EXHIBIT 99.2
FIRST STATE FINANCIAL SERVICES, INC.
INDEPENDENT AUDITORS' REPORT
The Board of Directors
First State Financial Services, Inc.
We have audited the accompanying consolidated balance sheets of First State
Financial Services, Inc. and subsidiaries as of September 30, 1996 and 1995, the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended September
30, 1996. These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First State
Financial Services, Inc. and subsidiaries at September 30, 1996 and 1995 and the
results of their operations, and their cash flows for each of the years in the
three-year period ended September 30, 1996, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Short Hills, New Jersey
November 26, 1996
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Balance Sheets
September 30,
-----------------------
1996 1995
---------- ----------
(in thousands)
ASSETS
Cash on hand and in banks $ 12,395 $ 11,792
Investment securities available for sale (note 3) 9,466 11,799
Investment securities, market value of $24,355 and
$20,657 at September 30, 1996 and 1995 (note 3) 24,643 20,889
Stock in FHLB of New York, at cost 3,404 3,715
Loans receivable, net (note 4) 480,931 461,648
Mortgage loans held for resale, market value of
$9,106 and $67,642 at September 30, 1996 and 1995 9,106 67,219
Mortgage-backed securities, market value of $30,560
and $19,002 at September 30, 1996 and 1995
(notes 3 and 6) 31,024 18,961
Accrued interest receivable (note 8) 3,942 4,046
Office properties and equipment, net (note 7) 10,171 10,523
Real estate owned 4,045 8,564
Cost in excess of fair value of net assets acquired 2,149 2,349
Cash surrender value of life insurance (note 11) 11,978 11,582
Other assets 7,163 3,933
---------- ----------
$ 610,417 $ 637,020
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 5) $ 554,320 $ 567,710
Borrowed money (note 6) 5,928 23,105
Advance payments by borrowers for taxes and
insurance 2,614 3,253
Accrued expenses and other liabilities 12,319 1,360
---------- ----------
Total liabilities 575,181 595,428
---------- ----------
Stockholders' Equity (note 14 and note 16):
Preferred stock, $.01 par value, 2 million
shares authorized; none issued - -
Common stock, $.01 par value, 8 million
shares authorized;3,938,815 issued,
3,929,455 outstanding in 1996 and 3,883,765
issued, 3,874,405 outstanding in 1995 39 39
Additional paid-in capital 21,242 20,949
Net unrealized loss on securities
available for sale (228) (89)
Retained income, substantially restricted
(notes 10 and 16) 14,183 20,693
---------- ----------
Total stockholders' equity 35,236 41,592
Commitments and Contingencies (note 12) ---------- ----------
$ 610,417 $ 637,020
========== ==========
See accompanying notes to the consolidated
financial statements
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Operations
(In thousands, except per share amounts)
Year Ended September 30,
-------------------------------
1996 1995 1994
-------- -------- --------
Interest income:
Interest on mortgage loans (note 4) 31,948 32,738 25,217
Interest on consumer and commercial loans 12,914 8,138 5,885
Interest on mortgage-backed securities 1,943 1,238 1,587
Interest on investments available for sale 839 525 1,104
Interest on investment securities 1,595 1,710 1,142
-------- -------- --------
Total interest income 49,239 44,349 34,935
-------- -------- --------
Interest expense:
Interest on deposits (note 5) 22,965 20,654 13,087
Interest on borrowed money 1,089 1,111 361
-------- -------- --------
Total interest expense 24,054 21,765 13,448
-------- -------- --------
Net interest income 25,185 22,584 21,487
Provision for loan losses (note 4) 8,900 1,650 1,892
-------- -------- --------
Net interest income after
provision for loan losses 16,285 20,934 19,595
-------- -------- --------
Other income:
Loan fees and other loan charges 13,591 3,725 1,589
Service charges on deposit accounts 1,874 1,784 1,586
Net gain on sales of loans 1,070 88 474
Net gain (loss) on sales of investments 69 (125) 82
Other 876 896 419
-------- -------- --------
Total other income 17,480 6,368 4,150
-------- -------- --------
Operating expenses:
Compensation and employee benefits (note 11) 8,457 7,362 7,648
Premises and occupancy expense, net 2,324 2,007 2,046
Amortization of cost of intangible assets 200 427 536
Loan expenses 17,270 4,491 1,254
Data processing 1,250 1,100 1,036
Advertising and promotion 642 812 724
Federal insurance premiums 1,261 1,234 1,097
SAIF special assessment (note 16) 3,096 - -
Problem asset expenses, inclusive of
real estate owned writedowns 3,671 1,615 1,456
Other expenses (note 9) 2,851 3,124 3,084
-------- -------- --------
Total operating expenses 41,022 22,172 18,881
-------- -------- --------
Income (loss) before income tax
expense (benefit) (7,257) 5,130 4,864
Income tax expense (benefit) (note 10) (1,608) 1,132 1,363
-------- -------- --------
Net income (loss) $(5,649) $ 3,998 $ 3,501
======== ======== ========
Net income (loss) per share $ (1.40) $ 1.01 $ 0.91
======== ======== ========
See accompanying notes to consolidated financial statements.
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)
Common Stock
Net Unrealized Acquired by
Retained Loss on Employees
Additional Income Securities Stock
Common Paid-In Substantially Available Ownership
Stock Capital Restricted for Sale Plan Total
------- --------- --------- -------- -------- ---------
Balance at September 30, 1993 $ 38 $ 20,869 $ 14,431 $ - $(1,159) $ 34,179
Distributions of Employee Stock
Ownership Plan Stock - 210,798 shares 1,159 1,159
Cash dividends declared and paid (476) (476)
Change in net unrealized loss on securities
classified as available for sale (278) (278)
Net income for the year 3,501 3,501
Stock cancellation upon Ocean
merger - 18,302 shares (109) (109)
Adjustment for the pooling of a company
with a different year end (3) (3)
------- --------- --------- -------- -------- ---------
Balance at September 30, 1994 $ 38 $ 20,760 $ 17,453 $ (278) $ - $ 37,973
Cash dividends declared and paid (758) (758)
Issuance of common stock under stock
option plans (note 14) - 46,142 shares 1 189 190
Change in net unrealized loss on securities
classified as available for sale 189 189
Net income for the year 3,998 3,998
------- --------- --------- -------- -------- ---------
Balance at September 30, 1995 $ 39 $ 20,949 $ 20,693 $ (89) $ - $ 41,592
Cash dividends declared and paid (861) (861)
Issuance of common stock under stock
option plans (note 14) - 55,050 shares - 293 293
Change in net unrealized loss on securities
classified as available for sale (139) (139)
Net loss for the year (5,649) (5,649)
------- --------- --------- -------- -------- ---------
Balance at September 30, 1996 $ 39 $ 21,242 $ 14,183 $ (228) $ - $ 35,236
======= ========= ========= ======== ======== =========
See accompanying notes to the consolidated financial statements
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Cash Flows
(In thousands, except per share amounts)
Year ended September 30,
-------------------------------
1996 1995 1994
---------- --------- ---------
OPERATING ACTIVITIES
Net (loss) income $ (5,649) $ 3,998 $ 3,501
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of intangible assets 200 428 534
Depreciation 1,263 962 1,087
Net accretion of loan fees and discounts (255) (376) (382)
Net amortization and (accretion) of investment
premium and discount 67 (96) (733)
Net amortization and (accretion) of MBS
premium and discount 34 58 (102)
Decrease (increase) in interest receivable 104 (935) (598)
Proceeds from sales of loans held for resale 81,856 7,012 26,864
Proceeds from sales of credit cards receivable 59,635 - -
Origination of loans held for resale (21,414) (10,278) (7,962)
Net gain on sale of real estate owned (261) (19) -
Net gain on sale of loans (1,070) (88) (474)
Net (gain) loss on sale of investments (69) 125 (82)
Provision for losses on loans 8,900 1,650 1,892
Provision for writedowns of real estate owned 3,000 900 700
Increase in cash surrender value of life insurance (396) (572) (11,010)
(Increase) decrease in other assets (3,230) 734 (192)
Increase (decrease) in other liabilities 10,959 (260) 908
---------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 133,674 3,243 13,951
---------- --------- ---------
INVESTING ACTIVITIES
Net increase in loans receivable (90,760) (82,753) (91,881)
Mortgage loans purchased - (292) -
Purchase of mortgage-backed securities (15,174) (5,809) (5,048)
Purchase of mortgage-backed securities
available for sale (1,241) - -
Proceeds from sales of mortgage-backed securities - 1,630 5,207
Proceeds from sales of mortgage-backed securities
available for sale 1,224 - -
Principal payments on mortgage-backed securities 3,094 4,065 7,029
Proceeds from dispositions of real estate owned 3,718 3,231 6,935
Office properties and equipment expenditures (911) (1,167) (669)
Purchase of investment securities (14,132) (8,297) (14,901)
Purchase of investment securities available
for sale (30,588) (12,934) (1,427)
Proceeds from sale of investment securities
available for sale 39,746 16,538 4,704
Redemption (purchase) of Federal Home Loan Bank Stock 311 (710) 414
Proceeds from maturities of investment securities 3,416 9,419 -
---------- --------- ---------
NET CASH USED BY INVESTING ACTIVITIES (101,297) (77,079) (89,637)
---------- --------- ---------
FINANCING ACTIVITIES
Net (decrease) increase in deposits (13,390) 88,346 47,352
Dividends paid on common stock (861) (758) (476)
Principal repayments of borrowings (17,177) (13,633) (1,176)
Additional borrowings - 5,000 27,234
Net (decrease) increase in advance payments by
borrowers for taxes and insurance (639) 465 160
Common stock issued 293 190 -
Adjustment for the pooling of a company with a
different year-end - - (173)
---------- --------- ---------
NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (31,774) 79,610 72,921
---------- --------- ---------
Increase (decrease) in cash and cash equivalents 603 5,774 (2,765)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 11,792 6,018 8,783
---------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 12,395 $ 11,792 $ 6,018
========== ========= =========
CASH PAID DURING THE YEAR FOR:
Interest $ 24,165 $ 21,467 $ 13,346
Income taxes $ 375 $ 2,213 $ 1,235
NON-CASH TRANSFERS:
Loans classified as Real Estate Owned $ 1,938 $ 2,672 $ 2,319
Transfer of investment securities held to maturity
to investment securities available for sale $ 8,454 $ 2,300 -
Transfer of investment securities available for
sale to investment securities held to maturity $ 1,559 - -
Transfer of mortgage-backed securities held to maturity
to mortgage-backed securities available for sale $ 627 - -
Transfer of mortgage-backed securities available for
sale to mortgage-backed securities held to
maturity $ 644 - -
Reclassification of Loans rec. to mortgage
loans held for resale - $ 60,770 -
Cancellation of common shares in conjunction
with Ocean merger - - $ 109
Release of ESOP stock - - $ 1,159
See accompanying notes to consolidated financial statements.
FIRST STATE FINANCIAL SERVICES, INC.
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The following is a description of the more significant accounting policies used
in preparation of the accompanying consolidated financial statements.
Principles of Consolidation
The consolidated financial statements are comprised of the accounts of First
State Financial Services, Inc. (First State and/or the Corporation), its wholly
owned subsidiaries, First DeWitt Bank, (First DeWitt or the Bank), and First
State Investment Services, Inc. (FSIS); and First DeWitt's wholly owned
subsidiaries, Cedar Grove Service Corporation (CGSC), Ridge (Caldwell)
Associates (Ridge) and Southport (Wall) Associates (Southport). All intercompany
accounts and transactions have been eliminated in consolidation.
Business
First State conducts its principal business activity through First DeWitt Bank
First DeWitt provides a full range of banking services to individual and
corporate customers through branch offices in New Jersey. First DeWitt is
subject to competition from other financial institutions and is subject to the
regulations of certain federal agencies and undergoes periodic examinations by
those regulatory authorities.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP"). In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the balance
sheet date. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in
the next accounting cycle relate to the determination of the allowance for loan
losses and the current valuation of real estate acquired in connection with
foreclosures or in satisfaction of loans. In connection with the determination
of these allowances and the valuation of real estate owned, management obtains
independent appraisals for significant properties.
Cash and Cash Equivalents
The caption of cash and cash equivalents used in the statements of cash flows
includes the balance sheet caption cash on hand and in banks.
Investments, Investments Available for Sale and Mortgage-backed Securities
Investment securities and mortgage-backed securities are carried at amortized
cost. Investment securities available for sale are carried at market value. They
are adjusted for unamortized premiums and unearned discounts which are
recognized as interest income over the terms of the securities for investments
and the estimated remaining lives based on anticipated prepayments for
mortgage-backed securities using a method which approximates the level-yield
interest method. Investment and mortgage-backed securities are carried at cost
because First State intends and has the ability to hold them to maturity. Gains
or losses on the sale of securities are determined using the specific
identification method and are recognized upon realization.
Under Statement of Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115), debt securities to be
held for indefinite periods of time and not intended to be held to maturity, as
well as marketable equity securities, are classified as available for sale.
Investment securities available for sale are carried at fair value and
unrealized gains and losses, net of related tax effect, on such securities are
excluded from earnings but are included in stockholders' equity.
First DeWitt, as a member of the FHLB of N.Y., is required to hold shares of
capital stock in the FHLB of N.Y. in an amount equal to 1% of the outstanding
balance of residential mortgage loans and similar obligations or 5% of its
outstanding advances from the FHLB of N.Y., whichever is greater. First DeWitt
complied with this requirement as of September 30, 1996.
Loans
Loans are stated at their principal amounts outstanding net of unearned income.
Interest is accrued monthly as earned, except when a loan becomes 90 days or
more past due or collection becomes uncertain, in which case the accrual of
income is discontinued. Any accrued but unpaid interest on such loans is
reversed against current earnings. These loans are classified as nonaccrual and
interest income is only recognized subsequently in the period collected. Loans
are returned to an accrual status when all past due amounts have been collected
and factors indicating doubtful collectability on a timely basis no longer
exists.
Discounts on loans purchased are accreted to income over the expected lives of
such loans using a method that approximates the level-yield interest method of
accounting.
Loan origination fees and certain direct loan origination costs are deferred and
amortized into income using a method which approximates the level-yield interest
method over the estimated lives of the related loans as an adjustment to the
related loan yields.
Mortgage Loans Held for Resale
First DeWitt from time to time sells its fixed rate conforming loan originations
and retains all other types of loan originations for its loan portfolio.
Mortgage loans intended for sale are carried at the lower of cost or market
using the aggregate method. Valuation adjustments, if applicable, are reflected
in current operations. Gains and losses on sales are recorded using the specific
identification method.
Allowance for Loan Losses
Provisions for losses on loans are charged to operations based upon periodic
review and management's assessment of the risk inherent in the loan portfolio in
relation to the level of the allowance for loan losses, loan loss experience,
changes in the nature and volume of the loan portfolio, estimated value of the
collateral underlying the loan agreements, economic conditions and other matters
which warrant consideration.
Management believes that the allowance for losses on loans is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions in their market area. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the allowance
for losses on loans. Such agencies may require the Corporation to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination.
On October 1, 1995, First State adopted Statement of Accounting Standards No.
114, "Accounting by Creditors for the Impairment of a Loan", as amended by SFAS
118, "Accounting by Creditors for the Impairment of a Loan-Income Recognition
and Disclosures. As defined by these statements, a loan is considered impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. As a result, certain impaired loans are reported at the
present value of expected future cash flows discounted at the loan's effective
interest rate or the fair value of the collateral if the loan is collateral
dependent. The adoption of these statements did not impact the Corporation's
operating results or total allowances for loan losses.
Office Properties and Equipment
Office properties and equipment are stated at cost less accumulated
depreciation. Depreciation of office properties and equipment is accumulated on
a straight-line basis over their estimated useful lives of three to forty years.
Real Estate Owned
Real estate acquired through foreclosure or by deed in lieu of foreclosure, is
recorded at the lower of cost or fair value less estimated costs to sell. An
allowance for REO losses is maintained for subsequent declines in fair value.
Gains and losses from sales are recognized as incurred. Carrying costs are
generally expensed as incurred.
Cost in Excess of Fair Value of Net Assets Acquired
Costs in excess of fair value of net assets acquired in business combinations
are being amortized on a straight-line basis over periods of either 10 or 25
years. The remaining balance at September 30, 1996, is being amortized over 25
years.
Income Taxes
The Corporation and the Bank file a consolidated Federal income tax return.
State income tax returns are filed on a separate basis.
Loan Servicing
The Bank services real estate loans for investors which are not included in the
accompanying consolidated balance sheets. Fees earned for servicing loans are
reported as income when the related mortgage loan payments are collected. Loan
servicing costs are charged to expense as incurred.
Originated Mortgage Servicing Rights
Effective October 1, 1995, First State adopted Statement of Accounting Standards
No. 122, "Accounting for Mortgage Servicing Rights" (SFAS 122). SFAS 122
requires that a mortgage banking enterprise recognize as separate assets the
rights to service mortgage loans for others that have been acquired through
either the purchase or origination of a loan. A mortgage banking enterprise that
sells or securitizes those loans with servicing rights retained should allocate
the total cost of the mortgage loans to the mortgage servicing rights and the
loans based on their relative fair values.
The fair value of capitalized originated mortgage servicing rights is determined
based on the estimated discounted net cash flows to be received. Originated
mortgage servicing rights are amortized in proportion to and over the period of
estimated net loan servicing income. These capitalized mortgage servicing rights
are periodically reviewed for impairment based on the fair value of those
rights. First State capitalized $535,000 of originated mortgage servicing rights
during the year ended September 30, 1996.
Net Income Per Share
Net income per share is computed by dividing net income by the average number of
common shares outstanding during the period. Shares exercisable under stock
option plans have been included in the calculation of primary earnings per share
using the treasury stock method for periods in which this calculation was
dilutive.
Financial Statement Presentation
Certain amounts in the 1995 and 1994 consolidated financial statements have been
reclassified to comply with the 1996 presentation.
(2) Merger Agreement and Business Combinations
On June 24, 1996, the Corporation signed a definitive merger agreement providing
for the acquisition of all of the outstanding stock of First State Financial
Services, Inc. by Sovereign Bancorp, Inc. (Sovereign). This merger agreement was
amended by an agreement (the "amendment") signed by both parties on November 26,
1996. The amendment calls for First State shareholders to receive between 1.225
and 1.84 shares of Sovereign's common stock under a floating exchange ratio for
each share of First State common stock if Sovereign's average closing price as
defined in the amendment (the "Sovereign Market Value") is greater than or equal
to $8.00 but less than or equal to $12.04. Within this range, the exchange ratio
will be $14.75 divided by the Sovereign Market Value. If the Sovereign Market
Value is greater than $12.04, the exchange ratio will be 1.225. If the Sovereign
Market Value falls below $8.00, the agreement may be terminated by First State
unless certain conditions are met. In a related agreement, Sovereign was given
an option to purchase up to 783,000 shares of First State's issued and
outstanding common stock if certain conditions occur. The merger is subject to
certain conditions, including approval by First State's shareholders and various
regulatory authorities and is expected to be completed by the first calendar
quarter of 1997.
On October 21, 1994, the Corporation issued approximately 678,000 shares of its
common stock for all the outstanding stock of Ocean Independent Bank, a New
Jersey chartered bank located in Ocean, New Jersey (Ocean). This business
combination was accounted for as a pooling-of-interests combination and,
accordingly, the Corporation's historical consolidated financial statements have
been restated to include the accounts and results of operations of Ocean for all
years presented. The results of operation of the Corporation and Ocean for the
year ended September 30, 1994 prior to restatement is as follows:
Year ended
September 30,
1994
-------------
(in thousands)
The Corporation:
Net Interest Income $ 19,058
Net Income 3,189
Ocean:
Net Interest Income 2,429
Net Income 312
Combined:
Net Interest Income 21,487
Net Income 3,501
Prior to the combination, Ocean's fiscal year ended December 31. In recording
the pooling-of-interests combination, Ocean's unaudited financial statements for
the twelve months ended September 30, 1994 were combined with the Corporation's
financial statements for the same period. In addition, Ocean's financial
statements for the years ended December 31, 1993 and 1992 were combined with the
Corporation's financial statements for the years ended September 30, 1993 and
1992. Ocean's unaudited results of operation for the three months ended December
31, 1993, included net interest income of $649,000 and net income of $3,000. An
adjustment has been made to stockholders' equity to eliminate the effect of
including Ocean's results of operations for the three months ended December 31,
1994 in both the year ended September 30, 1994 and the year ended September 30,
1993.
(3) Investment Securities Available for Sale, Investments and
Mortgage-Backed Securities
The amortized costs, gross unrealized gains and losses and estimated market
values of investment debt securities are as follows:
September 30, 1996
--------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ------------ ---------- -----------
(Dollars in thousands)
Held to Maturity Portfolio:
Investment Securities
US Treasury Securities $ 847 $ 6 $ - $ 853
US Government & Agency Obligations 9,310 8 (146) 9,172
Municipal Obligations 14,486 86 (242) 14,330
-------- ---------- ---------- --------
24,643 100 (388) 24,355
-------- ---------- ---------- --------
Mortgage-Backed Securities
GNMA 6,839 31 (163) 6,707
FNMA 7,102 61 (106) 7,057
FHLMC 14,997 63 (314) 14,746
FHA 2,086 - (36) 2,050
-------- ---------- ---------- --------
31,024 155 (619) 30,560
-------- ---------- ---------- --------
$ 55,667 $ 255 $ (1,007) $ 54,915
======== ========== ========== ========
Available for Sale Portfolio:
Investment Securities
US Treasury Securities $ 750 $ - $ (7) $ 743
Municipal Obligations 7,720 - (248) 7,472
Other Investments 3 11 - 14
-------- ---------- ---------- --------
8,473 11 (255) 8,229
-------- ---------- ---------- --------
Mutual Funds
US Government Securities 250 - - 231
Adjustable Rate Mortgages 582 - - 579
Commercial Paper 427 - - 427
-------- ---------- ---------- --------
1,259 - (22) 1,237
-------- ---------- ---------- --------
$ 9,732 $ 11 $ (277) $ 9,466
======== ========== ========== ========
September 30, 1995
--------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ------------ ------------ -----------
(Dollars in thousands)
Held to Maturity Portfolio:
Investment Securities
US Treasury Securities $ 1,256 $ 12 $ - $ 1,268
US Government & Agency Obligations 9,647 10 (171) 9,486
Municipal Obligations 9,986 75 (158) 9,903
---------- ------------ ------------ ---------
20,889 97 (329) 20,657
---------- ------------ ------------ ---------
Mortgage-Backed Securities
GNMA 3,873 39 (6) 3,906
FNMA 6,396 120 (79) 6,437
FHLMC 8,692 88 (121) 8,659
---------- ------------ ------------ ---------
18,961 247 (206) 19,002
---------- ------------ ------------ ---------
$ 39,850 $ 344 $ (535) $ 39,659
========== ============ ============ =========
Available for Sale Portfolio:
Investment Securities
US Treasury Securities $ 1,007 $ - $ (6) $ 1,001
Municipal Obligations 2,728 6 (17) 2,717
Other Investments 28 6 - 34
---------- ------------ ------------ ---------
3,763 12 (23) 3,752
---------- ------------ ------------ ---------
Mutual Funds
US Government Securities 236 - (15) 221
Adjustable Rate Mortgages 7,475 - (68) 7,407
Commercial Paper 419 - - 419
---------- ------------ ------------ ---------
8,130 - (83) 8,047
---------- ------------ ------------ ---------
$ 11,893 $ 12 $ (106) $ 11,799
========== ============ ============ =========
The amortized cost and estimated market value of investment debt securities at
September 30,1996, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties. The contractual maturities
of mortgage-backed securities generally exceeds twenty years; however, the
effective lives are expected to be less due to anticipated prepayments.
Estimated
Amortized Market Average
Cost Value Yield(a)
--------- --------- ---------
(Dollars in thousands)
Held to Maturity Portfolio:
Investment Securities
Due in one year or less $ 2,055 $ 2,057 6.11%
Due after one year through five years 7,597 7,562 6.01
Due after five years through ten years 3,030 2,948 6.72
Due after ten years 11,961 11,788 7.81
--------- --------- ------
24,643 24,355 6.98
Mortgage-Backed Securities 31,024 30,560 6.78
--------- --------- ------
$ 55,667 $ 54,915 6.85%
========= ========= ======
Available for Sale Portfolio:
Investment Securities
Due in one year or less $ - $ - -%
Due after one year through five years 750 743 5.03
Due after five years through ten years 419 408 6.76
Due after ten years 7,304 7,078 7.47
--------- --------- ------
8,473 8,229 7.22
Mutual Funds
Due in one year or less 1,259 1,237 5.74
--------- --------- ------
$ 9,732 $ 9,466 7.03%
========= ========= ======
(a) Tax equivalent yields
The carrying value of investment securities pledged as required for public funds
and deposits amounted to $2.6 million at September 30,1996. In addition, certain
investment and mortgage-backed securities are pledged as collateral under
various borrowing agreements. See note 6.
Pursuant to the provisions and implementation guidance contained within the
Financial Accounting Standards Board's special report "A Guide to Implementation
of Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities", on November 15, 1995, the Corporation reassessed the classification
of all securities within its portfolio and transferred $9.1 million from its
held-to-maturity investment portfolio to its available- for-sale portfolio.
These securities had a market value of $9.2 million which resulted in the
Corporation recording an unrealized gain on securities available-for-sale, net
of tax, within stockholders' equity of $87,000. Gross gains (losses) realized on
sales of investment securities and mortgage-backed securities for the years
ended September 30, 1996, 1995, and 1994 were as follows:
1996 1995 1994
-------- ------- -------
(in thousands)
Gross gains $ 177 $ 32 $ 137
Gross losses (108) (157) (55)
-------- ------- -------
Net gain (loss) on sales of investments $ 69 $ (125) $ 82
======== ======= =======
Cash proceeds from sales transactions approximated $41.0 million, $18.2 million
and $9.9 million for the years ended September 30, 1996, 1995, and 1994,
respectively.
(4) Loans Receivable, Net
Loans receivable, net consists of the following:
September 30,
--------------------------
1996 1995
----------- -----------
(in thousands)
First Mortgage loans:
Conventional $ 380,530 $ 351,416
Partially guaranteed by VA or insured by FHA 1,889 2,377
Participation in conventional loans 13,539 10,093
Loans for land and construction 17,624 23,031
----------- -----------
413,582 386,917
----------- -----------
Commercial loans 38,289 35,470
Property improvement loans 26,503 28,847
Credit card receivable 17,079 19,729
Guaranteed student loans 306 658
Loans secured by deposits 1,263 1,122
Other loans 2,528 3,022
----------- -----------
85,968 88,848
----------- -----------
Less:
Allowance for loan losses 12,284 6,082
Deferred loan fees 847 350
Net unearned discounts 10 22
Loans in process 5,478 7,663
----------- -----------
18,619 14,117
----------- -----------
$ 480,931 $ 461,648
=========== ===========
First DeWitt has granted loans to officers, directors, and to associates.
Related party loans are made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with unrelated persons and do not involve more than the normal risk
of collectibilty. The aggregate dollar amount of these loans was $10.6 million
and $4.3 million at September 30,1996 and 1995, respectively.
The following table presents information concerning loans accounted for on a
nonaccrual basis and loans whose terms have been restructured to provide a
reduction of interest rate charged to the borrower:
September 30,
----------------------------------------
1996 1995
----------------- -----------------
No. Amount No. Amount
(in thousands)
Nonaccrual loans 113 $ 19,859 159 $ 18,503
Current restructured loans 1 1,416 3 3,476
----- ---------- ----- ----------
Total 114 $ 21,275 162 $ 21,979
===== ========== ===== ==========
There were approximately $2.4 million and $1.1 million in loans that were 90
days or more past due in principal repayments while maintaining current interest
payments at September 30, 1996 and 1995, respectively. If the total nonaccrual
loans had been current and performing in accordance with their original terms,
total interest income would have been increased by approximately $1.7 million,
$1.5 million, and $899,000 for the years ended September 30, 1996, 1995 and
1994, respectively.
At September 30,1996, the impaired loan portfolio was primarily collateral
dependent as defined under SFAS 114 and totaled $14.6 million for which general
and specific allocations to the allowance for loan losses of $6.4 million were
identified. The average balance of impaired loans during 1996 was approximately
$12.1 million. The amount of cash basis interest income that was recognized on
impaired loans during 1996 was $407,000.
The following is an analysis of the allowance for loan losses:
Year ended September 30,
-------------------------------
1996 1995 1994
---------- --------- ---------
(in thousands)
Balance, beginning of period $ 6,082 $ 6,351 $ 8,111
Adjustment for the pooling of a company
with a different year-end - - 170
Provisions charged to operations 8,900 1,650 1,722
Recoveries 141 72 409
Losses charged against the allowance (2,839) (1,991) (4,061)
---------- --------- ---------
Balance, end of period $ 12,284 $ 6,082 $ 6,351
========== ========= =========
First DeWitt services real estate loans for investors which are not included in
the accompanying consolidated balance sheets. The total of such loans serviced
amounted to approximately $166.8 million, $113.4 million, and $115.2 million at
September 30, 1996, 1995, and 1994, respectively. Servicing income generated
from these loans amounted to $562,000, $390,000, and $351,000 for the years
ended September 30, 1996, 1995 and 1994, respectively.
As discussed in note (1), the Corporation prospectively adopted SFAS 122 on
October 1, 1995. The Corporation capitalized originated mortgage servicing
rights of $535,000 during the year ended September 30, 1996. Amortization of
originated mortgage servicing rights for the year ended September 30, 1996 was
$63,000.
(5) Deposits
Savings deposits are comprised of the following:
September 30,
----------------------------------------------------------------
1996 1995
----------------------------- -------------------------------
Rate Amount % Rate Amount %
---------- --------- ------- ---------- --------- ---------
(dollars in thousands)
Balance by type of account
and interest rate:
Commercial Checking -% $ 23,651 4.27% -% $ 19,563 3.45 %
Personal Checking 2.47 58,776 10.60 2.47 50,075 8.82
Money Market Checking 2.52 19,070 3.44 2.52 21,268 3.75
Money Market Passbook 2.52-4.89 32,426 5.85 2.52-3.93 31,898 5.62
Savings 2.13 97,361 17.56 2.37 108,240 19.06
Club 2.13 2,225 0.40 2.37 2,064 0.36
--------- ------- --------- -------
233,509 42.12 233,108 41.06
--------- ------- --------- -------
Certificates:
Regular 3.40-5.84(a) 279,350 50.40 3.20-5.51 266,754 46.99
Negotiable 4.35-7.68(a) 41,033 7.40 5.50-7.68 67,464 11.88
--------- ------- --------- -------
320,383 57.80 334,218 58.87
--------- ------- --------- -------
Accrued interest payable 428 0.08 384 0.07
--------- ------- --------- -------
$ 554,320 100.00% $ 567,710 100.00%
========= ======= ========= =======
(a) At September 30,1996, the weighted average interest rates
for regular and negotiable certificates were 5.32% and
5.87%, respectively.
1996 1995
------------------ ------------------
Amount % Amount %
---------- ------- ---------- -------
(dollars in thousands)
Contractual maturity of
certificate accounts:
Within one year $ 288,982 90.20% $ 298,070 89.18%
One to two years 14,089 4.40 18,553 5.56
Two to three years 4,702 1.47 5,627 1.68
Three to Five Years 6,111 1.91 4,853 1.45
Over Five Years 6,499 2.02 7,115 2.13
---------- ------- ---------- -------
$ 320,383 100.00% $ 334,218 100.00%
========== ======= ========== =======
Interest expense on deposits is comprised of the following:
Year Ended September 30,
-----------------------------------
1996 1995 1994
--------- --------- ---------
(Dollars in thousands)
Personal and money market
checking accounts $ 1,877 $ 1,742 $ 1,450
Savings, money market passbook
and certificate accounts. 21,088 18,912 11,637
--------- --------- ---------
$ 22,965 $ 20,654 $ 13,087
========= ========= =========
(6) Borrowed Money
Notes payable and other borrowings are as follows:
September 30,
Interest --------------------
Due Date Rate 1996 1995
-------------- -------- --------- ---------
(dollars in thousands)
FHLB of N.Y. (a)(d) Mar. 3, 2008 6.56% $ 128 $ 130
FHLB of N.Y. (b)(d) Sept. 11, 2006 8.16 200 200
FHLB of N.Y. (b)(d) May 25, 2000 6.63 3,000 3,000
FHLB of N.Y. (b)(d) Jan. 30, 1998 7.97 2,000 2,000
FHLB of N.Y. (c)(d) Demand 6.13 600 -
FHLB of N.Y. (c)(d) Demand 6.63 - 17,775
--------- ---------
$ 5,928 $ 23,105
========= =========
(a) These borrowings require periodic amortization.
(b) These borrowings do not require periodic amortization.
(c) The Corporation maintains a $63.3 million line of credit.
(d) First DeWitt maintains a blanket collateral agreement with
FHLB for the above borrowings. The amortized cost of
mortgage-backed securities, investments, and mortgage loans
pledged toward this agreement at September 30,1996 was $28.0
million, $8.1 million and $25.5 million, respectively. The
maximum borrowings outstanding cannot exceed 90% of the
amounts pledged.
(7) Office Properties and Equipment
Office properties and equipment are summarized as follows:
September 30,
----------------------
1996 1995
---------- ---------
(in thousands)
At cost:
Land $ 1,584 $ 1,563
Buildings and improvements 9,138 9,076
Furniture, equipment and automobiles 7,888 7,111
---------- ---------
18,610 17,750
Less accumulated depreciation 8,439 7,227
---------- ---------
$ 10,171 $ 10,523
========== =========
(8) Accrued Interest Receivable
A breakdown of accrued interest receivable on assets follows:
September 30,
--------------------
1996 1995
-------- --------
(in thousands)
Mortgage and other loans $ 5,140 $ 5,292
Mortgage-backed securities 212 122
Investments 579 495
-------- --------
5,931 5,909
Reserve for uncollectible interest (1,989) (1,863)
-------- --------
$ 3,942 $ 4,046
======== ========
(9) Other Expenses
Other expenses include the following:
Year ended September 30,
--------------------------------
1996 1995 1994
-------- -------- --------
(in thousands)
Telephone, postage and supplies $ 687 $ 669 $ 559
Insurance and bond premium 328 457 425
Legal expenses 314 256 215
Branch operations expense 304 276 223
Examination and audit services expense 317 315 445
Other employee expense 217 280 246
Other 684 871 971
-------- -------- --------
$ 2,851 $ 3,124 $ 3,084
======== ======== ========
(10) Income Taxes
Income tax expense (benefit) is made up of the following
components:
Year ended September 30,
---------------------------------
1996 1995 1994
--------- -------- --------
(in thousands)
Current tax expense:
Federal $ 336 $ 1,575 $ 1,550
State - 147 142
--------- -------- --------
336 1,722 1,692
--------- -------- --------
Deferred federal tax benefit (1,944) (590) (329)
--------- -------- --------
Total income tax expense (benefit) $ (1,608) $ 1,132 $ 1,363
========= ======== ========
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at September 30, 1996
and 1995 are as follows:
1996 1995
-------- --------
Deferred tax assets:
Allowance for losses on loans
and real estate owned per books $ 3,633 $ 1,850
Loan origination fees deferred
for book purposes 177 126
Accrued SAIF special assessment 1,115 -
Reserve for uncollected interest 426 476
Other, net 344 89
Net operating loss carryforwards 417 564
-------- --------
Total gross deferred tax assets 6,112 3,105
-------- --------
Less valuation allowance 1,106 281
-------- --------
5,006 2,824
-------- --------
Deferred tax liabilities:
Depreciation 867 862
Tax reserve for bad-debt 174 -
-------- --------
Total gross deferred tax liability 1,041 862
-------- --------
$ 3,965 $ 1,962
======== ========
A reconciliation of income tax expense (benefit) per consolidated financial
statements and the "expected" income tax expense (benefit) follows:
Year ended September 30,
------------------------
1996 1995
-------- --------
(in thousands)
Expected income tax expense (benefit) $(2,467) $ 1,744
Amortization of excess cost over fair
value of net assets acquired 68 145
State tax, net of Federal benefit - 33
Increase in cash surrender value of
insurance policies (135) (227)
Interest income exclusion (241) (265)
Other, net 342 104
Change in the beginning-of-the-year
balance of the valuation allowance
for deferred tax assets allocated
as income tax expense 825 (402)
Income tax expense (benefit) per -------- --------
consolidated financial statements $(1,608) $ 1,132
======== ========
The valuation allowance for deferred assets as of October 1, 1995 was $281,000.
The net change in the total valuation allowance for the year ended September 30,
1996 was an increase of $825,000. Included in deferred tax assets "Other, net"
is an asset related to the unrealized loss on securities available for sale, in
the amounts of $89,000 and $30,000 for 1996 and 1995, respectively.
The Corporation will need to generate future taxable income, in order to fully
realize the deferred tax asset. Management believes it is more likely than not
that the Corporation will realize the benefit of net deductible temporary
differences and that such net deductible temporary differences will reverse
during periods in which the Corporation generates net taxable income. The net
deferred tax asset is predicated on the Corporation generating sufficient
taxable income to utilize the deferred tax assets. There can be no assurance,
however, that the Corporation will generate any earnings or any specific level
of continuing earnings.
The Congress in August of 1996, repealed, for tax purposes, the percentage of
taxable income bad debt reserve method. Pursuant to SFAS 109, retained income at
September 30, 1996 includes approximately $10.0 million for which no provision
for income tax has been made. This amount represents an allocation of income to
bad-debt deductions for tax purposes only. Events that would result in taxation
of these reserves include failure to qualify as a bank for tax purposes,
distributions in complete or partial liquidation, and excess distributions to
shareholders. The Corporation at September 30, 1996 had an unrecognized deferred
tax liability of $3.6 million with respect to this reserve.
(11) Employee Benefit Plans
The Corporation has a noncontributory defined benefit pension plan. The plan
covers all employees provided they are at least 21 years of age and have worked
a minimum of 1000 hours in the plan year. Benefits are generally based on years
of service and the employee's compensation during the last 5 years of
employment. In 1995, the Bank froze all future benefit accruals to participants
in the pension plan. Accordingly, 1996 net periodic pension cost and the
projected benefit obligation reflect the effects of the plan curtailment.
The following table sets forth the plan's funded status:
September 30,
-------------------
1996 1995
------- -------
(in thousands)
Plan assets at fair value, primarily
investment rated bonds and
mortgages with call protection $3,126 $2,337
------- -------
Actuarial present value of benefit obligations:
Accumulated benefit obligation for service
rendered to date, including vested benefits
of $2,791 and $2,860, respectively 3,066 3,106
Additional future benefits based on estimated
salary levels - 301
------- -------
Projected benefit obligation 3,066 3,407
------- -------
Excess of projected benefit obligation over
plan assets 60 (1,070)
Unrecognized net transition asset being
recognized over 20.5 and 21.5 years, respectively (9) (9)
Unrecognized prior service cost - 843
Unrecognized net gain (398) (37)
Additional minimum balance sheet liability - (496)
------- -------
Accrued pension cost included in other
(assets) liabilities $ (347) $ (769)
======= =======
Year ended September 30,
------------------------
1996 1995 1994
------ ------ -------
(in thousands)
Net periodic pension cost included the
following components:
Service cost-benefits earned during the
period $ - $ 273 $ 265
Interest cost on projected benefit
obligation 244 226 202
Actual return on plan assets (586) (112) (43)
Net amortization and deferral 361 10 (72)
Curtailments loss 542 - -
------ ------ -------
Total net periodic pension cost $ 561 $ 397 $ 352
Annual pension contributions are made by the Bank in accordance with the
requirements of the Employee Retirement Income Security Act of 1974. The
weighted average discount rate of 7.5% in 1996, 1995 and 1994, and the rate of
increase in future compensation levels of 5.5% in 1995 and 1994 were used in
determining the actuarial present value of benefit obligations. The expected
long-term rate of return on assets was 9.0% for 1996, 1995 and 1994.
First DeWitt has established an Employee Stock Ownership Plan ("ESOP"). This
plan covers all employees included in the pension benefit plan except the
President and Chief Executive Officer. The ESOP, which is a tax-qualified
employee benefit plan, became effective upon conversion. At September 30, 1996,
the ESOP held, in trust, 171,302 shares of the Corporation's common stock.
First DeWitt has established a qualified defined contribution 401(k) Thrift Plan
(the Plan) under Section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible for participation after one year of credited service, as
defined, provided they have attained age 21. Under the Plan, employee
contributions are partially matched by the Corporation. All employee and
employer matching contributions and income thereon are fully vested at all
times. Total 401(k) expense was $111,000, $82,000 and $75,000 for the years
ended September 30, 1996, 1995 and 1994, respectively.
As of October 1, 1994, the Bank adopted deferred compensation plans for the
benefit of certain executive officers. Under the plans, the Bank agrees (i) in
return for the participants relinquishing the right to a portion of their
current compensation and (ii) as a supplemental retirement benefit, to pay
certain officers retirement benefits in a lump sum or in the form of monthly
payments of up to 240 months. The Bank will accrue on the books the present
value of the benefits, so the amounts required will be provided at normal
retirement dates and thereafter. Full retirement benefits are immediately
payable to the participant's beneficiary if death of the participant occurs
prior to retirement. The Bank incurred $666,000 and $198,000 of expense relating
to these plans during the years ended September 30, 1996 and 1995, respectively.
In conjunction with the formation of these plans, the Bank purchased life
insurance on the participants. The cash surrender value of that insurance was
approximately $12.0 million and $11.6 million at September 30, 1996 and 1995,
respectively.
(12) Commitments and Contingencies
Certain bank facilities are occupied under non-cancelable long term operating
leases which expire at various dates through 2007. Certain lease agreements
provide for renewal options and increases in rental payments based upon
increases in the consumer price index. Minimum aggregate lease payments for the
remainder of the lease terms are as follows:
September 30, (in thousands)
------------- --------------
1997 $ 253
1998 246
1999 247
2000 258
2001 163
Thereafter 465
--------------
Total lease commitments $ 1,632
==============
Net premises and occupancy expenses for 1996, 1995, and 1994 includes
approximately $239,800, $137,000 and $148,200, respectively, of rental expenses
for bank facilities.
In the ordinary course of business, to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates, the
Bank is a party to various financial instruments which are not reflected in the
consolidated financial statements. These instruments consist of commitments to
extend credit and unused lines of credit available under consumer loan credit
lines and involve elements of credit and interest rate risk in excess of the
amounts recognized in the consolidated financial statements. The Bank uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The amount of collateral obtained, if
deemed necessary upon extension of credit, is based upon management's credit
evaluation of the counterparty.
Loan commitments outstanding at September 30, 1996 and 1995 totaled $9.9
million and $17.3 million, respectively. The loan commitments outstanding at
September 30, 1996 consist of variable rate commitments approximating $6.7
million and fixed rate commitments approximating $3.2 million. The later
commitments had rates primarily from 6.63% to 8.75%. Unused line of credit
available under credit lines aggregated $28.8 million and $34.6 million at
September 30, 1996 and 1995. These off-balance sheet commitments generally have
fixed expiration dates or other termination clauses.
In addition, the Bank had commitments to sell mortgage loans outstanding at
September 30, 1996 totaling $4.8 million with interest rates ranging from 6.50%
to 8.75%. At September 30, 1995, there were similar commitments to sell mortgage
loans outstanding totaling $34.7 million.
The Bank grants residential, consumer, construction and commercial loans secured
generally by real estate to customers located primarily in New Jersey.
Accordingly, as with most financial institutions in the market area, the
ultimate collectability of a substantial portion of the loan portfolio and
recoverability of in-substance foreclosed loans and real estate acquired by
foreclosure are susceptible to changes in market conditions.
In the normal course of business, First State may be party to various
outstanding legal proceedings and claims. In the opinion of management, the
disposition of such legal proceedings and claims will not materially affect
First State's consolidated financial statements.
(13) Selected Quarterly Financial Data (unaudited)
Quarterly results from 1996 and 1995 are shown below (in thousands, except per
share amounts):
1996
----------------------------------------
First Second Third Fourth
-------- -------- -------- --------
Interest income 11,844 11,601 13,050 12,744
Net interest income 5,905 5,880 6,928 6,472
Provisions for loan losses 300 900 4,400 3,300
Income (loss) before income taxes 2,263 439 (3,503) (6,456)
Net income (loss) 1,505 308 (2,809) (4,653)
Net income (loss) per share 0.36 0.08 (0.69) (1.15)
1995
----------------------------------------
First Second Third Fourth
-------- -------- -------- --------
Interest income 10,151 10,907 11,450 11,841
Net interest income 5,569 5,669 5,724 5,622
Provisions for loan losses 200 300 600 550
Income before income taxes 1,476 1,487 1,332 835
Net income 961 988 958 1,091
Net income per share 0.25 0.25 0.24 0.27
(14) Stock Option Plans
The Corporation has various stock option plans which have been approved by the
Corporation's stockholders. The table below details their status at September
30, 1996.
STOCK OPTIONS STOCK AWARDS
------------------------------------- ---------------
Total Wht. Total
Shares Avg. Options Shares
Plan Outstanding Issued Vested Price Exercised Issued Vested Unissued
- ------------------------- ------------- -------- ------- ------- --------- ------ ------ --------
The 1987 Plan 190,700(a) 190,700 190,700 $ 5.50 44,250 N/A N/A -
The 1993 Directors Plan 50,800 50,800 12,700 $ 6.98 12,700 - - -
The 1993 Plan:
1995 Distribution 254,000 48,700 19,480 $ 7.25 - 11,700 4,680
1996 Distribution 75,600 15,120 $ 13.25 - 17,100 3,420 95,500
(a) Options that have expired under this plan total 82,550.
On October 14, 1994, Ocean Independent Bank issued shares under an existing
stock option plan that converted to 15,443 shares of First State common stock.
(15) Condensed Financial Information of Parent Company
September 30,
---------------------
1996 1995
--------- ---------
(in thousands)
Balance Sheets
Assets
Cash $ 59 $ 220
Investments securities available for sale 1,007 964
Investment securities - 410
Loans receivable 207 217
Investments in subsidiaries 33,965 39,779
Other assets - 2
--------- ---------
Total assets $ 35,238 $ 41,592
========= =========
Liabilities and Stockholders' equity
Other liabilities 2 -
Stockholders' equity 35,236 41,592
--------- ---------
Total stockholders' equity $ 35,238 $ 41,592
========= =========
Years ended September 30,
-----------------------------
1996 1995 1994
--------- -------- --------
(dollars in thousands)
Statement of Operations:
Dividends from subsidiary $ - $ 1,000 $ 1,250
Other income 76 76 31
--------- -------- --------
Total income 76 1,076 1,281
Operating expenses 109 276 274
Income (loss) before income taxes and
equity in undistributed earnings of
subsidiaries (33) 800 1,007
Income tax benefit (58) (384) -
--------- -------- --------
Income before equity in undistributed
earnings of subsidiaries 25 1,184 1,007
Equity in undistributed earnings (losses)
of subsidiaries (5,674) 2,814 2,494
--------- -------- --------
Net income (loss) $ (5,649) $ 3,998 $ 3,501
========= ======== ========
Years ended September 30,
----------------------------
1996 1995 1994
--------- -------- --------
(in thousands)
Statement of Cash Flows:
Operating activities:
Net income (loss) $ (5,649) $ 3,998 $ 3,501
Net accretion of investment discount - (29) -
Provision for losses on loans - 50 -
Decrease in other assets 2 218 100
Increase in other liabilities 2 - -
--------- -------- --------
Net cash (used) provided by operating activities (5,645) 4,237 3,601
--------- -------- --------
Investing activities:
Decrease (increase) in investment in subsidiaries 5,675 (2,845) (2,417)
Proceeds from loan repayments 10 8 20
Origination of loans receivable - (44) (154)
Purchase of investment securities available for sale (473) (454) (510)
Purchase of investment securities - (1,097) -
Proceeds from sale of investment securities available
for sale 430 - -
Proceeds from maturities of investment securities 410 716 -
--------- -------- --------
Net cash provided (used) by investing activities 6,052 (3,716) (3,061)
--------- -------- --------
Financing activities:
Dividends paid on common stock (861) (758) (476)
Common stock issued 293 190 -
--------- -------- --------
Net cash used by financing activities (568) (568) (476)
--------- -------- --------
(Decrease) increase in cash (161) (47) 64
Cash at beginning of year 220 267 203
--------- -------- --------
Cash at end of year $ 59 $ 220 $ 267
========= ======== ========
NON-CASH TRANSFERS:
Release of Employee Stock Ownership Plan stock $ - $ - $ 1,159
Cancellation of common shares in conjunction with
merger $ - $ - $ 109
(16) Stockholders' Equity and Regulatory Matters
Subject to applicable law, the Board of Directors of the Bank and of the
Corporation may each provide for the payment of dividends.
Future declaration of cash dividends by First State will depend upon
dividend payments by the Bank to the Corporation, which is its primary source of
income. Under Office of Thrift Supervision ("OTS") regulations, if the Bank
satisfies all applicable capital requirements, the Bank is permitted to pay cash
dividends during a calendar year in an amount equal to 100% of its net income to
date during that calendar year plus 50% of the amount by which its capital
exceeds its capital requirements at the beginning of the year. The Bank is
required to give 30 days' prior notice to the OTS of the intention to pay a
dividend, and the OTS may prohibit the payment of the dividend.
Earnings allocated to bad debt reserves for losses and deducted for federal
income tax purposes are not available for dividends or other distributions with
respect to the Bank's capital stock without the payment of tax at the then
current income tax rate on approximately 150% of the amount so used, assuming a
34% corporate income tax rate.
At the time of conversion from mutual to stock form, a liquidation account was
established in an amount equal to the Bank's retained income at December 31,
1986. The liquidation account was established for the benefit of eligible
account holders who continue to maintain their accounts at First DeWitt after
conversion. The liquidation account will be reduced annually to the extent that
eligible account holders have reduced their eligible deposits. Subsequent
increases will not restore an eligible account holder's interest in the
liquidation account. In the event of a complete liquidation, each eligible
account holder will be entitled to receive a distribution from the liquidation
account in a proportionate amount to the current adjusted eligible account
balances then held. The balance of the liquidation account at September 30, 1996
was $69,000 ($1.7 million at September 30, 1995).
OTS regulations require savings institutions to maintain minimum levels of
regulatory capital. Under the regulations in effect at September 30, 1996, the
Bank was required to maintain a minimum ratio of tangible capital to total
adjusted assets of 1.5%; a minimum ratio of Tier 1 (core) capital to total
adjusted assets of 3.0%; and a minimum ratio of total (core and supplementary)
capital to risk- weighted assets of 8.0%.
Under its prompt corrective action regulations, the OTS is required to take
certain supervisory actions (and may take additional discretionary actions) with
respect to an undercapitalized institution. Such actions could have a direct
material effect on the institution's financial statements. The regulations
establish a framework for the classification of savings institutions into five
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. Generally, an
institution is considered adequately capitalized if it has a Tier 1 (core)
capital ratio of at least 3.0%; a Tier 1 risk-based capital ratio of at least
4.0%; and a total risk- based capital ratio of at least 8.0%. Under the
framework, the Bank's capital levels do not allow the Bank to accept brokered
deposits without prior approval from regulators.
The foregoing capital ratios are based in part on specific quantitative measures
of assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by the OTS about capital components, risk
weightings, and other factors.
Management believes that, as of September 30, 1996, the Bank meets all capital
adequacy requirements to which it is subject. The following is a summary of the
Bank's actual capital amounts and ratios as of September 30, 1996 and 1995,
compared to the OTS minimum capital adequacy requirements and the OTS
requirements for classification as a well-capitalized institution.
To Be Well
Capitalized
Under
Prompt
Minimum Corrective
Capital Action
Actual Requirements Provisions:
-------------- -------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------ ------ ------ ------ ------ -------
( in thousands )
As of September 30, 1996:
Tangible Capital 31,954 5.24% 9,143 1.50% 9,143 1.50%
Core Capital 31,954 5.24% 18,285 3.00% 30,474 5.00%
Tier 1 Risk-Based Capital 31,954 8.14% 15,710 4.00% 23,565 6.00%
Risk-Based Capital 36,921 9.40% 31,419 8.00% 39,274 10.00%
As of September 30, 1995:
Tangible Capital 37,404 5.87% 9,563 1.50% 9,563 1.50%
Core Capital 37,404 5.87% 19,126 3.00% 31,877 5.00%
Tier 1 Risk-Based Capital 37,404 9.27% 16,137 4.00% 24,205 6.00%
Risk-Based Capital 42,448 10.52% 32,273 8.00% 40,341 10.00%
SAIF Special Assessment
The Deposit Insurance Funds Act of 1996 (the "Act") was signed into law on
September 30, 1996. Among other things, the Act requires depository institutions
to pay a one-time special assessment of 65.7 basis points on their
SAIF-assessable deposits, in order to recapitalize the SAIF to the reserve level
required by law. The Corporation's financial statements for the year ended
September 30, 1996 reflect a separate charge of $3.1 million this special
assessment.
(17) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (Statement 107), requires disclosure of
estimated fair value for financial instruments. Fair value estimates, methods
and assumption are set forth below for the Bank's financial instruments for
which it is practical to estimate those values.
Cash on hand and in banks
For cash on hand and in banks the carrying amount approximates fair value.
Investments Available for Sale, Investments and Mortgage-backed Securities
The fair value of investments available for sale, investments and
mortgage-backed securities, were based on quoted market prices or dealer quotes,
if available. If a quoted market price or dealer quote was not available, fair
value was estimated using quoted market prices of similar securities.
Stock in Federal Home Loan Bank of New York
The fair value for FHLB stock is its carrying value, since this is the amount
for which it could be redeemed. There is no active market for this stock and the
Bank is required to maintain a minimum balance based upon the unpaid principal
of home mortgage loans and similar obligations.
Loans, Receivable
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans were segregated by type. Each loan category was further
segmented into fixed and adjustable rate interest terms.
The fair value of loans is estimated by discounting the future cash flows and
prepayments using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining terms.
Cash surrender value of life insurance
The fair value of the cash surrender value of life insurance is the approximate
cash value at September 30, 1996 and 1995.
Deposit Liabilities
The fair value of deposits with no stated maturity, such as passbook, NOW, money
market and commercial deposit accounts, is equal to the amount payable on demand
as of September 30,1996 and 1995. The fair value of certificates of deposit is
based on the discounted value of contractual cash flows. The discount rate is
estimated using the rates currently offered for deposits of similar remaining
maturities.
Borrowed Money
The fair value of borrowed money is the carrying value for short-term
obligations while long-term borrowing fair values are estimated using rates
available on borrowings with similar terms and maturities.
The estimated fair values of the Bank's financial instruments as of September
30, 1996 and 1995 are presented in the following table. Since the fair value of
off-balance-sheet commitments approximates book value, these disclosures are not
included.
1996 1995
------------------- -------------------
Book Fair Book Fair
Value Value Value Value
--------- --------- --------- ---------
(in thousands)
Financial assets:
Cash on hand and in banks $ 12,395 $ 12,395 $ 11,792 $ 11,792
Investment securities 24,643 24,355 20,889 20,657
Investment securities,available for sale 9,466 9,466 11,799 11,799
Mortgage-backed securities 31,024 30,560 18,961 19,002
Federal Home Loan Bank of New York stock 3,404 3,404 3,715 3,715
Loans receivable, net 480,931 486,529 461,648 465,742
Mortgage loans held for resale 9,106 9,106 67,219 67,642
Cash surrender value of life insurance 11,978 11,978 11,582 11,582
--------- --------- --------- ---------
Financial liabilities:
Deposits $554,320 $553,205 $567,710 $567,126
Borrowed money 5,928 5,997 23,105 23,159
--------- --------- --------- ---------
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Bank's entire holdings of a particular financial
instrument. Because no market exists for a significant portion of the Bank's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on-balance-sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. The tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in the estimates.
(18) Recent Accounting Pronouncements
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). This statement establishes financial accounting and
reporting standards for stock-based employee compensation plans. SFAS 123
encourages all entities to adopt the "fair value base method" of accounting for
employee stock compensation plans. However, SFAS 123 also allows an entity to
continue to measure compensation cost under such plans using the "intrinsic
value based method." Under the fair value based method, compensation cost is
measured at the grant date based on the value of the award and is recognized
over the service period, usually the vesting period. Fair value is determined
using an option pricing model that takes into account the stock price at the
grant date, the exercise price, the expected life of the option, the volatility
of the underlying stock and the expected dividends on it, and the risk-free
interest rate over the expected life of the option. Under the intrinsic value
based method, compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date or other measurement date over the amount
an employee must pay to acquire the stock. Most stock plans have no intrinsic
value at date of grant, and under previous accounting guidance, no compensation
cost was to be recognized.
The accounting requirements of this statement are effective for transactions
entered into in fiscal years that begin after December 15, 1995. The Bank
intends to continue accounting for compensation costs under the intrinsic value
based method and will provide pro forma disclosures for all awards granted after
October 1, 1995. Such disclosures include net income and earnings per share
after the fair value based method of accounting has been applied.
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" (SFAS 125). SFAS 125
amends portions of SFAS 115, and extends to all servicing assets and
liabilities, the accounting standards for mortgage servicing rights now governed
by SFAS 65, and SFAS 122. The statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. Those standards are based upon consistent application of
a financial components approach that focuses on control. The statement also
defines accounting treatment for servicing assets and other retained interests
in the assets that are transferred. SFAS 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996 and is to be applied prospectively. The Bank does not expect
the adoption of SFAS 125 to have material effect on its future financial
position or results of operations.