________________________________________________________________________________
________________________________________________________________________________
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-22599
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POUGHKEEPSIE FINANCIAL CORP.
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UNITED STATES OF AMERICA 16-1518711
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
ORGANIZATION)
249 MAIN MALL, POUGHKEEPSIE, NEW YORK 12601
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (914) 431-6200
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
(NOT APPLICABLE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
(TITLE OF CLASS)
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COMMON STOCK, PAR VALUE $0.01 PER SHARE
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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 [ ]
Based upon the market price of the Registrant's Common Stock as of March 9,
1998 the aggregate market value of the voting stock held by non-affiliates of
the Registrant was approximately $131.8 million.
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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The number of shares outstanding of the Registrant's Common Stock as of
March 9, 1998 was 12,747,851 shares.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement -- Prospectus for the Special
Meeting of Shareholders to be held on April 22, 1998 are incorporated by
reference in Part III hereof.
________________________________________________________________________________
________________________________________________________________________________
[THIS PAGE INTENTIONALLY LEFT BLANK]
POUGHKEEPSIE FINANCIAL CORP.
ANNUAL REPORT FOR 1997 ON FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business of the Company........................................................................ 1
Item 2. Properties..................................................................................... 31
Item 3. Legal Proceedings.............................................................................. 31
Item 4. Submission of Matters to a Vote of Security Holders............................................ 31
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 32
Item 6. Selected Consolidated Financial Data........................................................... 33
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 34
Item 7a. Quantitative and Qualitative Disclosures about Market Risk..................................... 44
Item 8. Financial Statements and Supplementary Data.................................................... 48
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure..................................................................................... 83
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 83
Item 11. Executive Compensation......................................................................... 85
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 87
Item 13. Certain Relationships and Related Transactions................................................. 88
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 89
[THIS PAGE INTENTIONALLY LEFT BLANK]
PART I
ITEM 1. BUSINESS OF THE COMPANY.
On May 30, 1997, Poughkeepsie Financial Corp. (the 'Holding Company' or
together with its wholly-owned subsidiary, the 'Company') became the holding
company for Poughkeepsie Savings Bank, FSB after a stockholder approved
reorganization. On October 14, 1997, Poughkeepsie Savings Bank, FSB changed its
name to Bank of the Hudson (the 'Bank'). The Holding Company's primary business
activity has been limited to its ownership of the Bank.
Poughkeepsie Financial Corp., Bank of the Hudson and HUBCO, Inc. entered
into an Amended and Restated Agreement and Plan of Merger ('Merger Agreement')
dated as of October 22, 1997. Under the terms of this agreement each share of
Poughkeepsie Financial Corp. Common Stock will be exchanged for .30 shares of
HUBCO Common Stock, as long as the median closing price for HUBCO Common Stock
during a pre-closing period is at or above $33.33. If the median HUBCO price
during the pre-closing period is below $33.33 but above $31.25, each share of
Poughkeepsie Financial Corp. Common Stock would be exchanged for shares of HUBCO
Common Stock with value of $10.00. If HUBCO's median pre-closing price is $31.25
or below, a maximum exchange ratio of .32 would apply. In addition, the
agreement provided that Poughkeepsie Financial Corp. was able to increase its
quarterly cash dividends to amounts substantially equivalent to HUBCO's cash
dividend as adjusted for the exchange ratio. In connection with the execution of
the Merger Agreement, Poughkeepsie Financial Corp. issued an option to HUBCO
which, under certain defined circumstances, would enable HUBCO to purchase up to
2,000,000 shares of Poughkeepsie Financial Common Stock at $7.875 per share. The
transaction, which is expected to close in the second quarter of 1998, is
expected to be treated as a tax-free exchange to holders of Poughkeepsie
Financial Corp. stock and to be accounted for as a pooling of interests.
The Bank was chartered as a mutual savings bank by the New York State
Legislature in 1831, converted to a federal mutual savings bank in 1981 and
converted to stock form in 1985. At December 31, 1997, the Company had total
assets of $875 million, net loans of $665 million, total deposits of $620
million and stockholders' equity of $73 million.
Bank of the Hudson is a federally chartered community savings bank serving
the Mid-Hudson Valley region of New York through sixteen branches in Dutchess,
Orange and Rockland counties and six residential loan origination offices. In
recent years, the business of the Bank has consisted primarily of obtaining
funds in the form of deposits from the general public and borrowings, and using
such funds to make residential mortgage loans and commercial mortgage loans as
well as commercial business loans, consumer loans, student loans and other
investments. The Bank's deposits are insured up to applicable limits by the
Savings Association Insurance Fund ('SAIF'), which is administered by the
Federal Deposit Insurance Corporation ('FDIC'). The Bank is subject to
comprehensive regulation, examination and supervision by the Office of Thrift
Supervision ('OTS'), its primary regulator, and the FDIC. The Bank also is a
member of the Federal Home Loan Bank ('FHLB') system. The Bank is further
subject to regulations of the Board of Governors of the Federal Reserve System
('Federal Reserve Board') governing reserves required to be maintained against
deposits and certain other matters.
The Company's principal executive offices are located at 249 Main Mall,
Poughkeepsie, New York 12601, and its telephone number is (914) 431-6200.
FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the meaning of The
Private Securities Litigation Reform Act of 1995. Such statements are not
historical facts and involve certain risks and uncertainties. Actual results may
differ materially from the results discussed in these forward-looking
statements. Factors that might cause a difference include, but are not limited
to, changes in interest rates, economic conditions, deposit and loan growth,
loan loss provisions, and customer retention. The Company assumes no obligation
for updating any such forward-looking statements at any time.
1
LENDING ACTIVITIES
Bank of the Hudson is a community bank serving the individual and business
borrowers of the Mid-Hudson Valley. The Bank's loan portfolio (net of deferred
fees and the allowance for loan losses) totaled $665.1 million at December 31,
1997, representing 76.0% of total assets.
The following tables set forth information concerning the composition of
the loan portfolio by type of loan and by type of collateral.
DECEMBER 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- -------- -------- -------- --------
TYPE OF LOAN AMOUNT PERCENT AMOUNT AMOUNT AMOUNT AMOUNT
- ------------------------------------------- -------- ------- -------- -------- -------- --------
(Dollars in thousands)
Conventional mortgage loans:
Existing property..................... $569,834 85.7% $565,784 $469,756 $448,643 $414,949
Construction.......................... 57,206 8.6 39,602 17,138 8,287 6,994
Commercial business loans.................. 8,418 1.3 7,196 7,397 10,181 9,393
Other loans(1)............................. 39,529 5.9 30,907 28,453 27,103 24,706
-------- ------- -------- -------- -------- --------
674,987 101.5 643,489 522,744 494,214 456,042
Deferred loan origination fees............. (441) (0.1) (606) (679) (304) 5
Allowance for loan losses.................. (9,421) (1.4) (8,652) (8,259) (18,195) (19,726)
Commercial loans held for sale(2).......... -- -- -- 61,510 -- --
Residential loans held for sale............ -- -- 456 192 279 3,560
-------- ------- -------- -------- -------- --------
$665,125 100.0% $634,687 $575,508 $475,994 $439,881
-------- ------- -------- -------- -------- --------
-------- ------- -------- -------- -------- --------
TYPE OF COLLATERAL
----------------------------------------
Residential:
One-to-four-family.................... $388,830 58.5% $393,941 $317,441 $248,729 $220,909
Multi-family.......................... 81,315 12.2 85,609 72,029 98,731 100,027
Commercial real estate..................... 156,895 23.6 126,292 97,616 109,749 104,567
Savings accounts........................... 25 -- 31 40 51 69
Property improvement loans(3).............. 249 -- 175 190 212 175
Commercial businesss loans(4).............. 8,418 1.3 7,196 7,397 10,181 9,393
Other installment loans(5)................. 39,255 5.9 30,701 28,223 26,840 24,462
-------- ------- -------- -------- -------- --------
674,987 101.5 643,945 522,936 494,493 459,602
Deferred loan origination fees............. (441) (0.1) (606) (679) (304) 5
Allowance for loan losses.................. (9,421) (1.4) (8,652) (8,259) (18,195) (19,726)
Commercial loans held for sale(2).......... -- -- -- 61,510 -- --
-------- ------- -------- -------- -------- --------
$665,125 100.0% $634,687 $575,508 $475,994 $439,881
-------- ------- -------- -------- -------- --------
-------- ------- -------- -------- -------- --------
- ------------
(1) Includes auto & home equity loans, property improvement loans, savings
account loans, and student loans.
(2) Represents commercial real estate, multi-family and commercial business
loans which were identified for bulk sale and carried at the lower of cost
or market value.
(3) Includes FHA Title I loans.
(4) Includes secured and unsecured loans. The security for secured commercial
loans generally includes general business assets such as inventory,
receivables, property and equipment.
(5) Includes automobile, home equity loans, and student loans.
2
The following tables show the contractual maturities of the loan portfolio
as of December 31, 1997 and 1996. 1-4 Family Residential Mortgage Loans held for
sale, which are typically sold within 90 days of origination, and deferred loan
origination fees have been excluded. The tables do not include estimated future
repayments and scheduled amortization.
AT DECEMBER 31, 1997
------------------------------------------------------------------------------------------
REAL ESTATE MORTGAGE LOANS
----------------------------------------
COMMERCIAL TOTAL COMMERCIAL
REAL MORTGAGE BUSINESS CONSUMER
CONSTRUCTION 1-4 FAMILY ESTATE LOANS LOANS LOANS TOTAL
------------ ---------- ---------- -------- ---------- -------- --------
(Dollars in thousands)
Amounts due:
Within 1 year............... $ 25,294 $ 1,395 $ 27,594 $ 54,283 $2,531 $ 1,058 $ 57,872
------------ ---------- ---------- -------- ---------- -------- --------
1 - 2 years................. 31,320 1,340 24,908 57,568 5,232 1,289 64,089
2 - 3 years................. 592 399 36,689 37,680 229 2,550 40,459
3 - 5 years................. -- 2,202 80,019 82,221 391 5,864 88,476
5 - 10 years................ -- 7,063 18,669 25,732 35 5,148 30,915
10 - 15 years............... -- 38,631 571 39,202 -- 8,529 47,731
Beyond 15 years............. -- 329,095 1,259 330,354 -- 15,091 345,445
------------ ---------- ---------- -------- ---------- -------- --------
Total due after
1 year............... 31,912 378,730 162,115 572,757 5,887 38,471 617,115
------------ ---------- ---------- -------- ---------- -------- --------
Total.................. $ 57,206 $380,125 $189,709 $627,040 $8,418 $39,529 $674,987
------------ ---------- ---------- -------- ---------- -------- --------
------------ ---------- ---------- -------- ---------- -------- --------
Amounts due after 1 year:
Fixed-rate.................. $ 400 $164,354 $133,347 $298,101 $ 565 $20,632 $319,298
Adjustable-rate(1).......... 31,512 214,376 28,768 274,656 5,322 17,839 297,817
------------ ---------- ---------- -------- ---------- -------- --------
Total due after
1 year............... $ 31,912 $378,730 $162,115 $572,757 $5,887 $38,471 $617,115
------------ ---------- ---------- -------- ---------- -------- --------
------------ ---------- ---------- -------- ---------- -------- --------
- ------------
(1) Adjustable rate loans includes loans whose rates are subject to adjustment
at intervals ranging from daily to 10 years.
AT DECEMBER 31, 1996
------------------------------------------------------------------------------------------
REAL ESTATE MORTGAGE LOANS
----------------------------------------
COMMERCIAL TOTAL COMMERCIAL
REAL MORTGAGE BUSINESS CONSUMER
CONSTRUCTION 1-4 FAMILY ESTATE LOANS LOANS LOANS TOTAL
------------ ---------- ---------- -------- ---------- -------- --------
(Dollars in thousands)
Amounts due:
Within 1 year............... $ 18,564 $ 2,204 $ 39,344 $ 60,112 $ 992 $ 823 $ 61,927
------------ ---------- ---------- -------- ---------- -------- --------
1 - 2 years................. 16,799 808 21,741 39,348 49 981 40,378
2 - 3 years................. 3,515 1,466 30,141 35,122 5,427 1,873 42,422
3 - 5 years................. 724 3,397 60,861 64,982 556 3,072 68,610
5 - 10 years................ -- 8,894 23,874 32,768 172 4,372 37,312
10 - 15 years............... -- 41,259 435 41,694 -- 6,624 48,318
Beyond 15 years............. -- 330,548 812 331,360 -- 13,162 344,522
------------ ---------- ---------- -------- ---------- -------- --------
Total due after
1 year............... 21,038 386,372 137,864 545,274 6,204 30,084 581,562
------------ ---------- ---------- -------- ---------- -------- --------
Total.................. $ 39,602 $388,576 $177,208 $605,386 $7,196 $30,907 $643,489
------------ ---------- ---------- -------- ---------- -------- --------
------------ ---------- ---------- -------- ---------- -------- --------
Amounts due after 1 year:
Fixed-rate.................. $ 400 $160,666 $104,151 $265,217 $ 643 $14,039 $279,899
Adjustable-rate(1).......... 20,638 225,706 33,713 280,057 5,561 16,045 301,663
------------ ---------- ---------- -------- ---------- -------- --------
Total due after
1 year............... $ 21,038 $386,372 $137,864 $545,274 $6,204 $30,084 $581,562
------------ ---------- ---------- -------- ---------- -------- --------
------------ ---------- ---------- -------- ---------- -------- --------
3
The following tables show as of December 31, 1997 and 1996 fixed-rate and
adjustable-rate mortgage loans by interest rate ranges and by contractual
maturity date. Loans held for sale of $0.5 million as of December 31, 1996, have
been excluded.
AT DECEMBER 31, 1997
----------------------------------------------------------------------------------------------------------
FIXED-RATE MORTGAGE LOANS ADJUSTABLE-RATE MORTGAGE LOANS
--------------------------------------------------- ---------------------------------------------------
CONTRACTUAL LESS 10.01- OVER LESS 10.01- OVER
MATURITY THAN 8% 8-10% 12% 12% TOTAL THAN 8% 8-10% 12% 12% TOTAL
- ------------------ -------- -------- ------ ----- -------- -------- -------- ------ ----- --------
(Dollars in thousands)
0 - 1 years....... $ 33 $ 8,412 $ 396 $ 77 $ 8,918 $ 14 $ 39,695 $5,656 -- $ 45,365
1 - 2 years....... 1,216 19,722 6 9 20,953 14 36,275 326 -- 36,615
2 - 3 years....... 6,852 25,408 21 36 32,317 -- 5,171 192 -- 5,363
3 - 5 years....... 718 69,763 56 0 70,537 69 11,488 127 -- 11,684
5 - 10 years...... 10,099 5,655 438 117 16,309 346 8,075 897 $105 9,423
10 - 15 years..... 33,568 450 595 93 34,706 1,243 2,960 275 18 4,496
Over 15 years..... 83,001 38,697 1,436 144 123,278 124,512 81,264 1,144 156 207,076
-------- -------- ------ ----- -------- -------- -------- ------ ----- --------
$135,487 $168,107 $2,948 $476 $307,018 $126,198 $184,928 $8,617 $279 $320,022
-------- -------- ------ ----- -------- -------- -------- ------ ----- --------
-------- -------- ------ ----- -------- -------- -------- ------ ----- --------
AT DECEMBER 31, 1996
-----------------------------------------------------------------------------------------------------------
FIXED-RATE MORTGAGE LOANS ADJUSTABLE-RATE MORTGAGE LOANS
--------------------------------------------------- ----------------------------------------------------
CONTRACTUAL LESS 10.01- OVER LESS 10.01- OVER
MATURITY THAN 8% 8-10% 12% 12% TOTAL THAN 8% 8-10% 12% 12% TOTAL
- ----------------- -------- -------- ------ ----- -------- -------- -------- ------- ----- --------
(Dollars in thousands)
0 - 1 years...... $ 871 $ 21,670 $1,613 $ 36 $ 24,190 $ 3,801 $ 23,813 $ 8,308 -- $ 35,922
1 - 2 years...... 8,632 1,715 404 6 10,757 40 25,107 3,444 -- 28,591
2 - 3 years...... 8,201 8,306 2,136 15 18,658 25 12,323 4,116 -- 16,464
3 - 5 years...... 5,951 51,789 223 78 58,041 39 6,806 96 -- 6,941
5 - 10 years..... 21,044 5,601 737 137 27,519 701 3,501 941 $106 5,249
10 - 15 years.... 29,807 6,328 376 118 36,629 2,115 2,693 239 18 5,065
Over 15 years.... 76,910 34,809 1,747 147 113,613 123,047 93,855 845 -- 217,747
-------- -------- ------ ----- -------- -------- -------- ------- ----- --------
$151,416 $130,218 $7,236 $537 $289,407 $129,768 $168,098 $17,989 $124 $315,979
-------- -------- ------ ----- -------- -------- -------- ------- ----- --------
-------- -------- ------ ----- -------- -------- -------- ------- ----- --------
4
LOAN ORIGINATIONS
GENERAL
The Bank's loan origination operations are divided among: one-to-four
family residential, commercial real estate, commercial business and consumer
installment lending. Each area originates loans within policies established by
the Board of Directors. Among other things these policies address requirements
such as acceptable collateral, underwriting (such as evaluating debt service
coverage ratios), maximum loan amounts, geographic concentrations, appraisal
requirements, documentation requirements and compliance with the Community
Reinvestment Act. These policies are maintained by the Credit Department which
is independent of the loan origination operations.
The Bank's Management Loan Committee, consisting of several senior officers
of the Bank, has authority to approve loans up to $1 million and recommends
loans in excess of $1 million to the Directors' Loan Committee. The Directors'
Loan Committee must approve all loans in excess of $1 million. The Board of
Directors' has set specific parameters whereby certain commercial loans of less
than $1 million, with limits determined by a risk rating assigned by the Bank's
Credit Department, may have the origination, credit review, appraisal review and
approval process accomplished by a minimum of three specifically designated
officers of the Bank. One-to-four family residential mortgage loans and consumer
loans can be processed and approved with two authorized signatures within
certain size limitations.
The following table summarizes activity in the loan portfolio:
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- -------- --------
(Dollars in thousands)
Originations and purchases:
One-to-four family residential real estate loans:
Originations............................................................ $ 72,393 $130,396 $102,789
Purchases............................................................... -- -- 2,203
--------- -------- --------
Subtotal one-to-four family............................................. 72,393 130,396 104,992
Commercial real estate and multi-family residential loans.................... 103,900 73,447 64,597
Commercial business loans.................................................... 1,826 1,343 3,649
Consumer and other loans..................................................... 22,416 14,398 11,317
--------- -------- --------
Total originations and purchases........................................ 200,535 219,584 184,555
Sales of one-to-four family residential loans................................ (35,582) (18,874) (8,408)
Bulk sale of certain commercial loans........................................ -- (33,178) --
Sales of student loans....................................................... (886) (954) (1,049)
Principal reductions......................................................... (132,404) (107,269) (85,434)
--------- -------- --------
Increase in loans receivable................................................. $ 31,663 $ 59,309 $ 89,664
--------- -------- --------
--------- -------- --------
ONE-TO-FOUR FAMILY RESIDENTIAL MORTGAGE LOAN ORIGINATION
Under applicable regulations, the Bank may originate or purchase whole
one-to-four family residential mortgage loans secured by properties located
anywhere in the United States. Currently, the Bank is generally limiting its
origination of new residential mortgage loans to properties within the Bank's
Mid-Hudson Valley market area and nearby counties, as well as northern New
Jersey and southern Connecticut.
The Bank operates a full service residential mortgage loan origination
division, which originates 'investment quality' loans for portfolio and for sale
in the secondary mortgage market. Currently, the Bank is an approved
originator/seller with various mortgage investors, an approved originator/seller
servicer with the Federal Home Loan Mortgage Corporation ('FHLMC'), the Federal
National Mortgage Association ('FNMA') and an approved State of New York
Mortgage Agency ('SONYMA') lender. The Bank retains the servicing on most of the
loans it originates in order to generate future loan servicing fees and build
customer relationships.
5
Residential lending is pursued through the use of qualified loan
originators located throughout the Bank's market area with a number of
residential loan products, both fixed-rate and variable-rate. Each loan officer
is equipped with a laptop computer and trained to submit applications
electronically. The Bank also participates in the 'Loan Prospector' program of
FHLMC. The 'Loan Prospector' program links the Bank to FHLMC's database and uses
artificial intelligence to produce a credit decision within four minutes from
the time the application data is electronically transmitted to FHLMC.
The Bank's goal in residential lending is to serve a broad spectrum of
borrowers. Special emphasis is placed on serving the low to moderate income
sector by the use of insured programs such as Federal Housing Administration
('FHA'), Veterans Administration ('VA') and a variety of affordable housing
programs. The Bank's total residential loan originations, including loans
originated for sale in the secondary market, were $72.4 million for 1997 as
compared to $130.4 million in 1996 and $102.8 million in 1995.
Excluding SONYMA, FHA, VA and certain low/moderate income and first-time
homebuyer mortgages, the Bank primarily originates residential mortgage loans
with loan-to-value ratios up to 95%. On all conventional mortgage loans
exceeding an 80% loan-to-value ratio, the Bank requires private mortgage
insurance. As part of its residential lending program, the Bank offers
construction loans with up to 80% loan-to-value ratios to qualified builders and
individuals for terms of up to twelve months.
With few exceptions, residential mortgage loans are underwritten and
documented in accordance with secondary market standards and are intended to be
saleable in the secondary market. Property securing real estate loans originated
by the Bank is appraised by independent appraisers who have met the Bank's
criteria and have been approved by the Board of Directors.
The Bank originates fixed-rate residential mortgage loans and
adjustable-rate mortgage loans ('ARMs') on which the payment amount and the
amortization schedule may change periodically as a result of changes in interest
rates. ARMs are not subject to regulatory limitations on interest rate
adjustments, provided that changes in interest rates are based upon an index
agreed to by the Bank and the borrower. The index must be readily available to
and verifiable by the borrower, and, except with respect to downward adjustments
in the interest rate, adjustments must correspond directly to the movement of
the index agreed to by the Bank and the borrower, subject only to such
limitations as are contained in the loan contract.
The Bank's ARMs are typically written at or near competitive market rates
and are subsequently repriced relative to the specified rate index. Initial
rates on ARMs originated by the Bank are often lower than those that would
prevail were the index used for repricing applied at origination. However, the
accretion of fees charged in connection with the origination of the Bank's ARMs
generally results in a yield in the period prior to the first adjustment at or
near the yield that would result from application of the index.
The Bank's current ARM programs call for interest rate adjustments based
upon a spread over the weekly average yield on U.S. Treasury securities adjusted
to a constant maturity as published by the Federal Reserve Board, corresponding
to the rate adjustment period. The interest rate on the Bank's ARMs normally
adjusts annually, with the change in the rate limited to a maximum of two
percentage points at any adjustment date. Currently, the maximum lifetime
adjustment is between five and six percentage points above the initial rate.
Upon each interest rate increase or decrease, the borrower's monthly principal
and interest payment is adjusted to amortize the remaining principal balance
over the remaining loan term. Due to the nature of ARMs, there are
unquantifiable risks resulting from potential increases in the borrower's
monthly payments as a result of the repricing.
The Bank uses its headquarters-based loan servicing operation to service
all new residential loans originated for its portfolio. Beginning in 1997, the
Bank has used a subservicer to service a majority of its loans sold to investors
with servicing retained. At December 31, 1997, the Bank serviced $316.6 million
of one-to-four family residential mortgage loans, including $15.5 million of
loans serviced for others, while third parties serviced $88.9 million of
one-to-four family residential mortgage loans owned by the Bank.
6
At December 31, 1997, the Bank's residential mortgage portfolio was
comprised of $219 million of adjustable-rate loans with interest rates ranging
from 5.50% to 10.75% and $169 million of fixed-rate loans with interest rates
ranging from 5.75% to 13.5%. Non-performing residential mortgage loans amounted
to $3.1 million, or .79% of such portfolio at December 31, 1997 as compared to
$5.5 million, or 1.39% as of December 31, 1996, and $4.8 million, or 1.5%, as of
December 31, 1995.
The Bank's first mortgage loans customarily include 'due-on-sale' clauses,
which are provisions giving the Bank the right to declare a loan immediately due
and payable in the event the borrower sells or otherwise disposes of the real
property subject to the mortgage and the loan is not repaid. The Bank enforces
'due-on-sale' clauses through foreclosures and other legal proceedings to the
extent available under applicable laws. Loans insured by the FHA or partially
guaranteed by the VA do not contain due-on-sale clauses. As of December 31,
1997, FHA and VA loans represented 0.6% of the Bank's total loan portfolio.
SALE AND SERVICING OF ONE-TO-FOUR FAMILY RESIDENTIAL MORTGAGE LOANS
In addition to originating residential mortgage loans for its portfolio,
the Bank also originates such loans to be sold. During 1997, 1996, and 1995, the
Bank sold $35.6 million, $18.9 million, and $8.4 million, respectively, of
mortgage loans to investors. These sales generated gains (including Mortgage
Servicing Rights) of $.2 million, $.2 million and $.1 million in 1997, 1996 and
1995, respectively.
The fair value of rights to service mortgages for others is required to be
recognized as an asset regardless of how originated. As a result, loans sold
servicing retained now generate approximately the same accounting results as
loans sold servicing released. The Bank retained the servicing rights on $2.7
million, $17.1 million, and $5.5 million of loans sold to investors in 1997,
1996 and 1995, respectively.
Servicing includes collecting and remitting loan payments, monthly
reporting to investors, holding escrow funds for the payment of real estate
taxes and insurance premiums, contacting delinquent mortgagors, in some cases
advancing to the investor principal and interest when the mortgage is
delinquent, supervising foreclosures in the event of unremedied defaults and
generally administering the loans. The Bank recorded servicing income, net of
amortization of mortgage servicing rights, of $17,000 in 1997, $18,000 in 1996,
and $12,000 in 1995.
COMMERCIAL AND MULTI-FAMILY MORTGAGE LOAN ORIGINATION
The Bank has established itself as a commercial lender which focuses its
efforts on commercial and multi-family mortgage loans in the Mid-Hudson Valley
and nearby counties. On a selective basis, the Bank will entertain prudent
lending opportunities in immediately contiguous counties should they arise.
Commercial and multi-family mortgage loan originations and advances amounted to
$103.9 million in 1997, $73.4 million in 1996, and $64.6 million in 1995.
The Bank generally has offered construction loans with 18-month terms and
loan-to-value ratios of up to 75% on multi-family and commercial properties, and
single family sub-divisions. This 75% loan-to-value ratio is based on the lesser
of the current appraised value or the cost of construction (land plus building).
Appraisal reports on the properties are completed by qualified independent fee
appraisers. In most cases, the rates associated with these interim loans 'float'
over national prime rate indices.
The Bank also offers permanent commercial and multi-family real estate
financing with loan-to-value ratios of up to 80%. Permanent mortgage loans are
generally made on the basis of a 20 to 25 year amortization schedule with a
'balloon payment' due after five years. Permanent loans generally have
adjustable/variable interest rates tied to national prime rate indices, or are
fixed-rate loans based on one-to-five year Treasury note rates plus a margin.
The Bank had conducted its commercial and multi-family mortgage lending in
selected areas along the eastern seaboard, but now lends primarily in the
Mid-Hudson Valley region of New York (and nearby counties) except to facilitate
the sale of OREO located outside this region.
As of December 31, 1997, the Bank's commercial real estate and multi-family
mortgage loan portfolio amounted to $238.0 million, or 35.3% of the Bank's total
loan portfolio compared to 32.9% at December 31, 1996. The largest aggregate
amount of commercial mortgage loans and commitments to
7
one borrower or affiliated borrowers at December 31, 1997 was $9.5 million.
Commercial and multi-family mortgage loans are generally considered to involve a
higher degree of risk than residential mortgage loans because the borrowers are
generally more sensitive to negative changes in the economic environment.
Commercial and multi-family mortgage loans typically involve large loan balances
to single borrowers or groups of related borrowers. The payment experience on
such loans is typically dependent on the successful operation of the real estate
project. These risks can be significantly affected by supply and demand
conditions in the local real estate market, and as such, commercial real estate
and multi-family residential loans may be subject to a greater extent to adverse
conditions in the local real estate market and in the economy in general.
The following table sets forth information concerning non-performing
commercial real estate and multi-family residential mortgage loans and
commercial OREO properties at December 31, 1997, 1996 and 1995, respectively.
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
------- ------- -------
(Dollars in thousands)
Non-performing commercial real estate and multi-family residential mortgage
loans..................................................................... $ 6,579 $ 9,447 $ 471(1)
Commercial OREO............................................................. 4,116 9,733 11,424
------- ------- -------
Total.................................................................. $10,695 $19,180 $11,895
------- ------- -------
------- ------- -------
As a percent of total non-performing assets................................. 72.2% 73.3% 65.3%
As a percent of total assets................................................ 1.2% 2.2% 1.4%
- ------------
(1) Excludes $8.8 million of commercial real estate loans which were written
down to fair value and included with 'Commercial Loans Held for Bulk Sale,'
at December 31, 1995. These loans would otherwise have been considered
non-accrual. See Bulk Sale of Certain Commercial Loans.
As of December 31, 1997 the Bank had 14 loans aggregating $44.6 million
which were made to facilitate the sale of OREO which are performing in
accordance with their terms.
COMMERCIAL BUSINESS LOAN ORIGINATION
The Bank also pursues commercial business loan opportunities in the
Mid-Hudson Valley region of New York (and nearby counties). As of December 31,
1997, the Bank's commercial business loan portfolio amounted to $8.4 million, or
1.3% of its total loan portfolio, as compared to $7.2 million at December 31,
1996 and $7.3 million at December 31, 1995. The largest aggregate amount of
outstanding commercial business loans and commitments to one borrower or
affiliated borrowers at December 31, 1997 was $5.2 million.
Commercial business loans are generally considered to involve a higher
degree of risk than residential mortgage loans because the collateral is
typically in the form of intangible assets and inventory subject to market
obsolescence. Commercial business loans typically involve large loan balances to
single borrowers or groups of related borrowers, with the repayment of such
loans typically dependent on the successful operations and income stream of the
borrower. Such risks can be significantly affected by economic conditions. In
addition, commercial lending generally requires substantially greater oversight
efforts compared to residential real estate lending. At December 31, 1997, $0.4
million, or 5.2%, of the Bank's commercial business loan portfolio was
non-performing, as compared to $0.4 million at December 31, 1996 and $.1 million
at December 31, 1995.
BULK SALE OF CERTAIN COMMERCIAL LOANS
As of December 31, 1995, the Bank transferred certain commercial loans to
the 'Commercial Loans Held for Bulk Sale' category. These loans, which totaled
$78.2 million before transfer, were transferred to the Held for Sale category at
their then fair value of $61.5 million. Fair value was
8
determined by competitive bid. The following table summarizes the activity in
the 'Commercial Loans Held for Bulk Sale' category during 1996:
AMOUNT
TOTAL NON-ACCRUAL
-------- -----------
(in thousands)
Balance as of 1/1/96.......................................................... $ 61,510 $ 11,201
Sold during 1996.............................................................. (33,178) (10,470)
Paid off during 1996.......................................................... (4,564) --
Additional Write-downs........................................................ (894) --
Principal payments received................................................... (227) --
Returned to portfolio......................................................... (22,647) (731)
-------- -----------
Balance as of 12/31/96........................................................ $ -- $ --
-------- -----------
-------- -----------
Of the amount returned to portfolio, two loans totaling $6.1 million became
non-performing during 1996 and were subsequently disposed of in January and
February 1997 at no additional loss to the Bank. A $3.1 million loan paid off in
January 1997; the other loan totaling $3.0 million became OREO in December 1996
and was sold in February 1997.
CONSUMER LOAN ORIGINATION
Federal savings banks are permitted to make secured and unsecured consumer
loans aggregating up to 35% of their assets. The Bank's consumer loan portfolio
totaled $39.9 million at December 31, 1997, representing 5.9% of its total loan
portfolio, as compared to $31.2 million at December 31, 1996 and $28.7 million
at December 31, 1995.
The Bank currently originates a variety of consumer loans, including home
equity, property improvement, automobile, mobile home and other secured and
unsecured personal installment loans at each of its banking offices. Consumer
loans generally have terms ranging from three to five years. The Bank originates
these loans through its branch offices on a direct basis.
The Bank offers a home equity line of credit, a variable-rate open line of
credit which the customer can access by writing a check and which is
collateralized by a lien on residential real property. The line of credit,
together with all loans collateralized by such property, is limited to 80% of
the property's appraised value. The Bank also offers a single disbursement
fixed-rate home equity loan which, together with all other loans secured by the
same property, is limited to 90% of the property's appraised value.
The Bank also offers 'Totally Business Banking,' a package of products and
services designed to meet the banking needs of small businesses. Totally
Business Banking offers a business line of credit from $5,000 to $50,000, a
business checking account with no per transaction charges, and other business
services including: merchant card processing, direct deposit, night depository,
payroll, wire transfer and tax filing services.
FEE INCOME FROM LENDING ACTIVITIES
The Bank realizes interest and loan fee income from its lending activities,
including loan origination fees for originating loans and fees for making
commitments to originate construction, residential and commercial mortgage
loans. Most of these fees, net of direct origination costs, are amortized over
the life of the respective loan. In addition, the Bank receives loan fees
related to existing loans, which include prepayment charges, late charges,
assumption fees and extension fees.
The Bank offers a range of loan commitments for which it charges fees. As
part of certain loan applications, the borrower also pays the Bank for its
out-of-pocket costs in reviewing the application, whether or not the loan is
closed. The interest rate charged on the mortgage loan is normally the
prevailing rate at the time the loan application is received, approved, or when
the loan is closed. At December 31, 1997, the Bank was committed to originate or
fund $16.3 million of one-to-four family residential mortgage loans and $32.8
million of commercial loans. At December 31, 1997, the Bank had commitments to
sell one-to-four family residential mortgage loans totaling $9.4 million; the
Bank uses forward contracts to hedge against the price risk on its 'pipeline' of
loans committed to secondary market investors.
9
NON-PERFORMING ASSETS
GENERAL
Management of the Bank regularly reviews the loan portfolio. Generally,
loans are placed on non-accrual status when the loan is past due more than 90
days, or earlier if in management's judgment, the ability of a borrower to repay
principal or interest is in doubt. When a loan is placed on non-accrual status,
previously accrued but unpaid interest is deducted from interest income.
Consumer loans that are 120 days delinquent are generally charged-off against
the allowance for loan losses; subsequent recoveries are credited back to the
allowance.
The Bank's Asset Recovery Group is responsible for the resolution of all
problem commercial and residential real estate assets. Non-performing assets
totaled $14.8 million, $26.1 million and $18.2 million as of December 31, 1997,
1996 and 1995, respectively.
When a borrower fails to make a required payment on a residential mortgage
loan, the Bank attempts to cure the deficiency by contacting the borrower.
Written contacts are made after payment is 15 days past due and, in most cases,
deficiencies are cured promptly. If the delinquency is not cured by the 30th
day, the Bank attempts to contact the borrower by telephone to arrange payment
of the delinquency. If these efforts have not resolved the delinquency within 45
days after the due date, a second written notice is sent to the borrower, and on
the 60th day a notice is sent to the borrower warning that foreclosure
proceedings will be commenced unless the delinquent amount is paid. If the
delinquency has not been cured within a reasonable period of time after the
foreclosure notice has been sent, the Bank institutes appropriate legal action
to foreclose the property. If foreclosed, property collateralizing the loan is
sold at a public sale and may be purchased by the Bank. If the Bank is in fact
the successful bidder at the foreclosure sale, upon receipt of a deed to the
property, the Bank initiates a sales program to dispose of the property at the
earliest possible date.
Collection efforts on commercial real estate and multi-family residential
loans are similar to efforts on 1-4 family residential mortgages; however, these
efforts generally begin as soon as a payment date is missed. The Bank also
maintains periodic contact with commercial loan customers and monitors and
reviews the borrowers' financial statements and compliance with debt covenants
on a regular basis.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure are classified as Other Real Estate Owned ('OREO')
until sold. When property is classified as OREO, it is recorded at the lower of
cost or fair value (net of disposition costs) at that date and any writedown
resulting therefrom is charged to the allowance for loan losses. Subsequent
writedowns are charged to operating expense. Interest accrual, if any, ceases on
the date of transfer to OREO. Net income from operating OREO reduces the
carrying value of the asset. Net expense from OREO is expensed as incurred, on a
property by property basis (See discussion of OREO included in 'Management's
Discussion and Analysis of Financial Condition and Results of Operations' at
Item 7).
The following table sets forth information concerning the principal
balances and percent of the total loan portfolio represented by loans delinquent
as to interest as of December 31 for the periods indicated:
1997 1996 1995(1)
------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Delinquencies:
30 to 59 days........................ $ 7,688 1.14% $11,486 1.79% $ 9,834 1.88%
60 to 89 days........................ 6,569 0.97 2,286 0.36 3,880 0.74
90 or more days...................... 10,248 1.52 15,423 2.40 5,435 1.04
------- ------- ------- ------- ------- -------
Total........................... $24,505 3.63% $29,195 4.55% $19,149 3.66%
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
- ------------
(1) Excludes delinquent loans included with 'Commercial Loans Held for Bulk
Sale.'
10
The following table presents information regarding non-performing assets,
performing troubled debt restructurings ('TDRs'), performing investment in real
estate, and accruing loans 90 days or more past contractual maturity at year-end
for each period indicated.
DECEMBER 31,
-------------------------------------------------------
1997 1996 1995(1) 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One-to-four family....................... $ 3,062 $ 5,453 $ 4,829 $ 4,965 $ 7,561
Commercial and multi-family.............. 6,579 9,447 471 8,135 6,630
Commercial business loans................ 431 436 51 2,410 528
Loans 90 days or more past due on interest and
still accruing................................... 176 87 84 172 76
------- ------- ------- ------- -------
Total non-performing loans............... 10,248 15,423 5,435 15,682 14,795
Other real estate owned............................ 4,564 10,726 12,781 12,636 24,948
------- ------- ------- ------- -------
Total non-performing assets.............. $14,812 $26,149 $18,216 $28,318 $39,743
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Allowance for loan losses.......................... $ 9,421 $ 8,652 $ 8,259 $18,195 $19,726
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Ratio of:
Non-performing loans to total loans........... 1.5% 2.4% 1.0% 3.2% 3.2%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Non-performing assets to total assets......... 1.7% 3.0% 2.2% 3.9% 5.5%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Allowance for loan losses to:
Total non-performing loans............... 91.9% 56.1% 152.0% 116.0% 133.3%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total loans.............................. 1.4% 1.3% 1.6% 3.7% 4.3%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total non-performing assets (details above)........ $14,812 $26,149 $18,216 $28,318 $39,743
Accruing loans 90 days or more past contractual
maturity......................................... 6,224 7,016 2,023 3,320 21,531
Performing TDRs.................................... 14,402 9,499 29 27,953 25,428
Performing investment in real estate............... -- -- 1,192 1,136 --
------- ------- ------- ------- -------
Total non-performing assets, accruing loans 90 days
or more past contractual maturity, performing
TDRs, and performing investment in real estate... $35,438 $42,664 $21,460 $60,727 $86,702
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total non-performing loans and accruing loans 90
days or more past contractual maturity........... $16,472 $22,439 $ 7,458 $19,002 $36,326
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Ratio of allowance for loan losses to total
non-performing loans and accruing loans 90 days
or more past contractual maturity................ 57.2% 38.6% 110.7% 95.8% 54.3%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
- ------------
(1) Loans included as part of the 'Bulk Sale,' and which are carried at the
lower of cost or market value, have been excluded.
At December 31, 1995, $8.8 million of non-accrual commercial real estate
and multi-family residential loans and $2.4 million of non-accrual commercial
business loans, were included with 'Commercial Loans Held for Bulk Sale' at
their then fair value and excluded from non-accrual loans at December 31, 1995
in the above table. See 'Bulk Sale of Certain Commercial Loans' on page 8.
Had non-accrual and restructured loans performed in accordance with their
original terms and conditions, interest income recorded in 1997, 1996, and 1995
would have increased by $1.2 million, $1.9 million and $2.6 million,
respectively.
11
The table below lists the aggregate of non-accrual loans and OREO by type
of collateral as of December 31, 1997, 1996 and 1995:
TOTAL TOTAL TOTAL
AT AT AT
12/31/97 12/31/96 12/31/95
-------- -------- --------
Office/industrial buildings............................................ $ 6,333 $ 9,819 $ 3,668
Single-family residential.............................................. 3,411 6,445 6,186
Condominiums/cooperatives.............................................. 411 1,012 3,090
Land................................................................... 865 1,659 1,712
Commercial business loans.............................................. 431 436 51
Construction........................................................... 2,079 3,169 2,913
Shopping/retail centers................................................ 62 100 106
Multi-family apartments................................................ 1,044 3,422 405
Other.................................................................. 176 87 85
-------- -------- --------
$ 14,812 $ 26,149 $ 18,216
-------- -------- --------
-------- -------- --------
Note: The majority of the non accrual loans and OREO as of December 31,
1997 were located in New York State.
The following table summarizes the activity in OREO during the periods
indicated.
ACTIVITY 1997 1996 1995
-------- ------- ------- -------
(In thousands)
Balance at beginning of year........................................... $10,726 $13,973 $13,772
Real estate acquired in settlement of loans............................ 831 4,080 4,788
Capital improvements................................................... 305 907 1,091
Dispositions........................................................... (2,556) (2,480) (3,598)
Transfer to performing loans........................................... (2,585) (5,236) (1,845)
Net excess cash flow................................................... (439) (147) (141)
Write-downs............................................................ (1,718) (371) (94)
------- ------- -------
Balance at end of year(1).............................................. $ 4,564 $10,726 $13,973
------- ------- -------
------- ------- -------
- ------------
(1) Includes $1.2 million of performing investments in real estate as of
December 31, 1995 which was transferred to performing loan status in 1996.
12
The following table sets forth the types of properties which comprise OREO
and investment in real estate.
12/31/97
--------------------
# OF
TYPE OF PROPERTIES AMOUNT PROPERTIES 12/31/96 12/31/95
------------------ ------ ---------- -------- --------
(Dollars in thousands)
Townhouses, condominiums and cooperatives................... $ 321 1 $ 410 $ 3,090
Office and industrial buildings............................. 951 2 4,496 3,530
Apartment buildings(1)...................................... -- -- -- 1,371
Construction................................................ 2,079 3 3,169 2,913
Land........................................................ 864 3 1,659 1,712
Single-family residential................................... 349 11 992 1,357
Other....................................................... -- -- -- --
------ --- -------- --------
Total.................................................. $4,564 20 $ 10,726 $ 13,973
------ --- -------- --------
------ --- -------- --------
- ------------
(1) Includes $1.2 million of performing investments in real estate as of
December 31, 1995 which was transferred to performing loan status in 1996.
ASSET CLASSIFICATION
Under OTS regulations, the Bank is required to assign risk ratings to all
its assets and to establish prudent allowances for losses. The regulations
include the defined categories of 'substandard,' 'doubtful' and 'loss' as
classified assets. Substandard assets must have one or more defined weaknesses
and are characterized by the distinct possibility that the institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets, with the additional characteristic that
the weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, highly questionable or improbable. Assets
classified as loss are considered uncollectible and of such little value that
their continuance as assets is not warranted without establishment of a specific
reserve in the full amount of the loan or property. Institutions are not
required to establish specific valuation allowances for assets classified as
doubtful, although general allowances should be adjusted to reflect doubtful
assets. In addition, a 'special mention' designation identifies assets that do
not yet warrant classification but nonetheless possess credit or other
deficiencies or potential weaknesses deserving management's close attention.
With respect to assets classified substandard or doubtful, if an OTS examiner
concludes that the existing aggregate general valuation allowances are
inadequate, the examiner will determine the extent of any increase necessary in
the general allowance for loan losses, subject to review by the OTS Field
Manager. For the portion of assets classified as loss, the regulations require
institutions either to establish specific allowances for losses equal to 100% of
the amount classified as loss, or to charge-off the asset.
13
Classified assets, including unfunded commitments, as of December 31, 1997
and 1996 are set forth in the following table:
CLASSIFIED ASSETS
----------------------------------------------
TOTAL TOTAL
SUBSTANDARD DOUBTFUL LOSS 12/31/97 12/31/96
----------- -------- ------- -------- --------
(Dollars in thousands)
Commercial real estate and multi-family
residential loans........................... $ 7,584 -- -- $ 7,584 $ 12,375
1-4 family residential loans.................. 5,902 -- -- 5,902 7,524
Other loans................................... 625 -- -- 625 569
----------- -------- ------- -------- --------
Total classified loans................... 14,111 -- -- 14,111 20,468
Other real estate owned....................... 4,664 -- -- 4,664 10,828
----------- -------- ------- -------- --------
Total classified assets.................. $18,775 -- -- $ 18,775 $ 31,296
----------- -------- ------- -------- --------
----------- -------- ------- -------- --------
The table below summarizes classified assets by type of collateral as of
December 31, 1997, 1996 and 1995:
TOTAL TOTAL TOTAL
12/31/97 12/31/96 12/31/95
-------- -------- --------
Office and industrial buildings........................................ $ 6,333 $ 9,847 $ 3,717
Single-family residential.............................................. 6,333 8,516 7,587
Condominiums/cooperatives.............................................. 411 2,637 3,090
Construction........................................................... 2,079 3,271 3,015
Land................................................................... 865 1,824 2,537
Commercial business loans.............................................. 431 486 501
Shopping/retail centers................................................ 718 762 781
Multi-family apartments................................................ 1,429 3,820 405
Other.................................................................. 176 133 235
-------- -------- --------
Total............................................................. $ 18,775 $ 31,296 $ 21,868
-------- -------- --------
-------- -------- --------
14
SECURITIES
The Bank may invest in various securities, including mortgage-backed
securities, U.S. Treasury obligations and securities of various government
agencies, municipal and state obligations, corporate obligations and short-term
money market instruments.
The following table shows the components of the investment securities
portfolio at the dates indicated:
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(Dollars in thousands)
Available for sale:
Mortgage-backed securities.................................... $119,730 $113,575 $161,961
Corporate bonds............................................... 116 5,180 23,535
U.S. Treasury and agency securities........................... 7,091 17,035 104
Other securities.............................................. -- -- --
-------- -------- --------
126,937 135,790 185,600
Held to maturity:
Mortgage-backed securities.................................... 25,537 29,957 --
-------- -------- --------
$152,474 $165,747 $185,600
-------- -------- --------
-------- -------- --------
In February 1996, the Bank reclassified $35.3 million of fixed rate
mortgage-backed securities from the available-for-sale category to the
held-to-maturity category. At the time of transfer, these securities had a net
unrealized loss of $0.3 million which is being amortized over the remaining life
of the underlying securities.
Securities provide an investment alternative to loans and are periodically
acquired pending the funding of loans, as well as to maintain minimum liquidity
requirements set by the OTS. ('See Regulation -- Equity Risk Investments' and
'Regulation -- Other Restrictions.') With deposits becoming increasingly
sensitive to interest rate movements, most of the Bank's investments in recent
years have been in short-term securities with maturities of five years or less.
For further information, see Note 4 of 'Notes to Consolidated Financial
Statements' at Item 8.
The Bank maintains a significant portfolio of mortgage-backed securities as
a means of investing in housing-related mortgage instruments without the costs
associated with originating mortgage loans for portfolio retention and to
provide liquidity. Mortgage-backed securities are also generally deemed to have
a lesser degree of risk than traditional mortgage loans. At December 31, 1997,
the Bank's mortgage-backed securities portfolio amounted to $145.3 million or
16.6% of total assets. Of this amount, $139.9 million or 96% are U.S. Government
Agency securities which carry the highest investment grade and are readily
liquid through active markets. At December 31, 1997, the mortgage-backed
security portfolio had $119.8 million of adjustable rate securities (with annual
and lifetime caps) and $25.5 million of fixed rate securities. Generally, fixed
rate securities either fully amortize over 15 years or have balloon payments due
after 5 years. All of the Bank's investments in recent years have been in such
'Agency' securities. By acquiring mortgage-backed securities, management seeks
to achieve a positive spread over the cost of funds used to purchase these
securities.
The unrealized holding losses of the Bank's securities portfolio totalled
$0.1 million at December 31, 1997. The offset for unrealized holding gains
(losses) on available-for-sale securities is shown as a separate component of
stockholders' equity, after adjustments for deferred income tax effects. These
securities are subject to future market value adjustments depending on future
interest rate changes and periodic rate adjustments on adjustable rate
mortgage-backed securities.
During 1989, the Bank securitized approximately $100.0 million of seasoned
one-year ARMs, originated primarily in the Hudson Valley, with FHLMC. At the
time of securitization, an agreement was entered into requiring the Bank to
repay the FHLMC for any foreclosure losses incurred on that portfolio through
1999. During 1997, payments of $64,000 were made on this agreement. Since 1989,
15
payments on this agreement have totaled $670,000. The outstanding balance on
these mortgage-backed securities was approximately $24.2 million at December 31,
1997, $27.8 million at December 31, 1996 and $32.7 million at December 31, 1995.
SOURCES OF FUNDS
GENERAL
Deposit accounts, including savings accounts, have been an important source
of funds for lending and for other general business purposes. The Bank also
obtains funds from borrowings under repurchase agreements, proceeds from
maturing securities, loan repayments, proceeds from loan sales, cash flow from
operations and borrowings from the FHLB of New York.
The Bank seeks to obtain funds to finance its loan originations and
operations from the most competitively priced sources. The Bank has followed a
policy of pricing its deposits based primarily upon its borrowing alternatives
and upon prevailing local competitive pricing.
DEPOSITS
Consumer and commercial deposits are attracted principally from within the
Bank's primary market areas through the offering of a selection of deposit
instruments including consumer and commercial demand deposit accounts,
negotiable order of withdrawal ('NOW') accounts, money market accounts, passbook
accounts, certificates of deposit and retirement plans.
During 1997, the Bank opened five additional retail branches, four of which
are in-store locations. This brings the total number of branches to sixteen, of
which nine are in-store locations. All in-store banking centers are open for
extended hours seven days a week and utilize the latest technology and customer
delivery systems for maximum customer convenience.
In July 1995, the Bank introduced, via a direct mailing campaign, a new
checking account program under the banner 'Totally Free Checking.' The program
offers customers a choice of seven different checking account products, each
tailored to different customer needs. The Bank has continued to aggressively
market this program which has increased the Bank's share of local market
deposits, particularly demand deposits. Total deposits under the 'Totally Free
Checking' program were $26.5 million and $16.5 million as of December 31, 1997
and 1996, respectively.
ALLOWANCE FOR LOAN LOSSES
At December 31, 1997, the allowance for loan losses amounted to $9.4
million compared with $8.7 million at December 31, 1996. The allowance for loan
losses is maintained at a level which management considers adequate based on its
regular review of the loan portfolios taking into consideration the likelihood
of repayment, the diversity of the borrowers, the type of loan, the quality of
the collateral, current market conditions and associated risks. The allowance
for loan losses is not allocated by loan category. (See 'Provision for loan
losses,' included in Management's Discussion and Analysis of Financial Condition
and Results of Operations' at Item 7 and Notes 3 and 5 of 'Notes to Consolidated
Financial Statements' at Item 8).
16
The following table sets forth the activity in the allowance for loan
losses during the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------- -------
(Dollars in thousands)
Balance at beginning of year...................... $8,652 $8,259 $18,195 $19,726 $20,293
------ ------ ------ ------- -------
Provision for loan losses......................... 1,850 850 1,525 120 400
------ ------ ------ ------- -------
Loans charged-off:
1-4 family residential real estate........... 1,656 457 562 1,317 482
Commercial real estate and multi-family
residential................................ 101 208 1,395 667 358
Commercial business.......................... 36 6 -- 123 363
Consumer..................................... 85 62 108 92 365
------ ------ ------ ------- -------
Total charge-offs....................... 1,878 733 2,065 2,199 1,568
------ ------ ------ ------- -------
Recoveries:
Commercial real estate and multi-family
residential(1)............................. 647 110 308 50 6
Commercial business.......................... 128 93 43 42 10
Consumer..................................... 22 73 254 456 585
------ ------ ------ ------- -------
Total recoveries........................ 797 276 605 548 601
------ ------ ------ ------- -------
Net charge-offs................................... 1,081 457 1,460 1,651 967
Writedowns of loans transferred to Commercial
Loans Held for Bulk Sale(2)..................... -- -- 10,001 -- --
------ ------ ------ ------- -------
Balance at end of year............................ $9,421 $8,652 $8,259 $18,195 $19,726
------ ------ ------ ------- -------
------ ------ ------ ------- -------
Ratio of:
Net charge-offs to average loans
outstanding................................ 0.2% 0.1% 0.3% 0.4% 0.2%
------ ------ ------ ------- -------
------ ------ ------ ------- -------
Net charge-offs to allowance for loan losses
at beginning of year....................... 12.5% 5.5% 8.0% 8.4% 4.8%
------ ------ ------ ------- -------
------ ------ ------ ------- -------
- ------------
(1) Once a real estate loan is foreclosed, the asset balance is transferred to
OREO. Any recoveries on foreclosed assets are credited to OREO expense;
therefore, recoveries credited to the allowance for loan losses tend to be
low.
(2) See Bulk Sale of Certain Commercial Loans on page 8.
BORROWINGS
As of December 31, 1997, the Bank had $168.8 million in outstanding
borrowings, consisting of Federal Home Loan Bank ('FHLB') advances and
borrowings under repurchase agreements.
FHLB SYSTEM BORROWINGS
The FHLB of New York functions as a central reserve bank providing credit
for member savings banks, savings and loan associations and certain other member
financial institutions. As a member of the FHLB of New York, the Bank is
required to own capital stock in the FHLB of New York. The capital stock owned
by the Bank is pledged to the FHLB as collateral for any advances made by the
FHLB to the Bank. The Bank may apply for advances from the FHLB, subject to the
limitations noted below and the pledging of acceptable collateral. Collateral
acceptable to the FHLB includes mortgage loans, mortgage-backed securities,
securities of the United States or any agency thereof, and deposits at the FHLB.
Other collateral is subject to the specific approval of the FHLB, and must be
housing related. Advances are made pursuant to several different credit
programs. Each credit program has its
17
own interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based either on a fixed percentage of a savings
bank's assets or on the FHLB of New York's assessment of the savings bank's
credit worthiness. The FHLB of New York is required to review its credit
limitations and standards at least once every six months. The FHLB's current
collateralization requirement is 110% for most assets acceptable as collateral.
Changes in the FHLB's policies regarding credit and collateral can impact the
Bank by changing the level of advances which can be drawn against a given pool
of collateral. The FHLB may change its policies at its discretion. As of
December 31, 1997, the Bank had $35.0 million of advances outstanding. The
maximum amount of FHLB advances outstanding at any month-end during 1997 was
$35.0 million. As of December 31, 1997, the Bank's maximum borrowing authority
from the FHLB was $264.9 million, or 30% of total assets, subject to collateral
availability. (See 'Regulation -- Capital Requirements' at Item 1.) Increases in
the collateral requirement for the Bank would result in lower advances to the
Bank by the FHLB, require the Bank to repay current advances or require the Bank
to provide additional collateral.
At December 31, 1997, the Bank was approved by the FHLB of New York for a
$84.7 million line of credit under the FHLB's 'Overnight Advance Program.'
Advances under this program carry competitive market rates and are used to meet
short-term funding needs. The advances are subject to various terms and
conditions, including the Bank's overall borrowing limit from the FHLB and
collateral requirements. As of December 31, 1997, the Bank had $31.9 million of
outstanding advances pursuant to such line of credit. The line of credit is
subject to annual renewal. The current line will expire in August 1998. (See
Borrowings from the Federal Home Loan Bank table set forth in Note 8 of 'Notes
to Consolidated Financial Statements' at Item 8 and 'Regulation.')
OTHER BORROWINGS
The Bank uses borrowings under repurchase agreements as a short-term
funding source; all such repurchase agreements are with dealers who must meet
the Bank's internal selection criteria. At December 31, 1997 these agreements
totaled $97.1 million. The Bank also sold certain municipal investment
securities in 1984 to a unit investment trust, which, under certain
circumstances, can be put back to the Bank; this sale was accounted for as a
financing and has a remaining balance of $4.8 million as of December 31, 1997.
The maximum amounts of borrowings under repurchase agreements and borrowings
under the unit investment trust at any month end during 1997 were $124.5 million
and $4.9 million, respectively. The average repurchase agreements outstanding
during 1997, 1996 and 1995 were $112.5 million, $70.7 million and $72.0 million,
respectively. (See Note 9 of 'Notes to Consolidated Financial Statements' at
Item 8.)
The Bank actively manages its interest rate sensitivity and uses interest
rate hedge agreements to help achieve certain targets. See the 'Asset/Liability
and Interest Rate Risk Management' section under 'Item 7a -- Quantitative And
Qualitative Disclosure About Market Risk' located elsewhere herein.
18
The following tables show balances and weighted average rates paid by
deposit categories and maturities of certificates of deposit by rate range at
the indicated dates.
DECEMBER 31,
--------------------------------------------
1997 1996
-------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
-------- -------- -------- --------
(Dollars in thousands)
Money market and demand:
Checking accounts............................................. $ 37,282 -- $ 25,787 --
NOW and Super NOW checking.................................... 15,450 2.16% 15,796 2.16%
Money Market Deposits......................................... 140,387 4.81 126,233 4.56
-------- --------
Total money market and demand............................ 193,119 3.67 167,816 3.64
-------- --------
Savings:
Passbook accounts............................................. 96,581 3.26 93,061 3.27
Clubs......................................................... 398 3.00 310 3.00
-------- --------
Total savings............................................ 96,979 3.26 93,371 3.27
-------- --------
Certificate accounts (see below)................................... 330,279 5.72 314,059 5.56
-------- --------
Total Deposits..................................................... $620,377 4.70% $575,246 4.63%
-------- --------
-------- --------
CERTIFICATES OF DEPOSIT AT DECEMBER 31, 1997
----------------------------------------------------------
MATURING IN
--------------------------------------------
AMOUNT 1998 1999 2000 THEREAFTER
-------- -------- ------- ------- ----------
(Dollars in thousands)
3 - 3.99%(1)...................................... $ 1,168 $ 1,155 $ 12 -- $ 1
4 - 5.99%......................................... 261,663 184,844 50,888 $20,965 4,966
6 - 7.99%......................................... 64,841 3,957 18,269 39,262 3,353
8 - 9.99%......................................... 1,589 961 105 22 501
10 - 11.99%......................................... 1,018 36 71 201 710
-------- -------- ------- ------- ----------
$330,279(2) $190,953 $69,345 $60,450 $9,531
-------- -------- ------- ------- ----------
-------- -------- ------- ------- ----------
- ------------
(1) Primarily matured certificates of deposits in which the customer has not
provided reinvestment instructions; these deposits earn at the passbook
savings rate.
(2) Includes $30.7 million in 'jumbo' (over $100,000) certificates of deposit
which mature as follows: $22.7 million in 1998, $3.8 million in 1999, $3.0
million in 2000 and $1.2 million thereafter.
19
RATE AND MATURITY ANALYSIS
The following table sets forth, as of December 31, 1997, the maturity and
rate sensitivity of interest-earning assets (excluding non-performing and cash
basis assets) and interest-bearing liabilities as well as the weighted average
rates and cost of funds.
LESS THAN 1 YEAR 1-5 YEARS 5-10 YEARS OVER 10 YEARS
---------------- --------------- ---------------- ---------------
INTEREST-EARNING ASSETS AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE TOTAL
- --------------------------------------- --------- ---- -------- ---- -------- ----- ------- ----- --------
(Dollars in thousands)
Residential mortgage loans............. $ 143,302 8.12% $112,813 7.68% $102,688 7.39% $26,417 7.73% $385,220
Commercial real estate loans........... 116,312 9.35 108,762 8.66 6,064 8.31 263 9.81 231,401
Commercial business loans.............. 7,609 9.24 393 9.14 -- -- -- -- 8,002
Installment loans...................... 22,373 9.24 11,339 9.52 5,960 9.35 229 10.08 39,901
Mortgage backed securities............. 94,623 6.55 42,699 5.99 6,050 6.53 1,895 6.37 145,267
Other securities....................... 10,104 7.05 7,146 7.19 28 8.13 -- -- 17,278
--------- -------- -------- ------- --------
Total interest-earning assets.......... 394,323 8.17 283,152 7.86 120,790 7.49 28,804 7.68 827,069
--------- -------- -------- ------- --------
INTEREST-BEARING LIABILITIES
- ---------------------------------------
Time deposits.......................... 190,954 5.47 138,315 6.04 963 10.21 47 9.16 330,279
Money market deposits.................. 139,030 4.77 -- -- -- -- -- -- 139,030
FHLB Advances.......................... 66,900 5.72 -- -- -- -- -- -- 66,900
Repurchase agreements.................. 97,102 5.80 -- -- -- -- 4,834 8.70 101,936
Core deposits:
Savings........................... 98,336 3.18 -- -- -- -- -- -- 98,336
Demand............................ 52,834 1.28 -- -- -- -- -- -- 52,834
Escrow............................ 4,563 1.22 -- -- -- -- -- -- 4,563
--------- -------- -------- ------- --------
Total static interest-bearing
liabilities.......................... 649,719 4.68 138,315 6.04 963 10.21 4,881 8.70 793,878
Adjustment:
Core deposit accounts............. (104,315) 50,649 30,012 23,654 --
Interest rate swap................ (20,000) 20,000 -- -- --
Interest rate collar.............. (65,000) 65,000 -- -- --
--------- -------- -------- ------- --------
Total interest-bearing liabilities..... 460,404 273,964 30,975 28,535 793,878
--------- -------- -------- ------- --------
Excess (deficiency) of
interest-earning assets over
interest-bearing liabilities.... $ (66,081) $ 9,188 $ 89,815 $ 269 $ 33,191
--------- -------- -------- ------- --------
--------- -------- -------- ------- --------
- ------------
For purposes of the above Rate and Maturity Analysis:
Fixed rate assets are scheduled by contractual maturity, and
adjustable rate assets are scheduled by the next repricing date.
Normal amortization and prepayment estimates have been applied to
both fixed rate and adjustable rate assets, where appropriate.
For purposes of measuring interest sensitivity, interest-bearing
liabilities are reduced by the amount of core deposits, interest rate
swaps, and interest rate collars. Core deposits are estimated to be
withdrawn at rates ranging from 15% to 20% per year.
20
SERVICE CORPORATION ACTIVITIES
OTS regulations limit the Bank's equity investment in service corporations
to 10% of total assets. As of December 31, 1997, the Bank's investment in
service corporation subsidiaries was $6.7 million, or 0.7% of total assets. Such
investments eliminate in consolidation. At December 31, 1997, the Bank's
subsidiary operations included six corporations each of which is 100% owned by
the Bank. The following is a brief description of the Bank's two significant
service corporations and their principal activities. The Bank owns several other
service corporations which are either inactive or primarily serve as a holding
company for assets acquired through foreclosure or are otherwise held for
disposition.
PSB ASSOCIATES, INC.
PSB Associates, Inc. ('PSB Associates') was organized in 1983 as a life
insurance agency. Its principal office is located at 25 Market Street,
Poughkeepsie, New York. Through agreements entered into with insurance companies
and general agencies, PSB Associates, as agent, offers diversified life
insurance products and services through an insurance office of the Bank and
financial service representatives located in the Bank's branches. Since 1988,
through agreements with a third party broker/dealer, the product list was
expanded to include mutual funds, variable annuities, and unit investment
trusts. Effective January 1, 1995, the Bank began using Prime Capital Services,
Inc., a Poughkeepsie, New York based broker/dealer, to provide these products.
Prior to 1995, the Bank used GNA Securities, Inc., a Seattle, Washington based
broker/dealer. Effective February 1997, PSB Associates launched
'HudsonTrader'sm' Discount Brokerage Service' which offers discount trading
through Prime Capital Services, Inc. HudsonTrader Discount Brokerage Service
affords individuals the opportunity to purchase and sell a variety of
investment products including stocks, bonds and mutual funds. Investments
purchased through HudsonTrader Discount Brokerage Service are not FDIC insured
and are not deposits of the Bank.
In connection with the Amended and Restated Agreement and Plan of Merger,
dated as of October 22, 1997, between Poughkeepsie Financial Corp., Bank of the
Hudson and HUBCO, Inc., the Federal Reserve Bank of New York rendered its
approval of the merger with the condition that Bank of the Hudson or its
subsidiary, PSB Associates, Inc., effective on the consummation of the merger,
would not engage in the sale of any new, or the renewal of existing, insurance
policies and that it would cease any life insurance activities and the sale of
annuity products which may be impermissible under banking regulations within two
years from consummation of the merger. It is expected that this requirement of
the Federal Reserve Bank of New York will substantially curtail the activities
of PSB Associates, Inc. upon consummation of the merger.
PSB BUILDING CORP.
PSB Building Corp. was organized in 1993. PSB Building Corp. holds the
leasehold interest to a 100,000 square foot office building located at 249 Main
Mall, Poughkeepsie, New York, which the Bank acquired in 1993. A portion of the
249 Main Mall building serves as the Bank's headquarters.
OTHER SERVICES
SAVINGS BANK LIFE INSURANCE
Savings banks in New York may offer Savings Bank Life Insurance ('SBLI')
with a maximum policy coverage of $50,000 and up to $350,000 of Financial
Institutions Group Life Insurance. The Bank's SBLI program is administered
through the Savings Bank Life Insurance Fund, a corporate body established by
the New York legislature. Although the Bank's employees administer the Bank's
SBLI program, the Bank is not liable under any policy, and premiums are not at
the Bank's disposal. The Bank's SBLI program is kept separate from the rest of
the Bank's operations for purposes of accounting and investment. Any surplus
earned by the program must be maintained to meet losses incurred by the program
or to pay dividends to policyholders and does not accrue to the benefit of the
Bank's general operations. Upon any discontinuance of the program, the Bank
would be required to transfer, perform or reinsure the life insurance policies
and to transfer to the Savings Bank Life Insurance Fund all assets
21
remaining after payment of the program's liabilities. As of December 31, 1997,
the Bank's SBLI program had $347.2. million of ordinary and group policies in
force and a surplus of $1.4 million. SBLI is subject to regulation by the New
York State Banking Department and the New York State Insurance Department.
In connection with the Amended and Restated Agreement and Plan of Merger,
dated as of October 22, 1997, among Poughkeepsie Financial Corp., Bank of the
Hudson and HUBCO, Inc., the Federal Reserve Bank of New York rendered its
approval of the merger with the condition that Bank of the Hudson and its
subsidiaries will cease to engage in savings bank life insurance activities. It
is expected that this requirement will substantially curtail or eliminate the
Bank's activities with respect to savings bank life insurance.
COMPETITION
As with the thrift and banking industries generally, the Company
experiences substantial competition in attracting and retaining deposits and in
lending funds. The primary factors in competing for deposits are the ability to
offer attractive rates and the availability of convenient office locations.
Direct competition for deposits comes from other savings banks, savings and loan
associations and commercial banks, and credit unions, many of which have
substantially greater resources than the Company. The Hudson Valley Employees
Federal Credit Union is a major competitor in the Company's Dutchess County
market area. Significant competition for savings deposits also comes from
broker/dealers, mutual funds and corporate and government securities.
EMPLOYEES
At December 31, 1997, the Company and its subsidiaries employed 239
full-time employees and 43 part-time employees, none of whom are represented by
a collective bargaining group. Management believes it has a good relationship
with its employees.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company. The description of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, does not purport to be complete and is qualified in its entirety by
reference to applicable laws and regulations.
GENERAL
The OTS has extensive authority over the operations of savings
associations. As part of this authority, savings associations are required to
file periodic reports with the OTS and are subject to periodic examinations by
the OTS and the FDIC. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and savings
associations are prohibited from engaging in any activities not permitted by
such laws and regulations. Those laws and regulations generally are applicable
to all federally chartered savings associations and may also apply to state-
chartered savings associations. Such regulation and supervision is primarily
intended for the protection of depositors.
On December 19, 1991, the Federal Deposit Insurance Corporation Improvement
Act of 1991 ('FDICIA') was enacted into law. The FDICIA provides for, among
other things, the recapitalization of the Bank Insurance Fund ('BIF'); the
authorization of the FDIC to make emergency special assessments under certain
circumstances against BIF members and members of the Savings Association
Insurance Fund ('SAIF'); the establishment of risk-based deposit insurance
premiums; and improved examinations and reporting requirements. The FDICIA also
provides for enhanced federal supervision of depository institutions based on,
among other things, an institution's capital level. See 'Prompt Corrective
Action.'
The OTS' enforcement authority over all savings associations and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal
22
orders and to initiate injunctive actions. In general, these enforcement actions
may be initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS.
INSURANCE OF ACCOUNTS
The deposits of the Bank are insured up to $100,000 per insured member (as
defined by law and regulation) by the SAIF and are backed by the full faith and
credit of the United States Government. SAIF is administered by the FDIC. As
insurer, the FDIC is authorized to conduct examinations of, and to require
reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured
institution from engaging in any activity the FDIC determines by regulation or
order to pose a serious threat to the FDIC. The FDIC also has the authority to
initiate enforcement actions against savings associations, after giving the OTS
an opportunity to take such action.
Under current FDIC regulations, SAIF member institutions are assigned to
one of three capital groups which are based solely on the level of an
institution's capital -- 'well-capitalized,' adequately-capitalized,' 'and
undercapitalized' -- which are defined in the same manner as the regulations
establishing the prompt corrective action system under Section 38 of the Federal
Deposit Insurance Act ('FDIA'). These three groups are then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. As of December 31, 1997, these nine assessment risk
classifications carry premiums ranging from 0% for well-capitalized, healthy
institutions to .27% for undercapitalized institutions with substantial
supervisory concerns. The insurance premium applicable to the Bank as of
December 31, 1997 was 0% of insured deposits.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged in or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
The BIF fund met its target reserve level in September 1995, but the SAIF
fund was not expected to meet its target reserve level until at least 2002.
Consequently, in late 1995, the FDIC approved a final rule regarding deposit
insurance premiums which, effective with respect to the semiannual premium
assessment beginning January 1, 1996, reduced deposit insurance premiums for BIF
member institutions to zero basis points (subject to an annual minimum of
$2,000) for institutions in the lowest risk category. Deposit insurance premiums
for SAIF members were maintained at their existing levels (23 basis points for
institutions in the lowest risk category).
On September 30, 1996, President Clinton signed into law legislation which
eliminated the premium differential between SAIF-insured institutions and
BIF-insured institutions by recapitalizing the SAIF's reserves to the required
ratio. The legislation provided that all SAIF member institutions pay a one-time
special assessment to recapitalize the SAIF, which in the aggregate will be
sufficient to bring the reserve ratio in the SAIF to 1.25% of insured deposits.
The legislation also provided for the merger of the BIF and the SAIF, with such
merger being conditioned upon the prior elimination of the thrift charter.
Effective October 8, 1996, FDIC regulations imposed a one-time special
assessment equal to 65.7 basis points for all SAIF-assessable deposits as of
March 31, 1995, which was collected on November 27, 1996. The Bank's one-time
assessment amounted to $2.6 million. Net of related tax benefits, the one-time
special assessment amounted to $1.6 million which immediately reduced the Bank's
capital by such an amount. Nevertheless, management does not believe that this
one-time special assessment will have a material adverse effect on the Bank's
consolidated financial condition and the Bank continues to be in full compliance
with all regulatory capital requirements.
23
In the fourth quarter of 1996, the FDIC lowered the assessment rates for
SAIF members to reduce the disparity in the assessment rates paid by BIF and
SAIF members. Beginning October 1, 1996, effective SAIF rates generally ranged
from zero basis points to 27 basis points, except that during the fourth quarter
of 1996, the rates for SAIF members ranged from 18 basis points to 27 basis
points in order to include assessments paid to the Financing Corporation
('FICO'). From 1997 through 1999, SAIF members will pay 6.4 basis points to fund
the FICO while BIF member institutions will pay approximately 1.3 basis points.
While the Bank's insurance premiums were reduced from 23 basis points to 0 basis
points, the Bank is required to pay 6.4 basis points related to funding for the
FICO debt.
THRIFT CHARTER
Congress has been considering legislation in various forms that would
require federal thrifts, such as the Bank, to convert their charters to national
or state bank charters. Recent legislation required the Treasury Department to
prepare for Congress a comprehensive study on development of a common charter
for federal savings associations and commercial banks; and, in the event that
the thrift charter was eliminated by January 1, 1999, would require the merger
of the BIF and the SAIF into a single Deposit Insurance Fund on that date. The
Bank cannot determine whether, or in what form, such legislation may eventually
be enacted and there can be no assurance that any legislation that is enacted
would not adversely affect the Bank.
CAPITAL REQUIREMENTS
Federally insured savings associations are required to maintain minimum
levels of regulatory capital. The OTS has established capital standards
applicable to all savings associations. These standards generally must be as
stringent as the comparable capital requirements imposed on national banks. The
OTS also is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis.
Current OTS capital standards require savings associations to satisfy three
different capital requirements. Under these standards, savings associations must
maintain 'tangible' capital equal to 1.5% of adjusted total assets, 'core'
capital equal to 3% of adjusted total assets depending on the OTS's capital
adequacy evaluation and 'total' capital (a combination of core and
'supplementary' capital) equal to 8.0% of 'risk-weighted' assets. As discussed
below, under the OTS' prompt corrective action regulations, the core capital
ratio generally must be at least 4.0%. For purposes of the regulation, core
capital generally consists of common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
non-withdrawable accounts and pledged deposits, and 'qualifying supervisory
goodwill.' Unrealized gains (losses) on available-for-sale securities are not
included in determining core capital. Tangible capital is given the same
definition as core capital but does not include qualifying supervisory goodwill
and is reduced by the amount of all the savings association's intangible assets,
except for mortgage servicing rights and deferred tax assets which are
includable within certain specified limits.
Both core and tangible capital are further reduced where applicable by an
amount equal to a savings association's debt and equity investments in
subsidiaries engaged in activities not permissible to national banks (other than
subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies).
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no capital) for assets such as cash to 100% for repossessed
assets or loans more than 90 days past due. Single-family residential real
estate loans which are not past-due or non-performing and which have
24
been made in accordance with prudent underwriting standards are assigned a 50%
level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with a greater than 'normal' level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating the risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. An institution with a greater
than 'normal' interest rate risk is defined as an institution that would suffer
a loss of net portfolio value exceeding 2.0% of the estimated market value of
its assets in the event of a 200 basis point increase or decrease (with certain
minor exceptions) in interest rates. The interest rate risk component will be
calculated, on a quarterly basis, as one-half of the difference between an
institution's measured interest rate risk and 2.0%, multiplied by the market
value of its assets. The rule also authorizes the director of the OTS, or his
designee, to waive or defer an institution's interest rate risk component on a
case-by-case basis. The final rule was originally effective as of January 1,
1994, subject however to a two quarter 'lag' time between the reporting date of
the data used to calculate an institution's interest rate risk and the effective
date of each quarter's interest rate risk component. However, in October 1994
the Director of the OTS indicated that it would waive the capital deductions for
institutions with a greater than 'normal' risk until the OTS publishes an
appeals process. In August 1995, the OTS indefinitely delayed implementation of
its interest rate risk regulation. On August 21, 1995, the OTS released Thrift
Bulletin 67 which established (i) an appeals process to handle requests for
adjustments' to the interest rate risk component and (ii) a process by which
'well-capitalized' institutions may obtain authorization to use their own
interest rate risk model to determine their interest rate risk component. The
Director of the OTS indicated, concurrent with the release of Thrift Bulletin
67, that the OTS will continue to delay the implementation of the capital
deduction for interest rate risk pending the testing of the appeals process set
forth in Thrift Bulletin 67.
Management of the Bank believes that the OTS' implementation of an interest
rate risk component to the risk-based capital requirement will not adversely
affect the Bank.
The following table sets forth the Bank's compliance with each of the
above-described capital requirements at December 31, 1997.
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
-------- -------- ----------
(Dollars in thousands)
Stockholders' equity under GAAP -- Holding Company........................... $ 72,571 $ 72,571 $ 72,571
Adjustments: Primarily loss at Holding Company............................... 489 489 489
-------- -------- ----------
Stockholders' equity under GAAP -- Bank...................................... 73,060 73,060 73,060
Unrealized losses on available for sale securities, net of tax............... 124 124 124
Limitation on deferred tax assets............................................ (13,224) (13,224) (13,224)
General allowance for loan losses (to extent allowable)...................... n/a n/a 7,220
-------- -------- ----------
Regulatory capital........................................................... 59,960 59,960 67,180
Minimum required regulatory capital.......................................... 12,943 34,522 46,232
-------- -------- ----------
Excess....................................................................... $ 47,017 $ 25,438 $ 20,948
-------- -------- ----------
-------- -------- ----------
Regulatory capital as a percent of assets(1)................................. 6.95% 6.95% 11.62%
Minimum required............................................................. 1.50% 4.00% 8.00%
-------- -------- ----------
Excess....................................................................... 5.45% 2.95% 3.62%
-------- -------- ----------
-------- -------- ----------
- ------------
(1) Tangible and core capital are computed as a percentage of adjusted total
assets of $863.0 million. Risk-based capital is computed as a percentage of
total risk-weighted assets of $577.9 million.
25
PROMPT CORRECTIVE ACTION
Under Section 38 of the FDIA as added by the 'FDICIA', each federal banking
agency is required to implement a system of prompt corrective action for
institutions which it regulates. In early September 1992, the federal banking
agencies, including the OTS, adopted substantially similar regulations which are
intended to implement Section 38 of the FDIA. These regulations became effective
December 19, 1992. Under the regulations, an institution shall be deemed to be
(i) 'well-capitalized' if it has total risk-based capital of 10.0% or more, has
a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital
ratio of 5.0% or more and is not subject to any order or final capital directive
to meet and maintain a specific capital level for any capital measure; (ii)
'adequately-capitalized' if it has a total risk-based capital ratio of 8.0% or
more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage
capital ratio of 4.0% or more (3.0% under certain circumstances) and does not
meet the definition of 'well-capitalized'; (iii) 'undercapitalized' if it has a
total risk-based capital ratio that is less than 8.0%, a Tier I risk-based
capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is
less than 4.0% (3.0% under certain circumstances); (iv) 'significantly
undercapitalized' if it has a total risk-based capital ratio that is less than
6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I
leverage capital ratio that is less than 3.0%; and (v) 'critically
undercapitalized' if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Section 38 of the FDIA and the regulations
promulgated thereunder also specify circumstances under which a federal banking
agency may reclassify a well-capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category (except that the FDIC may not reclassify a significantly
undercapitalized institution as critically undercapitalized). At December 31,
1997, the Bank was in the 'well-capitalized' category.
LIQUIDITY REQUIREMENTS
All savings associations are required to maintain an average daily balance
of liquid assets equal to a certain percentage of the sum of its average daily
balance of net withdrawable deposit accounts and borrowings payable in one year
or less. The liquidity requirement may vary from time to time (between 4% and
10%) depending upon economic conditions and savings flows of all savings
associations. At the present time, the required minimum liquid asset ratio is
4%. The Bank was in compliance with this requirement throughout the year.
SAFETY AND SOUNDNESS
FDICIA requires each federal banking regulatory agency to prescribe by
regulation or guideline, standards for all insured depository institutions and
depository institution holding companies relating to (i) internal controls,
information systems and audit systems; (ii) loan documentation; (iii) credit
underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi)
compensation, fees and benefits; and (vii) such other operational and managerial
standards as the agency determines to be appropriate. The compensation standards
would prohibit employment contracts or other compensatory arrangements that
provide excess compensation, fees or benefits or could lead to material
financial loss. In addition, each federal banking regulatory agency must
prescribe, by regulation or guideline, standards relating to asset quality,
earnings and stock valuation as the agency determines to be appropriate. On July
10, 1995, the federal banking agencies, including the OTS, adopted final rules
and proposed guidelines concerning standards for safety and soundness required
to be prescribed by regulation pursuant to Section 39 of the FDIA. In general,
the standards relate to (1) operational and managerial matters; (2) asset
quality and earnings; and (3) compensation. The operational and managerial
standards cover (a) internal controls and information systems, (b) internal
audit system, (c) loan documentation, (d) credit underwriting, (e) interest rate
exposure, (f) asset growth, and (g) compensation, fees and underwriting. Under
the proposed asset quality and earnings standards, a savings association would
be required to establish and maintain systems to (i) identify problem assets and
prevent deterioration in those assets, and (ii) evaluate and monitor earnings
and ensure that earnings are sufficient to maintain adequate capital reserves.
Finally, the proposed compensation standard states that compensation will be
considered excessive if it is unreasonable or disproportionate to the services
actually performed by the individual
26
being compensated. If a savings association fails to meet any of the standards
promulgated by regulation, then such institution will be required to submit a
plan within 30 days to the OTS specifying the steps it will take to correct the
deficiency. In the event that a savings association fails to submit or fails in
any material respect to implement a compliance plan within the time allowed by
the federal banking agency, Section 39 of the FDIA provides that the OTS must
order the institution to correct the deficiency and may (1) restrict asset
growth; (2) require the savings association to increase its ratio of tangible
equity to assets; (3) restrict the rates of interest that the savings
association may pay; or (4) take any other action that would better carry out
the purpose of prompt corrective action. On August 27, 1996, the federal banking
agencies, including the OTS, adopted final guidelines substantially as proposed.
The Bank believes that it has been and will continue to be in full compliance
with each of the standards as they have been adopted by the OTS.
QUALIFIED THRIFT LENDER (QTL) TEST
Under Section 2303 of the Economic Growth and regulatory Paperwork
Reduction Act of 1996, a savings association can comply with the QTL test by
either meeting the QTL test set forth in the Home Owners' Loan Act, as amended
('HOLA'), and implementing regulations or qualifying as a domestic building and
loan association as defined in Section 7701(a)(19) of the Internal Revenue Code
of 1986, as amended (the 'Code'). A savings association that does not comply
with the QTL Test must either convert to a bank charter or comply with the
following restrictions on its operations: (i) the association may not engage in
any new activity or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (ii) the branching
powers of the association shall be restricted to those of a national bank; (iii)
the association shall not be eligible to obtain any advances from its FHLB; and
(iv) payment of dividends by the association shall be subject to the rules
regarding payment of dividends by a national bank. Upon the expiration of three
years from the date the association ceases to be a QTL, it must cease any
activity and not retain any investment not permissible for a national bank and
immediately repay any outstanding FHLB advances (subject to safety and soundness
considerations).
The QTL Test set forth in the HOLA requires that Qualified Thrift
Investments ('QTIs') represent 65% of portfolio assets. Portfolio assets are
defined as total assets less intangibles, property used by a savings association
in its business and liquidity investments in an amount not exceeding 20% of
assets. Generally, QTIs are residential housing related assets. The 1996
amendments allow small business loans, credit card loans, student loans and
loans for personal, family and household purposes to be included without
limitation as qualified investments. At December 31, 1997, approximately 78.1%
of the Bank's assets were invested in QTIs, which was in excess of the
percentage required to qualify the Bank under the QTL test in effect at that
time.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS
OTS regulations govern capital distributions by savings associations, which
include cash dividends, stock redemptions or repurchases, cash-out mergers,
interest payments on certain convertible debt and other transactions charged to
the capital account of a savings association to make capital distributions.
Generally, the regulation creates a safe harbor for specified levels of capital
distributions from associations meeting at least their minimum capital
requirements, so long as such associations notify the OTS and receive no
objection to the distribution from the OTS. Savings institutions and
distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.
Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its 'surplus capital ratio' at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The surplus capital ratio'
is defined to mean the percentage by which the association's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. 'Fully phased-in capital requirement' is defined to mean an
association's capital requirement under the statutory and regulatory standards
applicable on December 31, 1994, as modified to reflect
27
any applicable individual minimum capital requirement imposed upon the
association. Tier 2 associations, which generally are associations that before
and after the proposed distribution meet or exceed their minimum capital
requirements, may make capital distributions over the most recent four quarter
period up to a specified percentage of their net income during that four quarter
period, depending on how close the association is to meeting its fully phased-in
capital requirements. Tier 2 associations that meet all capital requirements are
permitted to make distributions totaling up to 75% of net income over the four
quarter period. Tier 3 associations, which generally are associations that do
not meet current minimum capital requirements, cannot make any capital
distribution without obtaining OTS approval prior to making such distributions.
In order to make distributions under these safe harbors, Tier 1 and Tier 2
associations must submit written notice to the OTS 30 days prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. In addition, a Tier 1 association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination. The Bank
currently is a Tier 1 institution for purposes of the regulation on capital
distribution.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
On January 7, 1998, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, a savings
institution that would remain at least 'adequately capitalized' following the
capital distribution and that meets other specified requirements, would not be
required to provide any notice or application to the OTS for cash dividends
below a specified amount. A savings institution is 'adequately capitalized' if
it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based
capital ratio of 4.0% or more, a Tier 1 leverage capital ratio of 4.0% or more
(or 3% or more if the savings institution is assigned a composite rating of 1),
and does not meet the definition of 'well capitalized.' Because the Bank is a
subsidiary of the Company, the proposal, however would require the Bank to
provide notice to the OTS of its intent to make a capital distribution, unless
an application is otherwise required. The Bank does not believe that the
proposal will adversely affect its ability to make capital distributions if it
is adopted substantially as proposed.
POLICY STATEMENT ON NATIONWIDE BRANCHING
Effective May 11, 1992, the OTS amended its policy statement on branching
by federally chartered savings associations to delete then-existing regulatory
restrictions on the branching authority of such associations and to permit
nationwide branching to the extent allowed by federal statute. (Prior OTS policy
generally permitted interstate branching for federally chartered savings
associations only to the extent allowed state-chartered savings associations in
the states where the association's home office was located and where the branch
was sought or if the branching resulted from OTS approval of a supervisory
interstate acquisition of a troubled institution.) Current OTS policy generally
permits a federally chartered savings association to establish branch offices
outside of its home state if the association meets the domestic building and
loan test in Section 7701(a)(19) of the Internal Revenue Code of 1986, as
amended (the 'Code'), or the asset composition test of subparagraph (c) of that
section, and if, with respect to each state outside of its home state where the
association has established branches, the branches, taken alone, also satisfy
one of the two tax tests. An association seeking to take advantage of this
authority would have to have a branching application approved by the OTS, which
would consider the regulatory capital of the association and its record under
the Community Reinvestment Act of 1977, as amended, among other things.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of New York, which is one of 12 regional
FHLBs that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived
28
from the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures established
by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of New York in an amount equal to the greater of 1% of its aggregate unpaid
residential mortgage loans, or 5% of outstanding FHLB advances, or 0.3% of total
assets. At December 31, 1997 the Bank had $10.1 million in FHLB stock, which met
this requirement. The FHLB may, at its option, redeem through repurchase,
investments in its common stock in excess of the required amount.
The FHLBs are required to provide funds for the resolution of troubled
savings associations and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future. These contributions also could have an adverse effect on the
value of FHLB stock in the future. For the years ended December 31, 1997, 1996,
and 1995, dividends paid by the FHLB of New York to the Bank totaled
approximately $0.7 million, $0.6 million and $0.5 million, respectively.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to maintain
reserves against their transaction accounts (primarily checking and NOW
accounts) and non-personal time deposits. At December 31, 1997, the Bank was in
compliance with applicable requirements. However, because required reserves must
be maintained in the form of vault cash or a non-interest bearing account at a
Federal Reserve Bank, the effect of this reserve requirement is to reduce an
institution's earning assets.
FEDERAL AND STATE TAXATION
Until federal tax law changes were enacted in August 1996, savings
institutions such as the Bank that met certain definitional tests relating to
composition of assets and the nature of its business were permitted to establish
reserves for bad debts and to make annual additions thereto which qualify as
deductions in computing taxable income based upon a savings institution's actual
loss experience (the 'experience method') or by reference to a percentage of its
taxable income (the 'percentage of taxable income method').
The percentage used to compute the bad debt reserve addition under the
percentage of taxable income method (the 'percentage bad debt deduction') was
8%. The percentage bad debt deduction thus computed is reduced by the amount
permitted as a deduction for the addition to the reserve for losses on
non-qualifying loans under the experience method. Also, the percentage bad debt
deduction for any taxable year may not exceed the lesser of (i) the amount
necessary to increase the balance in the reserve for losses on qualifying real
property loans to 6% of such loans at the end of the taxable year, or (ii) the
amount by which 12% of the institution's deposits at the end of the taxable year
exceeds the surplus, undivided profits and reserves at the beginning of the
taxable year.
If an institution's qualifying assets (generally, loans secured by
residential real estate or deposits, educational loans, cash, government
obligations and certificates of deposit) constitute less than 60% of its total
assets, the institution is not eligible to compute its bad debt deduction under
the percentage of taxable income method. At December 31, 1997, 1996 and 1995,
the Bank's qualifying assets exceeded the 60% requirement. The Bank intends to
continue to meet this test in the future; however, management will consider
alternatives should favorable circumstances arise.
A savings institution organized in stock form that has computed its
allowable addition to its bad debt reserve under the percentage of taxable
income method may also be subject to recapture taxes on a portion of such
reserves if it made certain types of distributions to its stockholders. The Bank
has no current intentions to make such distributions to stockholders or redeem
any shares of common stock which could require any amount of its bad debt
reserves to be recaptured into taxable income.
Pursuant to federal legislation enacted in August 1996, which was effective
for tax years that began after December 31, 1995, thrifts were no longer
permitted to make additions to their tax bad debt
29
reserve under the percentage of taxable income method. Such legislation also
requires the thrifts to realize increased tax liability over a period of at
least six years, beginning in 1996, relating to their 'applicable excess
reserves.' The amount of applicable excess reserves is taken into account
ratably over a six-taxable year period, beginning with the first taxable year
beginning after 1995, subject to the residential loan requirement described
below. The amount of the Bank's applicable excess reserves at December 31, 1995
was $2.0 million, calculated as the excess of (1) the balance of its reserves,
as defined in the Code, as of December 31, 1995 over (2) the balance of such
reserves (i.e., its reserve for losses on qualifying real property loans and its
reserve for losses on nonqualifying loans) as of December 31, 1987 (as
adjusted). The recapture requirement would be suspended for each of two
successive taxable years beginning January 1, 1996 in which the Bank originates
an amount of certain kinds of residential loans which in the aggregate are equal
to or greater than the average of the principal amounts of such loans made by
the Bank during its six taxable years preceding 1996.
While New York State tax law is generally based on federal law, on July 30,
1996, New York State enacted legislation, effective January 1, 1996, which
generally retains the percentage of taxable income method for calculating the
tax bad debt deduction and does not require the Bank to recapture into income
its excess tax bad debt reserves over its base year reserves for New York State
tax purposes. The New York State percentage of taxable income tax bad debt
deduction is equal to 32% of New York State taxable income, with certain
adjustments.
At December 3l, 1997, the Bank's recorded tax bad debt reserves are
available to be deducted for tax purposes in the future.
A savings institution may carryback net operating losses to the preceding
three taxable years and carryforward such losses to the succeeding 15 taxable
years on its federal income tax return. At December 31, 1997, the Bank had a net
operating loss carryforward for tax purposes of approximately $21.3 million
which begins to expire in 2005. The Bank has been audited by the Internal
Revenue Service with respect to its income tax returns through 1993.
New York has a bank franchise tax which subjects the Bank to a tax
generally equal to the greater of (i) 9% of the Bank's 'New York entire net
income,' (ii) 0.01% (or, in certain instances, a lesser portion) of the Bank's
New York taxable assets,' or (iii) 3% of the Bank's 'New York alternative net
income.' In addition, such tax is subject to a surcharge of 17% under a New York
law designed to raise funds for mass transit. New York does not allow net
operating loss carrybacks or carryforwards for financial institutions. For
additional information regarding taxation see Note 10 of Notes to Consolidated
Financial Statements at Item 8.
30
ITEM 2. PROPERTIES.
The Company's executive offices are located at 249 Main Mall, Poughkeepsie,
New York. The Company conducts business from sixteen (16) full service retail
branches and six (6) residential loan production offices.
The Bank also has its own automated teller machines ('ATMs') in twenty (20)
locations in the Hudson Valley and has a link to the New York Cash Exchange
('NYCE') and the PLUS Network.
The table below sets forth certain information on properties used for
retail banking and administrative purposes as of December 31, 1997. Loan
production offices are excluded.
TOTAL
OWNED NUMBER OF OFFICE
OR YEARS AT SQUARE
LEASED LOCATION FEET
-------- --------- -----------
Home Office:
21 Market Street, Poughkeepsie, NY.................................... Owned 50+ 7,500
Branch Offices:
Main Street & Innis Ave, Poughkeepsie, NY............................. Owned 31 4,500
Hudson Plaza, Poughkeepsie, NY........................................ Leased 25 3,500
Hyde Park Mall, Hyde Park, NY......................................... Leased 23 2,400
South Hills Mall, Poughkeepsie, NY.................................... Leased 21 2,300
Lakeside Plaza, Newburgh, NY.......................................... Leased 6 2,860
Hudson Valley Outlet Center, Fishkill, NY............................. Leased 1 2,880
In-Store Locations:
Super Stop & Shop, Wappingers Falls, NY............................... Leased 2 680
Super Stop & Shop, Poughkeepsie, NY................................... Leased 1 400
ShopRite, Spring Valley, NY........................................... Leased 2 400
ShopRite, West Haverstraw, NY......................................... Leased 1 400
Price Chopper, Vails Gate, NY......................................... Leased 1 400
Price Chopper, Newburgh, NY........................................... Leased 1 400
Price Chopper, Middletown, NY......................................... Leased 1 365
ShopRite, Suffern, NY................................................. Leased 1 604
ShopRite, New City, NY................................................ Leased 1 453
Operations/Office Buildings:
13 Market Street, Poughkeepsie, NY.................................... Owned 18 9,000
25 Market Street, Poughkeepsie, NY.................................... Owned 50+ 11,900
249 Main Mall, Poughkeepsie, NY....................................... Note (1) 7 40,000
- ------------
(1) The Bank purchased the leasehold interest on the headquarters building in
1993. The building contains 100,000 square feet of useable space of which
the Bank continues to occupy approximately 40,000 square feet.
The net book value of land, buildings and leasehold improvements was
approximately $7.1 million and $6.1 million at December 31, 1997 and 1996,
respectively. The Bank leases certain Branch locations from other parties and
paid rents of $0.7 million on these properties in 1997.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the
ordinary course of business. In the opinion of management, final disposition of
these lawsuits will not have a material adverse affect on the financial
condition or results of operation of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
No matters were submitted to a vote of securities holders in the fourth
quarter of 1997.
31
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER'S MATTERS.
The Company's common stock was initially issued on November 19, 1985 and is
traded on the Nasdaq Stock Marketsm under the symbol PKPS. Information
concerning the range of high and low sales prices for the Company's common stock
for each quarterly period within the past two fiscal years, as well as net
income (loss) and dividends declared per share, is set forth below.
NET END OF DIVIDENDS
QUARTER ENDED INCOME HIGH LOW PERIOD DECLARED
- ------------- ------ ------ ----- ------ ---------
1997
December 31....................................... $(.08 ) $11.63 $9.00 $11.63 $.050
September 30...................................... .08 9.38 7.25 9.25 .025
June 30........................................... .09 7.31 5.44 7.31 .025
March 31.......................................... .09 6.50 5.25 6.00 .025
1996
December 31....................................... $ .09 $ 5.38 $5.00 $ 5.25 $.025
September 30...................................... (.05) 5.25 4.75 5.00 .025
June 30........................................... .00 5.63 4.88 5.00 .025
March 31.......................................... .06 5.63 5.00 5.38 .025
As of March 9, 1998, the closing price of the Company's common stock was
$10.63 per share. As of that date, the Company had 1,628 stockholders of record
and 12,747,851 outstanding shares of common stock. This does not reflect the
number of persons or entities who hold their stock in nominee or 'street' name
through various brokerage firms.
As part of its regulations covering capital distributions, the OTS may
object to the Bank making any capital distribution, which includes dividends.
The Company relies on dividends received from the Bank to make and pay dividends
to its stockholders. See 'Regulation -- Restrictions on Capital Distributions.'
On January 28, 1998, the Company declared a dividend of $.06 per share on its
outstanding common stock to be paid on March 5, 1998 to stockholders of record
on February 13, 1998.
Poughkeepsie Financial Corp., Bank of the Hudson and HUBCO, Inc. entered
into an Amended and Restated Agreement and Plan of Merger ('Merger Agreement')
dated as of October 22, 1997 . See the discussion of the Merger Agreement at
Item 1 -- 'Business of the Company' included elsewhere herein. The transaction,
which is expected to close in the second quarter of 1998, is expected to be
treated as a tax-free exchange to holders of Poughkeepsie Financial Corp. stock
and to be accounted for as a pooling of interests.
32
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
(Dollars in thousands, except
per share amounts)
Earnings Summary:
Interest income............... $66,723 $63,620 $58,959
Interest expense.............. 39,275 37,857 35,475
-------- -------- --------
Net interest income........... 27,448 25,763 23,484
Provision for possible loan
losses...................... 1,850 850 1,525
-------- -------- --------
Net interest income after
provision for possible loan
losses...................... 25,598 24,913 21,959
Other income(1)............... 3,574 1,462 (5,914)
Other expenses(2)............. 24,484 23,976 18,269
-------- -------- --------
Income (loss) before income
taxes....................... 4,688 2,399 (2,224)
Income tax provision
(benefit)(3)................ 2,259 963 (18,486)
-------- -------- --------
Net income.................... $ 2,429 $ 1,436 $ 16,262
-------- -------- --------
-------- -------- --------
Per Share Data:
Earnings per share:
Basic.................... $0.19 $0.11 $1.30
Diluted.................. 0.18 0.11 1.27
Cash Dividends Per Share...... 0.125 0.10 0.08
Book Value Per Share At Year
End......................... 5.75 5.69 5.66
Weighted average shares
outstanding (In thousands):
Basic.................... 12,595 12,547 12,483
Diluted.................. 13,239 12,910 12,855
Common Shares Outstanding (In
thousands):................. 12,610 12,592 12,531
Balance Sheet Summary:
Securities available for
sale........................ $126,937 $135,790 $185,600
Securities held to maturity... 25,537 29,957 --
Loans......................... 674,546 643,339 583,767
Total assets.................. 875,492 858,690 825,448
Deposits...................... 620,377 575,246 534,041
Stockholders' equity.......... 72,571 71,668 70,924
Performance Ratios:
Return on average assets...... 0.28% 0.17% 2.12%
Return on average equity...... 3.32% 2.02% 28.48%
Dividend payout ratio......... 69.44% 90.91% 6.35%
Average equity to average
assets...................... 8.39% 8.41% 7.44%
Net interest margin........... 3.30% 3.21% 3.12%
Asset Quality Ratios:
Allowance for possible loan
losses to total loans....... 1.40% 1.34% 1.41%
Allowance for possible loan
losses to non-performing
loans....................... 91.93% 56.10% 151.96%
Non-performing loans to total
loans....................... 1.52% 2.40% 0.93%
Non-performing assets to total
loans plus OREO............. 2.18% 4.00% 3.05%
Net charge-offs to average
loans....................... 0.17% 0.07% 0.27%
YEARS ENDED DECEMBER 31,
------------------------
1994 1993
-------- --------
Earnings Summary:
Interest income............... $49,536 $47,433
Interest expense.............. 27,620 29,941
-------- --------
Net interest income........... 21,916 17,492
Provision for possible loan
losses...................... 120 400
-------- --------
Net interest income after
provision for possible loan
losses...................... 21,796 17,092
Other income(1)............... 2,851 6,923
Other expenses(2)............. 17,980 18,196
-------- --------
Income (loss) before income
taxes....................... 6,667 5,819
Income tax provision
(benefit)(3)................ 150 --
-------- --------
Net income.................... $ 6,517 $ 5,819
-------- --------
-------- --------
Per Share Data:
Earnings per share:
Basic.................... $0.53 $0.71
Diluted.................. 0.51 0.71
Cash Dividends Per Share...... -- --
Book Value Per Share At Year
End......................... 4.05 4.01
Weighted average shares
outstanding (In thousands):
Basic.................... 12,410 8,252
Diluted.................. 12,746 8,252
Common Shares Outstanding (In
thousands):................. 12,467 12,377
Balance Sheet Summary:
Securities available for
sale........................ $203,883 $218,646
Securities held to maturity... -- --
Loans......................... 494,189 459,607
Total assets.................. 727,625 718,874
Deposits...................... 489,144 437,660
Stockholders' equity.......... 50,478 49,600
Performance Ratios:
Return on average assets...... 0.91% 0.82%
Return on average equity...... 13.31% 11.73%
Dividend payout ratio......... -- --
Average equity to average
assets...................... 6.84% 5.53%
Net interest margin........... 3.17% 2.60%
Asset Quality Ratios:
Allowance for possible loan
losses to total loans....... 3.68% 4.29%
Allowance for possible loan
losses to non-performing
loans....................... 116.02% 133.33%
Non-performing loans to total
loans....................... 3.17% 3.22%
Non-performing assets to total
loans plus OREO............. 5.57% 8.20%
Net charge-offs to average
loans....................... 0.36% 0.21%
- ------------
(1) In 1995, PFC recorded a $7.5 million loss related to certain commercial
loans held for bulk sale.
(2) In 1996, PFC recorded a $2.6 million special assessement levied by the FDIC
to recapitalize the SAIF Insurance Fund.
(3) In 1995, PFC recognized deferred tax assets of $17.6 million by reducing
previously established valuation reserves.
33
ITEM 7. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
SUMMARY
The Company reported net income of $2.4 million, or $0.18 per share
(diluted), for the year ended December 31, 1997, compared with $1.4 million, or
$0.11 per share (diluted), for 1996, and $16.3 million, or $1.27 per share
(diluted), for 1995. The results for 1997, 1996 and 1995 included the following
non-operating and special items:
1997
Merger related costs of $0.5 million related to the Company's pending
merger with HUBCO.
Charges of $0.8 million ($0.5 million, net of tax) associated with
termination of the Company's Retirement Plan for Non-Employee
Directors.
1996
SAIF Special Assessment of $2.6 million ($1.6 million, net of tax).
Loss on Bulk Sale of $0.9 million ($0.5 million, net of tax)
1995
Income tax benefits of $18.7 million attributable to the reduction of
valuation allowances in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, 'Accounting for Income Taxes.'
A $7.5 million ($4.5 million, net of tax) loss on the pending 'bulk
sale' of certain commercial loans and a $1.0 million ($0.6 million,
net of tax) special addition to the allowance for loan losses.
The following table shows comparable results (net of tax) for the years
ended December 31, 1997, 1996, and 1995, respectively:
1997 1996 1995
------ ------- -------
(in 000's)
Earnings from operations................................................ $3,435 $ 3,547 $ 3,793
Merger related expenses................................................. (540) -- --
Termination of Directors' Retirement Plan............................... (466) -- --
SAIF special assessment................................................. -- (1,575) --
Loss on bulk sale....................................................... -- (536) (4,527)
Additional loan loss provision.......................................... -- -- (600)
Recognition of future tax benefits and higher effective tax rate........ -- -- 17,596
------ ------- -------
Net Income......................................................... $2,429 $ 1,436 $16,262
------ ------- -------
------ ------- -------
Earnings from operations, which consists of net income excluding certain
items deemed to be non-operating or special, are down $0.1 million from 1996 and
$0.4 million from 1995. Earnings from operations in 1997 were lower than both
1996 and 1995 as the costs of operating OREO and the operating costs of new
branches and new product promotions more than offset the increases recorded in
net interest income and fee income, and the reduction in deposit insurance
premiums.
The following discussion of the Company's financial condition and results
of operations should be read in conjunction with the Company's Consolidated
Financial Statements which are included elsewhere herein.
FINANCIAL CONDITION
Total assets increased in 1997 by $16.8 million, or 2.0%, from $858.7
million at December 31, 1996 to $875.5 million at December 31, 1997. This is
compares with asset growth of 4.0% in 1996. Asset growth in 1997 was due
primarily to a $30.4 million increase in net loans, partially offset by a $13.3
million decrease in investment securities. Other real estate owned declined by
$6.1 million, to $4.6 million at December 31, 1997.
Net loans increased during 1997 due largely to a $26.9 million (or 12.8%)
increase in commercial real estate loans and a $8.7 million (or 27.9%) increase
in consumer loans. One-to-four family residential real estate loans declined by
$5.2 million (or 1.3%). One-to-four family residential loan
34
originations were $72.5 million in 1997 as compared with $130.4 million in 1996
and $102.8 million in 1995. Commercial real estate and multi-family residential
loan originations during 1997 totaled $103.9 million as compared to $73.4
million in 1996.
Investment securities declined by $13.3 million (or 8.0%) in 1997 due
largely to the call of a $17.0 million security in December 1997. Proceeds were
used to pay down short-term borrowings. During 1996, $35.3 million of fixed-rate
mortgage-backed securities were transferred from 'Available for Sale' to 'Held
to Maturity' classification as the Bank has the positive intent and ability to
hold these securities to maturity. For additional information, see Note 4 to the
'Notes to Consolidated Financial Statements.'
Other real estate owned decreased by $6.2 million in 1997 to $4.6 million
at December 31, 1997. OREO activity during 1997 included sales of $2.6 million,
acquisitions of $1.1 million, transfers to performing loans of $2.6 million and
write-downs of $1.7 million. The Company's efforts to dispose of other real
estate owned include, where appropriate, extending loans to facilitate such
sales. However, in such instances it is the Company's general practice to seek a
down-payment of at least 10% to 20% in order to ensure that there is a
sufficient transfer of risk to the borrower. In 1997, the Company made loans to
facilitate the disposition of OREO totaling $2.0 million at the time of
origination. Loans in portfolio which were made to facilitate the sales of OREO
properties aggregated $44.6 million at December 31, 1997.
Real estate acquired by the Bank through foreclosure proceedings or the
acceptance of a deed-in-lieu of foreclosure are classified as other real estate
owned until sold. When property is acquired, it is recorded at the lesser of the
loan's remaining principal balance or the estimated fair value of the property,
after reduction for estimated selling costs. Any balance in excess of such
estimated fair value on the date the property is acquired is charged to the
allowance for loan losses. All costs incurred thereafter in maintaining the
property and subsequent declines in fair value are charged to operating expense.
For additional analysis of OREO activity during 1996 and 1997, see Note 6 to the
'Notes to Consolidated Financial Statements.'
Net deferred tax assets decreased by $1.8 million in 1997 to $15.0 million
at December 31, 1997 as deferred tax assets (e.g. net operating loss carry
forwards) were utilized to reduce taxes otherwise payable. For further
information, see Note 10 of the 'Notes to Consolidated Financial Statements.'
Deposits increased in 1997 by $45.1 million (or 7.8%) to $620.4 million
following a 7.7% increase in 1996. The increase in deposits was the result of
new branches and aggressive pricing. During 1997, money market and demand
deposits posted double digit increases, while savings accounts and time deposits
increased at more modest rates.
Total borrowings decreased in 1997 by $29.9 million (or 15.0%) to $168.8
million as deposit increases exceeded net asset growth.
YEAR 2000 CONSIDERATIONS
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
'00' as the year 1900 rather than the year 2000.
A 'Year 2000 Project Team' was formed in June, 1997 and is comprised of
certain managers and staff of all significant operating departments of the
Company. This team is responsible for the development and implementation of a
plan to deal with Year 2000 issues. The Company's Year 2000 Action Plan (the
'Plan') was presented to the Audit Committee of the Board of Directors on July
21, 1997. The Plan was developed using the guidelines outlined in the Federal
Financial Examination Council's 'The Effect of Year 2000 on Computer Systems.'
Periodic updates to the Plan are provided to the Audit Committee and the Board
of Directors, as appropriate.
The Company has initiated formal communications with its significant
vendors, service providers and customers to determine the extent to which the
Company is vulnerable to those third parties' failure to remediate their own
2000 issue. There can be no guarantee that the systems of other companies on
which the Company relies will be timely remediated. Therefore, the Company could
possibly be negatively impacted to the extent other entities are unsuccessful in
properly addressing this issue. Contingency plans are being developed wherever
possible.
35
An OTS off-site examination was conducted on September 30, 1997 and based
upon the examination results, the Company was progressing satisfactorily towards
completing the Plan requirements. Management believes the Company's Plan
continues to be on schedule.
Based on our assessment of the Company's Year 2000 risks and our monitoring
of and conferences with third party service providers, we do not expect to incur
significant expenses nor encounter significant difficulties in connection with
issues related to the Year 2000. Additionally, subsequent to the Company's
expected merger with HUBCO, all issues related to the Year 2000 will be
incorporated into the HUBCO Year 2000 Plan.
LIQUIDITY AND CAPITAL RESOURCES
The Company manages its liquidity position within the overall context of
its asset/liability management program. Liquidity is maintained to meet
regulatory requirements, to meet normal funding needs and to be responsive to
the inherent credit and maturity risks of its assets and liabilities.
Under OTS regulations, the Bank is required to maintain average primary
liquidity levels, as defined by the OTS, equal to 4.0% of net withdrawable
deposit accounts plus borrowings due within one year. The required level may be
changed by the OTS from time to time. The Bank complied with this requirement
throughout 1997.
The Bank's funding requirements consist primarily of loan commitments, debt
repayments, deposit withdrawals and operating expenses. As of December 31, 1997,
the Bank had commitments under standby letters of credit, and unused lines of
credit of approximately $2.3 million and $14.6 million, respectively. At
December 31, 1997, the Bank was also committed to originate or fund $16.3
million one-to-four family residential mortgage loans and $32.8 million of
commercial loans.
Sources of funds include payments and prepayments on loans and securities,
deposits, borrowings, interest income, other revenue and asset sales. The Bank
had a $84.7 million ($52.8 million of which was unused) overnight line of credit
from the FHLB of New York at December 31, 1997. The line is subject to various
conditions, including the pledging and delivery of acceptable collateral. As of
December 31, 1997, the Bank had sufficient available collateral to borrow up to
an additional $258 million in the form of FHLB advances or reverse repurchase
agreements. The sources of funds described above are believed to be sufficient
to meet funding demands.
Management continually reviews the Bank's expected cash inflows and
outflows in order to ensure its ability to meet its overall funding
requirements. The Bank relies primarily on operating cash flows to meet its
daily requirements, and on borrowings to meet additional significant
requirements.
While the Bank can exert significant control over some items affecting
liquidity, such as the making of new loan commitments, it has more limited
ability to control others, such as net changes in deposit levels and prepayment
rates. While deposit products are, in management's opinion, competitively
priced, future deposit flows will be subject to the Bank's ability to
effectively compete for customer funds with other financial institutions and
investment alternatives.
OTS regulations require the Bank to meet certain minimum regulatory capital
requirements. At December 31, 1997 the Bank had regulatory capital substantially
in excess of requirements. The Bank is deemed to be 'well capitalized' by its
regulators. 'Additional information concerning the Bank's regulatory capital
position is provided in Note 16 of Notes to Consolidated Financial Statements'
at Item 8.
RESULTS OF OPERATIONS
The earnings of the Company are dependant on the earnings of its bank
subsidiary. In turn, the earnings of the Bank are largely dependent upon net
interest income and fee income. Net interest income is the difference between
interest earned on its loan and securities portfolios and interest paid on
deposit accounts and borrowed funds. Non-interest income is primarily the result
of deposit account and transaction fees and net gains (losses) on sales of
securities and other assets.
Net interest income is affected by a number of variables. One such variable
is the interest rate spread, that is, the difference between the yields on
average interest-earning assets and the cost of average interest-bearing
liabilities. Another important variable is the relative amounts of interest-
earning assets and interest-bearing liabilities. Net interest margin represents
net interest income divided
36
by average interest-earning assets. Net interest margins were 3.30%, 3.21% and
3.12% for the years ended December 31, 1997, 1996 and 1995, respectively.
The table below sets forth information relating to interest-earning assets
(including non-performing assets), interest-bearing liabilities and net interest
income during the periods indicated.
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- ---------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE(1) BALANCE INTEREST RATE(1) BALANCE INTEREST RATE(1)
-------- -------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Mortgage loans...... $611,727 $ 51,260 8.39% $579,578 $ 48,519 8.37% $501,973 $ 42,071 8.38%
Other loans......... 42,629 3,790 8.87 37,581 3,388 9.02 38,210 3,425 8.96
Mortgage-backed
securities........ 144,375 9,438 6.54 151,424 9,593 6.33 181,084 11,454 6.33
Other securities.... 32,751 2,164 6.61 30,762 1,973 6.41 27,962 1,824 6.52
Money market
investments and
federal funds..... 1,317 71 5.42 2,804 147 5.22 3,186 185 5.81
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total.......... 832,799 66,723 8.01% 802,149 63,620 7.93% 752,415 58,959 7.84%
-------- -------- ------- -------- -------- ------- -------- -------- -------
Interest-bearing
liabilities:
Deposits............ 603,885 28,211 4.66 554,925 25,834 4.64 517,142 24,321 4.70
FHLB Advances....... 35,000 1,998 5.61 79,637 4,492 5.55 67,881 4,016 5.84
Other
borrowings(2)..... 150,519 9,066 6.01 128,699 7,531 5.84 118,945 7,138 6.00
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total.......... 789,404 39,275 4.96% 763,261 37,857 4.95% 703,968 35,475 5.04%
-------- -------- ------- -------- -------- ------- -------- -------- -------
Excess of interest-
earning assets over
interest-bearing
liabilities............ $ 43,395 $ 38,888 $ 48,447
-------- -------- --------
-------- -------- --------
Net interest and dividend
income................. $ 27,448 $ 25,763 $ 23,484
-------- -------- --------
-------- -------- --------
Interest rate
spread(3).............. 3.05% 2.98% 2.80%
------- ------- -------
------- ------- -------
Net interest margin(4)... 3.30% 3.21% 3.12%
------- ------- -------
------- ------- -------
- ------------
(1) Includes loan origination fees and costs treated as adjustments to loan
yields.
(2) Other borrowings include notes payable, securities sold under repurchase
agreements and draws against the Federal Home Loan Bank line of credit.
(3) Interest rate spread represents the difference between the yield on average
interest-earning assets and the cost of average interest-bearing
liabilities.
(4) Net interest margin represents net interest and dividend income divided by
average interest-earning assets.
37
The following table sets forth the weighted-average coupons and costs of
interest-earning assets (excluding non-performing loans) and interest-bearing
liabilities at the dates indicated.
DECEMBER 31,
------------------------
1997 1996 1995
---- ---- ----
Weighted-average yield on:
Loan portfolio...................................................... 8.23% 8.20% 8.38%
Mortgage-backed securities.......................................... 7.30 7.26 7.41
Other securities.................................................... 7.11 6.55 6.78
Other interest earning assets....................................... 9.32 9.38 9.19
All interest-earning assets......................................... 7.95 8.02 8.21
Weighted-average cost of:
Deposits............................................................ 4.73 4.67 4.86
Federal Home Loan Bank term advances................................ 5.73 5.58 5.65
Other borrowings.................................................... 5.94 5.61 6.29
All interest-bearing liabilities.................................... 4.95 4.88 5.09
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Earnings Overview. The Company recorded net income of $2.4 million, or
$0.18 per share (diluted), for the year ended December 31, 1997, compared with
net income of $1.4 million, or $0.11 per share (diluted), for 1996. Full year
results for 1997 included aggregate net of tax costs of $1.0 million related to
costs incurred in connection with the pending merger ($0.5 million) and
termination of the Directors' retirement plan ($0.5 million). Full year results
for 1996 included aggregate net of tax costs of $2.1 million, or $0.16 per
share, related to the SAIF special assessment ($1.6 million) and an additional
loss on 'bulk sale' of certain assets ($0.5 million) and $1.0 million in related
additional loan loss provisions. Excluding these non-recurring items, net income
would have been $3.4 million in 1997 as compared with $3.5 million in 1996.
Operating results for 1997 were level with 1996 as increased expenses
related to new branches, higher loan loss provisions and higher costs of
operating OREO were offset by growth in net interest and fee income, and by
lower deposit insurance premiums.
Net interest income. Net interest income for the year ended December 31,
1997 totaled $27.4 million, an increase of $1.6 million from 1996 net interest
income of $25.8 million. Average yields on interest-earning assets increased by
8 basis points (with 100 basis points equal to 1%) to 8.01% while the average
cost of interest-bearing liabilities increased by only 1 basis point to 4.96%.
Interest income rose $3.1 million, or 4.9%, reflecting an increase in
average interest earning assets together with the effect of higher average
yields. Average-earning assets increased due largely to new loan originations.
Average yields earned during the year increased largely as a result of higher
yields on mortgage-backed securities.
Non-performing and restructured assets also effect net interest income. As
of December 31, 1997 and 1996, non-accrual loans totaled $10.2 million and $15.4
million, respectively, while performing troubled debt restructurings (TDRs) were
$14.4 and $9.5 million, respectively. Had these assets performed in accordance
with their original terms throughout the year, interest income would have been
greater than the reported amounts by $1.2 million in 1997 and $1.9 million in
1996.
Interest expense increased by $1.4 million, or 3.7%, reflecting higher
average deposits outstanding during 1997 compared to 1996 and slightly higher
rates on both deposits and borrowings. The weighted average cost of deposits
increased by only 2 basis points to 4.66% and the weighted average cost of
borrowings, which includes borrowings from the Federal Home Loan Bank and under
short-term repurchase agreements, increased by 20 basis points to 5.95%.
38
The changes in net interest income from 1996 to 1997, including
non-performing assets, attributable to changes in average balances and interest
rates is summarized as follows:
CHANGE ATTRIBUTABLE TO
-------------------------- NET
VOLUME RATE CHANGE
----------- ----------- -------
(Dollars in thousands)
Interest-earning assets:
Mortgage loans.............................................. $ 2,524 $ 217 $ 2,741
Other loans................................................. 452 (50) 402
Mortgage-backed securities.................................. (447) 292 (155)
Other securities............................................ 48 143 191
Money market investments and federal funds.................. (79) 3 (76)
----------- ----------- -------
Total interest income....................................... 2,498 605 3,103
----------- ----------- -------
Interest-bearing liabilities:
Deposits.................................................... (2,285) (92) (2,377)
Borrowings.................................................. 1,363 (404) 959
----------- ----------- -------
Total interest expense................................. (922) (496) (1,418)
----------- ----------- -------
Net interest income.................................... $ 1,576 $ 109 $ 1,685
----------- ----------- -------
----------- ----------- -------
As noted earlier, interest spread is a factor in determining net interest
income. The following table summarizes the components of the Bank's interest
rate spread in 1997 and 1996:
1997 1996
---- ----
Average yield on loans................................................................. 8.41% 8.41%
Average yield on mortgage-backed securities............................................ 6.54 6.33
Average yield on other securities...................................................... 6.61 6.41
Average yield on money market investments and federal funds............................ 5.42 5.22
Combined average yield on interest-earning assets...................................... 8.01 7.93
Average cost of deposits............................................................... 4.66 4.64
Average cost of FHLB Advances.......................................................... 5.61 5.55
Average cost of other borrowings....................................................... 6.01 5.84
Combined average cost of funds......................................................... 4.96 4.95
Interest rate spread during the year................................................... 3.05 2.98
Provision for Possible Loan Losses. The provision for loan losses was $1.9
million in 1997 as compared to $0.9 million in 1996. In 1997 additional
provisions $0.6 million were recorded to provide flexibility in working out
certain problem loans. The remaining increase of $0.4 million relates mainly to
loan growth recorded during 1997.
From December 31, 1996 to December 31, 1997, non-accrual loans declined
from $15.4 million to $10.2 million while classified assets (which include
non-accrual loans) declined from $31.3 million to $18.8 million. The allowance
for loan losses was $9.4 million and $8.7 million at December 31, 1997 and 1996,
respectively. The allowance represented 1.4% and 1.3% of the total loan
portfolios and 92% and 56% of total non-performing loans at December 31, 1997
and 1996, respectively.
The allowance for loan losses is maintained at a level which management
considers adequate based on its regular review of the Bank's loan portfolios
taking into consideration the likelihood of repayment, the diversity of the
borrowers, the type of loan, delinquency data, the quality of the collateral,
current market conditions and the associated risks. Further additions to the
allowance for loan losses may be necessary if the economic conditions currently
affecting the likelihood of repayment and property values deteriorate further
and until management's efforts further reduce the amount of non-performing
loans.
Non-interest Income. Excluding the additional loss recognized on the bulk
sale of certain commercial loans in 1996, non-interest income amounted to $3.6
million in 1997 as compared with $2.4 million in 1996.
39
Banking service fees and other income rose by $1.2 million to $3.3 million
in 1997 primarily as the result of an increase in the number of customer
checking accounts and number of bank branches. Banking service fees and other
income relates to recurring income generated from retail banking fees, net
commission income on sales of investment products and loan charges and late
fees.
In 1996, a loss of $0.9 million was recognized to further reduce the
carrying value of certain loans held for bulk sale which became non-accrual
during 1996. In 1995, a $7.5 million loss was recorded to write down loans held
for bulk sale to the lower of cost or market value.
Non-Interest Expenses. The following table sets forth the primary
components of non-interest expense for the periods indicated.
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996
------------ -----------
(In thousands)
Salaries and wages........................................................ $ 8,968 $ 8,284
Employee benefits......................................................... 3,188 2,467
Legal..................................................................... 611 511
Occupancy................................................................. 1,737 1,447
Furniture and equipment................................................... 1,218 1,001
Deposit insurance......................................................... 551 1,426
Net cost of operating other real estate owned............................. 2,508 1,143
Third party loan servicing expenses....................................... 486 549
Advertising/Marketing..................................................... 1,181 1,101
Insurance................................................................. 232 243
Professional services..................................................... 1,334 1,115
Other..................................................................... 2,470 2,065
------------ -----------
Sub-total............................................................ 24,484 21,352
SAIF special assessment................................................... -- 2,624
------------ -----------
Total non-interest expenses.......................................... $ 24,484 $23,976
------------ -----------
------------ -----------
Most operating expense categories posted increases in 1997 over 1996 levels
due largely to increased staffing and related expenses of new supermarket
branches and costs of enhanced customer delivery systems; professional service
costs also increased in 1997 related to merger related matters and the formation
of the holding company. Employee benefits expense increased due mainly to costs
incurred for the termination of the Directors' Retirement plan. The net cost of
operating OREO increased by $1.4 million due primarily to increased writedowns
on several OREO properties.
The one-time SAIF Special Assessment recorded in 1996 resulted from
legislation signed into law on September 30, 1996 and was applicable to all SAIF
insured institutions. The special assessment was levied by the FDIC to
recapitalize the SAIF. The recapitalization of the SAIF fund enabled the FDIC to
lower deposit insurance premiums starting in 1997.
Income Taxes. In 1997, income tax expense totaled $2.3 million as compared
with $1.0 million in 1996. The combined effective tax rate was 48% for 1997 and
40% for 1996. The effective tax rate in 1997 was higher than in 1996 due to the
effect of certain non-deductible professional costs incurred in connection with
the proposed merger.
Net deferred tax assets totaled $15.0 million at December 31, 1997 as
compared with $16.8 million at December 31, 1996. The principal components of
the Company's deferred tax assets are net operating loss carryforwards, and
temporary differences attributable to loan loss reserves, the bulk sale
transaction, and certain OREO activity.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Earnings Overview. The Company reported net income for 1996 of $1.4
million, or $0.11 per share (diluted), as compared with net income of $16.3
million, or $1.27 per share (diluted), for 1995. Earnings from operations, which
consists of net income excluding certain items deemed to be non-operating or
special, were $3.5 million, or $0.27 per share (diluted), in 1996 as compared
with $3.8 million, or $0.30
40
per share (diluted), in 1995. A reconciliation of earnings from operations to
net income is presented below (amounts are in thousands, except per share data
and are net-of-tax):
1996 1995
-------------------- --------------------
PER SHARE PER SHARE
-- DILUTED -- DILUTED
--------- ---------
Earnings from operations................................... $ 3,547 $ 0.27 $ 3,793 $ 0.30
SAIF Special Assessment.................................... (1,575) (0.12) -- --
Loss on Bulk Sale.......................................... (536) (0.04) (4,527) (0.35)
Additional loan loss provision............................. -- -- (600) (0.05)
Recognition of future tax benefits and higher effective tax
rate..................................................... -- -- 17,596 1.37
------- --------- ------- ---------
Net income............................................ $ 1,436 $ 0.11 $16,262 $ 1.27
------- --------- ------- ---------
------- --------- ------- ---------
The $0.2 million decrease in earnings from operations from 1995 to 1996 was
primarily the result of increased operating expenses related to new branches and
product promotions partially offset by higher net interest income related to
portfolio growth and increased margins.
Net interest income. Net interest income for the year ended December 31,
1996 totaled $25.8 million, an increase of $2.3 million from 1995 net interest
income of $23.5 million. Average yields on interest-earning assets rose 9 basis
points (with 100 basis points equal to 1%) to 7.93% while the average cost of
interest-bearing liabilities decreased by 9 basis points to 4.95%.
Interest income rose $4.7 million, or 7.9%, reflecting an increase in
average interest earning assets together with the effect of higher average
rates. Average-earning assets increased due largely to new loan originations.
Non-performing and restructured assets also effect interest income. During
1996 and 1995, non-performing assets averaged $21.6 million and $31.9 million
respectively, while performing troubled debt restructurings (TDR's) averaged
$3.2 million and $26.5 million, respectively. Had these assets performed in
accordance with their original terms throughout the year, interest income would
have been greater than the reported amounts by $1.9 million in 1996 and $2.6
million in 1995.
Interest expense increased by $2.4 million, or 6.7%, reflecting higher
average deposits and borrowings outstanding during 1996 compared to 1995 and
offset by lower average rates on both deposits and borrowings. The weighted
average cost of deposits decreased by 6 basis points to 4.64% and the weighted
average cost of borrowings, which includes borrowings from the Federal Home Loan
Bank and short-term repurchase agreements, decreased by 22 basis points to
5.75%.
The changes in net interest income from 1995 to 1996, including
non-performing assets, attributable to changes in average balances and interest
rates is summarized as follows:
CHANGE
ATTRIBUTABLE TO
----------------
VOLUME RATE NET CHANGE
------- ----- ----------
(Dollars in thousands)
Interest-earning assets:
Mortgage loans.................................................... $ 6,504 $ (56) $ 6,448
Other loans....................................................... (56) 20 (36)
Mortgage-backed securities........................................ (1,876) 14 (1,862)
Other securities.................................................. 183 (34) 149
Money market investments and federal funds........................ (22) (16) (38)
------- ----- ----------
Total interest income........................................ 4,733 (72) 4,661
------- ----- ----------
Interest-bearing liabilities:
Deposits.......................................................... 1,777 (264) 1,513
FHLB advances..................................................... 696 (220) 476
Other borrowings.................................................. 585 (192) 393
------- ----- ----------
Total interest expense....................................... 3,058 (676) 2,382
------- ----- ----------
Net interest income.......................................... $ 1,675 $ 604 $ 2,279
------- ----- ----------
------- ----- ----------
41
As noted earlier, interest spread is a factor in determining net interest
income. The following table summarizes the components of the Bank's interest
rate spread in 1996 and 1995:
1996 1995
---- ----
Average yield on loans.................................................................... 8.41% 8.42%
Average yield on mortgage-backed securities............................................... 6.33 6.33
Average yield on other securities......................................................... 6.41 6.52
Average yield on money market investments and federal funds............................... 5.22 5.81
Combined average yield on interest-earning assets......................................... 7.93 7.84
Average cost of deposits.................................................................. 4.64 4.70
Average cost of FHLB Advances............................................................. 5.55 5.84
Average cost of other borrowings.......................................................... 5.84 6.00
Combined average cost of funds............................................................ 4.95 5.04
Interest rate spread during the year...................................................... 2.98 2.80
Provision for Possible Loan Losses. The provision for loan losses was $0.9
million in 1996 as compared to $1.5 million in 1995. As mentioned in the
earnings overview, an additional non-recurring $1.0 million provision for loan
losses was recorded in the fourth quarter of 1995; this provision was made to
strengthen the allowance for loan losses and provide increased flexibility in
working out or selling certain commercial loans not included in the 'bulk sale.'
Excluding the non-recurring $1.0 million provision made in 1995, the provision
for loan losses was increased by $0.4 million in 1996 as a result of loan
growth.
From December 31, 1995 to December 31, 1996, non-accrual loans increased
from $5.4 million to $15.4 million while classified assets (which include
non-accrual loans) increased from $21.9 million to $31.3 million. The allowance
for loan losses was $8.7 million and $8.3 million at December 31, 1996 and 1995,
respectively. The allowance represented 1.3% and 1.6% of the total loan
portfolios and 56% and 152% of total non-performing loans at December 31, 1996
and 1995, respectively. Of this increase, $6.1 million related to commercial
loans held for bulk sale which became non-accrual during 1996; commercial loans
held for bulk sale are carried at fair value.
The allowance for loan losses is maintained at a level which management
considers adequate based on its regular review of the Bank's loan portfolios
taking into consideration the likelihood of repayment, the diversity of the
borrowers, the type of loan, delinquency data, the quality of the collateral,
current market conditions and the associated risks. Further additions to the
allowance for loan losses may be necessary if the economic conditions currently
affecting the likelihood of repayment and property values deteriorate further
and until management's efforts further reduce the amount of non-performing
loans.
Non-Interest Income. Excluding the loss recognized on the bulk sale of
certain commercial loans, non-interest income amounted to $2.4 million in 1996
as compared with $1.6 million in 1995.
Banking service fees and other income rose by $0.5 million to $2.2 million
in 1996 primarily as the result of an increase in the number of customer
checking accounts. Banking service fees and other income relates to recurring
income generated from retail banking fees, net commission income on sales of
investment products and loan charges and late fees.
Mortgage banking income rose by $0.1 million due to increased sales of
residential mortgage loan production to secondary market investors.
In 1996, a loss of $0.9 million was recognized to further reduce the
carrying value of certain loans held for bulk sale which became non-accrual
during 1996. In 1995, a $7.5 million loss was recorded to write down loans held
for bulk sale to the lower of cost or market value.
42
Non-Interest Expenses. The following table sets forth the primary
components of non-interest expense for the periods indicated.
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995
------------ -----------
(In thousands)
Salaries and wages........................................................ $ 8,284 $ 7,074
Employee benefits......................................................... 2,467 2,127
Legal..................................................................... 511 595
Occupancy................................................................. 1,447 1,139
Furniture and equipment................................................... 1,001 1,006
Deposit insurance......................................................... 1,426 1,447
Net cost of operating other real estate owned............................. 1,143 249
Third party loan servicing expenses....................................... 549 645
Advertising/Marketing..................................................... 1,101 1,003
Insurance................................................................. 243 204
Professional services..................................................... 1,115 1,051
Other..................................................................... 2,065 1,729
------------ -----------
Sub-total............................................................ 21,352 18,269
SAIF special assessment................................................... 2,624 --
------------ -----------
Total non-interest expenses..................................... $ 23,976 $18,269
------------ -----------
------------ -----------
Most operating expense categories posted increases in 1996 over 1995 levels
due largely to increased staffing and related expenses of new supermarket
branches and costs of enhanced customer delivery systems; marketing costs also
increased in 1996 related to new products and new branches. The net cost of
operating OREO increased by $1.4 million in 1997. Primarily due to valuation
adjustments of $1.0 million on certain commercial OREO properties recognized in
the fourth quarter of 1997.
The one-time SAIF Special Assessment resulted from legislation signed into
law on September 30, 1996 and is applicable to all SAIF insured institutions.
The special assessment was levied by the FDIC to recapitalize the SAIF. The
recapitalization of the SAIF fund is expected to provide lower deposit insurance
premiums for at least the next three years. The anticipated savings in the
Company's deposit insurance premiums is estimated to be approximately $0.9
million per year, beginning in 1997.
Income Taxes. In 1996, income tax expense totaled $1.0 million as compared
with an income tax benefit of $18.5 million in 1995. The 1995 income tax amount
included the reversal of a $19.8 million valuation allowance previously
established against deferred tax assets. Excluding the effect of reversing the
valuation allowance in 1995, the combined effective tax rate for 1996 and 1995
was approximately 40%.
The Bank adopted SFAS No. 109, 'Accounting for Income Taxes,' effective
January 1, 1993. Among other provisions, SFAS No. 109 requires that a valuation
allowance be recorded to reduce net deferred tax assets to an amount that will
be realized based on a 'more likely than not' criteria. The valuation allowance
is subject to adjustment based on changes in circumstances that affect
management's judgment about the realizability of the deferred tax asset.
Adjustments to increase or decrease the valuation allowance are charged or
credited, respectively, to income tax expense.
The income tax benefit in 1995 was primarily due to a reduction in the
valuation allowance reflecting management's best judgment regarding the amounts
and timing of future taxable income. The valuation allowance was reduced by
$19.8 million, of which $15.3 million related to deferred tax asset balances
prior to the effects of the bulk sale'. As a result, net deferred tax assets
totaled $17.8 million at December 31, 1995 as compared with $2.0 million at
December 31, 1994. The principal components of the Bank's deferred tax assets
are net operating loss carryforwards, and temporary differences attributable to
loan loss reserves, the bulk sale transaction, and certain OREO activity.
Elimination of the valuation allowance for future tax benefits in 1995 requires
that earnings reported in future periods be tax effected at the statutory rates.
43
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented here have been prepared
in accordance with generally accepted accounting principles which require the
measurement of most elements of financial position and operating results in
terms of historical dollars, without considering changes in the relative
purchasing power of money over time due to inflation. Unlike most industrial
companies, virtually all of the assets and liabilities of the Company are
monetary in nature. As a result, interest rates have a more significant impact
on the Company's earnings than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as do the prices of goods and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Market risk represents the sensitivity of income and capital levels to
changes in interest rates. The Company manages its Market Risk in conjunction
with its Asset/Liability Management and Interest Rate Risk Management
strategies. Asset-liability and Interest-rate risk management is governed by
policies and procedures approved annually by the Company's Board of Directors
(the 'Board'). The Board delegates responsibility for asset-liability and
interest-rate risk management to the Asset-Liability Management Committee
('ALCO'). ALCO sets strategies that guide the asset-liability management
activities of the Company and review all major market risk, liquidity and
capital management activities of the Company. ALCO is comprised of members of
Senior Management representing the Finance, Lending and Retail Banking areas,
among others.
ASSET/LIABILITY AND INTEREST RATE RISK MANAGEMENT
The Company attempts to manage the maturity and repricing characteristics
of its balance sheet in order to maintain the sensitivity of both net interest
income and the market value of the balance sheet within acceptable ranges.
Specific areas subject to interest rate risk include: net interest margins,
prepayments on residential mortgages and mortgage-backed securities, and the
residential mortgage applications in the 'pipeline' which have been rate locked
by the borrower. The Company has no market risk sensitive instruments entered
into for trading purposes.
Modifying the interest sensitivity embedded in the balance sheet can be
accomplished in several ways. By emphasizing the origination of new assets and
liabilities, or the rollover of existing assets and liabilities, which have
favorable characteristics compared to the existing balance sheet, incremental
change towards the desired sensitivity position can be achieved. Hedging
activities such as the utilization of interest rate hedge agreements, ('caps,'
'swaps' and 'collars') can effect immediate change in the sensitivity position.
Restructuring of the balance sheet can also be used to effect immediate change.
In recent years, the Company has utilized each of these strategies to manage its
sensitivity position.
In order to measure its sensitivity to changes in interest rates, the
Company utilizes Net Portfolio Value ('NPV') simulation modeling to measure the
variability of net interest income and the market value of its balance sheet
under a number of different interest rate scenarios. In addition to NPV
simulation modeling, management uses gap (the difference between the amount of
assets and liabilities repricing in any particular period) analysis as a part of
its review of the Company's position with respect to potential exposure to risk
under various interest-rate scenarios. The results of these analyses are
periodically presented to both ALCO and the Board. The Board has set specific
limits on the Company's sensitivity position, as required by OTS regulations.
The Company's net interest margin is affected by fluctuations in market
interest rates as a result of timing differences in the repricing of its assets
and liabilities. The repricing differences are measured in specific time
intervals and are referred to within the banking industry as interest rate
sensitivity gaps. The Company manages the interest rate risk of current and
future earnings to a level consistent with the Company's mix of businesses and
seeks to limit such risk exposure to a percentage of earnings and stockholders'
equity. The Company has established interest rate risk limits based on a Net
Portfolio Value ('NPV') concept consistent with the approach used by the OTS in
determining risk based capital requirements. The Company uses interest rate
hedge agreements and manages the mix of its short and
44
long term borrowings to achieve its desired risk profile relative to NPV under a
variety of interest rate assumptions.
Prepayments on residential mortgages and mortgage-backed securities, which
are generally not subject to prepayment penalties, can alter the Company's
interest sensitivity gap. Prepayments on fixed-rate commercial real estate loans
are generally subject to prepayment penalties. The Company considers estimates
of prepayments when calculating its interest rate sensitivity and NPV limits.
Prepayments tend to accelerate in a falling interest rate environment when it
may be difficult to reinvest the funds at the same interest rate.
The residential mortgage pipeline is also susceptible to changes in
interest rates. Loans in the pipeline originated for portfolio have not been
hedged. Loans in the pipeline which are targeted for sale to secondary market
investors (e.g. FHLMC and FNMA) are either price locked with the investor or
hedged using off-balance instruments (generally forward contracts).
Hedging Activities. In accordance with policies approved by the Board of
Directors, the Company uses certain derivative financial instruments and forward
contracts to assist in managing its interest rate risk exposure, but does not
utilize such instruments for speculative purposes. Derivative financial
instruments used by the Company during 1997 were interest rate swaps, caps and
collars. The Company has not entered into any derivative financial instrument
agreements containing embedded options.
The Company has entered into interest rate hedge agreements with certain
approved broker/dealers ('Brokers'). (See Note 17 of Notes to Consolidated
Financial Statements at Item 8.) The following table summarizes, by category of
asset or liability hedged, the notional amount of the Company's outstanding
derivative financial instruments as of December 31, 1997:
INTEREST INTEREST FORWARD
RATE SWAPS RATE COLLARS CONTRACTS TOTAL
---------- ------------ --------- --------
(in 000's)
Item hedged:
MBS available for sale.......................... $ -- $ 90,000 $ -- $ 90,000
Mortgage pipeline............................... -- -- 1,000 1,000
Adjustable-rate borrowings...................... 20,000 25,000 -- 45,000
---------- ------------ --------- --------
Total Notional Amount...................... $ 20,000 $115,000 $ 1,000 $136,000
---------- ------------ --------- --------
---------- ------------ --------- --------
Interest rate swaps and collars generally are long term contracts made at
market interest rates when purchased. Forward contracts are generally of short
term duration, usually 60 to 90 days in length. The market value of all hedge
transactions are measured monthly. At December 31, 1997, the unrealized gain or
(loss) on hedge transactions was $(0.6) million on interest rate swaps, $0.3
million on interest rate collars, and zero on forward contracts. The asset or
liability being hedged generally has an offsetting unrealized gain or loss. It
is the Company's intention to hold the hedging instruments until the contracts
expire.
45
Net Portfolio Value Model and Interest Sensitivity Gap. The NPV approach
calculates the difference between the present value of liabilities and the
expected cash flows from assets and off-balance sheet contracts which would
result from instantaneous and sustained parallel shifts in the yield curve. The
following table sets forth the sensitivity of the Company's NPV and the
calculated change in the Company's annual Net Interest Income based upon
immediate and sustained hypothetical changes in interest rates as of December
31, 1997:
CHANGE IN NPV CHANGE IN NET INTEREST INCOME
CHANGE IN ------------------------------- -------------------------------
MARKET INTEREST RATES COMPUTED CHANGE POLICY LIMIT COMPUTED CHANGE POLICY LIMIT
- --------------------- --------------- ------------ --------------- ------------
+2% - 15.2% - 20.0% - 8.0% - 20.0%
+1% - 6.3% - 10.0% - 4.6% - 10.0%
Unchanged -- -- -- --
- 1% +2.3% - 10.0% +2.4% - 10.0%
- 2% +5.5% - 20.0% +4.5% - 20.0%
These calculations indicate that our NPV and Net Interest Income would be
adversely affected by increases in interest rates and favorably affected by
interest rate declines. All computed changes are within policy limits.
While we cannot predict future interest rates or their effects on our NPV
or net interest income, we do not expect current interest rates to have a
material adverse effect on our NPV or net interest income in the future.
Computations of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, prepayments and deposit flows, and should not be relied upon as
indicative of actual results. Certain shortcomings are inherent in such
computations. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react at different times and in
different degrees to changes in market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while rates on other types of assets and liabilities may
lag behind changes in market interest rates. Certain assets, such as adjustable
rate mortgage loans and mortgage-backed securities, generally have features
which restrict changes in interest rates on both a short-term basis and over the
life of the asset. In the event of a change in interest rates, prepayments and
early withdrawal levels could be significantly different from those assumed in
making the calculations set forth above, and an increased credit risk may result
as the ability of certain borrowers to service their debt may be affected in the
event of an interest rate increase.
Additionally, the OTS has proposed an interest rate risk ('IRR') component
as part of its risk-based capital requirement and also considers IRR when
assigning a composite rating to the institutions it regulates. Under the
proposed regulations, an institution's IRR is measured by the decline in net
portfolio value that would result from a 200 basis point increase or decrease in
market interest rates divided by the estimated value of assets. An institution
with a change in this ratio (a change defined by the OTS as 'IRR exposure') in
excess of 2% must deduct an IRR component when calculating its risk-based
capital requirement. At December 31, 1997, the Bank's IRR exposure was
approximately 1.5% which is considered 'normal.'
46
The following table represents the composition of the one-year interest
sensitive gap for the dates indicated:
DECEMBER 31,
----------------------------
1997 1996 1995
------- ------- ------
(Dollars in millions)
Interest-earning assets subject to repricing in one year:
Residential mortgage loans....................................... $ 143.3 $ 144.7 $178.9
Commercial real estate loans..................................... 116.3 110.2 81.9
Commercial loans held for bulk sale.............................. -- -- 61.5
Commercial business loans........................................ 7.6 6.3 7.0
Installment loans................................................ 22.4 19.3 19.8
Mortgage backed securities....................................... 94.6 118.1 129.2
Other securities................................................. 10.1 14.7 24.3
------- ------- ------
Total rate-sensitive assets................................. 394.3 413.3 502.6
------- ------- ------
Interest-bearing liabilities subject to repricing within one year:
Money-rate deposits and borrowings:
Time deposits............................................... 191.0 217.6 192.9
Money market accounts....................................... 139.0 126.2 102.9
Securities sold under repurchase agreements................. 97.1 109.0 28.5
FHLB advances............................................... 66.9 59.8 148.5
Core Deposits:
Savings..................................................... 98.3 93.4 93.8
Demand...................................................... 52.8 41.6 35.5
Escrow...................................................... 4.6 4.1 4.2
------- ------- ------
Total static rate-sensitive liabilities..................... 649.7 651.7 606.3
Adjustments:
Core deposit accounts............................................ (104.3) (93.6) (91.8)
Interest rate hedge agreements................................... (85.0) (115.0) (70.0)
------- ------- ------
Total rate-sensitive liabilities............................ 460.4 443.1 444.5
------- ------- ------
One-year interest-sensitive gap -- excess (deficiency) of rate-
sensitive assets over rate sensitive liabilities.................... $ (66.1) $ (29.8) $ 58.1
------- ------- ------
------- ------- ------
Rate-sensitive assets as a % of rate-sensitive liabilities............ 85.6% 93.3% 113.1%
One-year interest sensitive gap as a % of total assets................ (7.5)% (3.5)% 7.0%
The gap table presented above is based on the contractual maturity of
fixed-rate products, and the next repricing date of adjustable-rate products.
Normal amortization and prepayment estimates have been applied to both fixed
rate and adjustable rate assets, where appropriate.
From December 31, 1996 to December 31, 1997 the one-year interest sensitive
gap declined by $36.3 million due primarily to the advancing expiration dates of
certain interest rate hedge agreements. From December 31, 1995 to December 31,
1996 the one-year interest sensitive gap declined by $87.9 million primarily due
to the redeployment of loans designated as held for bulk sale.
47
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
--------------------
1997 1996
-------- --------
(Dollars in
thousands)
ASSETS
Cash and due from banks................................................................... $ 11,750 $ 6,863
Securities available for sale: (Notes 4 and 9)
Mortgage-backed securities........................................................... 119,730 113,575
Other securities..................................................................... 7,207 22,215
Securities held to maturity: (Note 4)
Mortgage-backed securities, fair value of
$25,425 in 1997 and $25,597 in 1996................................................ 25,537 29,957
-------- --------
Total securities................................................................ 152,474 165,747
-------- --------
Loans, net:
Residential real estate mortgage loans............................................... 388,284 393,513
Commercial real estate and multi-family residential mortgage loans................... 237,944 210,982
Commercial loans..................................................................... 8,417 7,194
Installment loans.................................................................... 39,901 31,194
-------- --------
674,546 642,883
Less allowance for loan losses (Note 5)................................................... (9,421) (8,652)
Residential loans held for sale........................................................... -- 456
-------- --------
Total loans, net................................................................ 665,125 634,687
-------- --------
Federal Home Loan Bank stock.............................................................. 10,071 9,760
Accrued interest and dividends receivable................................................. 5,325 5,278
Premises and equipment, net (Note 7)...................................................... 8,411 6,793
Other real estate owned (Note 6).......................................................... 4,564 10,726
Net deferred tax assets (Note 10)......................................................... 14,991 16,812
Other assets.............................................................................. 2,781 2,024
-------- --------
Total assets.................................................................... $875,492 $858,690
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
48
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION -- (CONTINUED)
DECEMBER 31,
--------------------
1997 1996
-------- --------
(Dollars in
thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposit accounts (Note 14)
Savings accounts..................................................................... $ 96,979 $ 93,371
Time deposits........................................................................ 330,279 314,059
Money market deposits................................................................ 140,387 126,233
Demand deposits...................................................................... 52,732 41,583
-------- --------
Total deposits.................................................................. 620,377 575,246
-------- --------
Borrowings from the FHLB (Note 8)......................................................... 66,900 84,800
Securities Sold Under Repurchase Agreements (Note 9)...................................... 101,936 113,894
Accrued interest payable.................................................................. 1,343 1,618
Mortgagors' escrow deposits............................................................... 4,563 4,134
Other liabilities......................................................................... 7,802 7,330
-------- --------
Total liabilities............................................................... 802,921 787,022
-------- --------
Commitments and contingencies (Notes 9 and 13)
STOCKHOLDERS' EQUITY
Common stock ($0.01 par value; 40,000,000 shares authorized; 12,715,315 and 12,696,825
shares issued and 12,610,315 and 12,591,825 shares outstanding in 1997 and 1996,
respectively)........................................................................... 127 127
Additional paid in capital................................................................ 66,823 66,736
Retained earnings (Note 15)............................................................... 7,682 6,827
Unrealized losses on securities, net...................................................... (124) (85)
Treasury stock, at cost, 105,000 shares................................................... (1,937) (1,937)
-------- --------
Total stockholders' equity (Notes 15 and 16).................................... 72,571 71,668
-------- --------
Total liabilities and stockholders' equity...................................... $875,492 $858,690
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
49
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(Dollars in thousands,
except per share data)
Interest and dividend income:
Real estate mortgage loans.................................................. $51,260 $48,519 $42,071
Other loans................................................................. 3,790 3,388 3,425
Mortgage-backed securities.................................................. 9,438 9,593 11,454
Other securities............................................................ 2,164 1,973 1,824
Federal funds and money market investments.................................. 71 147 185
------- ------- -------
Total interest and dividend income..................................... 66,723 63,620 58,959
------- ------- -------
Interest expense:
Deposits.................................................................... 28,211 25,834 24,321
Borrowings.................................................................. 11,064 12,023 11,154
------- ------- -------
Total interest expense................................................. 39,275 37,857 35,475
------- ------- -------
Net interest income......................................................... 27,448 25,763 23,484
Provision for loan losses........................................................ 1,850 850 1,525
------- ------- -------
Net interest income after provision for loan losses......................... 25,598 24,913 21,959
------- ------- -------
Non-interest income:
Retail banking fees and other income........................................ 3,340 2,188 1,568
Residential mortgage banking income......................................... 234 168 64
Loss on bulk sale of commercial loans....................................... -- (894) (7,546)
------- ------- -------
Total non-interest income.............................................. 3,574 1,462 (5,914)
------- ------- -------
Non-interest expense:
Salaries and wages.......................................................... 8,968 8,284 7,074
Employee benefits (Note 11)................................................. 3,188 2,467 2,127
Legal....................................................................... 611 511 595
Occupancy................................................................... 1,737 1,447 1,139
Furniture and equipment..................................................... 1,218 1,001 1,006
Deposit insurance........................................................... 551 1,426 1,447
SAIF -- special assessment (Note 20)........................................ -- 2,624 --
Net cost of operating other real estate owned (Note 6)...................... 2,508 1,143 249
Third party loan servicing expenses......................................... 486 549 645
Other....................................................................... 5,217 4,524 3,987
------- ------- -------
Total non-interest expenses............................................ 24,484 23,976 18,269
------- ------- -------
Income (loss) before income taxes........................................... 4,688 2,399 (2,224)
Income tax expense (benefit) (Note 10)........................................... 2,259 963 (18,486)
------- ------- -------
Net income............................................................. $ 2,429 $ 1,436 $16,262
------- ------- -------
------- ------- -------
Net income per share -- basic (Note 3)........................................... $ 0.19 $ 0.11 $ 1.30
------- ------- -------
------- ------- -------
Net income per share -- diluted (Note 3)......................................... $ 0.18 $ 0.11 $ 1.27
------- ------- -------
------- ------- -------
Dividends per share.............................................................. $ 0.125 $ 0.10 $ 0.08
------- ------- -------
------- ------- -------
See accompanying notes to consolidated financial statements.
50
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
COMMON
RETAINED UNREALIZED STOCK
ADDITIONAL EARNINGS GAINS HELD
COMMON PAID-IN (ACCUMULATED (LOSSES) BY TREASURY
STOCK CAPITAL DEFICIT) ON SECURITIES ESOP STOCK
------ ---------- ------------- ------------- ------ --------
(Dollars in thousands, except per share data)
Balance at January 1, 1995.................... $125 $ 66,521 $(8,615) $(5,425) $(191 ) $ (1,937)
Net income.................................... 16,262
Cash dividends, $.08 per share................ (1,000)
Allocation of ESOP Shares..................... (120) 191
Stock options exercised....................... 1 114
Change in unrealized losses on available for
sale securities, net........................ 4,998
------ ---------- ------------- ------------- ------ --------
Balance at December 31, 1995.................. 126 66,515 6,647 (427) -- (1,937)
Net income.................................... 1,436
Cash dividends, $.10 per share................ (1,256)
Stock options exercised....................... 1 221
Change in unrealized losses on available for
sale securities, net........................ 342
------ ---------- ------------- ------------- ------ --------
Balance at December 31, 1996.................. 127 66,736 6,827 (85) -- (1,937)
Net income.................................... 2,429
Cash dividends, $.125 per share............... (1,574)
Stock options exercised....................... 87
Change in unrealized losses on available for
sale securities, net........................ (39)
------ ---------- ------------- ------------- ------ --------
Balance at December 31, 1997.................. $127 $ 66,823 $ 7,682 $ (124) -- $ (1,937)
------ ---------- ------------- ------------- ------ --------
------ ---------- ------------- ------------- ------ --------
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance at January 1, 1995.................... $50,478
Net income.................................... 16,262
Cash dividends, $.08 per share................ (1,000)
Allocation of ESOP Shares..................... 71
Stock options exercised....................... 115
Change in unrealized losses on available for
sale securities, net........................ 4,998
-------------
Balance at December 31, 1995.................. 70,924
Net income.................................... 1,436
Cash dividends, $.10 per share................ (1,256)
Stock options exercised....................... 222
Change in unrealized losses on available for
sale securities, net........................ 342
-------------
Balance at December 31, 1996.................. 71,668
Net income.................................... 2,429
Cash dividends, $.125 per share............... (1,574)
Stock options exercised....................... 87
Change in unrealized losses on available for
sale securities, net........................ (39)
-------------
Balance at December 31, 1997.................. $72,571
-------------
-------------
See accompanying notes to consolidated financial statements.
51
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
-------- --------
(Dollars in
thousands)
Increase (decrease)
in cash
Cash flows from operating activities:
Net income..................................................................................... $ 2,429 $ 1,436
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses................................................................. 1,850 850
Writedowns on other real estate owned..................................................... 1,718 372
Depreciation.............................................................................. 935 743
Amortization of premiums and discounts on mortgage-backed securities, other securities and
loans................................................................................... 1,094 239
Net (gains) losses on sale of assets...................................................... (55) 687
Deferred tax expense (benefit)............................................................ 1,946 883
(Increase) decrease in interest and dividend receivable................................... (47) 621
(Increase) decrease in other assets....................................................... (788) (666)
Increase (decrease) in interest payable................................................... (275) (229)
Increase (decrease) in other liabilities.................................................. 472 (129)
(Increase) decrease in residential loans held for sale.................................... 456 (263)
-------- --------
Net cash provided by operating activities................................................. 9,735 4,544
-------- --------
Cash flows from investing activities:
Purchases of mortgage-backed securities -- available for sale.................................. (39,203) (19,841)
Purchases of other securities -- available for sale............................................ (7,001) (36,459)
Proceeds from sales of mortgage-backed securities -- available for sale........................ 5,534 3,096
Proceeds from sales of other securities -- available for sale.................................. -- 37,626
Principal repayments on mortgage-backed securities -- available for sale....................... 26,833 31,278
Principal repayments on mortgage-backed securities -- held to maturity......................... 4,227 3,623
Proceeds from maturities of other securities -- available for sale............................. 22,055 133
FHLB Stock purchases........................................................................... (311) (843)
Loan originations, net of repayments........................................................... (67,668) (112,267)
Proceeds from sales of commercial loans held for bulk-sale..................................... -- 33,178
Proceeds from sales of loans in portfolio...................................................... 36,468 19,828
Purchases of fixed assets...................................................................... (2,553) (1,295)
Proceeds from sale of other real estate owned.................................................. 2,556 2,480
-------- --------
Net cash used in investing activities.............................................................. (19,063) (39,463)
-------- --------
Cash flows from financing activities:
Net increase (decrease) in demand, money market, and savings accounts.......................... 28,911 29,025
Net increase in time deposits.................................................................. 16,220 12,180
Net increase (decrease) in repurchase agreements............................................... (11,958) 80,408
Net increase (decrease) in FHLB borrowings..................................................... (17,900) (88,699)
Increase (decrease) in escrow deposits......................................................... 429 (58)
Stock issued................................................................................... 87 222
Dividends paid................................................................................. (1,574) (1,256)
-------- --------
Net cash provided by financing activities.......................................................... 14,215 31,822
-------- --------
Net increase (decrease) in cash and cash equivalents............................................... 4,887 (3,097)
Cash and cash equivalents, beginning of year....................................................... 6,863 9,960
-------- --------
Cash and cash equivalents, end of year............................................................. $ 11,750 $ 6,863
-------- --------
-------- --------
Supplemental disclosures of cash flow information:
Cash paid during year for:
Interest credited on deposits............................................................. $ 28,165 $ 25,779
Interest paid on borrowings............................................................... 11,385 12,309
Income/franchise taxes paid............................................................... 500 240
Net non-cash investing and financing activities:
(Increase) decrease in net unrealized losses on available for sale securities, net of
deferred tax effect..................................................................... (39) 342
Investment securities transferred from available-for-sale to held-to-maturity category.... -- 35,300
Change in common stock held by ESOP....................................................... -- --
Loans transferred to other real estate.................................................... 831 4,080
Loans to facilitate asset sales........................................................... 2,585 4,000
YEAR ENDED DECEMBER 31,
1995
---------
Cash flows from operating activities:
Net income..................................................................................... $ 16,262
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses................................................................. 1,525
Writedowns on other real estate owned..................................................... 94
Depreciation.............................................................................. 809
Amortization of premiums and discounts on mortgage-backed securities, other securities and
loans................................................................................... 436
Net (gains) losses on sale of assets...................................................... 6,715
Deferred tax expense (benefit)............................................................ (18,760)
(Increase) decrease in interest and dividend receivable................................... (1,083)
(Increase) decrease in other assets....................................................... 480
Increase (decrease) in interest payable................................................... 1,351
Increase (decrease) in other liabilities.................................................. 681
(Increase) decrease in residential loans held for sale.................................... 86
---------
Net cash provided by operating activities................................................. 8,596
---------
Cash flows from investing activities:
Purchases of mortgage-backed securities -- available for sale.................................. (44,624)
Purchases of other securities -- available for sale............................................ (15,132)
Proceeds from sales of mortgage-backed securities -- available for sale........................ 49,781
Proceeds from sales of other securities -- available for sale.................................. 3,000
Principal repayments on mortgage-backed securities -- available for sale....................... 27,629
Principal repayments on mortgage-backed securities -- held to maturity......................... --
Proceeds from maturities of other securities -- available for sale............................. 5,129
FHLB Stock purchases........................................................................... (1,587)
Loan originations, net of repayments........................................................... (119,681)
Proceeds from sales of commercial loans held for bulk-sale..................................... --
Proceeds from sales of loans in portfolio...................................................... 9,457
Purchases of fixed assets...................................................................... (1,348)
Proceeds from sale of other real estate owned.................................................. 3,598
---------
Net cash used in investing activities.............................................................. (83,778)
---------
Cash flows from financing activities:
Net increase (decrease) in demand, money market, and savings accounts.......................... (19,644)
Net increase in time deposits.................................................................. 64,541
Net increase (decrease) in repurchase agreements............................................... 1,451
Net increase (decrease) in FHLB borrowings..................................................... 26,899
Increase (decrease) in escrow deposits......................................................... 983
Stock issued................................................................................... 186
Dividends paid................................................................................. (1,000)
---------
Net cash provided by financing activities.......................................................... 73,416
---------
Net increase (decrease) in cash and cash equivalents............................................... (1,766)
Cash and cash equivalents, beginning of year....................................................... 11,726
---------
Cash and cash equivalents, end of year............................................................. $ 9,960
---------
---------
Supplemental disclosures of cash flow information:
Cash paid during year for:
Interest credited on deposits............................................................. $ 24,334
Interest paid on borrowings............................................................... 9,887
Income/franchise taxes paid............................................................... 129
Net non-cash investing and financing activities:
(Increase) decrease in net unrealized losses on available for sale securities, net of
deferred tax effect..................................................................... 4,998
Investment securities transferred from available-for-sale to held-to-maturity category.... --
Change in common stock held by ESOP....................................................... 191
Loans transferred to other real estate.................................................... 4,788
Loans to facilitate asset sales........................................................... 1,080
See accompanying notes to consolidated financial statements
52
POUGHKEEPSIE FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
On May 30, 1997, Poughkeepsie Financial Corp. (the 'Holding Company' or
together with its wholly-owned subsidiary, the 'Company') became the holding
company for Poughkeepsie Savings Bank, FSB after a stockholder approved
reorganization. On October 14, 1997, Poughkeepsie Savings Bank, FSB changed its
name to Bank of the Hudson (the 'Bank').
Bank of the Hudson is a federally chartered community savings bank serving
the Mid-Hudson Valley region of New York through sixteen branches in Dutchess,
Orange and Rockland counties and six residential loan origination offices. In
recent years, the business of the Bank has consisted primarily of obtaining
funds in the form of deposits from the general public and borrowings, and using
such funds to make residential mortgage loans and commercial mortgage loans as
well as commercial business loans, consumer loans, student loans and other
investments. The Bank's deposits are insured up to applicable limits by the
Savings Association Insurance Fund ('SAIF'), which is administered by the
Federal Deposit Insurance Corporation ('FDIC'). The Bank is subject to
comprehensive regulation, examination and supervision by the Office of Thrift
Supervision ('OTS'), its primary regulator, and the FDIC. The Bank also is a
member of the Federal Home Loan Bank ('FHLB') system.
2. AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER
Poughkeepsie Financial Corp., Bank of the Hudson and HUBCO, Inc. entered
into an Amended and Restated Agreement and Plan of Merger ('Merger Agreement')
dated as of October 22, 1997. Under the terms of this agreement each share of
Poughkeepsie Financial Corp. Common Stock will be exchanged for .30 shares of
HUBCO Common Stock, as long as the median closing price for HUBCO Common Stock
during a pre-closing period is at or above $33.33. If the median HUBCO price
during the pre-closing period is below $33.33 but above $31.25, each share of
Poughkeepsie Financial Corp. Common Stock would be exchanged for shares of HUBCO
Common Stock with value of $10.00. If HUBCO's median pre-closing price is $31.25
or below, a maximum exchange ratio of .32 would apply. In addition, the
agreement provided that Poughkeepsie Financial Corp. was able to increase its
quarterly cash dividends to amounts substantially equivalent to HUBCO's cash
dividend as adjusted for the exchange ratio. In connection with the execution of
the Merger Agreement, Poughkeepsie Financial Corp. issued an option to HUBCO
which, under certain defined circumstances, would enable HUBCO to purchase up to
2,000,000 shares of Poughkeepsie Financial Corp. Common Stock at $7.875 per
share. The transaction, which is expected to close in the second quarter of
1998, is expected to be treated as a tax-free exchange to holders of
Poughkeepsie Financial Corp. stock and to be accounted for as a pooling of
interests.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements include the accounts of Poughkeepsie
Financial Corp. and Bank of the Hudson and its wholly-owned subsidiaries: PSB
Associates, Inc., a life insurance agency; PSB Building Corp., a holding company
for the Bank's headquarters building; and several other subsidiaries primarily
engaged in holding real estate acquired through foreclosure or otherwise
intended for disposition, including: PoSaBk, Inc. and Plural Realty, Inc. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Certain 1996 and 1995 amounts in the consolidated financial statements have
been reclassified to conform with the 1997 presentation.
53
USE OF ESTIMATES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and prevalent practices used within the
banking industry. In preparing such financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the consolidated statement of financial condition
and the revenues and expenses for the period. Actual results could differ
significantly from those estimates. Estimates that are particularly susceptible
to significant change relate to the determination of the adequacy of the
allowance for loan losses and the valuation of real estate acquired in
connection with foreclosures or in satisfaction of loans. In connection with the
determination of the allowance for loan losses and the valuation of other real
estate owned ('OREO'), management obtains independent appraisals for significant
properties.
Management believes that the allowance for loan losses is adequate and the
valuation of OREO is appropriate. While management uses available information to
recognize possible loan losses, future additions to the allowance may be
necessary based on changes in economic conditions. In addition, regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses and the valuation of OREO. Such agencies
may require the Bank to recognize additions to the allowance or reduce the
valuation of OREO based on their judgments of information available to them at
the time of their examination.
SECURITIES
The Company classifies its securities at acquisition and each reporting
date thereafter as either held-to-maturity, available-for-sale or trading.
Securities classified as held-to-maturity are limited to debt securities for
which the Company has the positive intent and ability to hold to maturity.
Trading securities are debt and equity securities that are bought for the
purpose of selling them in the near term. All other securities are classified as
available-for-sale.
Held-to-maturity securities are carried at amortized cost;
available-for-sale securities are carried at fair value, with unrealized gains
and losses excluded from earnings and reported on a net-of-tax basis as a
separate component of stockholders' equity. Fair values for these securities are
based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices for similar securities.
The Company has no trading securities. Federal Home Loan Bank stock is a
restricted security held in accordance with certain regulatory requirements and
is carried at cost.
Purchases and sales are recorded on the trade date and realized gains and
losses on sales of securities are determined using the specific identification
method. Premiums and discounts are amortized to interest income using the level
yield method over the term of the securities, adjusted, in the case of
mortgage-based securities, for actual prepayments.
LOANS
Loans generally are stated at their outstanding unpaid principal balance
net of any deferred fees or costs. Interest income on loans is recognized as
earned based on principal amounts outstanding. Non-refundable loan origination
fees and costs directly associated with the loan origination process are
deferred and recognized as a yield adjustment over the life of the related loan.
Non-Accrual Loans: Generally, a loan (including a loan defined as impaired
under SFAS No. 114) is classified as non-accrual when the loan becomes 90 days
past due, or earlier if the probability of collection is deemed to be
insufficient to warrant continued accrual, even though the loan currently is
performing. A loan may remain on accrual status if it is in the process of
collection and is either guaranteed or well secured. All previously accrued
interest for loans placed on non-accrual is deducted from interest income and
any cash receipts from these assets are generally credited directly to the
outstanding principal balances. Generally, loans are returned to accrual status
when the obligation is brought current, has performed in accordance with the
contractual terms for a reasonable period of time and the ultimate
collectibility is no longer in doubt. Consumer loans that are more than 120 days
delinquent are generally charged off against the allowance for loan losses.
54
Allowance for Loan Losses: The allowance for loan losses is maintained at a
level which management considers adequate based on its regular review of the
Bank's loan portfolios taking into consideration the likelihood of repayment,
the diversity of the borrowers, the type of loan, the quality of the collateral,
current market conditions and associated risks.
SFAS No. 114, 'Accounting by Creditors for Impairment of a Loan,' as
amended by SFAS No. 118, 'Accounting for Impairment of a Loan -- Income
Recognition and Disclosures,' was adopted by the Bank as of January 1, 1995.
Adoption of SFAS No. 114, as amended, did not result in any adjustment to the
allowance for loan losses. The Bank uses the loan-by-loan measurement method,
however, one-to-four family residential loans and consumer installment loans are
collectively evaluated for impairment and are not subject to SFAS No. 114
measurement criteria.
Under SFAS No. 114, a loan is recognized as impaired when it is probable
that principal and/or interest will not be collected in accordance with its
contractual terms. A loan in not considered impaired if there is a insignificant
delay in receipt of payment. The Bank measures impairment based on the fair
value of the collateral for all collateral dependent loans. Impaired loans which
are not collateral dependent are measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate; this
evaluation is inherently subjective, as it requires material estimates that may
be susceptible to significant change. If the fair value of an impaired loan is
less than the related recorded amount, a valuation allowance is established or
the write-down is charged against the allowance for loan losses if the
impairment is considered to be permanent.
Mortgage Banking Activities: The Bank originates certain one-to-four family
residential mortgage loans in its local market area for sale to unrelated
investors. Residential mortgage loans held for sale are carried at the lower of
aggregate cost or market. Interest rate exposure with respect to mortgage
production is hedged primarily through mortgage sale commitments. Gains (losses)
on the sale of loans are recorded when the loans are sold to unrelated
investors.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation
and amortization. Depreciation on premises, leasehold improvements, and
furniture and equipment is computed by the straight-line method over the
estimated useful lives of the related assets or, if shorter, the related lease
terms, which range from 3 to 40 years.
OTHER REAL ESTATE OWNED ('OREO')
Real estate acquired by foreclosure or deed in lieu of foreclosure is
stated at the lower of the recorded investment or estimated fair value less
costs of disposition. Upon classification as OREO, the excess of the recorded
investment over the estimated fair value of the collateral, if any, is charged
to the allowance for loan losses. Net income derived from these properties
reduces the carrying value of the property. Net expenses incurred in maintaining
properties, subsequent write-downs due to reductions in estimated fair values,
and gains or losses upon disposition are included in operating expenses.
Expenditures to complete or improve properties are capitalized only if
reasonably expected to be recovered; otherwise they are expensed as incurred.
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights (MSRs) on loans serviced for others are
recognized based on their fair value (relative to the fair value of the loan
without the servicing rights) at the time the loan is sold. Mortgage servicing
rights are amortized as a reduction of loan servicing income over the estimated
servicing period. MSRs are assessed for impairment based upon their estimated
fair value. To evaluate impairment MSRs are stratified based principally on the
loan type and interest rate. MSR impairment, if any, is recognized through a
valuation allowance.
55
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
The Company enters into sales of securities under agreements to repurchase
the same securities. These agreements are treated as financings, and the
obligations to repurchase securities sold are reflected as a liability in the
consolidated statement of financial condition. The securities underlying the
agreements are included in the asset accounts.
SFAS No. 125, 'Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities,' adopted by the Company, specifies
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities and for distinguishing whether a
transfer of financial assets in exchange for cash or other consideration should
be accounted for as a sale or as a pledge of collateral in a secured borrowing.
SFAS No. 125 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, except for
certain provisions (relating to the accounting for secured borrowings and
collateral and the accounting for transfers and servicing of repurchase
agreements, dollar rolls, securities lending and similar transactions) which
have been deferred until January 1, 1998 in accordance with SFAS No. 127,
'Deferral of the Effective Date of Certain Provisions of FASB Statement No.
125.' The adoption of these standards has not had a material impact on the
Company's consolidated financial statements.
INTEREST ON DEPOSITS
Interest on deposits is compounded annually, monthly or continuously using
a daily percentage rate (except for certain money market deposits and time
deposits over one hundred thousand dollars, which do not receive compound
interest) and is credited to depositors' accounts monthly, quarterly, annually
or at maturity.
STOCK OPTIONS
Statement of Financial Accounting Standards No. 123, 'Accounting for
Stock-Based Compensation,' encourages, but does not require companies to record
compensation cost for stock-based employee compensation plans at fair value. The
Company has opted to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
'Accounting for Stock Issued to Employees,' and related interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's stock at the date of grant over
the amount an employee must pay to acquire the stock. See Note 12 for a further
discussion of the Company's stock option plans.
HEDGING ACTIVITIES
In accordance with policies approved by the Board of Directors, the Company
uses certain derivative financial instruments and forward contracts to assist in
managing its interest rate risk exposure, but does not utilize such instruments
for speculative purposes. The Company uses three principle types of derivative
financial instruments: interest rate caps and collars (which reduce the
Company's cash flow exposures to changing interest rates), interest rate swaps
(which effectively convert a portion of the Company's variable rate borrowings
to a fixed rate), and forward contracts (which effectively reduce the Company's
exposure to interest rate changes on residential mortgage applications which
have been rate locked by the borrower and, if funded, the Company plans to sell
into the secondary market). The change in fair value of forward contracts which
hedge mortgage applications in the pipeline are deferred and recognized as
adjustments to gain or loss on sale of the underlying loans. Interest rate swaps
are accounted for on a settlement basis, with the net amounts paid or received
under such contracts included in interest income or expense. Interest rate caps
and collars are also accounted for on a settlement basis. See Notes 17 and 19
for more information regarding the Company's derivative financial instruments.
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for
the current year (after exclusion of non-taxable items) plus deferred taxes.
Deferred taxes are provided when income or
56
expense is recognized in different periods for tax purposes than for financial
reporting purposes using an asset and liability approach for recognizing the tax
effects of temporary differences. Significant temporary differences include
additions to the allowance for loan losses and write-downs of OREO, which
generally are not deductible for tax purposes until the loans are charged off or
the properties are sold. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be realized or settled. The effect
on deferred tax assets and liabilities of a change in tax laws or rates is
recognized in income in the period the change is enacted.
The Company and its subsidiary file a consolidated Federal income tax
return.
PENDING ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, 'Reporting Comprehensive Income.' SFAS No. 130 establishes standards
for reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. SFAS No. 130 requires that
financial statements report and display comprehensive income in the same
prominence as net income, but permits the statement of comprehensive income to
be presented either together with or apart from the income statement.
Comprehensive income, as defined by SFAS No. 130, includes revenues, expenses,
gains and losses, which under current generally accepted accounting principles,
bypass net income and are typically reported as a component of stockholders'
equity. SFAS No. 130 is effective for the Company's 1998 financial statements.
The adoption of this standard is not expected to have a material impact on the
Company's financial statements.
In June 1997, the FASB issued SFAS No. 131, 'Disclosure About Segments of
an Enterprise and Related Information.' SFAS No. 131 introduces a new model for
segment reporting entitled the 'management approach,' which focuses upon the
manner in which the chief operating decision makers organize segments within a
company for making operating decisions and assessing performance. Under the
management approach, reportable segments can be based upon, but not limited to,
products and services, geography and legal or management structure. SFAS No. 131
requires full financial disclosure for each segment, but only requires limited
quarterly segment disclosure. SFAS No. 131 is effective for the Company's 1998
financial statements. The adoption of this standard is not expected to have a
material impact on the Company's financial statements.
EARNINGS PER SHARE
The Company adopted SFAS No. 128, 'Earnings Per Share,' which became
effective in the fourth quarter of 1997. As required, the Company has restated
all prior periods to the new definitions of Basic and Diluted Earnings per
share. The restatement did not have a material effect on previously reported
earnings per share amounts. Basic earnings per common share is computed by
dividing net income by the weighted average number of common shares outstanding.
Diluted earnings per common share includes the additional dilutive effect of
stock options using the average market price of the Company's common stock for
the period.
A summary of the basic and diluted earnings per share calculations for
1997, 1996 and 1995 is as follows:
1997 1996 1995
----------- ----------- -----------
Net income (in thousands)............................... $ 2,429 $ 1,436 $ 16,262
----------- ----------- -----------
----------- ----------- -----------
Weighted average basic shares outstanding............... 12,595,307 12,546,881 12,483,085
Effect of dilutive stock options........................ 643,404 363,577 372,166
----------- ----------- -----------
Weighted average diluted shares outstanding............. 13,238,711 12,910,458 12,855,251
----------- ----------- -----------
----------- ----------- -----------
Earnings per share:
Basic.............................................. $ 0.19 $ 0.11 $ 1.30
----------- ----------- -----------
----------- ----------- -----------
Diluted............................................ $ 0.18 $ 0.11 $ 1.27
----------- ----------- -----------
----------- ----------- -----------
57
4. SECURITIES
A summary of securities at December 31 follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ----------- ---------- --------
(In thousands)
1997
Available-for-Sale Securities:
Securities of U.S. Government agencies and
corporations.................................. $ 7,059 $ 32 $ 7,091
Securities of financial institutions and
corporations.................................. 115 1 116
Mortgage-backed securities...................... 119,763 652 $685 119,730
--------- ----------- ---------- --------
$126,937 $ 685 $685 $126,937
--------- ----------- ---------- --------
--------- ----------- ---------- --------
Held-to-Maturity Securities:
Mortgage-backed securities...................... $ 25,537 $ -- $112 $ 25,425
--------- ----------- ---------- --------
--------- ----------- ---------- --------
1996
Available-for-Sale Securities:
Securities of U.S. Government agencies and
corporations.................................. $ 17,071 $ 2 $ 38 $ 17,035
Securities of financial institutions and
corporations.................................. 5,157 23 -- 5,180
Mortgage-backed securities...................... 113,456 718 599 113,575
--------- ----------- ---------- --------
$135,684 $ 743 $637 $135,790
--------- ----------- ---------- --------
--------- ----------- ---------- --------
Held-to-Maturity Securities:
Mortgage-backed securities...................... $ 29,957 $ -- $360 $ 29,597
--------- ----------- ---------- --------
--------- ----------- ---------- --------
In February 1996, the Bank reclassified $35.3 million of fixed rate
mortgage-backed securities from the available-for-sale category to the
held-to-maturity category. At the date of transfer, these securities had a net
unrealized loss of $0.3 million which is being amortized over the remaining life
of the underlying securities, 14 years. The net unrealized loss on securities
classified as available for sale is reported, net of income taxes, as a separate
component of stockholders' equity. Proceeds from sales of investment securities
during 1997, 1996 and 1995 totaled approximately $5.5 million, $40.7 million and
$52.8 million, respectively, and resulted in gross gains of $0, $0.1 million,
and $0.4 million, respectively, and gross losses of $0, $0.1 million and $0.5
million, respectively.
The amortized cost and fair value of securities at December 31, 1997, by
maturity date, are summarized below. Mortgage-backed securities are included in
the table based upon remaining contractual term. Due to prepayment features,
certain of these securities may repay prior to contractual maturity.
AVAILABLE-FOR-SALE HELD-TO-MATURITY
--------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- -------- --------- -------
(In thousands)
Due in one year or less................................. $ 2,466 $ 2,466 -- --
Due after one year through five years................... 7,146 7,177 -- --
Due after five years through ten years.................. 28 30 -- --
Due after ten years..................................... 117,297 117,264 $25,537 $25,425
--------- -------- --------- -------
Total.............................................. $126,937 $126,937 $25,537 $25,425
--------- -------- --------- -------
--------- -------- --------- -------
58
The composition of the mortgage-backed securities portfolio at December 31,
1997 is as follows:
AVAILABLE- HELD-TO-
FOR-SALE MATURITY
--------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- -------- --------- -------
(In thousands)
FHLMC participation certificates........................ $ 43,857 $ 43,870 $12,243 $12,176
GNMA certificates....................................... 46,412 46,202 -- --
FNMA mortgage-backed securities......................... 29,494 29,658 7,860 7,815
Private mortgage-backed securities...................... -- -- 5,434 5,434
--------- -------- --------- -------
Total.............................................. $119,763 $119,730 $25,537 $25,425
--------- -------- --------- -------
--------- -------- --------- -------
At December 31, 1997, mortgage-backed securities with a book value of
$114.4 million were pledged as collateral for FHLB borrowings, repurchase
agreements, certain interest rate hedge agreements and for other purposes.
5. ALLOWANCE FOR LOAN LOSSES
The following is a summary of changes in the allowance for loan losses:
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------ ------ -------
(In thousands)
Balance, beginning of year...................................... $8,652 $8,259 $18,195
------ ------ -------
Provision for loan losses....................................... 1,850 850 1,525
------ ------ -------
Charge-offs:
1-4 family residential real estate......................... 1,656 457 562
Commercial real estate..................................... 101 208 1,395
Commercial business........................................ 36 6 --
Consumer................................................... 85 62 108
------ ------ -------
Total charge-offs.......................................... 1,878 733 2,065
------ ------ -------
Recoveries:
Commercial real estate..................................... 647 110 308
Commercial business........................................ 128 93 43
Consumer................................................... 22 73 254
------ ------ -------
Total recoveries........................................... 797 276 605
------ ------ -------
Net charge-offs................................................. 1,081 457 1,460
------ ------ -------
Writedowns of loans transferred to Commercial Loans Held for
Bulk Sale..................................................... -- -- 10,001
------ ------ -------
Balance, end of year............................................ $9,421 $8,652 $ 8,259
------ ------ -------
------ ------ -------
The Bank currently originates loans primarily in the Mid-Hudson Valley
region of New York and adjacent counties in New Jersey and Connecticut. The
ability of borrowers to perform in accordance with the terms of their loan
agreements is affected by, among other things, the real estate market conditions
prevailing within the Bank's market area.
During the fourth quarter of 1995, the Bank charged-off $10.1 million
related to its efforts to sell, in bulk, certain non-performing, sub-performing,
and performing commercial loans. In addition to this $10.1 million charge-off
against the allowance for loan losses, a loss of $7.5 million was recorded to
write these loans down to their then fair value of $61.5 million. During 1996,
an additional $0.9 million write-down was recorded to recognize a decline in
fair value on certain loans held for bulk sale which became non-performing in
1996. During 1996, the Bank closed on the sale of $33.1 million of these loans,
was paid off on an additional $4.6 million, and the balance of $22.6 million was
returned to portfolio.
59
Loans delinquent 90 days or more as to interest (including non-accrual
loans) amounted to $10.2 million and $15.4 million at December 31, 1997 and
1996, respectively. Loans which are 90 days or more past their contractual
maturity, predominantly commercial real estate mortgages, were approximately
$6.2 million and $7.0 million at December 31, 1997 and 1996, respectively. These
loans have not 'performed' in accordance with their principal repayment terms
but continue to perform in accordance with their interest terms. Interest income
is recognized on these loans. The loan portfolio also includes certain
restructured loans that are performing in accordance with their modified terms.
Restructured loans totaled $14.4 million and $9.5 million at December 31, 1997
and 1996, respectively.
Interest income recorded in 1997, 1996 and 1995 would have increased by
approximately $1.2 million, $1.9 million and $2.6 million had non-accrual loans
and restructured loans performed in accordance with their original terms and
conditions. Interest income recorded on these loans totaled approximately $1.0
million in 1997 and $1.4 million in 1996.
At December 31, 1997, the recorded investment in loans that are considered
to be impaired under SFAS No. 114 was $21.3 million. Generally, the fair value
of impaired loans was determined using the fair value of the underlying
collateral. Included in this amount is $4.2 million of impaired loans for which
the related valuation allowance for loan losses is $0.9 million and $9.7 million
of impaired loans that as a result of write-downs do not have an allowance for
credit losses. During 1997 and 1996, the average recorded investment in impaired
loans was approximately $19.2 million and $9.4 million, respectively, and the
Bank recognized interest income on these impaired loans of approximately $1.5
million and $1.4 million. No interest income was recognized on the cash basis
method of interest recognition.
At December 31, 1996, the recorded investment in loans that are considered
to be impaired under SFAS No. 114 was $19.4 million. Generally, the fair value
of impaired loans was determined using the fair value of the underlying
collateral. Included in this amount was $0.9 million of impaired loans for which
the related valuation allowance for loan losses is $0.3 million, and $13.3
million of impaired loans that as a result of write-downs do not have an
allowance for credit losses.
6. OTHER REAL ESTATE OWNED
The following is a summary of the activity in the other real estate owned
accounts (including investment in real estate):
NON-PERFORMING
PERFORMING -------------------------
INVESTMENT COMMERCIAL RESIDENTIAL
IN REAL ESTATE OREO OREO TOTAL
-------------- ---------- ----------- -------
(In thousands)
Balance at January 1, 1996......................... $ 1,192 $ 11,424 $ 1,357 $13,973
Real estate acquired in settlement of loans........ 3,000 1,080 4,080
Capital improvements............................... 907 907
Dispositions....................................... (1,180) (1,300) (2,480)
Transfer to performing loans....................... (1,192) (4,044) (5,236)
Net excess cash flow............................... (39) (108) (147)
Write-downs........................................ (335) (36) (371)
-------------- ---------- ----------- -------
Balance at December 31, 1996....................... -- 9,733 993 10,726
--------------
--------------
Real estate acquired in settlement of loans........ 831 831
Capital improvements............................... 305 305
Dispositions....................................... (1,234) (1,322) (2,556)
Transfer to performing loans....................... (2,585) (2,585)
Net excess cash flow............................... (439) (439)
Write-downs........................................ (1,664) (54) (1,718)
---------- ----------- -------
Balance at December 31, 1997....................... $ 4,116 $ 448 $ 4,564
---------- ----------- -------
---------- ----------- -------
60
The investment in real estate represents advances on a loan to facilitate
the sale of OREO. In 1996 this loan met all the criteria for classification as a
performing loan and was transferred to the commercial real estate loan category.
7. PREMISES AND EQUIPMENT
Below is a summary of premises and equipment:
DECEMBER 31,
--------------------
1997 1996
-------- --------
(In thousands)
Banking offices....................................................... $ 7,747 $ 7,600
Furniture and equipment............................................... 8,698 7,517
Leasehold improvements................................................ 3,760 2,521
-------- --------
20,205 17,638
Accumulated depreciation.............................................. (11,794) (10,845)
-------- --------
Total, net............................................................ $ 8,411 $ 6,793
-------- --------
-------- --------
8. BORROWINGS FROM THE FEDERAL HOME LOAN BANK OF NEW YORK
The following table provides certain information regarding term advances
and short-term borrowings as of December 31, 1997 and 1996:
1997 1996
------------------ ------------------
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------- ------- ------- -------
(Dollars in thousands)
Term advances............................................ $35,000 5.69% $35,000 5.64%
Short-term advances and overnight borrowings under the
FHLB line of credit.................................... 31,900 5.75 49,800 5.45%
------- -------
$66,900 $84,800
------- -------
------- -------
The term advances outstanding as of December 31, 1997 are scheduled to
mature in 1998 with interest rates of 5.7%.
In connection with term advances, the Bank has granted to the FHLB, as
collateral, a security interest in specific assets including mortgage loans with
an aggregate value of 110% of the outstanding advance. As of December 31, 1997,
the Bank had sufficient available collateral to borrow an additional $258
million in the form of FHLB advances or reverse repurchase agreements.
In addition, at December 31, 1997, the Bank had available an unused line of
credit of $52.8 million, from a total line of $84.7 million granted by the FHLB,
which is subject to various terms and conditions, including collateralization.
9. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Securities sold under repurchase agreements are as follows:
DECEMBER 31,
--------------------
1997 1996
-------- --------
(In thousands)
Repurchase agreements........................................................... $ 97,102 $109,005
Unit investment trust........................................................... 4,834 4,889
-------- --------
$101,936 $113,894
-------- --------
-------- --------
The securities underlying the agreements to repurchase were delivered to
the various counterparties, who may have sold, loaned or otherwise disposed of
such securities to other parties in the normal course of their operations and
have agreed to resell to the Bank the same (or substantially the same)
61
securities upon maturity of the agreements. The amount of risk under these
borrowings with any one counterparty, defined as the excess of carrying value of
the asset sold under agreements to repurchase, including accrued interest, over
the amount borrowed, adjusted for accrued interest was approximately $0.4
million at December 31, 1997. The weighted average rate for the borrowings under
repurchase agreements was 5.8% and 5.46% at December 31, 1997 and 1996,
respectively.
The repurchase agreements outstanding at December 31, 1997 matured during
January 1998. The maximum amounts outstanding at any month-end during 1997, 1996
and 1995 were $129.3 million, $112.4 million and $142.4 million, respectively.
In 1984, the Bank sold tax-exempt municipal investment securities subject
to a 14 day put option, under certain circumstances, to a unit investment trust.
The transaction was accounted for as a borrowing due to the recourse nature of
the put option and the municipal securities are included in the securities
portfolio. The underlying collateral to the municipal security is a first
mortgage secured by a commercial property which may prepay without penalty. Such
prepayment would cause the dissolution of the put option as well as the
elimination of the Bank's investment and borrowing. Such prepayment could result
in a loss to the Bank. The Bank accrued $0.2 million for this potential loss in
1997. The weighted average interest rate on borrowings under the unit investment
trust was 8.0% at both December 31, 1997 and 1996.
The following were pledged as additional collateral for the unit investment
trust as of December 31 for the periods indicated:
1997 1996
------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ------ --------- ------
(In thousands)
FHLMC participation certificates............................ $ 2,707 $2,717 $ 697 $ 690
Private mortgage-backed securities.......................... 182 137 234 152
FNMA mortgage-backed securities............................. 4,326 4,299 6,548 6,451
--------- ------ --------- ------
$ 7,215 $7,153 $ 7,479 $7,293
--------- ------ --------- ------
--------- ------ --------- ------
10. INCOME TAXES
A reconciliation of the income tax provision to the amount computed using
the federal statutory rate is as follows:
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ---- --------
(In thousands)
Income tax expense (benefit) at federal statutory rate (34%)..... $1,593 $816 $ (756)
State income tax, net of federal benefit......................... 408 177 181
Tax-exempt interest income....................................... 20 21 21
Bad debt deduction............................................... -- -- 1,768
Decrease in valuation allowance.................................. -- -- (19,808)
Effect of non-deductible merger related costs.................... 147 -- --
Other............................................................ 91 (51) 108
------ ---- --------
Income tax expense (benefit)..................................... $2,259 $963 $(18,486)
------ ---- --------
------ ---- --------
62
The components of the provision for income taxes are as follows:
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ---- --------
(In thousands)
Federal:
Deferred.................................................... $1,851 $696 $(16,849)
State:
Current..................................................... 313 80 274
Deferred.................................................... 95 187 (1,911)
------ ---- --------
Income tax expense (benefit)..................................... $2,259 $963 $(18,486)
------ ---- --------
------ ---- --------
In accordance with SFAS No. 109, deferred income tax assets and liabilities
reflect the impact of temporary differences between values recorded as assets
and liabilities for financial reporting purposes and values utilized for
remeasurement in accordance with tax laws. The tax effects of temporary
differences giving rise to the Company's deferred tax assets at December 31,
1997 and 1996 are as follows:
1997 1996
------- -------
(In thousands)
Net operating loss (NOL) carryforward................................... $ 7,265 $ 8,495
Allowance for loan losses and OREO...................................... 3,640 3,230
Loans with different tax and book basis................................. 2,848 3,763
Deferred loan fees...................................................... 444 384
AMT credit.............................................................. 694 694
Net unrealized losses on available for sale securities.................. 83 (42)
Other, net.............................................................. 17 288
------- -------
14,991 16,812
Valuation allowance..................................................... -- --
------- -------
Net deferred tax asset.................................................. $14,991 $16,812
------- -------
------- -------
Under SFAS No. 109, deferred tax assets must be reduced by a valuation
allowance to an amount that is 'more likely than not' to be realized. Based on
recent historical and anticipated future pre-tax earnings, management believes
that it is more likely than not that the Company will realize its net deferred
tax assets. Accordingly, the Company eliminated the valuation allowance in
December 1995. At December 31, 1997, the Company had a net operating loss
carryforward and alternative minimum tax credit carryforward of $21.3 million
and $0.7 million, respectively. The net operating loss carryforward begins to
expire in 2005.
Until December 31, 1995, savings banks that met certain definitions, tests
and other conditions prescribed by the Internal Revenue Code were allowed a bad
debt deduction, subject to certain limitations. This deduction was computed
either as a percentage of taxable income before such deductions or based on
actual loss experience. SFAS No. 109 provides that the cumulative tax bad debt
reserves as of December 31, 1987 (the 'base year reserves') are permanent
differences which do not require the establishment of a deferred tax liability.
The tax 'base year reserves' for the Bank is approximately $5.7 million. This
'base year reserve' could be recognized as taxable income and create a current
tax liability at the income tax rates then in effect if one of the following
occur: 1) the Bank's retained earnings represented by the reserve is used for
purposes other than to absorb losses from bad debts; or 2) the Bank fails to
qualify as a Bank as defined by the Internal Revenue Code or; 3) there is a
change in the federal tax law. None of these events occurred as of December 31,
1997. Furthermore, no additions to the 'base year reserves' were made in the
years 1988 through 1995 for financial statement purposes. However, in September
1996 when the Bank filed its 1995 tax return, the deduction taken for bad debts
increased the Bank's tax bad debt reserves to an amount which exceeded the 'base
year reserves' by approximately $2.0 million.
On August 20, 1996, legislation was signed into law which repealed the
percentage of taxable income method of tax bad debt deduction available for
thrift institutions. This repeal is effective for the
63
Bank's taxable year beginning January 1, 1996. In addition, the legislation
requires that tax bad debt reserves in excess of 'base year reserves' be
recaptured into taxable income over a 6 to 8 year period dependent on whether
certain residential loan origination levels are maintained. As previously
mentioned, after the filing of its 1995 tax return, the Bank's tax bad debt
reserves exceed its base year reserves by approximately $2.0 million. However,
the change in tax law had no effect on the Bank's income tax expense recorded in
1996. The additional deferred tax liability related to excess reserves were
offset by an increase in deferred tax assets related to additional NOL
carryforwards created as a result of the bad debt deductions taken on the 1995
tax return. The effect of this change in tax law on the Bank is that some
available net operating loss carryforwards will be utilized earlier than
anticipated to offset the required recapture of these excess bad debt reserves
into taxable income in future years.
While New York State tax law is generally based on federal law, on July 30,
1996, New York State enacted legislation, effective January 1, 1996, which
generally retains the percentage of taxable income method for calculating the
tax bad debt deduction and does not require the Bank to recapture into income
its excess tax bad debt reserves over its base year reserves for New York State
tax purposes. The New York State percentage of taxable income tax bad debt
deduction is equal to 32% of New York State taxable income, with certain
adjustments.
11. EMPLOYEE BENEFIT PLANS
PENSION PLANS
The Company has a non-contributory defined benefit pension plan (the
'Plan') with the Retirement Systems Group, Inc., (formerly The Savings Bank
Retirement System), covering employees meeting certain eligibility requirements.
The Company's policy is to fund pension costs to the extent they can be deducted
for federal income tax purposes.
The following table sets forth the funded status of the pension plan
covering employees as of the plan's year ended September 30:
1997 1996
----- -----
(In thousands)
Accumulated benefit obligation:
Vested benefits........................................................ $ 833 $ 773
Nonvested benefits..................................................... -- 27
----- -----
Accumulated benefit obligation.............................................. 833 800
Effect of projected future compensation levels.............................. -- --
----- -----
Projected benefit obligation................................................ 833 800
Plan assets at fair value................................................... 1,385 1,307
----- -----
Plan assets in excess of projected benefit obligation....................... 552 507
Unrecognized loss........................................................... 176 221
Unrecognized past service liability......................................... 1 1
----- -----
Prepaid pension asset....................................................... $ 729 $ 729
----- -----
----- -----
1997 1996 1995
----- ----- -----
Components of pension expense are:
Interest cost.................................................. $ 62 $ 63 $ 61
Return on assets............................................... (240) (141) (185)
Amortization of deferred investment loss....................... 135 42 95
Amortization of unrecognized investment loss................... 10 18 18
Benefit settlement charges..................................... 33 -- --
----- ----- -----
Pension credit...................................................... $ -- $ (18) $ (11)
----- ----- -----
----- ----- -----
Due to the financial condition of the Bank in 1991, the Plan was amended,
effective October 1, 1991, to provide that there would be no new enrollments in
the Plan and that there would be no further benefit accruals under the Plan.
This benefit 'suspension' was initially intended to be temporary.
64
However, it is now expected to remain in effect indefinitely. Deferred
investment losses in the above table have been fully reserved.
The discount rate used in determining the actuarial present value of the
projected benefit obligations was 7.75% for 1997 and 7.50% for 1996, and the
expected long-term rate of return on plan assets was 8.0% for each period. Plan
assets consist primarily of equity and debt securities.
In 1996 the Company reactivated the Non-Employee Directors' Retirement Plan
which covers non-employee directors. This Plan is a defined benefit,
non-qualified and unfunded Plan. In December 1997, and in connection with the
Definitive Merger Agreement, the Plan was curtailed in anticipation of a
February 1998 termination and settlement. The following table sets forth
information on this Plan as of December 31, 1997 and 1996. Although this Plan
was not directly funded, the Company made contributions into a Grantor Trust
which was established to meet the benefit obligations of this Plan as they
become due. All of the funds held by the Grantor Trust are expected to be
distributed to the beneficiaries in lump sums in February 1998.
1997 1996
----- -----
(In thousands)
Accumulated benefit obligation:
Vested benefits......................................................... $ 949 $ 564
Nonvested benefits...................................................... -- --
----- -----
Accumulated benefit obligation............................................... 949 564
Effect of projected future compensation levels............................... -- --
----- -----
Projected benefit obligation................................................. 949 564
Plan assets at fair value.................................................... -- --
----- -----
Projected benefit obligation in excess of Plan assets........................ (949) (564)
Unrecognized loss............................................................ 42 46
Unrecognized past service liability.......................................... -- 491
----- -----
Accrued pension expense...................................................... $(907) $ (27)
----- -----
----- -----
Components of pension expense are:
Service cost............................................................ $ 24 $ 24
Interest cost........................................................... 43 44
Amortization of unrecognized past service liability..................... 47 47
Curtailment expense..................................................... 777 --
----- -----
Pension expense.............................................................. $ 891 $ 115
----- -----
----- -----
The discount rate used in determining the actuarial present value of the
projected benefit obligations was 7.25% for 1997 and 7.75% for 1996.
POSTRETIREMENT MEDICAL AND LIFE INSURANCE BENEFITS
The Company provides medical and life insurance benefits to all currently
eligible pension recipients. However, during 1992 the post-retirement medical
benefit plan was amended to eliminate substantially all current employees from
becoming eligible for these benefits. Post-retirement benefits are recognized on
an accrual basis over the employee's service period. Expenses for these post
retirement benefits are substantially lower than they may have been had all
current employees been expected to become eligible for these benefits.
65
The following tables set forth the status of the post-retirement benefit
plan:
DECEMBER 31,
--------------------
FINANCIAL POSITIONS 1997 1996
------------------- ------- -------
(Dollars in
thousands)
Accumulated post-retirement benefit obligation ('APBO')......................... $(1,279) $(1,231)
Unrecognized net gain........................................................... (345) (441)
Unrecognized net transition obligation.......................................... 1,247 1,330
------- -------
Accrued post-retirement benefit cost............................................ $ (377) $ (342)
------- -------
------- -------
NET PERIODIC POST-RETIREMENT EXPENSE 1997 1996 1995
------------------------------------ ---- ---- ----
Service cost.................................................................... $ 6 $ 6 $ 10
Interest cost................................................................... 89 85 94
Amortization of unrecognized net transition obligation.......................... 83 83 83
Amortization of unrecognized net gain........................................... (64) (71) (70)
---- ---- ----
Net periodic post-retirement expense charged to operations...................... $114 $103 $117
---- ---- ----
---- ---- ----
ASSUMPTIONS 1997 1996 1995
----------- ---- ---- ----
Discount rate................................................................... 7.50% 7.50% 7.25%
SERVICE PLUS
SERVICE INTEREST INTEREST
EFFECT OF A 1% INCREASE IN HEALTH TREND RATES APBO COST COST COST
--------------------------------------------- ------ ------- -------- ------------
(In thousands)
Current basis................................................. $1,278 $ 6 $ 89 $ 95
1% trend increase............................................. 1,363 7 95 101
--
------ --- ------
Change due to 1% increase..................................... $ 85 $ 1 $ 6 $ 6
------ --- --- ------
------ --- --- ------
OTHER BENEFIT PLANS
The Company has a defined contribution 401(k) plan, covering substantially
all full time employees meeting certain eligibility requirements. The Company's
401(k) contributions in 1997, 1996 and 1995 were $350,000, $339,000, and
$304,000, respectively.
In 1987, the Bank established a non-contributing leveraged Employee Stock
Ownership Plan (ESOP), which acquired shares of the Bank's stock for the benefit
of all eligible employees. The ESOP borrowed funds from an unrelated financial
institution and acquired 318,200 shares in 1987 and 37,673 shares in 1988 of the
Bank's stock in the open market at an average price of $14.05 per share. No
borrowings or unallocated shares remained as of December 31, 1997.
The Company has employment contracts with certain executive officers which
provide these individuals with post-termination benefits under certain specified
conditions, including a change in control of the Company. In connection with the
Amended and Restated Agreement and Plan of Merger with HUBCO, Inc., payments of
$1.0 million are anticipated under the change in control provisions of these
contracts.
12. STOCK OPTION PLANS
A description of each of the Company's three stock option plans follows:
1985 STOCK OPTION PLAN
The Bank received shareholder approval in 1985 for a stock option plan for
directors, officers and employees of the Bank and its subsidiaries under which
options granted may be either qualifying incentive stock options or nonqualified
options. A total of 391,867 shares were authorized under this plan. The options
are exercisable at the market price at the date of grant and vest over periods
ranging up to four years. The options may permit the holder to purchase any
combination of market value or book value shares or to exercise stock
appreciation rights. Book value options are exercisable at the
66
book value per share of common stock at the end of the most recent fiscal
quarter prior to the date of grant and require the Bank to repurchase shares
issued upon exercise of the options at the book value per share of common stock
at the end of the most recent fiscal quarter prior to the repurchase. All
options currently outstanding to non-directors do not contain book value share
exercise features or stock appreciation rights.
1993 STOCK INCENTIVE PLAN
The Bank received shareholder approval for a 1993 Stock Incentive Plan
('1993 Plan') which provides for the granting of incentive stock options
intended to comply with the requirements of Section 422 of the Internal Revenue
Code, non-incentive or compensatory stock options and stock appreciation rights.
The 1993 Plan is administered and interpreted by a committee of not less than
two members of the Board of Directors, none of whom is an officer or employee of
the Bank and each of whom is a 'disinterested person' within the meaning of the
applicable regulations under the federal securities law. The committee
determines who will be granted options, whether such options will be incentive
or compensatory options, the number of shares subject to each option and the
exercise price of each compensatory option when such options become exercisable.
The per share exercise price of an incentive stock option at least equals the
fair market value of a share of Common Stock on the date the option is granted.
Each stock option or portion thereof is exercisable at any time on or after it
vests. A total of 595,315 shares were authorized under this plan in 1993, and in
1996, stockholders approved an amendment to this plan which increased the number
of shares authorized by 525,288 shares for a total authorization of 1,120,603
shares.
1993 DIRECTORS' STOCK OPTION PLAN
The Bank also received shareholder approval for a 1993 Directors' Stock
Option Plan (the 'Directors' Plan'), which provides for the grant of
non-qualified stock options to non-employee directors of the Bank. The
Directors' Plan is administered and interpreted by the entire Board of Directors
of the Bank. A total of 255,135 shares were authorized under this plan.
Each non-employee director of the Bank in June 1993, upon the completion
date of the Bank's Offering, received compensatory options to purchase 25,000
shares of common stock, 7,000 of which vest and are exercisable twelve months
after the date of grant, and 18,000 of which vest and are exercisable thereafter
at the rate of 4,500 shares at the end of each succeeding twelve-month period.
All of these initial grants were at $2.50 per share, the subscription price for
a share of common stock in the Offering.
Any person who becomes a member of the Board of Directors of the Bank
subsequent to the Offering and who is not an employee of the Bank will receive
an option to purchase 25,000 shares of stock (or such lesser number as may then
be available for grant under the Directors' Plan), 7,000 of which vest and are
exercisable twelve months after the date of grant, and 18,000 of which vest and
are exercisable thereafter at the rate of 4,500 shares at the end of each
succeeding twelve-month period. The exercise price of such shares will be the
fair market value at the date of grant.
67
A summary of the transactions within each of the Company's Stock Option
Plans follows:
1993 DIRECTORS'
1985 OPTION PLAN 1993 INCENTIVE PLAN PLAN
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- ------- -------- ------- --------
Outstanding at 1/1/95.......................... 229,244 $ 4.12 556,250 $ 3.10 193,000 $ 2.89
Granted................................... -- 20,000 5.38 --
Exercised................................. (13,950) 2.24 (36,150) 2.50 --
Canceled.................................. (45,000) 9.61 (1,500) 2.50 --
------- ------- -------
Outstanding at 12/31/95........................ 170,294 2.83 538,600 3.22 193,000 2.89
Granted................................... -- 438,000 5.12 --
Exercised................................. (500) 1.50 (60,500) 3.98 --
Canceled.................................. -- -- --
------- ------- -------
Outstanding at 12/31/96........................ 169,794 2.84 916,100 4.08 193,000 2.89
Granted................................... -- -- --
Exercised................................. (8,540) 2.78 (9,950) 4.41 --
Canceled.................................. -- -- --
------- ------- -------
Outstanding at 12/31/97........................ 161,254 2.84 906,150 4.08 193,000 2.89
------- ------- -------
------- ------- -------
Exercisable as of 12/31/97..................... 161,254 $ 2.84 591,350 $ 3.76 148,000 $ 2.82
------- -------- ------- -------- ------- --------
------- -------- ------- -------- ------- --------
Available for future grant, as of 12/31/97..... 65,212 92,353 55,135
------- ------- -------
------- ------- -------
GENERAL
At December 31, 1997, the Company had three stock option plans as described
above. The Company applies APB Opinion 25 and related Interpretations in
accounting for these plans. Accordingly, no compensation cost has been
recognized for these plans. Had compensation cost for these stock option plans
been determined based on the fair value at the grant dates for awards under
these plans consistent with the fair value method of SFAS No. 123, 'Accounting
for Stock Based Compensation', net income and earnings per share would have been
reduced to the pro forma amounts indicated below (amounts in thousands, except
per share data):
1997 1996 1995
------ ------ -------
Net income As reported $2,429 $1,436 $16,262
Pro forma 2,227 1,375 16,258
Earnings per share -- Basic As reported $ 0.19 $ 0.11 $ 1.30
Pro forma 0.18 0.11 1.30
Earnings per share -- Diluted As reported $ 0.18 $ 0.11 $ 1.27
Pro forma 0.17 0.11 1.27
The fair value of each option grant was estimated as of the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants awarded in 1996 and 1995, respectively: dividend yield of
2.0% and 1.5%; expected volatility of 31% and 36%; risk-free interest rate of
5.5% in both years; and expected lives of 4.5 years and 4.0 years. There were no
options awarded in 1997.
The following table summarizes information about stock options outstanding
at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- -------------------------------
RANGE OF NUMBER REMAINING WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ------------------------------- ----------- ---------------- ---------------- ----------- ----------------
$1.00 to $3.00................. 603,474 5.3 years $ 2.34 523,974 $ 2.32
3.01 to 5.00................. 205,000 6.5 years 4.55 184,500 4.60
5.01 and greater.............. 451,930 8.7 years 5.31 192,130 5.57
----------- -----------
1,260,404 6.7 years 3.77 900,604 3.48
----------- -----------
----------- -----------
68
13. COMMITMENTS AND CONTINGENCIES
The Company leases various branch and loan origination offices and certain
equipment under noncancelable agreements. These leases have expiration dates
through 2021. Certain of the lease agreements contain escalation clauses which
have been aggregated into the annual rent expense and minimum annual rentals. At
December 31, 1997, aggregate minimum annual rentals were as follows:
YEAR ENDING
DECEMBER 31,
- ------------ (In thousands)
1998................................................... $1,257
1999................................................... 773
2000................................................... 665
2001................................................... 457
2002................................................... 260
Thereafter............................................. 2,267
-------
Total........................................... $5,679
-------
-------
Rental expense aggregated $0.9 million, $0.7 million, and $0.5 million in
1997, 1996 and 1995, respectively. Rent expense relates primarily to the cost of
leasing retail branch locations and loan production offices.
In the course of its business, the Company is involved in various legal
proceedings. No predictions can be made presently as to the outcome or nature of
any relief that may be ultimately granted with respect to any of these
proceedings. In the opinion of management, pending or threatened legal
proceedings are not expected to result in a material adverse effect on the
Company's consolidated financial statements.
During 1989 the Bank securitized approximately $100 million of seasoned
one-year adjustable rate mortgages, originated primarily in the Mid-Hudson
Valley, with the Federal Home Loan Mortgage Corporation (FHLMC). An agreement
was entered into requiring the Bank to repay FHLMC for any foreclosure losses
incurred on that portfolio through 1999. During 1997, payments of $64,000 were
made on this agreement. Since 1989, payments on this agreement have aggregated
$670,000. The outstanding balance on these mortgage-backed securities was
approximately $24.2 million at December 31, 1997 and $27.8 million at December
31, 1996. At December 31, 1997, there were reserves of $300,000 for estimated
future payments related to this agreement.
Loans sold with recourse are identified when a loan is sold and the buyer
retains the right to enforce a repurchase by the seller under certain
conditions. The Bank does not sell loans with recourse as part of normal
operations. However, it did so to facilitate the sale of its Farmers Federal
division in 1988. Repurchases under this agreement have not been material.
14. DEPOSIT ACCOUNTS
Below is a summary of the deposit accounts at December 31 for the periods
indicated:
1997 1996
----------------- -----------------
AMOUNT RATE AMOUNT RATE
-------- ---- -------- ----
(Dollars in thousands)
Checking accounts........................................ $ 37,282 -- $ 25,787 --
NOW accounts............................................. 15,450 2.16% 15,796 2.16%
Passbook accounts........................................ 96,581 3.26 93,061 3.27
Money market deposit accounts............................ 140,387 4.81 126,233 4.56
Club accounts............................................ 398 3.00 310 3.00
Certificate accounts..................................... 330,279 5.72 314,059 5.56
-------- --------
$620,377 4.70% $575,246 4.63%
-------- --------
-------- --------
69
The following is a summary of certificate accounts by remaining term to
contractual maturity at December 31:
1997 1996
----------------- -----------------
AMOUNT RATE AMOUNT RATE
-------- ---- -------- ----
(Dollars in thousands)
3 months or less......................................... $ 44,535 5.19% $ 69,976 5.27%
3 to 6 months............................................ 46,607 5.50 78,253 5.35
6 to 12 months........................................... 99,811 5.58 69,416 5.32
1 to 2 years............................................. 69,345 5.89 19,813 5.67
2 to 3 years............................................. 60,450 6.20 53,390 5.98
3 to 4 years............................................. 5,043 5.89 16,989 6.87
More than 4 years........................................ 4,488 7.07 6,222 6.67
-------- --------
Total certificates.................................. $330,279 5.72% $314,059 5.56%
-------- --------
-------- --------
Interest expense on deposits, summarized by major categories, were as
follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
(In thousands)
Savings accounts....................................................... $ 3,093 $ 3,036 $ 3,288
Time deposits.......................................................... 18,131 17,195 15,949
Money market deposits.................................................. 6,287 4,988 4,543
Demand deposits........................................................ 643 564 501
Mortgagors' escrow deposits............................................ 57 51 40
------- ------- -------
$28,211 $25,834 $24,321
------- ------- -------
------- ------- -------
At December 31, 1997 and 1996 there were no brokered deposits. Deposits in
excess of $100,000 at December 31, 1997 and 1996 were $88.3 million and $69.0
million, respectively.
15. STOCKHOLDERS' EQUITY
The Holding Company relies on dividends received from the Bank to declare
and pay dividends to stockholders. The Bank may not declare or pay dividends on
shares of its common stock if the effect thereof would cause stockholders equity
to be reduced below applicable regulatory capital maintenance requirements.
The Company's retained earnings at December 31, 1997 include certain
amounts which have been designated as a reserve for bad debts under federal
income tax regulations and has been deducted for federal income tax purposes.
See Income Taxes at Note 10.
Upon the Bank's conversion from mutual to stock form in 1985, a liquidation
account was established within stockholders' equity for the benefit of all
eligible account holders in an amount equal to $38.0 million, representing total
retained earnings at June 30, 1985. In the event of complete liquidation of the
Bank, such account holders would be entitled to their interest in the
liquidation account prior to any payments to shareholders. In addition, no
dividend declaration or payment would be permitted which would reduce
stockholders' equity below the aggregate amount required in the liquidation
account. The aggregate liquidation account is determined at the end of each
fiscal year and is reduced proportionately as eligible account holders reduce
their balances. In no event may the liquidation account be increased. The
liquidation account amounted to $6.5 million and $7.3 million at December 31,
1997 and 1996, respectively.
On May 1, 1988, the Bank's Board of Directors adopted a shareholder rights
plan which expires on May 1, 1998. The plan provides for a dividend of one share
purchase right for each of the Bank's common shares held of record as of the
close of business on May 18, 1988. Initially, the rights are not exercisable;
right certificates are not distributed, and the rights automatically trade with
the Bank's common shares. However, 20 days following the acquisition of 20% or
more of the Bank's common shares or 20 days following the commencement of a
tender offer for 30% or more of the Bank's
70
common shares, the rights will become exercisable and separate right
certificates will be distributed. The rights will entitle the holders of the
Bank's common shares to purchase additional shares at an exercise price of $75
per share. In addition, in the event of certain triggering events described in
the rights plan, holders of the rights (other than the acquiring person) will be
entitled to acquire the Bank's common shares having a market value of twice the
then-current exercise price of the rights. In addition, in the event the Bank
enters into certain business combination transactions, holders of the rights
will be provided a right to acquire equity securities of the acquiring entity
having a market value of twice the then-current exercise price of the rights.
The Bank will be entitled to redeem the rights upon the occurrence of certain
events. In connection with the October 22, 1997 definitive merger agreement with
HUBCO, Inc., the Company and the Bank agreed to terminate this shareholder
rights plan upon stockholder approval of the merger.
16. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators, that if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and its subsidiary bank must meet specific capital guidelines that
involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of Tangible and Core capital (as defined) to adjusted total assets (as
defined), and of Tier 1 and Total capital (as defined in the regulations) to
risk-weighted assets (as defined). Core capital to adjusted total assets is also
known as the 'Leverage' ratio. Management believes, as of December 31, 1997,
that the Bank exceeds all capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent information from the Bank's
primary regulator, the Office of Thrift Supervision ('the OTS'), categorized the
Bank as 'well capitalized' under the regulatory framework for prompt corrective
action. To be categorized as 'well capitalized' the Bank must maintain minimum
core, Tier 1 and risk-based capital ratios as set forth in the table below.
There are no conditions or events since that notification that management
believes have changed the Bank's category. The Bank's actual capital amounts and
ratios are also presented in the table.
OTS REQUIREMENTS
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
---------------- -----------------------
AMOUNT RATIO AMOUNT RATIO
------- ----- ------ ----
As of December 31, 1997:
Tangible Capital/Adjusted Total Assets........... $59,960 6.95% >$12,943 >1.5%
-- --
Core Capital/Adjusted Total Assets............... $59,960 6.95% >$25,887 >3.0%
-- --
Tier 1 Capital/Risk Weighted Assets.............. $59,960 10.38% -- --
Total Capital/Risk Weighted Assets............... $67,180 11.62% >$46,232 >8.0%
-- --
As of December 31, 1996:
Tangible Capital/Adjusted Total Assets........... $56,457 6.69% >$12,652 >1.5%
-- --
Core Capital/Adjusted Total Assets............... $56,457 6.69% >$25,304 >3.0%
-- --
Tier 1 Capital/Risk Weighted Assets.............. $56,457 10.22% -- --
Total Capital/Risk Weighted Assets............... $63,354 11.47% >$44,199 >8.0%
-- --
TO BE WELL CAPITALIZED
UNDER PROMPT CORRECTIVE
ACTION PROVISIONS
-----------------------
AMOUNT RATIO
------ -----
As of December 31, 1997:
Tangible Capital/Adjusted Total Assets...........
-- --
Core Capital/Adjusted Total Assets............... >$43,145 >5.0%
-- --
Tier 1 Capital/Risk Weighted Assets.............. >$34,674 >6.0%
-- --
Total Capital/Risk Weighted Assets............... >$57,790 >10.0%
-- --
As of December 31, 1996:
Tangible Capital/Adjusted Total Assets........... -- --
Core Capital/Adjusted Total Assets............... >$42,175 >5.0%
-- --
Tier 1 Capital/Risk Weighted Assets.............. >$33,150 >6.0%
-- --
Total Capital/Risk Weighted Assets............... >$55,250 >10.0%
-- --
71
A reconciliation of the Company's stockholders' equity under generally
accepted accounting principles to the Bank's Regulatory Capital is summarized as
follows:
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
-------- ------- ----------
(Dollars in thousands)
Stockholders' equity under GAAP - Holding Company.............................. $ 72,571 $72,571 $ 72,571
Adjustments: primarily loss at Holding Company................................. 489 489 489
-------- ------- ----------
Stockholders' equity under GAAP - Bank......................................... 73,060 73,060 73,060
Unrealized losses on available for sale securities, net of tax................. 124 124 124
Limitation on deferred tax assets.............................................. (13,224) (13,224) (13,224)
General allowance for loan losses (to extent allowable)........................ n/a n/a 7,220
-------- ------- ----------
Regulatory capital............................................................. $ 59,960 $59,960 $ 67,180
-------- ------- ----------
-------- ------- ----------
Adjusted total assets for Bank were $862.9 million and $843.5 million as of
December 31, 1997 and 1996, respectively. Risk-weighted assets for the Bank were
$577.9 million and $552.5 million as of December 31, 1997 and 1996,
respectively.
The Federal Reserve System requires all depository institutions to maintain
reserves against their transaction accounts (primarily NOW, SuperNOW and
checking accounts). As of December 31, 1997, a 3% reserve was required on total
transaction balances in excess of $4.3 million but less than $47.7 million.
Reserves of 10% were required on total transaction balances in excess of $47.7
million. Because required reserves must be maintained in the form of vault cash
or a non-interest bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce the Bank's earning assets. Required reserves
aggregated $2.0 million at December 31, 1997.
17. OFF-BALANCE SHEET RISK
In the normal course of business, the Company utilizes various financial
instruments with off-balance sheet risk to meet the financing needs of its
customers, and to reduce its own exposure to fluctuations in interest rates.
These off-balance sheet activities may include commitments to extend credit,
commercial letters of credit, standby letters of credit, commitments to purchase
and sell loans, and interest rate hedge agreements. The credit and market risks
associated with these financial instruments are generally managed in conjunction
with the Company's balance sheet activities and are subject to normal credit
policies, financial controls and risk limiting and monitoring procedures. The
maximum dollar effect of the risks may be in excess of the amounts recognized in
the consolidated statements of condition because these amounts vary depending on
the nature of the underlying instrument and the related accounting policy.
Credit losses are incurred when one of the parties fails to perform in
accordance with the terms of the contract. The Company's exposure to credit loss
is represented by the contractual amount of the commitments to extend credit,
commitments to purchase and sell loans, commercial letters of credit and standby
letters of credit. This is the maximum potential loss of principal in the event
the commitment is drawn upon and the counterparty defaults. With respect to
other financial instruments, the contractual or notional amounts of interest
rate caps do not necessarily represent the actual credit exposure, but the
extent of involvement in a particular class of instrument. In addition, the
measurement of the risks associated with these financial instruments is
meaningful only when all related and offsetting transactions are identified.
72
A summary of the contractual or notional amounts for off-balance sheet
activities at December 31, 1997 and 1996 and further discussion of these
activities follows:
1997 1996
-------- -------
(In thousands)
Credit activities:
Commitments to extend credit:
1-4 family residential mortgage loans.................................. $ 14,262 $29,026
Commercial loans....................................................... 6,359 8,040
Unfunded commitments on:
One-to-four family construction loans.................................. 2,057 2,567
Other construction loans, primarily residential sub-divisions.......... 26,443 24,181
Consumer lines......................................................... 14,565 12,312
Commercial lines....................................................... 323 192
Standby letters of credit.............................................. 2,312 2,790
Securitized 1-4 family mortgage loans sold with recourse............... 11,696 13,440
Loans sold with recourse............................................... 6,157 5,900
Commitments to sell loans:
1-4 family residential mortgage loans.................................. 9,386 12,985
Other financial instrument activities:
Interest rate swap agreements (notional amount)............................. 20,000 20,000
Interest rate collar agreements (notional amount)........................... 115,000 95,000
Forward contracts........................................................... 1,000 8,000
CREDIT ACTIVITIES
Commitments to extend credit are legally binding agreements to lend money
at predetermined interest rates for a specific period of time. The exposure to
loss is minimized by maintaining specific credit standards and by requiring the
borrower to comply with certain terms and conditions prior to the disbursement
of funds. Collateral is obtained when deemed necessary and may include but is
not limited to accounts receivable, inventory, equipment, real estate, or income
producing assets. Since commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent the total amount of future
outlays.
Commercial letters of credit, which are included in commitments to extend
credit in the preceding table, are issued to facilitate certain trade
transactions. The risks associated with these transactions would be a result of
the customer's failure to perform in accordance with the terms and conditions of
the agreement which is limited by applying adequate monitoring procedures.
Standby letters of credit are conditional commitments issued to guarantee
the performance of a customer to a third party. The Bank issues standby letters
of credit to ensure contract performance or assure payment by its customers. The
risk involved in issuing standby letters of credit is the same as the credit
risk involved in extending loan facilities to customers; therefore, standby
letters of credit are subject to the same credit approvals and monitoring
procedures.
Commitments to sell loans are primarily utilized by the Bank to hedge
origination activity. These commitments obligate the Bank to deliver a fixed
amount of loans by a specified date. Risk originates from the inability of
counterparties to meet the terms of their contracts (credit risk).
OTHER FINANCIAL INSTRUMENT ACTIVITIES
An interest rate swap is an agreement where one party (a broker) agrees to
pay a floating rate of interest (based on the 3-month LIBOR) on a notional
principal amount to another party (the Bank) in exchange for receiving a fixed
rate of interest on the same notional amount. As of December 31, 1997, the Bank
had one outstanding swap on which it receives a floating rate of 5.72% and pays
a fixed rate of 7.335%. The swap expires in March 2000. The Bank's risk of loss
on this swap is equal to the fair value of the swap, which as of December 31,
1997 was an unrealized loss of $0.6 million.
73
An interest rate collar involves the simultaneous purchase of an interest
rate cap and sale of an interest rate floor, both tied to specific indices and
based on notional principal amounts. The premium paid on interest rate collars
is amortized on a straight-line basis over the life of the individual
agreements. As of December 31, 1997, the weighted average cap rate, floor rate
and maturity of the Bank's $115 million notional amount of interest rate collar
agreements were, 6.76%, 5.42%, and 18 months, respectively. The rate caps and
floor are based on 3-month LIBOR which was 5.72% at December 31, 1997. During
1995, 1996, and 1997 the Bank neither paid nor received any amounts on these
interest rate collars.
Forward contracts are agreements where the Bank has agreed to deliver to a
counterparty a specific type of security at a agreed upon rate. These contracts
are generally settled within 60 to 90 days. At December 31, 1997, the Bank had
committed to sell, under forward agreements, an aggregate principal amount of
$1.0 million of mortgage-backed securities with a weighted average rate of 7.0%.
These agreements were entered into in connection with mortgage banking
activities.
Interest rate caps are an agreement between two parties to limit the
effects of rising interest rates. The issuer of an interest rate cap assumes a
liability to the purchaser for the excess interest of a stated market rate over
a contracted cap rate on a notional amount of principal. The Bank uses interest
rate caps to protect itself from rising interest rates on certain liabilities.
The risks associated with these caps are the abilities of the counterparties to
meet the terms of the contract (credit risk) and exposure to movements in
interest rates (market risk). These risks are subject to the review and approval
process of the asset/liability committee. The premium paid on interest rate caps
is amortized on a straight-line basis over the life of the individual
agreements. The Bank's risk of loss is limited to the remaining unamortized
premiums on these agreements.
18. RELATED PARTY TRANSACTIONS
Loans and lines of credit are made available to directors and senior
officers on the same terms, including interest rates and collateral
requirements, as loans to other employees and to the public.
At December 31, 1997, the full amount of credit extended to directors,
senior officers and their affiliates was $1.2 million which includes the
unfunded portion of lines of credit. The table below indicates the activity in
these loan accounts during 1997 (amounts in whole dollars):
Outstanding balance at December 31, 1996........................................ $ 592,000
Additions.................................................................. 655,000
Deductions................................................................. (138,000)
----------
Outstanding balance at December 31, 1997........................................ $1,109,000
----------
----------
74
19. FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of certain
financial instruments. The following estimated fair values have been determined
using available market information and appropriate valuation methodologies.
Considerable judgment is required to interpret market data and to develop
estimates of fair value. The estimates presented are not necessarily indicative
of amounts the Company could realize in a current market exchange. The use of
alternative market assumptions and estimation methodologies could have a
material effect on these estimates of fair value.
DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(In millions)
Assets:
Cash and due from banks.............................. $ 11.8 $ 11.8 $ 6.9 $ 6.9
Mortgage-backed securities and accrued interest...... 146.4 146.3 144.7 144.3
Other securities and accrued interest................ 17.4 17.4 32.1 32.1
Loans and accrued interest, net...................... 669.2 673.4 638.7 636.6
Liabilities:
Deposits with no stated maturity..................... 290.4 290.4 261.5 261.5
Time deposits and accrued interest................... 330.6 329.7 314.4 313.4
Borrowings........................................... 168.8 168.8 198.7 198.7
Mortgagors' escrow deposits.......................... 4.6 4.6 4.1 4.1
Other Financial Instruments:
Interest rate hedge agreements....................... 0.4 (0.5) -- (1.0)
Cash and Due From Banks: The estimated fair value approximates the carrying
amount because of the immediate availability of these funds or based on the
short maturities and current rates for similar deposits with other banks.
Mortgage-backed and Other Securities: The fair value was estimated based on
quoted market prices or dealer quotes, where available. If quoted market prices
are not available, fair values are based on quoted market prices for similar
securities.
Loans: The fair value of fixed rate loans has been estimated by discounting
projected cash flows using current rates for similar loans reduced by specific
and general loan loss allowances. For loans which reprice frequently to market
rates, the carrying amount, net of the applicable credit factor, is a reasonable
estimate of fair value. Impaired loans, which include non-accrual loans, are
included in the above table based generally on the fair value of the underlying
collateral.
Deposits: The estimated fair value of demand deposits, savings accounts,
and certain money market deposits, as required by SFAS No. 107, is the amount
payable at the reporting date. The fair value of fixed-maturity certificates of
deposit is estimated using the rates currently offered for deposits of similar
remaining maturities.
Borrowings: Rates currently available to the Company for borrowings with
similar terms and remaining maturities are used to estimate fair value.
Mortgagors' Escrow Deposits: The estimated fair value of mortgagors' escrow
deposits is the amount payable at the reporting date.
75
Other Financial Instruments: The fair value of interest rate hedge
instruments is the amount at which they could be settled, based on estimates
obtained from dealers.
At December 31, 1997, the Bank had an interest rate swap agreement which
expires in March 2000, covering an aggregate notional amount of $20.0 million,
where the Bank receives 3-month LIBOR and pays 7.335% fixed.
At December 31, 1997, the Bank had interest rate collar agreements covering
an aggregate notional amount of $115.0 million which expire as follows: $50.0
million in 1998, $20.0 million in 1999, and $45.0 million in 2000. The interest
rate floors and caps are based on the 3-month LIBOR. At December 31, 1997, the
weighted average floor rate was 5.42% and the weighted cap rate was 6.76%. Under
these interest rate collar agreements, the Bank receives payments if 3-month
LIBOR is greater than cap rate and pays if 3-month LIBOR is less than floor
rate.
At December 31, 1997, the Bank had committed to sell, under forward
agreements, an aggregate principal amount of $1.0 million of mortgage-backed
securities with a weighted average rate of 7.00%. These agreements were entered
into in connection with mortgage banking activities and generally must be
settled within 90 days.
Commitments include commitments to extend permanent financing and letters
of credit. The fair value of commitments is estimated based upon fees currently
charged to enter into similar agreements taking into account the remaining terms
of the agreement and the present creditworthiness of the counterparties. The
fair value of letters of credit is based on fees currently charged for similar
agreements. The fair value of commitments at December 31, 1997 and 1996,
respectively, approximate the recorded amounts of related fees, which are not
material.
20. SAVINGS ASSOCIATION INSURANCE FUND ('SAIF') SPECIAL ASSESSMENT
On September 30, 1996, legislation was signed into law which included
provisions designed to replenish the Savings Association Insurance Fund. Under
this legislation, all SAIF insured institutions (including the Bank) were
assessed a one-time fee of 65.7 cents on every $100 of insured deposits held on
March 31, 1995, as adjusted. This one-time special assessment charged to the
Bank totaled $2.6 million and was paid on November 27, 1996. This assessment was
recorded as a charge to earnings on September 30, 1996 and is included in the
accompanying Statement of Income with non-interest expenses. The
recapitalization of the SAIF fund is expected to provide for lower deposit
insurance premiums through at least 1999.
76
21. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Earnings of the Bank are recognized by Poughkeepsie Financial Corp. (the
'Holding Company') using the equity method of accounting. Accordingly, earnings
of the Bank are recorded as increases in the Holding Company's investment and
any dividend received from the Bank reduces the Holding Company's investment in
the Bank. The condensed financial statements for the Holding Company at December
31, 1997 and for the period May 30, 1997 (date Holding Company commenced
operations) to December 31, 1997 are presented below (dollar amounts are in
thousands):
CONDENSED STATEMENT OF FINANCIAL CONDITION
Assets:
Cash and due from banks........................................................................... $ 102
Investment in the Bank............................................................................ 73,060
Other assets...................................................................................... 96
-------
Total assets...................................................................................... $73,258
-------
-------
Liabilities and Stockholders' Equity:
Due to the Bank................................................................................... $ 607
Other liabilities................................................................................. 80
-------
Total liabilities................................................................................. 687
Stockholders' equity.............................................................................. 72,571
-------
Total liabilities and stockholders' equity........................................................ $73,258
-------
-------
CONDENSED STATEMENT OF INCOME
Dividend income from the Bank..................................................................... $ 1,260
Interest income................................................................................... 2
Other operating expenses.......................................................................... 686
-------
Income before income taxes and equity in undistributed earnings of the Bank....................... 576
Income tax benefit................................................................................ (95)
-------
Income before equity in undistributed earnings of the Bank........................................ 671
Undistributed earnings of the Bank................................................................ 1,758
-------
Net income........................................................................................ $ 2,429
-------
-------
CONDENSED STATEMENT OF CASH FLOW
Operating activities:
Net Income................................................................................... $ 2,429
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings of the Bank............................................ (1,758)
Net change in other assets and liabilities.............................................. 504
-------
Net cash provided by operating activities............................................... 1,175
-------
Financing activities:
Issuance of common stock..................................................................... 87
Cash dividends paid.......................................................................... (1,260)
-------
Net cash used in financing activities................................................... (1,173)
-------
Net increase in cash and cash equivalents......................................................... 2
Cash and cash equivalents at May 30, 1997......................................................... 100
-------
Cash and cash equivalents at December 31, 1997.................................................... $ 102
-------
-------
77
22. QUARTERLY DATA (UNAUDITED)
Quarterly financial information for 1997 and 1996 follows. In the opinion
of management, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the results of operations for such periods
are reflected.
THREE MONTHS ENDED
--------------------------------------------
12/31/97 9/30/97 6/30/97 3/31/97
------- ------- ------- -------
(Dollars in thousands, except per share
data)
Interest and dividend income................................ $16,978 $16,968 $16,481 $16,296
Interest expense............................................ 10,122 9,969 9,685 9,499
------- ------- ------- -------
Net interest and dividend income............................ 6,856 6,999 6,796 6,797
Provision for loan losses................................... 900 350 300 300
------- ------- ------- -------
Net interest income after provision for loan losses......... 5,956 6,649 6,496 6,497
Other income................................................ 820 1,173 797 784
Other expenses.............................................. 7,795 6,043 5,267 5,379
------- ------- ------- -------
Income (loss) before taxes.................................. (1,019) 1,779 2,026 1,902
Income tax expense (benefit)................................ (66) 725 824 776
------- ------- ------- -------
Net income (loss)........................................... $ (953) $ 1,054 $ 1,202 $ 1,126
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) per share -- basic........................ $ (0.08) $ 0.08 $ 0.10 $ 0.09
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) per share -- diluted...................... $ (0.08) $ 0.08 $ 0.09 $ 0.09
------- ------- ------- -------
------- ------- ------- -------
Dividends per share......................................... $ 0.050 $ 0.025 $ 0.025 $ 0.025
------- ------- ------- -------
------- ------- ------- -------
Weighted average shares outstanding:
Basic.................................................. 12,598,758 12,594,855 12,594,725 12,592,829
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted................................................ 13,398,272 13,263,963 13,110,509 13,047,587
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
THREE MONTHS ENDED
----------------------------------------------
12/31/96 9/30/96 6/30/96 3/31/96
------- ------- ------- -------
(Dollars in thousands, except per share data)
Interest and dividend income............................. $16,586 $15,938 $15,172 $15,924
Interest expense......................................... 9,751 9,594 9,100 9,412
------- ------- ------- -------
Net interest and dividend income......................... 6,835 6,344 6,072 6,512
Provision for loan losses................................ 300 250 150 150
------- ------- ------- -------
Net interest income after provision for loan losses...... 6,535 6,094 5,922 6,362
Other income............................................. 708 597 (331) 488
Other expenses........................................... 5,204 7,673 5,568 5,531
------- ------- ------- -------
Income (loss) before taxes............................... 2,039 (982) 23 1,319
Income tax expense (benefit)............................. 817 (394) 7 533
------- ------- ------- -------
Net income (loss)........................................ $ 1,222 $ (588) $ 16 $ 786
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) per share -- basic..................... $ 0.10 $ (0.05) $ 0.00 $ 0.06
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) per share -- diluted................... $ 0.09 $ (0.05) $ 0.00 $ 0.06
------- ------- ------- -------
------- ------- ------- -------
Dividends per share...................................... $ 0.025 $ 0.025 $ 0.025 $ 0.025
------- ------- ------- -------
------- ------- ------- -------
Weighted average shares outstanding:
Basic............................................... 12,561,010 12,550,765 12,543,885 12,531,666
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted............................................. 12,920,090 12,890,832 12,907,787 12,922,124
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
78
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors
POUGHKEEPSIE FINANCIAL CORP.
Poughkeepsie, New York
We have audited the accompanying consolidated statements of financial
condition of Poughkeepsie Financial Corp. and subsidiary (the 'Company') as of
December 31, 1997 and 1996 and the related consolidated statements of income,
changes in stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 Poughkeepsie
Financial Corp. and subsidiary at December 31, 1997 and 1996 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
- ------------------------------
DELOITTE & TOUCHE LLP
Stamford, Connecticut
January 23, 1998
79
REPORT OF MANAGEMENT TO THE STOCKHOLDERS
CONSOLIDATED FINANCIAL STATEMENTS
The management of Poughkeepsie Financial Corp. and subsidiary ('the
Company') is responsible for the preparation, integrity, and fair presentation
of its published financial statements and all other information presented in
this Annual Report. The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and, as such, include
amounts based on informed judgments and estimates made by management.
The consolidated financial statements have been audited by an independent
accounting firm, which was given unrestricted access to all financial records
and related data, including minutes of all meetings of stockholders, the Board
of Directors and committees of the Board. Management believes all
representations made to the independent auditors during their audit were valid
and appropriate. The independent auditors' report is presented on page 79.
INTERNAL CONTROL
Management is responsible for establishing and maintaining effective
internal control over financial reporting, including safeguarding of assets,
presented in conformity with generally accepted accounting principles and for
the Company's bank subsidiary, Bank of the Hudson, in conformity with the Office
of Thrift Supervision instructions for Thrift Financial Reports ('TFR
Instructions'). Internal control contains monitoring mechanisms and actions that
are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal
control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even effective internal control can provide
only reasonable assurance with respect to financial statement preparation.
Further, because of changes in conditions, the effectiveness of internal control
may vary over time.
Management assessed the Company's internal control over financial
reporting, including safeguarding of assets, presented in conformity with
generally accepted accounting principles and TFR Instructions as of December 31,
1997. This assessment was based on criteria for effective internal control over
financial reporting, including safeguarding of assets, described in 'Internal
Control -- Integrated Framework' issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that the Company maintained effective internal control over financial
reporting, including safeguarding of assets, presented in conformity with
generally accepted accounting principles and, for the Company's bank subsidiary,
TFR Instructions as of December 31, 1997.
AUDIT COMMITTEE
The Audit Committee of the Board of Directors is comprised entirely of
non-employee directors who are independent of the Company's management. The
Audit Committee is responsible for recommending to the Board of Directors the
selection of independent auditors, which selection is then ratified by the
stockholders. The Audit Committee meets periodically with management, the
independent auditors, and the internal auditors to ensure that they are carrying
out their responsibilities. The Audit Committee is also responsible for
performing an oversight role by reviewing and monitoring the financial,
accounting and auditing procedures of the Company in addition to reviewing the
Company's financial reports. The independent auditors and the internal auditors
have full and free access to the Audit Committee, with or without the presence
of management, to discuss the adequacy of internal control for financial
reporting and any other matters which they believe should be brought to the
attention of the Audit Committee.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for ensuring compliance with the federal
laws and regulations concerning loans to insiders and the federal and state laws
and regulations concerning dividend
80
restrictions, both of which are designated by the Federal Deposit Insurance
Corporation as safety and soundness laws and regulations.
Management assessed its compliance with the designated safety and soundness
laws and regulations and has maintained records of its determinations and
assessments as required by the Federal Deposit Insurance Corporation. Based on
this assessment, management believes that the Company and its bank subsidiary
has complied, in all material respects, with the designated safety and soundness
laws and regulations for the year ended December 31, 1997.
/s/ JOSEPH B. TOCKARSHEWSKY /s/ ROBERT J. HUGHES
------------------------------ ------------------------
JOSEPH B. TOCKARSHEWSKY ROBERT J. HUGHES
Chairman, President and Executive Vice President
Chief Executive Officer and Chief Financial Officer
January 23, 1998
81
INDEPENDENT ACCOUNTANTS' REPORT
To the Audit Committeee
POUGHKEEPSIE FINANCIAL CORP.
Poughkeepsie, New York
We have examined management's assertion that, as of December 31, 1997,
Poughkeepsie Financial Corp. and subsidiary ( the 'Company') maintained
effective internal control over financial reporting, including safeguarding of
assets, presented in conformity with generally accepted accounting principles
and for the Company's bank subsidiary, Bank of the Hudson, in conformity with
the Office of Thrift Supervision instructions for Thrift Financial Reports
included in the accompanying Report of Management to the Stockholders.
Our examination was made in accordance with standards established by the
American Institute of Certified Public Accountants and, accordingly, included
obtaining an understanding of internal control over financial reporting,
testing, and evaluating the design and operating effectiveness of internal
control over financial reporting, including safeguarding of assets, and such
other procedures as we considered necessary in the circumstances. We believe
that our examination provides a reasonable basis for our opinion.
Because of inherent limitations in internal control, errors or
irregularities may occur and not be detected. Also, projections of any
evaluation of internal control over financial reporting to future periods are
subject to the risk that the internal control may become inadequate because of
changes in conditions, or that the degree of compliance with the policies may
deteriorate.
In our opinion, management's assertion that, as of December 31, 1997, the
Company maintained effective internal control over financial reporting,
including safeguarding of assets, presented in conformity with generally
accepted accounting principles and, for the Company's bank subsidiary, the
Office of Thrift Supervision instructions for Thrift Financial Reports is fairly
stated, in all material respects, based on the criteria established in 'Internal
Control -- Integrated Framework' issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
/s/ DELOITTE & TOUCHE LLP
- ------------------------------
DELOITTE & TOUCHE LLP
Stamford, Connecticut
January 23, 1998
82
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 following is a list of Directors and Executive Officers of the Company
and its sole subsidiary, Bank of the Hudson:
Noel deCordova, Jr. Director since May, 1997. Previously, he served as
a director of Poughkeepsie Savings Bank, FSB since 1970. Of counsel to the
law firm of Van DeWater and Van DeWater, Poughkeepsie, New York. Partner in
the firm from 1958 to December, 1990. Served as Director of The Hammond
Company, a holding company for various subsidiaries including its primary
operating subsidiary, The Hammond Company,The Mortgage Bankers, from 1982
until December, 1995.
Burton Gold. Director since May, 1997. Previously, he served as a
director of Poughkeepsie Savings Bank, FSB since 1988. President and Chief
Executive Officer of Stewart-Scott Associates, Inc., a building, developing
and contracting firm since 1952, and owner of Fallkill Properties, a real
estate property management firm since 1989. Both firms are located in
Poughkeepsie, New York.
Jeh V. Johnson. Director since May, 1997. Previously, he served as a
director of Poughkeepsie Savings Bank, FSB since 1977. Principal in Jeh V.
Johnson, F.A.I.A., Architect, Wappingers Falls, New York, and, since 1964,
lecturer in architecture at Vassar College, Poughkeepsie, New York.
Henry C. Meagher. Director since May, 1997. Previously, he served as a
director of Poughkeepsie Savings Bank, FSB since 1972. Since 1994, Chairman
and Chief Executive Officer of MCC Hudson Valley, Inc., Poughkeepsie, New
York and, from 1956 to 1995, Chairman and Chief Executive Officer of
Mechanical Construction Corp. Both firms are located in Poughkeepsie, New
York and are mechanical contracting companies specializing in commercial
and industrial construction.
Robert M. Perkins. Director since May, 1997. Previously, he served as
a director of Poughkeepsie Savings Bank, FSB since 1994. President since
1984 of Perkins Values and Findings, Inc. ('PVF Inc.'), a Registered
Investment Advisor in Millbrook, New York. From 1973 to 1984, served as
Managing Director, The First Boston Corporation in New York City and, from
1960 to 1973 was associated with Halsey, Stuart & Co., Inc., an investment
banking firm in New York City, serving as Executive Vice President of the
firm from 1971 to 1973.
Elizabeth K. Shequine. Director since May, 1997. Previously, she
served as a director of Poughkeepsie Savings Bank, FSB since 1979.
Principally employed as an attorney engaged in the private practice of law
in Poughkeepsie, New York, and as town justice for the Town of Washington,
New York.
James V. Tomai, Jr. Director since May, 1997. Previously, he served as
a director of Poughkeepsie Savings Bank, FSB since 1994. Vice Chairman
Emeritus of Sterling Forest Corporation, Tuxedo, New York, since June,
1991. Served as President of the Corporation from 1979 to January, 1990 and
Vice Chairman from January, 1990 to June, 1991. Sterling Forest Corporation
was a subsidiary of The Home Insurance Company, New York City. Served as a
Trustee of Dry Dock Savings Bank from 1972 to 1983 and as a director of
Investors Preference Fund for Income, Inc. and Investors Preference New
York Tax-Free Fund, Inc. from their inceptions in May, 1987 and February,
1991, respectively, until May, 1994.
83
Joseph B. Tockarshewsky, has been Chairman, President and Chief Executive
Officer since July, 1992. From 1986 to 1992, he served as Executive Vice
President at American Security Bank in Washington, DC. From 1983 to 1986, Mr.
Tockarshewsky served as Executive Vice President of Carteret Savings and Loan
Association in Morristown, NJ. Prior to that, from 1979 to 1982, he served as
Executive Vice President and Director at First Federal Savings and Loan
Association in New York City.
Robert J. Hughes, has been Executive Vice President and Chief Financial Officer
since February, 1992 and Director since April 1995, and was a consultant to the
Bank during January and February, 1992. From April, 1983 to December, 1991, he
was Executive Vice President and Chief Financial Officer of American Savings
Bank, White Plains, NY. From July, 1978 to March, 1983, he was Vice President
and Assistant Corporate Comptroller of American Express Company.
Joel A. Brotman, has been Senior Vice President/Residential Lending of Bank of
the Hudson since July, 1995, and was a consultant to the Bank from April to
July, 1995. Mr. Brotman served as Senior Vice President-Retail Mortgage
Production Manager at First Fidelity Bank, North Brunswick, NJ from 1993 to
1995; as Senior Vice President/Wholesale and Retail Production at First Town
Mortgage Corporation, Secaucus, NJ from 1991 to 1993 and as Senior Vice
President of The Howard Savings Bank and President & Chief Executive Officer of
The Howard Mortgage Group, Inc., Livingston, NJ from 1990 to 1991. Prior
thereto, Mr. Brotman was Senior Vice President Production/Secondary Market
Support at Margaretten and Company, Inc., Perth Amboy, NJ from 1984 to 1990.
Richard J. Malena, has been a Executive Vice President of Bank of the Hudson
since December 1996, and was a Senior Vice President of the Bank since September
1988. He joined the Bank in 1983 as an Assistant Vice President and Manager of
the Consumer Lending Department. From 1988 to 1990, Mr. Malena was Northeast
Regional Manager of Market Street Mortgage Corporation (former Bank Subsidiary).
Since 1990, he has served as Senior Vice President/Retail Banking. From 1965 to
1983, Mr. Malena served in various capacities of retail banking with the Bank of
New York.
Jeffrey C. McDonough, was elected Vice President/Human Resources of Bank of the
Hudson in December 1992; he had been the Director of Human Resources since June,
1992. Prior thereto, he served as Compensation and Benefits Manager. From 1985
to 1988, he was a Regional Human Resources Manager for Marshalls, Inc. in
Hartsdale, NY.
Sten F. B. Sandlund, has been Senior Vice President/Commercial Real Estate
Division of Bank of the Hudson since January, 1997. From September, 1993 to
1996, he was Vice President/Special Assets. From June 1991 to September, 1993,
Mr. Sandlund served as Senior Vice President, American Institutional Advisors of
Illinois, Inc., a real estate debt and equity placement firm in Chicago,
Illinois.
Tanya G. Vanasse, has been Vice President/Marketing Director of Bank of the
Hudson since May, 1996. From May 1994 to May 1996, Ms. Vanasse was Second Vice
President/Workplace Banking Manager at The Chase Manhattan Bank; from November,
1989 to April, 1994, she served as Division Marketing & Sales Manager
(Westchester County) at The Chase Manhattan Bank.
Ellen K. Rose, has been Vice President/Director of Internal Audit of Bank of the
Hudson since September, 1992. From June 1991 to 1992, Ms. Rose was Vice
President/Director of Internal Audit of American Savings Bank, White Plains, NY.
From 1987 to 1991, she was Assistant Vice President, EDP Audit Manager at
American Savings Bank.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT
During 1997, all directors and executive officers made timely filings with
respect to Form 4 reports. In making this statement, the Company has relied on
the written representations of its directors and officers.
84
ITEM 11. EXECUTIVE COMPENSATION.
The following table summarizes all compensation earned in the past three
years by the named officers of Poughkeepsie Financial Corp. ('PFC') and of PFC's
wholly-owned subsidiary, Bank of the Hudson ('BTH').
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------ --------------------------
SECURITIES
UNDERLYING
OTHER ANNUAL OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION (IN SHARES) COMPENSATION
--------------------------- ---- ------ ----- ------------ ----------- ------------
(ii) (iii)
Joseph B. Tockarshewsky .............. 1997 $291,463 $183,527(i) 0 0 $ 13,175
Chairman, President & CEO 1996 275,000 44,087 150,000 11,633
PFC and BTH 1995 275,000 67,316 0 12,538
Robert J. Hughes ..................... 1997 207,174 92,138(i) 0 0 13,175
Executive Vice President & 1996 199,650 25,605 87,000 11,711
CFO, PFC and BTH 1995 199,650 49,292 0 12,411
Richard J. Malena .................... 1997 126,362 49,920 0 0 9,965
Executive Vice President 1996 121,866 17,078 65,000 9,060
BTH 1995 114,693 26,250 0 9,931
Joel A. Brotman ...................... 1997 108,853 30,002 0 0 8,669
Senior Vice President 1996 105,000 57,919 65,000 9,810
BTH 1995 74,714 38,168 20,000 7,592
Sten F. B. Sandlund .................. 1997 99,731 31,200 0 0 7,534
Senior Vice President 1996 86,781 4,703 22,000 5,672
BTH 1995 79,384 13,603 0 4,925
- ------------
(i) Awards made under the Bank of the Hudson ('Bank') 1997 Management Award
Program. Messrs. Tockarshewsky and Hughes elected to defer their awards
under the Bank of the Hudson Employees Deferred Compensation Plan.
(ii) The dollars value of perquisites and other personal benefits for each of
the named executive officers was less than the established reporting
thresholds.
(iii) Matching contribution made by the Bank and a discretionary profit sharing
payment under the Bank of the Hudson 401(k) Plan.
COMPENSATION OF DIRECTORS
Non-employee directors of the Company receive a fee of $300 and $400 for
participation in meetings of the Board of Directors and its Committees,
respectively, including any ad-hoc committees.
Non-employee directors of the Company's wholly-owned subsidiary, Bank of
the Hudson ('Bank'), receive a $12,000 annual retainer, which is paid in
quarterly installments. In addition to the annual retainer, all non-employee
directors receive a fee of $300 and $400 for participation in meetings of the
Board of Directors and the Audit, Executive, Loan and any ad-hoc committees,
respectively. In recognition of his additional responsibilities, the Chairman of
the Audit Committee receives $800 for his attendance at each meeting of this
committee. Director Emeritus Milton Chazen receives $150 and $200 for his
participation in each meeting of the Board of Directors and the Loan Committee,
respectively.
85
Individual directors of the Bank also may be paid for special services
rendered to the Bank at the specific direction of the Board of Directors and may
be reimbursed for reasonable expenses for attendance at meetings of the Board of
Directors and Board committees. During 1997, non-employee directors received
compensation for an all-day strategic planning meeting.
The Bank has had a non-contributory, non-qualified Non-Employee Directors'
Retirement Plan ('Retirement Plan') for directors who are not employees of the
Bank. Benefits are payable to non-employee directors who are Participants in the
Retirement Plan. All of the Bank's non-employee directors are Participants.
On December 18, 1997, the Board of the Bank terminated the Retirement Plan,
effective January 31, 1998, and directed that distributions be paid, as soon as
administratively possible, in a lump sum amount equal to the present value of a
Participant's benefit under the Plan. The lump sum amount was determined based
upon a 7.25% interest rate assumption and the 1983 Group Annuity Mortality
Table. The lump sum payments were made to each Participant and to the surviving
spouse of each deceased Participant.
Since 1986, the Bank has had a deferred compensation plan for eligible
non-employee members of its Board of Directors, whereby such directors may defer
all or a percentage of his or her directors' fees. The director may elect the
time and manner of distribution of deferred fees. Effective April 18, 1995, the
Board of Directors adopted an amended Poughkeepsie Savings Bank, FSB Board of
Directors Deferred Compensation Plan ('Directors Deferred Compensation Plan').
EMPLOYMENT AGREEMENTS WITH MANAGEMENT
The Bank entered into a two-year employment agreement with Joseph B.
Tockarshewsky on February 27, 1997. The agreement provides that the term of the
agreement will continue to extend each year upon approval by the Board of
Directors, but the term of the agreement will not extend beyond January 11,
2005. The agreement provides for an annual base salary of $295,000 effective
January 1, 1997.
The Bank entered into a two-year employment agreement with Robert J. Hughes
on April 1, 1997. The agreement provides that the term of the agreement will
continue to extend each year upon approval by the Board of Directors, but the
term of the agreement will not extend beyond December 9, 2011. The agreement
provides for an annual base salary of $210,000 effective April 1, 1997.
Under their respective employment agreements, Messrs. Tocharshewsky and
Hughes will receive payments or entitlements under any incentive compensation
program of the Bank in effect, from time to time, which shall include
participation in the Bank's existing Management Award Program ('MAP'), in such
amounts as the Board determines to be appropriate, in a profit-sharing provision
of the Bank's 401(k) Plan and in option award grants.
If Messrs. Tockarshewsky and Hughes are terminated without cause, they will
receive all accrued by unpaid compensation, including incentive compensation,
then owed, and will receive a severance benefit commensurate with the
predetermined formula contained in their respective employment agreements.
86
TABLE OF OPTION EXERCISES IN 1997 AND YEAR-END OPTION VALUES
The following table sets forth information with respect to the named
executive officers concerning the exercise of options during 1997, and
unexercised options held as of December 31, 1997.
AGGREGATED OPTION EXERCISES IN 1997
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL FISCAL
SHARES YEAR-END(#) YEAR END
ACQUIRED VALUE EXERCISABLE(E) EXERCISABLE(E)
NAME ON EXERCISE REALIZED(1) UNEXERCISABLE(U) UNEXERCISABLE(U)
---- ----------- ----------- ---------------- ----------------
Joseph B. Tockarshewsky........................... 0 0 333,975/E $2,769,284/E(2)
125,000/U 904,375/U
Robert J. Hughes.................................. 0 0 183,699/E 1,540,372/E(2)
69,700/U 498,988/U
Joel A. Brotman................................... 0 0 46,000/E 294,000/E(2)
39,000/U 199,875/U
Richard J. Malena................................. 1,100 $ 1,925 75,880/E 582,433/E(2)
39,000/U 253,500/U
Sten F. B. Sandlund............................... 5,000 $29,063 3,800/E 24,700/E(2)
13,200/U 85,800/U
- ------------
(1) Market Value of underlying securities at exercise date or year-end, as the
case may be, minus the exercise price of 'in-the-money' options.
(2) At December 31, 1997, all 333,975, 183,699, 46,000, 75,880, 3,800 options,
respectively, were fully exercisable. Values are based on the closing market
price of the common stock on December 31, 1997, the last trading date in
1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The ages, holdings and percentages of common stock ownership of the
Company's Board of Directors and, each of the executive officers of the
wholly-owned subsidiary, Bank of the Hudson, named in the Summary Compensation
Table are as follows:
BENEFICIAL
AGE AT OWNERSHIP AT
NAME OF BENEFICIAL OWNER MARCH 9, 1998 MARCH 9, 1998*
- ------------------------ ------------- --------------
Noel deCordova, Jr.............................................. 68 67,172(a)(b)
Burton Gold..................................................... 71 30,965(a)(c)(d)
Robert J. Hughes................................................ 51 232,546(e)
Jeh V. Johnson.................................................. 66 28,971(a)(f)
Henry C. Meagher................................................ 72 63,942(a)(g)
Robert M. Perkins............................................... 62 25,000(h)
Elizabeth K. Shequine........................................... 67 37,000(a)
Joseph B. Tockarshewsky......................................... 58 415,657(i)
James V. Tomai, Jr.............................................. 76 21,617(h)(j)
Joel A. Brotman................................................. 54 56,972(k)
Richard J. Malena............................................... 50 102,023(l)
Sten F. B. Sandlund............................................. 42 12,899(m)
Directors and executive officers of the Company as a group (16 persons). Does
not include options to acquire an additional 290,350 shares which will vest
upon change of control........................................................ 1,171,371
(footnotes on next page)
87
(footnotes from previous page)
* Based upon information furnished by the respective individuals, each of the
above-named individuals, except Joseph B. Tockarshewsky and Robert J. Hughes
owns less than 1 percent of the issued and outstanding Common Stock. Mr.
Tockarshewsky and Mr. Hughes beneficially own 3.26 and 1.82 percent
respectively of the issued and outstanding Common Stock. Under applicable
regulations, shares are deemed to be beneficially owned by a person if he or
she, directly or indirectly, has or shares the power to vote or dispose of
the shares, whether or not he or she has any economic interest in the
shares. A person is deemed to have beneficial ownership of shares which may
be received upon the exercise of outstanding options if the option is
exercisable within 60 days.
(a) Includes currently exercisable nonqualified options for 20,500 shares under
the 1993 Directors' Stock Option Plan. Does not include nonqualified
options to acquire an additional 4,500 shares which will vest upon a change
of control.
(b) Includes 12,001 shares held by Mr. deCordova's wife who has sole voting and
investment power. Mr. deCordova disclaims beneficial ownership of these
shares.
(c) Includes currently exercisable nonqualified options for 5,000 shares under
the 1985 Stock Option Plan.
(d) Includes 465 shares held by Mr. Gold's wife, who has sole voting and
investment power. Mr. Gold disclaims beneficial ownership of these shares.
(e) Includes currently exercisable options for 164,187 shares, 3,261 shares
allocated to him under the Employee Stock Ownership Plan ('ESOP'), and
7,536 shares under the Employees Deferred Compensation Plan. Does not
include options to acquire an additional 56,650 shares which will vest upon
a change of control.
(f) Includes 1,044 shares held by Mr. Johnson's wife, who has sole voting and
investment power. Mr. Johnson disclaims beneficial ownership of these
shares.
(g) Includes 6,196 shares held by Mr. Meagher's wife, who has sole voting and
investment power. Mr. Meagher disclaims beneficial ownership of these
shares.
(h) Includes currently exercisable nonqualified options for 16,000 shares under
the 1993 Directors' Stock Option Plan. Does not include options to acquire
an additional 9,000 shares which will vest upon a change of control.
(i) Includes currently exercisable options for 336,963 shares, 3,261 shares
allocated to him under the ESOP, and 11,205 shares under the Employees
Deferred Compensation Plan. Does not include options to acquire an
additional 102,500 shares which will vest upon a change of control.
(j) Includes 3,031 shares held by Mr. Tomai's wife, who has sole voting and
investment power. Mr. Tomai disclaims beneficial ownership of these shares.
(k) Includes currently exercisable options for 55,750 shares, 192 shares
allocated to him under the ESOP, and 1,030 shares under the Employee
Deferred Compensation Plan. Does not include options to acquire an
additional 29,250 shares which will vest upon a change of control.
(l) Includes 2,124 shares and 338 shares held by Mr. Malena's wife and
daughter, respectively, each of whom has sole voting and investment power.
Mr. Malena disclaims beneficial ownership of these shares and 338 shares
for which Mr. Malena's wife is custodian for their son. Also includes
currently exercisable options for 56,368 shares, 4,827 shares allocated to
him under the ESOP, and 1,232 shares under the Employee Deferred
Compensation Plan. Does not include options to acquire an additional 29,250
shares which will vest upon a change of control.
(m) Includes 750 shares allocated to him under the ESOP. Does not include
options to acquire an additional 9,900 shares which will vest upon a change
of control.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Noel deCordova, Jr., a director, is of counsel to the law firm of Van
DeWater and Van DeWater of Poughkeepsie, New York. Van DeWater and Van DeWater
performed services for the Bank during 1997. The fees paid did not exceed five
percent of Van DeWater and Van DeWater's gross revenues for that firm's last
fiscal year. Mr. deCordova did not share in any income derived from services
performed by Van DeWater and Van DeWater for the Bank.
88
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents Filed as Part of this Report:
(1) Financial Statements:
PAGE
REFERENCE
----------
Consolidated Statements of Financial Condition as of December 31, 1997 and 1996........ 48 - 49
Consolidated Statements of Income for the fiscal years ended December 31, 1997, 1996
and 1995............................................................................. 50
Consolidated Statements of Changes in Stockholders' Equity for the fiscal years ended
December 31, 1997, 1996 and 1995..................................................... 51
Consolidated Statements of Cash Flows for the fiscal years ended December 31, 1997,
1996 and 1995........................................................................ 52
Notes to Consolidated Financial Statements............................................. 53 - 78
Independent Auditors' Report........................................................... 79
Report of Management to the Stockholders............................................... 80 - 81
Independent Accountants' Report........................................................ 82
(2) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission which apply to the Company
are included in Items 1 through 8 and are incorporated herein by reference.
(3) Exhibits.
EXHIBIT
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
2.1 --Agreement and Plan of Reorganization, dated Incorporated by reference from Exhibit 3(a) to the
as of January 17, 1997 by and between Registration Statement on Form S-4 filed February 27,
Poughkeepsie Savings Bank, FSB, Poughkeepsie 1997 with the Securities and Exchange Commission ('Form
Interim Federal Savings Bank and Poughkeepsie S-4').
Financial Corp.
2.2 --Amended and Restated Agreement and Plan of Incorporated by reference from Appendix A to the Proxy
Merger, dated as of October 22, 1997, by and Statement -- Prospectus dated March 13, 1998 ('Proxy
among HUBCO, Inc., Poughkeepsie Financial Statement -- Prospectus').
Corp. and Bank of the Hudson ('Agreement').
2.3 --Stock Option Agreement dated as of October Incorporated by reference from Appendix B to the Proxy
22, 1997 by and between HUBCO, Inc. and Statement -- Prospectus.
Poughkeepsie Financial Corp. ('Stock Option
Agreement').
3.1 --Certificate of Incorporation of Poughkeepsie Incorporated by reference from Exhibit 3(a) to the Form
Financial Corp. S-4.
3.2 --Bylaws of Poughkeepsie Financial Corp. Incorporated by reference from Exhibit 3(b) to the Form
S-4.
4.1 --Rights Agreement between Poughkeepsie Incorporated by reference from Exhibit 3 (v) to the
Savings Bank, FSB and the Bank of New York Registration Statement on Form 8-B filed on May 22, 1997
dated as of with the Securities and Exchange Commission ('Form 8-B').
May 1, 1988.
4.2 --Form of Common Stock Certificate. Incorporated by reference from Exhibit 3 (iii) to the
Form 8-B.
10.1 --Agreement between the Bank and Joseph B. Incorporated by reference from Exhibit 10.1 to the Annual
Tockarshewsky dated February 25, 1997. Report on Form 10-K for the year ended December 31, 1996
('1996 10-K').
89
EXHIBIT
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
10.2 -- Amendment Number 1, dated July 29, 1997, to Filed herewith.
the Agreement between Poughkeepsie Savings
Bank, FSB and Joseph B. Tockarshewsky.
10.3 -- Agreement between the Bank and Robert J. Filed herewith.
Hughes dated April 1, 1997.
10.4 -- Amendment Number 1, dated July 29, 1997, to Filed herewith.
the Agreement between Poughkeepsie Savings
Bank, FSB and Robert J. Hughes.
10.5 -- Form of Indemnification Agreement between Incorporated by reference from Exhibit 10.8 to the
the Bank and its directors, director emeritus Annual Report on Form 10-K for the fiscal year ended
and certain executive officers. December 31, 1985 ('1985 10-K').
10.6 -- Form of Amendment Number 1, dated July 29, Filed herewith.
1997, to the Indemnification Agreement
between the Bank and its directors, director
emeritus and certain executive officers.
10.7 -- Poughkeepsie Savings Bank, FSB 1985 Stock Incorporated by reference from Exhibit 10.1 to the
Option Plan, as amended. Registration Statement on Form S-8 filed June 10, 1997
with the Securities and Exchange Commission ('Form S-8').
10.8 -- Poughkeepsie Savings Bank, FSB 1993 Incorporated by reference from Exhibit 10.2 to Form S-8.
Directors' Stock Option Plan.
10.9 -- Poughkeepsie Savings Bank, FSB 1993 Stock Incorporated by reference from Exhibit 10.3 to the Form
Incentive Plan, as amended. S-8.
10.10 -- Poughkeepsie Savings Bank, FSB Employees Incorporated by reference from Exhibit 10.8 to the Annual
Deferred Compensation Plan effective as of Report on Form 10-K for the fiscal year ended December
April 18, 1995 and as amended and restated 31, 1995 ('1995 10-K').
December 1, 1995.
10.11 -- Poughkeepsie Savings Bank, FSB Board of Incorporated by reference from Exhibit 10.9 to the 1995
Directors Deferred Compensation Plan, 10-K.
effective as of April 18, 1995.
10.12 -- Poughkeepsie Savings Bank, FSB Non-Employee Incorporated by reference from Exhibit 10.21 to the
Directors' Retirement Plan. Annual Report on Form 10-K for the year ended December
31, 1988 ('1988 10-K').
10.13 -- Amendment Number One, dated December 19, Filed herewith.
1997, to the Poughkeepsie Savings Bank, FSB
Non-Employee Directors' Retirement Plan.
10.14 -- Management Award Program ('MAP') for Incorporated by reference from Exhibit 10.12 to the
designated Bank Officers. Annual Report on Form 10-K for the fiscal year ended
December 31, 1994 ('1994 10-K').
27. -- Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K
On November 12, 1997, the Company filed a Current Report on Form 8-K
covering the Agreement and Plan of Merger with HUBCO, Inc. previously announced
on October 22, 1997.
On January 28, 1998, the Company filed a Current Report on Form 8-K
covering a press release dated January 28, 1998 which reported results for the
fourth quarter and year ended December 31, 1998.
90
SIGNATURES
Pursuant to the requirements of Sections 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.
POUGHKEEPSIE FINANCIAL CORP.
March 24, 1998
By: /s/ JOSEPH B. TOCKARSHEWSKY
..................................
JOSEPH B. TOCKARSHEWSKY,
CHAIRMAN OF THE BOARD,
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 24, 1998.
SIGNATURE TITLE
--------- -----
/S/ JOSEPH B. TOCKARSHEWSKY Chairman of the Board, President and Chief
......................................... Executive Officer
JOSEPH B. TOCKARSHEWSKY
/S/ ROBERT J. HUGHES Director, Executive Vice President and Chief
......................................... Financial Officer
ROBERT J. HUGHES
/S/ NOEL DECORDOVA, JR. Director
.........................................
NOEL DECORDOVA, JR.
/S/ BURTON GOLD Director
.........................................
BURTON GOLD
/S/ JEH V. JOHNSON Director
.........................................
JEH V. JOHNSON
/S/ HENRY C. MEAGHER Director
.........................................
HENRY C. MEAGHER
/S/ ROBERT M. PERKINS Director
.........................................
ROBERT M. PERKINS
/S/ ELIZABETH K. SHEQUINE Director
.........................................
ELIZABETH K. SHEQUINE
/S/ JAMES V. TOMAI, JR. Director
.........................................
JAMES V. TOMAI, JR.
91
(3) Exhibits.
2.1 Agreement and Plan of Reorganization, dated as of January 17, 1997 by and
between Poughkeepsie Savings Bank, FSB, Poughkeepsie Interim Federal
Savings Bank and Poughkeepsie Financial Corp.
Incorporated by reference from Exhibit 3(a) to the Registration
Statement on Form S-4 filed February 27, 1997 with the Securities and
Exchange Commission ("Form S-4").
2.2 Amended and Restated Agreement and Plan of Merger, dated as
of October 22, 1997, by and among HUBCO, Inc., Poughkeepsie
Financial Corp. and Bank of the Hudson ("Agreement").
Incorporated by reference from Appendix A to the Proxy Statement -
Prospectus dated March 13, 1998 ("Proxy Statement - Prospectus").
2.3 Stock Option Agreement dated as of October 22, 1997 by andbetween HUBCO,
Inc. and Poughkeepsie Financial Corp. ("Stock Option Agreement").
Incorporated by reference from Appendix B to the Proxy Statement -
Prospectus.
3.1 Certificate of Incorporation of Poughkeepsie Financial Corp.
Incorporated by reference from Exhibit 3(a) to the Form S-4.
3.2 Bylaws of Poughkeepsie Financial Corp.
Incorporated by reference from Exhibit 3(b) to the Form S-4.
4.1 Rights Agreement between Poughkeepsie Savings Bank, FSB and the Bank of New
York dated as of May 1, 1988.
Incorporated by reference from Exhibit 3 (v) to the Registration
Statement on Form 8-B filed on May 22, 1997 with the Securities and
Exchange Commission ("Form 8-B").
4.2 Form of Common Stock Certificate.
Incorporated by reference from Exhibit 3 (iii) to the Form 8-B.
10.1 Agreement between the Bank and Joseph B. Tockarshewsky
dated February 25, 1997.
Incorporated by reference from Exhibit 10.1 to the Annual Report on
Form 10-K for the year ended December 31, 1996 ("1996 10-K").
10.2 Amendment Number 1, dated July 29, 1997, to the Agreement between
Poughkeepsie Savings Bank, FSB and Joseph B. Tockarshewsky.
Filed herewith.
10.3 Agreement between the Bank and Robert J. Hughes dated April 1, 1997.
Filed herewith.
10.4 Amendment Number 1, dated July 29, 1997, to the Agreement between
Poughkeepsie Savings Bank, FSB and Robert J. Hughes.
Filed herewith.
10.5 Form of Indemnification Agreement between the Bank and its directors,
director emeritus and certain executive officers.
Incorporated by reference from Exhibit 10.11 to the Annual Report on
Form 10-K for the fiscal year ended December 31, 1985 ("1985 10-K").
10.6 Form of Amendment Number 1, dated July 29, 1997, to the Indemnification
Agreement between the Bank and its directors, director emeritus and certain
executive officers.
Filed herewith.
10.7 Poughkeepsie Savings Bank, FSB 1985 Stock Option Plan, as
amended.
Incorporated by reference from Exhibit 10.1 to the Registration
Statement on Form S-8 filed June 10, 1997 with the Securities and
Exchange Commission ("Form S-8").
10.8 Poughkeepsie Savings Bank, FSB 1993 Directors' Stock Option Plan.
Incorporated by reference from Exhibit 10.2 to Form S-8.
10.9 Poughkeepsie Savings Bank, FSB 1993 Stock Incentive Plan, as amended.
Incorporated by reference from Exhibit 10.3 to the Form S-8.
10.10 Poughkeepsie Savings Bank, FSB Employees Deferred Compensation Plan
effective as of April 18, 1995 and as amended and restated December 1,
1995.
Incorporated by reference from Exhibit 10.8 to the Annual Report on
Form 10-K for the fiscal year ended December 31, 1995 ("1995 10-K").
10.11 Poughkeepsie Savings Bank, FSB Board of Directors Deferred
Compensation Plan, effective as of April 18, 1995.
Incorporated by reference from Exhibit 10.9 to the 1995 10-K.
10.12 Poughkeepsie Savings Bank, FSB Non-Employee Directors' Retirement Plan.
Incorporated by reference from Exhibit 10.21 to the Annual Report on
Form 10-K for the year ended December 31, 1988 ("1988 10-K").
10.13 Amendment Number One, dated December 19, 1997, to the Poughkeepsie
Savings Bank, FSB Non-Employee Directors' Retirement Plan.
Filed herewith.
10.14 Management Award Program ("MAP") for designated Bank Officers.
Incorporated by reference from Exhibit 10.12 to the Annual Report on
Form 10-K for the fiscal year ended December 31, 1994 ("1994 10-K").
27. Financial Data Schedule.
Filed herewith.
(b) Reports on Form 8-K
On November 12, 1997, the Company filed a Current Report on Form 8-K
covering the Agreement and Plan of Merger with HUBCO, Inc. previously
announced on October 22, 1997.
On January 28, 1998, the Company filed a Current Report on Form 8-K
covering a press release dated January 28, 1998 which reported results for
the fourth quarter and year ended December 31, 1998.
STATEMENT OF DIFFERENCES
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The service mark symbol shall be expressed as ...................'sm'