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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended DECEMBER 31, 2002
Commission file number: 0-23809
FIRST SENTINEL BANCORP, INC.
- --------------------------------------------------------------------------------
(exact name of registrant as specified in its charter)
DELAWARE 22-3566151
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1000 WOODBRIDGE CENTER DRIVE, WOODBRIDGE, NJ, 07095
- --------------------------------------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (732) 726-9700
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01
(Title of class)
Check whether the Registrant (1) 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) had been subject to such filing requirements for the past
90 days.
Yes[X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes[X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of the
issuer, based on the closing price of its Common Stock on June 28, 2002, as
quoted by the Nasdaq Stock Market, was approximately $335.9 million. Solely for
the purposes of this calculation, the shares held by directors and officers of
the registrant are deemed to be shares held by affiliates.
As of March 15, 2003, there were 42,982,088 shares issued and 27,772,350 shares
outstanding of the Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
I. Portions of the Annual Report to Stockholders for the Fiscal Year Ended
December 31, 2002 (Part II).
II. Portions of the Proxy Statement for the 2003 Annual Meeting of Stockholders
to be held on April 28, 2003 and any adjournment thereof filed with the
Securities and Exchange Commission on March 28, 2003 (Part III).
1
INDEX
PAGE
----
PART I
Item 1. Business.............................................. 3
Item 2. Properties............................................ 32
Item 3. Legal Proceedings..................................... 33
Item 4. Submission of Matters to a Vote of Security Holders... 33
PART II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................... 34
Item 6. Selected Financial Data............................... 34
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 34
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk........................................... 34
Item 8. Financial Statements and Supplementary Data .......... 34
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant.... 34
Item 11. Executive Compensation................................ 34
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters ....... 35
Item 13. Certain Relationships and Related Transactions........ 35
Item 14. Controls and Procedures............................... 35
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K .................................. 35
SIGNATURES 38
CERTIFICATIONS 39
2
PART I
ITEM 1. BUSINESS
- ----------------
FIRST SENTINEL BANCORP, INC.
First Sentinel Bancorp, Inc. ("First Sentinel" or the "Company") is
a Delaware corporation organized in 1998 by First Savings Bank ("First Savings"
or the "Bank") for the purpose of holding all of the capital stock of the Bank.
At December 31, 2002, the Company had consolidated total assets of $2.3 billion
and total stockholders' equity of $221.2 million. The Company is a unitary
thrift holding company subject to regulation by the Office of Thrift Supervision
("OTS") and the Securities and Exchange Commission ("SEC").
The Company's executive offices are located at 1000 Woodbridge
Center Drive, Woodbridge, New Jersey 07095. The Company's telephone number is
(732) 726-9700.
FIRST SAVINGS BANK
First Savings is a New Jersey-chartered, capital stock savings bank
headquartered in Woodbridge, New Jersey. First Savings has operated in its
present market area since 1901.
The Bank's executive offices are located at 1000 Woodbridge Center
Drive, Woodbridge, New Jersey 07095. The Bank's telephone number is
(732)726-9700.
AVAILABLE INFORMATION
The Company's Internet address is WWW.FIRSTSENTINELBANCORP.COM. The
Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 78m(a) or 78o(d)) are
made available free of charge on the Company's website.
BUSINESS STRATEGY
STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACT ARE
FORWARD-LOOKING STATEMENTS, AS THAT TERM IS DEFINED IN THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS MAY BE CHARACTERIZED AS
MANAGEMENT'S INTENTIONS, HOPES, BELIEFS, EXPECTATIONS OR PREDICTIONS OF THE
FUTURE. IT IS IMPORTANT TO NOTE THAT SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT
TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE PROJECTED IN SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE FUTURE RESULTS TO VARY MATERIALLY FROM CURRENT EXPECTATIONS INCLUDE, BUT
ARE NOT LIMITED TO, CHANGES IN INTEREST RATES, ECONOMIC CONDITIONS, DEPOSIT AND
LOAN GROWTH, REAL ESTATE VALUES, LOAN LOSS PROVISIONS, COMPETITION, CUSTOMER
RETENTION, CHANGES IN ACCOUNTING PRINCIPLES, POLICIES OR GUIDELINES AND
LEGISLATIVE AND REGULATORY CHANGES.
The Company's objectives are to enhance shareholder value by
profitably meeting the needs of its customers and seeking controlled growth,
while preserving asset quality and maintaining a strong capital position. The
Company's strategy emphasizes customer service and convenience, and the Company
attributes the loyalty of its customer base to its commitment to maintaining
customer satisfaction. The Company attempts to set itself apart from its
competitors by providing the type of personalized service not generally
available from larger banks while offering a greater variety of products and
services than is typically available from smaller depository institutions.
The Company's principal business, which is conducted through the
Bank, is attracting retail deposits from the general public and investing those
deposits, together with funds generated from operations and borrowings,
primarily in single-family residential mortgage loans, real estate construction
loans, commercial real estate loans, home equity loans and lines of credit and
multi-family residential mortgage loans. The Company maintains a significant
portfolio of mortgage-backed securities and also invests in U.S. Government,
federal agency and corporate debt securities and other marketable securities.
The Company's revenues are derived principally from interest on its loan and
mortgage-backed securities portfolios and interest and dividends on its
investment securities. The Company's primary sources of funds are deposits,
proceeds from principal and interest payments on loans and mortgage-backed
securities; sales of loans, mortgage-backed and investment securities available
for sale; maturities
3
of investment securities and short-term investments; advances from the Federal
Home Loan Bank of New York ("FHLB-NY"), reverse repurchase agreements and other
borrowed funds.
In an effort to enhance its long-term profitability and increase its
market share, the Company has endeavored to expand its traditional thrift
lending and securities investment strategy. Toward this end, the Bank continues
to diversify and expand upon the products and services it offers by focusing on
both lending and deposit services to small and medium-sized retail businesses.
The Bank has increased its emphasis on the origination of commercial real
estate, construction and commercial loans, as well as the marketing of its
business checking accounts and other business-related services. To develop
full-service relationships with commercial customers, the Bank provides merchant
services, such as merchant credit card processing, express teller services and
escrow management. The Bank has hired, and intends to continue hiring,
additional personnel with expertise in commercial lending to facilitate growth
in this area. The Bank has also increased loan volumes through the use of
third-party correspondent lending. Purchased loans were primarily one-to-four
family adjustable-rate mortgages, underwritten internally, with higher rates
than those currently offered by the Bank. Third-party correspondent lending is
expected to continue to play a minor role in the future operations of the Bank.
As part of the Company's asset/liability management strategy, and as
a means of enhancing profitability, the Company also invests in investment and
mortgage-backed securities. In recent years, the Company has utilized its
ability to borrow as an alternative means of funding asset growth. The average
balance of borrowings outstanding for the years ended December 31, 2002, 2001
and 2000 was $588.0 million, $495.7 million and $503.4 million, respectively.
The Company will continue to evaluate leveraged growth opportunities as market
conditions allow and manage its borrowing levels to mitigate interest rate risk
and/or reduce funding costs.
The Company repurchased 2.6 million shares, or $36.0 million, of its
common stock during 2002 as part of its ongoing capital management strategy. In
December 2002, the Company completed a 5% stock repurchase program authorized in
May 2002. In January 2003, the Board of Directors authorized a new 5% stock
repurchase program under which an additional 1.4 million shares of the Company's
stock may be repurchased. The Company's dividend payout ratio was 39.5%, 35.9%,
34.8%, 61.7% and 32.6% for the years ended December 31, 2002, 2001, 2000, 1999
and 1998, respectively.
The Company intends to actively seek additional expansion
opportunities in the areas surrounding its current branch locations.
Accordingly, the Company purchased an existing bank branch facility in Somerset,
New Jersey, in December 2001. This new branch location opened in February 2002.
In addition, the Company plans to relocate one branch and add two new retail
locations in 2003.
4
MARKET AREA AND COMPETITION
The Company currently operates 23 branch offices in central New
Jersey, 18 of which are located in Middlesex County, two in Monmouth County and
one in each of Mercer, Somerset and Union Counties. The Company's deposit
gathering base is concentrated in the communities surrounding its offices. The
majority of the Company's loan originations are derived from northern and
central New Jersey, which is a part of the New York City metropolitan area and
which has historically benefited from having a large number of corporate
headquarters and a concentration of financial services-related industries. The
area also has a well-educated employment base and a large number of industrial,
service and high-technology businesses. Relatively low unemployment levels and
favorable interest rates have contributed to the appreciation in New Jersey's
real estate market in recent years. Whether such appreciation will continue is
dependent, in large part, upon the general economic condition of both New Jersey
and the United States and other factors beyond the Company's control and,
therefore, cannot be estimated.
The Company faces significant competition both in making loans and
in attracting deposits. The State of New Jersey has a high density of financial
institutions, many of which are branches of significantly larger institutions
which have greater financial resources than the Company, and all of which are
competitors of the Company to varying degrees. The Company's competition for
loans comes principally from commercial banks, savings banks, savings and loan
associations, credit unions, mortgage banking companies and insurance companies.
Its most direct competition for deposits has historically come from commercial
banks, savings banks, savings and loan associations and credit unions. The
Company faces additional competition for deposits from short-term money market
funds, other corporate and government securities funds and from other financial
institutions such as brokerage firms and insurance companies.
ANALYSIS OF NET INTEREST INCOME
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income also depends on the relative amounts of interest-earning assets
and interest-bearing liabilities and the interest rate earned or paid on them.
5
AVERAGE BALANCE SHEET. The following table sets forth certain information
relating to the Company's average balance sheet and reflects the average yield
on assets and average cost of liabilities for the periods indicated. Average
balances are derived from month-end balances.
(Dollars in thousands)
For the Year Ended December 31,
--------------------------------------------------------------------------\-
2002 2001
------------------------------------- ------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------------------------------------- ------------------------------------
ASSETS:
Interest-earning assets:
Loans, net (1) ............................... $1,263,513 $ 84,219 6.67% $1,220,059 $ 89,678 7.35%
Investment and mortgage-backed
securities available for sale (2) .......... 888,124 41,783 4.70 735,600 43,907 5.97
------------------------ -----------------------
Total interest-earning assets ............. 2,151,637 126,002 5.86 1,955,659 133,585 6.83
Non-interest earning assets .................... 74,982 63,937
---------- ----------
Total assets .............................. $2,226,619 $2,019,596
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
NOW and money market accounts .............. $ 466,811 7,725 1.65 $ 381,613 9,654 2.53
Savings accounts ........................... 201,358 3,543 1.76 168,520 3,790 2.25
Certificate accounts ....................... 628,535 21,189 3.37 660,120 33,764 5.11
Borrowed funds ............................. 587,986 29,964 5.10 495,674 27,476 5.54
------------------------ -----------------------
Total interest-bearing liabilities ........ 1,884,690 62,421 3.31 1,705,927 74,684 4.38
Non-interest bearing deposits .................. 67,061 53,394
Other liabilities .............................. 45,860 31,941
---------- ----------
Total liabilities ......................... 1,997,611 1,791,262
---------- ----------
Stockholders' equity ........................... 229,008 228,334
---------- ----------
Total liabilities and stockholders'
equity.................................. $2,226,619 $2,019,596
========== ==========
Net interest income/interest rate spread (3) ...... $ 63,581 2.55% $ 58,901 2.45%
===================== ====================
Net interest-earning assets/net interest margin (4) $ 266,947 2.96% $ 249,732 3.01%
========== ========== ========== =========
Ratio of interest-earning assets to
interest-bearing liabilities .................... 1.14 X 1.15 X
========== ==========
(Dollars in thousands)
For the Year Ended December 31,
--------------------------------------
2000
--------------------------------------
Average Average
Balance Interest Yield/Cost
--------------------------------------
ASSETS:
Interest-earning assets:
Loans, net (1) ............................... $1,121,386 $ 84,174 7.51 %
Investment and mortgage-backed
securities available for sale (2) .......... 818,035 52,615 6.43
-------------------------
Total interest-earning assets ............. 1,939,421 136,789 7.05
Non-interest earning assets .................... 20,695
----------
Total assets .............................. $1,960,116
==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
NOW and money market accounts .............. $ 354,135 9,452 2.67
Savings accounts ........................... 166,127 3,744 2.25
Certificate accounts ....................... 646,791 34,783 5.38
Borrowed funds ............................. 503,372 30,893 6.14
-------------------------
Total interest-bearing liabilities ........ 1,670,425 78,872 4.72
Non-interest bearing deposits .................. 48,582
Other liabilities .............................. 15,253
----------
Total liabilities ......................... 1,734,260
----------
Stockholders' equity ........................... 225,856
----------
Total liabilities and stockholders'
equity.................................. $1,960,116
==========
Net interest income/interest rate spread (3) ...... $ 57,917 2.33%
===================
Net interest-earning assets/net interest margin (4) $ 268,996 2.99%
========== =======
Ratio of interest-earning assets to
interest-bearing liabilities .................... 1.16 x
==========
(1) Loans receivable, net includes non-accrual loans.
(2) Includes federal funds sold and FHLB-NY stock. All securities are presented
at amortized cost.
(3) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(4) Net interest margin represents net interest income divided by average
interest-earning assets.
6
RATE/VOLUME ANALYSIS
Net interest income can also be analyzed in terms of the impact of
changing interest rates on interest-earning assets and interest-bearing
liabilities and changing volume or amount of these assets and liabilities. The
following table represents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to (i) changes attributable to changes in volume (change in volume
multiplied by prior rate), (ii) changes attributable to changes in rate (change
in rate multiplied by prior volume), and (iii) the net change. Changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the change due to volume and the change due to rate.
(In thousands)
Year Ended December 31, 2002 Year Ended December 31, 2001
Compared to Year Ended Compared to Year Ended
December 31, 2001 December 31, 2000
------------------------------------ ------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------- -------- ---------------------- --------
Volume Rate Net Volume Rate Net
-------- -------- -------- -------- -------- --------
INTEREST-EARNING ASSETS:
Loans receivable, net ........... $ 3,095 $ (8,554) $ (5,459) $ 7,320 $ (1,816) $ 5,504
Investment and mortgage-backed
securities and loans available
for sale ..................... 8,174 (10,298) (2,124) (5,093) (3,615) (8,708)
-------- -------- -------- -------- -------- --------
Total ........................... 11,269 (18,852) (7,583) 2,227 (5,431) (3,204)
-------- -------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES:
Deposits:
NOW and money market demand ... 1,872 (3,801) (1,929) 713 (511) 202
Savings ....................... 663 (910) (247) 46 -- 46
Certificates of deposit ....... (1,549) (11,026) (12,575) 720 (1,739) (1,019)
Borrowed funds .................. 4,802 (2,314) 2,488 (463) (2,954) (3,417)
-------- -------- -------- -------- -------- --------
Total ........................... 5,788 (18,051) (12,263) 1,016 (5,204) (4,188)
-------- -------- -------- -------- -------- --------
Change in net interest income ..... $ 5,481 $ (801) $ 4,680 $ 1,211 $ (227) $ 984
======== ======== ======== ======== ======== ========
7
LENDING ACTIVITIES
LOAN AND MORTGAGE-BACKED SECURITIES PORTFOLIO COMPOSITIONS. The
Company's loan portfolio consists primarily of conventional first mortgage loans
secured by one-to-four family residences and, to a lesser extent, multi-family
residences and commercial real estate. At December 31, 2002, the Company's loan
portfolio totaled $1.2 billion, of which $835.6 million, or 68.9% were
one-to-four family residential mortgage loans. At that date, the Company's loan
portfolio also included $110.8 million of home equity loans and lines of credit
generally secured by second liens on one-to-four family residential properties,
$77.1 million of net construction loans, $164.6 million of commercial real
estate loans, and $12.7 million of multi-family residential mortgage loans,
which represented 9.1%, 6.4%, 13.6% and 1.1%, respectively, of total loans
receivable. Of the mortgage loan portfolio outstanding at December 31, 2002,
47.6% were fixed-rate loans and 52.4% were adjustable-rate mortgage ("ARM")
loans. Other loans held by the Company, which consist of loans on deposit
accounts, commercial, personal, and automobile loans, totaled $12.5 million, or
1.0% of total loans outstanding at December 31, 2002. The Company anticipates
continued growth in construction, commercial and commercial real estate loans,
both in amount and as a percentage of total loans receivable, in the foreseeable
future due to its efforts to diversify the loan portfolio.
The majority of the loans originated by the Company are held for
investment. In order to manage interest rate risk and diversify credit risk,
however, the Company periodically sells 30-year, fixed-rate conforming loans to
the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC"), FHLB-NY
and institutional investors and generally retains servicing rights. All such
loans are sold without recourse. At December 31, 2002, the Company's servicing
portfolio totaled $106.1 million. The Company had $563,000 in loans held for
sale at December 31, 2002.
The Company also invests in mortgage-backed securities and other
mortgage-backed products such as collateralized mortgage obligations ("CMOs").
At December 31, 2002, mortgage-backed securities, including CMOs, were $790.6
million, or 35.0% of total assets, of which 67.6% were secured by ARM loans. The
majority of the Company's mortgage-backed securities are insured or guaranteed
by Freddie Mac, the Government National Mortgage Association ("GNMA"), or Fannie
Mae ("FNMA"). At December 31, 2002, all mortgage-backed securities were
classified as available for sale. Mortgage-backed securities available for sale
are held for an indefinite period of time and may be sold in response to
changing market and interest rate conditions, or to provide liquidity to fund
activities such as common stock repurchases or loan originations. The Company
expects to classify all mortgage-backed security purchases as available for sale
in the foreseeable future.
8
The following table sets forth the composition of the Company's loan
and mortgage-backed securities portfolio in dollar amounts and as a percentage
of the portfolio at the dates indicated (dollars in thousands):
At December 31,
---------------------------------------------------------------------
2002 2001
------------------------------- -------------------------------
Percent Percent
Amount of total Amount of total
------------- ------------- ------------- -------------
Mortgage loans (1):
One-to-four family ................. $ 835,593 68.87% $ 857,973 68.37%
Home equity ........................ 110,835 9.13 112,958 9.00
Construction (2) ................... 77,091 6.35 71,590 5.70
Commercial real estate ............. 164,639 13.57 167,806 13.37
Multi-family ....................... 12,714 1.05 23,396 1.86
------------- ------------- ------------- -------------
Total mortgage loans ............. 1,200,872 98.97 1,233,723 98.30
Other loans ........................... 12,537 1.03 21,347 1.70
------------- ------------- ------------- -------------
Total loans receivable ........... 1,213,409 100.00% 1,255,070 100.00%
============= =============
Less:
Net deferred loan fees (costs) and
(premiums) and discounts ........... (631) (641)
Allowance for loan losses ............. 12,830 12,932
------------- -------------
Total loans receivable, net ...... $ 1,201,210 $ 1,242,779
============= =============
Mortgage loans:
ARM ................................ $ 629,176 52.39% $ 660,047 53.50%
Fixed-rate ......................... 571,696 47.61 573,676 46.50
------------- ------------- ------------- -------------
Total mortgage loans ............. $ 1,200,872 100.00% $ 1,233,723 100.00%
============= ============= ============= =============
Mortgage-backed securities :
CMOs ............................... $ 118,693 15.47% $ 137,528 21.77%
FHLMC .............................. 322,914 42.08 296,710 46.97
GNMA ............................... 29,483 3.84 44,951 7.11
FNMA ............................... 296,248 38.61 152,603 24.15
------------- ------------- ------------- -------------
Total mortgage-backed securities . 767,338 100.00% 631,792 100.00%
============= =============
Net premiums .......................... 10,336 6,198
Net unrealized gain (loss) on mortgage-
backed securities available for sale 12,888 4,726
------------- -------------
Mortgage-backed securities, net ....... $ 790,562 $ 642,716
============= =============
At December 31,
---------------------------------------------------------------------
2000 1999
------------------------------ ------------------------------
Percent Percent
Amount of total Amount of total
------------- ------------- ------------- -------------
Mortgage loans (1):
One-to-four family ................. $ 879,578 73.59% $ 774,858 75.52%
Home equity ........................ 114,152 9.55 98,324 9.58
Construction (2) ................... 41,291 3.45 26,890 2.62
Commercial real estate ............. 131,072 10.97 96,821 9.44
Multi-family ....................... 13,079 1.09 12,499 1.22
------------- ------------- ------------- -------------
Total mortgage loans ............. 1,179,172 98.65 1,009,392 98.38
Other loans ........................... 16,121 1.35 16,638 1.62
------------- ------------- ------------- -------------
Total loans receivable ........... 1,195,293 100.00% 1,026,030 100.00%
============= =============
Less:
Net deferred loan fees (costs) and
(premiums) and discounts ........... (1,850) (1,090)
Allowance for loan losses ............. 12,341 11,004
------------- -------------
Total loans receivable, net ...... $ 1,184,802 $ 1,016,116
============= =============
Mortgage loans:
ARM ................................ $ 664,164 56.32% $ 531,859 52.69%
Fixed-rate ......................... 515,008 43.68 477,533 47.31
------------- ------------- ------------- -------------
Total mortgage loans ............. $ 1,179,172 100.00% $ 1,009,392 100.00%
============= ============= ============= =============
Mortgage-backed securities :
CMOs ............................... $ 201,802 44.79% $ 273,511 46.85%
FHLMC .............................. 159,755 35.45 166,992 28.60
GNMA ............................... 29,409 6.53 57,489 9.85
FNMA ............................... 59,628 13.23 85,828 14.70
------------- ------------- ------------- -------------
Total mortgage-backed securities . 450,594 100.00% 583,820 100.00%
============= =============
Net premiums .......................... 1,951 2,748
Net unrealized gain (loss) on mortgage-
backed securities available for sale (5,523) (11,409)
------------- -------------
Mortgage-backed securities, net ....... $ 447,022 $ 575,159
============= =============
At December 31,
------------------------------
1998
------------------------------
Percent
Amount of total
------------- -------------
Mortgage loans (1):
One-to-four family ................. $ 657,284 76.10%
Home equity ........................ 82,672 9.57
Construction (2) ................... 23,349 2.70
Commercial real estate ............. 65,069 7.53
Multi-family ....................... 17,589 2.04
------------- -------------
Total mortgage loans ............. 845,963 97.94
Other loans ........................... 17,817 2.06
------------- -------------
Total loans receivable ........... 863,780 100.00%
=============
Less:
Net deferred loan fees (costs) and
(premiums) and discounts ........... (422)
Allowance for loan losses ............. 9,505
-------------
Total loans receivable, net ...... $ 854,697
=============
Mortgage loans:
ARM ................................ $ 439,234 51.92%
Fixed-rate ......................... 406,729 48.08
------------- -------------
Total mortgage loans ............. $ 845,963 100.00%
============= =============
Mortgage-backed securities :
CMOs ............................... $ 209,468 32.00%
FHLMC .............................. 235,415 35.97
GNMA ............................... 71,347 10.90
FNMA ............................... 138,286 21.13
------------- -------------
Total mortgage-backed securities . 654,516 100.00%
=============
Net premiums .......................... 3,639
Net unrealized gain (loss) on mortgage-
backed securities available for sale 3,726
-------------
Mortgage-backed securities, net ....... $ 661,881
=============
- -------------------------
(1) Includes $563,000, $5.5 million and $277,000 in mortgage loans held for sale
at December 31, 2002, 2001 and 2000, respectively. No loans were classified as
held for sale at December 31, 1999 or 1998.
(2) Net of loans in process of $62.1 million, $65.1 million, $19.2 million,
$28.0 million and $41.8 million at December 31, 2002, 2001, 2000, 1999 and 1998,
respectively.
9
LOAN MATURITY AND REPRICING
The following table shows the maturity or period to repricing of the
Company's loan portfolio at December 31, 2002. Loans that have adjustable rates
are shown as being due in the period during which the interest rates are next
subject to change. The table does not include prepayments or scheduled principal
amortization.
(In thousands)
At December 31, 2002
----------------------------------------------------------------
One Year
One Year To Five After
or Less Years Five Years Total
--------------- --------------- -------------- ----------------
Mortgage loans:
One-to-four family ............... $85,548 $248,517 $501,528 $ 835,593
Home equity....................... 48,697 14,117 48,021 110,835
Construction (1) ................. 77,091 -- -- 77,091
Commercial real estate ........... 17,533 58,349 88,757 164,639
Multi-family ..................... 5,144 1,191 6,379 12,714
--------------- --------------- -------------- ----------------
Total mortgage loans ........... 234,013 322,174 644,685 1,200,872
Other loans ........................ 6,795 3,525 2,217 12,537
--------------- --------------- -------------- ----------------
Total loans .................... $240,808 $325,699 $646,902 1,213,409
=============== =============== ==============
Net deferred loan costs and unearned premiums ........................................ 631
Allowance for loan losses............................................................. (12,830)
----------------
Loans receivable, net ................................................................ 1,201,210
=======-========
(1) Excludes loans in process of $62.1 million.
The following table sets forth at December 31, 2002, the dollar
amount of loans contractually due or repricing after December 31, 2003, and
whether such loans have fixed interest rates or adjustable interest rates (in
thousands):
DUE OR REPRICING AFTER DECEMBER 31, 2003
----------------------------------------
FIXED ADJUSTABLE TOTAL
---------- ---------- ----------
Mortgage loans:
One-to-four family .............. $ 393,102 $ 356,943 $ 750,045
Home equity ..................... 62,138 -- 62,138
Commercial real estate .......... 67,945 79,161 147,106
Multi-family .................... 4,720 2,850 7,570
Other loans ........................ 3,175 2,567 5,742
---------- ---------- ----------
Total loans receivable ............. 531,080 441,521 972,601
Mortgage-backed securities
(at amortized cost) ............. 298,145 383,213 681,358
---------- ---------- ----------
Total loans receivable and mortgage-
backed securities .............. $ 829,225 $ 824,734 $1,653,959
========== ========== ==========
ONE-TO-FOUR FAMILY MORTGAGE LOANS. The Company offers fixed and
adjustable-rate first mortgage loans secured by one-to-four family residences in
New Jersey. Typically, such residences are single family homes that serve as the
primary residence of the owner. Loan originations are generally obtained from
existing or past
10
customers, members of the local community, and referrals from attorneys,
established builders, and realtors within the Company's market area. In
addition, one-to-four family residential mortgage loans are also originated in
the Company's market area through loan originators who are employees of the
Company and are compensated on a commission basis. Originated mortgage loans in
the Company's portfolio include due-on-sale clauses which provide the Company
with the contractual right to deem the loan immediately due and payable in the
event that the borrower transfers ownership of the property without the
Company's consent.
At December 31, 2002, 68.9% of total loans receivable consisted of
one-to-four family residential loans. The Company offers ARM loans with initial
fixed-rate terms of either one, three, five, seven or ten years. After the
initial fixed-rate term, the loan then converts into a one-year ARM. The
Company's ARM loans may carry an initial interest rate which is less than the
fully-indexed rate for the loan. The initial discounted rate is determined by
the Company in accordance with market and competitive factors. The majority of
the Company's ARM loans adjust by a maximum of 2.00% per year, with a lifetime
cap on increases of up to 6.00%. ARM loans are originated for terms of up to 30
years. Interest rates charged on fixed-rate loans are competitively priced based
on market conditions and the Company's cost of funds. The Company's fixed-rate
mortgage loans currently are made for terms of 10 through 30 years.
Generally, ARM loans pose credit risks different than risks inherent
in fixed-rate loans, primarily because as interest rates rise, the payments of
the borrower rise, thereby increasing the potential for delinquency and default.
At the same time, the marketability of the underlying property may be adversely
affected by higher interest rates. In order to minimize risks, borrowers of
one-year ARM loans are qualified at the starting interest rate plus 2.00% or the
fully-indexed rate, whichever is lower. The Company does not originate ARM loans
which provide for negative amortization. The Company also offers Limited
Documentation loans that do not require income verification but do require full
asset verification.
The Company generally originates one-to-four family residential
mortgage loans in amounts up to 97% of the appraised value or selling price of
the mortgaged property, whichever is lower. The Company requires private
mortgage insurance for all loans originated with loan-to-value ratios exceeding
80%. Generally, the minimum one-to-four family loan amount is $25,000, and the
maximum loan amount is $1,000,000. The Company offers residential mortgage loans
with origination fees ranging from 0.00% to 3.00%.
HOME EQUITY LOANS AND LINES OF CREDIT. The Company originates home
equity loans secured by one-to-four family residences. These loans generally are
originated as fixed-rate loans with terms from five to 15 years. Home equity
loans are primarily made on owner-occupied, one-to-four family residences and to
the Company's first mortgage customers. These loans are generally subject to a
80% loan-to-value limitation including any other outstanding mortgages or liens.
In addition, the Company currently offers home equity loans for qualified
borrowers with a loan-to-value ratio of up to 100%. The Company obtains private
mortgage insurance for some of these types of loans, depending on the
underwriting and first lien position. The Company also offers "Helping Hand"
home equity loans for low income borrowers, with a maximum term of ten years,
with loan-to-value ratios of up to 100% and a maximum loan amount of $20,000.
Generally, the Company's minimum equity loan is $10,000 and the maximum equity
loan is $500,000. As of December 31, 2002, the Company had $62.4 million in
fixed-rate home equity loans outstanding.
The Company also offers a variable rate, home equity line of credit,
which is a credit line based on the applicant's income and equity in the home.
Generally, the credit line, when combined with the balance of the first mortgage
lien, may not exceed 80% of the appraised value of the property at the time of
the loan commitment. Home equity lines of credit are secured by a mortgage on
the underlying real estate. The Company presently charges no origination fees
for these loans. A borrower is required to make monthly payments of principal
and interest, at a minimum of $100.00 plus interest, based upon a 20-year
amortization period. The interest rate charged is the prime rate of interest (as
published in THE WALL STREET JOURNAL) (the "prime rate") plus up to 0.25%. The
Company also offers a credit line product based on a 15-year amortization and
the interest rate charged is the prime rate. The Company offers a fixed 6-month
introductory rate on both home equity line of credit products. The introductory
rate is currently 3.99%. The Company offers an additional credit line product
that allows for a loan-to-value ratio of up to 100%. Payments are based on 15 or
20-year amortization periods with interest rates varying between the prime rate
plus 1.50% to the prime rate plus 1.75%. All home equity lines of credit are
subject to a maximum annual
11
interest rate change of 2.00% with a 14.99% ceiling. The Company's home equity
lines of credit outstanding at December 31, 2002 totaled $48.5 million, with
additional available credit lines of $65.5 million.
CONSTRUCTION LENDING. At December 31, 2002, construction loans
totaled $77.1 million, or 6.4% of the Company's total loans outstanding.
Available credit lines totaled $62.1 million at December 31, 2002. Construction
loans generally bear interest rates that float at margins of up to 1.5% above
the prime rate, with the majority also having floor rates. The Company's
construction loans typically have original principal balances that are larger
than its one-to-four family mortgage loans, with the majority of the loans
ranging from available lines of credit of $400,000 to $11.5 million. At December
31, 2002, the Company had 49 construction loans, 21 of which had principal
outstanding of $1.0 million or more, with the largest outstanding loan balance
being $9.9 million. At December 31, 2002, all of the Company's construction
lending portfolio consisted of loans secured by property located in the State of
New Jersey, primarily for the purpose of constructing one-to-four family homes.
The Company will originate construction loans on unimproved land in
amounts up to 70% of the lower of the appraised value or the cost of the land.
The Company also originates loans for site improvements and construction costs
in amounts up to 75% of actual costs or sales price where contracts for sale
have been executed. Generally, construction loans are offered for 12-month to
18-month terms with up to four six-month options to extend the original term.
Typically, additional loan origination fees are charged for each extension
granted however, these fees have been waived occasionally. The Company requires
an appraisal of the property, credit reports, and financial statements on all
principals and guarantors, among other items, on all construction loans.
Construction lending, by its nature, entails additional risks as
compared with one-to-four family mortgage lending, attributable primarily to the
fact that funds are advanced upon the security of the project under construction
prior to its completion. As a result, construction lending often involves the
disbursement of substantial funds with repayment dependent on the success of the
ultimate project and the ability of the borrower or guarantor to repay the loan.
Because of these factors, the analysis of prospective construction loan projects
requires an expertise that is different in significant respects from that which
is required for residential mortgage lending. The Company addresses these risks
through its underwriting procedures. See "Asset Quality" for further discussion.
COMMERCIAL REAL ESTATE. At December 31, 2002, the Company had 163
loans secured by commercial real estate, totaling $164.6 million, or 13.6% of
the Company's total loan portfolio. Commercial real estate loans are generally
originated in amounts up to 75% of the appraised value of the mortgaged
property. The Company's commercial real estate loans are permanent loans secured
by improved property such as office buildings, retail stores, small shopping
centers, medical offices, small industrial facilities, warehouses, storage
facilities and other non-residential buildings. The largest commercial real
estate loan at December 31, 2002 had an outstanding balance of $7.6 million and
was secured by a hotel. Substantially all commercial real estate loans in the
Company's portfolio are secured by properties located within New Jersey.
The Company's commercial real estate loans are generally made for
terms of up to 15 years. These loans typically are based upon a payout period of
10 to 25 years. To originate commercial real estate loans, the Company requires
a security interest in personal property, standby assignment of rents and leases
and some level of personal guarantees, if possible. The Company has established
a $20.0 million maximum for any individual commercial real estate loan.
Loans secured by commercial real estate properties are generally
larger and involve a greater degree of risk than residential mortgage loans.
Because payments on loans secured by commercial real estate properties are often
dependent on successful operation or management of the properties, repayment of
such loans may be subject, to a greater extent, to adverse conditions in the
real estate market or the economy. The Company seeks to minimize these risks by
limiting the number of such loans, lending only to established customers and
borrowers otherwise known or recommended to the Company, generally restricting
such loans to New Jersey, and obtaining personal guarantees, if possible.
MULTI-FAMILY MORTGAGE LOANS. The Company originates multi-family
mortgage loans in its primary lending area. As of December 31, 2002, $12.7
million, or 1.1%, of the Company's total loan portfolio consisted of
multi-family residential loans. At December 31, 2002, the Company had two
multi-family loans with an outstanding
12
balance in excess of $1.7 million. Large multi-family loans such as these are
originated using the Company's underwriting standards for commercial real estate
loans.
OTHER LENDING. The Company also offers other loans, primarily
commercial, personal, automobile, boat, motorcycle and motor home loans and
loans secured by deposit accounts. At December 31, 2002, $12.5 million, or 1.0%,
of the loan portfolio consisted of such other loans.
LOAN APPROVAL AUTHORITY AND UNDERWRITING. All loans secured by real
estate must have the approval or ratification of the members of the Loan
Committee, which consists of at least two outside directors and at least two
officers engaged in the lending area. The Loan Committee meets at least monthly
to review and ratify management's approval of loans made within the scope of its
authority since the last committee meeting, and to approve mortgage loans made
in excess of $750,000, but not greater than $1.0 million. Real estate loans in
excess of $1.0 million require prior Board approval. Prior Board approval is
also required for the origination of consumer and business loans in excess of
$100,000 for unsecured loans, and $500,000 for secured loans.
One-to-four family residential mortgage loans are generally
underwritten according to Freddie Mac guidelines, except as to loan amount and
certain documentation. For all loans originated by the Company, upon receipt of
a completed loan application from a prospective borrower, a credit report is
requested, income, assets and certain other information are verified and, if
necessary, additional financial information is requested. An appraisal of the
real estate intended to secure the proposed loan is required, performed by
independent appraisers designated and approved by the Board of Directors. It is
the Company's policy to obtain appropriate insurance protections, including
title and flood insurance, on all real estate first mortgage loans. Borrowers
must also obtain hazard insurance prior to closing. Borrowers generally are
required to advance funds for certain items such as real estate taxes, flood
insurance and private mortgage insurance, when applicable.
LOAN SERVICING. The Company generally retains the servicing rights
on loans it has sold. The Company receives fees for these servicing activities,
which include collecting and remitting loan payments, inspecting the properties
and making certain insurance and tax payments on behalf of the borrowers. The
Company was servicing $106.1 million and $96.1 million of mortgage loans for
others at December 31, 2002 and 2001, respectively. The Company received
$204,000 and $193,000 in servicing fees for the years ended December 31, 2002
and 2001, respectively.
LOAN PURCHASES AND SALES. The Company is a Freddie Mac qualified
servicer in good standing, and may sell any of its conforming loans originated,
subject to Freddie Mac requirements, and retain the servicing rights. The
Company may also sell loans to the FHLB-NY and institutional investors, and
generally retains servicing rights. As a part of its asset/liability management,
the Company will sell loans, on occasion, in order to reduce or minimize
potential interest rate and credit risk. As of December 31, 2002, $563,000 of
mortgage loans were classified as held for sale. Mortgage loans sold totaled
$46.6 million for each of the years ended December 31, 2002 and 2001.
Periodically, the Company may also purchase mortgage loans. The Company
purchased $27.6 and $19.1 million in mortgage loans from third-party
correspondents for the years ended December 31, 2002 and 2001, respectively. The
Company underwrote the loans and verified documentation prior to purchase and
received representations and warranties for a one year period, including
repayment of remaining purchase premiums if a loan prepays within the first 12
months.
13
ASSET QUALITY
The following table sets forth information regarding non-accrual
loans, loans delinquent 90 days or more, and real estate owned ("REO"). At
December 31, 2002, REO totaled $72,000 and consisted of one residential
property. It is the policy of the Company to cease accruing interest on loans 90
days or more past due with loan-to-value ratios in excess of 55% and to reverse
all previously accrued interest. For the year ended December 31, 2002, the
amount of additional interest income that would have been recognized on
nonaccrual loans if such loans had continued to perform in accordance with their
contractual terms was $118,000.
(Dollars in thousands)
At December 31,
------------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Non-accrual mortgage loans ......... $1,541 $1,787 $2,334 $2,311 $2,647
Non-accrual other loans ............ -- -- 15 45 93
------ ------ ------ ------ ------
Total non-accrual loans ...... 1,541 1,787 2,349 2,356 2,740
Loans 90 days or more delinquent
and still accruing .............. 223 62 40 326 1,525
------ ------ ------ ------ ------
Total non-performing loans .. 1,764 1,849 2,389 2,682 4,265
Restructured loans ................. -- -- -- -- --
Total real estate owned, net of
related allowance for loss ...... 72 42 257 466 1,453
------ ------ ------ ------ ------
Total non-performing assets ........ $1,836 $1,891 $2,646 $3,148 $5,718
====== ====== ====== ====== ======
Non-performing loans to total loans
receivable, net ............ 0.15% 0.15% 0.20% 0.26% 0.50%
Total non-performing assets to total
assets ..................... 0.08% 0.09% 0.13% 0.17% 0.31%
CLASSIFICATION OF ASSETS. The Company classifies loans and other
assets such as debt and equity securities considered to be of lesser quality as
"substandard," "doubtful," or "loss" assets. An asset is considered
"substandard" if it is inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the Company will sustain "some loss" if the deficiencies are not corrected.
Assets classified as "doubtful" have all of the weaknesses inherent in those
classified "substandard," with the added characteristic that the weaknesses
present make "collection or liquidation in full," on the basis of currently
existing facts, conditions, and values, "highly questionable and improbable."
Assets classified as "loss" are those considered "uncollectible" and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted. Assets that do not expose the Company to
risk sufficient to warrant classification in one of the aforementioned
categories, but which possess some weaknesses, are required to be designated
"special mention" by management. Loans designated as special mention are
generally loans that, while current in required payment, have exhibited some
potential weaknesses that, if not corrected, could increase the level of risk in
the future. Pursuant to the Company's internal guidelines, all one-to-four
family residential mortgage loans with loan-to-value ratios in excess of 55%
which are 90 days past due and all other loans which are 90 days past due are
classified substandard, doubtful, or loss.
The Company's classified assets totaled $2.1 and $9.0 million at
December 31, 2002 and 2001, respectively. At December 31, 2002, $1.2 million of
classified loans were secured by residential properties. The majority of the
remaining $900,000 in classified loans consisted of a $668,000 construction loan
secured by a residential housing development with an estimated loan-to-value
ratio of 66%.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is
established through a provision for loan losses based on management's evaluation
of the adequacy of the allowance, including an assessment of known and inherent
14
risks in the Bank's loan portfolio, review of individual loans for adverse
situations that may affect the borrower's ability to repay, the estimated value
of any underlying collateral, and consideration of current economic conditions.
Such evaluation, which includes a review of all loans on which full
collectibility may not be reasonably assured, considers the fair value of the
underlying collateral, economic conditions, historical loan loss experience, and
other factors that warrant recognition in providing for an adequate loan loss
allowance. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses and valuation of real estate owned. Such agencies may require the Company
to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.
The Company recorded $1.3 million and $650,000 in provisions for
loan losses for the years ended December 31, 2002 and 2001, respectively. The
increase in the provision for loan losses was largely attributable to a $1.4
million charge against the allowance for loan losses related to a participation
loan to an insurance premium financier. This charge-off was precipitated by
alleged acts of fraud and/or misrepresentation. The Company has received payment
in full settlement of the remaining loan balance and has no further exposure to
this item. At December 31, 2002, the Company holds no other insurance premium
financing loans, nor does it have any other loans similar to this loan wherein
the primary collateral is a surety bond. The Company believes that the allowance
for loan losses is adequate. At December 31, 2002, the total allowance was $12.8
million, which amounted to 1.06% of loans receivable, net of unearned and
deferred fees, and 7.3 times non-performing loans. The Company will continue to
monitor the level of its allowance for loan losses in order to maintain it at a
level which management considers adequate to provide for probable loan losses.
The following table sets forth activity in the Company's allowance
for loan losses for the periods indicated (in thousands):
For the Years Ended December 31,
------------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- -------
Balance at beginning of period .............. $ 12,932 $ 12,341 $ 11,004 $ 9,505 $ 8,454
Provision for loan losses ................... 1,310 650 1,441 1,650 1,469
Charge-offs (domestic):
Commercial loans ......................... (1,388) -- -- -- --
Real estate - mortgage ................... (18) (71) (97) (151) (594)
Installment loans to individuals ......... (34) -- (7) -- (2)
Recoveries (domestic):
Commercial loans ......................... 9 -- -- -- --
Real estate - mortgage ................... 16 12 -- -- 28
Installment loans to individuals ......... 3 -- -- -- --
Allowance activity of Pulse
during conforming period, net ............ -- -- -- -- 150
-------- -------- -------- -------- -------
Balance at end of period .................... $ 12,830 $ 12,932 $ 12,341 $ 11,004 $ 9,505
======== ======== ======== ======== =======
Ratio of net charge-offs during the period to
average loans during the period ............ 0.11% --% 0.01% 0.02% 0.07%
======== ======== ======== ======== =======
15
The following tables set forth the Company's percentage of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated (dollars in
thousands):
At December 31,
----------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
Percent Percent Percent Percent
of of of of
Allowance Loans in Allowance Loans in
to Each to Each
Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------ --------- ----------- ------ --------- -----------
One-to-four family .............. $ 4,420 34.45% 68.87% $ 4,579 35.41% 68.37%
Home equity loans ............... 1,334 10.40 9.13 1,270 9.82 9.00
Construction .................... 2,123 16.55 6.35 2,209 17.09 5.70
Commercial real estate .......... 2,614 20.37 13.57 3,674 28.41 13.37
Multi-family .................... 191 1.49 1.05 351 2.71 1.86
------- ------- ------- ------- ------- -------
Total mortgage loans .......... 10,682 83.26 98.97 12,083 93.44 98.30
Other ........................... 690 5.38 1.03 849 6.56 1.70
Unallocated ..................... 1,458 11.36 -- -- -- --
------- ------- ------- ------- ------- -------
Total allowance for loan losses $12,830 100.00% 100.00% $12,932 100.00% 100.00%
======= ======= ======= ======= ======= =======
At December 31,
------------------------------------------------------------------------------------
2000 1999
--------------------------------------- ---------------------------------------
Percent of Percent of
Loans in Loans in
Percent of Each Percent of Each
Allowance Category Allowance Category
to Total to to Total to
Amount Allowance Total Loans Amount Allowance Total Loans
------ --------- ----------- ------ --------- -----------
One-to-four family .. $ 4,831 39.15% 73.59% $ 4,667 42.41% 75.52%
Home equity loans ... 1,243 10.07 9.55 1,086 9.87 9.58
Construction ........ 1,275 10.33 3.45 1,573 14.29 2.62
Commercial real
estate ........... 2,637 21.37 10.97 2,630 23.90 9.44
Multi-family ........ 197 1.60 1.09 250 2.27 1.22
------- ------- ------- ------- ------- -------
Total mortgage .. 10,183 82.51 98.65 10,206 92.74 98.38
loans
Other ............... 587 4.76 1.35 541 4.92 1.62
Unallocated ......... 1,571 12.73 -- 257 2.34 --
------- ------- ------- ------- ------- -------
Total allowance for
loan losses .... $12,341 100.00% 100.00% $11,004 100.00% 100.00%
======= ======= ======= ======= ======= =======
At December 31,
---------------------------------------
1998
---------------------------------------
Percent of
Loans in
Percent of Each
Allowance Category
to Total to
Amount Allowance Total Loans
------ --------- -----------
One-to-four family .. $ 4,027 42.37% 76.10%
Home equity loans ... 1,090 11.47 9.57
Construction ........ 1,223 12.87 2.70
Commercial real
estate ........... 1,963 20.65 7.53
Multi-family ........ 522 5.49 2.04
------- ------- -------
Total mortgage .. 8,825 92.85 97.94
loans
Other ............... 486 5.11 2.06
Unallocated ......... 194 2.04 --
------- ------- -------
Total allowance for
loan losses .... $ 9,505 100.00% 100.00%
======= ======= =======
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent a participation interest in a
pool of single-family or multi-family mortgages, the principal and interest
payments on which, in general, are passed from the mortgage originators, through
intermediaries that pool and repackage the participation interest in the form of
securities, to investors such as the Company. Such intermediaries may be private
issuers, or agencies of the U.S. Government, including Freddie Mac, FNMA and
GNMA, that guarantee the payment of principal and interest to investors.
Mortgage-backed securities typically are issued with stated
principal amounts, and the securities are backed by pools of mortgages that have
loans with interest rates that are within a specified range and have varying
maturities. The underlying pool of mortgages can be composed of either
fixed-rate or ARM loans. Mortgage-
16
backed securities are generally referred to as mortgage participation
certificates or pass-through certificates. As a result, the interest rate risk
characteristics of the underlying pool of mortgages (e.g., fixed-rate or
adjustable-rate) as well as prepayment, default and other risks associated with
the underlying mortgages (see "Lending Activities") are passed on to the
certificate holder. The life of a mortgage-backed pass-through security is equal
to the life of the underlying mortgage(s).
The actual maturity of a mortgage-backed security varies, depending
on when the mortgagors repay or prepay the underlying mortgages. Prepayments of
the underlying mortgages may shorten the life of the security, thereby affecting
its yield to maturity and the related market value of the mortgage-backed
security. The yield is based upon the interest income and the amortization or
accretion of the premium or discount related to the mortgage-backed security.
Premiums and discounts are amortized or accreted over the anticipated life of
the loans. The prepayment assumptions used to determine the amortization or
accretion period for premiums and discounts can significantly affect the yield
calculation of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rates, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages, general levels of market
interest rates, and general economic conditions. GNMA mortgage-backed securities
that are backed by assumable Federal Housing Authority ("FHA") or Veterans
Administration ("VA") loans generally have a longer life than conventional
non-assumable loans underlying Freddie Mac and FNMA mortgage-backed securities.
The difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates is an important determinant in the rate of
prepayments. During periods of falling mortgage interest rates, prepayments
generally increase, as opposed to periods of increasing interest rates whereby
prepayments generally decrease. If the interest rate of underlying mortgages
significantly exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages. Prepayment experience is more difficult to estimate for
adjustable-rate mortgage-backed securities, both convertible and
non-convertible.
The Company has significant investments in mortgage-backed
securities and has utilized such investments to complement its mortgage lending
activities. At December 31, 2002, mortgage-backed securities, net, totaled
$790.6 million, or 35.0% of total assets. All such securities were classified as
available for sale and carried at market value. The Company invests in a large
variety of mortgage-backed securities, including ARM, balloon and fixed-rate
mortgage-backed securities, the majority of which are directly insured or
guaranteed by Freddie Mac, GNMA and FNMA. At December 31, 2002, the
mortgage-backed securities portfolio had a weighted average interest rate of
5.39%. Fixed coupon rates ranged from 6.00% to 9.50% for GNMA, 5.50% to 9.00%
for Freddie Mac, 5.50% to 7.00% for FNMA fixed-rate securities and 2.28% to
6.50% for fixed-rate CMOs. Adjustable-rate coupon ranges were as follows: 4.00%
to 6.63% for GNMA ARM mortgage-backed securities; 4.35% to 7.13% for Freddie Mac
ARM mortgage-backed securities; and 4.29% to 6.06% for FNMA ARM mortgage-backed
securities.
Included in the total mortgage-backed securities portfolio are CMOs,
which had a market value of $120.8 million at December 31, 2002. The Company
generally purchases short-term, sequential or planned amortization class ("PAC")
CMOs. CMOs are securities created by segregating or portioning cash flows from
mortgage pass-through securities or from pools of mortgage loans. CMOs provide a
broad range of mortgage investment vehicles by tailoring cash flows from
mortgages to meet the varied risk and return preferences of investors. These
securities enable the issuer to "carve up" the cash flows from the underlying
securities and thereby create multiple classes of securities with different
maturity and risk characteristics. The CMOs and other mortgage-backed securities
in which the Company invests may have a multi-class structure ("Multi-Class
Mortgage Securities"). Multi-Class Mortgage Securities issued by private issuers
may be collateralized by pass-through securities guaranteed by GNMA or issued by
FNMA or Freddie Mac, or they may be collateralized by whole loans or
pass-through mortgage-backed securities of private issuers. Each class has a
specified maturity or final distribution date. In one structure, payments of
principal, including any principal prepayments, on the collateral are applied to
the classes in the order of their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any class
until all classes having an earlier stated maturity or final distribution date
have been paid in full. In other structures, certain classes may pay
concurrently, or one or more classes may have a priority with respect to
payments on the underlying collateral up to a specified amount. The Company's
funds have not and will not be invested in any class with residual
characteristics. The weighted average life of CMOs at December 31, 2002, was 3.8
years. The stated weighted average contractual maturity of the Company's CMOs at
December 31, 2002, was 17.0 years.
17
The Company only purchases CMOs and mortgage-backed securities that
are rated "AA" or higher at the time of purchase. Prior to purchasing CMOs and
periodically throughout their lives, individual securities are reviewed for
suitability with respect to projected weighted average lives and price
sensitivity. Generally, fixed-rate CMOs purchased have projected average
durations of three years or less using current market prepayment assumptions
prevalent at the time of purchase and projected average durations that do not
exceed nine years in the event of a 300 basis point increase in market rates of
interest. The Company receives a detailed analysis from the broker/dealer or
from the Bloomberg System on each security.
The amortized cost and market value of mortgage-backed securities at
December 31, 2002, by contractual maturity are shown below. Expected maturities
will differ from contractual maturities due to prepayments (in thousands):
Amortized Market
Cost Value
------------------- -----------------
Mortgage-backed securities available for sale due in:
Less than one year............................ $ 126 $ 130
One year through five years................. 15,931 16,236
Five years through ten years................ 50,015 50,967
Greater than ten years........................ 711,602 723,229
------------------- -----------------
$777,674 $790,562
=================== =================
INVESTMENT ACTIVITIES
The Investment Policy of the Company, which is established by the
Board of Directors and reviewed by the Investment Committee, is designed
primarily to provide and maintain liquidity, to generate a favorable return on
investments without incurring undue interest rate and credit risk and to
complement the Company's lending activities. The Policy currently provides for
held to maturity, available for sale and trading portfolios, although all
securities are currently classified as available for sale.
New Jersey state-chartered savings institutions have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers' acceptances,
repurchase agreements and loans on federal funds. Subject to various
restrictions, state-chartered savings institutions may also invest a portion of
their assets in commercial paper, corporate debt securities and asset-backed
securities.
INVESTMENTS AVAILABLE FOR SALE. The Company maintains a portfolio of
investments available for sale to minimize interest rate and market value risk.
These investments, designated as available for sale at purchase, are marked to
market in accordance with Statement of Financial Accounting Standard No. 115.
The Company's Investment Policy designates what type of securities may be
contained in the available for sale portfolio. This portfolio of available for
sale investments is reviewed and priced at least monthly. As of December 31,
2002, the market value of investment securities available for sale was $114.2
million, with an amortized cost basis of $112.1 million, and was composed of
U.S. Government and Agency securities, state and political obligations,
corporate obligations and equity securities. The available for sale portfolio,
excluding equity securities, had a weighted average contractual maturity of 9.0
years. A portion of the investment portfolio is comprised of callable agency
notes, which have a variety of call options available to the issuer at
predetermined dates. The investment portfolio's yield is enhanced by the
addition of callable agency notes, due to the issuer's flexibility in repricing
their funding source, while creating reinvestment risk to the Company. At
December 31, 2002, $71.7 million, or 62.8% of the total investment portfolio was
callable.
18
INVESTMENT PORTFOLIO. The following table sets forth certain information
regarding the carrying and market values of the Company's investment portfolio
at the dates indicated (in thousands):
At December 31,
-----------------------------------------------------------------------------------
2002 2001 2000
----------------------- ----------------------- -----------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
-------- -------- -------- -------- -------- --------
Investment securities available for sale:
U.S. Government and agency
obligations ....................... $ 53,904 $ 55,037 $ 26,999 $ 27,014 $151,753 $149,149
State and political obligations ....... 11,811 12,659 14,029 14,029 12,813 12,451
Corporate obligations ................. 35,418 35,420 60,330 59,357 67,267 62,880
Equity securities ..................... 10,953 11,103 8,051 7,588 10,817 10,490
-------- -------- -------- -------- -------- --------
Total investment securities
available for sale .............. $112,086 $114,219 $109,409 $107,988 $242,650 $234,970
======== ======== ======== ======== ======== ========
19
The table below sets forth certain information regarding the contractual
maturities, amortized costs, market values, and weighted average yields for the
Company's investment portfolio at December 31, 2002. Investments in equity
securities, which have no contractual maturities, are excluded from this table.
(Dollars in thousands)
At December 31, 2002
-----------------------------------------------------------------------------
More than One Year to More than Five Years to
One Year or Less Five Years Ten Years
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
-------- -------- -------- -------- -------- --------
Investment securities available for sale:
U.S. Government and agency obligations ....... $ -- --% $ 37,972 4.13% $ 12,953 4.98%
State and political obligations .............. 2,638 3.30 2,069 5.01 2,787 6.35
Corporate obligations ........................ -- -- 14,601 7.56 3,034 8.03
-------- -------- -------- -------- -------- --------
Total investment securities available for sale $ 2,638 3.30% $ 54,642 5.08% $ 18,774 5.68%
======== ======== ======== ======== ======== ========
At December 31, 2002
-----------------------------------------------------------------------------
More than Ten Years Total
--------------------- -----------------------------------------------
Weighted Average Weighted
Amortized Average Maturity Amortized Market Average
Cost Yield in Years Cost Value Yield
-------- -------- -------- -------- -------- --------
Investment securities available for sale:
U.S. Government and agency obligations ....... $ 2,979 4.81% 5.34 $ 53,904 $ 55,037 4.37%
State and political obligations .............. 4,317 5.98 6.55 11,811 12,659 5.30
Corporate obligations ........................ 17,783 5.75 15.24 35,418 35,420 6.69
-------- -------- -------- -------- -------- --------
Total investment securities available for sale $ 25,079 5.68% 8.95 $101,133 $103,116 5.29%
======== ======== ======== ======== ======== ========
20
SOURCES OF FUNDS
GENERAL. The Company's primary source of funds are deposits;
proceeds from principal and interest payments on loans and mortgage-backed
securities; sales of loans, mortgage-backed securities and investments available
for sale; maturities of investment securities and short-term investments; and
advances from the FHLB-NY, reverse repurchase agreements and other borrowed
funds.
DEPOSITS. The Company offers a variety of deposit accounts having a
range of interest rates and terms. The Company's deposits principally consist of
fixed-term fixed-rate certificates, passbook and statement savings, money
market, Individual Retirement Accounts ("IRAs") and Negotiable Order of
Withdrawal ("NOW") accounts. The flow of deposits is significantly influenced by
general economic conditions, changes in money market and prevailing interest
rates and competition. The Company's deposits are typically obtained from the
areas in which its offices are located. The Company relies primarily on customer
service and long-standing relationships to attract and retain these deposits. At
December 31, 2002, $133.2 million, or 9.6%, of the Company's deposit balance
consisted of IRAs. Also at that date, $277.1 million, or 20.0%, of the Company's
deposit balance consisted of accounts with balances greater than or equal to
$100,000. The Company does not currently accept brokered deposits.
At December 31, 2002, certificate accounts in amounts of $100,000 or
more mature as follows (in thousands):
MATURITY PERIOD Amount
--------------- -------------------
Three months or less ................ $ 29,551
Over 3 through 6 months ............. 16,740
Over 6 through 12 months ............ 11,419
Over 12 months ...................... 22,433
--------------------
Total ........................ $ 80,143
====================
The following table sets forth the distribution of the Company's
average accounts for the periods indicated and the weighted average nominal
interest rates on each category of deposits presented (dollars in thousands):
For the Year Ended December 31,
-------------------------------------------------------------------------------
2002 2001
------------------------------------ ------------------------------------
Average Average Average Average
Balance Rate Balance Rate
----------------- ---------------- ----------------- -----------------
Non-interest bearing deposits ..................... $ 67,061 --% $ 53,394 --%
NOW and money market accounts ..................... 466,811 1.65 381,613 2.53
Savings accounts .................................. 201,358 1.76 168,520 2.25
----------------- ---------------- ----------------- -----------------
Sub-total....................................... 735,230 1.53 603,527 2.23
Certificate accounts .............................. 628,535 3.37 660,120 5.11
----------------- ---------------- ----------------- -----------------
Total average deposits ......................... $1,363,765 2.38% $1,263,647 3.73%
================= ================ ================= =================
For the Year Ended December 31,
------------------------------------
2000
------------------------------------
Average Average
Balance Rate
----------------- -----------------
Non-interest bearing deposits ..................... $ 48,582 --%
NOW and money market accounts ..................... 354,135 2.67
Savings accounts .................................. 166,127 2.25
----------------- -----------------
Sub-total....................................... 568,844 2.32
Certificate accounts .............................. 646,791 5.38
----------------- -----------------
Total average deposits ......................... $1,215,635 3.95%
================= =================
BORROWINGS. The Company's policy has been to utilize borrowings as
an alternate and/or less costly source of funds. The Company obtains advances
from the FHLB-NY, which are collateralized by the capital stock of the FHLB-NY
held by the Company and certain one-to-four family mortgage loans held by the
Company. The Company also borrows funds via reverse repurchase agreements with
the FHLB-NY and primary broker/dealers. Advances from the FHLB-NY are made
pursuant to varying terms, including interest rate, maturity, amortization and
call options. The maximum amount that the FHLB-NY will advance to member
institutions, including the Bank, for purposes other than withdrawals,
fluctuates from time to time in accordance with the policies of the FHLB-NY. The
maximum amount of FHLB-NY advances permitted to a member institution generally
is reduced by borrowings from any other source. At December 31, 2002, the
Company's FHLB-NY advances totaled $140.7 million, representing 7.0% of total
liabilities.
21
At December 31, 2002, borrowings from the FHLB-NY and approved
primary broker/dealers collateralized by designated mortgage-backed and
investment securities totaled $456.0 million, representing 22.7% of total
liabilities.
The Company also had an available overnight line-of-credit with the
FHLB-NY for a maximum of $50.0 million.
The following table sets forth certain information regarding the
Company's borrowed funds on the dates indicated (dollars in thousands):
At or For the Year Ended December 31,
------------------------------------
2002 2001 2000
-------- -------- --------
FHLB-NY advances:
Average balance outstanding .................... $151,145 $128,492 $ 99,102
Maximum amount outstanding at any month-end
during the period ......................... 165,802 165,814 140,200
Balance outstanding at end of period ........... 140,663 165,814 80,955
Weighted average interest rate during the period 5.09% 5.44% 6.11%
Weighted average interest rate at end of period 5.24% 4.76% 6.21%
Other borrowings:
Average balance outstanding .................... $436,841 $367,182 $404,270
Maximum amount outstanding at any month-end
during the period ......................... 461,000 425,000 440,000
Balance outstanding at end of period ........... 456,000 380,000 425,000
Weighted average interest rate during the period 5.11% 5.59% 6.14%
Weighted average interest rate at end of period 4.97% 5.29% 6.16%
SUBSIDIARY ACTIVITIES
FSB FINANCIAL LLC FSB Financial LLC is a wholly-owned subsidiary of
the Bank and provides a line of fixed and variable rate annuity products, along
with mutual funds and term life insurance. For the year ended December 31, 2002,
FSB Financial LLC had net income of $255,000.
1000 WOODBRIDGE CENTER DRIVE, INC. 1000 Woodbridge Center Drive,
Inc. is a wholly-owned subsidiary of the Bank. 1000 Woodbridge Center Drive,
Inc. is a real estate investment trust and the majority of the Bank's mortgage
loan portfolio is held by this subsidiary. 1000 Woodbridge Center Drive, Inc.
had net income of $36.1 million for the year ended December 31, 2002.
FIRST SENTINEL CAPITAL TRUST I AND FIRST SENTINEL CAPITAL TRUST II.
These subsidiaries are special purpose business trusts established for the
issuance of $25.0 million in preferred capital securities. Each is a
wholly-owned subsidiary of the Company.
In addition, the Company has three wholly-owned subsidiaries which were
inactive in 2002.
PERSONNEL
As of December 31, 2002, the Company had 292 full-time employees and
43 part-time employees. The employees are not represented by a collective
bargaining unit, and the Company considers its relationship with its employees
to be good.
22
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a
consolidated basis. The Company and the Bank will report their income on a
calendar year basis using the accrual method of accounting and will be subject
to federal income taxation in the same manner as other corporations with some
exceptions. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Company or the Bank.
BAD DEBT RESERVE. Retained earnings at December 31, 2002 and 2001,
included approximately $18.1 million for which no provision for income tax has
been made. This amount represents an allocation of income to bad debt deductions
for tax purposes only. Events that would result in taxation of these reserves
include failure to qualify as a bank for tax purposes, distributions in complete
or partial liquidation, stock redemptions, excess distributions to shareholders
or a change in Federal tax law. At December 31, 2002 and 2001, the Company had
an unrecognized tax liability of $6.5 million with respect to this reserve.
However, dividends paid out of the Bank's current or accumulated earnings and
profits, as calculated for federal income tax purposes, will not be considered
to result in a distribution from the Bank's bad debt reserve. Thus, any
dividends to the Company that would reduce amounts appropriated to the Bank's
bad debt reserve and deducted for federal income tax purposes would create a tax
liability for the Bank. The amount of additional taxable income created from an
Excess Distribution is an amount that, when reduced by the tax attributable to
the income, is equal to the amount of the distribution. Thus, if the Bank makes
a "non-dividend distribution," then approximately one and one-half times the
amount so used would be includable in gross income for federal income tax
purposes, assuming a 35% corporate income tax rate (exclusive of state and local
taxes). The Bank does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserve.
CORPORATE ALTERNATIVE MINIMUM TAX. The Internal Revenue Code of
1986, as amended, imposes a tax on alternative minimum taxable income ("AMTI")
at a rate of 20%. Only 90% of AMTI can be offset by net operating loss
carryovers, of which the Company currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Company's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses). The Company does not expect to be
subject to the alternative minimum tax.
STATE AND LOCAL TAXATION
STATE OF NEW JERSEY. The Bank files a New Jersey income tax return.
For New Jersey income tax purposes, savings institutions are presently taxed at
a rate equal to 9% of taxable income. For this purpose, "taxable income"
generally means federal taxable income, subject to certain adjustments
(including the addition of net interest income on state and municipal
obligations).
The Company is required to file a New Jersey income tax return
because it is doing business in New Jersey. For New Jersey tax purposes, regular
corporations are presently taxed at a rate equal to 9% of taxable income. For
this purpose, "taxable income" generally means Federal taxable income subject to
certain adjustments (including addition of interest income on state and
municipal obligations).
New Jersey corporate taxpayers are subject to an alternative minimum
assessment ("AMA") of up to $5.0 million. The AMA is computed on either gross
receipts or gross profits, based on an ascending scale. AMA is payable when the
calculated amount exceeds the normally computed Corporation Business Tax
liability.
DELAWARE TAXATION. As a Delaware holding company not earning income
in Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with, and pay an annual franchise tax to, the
State of Delaware.
23
REGULATION AND SUPERVISION
GENERAL
The Company, as holding company for the Bank, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act, as amended
(the "HOLA"). In addition, the activities of savings institutions, such as the
Bank, are governed by the HOLA and the Federal Deposit Insurance Act, as amended
(the "FDI Act"). The Company is also required to file certain reports with, and
otherwise comply with, the rules and regulations of the Securities and Exchange
Commission under the federal securities laws.
As a New Jersey chartered savings bank, the Bank is subject to
extensive regulation, examination and supervision by the Commissioner of the New
Jersey Department of Banking and Insurance (the "Commissioner") as its
chartering agency, and by the Federal Deposit Insurance Corporation ("FDIC"), as
the deposit insurer. The Bank's deposit accounts are insured up to applicable
limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC.
The Bank must file reports with the Commissioner and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals
prior to entering into certain transactions such as mergers with, or
acquisitions of, other depository institutions and opening or acquiring branch
offices. The Commissioner and the FDIC conduct periodic examinations to assess
the Bank's compliance with various regulatory requirements.
The regulation and supervision of the Company and the Bank establish
a comprehensive framework of activities in which an institution can engage and
are intended primarily for the protection of the insurance fund and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulatory requirements and policies, whether by
the Commissioner, the FDIC, the OTS or through legislation, could have a
material adverse impact on the Company, the Bank and their operations and
stockholders. Certain of the regulatory requirements applicable to the Bank and
to the Company are referred to below or elsewhere herein.
HOLDING COMPANY REGULATION
Federal law allows a state savings bank that qualifies as a
"qualified thrift lender" ("QTL") to elect to be treated as a savings
association for purposes of the savings and loan holding company provisions of
the HOLA. Such election would result in its holding company being regulated as a
savings and loan holding company by the OTS, rather than as a bank holding
company by the Federal Reserve Board. The Bank made such election and received
approval from the OTS to become a savings and loan holding company. The Company
is regulated as a nondiversified unitary savings and loan holding company within
the meaning of the HOLA. As such, the Company is registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the OTS has enforcement authority over the Company.
As a unitary savings and loan holding company, the Company generally is not
restricted under existing laws as to the types of business activities in which
it may engage, provided that the Bank continues to be a QTL. Under the QTL test,
a savings association is required to maintain at least 65% of its "portfolio
assets" (total assets less: (i) specified liquid assets up to 20% of total
assets; (ii) certain intangibles, including goodwill; and (iii) the value of
property used to conduct business) in certain "qualified thrift investments"
(primarily residential mortgages and related investments, including certain
mortgage-backed securities, credit card loans, student loans and small business
loans) on a monthly basis in at least 9 months out of each 12 month period. If
First Savings fails the QTL test, First Sentinel Bancorp must convert to a bank
holding company. Additionally, First Savings must wait five years before
applying to the OTS to regain its status as a "qualified thrift lender." As of
December 31, 2002, the Bank maintained 86.1% of its portfolio assets in
qualified thrift investments and had more than 80% of its portfolio assets in
qualified thrift investments for each of the 12 months ending December 31, 2002,
thereby qualifying under the QTL test.
The Gramm-Leach Bliley Act ("Gramm-Leach") also restricts the powers
of new unitary savings and loan association holding companies. Unitary savings
and loan holding companies that are "grandfathered," i.e., unitary savings and
loan holding companies in existence or with applications filed with the OTS on
or before May 4, 1999, such as the Company, retain their authority under the
prior law. All other unitary savings and loan holding companies are limited to
financially related activities permissible for bank holding companies, as
defined under
24
Gramm-Leach. Gramm-Leach also prohibits non-financial companies from acquiring
grandfathered unitary savings and loan association holding companies.
Upon any non-supervisory acquisition by the Company of another
savings institution or savings bank that meets the QTL test and is deemed to be
a savings institution by the OTS, the Company would become a multiple savings
and loan holding company (if the acquired institution is held as a separate
subsidiary) and would be subject to extensive limitations on the types of
business activities in which it could engage. The HOLA limits the activities of
a multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"), subject to
the prior approval of the OTS, and certain activities authorized by OTS
regulation, and no multiple savings and loan holding company may acquire more
than 5% of the voting stock of a company engaged in impermissible activities,
except in certain limited circumstances.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would
result in a multiple savings and loan holding company controlling savings
institutions in more than one state, subject to two exceptions: (i) the approval
of interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
NEW JERSEY HOLDING COMPANY REGULATION. Under the New Jersey Banking
Act, a company owning or controlling a savings bank is regulated as a bank
holding company. The New Jersey Banking Act defines the terms "company" and
"bank holding company" as such terms are defined under the BHC Act. Each bank
holding company controlling a New Jersey chartered bank or savings bank is
subject to examination by the Commissioner. The Commissioner regulates, among
other things, the Bank's internal business procedures as well as its deposits,
lending and investment activities. The Commissioner must approve changes to the
Bank's Certificate of Incorporation, establishment or relocation of branch
offices, mergers and the issuance of additional stock.
New Jersey law provides that, upon satisfaction of certain
triggering conditions, as determined by the Commissioner, insured institutions
or savings and loan holding companies located in a state which has reciprocal
legislation in effect on substantially the same terms and conditions as stated
under New Jersey law may acquire, or be acquired by New Jersey insured
institutions or holding companies on either a regional or national basis. New
Jersey law explicitly prohibits interstate branching.
FEDERAL BANKING REGULATION
CAPITAL REQUIREMENTS. FDIC regulations require SAIF-insured banks,
such as the Bank, to maintain minimum levels of capital. The FDIC regulations
define two Tiers, or classes, of capital.
Tier 1 capital is comprised of the sum of common stockholders'
equity (excluding the net unrealized appreciation or depreciation, net of tax,
from available-for-sale securities), non-cumulative perpetual preferred stock
(including any related surplus) and minority interests in consolidated
subsidiaries, minus all intangible assets (other than qualifying servicing
rights), and any net unrealized loss on marketable equity securities.
The components of Tier 2 capital currently include cumulative
perpetual preferred stock, certain perpetual preferred stock for which the
dividend rate may be reset periodically, mandatory convertible securities,
subordinated debt, intermediate preferred stock and allowance for possible loan
losses. Allowance for possible loan losses
25
includible in Tier 2 capital is limited to a maximum of 1.25% of risk-weighted
assets. Overall, the amount of Tier 2 capital that may be included in total
capital cannot exceed 100% of Tier 1 capital.
The FDIC regulations establish a minimum leverage capital
requirement for banks in the strongest financial and managerial condition, with
a rating of 1 (the highest examination rating of the FDIC for banks) under the
Uniform Financial Institutions Rating System, of not less than a ratio of 3.0%
of Tier 1 capital to total assets. For all other banks, the minimum leverage
capital requirement is 4.0%, unless a higher leverage capital ratio is warranted
by particular circumstances or risk profile of the depository institution.
The FDIC regulations also require that savings banks meet a
risk-based capital standard. The risk-based capital standard requires the
maintenance of a ratio of total capital (which is defined as the sum of Tier 1
capital and Tier 2 capital) to risk-weighted assets of at least 8% and a ratio
of Tier 1 capital to risk-weighted assets of at least 4%. In determining the
amount of risk-weighted assets, all assets, plus certain off balance sheet
items, are multiplied by a risk-weight of 0% to 100%, based on the risks the
FDIC believes are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to declines in
the economic value of a bank's capital due to changes in interest rates when
assessing the bank's capital adequacy. Under such a risk assessment, examiners
will evaluate a bank's capital for interest rate risk on a case-by-case basis,
with consideration of both quantitative and qualitative factors. According to
the agencies, applicable considerations include the quality of the bank's
interest rate risk management process, the overall financial condition of the
bank and the level of other risks at the bank for which capital is needed.
Institutions with significant interest rate risk may be required to hold
additional capital. The agencies also issued a joint policy statement providing
guidance on interest rate risk management, including a discussion of the
critical factors affecting the agencies' evaluation of interest rate risk in
connection with capital adequacy. The Bank is in compliance with all minimum
capital requirements.
The FDIC adopted a regulation, effective April 1, 2002, that
established minimum regulatory capital requirements for equity investments in
non-financial companies. The regulation applies a series of marginal capital
charges that range from 8% to 25% depending upon the size of the aggregate
equity investment portfolio of the banking organization relative to its Tier 1
capital. The capital charge would be applied by making a deduction, which would
be based on the adjusted carrying value of the equity investment from the
organization's Tier 1 capital. This new capital requirement has not had a
material adverse effect upon the Company's operations. However, management will
have to take this requirement into consideration should the Company, at some
point in the future, decide to invest in non-financial companies.
ACTIVITY RESTRICTIONS ON STATE-CHARTERED BANKS. Section 24 of the
FDI Act, which was added by the Federal Deposit Insurance Corporation
Improvement Act of 1991, generally limits the activities and investments of
state-chartered FDIC insured banks and their subsidiaries to those permissible
for federally chartered national banks and their subsidiaries, unless such
activities and investments are specifically exempted by Section 24 or consented
to by the FDIC.
Section 24 provides an exception for investments by a bank in common
and preferred stocks listed on a national securities exchange or the shares of
registered investment companies if:
o the bank held such types of investments during the
14-month period from September 30, 1990 through November
26, 1991;
o the state in which the bank is chartered permitted such
investments as of September 30, 1991; and
o the bank notifies the FDIC and obtains approval from the
FDIC to make or retain such investments. Upon receiving
such FDIC approval, an institution's investment in such
equity securities will be subject to an aggregate limit
up to the amount of its Tier 1 capital.
First Savings received approval from the FDIC to retain and acquire
such equity investments subject to a maximum permissible investment equal to the
lesser of 100% of First Savings' Tier 1 capital or the maximum permissible
amount specified by the New Jersey Banking Act. Section 24 also provides an
exception for majority
26
owned subsidiaries of a bank, but Section 24 limits the activities of such
subsidiaries to those permissible for a national bank under Section 24 of the
FDI Act and the FDIC regulations issued pursuant thereto, or as approved by the
FDIC.
Before making a new investment or engaging in a new activity not
permissible for a national bank or otherwise permissible under Section 24 of the
FDIC regulations thereunder, an insured bank must seek approval from the FDIC to
make such investment or engage in such activity. The FDIC will not approve the
activity unless the bank meets its minimum capital requirements and the FDIC
determines that the activity does not present a significant risk to the FDIC
insurance funds.
PROMPT CORRECTIVE ACTION. Under the FDIC prompt corrective action
regulations, the FDIC is required to take certain, and authorized to take other,
supervisory actions against undercapitalized institutions, the severity of which
depends upon the institution's degree of undercapitalization. Generally, a
savings institution that has a total risk-based capital of less than 8% or a
leverage ratio or a Tier 1 capital ratio that is less than 4% is considered to
be "undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio
that is less than 3% is considered to be "significantly undercapitalized" and a
savings institution that has a tangible capital to assets ratio equal to or less
than 2% is deemed to be "critically undercapitalized." Subject to a narrow
exception, the banking regulator is required to appoint a receiver or
conservator for an institution that is "critically undercapitalized." The
regulation also provides that a capital restoration plan must be filed with the
FDIC within 45 days of the date a savings institution receives notice that it is
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions become
immediately applicable to the institution depending upon its category,
including, but not limited to, increased monitoring by regulators and
restrictions on growth, capital distributions and expansion. The FDIC could also
take any one of a number of discretionary supervisory actions, including the
issuance of a capital directive and the replacement of senior executive officers
and directors.
Under the OTS regulations, generally, a federally chartered savings
association is treated as well capitalized if its total risk-based capital ratio
is 10% or greater, its Tier 1 risk-based capital ratio is 6% or greater, and its
leverage ratio is 5% or greater, and it is not subject to any written agreement,
order or directive by the OTS to meet a specific capital level. As of December
31, 2002, First Sentinel was considered "well capitalized" by the OTS.
INSURANCE OF DEPOSIT ACCOUNTS. Deposits of the Bank are presently
insured by SAIF. The FDIC maintains a risk-based assessment system by which
institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for SAIF member
institutions are determined semiannually by the FDIC and currently range from
zero basis points for the healthiest institutions to 27 basis points for the
riskiest. The assessment rates for the Bank's SAIF-assessable deposits are zero
basis points. If the FDIC determines that assessment rates should be increased,
institutions in all risk categories could be affected. The FDIC has exercised
this authority several times in the past and could raise insurance assessment
rates in the future. SAIF-assessed deposits are also subject to assessments for
payments on the bonds issued in the late 1980's by the Financing Corporation, or
FICO, to recapitalize the now defunct Federal Savings and Loan Insurance
Corporation. The Bank's total expense in 2002 for the assessment for deposit
insurance and the FICO payments was $234,000.
Insurance of deposits may be terminated by the FDIC upon a finding
that the institution has engaged in unsafe or unsound practices, is in an unsafe
or unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
STANDARDS FOR SAFETY AND SOUNDNESS. The FDI Act requires each
federal banking agency to prescribe for all insured depository institutions
standards relating to, among other things, internal controls, information
systems and audit systems, loan documentation, credit underwriting, interest
rate risk exposure, asset growth, and compensation, fees and benefits and such
other operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety
27
and soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final rule
establishes deadlines for the submission and review of such safety and soundness
compliance plans.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act
("CRA"), any insured depository institution, including First Savings, has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community. The CRA requires the FDIC,
in connection with its examination of a savings bank, to assess the depository
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such
institution, including applications for branch relocations, additional branches
and acquisitions.
Among other things, current CRA regulations apply an evaluation
system that rates an institution based on its actual performance in meeting
community needs. In particular, the evaluation system focuses on three tests:
o a lending test, to evaluate the institution's record of
making loans in its service areas;
o an investment test, to evaluate the institution's record
of investing in community development projects,
affordable housing, and programs benefiting low or
moderate income individuals and businesses; and
o a service test, to evaluate the institution's delivery
of services through its branches, ATMs and other
offices.
The CRA requires the FDIC to provide a written evaluation of an
institution's CRA performance utilizing a four-tiered descriptive rating system
and requires public disclosure of an institution's CRA rating. First Savings has
received a "satisfactory" rating in its most recent CRA examination. In
addition, the FDIC adopted regulations implementing the requirements under
Gramm-Leach that insured depository institutions publicly disclose certain
agreements that are in fulfillment of the CRA. The Bank has no such agreement in
place at this time.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB
system, which consists of twelve regional FHLBs, each subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The FHLB provides a
central credit facility primarily for member thrift institutions as well as
other entities involved in home mortgage lending. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLBs. It
makes loans to members (i.e., advances) in accordance with policies and
procedures, including collateral requirements, established by the respective
boards of directors of the FHLBs. These policies and procedures are subject to
the regulation and oversight of the FHFB. All long-term advances are required to
provide funds for residential home financing. The FHFB has also established
standards of community or investment service that members must meet to maintain
access to such long-term advances. The Bank, as a member of the FHLB-NY, is
currently required to purchase and hold shares of capital stock in that FHLB in
an amount at least equal to the greater of (i) 1% of the aggregate principal
amount of its unpaid mortgage loans, home purchase contracts and similar
obligations at the beginning of each year; (ii) 0.3% of its assets; or (iii) 5%
(or such greater fraction as established by the FHLB) of its advances from the
FHLB as of December 31, 2002. The Company is in compliance with these
requirements. Pursuant to regulations promulgated by the FHFB, as required by
Gramm-Leach, the FHLB-NY has adopted a capital plan, which is expected to become
effective during the second half of 2003, that will change the foregoing minimum
stock ownership requirements for FHLB-NY stock. Under the new capital plan, each
member of the FHLB-NY will have to maintain a minimum investment in FHLB-NY
capital stock in an amount equal to the sum of (i) the greater of $1,000 or
0.20% of the member's mortgage-related assets and (ii) 4.50% of the dollar
amount of any outstanding advances under such member's Advances, Collateral
Pledge and Security Agreement with the FHLB-NY.
28
INSURANCE ACTIVITIES. The Bank is subject to regulations prohibiting
depository institutions from conditioning the extension of credit to individuals
upon either the purchase of an insurance product or annuity or an agreement by
the consumer not to purchase an insurance product or annuity from an entity that
is not affiliated with the depository institution. The regulations also require
prior disclosure of this prohibition to potential insurance product or annuity
customers.
PRIVACY STANDARDS. First Sentinel is subject to FDIC regulations
implementing the privacy protection provisions of Gramm-Leach. These regulations
require First Sentinel and First Savings to disclose their privacy policy,
including identifying with whom they share "nonpublic personal information," to
customers at the time of establishing the customer relationship and annually
thereafter. The regulations also require First Sentinel and First Savings to
provide their customers with initial and annual notices that accurately reflect
its privacy policies and practices. In addition, First Sentinel and First
Savings are required to provide their customers with the ability to "opt-out" of
having First Sentinel and First Savings share their non-public personal
information with unaffiliated third parties before they can disclose such
information, subject to certain exceptions. The implementation of these
regulations did not have a material adverse effect on the Company's operations.
INTERNET BANKING. Technological developments are dramatically
altering the ways in which most companies, including financial institutions,
conduct their business. The growth of the Internet is prompting banks to
reconsider business strategies and adopt alternative distribution and marketing
systems. The federal bank regulatory agencies have conducted seminars and
published materials targeted to various aspects of internet banking, and have
indicated their intention to reevaluate their regulations to ensure that they
encourage banks' efficiency and competitiveness consistent with safe and sound
banking practices. No assurance can be given that the federal bank regulatory
agencies will not adopt new regulations that will materially affect First
Savings' Internet operations or restrict any such further operations.
TRANSACTIONS WITH AFFILIATES OF FIRST SAVINGS. First Savings is
subject to the affiliate and insider transaction rules set forth in Sections
23A, 23B, 22(g) and 22(h) of the Federal Reserve Act ("FRA"), and the
regulations of the Federal Reserve Board ("FRB") promulgated thereunder. These
provisions, among other things, prohibit or limit a savings banks from extending
credit to, or entering into certain transactions with, its affiliates (which for
First Savings would include First Sentinel) and principal stockholders,
directors and executive officers of First Savings.
Effective April 1, 2003, the FRB is rescinding its interpretations
of Sections 23A and 23B of the FRA and is replacing these interpretations with
Regulation W. In addition, Regulation W makes various changes to existing law
regarding Sections 23A and 23B, including expanding the definition of what
constitutes an affiliate subject to Sections 23A and 23B and exempting certain
subsidiaries of state-chartered banks from the restrictions of Sections 23A and
23B.
Under Regulation W, all transactions entered into on or before
December 12, 2002, which either became subject to Sections 23A and 23B solely
because of Regulation W, and all transactions covered by Sections 23A and 23B,
the treatment of which will change solely because of Regulation W, will become
subject to Regulation W on July 1, 2003. All other covered affiliate
transactions become subject to Regulation W on April 1, 2003. The FRB expects
each depository institution that is subject to Sections 23A and 23B to implement
policies and procedures to ensure compliance with Regulation W. We do not expect
that the changes made by Regulation W will have a material adverse effect on the
Company's business.
In addition, provisions of the BHCA prohibit extensions of credit to
a bank's insiders and their related interests by any other institution that has
a correspondent banking relationship with the bank, unless such extension of
credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
Section 402 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley")
prohibits the extension of personal loans to directors and executive officers of
issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply
to loans advanced by an insured depository institution, such as First Savings,
that are subject to the insider lending restrictions of Section 22(h) of the
FRA.
29
Provisions of the New Jersey Banking Act impose conditions and
limitations on the liabilities to a savings bank of its directors and executive
officers and of corporations and partnerships controlled by such persons that
are comparable in many respects to the conditions and limitations imposed on the
loans and extensions of credit to insiders and their related interests under
federal law and regulation, as discussed above. The New Jersey Banking Act also
provides that a savings bank that is in compliance with the applicable federal
laws and regulations is deemed to be in compliance with such provisions of the
New Jersey Banking Act.
NEW JERSEY BANKING REGULATION
ACTIVITY POWERS. The Bank derives its lending, investment and other
activity powers primarily from the applicable provisions of the New Jersey
Banking Act and its related regulations. Under these laws and regulations,
savings banks, including First Savings, generally may invest in:
(1) real estate mortgages;
(2) consumer and commercial loans;
(3) specific types of debt securities, including certain corporate
debt securities and obligations of federal, state and local
governments and agencies;
(4) certain types of corporate equity securities; and
(5) certain other assets.
A savings bank may also invest pursuant to a "leeway" power that
permits investments not otherwise permitted by the New Jersey Banking Act. Such
investments must comply with a number of limitations on the individual and
aggregate amounts of the investments. A savings bank may also exercise trust
powers upon approval of the Department. New Jersey savings banks may also
exercise any power authorized for federally chartered savings banks unless the
Department determines otherwise. The exercise of these lending, investment and
activity powers are limited by federal law and the related regulations.
LOANS-TO-ONE-BORROWER LIMITATIONS. With certain specified
exceptions, a New Jersey chartered savings bank may not make loans or extend
credit to a single borrower and to entities related to the borrower in an
aggregate amount that would exceed 15% of the bank's capital funds. A savings
bank may lend an additional 10% of the bank's capital funds if secured by
collateral meeting the requirements of the New Jersey Banking Act. The Bank
currently complies with applicable loans-to-one-borrower limitations.
DIVIDENDS. Under the New Jersey Banking Act, a stock savings bank
may declare and pay a dividend on its capital stock only to the extent that the
payment of the dividend would not impair the capital stock of the savings bank.
In addition, a stock savings bank may not pay a dividend if the surplus of the
savings bank would, after the payment of the dividend, be reduced unless after
such reduction the surplus was 50% or more of the bank's capital stock.
MINIMUM CAPITAL REQUIREMENTS. Regulations of the Department impose
on New Jersey chartered depository institutions, including the Bank, minimum
capital requirements similar to those imposed by the FDIC on insured state
banks.
EXAMINATION AND ENFORCEMENT. The New Jersey Department of Banking
and Insurance may examine the Bank whenever it deems an examination advisable.
The Commissioner will examine the Bank at least every two years. The Department
may order any savings bank to discontinue any violation of law or unsafe or
unsound business practice and may direct any director, officer, attorney or
employee of a savings bank engaged in an objectionable activity, after the
Department has ordered the activity to be terminated, to show cause at a hearing
before the Department why such person should not be removed.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions
to maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally require that reserves be maintained against aggregate
transaction accounts as follows: for
30
accounts aggregating $42.1 million or less (subject to adjustment by the Federal
Reserve Board) the reserve requirement was 3%; and for accounts aggregating
greater than $42.1 million, the reserve requirement was $1.1 million plus 10%
(subject to adjustment by the Federal Reserve Board) against that portion of
total transaction accounts in excess of $42.1 million. The first $6.0 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) were exempted from the reserve requirements. The Bank maintained
compliance with the foregoing requirements. Because required reserves must be
maintained in the form of either vault cash, a non-interest bearing account at a
Federal Reserve Bank or a pass-through accounts as defined by the Federal
Reserve Board, the effect of this reserve requirement is to reduce the Bank's
interest-earning assets.
THE USA PATRIOT ACT
In response to the events of September 11, 2001, President George W.
Bush signed into law the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or
the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal
government new powers to address terrorist threats through enhanced domestic
security measures, expanded surveillance powers, increased information sharing,
and broadened anti-money laundering requirements. By way of amendments to the
Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to
encourage information sharing among bank regulatory agencies and law enforcement
bodies. Further, certain provisions of Title III impose affirmative obligations
on a broad range of financial institutions, including banks, thrifts, brokers,
dealers, credit unions, money transfer agents and parties registered under the
Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes
the following requirements with respect to financial institutions:
Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at minimum: (i) internal policies,
procedures, and controls, (ii) specific designation of an anti-money laundering
compliance officer, (iii) ongoing employee training programs, and (iv) an
independent audit function to test the anti-money laundering program. Interim
final rules implementing Section 352 were issued by the Treasury Department on
April 29, 2002. Such rules state that a financial institution is in compliance
with Section 352 if it implements and maintains an anti-money laundering program
that complies with the anti-money laundering regulations of its federal
functional regulator. First Savings is in compliance with the FDIC's anti-money
laundering regulations.
Section 326 of the Act authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue regulations that
provide for minimum standards with respect to customer identification at the
time new accounts are opened. On July 23, 2002, the FDIC and the other federal
bank regulators jointly issued proposed rules to implement Section 326. The
proposed rules require financial institutions to establish a program specifying
procedures for obtaining identifying information from customers seeking to open
new accounts. This identifying information would be essentially the same
information currently obtained by most financial institutions for individual
customers generally. A financial institution's program would also have to
contain procedures to verify the identity of customers within a reasonable
period of time, generally through the use of the same forms of identity
verification currently in use, such as through driver's licenses, passports,
credit reports and other similar means.
Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United States persons or
their representatives (including foreign individuals visiting the United States)
to establish appropriate, specific, and, where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report money
laundering. Interim rules under Section 312 were issued by the Treasury
Department on July 23, 2002. The interim rules state that a due diligence
program is reasonable if it comports with existing best practices standards for
banks that maintain correspondent accounts for foreign banks and evidences good
faith efforts to incorporate due diligence procedures for accounts posing
increased risk of money laundering. In addition, an enhanced due diligence
program is reasonable if it comports with best practices standards and focuses
enhanced due diligence measures on those correspondent accounts posing a
particularly high risk of money laundering based on the bank's overall
assessment of the risk posed by the foreign correspondent bank. Finally, a
private banking due diligence program must be reasonably designed to detect and
report money laundering and the existence of proceeds of foreign corruption.
Such a program is reasonable if it focuses on those private banking accounts
that present a high risk of money
31
laundering.
Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts for foreign shell
banks (foreign banks that do not have a physical presence in any country), and
will be subject to certain recordkeeping obligations with respect to
correspondent accounts of foreign banks.
Compliance with the regulations adopted under the USA PATRIOT Act is
not expected to have a material adverse effect on the Company's operations.
Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal Reserve Act
and Bank Merger Act applications.
DELAWARE CORPORATION LAW
The Company is incorporated under the laws of the State of Delaware,
and is therefore subject to regulation by the State of Delaware. In addition,
the rights of the Company's shareholders are governed by the Delaware General
Corporation Law.
ITEM 2. PROPERTIES
- -------------------
The Company conducts its business through its main office and 22
full service branch offices, all located in central New Jersey. The following
table sets forth certain information concerning the main office and each branch
office of the Company at December 31, 2002. The aggregate net book value of the
Company's premises and equipment was $15.9 million at December 31, 2002.
Location Date Leased or Acquired Leased or Owned
--------------------- ------------------------------ -------------------
MAIN OFFICE:
339 State Street 4/29 Owned
Perth Amboy, NJ 08861(1)
CORPORATE HEADQUARTERS: 5/94 Owned
1000 Woodbridge Center Drive
Woodbridge, NJ 07095
BRANCH OFFICES:
213 Summerhill Road 8/97 Leased
East Brunswick, NJ 08816
980 Amboy Avenue 6/74 Owned
Edison, NJ 08837
2100 Oak Tree Road 4/84 Owned
Edison, NJ 08820
206 South Avenue 9/91 Owned
Fanwood, NJ 07023
32
Location Date Leased or Acquired Leased or Owned
--------------------- ------------------------------ -------------------
33 Lafayette Road 4/84 Leased
Fords, NJ 08863
3044 Highway 35 S. 1/91 Leased
Hazlet, NJ 07730
301 Raritan Avenue 5/98 Owned
Highland Park, NJ 08904
101 New Brunswick Avenue 6/76 Leased
Hopelawn, NJ 08861
1220 Green Street 11/84 Owned
Iselin, NJ 08830
1225 Brunswick Avenue 5/92 Owned
Lawrenceville, NJ 08648 (2)
599 Middlesex Avenue 1/95 Leased
Metuchen, NJ 08840 (2)
1580 Rt. 35 South 4/95 Leased
Middletown, NJ 07748
97 North Main Street 1/95 Owned
Milltown, NJ 08850 (2)
225 Prospect Plains Road 7/76 Owned
Monroe Township, NJ 08512
3117 Rt. 9 N. 6/79 Leased
Old Bridge, NJ 08857
100 Stelton Road 9/91 Leased
Piscataway, NJ 08854
600 Washington Avenue 7/71 Owned
South Amboy, NJ 08879
6 Jackson Street 8/65 Owned
South River, NJ 08882
371 Spotswood - Englishtown Road 5/98 Owned
Spotswood, NJ 08884
325 Amboy Avenue 1/70 Owned
Woodbridge, NJ 07095
780 Easton Avenue 12/01 Owned
Somerset, NJ 08873
(1) Includes an adjacent administrative building.
(2) Acquired/leased in conjunction with the purchase of deposits.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal actions arising in the
normal course of its business. In the opinion of management, the resolution of
these legal actions is not expected to have a material adverse effect on the
Company's results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of stockholders during the
quarter ended December 31, 2002.
33
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information contained in the section captioned "Market
Information for Common Stock" on page 31 of the 2002 Annual Report to
Stockholders ("2002 Annual Report") is incorporated herein by reference. At
December 31, 2002, 28,422,028 shares of the Company's outstanding common stock
were held of record by approximately 2,630 persons or entities, not including
the number of persons or entities holding stock in nominee or stock name through
various brokers or banks.
The information contained in the section captioned "Equity
Compensation Plan Information" on page 25 of the Company's proxy statement for
the 2003 Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 28, 2003, ("2003 Proxy Statement") is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA
The information contained in the section captioned "Consolidated
Financial Highlights" on page 5 of the 2002 Annual Report is incorporated herein
by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Comparison of Operating
Results" on pages 6 through 11 of the 2002 Annual Report is incorporated herein
by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Disclosure relating to market risk is included in "Management's
Discussion and Analysis of Financial Condition and Comparison of Operating
Results," on page 11 of the 2002 Annual Report and is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS
The Company's consolidated financial statements, together with the
report thereon by KPMG LLP, are found in the 2002 Annual Report on pages 12
through 30 and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT OF THE REGISTRANT
The disclosures required by Item 10 are included under the captions
"Who Our Directors and Executive Officers Are" on pages 6 through 8 of the 2003
Proxy Statement and "Section 16(a) Beneficial Ownership Reporting Compliance" on
page 9 of the 2003 Proxy Statement and are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The disclosures required by Item 11 are included on pages 9 through 25 of
the 2003 Proxy Statement under the captions "Compensation of Directors and
Executive Officers", (with the exception of the "Compensation Committee Report"
and the "Stock Performance Graph"), "Compensation Committee Interlocks and
Insider Participation" and "Equity Compensation Plan Information" and are
incorporated herein by reference.
34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Disclosure relating to Security Ownership of Certain Beneficial
Owners and Management is incorporated herein by reference to the 2003 Proxy
Statement under the captions "Equity Compensation Plan Information" on page 25,
"Security Ownership of Certain Beneficial Owners" on page 4 and "Who Our
Directors and Executive Officers Are" on page 6.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The disclosures required by Item 13 are included under the caption
"Transactions With Certain Related Persons" on page 21 of the 2003 Proxy
Statement and are incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
a.) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Christopher Martin, the Company's Chief Executive Officer, and
Thomas M. Lyons, the Company's Chief Financial Officer,
conducted an evaluation of the effectiveness of the Company's
disclosure controls and procedures (as defined in Rule
13a-14(c) under the Securities Exchange Act of 1934, as
amended) as of March 27, 2003. Based upon their evaluation,
they each found the Company's disclosure controls and
procedures were adequate to ensure that information required
to be disclosed in the reports that the Company files and
submits under the Exchange Act is recorded, processed,
summarized and reported as and when required.
b.) CHANGES IN INTERNAL CONTROLS.
There were no significant changes in the Company's disclosure
controls and procedures or internal controls for financial
reporting or other factors that could significantly affect
those controls subsequent to March 27, 2003, and the Company
identified no significant deficiencies or material weaknesses
requiring corrective action with respect to those controls.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial statements.
The Consolidated Financial Statements and Independent Auditors' Report for the
year ended December 31, 2002, included in the 2002 Annual Report, listed below,
are incorporated herein by reference.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2002
AND 2001 (2002 ANNUAL REPORT - PAGE 12).
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,
2002, 2001 AND 2000 (2002 ANNUAL REPORT - PAGE 13).
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
DECEMBER 31, 2002, 2001, AND 2000 (2002 ANNUAL REPORT - PAGE 14).
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER
31, 2002, 2001 AND 2000 (2002 ANNUAL REPORT - PAGE 15).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2002 ANNUAL REPORT -
PAGES 16 THROUGH 29).
35
INDEPENDENT AUDITORS' REPORT (2002 ANNUAL REPORT - PAGE 30).
(2) Financial Statement Schedules.
All schedules have been omitted because the required information is
either inapplicable or included in the Notes to Consolidated
Financial Statements.
(3) Exhibits
The following exhibits are filed as part of this report.
---------------- ------------------------------------------------------------------------------- ----------------
Exhibit Number Description Reference
---------------- ------------------------------------------------------------------------------ ----------------
3.1 Certificate of Incorporation of First Sentinel Bancorp, Inc. a
3.2 Bylaws of First Sentinel Bancorp, Inc. Filed herein
4.0 Stock Certificate of First Sentinel Bancorp, Inc. b
4.1 Certificate of Designations, Preferences and Rights of Series
A Junior Participating Preferred Stock c
4.2 Rights Agreement by and between First Sentinel Bancorp, Inc. and
Registrar and Transfer Company, as Rights Agent c
4.3 Form of Right Certificate c
10.1 First Sentinel Bancorp, Inc. 1996 Omnibus Incentive Plan b
10.2 First Sentinel Bancorp, Inc. Amended and Restated 1998 Stock-based
Incentive Plan d
10.3 First Sentinel Bancorp, Inc. 1986 Acquisition Stock Option Plan e
10.4 First Sentinel Bancorp, Inc. 1993 Acquisition Stock Option Plan e
10.5 First Sentinel Bancorp, Inc. 1997 Acquisition Stock Option Plan e
10.6 First Savings Bank Deferred Fee Plan f
10.7 First Savings Bank, SLA Supplemental Executive Retirement Plan b
10.8 First Savings Bank Supplemental Executive Retirement Plan II f
10.9 First Savings Bank Non-Employee Director Retirement Plan g
10.10 Form of Employment Agreement between First Sentinel Bancorp,
Inc. and Christopher Martin f
10.11 Form of Employment Agreement between First Savings Bank
and Christopher Martin f
10.12 Form of Two-year Change in Control Agreement between First Savings
Bank and certain executive officers f
10.13 Form of Three-year Change in Control Agreement between First
Savings Bank and certain executive officers f
10.14 First Savings Bank, SLA Employee Severance Compensation Plan b
11.0 Computation of per share earnings h
13.0 2002 Annual Report to Stockholders Filed herein
21.0 Subsidiaries of Registrant incorporated by reference herein
to Part I - Subsidiaries
23.0 Consent of KPMG LLP Filed herein
99.0 Statements furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 Filed herein
a Previously filed and incorporated herein by reference to the December 31,
1998 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No.
000-23809) dated March 30, 1999.
b Previously filed and incorporated herein by reference to the Exhibits to
the Registration Statement on Form S-1 (File No. 333-42757) of First
Sentinel Bancorp, Inc. (formerly known as First Source Bancorp, Inc.)
dated December 19, 1997, and all amendments thereto.
36
c Previously filed and incorporated herein by reference to the Exhibits to
the Registration Statement on Form 8-A (File No. 000-23809) of First
Sentinel Bancorp, Inc. dated December 20, 2001.
d Previously filed and incorporated herein by reference to the Proxy
Statement for the 1999 Annual Meeting of Stockholders of First Sentinel
Bancorp, Inc. (File No. 000-23809) filed on March 30, 1999.
e Previously filed and incorporated herein by reference to the December 31,
1999 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No.
000-23809) dated March 30, 2000.
f Previously filed and incorporated herein by reference to the December 31,
2000 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No.
000-23809) dated March 30, 2001.
g Previously filed and incorporated herein by reference to the June 30, 2002
Quarterly Report on Form 10-Q of First Sentinel Bancorp, Inc. (File No.
000-23809) dated August 14, 2002.
h Filed herein as a component of Exhibit 13.0, under Note 1 of the Notes to
Consolidated Financial Statements.
(b) Reports on Form 8-K.
None.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2003 FIRST SENTINEL BANCORP, INC.
/s/ CHRISTOPHER MARTIN
------------------
Christopher Martin
President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
PHILIP T. RUEGGER, JR. Chairman of the Board March 31, 2003
- -----------------------------
Philip T. Ruegger, Jr.
CHRISTOPHER MARTIN President, Chief Executive March 31, 2003
- ----------------------------- Officer and Director
Christopher Martin
THOMAS M. LYONS Senior Vice President, March 31, 2003
- ----------------------------- Chief Financial Officer
Thomas M. Lyons
JOSEPH CHADWICK Director March 31, 2003
- -----------------------------
Joseph Chadwick
GEORGE T. HORNYAK, JR. Director March 31, 2003
- -----------------------------
George T. Hornyak, Jr.
KEITH H. MCLAUGHLIN Director March 31, 2003
- -----------------------------
Keith H. McLaughlin
JOHN P. MULKERIN Director March 31, 2003
- -----------------------------
John P. Mulkerin
JEFFRIES SHEIN Director March 31, 2003
- -----------------------------
Jeffries Shein
WALTER K. TIMPSON Director March 31, 2003
- -----------------------------
Walter K. Timpson
38
CERTIFICATION
I, Christopher Martin, certify that:
1. I have reviewed this annual report on Form 10-K of First Sentinel Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: MARCH 31, 2003 /S/ CHRISTOPHER MARTIN
-------------- ----------------------
Christopher Martin
President and
Chief Executive Officer
39
CERTIFICATION
I, Thomas M. Lyons, certify that:
1. I have reviewed this annual report on Form 10-K of First Sentinel Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: MARCH 31, 2003 /S/ THOMAS M. LYONS
-------------- -------------------
Thomas M. Lyons
Chief Financial Officer
40