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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, 2003
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 (IRS Employer
of incorporation or organization) Identification No.)
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)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes[X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of 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 Common Stock held by non-affiliates of the
registrant, based on the closing price of the Common Stock on June 30, 2003, as
quoted by the Nasdaq Stock Market, was approximately $331.7 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 1, 2004, there were 43,106,742 shares issued and 26,268,402 shares
outstanding of the registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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 ........................... 33
Item 6. Selected Financial Data ............................... 34
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ......... 35
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk ..................................... 43
Item 8. Financial Statements and Supplementary Data ........... 44
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ................ 74
Item 9A. Controls and Procedures ............................... 74
PART III
Item 10. Directors and Executive Officers of the Registrant .... 75
Item 11. Executive Compensation ................................ 78
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters ........ 84
Item 13. Certain Relationships and Related Transactions ........ 86
Item 14. Principal Accounting Fees and Services ................ 86
PART IV
Item 15. Exhibits, Financial Statement Schedules
and Reports on Form 8-K ............................... 87
SIGNATURES 90
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, 2003, the Company had consolidated total assets of $2.2
billion and total stockholders' equity of $227.6 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 as soon as reasonably
practicable after such material is electronically filed with or furnished to the
SEC.
PENDING MERGER WITH PROVIDENT FINANCIAL SERVICES, INC.
On December 22, 2003, the Company entered into a definitive agreement to
merge into Provident Financial Services, Inc. ("PFS"). At the time of
announcement, the stock and cash transaction was valued at approximately $642.0
million. The transaction is currently expected to close in the second quarter of
2004. It remains subject to regulatory and shareholder approvals. See Item 7. -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a more detailed discussion of the pending merger.
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; LEGISLATIVE
AND REGULATORY CHANGES; AND THE INABILITY TO COMPLETE THE MERGER WITH PFS AS AND
WHEN EXPECTED. THE COMPANY HAS NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING
STATEMENTS AT ANY TIME.
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
3
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 of investment securities and short-term investments; and
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 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, 2003, 2002
and 2001 was $597.0 million, $588.0 million and $495.7 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.
In January 2003, the Board of Directors authorized a 5% stock repurchase
program. Under this program, the Company repurchased 871,000 shares, or $12.4
million, of its common stock during 2003 as part of its ongoing capital
management strategy. The Company's dividend payout ratio was 59.8%, 40.4%,
36.2%, 36.1% and 59.9% for the years ended December 31, 2003, 2002, 2001, 2000
and 1999, respectively.
The Company relocated an existing bank branch facility in Old Bridge,
New Jersey, to a new location in the same neighborhood in July 2003. The new
branch location offers a larger lobby area, better street access, drive-through
facilities and safe deposit box storage. In addition, the Company sold its sole
Mercer County branch, located in Lawrenceville, NJ, to another financial
institution in December 2003. The out-of-market branch divestiture will allow
the Company to better focus its marketing and business development efforts in
its core franchises.
4
MARKET AREA AND COMPETITION
The Company currently operates 22 branch offices in central New Jersey,
18 of which are located in Middlesex County, two in Monmouth County and one in
each of 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,
--------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------ ------------------------------ ------------------------------
Average Average Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost
---------- -------- ---------- ---------- -------- ---------- ---------- -------- ----------
ASSETS:
Interest-earning assets:
Loans, net (1) ...................... $1,229,428 $ 73,333 5.96% $1,263,513 $84,219 6.67% $1,220,059 $89,678 7.35%
Investment and other and
mortgage-backed securities
available for sale (2) ............. 928,267 35,626 3.84 888,124 41,783 4.70 735,600 43,907 5.97
------------------- ------------------- --------------------
Total interest-earning assets ..... 2,157,695 108,959 5.05 2,151,637 126,002 5.86 1,955,659 133,585 6.83
Non-interest earning assets ........... 96,029 77,205 65,845
---------- ---------- ----------
Total assets ...................... $2,253,724 $2,228,842 $2,021,504
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
NOW and money market ................ $ 514,580 4,621 0.90 $ 466,811 7,725 1.65 $ 381,613 9,654 2.53
Savings ............................. 227,428 2,267 1.00 201,358 3,543 1.76 168,520 3,790 2.25
Certificates of deposit.............. 569,349 14,645 2.57 628,535 21,189 3.37 660,120 33,764 5.11
Borrowed funds ...................... 597,047 28,860 4.83 587,986 29,964 5.10 495,674 27,476 5.54
------------------- ------------------- --------------------
Total interest-bearing
liabilities ...................... 1,908,404 50,393 2.64 1,884,690 62,421 3.31 1,705,927 74,684 4.38
Non-interest bearing deposits ........ 76,245 67,061 53,394
Other liabilities .................... 61,379 52,897 38,061
---------- ---------- ----------
Total liabilities ................. 2,046,028 2,004,648 1,797,382
---------- ---------- ----------
Stockholders' equity ................. 207,696 224,194 224,122
---------- ---------- ----------
Total liabilities and
stockholders' equity ............. $2,253,724 $2,228,842 $2,021,504
========== ========== ==========
Net interest income/interest rate
spread (3) ........................... $ 58,566 2.41% $63,581 2.55% $58,901 2.45%
================= ================ ===============
Net interest-earning assets/net
interest margin (4) .................. $ 249,291 2.71% $ 266,947 2.96% $ 249,732 3.01%
========== ======= ========== ======= ========== ======
Ratio of interest-earning assets
to interest-bearing liabilities ..... 1.13 X 1.14 X 1.15 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, 2003 Year Ended December 31, 2002
Compared to Year Ended Compared to Year Ended
December 31, 2002 December 31, 2001
-------------------------------- ----------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
-------------------- ---------------------
Volume Rate Net Volume Rate Net
-------- -------- ------- -------- -------- --------
INTEREST-EARNING ASSETS:
Loans receivable, net ....................... $(2,201) $ (8,685) $(10,886) $ 3,095 $ (8,554) $ (5,459)
Investment and other and mortgage-backed
securities available for sale ............. 1,807 (7,964) (6,157) 8,174 (10,298) (2,124)
------- -------- ------- -------- -------- --------
Total ....................................... (394) (16,649) (17,043) 11,269 (18,852) (7,583)
------- -------- ------- -------- -------- --------
INTEREST-BEARING LIABILITIES:
Deposits:
NOW and money market ...................... 716 (3,820) (3,104) 1,872 (3,801) (1,929)
Savings ................................... 412 (1,688) (1,276) 663 (910) (247)
Certificates of deposit ................... (1,859) (4,685) (6,544) (1,549) (11,026) (12,575)
Borrowed funds .............................. 467 (1,571) (1,104) 4,802 (2,314) 2,488
------- -------- ------- -------- -------- --------
Total ....................................... (264) (11,764) (12,028) 5,788 (18,051) (12,263)
------- -------- ------- -------- -------- --------
Change in net interest income ................. $ (130) $ (4,885) $(5,015) $ 5,481 $ (801) $ 4,680
======= ======== ======= ======== ======== ========
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, 2003, the Company's loan
portfolio totaled $1.2 billion, of which $755.7 million, or 61.8%, were
one-to-four family residential mortgage loans. At that date, the Company's loan
portfolio also included $113.8 million of home equity loans and lines of credit
generally secured by second liens on one-to-four family residential properties,
$130.7 million of net construction loans, $195.6 million of commercial real
estate loans, and $16.5 million of multi-family residential mortgage loans,
which represented 9.3%, 10.7%, 16.0% and 1.4%, respectively, of total loans
receivable. Of the mortgage loan portfolio outstanding at December 31, 2003,
51.0% were fixed-rate loans and 49.0% were adjustable-rate mortgage ("ARM")
loans. Other loans held by the Company, which consist of loans on deposit
accounts and commercial, personal, and automobile loans, totaled $10.0 million,
or 0.8% of total loans outstanding at December 31, 2003. 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
portfolio. In order to manage interest rate risk and diversify credit risk,
however, the Company 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, 2003, the Company's servicing
portfolio totaled $120.0 million. The Company had $777,000 in loans held for
sale at December 31, 2003.
The Company also invests in mortgage-backed securities and other
mortgage-backed products such as collateralized mortgage obligations ("CMOs").
At December 31, 2003, mortgage-backed securities, including CMOs, were $722.8
million, or 32.8% of total assets, of which 66.1% 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, 2003, 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,
-------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ------------------ ------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
Amount of total Amount of total Amount of total Amount of total Amount of total
---------- -------- ---------- ------- ---------- -------- ---------- -------- ---------- --------
Mortgage loans (1):
One-to-four family ...... $ 755,671 61.83% $ 835,593 68.87% $ 857,973 68.37% $ 879,578 73.59% $ 774,858 75.52%
Home equity ............. 113,840 9.31 110,835 9.13 112,958 9.00 114,152 9.55 98,324 9.58
Construction (2) ........ 130,687 10.69 77,091 6.35 71,590 5.70 41,291 3.45 26,890 2.62
Commercial real estate .. 195,566 16.00 164,639 13.57 167,806 13.37 131,072 10.97 96,821 9.44
Multi-family ............ 16,506 1.35 12,714 1.05 23,396 1.86 13,079 1.09 12,499 1.22
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total mortgage loans .. 1,212,270 99.18 1,200,872 98.97 1,233,723 98.30 1,179,172 98.65 1,009,392 98.38
Other loans ............... 9,967 0.82 12,537 1.03 21,347 1.70 16,121 1.35 16,638 1.62
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total loans
receivable .......... 1,222,237 100.00% 1,213,409 100.00% 1,255,070 100.00% 1,195,293 100.00% 1,026,030 100.00%
====== ====== ====== ====== ======
Less:
Net deferred loan costs
and unearned premiums ... (1,252) (631) (641) (1,850) (1,090)
Allowance for loan losses . 12,768 12,830 12,932 12,341 11,004
---------- ---------- ---------- ---------- ----------
Total loans
receivable, net ..... $1,210,721 $1,201,210 $1,242,779 $1,184,802 $1,016,116
========== ========== ========== ========== ==========
Mortgage loans:
ARM ..................... $ 593,782 48.98% $ 629,176 52.39% $ 660,047 53.50% $ 664,164 56.32% $ 531,859 52.69%
Fixed-rate .............. 618,488 51.02 571,696 47.61 573,676 46.50 515,008 43.68 477,533 47.31
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total mortgage loans .. $1,212,270 100.00% $1,200,872 100.00% $1,233,723 100.00% $1,179,172 100.00% $1,009,392 100.00%
========== ====== ========== ====== ========== ====== ========== ====== ========== ======
Mortgage-backed securities:
CMOs .................... $ 84,898 11.98% $ 118,693 15.47% $ 137,528 21.77% $ 201,802 44.79% $ 273,511 46.85%
FHLMC ................... 225,296 31.78 322,914 42.08 296,710 46.97 159,755 35.45 166,992 28.60
GNMA .................... 15,100 2.13 29,483 3.84 44,951 7.11 29,409 6.53 57,489 9.85
FNMA .................... 383,656 54.11 296,248 38.61 152,603 24.15 59,628 13.23 85,828 14.70
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total mortgage-backed
securities .......... 708,950 100.00% 767,338 100.00% 631,792 100.00% 450,594 100.00% 583,820 100.00%
====== ====== ====== ====== ======
Net premiums .............. 9,026 10,336 6,198 1,951 2,748
Net unrealized gain (loss)
on mortgage-backed
securities available
for sale ................ 4,818 12,888 4,726 (5,523) (11,409)
---------- ---------- ---------- ---------- ----------
Mortgage-backed
securities, net ......... $ 722,794 $ 790,562 $ 642,716 $ 447,022 $ 575,159
========== ========== ========== ========== ==========
- ----------
(1) Includes $777,000, $563,000, $5.5 million and $277,000 in mortgage loans
held for sale at December 31, 2003, 2002, 2001 and 2000, respectively. No
loans were classified as held for sale at December 31, 1999.
(2) Net of loans in process of $74.6 million, $62.1 million, $65.1 million,
$19.2 million, and $28.0 million at December 31, 2003, 2002, 2001, 2000,
and 1999, 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, 2003. 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, 2003
----------------------------------------------
One Year After
One Year To Five Five
or Less Years Years Total
-------- -------- -------- ----------
Mortgage loans:
One-to-four family ........... $ 58,653 $211,213 $485,805 $ 755,671
Home equity .................. 52,106 13,826 47,908 113,840
Construction (1) ............. 130,687 -- -- 130,687
Commercial real estate ....... 7,285 61,429 126,852 195,566
Multi-family ................. 3,602 7,022 5,882 16,506
-------- -------- -------- ----------
Total mortgage loans ....... 252,333 293,490 666,447 1,212,270
Other loans .................... 5,548 2,653 1,766 9,967
-------- -------- -------- ----------
Total loans ................ $257,881 $296,143 $668,213 1,222,237
======== ======== ========
Net deferred loan costs and unearned premiums .................... 1,252
Allowance for loan losses ........................................ (12,768)
-----------
Loans receivable, net ............................................ $1,210,721
===========
(1) Excludes loans in process of $74.6 million.
The following table sets forth at December 31, 2003, the dollar amount
of loans contractually due or repricing after December 31, 2004, and whether
such loans have fixed interest rates or adjustable interest rates (in
thousands):
Due or repricing after December 31, 2004
----------------------------------------
Fixed Adjustable Total
-------- ---------- ----------
Mortgage loans:
One-to-four family .............. $411,559 $285,459 $ 697,018
Home equity ..................... 61,734 -- 61,734
Commercial real estate .......... 126,164 62,117 188,281
Multi-family .................... 11,241 1,663 12,904
Other loans ........................ 2,047 2,372 4,419
-------- -------- ----------
Total loans receivable ............. 612,745 351,611 964,356
Mortgage-backed securities
(at amortized cost) ............. 84,631 429,740 514,371
-------- -------- ----------
Total loans receivable and
mortgage-backed securities ....... $697,376 $781,351 $1,478,727
======== ======== ==========
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, 2003, 61.8% 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 $40,000, and the
maximum loan amount is $1.5 million. 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 home equity loan is $10,000 and the maximum
home equity loan is $500,000. As of December 31, 2003, the Company had $62.0
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.
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 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") minus 0.25%. For borrowers wherein the credit line, when
combined with the balance of the first mortgage lien, does not exceed 80% of the
appraised value of the property at the time of the loan commitment, the Company
offers the option of a fixed 3-month or 6-month introductory rate. The
introductory rate is currently 2.99% for three months or 3.74% for six months.
All home equity lines of credit are subject to a maximum annual interest rate
change of 2.00% with a 14.99% ceiling. The Company's home equity lines of credit
outstanding at December 31, 2003 totaled $51.9 million, with additional
available credit lines of $79.3 million.
11
CONSTRUCTION LENDING. At December 31, 2003, construction loans totaled
$130.7 million, or 10.7% of the Company's total loans outstanding. Available
credit lines totaled $74.6 million at December 31, 2003. 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 $500,000 to $15.0 million. At December
31, 2003, the Company had 63 construction loans, 29 of which had principal
outstanding of $1.0 million or more, with the largest outstanding loan balance
being $15.0 million. At December 31, 2003, all of the Company's construction
lending portfolio consisted of loans secured by property located in the State of
New Jersey, a majority of which are 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, 2003, the Company had 185 loans
secured by commercial real estate, totaling $195.6 million, or 16.0% 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, 2003 had an outstanding balance of $8.5 million and
was secured by a retail shopping plaza, a portion of which is occupied by the
Bank's Old Bridge branch. 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 the 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, 2003, $16.5
million, or 1.4%, of the Company's total loan portfolio consisted of
multi-family residential loans. At December 31, 2003, the Company had five
multi-family loans with an outstanding 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.
12
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, 2003, $10.0 million, or 0.8%,
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 $1.5 million. Real estate loans in
excess of $1.5 million require prior Board approval. Prior Board approval is
also required for the origination of consumer and business loans in excess of
$200,000 for unsecured loans, and $1.0 million 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 $120.0 million and $106.1 million of mortgage loans for
others at December 31, 2003 and 2002, respectively. The Company received
$261,000 and $204,000 in servicing fees for the years ended December 31, 2003
and 2002, 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, 2003, $777,000 of
mortgage loans were classified as held for sale. Mortgage loans sold totaled
$67.2 million and $46.6 million for the years ended December 31, 2003 and 2002,
respectively. Periodically, the Company may also purchase mortgage loans. The
Company purchased $29.8 and $27.6 million in primarily hybrid ARM loans from
third-party correspondents for the years ended December 31, 2003 and 2002,
respectively. The Company underwrites the loans and verifies documentation prior
to purchasing mortgage loans from third-party correspondents and receives
representations and warranties for a one year period, including repayment of
remaining purchase premiums if a loan prepays within the first 12 months.
ASSET QUALITY
The following table sets forth information regarding non-accrual loans,
loans delinquent 90 days or more, and real estate owned ("REO"). 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, 2003, the amount of interest
income that would have been recognized on nonaccrual loans if such loans had
continued to perform in accordance with their contractual terms was $62,000, as
compared to actual interest income recognized on a cash basis with respect to
such loans of $16,000.
13
(Dollars in thousands)
At December 31,
------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Non-accrual mortgage loans ........ $1,176 $1,541 $1,787 $2,334 $2,311
Non-accrual other loans ........... 17 -- -- 15 45
------ ------ ------ ------ ------
Total non-accrual loans ....... 1,193 1,541 1,787 2,349 2,356
Loans 90 days or more delinquent
and still accruing .............. 634 223 62 40 326
------ ------ ------ ------ ------
Total non-performing loans .... 1,827 1,764 1,849 2,389 2,682
Restructured loans ................ -- -- -- -- --
Total real estate owned, net of
related allowance for loss ...... -- 72 42 257 466
------ ------ ------ ------ ------
Total non-performing assets ....... $1,827 $1,836 $1,891 $2,646 $3,148
====== ====== ====== ====== ======
Non-performing loans to total
loans receivable, net ......... 0.15% 0.15% 0.15% 0.20% 0.26%
Total non-performing assets to
total assets .................. 0.08% 0.08% 0.09% 0.13% 0.17%
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 $2.2 million and $2.1 million at
December 31, 2003 and 2002, respectively. At December 31, 2003, $1.1 million of
classified loans consisted of participations with the Thrift Institutions
Investment Corporation ("TICIC") in second mortgage loans which resulted from
construction cost overruns on two assisted care facilities. Additional
classified assets consisted of three construction loans to the same principals
secured by partially developed residential subdivisions which totaled $807,000
and residential mortgage loans which totaled $291,000.
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 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.
14
As a result of stable loan portfolio size and asset quality, the Company
did not record a provision for loan losses in 2003, compared with $1.3 million
in 2002. The 2002 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. The Company believes that the allowance for loan losses is adequate.
At December 31, 2003, the total allowance was $12.8 million, which amounted to
1.04% of loans receivable, net of unearned and deferred fees, and 7.0 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,
-----------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Balance at beginning of period ........ $ 12,830 $ 12,932 $ 12,341 $ 11,004 $ 9,505
Provision for loan losses ............. -- 1,310 650 1,441 1,650
Charge-offs (domestic):
Commercial loans ................... -- (1,388) -- -- --
Real estate - mortgage ............. (18) (18) (71) (97) (151)
Installment loans to individuals ... (49) (34) -- (7) --
Recoveries (domestic):
Commercial loans ................... -- 9 -- -- --
Real estate - mortgage ............. 1 16 12 -- --
Installment loans to individuals ... 4 3 -- -- --
-------- -------- -------- -------- --------
Balance at end of period .............. $ 12,768 $ 12,830 $ 12,932 $ 12,341 $ 11,004
======== ======== ======== ======== ========
Ratio of net charge-offs during
the period to average loans
during the period ..................... 0.01% 0.11% --% 0.01% 0.02%
======== ======== ======== ======== ========
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,
--------------------------------------------------------------------------
2003 2002
----------------------------------- -----------------------------------
Percent of Percent of
Percent of Loans in Percent of Loans in
Allowance to Each Allowance to Each
Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------- ------------ ----------- ------- ------------ -----------
One-to-four family .................. $ 3,784 29.64% 61.83% $ 4,420 34.45% 68.87%
Home equity loans ................... 1,460 11.43 9.31 1,334 10.40 9.13
Construction ........................ 3,525 27.61 10.69 2,123 16.55 6.35
Commercial real estate .............. 3,039 23.80 16.00 2,614 20.37 13.57
Multi-family ........................ 248 1.94 1.35 191 1.49 1.05
------- ------ ------ ------- ------ ------
Total mortgage loans .............. 12,056 94.42 99.18 10,682 83.26 98.97
Other ............................... 712 5.58 0.82 690 5.38 1.03
Unallocated ......................... -- -- -- 1,458 11.36 --
------- ------ ------ ------- ------ ------
Total allowance for loan losses ... $12,768 100.00% 100.00% $12,830 100.00% 100.00%
======= ====== ====== ======= ====== ======
At December 31,
--------------------------------------------------------------------------------------------------------
2001 2000 1999
-------------------------------- -------------------------------- --------------------------------
Percent of Percent of Percent of
Percent of Loans in Percent of Loans in Percent of Loans in
Allowance Each Allowance Each Allowance Each
to Total Category to to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------- ---------- ----------- ------- ---------- ----------- ------- ---------- -----------
One-to-four family ....... $ 4,579 35.41% 68.37% $ 4,831 39.15% 73.59% $ 4,667 42.41% 75.52%
Home equity loans ........ 1,270 9.82 9.00 1,243 10.07 9.55 1,086 9.87 9.58
Construction ............. 2,209 17.09 5.70 1,275 10.33 3.45 1,573 14.29 2.62
Commercial real estate ... 3,674 28.41 13.37 2,637 21.37 10.97 2,630 23.90 9.44
Multi-family ............. 351 2.71 1.86 197 1.60 1.09 250 2.27 1.22
------- ------ ------ ------- ------ ------ ------- ------ ------
Total mortgage loans ... 12,083 93.44 98.30 10,183 82.51 98.65 10,206 92.74 98.38
Other .................... 849 6.56 1.70 587 4.76 1.35 541 4.92 1.62
Unallocated .............. -- -- -- 1,571 12.73 -- 257 2.34 --
------- ------ ------ ------- ------ ------ ------- ------ ------
Total allowance
for loan losses ...... $12,932 100.00% 100.00% $12,341 100.00% 100.00% $11,004 100.00% 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, 2003, mortgage-backed securities, net, totaled $722.8 million,
or 32.8% 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 or FNMA. At December 31, 2003, the
mortgage-backed securities portfolio had a weighted average interest rate of
4.74%. Fixed coupon rates ranged from 6.13% to 9.50% for GNMA, 4.00% to 7.00%
for Freddie Mac, 5.00% to 7.00% for FNMA fixed-rate securities and 4.00% to
6.75% for fixed-rate CMOs. Adjustable-rate coupon ranges were as follows: 3.00%
to 5.625% for GNMA ARM mortgage-backed securities; 3.16% to 6.27% for Freddie
Mac ARM mortgage-backed securities; and 3.43% to 6.07% for FNMA ARM
mortgage-backed securities.
Included in the total mortgage-backed securities portfolio are CMOs,
which had a market value of $86.0 million at December 31, 2003. 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, 2003, was 3.5
years. The stated weighted average contractual maturity of the Company's CMOs at
December 31, 2003, was 14.6 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, 2003, 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 .................................... $ 43 $ 44
One year through five years ........................... 9,116 9,326
Five years through ten years .......................... 56,429 56,887
Greater than ten years ................................ 652,388 656,537
-------- --------
$717,976 $722,794
======== ========
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 Standards 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,
2003, the market value of investment securities available for sale was $106.5
million, with an amortized cost basis of $105.0 million, and was composed of
U.S. Government and U.S. Government-sponsored Agency obligations, state and
municipal obligations, corporate obligations and equity securities. The
available for sale portfolio, excluding equity securities, had a weighted
average contractual maturity of 7.7 years. A portion of the investment portfolio
is comprised of callable agency and municipal notes, as well as callable trust
preferred securities 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 securities, due to the issuer's flexibility in
repricing their funding source, while creating reinvestment risk to the Company.
At December 31, 2003, $61.9 million, or 59.0% 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,
---------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
Investment securities available for sale:
U.S. Government and Agency obligations .... $ 52,915 $ 52,808 $ 53,904 $ 55,037 $ 26,999 $ 27,014
State and municipal obligations ........... 14,135 14,855 11,811 12,659 14,029 14,029
Corporate obligations ..................... 26,785 27,452 35,418 35,420 60,330 59,357
Equity securities ......................... 11,187 11,344 10,953 11,103 8,051 7,588
-------- -------- -------- -------- -------- --------
Total investment securities
available for sale .................... $105,022 $106,459 $112,086 $114,219 $109,409 $107,988
======== ======== ======== ======== ======== ========
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, 2003. Investments in equity
securities, which have no contractual maturities, are excluded from this table.
(Dollars in thousands)
At December 31, 2003
---------------------------------------------------------------------------------------------------------
More than More than
One Year One Year Five Years More than
or Less to Five Years to Ten Years Ten Years Total
---------------- ---------------- ----------------- ---------------- -----------------------------------
Amor- Weighted Amor- Weighted Amor- Weighted Amor- Weighted Average Amor- Weighted
tized Average tized Average tized Average tized Average Maturity tized Market Average
Cost Yield Cost Yield Cost Yield Cost Yield in Years Cost Value Yield
------ -------- ------- -------- ------- -------- ------- -------- -------- ------- ------- --------
Investment securities
available for sale:
U.S. Government and
Agency obligations ... $ -- --% $43,931 3.84% $ 8,984 4.10% $ -- --% 4.79 $52,915 $52,808 3.88%
State and municipal
obligations .......... 331 3.67 2,122 6.00 9,840 5.42 1,842 3.59 7.88 14,135 14,855 5.23
Corporate obligations .. 2,994 7.54 8,719 7.44 2,031 6.68 13,041 6.15 13.50 26,785 27,452 6.77
------ ---- ------- ---- ------- ---- ------- ---- ----- ------- ------- ----
Total investment
securities available
for sale ............. $3,325 7.15% $54,772 4.50% $20,855 4.97% $14,883 5.83% 7.74 $93,835 $95,115 4.91%
====== ==== ======= ==== ======= ==== ======= ==== ===== ======= ======= ====
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, 2003, $128.2 million, or 9.6%, of the Company's deposit balance
consisted of IRAs. Also at that date, $295.0 million, or 22.0%, of the Company's
deposit balances consisted of accounts with balances greater than or equal to
$100,000. Currently, the Company does not accept brokered deposits.
At December 31, 2003, certificate accounts in amounts of $100,000 or
more mature as follows (in thousands):
Maturity period Amount
------------------------------------ -------
Three months or less ............... $21,943
Over 3 through 6 months ............ 15,343
Over 6 through 12 months ........... 15,814
Over 12 months ..................... 22,560
-------
Total ....................... $75,660
=======
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,
---------------------------------------------------------------------------------------
2003 2002 2001
-------------------------- -------------------------- ----------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------ ------------ ------------ ------------ ------------- -------------
Non-interest bearing deposits ....... $ 76,245 --% $ 67,061 --% $ 53,394 --%
NOW and money market accounts ....... 514,580 0.90 466,811 1.65 381,613 2.53
Savings accounts .................... 227,428 1.00 201,358 1.76 168,520 2.25
------------ ------------ -------------
Sub-total ........................ 818,253 0.84 735,230 1.53 603,527 2.23
Certificate accounts ................ 569,349 2.57 628,535 3.37 660,120 5.11
------------ ------------ -------------
Total average deposits ........... $1,387,602 1.55% $1,363,765 2.38% $1,263,647 3.73%
============ ============ ============ ============ ============= =============
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. 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, 2003, the Company's FHLB-NY advances totaled $125.5 million,
representing 6.3% of total liabilities.
The Company also borrows funds via reverse repurchase agreements with
the FHLB-NY and primary broker/dealers. At December 31, 2003, borrowings via
reverse repurchase agreements with the FHLB-NY and approved primary
broker/dealers collateralized by designated mortgage-backed and investment
securities totaled $466.0 million, representing 23.6% of total liabilities.
21
The Company also had an available overnight line-of-credit with the
FHLB-NY for a maximum of $50.0 million at December 31, 2003.
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,
---------------------------------
2003 2002 2001
-------- -------- --------
FHLB-NY advances:
Average balance outstanding .............. $135,309 $151,145 $128,492
Maximum amount outstanding at any
month-end during the period ............ 140,663 165,802 165,814
Balance outstanding at end of period ..... 125,500 140,663 165,814
Weighted average interest rate
during the period ...................... 5.28% 5.09% 5.44%
Weighted average interest rate at
end of period .......................... 5.19% 5.24% 4.76%
Other borrowings:
Average balance outstanding .............. $461,738 $436,841 $367,182
Maximum amount outstanding at any
month-end during the period ............ 481,000 461,000 425,000
Balance outstanding at end of period ..... 466,000 456,000 380,000
Weighted average interest rate
during the period ...................... 4.70% 5.11% 5.59%
Weighted average interest rate
at end of period ....................... 4.43% 4.97% 5.29%
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, 2003, FSB
Financial LLC had net income of $222,000.
SENTINEL INVESTMENT CORP. Sentinel Investment Corp. is a wholly-owned
subsidiary of the Bank. Sentinel Investment Corp. serves as the parent company
to 1000 Woodbridge Center Drive, Inc., a real estate investment trust, and
derives all of its income from its investment in 1000 Woodbridge Center Drive,
Inc.
1000 WOODBRIDGE CENTER DRIVE, INC. 1000 Woodbridge Center Drive, Inc. is
a majority-owned subsidiary of Sentinel Investment Corp. 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.
FIRST SENTINEL CAPITAL TRUST I AND FIRST SENTINEL CAPITAL TRUST II.
These entities are special purpose business trusts established for the purpose
of issuing $25.0 million in preferred capital securities. The Company owns 100%
of the common securities of each entity. Effective December 31, 2003, the
Company adopted revised Financial Accounting Standards Board ("FASB")
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51," which requires the Company to deconsolidate these
entities for financial reporting purposes. The impact of this deconsolidation is
immaterial to the Company's financial condition and results of operations. See
Note 10 to the Company's Audited Consolidated Financial statements included in
Item 8 of this report.
PERSONNEL
As of December 31, 2003, the Company had 280 full-time employees and 37
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, 2003 and 2002,
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, 2003 and 2002, 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 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, 2003, the
Bank maintained 84.7% 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, 2003, 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 Gramm-Leach. Gramm-Leach also prohibits non-financial companies
from acquiring grandfathered unitary savings and loan association holding
companies.
24
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 includable 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.
25
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 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 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
26
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, 2003, 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 2003 for the assessment for deposit
insurance and the FICO payments was $225,000.
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 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;
27
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; or (ii) 5% (or such greater fraction
as established by the FHLB) of its outstanding advances from the FHLB. 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 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. The FHLB-NY, however, has postponed the implementation of the
new capital plan, and the new implementation date has not yet been determined.
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"), as well as additional
limitations as may be adopted by the Director of the OTS. These provisions,
among other things, prohibit or limit a savings banks from
28
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 Federal Reserve Board ("FRB") rescinded its
interpretations of Sections 23A and 23B of the FRA and replaced these
interpretations with Regulation W. Regulation W made various changes to certain
interpretations 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.
The OTS issued a final rule, effective as of October 6, 2003, which
conforms the OTS's regulations on transactions with affiliates to Regulation W.
In addition, the rule implements additional restrictions imposed on savings
associations under Section 11 of HOLA, including provisions prohibiting a
savings association from making a loan to an affiliate that is engaged in
non-bank holding company activities and provisions prohibiting a savings
association from purchasing or investing in securities issued by an affiliate
that is not a subsidiary. The final rule also includes certain specific
exemptions from these prohibitions. The final rule is applicable to First
Savings by virtue of the election made by First Savings to be treated as a
savings association for purposes of the savings and loan holding company
provisions of HOLA. The FRB and the OTS expect each depository institution that
is subject to Sections 23A and 23B to implement policies and procedures to
ensure compliance with Regulation W and the final OTS rule. We do not expect
that the changes made by Regulation W and the final OTS rule 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.
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.
ANTI-MONEY LAUNDERING AND CUSTOMER IDENTIFICATION
First Savings is subject to FDIC regulations implementing the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept
and Obstruct Terrorism Act of 2001 ("USA PATRIOT Act"). The USA PATRIOT Act
gives the federal government 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.
Title III of the USA PATRIOT Act and the related FDIC regulations impose
the following requirements with respect to financial institutions:
o Establishment of anti-money laundering programs.
o Establishment of a program specifying procedures for obtaining
identifying information from customers seeking to open new accounts, including
verifying the identity of customers within a reasonable period of time.
o Establishment of enhanced due diligence policies, procedures and
controls designed to detect and report money laundering.
29
o Prohibition on correspondent accounts for foreign shell banks and
compliance with recordkeeping obligations with respect to correspondent accounts
of foreign banks.
The FDIC adopted interim final rules implementing the USA PATRIOT Act in 2002
and adopted final rules implementing the customer identification requirements on
May 9, 2003. The final rule became effective June 9, 2003, however, financial
institutions had until October 1, 2003 to come into compliance with such final
rule. Compliance with the regulations adopted under the USA PATRIOT Act did not
have a material adverse impact on our financial condition or results of
operations.
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.
NEW JERSEY HOME OWNERSHIP SECURITY ACT OF 2002. On May 1, 2003, Governor
James E. McGreevey signed into law the New Jersey Home Ownership Security Act of
2002 (the "Predatory Lending Law"). The Predatory Lending Law, which became
effective on November 28, 2003, prohibits certain abusive lending practices
generally considered to constitute predatory lending in connection with certain
home loan mortgages, and gives the Department enhanced enforcement powers to
exercise a board range of remedies designed to both protect borrowers and
penalize lenders for abusive lending practices. In addition, the Predatory
Lending Law imposes specific conditions which must be satisfied before a
financial institution may originate certain home loan mortgages. First Savings
has not originated any loans that
30
would have been prohibited by the Predatory Lending Law and does not expect the
enactment of the Predatory Lending Law to have a material adverse effect on its
business.
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 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.
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.
31
ITEM 2. PROPERTIES
The Company conducts its business through its main office and 21 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, 2003. The aggregate net book value of the
Company's premises and equipment was $15.9 million at December 31, 2003.
Date Leased Leased
Location or Acquired 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
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
599 Middlesex Avenue 1/95 Leased
Metuchen, NJ 08840
1580 Rt. 35 South 4/95 Leased
Middletown, NJ 07748
97 North Main Street 1/95 Owned
Milltown, NJ 08850
225 Prospect Plains Road 7/76 Owned
Monroe Township, NJ 08512
3889 Rt. 516 4/03 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.
32
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, 2003.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
First Sentinel Bancorp, Inc. common stock trades on the Nasdaq Stock
Market under the symbol "FSLA." Newspaper financial sections list the stock as
FSLA or FSentBc. At March 1, 2004, 26,268,402 shares of the Company's
outstanding common stock were held of record by approximately 2,523 persons or
entities, not including the number of persons or entities holding stock in
nominee or stock name through various brokers or banks. The following table sets
forth high and low bid prices per share of the Company's common stock, as
reported on the Nasdaq National Market, as well as dividends paid, for the
periods indicated.
2003 2002
--------------------------------------------------------------
Dividends Dividends
High Low paid High Low paid
--------------------------------------------------------------
Fourth quarter $21.54 $17.58 $0.105 $14.96 $12.71 $0.095
Third quarter 17.88 15.57 0.105 14.67 12.90 0.095
Second quarter 16.11 14.03 0.105 15.58 13.04 0.095
First quarter 14.95 13.82 0.105 13.55 12.05 0.075
The Company also paid a regular quarterly cash dividend of $0.105 per
common share on February 27, 2004 to stockholders of record as of the close of
business on February 13, 2004. The Company's Board of Directors reviews the
payment of dividends quarterly and plans to continue to maintain a regular
quarterly dividend in the future, depending on the Company's earnings, financial
condition and other factors.
The Company is subject to the laws of the State of Delaware which
generally limit dividends to an amount equal to the excess of the Company's net
assets (the amount by which total assets exceed total liabilities) over the
Company's statutory capital (which is equal to the aggregate par value of the
outstanding shares of capital stock). If there is no such excess, dividends are
limited to the Company's net profits for the current and/or immediately
preceding fiscal year.
The Company's payment of dividends is dependent, in large part, upon
receipt of dividends from the Bank. The Bank is subject to certain restrictions
which may limit its ability to pay dividends to the Company. See Item 1,
"Business - Regulation and Supervision." Also see Item 1, "Business - Federal
and State Taxation" for an explanation of the tax impact of the unlikely event
that the Bank (1) makes distributions in excess of current and accumulated
earnings and profits, as calculated for federal income tax purposes; (2) redeems
its stock; or (3) liquidates.
33
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data and selected operating data should
be read in conjunction with the consolidated financial statements of the Company
and accompanying notes thereto, which are presented elsewhere herein.
December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
SELECTED FINANCIAL DATA:
Total assets ................................................. $2,204,670 $2,261,479 $2,142,734 $1,972,080 $1,907,139
Loans receivable, net ........................................ 1,210,721 1,201,210 1,242,779 1,184,802 1,016,116
Investment securities available for sale ..................... 106,459 114,219 107,988 234,970 213,590
Other interest-earning assets (1) ............................ 80,875 65,085 40,541 40,693 37,175
Mortgage-backed securities available for sale ................ 722,794 790,562 642,716 447,022 575,159
Deposits ..................................................... 1,339,858 1,387,986 1,315,264 1,219,336 1,213,724
Borrowed funds ............................................... 591,500 596,663 545,814 505,955 422,000
Subordinated debentures (2) .................................. 25,774 -- -- -- --
Preferred capital securities (2) ............................. -- 25,000 25,000 -- --
Stockholders' equity ......................................... 227,574 211,572 221,703 214,630 238,700
------------------------------------------------------------------
Year Ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
SELECTED OPERATING DATA:
Interest income .............................................. $ 108,959 $ 126,002 $ 133,585 $ 136,789 $ 123,388
Interest expense ............................................. 50,393 62,421 74,684 78,872 65,006
---------- ---------- ---------- ---------- ----------
Net interest income ...................................... 58,566 63,581 58,901 57,917 58,382
Provision for loan losses .................................... -- 1,310 650 1,441 1,650
---------- ---------- ---------- ---------- ----------
Net interest income after provision for loan losses ...... 58,566 62,271 58,251 56,476 56,732
Non-interest income (3) ...................................... 9,703 6,543 4,455 2,269 3,631
Non-interest expense (4) ..................................... 37,736 31,058 27,205 26,634 24,556
---------- ---------- ---------- ---------- ----------
Income before income tax expense ......................... 30,533 37,756 35,501 32,111 35,807
Income tax expense ........................................... 12,197 12,852 11,016 10,414 12,155
---------- ---------- ---------- ---------- ----------
Net income .............................................. $ 18,336 $ 24,904 $ 24,485 $ 21,697 $ 23,652
========== ========== ========== ========== ==========
Basic earnings per share ..................................... $ 0.71 $ 0.90 $ 0.84 $ 0.67 $ 0.62
========== ========== ========== ========== ==========
Diluted earnings per share ................................... $ 0.69 $ 0.88 $ 0.82 $ 0.66 $ 0.60
========== ========== ========== ========== ==========
Dividends per share .......................................... $ 0.42 $ 0.36 $ 0.30 $ 0.24 $ 0.37
========== ========== ========== ========== ==========
Dividend payout ratio ........................................ 59.78% 40.43% 36.19% 36.13% 59.88%
========== ========== ========== ========== ==========
At or For the Year Ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
SELECTED FINANCIAL RATIOS:
Return on average assets (3) (4) ............................. 0.81% 1.12% 1.21% 1.11% 1.25%
Return on average stockholders' equity (3) (4) ............... 8.83 11.11 10.92 9.77 8.07
Average stockholders' equity to average assets ............... 9.22 10.06 11.09 11.32 15.53
Stockholders' equity to total assets ......................... 10.32 9.36 10.35 10.88 12.52
===================================================================================================================================
(1) Includes federal funds sold and investment in the stock of the FHLB-NY.
(2) The Company adopted revised FASB Interpretation No. 46 on December 31,
2003, which required the deconsolidation of its investments in First
Sentinel Capital Trust I and II. See Note 10 to the Company's Audited
Consolidated Financial Statements included in Item 8 of this report.
(3) Includes the effect of the sale of the Lawrenceville branch that realized a
$2.4 million gain, or $1.6 million net of tax, in 2003.
(4) Includes the effect of non-tax deductible merger-related charges totaling
$4.3 million in 2003 in connection with entering into a definitive
agreement to merge with PFS.
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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; legislative
and regulatory changes; and the inability to complete the merger with PFS as and
when expected. The Company has no obligation to update any forward-looking
statements at any time.
PENDING MERGER WITH PROVIDENT FINANCIAL SERVICES, INC.
On December 22, 2003, the Company entered into a definitive agreement to merge
into PFS in a cash and stock transaction valued at approximately $642.0 million.
Under the terms of the agreement, 60% of the Company's common stock will be
converted into PFS stock and the remaining 40% will be converted into cash. The
Company's stockholders will have the option to receive for each share of the
Company's common stock held either 1.092 shares of PFS common stock, $22.25 of
cash, or some combination thereof, subject to an election and allocation
procedure as set forth in the merger agreement. The merger agreement has been
approved by the directors of both PFS and the Company. The transaction, which is
expected to close in June 2004, is subject to customary closing conditions,
including regulatory approvals and the approval of the Company's shareholders
and PFS's shareholders. The merger agreement requires the Company to pay PFS a
termination fee of $24.0 million if the agreement is terminated under certain
circumstances following the Company's receipt of a superior acquisition
proposal.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" is based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. Note 1 to the
Company's Audited Consolidated Financial Statements for the year ended December
31, 2003, which are included in Item 8 of this report, contains a summary of the
Company's significant accounting policies. Management believes the Company's
policy with respect to the methodology for the determination of the allowance
for loan losses involves a higher degree of complexity and requires management
to make difficult and subjective judgments which often require assumptions or
estimates about highly uncertain matters. Changes in these judgments,
assumptions or estimates could materially impact results of operations. This
critical policy and its application is reviewed quarterly with the Audit
Committee and the Board of Directors.
The allowance for loan losses is established through a provision for loan losses
based upon management's evaluation of the adequacy of the allowance, including
an assessment of known and inherent risks in the loan portfolio, giving
consideration to the size and composition of the portfolio, review of individual
loans for adverse situations that may affect the borrowers' ability to repay,
actual loan loss experience, level of delinquencies, detailed analysis of
individual loans for which full collectibility may not be assured, the existence
and estimated net realizable value of any underlying collateral and guarantees
securing the loans, and current economic and market conditions. Although
management uses the best information available, the level of the allowance for
loan losses remains an estimate which is subject to significant judgment and
short-term change. Various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to make additional provisions for
loan losses based upon information available to them at the time of their
examination. Furthermore, the majority of the Company's loans are secured by
real estate in the State of New Jersey. Accordingly, the collectibility of a
substantial portion of the carrying value of the Company's loan portfolio is
susceptible to changes in local market conditions and may be adversely affected
should real estate values decline or the New Jersey area experience an adverse
economic shock. Future adjustments to the allowance for loan losses may be
necessary due to economic, operating, regulatory and other conditions beyond the
Company's control.
The determination of the loans on which full collectibility is not reasonably
assured, the estimates of the fair value of the underlying collateral and the
assessments of economic and regulatory conditions are subject to assumptions and
judgments by management. The allowance could differ materially as a result of
changes in these assumptions and judgments.
35
These evaluations are inherently subjective because, even though they are based
on objective data, it is management's interpretation of that data that
determines the amount of the appropriate allowance. Therefore, the Company
periodically reviews the actual performance and charge-off of its portfolio and
compares that to the previously determined allowance coverage percentages. In
doing so, the Company evaluates the impact the previously mentioned variables
may have had on the portfolio to determine which changes, if any, should be made
to the assumptions and analyses.
Actual results could differ from the Company's estimates as a result of changes
in economic or market conditions. Changes in estimates could result in a
material change in the allowance for loan losses. While the Company believes
that the allowance for loan losses has been established and maintained at levels
adequate to reflect the risks inherent in its loan portfolio, future increases
may be necessary if economic or market conditions decline substantially from the
conditions that existed at the time of the initial determinations.
EXECUTIVE SUMMARY
Net income for the year ended December 31, 2003 was $18.3 million, or $0.69 per
diluted share, compared with $24.9 million, or $0.88 per diluted share for the
year ended December 31, 2002. Return on average equity was 8.83% for 2003,
compared with 11.11% for 2002, while the return on average assets was 0.81% for
2003 compared with 1.12% for 2002. Results for the year ended December 31, 2003
were impacted by non-tax deductible merger-related charges totaling $4.3
million, or $0.16 per diluted share, in connection with the Company's pending
merger with PFS, as well as an after-tax gain of $1.6 million, or $0.06 per
diluted share, recognized on the sale of one of the Bank's branch offices to
another financial institution. Interest rates remained at historic lows
throughout 2003, resulting in net interest margin compression and constraining
balance sheet growth as mortgage-related assets refinanced and prepaid and the
Company sold longer-term fixed-rate assets to maintain its asset sensitive
interest rate risk position.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2003 AND DECEMBER 31, 2002
ASSETS. Total assets decreased by $56.8 million, or 2.5%, to $2.2 billion at
December 31, 2003. The decrease in assets was primarily a result of the
Company's decision not to pursue growth at historically low interest rate
levels, reductions in assets due to refinancings and prepayments of loans and
mortgage-backed securities ("MBS"), and the sale of certain longer-term
fixed-rate assets originated at historically low interest rate levels to manage
interest rate risk under rising rate scenarios. The change in assets consisted
primarily of decreases in MBS and investment securities available for sale,
partially offset by increases in cash and cash equivalents and loans receivable.
MBS available for sale decreased $67.8 million, or 8.6%, to $722.8 million at
December 31, 2003, from $790.6 million at December 31, 2002. The decrease was
primarily due to principal repayments and sales of $409.1 million and $230.0
million, respectively, exceeding purchases of $586.8 million for 2003.
Accelerated principal repayments on MBS were attributable to the historically
low interest rate environment and the resultant refinance activity in the
underlying mortgage loans. This prepayment activity also resulted in accelerated
amortization of premiums paid on MBS. Purchases consisted primarily of MBS
issued by U.S. government-sponsored agencies. At December 31, 2003,
approximately 66% of the Company's MBS had adjustable rates and the MBS
portfolio had a modified duration of 1.8 years.
Investment securities available for sale decreased $7.8 million, or 6.8%, to
$106.5 million as of December 31, 2003, from $114.2 million at December 31,
2002. For 2003, purchases totaled $81.5 million, while sales, calls and
maturities totaled $88.5 million. Purchases during 2003 consisted primarily of
debt securities issued by the U.S. government and government-sponsored agencies.
Cash and cash equivalents increased $9.9 million, or 15.0%, to $75.8 million as
of December 31, 2003, from $65.9 million at December 31, 2002, primarily as a
result of proceeds realized from the sale of MBS and investment securities
available for sale as the Company repositioned portions of its securities
portfolio to better manage interest rate risk and improve future returns. The
Company intends to prudently deploy investable funds in a manner which does not
expose it to significant interest rate or market risk.
Loans receivable, net totaled $1.2 billion at December 31, 2003, an increase of
$9.5 million, or 0.8%, from December 31, 2002. Loan originations totaled $736.4
million for 2003, compared to $623.5 million for 2002. The increase in loan
originations in 2003, compared with 2002, was largely attributable to the
prolonged, historically low interest rate environment experienced throughout
2003. Fixed-rate, one-to-four family first mortgage loan originations totaled
$228.1 million, or 31.0% of total production, while adjustable-rate, one-to-four
family mortgage loans accounted for $137.1 million, or 18.6% of total
originations for 2003. Consumer loan originations, including home equity loans
and credit lines,
36
totaled $158.8 million, or 21.6% of total originations, while construction
lending totaled $142.7 million, or 19.4% of total originations. Commercial real
estate, commercial and multi-family loan originations totaled $69.8 million, or
9.5% of total originations. Mortgage loans purchased totaled $29.8 million in
2003, compared with $27.6 million in 2002. Loans purchased were primarily
adjustable-rate, one-to-four family mortgages underwritten internally, with
rates higher than those currently offered by the Company.
Repayment of principal on loans totaled $690.1 million for 2003, compared to
$644.7 million for 2002. Included in the repayment of principal on loans,
mortgage loan refinancing totaled $169.4 million for 2003, compared with $110.6
million for 2002, reflecting the low interest rate environment. The Company also
sold $67.2 million of primarily fixed-rate, one-to-four family mortgage loans
during 2003 as part of its ongoing interest rate risk management process. At
December 31, 2003, one-to-four family mortgage loans comprised 61.8% of total
loans receivable, net of loans in process, while commercial real estate,
multi-family and construction loans comprised 28.0%, and home equity loans
accounted for 9.3% of the loan portfolio. In comparison, at December 31, 2002,
one-to-four family mortgage loans comprised 68.9% of total loans receivable, net
of loans in process, while commercial real estate, multi-family and construction
loans comprised 21.0%, and home equity loans accounted for 9.1% of the loan
portfolio. The Company intends to continue to prudently expand its
non-residential mortgage lending activities while maintaining its underwriting
standards and commitment to community-based lending. While management intends to
continue emphasizing the origination of loans, the future levels of loan
originations and repayments will be significantly influenced by external
interest rates and other economic factors outside of the control of the Company.
LIABILITIES. Deposits decreased $48.1 million, or 3.5%, to $1.3 billion at
December 31, 2003. In December 2003, the Company sold its Lawrenceville, New
Jersey branch, which held $38.8 million in deposits, to another financial
institution. Including the impact of the branch sale, core deposits, consisting
of checking, savings and money market accounts, increased $37.4 million, or
4.8%, while certificates of deposit declined $85.5 million, or 14.2%. Checking
accounts increased $22.4 million at December 31, 2003 compared with December 31,
2002, while money market accounts increased $11.0 million and savings accounts
increased $4.0 million. The increase in core deposits was primarily attributable
to focused sales efforts throughout the Company's retail distribution network.
The decrease in certificates of deposit occurred primarily in the one-year and
six-month maturity categories, and was part of a concerted effort to prudently
price deposit products and reduce overall funding costs, while developing and
maintaining core relationships. At December 31, 2003, core deposits accounted
for 61.4% of total deposits, up from 56.6% at December 31, 2002. The Company
intends to continue its emphasis on core deposit relationships, differentiating
itself through exemplary service and comprehensive product offerings.
Other liabilities decreased $20.2 million, or 65.9%, to $10.4 million at
December 31, 2003. The decrease was primarily attributable to the
reclassification of a $17.4 million deferred compensation obligation from
liabilities to stockholders' equity as a result of an amendment of the Bank's
Directors' Deferred Fee Plan ("DDFP"), effective October 1, 2003, to require
that all future distributions be made in First Sentinel Common Stock. As a
result of the DDFP amendment, the obligation related to the market value of
Company stock held in the underlying rabbi trust for the DDFP was reclassified
as a deferred compensation equity instrument, with no further changes in the
fair value of the common stock required to be recognized as a periodic charge or
credit to compensation cost.
STOCKHOLDERS' EQUITY. Stockholders' equity increased $16.0 million for 2003. The
increase was a result of net income of $18.3 million, the reclassification of a
$17.4 million deferred compensation obligation from liabilities to stockholders'
equity as a result of the amendment of the DDFP, proceeds from the exercise of
stock options, net amortization of benefit plans and related tax benefits
totaling $9.6 million, partially offset by $12.7 million of common stock
repurchases, cash dividends totaling $11.0 million, and a decrease in
accumulated other comprehensive income of $5.7 million as a result of the
decrease in market values of investment securities and MBS available for sale,
net of related tax benefit. The Company repurchased 871,000 common shares at an
average cost per share of $14.26 in 2003. Book value and tangible book value per
share were $8.35 and $8.21, respectively, at December 31, 2003, compared to
$7.71 and $7.54, respectively, at December 31, 2002.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2003
AND DECEMBER 31, 2002
RESULTS OF OPERATIONS. For the year ended December 31, 2003, basic and diluted
earnings per share totaled $0.71 and $0.69, respectively, compared with basic
and diluted earnings per share of $0.90 and $0.88, respectively, for the year
ended December 31, 2002. Net income for 2003 totaled $18.3 million, compared
with net income of $24.9 million for 2002. Return on average equity was 8.83%
for 2003, compared with 11.11% for 2002. Return on average assets was 0.81% for
2003, compared with 1.12% for 2002.
37
2003 results included $4.3 million, or $0.16 per diluted share, of non-tax
deductible charges in connection with the Company's pending merger with PFS, as
well as an after-tax gain of $1.6 million, or $0.06 per diluted share,
recognized on the sale of one of the Bank's branch offices to another financial
institution.
INTEREST INCOME. Interest income decreased $17.0 million, or 13.5%, to $109.0
million for 2003, compared to $126.0 million for 2002. Interest on loans
decreased $10.9 million, or 12.9%, to $73.3 million for 2003, compared to $84.2
million for 2002. This decrease was due to a $34.1 million decrease in the
average balance of the loan portfolio from 2002, to $1.2 billion for the year
ended December 31, 2003, and the decline in the average yield on the portfolio
to 5.96% for 2003, from 6.67% for 2002. The decline in yield was attributable to
cash flows from loan prepayments being replaced by new loans with lower market
yields and adjustable-rate loans repricing to lower current interest rates. The
majority of the Company's adjustable-rate loans adjust by a maximum of 2.00% per
year. The decline in the average balance of the loan portfolio was primarily due
to refinancings and prepayments of 1-4 family mortgage loans, partially offset
by growth in construction and commercial real estate loans.
Interest on investment and other securities and MBS available for sale decreased
$6.2 million, or 14.7%, to $35.6 million for 2003, compared to $41.8 million for
2002. This decrease was primarily attributable to a decline in the average yield
on the investment securities and MBS portfolio to 3.84% for 2003 from 4.70% for
2002, partially offset by an increase in the average balance of investment
securities and MBS available for sale to $928.3 million for 2003, compared with
an average balance of $888.1 million for 2002. The decline in yield was
attributable to the reinvestment of cash flows from the repayment and prepayment
of MBS and called or matured securities at lower market interest rates
throughout 2003, as well as related premium amortization and downward repricing
of variable rate investments.
INTEREST EXPENSE. Interest expense decreased $12.0 million, or 19.3%, to $50.4
million for 2003, compared to $62.4 million for 2002. The majority of the
decrease was attributable to interest expense on deposits, which decreased $10.9
million, or 33.7%, to $21.5 million for 2003, compared to $32.5 million for
2002. The average balance of interest-bearing checking, savings and money market
accounts increased $73.8 million, or 11.1%, for 2003 compared with 2002,
primarily as a result of focused sales efforts throughout the Company's retail
distribution network, while the average rate paid on these deposits decreased 76
basis points to 0.93% as a result of declining market interest rates. Average
non-interest bearing deposits grew $9.2 million, or 13.7%, to $76.2 million for
2003, compared with 2002. The average balance of certificates of deposit
declined $59.2 million, or 9.4%, for the year ended December 31, 2003, compared
with 2002, as a result of the Company's continued efforts to reduce reliance on
certificates as a primary funding vehicle and continue to promote core deposit
relationships, while the average rate paid on certificates decreased 80 basis
points to 2.57% due to declining market interest rates. The ratio of average
core deposits to total average deposits improved to 59.0% for 2003, from 53.9%
for 2002.
Interest on borrowed funds for 2003 decreased $1.1 million, or 3.7%, to $28.9
million, compared to $30.0 million for 2002. The average cost of borrowed funds
declined to 4.83% for 2003, from 5.10% for 2002, while average borrowings for
2003 increased to $597.0 million, from $588.0 million for 2002.
NET INTEREST INCOME. Net interest income decreased $5.0 million, or 7.9%, to
$58.6 million for 2003, compared to $63.6 million for 2002. The decrease was due
to the changes in interest income and interest expense described previously. See
also the "Average Balance Sheet" and "Rate/Volume Analysis" included in Item 1
of this report. Changes in earning asset yields and interest-bearing liability
costs reflect the sustained historically low interest rate environment including
additional rate reductions in 2003, as the Federal Reserve reduced the federal
funds target rate from 1.75% at January 1, 2002 to 1.00% at December 31, 2003.
Net interest spread, defined as the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities,
decreased 14 basis points to 2.41% in 2003, from 2.55% in 2002. This decrease
was due to a decrease in the yield on interest-earning assets to 5.05% for 2003,
from 5.86% in 2002, partially offset by a decrease in the cost of
interest-bearing liabilities to 2.64% from 3.31% for the same respective
periods. Earning asset yields declined faster than the cost of interest-bearing
liabilities as a result of the Company's asset sensitive interest rate risk
position, and the record level of refinancing and prepayment activity resulting
from historically low market interest rates. The net interest margin, defined as
net interest income divided by average total interest-earning assets, decreased
25 basis points to 2.71% in 2003, compared to 2.96% in 2002. The decline in net
interest margin was primarily attributable to the decline in earning asset
yields resulting from loan refinancings and prepayments of loans and MBS, with
resulting cash flows being reinvested at lower market rates.
PROVISION FOR LOAN LOSSES. As a result of stable loan portfolio size and asset
quality, the Company did not record a provision for loan losses during 2003,
compared to $1.3 million in provisions for 2002.
The provision for loan losses was based upon management's review and evaluation
of the size and composition of the loan portfolio, actual loan loss experience,
level of delinquencies, general market and economic conditions, detailed
analysis of individual loans for which full collectibility may not be assured,
and the existence and net realizable value of the collateral
38
and guarantees securing the loans. Total non-performing loans totaled $1.8
million, or 0.15% of loans at both December 31, 2003 and 2002. The allowance for
loan losses represented 1.04% of total loans, net of in-process loans, or 6.99
times non-performing loans at December 31, 2003, compared with 1.06% of total
loans, or 7.27 times non-performing loans at December 31, 2002. In management's
opinion, the allowance for loan losses, totaling $12.8 million, was adequate to
cover losses inherent in the portfolio at December 31, 2003.
NON-INTEREST INCOME. Non-interest income increased $3.2 million, or 48.3%, to
$9.7 million for 2003, from $6.5 million for 2002. The increase primarily was
due to a $2.4 million gain on the sale of one of the Bank's branch offices to
another financial institution, a $450,000 increase in fee and service charge
income compared with 2002, and a $300,000 increase in net gains on sales of
loans and securities compared with 2002. The increase in fee and service charge
income was a result of prepayment penalties on commercial mortgage loans, growth
in the assessable customer base and the implementation of new fee and service
charge levels in the second half of 2002, following a periodic review of fee
structures. The increase in net gains on sales of loans and securities was
primarily attributable to an increase in securities sales as a result of
interest rate risk management needs given the sustained historically low
interest rate environment. Securities sales are dependent on market conditions,
projections of future price performance and interest rate movements and interest
rate risk management and cash flow requirements.
NON-INTEREST EXPENSE. Non-interest expense increased $6.7 million, or 21.5%, to
$37.7 million for 2003, compared to $31.1 million for 2002. This increase was
primarily due to the incurrence in December 2003 of $4.3 million of merger-
related expenses, consisting of investment banking and legal fees and costs
under certain employee benefit agreements, in connection with the pending merger
with PFS. Through the closing of the transaction, additional investment banking
fees of $5.1 million as well as an undetermined amount of professional fees and
payments due under employment contracts and severance agreements are expected to
be incurred.
In addition, compensation and benefits expense increased $2.6 million for 2003
compared with 2002, primarily as a result of non-cash compensation expense
related to the DDFP and the Bank's Employee Stock Ownership Plan ("ESOP") as a
result of appreciation in the Company's stock price. For the year ended December
31, 2003, DDFP expense increased $1.5 million compared with 2002 and ESOP
expense increased $356,000 over 2002. The Company amended the structure and
operation of the DDFP effective October 1, 2003. As a result of the amendment,
no further changes in the fair value of the common stock held in the underlying
rabbi trust for the DDFP are required to be recognized as a periodic charge or
credit to compensation costs.
INCOME TAX EXPENSE. The increase in the Company's effective tax rate to 39.9%
for 2003, from 34.0% for 2002, was primarily attributable to the recognition of
$4.3 million in non-deductible merger-related charges in 2003.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002
AND DECEMBER 31, 2001
RESULTS OF OPERATIONS. For the year ended December 31, 2002, basic and diluted
earnings per share totaled $0.90 and $0.88, respectively, representing increases
of 7.9% and 7.4%, respectively, over basic and diluted earnings per share of
$0.84 and $0.82, respectively, for the year ended December 31, 2001. Net income
for 2002 totaled $24.9 million, an increase of $419,000, or 1.7%, compared with
net income of $24.5 million for 2001. Return on average equity improved to
11.11% for 2002, from 10.92% for 2001. Return on average assets was 1.12% for
2002, compared with 1.21% for 2001.
Fiscal 2002 results were adversely affected by two events precipitated by
alleged acts of fraud and/or misrepresentation. As previously reported on Form
8-K, the Company recorded an impairment charge totaling $1.2 million, or $0.04
per diluted share, net of tax, related to the liquidation of WorldCom, Inc.
corporate bonds. In addition, the Company substantially increased its provision
for loan losses during the year due to a $1.4 million charge-off on a
participation loan to an insurance premium financier. At December 31, 2002, both
of these items were fully resolved with no remaining related balances recorded
in the Company's consolidated financial statements.
INTEREST INCOME. Interest income decreased $7.6 million, or 5.7%, to $126.0
million for 2002, compared to $133.6 million for 2001. Interest on loans
decreased $5.5 million, or 6.1%, to $84.2 million for 2002, compared to $89.7
million for 2001. The average balance of the loan portfolio for 2002 increased
$43.5 million to $1.3 billion, from $1.2 billion for 2001, while the average
yield on the portfolio decreased to 6.67% for 2002, from 7.35% for 2001. The
decline in yield was attributable to cash flows from loan prepayments being
replaced by new loans with lower market yields and adjustable-rate loans
repricing to lower current interest rates. The majority of the Company's
adjustable-rate loans adjust by a maximum of 2.00% per year.
Interest on investment and other securities and MBS available for sale decreased
$2.1 million, or 4.8%, to $41.8 million for 2002, compared to $43.9 million for
2001. The average balance of investment securities and MBS available for sale
totaled
39
$888.1 million, with an average yield of 4.70% for 2002, compared with an
average balance of $735.6 million, with an average yield of 5.97% for 2001. The
decline in yield was attributable to the reinvestment of cash flows from the
repayment and prepayment of MBS and called or matured securities at lower market
interest rates throughout 2002, as well as the downward repricing of variable
rate investments.
INTEREST EXPENSE. Interest expense decreased $12.3 million, or 16.4%, to $62.4
million for 2002, compared to $74.7 million for 2001. Interest expense on
deposits decreased $14.8 million, or 31.3%, to $32.5 million for 2002, compared
to $47.2 million for 2001. The decreased interest expense on deposits was
primarily attributable to a reduction in interest paid on certificates of
deposit of $12.6 million. The average cost of certificates of deposit for 2002
was 3.37%, compared to 5.11% for 2001. The average balance of certificates of
deposit was $628.5 million for 2002, compared with $660.1 million for 2001. The
average balance of core deposits was $735.2 million for 2002, compared to $603.5
million for 2001. The average interest cost on interest-bearing core deposits
for 2002 was 1.69%, compared to 2.44% for 2001. In addition, non-interest
bearing accounts averaged $67.1 million for 2002, up from $53.4 million for
2001. Average core deposits to total average deposits improved to 53.9% for
2002, from 47.8% for 2001.
Interest on borrowed funds for 2002 increased $2.5 million, or 9.1%, to $30.0
million, compared to $27.5 million for 2001. The average interest cost of
borrowed funds declined to 5.10% for 2002, from 5.54% for 2001, while average
borrowings for 2002 totaled $588.0 million, compared with $495.7 million for
2001.
NET INTEREST INCOME. Net interest income increased $4.7 million, or 8.0%, to
$63.6 million for 2002, compared to $58.9 million for 2001. The increase was due
to the changes in interest income and interest expense described previously.
Changes in earning asset yields and interest-bearing liability costs reflect
downward interest rate movements throughout 2001 and 2002, as the Federal
Reserve moved to reduce the federal funds rate twelve times, from 6.5% at
January 1, 2001 to 1.25% at December 31, 2002. Net interest spread increased ten
basis points to 2.55% in 2002, from 2.45% in 2001. This increase was due to a
decrease in the cost of interest-bearing liabilities to 3.31% for 2002, from
4.38% in 2001, partially offset by a decrease in the yield on interest-earning
assets to 5.86%, from 6.83% for the same respective periods. The net interest
margin decreased five basis points to 2.96% in 2002, compared to 3.01% in 2001.
The decline in net interest margin is attributable to the rapid decline in
earning asset yields resulting from loan refinancings and prepayments of loans
and MBS, with resulting cash flows being reinvested at lower market rates. The
purchase of $25.0 million of Bank Owned Life Insurance ("BOLI") in June 2001,
contributed to earnings and return on equity growth but reduced interest-earning
assets and related net interest income, thereby adversely impacting net interest
margin. BOLI is classified in Other assets on the statement of financial
condition and related income is classified as non-interest income. Common stock
repurchases totaling $36.0 million during 2002 further reduced earning assets
and impacted net interest margin.
PROVISION FOR LOAN LOSSES. The provision for loan losses increased $660,000 to
$1.3 million for 2002, compared to $650,000 for 2001. The increased provision
was largely attributable to a $1.4 million charge against the allowance for loan
losses recorded in June 2002, relating 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 held no other insurance premium financing loans, nor did
it have any other loans similar to this loan wherein the primary collateral is a
surety bond.
Total non-performing loans totaled $1.8 million, or 0.15% of loans at December
31, 2002 and 2001. The allowance for loan losses represented 1.06% of total
loans, net of in-process loans, or 7.27 times non-performing loans at December
31, 2002, compared with 1.03% of total loans, or 6.99 times non-performing loans
at December 31, 2001.
NON-INTEREST INCOME. Non-interest income increased $2.1 million, or 46.9%, to
$6.5 million for 2002, from $4.5 million for 2001. The Company recorded fee and
service charge income of $3.9 million in 2002, compared with $2.4 million in
2001. The increase was a result of prepayment penalties on commercial mortgage
loans, growth in the assessable customer base and the implementation of new fee
and service charge levels in the second half of 2002, following a periodic
review of fee structures. Income attributable to the increase in cash surrender
value of BOLI, purchased in June 2001, amounted to $1.5 million for 2002,
compared with $791,000 for 2001.
NON-INTEREST EXPENSE. Non-interest expense increased $3.9 million, or 14.2%, to
$31.1 million for 2002, compared to $27.2 million for 2001. The increase was
attributable to distributions on preferred capital securities issued in November
2001, which totaled $2.0 million for 2002, compared with $194,000 for 2001. In
addition, compensation and benefits expense grew $1.9 million as a result of
increased healthcare and other benefit costs, including costs associated with
the retirement of the Company's former CEO in December 2002, and non-cash
compensation expense related to the Bank's ESOP and DDFP as a result of
appreciation in the Company's stock price.
40
INCOME TAX EXPENSE. On July 2, 2002, the State of New Jersey passed the Business
Tax Reform Act, which was retroactive to January 1, 2002. Among other things,
this legislation repealed the 3% Savings Institution Tax and imposed a 9%
Corporation Business Tax on savings institutions, as well as enacting new
Alternative Minimum Assessment rules on a corporation's gross receipts or gross
profits. Largely as a result of this legislation, the Company's effective tax
rate increased to 34.0% for 2002, from 31.0% for 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity is a measure of its ability to generate sufficient cash
flows to meet all of its current and future financial obligations and
commitments. The Company's primary sources of funds are deposits; proceeds from
principal and interest payments on loans and MBS; sales of loans, MBS and
investment securities available for sale; maturities or calls of investment
securities; and advances from the Federal Home Loan Bank of New York ("FHLB-NY")
and other borrowed funds. While maturities and scheduled amortization of loans
and MBS are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by interest rates, economic conditions, and
competition.
The primary investing activity of the Company is the origination of loans.
During 2003, 2002 and 2001, the Company originated loans in the amounts of
$736.4 million, $623.5 million and $486.6 million, respectively. The Company
also purchases loans, MBS and investment securities. Purchases of mortgage loans
totaled $29.8 million, $27.6 million and $19.1 million in 2003, 2002 and 2001,
respectively. Purchases of MBS totaled $586.8 million, $585.1 million and $549.1
million in 2003, 2002 and 2001, respectively. Purchases of investment securities
totaled $81.5 million, $75.8 million and $59.3 million for 2003, 2002 and 2001,
respectively.
The investing activities were funded primarily by principal repayments on loans
and MBS of $1.1 billion, $920.2 million and $545.7 million for 2003, 2002 and
2001, respectively. Additionally, proceeds from sales, calls and maturities of
mortgage-backed and investment securities totaling $319.3 million, $238.5
million and $407.8 million for 2003, 2002 and 2001, respectively, provided
additional liquidity. Liquidity was also provided by proceeds from sales of
loans totaling $67.1 million, $46.6 million and $46.6 million for 2003, 2002 and
2001, respectively.
The Company has several other sources of liquidity, including FHLB-NY advances.
At December 31, 2003, such advances totaled $125.5 million, of which none are
due in 2004. If necessary, the Company has additional borrowing capacity with
the FHLB-NY, including an available overnight line of credit of up to $50.0
million. The Company also had other borrowings that provided additional
liquidity, totaling $466.0 million at December 31, 2003, $71.0 million of which
are contractually due in 2004. Other sources of liquidity include unpledged
investment and mortgage-backed securities available for sale, with a market
value totaling $376.3 million at December 31, 2003.
The Company's primary uses of funds include the payment of common stock
dividends, payment of principal and interest on its debt obligations and
repurchases of common stock. First Sentinel's ability to pay dividends, service
its debt obligations and repurchase common stock is dependent, in large part,
upon receipt of dividends from the Bank. The Bank is subject to certain
restrictions which may limit its ability to pay dividends to First Sentinel. See
Item 1, "Business - Regulation and Supervision."
The Company anticipates that it will have sufficient funds available to meet its
current commitments. At December 31, 2003, the Company had commitments to
originate and purchase mortgage loans of $143.8 million. The Company is
obligated to pay $1.9 million under its lease agreements for branch and
administrative facilities, of which $464,000 is due in 2004. Certificates of
deposit scheduled to mature in one year or less totaled $376.1 million at
December 31, 2003. Based upon historical experience, management estimates that a
significant portion of such deposits will remain with the Company.
OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of its business to meet the financing needs of its customers.
These instruments involve, to varying degrees, elements of credit, interest rate
and liquidity risk in and are not recorded in the Company's consolidated
financial statements. The Company's off-balance sheet arrangements consist
primarily of lending commitments, operating lease commitments and letters of
credit.
Lending commitments include commitments to originate and purchase loans and
commitments to fund unused lines of credit. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may
41
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company's exposure to credit risk is
represented by the contractual amount of the instruments.
Operating lease commitments are obligations under various non-cancelable
operating leases on buildings and land used for office space and banking
purposes. The leases generally have rent escalation provisions based upon
certain defined indexes.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. The guarantees
generally extend for a term of up to one year and are fully collateralized. For
each guarantee issued, if the customer fails to perform or defaults on a payment
to the third party, the Company would have to perform under the guarantee.
Commitments under standby letters of credit, both financial and performance, do
not necessarily represent future cash requirements, in that these commitments
often expire without being drawn upon.
Borrowed funds include fixed-term borrowings from the Federal Home Loan Bank and
reverse repurchase agreements. The borrowings have defined terms and under
certain circumstances are callable at the option of the lender.
Subordinated debentures represent debentures issued by the Company to First
Sentinel Capital Trust I and II, which were formed in connection with the
issuance of preferred capital securities.
The following table shows the contractual obligations of the Company by
expected payment period as of December 31, 2003. Further discussion of these
commitments is included in Notes 9, 10 and 14 to the Consolidated Financial
Statements.
MORE
LESS THAN 1-3 3-5 THAN
CONTRACTUAL OBLIGATION TOTAL ONE YEAR YEARS YEARS 5 YEARS
- ----------------------------- -------- -------- ------- ------- -------
Lending commitments .......... $315,237 $315,237 $ -- $ -- $ --
Operating lease commitments .. 1,929 464 687 378 400
Standby letters of credit .... 1,316 429 137 750 --
Borrowed funds ............... 591,500 71,000 251,000 109,500 160,000
Subordinated debentures ...... 25,774 -- -- -- 25,774
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes presented herein have been
prepared in accordance with GAAP, which require the measurement of financial
position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money due to
inflation. The impact of inflation is reflected in the increased cost of the
Company's operations. Unlike most industrial companies, nearly all of the assets
and liabilities of the Company are monetary in nature. As a result, interest
rates have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
MARKET RISK
Market risk is the risk of loss from adverse changes in market rates and prices.
The Company's market risk arises primarily from interest rate risk inherent in
its lending, investment and deposit activities. The Company's profitability is
affected by fluctuations in interest rates. A sudden and substantial change in
interest rates may adversely impact the Company's earnings to the extent that
the interest rates borne by assets and liabilities do not change at the same
speed, to the same extent or on the same basis. To that end, management actively
monitors and manages its interest rate risk exposure.
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain balance sheet accounts,
determine the level of risk appropriate given the Company's business strategy,
operating
42
environment, capital and liquidity requirements and performance objectives, and
manage the risk consistent with the Board of Directors' approved guidelines.
Through such management, the Company seeks to minimize the vulnerability of its
operations to changes in interest rates. The Company's Board of Directors
reviews the Company's interest rate risk position quarterly. The Company's
Asset/Liability Committee is comprised of the Company's senior management under
the direction of the Board of Directors, with senior management responsible for
reviewing with the Board of Directors its activities and strategies, the effect
of those strategies on the Company's net interest income, the market value of
the Company's earning assets and costing liabilities, the effect that changes in
interest rates will have on the Company's financial condition and results of
operations and its exposure limits.
The Company utilizes the following strategies to manage interest rate risk: (1)
emphasizing the origination and retention of fixed-rate mortgage loans having
terms to maturity of not more than 22 years, adjustable-rate loans and consumer
loans consisting primarily of home equity loans and lines of credit; (2) selling
substantially all fixed-rate conforming mortgage loans with terms of thirty
years without recourse and on a servicing-retained basis; (3) investing
primarily in adjustable-rate and short average-life MBS, which may generally
bear lower yields as compared to longer-term investments, but which better
position the Company for increases in market interest rates, and holding these
securities as available for sale; and (4) investing in U.S. government and
agency securities that have call features which, historically, have
significantly decreased the duration of such securities. The Company currently
does not participate in hedging programs, interest rate swaps or other
activities involving the use of off-balance sheet derivative financial
instruments, but may do so in the future to mitigate interest rate risk.
The Company's interest rate sensitivity is monitored by management through the
use of an interest rate risk ("IRR") model which measures IRR by projecting the
change in net interest income ("NII") and the economic value of equity ("EVE")
over a range of interest rate scenarios. The EVE is defined as the current
market value of assets, minus the current market value of liabilities, plus or
minus the current value of off-balance sheet items.
The greater the potential change, positive or negative, in NII or EVE, the more
interest rate risk is assumed to exist within the institution. The following
table lists the Company's percentage change in NII and EVE assuming an immediate
increase of up to 200 basis points from the level of interest rates at December
31, 2003 and 2002, as calculated by the Company. The Company does not anticipate
a significant decline in interest rates from December 31, 2003 levels.
CHANGE IN INTEREST RATES PERCENTAGE CHANGE IN NII PERCENTAGE CHANGE IN EVE
IN BASIS POINTS -------------------------- --------------------------
(RATE SHOCK) 2003 2002 2003 2002
- -------------------------- ------------ ------------ ------------ ------------
+200 16 4 -4 4
+100 10 3 -1 1
Static -- -- -- --
Certain shortcomings are inherent in the methodology used in the above interest
rate risk measurements. Modeling changes in NII and EVE requires the making of
certain assumptions which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. In this regard,
the model presented assumes that the composition of the Company's interest
sensitive assets and liabilities existing at the beginning of a period remains
constant over the period being measured, assumes that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities and also
does not consider the Company's strategic plans. Accordingly, although the EVE
and NII models provide an indication of the Company's IRR exposure at a
particular point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest rates on
the Company's net interest income and will differ from actual results.
The results of the IRR analysis described above depict the Company's asset
sensitive position at December 31, 2003. This asset sensitivity is expected to
decline somewhat in the coming months, as management anticipates that near-term
cash flows from loan and MBS refinancing and prepayments will diminish. The
Company has managed its IRR position with a rising rate bias at December 31,
2003, as management believes the interest rate and economic cycle have bottomed.
Accordingly, IRR model results at December 31, 2003 under rising rate scenarios
are favorable. All results presented are within Board-approved risk management
limits.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Disclosure relating to market risk is included in Item 7 hereof.
43
ITEM 8. FINANCIAL STATEMENTS
FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share amounts)
December 31,
--------------------------
2003 2002
----------- -----------
ASSETS
Cash and due from banks ........................... $ 16,007 $ 21,695
Federal funds sold ................................ 59,800 44,250
----------- -----------
Total cash and cash equivalents ................ 75,807 65,945
Federal Home Loan Bank of New York
(FHLB-NY) stock, at cost ........................ 21,075 20,835
Investment securities available for sale,
at fair value .................................. 106,459 114,219
Mortgage-backed securities available for sale,
at fair value .................................. 722,794 790,562
Loans receivable, net ............................. 1,210,721 1,201,210
Interest and dividends receivable ................. 9,282 11,055
Premises and equipment, net ....................... 15,160 15,882
Core deposit intangibles .......................... 3,730 4,568
Other assets ...................................... 39,642 37,203
----------- -----------
Total assets ................................... $ 2,204,670 $ 2,261,479
=========== ===========
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits .......................................... $ 1,339,858 $ 1,387,986
Borrowed funds .................................... 591,500 596,663
Subordinated debentures ........................... 25,774 --
Advances by borrowers for taxes and insurance ..... 9,519 9,615
Other liabilities ................................. 10,445 30,643
----------- -----------
Total liabilities .............................. 1,977,096 2,024,907
----------- -----------
Commitments and contingencies (Note 14)
Company-obligated mandatorily redeemable
preferred capital securities of a
subsidiary trust holding solely junior
subordinated debentures of the Company .......... -- 25,000
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; authorized 10,000,000 shares;
issued and outstanding - none ................... -- --
Common stock, $.01 par value, 85,000,000 shares
authorized; 43,106,742 and 27,251,064 shares
issued and outstanding in 2003 and 43,106,742
and 27,444,098 shares issued and outstanding
in 2002 ......................................... 430 430
Paid-in capital ................................... 208,523 205,915
Retained earnings ................................. 166,902 161,453
Accumulated other comprehensive income ............ 4,059 9,776
Common stock acquired by the Employee
Stock Ownership Plan (ESOP) ..................... (8,486) (9,404)
Common stock acquired by the Recognition and
Retention Plan (RRP) ............................ (280) (1,032)
Treasury stock (14,748,818 and 14,586,591 common
shares in 2003 and 2002, respectively) .......... (150,571) (145,480)
Common stock acquired by the Directors' Deferred
Fee Plan (DDFP) (978,985 and 977,930 common
shares in 2003 and 2002, respectively) .......... (2,768) (2,412)
DDFP Transition Differential ...................... (7,674) (7,674)
Deferred compensation - DDFP ...................... 17,439 --
----------- -----------
Total stockholders' equity ................... 227,574 211,572
----------- -----------
Total liabilities and stockholders' equity ... $ 2,204,670 $ 2,261,479
=========== ===========
See accompanying notes to the consolidated financial statements.
44
FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
Year Ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
INTEREST INCOME:
Loans .................................. $ 73,333 $ 84,219 $ 89,678
Investment and other and mortgage-backed
securities available for sale ........ 35,626 41,783 43,907
----------- ----------- -----------
Total interest income ............... 108,959 126,002 133,585
----------- ----------- -----------
INTEREST EXPENSE:
Deposits:
NOW and money market .................. 4,621 7,725 9,654
Savings ............................... 2,267 3,543 3,790
Certificates of deposit ............... 14,645 21,189 33,764
----------- ----------- -----------
Total interest expense - deposits ... 21,533 32,457 47,208
Borrowed funds ......................... 28,860 29,964 27,476
----------- ----------- -----------
Total interest expense .............. 50,393 62,421 74,684
----------- ----------- -----------
Net interest income ................. 58,566 63,581 58,901
Provision for loan losses .............. -- 1,310 650
----------- ----------- -----------
Net interest income after provision
for loan losses ................... 58,566 62,271 58,251
----------- ----------- -----------
NON-INTEREST INCOME:
Fees and service charges ............... 4,342 3,892 2,416
Net gain on sales of loans
and securities ....................... 825 525 587
Income on Bank Owned Life
Insurance (BOLI) ..................... 1,563 1,499 791
Gain on sale of branch and deposits .... 2,442 -- --
Other, net ............................. 531 627 661
----------- ----------- -----------
Total non-interest income ........... 9,703 6,543 4,455
----------- ----------- -----------
NON-INTEREST EXPENSE:
Compensation and benefits .............. 21,152 18,542 16,648
Occupancy .............................. 2,449 2,259 2,255
Equipment .............................. 1,574 1,695 1,698
Advertising ............................ 802 983 1,062
Federal deposit insurance premium ...... 225 234 235
Amortization of core deposit
intangibles .......................... 838 843 848
Distributions on preferred
capital securities ................... 1,875 1,978 194
General and administrative ............. 4,507 4,524 4,265
Merger-related expense ................. 4,314 -- --
----------- ----------- -----------
Total non-interest expense .......... 37,736 31,058 27,205
----------- ----------- -----------
Income before income tax expense .... 30,533 37,756 35,501
Income tax expense ....................... 12,197 12,852 11,016
----------- ----------- -----------
Net income .......................... $ 18,336 $ 24,904 $ 24,485
=========== =========== ===========
Basic earnings per share ................. $ 0.71 $ 0.90 $ 0.84
=========== =========== ===========
Diluted earnings per share ............... $ 0.69 $ 0.88 $ 0.82
=========== =========== ===========
Weighted average shares
outstanding - Basic .................... 25,706,054 27,630,380 29,313,479
=========== =========== ===========
Weighted average shares
outstanding - Diluted .................. 26,698,962 28,401,420 29,998,256
=========== =========== ===========
- --------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
- --------------------------------------------------------------------------------
45
FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
ACCUMULATED
OTHER
COMPRE- COMMON COMMON COMMON DDFP DEFERRED TOTAL
HENSIVE STOCK STOCK STOCK TRANSITION COMPEN- STOCK-
COMMON PAID-IN RETAINED INCOME ACQUIRED ACQUIRED TREASURY ACQUIRED DIFFER- SATION HOLDERS'
STOCK CAPITAL EARNINGS (LOSS) BY ESOP BY RRP STOCK BY DDFP ENTIAL DDFP EQUITY
==================================================================================================
Balance at December 31, 2000 .. $430 $203,950 $131,773 $(8,534) $(11,238) $(2,788) $(89,508) $(1,781) $(7,674) $ -- $214,630
Comprehensive income:
Net income for the year
ended December 31, 2001 ... -- -- 24,485 -- -- -- -- -- -- -- 24,485
Other comprehensive income:
Unrealized holding gains
arising during the period
(net of tax of $6,014) .. -- -- -- 11,115 -- -- -- -- -- -- 11,115
Reclassification adjustment
for gains in net income
(net of tax of $(218)) .. -- -- -- (403) -- -- -- -- -- -- (403)
---------
Total comprehensive income .... 35,197
---------
Cash dividends declared
($0.30 per share) ........... -- -- (8,861) -- -- -- -- -- -- -- (8,861)
Exercise of stock options ..... -- -- (238) -- -- -- 1,164 -- -- -- 926
Tax benefit on stock options
and awards .................. -- 394 -- -- -- -- -- -- -- -- 394
Purchase and retirement of
common stock ................ -- (110) -- -- -- -- -- -- -- -- (110)
Purchases of treasury stock ... -- -- -- -- -- -- (22,227) -- -- -- (22,227)
Increase in cost of DDFP, net . -- -- -- -- -- -- -- (351) -- -- (351)
Amortization of RRP ........... -- -- -- -- -- 878 -- -- -- -- 878
ESOP expense .................. -- 310 -- -- 917 -- -- -- -- -- 1,227
----------------------------------------------------------------------------------------------------
Balance at December 31, 2001 .. 430 204,544 147,159 2,178 (10,321) (1,910) (110,571) (2,132) (7,674) -- 221,703
Comprehensive income:
Net income for the year
ended December 31, 2002 ... -- -- 24,904 -- -- -- -- -- -- -- 24,904
Other comprehensive income:
Unrealized holding gains
arising during the period
(net of tax of $4,292) .. -- -- -- 7,921 -- -- -- -- -- -- 7,921
Reclassification adjustment
for gains in net income
(net of tax of $(174)) .. -- -- -- (323) -- -- -- -- -- -- (323)
---------
Total comprehensive income .... 32,502
---------
Cash dividends declared
($0.36 per share) ........... -- -- (10,068) -- -- -- -- -- -- -- (10,068)
Exercise of stock options ..... -- -- (542) -- -- -- 846 -- -- -- 304
Tax benefit on stock options
and awards .................. -- 1,181 -- -- -- -- -- -- -- -- 1,181
Purchase and retirement of
common stock ................ -- (273) -- -- -- -- -- -- -- -- (273)
Purchases of treasury stock ... -- -- -- -- -- -- (35,755) -- -- -- (35,755)
Increase in cost of DDFP, net . -- -- -- -- -- -- -- (280) -- -- (280)
Amortization of RRP ........... -- -- -- -- -- 878 -- -- -- -- 878
ESOP expense .................. -- 463 -- -- 917 -- -- -- -- -- 1,380
----------------------------------------------------------------------------------------------------
Balance at December 31, 2002 .. 430 205,915 161,453 9,776 (9,404) (1,032) (145,480) (2,412) (7,674) -- 211,572
Comprehensive income:
Net income for the year
ended December 31, 2003 ... -- -- 18,336 -- -- -- -- -- -- -- 18,336
Other comprehensive income:
Unrealized holding losses
arising during the period
(net of tax of $(2,752)). -- -- -- (5,166) -- -- -- -- -- -- (5,166)
Reclassification adjustment
for gains in net income
(net of tax of $(297)) .. -- -- -- (551) -- -- -- -- -- -- (551)
---------
Total comprehensive income .... 12,619
---------
Cash dividends declared
($0.42 per share) ........... -- -- (10,961) -- -- -- -- -- -- -- (10,961)
Exercise of stock options ..... -- (53) (1,926) -- -- -- 7,222 -- -- -- 5,243
Tax benefit on stock options
and awards .................. -- 1,916 -- -- -- -- -- -- -- -- 1,916
Purchase and retirement of
common stock ................ -- (237) -- -- -- -- -- -- -- -- (237)
Purchases of treasury stock ... -- -- -- -- -- -- (12,429) -- -- -- (12,429)
Increase in cost of DDFP, net . -- -- -- -- -- -- -- (356) -- 17 (339)
Amendment of DDFP ............. -- -- -- -- -- -- -- -- -- 17,422 17,422
RRP shares granted ............ -- 96 -- -- -- (212) 116 -- -- -- --
Amortization of RRP ........... -- 68 -- -- -- 964 -- -- -- -- 1,032
ESOP expense .................. -- 818 -- -- 918 -- -- -- -- -- 1,736
----------------------------------------------------------------------------------------------------
Balance at December 31, 2003 .. $430 $208,523 $166,902 $4,059 $(8,486) $(280) $(150,571) $(2,768) $(7,674) $17,439 $227,574
====================================================================================================
See accompanying notes to the consolidated financial statements.
46
FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Year Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................................................. $18,336 $24,904 $24,485
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment ............................................... 1,415 1,416 1,353
Amortization of core deposit intangibles ............................................. 838 843 848
ESOP expense ......................................................................... 1,736 1,380 1,227
Amortization of RRP .................................................................. 1,032 878 878
DDFP expense ......................................................................... 3,298 1,799 1,271
Income on BOLI ....................................................................... (1,563) (1,499) (791)
Provision for loan losses ............................................................ -- 1,310 650
Provision for losses on real estate owned ............................................ -- -- 3
Net gain on sales of loans and securities ............................................ (825) (525) (587)
Loans originated for sale ............................................................ (67,131) (41,655) (51,968)
Proceeds from sales of mortgage loans available for sale ............................. 67,138 46,587 46,625
Net (gain) loss on sales of real estate owned ........................................ (79) 10 (188)
Net gain on sale of branch and deposits .............................................. (2,442) -- --
Net loss on sales of premises and equipment .......................................... -- -- 102
Net amortization of premiums and accretion of discounts and deferred fees ............ 6,813 5,022 3,194
Decrease in interest and dividends receivable ........................................ 1,773 984 1,442
Tax benefit on stock options and awards .............................................. 1,916 1,181 394
(Decrease) increase in other liabilities ............................................. (1,110) (526) 878
(Increase) decrease in other assets .................................................. (2,090) 5,732 (5,886)
--------- --------- ---------
Net cash provided by operating activities ........................................ 29,055 47,841 23,930
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales, calls and maturities of investment securities available for sale ... 89,481 71,440 193,199
Proceeds from sales of mortgage-backed securities available for sale .................... 229,858 167,067 214,637
Proceeds from sales of real estate owned ................................................ 235 157 785
Purchases of investment securities available for sale ................................... (81,496) (75,807) (59,254)
Purchases of mortgage-backed securities available for sale .............................. (586,769) (585,059) (549,076)
Principal payments on mortgage-backed securities ........................................ 409,103 275,482 146,924
Origination of loans .................................................................... (669,297) (581,893) (434,666)
Purchases of mortgage loans ............................................................. (29,816) (27,633) (19,099)
Principal repayments on loans ........................................................... 690,109 644,674 398,735
Purchase of FHLB-NY stock ............................................................... (240) (294) (898)
Purchase of BOLI ........................................................................ -- -- (25,000)
Purchases of premises and equipment ..................................................... (1,032) (1,284) (1,563)
Proceeds from sales of premises and equipment ........................................... 738 -- 186
--------- --------- ---------
Net cash provided by (used in) investing activities .............................. 50,874 (113,150) (135,090)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Stock options exercised ................................................................. 5,243 304 926
Cash dividends paid ..................................................................... (10,961) (10,068) (8,861)
Net proceeds from issuance of preferred capital securities .............................. -- -- 24,171
Sale of deposits ........................................................................ (36,812) -- --
Net (decrease) increase in deposits ..................................................... (9,273) 72,722 95,928
Net decrease in short-term borrowed funds ............................................... -- -- (25,000)
Proceeds from borrowed funds ............................................................ 55,000 117,000 325,000
Repayment of borrowed funds ............................................................. (60,163) (66,151) (260,141)
Net (decrease) increase in advances by borrowers for taxes and insurance ................ (96) (120) 581
Increase in cost of DDFP, net ........................................................... (339) (280) (351)
Purchases of treasury stock ............................................................. (12,429) (35,755) (22,227)
Purchase and retirement of common stock ................................................. (237) (273) (110)
--------- --------- ---------
Net cash (used in) provided by financing activities .............................. (70,067) 77,379 129,916
--------- --------- ---------
Net increase in cash and cash equivalents ........................................ 9,862 12,070 18,756
Cash and cash equivalents at beginning of year ............................................ 65,945 53,875 35,119
--------- --------- ---------
Cash and cash equivalents at end of year .................................................. $ 75,807 $ 65,945 $ 53,875
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest .............................................................................. $ 51,203 $ 62,147 $ 75,543
Income taxes .......................................................................... 5,300 9,863 16,377
Non-cash investing and financing activities for the year:
Increase in subordinated debentures ................................................... 25,774 -- --
Increase in investment in unconsolidated subsidiary trusts ............................ 774 -- --
Decrease in preferred capital securities .............................................. (25,000) -- --
Transfer of loans to real estate owned ................................................ 84 197 385
========= ========= =========
See accompanying notes to the consolidated financial statements.
47
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the significant accounting policies used in
preparation of the accompanying consolidated financial statements of First
Sentinel Bancorp, Inc. and Subsidiaries (the "Company").
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements are comprised of the accounts of the
Company and its wholly-owned subsidiaries, First Sentinel Capital Trust I, First
Sentinel Capital Trust II, and First Savings Bank (the "Bank"); the Bank's
wholly-owned subsidiaries, Sentinel Investment Corp. and FSB Financial LLC; and
Sentinel Investment Corp.'s majority-owned subsidiary, 1000 Woodbridge Center
Drive, Inc. First Sentinel Capital Trust I and First Sentinel Capital Trust II
were deconsolidated at December 31, 2003. All significant intercompany accounts
and transactions have been eliminated in consolidation.
(B) BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the allowance for loan losses and
the valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowance for
loan losses, management generally obtains independent appraisals for significant
properties.
(C) COMPREHENSIVE INCOME
Comprehensive income is divided into net income and other comprehensive income.
Other comprehensive income includes items recorded directly to equity, such as
unrealized gains and losses on securities available for sale.
Comprehensive income is presented in the consolidated statements of
stockholders' equity.
(D) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, amounts due from depository
institutions and federal funds sold. Generally, federal funds sold are sold for
a one-day period.
(E) INVESTMENT AND MORTGAGE-BACKED SECURITIES
Management determines the appropriate classification of investment and
mortgage-backed securities as either available for sale, held to maturity, or
trading at the purchase date. Securities available for sale include debt,
mortgage-backed and marketable equity securities that are held for an indefinite
period of time and may be sold in response to changing market and interest rate
conditions. These securities are reported at fair value with unrealized gains
and losses, net of tax, included as a separate component of stockholders'
equity. Upon realization, such gains and losses are included in earnings using
the specific identification method.
Trading account securities are adjusted to market value through earnings. Gains
and losses from adjusting trading account securities to market value and from
the sale of these securities are included in Non-interest Income.
Investment securities and mortgage-backed securities, other than those
designated as available for sale or trading, are carried at amortized historical
cost and consist of those securities for which there is a positive intent and
ability to hold to maturity. All securities are adjusted for amortization of
premiums and accretion of discounts using the level-yield method over the
estimated lives of the securities.
(F) FEDERAL HOME LOAN BANK OF NEW YORK STOCK
The Bank, as a member of the FHLB-NY, is required to hold shares of capital
stock in the FHLB-NY in an amount equal to the greater of 1% of the Bank's
outstanding balance of residential mortgage loans or 5% of its outstanding
advances from the FHLB-NY.
(G) LOANS RECEIVABLE, NET
Loans receivable, other than loans held for sale, are stated at the unpaid
principal balance, net of premiums, unearned discounts, net deferred loan
origination and commitment fees, and the allowance for loan losses.
Loans are classified as non-accrual when they are past due 90 days or more as to
principal or interest, or where reasonable doubt exists as to timely
collectibility. If,
48
however, a loan meets the above criteria, but a current appraisal of the
property indicates that the total outstanding balance is less than 55% of the
appraised value and the loan is in the process of collection, the loan is not
classified as non-accrual. At the time a loan is placed on non-accrual status,
previously accrued and uncollected interest is reversed against interest income.
Interest received on non-accrual loans is generally credited to interest income
for the current period. If principal and interest payments are brought
contractually current and future collectibility is reasonably assured, loans are
returned to accrual status. Discounts are accreted and premiums amortized to
income using the level-yield method over the estimated lives of the loans. Loan
fees and certain direct loan origination costs are deferred, and the net fee or
cost is recognized in interest income using the level-yield method over the
contractual life of the individual loans, adjusted for actual prepayments.
The Company has defined the population of impaired loans to be all non-accrual
commercial real estate, multi-family and construction loans. Impaired loans are
individually assessed to determine that the loan's carrying value is not in
excess of the fair value of the collateral or the present value of the loan's
expected future cash flows. Smaller balance homogeneous loans that are
collectively evaluated for impairment, such as residential mortgage loans and
consumer loans, are specifically excluded from the impaired loan portfolio.
Income recognition policies for impaired loans are the same as non-accrual
loans.
Loans held for sale are carried at the lower of cost or market using the
aggregate method. Valuation adjustments, if applicable, are reflected in current
operations. Gains and losses on sales are recorded using the specific
identification method. Management determines the appropriate classification of
loans as either held for portfolio or held for sale at origination, in
conjunction with the Company's overall asset/liability management strategy.
The majority of the Company's loans are secured by real estate in the State of
New Jersey. Accordingly, the collectibility of a substantial portion of the
carrying value of the Company's loan portfolio and real estate owned is
susceptible to changes in market conditions in New Jersey.
(H) ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is based on management's evaluation of the
adequacy of the allowance, including an assessment of known and inherent risks
in the 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.
Additions to the allowance arise from charges to operations through the
provision for loan losses or from the recovery of amounts previously charged
off. The allowance is reduced by loan charge-offs.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions in the Company's market area; size and composition of the loan
portfolio; review of individual loans for adverse situations; actual delinquency
and loan loss experience; changes in the estimated net realizable value of
underlying collateral and guarantees; and economic, operating, regulatory and
other conditions beyond the Company's control. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. 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.
(I) REAL ESTATE OWNED, NET
Real estate owned is recorded at the fair value at the date of acquisition, with
a charge to the allowance for loan losses for any excess of cost over fair
value. Subsequently, real estate owned is carried at the lower of cost or fair
value, as determined by current appraisals, less estimated selling costs.
Certain costs incurred in preparing properties for sale are capitalized, while
expenses of holding foreclosed properties are charged to operations as incurred.
(J) CORE DEPOSIT INTANGIBLES
Core deposit intangible premiums arising from the acquisition of deposits are
amortized to expense over the expected life of the acquired deposit base using
the straight-line method. Management periodically reviews the potential
impairment of the core deposit intangible asset on a non-discounted cash flow
basis to assess recoverability. If the estimated future cash flows are projected
to be less than the carrying amount, an impairment write-down, representing the
carrying amount of the intangible asset which exceeds the present value of the
estimated expected future cash flows, would be recorded as a period expense.
Amortization of core deposit intangibles for the years ended December 31, 2003,
2002 and 2001, was $838,000, $843,000 and $848,000, respectively. Annual
amortization for each of the subsequent 4.5 years is projected to approximate
$838,000 per year.
49
(K) BOLI
BOLI is accounted for using the cash surrender value method and is recorded at
its realizable value. The change in net asset value is included in non-interest
income.
(L) PREMISES AND EQUIPMENT
Premises and equipment, including leasehold improvements, are stated at cost,
less accumulated amortization and depreciation. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives,
ranging from three years to forty years depending on the asset or lease. Repair
and maintenance items are expensed and improvements are capitalized. Upon
retirement or sale, any gain or loss is recorded to operations.
(M) INCOME TAXES
The Company accounts for income taxes according to the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using the enacted tax rates applicable to taxable income for the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. Valuation allowances are
established against certain deferred tax assets when the collectibility of the
deferred tax assets cannot be reasonably assured. Increases or decreases in
valuation allowances are charged or credited to income tax expense (benefit).
(N) EMPLOYEE BENEFIT PLANS
Pension plan costs, based on actuarial computation of current and future
benefits for employees, are charged to expense and are funded based on the
maximum amount that can be deducted for Federal income tax purposes.
The Company accrues the expected cost of providing health care and other
benefits to employees subsequent to their retirement during the estimated
service periods of the employees.
The Company applies the "intrinsic value based method" as described in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations in accounting for its stock-based
compensation. No employee compensation cost for stock options is reflected in
net income, as all options granted under the Company's stock option plans had
exercise prices greater than or equal to the market value of the underlying
common stock on the date of grant. Stock awarded to employees under the
Company's Recognition and Retention Plan is expensed by the Company over the
awards' vesting period based upon the fair market value of the stock on the date
of the grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions for stock-based compensation pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based
Compensation," amended by SFAS No. 148, "Accounting for Stock-based Compensation
- - Transition and Disclosures" (in thousands, except per share data):
2003 2002 2001
--------------------------------------
Net income, as reported ................ $18,336 $24,904 $24,485
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects (RRP awards) ....... 671 571 571
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all options
and RRP awards, net of related
tax effects ............................ 696 1,328 1,313
--------------------------------------
Pro forma net income ................... $18,311 $24,147 $23,743
======================================
EARNINGS PER SHARE:
Basic - as reported .................... $0.71 $0.90 $0.84
Basic - pro forma ...................... 0.71 0.87 0.81
Diluted - as reported .................. $0.69 $0.88 $0.82
Diluted - pro forma .................... 0.69 0.85 0.79
Stock earned under the Bank's ESOP is expensed at the then current fair market
value when shares are committed to be released.
50
(O) EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income by the daily
average number of common shares outstanding during the period. Diluted earnings
per share is computed similarly to basic earnings per share except that the
denominator is increased to include the number of additional common shares that
would have been outstanding if all potential dilutive common shares were issued
utilizing the treasury stock method. All share amounts exclude unallocated
shares held by the ESOP.
(Dollars in thousands, except per share data):
2003 2002 2001
----------- ----------- -----------
Net income $ 18,336 $ 24,904 $ 24,485
=========== =========== ===========
Basic weighted average
common shares outstanding 25,706,054 27,630,380 29,313,479
Plus:
Dilutive DDFP shares 244,746 -- --
Dilutive stock options 720,417 705,621 611,853
Dilutive RRP awards 27,745 65,419 72,924
----------- ----------- -----------
Diluted weighted average
common shares outstanding 26,698,962 28,401,420 29,998,256
=========== =========== ===========
Net income per common share:
Basic $ 0.71 $ 0.90 $ 0.84
Diluted 0.69 0.88 0.82
51
- --------------------------------------------------------------------------------
(2) PENDING MERGER
On December 22, 2003, the Company entered into a definitive agreement to merge
into Provident Financial Services, Inc. ("PFS") in a cash and stock transaction
valued at approximately $642.0 million. Under the terms of the agreement, 60% of
the Company's common stock will be converted into PFS stock and the remaining
40% will be converted into cash. The Company's stockholders will have the option
to receive for each share of the Company's common stock held either 1.092 shares
of PFS common stock, $22.25 of cash, or some combination thereof, subject to an
election and allocation procedure as set forth in the merger agreement. The
merger agreement has been approved by the directors of both PFS and the Company.
The transaction, which is expected to close in June 2004, is subject to
customary closing conditions, including regulatory approvals and the approval of
the Company's shareholders and PFS's shareholders. The Merger Agreement requires
the Company to pay PFS a termination fee of $24.0 million if the Agreement is
terminated under certain circumstances following the Company's receipt of a
superior acquisition proposal.
At December 31, 2003, the Company had incurred professional fees and costs
amounting to $4.3 million directly related to the merger agreement, comprised of
investment banking and legal fees of $1.3 million and costs under certain
employee benefit agreements of $3.0 million. (See Note 13.)
52
(3) INVESTMENT SECURITIES
A summary of investment securities at December 31, 2003 and 2002 is as follows
(in thousands):
2003
-----------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
INVESTMENT SECURITIES AVAILABLE FOR SALE
U.S. Government and Agency obligations ............... $ 52,915 $ 322 $ (429) $ 52,808
State and municipal obligations ...................... 14,135 868 (148) 14,855
Corporate obligations ................................ 26,785 1,185 (518) 27,452
Equity securities .................................... 11,187 550 (393) 11,344
---------- ---------- ---------- ----------
Total investment securities available for sale ... $ 105,022 $ 2,925 $ (1,488) $ 106,459
========== ========== ========== ==========
2002
-----------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---------- ---------- ---------- ----------
Investment Securities Available For Sale
U.S. Government and Agency obligations ............... $ 53,904 $ 1,133 $ -- $ 55,037
State and municipal obligations ...................... 11,811 848 -- 12,659
Corporate obligations ................................ 35,418 1,499 (1,497) 35,420
Equity securities .................................... 10,953 420 (270) 11,103
---------- ---------- ---------- ----------
Total investment securities available for sale ... $ 112,086 $ 3,900 $ (1,767) $ 114,219
========== ========== ========== ==========
53
Gross unrealized losses and the estimated market value of investment securities
available for sale aggregated by security category and length of time that
individual securities have been in a continuous unrealized loss position at
December 31, 2003 are as follows (in thousands):
Less than 12 months 12 months or longer Total
------------------------ ------------------------ ------------------------
Estimated Estimated Estimated
market Unrealized market Unrealized market Unrealized
value losses value losses value losses
---------- ---------- ---------- ---------- ---------- ----------
U.S. government and Agency obligations $ 24,529 $ (429) $ -- $ -- $ 24,529 $ (429)
State and municipal obligations 3,197 (148) -- -- 3,197 (148)
Corporate obligations 3,463 (31) 3,980 (487) 7,443 (518)
---------- ---------- ---------- ---------- ---------- ----------
Subtotal-Debt securities 31,189 (608) 3,980 (487) 35,169 (1,095)
Equity securities 177 -- 3,608 (393) 3,785 (393)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired investment securities $ 31,366 $ (608) $ 7,588 $ (880) $ 38,954 $ (1,488)
========== ========== ========== ========== ========== ==========
The unrealized losses on debt securities were caused by interest rate increases.
The contractual terms of these investments do not permit the issuer to settle
the securities at a price less than the amortized cost of the investment. The
corporate obligations consist of trust preferred and debt issuances of other
financial institutions, all of which carry investment grade debt ratings with
the exception of one $1.3 million issue which is unrated due to the small size
and limited liquidity of the issuance. This investment is in a $214,000
unrealized loss position at December 31, 2003, and has been in a continuous loss
position for more than twelve months. The Company monitors the credit quality of
all corporate debt issuers. Because the declines in estimated market value are
attributable to changes in interest rates and not credit quality, and because
the Company has the ability to hold these investments until a market price
recovery or maturity, these investments are not considered other than
temporarily impaired.
The unrealized loss on equity securities relates to holdings of FHLMC
variable-rate preferred stock. Because the declines in estimated market value
are attributable to changes in interest rates and not credit quality, and
because the Company has the ability to hold these investments until a market
price recovery, these investments are not considered other than temporarily
impaired.
54
The cost and estimated fair value of debt investment securities at December 31,
2003, by contractual maturity, are shown below. Expected maturities may differ
from contractual maturities because issuers may have the right to call or repay
obligations at par value without prepayment penalties.
Estimated
Amortized market
INVESTMENT SECURITIES AVAILABLE FOR SALE cost value
------- -------
Due in:
Less than one year .......................... $ 3,325 $ 3,317
One to five years ........................... 54,772 55,667
Five to ten years ........................... 20,855 21,499
Greater than ten years ...................... 14,883 14,632
------- -------
$93,835 $95,115
======= =======
The realized gross gains and losses from sales are as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
2003 2002 2001
------- ------- -------
Gross realized gains .......................... $ 1,126 $ 1,168 $ 1,061
Gross realized losses ......................... (128) (2,830) (696)
------- ------- -------
$ 998 $(1,662) $ 365
======= ======= =======
Investment securities with an amortized cost of $7.0 million at December 31,
2003, are pledged as collateral for other borrowings. Pursuant to a collateral
agreement with the FHLB-NY, all otherwise unpledged, qualifying investment
securities, including those available for sale, are pledged to secure advances
from the FHLB-NY (see Note 9).
55
(4) MORTGAGE-BACKED SECURITIES
A summary of mortgage-backed securities at December 31, 2003 and 2002 is as
follows (in thousands):
2003
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
FHLMC ....................................... $ 228,283 $ 3,247 $ (206) $ 231,324
GNMA ........................................ 15,134 525 -- 15,659
FNMA ........................................ 388,819 2,626 (1,635) 389,810
Collateralized mortgage obligations ......... 85,740 512 (251) 86,001
---------- ---------- ---------- ----------
Total mortgage-backed securities
available for sale .................... $ 717,976 $ 6,910 $ (2,092) $ 722,794
========== ========== ========== ==========
2002
--------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
---------- ---------- ---------- ----------
Mortgage-Backed Securities Available For Sale
FHLMC ....................................... $ 327,450 $ 6,263 $ (7) $ 333,706
GNMA ........................................ 29,615 1,086 -- 30,701
FNMA ........................................ 300,668 4,746 (27) 305,387
Collateralized mortgage obligations ......... 119,941 911 (84) 120,768
---------- ---------- ---------- ----------
Total mortgage-backed securities
available for sal$ .................... $ 777,674 $ 13,006 $ (118) $ 790,562
========== ========== ========== ==========
Collateralized mortgage obligations ("CMOs") issued by FHLMC, FNMA, GNMA and
private interests amounted to $50.7 million, $27.8 million, $45,000 and $7.5
million, respectively, at December 31, 2003, and $64.9 million, $37.2 million,
$1.8 million and $16.8 million, respectively, at December 31, 2002. The
privately-issued CMOs have generally been underwritten by large investment
banking firms, with the timely payment of principal and interest on these
securities supported (credit enhanced) in varying degrees by either insurance
issued by a financial guarantee insurer, letters of credit or subordination
techniques. Substantially all such securities are "AAA" rated by one or more
nationally recognized securities rating agencies. The privately-issued CMOs are
subject to certain credit-related risks normally not associated with U.S.
Government and U.S. Government-sponsored Agency CMOs. Among such risks is the
limited loss protection generally provided by the various forms of credit
enhancements, as losses in excess of certain levels are not protected.
Furthermore, the credit enhancement itself is subject to the credit worthiness
of the enhancer. Thus, in the event a credit enhancer does not fulfill its
obligations, the CMO holder could be subject to risk of loss similar to a
purchaser of a whole loan pool. Management believes that the credit enhancements
are adequate to protect the Company from losses.
Gross unrealized losses and the estimated market value of mortgage-backed
securities available for sale aggregated by issuer and length of time that
individual securities have been in a continuous unrealized loss position at
December 31, 2003 are as follows (in thousands):
Less than 12 months 12 months or longer Total
------------------------ ------------------------ ------------------------
Estimated Estimated Estimated
market Unrealized market Unrealized market Unrealized
value losses value losses value losses
---------- ---------- ---------- ---------- ---------- ----------
FHLMC $ 40,156 $ (206) $ -- $ -- $ 40,156 $ (206)
FNMA 159,464 (1,635) -- -- 159,464 (1,635)
CMOs 40,621 (251) -- -- 40,621 (251)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired
mortgage-backed securities $ 240,241 $ (2,092) $ -- $ -- $ 240,241 $ (2,092)
========== ========== ========== ========== ========== ==========
56
The unrealized losses on mortgage-backed securities were caused by interest rate
increases. The contractual cash flows of these securities are predominantly
guaranteed by U.S. Government-sponsored agencies. It is expected that the
securities would not be settled at a price less than the par value of the
investment. Because the declines in estimated market value are attributable to
changes in interest rates and not credit quality, and because the Company has
the ability to hold these investments until a market price recovery or maturity,
these investments are not considered other than temporarily impaired.
The realized gross gains and losses from sales are as follows (in thousands):
Year Ended December 31,
----------------------------------------
2003 2002 2001
---------- ---------- ----------
Gross realized gains ................ $ 1,914 $ 2,325 $ 778
Gross realized losses ............... (2,064) (166) (523)
---------- ---------- ----------
$ (150) $ 2,159 $ 255
========== ========== ==========
Mortgage-backed securities with an amortized cost of $601,000 at December 31,
2003, were pledged as collateral to secure deposits held for municipalities
within the State of New Jersey. Mortgage-backed securities with an amortized
cost of $439.5 million at December 31, 2003, were pledged as collateral for
other borrowings. Pursuant to a collateral agreement with the FHLB-NY, all
otherwise unpledged, qualifying mortgage-backed securities are pledged to secure
advances from the FHLB-NY (see Note 9). The contractual maturities of
mortgage-backed securities generally exceed ten years, however the effective
lives are expected to be shorter due to prepayments of the underlying mortgages.
(5) LOANS RECEIVABLE, NET
A summary of loans receivable at December 31, 2003 and 2002 is as follows (in
thousands):
LOANS RECEIVABLE 2003 2002
----------- -----------
Real estate mortgages:
One-to-four family ........................... $ 755,671 $ 835,593
Multi-family and commercial .................. 212,072 177,353
Home equity .................................. 113,840 110,835
----------- -----------
1,081,583 1,123,781
Real estate construction ........................ 205,244 139,228
Other ........................................... 9,967 12,537
----------- -----------
Total loans receivable .................. 1,296,794 1,275,546
----------- -----------
Loans in process ................................ (74,557) (62,137)
Net unamortized premium and deferred
origination costs ............................. 1,252 631
Allowance for loan losses ....................... (12,768) (12,830)
----------- -----------
(86,073) (74,336)
----------- -----------
Loans receivable, net ................... $ 1,210,721 $ 1,201,210
=========== ===========
Loans receivable included loans held for sale totaling $777,000 and $563,000 at
December 31, 2003 and 2002, respectively.
The Company serviced loans for others in the amount of $120.0 million, $106.1
million and $96.1 million at December 31, 2003, 2002 and 2001, respectively.
Related servicing income earned on loans serviced for others totaled $261,000,
$204,000 and $193,000 for the years ended December 31, 2003, 2002, and 2001,
respectively.
Loans in the amount of $3.2 million and $3.7 million were outstanding to
directors and executive officers of the Bank and their related interests at
December 31, 2003 and 2002, respectively. During 2003, new extensions of credit
totaled $250,000 while repayments by directors and executive officers of the
Bank totaled $757,000. New extensions of credit consisted of one loan secured by
residential property. The remaining loans to directors and executive officers of
the Bank and their related interests consisted primarily of loans secured by
mortgages on residential and commercial properties.
The Company has pledged, under a blanket assignment, its unpledged and
qualifying mortgage portfolio to secure advances from the FHLB-NY (see Note 9).
57
A summary of non-performing assets at December 31, 2003 and 2002 is as follows
(in thousands):
2003 2002
-------- --------
Non-accrual loans .................................... $ 1,193 $ 1,541
Loans 90 days or more delinquent and still accruing .. 634 223
-------- --------
Total non-performing loans ....................... 1,827 1,764
Real estate owned (included in Other assets) ......... -- 72
-------- --------
Total non-performing assets ...................... $ 1,827 $ 1,836
======== ========
At December 31, 2003 and 2002, impaired loans totaled $807,000 and $518,000,
respectively, for which allocations to the allowance for loan losses of $192,000
and $90,000 were identified at December 31, 2003 and 2002, respectively. The
average balance of impaired loans during 2003, 2002 and 2001 was $387,000,
$306,000 and $195,000, respectively.
If interest income on non-accrual and impaired loans had been current in
accordance with their original terms, approximately $62,000, $118,000 and
$130,000 of interest income for the years ended December 31, 2003, 2002 and
2001, respectively, would have been recorded. Interest income recognized on
non-accrual and impaired loans totaled $16,000, $129,000 and $103,000 for the
years ended December 31, 2003, 2002 and 2001, respectively. At December 31,
2003, there were no commitments to lend additional funds to borrowers whose
loans are classified as non-performing.
An analysis of the allowance for loan losses for the years ended December 31,
2003, 2002 and 2001 is as follows (in thousands):
2003 2002 2001
-------- -------- --------
Balance at beginning of year ........... $ 12,830 $ 12,932 $ 12,341
Provision charged to operations ........ -- 1,310 650
-------- -------- --------
12,830 14,242 12,991
Charge-offs ............................ (67) (1,440) (71)
Recoveries ............................. 5 28 12
-------- -------- --------
Balance at end of year ................. $ 12,768 $ 12,830 $ 12,932
======== ======== ========
(6) INTEREST AND DIVIDENDS RECEIVABLE
A summary of interest and dividends receivable at December 31, 2003 and 2002 is
as follows (in thousands):
2003 2002
-------- --------
Loans ................................................ $ 4,772 $ 5,152
Investment securities ................................ 1,150 1,322
Mortgage-backed securities ........................... 3,360 4,581
-------- --------
Interest and dividends receivable ................ $ 9,282 $ 11,055
======== ========
(7) PREMISES AND EQUIPMENT, NET
Premises and equipment at December 31, 2003 and 2002 are summarized as follows
(in thousands):
2003 2002
-------- --------
Land ................................................. $ 4,088 $ 4,435
Buildings and improvements ........................... 13,801 14,146
Leasehold improvements ............................... 1,585 1,288
Furnishings, equipment and automobiles ............... 11,115 9,804
Construction in progress ............................. 19 621
-------- --------
Total ............................................ 30,608 30,294
Accumulated depreciation and amortization ............ (15,448) (14,412)
-------- --------
Premises and equipment, net ...................... $ 15,160 $ 15,882
======== ========
58
(8) DEPOSITS
Deposits at December 31, 2003 and 2002 are summarized as follows (dollars in
thousands):
2003 2002
----------------------------------------- -----------------------------------------
INTEREST WEIGHTED Interest Weighted
RATE AVERAGE rate average
AMOUNT RANGE RATE Amount range rate
----------- ----------- ----------- ----------- ----------- -----------
Non-interest bearing demand .... $ 78,860 --% --% $ 71,330 --% --%
NOW and money market ........... 526,773 0.25 - 1.29 0.80 501,024 0.75 - 1.36 1.15
Savings ........................ 217,000 0.75 - 2.15 0.90 212,959 1.24 - 2.43 1.38
Certificates of deposit ........ 517,225 0.50 - 7.72 2.31 602,673 0.90 - 7.72 2.97
----------- -----------
$ 1,339,858 0 - 7.72% 1.35% $ 1,387,986 0 - 7.72% 1.92%
=========== =========== =========== =========== =========== ===========
The scheduled maturities of certificates of deposit at December 31, 2003 are as
follows (in thousands):
One year or less ................................................. $376,050
After one to two years ........................................... 50,050
After two to three years ......................................... 18,807
After three to four years ........................................ 27,931
After four to five years ......................................... 9,939
After five years ................................................. 34,448
--------
$517,225
========
Included in deposits at December 31, 2003 and 2002, are $295.0 million and
$277.1 million of deposits of $100,000 and over, and $46,000 and $139,000,
respectively, of accrued interest payable on deposits.
(9) BORROWED FUNDS
FEDERAL HOME LOAN BANK-NEW YORK ADVANCES
Advances from the FHLB-NY at December 31, 2003 and 2002 are summarized as
follows (dollars in thousands):
2003 2002
------------------------- -------------------------
WEIGHTED Weighted
AVERAGE average
INTEREST interest
Maturity AMOUNT RATE Amount rate
-------- ------------- ----------- ------------- -----------
2003................... $ -- --% $ 15,000 5.68%
2005 .................. 45,000 5.15 45,000 5.15
2006 .................. 35,000 4.68 35,000 4.68
2007 .................. 5,500 7.32 5,663 7.32
2009 .................. 5,000 5.52 5,000 5.52
2011 .................. 35,000 5.37 35,000 5.37
------------ -------------
$ 125,500 5.19% $ 140,663 5.24%
============ =========== ============= ===========
The Company has entered into FHLB-NY advances that have all features that may
be exercised by the FHLB-NY, at par, at predetermined dates. Such advances
totaled $75.0 million and $100.0 million at December 31, 2003 and 2002,
respectively. The maximum amount of FHLB-NY advances outstanding at any
month-end was $140.6 million and $165.8 million during the years ended December
31, 2003 and 2002, respectively. The average amount of FHLB-NY advances
outstanding during the years ended December 31, 2003 and 2002 was $135.3 million
and $151.1 million, respectively. As of December 31, 2003 and 2002, all FHLB-NY
advances had fixed rates.
59
Advances from the FHLB-NY were secured by pledges of FHLB-NY stock of $21.1
million and $20.8 million at December 31, 2003 and 2002, respectively, and a
blanket assignment of the Company's unpledged, qualifying mortgage loans,
mortgage-backed securities and investment securities. Such loans and securities
remain under the control of the Company.
The Company had an available overnight line of credit with the FHLB-NY for a
maximum of $50.0 million at December 31, 2003.
OTHER BORROWINGS
The following is a summary of reverse repurchase agreements at December 31, 2003
and 2002 (dollars in thousands):
2003 2002
---------------------- -----------------------
WEIGHTED Weighted
AVERAGE average
INTEREST interest
Maturity AMOUNT RATE Amount Rate
-------- -------- -------- -------- ---------
2003 ............... $ -- --% $ 45,000 4.17%
2004 ............... 71,000 4.10 126,000 5.03
2005 ............... 116,000 4.43 126,000 4.76
2006 ............... 55,000 4.54 48,000 4.84
2007 ............... 12,000 3.93 6,000 4.89
2008 ............... 92,000 3.89 35,000 5.09
2009 ............... 30,000 5.64 30,000 5.64
2010 ............... 75,000 4.79 25,000 6.47
2011 ............... 15,000 5.07 15,000 5.07
-------- --------
$466,000 4.43% $456,000 4.97%
======== ======== ======== =========
The maximum amount of other borrowings outstanding at any month-end during the
years ended December 31, 2003 and 2002 was $481.0 million and $461.0 million,
respectively. The average amount of other borrowings outstanding during the
years ended December 31, 2003 and 2002 was $461.7 million and $436.8 million,
respectively. Securities underlying other borrowings included mortgage-backed
and investment securities, which had an amortized cost of $446.6 million and
$471.0 million, with market values of $450.9 million and $480.7 million, at
December 31, 2003 and 2002, respectively. The securities underlying the other
borrowing agreements are under the Company's control. At December 31, 2003 and
2002, $315.0 million and $136.0 million, respectively, of other borrowings were
callable at par, at defined dates and at the lender's discretion prior to the
contractual maturity of the borrowings.
(10) SUBORDINATED DEBENTURES
In November 2001, the Company issued $25.0 million of Company-obligated
mandatorily redeemable preferred capital securities through special purpose
business trusts. Of the $25.0 million of preferred capital securities sold,
$12.5 million have a floating rate of interest, which resets semi-annually,
equal to 6-month LIBOR plus 3.75%. The floating rate, however, may not exceed
11.0% for the first five years. The remaining $12.5 million of preferred capital
securities have a fixed interest rate of 9.95%. Distributions on the preferred
capital securities are payable semi-annually. The stated maturity of the
preferred capital securities is December 8, 2031, with early redemption
permitted on any June 8 or December 8 on or after December 8, 2006, at par.
In accordance with FIN 46R, the Company was required to deconsolidate its
investments in First Sentinel Capital Trust I and II at December 31, 2003. The
deconsolidation of these subsidiary trusts of the Company, which were formed in
connection with the issuance of the preferred capital securities resulted in
$25.0 million of preferred capital securities issued by the trusts being
replaced on the Consolidated Statements of Financial Condition by the Company's
$774,000 investment in common securities issued by the trusts and the $25.8
million of subordinated debentures that were issued by the Company to the
trusts. Costs associated with the preferred capital securities recognized
subsequent to December 31, 2003 shall be characterized as interest expense,
rather than non-interest expense, as they had been through December 31, 2003.
60
(11) REGULATORY MATTERS
Subject to applicable law, the Board of Directors of the Bank may provide for
the payment of dividends. New Jersey law provides that no dividend may be paid
unless, after the payment of such dividend, the capital stock of the Bank will
not be impaired and either the Bank will have a statutory surplus of not less
than 50% of its capital stock or, if not, the payment of such dividend will not
reduce the statutory surplus of the Bank.
The Bank is subject to various regulatory capital requirements administered by
the federal and state banking agencies. Failure to meet minimum requirements can
result in the initiation of certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk-weightings and other factors.
The prompt corrective action regulations define specific capital categories
based on an institution's capital ratios. The capital categories, in declining
order, are "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized."
Institutions categorized as "undercapitalized" or worse are subject to certain
restrictions on the payment of dividends and management fees, restrictions on
asset growth and executive compensation, and increased supervisory monitoring,
among other things. Other restrictions may be imposed on the institution by the
regulatory agencies, including requirements to raise additional capital, sell
assets, or sell the entire institution. Once an institution becomes "critically
undercapitalized" it must generally be placed in receivership or conservatorship
within 90 days. An institution is deemed to be "critically undercapitalized" if
it has a tangible equity ratio, as defined, of 2% or less.
To be considered "well capitalized," an institution must generally have a
leverage ratio (Tier 1 capital to average total assets), as defined, of at least
5.0%; a Tier 1 risk-based capital ratio, as defined, of at least 6.0%; and a
total risk-based capital ratio, as defined, of at least 10.0%.
Management believes that, as of December 31, 2003, the Bank met all capital
adequacy requirements to which it was subject. Further, the most recent FDIC
notification categorized the Bank as a well capitalized institution under the
prompt corrective action regulations. There have been no conditions or events
since that notification that management believes have changed the Bank's capital
classification.
The following is a summary of the Bank's actual capital amounts and ratios as of
December 31, 2003 and 2002 compared to the FDIC minimum capital adequacy
requirements and the FDIC requirements for classification as a "well
capitalized" institution (dollars in thousands):
FDIC Requirements
-------------------------------------------------------------
Minimum capital For classification
Bank actual adequacy as well capitalized
----------------- ---------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- ------- ----- -------- -----
DECEMBER 31, 2003
- -------------------------
LEVERAGE (TIER 1) CAPITAL $203,771 9.18% $88,775 4.00% $110,969 5.00%
RISK-BASED CAPITAL:
TIER 1 ............. 203,771 18.29 44,567 4.00 66,851 6.00
TOTAL .............. 216,539 19.43 89,134 8.00 111,418 10.00
December 31, 2002
- -------------------------
Leverage (Tier 1) capital $180,768 8.03% $90,054 4.00% $112,568 5.00%
Risk-based capital:
Tier 1 ............. 180,768 16.86 42,892 4.00 64,338 6.00
Total .............. 193,598 18.05 85,784 8.00 107,230 10.00
61
(12) INCOME TAXES
Income tax expense applicable to income for the years ended December 31, 2003,
2002 and 2001 consists of the following (in thousands):
2003 2002 2001
-------- -------- --------
FEDERAL:
Current ............ $ 12,431 $ 13,626 $ 12,667
Deferred ........... (673) (1,431) (1,716)
-------- -------- --------
11,758 12,195 10,951
-------- -------- --------
STATE:
Current ............ 439 657 65
Deferred ........... -- -- --
-------- -------- --------
439 657 65
-------- -------- --------
$ 12,197 $ 12,852 $ 11,016
======== ======== ========
A reconciliation between the effective income tax expense and the amount
computed by multiplying the applicable statutory federal income tax rate for the
years ended December 31, 2003, 2002 and 2001 is as follows (in thousands):
2003 2002 2001
-------- -------- --------
Income before income taxes .................. $ 30,533 $ 37,756 $ 35,501
Applicable statutory federal tax rate ....... 35% 35% 35%
-------- -------- --------
Computed "expected" federal income
tax expense ............................... 10,687 13,215 12,425
Increase (decrease) in income tax
expense resulting from:
State income taxes, net of
federal benefit ......................... 285 427 42
Merger-related expenses ................... 1,510 -- --
Income on BOLI ............................ (547) (525) (277)
Change in NJ Net Operating Loss not used .. (477) -- --
Change in NJ Alternative Minimum
Assessment not used ..................... (425) (469) --
Change in valuation allowance ............. 2,469 880 --
Change in other state deferred
tax balances ............................ (1,567) -- --
Other items, net .......................... 262 (676) (1,174)
-------- -------- --------
$ 12,197 $ 12,852 $ 11,016
======== ======== ========
62
The tax effects of temporary differences that give rise to a significant portion
of deferred tax assets and liabilities at December 31, 2003 and 2002 are as
follows (in thousands):
2003 2002
-------- --------
DEFERRED TAX ASSETS
Allowance for loan losses-book ........................ $ 5,618 $ 4,754
Postretirement medical benefits ....................... 907 693
Tax depreciation less than book depreciation .......... 230 194
Retirement benefits ................................... 1,121 1,494
Stock awards .......................................... 189 163
Core deposit intangibles .............................. 594 500
NJ Alternative Minimum Assessment
in excess of Corporation
Business Tax ........................................ 894 469
Deferred directors fees ............................... 5,896 4,445
NJ Net Operating Loss ................................. 477 --
Other ................................................. 1 2
-------- --------
Gross deferred tax assets ......................... 15,927 12,714
Valuation Allowance ................................... (3,349) (880)
-------- --------
Total deferred tax assets ......................... 12,578 11,834
-------- --------
DEFERRED TAX LIABILITIES
Unrealized gain on securities available for sale ...... 2,196 5,245
Deferred loan origination fees and costs .............. 187 317
Other ................................................. 255 55
-------- --------
Total deferred tax liabilities ................... 2,638 5,617
-------- --------
Net deferred tax asset ........................ $ 9,940 $ 6,217
======== ========
Retained earnings at December 31, 2003 and 2002, included approximately $18.1
million for which no provision for income tax has been made. This amount
represented 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, 2003 and 2002, the Company had an
unrecognized tax liability of $6.5 million with respect to this reserve.
Included in other comprehensive income is income tax (benefit) expense
attributable to net unrealized (losses) gains on securities available for sale
in the amounts of $(3.0) million, $4.1 million and $5.8 million for the years
ended December 31, 2003, 2002 and 2001, respectively. In addition, income tax
benefits of $1.9 million, $1.2 million, and $394,000 were recognized in
stockholders' equity in 2003, 2002 and 2001, respectively, related to the
exercise or disqualifying disposition of stock options and awards.
In 2003, the Company maintained a $3.3 million valuation allowance pertaining to
certain state deferred tax assets which are not expected to be realized based
upon projected future taxable income. Management has determined that it is more
likely than not that it will realize the net deferred tax assets based upon the
nature and timing of the items listed above. There can be no assurances,
however, that there will be no significant differences in the future between
taxable income and pretax book income if circumstances change. In order to fully
realize the net deferred tax asset, the Company will need to generate future
taxable income. Management has projected that the Company will generate
sufficient taxable income to utilize the net deferred tax asset; however, there
can be no assurance that such levels of taxable income will be generated.
(13) EMPLOYEE BENEFIT PLANS
The Company is a participant in the Financial Institutions Retirement Fund, a
multi-employer defined benefit plan. All employees who attain the age of 21
years and complete one year of service are eligible to participate in this plan.
Retirement benefits are based upon a formula utilizing years of service and
average compensation, as defined. Participants are vested 100% upon the
completion of five years of service. Effective August 1, 2003, First Savings
amended the plan to reduce the retirement benefit and close the plan to new
participants hired on or after that date. Pension expense was $648,000, $602,000
and $384,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
63
Financial Institutions Retirement Fund does not segregate its assets,
liabilities or costs by participating employer. Therefore, disclosure of the
accumulated and projected benefit obligations, plan assets and the components of
annual pension expense attributable to the Company cannot be made.
The Company maintained a Supplemental Executive Retirement Plan ("SERP I"),
which provided postemployment supplemental retirement benefits to certain
officers of the Company. SERP I was a non-qualified employee benefit plan. In
December 2003, SERP I was terminated and the benefits accrued thereunder were
paid pursuant to change in control provisions triggered by the Company's
entering into a definitive agreement to merge with PFS. The Company recognized
$2.6 million as accelerated merger-related expense in conjunction with the
termination of the plan.
The Company has a non-pension postretirement benefit plan ("Other Benefits"),
which provides certain healthcare benefits to eligible employees hired prior to
January 1, 1993. The plan is unfunded as of December 31, 2003, and the
obligation is included in Other liabilities as an accrued postretirement benefit
cost. In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") became law in the United States. The Act
introduces a prescription drug benefit under Medicare as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to the Medicare benefit. In accordance
with FASB Staff Position FAS 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," the Company has elected to defer recognition of the effects of the Act in
any measures of the benefit obligation or cost. Specific authoritative guidance
on the accounting for the federal subsidy is pending and that guidance, when
issued, could require the Company to change previously reported information.
Currently, the Company does not believe it will need to amend its plan to
benefit from the Act.
The following table shows the change in benefit obligation, the funded status
for SERP I and Other Benefits, and accrued cost at December 31, 2003 and 2002
(dollars in thousands):
SERP I OTHER BENEFITS
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Benefit obligation at beginning of year .... $ 1,778 $ 1,640 $ 2,062 $ 1,661
Service cost ............................... 35 27 81 62
Interest cost .............................. 112 110 138 119
Actuarial loss (gain) ...................... 323 1 (8) 258
Benefits paid .............................. (3,998) -- (40) (38)
Curtailments ............................... 1,742 -- -- --
Settlements ................................ 8 -- -- --
---------- ---------- ---------- ----------
Benefit obligation at the end of the year .. $ -- $ 1,778 $ 2,233 $ 2,062
========== ========== ========== ==========
Funded status .............................. $ -- $ (1,778) $ (2,233) $ (2,062)
Unrecognized net actuarial loss ............ -- 282 186 193
---------- ---------- ---------- ----------
Accrued benefit cost ....................... $ -- $ (1,496) $ (2,047) $ (1,869)
========== ========== ========== ==========
SERP I OTHER BENEFITS
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Weighted average assumptions as of December 31:
Discount rate .............................. 6.25% 6.75% 6.25% 6.75%
Rate of compensation increase .............. 5.00% 5.00%
64
Net periodic cost for the years ended December 31, 2003, 2002 and 2001 includes
the following components (in thousands):
SERP I OTHER BENEFITS
---------------------------------- ----------------------------------
2003 2002 2001 2003 2002 2001
---------- ---------- ---------- ---------- ---------- ----------
Service cost ............................... $ 35 $ 27 $ 117 $ 81 $ 62 $ 61
Interest cost .............................. 112 110 100 138 119 123
Recognized settlement loss ................. 613 -- -- -- -- --
Recognized curtailment loss ................ 1,742 -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Net periodic cost .......................... $ 2,502 $ 137 $ 217 $ 219 $ 181 $ 184
========== ========== ========== ========== ========== ==========
For measurement purposes, a ten percent annual rate of increase in the per
capita cost of covered health care benefits was assumed for 2004, grading down
one percent per year for six years to an ultimate level of five percent per
annum, compounded annually. Assumed health care trend rates have a significant
effect on the amounts reported for the health care plans. A one percentage point
change in the assumed health care cost trend rates would have the following
effects (in thousands):
One Percentage Point
-----------------------
Increase Decrease
---------- ----------
Effect on total of service and interest
cost components .................................. $ 52 $ (38)
Effect on Other Benefits obligation ................. 467 (363)
The Company also maintains an incentive savings plan for eligible employees.
Employees may make contributions to the plan of 2% to 15% of their compensation.
For the first 6% of the employee's contribution, the Company contributes 25% of
that amount to the employee's account. At the end of the plan year, the Company
may make an additional contribution to the plan. The contributions under this
plan were $107,000, $102,000 and $94,000 for the years ended December 31, 2003,
2002 and 2001, respectively.
The Company maintained an additional Supplemental Executive Retirement Plan
("SERP II"), which provided a participant the benefits that he would have
received under the ESOP and the incentive savings plan if certain Internal
Revenue Code benefit limitations did not apply. Upon normal retirement, the
participant also would receive any benefits he would have received under the
ESOP had he remained in service throughout the term of the ESOP loan and all
unallocated shares in the ESOP that were acquired by an ESOP loan were allocated
to ESOP participants. Vesting under SERP II was subject to a five year graded
vesting schedule. The Company recognized expense related to SERP II totaling
$412,000, $564,000 and $52,000 for the years ended December 31, 2003, 2002 and
2001, respectively. In December 2003, SERP II was terminated and the benefits
accrued thereunder were paid pursuant to change in control provisions triggered
by the Company's entering into a definitive agreement to merge with PFS. The
Company recognized $395,000 in 2003 as accelerated merger-related expense in
conjunction with the termination of the plan. Expense incurred in 2002 included
$519,000 in supplemental benefits accrued in connection with the normal
retirement of the Company's former President and CEO.
RECOGNITION AND RETENTION PLAN
The Company maintains a Recognition and Retention Plan ("RRP") for the benefit
of directors, officers and key employees. In 1998, the Board of Directors and
stockholders approved the granting of 662,014 shares as awards under the 1998
Stock-Based Incentive Plan ("1998 Plan"). As of December 31, 2003, the Company
had granted 662,014 shares under the 1998 Plan. In 2003, the Board of Directors
and stockholders approved the granting of up to 200,000 shares as awards under
the 2003 Key Employee Equity Compensation Plan ("2003 Plan"). As of December 31,
2003, the Company had granted 11,350 shares under the 2003 Plan.
RRP awards are granted in the form of shares of common stock held by the RRP.
Awards granted in 1998 vested over a five-year period at a rate of 20% per year,
commencing one year from the date of the award grant. Awards granted in January
2003 vest evenly over a two year period, and awards granted in December 2003
vest one year from the date of the award grant.
65
Amortization of the RRP was $1.0 million, $878,000, and $878,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
The Bank maintains an ESOP for eligible employees who have completed a
twelve-month period of employment with the Company. ESOP shares were purchased
in each of the Company's public offerings. Funds for the purchase of shares were
borrowed from the Company. Shares purchased by the ESOP are held by a trustee
for allocation among participants as the loan is repaid. The Company, at its
discretion, contributes funds, in cash, to pay principal and interest on the
ESOP loan. The number of shares of common stock released each year is
proportional to the amount of principal and interest paid on the ESOP loan for
the year. Dividends paid on unallocated ESOP shares are used to repay the loan.
Unallocated ESOP shares are not considered outstanding for purposes of
calculating earnings per share. At December 31, 2003, there were 933,506
unallocated ESOP shares with a market value of $19.7 million.
The Company recognizes compensation expense based on the fair value of shares
committed to be released. Compensation expense recognized for 2003, 2002 and
2001 amounted to $1.7 million, $1.4 million and $1.2 million, respectively. The
Company allocated 100,920 shares per year during 2003, 2002 and 2001.
STOCK OPTION PLANS
The Company maintains stock option plans (the "Plans") for the benefit of
directors, officers, and other key employees of the Company. Options granted
under the Plans are exercisable over a period not to exceed ten years from the
date of grant. The following table summarizes the options granted and exercised
under the Plans during the periods indicated and their respective weighted
average exercise price:
2003 2002 2001
------------------------ ------------------------ ------------------------
WEIGHTED Weighted Weighted
NUMBER AVERAGE Number average Number average
OF EXERCISE of exercise of exercise
SHARES PRICE shares price shares price
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at beginning of period ... 2,000,027 $ 7.91 2,067,513 $ 7.63 2,285,844 $ 7.65
Granted .............................. 26,000 13.97 25,000 14.00 -- --
Forfeited ............................ (1,400) 10.92 (2,368) 3.78 (86,350) 9.00
Exercised ............................ (710,478) 7.78 (90,118) 3.34 (131,981) 7.01
---------- ---------- ----------
Outstanding at end of period ......... 1,314,149 $ 8.10 2,000,027 $ 7.91 2,067,513 $ 7.63
========= ========== ========= ========== ========== ==========
Options exercisable at year-end ...... 1,298,315 1,559,848 1,375,895
========= ========== ==========
The following table summarizes information about the stock options outstanding
at December 31, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------- ---------------------------------
WEIGHTED
AVERAGE WEIGHTED NUMBER OF WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE SHARES AVERAGE
EXERCISE OF SHARES CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES OUTSTANDING LIFE IN YEARS PRICE AT PERIOD END PRICE
- ---------------------- --------------- --------------- --------------- --------------- ---------------
$ 3.3262 - 4.5165 229,026 2.8 $ 3.92 229,026 $ 3.92
6.6419 - 9.0000 1,049,223 5.0 8.81 1,049,223 8.81
13.8500 -14.3700 35,900 8.7 13.97 20,066 14.00
--------------- ---------------
$ 3.3262 - 14.3700 1,314,149 4.7 $ 8.10 1,298,315 $ 8.03
====================== =============== =============== =============== =============== ===============
The Company applies APB Opinion No. 25 in accounting for the Plans. The table in
Note 1(N) illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based compensation.
2003 2002 2001
------ ------ ------
Weighted average fair value of options
granted during year ................... $ 2.79 $ 3.19 $ --
The fair value of stock options granted by the Company was estimated through the
use of the Black-Scholes option-pricing model that takes into account the
following factors as of the grant dates: the exercise price and expected life of
the option, the market price of the underlying stock at the grant date and its
expected volatility, and the risk-free interest rate for
66
the expected term of the option. In deriving the fair value of a stock option,
the stock price at the grant date is reduced by the value of the dividends to be
paid during the life of the option. The following assumptions were used for
grants in 2003 and 2002: dividend yield of 2.50%; an expected volatility of 25%,
an expected term of five years, and a risk-free interest rate of 2.82% for 2003
and 4.44% for 2002. There were no options granted in 2001.
DIRECTORS' DEFERRED FEE PLAN
The Company maintains a DDFP under which directors may elect to defer all or
part of their fees and have such amounts held in a rabbi trust and invested in
the Company's common stock or a deferred money account. The DDFP was amended
effective October 1, 2003 to require that all future distributions from the DDFP
to participants be made in First Sentinel Common Stock. As a result of this
amendment, a $17.4 million deferred compensation obligation related to the
market value of the common stock held in the underlying rabbi trust for the DDFP
was reclassified from liabilities to stockholders' equity, with no further
changes in the fair value of the common stock required to be recognized as a
periodic charge or credit to compensation cost. Prior to this amendment, the
Company was required to recognize changes in the fair value of the common stock
held in the rabbi trust for the DDFP as periodic charges or credits to
compensation cost. Non-cash compensation costs attributable to the appreciation
in the fair value of the Company's common stock held in the rabbi trust for the
DDFP totaled $3.3 million, $1.8 million and $1.3 million for the years ended
December 31, 2003, 2002 and 2001, respectively.
(14) COMMITMENTS AND CONTINGENCIES
COMMITMENTS
FINANCIAL TRANSACTIONS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT
The Company, in the normal course of conducting its business, extends credit to
meet the financing needs of its customers through commitments and letters of
credit.
The following commitments and contingent liabilities existed at December 31,
2003 and 2002 which are not reflected in the accompanying consolidated financial
statements (in thousands):
2003 2002
-------- --------
Origination of mortgage loans:
Fixed rate ................................ $114,048 $ 67,460
Variable rate ............................. 28,038 44,878
Purchase of mortgage loans - variable rate .. 1,683 693
Undisbursed home equity credit lines ........ 79,309 65,537
Undisbursed construction credit lines ....... 74,557 62,137
Undisbursed consumer lines of credit ........ 17,602 12,178
Participations in Thrift Institutions
Community Investment Corp. of NJ .......... -- 500
Standby letters of credit ................... 1,316 1,868
These instruments involve elements of credit and interest rate risk in excess of
the amount recognized in the consolidated financial statements. The Company uses
the same credit policies and collateral requirements in making commitments and
conditional obligations as it does for on-balance-sheet loans. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since the commitments may expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained is based on management's
credit evaluation of the borrower.
The Company grants one-to-four family first mortgage real estate loans,
multi-family, construction loans, and nonresidential first mortgage real estate
loans to borrowers throughout New Jersey. Its borrowers' abilities to repay
their obligations are dependent upon various factors, including the borrowers'
income and net worth, cash flows generated by the underlying collateral, value
of the underlying collateral and priority of the Company's lien on the property.
Such factors are dependent upon various economic conditions and individual
circumstances beyond the Company's control; the Company is therefore subject to
risk of loss. The Company believes its lending policies and procedures
adequately minimize the potential exposure to such risks and that adequate
provisions for loan losses are provided for all known and inherent risks.
Collateral and/or guarantees are required for virtually all loans.
LEASE OBLIGATIONS
At December 31, 2003, the Company was obligated under noncancellable operating
leases for premises and equipment. Rental expense under these leases aggregated
approximately $585,000, $509,000 and $502,000 for the years ended December 31,
2003, 2002 and 2001, respectively.
The projected minimum rental commitments as of December 31, 2003, are as follows
(in thousands):
2004 ................. $ 464
2005 ................. 362
2006 ................. 325
2007 ................. 286
2008 ................. 92
Thereafter ........... 400
------
$1,929
======
67
CONTINGENCIES
The Company is a defendant in certain claims and legal actions arising in the
ordinary course of business. Management is of the opinion that the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial condition or results of operations.
STOCKHOLDER RIGHTS AGREEMENT
On December 19, 2001, the Company adopted a Stockholder Rights Agreement
("Rights Agreement") and declared a dividend of one preferred share purchase
right ("Right") for each outstanding share of the Company's common stock. The
dividend was payable on January 1, 2002, to stockholders of record on that date.
Each Right, initially, is not exercisable and transfers only with the Company's
common stock. Upon the public announcement that a person or group of persons has
acquired or intends to acquire 12% or more of the Company's common stock, the
Rights become exercisable, entitling holders to purchase one one-hundredth
interest in a share of Series A Junior Participating Preferred Stock of the
Company, at an exercise price of $37.00. The Rights are scheduled to expire on
January 1, 2012 and may be redeemed by the Company at a price of $0.01 per
Right. The Rights Agreement will not apply to the merger with PFS as the
Company's Board of Directors has determined that PFS is not, and will not be
upon consummation of the merger, an "Acquiring Person" as defined in the Rights
Agreement.
(15) RECENT ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46") was issued in January
2003 and was recently reissued as FASB Interpretation No. 46 (revised December
2003) ("FIN 46R"). For public entities, FIN 46 or FIN 46R is applicable to all
special-purpose entities ("SPEs") in which the entity holds a variable interest
no later than the end of the first reporting period ending after December 15,
2003, and immediately to all entities created after January 31, 2003. The
effective dates of FIN 46R vary depending on the type of reporting enterprise
and the type of entity that the enterprise is involved with. FIN 46 and FIN 46R
may be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated. FIN 46 and FIN 46R provide guidance on the
identification of entities controlled through means other than voting rights.
FIN 46 and FIN 46R specify how a business enterprise should evaluate its
interest in a variable interest entity to determine whether to consolidate that
entity. A variable interest entity must be consolidated by its primary
beneficiary if the entity does not effectively disperse risks among the parties
involved.
Under the above accounting literature, the Company was required to deconsolidate
its investments in First Sentinel Capital Trust I and II at December 31, 2003.
The deconsolidation of these subsidiary trusts of the bank holding company which
were formed in connection with the issuance of preferred capital securities
resulted in $25.0 million of preferred capital securities issued by the trust
being replaced on the Consolidated Statements of Financial Condition by the
Company's $774,000 investment in common securities issued by the trusts and
$25.8 million of subordinated debentures that were issued by the Company to the
trusts. Costs associated with the preferred capital securities recognized
subsequent to December 31, 2003 shall be characterized as interest expense,
rather than non-interest expense, as they had been through December 31, 2003.
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity," was issued in May 2003. This Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
Statement also includes required disclosures for financial instruments within
its scope. For the Company, the Statement was effective for instruments entered
into or modified after May 31, 2003 and otherwise will be effective as of
January 1, 2004, except for mandatorily redeemable financial instruments. For
certain mandatorily redeemable financial instruments, the Statement will be
effective for the Company on January 1, 2005. The effective date has been
deferred indefinitely for certain other types of mandatorily redeemable
financial instruments. The Company does not expect that the adoption of
Statement 150 will have a significant impact on the consolidated financial
statements of the Company.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following fair value estimates, methods and assumptions were used to measure
the fair value of each class of financial instrument for which it is practical
to estimate that value.
68
CASH AND CASH EQUIVALENTS
For such short-term investments, the carrying amount was considered to be a
reasonable estimate of fair value.
FEDERAL HOME LOAN BANK OF NY STOCK
Federal Home Loan Bank of NY stock was valued at cost.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
For investment and mortgage-backed securities, fair values were based on quoted
market prices or dealer quotes. If a quoted market price was not available, fair
values were estimated using quoted market prices for similar securities.
LOANS RECEIVABLE, NET
Fair values were estimated for portfolios of performing and non-performing loans
with similar financial characteristics. For certain analogous categories of
loans, such as residential mortgages, home equity loans, non-residential
mortgages, and consumer loans, fair value was estimated using the quoted market
prices for securities backed by similar loans, adjusted for differences in loan
characteristics. The fair value of other performing loan types was estimated by
discounting the future cash flows using market discount rates that reflect the
credit, collateral, and interest rate risk inherent in the loan.
DEPOSITS
The fair value of demand deposits, savings deposits and money market accounts
were the amounts payable on demand at December 31, 2003 and 2002. The fair
values of certificates of deposit were based on the discounted value of
contractual cash flows. The discount rate was estimated utilizing the rate
currently offered for deposits of similar remaining maturities.
BORROWINGS AND SUBORDINATED DEBENTURES
For short-term borrowings, the carrying amount was considered to be a reasonable
estimate of fair value. For long-term borrowings, the fair value was based upon
the discounted value of the cash flows. The discount rates utilized were based
on rates currently available with similar terms and maturities.
OFF-BALANCE SHEET INSTRUMENTS
For commitments to extend credit and letters of credit, the fair value would
approximate fees currently charged to enter into similar agreements. Such
amounts were not significant to the Consolidated Financial Statements.
The estimated fair values of the Company's financial instruments at December 31,
2003 and 2002 were as follows (in thousands):
2003 2002
----------------------- -----------------------
BOOK FAIR Book Fair
VALUE VALUE value value
---------- ---------- ---------- ----------
FINANCIAL ASSETS:
Cash and cash equivalents ....................... $ 75,807 $ 75,807 $ 65,945 $ 65,945
FHLB-NY stock ................................... 21,075 21,075 20,835 20,835
Investment securities available for sale ........ 106,459 106,459 114,219 114,219
Mortgage-backed securities available for sale ... 722,794 722,794 790,562 790,562
Loans receivable, net ........................... 1,210,721 1,227,715 1,201,210 1,221,249
FINANCIAL LIABILITIES:
Deposits ........................................ 1,339,858 1,347,296 1,387,986 1,402,892
Borrowed funds .................................. 591,500 612,319 596,663 600,583
Subordinated debentures ......................... 25,774 27,008 -- --
69
LIMITATIONS
The foregoing fair value estimates were made at December 31, 2003 and 2002,
based on pertinent market data and relevant information on the financial
instrument. These estimates do not include any premium or discount that could
result from an offer to sell, at one time, the Company's entire holdings of a
particular financial instrument or category thereof. Since no market exists for
a substantial portion of the Company's financial instruments, fair value
estimates were necessarily based on judgments with respect to future expected
loss experience, current economic conditions, risk assessments of various
financial instruments involving a myriad of individual borrowers, and other
factors. Given the innately subjective nature of these estimates, the
uncertainties surrounding them and the matters of significant judgment that must
be applied, these fair value estimations cannot be calculated with precision.
Modifications in such assumptions could meaningfully alter these estimates.
Since these fair value approximations were made solely for on- and off-balance
sheet financial instruments at December 31, 2003 and 2002, no attempt was made
to estimate the value of anticipated future business or the value of
non-financial assets and liabilities. Other important elements which are not
deemed to be financial assets or liabilities include the value of the Company's
retail branch delivery system, its existing core deposit base, premises and
equipment, and goodwill. Further, certain tax implications related to the
realization of the unrealized gains and losses could have a substantial impact
on these fair value estimates and have not been incorporated into any of the
estimates.
(17) CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY
The condensed financial statements of First Sentinel Bancorp (parent company
only) are presented below:
CONDENSED STATEMENTS OF FINANCIAL CONDITION December 31,
-------------------
(In thousands) 2003 2002
- --------------------------------------------------------------------------------
ASSETS
Cash ................................................... $ 3,831 $ 2,168
Due from subsidiaries .................................. -- 1,013
ESOP loan receivable ................................... 10,380 11,091
Investment in subsidiaries ............................. 212,295 196,585
Investment securities available for sale ............... 22,982 24,616
Other assets ........................................... 6,790 1,999
-------- --------
Total assets ....................................... $256,278 $237,472
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debentures ................................ $ 25,774 $ 25,774
Other liabilities ...................................... 2,930 126
Stockholders' equity ................................... 227,574 211,572
-------- --------
Total liabilities and stockholders' equity ......... $256,278 $237,472
======== ========
70
CONDENSED STATEMENTS OF INCOME Year Ended December 31,
------------------------------
(In thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
Income
Dividends from subsidiary ..................... $ 20,000 $ 30,000 $ 20,000
Interest and dividends on securities .......... 1,223 1,427 1,628
Net gain (loss) on sales of securities ........ 478 29 (118)
-------- -------- --------
Total income .............................. 21,701 31,456 21,510
-------- -------- --------
Expense
Other expense ................................. 3,995 2,689 1,030
-------- -------- --------
Total expense ............................. 3,995 2,689 1,030
-------- -------- --------
Income before taxes ....................... 17,706 28,767 20,480
Income taxes .................................. 107 194 1,474
-------- -------- --------
Income before equity in undistributed
income of subsidiaries .................... 17,599 28,573 19,006
Equity in undistributed income (dividends
in excess of earnings) of subsidiaries ...... 737 (3,669) 5,479
-------- -------- --------
Net income .................................... $ 18,336 $ 24,904 $ 24,485
======== ======== ========
CONDENSED STATEMENTS OF CASH FLOWS Year Ended December 31,
------------------------------
(In thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
Operating activities
Net income ...................................... $ 18,336 $ 24,904 $ 24,485
Adjustments to reconcile net income to net
cash provided by operating activities:
(Equity in undistributed income)
dividends in excess of earnings of
subsidiaries .............................. (737) 3,669 (5,479)
Net (gain) loss on sales of securities ...... (478) (29) 118
(Increase) decrease in other assets ......... (4,791) (887) 92
Increase (decrease) in other liabilities .... 502 (1,630) (1,193)
ESOP expense ................................ 1,736 1,380 1,227
Amortization of RRP ......................... 1,032 878 878
-------- -------- --------
Net cash provided by operating activities ....... 15,600 28,285 20,128
-------- -------- --------
Investing activities
Purchase of investment securities ........... (10,904) (11,502) (15,688)
Proceeds from sales and maturities of
investment securities available for sale .. 14,338 12,536 16,045
Decrease in due from subsidiaries ........... 1,013 1,721 869
-------- -------- --------
Net cash provided by investing activities ....... 4,447 2,755 1,226
-------- -------- --------
Financing activities
Cash dividends paid ......................... (10,961) (10,068) (8,861)
Stock options exercised ..................... 5,243 304 926
Net proceeds from issuance of
subordinated debentures ................... -- -- 24,171
Purchase of treasury stock .................. (12,429) (35,755) (22,227)
Purchase and retirement of common stock ..... (237) (273) (110)
-------- -------- --------
Net cash used in financing activities ........... (18,384) (45,792) (6,101)
-------- -------- --------
Net increase (decrease) in cash ................. 1,663 (14,752) 15,253
Cash at beginning of the year ................... 2,168 16,920 1,667
-------- -------- --------
Cash at end of year ............................. $ 3,831 $ 2,168 $ 16,920
======== ======== ========
71
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table contains quarterly financial data for the years ended
December 31, 2003 and 2002 (dollars in thousands, except per share data):
YEAR ENDED DECEMBER 31, 2003 FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
Interest income ......................... $ 28,781 $ 27,557 $ 26,423 $ 26,198
Interest expense ........................ 13,770 12,992 11,963 11,668
-------- -------- -------- --------
Net interest income ................... 15,011 14,565 14,460 14,530
Provision for loan losses ............... -- -- -- --
-------- -------- -------- --------
Net interest income after provision
for loan losses ..................... 15,011 14,565 14,460 14,530
Non-interest income ..................... 2,423 2,349 1,868 3,063
Non-interest expense .................... 7,092 9,311 9,152 12,181
-------- -------- -------- --------
Income before income tax expense ...... 10,342 7,603 7,176 5,412
Income tax expense ...................... 3,494 2,540 2,278 3,885
-------- -------- -------- --------
Net income ............................ $ 6,848 $ 5,063 $ 4,898 $ 1,527
======== ======== ======== ========
Basic earnings per share ................ $ 0.26 $ 0.20 $ 0.19 $ 0.06
======== ======== ======== ========
Diluted earnings per share .............. $ 0.24 $ 0.19 $ 0.19 $ 0.06
======== ======== ======== ========
Year Ended December 31, 2002 First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
Interest income ......................... $ 31,116 $ 32,732 $ 32,086 $ 30,068
Interest expense ........................ 16,083 15,868 15,611 14,859
-------- -------- -------- --------
Net interest income ................... 15,033 16,864 16,475 15,209
Provision for loan losses ............... 100 1,105 105 --
-------- -------- -------- --------
Net interest income after provision
for loan losses ..................... 14,933 15,759 16,370 15,209
Non-interest income ..................... 1,950 (125) 2,837 1,881
Non-interest expense .................... 7,346 8,062 7,300 8,349
-------- -------- -------- --------
Income before income tax expense ...... 9,537 7,572 11,907 8,741
Income tax expense ...................... 3,136 2,489 4,326 2,902
-------- -------- -------- --------
Net income ............................ $ 6,401 $ 5,083 $ 7,581 $ 5,839
======== ======== ======== ========
Basic earnings per share ................ $ 0.22 $ 0.18 $ 0.28 $ 0.22
======== ======== ======== ========
Diluted earnings per share .............. $ 0.22 $ 0.18 $ 0.26 $ 0.21
======== ======== ======== ========
72
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
First Sentinel Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of First Sentinel Bancorp, Inc. and Subsidiaries as of December 31, 2003 and
2002, and the related consolidated statements of income, stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Sentinel
Bancorp, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Short Hills, New Jersey
February 6, 2004
73
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. 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-15(e) under the Securities
Exchange Act of 1934, as amended) as of December 31, 2003. Based upon
their evaluation, they each found the Company's disclosure controls
and procedures were effective 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 and that such information is accumulated and
communicated to the Company's management as appropriate to allow
timely decisions regarding required disclosures.
b.) CHANGES IN INTERNAL CONTROLS.
In December 2003, the Company determined that its accounting for the
Bank's Directors Deferred Fee Plan did not conform with Emerging
Issues Task Force ("EITF") Issue No. 97-14, "Accounting for Deferred
Compensation Arrangements Where Amounts Earned Are Held in Rabbi Trust
and Invested" at the required implementation date (September 30,
1998). The Company has since conformed its accounting in accordance
with EITF Issue No. 97-14 and, as a result, has restated its
consolidated financial statements as of September 30, 1998 and for all
subsequent periods.
Due to the discovery in December 2003 that the Company's financial
statements did not conform with EITF Issue No. 97-14, Mr. Martin and
Mr. Lyons determined that the Company's disclosure controls and
procedures were not adequate as of December 31, 2002. As part of the
Company's disclosure controls and procedures over the selection and
application of accounting principles, the Company's accounting
officers relied on information regarding accounting developments as
provided by the Company's independent auditing firm, as well as
attendance at continuing education courses for the accounting
profession and receipt of various accounting journals and other
literature with respect to the existence of new accounting
pronouncements and their application to the Company. These controls
and procedures did not result in the Company's becoming aware of the
existence of EITF Issue No. 97-14 at the time of its pronouncement, at
the time of its required implementation or at any time prior to
December 2003. Therefore, the Company was not aware of its
applicability to the accounting for the Bank's Directors Deferred Fee
Plan. Mr. Martin and Mr. Lyons concluded that the procedures described
above were not sufficiently comprehensive to identify new accounting
developments required to be incorporated in the Company's financial
statements, resulting in the determination that the Company's
disclosure controls and procedures were not adequate.
Following the determination in December 2003 by Mr. Martin and Mr.
Lyons that the Company's disclosure controls and procedures were not
adequate as of December 31, 2002, the Company enhanced its procedures
for educating its financial officers with respect to the adoption of
new or revised accounting principles, practices and applications. In
particular, the Company's Chief Financial Officer will now perform the
following procedures quarterly:
1. Review the American Institute of Certified Public Accountants'
website for any new, or revised, interpretations or applications of
any accounting principles.
2. Correspond with accounting professionals, including but not
limited to the Company's independent auditing firm, to ascertain any
changes in or application of Generally Accepted Accounting Principles
(GAAP).
74
3. Review the Financial Accounting Standards Board's (FASB) website
and any other available information to acknowledge, review and
interpret any applicable FASB changes, including changes brought about
by the EITF.
4. Catalog any and all correspondence/information from America's
Community Banker's, Financial Managers Society, American Banker
Association, Independent Community Bankers Association, New Jersey
League (including the Accounting and Tax Committee) and other
financial organizations of any accounting pronouncements or
interpretations.
5. Discuss with industry specialists any changes in accounting
procedures or GAAP that they may be aware of.
The foregoing quarterly review is now required by the Company's
written policies for its disclosure controls and procedures. The
results of this review will be reported to the Audit Committee. This
will be in addition to any communications made directly to the Audit
Committee by the Company's independent auditors.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, as of March 1, 2004, the names of the nominees,
continuing directors and executive officers named in the compensation table
appearing elsewhere herein and their ages, the year in which each became a
director or officer of the Bank and the year in which their term (or in the case
of the nominees, their proposed term) as director of the Company expires. This
table also sets forth the number of shares of common stock and the percentage
beneficially owned by each director and named executive officer and by all
directors and executive officers as a group. For purposes of the table below and
the table set forth under "Security Ownership of Certain Beneficial Owners,"
under Item 12 herein, in accordance with Rule 13d-3 under the Exchange Act, a
person is deemed to be the beneficial owner of any shares of common stock (1)
over which he has or shares, directly or indirectly, voting or investment power,
or (2) of which he has a right to acquire beneficial ownership at any time
within 60 days after March 1, 2004. As used herein, "voting power" is the power
to vote or direct the voting of shares and "investment power" includes the power
to dispose or direct the disposition of shares. Except as otherwise indicated,
each stockholder shown in the tables has sole voting and investment power with
respect to the shares of common stock indicated.
AMOUNT AND
DIRECTOR/ NATURE
EXECUTIVE EXPIRATION OF BENEFICIAL PERCENT
OFFICER OF OWNERSHIP OF
AGE SINCE (1) TERM (2)(3)(4)(5)(6) CLASS(7)
----- ----------- ---------- --------------- ---------
NOMINEES:
George T. Hornyak, Jr. 54 1999 2007 710,952 2.50%
John P. Mulkerin 66 1987 2007 793,390 2.78%
Jeffries Shein 64 1985 2007 978,633 3.45%
CONTINUING DIRECTORS:
Christopher Martin 47 1984 2006 390,896 1.38%
Keith H. McLaughlin 68 1983 2006 337,041 1.19%
Philip T. Ruegger, Jr. 77 1983 2006 761,370 2.68%
Joseph Chadwick 61 1999 2005 526,864 1.86%
Walter K. Timpson 81 1964 2005 540,167 1.91%
NAMED EXECUTIVE OFFICERS:
Ann C. Clancy 40 1998 -- 25,535 *
Nancy E. Graves 51 2003 -- 11,331 *
Thomas M. Lyons 39 1999 -- 21,504 *
Richard Spengler 42 1983 -- 202,358 *
75
AMOUNT AND
DIRECTOR/ NATURE
EXECUTIVE EXPIRATION OF BENEFICIAL PERCENT
OFFICER OF OWNERSHIP OF
AGE SINCE (1) TERM (2)(3)(4)(5)(6) CLASS(7)
----- ----------- ---------- --------------- ---------
Stock ownership of all -- -- -- 5,380,311 18.33%
directors and executive
officers as a group
(13 persons)
- -------------------
* Less than 1 percent
(1) Includes years of service as a director or executive officer of the Bank.
(2) Each person or relative of such person whose shares are included herein,
exercises sole voting and dispositive powers as to the shares reported as
of March 1, 2004, except the following individuals may be deemed to share
voting and investment power as indicated: Mr. Hornyak, 13,496 shares; Mr.
Mulkerin, 20,250 shares; Mr. Shein, 93,988 shares; Mr. Martin, 112,772
shares; Mr. McLaughlin, 134,744 shares; Mr. Ruegger, 135,944 shares; Mr.
Chadwick, 131,991 shares; and Ms. Martino, 45,140 shares.
(3) The figures shown include the following shares which may be acquired upon
the exercise of stock options that are, or will become, exercisable within
60 days of March 1, 2004: Mr. Hornyak, 216,176 shares; Mr. Mulkerin,
300,000 shares; each of Mr. Shein, Mr. McLaughlin and Mr. Ruegger, 96,955
shares; Mr. Martin, 25,000 shares; Mr. Chadwick, 122,076 shares; Mr.
Timpson, 82,750 shares; Ms. Graves, 6,666 shares; Mr. Spengler, 46,500
shares; and all directors and executive officers as a group, 1,090,033
shares.
(4) The figures shown include unvested restricted stock that have been awarded
to individuals as follows: Mr. Martin, 8,000 shares; Ms. Clancy, 1,625
shares; Ms. Graves, 3,332 shares; Mr. Lyons, 1,625 shares; Mr. Spengler,
2,750 shares; and all directors and executive officers as a group, 18,457
shares. Such persons have sole voting power, but no investment power,
except in limited circumstances, as to such shares.
(5) The figures shown include the following shares that have been allocated as
of December 31, 2003 to individual accounts of participants in the First
Savings Bank ESOP: Mr. Martin, 40,570 shares; Ms. Clancy, 7,659 shares; Mr.
Lyons, 4,286 shares; Mr. Spengler, 28,784 shares; and all directors and
executive officers as a group, 150,137 shares. Such persons have voting
power (subject to the legal duties of the ESOP Trustee), but no investment
power, except in limited circumstances, as to such shares.
(6) The figures shown include shares held in custodial accounts pursuant to the
First Savings Bank Directors' Deferred Fee Plan, as follows: Mr. Shein,
350,430 shares; Mr. Martin, 15,703 shares; Mr. McLaughlin, 48,349 shares;
Mr. Ruegger, 284,720 shares; and Mr. Timpson, 264,610 shares. Each
participant has voting power, and in limited circumstances, investment
power, as to such shares.
(7) Based on the 28,268,402 total outstanding shares as of March 1, 2004, plus
the number of shares which such person or group of persons has the right to
acquire within 60 days after March 1, 2004.
BIOGRAPHICAL INFORMATION
DIRECTORS
JOSEPH CHADWICK, a former director of Pulse Bancorp, Inc., joined the Board of
First Sentinel in 1999 following the merger of Pulse with First Sentinel. Mr.
Chadwick is President of Thomas and Chadwick/Riverside Supply Company, a
retailer of building supplies. He has held this position since 1971.
GEORGE T. HORNYAK, JR. also joined the Board of First Sentinel in 1999 following
the merger of Pulse with the Company. Mr. Hornyak had been the President and
Chief Executive Officer of Pulse since 1989 and was a director of Pulse. He also
serves as a director of Mercer Insurance Group Inc., an insurance company whose
common stock is registered under Section 12 of the Exchange Act and is traded on
the Nasdaq Stock Market. Mr. Hornyak has been a private investor for the past
five years.
CHRISTOPHER MARTIN is the President and Chief Executive Officer of both the
Company and the Bank. Mr. Martin was named President in 2002 and Chief Executive
Officer as of January 1, 2003. He has served as a member of both Boards of
Directors since 1996. Prior to assuming his current position, Mr. Martin served
as Chief Operating Officer since 1996, Chief Financial Officer from 1989 until
2001, and as an Executive Vice President since 1994. He joined the Bank in 1984.
Mr. Martin is also the President and a director of FSB Financial LLC, Sentinel
Investment Corp. and 1000 Woodbridge Center Drive, Inc., the Bank's
subsidiaries.
76
KEITH H. MCLAUGHLIN joined the Board of First Savings in 1983. Until his
retirement in 2001, Mr. McLaughlin served as the President and Chief Executive
Officer of Raritan Bay Medical Center, which operates acute care hospitals in
Perth Amboy and Old Bridge, New Jersey. Mr. McLaughlin also serves as a director
of Medical Liability Insurance Company.
JOHN P. MULKERIN is the former President and Chief Executive Officer of both the
Company and the Bank. He retired as Chief Executive Officer effective December
31, 2002, but remains a director of both First Sentinel and First Savings Bank.
Prior to being named President and Chief Executive Officer in 1995, Mr. Mulkerin
served as Executive Vice President and General Counsel of the Bank. He joined
the Bank in 1987. Mr. Mulkerin is also a member of the Board of Directors of
Middlesex Water Company, Raritan Bay Medical Center and Daytop Village
Foundation. Middlesex Water Company is a water utility whose common stock is
registered under Section 12 of the Exchange Act and is traded on the Nasdaq
Stock Market. He also serves as Chairman of the Middlesex County College
Foundation and as a member of the Board of Trustees of the Metuchen Diocese of
Catholic Charities.
PHILIP T. RUEGGER, JR. has served as Chairman of the Board of First Sentinel and
First Savings Bank since 2000. He joined the Board of First Savings in 1983. Mr.
Ruegger has been an independent investor for the last six years. For more than
20 years, he was President of Northwest Construction Co., a real estate
construction and management firm. Mr. Ruegger served as director of the National
Bank of New Jersey, a commercial bank, from 1968 through 1981.
JEFFRIES SHEIN joined the Board of First Savings in 1985. He has been a
principal with JGT Management Co., LLC, a commercial real estate brokerage firm,
since 1972. Mr. Shein serves on the Board of Directors of Middlesex Water
Company and the Board of Directors of Raritan Bay Health Services Corp.
WALTER K. TIMPSON joined the Board of First Savings in 1964 and served as
Chairman of the Bank's and Company's Boards of Directors from June 1996 until
May 2000. Mr. Timpson has operated a real estate appraisal firm in Metuchen, New
Jersey, for over forty years.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
ANN C. CLANCY serves as Executive Vice President, General Counsel and Corporate
Secretary of the Company and the Bank. She also serves as the Company's Investor
Relations Officer. Ms. Clancy joined the Bank in 1998 as Vice President and
General Counsel. She was named Senior Vice President in 1999, and in 2003 was
named Executive Vice President. Prior to joining the Bank, Ms. Clancy was an
attorney with a Washington, D.C. law firm for 10 years.
NANCY E. GRAVES joined the Bank as Executive Vice President and Chief Operating
Officer in April 2003. Prior to joining the Bank, Ms. Graves was a Senior Vice
President for Mark Twain Bancshares Inc. for nine years until 1998. She then
founded and served as President of her own management consulting firm, offering
marketing and sales strategic planning services, from 1998 until 2001. From 2001
until 2003, Ms. Graves served as Chief Administrative Officer and Senior Vice
President of Heartland Bank in St. Louis, Missouri. Ms. Graves is also a
director of Sentinel Investment Corp., a subsidiary of the Bank.
KAREN IACULLO-MARTINO is Executive Vice President and Auditor for the Bank. She
served as the Bank's Senior Vice President and Auditor since 1990 and was named
Executive Vice President in 2003. Ms. Iacullo-Martino has also served as the
Bank's Compliance and Security Officer since 1987. She joined the Bank in 1984.
THOMAS M. LYONS is Executive Vice President and Chief Financial Officer for both
the Company and the Bank. He was named Senior Vice President and Chief Financial
Officer of the Bank in April 2001 and appointed to the same position at the
Company in January 2002. He was named Executive Vice President in 2003. Mr.
Lyons joined the Bank in September 1999 as Vice President and Chief Accounting
Officer. Prior to joining the Company, he was Vice President and Controller of
United National Bancorp, a financial institution holding company. Mr. Lyons is
also a director of FSB Financial LLC, Sentinel Investment Corp. and 1000
Woodbridge Center Drive, Inc., the Bank's subsidiaries.
RICHARD SPENGLER serves as Executive Vice President and Chief Lending Officer of
the Bank. Mr. Spengler joined the Bank in 1983 as a loan originator. He was
appointed Vice President of Mortgage Operations in 1991. In January 1995, Mr.
Spengler was named Senior Vice President-Chief Lending Officer, and in 1999, he
was named
77
Executive Vice President. Mr. Spengler also serves as a director of 1000
Woodbridge Center Drive, Inc., a subsidiary of the Bank.
There are no arrangements or understandings between First Sentinel and any
executive officer pursuant to which such person was selected to be an executive
officer of the Bank or the Company.
AUDIT COMMITTEE FINANCIAL EXPERT
First Sentinel maintains a standing Audit Committee, which is comprised of
Messrs. McLaughlin (Chairman), Chadwick and Ruegger, each of whom is independent
(as defined in Rule 4200(a)(14) of the National Association of Securities
Dealers' listing standards). In addition, the Company's Board of Directors has
determined that Keith H. McLaughlin is an "audit committee financial expert," as
defined by the SEC's rules and regulations. The Audit Committee acts under a
written charter adopted by First Sentinel's Board of Directors, a copy of which
is available on the Company's Internet Website at www.firstsentinelbancorp.com.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's executive officers and
directors, and persons who own more than ten percent (10%) of First Sentinel
common stock, to file reports of ownership and changes in ownership with the SEC
and to provide copies of such reports to the Company.
Based solely on its review of copies of such reports of ownership furnished to
the Company, or written representations that no forms were necessary, the
Company believes that all filing requirements applicable to its officers,
directors and greater than 10% beneficial owners were complied with, except that
Nancy E. Graves, Executive Vice President and Chief Operating Officer, was late
in filing one report of a grant of shares on December 16, 2003, due to
difficulties in the transmission of the report. In addition, Keith H.
McLaughlin, a director, inadvertently did not report a purchase made by a family
member in 1998.
CODE OF ETHICS
The Company has adopted a written code of ethics that applies to its principal
executive officer and principal financial officer. The code of ethics is
available on the Company's Internet website at www.firstsentinelbancorp.com. It
is intended that the Company will satisfy the disclosure requirement under Item
10 of Form 8-K regarding an amendment to or waiver from the code of ethics by
posting such information on its website.
ITEM 11. EXECUTIVE COMPENSATION
DIRECTORS' COMPENSATION
DIRECTORS' FEES. Directors of the Company received an annual retainer of $2,500
and special meeting attendance fees of $4,000 during 2003. Directors of the Bank
received a monthly retainer of $2,000. Directors who are not employees of the
Bank received $900 for each Board meeting attended and $350 for each committee
meeting attended. Committee chairmen received an additional $100 for each
meeting attended.
DIRECTORS' DEFERRED FEE PLAN. The Bank maintains the First Savings Bank
Directors' Deferred Fee Plan ("DDFP"). Under the DDFP, Directors may elect to
defer all or part of their fees and have them credited to a deferred money
account. At the end of each fiscal quarter, the amount credited to the deferred
money account is be converted into shares of common stock according to the stock
price at that time and credited to a stock account or the deferred money is used
to purchase shares which are held in a trust account. Any balance credited to
the stock account will be adjusted to reflect stock dividends or splits, and
cash dividends will be credited to the deferred money account or the stock
account, at the participant's election. The Bank will distribute a participant's
account in stock when the participant ceases to be a director, retires or
attains age 65 (or some other age specifically elected by the director), unless
the Bank determines it serves its best interests or the best interests of the
director to disburse these funds at an earlier date. The DDFP was amended,
effective October 1, 2003, to require that all future distributions be made in
First Sentinel Common Stock. Prior to the amendment, participants were entitled
to elect to receive distributions in the form of cash, First Sentinel common
stock, or a combination thereof. The DDFP replaces
78
the Agreement for Deferment of Directors' Fees and the First Savings Bank, SLA
1992 Deferred Fee Stock Unit Plan previously in effect.
RETIREMENT PLAN. First Savings also maintains the First Savings Bank
Non-employee Director Retirement Plan ("Directors' Retirement Plan"), a
nonqualified, unfunded retirement plan for directors who are not employees, have
served as a director for five (5) continuous years, and who retire from the
Board of Directors at or after the age of 55. Benefits, in general, are either
equal to all or a portion of the annual retainer received by a Board member at
the time of retirement, depending upon the director's age and length of service
at retirement. A participant in the Directors' Retirement Plan who retires at or
after the age of 70, or at or after the age of 55 with 10 years of continuous
service, will receive the maximum benefit. Benefits are paid monthly, to the
director or his or her surviving spouse, for the lesser of seven (7) years or
the director's years of service on the Board. Participation in the plan is
limited to those non-employee directors serving on the Board as of May 21, 2002.
In the event of a change in control, as defined in the Directors' Retirement
Plan, however, each participant's benefit may be increased or accelerated. The
merger with PFS will, upon its effective date, be considered a change in control
for purposes of the Directors' Retirement Plan. Each participant who would not
otherwise have satisfied the minimum requirements will be treated as meeting
such requirements and will receive the minimum benefit. Each participant who has
not yet begun receiving benefits may choose to receive a lump sum payment in
lieu of installments. Each participant who is collecting his benefit may choose
to receive the remainder of his benefit in a lump sum payment in lieu of
installments.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth certain information
about the compensation paid by the Company to the Chief Executive Officer and
the four other most highly compensated executive officers according to salary
and bonus during 2003, 2002 and 2001 (the "Named Executive Officers").
ANNUAL COMPENSATION LONG-TERM COMPENSATION(5)
---------------------- ---------------------------
RESTRICTED SECURITIES
STOCK UNDERLYING
FISCAL AWARDS OPTIONS/SARS ALL OTHER
NAME AND PRINCIPAL POSITIONS YEAR ENDED SALARY(2)(3) BONUS(4) ($)(6) (#)(7) COMPENSATION(8)
- ---------------------------- ---------- ------------ ------- ---------- ------------ --------------
Christopher Martin 2003 $380,500 $133,000 $189,760 -- $522,722
President and Chief Executive 2002 326,900 106,875 -- -- 54,942
Officer 2001 301,400 103,125 -- -- 49,248
Ann C. Clancy 2003 162,000 40,014 36,663 -- 45,348
Executive Vice President, General 2002 150,000 27,360 -- 5,400 24,682
Counsel and Corporate Secretary 2001 143,000 25,025 -- -- 22,061
Nancy E. Graves(1) 2003 142,500 48,750 74,310 20,000 --
Executive Vice President,
Chief Operating Officer
Thomas M. Lyons 2003 135,000 33,750 36,663 -- 37,938
Executive Vice President, 2002 98,000 16,275 -- 5,400 19,089
Chief Financial Officer 2001 93,000 13,200 -- -- 17,393
Richard Spengler 2003 170,000 41,438 63,975 -- 47,480
Executive Vice President, 2002 158,000 35,550 -- -- 30,488
Chief Lending Officer 2001 150,000 32,060 -- -- 27,794
- -------------------
(NOTES ON FOLLOWING PAGE)
79
(1) Ms. Graves started employment with First Savings on March 31, 2003.
(2) Includes directors' fees paid to Mr. Martin in 2003, 2002 and 2001.
(3) Includes amounts of salary deferred pursuant to the Incentive Savings Plan
for Employees of First Savings Bank (401(k)) and payroll deductions under
the Bank's health insurance plan.
(4) Includes bonuses granted pursuant to First Savings' Annual Incentive Plan.
Under this plan, bonuses are awarded by the Compensation Committee of the
Board of Directors based upon achieving certain predetermined performance
levels and other identifiable goals.
(5) First Savings provides certain executive officers with non-cash benefits
and perquisites, such as the use of Bank-owned automobiles. Management of
First Savings believes that the aggregate value of these benefits for each
year included in the table does not, in the case of any executive officer,
exceed $50,000 or 10% of the aggregate salary and bonus reported for the
officer in the table. The Company does not maintain a long-term incentive
plan.
(6) Under the Company's 1998 Stock Based Incentive Plan, Mr. Martin, Ms.
Clancy, Mr. Lyons and Mr. Spengler were awarded 8,000 shares, 1,250 shares,
1,250 shares, and 2,500 shares of Common Stock, respectively, on January
22, 2003 at a grant price of $14.37 per share, based on the closing price
of the Company's Common Stock on that date. Ms. Graves was awarded 2,665
shares of Common Stock under the same plan on March 31, 2003, at a grant
price of $13.85 per share, based on the closing price of the Company's
Common Stock on that date. Shares awarded under the 1998 Stock Based
Incentive Plan vest in two equal installments beginning on December 16,
2003 and ending on December 16, 2004. Dividends paid by the Company will be
accrued for plan share awards until such awards have vested, at which time
all accrued dividends will be paid to the award recipient. Under the
Company's 2003 Key Employee Equity Compensation Plan ("2003 Equity Plan"),
Mr. Martin, Ms. Clancy, Ms. Graves, Mr. Lyons and Mr. Spengler were awarded
4,000 shares, 1,000 shares, 2,000 shares, 1,000 shares and 1,500 shares of
Common Stock, respectively, on December 16, 2003, at a grant price of
$18.70 per share, based on the closing price of the Company's Common Stock
on that date. Shares awarded under the 2003 Equity Plan become fully vested
on December 16, 2004. Dividends paid by the Company will be accrued for
plan share awards until such awards have vested, at which time all accrued
dividends will be paid to the award recipient. The aggregate number of
shares awarded in 2003 to Mr. Martin, Ms. Clancy, Ms. Graves, Mr. Lyons and
Mr. Spengler under the 1998 Stock Based Incentive Plan and the 2003 Equity
Plan had a market value of $253,800, $47,588, $98,665, $47,588 and $84,600,
respectively, at December 31, 2003. The dollar amounts set forth in the
table represent the aggregate market value of the shares awarded on the
dates of grant. At December 31, 2003, Mr. Martin, Ms. Clancy, Ms. Graves,
Mr. Lyons and Mr. Spengler held, in the aggregate, unvested restricted
stock awards of 17,500 shares, 2,625 shares, 3,333 shares, 2,825 shares and
6,950 shares, respectively, with a market value of $370,125, $55,519,
$70,493, $59,749 and $146,993, respectively.
(7) For a discussion of options and stock appreciation rights ("SARs") granted
under the 1998 Incentive Plan, see the Fiscal Year-End Option/SAR Values
table.
(8) Includes $3,000, $2,252, $2,025 and $2,256, contributed by First Savings in
2003 to the accounts of Mr. Martin, Ms. Clancy, Mr. Lyons and Mr. Spengler,
respectively, under the Incentive Savings Plan for Employees of First
Savings Bank (401(k)). The figures also include $53,205, $43,096, $35,913,
and $45,224, contributed by First Savings pursuant to First Savings' ESOP
in 2003 allocated for the benefit of Mr. Martin, Ms. Clancy, Mr. Lyons and
Mr. Spengler, respectively. Ms. Graves was not a participant in the Bank's
Incentive Savings Plan or the ESOP. Also includes $466,517 paid by the Bank
in 2003 to Mr. Martin as a full payout upon termination of the Bank's
Supplemental Executive Retirement Plan II pursuant to the merger agreement
with PFS.
EMPLOYMENT AGREEMENTS. First Sentinel and First Savings have entered into
employment agreements with Mr. Martin, effective as of November 15, 2000. The
employment agreements are intended to ensure that First Sentinel and First
Savings will be able to maintain a stable and competent management base. The
employment agreements have rolling three-year terms unless and until the
executive, the Company or the Bank choose to convert to a fixed three-year term.
These agreements provide for a minimum current annual salary of $425,000 for Mr.
Martin and participation on generally applicable terms and conditions in other
compensation and fringe benefit plans to the extent that First Savings continues
those plans. The base salary will be reviewed at least annually by the Boards of
Directors of First Sentinel and First Savings.
First Sentinel and First Savings may discharge Mr. Martin, and Mr. Martin may
resign, at any time, with or without cause. If First Sentinel or First Savings
terminates the executive's employment without cause, however, the Company and
the Bank will owe the executive severance benefits generally equal to the value
of the cash
80
compensation and fringe benefits that the executive would have received if he
had continued working for three years. The same severance benefits would be
payable if the executive resigns during the term following: (i) failure to
re-elect the executive to his current offices or board seats; (ii) a material
change in the executive's functions, duties or responsibilities; (iii) a
relocation of the executive's principal place of employment by more than 25
miles; (iv) liquidation or dissolution of First Sentinel or First Savings; (v)
non-renewal of the agreement by First Sentinel or First Savings; (vi) a material
reduction in benefits, unless the reduction is general in nature and applicable
on a nondiscriminatory basis; or (vii) a breach of the agreement by First
Sentinel or First Savings. First Sentinel and First Savings would also continue,
and pay for, the executive's life, health and disability coverage for the
remaining term of the employment agreements.
Under the employment agreements, if the executive's service is terminated
following a change in control of First Sentinel or First Savings, the executive
will be entitled to a severance payment equal to the greater of: (1) the
payments due for the remaining term of the agreement; or (2) three times the
average of the three preceding years' compensation. First Sentinel and First
Savings would also continue the executive's life, health, and disability
coverage for 36 months. Payments made to the executive upon a change in control
may constitute "excess parachute payments" as defined under section 280G of the
Internal Revenue Code of 1986, as amended (the "Code"), which may result in the
imposition of an excise tax on the executive and the denial of federal income
tax deductions for such excess amounts for First Sentinel or First Savings.
Under the employment agreements, First Sentinel or First Savings would reimburse
the executive for the amount of this excise tax and would make an additional
gross-up payment so that, after payment of the excise tax and all income and
excise taxes imposed on the reimbursement and gross-up payments, the executive
would retain approximately the same net after-tax amounts under the employment
agreement that he would have retained if there was no excise tax.
First Sentinel and First Savings Bank have entered into an agreement with Mr.
Martin, effective as of December 19, 2003, pursuant to which approximately
$3,027,324 was paid to Mr. Martin in December 2003 in satisfaction of payments
owed under the First Savings Bank Supplemental Executive Retirement Plan and the
Amended and Restated First Savings Bank Supplemental Executive Retirement Plan
II, and approximately $2,488,937 will be paid to Mr. Martin in satisfaction of
other cash severance payments owed under the employment agreements. Under the
agreement, Mr. Martin has also waived his rights to receive a tax indemnity
payment under the employment agreements.
Payments under First Savings' employment agreement are guaranteed by First
Sentinel in the event that First Savings fails to make its payments. Payments
under First Sentinel's employment agreement will be made by First Sentinel.
Payments or benefits arising out of similar provisions from the First Sentinel
and First Savings employment agreements will be counted only once for the
executive. All reasonable costs and legal fees paid or incurred by the executive
pursuant to any dispute or question of interpretation relating to the employment
agreements will be paid by First Savings or First Sentinel, respectively, if the
executive is successful on the merits pursuant to a legal judgment, arbitration
or settlement. The employment agreements also provide that First Sentinel and
First Savings indemnify the executive to the fullest extent allowable under
Delaware and New Jersey law, respectively.
CHANGE IN CONTROL AGREEMENTS. First Savings has also entered into three-year
Change in Control Agreements ("CIC Agreements") with Messrs. Richard Spengler,
John F. Cerulo, Jr., Richard P. St. George and Thomas M. Lyons, and Mss. Ann C.
Clancy, Nancy E. Graves and Karen Iacullo-Martino. The term of these CIC
Agreements is perpetual until First Savings gives notice of non-renewal, at
which time the term is fixed for three years. First Savings generally may
terminate any of these officers' employment, with or without cause, at any time
prior to a change in control. If, however, one of these officer's employment is
terminated following a change in control, without cause, whether by the officer,
the Bank or its successor, the officer will be entitled to receive severance
benefits equal to three times the officer's average annual compensation for the
three years preceding termination. Annual compensation will include base salary
and any other taxable income paid by First Sentinel or First Savings, including
bonus, retirement benefits, director or committee fees and fringe benefits, as
well as contributions made to, or benefits accrued under, any employee benefit
plan. First Sentinel and First Savings will also continue, and pay for, the
officer's life, health and disability coverage for the severance term. Payments
to the officer under First Savings' CIC Agreements are guaranteed by First
Sentinel if payments or benefits are not paid by First Savings. Such payments
will be capped at $1 less than the amount that would constitute an excess
parachute payment under section 280G of the Code, unless such amount, after
employment and income taxes are imposed, is less than the severance payment
amount after any excise, employment and income taxes are imposed.
81
First Sentinel and First Savings Bank have entered into agreements with Messrs.
Richard Spengler, John F. Cerulo, Jr., Richard P. St. George and Thomas M.
Lyons, and Mss. Ann C. Clancy, Nancy E. Graves and Karen Iacullo-Martino
pursuant to which approximately $1,193,634, $591,035, $612,194, $633,806,
$772,480, $897,935, and $739,734 will be paid to each, respectively, in
satisfaction of change in control payments owed under the change in control
agreements.
All reasonable costs and legal fees incurred by the officer pursuant to any
dispute or question of interpretation relating to the CIC Agreements will be
paid by First Savings if the officer is successful with any legal judgment,
arbitration or settlement. The CIC Agreements also provide that First Savings
indemnify the Executive to the fullest extent allowable under New Jersey law.
OPTION PLANS. The Company maintains the 2003 Key Employee Equity Compensation
Plan, the 1998 Stock-Based Incentive Plan and the 1996 Omnibus Incentive Plan,
which provide discretionary awards to directors, officers and employees of the
Bank. All option awards are determined by the Compensation Committee.
The following table summarizes the grant of options during 2003 to Named
Executive Officers. The table discloses the gain that would be realized if the
stock options were exercised when the stock price had appreciated by the
percentage rates indicated.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF STOCK
INDIVIDUAL GRANTS PRICE APPRECIATION FOR OPTION TERM
- -------------------------------------------------------------------------------- ----------------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL
UNDERLYING OPTION/SARS
OPTIONS/SARS TO EMPLOYEES EXERCISE OR EXPIRATION
NAME GRANTED (#) IN FISCAL YEAR BASE PRICE DATE 5% 10%
- --------------- ------------ -------------- ----------- ----------- -------- --------
Nancy E. Graves 20,000(1) 76.9% $13.85 3/31/13 $174,500 $440,400
(1) These options were granted under the 1998 Stock-based Incentive Plan on
March 31, 2003. The options vest in three equal installments beginning on
December 16, 2003 and ending on December 16, 2005. The options were not
granted in tandem with any limited stock appreciation rights.
The following table provides certain information with respect to the
number of shares of common stock represented by outstanding stock options held
by the Named Executive Officers as of December 31, 2003.
AGGREGATED OPTIONS/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTIONS/SAR VALUES
SHARES NUMBER OF SECURITIES
ACQUIRED UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ON VALUE OPTIONS/SARS AT IN-THE-MONEY OPTIONS/SARS AT
NAME EXERCISE REALIZED DECEMBER 31, 2003 DECEMBER 31, 2003(1)
---- -------- -------- ---------------------- ----------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
Christopher Martin 260,000 $3,217,875 25,000 -- $434,375 $--
Ann C. Clancy 30,400 353,000 -- -- -- --
Nancy E. Graves -- -- 6,666 13,334 48,662 97,338
Thomas M. Lyons 30,400 353,000 -- -- -- --
Richard Spengler 50,470 653,366 46,500 -- 564,975 --
(footnotes on following page)
82
- -------------------
(1) The value of the in-the-money options represents the difference between the
fair market value of the common stock of $21.15 per share as of December
31, 2003 and the exercise price per share of the options. All options
granted under the 1996 Omnibus Incentive Plan had an exercise price of
$3.78 per share. All options granted under the 1998 Stock-based Incentive
Plan had an exercise price of $9.00 per share, with the exception of 20,000
of Ms. Graves' options which were granted on March 31, 2003 with an
exercise price of $13.85.
PENSION PLAN. First Savings is a participant in the Financial Institutions
Retirement Fund, a multi-employer defined benefit plan (the "Pension Plan"). All
employees age 21 or older who have completed one year of service are eligible to
participate in this Pension Plan. Retirement benefits are based upon a formula
utilizing years of service and average compensation. Participants are vested
100% upon the completion of five years of service. Effective August 1, 2003,
First Savings amended the Pension Plan to reduce the retirement benefit and
close the plan to new participants hired on or after that date.
The Financial Institutions Retirement Fund does not segregate its assets by
participating employer. Therefore, First Savings cannot ascertain the
accumulated benefit obligations, plan assets or the components of annual pension
expense attributable to it. The following table indicates the annual retirement
benefit that would be payable under the plan upon retirement at age 65 to a
participant electing to receive his retirement benefit in the standard form of
benefit, assuming various specified levels of plan compensation and various
specified years of credited service.
ESTIMATED ANNUAL RETIREMENT BENEFIT PAYABLE AT AGE 65
TEN YEAR CERTAIN AND LIFE ANNUITY TO AN EMPLOYEE RETIRING IN 2003
YEARS OF BENEFIT SERVICE (1)
----------------------------
1.0% CAREER
AVERAGE
SALARY (2)(3) 15 20 25 30 35
-------- ------- ------- -------- -------- --------
$125,000 $18,800 $25,000 $ 31,300 $ 37,500 $ 43,800
150,000 22,500 30,000 37,500 45,000 52,500
175,000 26,300 35,000 43,800 52,500 61,300
200,000 30,000 40,000 50,000 60,000 70,000
300,000 45,000 60,000 75,000 90,000 105,000
400,000 60,000 80,000 100,000 120,000 140,000
450,000 67,500 90,000 112,500 135,000 157,500
- -------------------
(1) As of December 31, 2003, Christopher Martin, Ann C. Clancy, Thomas M. Lyons
and Richard Spengler had 20 years, 4 years, 3 years, and 20 years of
credited service, respectively. Ms. Graves was not a participant in the
Pension Plan as of December 31, 2003.
(2) The compensation utilized to determine estimated benefits is the salary
amount listed under "Summary Compensation Table," minus any directors'
fees. Effective August 1, 2003, the Plan was amended from a 5-year Final
Average Compensation Plan to a Career Average Plan. Therefore, on a
prospective basis, career accruals will be added to the August 1, 2003
benefits. The Pension Plan does not provide a deduction for Social Security
benefits and there are no other offsets to benefits.
(3) Under Section 401(a)(17) of the Code, a participant's annual compensation
in excess of $200,000 (as adjusted to reflect cost-of-living increases) is
disregarded for purposes of determining average annual compensation. For
plan years 1997 through 1999, that limit was $160,000. For plan years 2000
and 2001, the limit increased to $170,000, and for 2002 and 2003, the limit
increased to $200,000. Benefits are not reduced below the level of benefits
accrued as of December 31, 1993. Under applicable law, the maximum annual
benefit for a Ten Year Certain and Life Annuity is $152,091 for 2003.
83
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN. Effective as of January 1, 1994, the
Board of Directors revised a previously existing plan entitled the Retirement
Benefit Maintenance Plan (the "Maintenance Plan") and restated it as the First
Savings Bank Supplemental Executive Retirement Plan ("SERP"). The SERP is a
nonqualified employee benefit plan that provides a post-employment supplemental
retirement benefit for certain participants designated by the Board of Directors
of First Savings. A participant's benefit under the SERP is equal to (i) the
excess of (A) seventy-five percent (75%) of the participant's base salary
payments during the twelve consecutive months in which he received the greatest
amount of such payments, over (B) the amount of the participant's "Pension Plan
Annual Benefit" and "Primary Social Security Benefit," as defined in the SERP,
reduced by (ii) four percent (4%) for each year of benefit service less than
twenty-five (25). Generally, if a participant retires at or after he attains the
age of 65, his benefit would not be subject to any reduction based on years of
benefit service. If a participant elects early payment of his benefit, unless he
has attained age 60 and accrued 25 years of benefit service, his benefit would
be reduced according to actuarial considerations. Upon a change in control, as
defined in the SERP, a participant's benefit would not be subject to any
reduction based on years of benefit service or early payment. Under the terms of
the merger agreement with PFS and the SERP, all benefits under the SERP were
paid in full to the plan's two participants, Mr. Mulkerin and Mr. Martin, as of
December 31, 2003. Messrs. Mulkerin and Martin received approximately $1.3
million and $2.6 million, respectively, in satisfaction of all unpaid benefits
due under the SERP.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN II. On November 15, 2000, the Bank's
Board of Directors approved the Amended and Restated First Savings Bank
Supplemental Executive Retirement Plan II ("SERP II"). Anyone who participates
in the ESOP or the Incentive Savings Plan for Employees of First Savings Bank
("Incentive Savings Plan") is eligible for selection as a participant in the
SERP II. Participants in the SERP II are determined by the Bank's Board of
Directors from a select group of management or highly compensated employees.
Generally, the SERP II provides a participant the benefits that he would have
received under the ESOP and the Incentive Savings Plan if certain Code benefit
limitations did not apply. The participant also would receive any benefits he
would have received under the ESOP had he remained in service throughout the
term of the ESOP loan and all unallocated ESOP shares were allocated to
participants. Vesting under the SERP II is subject to a five-year graded vesting
schedule. Upon a change in control, as defined in the SERP II, however, the
participant's portion of the unallocated ESOP shares would immediately vest.
Under the terms of the merger agreement with PFS and the SERP II all benefits
under the SERP II were paid in full to the plan's only participant, Mr. Martin,
as of December 31, 2003. Mr. Martin received $466,517 in satisfaction of all
unpaid benefits due under the SERP II.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. During 2003, the
Compensation Committee consisted of Messrs. Ruegger, Hornyak, Shein and Timpson.
There were no interlocks, as defined under the rules and regulations of the SEC,
between members of this committee or executive officers of the Company and
corporations with respect to which such persons are affiliated, or otherwise.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth certain information as to those persons believed
by management to be beneficial owners of more than 5% of the Company's common
stock outstanding as of March 1, 2004. Persons and groups owning in excess of 5%
of the Company's common stock are required to file certain reports regarding
such ownership with the Company and with the SEC, in accordance with the
Securities Exchange Act of 1934, as amended. Except as otherwise indicated, each
stockholder shown in the table has sole voting and investment power with respect
to the shares of common stock indicated. The Company is not aware of any person
or group that owns more than 5% of the Company's common stock as of March 1,
2004 other than those persons listed below.
84
AMOUNT AND NATURE OF PERCENT OF
TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS(1)
- -------------------------- ---------------------------------------------- ------------------------- -----------------------
Common Stock First Savings Bank 2,070,991(2) 7.3%
Employee Stock Ownership Plan and Trust
c/o First Savings Bank
Common Stock Private Capital Management 2,551,623(3) 9.0%
- ------------------
(1) Based on 28,268,402 total outstanding shares of First Sentinel Bancorp,
Inc. as of March 1, 2004.
(2) Based on a Schedule 13G filed with the SEC on February 12, 2004. The assets
of the First Savings Bank Employee Stock Ownership Plan ("ESOP") are held
in trust by First Bankers Trust Company (the "ESOP Trustee"). The ESOP
Trustee, subject to its fiduciary duty, must vote all allocated shares held
in the ESOP in accordance with the instructions of the participating
employees. At March 1, 2004, 1,137,485 shares of common stock had been
allocated to participating employee accounts and the ESOP Trustee shared
voting power with the participants with respect to such shares. As of this
same date, 933,506 unallocated shares remained in the ESOP and the ESOP
Trustee had sole voting power with respect to such shares. Subject to its
fiduciary duty, the ESOP Trustee will vote unallocated shares and allocated
shares for which no instructions are provided by participants in a manner
calculated to most accurately reflect the voting instructions received from
participants on allocated shares. The ESOP Committee, comprised of the
Compensation Committee of the Board of Directors, had sole power to direct
the disposition of all 2,070,991 shares.
(3) A Schedule 13G filed with the SEC on February 13, 2004 by Private Capital
Management, Bruce S. Sherman and Gregg J. Powers reported that: (i) Private
Capital Management and Messrs. Sherman and Powers had shared voting and
dispositive power over 2,551,623 shares of First Sentinel common stock and
(ii) Mr. Sherman had sole voting and dispositive power over 13,700 shares
of First Sentinel Common Stock. The Schedule 13G also disclosed that Mr.
Sherman in his capacity as Chief Executive Officer of Private Capital
Management, and Mr. Powers in his capacity as President of Private Capital
Management, exercise shared voting and dispositive power over shares of
First Sentinel common stock held by Private Capital Management's clients
and managed by Private Capital Management. Messrs. Sherman and Powers each
disclaim beneficial ownership for the shares held by Private Capital
Management's clients and disclaim the existence of a group.
For information regarding the security ownership of the management of the
Company, see "Directors and Executive Officers" under Item 10 herein.
EQUITY COMPENSATION PLAN INFORMATION.
The following table provides information regarding First Sentinel's stock
compensation plans under which the Company's equity securities are authorized
for issuance as of December 31, 2003.
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE NUMBER OF SECURITIES
ISSUED UPON EXERCISE OF EXERCISE PRICE OF REMAINING AVAILABLE FOR
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER EQUITY
PLAN CATEGORY WARRANTS AND RIGHTS (1) WARRANTS AND RIGHTS COMPENSATION PLANS (2)
- ------------------------------- ---------------------------- ----------------------- -----------------------------
Equity compensation plans
approved by security holders 1,314,149 $8.10 1,050,305
- ------------------------------- ---------------------------- ----------------------- -----------------------------
Equity compensation plans
not approved by security
holders - - - - - -
- ------------------------------- ---------------------------- ----------------------- -----------------------------
Total 1,314,149 $8.10 1,050,305
- ------------------------------- ---------------------------- ----------------------- -----------------------------
(1) The figures include 246,977 options that were granted by Pulse Bancorp,
Inc. prior to its merger with First Sentinel which remain outstanding.
First Sentinel assumed all stock compensation plans of Pulse Bancorp upon
its acquisition in December 1998, and each outstanding option to purchase
Pulse common shares was exchanged for options to purchase 3.764 shares of
First Sentinel common stock. All such options are currently exercisable.
(footnotes continued on following page)
85
(2) The figure includes 861,655 options and 188,650 restricted stock awards
that were available for issuance as of December 31, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH CERTAIN RELATED PERSONS
In the ordinary course of business, the Bank has made loans, and may continue to
make loans in the future, to its officers, directors and employees. Loans to
executive officers and directors are made in the ordinary course of business, on
substantially the same terms, including interest rate and collateral, as those
prevailing at the time for comparable transactions with other persons, except
that the Bank offers loans to directors and executive officers on terms not
available to the public, but available to all full-time employees. Such loans do
not involve more than the normal risk of collectibility or present other
unfavorable features.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
First Sentinel's independent auditors for the fiscal year ended December 31,
2003 were KPMG LLP. In fulfilling its responsibilities, the Company's Audit
Committee has re-appointed KPMG LLP to continue as independent auditors for
First Savings and First Sentinel for 2004, subject to ratification of such
appointment by the stockholders.
AUDIT FEES
The aggregate fees KPMG LLP billed to First Sentinel for professional services
rendered for the audit of the Company's financial statements and the reviews of
the financial statements included in First Sentinel's Quarterly Reports on Form
10-Q was $144,500 for the fiscal year ended December 31, 2003 and $129,000 for
the fiscal year ended December 31, 2002.
AUDIT-RELATED FEES
The aggregate fees KPMG LLP billed to First Sentinel for assurance and related
services that are reasonably related to the performance of the audit or review
of First Sentinel's financial statements was $15,000 for the fiscal year ended
December 31, 2003 and $14,000 for the fiscal year ended December 31, 2002. These
fees were billed to the Company in connection with audits KMPG LLP conducted on
the First Savings Bank Employee Stock Ownership Plan and the Incentive Savings
Plan for Employees of First Savings Bank.
TAX FEES
The aggregate fees KPMG LLP billed to First Sentinel for tax compliance, tax
advice and tax planning was $47,900 for the fiscal year ended December 31, 2003
and $34,500 for the fiscal year ended December 31, 2002. These fees consisted
primarily of tax return, preparation and consultation work performed by KPMG
LLP.
ALL OTHER FEES
The aggregate fees KPMG LLP billed to First Sentinel for all other services not
described above under the captions "Audit Fees," "Audit-Related Fees" and "Tax
Fees" was $0 for the fiscal year ended December 31, 2003 and $0 for the fiscal
year ended December 31, 2002.
The Audit Committee, acting under its charter, pre-approves all auditing
services, permitted non-audit services and the fees for such services performed
by First Sentinel's independent auditors.
86
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, 2003, listed below are included in Item 8 hereof.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2003
AND 2002.
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,
2003, 2002 AND 2001.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
DECEMBER 31, 2003, 2002, AND 2001.
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
2003, 2002 AND 2001.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
INDEPENDENT AUDITORS' REPORT.
(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
---------- -----------------------------------------------------------
2.1 Agreement and Plan of Merger, dated December
19, 2003, by and a between Provident Financial
Services, Inc. and First Sentinel Bancorp, Inc. a
3.1 Certificate of Incorporation of First Sentinel
Bancorp, Inc. b
3.2 Bylaws of First Sentinel Bancorp, Inc. c
3.3 Amendment to Bylaws of First Sentinel Bancorp,
Inc. Filed herein
4.0 Stock Certificate of First Sentinel Bancorp,
Inc. d
4.1 Certificate of Designations, Preferences and
Rights of Series A Junior Participating
Preferred Stock e
4.2 Rights Agreement by and between First Sentinel
Bancorp, Inc. and Registrar and Transfer
Company, as Rights Agent e
4.3 Form of Right Certificate e
10.1 First Sentinel Bancorp, Inc. 1996 Omnibus
Incentive Plan d
10.2 First Sentinel Bancorp, Inc. Amended and
Restated 1998 Stock-based Incentive Plan f
10.3 First Sentinel Bancorp, Inc. 1986 Acquisition
Stock Option Plan g
10.4 First Sentinel Bancorp, Inc. 1993 Acquisition
Stock Option Plan g
10.5 First Sentinel Bancorp, Inc. 1997 Acquisition
Stock Option Plan
g
10.6 First Savings Bank Directors' Deferred Fee
Plan h
10.7 Amendment to First Savings Bank Directors'
Deferred Fee Plan Filed herein
10.8 First Savings Bank, SLA Supplemental Executive
Retirement Plan d
10.9 First Savings Bank Supplemental Executive
Retirement Plan II h
10.10 First Savings Bank Non-Employee Director
Retirement Plan i
10.11 Form of Employment Agreement between First
Sentinel Bancorp, Inc. and Christopher Martin h
10.12 Form of Employment Agreement between First
Savings Bank and Christopher Martin h
----------------------------------------------------------------------
87
---------- -----------------------------------------------------------
Exhibit
Number Description Reference
---------- -----------------------------------------------------------
10.13 Form of Two-year Change in Control Agreement
between First Savings Bank and certain
executive officers h
10.14 Form of Three-year Change in Control Agreement
between First Savings Bank and certain
executive officers h
10.15 First Savings Bank, SLA Employee Severance
Compensation Plan d
10.16 First Sentinel Bancorp, Inc. Key Employee
Equity Compensation Plan J
11.0 Computation of per share earnings k
21.0 Subsidiaries of Registrant incorporated by
reference herein to Part I - Subsidiaries
23.0 Consent of KPMG LLP Filed herein
31.1 Certification of Chief Executive Officer Filed herein
31.2 Certification of Chief Financial Officer Filed herein
32.1 Statement of Chief Executive Officer furnished
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, 18 U.S.C. Section 1350 Filed herein
32.2 Statement of Chief Financial Officer 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,
2003 Current Report on Form 8-K of First Sentinel Bancorp, Inc. (File No.
000-23809) filed on December 31, 2003.
b 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.
c Previously filed and incorporated herein by reference to the December 31,
2002 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No.
000-23809) dated March 31, 2003.
d 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.
e 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.
f 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.
g 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.
h 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.
i 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.
j Previously filed and incorporated herein by reference to the Proxy
Statement for the 2003 Annual Meeting of Stockholders of First Sentinel
Bancorp, Inc. (File No. 000-23809) filed on March 28, 2003.
k Filed herein as a component of Item 8, under Note 1 of the Notes to
Consolidated Financial Statements.
88
(b) Reports on Form 8-K.
(1) On October 22, 2003 the Company filed a report on Form 8-K which includes,
under Item 12, a press release reporting the Company's financial results for the
quarter and nine months ended September 30, 2003.
(2) On December 22, 2003, the Company filed a report on Form 8-K which
includes, under Item 5, a joint press release announcing the Company's execution
of a merger agreement with Provident Financial Services, Inc. and a press
release announcing the expected restatement of the Company's financial
information and related amendment to the Directors Deferred Fee Plan.
(3) On December 31, 2003, the Company filed a report on Form 8-K which
includes, under Item 5, a copy of the merger agreement between the Company and
Provident Financial Services, Inc. and the joint press release issued by the
Company and Provident Financial Services, Inc. on December 22, 2003.
89
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 15, 2004 FIRST SENTINEL BANCORP, INC.
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 15, 2004
- ------------------------
Philip T. Ruegger, Jr.
CHRISTOPHER MARTIN President, Chief Executive March 15, 2004
- ------------------------ Officer and Director
Christopher Martin
THOMAS M. LYONS Executive Vice President, March 15, 2004
- ------------------------ Chief Financial Officer
Thomas M. Lyons
JOSEPH CHADWICK Director March 15, 2004
- ------------------------
Joseph Chadwick
GEORGE T. HORNYAK, JR. Director March 15, 2004
- ------------------------
George T. Hornyak, Jr.
KEITH H. MCLAUGHLIN Director March 15, 2004
- ------------------------
Keith H. McLaughlin
JOHN P. MULKERIN Director March 15, 2004
- ------------------------
John P. Mulkerin
JEFFRIES SHEIN Director March 15, 2004
- ------------------------
Jeffries Shein
WALTER K. TIMPSON Director March 15, 2004
- ------------------------
Walter K. Timpson
90