-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NWfJLJcJAYanAWIKqDlPqbJlmbKwIzBUPvI7RCtxF2MY1xD5CikNGX0Y5BCfjaX8 aE1MQT0/Nz3pWzm6qN+IHg== 0000928385-97-000497.txt : 19970326 0000928385-97-000497.hdr.sgml : 19970326 ACCESSION NUMBER: 0000928385-97-000497 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970325 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: OCEAN FINANCIAL CORP CENTRAL INDEX KEY: 0001004702 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 223412577 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 033-80123 FILM NUMBER: 97562606 BUSINESS ADDRESS: STREET 1: 74 BRICK BLVD CITY: BRICK STATE: NJ ZIP: 08723 BUSINESS PHONE: 9084775200 MAIL ADDRESS: STREET 1: 74 BRICK BLVD. CITY: BRICK TOWNSHIP STATE: NJ ZIP: 08723 10-K405 1 FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K Annual report pursuant to Section 13 of the Securities Exchange Act of 1934, as amended For the fiscal year ended DECEMBER 31, 1996 Commission File No.: 0-27428 OCEAN FINANCIAL CORP. (exact name of registrant as specified in its charter) DELAWARE 22-3412577 (State or other jurisdiction of (I.R.S. Employer I.D. No.) incorporation or organization) 975 HOOPER AVENUE, TOMS RIVER, NEW JERSEY 08753 (Address of principal executive offices) Registrant's telephone number, including area code: (908) 240-4500 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $0.01 PER SHARE (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ________. ------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, i.e., persons other than the directors and executive officers of the registrant, was $276,894,000, based upon the last sales price as quoted on The Nasdaq Stock Market for March 14, 1997. The number of shares of Common Stock outstanding as of March 14, 1997 is 9,059,124. DOCUMENTS INCORPORATED BY REFERENCE THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1996, IS INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K. THE PROXY STATEMENT FOR THE 1997 ANNUAL MEETING OF SHAREHOLDERS IS INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K. 50269 INDEX
PAGE PART I Item 1. Business........................................... 1 Item 2. Properties......................................... 32 Item 3. Legal Proceedings.................................. 32 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............................ 33 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 33 Item 8. Financial Statements and Supplementary Data........ 33 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 33 PART III Item 10 Directors and Executive Officers of the Registrant. 34 Item 11 Executive Compensation............................. 34 Item 12 Security Ownership of Certain Beneficial Owners and Management..................................... 34 Item 13 Certain Relationships and Related Transactions..... 34 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................................... 34
SIGNATURES PART I ITEM 1. BUSINESS - ----------------- GENERAL Ocean Financial Corp. (the "Company") was organized by the Board of Directors of Ocean Federal Savings Bank (the "Bank") for the purpose of acquiring all of the capital stock of the Bank issued in connection with the Bank's conversion from mutual to stock form, which was completed on July 2, 1996. At December 31, 1996, the Company had consolidated total assets of $1,303.9 million and total equity of $252.8 million. The Company was incorporated under Delaware law and is a savings and loan holding company subject to regulation by the Office of Thrift Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the Securities and Exchange Commission ("SEC"). Currently, the Company does not transact any material business other than through its subsidiary, the Bank. The Bank was originally founded as a state-chartered building and loan association in 1902, and converted to a federal savings and loan association in 1945. The Bank became a federally chartered mutual savings bank in 1989. The Bank's principal business has been and continues to be attracting retail deposits from the general public in the communities surrounding its branch offices and investing those deposits, together with funds generated from operations and borrowings, primarily in single-family, owner-occupied residential mortgage loans within its market area. To a significantly lesser extent, the Bank invests in commercial real estate, multi-family, construction and consumer loans. The Bank also invests in mortgage-backed securities, securities issued by the U.S. Government and agencies thereof, and other investments permitted by applicable law and regulations. The Bank may periodically sell newly originated 30-year, fixed-rate mortgage loans to the secondary market. Loan sales come from loans held in the Bank's portfolio designated as being held for sale or originated during the period and being so designated. The Bank retains all of the servicing rights of loans sold. The Bank's revenues are derived principally from interest on its mortgage loans, and to a lesser extent, interest on its investment and mortgage-backed securities and income from loan servicing. The Bank's primary sources of funds are deposits, principal and interest payments on loans, Federal Home Loan Bank ("FHLB") and other borrowings and to a lesser extent, investment maturities and proceeds from the sale of loans. MARKET AREA AND COMPETITION The Bank has been, and intends to continue to be, a community-oriented financial institution, offering a wide variety of financial services to meet the needs of the communities it serves. The Bank conducts its business through an administrative and branch office located in Toms River, Ocean County, New Jersey, and nine additional branch offices, eight of which are located in Ocean County and one of which is located in Middlesex County, New Jersey. The Bank's deposit gathering base is concentrated in the communities surrounding its offices. While its lending area extends throughout New Jersey, most of the Bank's mortgage loans are secured by properties located in Ocean County and Southern Monmouth County. The Bank is the only remaining community-based financial institution headquartered in Ocean County, New Jersey, which is located along the central New Jersey shore. Ocean County is among the fastest growing population areas in New Jersey and has a significant number of retired residents who have traditionally provided the Bank with a stable source of deposit funds. The economy in the Bank's primary market area is based upon a mixture of service and retail trade. Other employment is provided by a variety of wholesale trade, manufacturing, federal, state and local government, hospitals and utilities. The area is also home to commuters working in New Jersey suburban areas around New York and Philadelphia. In the late 1980's and early 1990's, due in part to the effects of a prolonged decline in the national and regional economy, layoffs in the financial services industry and corporate relocations, New Jersey experienced reduced levels of employment. These events, in conjunction with a surplus of available commercial and residential properties, resulted in an overall decline during this period in the underlying values of properties located in New Jersey. However, New Jersey's real estate market has stabilized in recent years. Whether such stabilization will continue is dependent, in large part, upon the general economic health of the United States and New Jersey, and other factors beyond the Bank's control and, therefore, cannot be estimated. The Bank faces significant competition both in making loans and in attracting deposits. The State of New Jersey has a high density of financial institutions, many of which are branches of significantly larger institutions which have greater financial resources than the Bank, all of which are competitors of the Bank to varying degrees. The Bank's competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies and insurance companies. Its most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. The Bank faces additional competition for deposits from short-term money market funds, other corporate and government securities funds and from other financial service institutions such as brokerage firms and insurance companies. LENDING ACTIVITIES Loan Portfolio Composition. The Bank's loan portfolio consists primarily of - -------------------------- conventional first mortgage loans secured by one- to four-family residences. At December 31, 1996, the Bank had total loans outstanding of $690.3 million, of which $628.5 million, or 91.05% of total loans, were one- to four-family, residential mortgage loans. The remainder of the portfolio consisted of $36.9 million of consumer loans, primarily home equity loans and lines of credit, equalling 5.34% of total loans; $15.6 million of commercial real estate, multi- family and land loans, or 2.26% of total loans; and $9.3 million of real estate construction loans, or 1.35% of total loans. The Bank had $727,000 in loans held for sale at December 31, 1996. At that same date, 63.41% of the Bank's total loans had adjustable interest rates. The types of loans that the Bank may originate are subject to federal and state law and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board, and legislative tax policies. 2 The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
At December 31, --------------------------------------------------------------------------------------------------------- 1996 1995 1994 1993 1992 ---------------------- --------------------- ------------------- ------------------- ------------------- PERCENT PERCENT PERCENT PERCENT PERCENT AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL ---------- ---------- -------- ----------- -------- --------- --------- --------- -------- ---------- (DOLLARS IN THOUSANDS) Real estate: One- to four-family....... $628,525 91.05% $575,010 92.01% $552,401 91.63% $505,984 91.66% $477,753 90.75% Commercial real estate, multi-family and land... 15,634 2.26 14,939 2.39 13,885 2.30 11,472 2.08 8,235 1.56 Construction.............. 9,287 1.35 8,153 1.30 10,474 1.74 8,123 1.47 12,484 2.37 Consumer (1)................ 36,860 5.34 26,867 4.30 26,100 4.33 26,427 4.79 28,003 5.32 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans............. 690,306 100.00% 624,969 100.00% 602,860 100.00% 552,006 100.00% 526,475 100.00% ====== ====== ====== ====== ====== Less: Undisbursed loan funds..... 3,517 2,687 2,661 2,341 2,233 Unamortized discounts, net. 11 12 13 27 36 Deferred loan fees......... 1,302 1,679 2,263 3,286 3,737 Allowance for loan losses.. 6,021 6,001 5,608 5,504 5,737 -------- -------- -------- -------- -------- Total loans, net........ 679,455 614,590 592,315 540,848 514,732 Less: Mortgage loans held for sale..................... 727 1,894 -- 963 545 -------- -------- -------- -------- -------- Loans receivable, net..... $678,728 $612,696 $592,315 $539,885 $514,187 ======== ======== ======== ======== ======== Total loans: Adjustable rate......... $437,706 63.41% $405,485 64.88% $386,424 64.10% $332,487 60.23% $311,898 59.24% Fixed rate.............. 252,600 36.59 219,484 35.12 216,436 35.90 219,519 39.77 214,577 40.76 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans........... $690,306 100.00% $624,969 100.00% $602,860 100.00% $552,006 100.00% $526,475 100.00% ======== ====== ======== ====== ======== ====== ======== ====== ======== ======
- --------------------------- (1) Consists primarily of home equity loans and lines of credit, and to a lesser extent, loans on savings accounts, automobile and student loans. 3 Loan Maturity. The following table shows the contractual maturity of the Bank's - ------------- total loans at December 31, 1996. There were $727,000 in loans held for sale at December 31, 1996. The table does not include principal repayments. Principal repayments, including prepayments, on total loans was $103.5 million, $89.6 million and $90.9 million for the years ended December 31, 1996, 1995 and 1994, respectively.
AT DECEMBER 31, 1996 --------------------------------------------------------------- COMMERCIAL REAL ESTATE, ONE- TO MULTI- TOTAL FOUR- FAMILY LOANS FAMILY AND LAND CONSTRUCTION CONSUMER RECEIVABLE ---------- ---------- ------------ -------- ---------- (IN THOUSANDS) Amounts due: One year or less...................... $ 21,525 $ 739 $9,287 $ 3,975 $ 35,526 ------- ----- ----- ------ ------ After one year: More than one year to three years.... 50,656 1,160 - 6,337 58,153 More than three years to five years.. 54,127 1,194 - 6,355 61,676 More than five years to 10 years..... 128,497 2,131 - 14,584 145,212 More than 10 years to 20 years....... 204,427 7,534 - 5,607 217,568 More than 20 years................... 169,293 2,876 - 2 172,171 ------- ------ ----- ------ ------- Total due after December 31, 1997.... 607,000 14,895 - 32,885 654,780 ------- ------ ----- ------ ------- Total amount due..................... $628,525 $15,634 $9,287 $36,860 690,306 ======= ====== ===== ====== Less: Undisbursed loan funds............ 3,517 Unamortized discounts, net........ 11 Deferred loan fees................ 1,302 Allowance for loan losses......... 6,021 ------- Total loans, net..................... 679,455 Less: Mortgage loans held for sale... 727 ------- Loans receivable, net................. $678,728 =======
4 The following table sets forth at December 31, 1996, the dollar amount of total loans receivable contractually due after December 31, 1997, and whether such loans have fixed interest rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 1997 ---------------------------------- FIXED ADJUSTABLE TOTAL -------- ---------- -------- Real estate loans: (IN THOUSANDS) One- to four-family...... $224,216 $382,784 $607,000 Commercial real estate, multi-family and land... 5,464 9,431 14,895 Construction............. - - - Consumer.................. 11,590 21,295 32,885 ------- ------- ------- Total loans receivable.. $241,270 $413,510 $654,780 ======= ======= =======
Origination, Sale, Servicing and Purchase of Loans. The Bank's mortgage lending - -------------------------------------------------- activities are conducted primarily by commissioned loan representatives in the exclusive employment of the Bank and through the Bank's branch offices. The Bank originates both adjustable-rate and fixed-rate mortgage loans. The Bank's ability to originate loans is dependent upon the relative customer demand for fixed-rate or adjustable-rate mortgage loans, which is affected by the current and expected future level of interest rates. The Bank may periodically sell part of the 30-year, fixed-rate mortgage loans that it originates and retain for portfolio ARM loans and shorter term fixed-rate loans with maturities of 15 years or less. The Bank retains all servicing of the loans sold. See "- Loan Servicing." At December 31, 1996 there were $727,000 in loans categorized as held for sale. In the past, the Bank has also originated loans through commitments negotiated with correspondent mortgage origination firms. 5 The following tables set forth the Bank's loan originations, purchases, sales, principal repayments and loan activity for the periods indicated.
FOR THE YEAR DECEMBER 31, ------------------------------ 1996 1995 1994 -------- -------- -------- (IN THOUSANDS) Total loans: Beginning balance............. $624,969 $602,860 $552,006 ------- ------- ------- Loans originated: One- to four-family........ 170,381 112,283 139,106 Commercial real estate, multi-family and land.. 2,031 4,058 2,558 Construction............... 1,537 6,010 11,647 Consumer................... 21,829 11,007 7,714 ------- ------- ------- Total loans originated.............. 195,778 133,358 161,025 ------- ------- ------- Total..................... 820,747 736,218 713,031 Less: Principal repayments......... 103,546 89,596 90,870 Sales of loans............... 24,711 18,861 16,578 Transfer to REO.............. 2,184 2,792 2,723 ------- ------- ------- Total loans................... $690,306 $624,969 $602,860 ======== ======== ========
6 One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate and adjustable-rate mortgage loans secured by one- to four-family residences with maturities up to 30 years. Substantially all of such loans are secured by property located in the Bank's primary market area. Loan originations are generally obtained from the Bank's existing or past customers, members of the local communities and commissioned loan representatives and their contacts with the local real estate industry. In the past, the Bank has also originated loans through commitments negotiated with correspondent mortgage origination firms. At December 31, 1996, the Bank's total loans outstanding were $690.3 million, of which $628.5 million, or 91.05%, were one- to four-family residential mortgage loans, primarily single-family and owner-occupied. To a lesser extent, the Bank also makes mortgage loans secured by seasonal second homes. The average size of the Bank's one- to four-family mortgage loan was approximately $77,000 at December 31, 1996. The Bank currently offers a number of ARM loan programs with interest rates which adjust every one-, three-, or five-years. The Bank's ARM loans generally provide for periodic (not less than 2%) and overall (not more than 6%) caps on the increase or decrease in the interest rate at any adjustment date and over the life of the loan. The interest rate on these loans is indexed to the applicable one-, three-, or five year U.S. Treasury constant maturity yield, with a repricing margin which ranges generally from 2.75% to 3.25% above the index. The Bank also offers three-, five-, seven-and ten year ARM loans which operate as fixed-rate loans for three, five, seven or ten years and then convert to one-year ARM loans for the remainder of the term. The ARM loans are then indexed to a margin of generally 2.75% to 3.25% above the one-year U.S. Treasury constant maturity yield. 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 with a loan-to-value ratio of 75% or less are qualified at the fully-indexed rate (the applicable U.S. Treasury index plus the margin, rounded to the nearest one-eighth of one percent), and borrowers of one-year ARM loans with a loan-to-value ratio over 75% are qualified at the higher of the fully indexed rate or the initial rate plus the 2% annual interest rate cap. The Bank does not originate ARM loans which provide for negative amortization. The Bank's fixed-rate mortgage loans currently are made for terms from 10 to 30 years. At December 31, 1996, the Bank had commitments for the origination of fixed-rate mortgage loans totalling $12.0 million. The normal terms for such commitments provide for a maximum of 90 days rate lock upon receipt of a 1.0% fee charged on the mortgage amount. The Bank may periodically sell part of the 30-year, fixed-rate residential mortgage loans that it originates. The Bank retains the servicing on all loans sold. The Bank generally retains for its portfolio shorter term, fixed-rate loans with maturities of 15 years or less, and certain longer term fixed-rate loans, generally consisting of loans to facilitate the sale of REO, loans to officers, directors or employees of the Bank and "jumbo", non-conforming loans as determined by applicable FNMA and FHLMC guidelines. The Bank's policy is to originate one- to four-family residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan and up to 95% of the appraised value or selling price if private mortgage insurance is obtained. Mortgage loans originated by the Bank include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank's consent. Due-on-sale clauses are an important means of adjusting the rates on the Bank's fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses. Commercial Real Estate, Multi-Family and Land Lending. The Bank originates - ----------------------------------------------------- commercial real estate loans that are secured by properties generally used for business purposes such as small office buildings or retail facilities located in the Bank's primary market area. The Bank's underwriting procedures provide that commercial real estate loans may be made in amounts up to 75% of the appraised value of the property to a maximum of generally $4 million. The Bank currently originates commercial real estate loans with terms of up to twenty five years with fixed or adjustable rates which are indexed to a margin above the one-, three-, or five-year U.S. Treasury constant maturity yield. In reaching its decision 7 on whether to make a commercial real estate loan, the Bank considers the net operating income of the property and the borrower's expertise, credit history and profitability. The Bank has generally required that the properties securing commercial real estate loans have debt service coverage ratios of at least 120%. Properties securing a loan are appraised by an independent appraiser and title insurance is required on all loans. The Bank typically requires the personal guarantee of the principal borrowers for all commercial real estate loans. The Bank's commercial real estate loan portfolio at December 31, 1996 was $10.7 million, or 1.55% of total loans. The largest commercial real estate loan in the Bank's portfolio at December 31, 1996 was a 10% participation in a performing loan for which the Bank had an outstanding carrying balance of $1.6 million, which was secured by a 200,000 square foot office building located in Fairfield, New Jersey. The Bank originates multi-family mortgage loans generally secured by buildings with five or more housing units located in the Bank's primary market area. As a result of market conditions in its primary market area, the Bank currently originates multi-family loans on a limited and highly selective basis. In reaching its decision on whether to make a multi-family loan, the Bank considers the qualifications of the borrower as well as the underlying property. Some of the factors to be considered are: the net operating income of the mortgaged premises before debt service and depreciation; the debt service ratio; and the ratio of loan amount to appraised value. Pursuant to the Bank's current underwriting policies, a multi-family adjustable-rate mortgage loan may only be made in an amount up to 75% of the appraised value of the underlying property to a maximum amount of generally $4 million. In addition, the Bank generally requires a debt service ratio of 120%. Properties securing a loan are appraised by an independent appraiser and title insurance is required on all loans. The Bank's multi-family loan portfolio at December 31, 1996, totalled $4.6 million. The Bank's largest multi-family loan at December 31, 1996, had an outstanding balance of $2.2 million and was secured by a 125-unit affordable-housing apartment complex located in Toms River, New Jersey. To a significantly lesser extent, the Bank also originates land loans. Such loans totalled $306,000 at December 31, 1996. Loans secured by commercial real estate and multi-family residential properties are generally larger and involve a greater degree of risk than one- to four- family residential mortgage loans. Because payments on loans secured by multi- family properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting policies, which require such loans to be qualified at origination on the basis of the property's income and debt coverage ratio. Construction Lending. At December 31, 1996, construction loans totalled $9.3 - -------------------- million, or 1.35%, of the Bank's total loans outstanding. The Bank originates single-family construction loans primarily on a construction/permanent basis with such loans converting to an amortizing loan following the completion of the construction phase. Most of the Bank's construction loans are made to individuals building their primary residence, while, to a lesser extent, loans are made to developers known to the Bank in order to build single-family houses under contract for sale, which loans become due and payable over terms not exceeding 18 months. The current policy of the Bank is to charge interest rates on its construction loans which float at margins which are generally 2.0% above the prime rate (as published in the Wall Street Journal). The Bank's construction loans improve the interest rate sensitivity of its earning assets. At December 31, 1996, the Bank had 49 construction loans, with the largest loan balance being approximately $825,000. At December 31, 1996, all of the Bank's construction lending portfolio consisted of loans secured by property located in the State of New Jersey, for the purpose of constructing one- to four-family homes. The Bank may originate construction loans to individuals and contractors on approved building lots in amounts up to 75% of the appraised value of the land. The terms to maturity of the Bank's construction/permanent loans are similar to the Bank's other one- to four-family mortgage products. The Bank requires an appraisal of the property, credit reports, and financial statements on all principals and guarantors, among other items, for all construction loans. Construction lending, by its nature, entails additional risks compared to 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 8 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 Bank has attempted to address these risks through its underwriting procedures. At December 31, 1996, the Bank held one construction loan for $314,000 which was classified as substandard. Consumer Loans. The Bank also offers consumer loans. At December 31, 1996, the - -------------- Bank's consumer loans totalled $36.9 million, or 5.34% of the Bank's total loan portfolio. Of that amount, home equity loans comprised $19.2 million, or 52.0%; home equity lines of credit comprised $14.7 million, or 39.8%; loans on savings accounts totalled $1.2 million, or 3.3%; and automobile and student loans totalled $1.8 million, or 4.9%. The Bank originates home equity loans secured by one- to four-family residences. These loans are originated as either adjustable-rate or fixed-rate loans with terms ranging from 10 to 20 years. Home equity loans are typically made on owner-occupied, one- to four-family residences and generally to the Bank's first mortgage customers. These loans are subject to a 75% loan-to-value limitation, including any other outstanding mortgages or liens. The Bank also offers a variable rate home equity line of credit which extends a credit line based on the applicant's income and equity in the home. Generally, the credit line, when combined with the balance of the first mortgage lien, may not exceed 75% of the appraised value of the property at the time of the loan commitment. Home equity lines of credit are secured by a mortgage on the underlying real estate. The Bank presently charges no origination fees for these loans, but may in the future charge origination fees for its home equity lines of credit. A borrower is required to make monthly payments of principal and interest, at a minimum of $50, based upon a 10 or 15 year amortization period. Generally, the adjustable rate of interest charged is the prime rate of interest (as published in the Wall Street Journal) plus up to 1.75%. The loans have an 18% lifetime cap on interest rate adjustments. The Bank's home equity lines of credit outstanding at December 31, 1996 totalled $14.7 million. Commercial Lending. During 1996, a Commercial Lending group was established - ------------------ within the Bank. The group's primary function is to service the business communities' banking and financing needs in the Bank's primary market area. The Commercial Lending group will handle both commercial loans (including loans for working capital; fixed asset purchases; and acquisition, receivable and inventory financing) and commercial mortgage loans (including acquisition, construction, expansion and refinancing of owner occupied and investment properties). Credit facilities such as lines of credit and term loans will be used to facilitate these requests. In all cases, the Bank will review and analyze financial history and capacity, collateral value, strength and character of the principals, and general payment history of the borrower and principals in coming to a credit decision. A well-defined credit policy has been approved by the Bank's Board of Directors. This policy discourages high risk credits, while focusing on quality underwriting, sound financial strength, and close management and Board monitoring. Commercial business lending, both secured and unsecured, is generally considered to involve a higher degree of risk than secured residential real estate lending. Risk of loss on a commercial business loan is dependent largely on the borrower's ability to remain financially able to repay the loan out of ongoing operations. If the Bank's estimate of the borrower's financial ability is inaccurate, the Bank may be confronted with a loss of principal on the loan. Loan Approval Procedures and Authority. The Board of Directors establishes the - -------------------------------------- loan approval policies of the Bank. The Board of Directors has authorized the approval of loans secured by real estate up to $750,000 by various employees of the Bank, on a scale which requires approval by personnel with progressively higher levels of responsibility as the loan amount increases. A minimum of two employees' signatures are required to approve loans over $150,000. Loans in amounts over $750,000 require approval by the Loan Committee of the Board of Directors. The Bank's policy is to refrain from making loans to a single borrower that in the aggregate exceed $4.0 million. Pursuant to OTS regulations, loans to one borrower generally cannot exceed 15% of the Bank's core capital, which at December 31, 1996 amounted to $24.8 million. 9 Loan Servicing. Loan servicing includes collecting and remitting loan payments, - -------------- accounting for principal and interest, making inspections as required of mortgaged premises, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. The Bank also services mortgage loans for others. All of the loans currently being serviced for others are loans which have been sold by the Bank. At December 31, 1996, the Bank was servicing $152.7 million of loans for others. For the years ended December 31, 1996, 1995 and 1994, loan servicing fees totalled $543,000, $522,000 and $633,000, respectively. Delinquencies and Classified Assets. The Board of Directors performs a monthly - ----------------------------------- review of all delinquent loan totals which includes loans sixty days or more past due, and the detail of each loan thirty days or more past due that were originated within the past year. In addition, management prepares a quarterly list of all classified loans and a narrative report of classified major loans (i.e., any mortgage or construction loan secured by other than a one- to four- family residence.) The procedures taken by the Bank with respect to delinquencies vary depending on the nature of the loan and period of delinquency. When a borrower fails to make a required payment on a loan, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. The Bank generally sends the borrower a written notice of non-payment after the loan is first past due. In the event payment is not then received, additional letters and phone calls generally are made. If the loan is still not brought current and it becomes necessary for the Bank to take legal action, which typically occurs after a loan is delinquent at least 90 days or more, the Bank will commence foreclosure proceedings against any real property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or an acceptable workout accommodation is not agreed upon before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. The Bank's Internal Asset Classification Committee, which is chaired by an officer who reports directly to the Audit Committee of the Board of Directors, reviews and classifies the Bank's assets quarterly and reports the results of its review to the Board of Directors. The Bank classifies assets in accordance with certain regulatory guidelines established by the OTS which are applicable to all savings associations. At December 31, 1996, the Bank had $9.4 million of assets, including all REO, classified as Substandard, $4,000 of assets classified as Doubtful and no assets classified as Loss. Loans and other assets may also be placed on a watch list as "Special Mention" assets. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated "Special Mention." Special Mention assets totalled $3.8 million at December 31, 1996, and consisted primarily of loans secured by single-family, owner-occupied residences. These loans are classified as Special Mention due to past delinquencies or other identifiable weaknesses. At December 31, 1996, the largest loan classified as Special Mention had a balance of $230,000 and the largest loan classified as Substandard had a balance of $429,000. 10 Non-Accrual Loans and REO - ------------------------- The following table sets forth information regarding non-accrual loans and REO. The Bank had no troubled-debt restructured loans within the meaning of SFAS 15, and 18 REO properties at December 31, 1996. It is the policy of the Bank to cease accruing interest on loans 90 days or more past due or in the process of foreclosure. For the years ended December 31, 1996, 1995, 1994, 1993 and 1992, respectively, 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 $345,000, $428,000, $607,000, $642,000 and $1,479,000 none of which was recognized.
December 31, --------------------------------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Non-accrual loans: Real estate: One- to four-family.................. $7,148 $ 8,296 $10,280 $ 9,705 $13,694 Commercial real estate, multi-family and land............... 122 154 96 315 145 Construction......................... 314 -- 265 250 337 Consumer............................... 113 221 298 224 330 ------- ------- ------- ------- ------- Total................................. 7,697 8,671 10,939 10,494 14,506 REO, net(1).............................. 1,555 1,367 1,580 3,056 3,927 ------- ------- ------- ------- ------- Total non-performing assets............. $9,252 $10,038 $12,519 $13,550 $18,433 ======= ======= ======= ======= ======= Allowance for loan losses as a percent of total loans receivable (2).. .88% .97% .94% 1.01% 1.10% Allowance for loan losses as a percent of total non-performing loans (3)...... 78.23% 69.21% 51.27% 52.45% 39.55% Non-performing loans as a percent of total loans receivable(2)(3)........... 1.12% 1.40% 1.83% 1.92% 2.79% Non-performing assets as a percent of total assets(3)........ .71% .97% 1.29% 1.45% 2.08%
____________________________ (1) REO balances are shown net of related loss allowances. (2) Total loans includes loans receivable and mortgage loans held for sale, less undisbursed loan funds, deferred loan fees and unamortized premiums and discounts. (3) Non-performing assets consist of non-performing loans and REO. Non- performing loans consist of all loans 90 days or more past due and other loans in the process of foreclosure. 11 Allowance for Loan Losses. The allowance for loan losses is established through - ------------------------- a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio based upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and the determination of the existence and realizable value of the collateral and guarantees securing the loan. Additions to the allowance are charged to earnings. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for loan losses based upon information available to them at the time of their examination. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control. As of December 31, 1996 and 1995, the Bank's allowance for loan losses was .88% and .97%, respectively, of total loans. The Bank had non-accrual loans of $7.7 million and $8.7 million at December 31, 1996 and 1995, respectively. The Bank will continue to monitor and modify its allowances for loan losses as conditions dictate. The following table sets forth activity in the Bank's allowance for estimated loan losses for the periods set forth in the table.
AT OR FOR THE YEAR ENDED DECEMBER 31, ------------------------------------- 1996 1995 1994 1993 1992 --------- -------- -------- -------- --------- (IN THOUSANDS) Balance at beginning of year............... $6,001 $5,608 $5,504 $5,737 $5,682 ------ ------ ------ ------ ------ Charge-offs: Real Estate: One- to four-family...................... 599 510 907 1,080 1,007 Commercial real estate, multi-family and land................ 30 28 141 334 106 Construction............................. -- -- -- 11 32 Consumer.................................. 63 30 5 122 25 ------ ------ ------ ------ ------ Total.................................. 692 568 1,053 1,547 1,170 Recoveries................................. 12 11 28 14 5 ------ ------ ------ ------ ------ Net charge-offs........................ 680 557 1,025 1,533 1,165 ------ ------ ------ ------ ------ Provision for loan losses.................. 700 950 1,129 1,300 1,220 ------ ------ ------ ------ ------ Balance at end of year..................... $6,021 $6,001 $5,608 $5,504 $5,737 ====== ====== ====== ====== ====== Ratio of net charge-offs during the year to average net loans outstanding during the year.......................... .11% .09% .18% .29% .23% ====== ====== ====== ====== ======
12 The following tables set forth the Bank's percent of allowance for loan losses to total allowance and the percent of loans to total loans in each of the categories listed at the dates indicated.
AT DECEMBER 31, ----------------------------------------------------------------------------------------------- 1996 1995 1994 ------------------------------ ---------------------------- ------------------------------- PERCENT PERCENT PERCENT OF OF OF LOANS IN LOANS IN LOANS IN PERCENT OF EACH PERCENT OF EACH PERCENT OF EACH ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS ----- --------- --------- ------ --------- -------- ------ ---------- -------- (DOLLARS IN THOUSANDS) One- to four-family....... $2,659 44.16% 91.05% $2,790 46.49% 92.01% $2,809 50.09% 91.63% Commercial real estate, multi- family and land.......... 330 5.48 2.26% 556 9.27 2.39 483 8.61 2.30 Construction............... 75 1.25 1.35% 41 .68 1.30 79 1.41 1.74 Consumer................... 324 5.38 5.34% 273 4.55 4.30 268 4.78 4.33 Unallocated................ 2,633 43.73 -- 2,341 39.01 -- 1,969 35.11 -- ------ ------ ------ ------ ------ ------ ------ ------ ------ Total...................... $6,021 100.00% 100.00% $6,001 100.00% 100.00% $5,608 100.00% 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== --------------------------------------------------------------- 1993 1992 ------------------------------ ------------------------------ PERCENT PERCENT OF OF PERCENT LOANS IN PERCENT LOANS IN OF EACH OF EACH ALLOWANCE CATEGORY ALLOWANCE CATEGORY TO TOTAL TO TOTAL TO TOTAL TO TOTAL AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS ------ --------- -------- ------ --------- ------- One- to four-family....... $2,941 53.43% 91.66% $3,354 58.46% 90.75% Commercial real estate, multi- family and land.......... 506 9.19 2.08 1,261 21.98 1.56 Construction............... 49 .89 1.47 47 .82 2.37 Consumer................... 275 5.00 4.79 346 6.03 5.32 Unallocated................ 1,733 31.49 -- 729 12.71 -- ------ ------ ------ ------ ------ ------ Total...................... $5,504 100.00% 100.00% $5,737 100.00% 100.00% ====== ====== ====== ====== ====== ======
13 INVESTMENT ACTIVITIES Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certificates of deposit of insured banks and savings institutions, bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment-grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. Additionally, the Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. See "Regulation and Supervision -Federal Savings Institution Regulation - Liquidity." Historically, the Bank has maintained liquid assets above the minimum OTS requirements and at a level considered to be adequate to meet its normal daily activities. The investment policy of the Bank as established by the Board of Directors attempts to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Bank's lending activities. Specifically, the Bank's policies generally limit investments to government and federal agency-backed securities and other non-government guaranteed securities, including corporate debt obligations, that are investment grade. The Bank's policies provide that all investment purchases must be approved by two officers (either the Senior Vice President/Treasurer, Executive Vice President/Chief Financial Officer or the President and Chief Executive Officer) and be ratified by the Board of Directors. In December 1995, the Bank reassessed its investment portfolio and reclassified all of its investment and mortgage-backed securities, totalling in the aggregate $382.7 million, from held-to-maturity to available for sale. 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 interests in the form of securities, to investors such as the Bank. Such intermediaries may be private issuers, or agencies including FHLMC, 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 range and have varying maturities. The underlying pool of mortgages can be composed of either fixed- or ARM loans. 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 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 the Department of Veterans Affairs ("VA") loans generally have a longer life than conventional non-assumable loans underlying FHLMC and FNMA mortgage-backed securities. During periods of falling mortgage interest rates, prepayments generally increase, as opposed to periods of increasing interest rates when 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 14 underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities. The Bank has significant investments in mortgage-backed securities and has utilized such investments to complement its mortgage lending activities. At December 31, 1996, mortgage-backed securities totalled $395.5 million, or 30.3% of total assets, all of which were classified as available for sale. The Bank 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 FHLMC, GNMA and FNMA. At such date, the mortgage- backed securities portfolio had a weighted average interest rate of 6.84%. The Bank generally purchases short-term, straight sequential or planned amortization class collateralized mortgage obligations ("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 Bank invests in U.S. Government and agency-backed CMOs and, to a lesser extent, privately issued CMOs, all of which have agency-backed collateral. All of the Bank's CMOs and mortgage-backed securities are currently rated "AAA". Prior to purchasing mortgage-backed securities, each security is tested for Federal Financial Institutions Examination Council ("FFIEC") qualification. At December 31, 1996, the Bank's investment in CMOs had an amortized cost of $5.6 million, and a market value of $5.8 million. 15 The following table sets forth the Bank's mortgage-backed securities activities for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- -------- -------- (IN THOUSANDS) Beginning balance................. $ 265,113 $224,569 $241,188 Mortgage-backed securities purchased....................... 251,004 88,490 50,042 Less: Principal repayments...... (117,048) (50,193) (65,978) (Amortization of premium)/accretion of discount....................... (1,804) (612) (683) Change in net unrealized gain (loss) on mortgage-backed securities available for sale.. (1,723) 2,859 -- --------- -------- -------- Ending balance.................... $ 395,542 $265,113 $224,569 ========= ======== ========
The following table sets forth certain information regarding the amortized cost and market value of the Bank's mortgage-backed securities at the dates indicated.
AT DECEMBER 31, --------------------------------------------------------------------- 1996 1995 1994 --------------------- --------------------- ---------------------- AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET COST VALUE COST VALUE COST VALUE ----------- -------- --------- -------- --------- --------- (IN THOUSANDS) Mortgage-backed securities: FHLMC................... $ 316,773 $317,735 $ 221,822 $223,884 $ 183,424 $178,542 FNMA.................... 69,190 69,108 27,307 27,624 21,602 21,445 GNMA.................... 2,800 2,931 3,561 3,763 4,586 4,588 CMOs.................... 5,643 5,768 9,564 9,842 14,957 14,999 ----------- -------- --------- -------- --------- --------- Total mortgage-backed securities.............. $ 394,406 $395,542 $ 262,254 $265,113 $ 224,569 $219,574 =========== ======== ========= ======== ========= =========
16 Investment Securities. Investment securities identified as held to maturity are - --------------------- carried at cost, adjusted for amortization of premium and accretion of discount, which are recognized as adjustments to interest income. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Bank has the ability at the time of purchase to hold securities until maturity, they are classified as held to maturity. Debt securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale. Securities available for sale include securities that management intends to use as part of its asset/liability management strategy. Such securities are carried at fair value and unrealized gains and losses, net of related tax effect, are excluded from earnings, but are included as a separate component of stockholders' equity. At December 31, 1996, the Bank had investment securities with an amortized cost of $175.7 million, and a market value of $174.0 million, all of which were classified as available for sale. The following table sets forth certain information regarding the amortized cost and market values of the Bank's investment securities at the dates indicated.
AT DECEMBER 31, ------------------------------------------------------------------------- 1996 1995 1994 --------------------- --------------------- ----------------------- AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET COST VALUE COST VALUE COST VALUE --------- -------- --------- -------- --------- -------- (IN THOUSANDS) Investment securities: U.S. Government and agency obligations............. $175,003 $173,327 $112,956 $113,302 $122,278 $114,986 State and municipal obligations.............. 693 701 1,549 1,579 2,173 2,158 Corporate obligations.... -- -- -- -- 3,000 3,000 --------- -------- --------- -------- --------- -------- Total investment securities............... $175,696 $174,028 $114,505 $114,881 $127,451 $120,144 ========= ======== ========= ======== ========= ========
17 The table below sets forth certain information regarding the amortized cost, weighted average yields and contractual maturities of the Bank's investment and mortgage-backed securities as of December 31, 1996.
AT DECEMBER 31, 1996 -------------------------------------------------------------------------------- MORE THAN ONE MORE THAN FIVE ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS -------------------------- ---------------------- ---------------------- WEIGHTED WEIGHTED WEIGHTED AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE COST YIELD COST YIELD COST YIELD ----------- -------- --------- -------- --------- -------- (DOLLARS IN THOUSANDS) Investment securities: U.S. Government and agency obligations....... $ -- --% $ 110,003 6.44% $ 65,000 6.97% State and municipal obligations (1).......... 250 9.09 308 9.06 -- -- ----------- --------- --------- Total investment securities................. $ 250 9.09 $ 110,311 6.45 $ 65,000 6.97 =========== ========= ========= Mortgage-backed securities: FHLMC.................... 2,546 7.95 $ 40,738 6.03 29,842 6.70 FNMA..................... 1,333 8.93 1,329 8.51 32,300 6.42 GNMA..................... -- -- 297 8.00 1,865 8.96 CMOs..................... 600 8.61 4,116 8.27 927 6.04 ----------- --------- --------- Total mortgage-backed securities................. $ 4,479 8.33% $ 46,480 6.26% $ 64,934 6.62% =========== ========= ========= AT DECEMBER 31, 1996 --------------------------------------------------------------- MORE THAN TEN YEARS TOTAL ---------------------- --------------------------------- WEIGHTED WEIGHTED AMORTIZED AVERAGE AMORTIZED MARKET AVERAGE COST YIELD COST VALUE YIELD --------- -------- --------- -------- -------- (DOLLARS IN THOUSANDS) Investment securities: U.S. Government and agency obligations.... $ -- --% $ 175,003 $173,327 6.64% State and municipal obligations (1)........ 135 8.71 693 701 9.00% --------- --------- -------- Total investment securities.............. $ 135 8.71 $ 175,696 $174,028 6.65% ========= ========= ======== Mortgage-backed securities: FHLMC................. $ 243,647 6.24 $ 316,773 $317,735 6.27% FNMA.................. 34,228 6.13 69,190 69,108 6.37% GNMA.................. 638 11.91 2,800 2,931 9.53% CMOs.................. -- -- 5,643 5,768 7.94% --------- --------- -------- Total mortgage-backed securities............... $ 278,513 6.24% $ 394,406 $395,542 6.33% ========= ========= ========
__________________________ (1) Tax equivalent yield. 18 SOURCES OF FUNDS General. Deposits, loan repayments and prepayments, proceeds from sales of - ------- loans, investment maturities, cash flows generated from operations and FHLB borrowings are the primary sources of the Bank's funds for use in lending, investing and for other general purposes. Deposits. The Bank offers a variety of deposit accounts with a range of - -------- interest rates and terms. The Bank's deposits consist of savings accounts, NOW accounts, money market accounts and time deposits. For the year ended December 31, 1996, time deposits constituted 65.3% of total average deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Bank's deposits are obtained predominantly from the areas in which its branch offices are located. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits. Time deposits in excess of $100,000 are not actively solicited by the Bank, nor does the Bank use brokers to obtain deposits. The following table presents the deposit activity of the Bank for the periods indicated:
FOR THE YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1995 1994 --------- --------- --------- (IN THOUSANDS) Net deposits (withdrawals)............. $(29,111) $23,097 $(20,261) Interest credited on deposit accounts.. 37,283 36,041 29,220 -------- ------- -------- Total increase in deposit accounts..... $ 8,172 $59,138 $ 8,959 ======== ======= ========
19 At December 31, 1996, the Bank had $43.8 million in certificate accounts in amounts of $100,000 or more maturing as follows:
WEIGHTED AVERAGE MATURITY PERIOD AMOUNT RATE - ------------------------------------------ -------- -------- (DOLLARS IN THOUSANDS) Three months or less...................... $ 8,665 5.21% Over three through six months............. 8,371 5.82 Over six through 12 months................ 9,497 5.67 Over 12 months............................ 17,308 6.24 ------- Total..................................... $43,841 5.83% =======
20 The following table sets forth the distribution of the Bank's average deposit accounts for the periods indicated and the weighted average interest rates at the end of each period, on each category of deposits presented.
AT OR FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------------------------- 1996 1995 1994 -------------------------------- ----------------------------- ----------------------------- PERCENT PERCENT PERCENT OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD ---------- ---------- -------- --------- ---------- --------- --------- ---------- ------- (DOLLARS IN THOUSANDS) Money market deposit accounts.. $ 70,209 7.52% 2.90% $ 68,987 7.71% 2.93% $ 78,288 9.02% 2.57% Savings accounts............... 175,060 18.75 2.28 178,973 20.00 2.53 206,131 23.76 2.54 NOW accounts................... 72,265 7.74 1.84 69,330 7.74 2.14 69,934 8.06 2.14 Non-interest-bearing accounts.. 6,425 .69 -- 2,902 .32 -- 1,694 .20 -- -------- ------ -------- ------ -------- ------ Total......................... 323,959 34.70 2.27 320,192 35.77 2.49 356,047 41.04 2.45 -------- ------ -------- ------ -------- ------ Time deposits: Six months or less............ 71,353 7.64 4.95 78,455 8.77 4.84 112,661 12.98 3.65 Over Six through 12 months.... 151,485 16.23 5.23 131,795 14.73 5.44 102,006 11.76 4.38 Over 12 through 24 months..... 150,085 16.08 5.49 123,825 13.83 5.59 70,582 8.13 4.54 Over 24 months................ 124,056 13.29 6.09 127,205 14.21 6.19 118,601 13.67 6.01 IRA/KEOGH..................... 112,641 12.06 5.86 113,564 12.69 6.39 107,784 12.42 5.97 -------- ------ -------- ------ -------- ------ Total time deposits......... 609,620 65.30 5.55 574,844 64.23 5.70 511,634 58.96 4.95 -------- ------ -------- ------ -------- ------ Total average deposits.... $933,579 100.00% 4.44% $895,036 100.00% 4.59% $867,681 100.00% 3.99% ======== ====== ======== ====== ======== ======
21 Borrowings From time to time the Bank has obtained advances from the FHLB as an alternative to retail deposit funds and may do so in the future as part of its operating strategy. FHLB advances may also be used to acquire certain other assets as may be deemed appropriate for investment purposes. These advances are collateralized primarily by certain of the Bank's mortgage loans and mortgage-backed securities and secondarily by the Bank's investment in capital stock of the FHLB. The Bank has an available overnight line of credit with the FHLB-NY for $50.0 million which expires November 25, 1997. When utilized, the line bears a floating interest rate of 1/8% over the current federal funds rate and is secured by the Bank's mortgage loans, mortgage-backed securities and U.S. Government securities. The maximum amount that the FHLB will advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the OTS and the FHLB. At December 31, 1996, the Bank had borrowed $8.8 million against the FHLB line of credit. The Bank also borrows funds using securities sold under agreements to repurchase. Under this form of borrowing specific U.S. Government agency and/or mortgage-backed securities are pledged as collateral to secure the borrowing. These securities are not under the Bank's control. At December 31, 1996, the Bank had borrowed $99.3 million through securities sold under agreements to repurchase. (See note 11 to the consolidated financial statements in the 1996 Annual Report to Stockholders.) SUBSIDIARY ACTIVITIES The Bank owns one subsidiary which is inactive. PERSONNEL As of December 31, 1996, the Bank had 212 full-time employees and 34 part-time employees. The employees are not represented by a collective bargaining unit and the Bank considers its relationship with its employees to be good. REGULATION AND SUPERVISION GENERAL The Company, as a savings and loan holding company, 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 ("FDI Act"). The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its 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 OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory 22 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 OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company. HOLDING COMPANY REGULATION The Company is a nondiversified unitary savings and loan holding company within the meaning of the HOLA. 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 qualified thrift lender ("QTL"). See "Federal Savings Institution Regulation - QTL Test." 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. 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; acquiring or retaining, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors. The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, 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. Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, HOLA does prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or 23 divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution. FEDERAL SAVINGS INSTITUTION REGULATION Capital Requirements. The OTS capital regulations require savings institutions - -------------------- to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital ratio (3% for institutions receiving the highest rating on the CAMEL financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain purchased mortgage servicing rights and credit card relationships. The OTS regulations also require that, in meeting the tangible, leverage (core) and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank. The risk-based capital standard for savings institutions requires the maintenance of Tier I (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of Tier I (core) capital are equivalent to those discussed earlier. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OTS regulatory capital requirements also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings institution's interest rate risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates divided by the estimated economic value of the institution's assets. In calculating its total capital under the risk-based capital rule, a savings institution whose measured interest rate risk exposure exceeds 2% must deduct an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the institution's assets. The Director of the OTS may waive or defer a savings institution's interest rate risk component on a case-by-case basis. A savings institution with assets of less than $300 million and risk-based capital ratios in excess of 12% is not subject to the interest rate risk component, unless the OTS determines otherwise. For the present time, the OTS has deferred implementation of the interest rate risk component. At December 31, 1996, the Bank met each of its capital requirements, in each case on a fully phased-in basis. Although the Bank may be subject to the interest rate risk component, the effect on the Bank's capital compliance is not expected to be significant. 24 The following table presents the Bank's capital position at December 31, 1996 relative to fully phased-in regulatory requirements.
EXCESS CAPITAL --------------------- ACTUAL REQUIRED (DEFICIENCY) ACTUAL REQUIRED CAPITAL CAPITAL AMOUNT PERCENT PERCENT -------- -------- ------------ -------- --------- (DOLLARS IN THOUSANDS) Tangible......... $165,537 $19,563 $145,974 12.69% 1.50% Core (Leverage).. 165,537 39,126 126,411 12.69% 3.00% Risk-based....... 171,199 42,773 128,426 32.02% 8.00%
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action - ----------------------------------- regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution is considered "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core capital to total assets is at least 5%, and it is not subject to any order or directive by the OTS to meet a specific capital level. A savings institution generally is considered "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%, and its ratio of core capital to total assets is at least 4% (3% if the institution receives the highest CAMEL rating). A savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS 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 an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Insurance of Deposit Accounts. Deposits of the Bank are presently insured by - ----------------------------- the SAIF. Both the SAIF and the Bank Insurance Fund ("BIF"), (the deposit insurance fund that covers most commercial bank deposits), are statutorily required to be recapitalized to a 1.25% of insured reserve deposits ratio. Until recently, members of the SAIF and BIF were paying average deposit insurance premiums of between 24 and 25 basis points. The BIF met the required reserve in 1995, whereas the SAIF was not expected to meet or exceed the required level until 2002 25 at the earliest. This situation was primarily due to the statutory requirement that SAIF members make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted a new assessment rate schedule of from 0 to 27 basis points under which 92% of BIF members paid an annual premium of only $2,000. With respect to SAIF member institutions, the FDIC adopted a final rule retaining the previously existing assessment rate schedule applicable to SAIF member institutions of 23 to 31 basis points. As long as the premium differential continued, it may have had adverse consequences for SAIF members, including reduced earnings and an impaired ability to raise funds in the capital markets. In addition, SAIF members, such as the Bank could have been placed at a substantial competitive disadvantage to BIF members with respect to pricing of loans and deposits and the ability to achieve lower operating costs. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special one- time assessment on SAIF member institutions, including the Bank, to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points on SAIF assessable deposits held as of March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special Assessment was recognized by the Bank as an expense in the quarter ended September 30, 1996 and is generally tax deductible. The SAIF Special Assessment recorded by the Bank amounted to $5.7 million on a pre-tax basis and $3.6 million on an after- tax basis. The Funds Act also spreads the obligations for payment of the FICO bonds across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits will be assessed for FICO payment of 1.3 basis points, while SAIF deposits will pay 6.48 basis points. Full pro rata sharing of the FICO payments between BIF and SAIF members will occur on the earlier of January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be merged on January 1, 1999, provided no savings associations remain as of that time. As a result of the Funds Act, the FDIC recently voted to effectively lower SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to that of BIF members. However, SAIF members will continue to make the FICO payments described above. The FDIC also lowered the SAIF assessment schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management cannot predict the level of FDIC insurance assessments on an on-going basis, whether the savings association charter will be eliminated or whether the BIF and SAIF will eventually be merged. The Bank's assessment rate for fiscal 1996 was .23 basis points and the premium paid for this period was $2.1 million. A significant increase in SAIF insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Under the FDI Act, 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. Thrift Rechartering Legislation. The Deposit Insurance Funds Act provides that - ------------------------------- the BIF and SAIF will merge on January 1, 1999, if there are no more savings 26 associations as of that date. That legislation also requires that the Department of Treasury submit a report to Congress by March 31, 1997 that makes recommendations regarding a common financial institutions charter, including whether the separate charters for thrifts and banks should be abolished. Various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter and abolish the OTS have been introduced in Congress. The bills would require federal savings institutions to convert to a national bank or some type of state charter by a specified date (January 1, 1998 in one bill, June 30, 1998 in the other) or they would automatically become national banks. Converted federal thrifts would generally be required to conform their activities to those permitted for the charter selected and divestiture of nonconforming assets would be required over a two year period, subject to two possible one year extensions. State chartered thrifts would become subject to the same federal regulation as applies to state commercial banks. Holding companies for savings institutions would become subject to the same regulation as holding companies that control commercial banks, with a limited grandfather provision for unitary savings and loan holding company activities. The Bank is unable to predict whether such legislation would be enacted, the extent to which the legislation would restrict or disrupt its operations or whether the BIF and SAIF funds will eventually merge. Loans to One Borrower. Under the HOLA, savings institutions are generally - --------------------- subject to the limits on loans to one borrower applicable to national banks. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion. At December 31, 1996, the Bank's limit on loans to one borrower as provided under the HOLA was $24.8 million, while the Bank's self-imposed limit was $4.0 million. At December 31, 1996, the Bank's largest aggregate outstanding balance of loans to one borrower was $2.2 million. QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the - -------- QTL test, a savings and loan 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) 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) in at least 9 months out of each 12 month period. A savings institution that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 1996, the Bank maintained 98% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test. Limitation on Capital Distributions. OTS regulations impose limitations upon - ----------------------------------- all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without obtaining approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" 27 (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. In December 1994, the OTS proposed amendments to its capital distribution regulation that would generally authorize the payment of capital distributions without OTS approval provided that the payment does not cause the institution to be undercapitalized within the meaning of the prompt corrective action regulation. However, institutions in a holding company structure would still have a prior notice requirement. At December 31, 1996, the Bank was a Tier 1 Bank. Liquidity. The Bank is required to maintain an average daily balance of - --------- specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 5% but may be changed from time to time by the OTS to any amount within the range of 4% to 10% depending upon economic conditions and the savings flows of member institutions. OTS regulations also require each member savings institution to maintain an average daily balance of short-term liquid assets at a specified percentage (currently 1%) of the total of its net withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's liquidity and short-term liquidity ratios for December 31, 1996 were 17.45% and 1.42% respectively, which exceeded the applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements. Assessments. Savings institutions are required to pay assessments to the OTS to - ----------- fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended December 31, 1996 totalled $214,160. Branching. OTS regulations permit nationwide branching by federally chartered - --------- savings institutions to the extent allowed by federal statute. This permits federal savings institutions to establish interstate networks and to geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions. Transactions with Related Parties. The Bank's authority to engage in - --------------------------------- transactions with related parties or "affiliates" (e.g.., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of covered transactions with any individual affiliate to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B generally provides that certain transactions with affiliates, including loans and 28 asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other things, such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and to not involve more than the normal risk of repayment. In accordance with recently modified federal regulations, the Bank's Loans to Insiders Policy now permits loans to be made to Executive Officers on terms available to all Bank employees under the "Loan Program." This Program allows loans to eligible employees at a discount of 1% below the prevailing interest rates at time of loan approval, subject to certain conditions. Regulation O also places individual and aggregate limits on the amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed. Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility - ----------- over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Standards for Safety and Soundness. The federal banking agencies have adopted - ---------------------------------- Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") and a final rule to implement safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans when such plans are required. 29 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 required that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $49.3 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts aggregating greater than $49.3 million, the reserve requirement is $1.48 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $49.3 million. The first $4.4 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The Bank is in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the OTS. FEDERAL AND STATE TAXATION FEDERAL TAXATION General. The Company and the Bank report their income on a calendar year basis - ------- using the accrual method of accounting, and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank has not been audited by the IRS in over 10 years. For its 1996 taxable year, the Bank is subject to a maximum federal income tax rate of 34.1%. Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995, - ----------------- thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans (generally secured by interests in real property improved or to be improved) under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying loans was computed using the Experience Method. The Small Business Job Protection Act of 1996 (the "1996 Act"), which was enacted on August 20, 1996, requires savings institutions to recapture (i.e., take into taxable income) certain portions of their accumulated bad debt reserves. The 1996 Act repeals the reserve method of accounting for bad debts effective for tax years beginning after 1995. Thrift institutions that would be treated as small banks are allowed to utilize the Experience Method applicable to such institutions, while thrift institutions that are treated as large banks (those generally exceeding $500 million in assets) are required to use only the specific charge-off method. Thus, the PTI Method of accounting for bad debts is no longer available for any financial institution. Use of the PTI Method had the effect of reducing the marginal rate of federal tax on the Bank's income to 32.2%, exclusive of any minimum or environmental tax, as compared to the maximum corporate federal income tax rate of 35%. 30 A thrift institution required to change its method of computing reserves for bad debts will treat such change as a change in method of accounting, initiated by the taxpayer, and having been made with the consent of the IRS. Any Section 481(a) adjustment required to be taken into income with respect to such change generally will be taken into income ratably over a six-taxable year period, beginning with the first taxable year beginning after 1995, subject to the residential loan requirement. Under the residential loan requirement provision, the recapture required by the 1996 Act will be suspended for each of two successive taxable years, beginning with the Bank's current taxable year, in which the Bank originates a minimum of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding its current taxable year. Under the 1996 Act, for its current and future taxable years, the Bank is not permitted to make additions to its tax bad debt reserves. In addition, the Bank is required to recapture (i.e., take into taxable income) over a six year period the excess of the balance of its tax bad debt reserves as of December 31, 1995 over the balance of such reserves as of December 31, 1987. As a result of such recapture, the Bank will incur an additional tax liability of approximately $2.3 million. The Bank has accrued for this liability in the consolidated financial statements. Distributions. Under the 1996 Act, if the Bank makes "non-dividend - ------------- distributions" to the Company, such distributions will be considered to have been made from the Bank's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from the Bank's supplemental reserve for losses on loans, to the extent thereof, and an amount based on the amount distributed (but not in excess of the amount of such reserves) will be included in the Bank's income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be so included in the Bank's income. The amount of additional taxable income triggered by a non-dividend 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 to the Company, approximately one and one-half times the amount of such distribution (but not in excess of the amount of such reserves) would be includable in income for federal income tax purposes, assuming a 35% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves. SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on every - -------------------------------- $100 of thrift deposits held on March 31, 1995. For financial statement purposes, this assessment must be reported as an expense for the quarter ended September 30, 1996. The Funds Act includes a provision which states that the amount of any special assessment paid to capitalize SAIF under this legislation is deductible under Section 162 of the Code in the year of payment. Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as - --------------------------------- amended (the "Code") imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing 31 the AMTI. Only 90% of AMTI can be offset by net operating loss carryovers of which the Bank currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). In addition, for taxable years beginning after December 31, 1986 and before January 1, 1996, an environmental tax of .12% of the excess of AMTI (with certain modifications) over $2.0 million is imposed on corporations, including the Bank, whether or not an Alternative Minimum Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may be subject to the environmental tax liability. Dividends Received Deduction and Other Matters. The Company may exclude from - ---------------------------------------------- its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank own more than 20% of the stock of a corporation distributing a dividend then 80% of any dividends received may be deducted. STATE AND LOCAL TAXATION New Jersey Taxation. The Bank files New Jersey income tax returns. For New - ------------------- Jersey income tax purposes, savings institutions are presently taxed at a rate equal to 3% of taxable income. For this purpose, "taxable income" generally means federal taxable income, subject to certain adjustments (including addition of interest income on State and municipal obligations). The Company will be required to file a New Jersey income tax return because it will be 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). However, if the Company meets certain requirements, it may be eligible to elect to be taxed as a New Jersey Investment Company at a tax rate presently equal to 2.25% (25% of 9%) of taxable income. Delaware Taxation. As a Delaware holding company not earning income in - ----------------- Delaware, the Company is exempted 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. ITEM 2. PROPERTIES The Bank currently conducts its business through its administrative office, which was recently relocated to Toms River and which includes a branch office, and nine other full service offices located in Ocean and Middlesex Counties. The Company believes that the Bank's current facilities will be adequate to meet the present and immediately foreseeable needs of the Bank and the Company. ITEM 3. LEGAL PROCEEDINGS The Company and the Bank are not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such other routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations. 32 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information relating to the market for Registrant's common equity and related stockholder matters appears under "Shareholder Information" on the Inside Back Cover in the Registrant's 1996 Annual Report to Stockholders and is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The above-captioned information appears under "Selected Consolidated and Other Data of the Company" in the Registrant's 1996 Annual Report to Stockholders on pages 7 and 8 and is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The above-captioned information appears under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Registrant's 1996 Annual Report to Stockholders on pages 9 through 18 and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements of Ocean Financial Corp. and its subsidiary, together with the report thereon by KPMG Peat Marwick LLP appears in the Registrant's 1996 Annual Report to Stockholders on pages 19 through 33 and are incorporated herein by reference. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 33 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information relating to Directors and Executive Officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 1997, at pages 4 through 6. ITEM 11. EXECUTIVE COMPENSATION The information relating to directors' compensation and executives' compensation is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 1997, at pages 8 and 9 and pages 13 through 18 (excluding the Executive Compensation Committee Report and Stock Performance Graph). ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 1997, at pages 3 and 5 through 6. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 1997, at page 19. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: (1) Consolidated Financial Statements of the Company are incorporated by reference to the following indicated pages of the 1996 Annual Report to Stockholders. 34
PAGE Independent Auditors' Report................................ 33 Consolidated Statements of Financial Condition at December 31, 1996 and 1995................................ 19 Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994.............. 20 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994...... 21 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994.............. 22 Notes to Consolidated Financial Statements for the Years Ended December 31, 1996, 1995 and 1994.............. 23-33
The remaining information appearing in the 1996 Annual Report to Stockholders is not deemed to be filed as part of this report, except as expressly provided herein. (2) All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto. (3) Exhibits (a) The following exhibits are filed as part of this report. 35 3.1 Certificate of Incorporation of Ocean Financial Corp.* 3.2 Bylaws of Ocean Financial Corp.* 4.0 Stock Certificate of Ocean Financial Corp.* 10.1 Form of Ocean Federal Savings Bank Employee Stock Ownership Plan* 10.1(a)Amendment to Ocean Federal Savings Bank Employee Stock Ownership Plan (filed herewith) 10.2 Ocean Federal Savings Bank Employees' Savings and Profit Sharing Plan* 10.3 Ocean Federal Savings Bank 1995 Supplemental Executive Retirement Plan* 10.4 Ocean Federal Savings Bank Deferred Compensation Plan for Directors* 10.5 Ocean Federal Savings Bank Deferred Compensation Plan for Officers* 10.6 Ocean Federal Savings Bank Long-Term Award Program* 10.7 Ocean Federal Savings Bank Performance Achievement Awards Program* 10.8 Ocean Financial Corp. 1997 Incentive Plan** 10.9 Form of Employment Agreement between Ocean Federal Savings Bank and certain executive officers including Michael J. Fitzpatrick and John R. Garbarino* 10.10 Form of Employment Agreement between Ocean Financial Corp. and certain executive officers including Michael J. Fitzpatrick and John R. Garbarino* 10.11 Form of Change in Control Agreement between Ocean Federal Savings Bank and certain executive officers including Michael E. Barrett, John K. Kelly and Karl E. Reinheimer* 10.12 Form of Change in Control Agreement between Ocean Financial Corp. and certain executive officers including Michael E. Barrett, John K. Kelly and Karl E. Reinheimer* 11.0 Computation of earnings per share (filed herewith) 13.0 Portions of 1996 Annual Report to Stockholders (filed herewith) 21.0 Subsidiary information is incorporated herein by reference to "Part I - Subsidiaries" 27.0 Financial Data Schedule (filed herewith) (b) Reports on Form 8-K None. __________________________________ * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, effective May 13, 1996 as amended, Registration No. 33-80123. ** Incorporated herein by reference into this document from the Proxy Statement for the Special Meeting of Shareholders of Ocean Financial Corp. held on February 4, 1997. 36 CONFORMED SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. OCEAN FINANCIAL CORP. By: /s/ John R. Garbarino ------------------------------------ John R. Garbarino Chairman of the Board, President and Chief Executive Officer and Director Date: March 19, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Name Date - ---- ---- /s/ John R. Garbarino March 19, 1997 - ---------------------------------------- --------- John R. Garbarino Chairman of the Board, President and Chief Executive Officer (principal executive officer) /s/ Michael J. Fitzpatrick March 19, 1997 - ---------------------------------------- --------- Michael J. Fitzpatrick Executive Vice President and Chief Financial Officer (principal accounting and financial officer) /s/ Michael E. Barrett March 19, 1997 - ---------------------------------------- --------- Michael E. Barrett Director /s/ Thomas F. Curtin March 19, 1997 - ---------------------------------------- --------- Thomas F. Curtin Director /s/ Carl Feltz, Jr. March 19, 1997 - ---------------------------------------- --------- Carl Feltz, Jr. Director /s/ Robert E. Knemoller March 19, 1997 - ---------------------------------------- --------- Robert E. Knemoller Director /s/ Donald E. McLaughlin March 19, 1997 - ---------------------------------------- --------- Donald E. McLaughlin Director 37 /s/ Diane F. Rhine - ---------------------------------------- March 19, 1997 Diane F. Rhine --------- Director /s/ Frederick E. Schlosser March 19, 1997 - ---------------------------------------- --------- Frederick E. Schlosser Director /s/ James T. Snyder March 19, 1997 - ---------------------------------------- --------- James T. Snyder Director 38 EX-10.1 2 EMPLOYEE STOCK OWNERSHIP PLAN EXHIBIT 10.1 FIRST AMENDMENT TO THE OCEAN FEDERAL SAVINGS BANK EMPLOYEE STOCK OWNERSHIP PLAN March 19, 1997 This First Amendment to the Ocean Federal Savings Bank Employee Stock Ownership Plan (the "ESOP"), executed on March 19, 1997, by Ocean Federal Savings Bank (the "Bank"). WITNESSETH THAT: WHEREAS, the Board of Directors of the Bank adopted the ESOP effective January 1, 1996; and WHEREAS, the Board of Directors desires to amend the ESOP to reflect certain changes which are required by the Internal Revenue Service in order for the ESOP to obtain a favorable determination of the plan's tax-qualified status from the Internal Revenue; and WHEREAS, The Board of Directors also desires to make certain other clarifying amendments to the ESOP regarding the allocation of discretionary contributions and the computation period for determining years of service for purposes of vesting; and WHEREAS, the Board of Directors also desires to include a discretionary provision in the plan providing for matching contributions made with respect to employee salary deferrals made under the Bank's 401(k) plan; WHEREAS, by previous resolution, the Board of Directors has duly authorized certain officers to take whatever action necessary to ensure that the Plan meets the qualification requirements of the Internal Revenue Code and obtains a favorable determination letter form the Internal Revenue Service regarding such qualifications; and WHEREAS, Section 13.4 permits the ESOP to be amended from time to time as is necessary. NOW, THEREFORE, BE IT RESOLVED, that the ESOP shall be, and hereby is, amended as follows: FIRST CHANGE ------------ Effective January 1, 1997, Section 4.1 is amended by adding the words "while a Participant" to the end of the last sentence thereof. Accordingly, the last sentence of Section 4.1 shall read in its entirety as follows: The Employers' contributions and available forfeitures for a Plan Year shall be credited as of the last day of the year to the Accounts of the Active Participants in proportion to their amounts of Cash Compensation while a Participant. SECOND CHANGE ------------- Effective January 1, 1996, the first sentence of the paragraph immediately following Section 5.1-2 is deleted in its entirety and replaced with the following: For purposes of this Section 5.1 and the following Section 5.2, "annual addition" means the sum for any year of (a) employer contributions and forfeitures allocable to a Participant under all plans (or portions thereof) maintained by an Employer subject to Section 415(c) of the Code, (b) the Participant's employee contributions under all such plans (or portions thereof), and (c) amounts described in Section 419A(d)(2) of the Code (relating to post- retirement medical benefits of key employees) or allocated to an annuity or pension plan individual medical account described in Section 415(1) of the Code, to the extent includable for purposes of Section 415(c)(2) of the Code. A Participant's employee contributions described in (a) above shall be determined without regard to (i) any rollover contributions, (ii) any repayments of loans, or (iii) any prior distributions repaid upon the exercise of buy-back rights. THIRD CHANGE ------------ Effective January 1, 1996, Section 5.2 is hereby amended by adding a new subsection to the end thereof. New subsection 5.2-3 shall provide as follows: This subsection applies, if, in addition to this Plan, a Participant is covered under another qualified defined contribution plan or a welfare benefit fund, as defined in Section 419(e) of the Code, maintained by the Employer, or an individual medical account, as defined in Section 415(1)(2) of the Code, maintained by the Employer which provides an annual addition during any limitation year. The annual additions which may be credited to a Participant's account under this Plan for any such limitation year will not exceed the maximum permissible amount (as determined under Section 5.1) reduced by the annual additions credited to a Participant's account under the other plans and welfare benefit funds for the same limitation year. If the allocations to a Participant's Account otherwise required under this Plan for any Plan Year would cause the limitations of Section 5.1 to be exceeded for that Plan Year, contributions otherwise required with respect to such Participant under this Plan, shall be reduced to the extent necessary to comply with the limitations of section 5.1; provided, however, that in the event that the limitations of Section 5.1 shall be exceeded by reason of the combined amounts contributed under all of the Employer's defined contribution plans, it is intended that contributions made under the Employer's other defined contribution plans be reduced first. FOURTH CHANGE ------------- Effective January 1, 1996, Section 9.2 is amended by deleting the first sentence in its entirety and replacing it with the following language: For purposes of this Plan, a "Vesting Year" means a twelve (12) consecutive month period in which an Employee has at least 1,000 Hours of Service. An Employee's initial Vesting Year shall be the twelve (12) consecutive month period beginning with the day the Employee first completes an Hour of Service. A Participant's subsequent Vesting Years shall be the twelve (12) consecutive month periods coinciding with the calendar year, commencing with the calendar year which includes the date the Participant first completed an Hour of Service with the Employer. FIFTH CHANGE ------------ Effective January 1, 1996, the third sentence of Section 10.1 is hereby amended and restated in its entirety to read as follows: Notwithstanding the foregoing, if the balance credited to his Account exceeds, or at the time of any prior distribution exceeded, $3,500, his benefit shall not be paid before the latest of his 65th birthday or the tenth anniversary in which he commenced participation in the Plan, unless he elects an early payment date in a written election filed with the Committee. SIXTH CHANGE ------------ Effective January 1, 1996, Section 12.4 shall be amended by deleting the last sentence thereof in its entirety and replacing it with the following sentence: The value of any stock that is not traded on a generally recognized public market shall be valued as of each Valuation Date by an appraiser meeting requirements similar to the requirements of the regulation prescribed under Section 170(a)(1) of the Code. SEVENTH CHANGE -------------- Effective January 1, 1997, Sections 2, 4, 5, and 9 of the ESOP shall be amended to include language that will permit the employer to make matching contributions (made with respect to the participant's 401(k) salary reduction contributions) to the ESOP. Specifically, Section 2 is hereby amended by including the definition of "Matching Employer Contributions" and Sections 4, 5 and 9 are hereby amended by adding new subsections 4.5 and 5.5, and revising subsections 9.1 and 9.6 as follows: Section 2. Definitions ----------- "Matching Employer Contributions" means contributions made by the Employer pursuant to Section 4.5 to a Participant's Matching Employer Contributions Account. Section 4.5 Matching Employer Contributions ------------------------------- For each Plan Year commencing with the Plan Year 1997, the Employer, in its sole discretion, may make a contribution equal to a percentage of the Employee Basic Contributions made for the Plan Year on behalf of each Participant under the terms of the Retirement plan for Ocean Federal Savings Bank ("401(k) Plan"). Section 5.5 Nondiscrimination Test for Matching Employer -------------------------------------------- Contributions ------------- Notwithstanding anything herein to the contrary, the Plan shall meet the nondiscrimination test of Section 401(m) of the Code (described in Section 5.5-1) and applicable regulations for each Plan Year. In order to meet the nondiscrimination test, any or all of the following steps may be taken: (a) At any time during the Plan Year, the Committee may limit the amount of Matching Employer Contributions that may be made on behalf of Highly Compensated Employees; (b) The Committee may reduce the Matching Employer contributions made for the Plan Year to the extent necessary to meet the requirements of Section 401(m) of Code, in the manner described in Section 5.5-1; (c) The Committee may recommend to the Board that the Employer make an additional Matching Employer Contribution to the plan for the benefit of Participants who are not Highly Compensated Employees. This additional allocation may be based on Participant's Total Compensation; and (d) The Committee may take any other steps that the Committee deems appropriate. 5.5-1 For Plan Years beginning after December 31, 1996, the nondiscrimination requirements of Section 401(m) of the Code require that, in each Plan Year, the Contribution Percentage (defined below) of the eligible Highly Compensated Employees for such Plan Year does not exceed the greater of: (a) The Contribution Percentage of all other eligible Employees for the preceding Plan Year multiplied by 1.25; or (b) The lesser of the Contribution Percentage of all other eligible Employees for the preceding Plan Year multiplied by 2, or the Contribution Percentage of all other eligible Employees for the preceding Plan Year plus 2 percentage points. The Committee may elect to calculate the Contribution Percentages using the Plan Year rather than the preceding Plan Year; provided, however, that if the Committee so elects, the election may only be changed as provided by the Secretary of the Treasury. 5.5-2 The Contribution Percentage for a group of Employees is the average of the ratios, calculated separately for each Employee in the group, of the amount of Matching Employer Contributions that are credited under the Plan on behalf of each Employee for the Plan Year, to the Employee's Compensation for the Plan Year. Use of the alternative limitation shall be subject to the provisions of Treasury Regulation Section 1.401(m)-2 regarding the multiple use of the alternative deferral tests set forth in Sections 401(k) and 401(m) of the Code. 5.5-3 Notwithstanding the foregoing, if the test described in Section 5.5-1 is not satisfied for a Plan Year, the Committee may use any other test permitted under Section 401(m) of the Code or applicable Treasury Regulations to determine whether the Plan meets the nondiscrimination requirements of Section 401(m) of the Code. 9.1 Deferred Vesting in Accounts ---------------------------------- _________ A Participant's vested interest in his Account attributable to his Employer's contributions pursuant to Sections 4.1 and 4.2 shall be based on his Vesting Years in accordance with the following table, subject to the balance of this Section 9: Percentage of Vesting Years Interest Vested ----------------------------------------- fewer than 5 0% 5 or more 100% A Participant's vested interest in his Account attributable to Employer's Matching Contribution shall be determined in accordance with the provisions of the Retirement plan for Ocean Federal Savings Bank. 9.6 Forfeitures, Repayment and Restoral ----------------------------------- Accounting for Forfeitures A forfeiture shall be charged to the Participant's - -------------------------- Account as of the first day of the first Valuation Period in which the forfeiture becomes certain pursuant to Section 9.5. Except as otherwise provided in that Section, at the discretion of the Committee, a forfeiture shall be used to reduce any matching Employer Contributions made by the terminated Participant's Employer under Section 4.5 or be added to the contributions of the terminated Participant's Employer which are to be credited to other Participants pursuant to Section 4.1, as of the last day of the Plan Year in which the forfeiture becomes certain. IN WITNESS WHEREOF, the Bank has adopted this First Amendment to the ESOP and caused this instrument to be executed by its duly authorized officers as of the above date. ATTEST: _________________________________By: _______________________________________ Secretary` President EX-11.0 3 COMPUTATION OF EARNINGS PER SHARE EXHIBIT 11 ---------- OCEAN FINANCIAL CORP. STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE FOR THE PERIOD FROM JULY 2, 1996 TO DECEMBER 31, 1996 (dollars in thousands, except per share amounts)
For the period from July 2, 1996 to ---------------------- December 31, 1996 ---------------------- Net income (loss) $ (6,612) =========== Weighted average shares outstanding: Weighted average shares issued 9,059,124 Less: Average shares held by the ESOP (671,046) Plus: ESOP shares released or committed to be released during the fiscal year 41,799 ----------- Weighted average shares outstanding 8,429,877 =========== Earnings (loss) per share $ ( .78) ===========
EX-13.0 4 PORTIONS OF 1996 ANNUAL REPORT TO STOCKHOLDERS EXHIBIT 13.0 PORTIONS OF OCEAN FINANCIAL CORP. 1996 ANNUAL REPORT Selected Consolidated Financial and Other Data of the Company The selected consolidated financial and other data of the Company set forth below is derived in part from, and should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere in this Annual Report.
At December 31, 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------- (dollars in thousands) SELECTED FINANCIAL CONDITION DATA: Total assets $1,303,865 $1,036,445 $971,651 $937,214 $886,494 Investment securities held to maturity -- -- 127,451 126,999 122,625 Investment securities available for sale 174,028 114,881 -- -- -- FHLB-NY stock 8,457 7,723 7,323 6,680 5,835 Mortgage-backed securities held to maturity -- -- 224,569 241,188 205,958 Mortgage-backed securities available for sale 395,542 265,113 -- -- -- Loans receivable, net 678,728 612,696 592,315 539,885 514,187 Mortgage loans held for sale 727 1,894 -- 963 545 Deposits 934,730 926,558 867,420 858,461 819,300 Federal Home Loan Bank borrowings 8,800 10,400 -- -- -- Securities sold under agreements to repurchase 99,322 -- -- -- -- Stockholders' equity 252,789 92,351 82,334 72,605 62,469 For the Year Ended December 31, 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------- (dollars in thousands, except per share amounts) SELECTED OPERATING DATA: Interest income $ 80,236 $ 70,210 $ 63,683 $ 64,853 $ 67,281 Interest expense 43,857 40,004 32,373 33,975 38,897 - ------------------------------------------------------------------------------------------------------------- Net interest income 36,379 30,206 31,310 30,878 28,384 Provision for loan losses 700 950 1,129 1,300 1,220 - ------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 35,679 29,256 30,181 29,578 27,164 Other income 2,881 1,356 2,057 2,740 1,869 Operating expenses 39,206 18,006 17,104 16,626 16,156 - ------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and cumulative effect of change in accounting (646) 12,606 15,134 15,692 12,877 Provision for income taxes 1,083 4,659 5,405 5,556 4,567 - ------------------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of change in accounting (1,729) 7,947 9,729 10,136 8,310 Cumulative effect of change in accounting for income taxes -- -- -- -- 1,665 ============================================================================================================= Net income (loss) $ (1,729) $ 7,947 $ 9,729 $ 10,136 $ 9,975 ============================================================================================================= Loss per share (based on net loss from July 2, 1996 to December 31, 1996) $(0.78) N/A N/A N/A N/A ============================================================================================================= Net income before non-recurring items (2) $ 11,576 $ 7,947 $ 9,729 $ 10,136 $ 9,975 =============================================================================================================
Selected Consolidated Financial and Other Data (continued) OCEAN FINANCIAL CORP. AND SUBSIDIARY 7
At or for the Year Ended December 31, 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL RATIOS AND OTHER DATA (1): PERFORMANCE RATIOS: Return on average assets (0.15)% 0.80% 1.02% 1.10% 1.19% Return on average assets, as adjusted (2) 1.00 0.80 1.02 1.10 1.19 Return on average stockholders' equity (1.03) 9.44 12.54 14.85 17.14 Return on average stockholders' equity, as adjusted (2) 6.91 9.44 12.54 14.85 17.14 Average stockholders' equity to average assets 14.42 8.51 8.11 7.41 6.96 Stockholders' equity to total assets at end of year 19.39 8.91 8.47 7.75 7.05 Average interest rate spread (3) 2.61 2.79 3.07 3.20 3.22 Net interest margin (4) 3.22 3.13 3.34 3.44 3.48 Average interest-earning assets to average interest-bearing liabilities 115.84 107.98 107.71 106.42 105.56 Operating expenses to average assets 3.37 1.82 1.79 1.81 1.93 Operating expenses to average assets, as adjusted (2) 1.73 1.82 1.79 1.81 1.93 Operating Efficiency Ratio (5) 99.86 57.05 51.26 49.46 53.40 Operating Efficiency Ratio, as adjusted (2)(5) 51.11 57.05 51.26 49.46 53.40 REGULATORY CAPITAL RATIOS (BANK ONLY): Tangible capital 12.69 8.72 8.43 7.73 7.05 Core capital 12.69 8.72 8.43 7.73 7.05 Risk-based capital 32.04 21.34 20.34 18.59 16.57 ASSET QUALITY RATIOS: Non-performing loans as a percent of total loans receivable (6)(7) 1.12 1.40 1.83 1.92 2.79 Non-performing assets as a percent of total assets (7) 0.71 0.97 1.29 1.45 2.08 Allowance for loan losses as a percent of total loans receivable (6) 0.88 0.97 0.94 1.01 1.10 Allowance for loan losses as a percent of total non-performing loans (7) 78.23 69.21 51.27 52.45 39.55 NUMBER OF FULL-SERVICE CUSTOMER FACILITIES 9 8 8 8 8
(1) With the exception of end of year ratios, all ratios are based on average daily balances for 1996 and 1995 and average monthly balances for 1994, 1993 and 1992. (2) Performance ratios are calculated to exclude the effect of non-recurring charges for charitable donation and the special Savings Association Insurance Fund assessment. (3) The average interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (4) The net interest margin represents net interest income as a percentage of average interest-earning assets. (5) Operating efficiency ratio represents the ratio of operating expenses to the aggregate of other income and net interest income. (6) Total loans receivable includes loans receivable and loans held for sale, less undisbursed loan funds, deferred loan fees and unamortized discounts/premiums. (7) Non-performing assets consist of non-performing loans and real estate acquired through foreclosure ("REO"). Non-performing loans consist of all loans 90 days or more past due and other loans in the process of foreclosure. It is the Company's policy to cease accruing interest on all such loans. 8 OCEAN FINANCIAL CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Ocean Financial Corp. (the "Company") was incorporated on November 21, 1995, and is the holding company for Ocean Federal Savings Bank (the "Bank"). On August 17, 1995, the Board of Directors of the Bank adopted a Plan of Conversion, as amended, to convert from a federally chartered mutual savings bank to a federally chartered capital stock savings bank with the concurrent formation of a holding company ("the Conversion"). The Conversion was completed on July 2, 1996 with the issuance by the Company of 8,388,078 shares of its common stock in a public offering to the Bank's eligible depositors and the Bank's employee stock ownership plan (the "ESOP"). The purchase of 671,046 shares of common stock (8% of the total shares offered) by the ESOP was funded by a loan of $13.4 million from the Company. In exchange for 50% of the net conversion proceeds ($81.6 million), the Company acquired 100% of the stock of the Bank and retained the remaining net conversion proceeds at the holding company level. Concurrent with the close of the Conversion, an additional 671,046 shares of common stock (8% of the offering) were issued and donated by the Company to the Ocean Federal Foundation (the "Foundation"), a private foundation dedicated to charitable purposes within Ocean County, New Jersey and its neighboring communities. The fair market value of the contribution of $13.4 million was reflected as an expense in the Company's 1996 operating results and as an increase to capital stock and paid in capital for the same amount. The Company had no operations prior to July 2, 1996 and, accordingly, the results of operations prior to that date reflect only those of the Bank and its subsidiaries. The Company conducts business, primarily through its ownership of the Bank which operates its administrative/branch office located in Toms River and nine other branch offices. Nine of the ten branch offices are located in Ocean County, New Jersey. The Company has historically operated as a consumer-oriented federal savings bank, with a focus on offering traditional savings deposit and loan products to its local community. In recent years, the Company's strategy has been to maintain profitability while limiting its credit and interest rate risk exposure. To accomplish these objectives, the Company has sought to: (1) control credit risk by emphasizing the origination of single-family, owner-occupied residential mortgage loans and consumer loans, consisting primarily of home equity loans and lines of credit; (2) offer superior service and competitive rates to increase the core deposit base consistent with its capital management goals; (3) invest funds in excess of loan demand in mortgage-backed and investment securities; (4) reduce exposure to interest rate risk by originating for the portfolio first mortgage loans having terms to maturity of not more than 15 years and adjustable-rate mortgage ("ARM") loans, selling most fixed-rate 30- year mortgage loans, and investing in shorter-term or adjustable-rate mortgage- backed securities; and (5) control operating expenses. The Company expects to continue to capitalize on its strengths -- the delivery of traditional thrift products and services (primarily single-family mortgages) with a high level of customer service, thereby maintaining its community orientation. Despite this emphasis, the Company took steps during 1996 to modify its historical operating strategy. With industry consolidation eliminating most locally headquartered competitors, the Company saw an opportunity to fill a perceived void for locally delivered commercial loan and deposit services. As such, in the second half of 1996 the Company assembled an experienced team of commercial lending professionals and began offering commercial loan and deposit services and merchant credit card services to businesses in Ocean County and surrounding communities. In 1997, the Company will consider the introduction of other products and services such as trust services and alternative investment products (e.g., annuities, mutual funds, etc.). Management believes that the diversification of the Company's loan products may expose the Company to a higher degree of credit risk than is involved in the Company's one- to four-family residential mortgage lending activity. As a consequence of this strategy, management has developed a well-defined credit policy, focusing on quality underwriting and close management and Board monitoring. Management is also seeking to increase the Company's market share in its primary market area by expanding the Bank's branch network. During 1996, the Company opened a branch office in Toms River at the site of its new administrative offices. In February 1997, an additional branch opened in Lacey Township. The Company is currently evaluating additional office sites within its existing market area. The Company's results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on the Company's interest-earning assets, such as loans and investments, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income such as income from secondary marketing activities, loan servicing and other fees. The Company's operating expenses primarily consist of compensation and employee benefits, general and administrative expenses, federal deposit insurance premiums, occupancy and equipment expenses, advertising expenses and other operating expenses. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory agencies. OCEAN FINANCIAL CORP. AND SUBSIDIARY 9 MANAGEMENT OF INTEREST RATE RISK The principal objectives of the Company's interest rate risk management function are to evaluate the interest rate risk included in certain balance sheet accounts; determine the level of risk appropriate given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives; and manage the risk consistent with Board approved guidelines. Through such management, the Company seeks to reduce the vulnerability of its operations to changes in interest rates. The Company monitors its interest rate risk as such risk relates to its operating strategies. The Company's Board of Directors has established an Asset/Liability Committee ("ALCO Committee") consisting of members of the Company's management, responsible for reviewing the Company's asset/liability policies and interest rate risk position. The ALCO Committee meets monthly and reports trends and the Company's interest rate risk position to the Board of Directors on a quarterly basis. The extent of the movement of interest rates, higher or lower, is an uncertainty that could have a negative impact on the earnings of the Company. In recent years, the Company has utilized the following strategies to manage interest rate risk: (i) emphasizing the origination for portfolio of fixed-rate mortgage loans having terms to maturity of not more than fifteen years, adjustable-rate loans, and consumer loans consisting primarily of home equity loans and lines of credit; (ii) selling most 30-year fixed-rate mortgage loans originated to the secondary market; (iii) holding primarily short-term and/or adjustable-rate mortgage-backed and investment securities; and (iv) attempting to reduce the overall interest rate sensitivity of liabilities by emphasizing core and longer-term deposits. In late 1996, however, the Company began retaining most of its 30-year fixed rate mortgage loan production. Management felt that the significant capital position of the Company resulting from the Conversion, coupled with reduced origination levels of this product, mitigated the additional interest rate risk associated with retaining these mortgages. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest- bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Accordingly, during a period of rising interest rates, an institution with a negative gap position generally would not be in as favorable a position, compared to an institution with a positive gap, to invest in higher yielding assets. This may result in the yield on the institution's assets increasing at a slower rate than the increase in its cost of interest- bearing liabilities. Conversely, during a period of falling interest rates, an institution with a negative gap might experience a repricing of its assets at a slower rate than its interest-bearing liabilities, which, consequently, may result in its net interest income growing at a faster rate than an institution with a positive gap position. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1996, which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table is intended to provide an approximation of the projected repricing of assets and liabilities at December 31, 1996, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. For loans on residential properties, adjustable-rate loans and fixed-rate loans are projected to repay at rates between 9% and 28% annually. Mortgage-backed securities are projected to prepay at rates between 11% and 30% annually. Passbook accounts and negotiable order of withdrawal ("NOW") accounts are assumed to decay at 9.53%, 8.62%, 14.85%, 36.92%, 16.58%, 11.68%, 1.82%, and money market savings accounts are assumed to decay at 15.90%, 13.38%, 20.71%, 37.50%, 9.38%, 3.03%, 0.10%, for the periods of three months or less, three to six months, six to 12 months, one to three years, three to five years, five to ten years and more than ten years, respectively. Prepayment and decay rates can have a significant impact on the Company's estimated gap. There can be no assurance that projected prepayment rates for loans and mortgage- backed securities will be achieved or that projected decay rates will be realized. 10 OCEAN FINANCIAL CORP. AND SUBSIDIARY
More than More than More than More than More than 3 Months 3 Months to 6 Months 1 Year to 3 Years to 5 Years to More than At December 31, 1996 or Less 6 Months to 1 Year 3 Years 5 Years 10 Years 10 Years Total - ----------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) INTEREST-EARNING ASSETS (1): Interest-earning deposits and short-term investments $ 2,849 $ -- $ -- $ -- $ -- $ -- $ -- $ 2,849 Investment securities 250 -- -- 5,080 104,368 64,195 135 174,028 Loans receivable (2) 78,926 41,719 93,004 154,492 138,114 94,088 89,963 690,306 Mortgage-backed securities 83,128 29,777 195,135 41,897 22,906 22,049 650 395,542 FHLB stock 8,457 -- -- -- -- -- -- 8,457 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 173,610 71,496 288,139 201,469 265,388 180,332 90,748 1,271,182 - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST-BEARING LIABILITIES: Money market deposit accounts 11,133 9,369 14,501 26,258 6,568 2,122 70 70,021 Savings accounts 16,157 14,613 25,175 62,589 28,107 19,801 3,085 169,527 NOW accounts 6,783 6,135 10,568 26,275 11,800 8,312 1,295 71,168 Time deposits 105,763 126,451 180,311 145,402 42,439 17,294 -- 617,660 FHLB borrowings 8,800 -- -- -- -- -- -- 8,800 Securities sold under agreements to repurchase 74,822 -- -- 24,500 -- -- -- 99,322 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 223,458 156,568 230,555 285,024 88,914 47,529 4,450 1,036,498 - ----------------------------------------------------------------------------------------------------------------------------------- Interest sensitivity gap (3) $(49,848) $ (85,072) $ 57,584 $ (83,555) $176,474 $132,803 $ 86,298 $ 234,684 =================================================================================================================================== Cumulative interest sensitivity gap $(49,848) $(134,920) $(77,336) $(160,891) $ 15,583 $148,386 $234,684 $ -- =================================================================================================================================== Cumulative interest sensitivity gap as a percent of total assets (3.82)% (10.35)% (5.93)% (12.34)% 1.20% 11.38% 18.00% Cumulative interest-earning assets as a percent of cumulative interest- bearing liabilities 77.69% 64.50% 87.33% 82.04% 101.58% 114.38% 122.64%
(1) Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities. (2) For purposes of the gap analysis, loans receivable includes loans held for sale and non-performing loans gross of the allowance for loan losses, undisbursed loan funds, unamortized discounts and deferred loan fees. (3) Interest sensitivity gap represents the difference between net interest- earning assets and interest-bearing liabilities. OCEAN FINANCIAL CORP. AND SUBSIDIARY 11 Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and decay rates would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may be impaired in the event of an interest rate increase. Another method of analyzing an institution's exposure to interest rate risk is by measuring the change in the institution's net portfolio value ("NPV") under various interest rate scenarios. NPV is the difference between the net present value of assets, liabilities and off-balance sheet contracts. The NPV ratio, in any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The Sensitivity Measure is the decline in the NPV ratio, in basis points, caused by a 2% increase or decrease in rates, whichever produces a larger decline. The higher an institution's Sensitivity Measure is, the greater its exposure to interest rate risk is considered to be. The Company's interest rate sensitivity is monitored by management through the use of an interest rate risk ("IRR") model which measures IRR by modeling the change in NPV over a range of interest rate scenarios. The OTS also produces a similar analysis using its own model, based upon data submitted on the Bank's quarterly Thrift Financial Reports, the results of which may vary from the results provided by the Company's model, primarily due to differences in the assumptions utilized, including estimated loan prepayment rates, reinvestment rates and deposit decay rates. The following table sets forth the Company's NPV as of December 31, 1996, as calculated by the Company.
NPV as % of Portfolio Change in Net Portfolio Value Value of Assets Interest Rates in ----------------------------------------------------- Basis Points NPV % (Rate Shock) Amount $ Change % Change Ratio Change (1) - ---------------------------------------------------------------------------------- (dollars in thousands) 400 $203,927 $(77,025) (27.4)% 14.6% (32.1)% 300 228,662 (52,290) (18.6) 16.7 (21.5) 200 252,117 (28,835) (10.3) 18.7 (13.0) 100 268,578 (12,374) (4.4) 20.2 (6.0) Static 280,952 -- -- 21.5 -- (100) 287,584 6,632 2.4 22.5 4.7 (200) 288,755 7,803 2.8 23.1 7.4 (300) 290,572 9,620 3.4 23.8 10.7 (400) 292,625 11,673 4.2 24.8 15.3
(1) Based on the portfolio value of the Company's assets assuming no change in interest rates. As is the case with the gap table, certain shortcomings are inherent in the methodology used in the NPV IRR measurements. Modeling changes in NPV require the making of certain assumptions which may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the models assume 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. Second, the models assume 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. Third, the model does not take into account the Company's business or strategic plans. Accordingly, although the NPV measurements do provide an indication of the Company's IRR exposure at a particular point in time, such measurements are not intended to provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and can be expected to differ from actual results. 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 upon the relative amounts of interest-earning assets and interest- bearing liabilities and the interest rate earned or paid on them. 12 OCEAN FINANCIAL CORP. AND SUBSIDIARY The following table sets forth certain information relating to the Company at December 31, 1996 and for each of the years ended December 31, 1996, 1995 and 1994. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown except where noted otherwise. Average balances are derived from average daily balances for 1996 and 1995, and average month-end balances for 1994. Management does not believe that the use of average monthly balances instead of average daily balances has caused any material differences in the information presented. The yields and costs include fees which are considered adjustments to yields.
Years Ended December 31, AT DECEMBER 31, -------------------------------------------------------------------- 1996 1996 1995 ------------------------------------------------------------------------------------------------ AVERAGE Average YIELD/ AVERAGE YIELD/ Average Yield/ BALANCE COST BALANCE INTEREST COST Balance Interest Cost - ----------------------------------------------------------------------------------------------------------------------------- ASSETS: Interest-earning assets: Interest earning deposits and short- term investments $ 2,849 5.03% $ 4,872 $ 251 5.15% $ 5,245 $ 331 6.31% Investment securities (1) 174,028 6.65 148,378 9,710 6.54 126,792 7,166 5.65 Loans receivable, net (2) 679,455 7.78 637,453 50,324 7.89 612,431 48,323 7.89 Mortgage-backed securities (3) 395,542 6.33 331,669 19,413 5.85 214,348 13,799 6.44 FHLB stock 8,457 6.61 8,323 538 6.46 7,679 591 7.70 ---------------------------------------------------------------------------------------------- Total interest-earning assets 1,260,331 7.15 1,130,695 80,236 7.10 966,495 70,210 7.26 ---------------------------------------------------------------------------------------------- Non-interest-earning assets 43,534 31,810 22,212 ---------------------------------------------------------------------------------------------- Total assets $1,303,865 $1,162,505 $988,707 ============================================================================================== LIABILITIES AND EQUITY: Interest-bearing liabilities: Money market deposit accounts $ 70,021 2.90% $ 70,209 1,994 2.84% $ 68,987 $ 2,083 3.02% Savings accounts 169,527 2.28 175,060 4,069 2.32 178,973 4,537 2.54 NOW accounts 71,168 1.84 72,265 1,371 1.90 69,330 1,483 2.14 Time deposits 617,660 5.55 609,620 33,555 5.50 574,844 31,723 5.52 ---------------------------------------------------------------------------------------------- Total 928,376 4.47 927,154 40,989 4.42 892,134 39,826 4.46 FHLB borrowings 8,800 7.13 39,135 2,298 5.87 2,933 178 6.07 Securities sold under agreements to repurchase 99,322 5.69 9,803 570 5.81 -- -- ---------------------------------------------------------------------------------------------- Total interest-bearing liabilities 1,036,498 4.61 976,092 43,857 4.49 895,067 40,004 4.47 ---------------------------------------------------------------------------------------------- Non-interest-bearing liabilities 14,578 18,778 9,457 ---------------------------------------------------------------------------------------------- Total liabilities 1,051,076 994,870 904,524 Stockholders' equity 252,789 167,635 84,183 ---------------------------------------------------------------------------------------------- Total liabilities and equity $1,303,865 $1,162,505 $988,707 ============================================================================================== Net interest income $36,379 $30,206 ============================================================================================== Net interest rate spread (4) 2.54% 2.61% 2.79% ============================================================================================== Net interest margin (5) 3.35% 3.22% 3.13% ============================================================================================== Ratio of interest-earning assets to interest- bearing liabilities 121.60% 115.84% 107.98% ==============================================================================================
Years Ended December 31, - --------------------------------------------------------------- 1994 - --------------------------------------------------------------- Average Average Yield/ Balance Interest Cost - --------------------------------------------------------------- ASSETS: Interest-earning assets: Interest earning deposits and short- term investments $ 1,322 $ 56 4.24% Investment securities (1) 127,762 6,933 5.43 Loans receivable, net (2) 559,862 42,706 7.63 Mortgage-backed securities (3) 241,944 13,440 5.56 FHLB stock 7,216 548 7.59 ---------------------------- Total interest-earning assets 938,106 63,683 6.79 ---------------------------- Non-interest-earning assets 18,282 ---------------------------- Total assets $956,388 ============================ Liabilities and Equity: Interest-bearing liabilities: Money market deposit accounts $ 78,288 $ 1,899 2.43% Savings accounts 206,131 5,246 2.54 NOW accounts 69,934 1,440 2.06 Time deposits 511,634 23,545 4.60 ---------------------------- Total 865,987 32,130 3.71 FHLB borrowings 5,006 243 4.85 Securities sold under agreements to repurchase -- -- ---------------------------- Total interest-bearing liabilities 870,993 32,373 3.72 ---------------------------- Non-interest-bearing liabilities 7,805 ---------------------------- Total liabilities 878,798 Stockholders' equity 77,590 ---------------------------- Total liabilities and equity $956,388 ============================ Net interest income $31,310 ============================ Net interest rate spread (4) 3.07% ============================ Net interest margin (5) 3.34% ============================ Ratio of interest-earning assets to interest- bearing liabilities 107.71% ============================
(1) Includes investment securities available for sale. (2) Amount is net of deferred loan fees, undisbursed loan funds, discounts and premiums and estimated loan loss allowances and includes loans held for sale and non-performing loans. (3) Includes mortgage-backed securities available for sale. (4) Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. (5) Net interest margin represents net interest income divided by average interest-earning assets. OCEAN FINANCIAL CORP. AND SUBSIDIARY 13 RATE VOLUME ANALYSIS The following table presents 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 (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
YEAR ENDED DECEMBER 31, 1996 Year Ended December 31, 1995 COMPARED TO Compared to YEAR ENDED DECEMBER 31, 1995 Year Ended December 31, 1994 ----------------------------------------------------------------- INCREASE (DECREASE) Increase (Decrease) DUE TO Due to ---------------------- --------------------- VOLUME RATE NET Volume Rate Net - --------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Interest-earning deposits and short-term investments $ (22) $ (58) $ (80) $ 236 $ 39 $ 275 Investment securities 1,321 1,223 2,544 (52) 285 233 Loans receivable 2,001 -- 2,001 4,121 1,496 5,617 Mortgage-backed securities 6,976 (1,362) 5,614 (1,633) 1,992 359 FHLB stock 47 (100) (53) 35 8 43 - --------------------------------------------------------------------------------------------------------- Total interest-earning assets 10,323 (297) 10,026 2,707 3,820 6,527 - --------------------------------------------------------------------------------------------------------- INTEREST-BEARING LIABILITIES: Money market deposit accounts 37 (126) (89) (243) 427 184 Savings accounts (94) (374) (468) (709) -- (709) NOW accounts 61 (173) (112) (13) 56 43 Time deposits 1,945 (113) 1,832 3,123 5,055 8,178 - --------------------------------------------------------------------------------------------------------- Total 1,949 (786) 1,163 2,158 5,538 7,696 FHLB borrowings 2,126 (6) 2,120 (116) 51 (65) Securities sold under agreements to repurchase 570 -- 570 -- -- -- - --------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 4,645 (792) 3,853 2,042 5,589 7,631 - --------------------------------------------------------------------------------------------------------- Net change in net interest income $ 5,678 $ 495 $ 6,173 $ 665 $(1,769) $(1,104) =========================================================================================================
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1996 AND DECEMBER 31, 1995 Total assets at December 31, 1996 were $1.304 billion, an increase of $267.4 million, or 25.8%, compared to $1.036 billion at December 31, 1995. This growth was funded by $149.9 million in net proceeds from the issuance of common stock in connection with the Bank's Conversion, which was completed on July 2, 1996. The Conversion proceeds were primarily used to repay borrowings and purchase investment and mortgage-backed securities. Investment securities available for sale increased by $59.1 million, to a balance of $174.0 million at December 31, 1996, compared to a balance of $114.9 million at December 31, 1995, and mortgage-backed securities increased by $130.4 million to $395.5 million at December 31, 1996 from $265.1 million at December 31, 1995. The increase in investment and mortgage-backed securities is due to the investment of Conversion proceeds and the adoption, in late 1996, of a wholesale leverage strategy designed to improve returns on invested capital. Wholesale leverage growth was funded through securities sold under agreements to repurchase, which increased to $99.3 million at December 31, 1996 from zero at December 31, 1995. The strategy involved the purchase of adjustable-rate mortgage-backed securities funded by short-term repurchase agreements and the purchase of medium term callable agency securities funded by repurchase agreements with maturities through the call date. Loans receivable, net, increased by $66.0 million, or 10.8%, to a balance of $678.7 million at December 31, 1996, compared to a balance of $612.7 million at December 31, 1995. Premises and equipment increased by $6.5 million, or 84.5%, to $14.1 million at December 31, 1996, from $7.6 million at December 31, 1995, as a result of renovations to a building purchased by the Company in July 1995, which is now the site of a new branch office and the Company's administrative facility. The renovation was completed and the building occupied in late 1996. Other assets increased $5.5 million from December 31, 1995 to December 31, 1996, primarily due to the recognition of deferred tax assets relating to the charitable donation and the net unrealized loss on securities available for sale. Total deposits at December 31, 1996 were $934.7 million, an increase of $8.2 million, compared to $926.6 million at December 31, 1995. The increase is net of $13.5 million in deposit withdrawals used to fund stock purchases in the Conversion. Stockholders' equity at December 31, 1996 was $252.8 million, compared to $92.4 million at December 31, 1995, an increase of $160.4 million, primarily due to net Conversion proceeds of $149.9 million. 14 OCEAN FINANCIAL CORP. AND SUBSIDIARY COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995 GENERAL The Company incurred a net loss of $1.7 million for the year ended December 31, 1996, as compared to net income of $7.9 million for the year ended December 31, 1995. The 1996 loss was caused by the charitable donation to the Ocean Federal Foundation of 671,046 shares of common stock which resulted in expense recognition of $13.4 million ($9.7 million net of tax), the fair market value of the stock at the time of the donation. (See note 2 to the consolidated financial statements.) Operating results for the year ended December 31, 1996 were further reduced by a special one-time assessment imposed on institutions such as the Bank insured by the Savings Association Insurance Fund ("SAIF") of the FDIC. The special assessment was 65.7 basis points on SAIF assessable deposits as of March 31, 1995. The Company's assessment was $5.7 million ($3.7 million net of taxes). (See note 17 to the consolidated financial statements.) INTEREST INCOME Interest income for the year ended December 31, 1996 was $80.2 million, compared to $70.2 million for the year ended December 31, 1995, an increase of $10.0 million, or 14.3%. The increase in interest income was the result of increases in the average size of the investment and mortgage-backed securities available for sale portfolios, which together increased $138.9 million on average, due to the 1996 purchases relating to the investment of net Conversion proceeds. Many of these purchases were made early in 1996 as the Company prefunded expected Conversion proceeds by increasing FHLB borrowings and investing the borrowed funds in investment and mortgage-backed securities. The FHLB borrowings were then repaid upon consummation of the Conversion. Additionally, the average balance of loans receivable increased by $25.0 million during 1996 as compared to 1995. The overall increase in interest-earning assets was partially offset by the effects of a lower average interest-earning asset yield which decreased to 7.10% for the year ended December 31, 1996, as compared to 7.26% for the year ended December 31, 1995. INTEREST EXPENSE Interest expense for the year ended December 31, 1996 was $43.9 million, compared to $40.0 million for the year ended December 31, 1995, an increase of $3.9 million, or 9.6%. The increase in interest expense for the year ended December 31, 1996, as compared to the same period in 1995 was the result of an increase in the average outstanding balance of both deposits (to $927.2 million for the year ended December 31, 1996, from $892.1 million for the same period in 1995) and Federal Home Loan Bank borrowings (to $39.1 million for the year ended December 31, 1996, from $2.9 million for the same period in 1995). PROVISION FOR LOAN LOSSES For the year ended December 31, 1996, the Company's provision for loan losses was $700,000, compared to $950,000 for the same prior year period. The decrease was partly due to the decline in non-performing loans, which decreased $1.0 million, to $7.7 million at December 31, 1996, from $8.7 million at December 31, 1995. Management of the Company is responsible for the determination of the level of the allowance for loan losses. The allowance for loan losses is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loan. Additions to this allowance are charged to earnings. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to provide additions to the allowance based upon information available to them at the time of their examination. Although management uses the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control. OTHER INCOME Other income was $2.9 million for the year ended December 31, 1996, an increase of $1.5 million, or 112.5%, compared to the same prior year period. Income from the net gain on sales of loans and securities available for sale increased $618,000 for the year ended December 31, 1996, compared to the same prior year period. The increase was primarily due to the recognition of a $587,000 loss in 1995 on the sale of investment securities available for sale. The net gain from real estate owned increased $396,000 for the year ended December 31, 1996, compared to the same prior year period due to the recognition of $311,000 in gains on the sale of two properties in late 1996. Other income increased $295,000 for the year ended December 31, 1996, compared to the same prior year period due to the recovery of $101,000 from the previous charge off of a financial asset and due to the recognition of $232,000 of income in 1996 relating to increases in the cash surrender value of life insurance policies on Bank officers. OCEAN FINANCIAL CORP. AND SUBSIDIARY 15 OPERATING EXPENSES Operating expenses were $39.2 million for the year ended December 31, 1996, an increase of $21.2 million compared to the same prior year period. The charitable donation to the Ocean Federal Foundation accounted for $13.4 million of the increase. The Bank's share of the special assessment imposed by the FDIC on SAIF-insured institutions of $5.7 million accounted for the increase in federal deposit insurance for the year ended December 31, 1996, as compared to the same prior year period. The increase in compensation and employee benefits expense of $1.6 million for the year ended December 31, 1996, as compared to the same prior year period, was due to the expense associated with the adoption, effective January 1, 1996, of the ESOP. This expense was partly offset by freezing the future accrual of benefits under the Bank's defined benefit pension plan. The Company expects that salary and benefits expense may increase during 1997, primarily as a result of the adoption of various employee benefit plans in connection with the Conversion. In this regard, the ESOP, which purchased 8% of the Common Stock sold in the Offering, and the stock programs which will purchase an amount of Common Stock equal to 4% of the Common Stock sold in the Offering, may result in increased salary and benefits expense as interest on and amortization of the ESOP loan and amortization of the stock program awards will be reflected as compensation expense (see notes 13 and 18 to the consolidated financial statements). In addition, the Company expects operating expenses to increase in future periods as a result of the opening of two new branch offices, one in late 1996 and the other in early 1997, and the creation, in the second half of 1996, of the Bank's Commercial Loan Department. PROVISION FOR INCOME TAXES Income tax expense was $1.1 million for the year ended December 31, 1996, compared to $4.7 million for the year ended December 31, 1995. The Company has been advised by its independent accountants that the Company's contribution of common stock to the Ocean Federal Foundation is tax deductible, subject to a limitation based on 10% of the Company's annual taxable income. The Company, however, is able to carry forward any unused portion of the deduction for five years following the year in which the contribution is made. Based on the Company's estimate of annual taxable income for the current year and for the next successive five years (the carryforward period), the Company recognized a tax benefit of $3.7 million on the $13.4 million charitable donation. An additional $1.2 million of tax benefit was unrecognized due to the limitations imposed by the tax code. (See notes 2 and 12 to the consolidated financial statements.) The unrecognized tax benefit relating to the charitable donation caused the Company to recognize an income tax expense for 1996 despite a pre-tax book loss. Although the Company and the Bank have received an opinion of their independent accountants that the Company will be entitled to the deduction for the charitable contribution, there can be no assurances that the IRS will recognize the Foundation as a Section 501(c)(3) exempt organization or that the deduction will be permitted. In such event, the Company's recorded tax benefit would be reversed, resulting in a reduction in earnings of $3.7 million in the year in which the IRS makes such a determination. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994 GENERAL Net income decreased $1.8 million, or 18.3%, to $7.9 million for the year ended December 31, 1995, from $9.7 million for the year ended December 31, 1994. The decrease was due primarily to a decline in net interest income, which resulted from a decrease in the interest rate spread to 2.79% for the year ended December 31, 1995, from 3.07% for the year ended December 31, 1994. The shift in the composition of the Company's interest-bearing liabilities from core savings accounts to higher yielding certificates of deposit was the primary reason for this decline. Additionally, the Company recognized a loss of $587,000 in 1995 on the sale of investment securities available for sale. Profitability further declined as a result of a decrease in other income (net of the $587,000 loss on the sale of investment securities) and increased operating expenses, partly offset by decreases in the provision for loan losses and the provision for income taxes. INTEREST INCOME Interest income for the year ended December 31, 1995 was $70.2 million, compared to $63.7 million for the year ended December 31, 1994, an increase of $6.5 million, or 10.2%. Increased interest income on loans accounted for substantially all of this increase. The increase in interest income on loans was a result of growth in the average balance of loans outstanding combined with an increase in the average yield. The average balance of loans receivable increased $52.6 million, while the yield on such loans increased by 26 basis points to 7.89% for 1995, from 7.63% for 1994. The growth in loans was attributable to an increase in the origination of ARM loans in the first half of 1995, which the Company maintains in portfolio. The increase in average yield for 1995 over 1994 was a result of the generally higher interest rate environment causing ARM loans to reprice upward. Interest income on mortgage-backed securities increased $359,000 for 1995, compared to 1994. The average balance of mortgage-backed securities declined by $27.6 million for 1995, compared to 1994, as a result of principal repayments and limited purchase activity due to an increased demand for loans. The yield on this portfolio, however, increased 88 basis points due to the repricing of adjustable-rate securities. Interest income on investment securities increased $233,000 for 1995, compared to 1994, primarily due to an increase in the average yield of 22 basis points. 16 OCEAN FINANCIAL CORP. AND SUBSIDIARY INTEREST EXPENSE Interest expense for the year ended December 31, 1995 was $40.0 million, compared to $32.4 million for the year ended December 31, 1994, an increase of $7.6 million, or 23.6%. The increase in interest expense was the result of a $26.1 million increase in the average balance of interest-bearing deposits and an increase in the average cost of deposits to 4.46% for 1995, from 3.71% for 1994. The increase in average cost was primarily due to a shift in the composition of deposit accounts from lower-yielding core accounts into higher- yielding certificates of deposit. Average balances on money market deposit and savings accounts decreased by $9.3 million and $27.2 million, respectively, for 1995, compared to 1994, while the average balance of time deposits increased by $63.2 million from 1994 to 1995. PROVISION FOR LOAN LOSSES During the year ended December 31, 1995, the Company's provision for loan losses was $950,000 compared to $1.1 million for the year ended December 31, 1994, a decrease of $179,000. The decrease was partly due to the decline in non- performing loans, which decreased by $2.2 million to $8.7 million at December 31, 1995, from $10.9 million at December 31, 1994. OTHER INCOME Other income decreased to $1.4 million for the year ended December 31, 1995, from $2.1 million for the year ended December 31, 1994. The decrease was primarily due to the recognition of a $587,000 loss in 1995 on the sale of investment securities available for sale. Additionally, fees and service charges declined by $82,000 in 1995, as compared to 1994. The decrease in this category can be attributed to a $112,000 decrease in mortgage loan servicing income. OPERATING EXPENSES Operating expenses increased to $18.0 million for the year ended December 31, 1995, from $17.1 million for the year ended December 31, 1994. Compensation and employee benefits increased $383,000, or 4.6%, primarily due to annual salary increases. Advertising expense increased by $120,000 to $836,000 for 1995, from $716,000 for 1994, as a result of increased advertising to maintain loan volume and market presence. General and administrative expenses increased $355,000, or 13.8%, to $2.9 million for 1995, compared to 1994. PROVISION FOR INCOME TAXES Income tax expense was $4.7 million for the year ended December 31, 1995, compared to $5.4 million for the year ended December 31, 1994. The decrease in the provision for income taxes was primarily the result of the decrease in earnings before income taxes. The effective tax rate for 1995 was 37.0%, an increase of 1.3% over the 35.7% effective tax rate for 1994. The increase in the effective tax rate for 1995 can be attributed to the non-deductibility of certain expenses incurred by the Company. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds are deposits, principal and interest payments on loans, FHLB and other borrowings and, to a lesser extent, investment maturities and proceeds from the sale of loans. While scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including an overnight line of credit and advances from the FHLB. At December 31, 1996, the Company had $8.8 million in overnight borrowings outstanding from the FHLB, representing a decrease from $10.4 million at December 31, 1995. The Company utilizes the overnight line from time-to-time to fund short-term liquidity needs. The Company also borrowed $99.3 million at December 31, 1996, through securities sold under agreements to repurchase. These borrowings were used to fund a wholesale leverage strategy designed to improve returns on invested capital. The Company's cash needs for the year ended December 31, 1996 were principally provided by net proceeds of common stock issuance, securities sold under agreements to repurchase, maturities of investment securities and principal payments on loans and mortgage-backed securities. The cash provided was principally used for investing activities, which included the purchase of investment and mortgage-backed securities and the origination of loans. For the year ended December 31, 1995, the cash needs of the Company were primarily satisfied by growth in the deposit base, investment sales and maturities and principal payments on loans and mortgage-backed securities. The cash was principally utilized for loan originations, purchases of investment and mortgage-backed securities and repayment of FHLB borrowings. Federal regulations require the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time-to-time based upon economic conditions and savings flows and is currently 5% of net withdrawable savings deposits and borrowings payable on demand or in one year or less during the preceding calendar month. Liquid assets for purposes of this ratio include cash, accrued interest receivable, certain time deposits, U.S. Treasury and Government agencies and other securities and obligations generally having remaining maturities of less than five years. The levels of these assets are dependent on the Bank's operating, financing, lending and investing activities during any given period. As of December 31, 1996 and December 31, 1995, the Bank's liquidity ratios were 17.5% and 17.2%, respectively, both in excess of the 5% minimum regulatory requirement. OCEAN FINANCIAL CORP. AND SUBSIDIARY 17 At December 31, 1996, the Bank exceeded all of its regulatory capital requirements with tangible capital of $165.5 million, or 12.7% of total adjusted assets, which is above the required level of $19.6 million, or 1.5%; core capital of $165.5 million, or 12.7% of total adjusted assets, which is above the required level of $39.1 million, or 3.0%; and risk-based capital of $171.2 million, or 32.0% of risk-weighted assets, which is above the required level of $42.8 million, or 8.0%. The Bank is considered a "well-capitalized" institution under the Office of Thrift Supervision's prompt corrective action regulations. IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and notes thereto presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike 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. IMPACT OF NEW ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). This Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. SFAS 123 encourages all entities to adopt the "fair value based method" of accounting for employee stock compensation plans. However, SFAS 123 also allows an entity to continue to measure compensation cost under such plans using the "intrinsic value based method." Under the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, usually the vesting period. Fair value is determined using an option pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock and the expected dividends on it, and the risk-free interest rate over the expected life of the option. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. Most stock plans have no intrinsic value at date of grant, and under previous accounting guidance, no compensation cost was to be recognized. The accounting requirements of this Statement are effective for transactions entered into in fiscal years that begin after December 15, 1995. The Statement had no effect on the Company in 1996; however, the Company will adopt the provisions of the Statement in 1997 in connection with shareholder ratification of the Ocean Financial Corp. 1997 Incentive Plan on February 4, 1997. The Company intends to account for compensation cost under the intrinsic value based method and will provide pro forma disclosures for awards granted in 1997, and thereafter. Such disclosures include net income and earnings per share as if the fair value based method of accounting had been applied. In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS 125). SFAS 125 amends portions of SFAS 115, amends and extends to all servicing assets and liabilities the accounting standards for mortgage servicing rights now in SFAS 65, and supersedes SFAS 122. The statement provides consistent standards for distinguishing transfers of financial assets, which are sales, from transfers that are secured borrowings. Those standards are based upon consistent application of a financial components approach that focuses on control. The statement also defines accounting treatment for servicing assets and other retained interests in assets that are transferred. SFAS 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 except for certain provisions which were deferred until January 1, 1998 by SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," issued in December 1996. The adoption of these statements is to be applied prospectively and is not expected to have a material effect on the Company's financial condition or results of operations. 18 OCEAN FINANCIAL CORP. AND SUBSIDIARY OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 1996 and 1995 (dollars in thousands, except per share amounts)
1996 1995 - -------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 5,372 $ 8,022 Investment securities available for sale (notes 4, 11 and 14) 174,028 114,881 Federal Home Loan Bank of New York stock, at cost 8,457 7,723 Mortgage-backed securities available for sale (notes 5, 11 and 14) 395,542 265,113 Loans receivable, net (notes 6 and 14) 678,728 612,696 Mortgage loans held for sale 727 1,894 Interest and dividends receivable (note 7) 9,757 7,480 Real estate owned, net (note 9) 1,555 1,367 Premises and equipment, net (note 8) 14,100 7,641 Servicing asset (note 6) 1,743 1,222 Other assets (note 12) 13,856 8,406 - -------------------------------------------------------------------------------- Total assets $1,303,865 $1,036,445 ================================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits (note 10) $ 934,730 $ 926,558 Federal Home Loan Bank borrowings 8,800 10,400 Securities sold under agreements to repurchase (note 11) 99,322 -- Advances by borrowers for taxes and insurance 3,832 3,321 Other liabilities (notes 12 and 13) 4,392 3,815 - -------------------------------------------------------------------------------- Total liabilities 1,051,076 944,094 - -------------------------------------------------------------------------------- Stockholders' Equity (notes 2, 3, 12, 13 and 18): Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued -- -- Common stock, $.01 par value, 55,000,000 shares authorized, 9,059,124 shares issued and outstanding at December 31, 1996 91 -- Additional paid-in capital 176,812 -- Unallocated Common Stock held by Employee Stock Ownership Plan (12,331) -- Retained earnings -- substantially restricted 88,552 90,281 Net unrealized (loss) gain on securities available for sale, net of tax (335) 2,070 - -------------------------------------------------------------------------------- Total stockholders' equity 252,789 92,351 - -------------------------------------------------------------------------------- Commitments and contingencies (note 14) Total liabilities and stockholders' equity $1,303,865 $1,036,445 ================================================================================
See accompanying notes to consolidated financial statements. OCEAN FINANCIAL CORP. AND SUBSIDIARY 19 OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands, except per share amounts)
1996 1995 1994 - -------------------------------------------------------------------------------- INTEREST INCOME: Loans $50,324 $48,323 $42,706 Mortgage-backed securities 19,413 13,799 13,440 Investment securities and other 10,499 8,088 7,537 - -------------------------------------------------------------------------------- Total interest income 80,236 70,210 63,683 - -------------------------------------------------------------------------------- INTEREST EXPENSE: Deposits (note 10) 40,989 39,826 32,130 Borrowed funds 2,868 178 243 - -------------------------------------------------------------------------------- Total interest expense 43,857 40,004 32,373 - -------------------------------------------------------------------------------- Net interest income 36,379 30,206 31,310 Provision for loan losses (note 6) 700 950 1,129 - -------------------------------------------------------------------------------- Net interest income after provision for loan losses 35,679 29,256 30,181 - -------------------------------------------------------------------------------- OTHER INCOME: Fees and service charges (note 6) 1,819 1,603 1,685 Net gain (loss) on sales of loans and securities available for sale (notes 4 and 6) 278 (340) 182 Net income from (cost of) other real estate operations 355 (41) 8 Other 429 134 182 - -------------------------------------------------------------------------------- Total other income 2,881 1,356 2,057 - -------------------------------------------------------------------------------- OPERATING EXPENSES: Compensation and employee benefits (note 13) 10,296 8,707 8,324 Occupancy (note 14) 1,882 1,721 1,652 Equipment 862 879 958 Advertising 818 836 716 Federal deposit insurance (note 17) 8,051 2,199 2,167 Data processing 941 737 715 General and administrative 2,937 2,927 2,572 Charitable donation (notes 2 and 12) 13,419 -- -- - -------------------------------------------------------------------------------- Total operating expenses 39,206 18,006 17,104 - -------------------------------------------------------------------------------- Income (loss) before provision for income taxes (646) 12,606 15,134 Provision for income taxes (note 12) 1,083 4,659 5,405 - -------------------------------------------------------------------------------- Net income (loss) $(1,729) $ 7,947 $ 9,729 ================================================================================ Loss per share (based on net loss from July 2, 1996 to December 31, 1996) $(0.78) N/A N/A
See accompanying notes to consolidated financial statements. 20 OCEAN FINANCIAL CORP. AND SUBSIDIARY OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands)
Net Unrealized Employee Gain (Loss) Additional Stock On Securities Common Paid-In Ownership Retained Available For Stock Capital Plan Earnings Sale, Net of Tax Total - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1993 $-- $ -- $ -- $72,605 $ -- $ 72,605 Net income for the year ended December 31, 1994 -- -- -- 9,729 -- 9,729 - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1994 -- -- -- 82,334 -- 82,334 Net income for the year ended December 31, 1995 -- -- -- 7,947 -- 7,947 Change in net unrealized gain (loss) on securities available for sale, net of tax -- -- -- -- 2,070 2,070 - -------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1995 -- -- -- 90,281 2,070 92,351 Sale of 8,388,078 shares of common stock in conversion 84 163,216 -- -- -- 163,300 Donation of 671,046 shares of common stock to the Ocean Federal Foundation at par value 7 13,414 -- -- -- 13,421 Acquisition of 671,046 shares of stock by ESOP -- -- (13,421) -- -- (13,421) Allocation of ESOP stock -- -- 1,090 -- -- 1,090 ESOP adjustment -- 182 -- -- -- 182 Change in net unrealized gain (loss) on securities available for sale, net of tax -- -- -- -- (2,405) (2,405) Net loss for the year ended December 31, 1996 -- -- -- (1,729) -- (1,729) - -------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 $91 $176,812 $(12,331) $88,552 $ (335) $252,789 ==========================================================================================================================
See accompanying notes to consolidated financial statements. OCEAN FINANCIAL CORP. AND SUBSIDIARY 21 OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands)
1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,729) $ 7,947 $ 9,729 - ------------------------------------------------------------------------------------------------------------------------- Adjustments to reconcile net income (loss) to net cash provided by operating activities: Donation of 671,046 shares of common stock to the Ocean Federal Foundation 13,419 -- -- Depreciation and amortization of premises and equipment 760 810 966 Amortization of ESOP 1,090 -- -- ESOP adjustment 182 -- -- Amortization of servicing asset 204 106 141 Net premium amortization in excess of discount accretion on securities 1,761 585 644 Net accretion of deferred fees and discounts in excess of premium amortization on loans (487) (535) (917) Provision for loan losses 700 950 1,129 Deferred taxes (3,263) 385 883 Net gain on sales of real estate owned (507) (256) (417) Net (gain) loss on sales of loans and securities available for sale (278) 340 (182) Proceeds from sales of mortgage loans held for sale 24,173 19,108 16,760 Mortgage loans originated for sale (23,453) (21,264) (15,946) Increase in interest and dividends receivable (2,277) (251) (839) Increase in other assets (830) (4,160) (2,799) Increase (decrease) in other liabilities 577 1,371 (1,231) - ------------------------------------------------------------------------------------------------------------------------- Total adjustments 11,771 (2,811) (1,808) - ------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 10,042 5,136 7,921 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net increase in loans receivable (68,429) (23,588) (55,320) Proceeds from sales of investment securities available for sale -- 63,713 -- Purchase of investment securities available for sale (105,006) (29,976) -- Purchase of mortgage-backed securities available for sale (251,004) (34,575) -- Purchase of investment securities held to maturity -- (54,975) (31,973) Purchase of mortgage-backed securities held to maturity -- (53,915) (50,042) Principal payments on mortgage-backed securities available for sale 117,048 -- -- Principal payments on mortgage-backed securities held to maturity -- 50,193 65,978 Proceeds from maturities of investments available for sale 43,858 -- -- Proceeds from maturities of investment securities held to maturity -- 33,624 31,573 Purchases of Federal Home Loan Bank of New York stock (734) (400) (643) Proceeds from sales of real estate owned 2,503 3,261 4,571 Purchases of premises and equipment (7,219) (4,121) (885) - ------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (268,983) (50,759) (36,741) - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in deposits 8,172 59,138 8,959 (Decrease) increase in Federal Home Loan Bank borrowings (1,600) (5,900) 16,300 Increase in securities sold under agreements to repurchase 99,322 -- -- Increase in advances by borrowers for taxes and insurance 511 168 680 Net proceeds of common stock issuance 149,886 -- -- - ------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 256,291 53,406 25,939 - ------------------------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and due from banks (2,650) 7,783 (2,881) Cash and due from banks at beginning of year 8,022 239 3,120 - ------------------------------------------------------------------------------------------------------------------------- Cash and due from banks at end of year $ 5,372 $ 8,022 $ 239 ========================================================================================================================= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 43,624 $ 39,849 $ 32,362 Income taxes 4,231 3,873 5,036 Noncash investing activities: Transfer of loans receivable to real estate owned 2,184 2,792 2,678 Transfer of investment and mortgage-backed securities from held to maturity to available for sale -- 382,713 -- Mortgage loans securitized into mortgage-backed securities $ 23,392 $ 17,180 $ 14,771 =========================================================================================================================
See accompanying notes to consolidated financial statements. 22 OCEAN FINANCIAL CORP. AND SUBSIDIARY OCEAN FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996 and 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES As more fully described in note 2, Ocean Federal Savings Bank (the "Bank") converted from a mutual savings bank to a capital stock savings bank on July 2, 1996. As part of the conversion, Ocean Financial Corp. (the "Company") was formed, acquired all of the Bank's conversion stock, and issued its common stock in a subscription offering. The acquisition of the Bank's conversion stock was accounted for similar to a pooling of interests and, therefore, the financial condition and results of operations of the Bank prior to July 2, 1996 became the financial condition and results of operations of the Company. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Ocean Federal Savings Bank, and its wholly-owned subsidiary, Dome Financial Services, Inc. (inactive). All significant intercompany accounts and transactions have been eliminated in consolidation. Business The Bank provides a range of banking services to customers through a network of branches in Ocean and Middlesex Counties in New Jersey. The Bank is subject to competition from other financial institutions; it is also subject to the regulations of certain regulatory agencies and undergoes periodic examinations by those regulatory authorities. Basis of Financial Statement Presentation The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. 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 consolidated statement of financial condition and revenues and expenses for the period then ended. Actual results could differ significantly from those estimates and assumptions. 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 settlement of loans. In connection with the determination of the allowances for loan losses and Real Estate Owned (REO), management obtains independent appraisals for significant properties. Cash Equivalents Cash equivalents consist of interest-bearing deposits in other financial institutions and loans of Federal funds. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Investment and Mortgage-Backed Securities Investment and mortgage-backed securities identified as held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using a method which approximates a level yield over the estimated average life of the security. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Bank has the ability at the time of purchase to hold securities until maturity, they are classified as held to maturity. Debt securities not intended to be held to maturity are classified as available for sale. Securities available for sale include securities that management intends to use as part of its asset/liability management strategy. Such securities are carried at fair value and unrealized gains and losses, net of related tax effect, are excluded from earnings, but are included as a separate component of stockholders' equity. Gains or losses on the sale of such securities are included in other income using the specific identification method. As permitted by the Financial Accounting Standards Board's, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities," the Company reassessed the classification of its held to maturity portfolios. As a result of such reassessment, the Company transferred, on December 20, 1995, securities with a book value of $382,713,000 and a fair value of $385,361,000, from held to maturity to available for sale. In connection with such transfer, an unrealized gain, net of deferred income taxes, of $1,695,000 was recognized and classified as a separate component of stockholders' equity. Loans Receivable Loans receivable, other than loans held for sale, are stated at unpaid principal balance less unearned discounts, unamortized premiums, net deferred loan origination and commitment fees, and the allowance for loan losses. Discounts and premiums are recognized in income using the level-yield method over the estimated lives of the loans. Loan origination and commitment 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 specifically identified loans, adjusted for actual prepayments. Loans in which interest is more than 90 days past due, including impaired loans and other loans in the process of foreclosure are placed on nonaccrual status. Interest income previously accrued on these loans, but not yet received, is reversed in the current period. Any interest subsequently collected is credited to income in the period of recovery. A loan is returned to accrual status when all amounts due have been received and the remaining principal balance is deemed collectible. A loan is considered impaired when it is deemed probable that the Company will not collect all amounts due according to the contractual terms of the loan agreement. The Company has defined the population of impaired loans to be all non-accrual commercial real estate, multi-family and land 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 installment loans, are specifically excluded from the impaired loan portfolio. OCEAN FINANCIAL CORP. AND SUBSIDIARY 23 Mortgage Loans Held for Sale The Company may periodically sell all or part of its 30-year fixed rate, conforming loan originations while retaining all other types of loan originations for its loan portfolio. Mortgage loans intended for sale are carried at the lower of unpaid principal balance, net, or market value on an aggregate basis. Allowance for Loan Losses The adequacy of the allowance for loan losses is based on management's evaluation of the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and 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. Loans are charged off when management believes such loans are uncollectible. Management believes that the allowance for losses on loans is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions in the Company's market area. In addition, various regulatory agencies, as an integral part of their routine examination process, periodically review the Bank's allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Sale of Loans with Servicing Retained Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" (SFAS No. 122), which requires the recognition as separate assets the rights to service mortgage loans for others that have been acquired through either the purchase or origination of a loan. At the time of sale or securitization of loans with servicing rights retained, the Company allocates the total cost of the mortgage loans to the mortgage servicing rights and the loans based on their relative fair values. The fair value of capitalized originated mortgage servicing rights is determined based on the estimated discounted net cash flows to be received. Originated mortgage servicing rights are amortized in proportion to and over the period of estimated net loan servicing income. These capitalized mortgage servicing rights are periodically reviewed for impairment based on the fair value of those rights. Adoption of SFAS No. 122 did not have a material impact on the Company's financial position or results of operations. Real Estate Owned Real estate owned is carried at fair value, less estimated costs to sell. When a property is acquired, the excess of the loan balance over fair value is charged to the allowance for loan losses. A reserve for real estate owned has been established to provide for subsequent declines in the fair values of properties. Real estate owned is carried net of the related reserve. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned, are recorded as incurred. Premises and Equipment Land is carried at cost and premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or leases. Repair and maintenance items are expensed and improvements are capitalized. Gains and losses on dispositions are reflected in current operations. Income Taxes The Company utilizes the asset and liability method of accounting for income taxes. 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 enacted tax rates expected to apply to taxable income in 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. Pension Plan Pension plan costs based on actuarial computation of current and future benefits for employees are charged to expense. The Company funds the Plan based on the maximum amount that can be deducted for Federal income tax purposes. Contributions Contributions made shall be recognized as expenses in the period made and as decreases of assets or increases of liabilities depending on the form of the benefits given. Contributions made shall be measured at the fair values of the asset given or, if made in the form of a settlement or cancellation of a donee's liabilities, at the fair value of the liabilities canceled. Loss Per Share Loss per share is computed by dividing net loss by the weighted average number of shares of common stock and dilutive common stock equivalents outstanding, adjusted for the unallocated portion of shares held by the Employee Stock Ownership Plan ("ESOP") in accordance with the American Institute of Certified Public Accountants' Statement of Position 93-6. For the period from July 2, 1996, (date of conversion) to December 31, 1996, the weighted average number of shares of common stock and common stock equivalents outstanding (adjusted for unallocated ESOP shares) was 8,429,877. Loss per share for 1996 was computed on net loss for the period from July 2, 1996 (conversion date) through December 31, 1996. Per share amounts are not presented for periods prior to conversion to stock form, as no stock was outstanding. (2) STOCK FORM OF OWNERSHIP On August 17, 1995, the Board of Directors of the Bank adopted a Plan of Conversion to convert from a federally chartered mutual savings bank to a federally chartered stock savings bank with the concurrent formation of a holding company. As part of the conversion, the Company was incorporated under Delaware law on November 21, 1995. The Company completed 24 OCEAN FINANCIAL CORP. AND SUBSIDIARY its initial public offering on July 2, 1996 with the issuance of 8,388,078 shares of common stock to the Bank's eligible depositors and the Bank's Employee Stock Ownership Plan (the "ESOP"), resulting in proceeds of $163.3 million (net of $4.5 million in costs). The Company retained $81.6 million of the net proceeds and used the remaining net proceeds to purchase all of the outstanding stock of the Bank. Concurrent with the close of the conversion, an additional 671,046 shares of common stock (8% of the offering) were issued and donated by the Company to the Ocean Federal Foundation (the "Foundation"), a private foundation dedicated to charitable purposes within Ocean County, New Jersey and its neighboring communities. The fair market value of the contribution of $13.4 million was reflected as a current expense and as an increase to capital stock and paid in capital for the same amount. The Company also recorded a related tax benefit of $3.7 million with a corresponding increase to the Company's deferred tax assets. Although the Company and the Bank have received an opinion of their independent accountants that the Company will be entitled to the deduction for the charitable contribution, there can be no assurances that the IRS will recognize the Foundation as a Section 501(c)(3) exempt organization or that the deduction will be permitted. In such event, the Company's contribution to the Foundation would be fully expensed, resulting in a further reduction in earnings of $3.7 million in the year in which the IRS makes such a determination. At the time of the conversion, the Bank established a liquidation account with a balance equal to its retained earnings at March 31, 1996. The balance in the liquidation account at December 31, 1996 was approximately $48.1 million. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after the conversion. The liquidation account will be reduced annually to the extent that the eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Company may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause stockholders' equity to be reduced below applicable regulatory capital maintenance requirements, the amount required for the liquidation account, or if such declaration and payment would otherwise violate regulatory requirements. (3) REGULATORY MATTERS Office of Thrift Supervision (OTS) regulations require savings institutions to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 1996, the Bank was required to maintain a minimum ratio of tangible capital to total adjusted assets of 1.5%; a minimum ratio of Tier 1 (core) capital to total adjusted assets of 3.0%; and a minimum ratio of total (core and supplementary) capital to risk-weighted assets of 8.0%. Under its prompt corrective action regulations, the OTS is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized institution. Such actions could have a direct material effect on the institution's financial statements. The regulations establish a framework for the classification of savings institutions into five categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Generally, an institution is considered well capitalized if it has a Tier 1 ratio of at least 6.0%; and a total risk-based capital ratio of at least 10.0%. At December 31, 1996 and 1995 the Bank was considered well capitalized. The following is a summary of the Bank's actual capital amounts and ratios as of December 31, 1996 and 1995, compared to the OTS minimum capital adequacy requirements and the OTS requirements for classification as a well capitalized institution (in thousands).
For To be well capital capitalized adequacy under prompt Actual purposes corrective action ------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1996: Tangible capital $165,537 12.7% $19,563 1.5% $ -- --% Core capital 165,537 12.7 39,126 3.0 65,210 5.0 Tier 1 risk-based capital 165,537 31.0 21,386 4.0 32,080 6.0 Risk-based capital 171,199 32.0 42,773 8.0 53,466 10.0 As of December 31, 1995: Tangible capital $ 90,281 8.7% $15,523 1.5% $ -- --% Core capital 90,281 8.7 31,047 3.0 51,744 5.0 Tier 1 risk-based capital 90,281 20.1 17,939 4.0 26,909 6.0 Risk-based capital 95,712 21.3 35,878 8.0 44,848 10.0 ==========================================================================================
OTS regulations impose limitations upon all capital distributions by savings institutions, like the Bank, such as dividends and payments to repurchase or otherwise acquire shares. Based on these limitations, approximately $35,371,000 of the Bank's retained earnings is unavailable for distribution to the Company. (4) INVESTMENT SECURITIES The amortized cost and estimated market value of investment securities at December 31, 1996 and December 31, 1995 are as follows (in thousands):
Gross Gross Estimated Amortized Unrealized Unrealized Market DECEMBER 31, 1996 Cost Gains Losses Value - -------------------------------------------------------------------------------- Investment Securities Available for Sale: United States Government and agency obligations $175,003 $172 $(1,848) $173,327 State and municipal obligations 693 8 -- 701 - -------------------------------------------------------------------------------- $175,696 $180 $(1,848) $174,028 ================================================================================ Gross Gross Estimated Amortized Unrealized Unrealized Market December 31, 1995 Cost Gains Losses Value - -------------------------------------------------------------------------------- Investment Securities Available for Sale: United States Government and agency obligations $112,956 $386 $ (40) $113,302 State and municipal obligations 1,549 30 -- 1,579 - -------------------------------------------------------------------------------- $114,505 $416 $ (40) $114,881 ================================================================================
OCEAN FINANCIAL CORP. AND SUBSIDIARY 25 The amortized cost and estimated market value of investment securities at December 31, 1996 by contractual maturity, are shown below (in thousands). Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Estimated Amortized Market DECEMBER 31, 1996 Cost Value - ---------------------------------------------------------------- Investment Securities Available For Sale: Due in one year or less $ 250 $ 250 Due after one year through five years 110,311 109,448 Due after five years through ten years 65,000 64,195 Due after ten years 135 135 - ---------------------------------------------------------------- $175,696 $174,028 ================================================================
Gross losses on the sale of investment securities available for sale of $587,000 were realized in 1995. There were no sales of investment securities for the years ended December 31, 1996 and 1994. (5) MORTGAGE-BACKED SECURITIES The amortized cost and estimated market value of mortgage-backed securities at December 31, 1996 and December 31, 1995 are as follows (in thousands):
Gross Gross Estimated Amortized Unrealized Unrealized Market DECEMBER 31, 1996 Cost Gains Losses Value - --------------------------------------------------------------------------- Mortgage-Backed Securities Available for Sale: FHLMC $316,773 $2,084 $(1,122) $317,735 FNMA 69,190 480 (562) 69,108 GNMA 2,800 131 -- 2,931 Collaterized mortgage obligations 5,643 126 (1) 5,768 - --------------------------------------------------------------------------- $394,406 $2,821 $(1,685) $395,542 =========================================================================== Gross Gross Estimated Amortized Unrealized Unrealized Market December 31, 1995 Cost Gains Losses Value - --------------------------------------------------------------------------- Mortgage-Backed Securities Available For Sale: FHLMC $221,822 $2,340 $ (278) $223,884 FNMA 27,307 317 -- 27,624 GNMA 3,561 202 -- 3,763 Collaterized mortgage obligations 9,564 278 -- 9,842 - --------------------------------------------------------------------------- $262,254 $3,137 $ (278) $265,113 ===========================================================================
Collateralized mortgage obligations issued by FHLMC, FNMA and private interests amounted to $4,143,000, $697,000 and $928,000, respectively, at December 31, 1996 and $7,377,000, $850,000 and $1,337,000, respectively, at December 31, 1995. The contractual maturities of mortgage-backed securities generally exceed 20 years; however, the effective lives are expected to be shorter due to anticipated prepayments. (6) Loans Receivable, Net A summary of loans receivable at December 31, 1996 and 1995 follows (in thousands):
December 31, 1996 1995 - --------------------------------------------------- Real estate mortgage: One to four-family $626,857 $572,632 Commercial real estate, multi-family and land 15,613 14,939 FHA insured & VA guaranteed 941 484 - --------------------------------------------------- 643,411 588,055 Real estate construction 9,287 8,153 Consumer 36,860 26,867 Commercial 21 -- - --------------------------------------------------- Total loans 689,579 623,075 - --------------------------------------------------- Loans in process (3,517) (2,687) Deferred fees (1,302) (1,679) Unearned discount (11) (12) Allowance for loan losses (6,021) (6,001) - --------------------------------------------------- (10,851) (10,379) - --------------------------------------------------- $678,728 $612,696 ===================================================
At December 31, 1996, 1995 and 1994, loans in the amount of $7,697,000, $8,671,000 and $10,939,000, respectively, were three or more months delinquent or in the process of foreclosure and the Company was not accruing interest income. If these loans had continued to realize interest in accordance with their contractual terms, approximately $345,000, $428,000 and $607,000 of additional interest income would have been recognized for the years ended December 31, 1996, 1995 and 1994, respectively. The Company was not committed to lend additional funds on any nonaccrual loans at December 31, 1996. An analysis of the allowance for loan losses for the years ended December 31, 1996, 1995 and 1994 is as follows (in thousands):
Year Ended December 31, 1996 1995 1994 - ------------------------------------------------------------ Balance at beginning of year $6,001 $5,608 $ 5,504 Provision charged to operations 700 950 1,129 Charge-offs (692) (568) (1,053) Recoveries 12 11 28 - ------------------------------------------------------------ Balance at end of year $6,021 $6,001 $ 5,608 ============================================================
At December 31, 1996, 1995 and 1994, the Company serviced loans for others in the amount of $152,717,000, $143,115,000 and $133,652,000, respectively. An analysis of the servicing asset for the years ended December 31, 1996, 1995 and 1994 is as follows (in thousands):
Year Ended December 31, 1996 1995 1994 - ------------------------------------------------------- Balance at beginning of year $1,222 $ 819 $ 642 Additions 725 509 318 Amortization (204) (106) (141) - ------------------------------------------------------- Balance at end of year $1,743 $1,222 $ 819 =======================================================
26 OCEAN FINANCIAL CORP. AND SUBSIDIARY (7) INTEREST AND DIVIDENDS RECEIVABLE A summary of interest and dividends receivable at December 31, 1996 and 1995 follows (in thousands):
December 31, 1996 1995 - ------------------------------------------------------------------------------ Loans $ 3,567 $ 3,554 Investment securities 2,811 1,527 Mortgage-backed securities 3,379 2,399 - ------------------------------------------------------------------------------ $ 9,757 $ 7,480 ==============================================================================
(8) PREMISES AND EQUIPMENT, NET Premises and equipment at December 31, 1996 and 1995 are summarized as follows (in thousands):
December 31, 1996 1995 - ------------------------------------------------------------------------------ Land $ 3,195 $ 2,971 Buildings and improvements 10,260 4,107 Leasehold improvements 1,101 1,097 Furniture and equipment 4,448 3,666 Automobiles 130 88 Construction in progress 735 1,452 - ------------------------------------------------------------------------------ Total 19,869 13,381 Accumulated depreciation and amortization (5,769) (5,740) - ------------------------------------------------------------------------------ $14,100 $ 7,641 ==============================================================================
(9) REAL ESTATE OWNED, NET An analysis of the allowance for losses on real estate owned for the years ended December 31, 1996, 1995 and 1994 is as follows (in thousands):
Year Ended December 31, 1996 1995 1994 - ----------------------------------------------------- Balance at beginning of year $ 411 $ 476 $ 506 Losses charged off (9) (65) (30) - ----------------------------------------------------- Balance at end of year $ 402 $ 411 $ 476 =====================================================
(10) DEPOSITS Deposits, including accrued interest payable of $105,000 and $93,000 at December 31, 1996 and 1995, respectively, are summarized as follows (in thousands):
December 31, 1996 1995 - ------------------------------------------------------------ WEIGHTED Weighted AVERAGE Average AMOUNT COST Amount Cost - ------------------------------------------------------------ NOW accounts $ 77,522 1.69% $ 75,010 2.00% Money Market deposit accounts 70,021 2.90% 70,556 2.93% Savings accounts 169,527 2.28% 175,777 2.53% Time deposits 617,660 5.55% 605,215 5.70% - ------------------------------------------------------------ $934,730 4.44% $926,558 4.59% ============================================================
Included in time deposits at December 31, 1996 and 1995, respectively, is $43,841,000 and $41,236,000 in deposits of $100,000 and over. The deposits of the Bank are insured up to $100,000 by the Savings Association Insurance Fund, which is administered by the FDIC and is backed by the full faith and credit of the U.S. Government. Time deposits at December 31, 1996 mature as follows (in thousands):
December 31, 1996 - -------------------------------------------------------------------------------- 1997 $412,525 1998 111,467 1999 33,935 2000 17,637 2001 24,802 Thereafter 17,294 - -------------------------------------------------------------------------------- $617,660 ================================================================================
Interest expense on deposits for the years ended December 31, 1996, 1995 and 1994 was as follows (in thousands):
Year Ended December 31, 1996 1995 1994 - -------------------------------------------------------------------------------- NOW accounts $ 1,371 $ 1,483 $ 1,440 Money Market deposit accounts 1,994 2,083 1,899 Savings accounts 4,069 4,537 5,246 Time deposits 33,555 31,723 23,545 - -------------------------------------------------------------------------------- $40,989 $39,826 $ 32,130 ================================================================================
(11) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Securities sold under agreements to repurchase are as follows (in thousands):
1996 - ------------------------------------------------------------ Balance at December 31, $99,322 Average Balance 9,803 Maximum amount outstanding at any month end 99,322 Average interest rate: During the year 5.81% At December 31, 5.69%
Securities sold under agreements to repurchase of $74,822,000 and $24,500,000 mature in January 1997 and October 1999, respectively. Securities sold under agreements to repurchase are collateralized by U.S. Government agency and mortgage-backed securities with an amortized cost and a market value of $102,943,000 and $102,974,000, respectively, at December 31, 1996. The securities underlying the agreements are not under the Company's control. During the year ended December 31, 1995, there were no securities sold under agreements to repurchase. (12) INCOME TAXES Under tax law that existed prior to 1996, the Company was generally allowed a special bad debt deduction in determining income for Federal income tax purposes. The deduction was based on either specified experience formulas or a percentage of taxable income before such deduction (previously 8%). For the years ended December 31, 1995 and 1994, the Company used the percentage of taxable income method. Legislation was enacted in August 1996 which repealed for tax purposes the percentage of taxable income bad debt reserve method. As a result, the Company must instead use the direct charge-off method to compute its bad debt deduction. The legislation also requires the Company to recapture its post-1987 additions to the tax bad debt reserve of $2,333,000. The Company has accrued for this liability in the consolidated financial statements. OCEAN FINANCIAL CORP. AND SUBSIDIARY 27 Retained earnings at December 31, 1996 include approximately $10,750,000 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 and excess distributions to shareholders. At December 31, 1996 the Company had an unrecognized deferred tax liability of $3,870,000 with respect to this reserve. The provision for income taxes for the years ended December 31, 1996, 1995 and 1994 consists of the following (in thousands):
Year Ended December 31, 1996 1995 1994 - --------------------------------------------------- Current: Federal $ 4,001 $3,936 $4,148 State 345 338 374 - --------------------------------------------------- Total Current 4,346 4,274 4,522 - --------------------------------------------------- Deferred: Federal (2,992) 353 811 State (271) 32 72 - --------------------------------------------------- Total Deferred (3,263) 385 883 =================================================== $ 1,083 $4,659 $5,405 ===================================================
A reconciliation between the provision for income taxes and the expected amount computed by multiplying income before provision for income taxes times the applicable statutory Federal income tax rate for the years ended December 31, 1996, 1995 and 1994 is as follows (in thousands):
Year Ended December 31, 1996 1995 1994 - ------------------------------------------------------------ Income (loss) before provision for income taxes $ (646) $12,606 $15,134 Applicable statutory Federal income tax rate 34.1% 34.1% 34.2% Computed "expected" Federal income tax (benefit) expense $ (220) $ 4,299 $ 5,176 Increase(decrease) in Federal income tax expense resulting from: Valuation allowance 1,166 -- -- State income taxes net of Federal benefit 49 253 318 Other items, net 88 107 (89) - ------------------------------------------------------------ $1,083 $ 4,659 $ 5,405 ============================================================ Effective tax rate N/A 37.0% 35.7% ============================================================
Included in other assets at December 31, 1996 and 1995 is a net deferred tax asset of $5,550,000 and $930,000, respectively. In addition, included in other liabilities at December 31, 1996 and 1995 is a current tax payable of $409,000 and $236,000, respectively. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below (in thousands).
December 31, 1996 1995 - --------------------------------------------------------------------- DEFERRED TAX ASSETS: Allowance for loan and real estate owned losses per books $ 2,319 $ 2,314 Reserve for uncollected interest 188 217 Deferred loan and commitment fees -- 132 Deferred compensation 247 132 Accrued pension expense 191 154 Premises and equipment, differences in depreciation 202 199 Other reserves 199 175 Charitable donation 4,321 -- Unrealized loss on securities available for sale 192 -- - ---------------------------------------------------------------------- Total gross deferred tax assets 7,859 3,323 Less valuation allowance (1,166) -- - ---------------------------------------------------------------------- Deferred tax assets, net 6,693 3,323 - ---------------------------------------------------------------------- DEFERRED TAX LIABILITIES: Allowance for loan and real estate owned losses for tax purposes (842) (831) Unrealized gain on securities available for sale -- (1,165) Excess servicing on sale of mortgage loans (95) (11) Prepaid FDIC insurance premium -- (373) Investments, discount accretion (24) (9) Deferred loan and commitment fees (182) -- Fair market value adjustment on loans available for sale -- (4) - ---------------------------------------------------------------------- Total deferred tax liabilities (1,143) (2,393) - ---------------------------------------------------------------------- Net deferred tax assets $ 5,550 $ 930 ======================================================================
As disclosed in footnote 2, the Company, as part of the conversion, recorded a charitable donation expense of $13,419,000. Under the Internal Revenue Code, charitable donations are tax deductible subject to a limitation based on 10% of the Company's annual taxable income. The Company, however, is able to carry forward any unused portion of the deduction for five years following the year in which the contribution is made. Based on the Company's estimate of taxable income for 1996 and the succeeding five years, $3,419,000 of the charitable donation expense was considered non-tax deductible as it was unlikely that the Company would realize sufficient earnings over the six-year period to take the full deduction. As a result, the Company has established a deferred tax valuation allowance of $1,166,000 relating to the nondeductible expense. The Company has determined that it is not required to establish a valuation reserve for the remaining deferred tax asset account since it is "more likely than not" that the remaining deferred tax assets will be realized through future reversals of existing taxable temporary differences, future taxable income and tax planning strategies. The conclusion that it is "more likely than not" that the remaining deferred tax assets will be realized is based on the history of earnings and the prospects for continued growth. Management will continue to review the tax criteria related to the recognition of deferred tax assets. 28 OCEAN FINANCIAL CORP. AND SUBSIDIARY (13) EMPLOYEE BENEFIT PLANS Employee Stock Ownership Plan As part of the conversion, the Bank established an ESOP to provide retirement benefits for eligible employees. All full-time employees are eligible to participate in the ESOP after they attain age 21 and complete one year of service during which they work at least 1,000 hours. The Bank's contribution is allocated among participants on the basis of compensation. Each participant's account will be credited with cash or shares of the Company's common stock based upon compensation earned during the year with respect to which the contribution is made. Employees are fully vested in their ESOP account after the completion of five years of credited service or completely if service was terminated due to death, retirement, disability, or change in control of the Company. ESOP participants are entitled to receive distributions from the ESOP account only upon termination of service, which includes retirement and death. The ESOP borrowed $13,421,000 from the Company to purchase 671,046 shares of common stock issued in the conversion. This loan is to be repaid from discretionary contributions by the Bank to the ESOP trust. The Bank intends to make contributions to the ESOP in amounts at least equal to the principal and interest requirement of the debt, assuming a twelve-year term and at the prime rate (8.25% for 1996). As of December 31, 1996, contributions to the ESOP, which were used to fund principal and interest payments on the ESOP debt, totaled $1,666,000. At December 31, 1996, the loan had an outstanding balance of $12,302,000 and the ESOP had unallocated shares of 615,314. Based upon a $25.50 closing price per share of common stock on December 31, 1996, the unallocated shares had a fair value of $15,691,000. The unamortized balance of the ESOP is shown as unallocated common stock held by the ESOP and is reflected as a reduction of stockholders' equity. For the year ended December 31, 1996, the Bank recorded compensation expense related to the ESOP of $1,272,000 including a $182,000 adjustment to reflect the increase in the average fair value of allocated shares for the period from time of purchase to December 31, 1996. For the year ended December 31, 1996, there were 55,732 shares committed to be released to participants of the plan. Pension Plan The Bank has a qualified noncontributory defined benefit pension plan (the Plan) covering all eligible employees. Retirement benefits are based upon a formula utilizing years of service and average monthly compensation. It is the Company's practice to fund the Plan for the maximum amount that can be deducted for Federal income tax purposes subject to the minimum funding requirements of ERISA. Effective June 7, 1996, the Company froze benefit accruals under the Plan. The Company further expects to terminate the Plan upon receipt of approval by the Internal Revenue Service. As a result of this action, the Company recognized a curtailment gain in 1996 of $24,000. The following table sets forth the Plan's latest available funded status and amounts recognized at December 31, 1996 and 1995 in the Company's consolidated statements of financial condition (in thousands):
1996 1995 - ----------------------------------------------------------------------- Actuarial present value of benefit obligations -- accumulated benefit obligation: Vested $(1,657) $(1,009) Non-vested (114) (97) - ----------------------------------------------------------------------- Projected benefit obligation for service rendered to date (1,771) (1,911) Plan assets at fair value, primarily a group annuity contract 1,476 1,636 - ----------------------------------------------------------------------- Plan assets less than projected benefit obligation (295) (275) Unrecognized net loss 165 233 Unrecognized net transition asset (343) (352) - ----------------------------------------------------------------------- Accrued pension cost (included in other liabilities) $ (473) $ (394) =======================================================================
The components of net pension expense for the years ended December 31, 1996, 1995 and 1994 are as follows (in thousands):
1996 1995 1994 - ----------------------------------------------------------------------- Service cost -- benefits earned during the year $ 98 $ 209 $ 200 Interest cost on projected benefit obligation 136 137 108 Actual return on plan assets (89) (79) (83) Net amortization and deferral (42) (40) (26) - ----------------------------------------------------------------------- Net pension expense $ 103 $ 227 $ 199 ======================================================================= Assumptions used to develop the net periodic pension cost are: Discount rate 6.51% 8.00% 8.00% Expected long-term rate of return on assets 6.75 6.75 6.75 Rate of increase in compensation level 5.00 5.00 5.00 =======================================================================
The Bank also maintains an incentive savings plan for eligible employees. An employee may make contributions to the plan of 1% to 15% of his or her compensation. Subsequent to July 1, 1996, the Bank contributed 50% of the first 6% of the employees contribution to the employee's account. Prior to July 1, 1996, the Bank contributed 75% of the first 6% of the employee's contribution to the employee's account. The Bank's contributions under this plan were $161,000, $242,000 and $241,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Executive Officer Employment Agreements The Company and Bank entered into employment agreements with its President and Chief Executive Officer and Executive Vice President and Chief Financial Officer. The employment agreements generally provide for the continued payment (either lump-sum or periodic) of specified compensation and benefits for three years and provide payments for the remaining term of the agreement after the officers are terminated, unless the termination is for "cause" as defined in the employment agreements. The agreements also provide for payments to the officer upon voluntary or involuntary termination of the officer following a OCEAN FINANCIAL CORP. AND SUBSIDIARY 29 change in control, as defined in the agreements. In addition, the Company and the Bank entered into change in control agreements with three other executives, which provide that in the event of voluntary or involuntary termination following a change in control of the Bank or the Company, the executive would be entitled to receive a severance payment equal to two times the executive's average annual compensation for the five years preceding termination. Employee Severance Compensation Plan The Company established an Employee Severance Compensation Plan. The Plan will provide eligible employees with severance pay benefits in the event of a change in control of the Bank or Company. Generally, employees are eligible to participate in the Plan unless eligible to receive benefits under the executive officer employment agreements. The Plan would provide for the payment, under certain circumstances, of lump-sum amounts up to 100% of annual compensation upon termination following change of control, as defined in the Plan. (14) COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK The Company, in the normal course of business, is party to financial instruments and commitments which involve, to varying degrees, elements of risk in excess of the amounts recognized in the consolidated financial statements. These financial instruments and commitments include unused consumer lines of credit and commitments to extend credit. At December 31, 1996, the following commitments and contingent liabilities existed which are not reflected in the accompanying consolidated financial statements (in thousands):
December 31, 1996 - ----------------------------------------------------------- Unused consumer and construction loan lines of credit (primarily floating-rate) $21,856 Other commitments to extend credit: Fixed Rate 12,679 Adjustable Rate 17,771 Floating Rate 960 ===========================================================
The Company's fixed-rate loan commitments expire within 90 days of issuance and carried interest rates ranging from 6.875% to 8.25% at December 31, 1996. The Company's maximum exposure to credit losses in the event of nonperformance by the other party to these financial instruments and commitments is represented by the contractual amounts. The Company uses the same credit policies in granting commitments and conditional obligations as it does for financial instruments recorded in the consolidated statements of financial condition. These commitments and obligations do not necessarily represent future cash flow requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's assessment of risk. The unused consumer and construction loan lines of credit are collateralized by mortgages on real estate. The Bank has an available overnight line of credit with the Federal Home Loan Bank of New York for $50,000,000 which expires November 25, 1997. When utilized, the line bears a floating interest rate of 1/8% over the current Federal funds rate and is secured by the Bank's mortgage loans, mortgage-backed securities and U.S. Government agency obligations. At December 31, 1996, the Company is obligated under noncancellable operating leases for premises and equipment. Rental expense under these leases aggregated approximately $822,000, $791,000 and $701,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The projected minimum rental commitments as of December 31, 1996 are as follows (in thousands):
December 31, 1996 - --------------------------------------------------------------------- 1997 $ 466 1998 389 1999 401 2000 254 2001 177 Thereafter 3,367 - --------------------------------------------------------------------- $5,054 =====================================================================
The Company grants one to four-family first mortgage real estate loans and multifamily first mortgage real estate loans to borrowers primarily located in Ocean, Middlesex and Monmouth Counties, 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 all loans. Contingencies The Company is a defendant in certain claims and legal actions arising in the ordinary course of business. Management and its legal counsel are of the opinion that the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial condition, results of operations or liquidity. (15) FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" (SFAS 107), requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments. Cash and due from banks For cash and due from banks, the carrying amount approximates fair value. 30 OCEAN FINANCIAL CORP. AND SUBSIDIARY Investments and Mortgage-backed securities The fair value of investment and mortgage-backed securities is estimated based on bid quotations received from securities dealers, if available. If a quoted market price was not available, fair value was estimated using quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Federal Home Loan Bank of New York stock The fair value for Federal Home Loan Bank of New York stock is its carrying value since this is the amount for which it could be redeemed. There is no active market for this stock and the Company is required to maintain a minimum balance based upon the unpaid principal of home mortgage loans. Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as residential mortgage, construction, land and consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. Fair value of performing loans was estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics, if applicable. Fair value for significant nonperforming loans is based on recent external appraisals of collateral securing such loans, adjusted for the timing of anticipated cash flows. Deposits The fair value of deposits with no stated maturity, such as non-interest- bearing demand deposits, savings, and NOW and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. Federal Home Loan Bank borrowings Federal Home Loan Bank borrowings are short-term in nature and the carrying amount approximates fair value. Securities sold under agreements to repurchase Fair value estimates are based on discounting contractual cash flows using rates which approximate the rates offered for borrowings of similar remaining maturities. Commitments to extend credit, and to purchase or sell securities The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The estimated fair values of the Bank's financial instruments as of December 31, 1996 and 1995 are presented in the following tables (in thousands). Since the fair value of off-balance sheet commitments approximate book value, these disclosures are not included.
Book Fair DECEMBER 31, 1996 Value Value - -------------------------------------------------------------------- FINANCIAL ASSETS: Cash and due from banks $ 5,372 $ 5,372 Investment securities available for sale 174,028 174,028 Mortgage-backed securities available for sale 395,542 395,542 Federal Home Loan Bank of New York stock 8,457 8,457 Loans receivable and mortgage loans held for sale 679,455 688,015 FINANCIAL LIABILITIES: Deposits 934,730 936,541 Federal Home Loan Bank borrowings 8,800 8,800 Securities sold under agreements to repurchase $ 99,322 $ 99,628 ==================================================================== Book Fair December 31, 1995 Value Value - -------------------------------------------------------------------- FINANCIAL ASSETS: Cash and due from banks $ 8,022 $ 8,022 Investment securities available for sale 114,881 114,881 Mortgage-backed securities available for sale 265,113 265,113 Federal Home Loan Bank of New York stock 7,723 7,723 Loans receivable and mortgage loans held for sale 614,590 632,606 Financial Liabilities: Deposits 926,558 932,606 Federal Home Loan Bank borrowings $ 10,400 $ 10,400 ====================================================================
Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include the mortgage banking operation, deferred tax assets, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. (16) PARENT-ONLY FINANCIAL INFORMATION The following condensed statement of financial condition at December 31, 1996 and condensed statements of operations and cash flows for the period from July 2, 1996 (date of conversion) to December 31, 1996 for Ocean Financial Corp. OCEAN FINANCIAL CORP. AND SUBSIDIARY 31 (parent company only) reflects the Company's investment in its wholly-owned subsidiary, the Bank, using the equity method of accounting. The Company had no results of operations prior to July 2, 1996. CONDENSED STATEMENT OF FINANCIAL CONDITION
December 31, 1996 - ------------------------------------------------------------------------- (in thousands) ASSETS Cash and due from banks $ 7 Advances to subsidiary Bank 71,553 ESOP loan receivable 12,302 Investment in subsidiary Bank 166,147 Deferred taxes 3,470 - ------------------------------------------------------------------------- Total Assets $253,479 ========================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Taxes payable $ 690 Stockholders' Equity 252,789 - ------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $253,479 ========================================================================= CONDENSED STATEMENT OF OPERATIONS For the period from July 2, 1996 to December 31, 1996 (in thousands) - ------------------------------------------------------------------------- Interest Income -- Advances to subsidiary Bank $ 1,840 Interest Income -- ESOP loan receivable 547 - ------------------------------------------------------------------------- Total Interest Income 2,387 Charitable donation 13,419 Other operating expenses 152 - ------------------------------------------------------------------------- Loss before income taxes and equity in undistributed earnings of subsidiary Bank (11,184) Income tax benefit (2,755) - ------------------------------------------------------------------------- Loss before equity in undistributed earnings of subsidiary Bank (8,429) Equity in undistributed earnings of subsidiary Bank 1,817 - ------------------------------------------------------------------------- Net loss $ (6,612) ========================================================================= CONDENSED STATEMENT OF CASH FLOWS For the period from July 2, 1996 to December 31, 1996 (in thousands) - ------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (6,612) Donation of 671,046 shares of common stock to the Ocean Federal Foundation 13,419 Increase in advances to subsidiary Bank (71,553) Equity in undistributed earnings of subsidiary Bank (1,817) Provision for deferred taxes (3,470) Increase in taxes payable 690 - ------------------------------------------------------------------------- Net cash used in operating activities (69,343) - ------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Funding of ESOP loan receivable, net of repayments (12,302) Payments for investments in subsidiary Bank (81,650) - ------------------------------------------------------------------------- Net cash used in investing activities (93,952) ========================================================================= CASH FLOWS PROVIDED BY FINANCING ACTIVITIES: Net proceeds of common stock issuance 163,302 - ------------------------------------------------------------------------- Net increase in cash and due from banks 7 Cash and due from banks at beginning of period 0 - ------------------------------------------------------------------------- Cash and due from banks at the end of period $ 7 =========================================================================
(17) RECAPITALIZATION OF SAVINGS ASSOCIATION INSURANCE FUND (SAIF) On September 30, 1996, legislation was enacted which, among other things, imposed a special one-time assessment on Savings Association Insurance Fund (SAIF) member institutions, including the Bank, to recapitalize the SAIF and spread the obligations for payment of Financing Corporation (FICO) bonds across all SAIF and Bank Insurance Fund (BIF) members. The Federal Deposit Insurance Corporation (FDIC) special assessment amounted to 65.7 basis points on SAIF assessable deposits held as of March 31, 1995. The Company incurred a charge of $5,720,000 before taxes as a result of the FDIC special assessment. This legislation will eliminate the substantial disparity between the amount that BIF and SAIF member institutions had been paying for deposit insurance premiums. Beginning on January 1, 1997, BIF members will pay a portion of the FICO payment equal to 1.3 basis points on BIF-insured deposits compared to 6.4 basis points on SAIF-insured deposits, and will pay a pro rata share of the FICO payment on the earlier of January 1, 2000, or the date upon which the last savings association ceases to exist. The legislation also requires BIF and SAIF to be merged by January 1, 1999, provided that subsequent legislation is adopted to eliminate the savings association charter and no savings associations remain as of that time. Beginning January 1, 1997 SAIF assessment rates will range from 0 to 27 basis points based upon an institutions risk classification and capital group. Based upon its current classification the rate applicable to the Bank is 0. (18) SUBSEQUENT EVENT (UNAUDITED) On February 4, 1997, a special meeting of the Company's shareholders ratified the Ocean Financial Corp. 1997 Incentive Plan (the "Incentive Plan"). The purpose of the Incentive Plan is to attract and retain qualified personnel in key positions, provide officers, employees and non-employee directors ("Outside Directors") with a proprietary interest in the Company as an incentive to contribute to the success of the Company, promote the attention of management to other stockholder's concerns and reward employees for outstanding performance. All officers, other employees and Outside Directors of the Company and its affiliates are eligible to receive awards under the Incentive Plan. The Incentive Plan will be administered by a committee (the "Committee"). Authorized but unissued shares or shares previously issued and reacquired by the Company may be used to satisfy awards under the Incentive Plan. The Incentive Plan authorizes the granting of options to purchase Common Stock, option-related awards and awards of Common Stock (collectively, "Awards"). Subject to certain adjustments to prevent dilution of Awards to participants, the maximum number of shares reserved for Awards under the Incentive Plan is 1,174,330 shares, representing 13% of the outstanding shares of Common Stock as of the effective date of the Incentive Plan. The maximum number of shares reserved for purchase pursuant to the exercise of options and option-related Awards which may be granted under the Incentive Plan is 838,807 shares. Subsequent to stockholder ratification, 793,095 option shares, subject to vesting over a five-year period, have been awarded at an exercise price of $28.82 per share, the average of the high and low share prices on February 4, 1997. The option exercise price may not be less than the fair market value of the common stock on the date of grant and all options expire in ten years. 32 OCEAN FINANCIAL CORP. AND SUBSIDIARY The maximum number of shares reserved for the award of shares of Common Stock ("Stock Awards") is 335,883 shares. Subsequent to shareholder ratification 314,883 shares have been awarded. Under the Incentive Plan, the vesting of Stock Awards may also be made contingent upon attainment of certain performance goals by the Company, Bank or grantee, which performance goals would be established by the Committee. The Committee intends to provide that the first and second annual installments will vest on the first and second anniversary dates, respectively, of the date of grant. Vesting of 25% of the third annual installment, and 50% of each of the fourth and fifth annual installments, will be subject to the attainment of performance goals established by the Committee. The performance goals may be set by the Committee on an individual basis, for all Stock Awards made during a given period of time, or for all Stock Awards for indefinite periods. No Stock Award that is subject to a performance goal is to be distributed to an employee until the Committee confirms that the underlying performance goal has been achieved. No Stock Award that is subject to a performance goal is to be distributed to an Outside Director until an independent third party confirms that the underlying performance goal has been achieved. OCEAN FINANCIAL CORP. SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (Unaudited) (dollars in thousands, except per share data)
Quarter ended Dec. 31, Sept. 30, June 30, March 31, - -------------------------------------------------------------------------------- 1996 Interest income $21,136 $ 20,342 $19,770 $18,988 Interest expense 10,898 10,178 11,573 11,208 - -------------------------------------------------------------------------------- Net interest income 10,238 10,164 8,197 7,780 Provision for loan losses 225 225 125 125 - -------------------------------------------------------------------------------- Net interest income after provision for loan losses 10,013 9,939 8,072 7,655 Other income 887 552 746 696 Operating expenses 5,715 23,999 5,032 4,460 - -------------------------------------------------------------------------------- Income (loss) before provision (benefit) for income taxes 5,185 (13,508) 3,786 3,891 Provision (benefit) for income taxes 1,980 (3,690) 1,313 1,480 - -------------------------------------------------------------------------------- Net income (loss) $ 3,205 $ (9,818) $ 2,473 $ 2,411 ================================================================================ Earnings (loss) per share $0.38 $(1.16) N/A N/A Quarter ended Dec. 31, Sept. 30, June 30, March 31, - -------------------------------------------------------------------------------- 1995 Interest income $18,077 $ 17,765 $17,530 $16,838 Interest expense 10,587 10,368 9,932 9,117 - -------------------------------------------------------------------------------- Net interest income 7,490 7,397 7,598 7,721 Provision for loan losses 238 238 237 237 - -------------------------------------------------------------------------------- Net interest income after provision for loan losses 7,252 7,159 7,361 7,484 Other income (loss) (16) 499 392 481 Operating expenses 4,620 4,817 4,331 4,238 - -------------------------------------------------------------------------------- Income before provision for income taxes 2,616 2,841 3,422 3,727 Provision for income taxes 906 1,061 1,286 1,406 - -------------------------------------------------------------------------------- Net income $ 1,710 $ 1,780 $ 2,136 $ 2,321 ================================================================================
INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Ocean Financial Corp: We have audited the consolidated statements of financial condition of Ocean Financial Corp. and subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ocean Financial Corp. and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Short Hills, New Jersey January 21, 1997 OCEAN FINANCIAL CORP. AND SUBSIDIARY 33 OCEAN FEDERAL SAVINGS BANK BANKING OFFICES MAIN OFFICE BRICK 321 Chambers Bridge Road (908) 477-5151 Doreen L. Rowe Manager BERKELEY Holiday City Plaza (908) 341-4100 Beverly A. Miriana Manager Holiday City Plaza III (908) 914-0137 Lorraine P. Smith Manager BRICK 70 Brick Boulevard (908) 477-3800 Tracy L. Schille Manager CONCORDIA Concordia Shopping Mall Monroe Township (609) 395-7080 Jessica Lewis Manager LACEY 900 Lacey Road Forked River (609) 242-1800 Jeanette Loftus Manager POINT PLEASANT BEACH 701 Arnold Avenue (908) 892-8500 Judith A. DiLauro Manager POINT PLEASANT BORO 2400 Bridge Avenue (908) 899-2800 Maureen P. Ambrose Manager TOMS RIVER 975 Hooper Avenue (908) 244-8989 Frank A. Scarpone Manager WHITING Whiting Shopping Center (908) 849-0500 Lois A. Velardo Manager OCEAN FINANCIAL CORP. SHAREHOLDER INFORMATION ADMINISTRATIVE OFFICES 975 Hooper Avenue Toms River, New Jersey 08754-2009 ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders will be held on April 24, 1997 at 10 a.m. at the Crystal Point Yacht Club at 3900 River Road at the intersection of State Highway 70, Point Pleasant, New Jersey. INVESTOR RELATIONS Copies of the Company's earnings releases and financial publications, including the annual report on Form 10-K (without exhibits) filed with the Securities and Exchange Commission are available without charge by contacting: Lynn Rhoads Ocean Financial Corp. 975 Hooper Avenue Toms River, New Jersey 08754-2009 (908) 240-4500, ext. 7516 STOCK TRANSFER AGENT AND REGISTRAR Shareholders wishing to change the name, address or ownership of stock, to report lost certificates or to consolidate accounts are asked to contact the Company's stock registrar and transfer agent directly: American Stock Transfer Shareholder Relations Department 40 Wall Street, 46th Floor New York, New York 10005 (800) 937-5449 INDEPENDENT AUDITORS KPMG Peat Marwick LLP 150 John F. Kennedy Parkway Short Hills, New Jersey 07078 SECURITIES COUNSEL Muldoon, Murphy & Faucette 5101 Wisconsin Avenue, NW Washington, DC 20016 MARKET INFORMATION FOR COMMON STOCK Ocean Financial Corp.'s common stock is traded on the NASDAQ National Market under the symbol OCFC. The stock is customarily listed as OCEAN FIN in the Asbury Park Press and the Ocean County Observer. Shares of the common stock were made available to qualified subscribers at $20.00 per share during the initial offering. The table below shows the reported high and low sales prices of the common stock during the period indicated in 1996. The common stock began trading on July 3, 1996. Therefore, prices for the first and second quarter of 1996 are not applicable.
First Second Third Fourth 1996 Quarter Quarter Quarter Quarter - ------------------------------------------------------------ High N/A N/A $23 7/8 $26 1/2 Low N/A N/A $19 3/8 $23 1/2
As of December 31, 1996, the Company had approximately 6,400 shareholders of record, including the number of persons or entities holding stock in nominee or street name through various brokers and banks. EX-27.0 5 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1996 DEC-31-1996 5,372 0 0 0 569,570 0 0 678,728 6,021 1,303,865 934,730 108,122 8,224 0 0 0 91 252,698 1,303,865 50,324 29,912 0 80,236 40,989 43,857 36,379 700 0 39,206 (646) (646) 0 0 (1,729) (0.78) (0.78) 7.10 7,697 0 0 3,800 6,001 692 12 6,021 3,388 0 2,633 BASED ON NET LOSS FROM JULY 2, 1996 TO DECEMBER 31, 1996.
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