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, 1998
Commission File No.: 0-29770
WEST ESSEX BANCORP, INC.
(exact name of registrant as specified in its charter)
UNITED STATES 22-3597632
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
417 Bloomfield Avenue, Caldwell, New Jersey 07006
(Address of principal executive offices)
Registrant's telephone number, including area code: (973) 226-7911
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
------- ------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [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 $15,548,290 based upon the last sales price of $9.563 as
listed on The Nasdaq National Market for March 1, 1999. Solely for purposes of
this calculation, the shares held by West Essex Bancorp, M.H.C. and the
directors and officers of the registrant are deemed to be shares held by
affiliates.
The number of shares of Common Stock outstanding as of March 1, 1999 is:
4,197,233.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 1998 Annual Report to Shareholders and the definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on April 21,
1999 are incorporated herein by reference to Parts II and III, respectively, of
this Form 10-K.
INDEX
PART I
PAGE
Item 1. Business.................................................. 1
Additional Item. Executive Officers of the Registrant............... 36
Item 2. Properties................................................ 37
Item 3. Legal Proceedings......................................... 37
Item 4. Submission of Matters to a Vote of Security Holders....... 37
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 38
Item 6. Selected Financial Data................................... 38
Item 7. Management's Discussion and Analysis of Financial......... 38
Condition and Results of Operations....................... 38
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data............... 38
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.................... 38
PART III
Item 10. Directors and Executive Officers of the Registrant........ 38
Item 11. Executive Compensation.................................... 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................ 39
Item 13. Certain Relationships and Related Transactions............ 39
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 39
SIGNATURES
Item 1. Business.
- - -----------------
General
West Essex Bancorp, Inc. (the "Company") became the federally chartered
stock holding company for West Essex Bank (the "Bank"), a federally chartered
stock savings bank on October 2, 1998 in connection with the conversion of the
Bank from the mutual to stock form and reorganization of the Bank into a mutual
holding company structure ("Reorganization"). In connection with the
Reorganization, West Essex Bancorp, M.H.C. (the "MHC") was organized and became
a majority holder of the Company's outstanding common stock. The Company, the
Bank and the MHC are regulated by the Office of Thrift Supervision (the "OTS").
The Bank is a federally chartered savings bank and is wholly-owned by the
Company. The Company is a savings and loan holding company and is subject to
regulation by the Office of Thrift Supervision ("OTS"), the Federal Deposit
Insurance Corporation ("FDIC") and the Securities and Exchange Commission
("SEC"). Currently, other than investing in various securities, the Company does
not directly transact any material business other than through the Bank.
Accordingly, the discussion herein addresses the operations of the Company as
they are conducted through the Bank. At December 31, 1998, the Company had
total assets of $328.6 million, total deposits of $238.3 million and total
stockholders' equity of $46.8 million.
The Bank was originally organized in 1915 as a New Jersey chartered
building and loan association and, in 1995, became a federally chartered savings
bank. The Bank is a community-oriented savings institution whose business
primarily consists of accepting deposits from customers and investing those
funds primarily in mortgage-backed securities and mortgage loans secured by one-
to four-family residences located in the Bank's primary market area. To a
significantly lesser extent, the Bank invests in commercial real estate loans,
multi-family loans, construction and land development loans and home equity
loans as well as consumer loans and obligations of the federal government and
federal agencies as well as states and municipalities. The Bank generally
retains for its portfolio all one- to four-family mortgage loans which it
originates.
The Company's and Bank's executive offices are located at 417 Bloomfield
Avenue, Caldwell, New Jersey 07006. The telephone number is (973) 226-7911.
Market Area and Competition
The Bank conducts its business through its administrative and branch office
located in Caldwell, New Jersey, and seven other full service branch offices
located in West Orange, Franklin Lakes, River Vale, Pine Brook, Old Tappan and
Northvale, all of which are located in the Northern New Jersey counties of
Essex, Morris and Bergen. The Bank's deposit gathering base is concentrated in
the communities surrounding its offices. While its lending area extends
throughout New Jersey, most of the Bank's mortgage loans are secured by
properties located in Essex, Morris and Bergen Counties in Northern New Jersey.
The economy in the Bank's primary market area is based upon a mixture of
service and retail trade. Other employment is provided by a variety of wholesale
trade, manufacturing, federal, state and local government, hospitals and
utilities. The area is also home to commuters working in the greater New York
City metropolitan area. Certain communities in Bergen, Essex and Morris
Counties are among the highest per capita income in the country. Essex County
contains many older residential commuter towns which function partially as
business and service centers. Morris County was once predominantly a rural
farming area. It has experienced rapid growth in the residential, commercial
and industrial sectors. Bergen County has benefitted from its geographical
proximity to New York City. Originally an agricultural region,
1
the county shifted toward manufacturing and service industries and many foreign
firms have set up their American headquarters in this County.
The Bank faces significant competition both in making loans and in
attracting deposits. The State of New Jersey has a high density of financial
institutions, many of which are branches of significantly larger institutions
which have greater financial resources than the Bank, all of which are
competitors of the Bank to varying degrees. The Bank's competition for loans
comes principally from commercial banks, savings banks, savings and loan
associations, credit unions, mortgage banking companies and insurance companies.
These companies compete aggressively through advertising and by cutting interest
rates on loans. The Bank has sought to compete for loans by advertising in
local papers, developing contacts with local real estate brokers, and providing
cash incentives to its mortgage origination staff to attract loans to the Bank.
In addition, the Bank is affiliated with several mortgage brokers who, for a
fee, provide the Bank with loans. The Bank does not attempt to compete by
offering interest rates below those offered by its competitors, but does
endeavor to keep its interest rates competitive in that the Bank's rates are
neither higher nor lower than rates generally available from the Bank's
competitors in its market area. Its most direct competition for deposits has
historically come from commercial banks, savings banks, savings and loan
associations and credit unions. The Bank faces additional competition for
deposits from short-term money market funds, common stock, other corporate and
government securities funds and from other financial service institutions such
as brokerage firms and insurance companies.
Lending Activities
Loan Portfolio Composition. The Bank's loan portfolio consists primarily
of first mortgage loans secured by one- to four-family residences. At December
31, 1998, the Bank had total loans receivable of $143.0 million, of which $114.7
million were one- to four-family, residential mortgage loans, equalling 80.2% of
the Bank's total loans receivable. At such date, the remainder of the Bank's
loan portfolio consisted primarily of: $11.6 million of commercial real estate
loans or 8.1% of total loans receivable; $9.6 million of home equity loans and
lines of credit, or 6.7% of total loans receivable; $1.9 million of multi-family
residential loans, or 1.4% of total loans receivable; $4.4 million of
construction and development loans, or 3.1% of total loans receivable; and
$706,000 of consumer loans, or 0.5% of total loans receivable, consisting
primarily of loans on passbook deposit accounts and automobile loans.
The types of loans that the Bank may originate are subject to federal and
state laws and regulations. Interest rates charged by the Bank on loans are
affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board, and legislative tax
policies. In recent years, the Bank has aggressively sought to increase its
originations of mortgage loans and has sought to purchase loans and loan
participations. This has resulted in total loans increasing from $84.5 million
at December 31, 1996 to $116.1 million at December 31, 1997 and $143.0 million
at December 31, 1998.
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,
-------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------- ------------------ ----------------- ----------------- -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
----------- --------- -------- --------- -------- -------- ------- --------- ------- ---------
Mortgage Loans:
Residential:
One- to four-family..... $114,690 80.20% $ 87,489 75.34% $60,741 71.88% $65,002 74.50% $61,747 70.33%
Multi-family............ 1,943 1.36 2,004 1.73 2,068 2.45 1,115 1.28 1,400 1.59
Home equity loans and
lines(1)............... 9,631 6.73 8,554 7.37 6,653 7.87 4,388 5.03 5,014 5.71
Commercial real estate 11,589 8.11 10,695 9.21 12,275 14.53 12,707 14.56 13,815 15.74
Construction and
development.............. 4,394 3.07 6,485 5.58 2,080 2.46 3,032 3.47 5,079 5.78
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
Total mortgage loan... 142,247 99.47 115,227 99.23 83,817 99.19 86,244 98.84 87,055 99.15
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
Commercial loans.......... 49 0.04 59 0.05 87 0.10 234 0.27 259 0.29
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
Consumer Loans:
Passbook or certificate. 401 0.28 550 0.47 427 0.51 543 0.62 398 0.46
Other................... 305 0.21 291 0.25 168 0.20 234 0.27 90 0.10
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
Total consumer loans.. 706 0.49 841 0.72 595 0.71 777 0.89 488 0.56
-------- ------ -------- ------ ------- ------ ------- ------ ------- ------
Total loans receivable.... 143,002 100.00% 116,127 100.00% 84,499 100.00% 87,255 100.00% 87,802 100.00%
====== ====== ====== ====== ======
Less:
Construction loans in
process................ (1,311) (1,437) (440) (592) (1,474)
Allowance for loan
losses................. (1,717) (1,885) (1,564) (1,200) (1,236)
Deferred loan fees, net. 298 (70) (361) (432) (481)
-------- -------- ------- ------- -------
Loans receivable, net..... $140,272 $112,735 $82,134 $85,031 $84,611
======== ======== ======= ======= =======
(1) Includes second mortgage loans other than home equity loans of $-0-,
$63,000, $74,000, $91,000 and $191,000 at March 31, 1998 and December 31,
1998, 1997, 1996, 1995 and 1994, respectively.
3
Loan Maturity. The following table shows the remaining contractual
maturity of the Bank's loans at December 31, 1998. The table does not include
the effect of future principal repayments or prepayments.
At December 31, 1998
--------------------------------------------------------------------------------------
One- to Equity Construction
Four- Multi- Loans and Commercial and Total
Family Family Lines Real Estate Development Commercial Consumer Loans
--------- --------- --------- -------------- ------------- ---------- --------- -------
(In thousands)
Amounts due:
One year or less....................... $ 374 $ - $ - $ 27 $ 4,351 $ - $415 $ 5,167
-------- ------ ------ ------- ------- -------- ---- --------
After one year:
More than one year to three years.... 1,913 140 379 454 9 -- 112 3,007
More than three years to five years.. 2,756 74 486 1,078 34 -- 148 4,576
More than five years to ten years.... 9,398 -- 2,557 1,621 -- 49 -- 13,625
More than 10 years to 20 years....... 25,913 1,668 5,650 8,279 -- -- 31 41,541
More than 20 years................... 74,336 61 559 130 -- -- -- 75,086
-------- ------ ------ ------- ------- -------- ---- --------
114,316 1,943 9,631 11,562 43 49 291 137,835
-------- ------ ------ ------- ------- -------- ---- --------
Total due after one year............... 114,690 1,943 9,631 11,589 4,394 49 706 143,002
-------- ------ ------ ------- ------- -------- ---- --------
Total due
Less:
Loans in process................... -- -- -- -- (1,311) -- -- (1,311)
Deferred loan (fees) costs......... 397 -- -- (78) (21) -- -- 298
Allowance for loan losses.......... (1,084) (20) (77) (112) (418) -- (6) (1,717)
-------- ------ ------ ------- ------- -------- ---- --------
(687) (20) (77) (190) (1,750) -- (6) (2,730)
-------- ------ ------ ------- ------- -------- ---- --------
Loans receivable, net................ $114,003 $1,923 $9,554 $11,399 $ 2,644 $49 $700 $140,272
======== ====== ====== ======= ======= ======== ==== ========
4
The following table sets forth, at December 31, 1998, the dollar amount of
loans contractually due after December 31, 1999, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 1999
-----------------------------
Fixed Adjustable Total
------- ---------- --------
(In thousands)
Mortgage loans:
One- to four-family.................... $72,544 $41,772 $114,316
Multi-family........................... 1,943 -- 1,943
Equity loans and lines................. 5,847 3,784 9,631
Commercial real estate................. 10,256 1,306 11,562
Construction and development........... 43 -- 43
------- ------- --------
Total mortgage loans.................. 90,633 46,862 137,495
Commercial loans........................ 49 -- 49
Consumer loans.......................... 260 31 291
------- ------- --------
Total loans.......................... $90,942 $46,893 $137,835
======= ======= ========
Origination, Purchase and Servicing of Loans. The Bank's mortgage lending
activities are conducted primarily by its loan personnel operating in all of the
Bank's branch offices. All loans originated by the Bank, either through internal
sources or through loan brokers, are underwritten by the Bank pursuant to the
Bank's policies and procedures. The Bank's underwriting policies, guidelines
and procedures are modeled after those of FNMA and FHLMC. The Bank originates
both adjustable-rate and fixed-rate loans. The Bank's ability to originate
fixed- or adjustable-rate loans is dependent upon the relative customer demand
for such loans, which is affected by the current and expected future level of
interest rates. It is the general policy of the Bank to retain all loans
originated in its portfolio. The Bank currently retains the servicing for all
loans originated in its portfolio. The Bank has faced significant competition
for loans in its market area. Until 1996, the Bank had relied solely upon its
own mortgage staff to originate loans and depended primarily upon getting loans
from the Bank's customer base. The Bank did not aggressively advertise, nor did
it pay brokers to introduce loans to the Bank. Since 1996, the Bank has sought
to compete more aggressively for loans. To that end, the Bank began paying its
loan origination staff bonuses based upon loan originations and has
significantly increased its advertising in its local market area. The Bank has
also begun working with mortgage brokers and paying them fees in return for
referring loan applicants to the Bank. The Bank's efforts have enabled it to
substantially increase loan originations since 1996. Specifically, in 1998, the
Bank originated $50.5 million in mortgage loans, up from $46.4 million in 1997
and $14.4 million in 1996.
During the years ended December 31, 1998 and December 31, 1997, the Bank
originated $45.8 million and $39.3 million of one- to four-family loans,
respectively, including home equity loans and lines of credit. Based upon the
Bank's investment needs and market opportunities, the Bank has, on occasion,
purchased loans, primarily one- to four-family loans, or participated in loans,
primarily multi-family loans through the Thrift Institutions Community
Investment Corporation of New Jersey ("TICIC"). At December 31, 1998, the Bank
had 5 loan participations through TICIC totalling $1.9 million. The Bank has
in its loan
5
portfolio loans generated by third-party mortgage companies which were
underwritten pursuant to the Bank's policies, and closed in the name of the
Bank.
The following table sets forth the Bank's loan originations, purchases, and
principal repayments for the periods indicated. The Bank sold no loans during
the periods indicated.
For the Years Ended
December 31,
---------------------------------
1998 1997 1996
-------- -------- ---------
Beginning balance.................................. $116,127 $ 84,499 $ 87,255
-------- -------- --------
Purchases--Multi-family mortgage loans........... 281 -- 1,621
-------- -------- --------
Loans originated:
Mortgage loans:
One- to four-family.......................... 41,194 35,017 6,546
Multi-family................................. -- -- --
Home equity lines............................ 4,644 4,330 4,726
Commercial real estate....................... 2,310 1,436 2,090
Construction and land development............ 2,317 5,610 1,015
-------- -------- --------
Total mortgage loans....................... 50,465 46,393 14,377
-------- -------- --------
Consumer loans:
Passbook loans............................... 371 477 660
Automobile................................... 167 222 65
Credit lines(1).............................. 3 28 --
-------- -------- --------
Total consumer loans....................... 541 727 725
-------- -------- --------
Loans made to facilitate the sale of
real estate owned............................. -- -- --
-------- -------- --------
Total originations......................... 51,006 47,120 15,102
-------- -------- --------
Loans transferred (to) from real estate owned.... -- (680) (377)
-------- -------- --------
Principal repayments and other, net............. (24,412) (14,812) (19,102)
-------- -------- --------
Ending balance..................................... $143,002 $116,127 $ 84,499
======== ======== ========
One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate and
adjustable-rate mortgage loans ("ARM") secured by one- to four-family residences
with maturities of up to 30 years. Loan originations are generally obtained
from the Bank's in-house loan representatives located at all of the Bank's
branch offices from local real estate agents, from wholesale brokers and their
contacts in the Bank's local real estate industry, from existing or past
customers and through referrals from members of the local communities and
advertising. One- to four-family mortgage loans are generally underwritten in
accordance with FHLMC/FNMA standards. At December 31, 1998, one- to four-family
mortgage loans totalled $114.7 million, or 80.2% of the Bank's total loans
receivable. Of the Bank's mortgage loans secured by one- to four-family
residences, $41.8 million, or 36.4%, were fixed-rate loans and $72.9 million or
63.6% were ARM loans.
6
The Bank currently offers fixed-rate mortgage loans with terms from 10 to
30 years. The Bank generally retains for its portfolio all loans it originates.
The Bank also offers ARM loan programs made for terms of 30 years and with
interest rates, which adjust every 12 months or any other term according to the
loan note. The Bank's ARM loans generally provide for periodic (not more than
2.0% over the existing interest rate) and overall (not more than 6.0%) caps on
the increase or decrease in the interest rate at any adjustment date and over
the life of the loan. The interest rate adjustment on these loans is indexed to
the one-year U.S. Treasury CMT Index with a repricing margin of 2.75% above the
index.
The origination of adjustable-rate residential mortgage loans, as opposed
to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to
increases in interest rates. However, adjustable-rate loans generally pose
credit risks not inherent in fixed-rate loans, primarily because as interest
rates rise, the underlying payments of the borrower rise, thereby increasing the
potential for default. Periodic and lifetime caps on interest rate increases
help to reduce the credit risk associated with the Bank's adjustable-rate loans
but also limit the interest rate sensitivity of its adjustable-rate mortgage
loans.
The Bank's policy generally is to originate one- to four-family residential
mortgage loans in amounts up to 90% of the lower of the appraised value or the
selling price of the property securing the loan, but generally requires private
mortgage insurance if the loan is in an amount in excess of 80% of the lower of
the appraised value or selling price. Mortgage loans originated by the Bank
include due-on-sale clauses which provide the Bank with the contractual right to
deem the loan immediately due and payable in the event the borrower transfers
ownership of the property without the Bank's consent. Due-on-sale clauses are
an important means of adjusting the rates on the Bank's fixed-rate mortgage loan
portfolio and the Bank has generally exercised its rights under these clauses.
The Bank requires fire, casualty, title and, in certain cases, flood insurance
on all properties securing real estate loans made by the Bank.
In an effort to provide financing for first-time home buyers, the Bank
offers its first-time home buyers program. This program offers one- to four-
family residential mortgage loans to qualified individuals. These loans are
originated using the Bank's standard underwriting guidelines. With respect to
loans granted under this program, the Bank originates these loans in amounts up
to 95% of the lower of the appraised value or selling price of the property
securing the loan. In addition, the Bank also participates in the First Home
Club Program through the FHLB-NY, which benefits low income first time
homebuyers.
Home Equity Loans. The Bank offers fixed-rate home equity loans and
floating rate home equity lines of credit in amounts of up to $150,000. Home
equity loans have fixed rates of interest with terms of up to 20 years.
Interest rates on such loans will vary depending on the amortization period
chosen by the borrowers. Home equity lines of credit have adjustable-rates of
interest, which adjust on a monthly basis. The adjustable-rate of interest
charged on such loans is indexed to the prime rate as published in The Wall
Street Journal. Currently, home equity lines of credit originated at this time
bear a maximum lifetime interest rate cap of 14.0%. The maximum combined loan-
to-value ("LTV") ratio on home equity loans and equity lines of credit is 70%;
however, this policy provides that management has the discretion to make such
real estate loans in excess of 70%. At December 31, 1998, the Bank had in its
loan portfolio an aggregate of $14.6 million of home equity loans and equity
lines of credit, of which $5.7 million were fixed-rate home equity loans and
$8.9 million were equity lines of credit. Of the $8.9 million equity lines of
credit, $3.9 million was drawn upon such loans at December 31, 1998. The
underwriting standards employed by the Bank for home equity loans and lines of
credit include a determination of the applicant's credit history and an
assessment of the applicant's ability to meet existing obligations and payments
on the proposed loan and the value of the collateral securing the loan. The
stability of the applicant's monthly income may be determined by verification of
gross monthly income from primary employment and, additionally, from any
verifiable secondary income. Creditworthiness of the applicant is of primary
consideration. The Bank's
7
home equity loans and lines of credit are secured by first or second liens on
one- to four-family residences and condominiums located in the Bank's primary
market area.
Commercial Real Estate and Multi-Family Lending. The Bank also originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small shopping centers located in Northern New Jersey. The Bank's multi-
family and commercial real estate underwriting policy provides that such real
estate loans may be made in amounts up to 65% of the appraised value of the
property; however, this policy provides that management has the discretion to
make such real estate loans in excess of 65% of the appraised value of the
property. The Bank's multi-family and commercial real estate lending is limited
by the regulatory loans-to-one borrower limit which at December 31, 1998 was
$5.2 million. The Bank currently originates multi-family and commercial real
estate loans, generally with terms of up to 15 years and has developed a variety
of programs, primarily balloon type mortgages, indexed to the FHLB advance rate,
the Prime Rate and the U.S. Treasury Bill rate. The Bank's multi-family and
commercial real estate loans have fixed or adjustable rates of interest that
adjust periodically and are indexed to either the prime rate as published in The
Wall Street Journal or the U.S. Treasury Bill. In reaching its decision on
whether to make a multi-family or commercial real estate loan, the Bank
considers the net operating income of the property, the borrower's expertise,
credit history and profitability and the value of the underlying property. The
Bank has generally required that the properties securing these real estate loans
have debt service coverage ratios (the ratio of earnings before debt service to
debt service) of at least 1.15x. In addition, environmental impact surveys may
be required for multi-family and commercial real estate loans. Generally,
multi-family and commercial real estate loans made to corporations, partnerships
and other business entities require personal guarantees by the principals. On
an exception basis, the Bank may not require a personal guarantee on such loans
depending on the creditworthiness of the borrower and the amount of the
downpayment and other mitigating circumstances. The Bank's multi-family real
estate loan portfolio at December 31, 1998 was $1.9 million, or 1.4%, of total
loans receivable and the Bank's commercial real estate loan portfolio at such
date was $11.6 million, or 8.1%, of total loans receivable.
Loans secured by multi-family and commercial real estate properties are
generally larger and involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
and commercial real estate properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to the then prevailing conditions in the real estate
market or the economy. The Bank seeks to minimize these risks through its
underwriting standards.
Construction and Development Lending. The Bank originates construction and
development loans for the development of one- to four-family residences. Such
loans are made principally to licensed and experienced developers known to the
Bank in its primary market area for the construction of single-family
developments. The Bank generally does not originate loans secured by unimproved
land. Construction loans are originated in amounts up to 70% of the lesser of
the appraised value of the property, as improved, or the sales price. Such
loans are offered for up to two year terms and adjustable interest rates which
adjust monthly and float at margins which are generally indexed to the Prime
Rate of interest as reported in The Wall Street Journal. Proceeds of
construction loans are disbursed as phases of the construction are completed.
Generally, if the borrower is a corporation, partnership or other business
entity, personal guarantees by the principals are required. At December 31,
1998, the Bank had $4.4 million of construction loans which amounted to 3.1% of
the Bank's total loans receivable.
Construction and development financing is generally considered to involve a
higher degree of credit risk than long-term financing on improved, owner-
occupied real estate. Risk of loss on a construction loan
8
is dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development compared to the estimated
cost (including interest) of construction and other assumptions, including the
estimated time to sell residential properties. If the estimate of value proves
to be inaccurate, the Bank may be confronted with a project, when completed,
having a value which is insufficient to assure full repayment.
Consumer Lending. Consumer loans at December 31, 1998 amounted to
$706,000, or 0.5% of the Bank's total loans receivable, and consisted primarily
of $401,000 in loans secured by deposit accounts and $274,000 in automobile
loans. Such loans are generally originated in the Bank's primary market area.
These loans are generally shorter term and have higher interest rates than one-
to four-family mortgage loans.
Loans secured by rapidly depreciable assets such as automobiles or that are
unsecured entail greater risks than one- to four-family mortgage loans. In such
cases, repossessed collateral for a defaulted loan may not provide an adequate
source of repayment of the outstanding loan balance, since there is a greater
likelihood of damage, loss or depreciation of the underlying collateral.
Further, consumer loan collections on these loans are dependent on the
borrower's continuing financial stability and, therefore, are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default.
Commercial Lending. At December 31, 1998, the Bank had $49,000 in
commercial loans, which the Bank originated through a FHLB program over ten
years ago. The Bank does not currently anticipate that commercial lending
activity will increase in the immediate future.
Loan Approval Procedures and Authority. The Board of Directors establishes
the lending policies and loan approval limits of the Bank. All loans originated
by the Bank with principal amounts in excess of $1.0 million require the
approval of the Board of Directors. All loans originated by the Bank with
principal amounts above $300,000, but less than or equal to $1.0 million require
the approval of the Lending Committee. All other loans may be approved by the
Bank's Chief Lending Officer. Pursuant to OTS regulations, loans to one
borrower cannot exceed 15% of the Bank's unimpaired capital and surplus. The
Bank will not make loans to one borrower that are in excess of the regulatory
limits.
Underwriting. With respect to all loans originated by the Bank, it is the
general policy of the Bank to retain all such loans in its portfolio. The Bank
usually underwrites loans in accordance with FNMA or FHLMC guidelines. While
the Bank generally does not consider whether a borrower is in compliance with
any requirements regarding Year 2000 issues, the Bank does consider such
compliance in connection with any commercial real estate loans it may originate.
Upon receipt of a completed loan application from a prospective borrower, a
credit report is ordered and certain other information is verified by an
independent credit agency. If necessary, additional financial information may
be required. An appraisal of real estate intended to secure a proposed loan
generally is required to be performed by outside appraisers approved by the
Bank. The Board annually approves independent appraisers used by the Bank and
approves the Bank's appraisal policy. The Bank's policy is to obtain title and
hazard insurance on all mortgage loans and flood insurance when necessary and
the Bank generally requires borrowers to make payments to a mortgage escrow
account for the payment of property taxes. No title or flood insurance is
required, however, for home equity loans.
9
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquencies and Classified Assets. Reports listing all delinquent
accounts are generated and reviewed by management at least twice a month and the
Board of Directors performs a monthly review of all loans or lending
relationships delinquent 60 days or more and all real estate owned ("REO"). The
procedures taken by the Bank with respect to delinquencies vary depending on the
nature of the loan, period and cause of delinquency and whether the borrower is
habitually delinquent. When a borrower fails to make a required payment on a
loan, the Bank takes a number of steps to have the borrower cure the delinquency
and restore the loan to current status. The Bank generally sends the borrower a
written notice of non-payment after the loan is first past due. The Bank's
guidelines provide that telephone, written correspondence and/or face-to-face
contact will be attempted to ascertain the reasons for delinquency and the
prospects of repayment. When contact is made with the borrower at any time
prior to foreclosure, the Bank will attempt to obtain full payment, offer to
work out a repayment schedule with the borrower to avoid foreclosure or, in some
instances, accept a deed in lieu of foreclosure. In the event payment is not
then received or the loan not otherwise satisfied, additional letters and
telephone calls generally are made. If the loan is still not brought current or
satisfied and it becomes necessary for the Bank to take legal action, which
typically occurs after a loan is 90 days or more delinquent, the Bank will
commence foreclosure proceedings against any real property that secures the
loan. If a foreclosure action is instituted and the loan is not brought
current, paid in full, or refinanced before the foreclosure sale, the property
securing the loan generally is sold at foreclosure and, if purchased by the
Bank, becomes real estate owned.
Federal regulations and the Bank's Asset Classification Policy require that
the Bank utilize an internal asset classification system as a means of reporting
problem and potential problem assets. The Bank has incorporated the OTS
internal asset classifications as a part of its credit monitoring system. The
Bank currently classifies problem and potential problem assets as "Substandard,"
"Doubtful" or "Loss" assets. An asset is considered "Substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include
those characterized by the "distinct possibility" that the insured institution
will sustain "some loss" if the deficiencies are not corrected. Assets
classified as "Doubtful" have all of the weaknesses inherent in those classified
"Substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets classified
as "Loss" are those considered "uncollectible" and of such little value that
their continuance as assets without the establishment of a specific loss reserve
is not warranted.
Management of the Bank, in determining the allowance for loan losses,
considers the risks inherent in its loan portfolio and changes in the nature and
volume of its loan activities, along with the general economic and real estate
market conditions. The Bank utilizes a two tier approach: (i) identification of
impaired loans and the establishment of specific loss allowances on such loans;
and (2) establishment of general valuation allowances on the remainder of its
loan portfolio. The Bank maintains a loan review system which allows for a
periodic review of its loan portfolio and the early identification of potential
impaired loans. Such system takes into consideration, among other things,
delinquency status, size of loans, type and estimated fair value of collateral
and financial condition of the borrowers. Specific loan loss allowances are
established for identified loans based on a review of such information. General
loan loss allowances are based upon a combination of factors including, but not
limited to, actual loan loss experience, composition of the loan portfolio,
current economic conditions and management's judgment. Although management
believes that adequate loan loss allowances are established, actual losses are
dependent upon future events and, as such, further additions to the level of the
allowance for loan losses may be necessary.
10
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
has adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
Although management believes that, based on information currently available to
it at this time, its allowance for loan losses is adequate, actual losses are
dependent upon future events and, as such, further additions to the level of
allowances for loan losses may become necessary.
The Board reviews classified assets reports prepared by management and
classifies its assets on a quarterly basis. The Bank classifies assets in
accordance with the management guidelines described above. At December 31, 1998,
the Bank had $2.6 million, or 0.80% of total assets, of assets designated as
"Substandard," consisting of fifteen one- to four-family mortgage loans,
totalling $1.4 million, two construction loans totalling $728,000, one
commercial mortgage of $160,000 and real estate owned totalling $373,000. At
December 31, 1998, the largest loan designated as "Substandard" had a carrying
balance of $694,000, and was a construction loan secured by a partially
completed condominium project. At December 31, 1998, no assets were designated
as "Doubtful" or "Loss."
11
The following table sets forth delinquencies in the Bank's loan
portfolio as of the dates indicated.
At December 31, 1998 At December 31, 1997
----------------------------------------- -----------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
-------------------- -------------------- -------------------- --------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
(Dollars in thousands)
Loans:
Residential Mortgage......... 1 $ 15 14 $1,201 10 $ 528 19 $1,652
---- ----- ---- ------ ------ -------- ---- ------
Commercial Mortgage.......... -- -- 1 158 -- -- 1 119
Construction and land
development............... -- -- 2 725 -- -- 2 718
---- ----- ---- ------ ------ -------- ---- ------
Total loans................. 1 $ 15 17 $2,084 10 $ 528 22 $2,489
===== ===== ==== ====== ====== ======== ==== ======
Delinquent loans to total
loans..................... 0.01% 0.01% 1.25% 1.46% 0.72% 0.45% 1.59% 2.14%
===== ===== ==== ====== ====== ======== ==== ======
At December 31, 1996
-----------------------------------------
60-89 Days 90 Days or More
-------------------- --------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
--------- ---------- ---------- ---------
(Dollars in thousands)
Loans:
Residential Mortgage......... 14 $ 904 14 $1,733
---- ----- ---- ------
Commercial Mortgage.......... -- -- 2 431
Construction and land
development............... -- -- 2 705
---- ----- ---- ------
Total loans................. 14 $ 904 18 $2,869
===== ===== ==== ======
Delinquent loans to total
loans..................... 1.15% 1.07% 1.48% 3.40%
===== ===== ==== ======
12
Non-Performing Assets and Impaired Loans. The following table sets
forth information regarding nonaccrual loans and REO. At December 31, 1998, REO
totalled $582,000 million and consisted of six properties. It is the policy of
the Bank to cease accruing interest on loans 90 days or more past due and to
fully reserve for all previously accrued interest. For the years ended
December 31, 1998 and 1997, the amount of additional interest income that would
have been recognized on non-accrual loans if such loans had continued to perform
in accordance with their contractual terms was $162,000 and $177,000,
respectively. On January 1, 1995, the Bank adopted SFAS No. 114 "Accounting by
Creditors for Impairment of a Loan," as amended by SFAS No. 118. At December 31,
1998 and 1997, total impaired loans were $1.46 million and $1.65 million,
respectively. All impaired loans are residential real estate mortgage loans
which have been measured for impairment using the fair value of the collateral
method. During the year ended December 31, 1998, the average recorded value of
impaired loans was $1.54 million. For these loans, no interest income was
recognized.
At December 31,
------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
Nonaccrual loans:
Residential Mortgages.............. $1,201 $1,576 $1,733 $ 931 $1,369
Commercial Mortgages............... 158 119 431 380 263
Construction and land development.. 725 718 705 734 1,346
------ ------ ------ ------ ------
Total nonaccrual loans............ 2,084 2,413 2,869 2,045 2,978
Restructured loans:
Residential Mortgages.............. 94 94 99 104 112
------ ------ ------ ------ ------
Total non-performing loans........ 2,188 2,507 2,968 2,149 3,090
Real estate owned, net(1)........... 582 1,215 1,394 1,352 1,864
------ ------ ------ ------ ------
Total non-performing assets....... $2,770 $3,722 $4,362 $3,501 $4,954
====== ====== ====== ====== ======
Non-performing loans as a
percent of total loans(2).......... 1.46% 2.16% 3.51% 2.46% 3.52%
====== ====== ====== ====== ======
Non-performing assets as
a percent of total assets(3)....... 0.84% 1.24% 1.85% 1.57% 2.48%
====== ====== ====== ====== ======
- - ----------
(1) REO balances are shown net of related valuation allowances. REO includes
$209,000 of property that is not considered substandard.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by the Bank as presenting
uncertainty with respect to the collectibility of interest or principal.
(3) Non-performing assets consist of non-performing loans and REO.
13
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses in loans receivable which are deemed probable and estimable
based on information currently known to management. The allowance is based upon
a number of factors, including current economic conditions, actual loss
experience and industry trends. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to make
additional provisions for estimated loan losses based upon judgments different
from those of management. As of December 31, 1998 and 1997, the Bank's
allowance for loan losses was 1.20% and 1.62%, respectively, of total loans
receivable and 0.82% and 0.78%, respectively, of nonaccrual loans. The Bank had
non-accrual loans of $2.1 million and $2.4 million at December 31, 1998 and
1997, respectively. The Bank will continue to monitor and modify its allowances
for loan losses as conditions dictate. While management believes the Bank's
allowance for loan losses is sufficient to cover losses inherent in its loan
portfolio at this time, no assurances can be given that the Bank's level of
allowance for loan losses will be sufficient to cover future loan losses
incurred by the Bank or that future adjustments to the allowance for loan losses
will not be necessary if economic and other conditions differ substantially from
the economic and other conditions used by management to determine the current
level of the allowance for loan losses.
The Bank has established a standardized process to assess the adequacy of
the allowance for loan losses and to identify the risks inherent in the loan
portfolio. The process incorporates credit reviews and gives consideration to
areas of exposure such as concentrations of credit, local economic conditions,
trends in delinquencies, collateral coverage, the composition of the performing
and non-performing loan portfolios, and other risks inherent in the loan
portfolio.
Specific allocations of the allowance for loan losses are identified by
individual loan based upon a detailed credit review of each such loan. General
loan loss allowances are allocated to pools of loans categorized by type and
assigned allowance percentages which take into effect past charge-off history,
industry averages and current trends and risks. Finally, an unallocated portion
of the allowance is maintained to account for the general inherent risk in the
loan portfolio, known circumstances which are not addressed in the allocated
portion of the allowance (such as the increased dependence on outside mortgage
brokers for originations), and the necessary imprecision in the determination of
the allocation portion of the allowance.
Among the more significant situations and circumstances which are
considered within the unallocated portion of the allowance is that the Bank
began aggressively competing in the market for loan originations in early 1997
via various means not previously utilized, such as the use of outside mortgage
brokers and paying bonuses to inside loan origination personnel. In addition,
the Bank increased its advertising efforts and expanded its product line to
include product types with more risk, such as a first-time homeowner loan which
allows for higher than normal loan to collateral ratios. The loan portfolio
grew by $26.9 million or 23.1% in 1998 and by $31.6 million or 37.4% in 1997 due
to these factors after declining in 1996, 1995 and 1994. The increased inherent
risk associated with the aforementioned circumstances are elements within the
unallocated allowance. Another element considered in unallocated allowance is
the continuing resolution of loans related to a large condominium project which
has been in default since 1993. The project is still not complete and various
borrowers, including some with mortgages with the Bank have defaulted on their
loans. Accordingly, while the loans were current and performing, the inherent
risk related to these loans was higher than that normally associated with these
types of loans. Finally, the determination of the allocated portion of the
allowance is highly subjective and requires significant reliance on estimates,
assumptions and judgments. Specific allowances are typically based upon the
appraised value of the underlying collateral, which can vary based upon the
particular appraiser involved, and management's
14
estimates of property disposal costs. General allowances are based upon loss
percentages applied to delineated loan categories. The loss percentages are a
particularly inexact science. As such, management has deemed it prudent to
recognize the inherent imprecision of the process by maintaining what it
believes to be a conservative, but appropriate level of unallocated reserves.
The following table sets forth activity in the Bank's allowance for loan
losses for the periods set forth in the following table.
At or For the Years Ended December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------- ------ ------
Balance at beginning of period............ $1,885 $1,564 $ 1,200 $1,236 $1,550
------ ------ ------- ------ ------
Provision for (recapture of) loan losses.. (131) 487 232 510 (247)
------ ------ ------- ------ ------
Charge-offs:
Mortgage loans:
One- to four-family.................... 37 60 -- -- 57
Multi-family........................... -- -- -- 56 --
Commercial real estate................... -- 106 -- -- --
Construction and land development........ -- -- -- 490 10
------ ------ ------- ------ ------
Total mortgage loans................... 37 166 -- 546 67
------ ------ ------- ------ ------
Recoveries:
Construction and land development........ -- -- 132 -- --
------ ------ ------- ------ ------
Balance at end of period.................. $1,717 $1,885 $ 1,564 $1,200 $1,236
====== ====== ======= ====== ======
Ratio of net charge-offs during
the period to average gross loans
during the period....................... 0.03% 0.17% (0.15)% 0.63% 0.08%
====== ====== ======= ====== ======
Allowance for loan losses as a
percent of total loans................... 1.20% 1.62% 1.85% 1.38% 1.41%
====== ====== ======= ====== ======
Allowance for loan losses as a
percent of non-performing loans.......... 78.47% 75.19% 52.70% 55.84% 40.00%
====== ====== ======= ====== ======
15
The following tables set forth the Bank's percent of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
At December 31, 1998
--------------------------------------------------------------------------------------------
1998 Percent of 1997 Percent 1996 Percent
------------------ Loans in ------------------ of Loans ------------------ of Loans
Percent of Each Percent of in Each Percent of in Each
Allowance Category Allowance Category Allowance Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
--------------------------------------------------------------------------------------------
(Dollars in thousands)
Mortgage loans:
Residential........................ $ 763 44.44% 88.29% $ 621 32.94% 84.44% $ 511 32.67% 82.20%
Commercial real estate............. 122 7.11 8.11 112 5.94 9.21 184 11.77 14.53
Construction and land development.. 418 24.34 3.07 628 33.32 5.58 349 22.31 2.46
------ ------ ------ ------ ------ ------ ------ ------ ------
Total mortgage loans............. 1,303 75.89 99.47 1,361 72.20 99.23 1,044 66.75 99.19
Commercial loans..................... -- -- 0.04 -- -- 0.05 -- -- 0.10
Consumer loans....................... 6 0.35 0.49 6 0.32 0.72 4 0.26 0.71
------ ------ ------ ------ ------ ------ ------ ------ ------
1,309 76.24 100.00% 1,367 72.52 100.00% 1,048 67.01 100.00%
====== ====== ======
Unallocated.......................... 408 23.76 518 27.48 516 32.99
------ ------ ------ ------ ------ ------
Total allowance
for loan losses.................. $1,717 100.00% $1,885 100.00% $1,564 100.00%
====== ====== ====== ====== ====== ======
At December 31,
------------------------------------------------------------
1995 Percent 1994 Percent
------------------ of Loans ------------------ of Loans
Percent of in Each Percent of in Each
Allowance Category Allowance Category
to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans
------------------------------------------------------------
(Dollars in thousands)
Mortgage loans:
Residential........................ $ 413 34.42% 80.81% $ 383 30.99% 77.63%
Commercial real estate............. 190 15.83 14.56 171 13.84 15.74
Construction and land development.. 141 11.75 3.47 223 18.04 5.78
------ ------ ------ ------ ------ ------
Total mortgage loans............. 744 62.00 98.84 777 62.87 99.15
Commercial loans..................... 1 0.08 0.27 1 0.08 0.29
Consumer loans....................... 6 0.50 0.89 2 0.16 0.56
------ ------ ------ ------ ------ ------
751 62.58 100.00% 780 63.11 100.00%
====== ======
Unallocated.......................... 449 37.42 456 36.89
------ ------ ------ ------
Total allowance
for loan losses.................. $1,200 100.00% $1,236 100.00%
====== ====== ====== ======
16
Real Estate Owned. At December 31, 1998, the Bank had $582,000 million of
real estate owned consisting of 6 properties, 5 of which were acquired through
foreclosure. When the Bank acquires property through foreclosure or deed in
lieu of foreclosure, it is initially recorded at the lower of the recorded
investment in the corresponding loan or the fair value of the related assets at
the date of foreclosure, less costs to sell. Thereafter, if there is a further
deterioration in value, the Bank provides for a specific valuation allowance and
charges operations for the diminution in value. It is the policy of the Bank to
have obtained an appraisal on all real estate subject to foreclosure proceedings
prior to the time of foreclosure. It is the Bank's policy to require appraisals
on a periodic basis on foreclosed properties and conduct inspections on
foreclosed properties.
Investment Activities
The Company can invest in common and preferred stocks, limited partnerships
and all investments the Bank is permitted to invest in. Anything other than
that requires the Board of Director's approval. Federally chartered savings
institutions have the authority to invest in various types of liquid assets,
including United States Treasury obligations, securities of various federal
agencies, certificates of deposit of insured banks and savings institutions,
bankers' acceptances, repurchase agreements and federal funds. Subject to
various restrictions, federally chartered savings institutions may also invest
their assets in commercial paper, investment-grade corporate debt securities and
mutual funds whose assets conform to the investments that a federally chartered
savings institution is otherwise authorized to make directly. Additionally, the
Bank must maintain minimum levels of investments that qualify as liquid assets
under OTS regulations. Historically, the Bank has maintained liquid assets above
the minimum OTS requirements and at a level considered to be adequate to meet
its normal daily activities.
The Bank's current policies generally limit securities investments to U.S.
Government and agency securities, municipal bonds and corporate debt obligations
and corporate equities. In addition, the Bank's policies permit investments in
mortgage-backed securities, including securities issued and guaranteed by FNMA,
FHLMC and GNMA. The Bank's current securities investment strategy is to
continue to emphasize the purchase of mortgage-backed securities and U.S.
Government and agency obligations as well as state and municipal obligations for
purposes of interest rate risk management.
At December 31, 1998, the Company had $155.5 million in securities,
consisting primarily of mortgage-backed securities, U.S. Government and agency
obligations, trust preferred securities and municipal obligations. SFAS No. 115
requires the Company to designate its securities as held-to-maturity, available-
for-sale or trading depending on the Company's intent regarding its investments.
The Company does not currently maintain a trading portfolio of securities. At
December 31, 1998, all of the Company's mortgage-backed securities were
classified as held-to-maturity. Also at that date, 18.3% of the Company's
investment securities were classified as available-for-sale and 81.7% were
classified as held-to-maturity. Of the Company's total investment securities and
mortgage-backed securities portfolio, the Company's securities classified as
held-to-maturity had an aggregate market value of $148.4 million and an
amortized cost of $147.2 million. The Company's securities classified as
available-for-sale had an aggregate market value of $8.3 million and an
amortized cost of $8.0 million at December 31, 1998.
Mortgage-Backed Securities. The Bank purchases mortgage-backed securities
in order to: (i) generate positive interest rate spreads with minimal
administrative expense; (ii) reduce its credit risk as a result of the guarantee
provided by FHLMC, FNMA and GNMA; (iii) utilize these securities as collateral
for borrowings; and (iv) increase the liquidity of the Bank. The Bank has
primarily invested in mortgage-backed securities issued or sponsored by FNMA,
FHLMC and GNMA and private issuers. At December 31, 1998, mortgage-backed
securities totalled $110.4 million, or 33.6% of total assets and 35.0% of total
17
interest-earning assets, and all were classified as held-to-maturity. At
December 31, 1998, 64.3% of the mortgage-backed securities were adjustable-rate
and 35.7% were fixed-rate. The mortgage-backed securities portfolio had coupon
rates ranging from 5.00% to 15.00% and had a weighted average yield of 6.63% at
December 31, 1998. The estimated fair value of the Bank's mortgage-backed
securities held to maturity at December 31, 1998, was $111.5 million, which is
$1.1 million more than the amortized cost of $110.4 million.
Mortgage-backed securities are created by the pooling of mortgages and
issuance of a security with an interest rate which is less than the interest
rate on the underlying mortgage. Mortgage-backed securities typically represent
a participation interest in a pool of single-family or multi-family mortgages,
although the Bank focuses its investments on mortgage-backed securities backed
by single-family mortgages. The issuers of such securities (generally U.S.
Government agencies and government sponsored enterprises, including FNMA, FHLMC
and GNMA) pool and resell the participation interests in the form of securities
to investors such as the Bank and guarantee the payment of principal and
interest to investors. Mortgage-backed securities generally yield less than the
loans that underlie such securities because of the cost of loan servicing and
payment guarantees. In addition, mortgage-backed securities are usually more
liquid than individual mortgage loans and may be used to collateralize certain
liabilities and obligations of the Bank. Investments in mortgage-backed
securities involve a risk that actual prepayments will differ from estimated
prepayments used in pricing the security at the time of purchase, which may
require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby changing the net yield on such
securities. There is also reinvestment risk associated with the cash flows from
such securities on in the event such securities are redeemed by the issuer. In
addition, the market value of such securities may be adversely affected by
changes in interest rates. The Bank estimates prepayments for its mortgage-
backed securities at purchase to ensure that prepayment assumptions are
reasonable considering the underlying collateral for the mortgage-backed
securities at issue and current mortgage interest rates and to determine the
yield and estimated maturity of its mortgage-backed security portfolio. Of the
Bank's $110.4 million mortgage-backed securities portfolio at December 31, 1998,
$817,000 with a weighted average yield of 7.79% had contractual maturities
within five years and $109.6 million with a weighted average yield of 6.62% had
contractual maturities over five years. However, the actual maturity of a
mortgage-backed security may be less than its stated maturity due to prepayments
of the underlying mortgages. Prepayments that are faster than anticipated may
shorten the life of the security and may result in a loss of any premiums paid
and thereby reduce the net yield on such securities. Although prepayments of
underlying mortgages depend on many factors, the difference between the interest
rates on the underlying mortgages and the prevailing mortgage interest rates
generally is the most significant determinant of the rate of prepayments.
During periods of declining mortgage interest rates, refinancing generally
increases and accelerates the prepayment of the underlying mortgages and the
related security. Under such circumstances, the Bank may be subject to
reinvestment risk because, to the extent that the Bank's mortgage-backed
securities prepay faster than anticipated, the Bank may not be able to reinvest
the proceeds of such repayments and prepayments at a comparable rate.
U.S. Government and Agency Obligations and Obligations of States and
Municipalities. At December 31, 1998, the U.S. Government and Agency securities
portfolio totalled $33.9 million, or 10.3% of total assets, $25.6 million of
which were classified as held-to-maturity. In addition, the Bank held $388,000
in obligations of a New Jersey municipal subdivision.
Trust Preferred Securities. At December 31, 1998, the investment portfolio
included $10.9 million, or 3.3% of total assets, in trust preferred securities,
all of which were purchased in 1998. Trust preferred securities are non-
perpetual cumulative preferred stock issued by a wholly owned subsidiary of a
bank and are classified as debt securities under generally accepted accounting
principles. Securities of this nature are permissible investments for banks and
thrifts provided they are of investment grade quality and are rated as
18
such by any of the top rating services. Before purchasing these investments, the
Bank researched extensively the permissibility and suitability of these
investments and whether they had a place on the balance sheet of the Bank. The
Bank's policy as approved by the Board of Directors allows for the purchase of
investments which are considered investment grade and are permissible
investments under OTS regulations. Securities considered investment grade must
be rated in on of the four highest categories by a nationally recognized
statistical rating agency. Additionally, the Board's policy limits these type of
investments to a maximum aggregate dollar amount to $10,000,000. The Bank's
conclusion was that these investments had a place on the balance sheet and over
a period of time $10.0 million of trust preferred security investments in five
of the most well known large commercial banks in the eastern United States was
made. In addition to such securities owned by the Bank, the Company owns one
trust preferred security which is carried at $907,000.
The $10.9 million in trust preferred securities is a combination of $7.0
million in floating rate (spread to Libor) investments and $3.9 million in fixed
rate investments. The adjustable investments offer quarterly interest
adjustments, uncapped coupons and call protection unavailable in most other
types of adjustable investments. The $3.9 million in fixed rate investments
offer yield for the balance sheet and presented a cost of funds spread which was
unavailable in other types of alternative investments. These investments
present the normal type of risk to the Company and the Bank that is associated
with other forms of marketable debt securities. These include credit risk,
which is associated with the underlying creditworthiness of the issuer,
liquidity risk, which is associated with the ability to dispose of a security
in a reasonable time period at a reasonable price, and call risk, which is
associated with these securities having call provisions after 10 years.
The following table sets forth certain information regarding the amortized
cost and fair value of securities at the dates indicated.
At December 31,
------------------------------------------------------------
1998 1997 1996
-------------------- ------------------ ------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
----------- ------- --------- ------- --------- -------
(In thousands)
Investment securities available-for-sale(1):
U.S. Government obligations................. $ 7,983 $ 8,282 $ 6,980 $ 7,081 $ -- $ --
Obligations of states and
municipal subdivisions..................... -- -- -- -- 115 120
Mutual fund................................. -- -- -- -- 1,554 1,527
------- ------- ------- ------- ------- -------
Total securities available-for-sale........ 7,983 8,282 6,980 7,081 1,669 1,647
------- ------- ------- ------- ------- -------
Investment securities held-to-maturity (1):
U.S. Government and
Agency obligations......................... 25,582 25,884 22,929 23,339 22,476 22,766
Trust preferred securities.................. 10,903 10,619 -- -- -- --
Obligations of states and
municipal subdivisions.................... 388 388 -- -- -- --
------- ------- ------- ------- ------- -------
36,873 36,891 22,929 23,339 22,476 22,766
------- ------- ------- ------- ------- -------
Federal Home Loan Bank of
New York stock (2).......................... 2,607 2,607 2,184 2,184 1,670 1,670
------- ------- ------- ------- ------- -------
Total...................................... $47,463 $47,780 $32,093 $32,604 $25,815 $26,083
======= ======= ======= ======= ======= =======
(1) Available-for-sale securities are carried at fair value while held-to-
maturity securities are carried at amortized cost.
(2) Investment is required by regulation. As the security is not readily
marketable, its cost approximates fair value.
The following table sets forth investment securities activities for the
periods indicated.
19
At December 31,
----------------------------
1998 1997 1996
-------- -------- --------
Investment securities:
Investment securities, beginning of period(1).. $30,009 $ 24,124 $20,414
------- -------- -------
Purchases:
Investment securities--held-to-maturity..... 23,640 10,400 10,998
Investment securities--available-for-sale... 1,000 7,034 88
Calls:
Investment securities--held-to-maturity..... (7,740) (10,000) (5,000)
Investment securities--available-for-sale... -- -- --
Maturities:
Investment securities--held-to-maturity..... (2,150) -- (2,000)
Investment securities--available-for-sale... -- (115) (192)
Sales of securities available-for-sale......... -- (1,608) (100)
Increase (decrease) in net premium............. 199 52 (2)
Increase (decrease) in unrealized gains........ 198 122 (82)
------- -------- -------
Net increase in investment securities....... 15,147 5,885 3,710
------- -------- -------
Investment securities, end of period........... $45,156 $ 30,009 $24,124
======= ======== =======
- - --------------
(1) Includes investment securities available-for-sale.
20
The following table sets forth certain information regarding the amortized
cost and fair values of the Bank's mortgage-backed securities, all of which are
held-to-maturity, at the dates indicated.
At December 31,
---------------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------- ------------------------------- -------------------------------
Percent Percent Percent
Amortized of Fair Amortized of Fair Amortized of Fair
Cost Total(1) Value Cost Total(1) Value Cost Total(1) Value
----------- --------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
By Issuer:
GNMA..................... $ 58,816 53.29% $ 59,500 $ 78,657 60.42% $ 79,775 $ 65,996 58.27% $ 67,095
FHLMC.................... 26,699 24.19 27,019 26,551 20.40 26,749 32,041 28.29 32,023
FNMA..................... 20,101 18.21 20,267 24,959 19.17 25,150 15,204 13.43 15,227
Other.................... 4,760 4.31 4,727 7 0.01 7 13 0.01 13
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed
securities (1)(2).. $110,376 100.00% $111,513 $130,174 100.00% $131,681 $113,254 100.00% $114,358
======== ====== ======== ======== ====== ======== ======== ====== ========
By Coupon Type:
Adjustable-rate.......... $ 70,919 64.25% $ 71,390 $ 82,938 63.71% $ 83,740 $ 62,849 55.49% $ 63,693
Fixed-rate............... 39,457 35.75 40,123 47,236 36.29 47,941 50,405 44.51 50,665
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed
securities (1)(2).. $110,376 100.00% $111,513 $130,174 100.00% $131,681 $113,254 100.00% $114,358
======== ====== ======== ======== ====== ======== ======== ====== ========
- - -----------------
(1) Based on amortized cost.
(2) Includes net unamortized premiums of $206, $243 and $193 at December 31,
1998, 1997 and 1996, respectively.
The following table sets forth the Bank's mortgage-backed securities
activities for the periods indicated.
For the Years
Ended December 31,
-------------------------------
1998 1997 1996
--------- -------- --------
Beginning balance............................. $130,174 $113,254 $100,031
Purchases.................................... 21,892 37,026 30,570
Principal repayments......................... (41,587) (20,084) (17,384)
Net amortization and accretion of discounts
and premiums............................... (103) (22) 37
-------- -------- --------
Ending balance................................ $110,376 $130,174 $113,254
======== ======== ========
21
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of investment securities
available-for-sale and held-to-maturity and mortgage-backed securities held-to-
maturity as of December 31, 1998.
At December 31, 1998
--------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years More than Ten Years Total
------------------ ------------------ ------------------ ------------------- ------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Investment securities
available-for-sale:
U.S. Treasury and
Government agency
obligations............. $ -- --% $7,283 5.92% $ -- --% $ 999 7.01% $ 8,282 6.05%
====== ====== ======= ======== ========
Investment securities
held-to-maturity:
U.S. Treasury and
Government agency
obligations............. $1,000 6.39 $2,000 6.10 $14,000 7.04 $ 8,582 7.08 $ 25,582 6.95
Municipal obligations...... 150 3.65 -- -- -- -- 238 4.46 388 4.15
Trust preferred
securities................ -- -- -- -- -- -- 10,903 6.65 10,903 6.65
------ ------ ------- -------- --------
Total investment
securities held
to maturity............ $1,150 6.03 $2,000 6.10 $14,000 7.04 $ 19,723 6.77 $ 36,873 6.83
====== ====== ======= ======== ========
Mortgage-backed securities
held-to-maturity:
Adjustable-rate:
GNMA..................... $ -- -- $ -- -- -- -- $ 48,833 6.44 $ 48,833 6.44
FHLMC.................... -- -- -- -- -- -- 8,941 5.95 8,941 5.95
FNMA..................... -- -- -- -- -- -- 13,145 6.27 13,145 6.27
------ ------ ------- -------- --------
Total................. -- -- -- -- -- -- 70,919 6.34 70,919 6.34
------ ------ ------- -------- --------
Fixed-rate:
GNMA..................... 3 12.00 4 8.00 3,429 7.60 6,547 7.48 9,983 7.52
FHLMC.................... 394 8.00 118 9.00 3,400 6.61 13,846 7.11 17,758 7.05
FNMA..................... 298 7.00 -- -- 717 7.00 5,941 7.09 6,956 7.08
Other.................... -- -- -- -- -- -- 4,760 6.76 4,760 6.76
------ ------ ------- -------- --------
Total................. 695 7.58 122 8.97 7,546 7.10 31,094 7.14 39,457 7.14
------ ------ ------- -------- --------
Total mortgage-backed
securities
held-to-maturity............ $ 695 7.58 $ 122 8.97 $ 7,546 7.10 $102,013 6.58 $110,376 6.63
====== ====== ======= ======== ========
22
Sources of Funds
General. Deposits, loan repayments and prepayments, security maturities,
cash flows generated from operations and FHLB borrowings are the primary sources
of the Bank's funds for use in lending, investing and for other general
purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. The Bank's deposits consist of savings, checking
accounts, NOW accounts, money market club accounts, certificate of deposit
accounts and Individual Retirement Accounts. For the year ended December 31,
1998, average core deposits represented 40.2% of total average deposits. The
flow of deposits is influenced significantly by general economic conditions,
changes in money market rates, prevailing interest rates and competition. The
Bank's deposits are obtained predominantly from the areas in which its branch
offices are located. The Bank has historically relied primarily on customer
service and long-standing relationships with customers to attract and retain
these deposits; however, market interest rates and rates offered by competing
financial institutions significantly affect the Bank's ability to attract and
retain deposits. The Bank uses traditional means of advertising its deposit
products through print media and generally does not solicit deposits from
outside its market area. The Bank does not actively solicit certificate
accounts in excess of $100,000 or use brokers to obtain deposits. At December
31, 1998, 83.8% of the Bank's certificate of deposit accounts had terms of less
than twelve months.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Years Ended December
31,
--------------------------------
1998 1997 1996
--------------------------------
Beginning balance $238,192 $179,946 $178,392
-------- -------- --------
Purchase of deposits from another -- 51,007 --
institution
Net deposits (withdrawals) (9,626) (850) (5,595)
Interest credited 9,747 8,089 7,149
-------- -------- --------
Increase in deposit accounts 121 58,246 1,554
-------- -------- --------
Ending balance $238,313 $238,192 $179,946
======== ======== ========
At December 31, 1998, the Bank had $17.7 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 $ 5,655 5.51%
Over 3 through 6 months 3,647 5.22
Over 6 through 12 months 5,549 5.71
Over 12 months 2,805 5.67
------- ----
Total $17,656 5.54%
======= ====
23
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. Averages for the periods
presented utilize month-end balances.
For the Years Ended December 31,
-----------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ------------------------------- -------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
---------- --------- -------- --------- --------- -------- -------- --------- ----------
(Dollars in thousands)
Demand accounts.............. $ 33,631 14.10% 1.01% $ 24,863 12.60% 1.18% $ 21,679 12.18% 1.24%
Savings and Club accounts.... 62,120 26.05 2.69 53,221 26.97 2.55 51,138 28.74 2.50
Certificates of deposit...... 142,714 59.85 5.42 119,272 60.43 5.40 105,141 59.08 5.33
-------- ------ -------- ------ -------- ------
Total................. $238,465 100.00% 4.09% $197,356 100.00% 4.10% $177,958 100.00% 4.02%
======== ====== ======== ====== ======== ======
Certificate accounts(1):
Less than six months...... $ 70,208 49.74% 5.15% $ 70,186 49.32% 5.24% $ 51,854 48.17% 5.08%
Over six through 12 months 48,109 34.08 5.32 44,047 30.95 5.59 34,720 32.25 5.45
Over 12 months through 36 19,572 13.86 5.46 25,309 17.78 5.96 16,417 15.25 5.54
months...................
Over 36 months............ 3,280 2.32 5.75 2,782 1.95 6.96 4,656 4.33 6.48
-------- ------ -------- ------ -------- ------
Total certificate
accounts............ $141,169 100.00% 5.26 $142,324 100.00% 5.51% $107,647 100.00% 5.33%
======== ====== ======== ====== ======== ======
(1) Based on remaining maturity of certificates calculated as of the end of the
period.
24
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1998.
Period to Maturity from December 31, 1998 At December 31,
-------------------------------------------------------------- -------------------------------
Two to Three to Four to After
Less than One to Three Four Five Five
One Year Two years years years years Years 1998 1997 1996
------------ ---------- -------- -------- ------- ------- -------- --------- ---------
(In thousands)
Certificate accounts:
to 4.00%.................... $ 4,811 $ 40 $ -- $ -- $ -- $ -- $ 4,851 $ 2,538 $ 11,101
4.01 to 5.00%.............. 39,298 5,243 822 9 113 -- 45,485 33,593 21,836
5.01 to 6.00%.............. 66,573 6,549 1,739 1,356 1,198 314 77,729 88,877 60,352
6.01 to 7.00%.............. 5,667 4,247 537 271 19 -- 10,741 14,451 11,851
7.01 to 8.00%.............. 1,734 395 -- -- -- -- 2,129 2,069 1,486
Over 9.00%................. -- -- -- -- -- -- -- 536 847
-------- ------- ------ ------ ------ ------ -------- -------- --------
$118,083 $16,474 $3,098 $1,636 $1,330 $314 $140,935 142,064 107,473
======== ======= ====== ====== ====== ======
Accrued interest payable................................................................ 234 260 174
-------- -------- --------
Total.................................................................................. $141,169 $142,324 $107,647
======== ======== ========
25
Borrowings. The Bank utilizes borrowings from the FHLB as an alternative
to retail deposits to fund its operations as part of its operating strategy.
These FHLB borrowings are collateralized primarily by certain of the Bank's
mortgage-related securities and secondarily by the Bank's investment in capital
stock of the FHLB. FHLB borrowings are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time to time in accordance
with the policies of the FHLB. See "Regulation and Supervision--Federal Home
Loan Bank System." At December 31, 1998, the Bank had $42.0 million in
outstanding FHLB borrowings, compared to $30.3 million at December 31, 1997.
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated.
At or For the Years
Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- -------
(Dollars in thousands)
Average balance outstanding............ $42,364 $26,223 $18,092
Maximum amount outstanding at any
month-end during the period........ 52,145 43,675 23,650
Balance outstanding at end of period... 42,010 30,300 23,650
Weighted average interest rate
during the period.................... 5.83% 5.97% 6.36%
Weighted average interest rate at
end of period........................ 5.69% 6.08% 6.20%
Subsidiary Activities
The Corporation is the parent corporation of one wholly owned subsidiary,
the Bank. In addition, the Bank is the parent corporation of one wholly owned
subsidiary corporation, West Essex Insurance Agency ("WEIA"). WEIA was formed in
December 1982 to offer insurance products and tax-deferred annuities through an
agent. Originally, these products were sold at one of the Bank's branches.
Commencing in 1993, customers have been referred to Anthony R. Davis Agency at
an off-site location. WEIA receives a fee for each customer referral resulting
in the purchase of an insurance and/or annuity product. Sales of annuity
products totalled $165,000 for the year ended December 31, 1998. WEIA's
earnings are at a nominal level since management decided in early 1994 to de-
emphasize this activity due to the lack of demand and controversial publicity
associated with uninsured annuity products.
Personnel
As of December 31, 1998, the Bank had 49 authorized full-time employee
positions and 6 authorized part-time employee positions. The employees are not
represented by a collective bargaining unit and the Association considers its
relationship with its employees to be good.
26
REGULATION AND SUPERVISION
General
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The
Bank is a member of the FHLB System. The Bank's deposit accounts are insured up
to applicable limits by the SAIF managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS and the FDIC to test
the Bank's compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS, the FDIC or the Congress, could have a material adverse impact on the
Company, the MHC and the Bank and their operations. The MHC, as a federal mutual
holding company and the Company, as a federal corporation, will also be required
to file certain reports with, and otherwise comply with the rules and
regulations of the OTS.
The following summary of the regulation and supervision of savings
associations and their holding companies does not purport to be a complete
description of the applicable statutes and regulations and is qualified in its
entirety by reference to such statutes and regulations.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are
governed by the HOLA and, in certain respects, the Federal Deposit Insurance Act
(the "FDI Act") and the regulations issued by the agencies to implement these
statutes. These laws and regulations delineate the nature and extent of the
activities in which federal associations may engage. In particular, many types
of lending authority for federal associations, e.g., commercial, non-residential
real property loans and consumer loans, are limited to a specified percentage of
the institution's capital or assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial instruments
and bullion. At December 31, 1998, the Bank's regulatory limit on loans-to-one
borrower was $5.2 million. At December 31, 1998, the Bank's largest aggregate
amount of loans-to-one borrower was $2.0 million, consisting of a $1.0 million
construction loan and a $980,000 commercial real estate loan.
QTL Test. The HOLA requires savings institutions to meet a qualified
thrift lender ("QTL") test. Under the QTL test, a savings association is
required to qualify as a "domestic building and loan association" as that term
is defined in the Code or maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed and related
securities) in at least nine months out of each 12 month period. A savings
association that fails the QTL test must either convert to a bank charter or
operate under certain restrictions. As of December 31, 1998, the Bank
maintained 81.0% 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 as "qualified thrift investments."
27
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by a savings institution, including cash
dividends, payments to repurchase its shares and payments to shareholders of
another institution in a cash-out merger. The rule effective in 1998
established three tiers of institutions based primarily on an institution's
capital level. An institution that exceeded all capital requirements before and
after a proposed capital distribution ("Tier 1 Association") and had not been
advised by the OTS that it was in need of more than normal supervision, could,
after prior notice but without obtaining approval of the OTS, make capital
distributions during the calendar year equal to the greater of (i) 100% of its
net earnings to date during the calendar year plus the amount that would reduce
by one-half the excess capital over its capital requirements at the beginning of
the calendar year or (ii) 75% of its net income for the previous four quarters.
Any additional capital distributions required prior regulatory approval. At
December 31, 1998, the Bank was a Tier 1 Association. Effective April 1, 1999,
the OTS's capital distribution regulation will change. Under the new
regulation, an application to and the prior approval of the OTS will be required
prior to any capital distribution if the institution does not meet the criteria
for "expedited treatment" of applications under OTS regulations (i.e.,
generally, examination ratings in the two top categories), the total capital
distributions for the calendar year exceed net income for that year plus the
amount of retained net income for the preceding two years, the institution would
be undercapitalized following the distribution or the distribution would
otherwise be contrary to a statute, regulation or agreement with OTS. If an
application is not required, the institution must still provide prior notice to
OTS of the capital distribution. In the event the Bank's capital fell below its
regulatory requirements or the OTS notified it that it was in need of more than
normal supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus short-
term borrowings. Monetary penalties may be imposed for failure to meet these
liquidity requirements. The Bank's average liquidity ratio for December 31,
1998 was 7.38%, which exceeded the applicable requirements. The Bank has never
been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general assessment,
paid on a semi-annual basis, is based upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the Bank's latest
quarterly Thrift Financial Report. The assessments paid by the Bank for the
year ended December 31, 1998 totalled $76,000.
Branching. OTS regulations permit federally chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Holding
Company and any non-savings institution subsidiaries that the Holding Company
may establish) is limited by Sections 23A and 23B of the Federal Reserve Act
("FRA"). Section 23A restricts the aggregate amount of covered transactions
with any individual affiliate to 10% of the capital and surplus of the savings
institution and also limits the aggregate amount of transactions with all
affiliates to 20% of the savings institution's capital and surplus. Certain
transactions with affiliates are required to be secured by collateral in an
amount and of a type described in Section 23A and the purchase of low quality
assets from affiliates is generally prohibited. Section 23B generally requires
that certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. A savings association also
28
is prohibited from extending credit to any affiliate engaged in activities not
permitted for a bank holding company and may not purchase the securities of an
affiliate (other than a subsidiary).
Section 22(h) of the Federal Reserve Act restricts a savings association
with respect to loans to directors, executive officers, and principal
stockholders. Under Section 22(h), loans to directors, executive officers and
stockholders who control, directly or indirectly, 10% or more of voting
securities of a savings association, and certain related interests of any of the
foregoing, may not exceed, together with all other outstanding loans to such
persons and affiliated entities, the savings association's total capital and
surplus. Section 22(h) also prohibits loans above amounts prescribed by the
appropriate federal banking agency to directors, executive officers, and
shareholders who directly or indirectly control 10% or more of voting securities
of a stock savings association, and their respective related interests, unless
such loan is approved in advance by a majority of the board of directors of the
savings association. Any "interested" director may not participate in the
voting. The loan amount (which includes all other outstanding loans to such
person) as to which such prior board of director approval is required, is the
greater of $25,000 or 5% of capital and surplus or any loans over $500,000.
Further, pursuant to Section 22(h), loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
in comparable transactions to other persons except for extensions of credit made
pursuant to a benefit or compensation program that is widely available to the
institution's employees and does not give preference to insiders over other
employees. Section 22(g) of the FRA places additional limitations on loans to
executive officers.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to have an adverse effect on an insured institution.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1.0 million per
day in especially egregious cases. Under the FDI Act, the FDIC has the
authority to recommend to the Director of the OTS that enforcement action be
taken with respect to a particular savings institution. If action is not taken
by the Director, the FDIC has authority to take such action under certain
circumstances. Federal and state law also establishes criminal penalties for
certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. 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 Guidelines address internal controls and information systems;
internal audit system; credit underwriting; loan documentation; interest rate
risk exposure; asset growth; asset quality; earnings; 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
regulations establish deadlines for the submission and review of such safety and
soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage ratio and an 8% risk-based capital ratio. In addition, the
prompt corrective action standards discussed below also establish, in effect, a
minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions
receiving the highest rating on the CAMEL financial institution
29
rating system), and, together with the risk-based capital standard itself, a 4%
Tier 1 risk-based capital standard. The OTS regulations also require that, in
meeting the tangible, leverage and risk-based capital standards, institutions
must generally deduct investments in and loans to subsidiaries engaged in
activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
The capital regulations also incorporate an interest rate risk component.
Savings institutions with "above normal" interest rate risk exposure are subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. For the present time, the OTS has deferred implementation
of the interest rate risk component. At December 31, 1998, the Bank met each of
its capital requirements.
The following table presents the Bank's capital position at December 31,
1998.
Excess Capital
---------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
-----------------------------------------------------
(Dollars in thousands)
Tangible.......... $33,000 $ 4,743 $28,257 10.44% 1.50%
Core (Leverage)... 33,000 12,649 20,351 10.44 4.00%
Risk-based........ 34,500 9,580 24,920 28.81 8.00%
Prompt Corrective Regulatory Action
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of capitalization.
Generally, a savings institution that has a total risk-based capital of less
than 8% or a leverage ratio or a Tier 1 capital ratio that is less than 4% is
considered to be undercapitalized. A savings institution that has a total risk-
based capital less than 6%, a Tier 1 risk-based capital ratio of less than 3% or
a leverage ratio that is less than 3% is considered to be "significantly
undercapitalized" and a savings institution that has a tangible capital to
assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
critically undercapitalized. The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
association receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions
30
may become immediately applicable to the institution depending upon its
category, including, but not limited to, increased monitoring by regulators,
restrictions on growth, and capital distributions and limitations on expansion.
The OTS could also take any one of a number of discretionary supervisory
actions, including the issuance of a capital directive and the replacement of
senior executive officers and directors.
Insurance of Deposit Accounts
Insurance of Deposit Accounts. Deposits of the Bank are presently insured
by the SAIF. The FDIC maintains a risk-based assessment system by which
institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon
the categories to which it is assigned. Assessment rates for SAIF member
institutions are determined semiannually by the FDIC and currently range from
zero basis points for the healthiest institutions to 27 basis points for the
riskiest.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 1998,
FICO payments for SAIF members approximated 6.10 basis points, while Bank
Insurance Fund ("BIF") members paid 1.22 basis points. By law, there will be
equal sharing of FICO payments between SAIF and BIF members on the earlier of
January 1, 2000 or the date the SAIF and BIF are merged.
The Bank's assessment rate for fiscal 1998 was zero basis points and no
premium was paid for this period. Payments toward the FICO bonds amounted to
$136,000. The FDIC has authority to increase insurance assessments. A
significant increase in SAIF insurance premiums would likely have an adverse
effect on the operating expenses and results of operations of the Association.
Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Community Reinvestment Act
Federal Regulation. Under the Community Reinvestment Act, as amended
("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA requires the OTS, in connection with its examination of a savings
institution, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications by such institution. The FIRREA amended the CRA to require the OTS
to provide a written evaluation of an institution's CRA performance utilizing a
four-tiered descriptive rating system, which replaced the five-tiered numerical
rating system. The Bank's latest CRA rating received from the OTS was
"Satisfactory."
31
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB of New York, is required to
acquire and hold shares of capital stock in the FHLB in an amount at least equal
to 1% of the aggregate principal amount of its unpaid residential mortgage loans
and similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at December 31, 1998 of
$2.6 million. FHLB borrowings must be secured by specified types of collateral
and all long-term borrowings may only be obtained for the purpose of providing
funds for residential housing finance. At December 31, 1998, the Bank had $42.0
million in FHLB borrowings.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended December 31, 1998, 1997 and
1996, dividends from the FHLB to the Bank amounted to approximately $180,000,
$126,000 and $107,000, respectively. If dividends were reduced, the Bank's net
interest income would likely also be reduced. Further, there can be no
assurance that the impact of recent or future legislation on the FHLBs will not
also cause a decrease in the value of FHLB stock held by the Bank, if any.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$47.8 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $47.8 million, the
reserve requirement is $1.4 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 $47.8 million. The first $4.7 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained
in the form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
Holding Company Regulation
General. The Company is a federal savings and loan holding company within
the meaning of the HOLA. As such, the Company will be required to register with
the OTS and will be subject to OTS regulations, examinations, supervision and
reporting requirements. In addition, the OTS has enforcement authority over the
Company and its non-savings institution subsidiaries. Among other things, this
authority permits the OTS to restrict or prohibit activities that are determined
to be a serious risk to the subsidiary savings institution. The Bank must
notify the OTS 30 days before declaring any dividend to the Company.
Restrictions Applicable to Mutual Holding Companies. Pursuant to Section
10(o) of the HOLA and the Regulations, a mutual holding company, such as the
MHC, may engage in the following activities: (i) investing in the stock of a
savings association; (ii) acquiring a mutual association through the merger of
such association into a savings association subsidiary of such holding
32
company or an interim savings association subsidiary of such holding company;
(iii) merging with or acquiring another holding company, one of whose
subsidiaries is a savings association; (iv) investing in a corporation, the
capital stock of which is available for purchase by a savings association under
federal law or under the law of any state where the subsidiary savings
association or associations share their home offices; (v) furnishing or
performing management services for a savings association subsidiary of such
company; (vi) holding, managing or liquidating assets owned or acquired from a
savings subsidiary of such company; (vii) holding or managing properties used or
occupied by a savings association subsidiary of such company properties used or
occupied by a savings association subsidiary of such company; (viii) acting as
trustee under deeds of trust; (ix) any other activity (A) that the Federal
Reserve Board, by regulation, has determined to be permissible for bank holding
companies under Section 4(c) of the Bank Holding Company Act (the "BHC Act"),
unless the Director, by regulation, prohibits or limits any such activity for
savings and loan holding companies; or (B) in which multiple savings and loan
holding companies were authorized (by regulation) to directly engage on March 5,
1987; and (x) purchasing, holding, or disposing of stock acquired in connection
with a qualified stock issuance if the purchase of such stock by such savings
and loan holding company is approved by the Director.
If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from such
merger or acquisition may only invest in assets and engage in activities listed
in (i) through (x) above, and it has a period of two years to cease any non-
conforming activities and divest of any nonconforming investments.
The HOLA prohibits a savings and loan holding company, including a federal
mutual holding company, directly or indirectly, or through one or more
subsidiaries, from acquiring more than 5% of the voting stock of another savings
institution, or holding company thereof, without prior written approval of the
OTS; from acquiring or retaining, with certain exceptions, more than 5% of a
non-subsidiary holding company or savings association. The HOLA also prohibits a
savings and loan holding company from acquiring more than 5% of a company
engaged in activities other than those authorized for savings and loan holding
companies by the HOLA; or acquiring or retaining control of a depository
institution that is not insured by the FDIC. In evaluating applications by
holding companies to acquire savings institutions, the OTS must consider the
financial and managerial resources and future prospects of the company and
institution involved, the effect of the acquisition on the risk to the insurance
funds, the convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
If the savings institution subsidiary of a savings and loan holding company
fails to meet the QTL test set forth in Section 10(m) of the HOLA and the
regulations of the OTS, the holding company must register with the Federal
Reserve Board as a Bank Holding Company within one year of the savings
institution's failure to so qualify.
Stock Holding Company Subsidiary Regulation. The OTS has adopted
regulations governing the two-tier mutual holding company form of organization
and mid-tier stock holding companies that are controlled by mutual holding
companies. Under these rules, the stock holding company subsidiary holds all the
shares of the mutual holding company's savings association subsidiary and issues
the majority of its own shares to the mutual holding company parent. In
addition, the stock holding company subsidiary is permitted to engage in
activities that are permitted for its mutual holding company parent and to have
the same indemnification and employment contract restrictions imposed that are
on the mutual holding company parent. Finally, OTS regulations maintain that the
stock holding company subsidiary must be federally chartered for supervisory
controls.
33
Thrift Rechartering
Legislation enacted in 1996 provided that hte BIF And SAIF were to have
merged on January 1, 1999 if there were no more savings associations as of that
date. Various proposals to eliminate the federal savings association charter,
create a uniform financial institutions charter, abolish the OTS and restrict
savings and loan holding company activities have been introduced in Congress.
The Bank is unable to predict whether such legislation will be enacted or the
extent to which the legislation would restrict or disrupt its operations.
34
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Bank, the Company and the MHC will report their income on a
calendar year basis using the accrual method of accounting and will be subject
to federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank, the Company and the MHC. The Bank was last audited by
the IRS in 1995 and has not been audited by the New Jersey Department of Revenue
("DOR") in the past five years.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Bank's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interest in real property, were computed using an amount based on the
Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable
income, computed with certain modifications and reduced by the amount of any
permitted addition to the non-qualifying reserve. Due to the Bank's loss
experience, the Bank generally recognized a bad debt deduction equal to 8% of
taxable income.
In August 1996, the provisions repealing the above thrift bad debt rules
were passed by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(last taxable year beginning before January 1, 1988). The Bank has previously
recorded a deferred tax liability equal to the bad debt recapture and as such,
the new rules will have no effect on net income or federal income tax expense.
For taxable years beginning after December 31, 1995, the Bank's bad debt
deduction will be equal to net charge-offs. The new rules allow an institution
to suspend the bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years is equal to or greater than the
institution's average mortgage lending activity for the six taxable years
preceding 1996. For this purpose, only home purchase and home improvement loans
are included and the institution can elect to have the tax years with the
highest and lowest lending activity removed from the average calculation. If an
institution is permitted to postpone the reserve recapture, it must begin its
six year recapture no later than the 1998 tax year. The unrecaptured base year
reserves will not be subject to recapture as long as the institution continues
to carry on the business of banking. In addition, the balance of the pre-1988
bad debt reserves continue to be subject to a provision of present law referred
to below that require recapture in the case of certain excess distributions to
shareholders.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method, or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock, and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not be
considered to result in a distribution from the Bank's bad debt reserve. Thus,
any dividends to the Company that would reduce amounts appropriated to the
Bank's bad debt reserve and deducted for federal income tax purposes would
create a tax liability for the Bank. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution.
35
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers. AMTI is increased by an amount equal to 75% of the amount by
which the Bank's adjusted current earnings exceeds its AMTI (determined without
regard to this preference and prior to reduction for net operating losses).
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 80% of dividends received from the Bank as long as it maintains
ownership in the Bank of at least 20%.
State and Local Taxation
State of New Jersey. The Bank, the Company and the MHC file New Jersey
income tax returns. For New Jersey income tax purposes, savings institutions
are presently taxed at a rate equal to 3% of taxable income. For this purpose,
"taxable income" generally means federal taxable income, subject to certain
adjustments (including addition of interest income on state and municipal
obligations). For New Jersey tax purposes, regular corporations are presently
taxed at a rate equal to 9% of taxable income.
Additional Item. Executive Officers of the Registrant.
- - ------------------------------------------------------
The following table sets forth certain information regarding the executive
officers of the Company and the Bank who are not also directors.
Name Age at 12/31/98 Position
- - ------------------- ---------------- ----------------------------------------------
Dennis A. Petrello 47 Executive Vice President and Chief Financial
Officer
Charles E. Filippo 58 Executive Vice President of the Company and
the Bank and Chief Lending Officer of the
Bank
Craig L. Montanaro 32 Senior Vice President, Secretary and Treasurer
36
Item 2. Properties.
- - -------------------
The Bank currently conducts its business through an administrative and full
service branch office located in Caldwell, New Jersey and seven other full
service branch offices located in West Orange, Franklin Lakes, River Vale, Pine
Brook, Old Tappan and Northvale, New Jersey. Management believes that the
Bank's facilities are adequate to meet the present and immediately foreseeable
needs of the Bank and the Company.
Original Net Book Value
Year of Property or
Leased Leased Leasehold
or or Improvements at
Location Owned Acquired December 31, 1998
- - -------- ------ -------- -----------------
(In thousands)
Administrative/Corporate/
Branch Office:
417 Bloomfield Avenue Owned 1962 $387
Caldwell, NJ 07006
Branch Offices:
216 Main Street Owned 1987 148
West Orange, NJ 07052
487 Pleasant Valley Way Owned 1987 226
West Orange, NJ 07052
574 Franklin Avenue Leased 1978 2
Franklin Lakes, NJ 07417
653 Westwood Avenue Owned 1997 478
River Vale, NJ 07675
267 Changebridge Road Owned 1974 245
Pine Brook, NJ 07058
207 Old Tappan Road Owned 1997 487
Old Tappan, NJ 07675
119 Paris Avenue Owned 1997 321
Northvale, NJ 07647
Item 3. Legal Proceedings.
- - ---------------------------
The Company and the Bank are parties to various litigation which arises
primarily in the ordinary course of business. Included in such litigation is a
case before the Superior Court of New Jersey related to a condominium
construction project. Currently, the plaintiffs have four loans with the Bank
totalling $390,901 in the aggregate; three of which are delinquent. Another
plaintiff defaulted on his loan, and the property has been foreclosed on by the
Bank and is currently held as REO. In the opinion of management the ultimate
disposition of such litigation should not have a material effect on the
consolidated financial position or operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
- - -------------------------------------------------------------
None.
37
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
- - -------------------------------------------------------------------------------
West Essex Bancorp, Inc. common stock is traded on the Nasdaq National
Market under the symbol "WEBK." The stock began trading on October 2, 1998.
The high and low sales price for the quarter ended December 31, 1998 were $9.25
and $10.125, respectively.
As of December 31, 1998, the Company had approximately 614 stockholders of
record.
Item 6. Selected Financial Data.
- - ---------------------------------
Information regarding selected financial data appears on pages 3 and 4 of
the 1998 Annual Report under the caption "Selected Consolidated Financial and
Other Data" and is incorporated herein by this reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- - --------------------------------------------------------------------------------
of Operations.
- - --------------
Information regarding management's discussion and analysis of financial
condition and results of operations appears on pages 5 through 20 of the 1998
Annual Report under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and is incorporated herein by
this reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
- - ---------------------------------------------------------------------
Information regarding qualitative and quantitative disclosures about market
risk are contained in the section captioned "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Management of Interest
Rate Risk and Market Risk Analysis" in the 1998 Annual Report and is
incorporated herein by this reference.
Item 8. Financial Statements and Supplementary Data.
- - -----------------------------------------------------
Information regarding the financial statements and the Independent
Auditors' Report appears on pages 21 through 58 of the 1998 Annual Report and is
incorporated herein by this reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- - ------------------------------------------------------------------------
Financial Disclosure.
- - ---------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- - -------------------------------------------------------------
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 21, 1999,
at pages 4 and 5.
38
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 21, 1999,
at pages 6 through 13 (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 21, 1999,
at pages 3 and 5.
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 21, 1999, at pages 13 through 14.
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 1998 Annual Report to
Stockholders.
PAGE
----
Report of Independent Accountants.................................... 21
Consolidated Statements of Financial Condition for the Years Ended
December 31, 1998 and 1997......................................... 22
Consolidated Statements of Income for the
Years Ended December 31, 1998, 1997 and 1996....................... 23
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1998, 1997 and 1996................................... 24
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996............... 25
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1998, 1997 and 1996....................... 26
Notes to Consolidated Financial Statements for the
Years Ended December 31, 1998, 1997 and 1996..................... 28
39
The remaining information appearing in the 1998 Annual Report to Stockholders
is not deemed to be filed as part of this report, except as expressly provided
herein.
(2) All schedules are omitted because they are not required or applicable, or
the required information is shown in the consolidated financial statements
or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Federal MHC Subsidiary Holding Company Charter of West Essex Bancorp, Inc.*
3.2 Bylaws of West Essex Bancorp, Inc.*
4.0 Draft Stock Certificate of West Essex Bancorp, Inc.*
10.1 West Essex Bank Employee Stock Ownership Plan
10.2 West Essex Bank Employee Stock Ownership Plan Trust
10.3 ESOP Loan Commitment Letter
10.4 West Essex Bank Employee Stock Ownership Trust Loan and Security Agreement
10.5 Employment Agreement between West Essex Bank and Leopold W. Montanaro
10.6 Employment Agreement between West Essex Bancorp, Inc. and Leopold W.
Montanaro
10.7 Three Year Change in Control Agreement between West Essex Bank and
Dennis A. Petrello
10.8 Three Year Change in Control Agrrement between West Essex Bank and
Charles E. Filippo
10.9 Three Year Change in Control Agreement bewteen West Essex Bank and Craig
L. Montanaro
10.10 Three Year Change in Control Agreement between West Essex Bancorp,
Inc. and Dennis A. Petrello
10.11 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and
Charles E. Filippo
10.12 Three Year Change in Control Agreement between West Essex Bancorp, Inc.
and Craig L. Montanaro
10.13 West Essex Bank Employee Severance Compensation Plan
10.14 West Essex Bank Supplemental Executive Retirement Plan
10.15 West Essex Bank Management Supplemental Executive Retirement Plan
10.16 Restated Executive Supplemental Retirement Income Agreement for Leopold
W. Montanaro*
10.17 Restated Executive Supplemental Retirement Income Agreement for Charles
E. Filippo*
11.0 Computation of Earnings Per Share
13.0 Portions of the 1998 Annual Report to Shareholders
21.0 Subsidiary information is incorporated herein by reference to "Part I-
Business-Subsidiary Activities"
23.0 Consent of Radics & Co., LLC
27.0 Financial Data Schedule
(b) Reports on Form 8-K
None.
__________________________________
* Incorporated herein by reference into this document from the Exhibits
to Form S-1, Registration Statement, filed on June 12, 1998, as
amended, Registration No. 333-56729.
40
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.
WEST ESSEX BANCORP, INC.
By: /s/ Leopold W. Montanaro
---------------------------------------
Leopold W. Montanaro
President, Chief Executive Officer and
Director
Date: March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Name Title Date
- - ---- ----- ----
/s/ Leopold W. Montanaro President, Chief Executive March 30, 1999
- - ------------------------ Officer and Director
Leopold W. Montanaro (principal executive officer)
/s/ Dennis A. Petrello Executive Vice President March 30, 1999
- - ------------------------ and Chief Financial Officer
Dennis A. Petrello (principal accounting and
financial officer)
/s/ William J. Foody Chairman of the Board March 30, 1999
- - -------------------------
William J. Foody
/s/ David F. Brandley Director March 30, 1999
- - -------------------------
David F. Brandley
/s/ Everett N. Leonard Director March 30, 1999
- - -------------------------
Everett N. Leonard
/s/ James P. Vreeland Director March 30, 1999
- - -------------------------
James P. Vreeland
/s/ John J. Burke Director March 30, 1999
- - -------------------------
John J. Burke
41