice requirement. At December 31, 1997, the Bank was a
Tier 1 Bank.
Liquidity. The Bank is required to maintain an average daily balance of
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specified liquid assets equal to a monthly average of not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement is currently 4% but may be changed from time to time
by the OTS to any amount within the range of 4% to 10% depending upon economic
conditions and the savings flows of member institutions. Monetary penalties may
be imposed for failure to meet the liquidity requirement. The Bank's liquidity
ratio for December 31, 1997 was 9.82%, which exceeded the applicable
requirement. The Bank has never been subject to monetary penalties for failure
to meet its liquidity requirement.
Assessments. Savings institutions are required to pay assessments to the OTS to
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fund the agency's operations. The general assessments, paid on a semi-annual
basis, are computed 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 fiscal year ended
December 31, 1997 totaled $237,000.
Branching. OTS regulations permit nationwide branching by federally chartered
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savings institutions to the extent allowed by federal statute. This permits
federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
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transactions with related parties or "affiliates" (e.g.., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited 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 provides 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. In addition, savings institutions are prohibited from
lending to any affiliate that is engaged in activities that are not permissible
for bank holding companies and no savings institution may purchase the
securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and 10%
shareholders ("insiders"), as well as entities such persons control, is governed
by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other
things, such loans are required to be made on terms substantially the same as
those offered to unaffiliated individuals and to not involve more than the
normal risk of repayment. In accordance with recently modified federal
regulations, the Bank's Loans to Insiders Policy now permits loans to be made to
Executive Officers on terms available to all Bank employees under the "Loan
Program." This Program allows loans to eligible employees at a discount of 1%
below the prevailing interest rates at time of loan approval, subject to certain
conditions. Regulation O also places individual and aggregate limits on the
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 actions against the
institution and 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 and/or directors to
institution of receivership, conservatorship or termination of
24
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to 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 law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted
- ----------------------------------
Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
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 rule establishes
deadlines for the submission and review of such safety and soundness compliance
plans when such plans are required.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain
non-interest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). The Federal Reserve Board regulations generally
required for most of 1997 that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $49.3 million or less
(subject to adjustment by the Federal Reserve Board) the reserve requirement was
3%; and for accounts aggregating greater than $49.3 million, the reserve
requirement was $1.48 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 $49.3 million. The first $4.4 million of otherwise
reservable balances (subject to adjustments by the Federal Reserve Board) are
exempted from the reserve requirements. The Bank is in compliance with the
foregoing requirements. For 1998, the Federal Reserve Bond has decreased from
$49.3 to $47.8 million the amount of transaction accounts subject to the 3%
reserve requirement and increased the amount of exempt reservable balances from
$4.4 million to $4.7 million. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
General. The Company and the Bank report their income on a calendar year basis
- -------
using the accrual method of accounting, and are 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 or the Company. The Bank has not been audited by the IRS in over 10 years.
For its 1997 taxable year, the Bank is subject to a maximum federal income tax
rate of 34.5%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
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thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (i.e.,
take into taxable income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are
25
treated as large banks (those generally exceeding $500 million in assets) are
required to use only the specific charge-off method. Thus, the PTI Method of
accounting for bad debts is no longer available for any financial institution.
Use of the PTI Method had the effect of reducing the marginal rate of federal
tax on the Bank's income to 32.2%, exclusive of any minimum or environmental
tax, as compared to the maximum corporate federal income tax rate of 35%.
A thrift institution required to change its method of computing reserves for bad
debts will treat such change as a change in method of accounting, initiated by
the taxpayer, and having been made with the consent of the IRS. Any Section
481(a) adjustment required to be taken into income with respect to such change
generally will be taken into income ratably over a six-taxable year period,
beginning with the first taxable year beginning after 1995, subject to the
residential loan requirement.
Under the residential loan requirement provision, the recapture required by the
1996 Act will be suspended for each of two successive taxable years, beginning
with the Bank's current taxable year, in which the Bank originates a minimum of
certain residential loans based upon the average of the principal amounts of
such loans made by the Bank during its six taxable years preceding its current
taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank is not
permitted to make additions to its tax bad debt reserves. In addition, the Bank
is required to recapture (i.e., take into taxable income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987. As a result of such
recapture, the Bank will incur an additional tax liability of approximately $2.3
million. The Bank has accrued for this liability in the consolidated financial
statements.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
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distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an amount
that, when reduced by the tax attributable to the income, is equal to the amount
of the distribution. Thus, if the Bank makes a non-dividend distribution to the
Company, approximately one and one-half times the amount of such distribution
(but not in excess of the amount of such reserves) would be includable in income
for federal income tax purposes, assuming a 35% federal corporate income tax
rate. The Bank does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on every
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$100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
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 of which the Bank currently has none. 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). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI. (with certain modifications) over $2.0 million is imposed
on corporations, including the Bank, whether or not an Alternative Minimum Tax
("AMT") is paid. The Bank does not expect to be subject to the AMT.
26
Dividends Received Deduction and Other Matters. The Company may exclude from
- ----------------------------------------------
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
STATE AND LOCAL TAXATION
New Jersey Taxation. The Bank files 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).
The Company is required to file a New Jersey income tax return because it will
be doing business in New Jersey. For New Jersey tax purposes, regular
corporations are presently taxed at a rate equal to 9% 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). However, if the Company meets certain requirements, it
may be eligible to elect to be taxed as a New Jersey Investment Company at a tax
rate presently equal to 2.25% (25% of 9%) of taxable income.
Delaware Taxation. As a Delaware holding company not earning income in
- -----------------
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
27
ITEM 2. PROPERTIES
The Bank currently conducts its business through its administrative office,
which was recently relocated to Toms River and which includes a branch office,
and nine other full service offices located in Ocean and Middlesex Counties.
The Company believes that the Bank's current facilities will be adequate to meet
the present and immediately foreseeable needs of the Bank and the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company and the Bank are not involved in any pending legal proceedings other
than routine legal proceedings occurring in the ordinary course of business.
Such other routine legal proceedings in the aggregate are believed by management
to be immaterial to the Company's financial condition or results of operations.
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 relating to the market for Registrant's common equity and related
stockholder matters appears under "Shareholder Information" on the Inside Back
Cover in the Registrant's 1997 Annual Report to Stockholders and is incorporated
herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The above-captioned information appears under "Selected Consolidated Financial
and Other Data of the Company" in the Registrant's 1997 Annual Report to
Stockholders on pages 11 and 12 and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The above-captioned information appears under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Registrant's
1997 Annual Report to Stockholders on pages 13 through 21 and is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The above captioned information appears under "Management Discussion and
Analysis of Financial Condition and Results of Operations - Management of
Interest Rate Risk" in the Registrant's 1997 Annual Report to Stockholders on
pages 14 to 16.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Ocean Financial Corp. and its
subsidiary, together with the report thereon by KPMG Peat Marwick LLP and the
"Selected Consolidated Quarterly Financial Data (Unaudited)" appears in the
Registrant's 1997 Annual Report to Stockholders on pages 22 through 37 and are
incorporated herein by reference.
28
ITEM 9. CHANGE 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
Annual Meeting of Stockholders to be held on April 23 , 1998, at pages 5
through 7.
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
Annual Meeting of Stockholders to be held on April 23, 1998, at pages 8 and 9
and pages 14 through 20 (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 Annual Meeting of Stockholders to be held on April 23, 1998,
at pages 3 through 4 and 6 through 7.
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
Annual Meeting of Stockholders to be held on April 23, 1998, at page 20.
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 1997 Annual Report to
Stockholders.
29
PAGE
Independent Auditors' Report................................ 36
Consolidated Statements of Financial Condition at
December 31, 1997 and 1996................................ 22
Consolidated Statements of Income for the
Years Ended December 31, 1997, 1996 and 1995.............. 23
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1997, 1996 and 1995...... 24
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1997, 1996 and 1995.............. 25
Notes to Consolidated Financial Statements for the
Years Ended December 31, 1997, 1996 and 1995.............. 26-36
The remaining information appearing in the 1997 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.
30
3.1 Certificate of Incorporation of Ocean Financial Corp.*
3.2 Bylaws of Ocean Financial Corp.*
4.0 Stock Certificate of Ocean Financial Corp.*
10.1 Form of Ocean Federal Savings Bank Employee Stock
Ownership Plan*
10.1(a) Amendment to Ocean Federal Savings Bank Employee Stock
Ownership Plan (filed previously)
10.2 Ocean Federal Savings Bank Employees' Savings and Profit Sharing Plan*
10.3 Ocean Federal Savings Bank 1995 Supplemental Executive Retirement Plan*
10.4 Ocean Federal Savings Bank Deferred Compensation Plan for Directors*
10.5 Ocean Federal Savings Bank Deferred Compensation Plan for Officers*
10.6 Ocean Federal Savings Bank Long-Term Award Program*
10.7 Ocean Federal Savings Bank Performance Achievement Awards Program*
10.8 Amended and Restated Ocean Financial Corp. 1997 Incentive Plan**
10.9 Form of Employment Agreement between Ocean Federal Savings Bank and
certain executive officers, including Michael J. Fitzpatrick and John
R. Garbarino*
10.10 Form of Employment Agreement between Ocean Financial Corp. and certain
executive officers, including Michael J. Fitzpatrick and John R.
Garbarino*
10.11 Form of Change in Control Agreement between Ocean Federal Savings Bank
and certain executive officers, including Michael E. Barrett, John K.
Kelly and Karl E. Reinheimer*
10.12 Form of Change in Control Agreement between Ocean Financial Corp. and
certain executive
officers, including Michael E. Barrett, John K. Kelly and Karl E.
Reinheimer*
11.0 Computation of earnings per share (filed herewith)
13.0 Portions of 1997 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by reference to "Part I -
Subsidiaries"
23.0 Consent of KPMG Peat Marwick LLP (filed herewith)
27.0 Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K
None.
__________________________________
* Incorporated herein by reference into this document from the Exhibits
to Form S-1, Registration Statement, effective May 13, 1996 as amended,
Registration No. 33-80123.
** Incorporated herein by reference into this document from the Proxy
Statement for the Annual Meeting of Shareholders of Ocean Financial Corp. to be
held on April 23, 1998.
31
CONFORMED 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.
OCEAN FINANCIAL CORP.
By: /s/ John R. Garbarino
---------------------
John R. Garbarino
Chairman of the Board,
President and
Chief Executive Officer and
Director
Date: March 18, 1998
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 Date
- ---- ----
/s/ John R. Garbarino March 18, 1998
- --------------------------
John R. Garbarino
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
/s/ Michael J. Fitzpatrick March 18, 1998
- --------------------------
Michael J. Fitzpatrick
Executive Vice President and
Chief Financial Officer
(principal accounting and financial officer)
/s/ Michael E. Barrett March 18, 1998
- ---------------------------
Michael E. Barrett
Director
/s/ Thomas F. Curtin March 18, 1998
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Thomas F. Curtin
Director
/s/ Carl Feltz, Jr. March 18, 1998
- --------------------
Carl Feltz, Jr.
Director
/s/ Robert E. Knemoller March 18, 1998
- ------------------------
Robert E. Knemoller
Director
32
/s/ Donald E. McLaughlin March 18, 1998
- ------------------------
Donald E. McLaughlin
Director
/s/ Diane F. Rhine March 18, 1998
- ------------------------
Diane F. Rhine
Director
/s/ Frederick E. Schlosser March 18, 1998
- --------------------------
Frederick E. Schlosser
Director
/s/ James T. Snyder March 18, 1998
- -------------------
James T. Snyder
Director
33