<PAGE>
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, 1997
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: (732) 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 $261,336,000, based upon the last sales price as quoted on The
Nasdaq Stock Market for March 18, 1998.
The number of shares of Common Stock outstanding as of March 18, 1998 is
7,767,067.
DOCUMENTS INCORPORATED BY REFERENCE
THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1997, IS
INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K.
THE PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF SHAREHOLDERS IS
INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K.
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<TABLE>
<CAPTION>
INDEX
PAGE
PART I
<S> <C> <C>
Item 1. Business.................................................. 1
Item 2. Properties................................................ 28
Item 3. Legal Proceedings......................................... 28
Item 4. Submission of Matters to a Vote of Security Holders....... 28
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 28
Item 6. Selected Financial Data................................... 28
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 28
Item 8. Financial Statements and Supplementary Data............... 28
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant........ 29
Item 11. Executive Compensation.................................... 29
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................ 29
Item 13. Certain Relationships and Related Transactions............ 29
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 29
</TABLE>
SIGNATURES
<PAGE>
PART I
ITEM 1. BUSINESS
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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, 1997,
the Company had consolidated total assets of $1,510.9 million and total equity
of $215.5 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,
consumer and commercial 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.
In addition to historical information, this Form 10-K may include certain
forward looking statements based on current management expectations. The
Company's actual results could differ materially from those management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of
federal and state tax authorities, changes in interest rates, deposit flows, the
cost of funds, demand for loan products, demand for financial services,
competition, changes in the quality or composition of the Bank's loan and
investment portfolios, changes in accounting principles, policies or guidelines,
and other economic, competitive, governmental and technological factors
affecting the Company's operations, markets, products, services and prices.
Further description of the risks and uncertainties to the business are included
in detail herein and in the Company's Annual Report to Stockholders.
MARKET AREA AND COMPETITION
The Bank is 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 oldest and largest 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
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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
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conventional first mortgage loans secured by one- to four-family residences. At
December 31, 1997, the Bank had total loans outstanding of $794.3 million, of
which $711.6 million or 89.57 % of total loans, were one- to four-family,
residential mortgage loans. The remainder of the portfolio consisted of $45.4
million of consumer loans, primarily home equity loans and lines of credit,
equaling 5.72% of total loans; $25.7 million of commercial real estate, multi-
family and land loans, or 3.24% of total loans; $8.7 million of real estate
construction loans, or 1.10% of total loans; and $2.9 million of commercial
loans, or .37% of total loans. The Bank had no loans held for sale at December
31, 1997. At that same date, 59.87% 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
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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.
<TABLE>
<CAPTION>
At December 31,
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1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Real estate:
One- to four-family........... $711,548 89.57% $628,525 91.05% $575,010 92.01% $552,401 91.63% $505,984 91.66%
Commercial real estate,
multi-family and land.... 25,699 3.24 15,634 2.26 14,939 2.39 13,885
Construction.................. 8,748 1.10 9,287 1.35 8,153 1.30 10,474 1.74 8,123 1.47
Consumer (1)................... 45,417 5.72 36,860 5.34 26,867 4.30 26,100 4.33 26,427 4.79
Commercial loans............... 2,904 .37 - - - - - - - -
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............... 794,316 100.00% 690,306 100.00% 624,969 100.00% 602,860 100.00% 552,006 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan funds........ 2,867 3,517 2,687 2,661 2,341
Unamortized discounts, net.... 9 11 12 13 27
Deferred loan fees............ 1,133 1,302 1,679 2,263 3,286
Allowance for loan losses..... 6,612 6,021 6,001 5,608 5,504
-------- -------- -------- -------- --------
Total loans, net.......... 783,695 679,455 614,590 592,315 540,848
Less:
Mortgage loans held for sale.. - 727 1,894 - 963
-------- -------- -------- -------- --------
Loans receivable, net......... $783,695 $678,728 $612,696 $592,315 $539,885
======== ======== ======== ======== ========
Total loans:
Adjustable rate............... $475,533 59.87% $437,706 63.41% $405,485 64.88% $386,424 64.10% $332,487 60.23%
Fixed rate.................... 318,783 40.13 252,600 36.59 219,484 35.12 216,436 35.90 219,519 39.77
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans............... $794,316 100.00% $690,306 100.00% $624,969 100.00% $602,860 100.00% $552,006 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
___________________________
(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
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Loan Maturity. The following table shows the contractual maturity of the Bank's
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total loans at December 31, 1997. There were no loans held for sale at
December 31, 1997. The table does not include principal repayments. Principal
repayments, including prepayments, on total loans was $120.9 million, $103.5
million and $89.6 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
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COMMERCIAL
ONE- TO REAL ESTATE, TOTAL
FOUR- MULTI-FAMILY COMMERCIAL LOANS
FAMILY AND LAND CONSTRUCTION CONSUMER LOANS RECEIVABLE
---------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One year or less........................ $ 23,692 $ 6,526 $8,748 $ 5,309 $1,099 $ 45,374
-------- ------- ------ ------- ------ --------
After one year:
More than one year to three years..... 51,973 763 - 8,304 290 61,330
More than three years to five years... 56,870 6,290 - 7,821 1,324 72,305
More than five years to 10 years...... 134,274 1,628 - 16,304 191 152,397
More than 10 years to 20 years........ 235,045 6,569 - 7,679 - 249,293
More than 20 years.................... 209,694 3,923 - - - 213,617
-------- ------- ------ ------- ------ --------
Total due after December 31, 1998..... 687,856 19,173 - 40,108 1,805 748,942
-------- ------- ------ ------- ------ --------
Total amount due...................... $711,548 $25,699 $8,748 $45,417 $2,904 794,316
======== ======= ====== ======= ======
Less:
Undisbursed loan funds............ 2,867
Unamortized discounts, net........ 9
Deferred loan fees................ 1,133
Allowance for loan losses......... 6,612
--------
Total loans, net...................... 783,695
Less: Mortgage loans held for sale..... -
--------
Loans receivable, net................... $783,695
========
</TABLE>
4
<PAGE>
The following table sets forth at December 31, 1997, the dollar amount of total
loans receivable contractually due after December 31, 1998, and whether such
loans have fixed interest rates or adjustable interest rates.
<TABLE>
<CAPTION>
DUE AFTER DECEMBER 31, 1998
-----------------------------------------------
Fixed ADJUSTABLE Total
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(In thousands)
<S> <C> <C> <C>
Real estate loans:
One- to four-family.................. $266,606 $421,250 $687,856
Commercial real estate,
multi-family and land............. 9,763 9,410 19,173
Consumer............................... 15,775 24,333 40,108
Commercial loans....................... 1,697 108 1,805
-------- -------- --------
Total loans receivable.............. $293,841 $455,101 $748,942
======== ======== ========
</TABLE>
Origination, Sale, Servicing and Purchase of Loans. The Bank's residential
- --------------------------------------------------
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, 1997 there were no
loans categorized as held for sale. In the past, the Bank has also originated
loans through commitments negotiated with correspondent mortgage origination
firms.
The following tables set forth the Bank's loan originations, purchases, sales,
principal repayments and loan activity for the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR DECEMBER 31,
-------------------------------------------------------
1997 1996 1995
-------------- ------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Total loans:
Beginning balance.......................... $690,306 $624,969 $602,860
-------- -------- --------
Loans originated:
One- to four-family................... 182,519 170,381 112,283
Commercial real estate,
multi-family and land............. 16,709 2,031 4,058
Construction.......................... 4,743 1,537 6,010
Consumer.............................. 22,982 21,829 11,007
Commercial ........................... 3,177 - -
-------- -------- --------
Total loans originated.......... 230,130 195,778 133,358
-------- -------- --------
Total........................... 920,436 820,747 736,218
Less:
Principal repayments..................... 120,905 103,546 89,596
Sales of loans........................... 2,752 24,711 18,861
Transfer to REO.......................... 2,463 2,184 2,792
-------- -------- --------
Total loans................................ $794,316 $690,306 $624,969
======== ======== ========
</TABLE>
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.
5
<PAGE>
At December 31, 1997, the Bank's total loans outstanding were $794.3 million, of
which $711.6 million, or 89.57%, 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 $82,000 at
December 31, 1997. 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-, five- or ten-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-, and seven-year ARM
loans which operate as fixed-rate loans for three, five or seven 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, 1997, the Bank had commitments for the origination of
fixed-rate mortgage loans totaling $24.5 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 may retain all or most of its longer term fixed rate
loans after considering volume and yield and after evaluating interest rate risk
and capital management considerations.
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 80% of the appraised
value of the property. 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 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, profitability and the
term and quantity of leases. The Bank has generally required that the properties
securing commercial real estate loans have debt service coverage ratios of at
least 120%. Generally, properties securing a loan are appraised by an
independent appraiser and title insurance is required on all first mortgage
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
6
<PAGE>
December 31, 1997 was $21.5 million, or 2.71% of total loans. The largest
commercial real estate loan in the Bank's portfolio at December 31, 1997 was a
performing loan for which the Bank had an outstanding carrying balance of $2.7
million, which was secured by a first mortgage on an owner-occupied 38,000
square foot commercial building.
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, 1997, totaled $4.0 million.
The Bank's largest multi-family loan at December 31, 1997, 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 totaled $153,000 at
December 31, 1997.
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, 1997, construction loans totaled $8.7
- --------------------
million, or 1.10%, 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 increase the interest rate sensitivity of its earning assets.
At December 31, 1997, the Bank had 44 construction loans, with the largest loan
balance being approximately $825,000. At December 31, 1997, 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 and the building. 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 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.
Consumer Loans. The Bank also offers consumer loans. At December 31, 1997, the
- --------------
Bank's consumer
7
<PAGE>
loans totaled $45.4 million, or 5.72% of the Bank's total loan portfolio. Of
that amount, home equity loans comprised $23.1 million, or 50.9%; home equity
lines of credit comprised $18.7 million, or 41.2%; loans on savings accounts
totaled $1.6 million, or 3.5%; and automobile and student loans totaled $2.0
million, or 4.4%.
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 80% 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 80% of the appraised value of the property at the time of the loan
commitment. Home equity lines of credit are secured by a mortgage on the
underlying real estate. The 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 a range of 0.0% to 1.25%. The
loans have an 18% lifetime cap on interest rate adjustments. The Bank's home
equity lines of credit outstanding at December 31, 1997 totaled $18.7 million.
Commercial Lending. At December 31, 1997, commercial loans totaled $2.9
- ------------------
million, or .37% of the Bank's total loans outstanding. 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 originates 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 $1 million and unsecured loans up
to $500,000 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
residential loans over $150,000. Loans secured by real estate in amounts over $1
million and unsecured loans over $500,000 require approval by the Loan Committee
of the Board of Directors. Loans in excess of $2 million require approval by the
Board of Directors. Pursuant to OTS regulations, loans to one borrower generally
cannot exceed 15% of the Bank's unimpaired capital, which at December 31, 1997
amounted to $26.8 million. At December 31, 1997, the Bank's maximum loan
exposure to a single borrower was $4.4 million.
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
8
<PAGE>
others are loans which have been sold by the Bank. At December 31, 1997, the
Bank was servicing $144.2 million of loans for others. For the years ended
December 31, 1997, 1996 and 1995, loan servicing fees totaled $529,000, $543,000
and $522,000, 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 commercial,
commercial real estate, multi-family, land and construction loans. 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, 1997, the Bank had $7.0 million of
assets, including all REO, classified as Substandard, $3,000 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 totaled
$3.6 million at December 31, 1997, 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, 1997, the largest loan classified as Special Mention had a balance of
$552,000 and the largest loan classified as Substandard had a balance of
$250,000.
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 114,
and 16 REO properties at December 31, 1997. 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, 1997, 1996, 1995, 1994 and 1993,
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 $278,000, $345,000, $428,000, $607,000 and $642,000 none
of which was recognized.
9
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------- ---------- ---------- ----------- --------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Real estate:
One- to four-family.................. $ 5,062 $7,148 $ 8,296 $10,280 $ 9,705
Commercial real estate,
multi-family and land............... 382 122 154 96 315
Construction......................... - 314 -- 265 250
Consumer................................. 110 113 221 298 224
------- ------ ------- ------- -------
Total............................. 5,554 7,697 8,671 10,939 10,494
REO, net(1)................................ 1,198 1,555 1,367 1,580 3,056
------- ------ ------- ------- -------
Total non-performing assets............. $ 6,752 $9,252 $10,038 $12,519 $13,550
======= ====== ======= ======= =======
Allowance for loan losses as a
percent of total loans receivable (2).. .83% .88% .97% .94% 1.01%
Allowance for loan losses as a
percent of total non-performing
loans (3).............................. 119.03 78.23 69.21 51.27 52.45
Non-performing loans as a percent of
total loans receivable(2)(3)........... .70 1.12 1.40 1.83 1.92
Non-performing assets
as a percent of total assets(3)........ .45 .71 .97 1.29 1.45
</TABLE>
- ----------------------------
(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.
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, 1997 and 1996, the
Bank's allowance for loan losses was .83% and .88%, respectively, of total
loans. The Bank had non-accrual loans of $5.6 million and $7.7 million at
December 31, 1997 and 1996, respectively. The Bank will continue to monitor and
modify its allowances for loan losses as conditions dictate.
10
<PAGE>
PAGE>
The following table sets forth activity in the Bank's allowance for estimated
loan losses for the periods set forth in the table.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED
------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year.................... $6,021 $6,001 $5,608 $5,504 $5,737
------ ------ ------ ------ ------
Charge-offs:
Real Estate:
One- to four-family.......................... 328 599 510 907 1,080
Commercial real estate,
multi-family and land.................... -- 30 28 141 334
Construction................................. -- -- -- -- 11
Consumer....................................... 9 63 30 5 122
------ ------ ------ ------ ------
Total...................................... 337 692 568 1,053 1,547
Recoveries...................................... 28 12 11 28 14
------ ------ ------ ------ ------
Net charge-offs.............................. 309 680 557 1,025 1,533
------ ------ ------ ------ ------
Provision for loan losses....................... 900 700 950 1,129 1,300
------ ------ ------ ------ ------
Balance at end of year.......................... $6,612 $6,021 $6,001 $5,608 $5,504
====== ====== ====== ====== ======
Ratio of net charge-offs during the year
to average net loans outstanding during
the year...................................... .05% .11% .09% .18% .29%
====== ====== ====== ====== ======
</TABLE>
11
<PAGE>
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.
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Percent of Each Percent of Each Percent of Each
Allowance to Category Allowance to Category Allowance to Category
Total to Total Total to Total Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to
four-family $2,485 37.58% 89.57% $2,659 44.16% 91.05% $2,790 46.49% 92.01%
Commercial real
estate, multi-
family and land 591 8.94 3.24 330 5.48 2.26 556 9.27 2.39
Construction 44 .67 1.10 75 1.25 1.35 41 .68 1.30
Consumer 471 7.12 5.72 324 5.38 5.34 273 4.55 4.30
Commercial 58 .88 .37 -- -- -- -- -- --
Unallocated 2,963 44.81 - 2,633 43.73 -- 2,341 39.01 --
------ ------ ------ ------ ------ ------ ------ ------ ------
Total $6,612 100.00% 100.00% $6,021 100.00% 100.00% $6,001 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
<CAPTION>
At December 31,
--------------------------------------------------------------------------
1994 1993
--------------------------------------------------------------------------
Percent of Percent of
Loans in Loans in
Percent of Each Percent of Each
Allowance to Category Allowance to Category
Total to Total Total to Total
Amount Allowance Loans Amount Allowance Loans
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
One- to
four-family $2,809 50.09% 91.63% $2,941 53.43% 91.66%
Commercial real
estate, multi-
family and land 483 8.61 2.30 506 9.19 2.08
Construction 79 1.41 1.74 49 .89 1.47
Consumer 268 4.78 4.33 275 5.00 4.79
Commercial -- -- -- -- -- --
Unallocated 1,969 35.11 -- 1,733 31.49 --
------ ------ ------ ------ ------ ------
Total $5,608 100.00% 100.00% $5,504 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
12
<PAGE>
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, totaling 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
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, 1997, mortgage-backed securities totaled $457.1 million, or 30.2%
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 6.73%.
The Bank generally purchases short-term, straight sequential or planned
amortization class collateralized
13
<PAGE>
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, 1997,
the Bank's investment in CMOs had an amortized cost of $3.4 million, and a
market value of $3.4 million.
The following table sets forth the Bank's mortgage-backed securities activities
for the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995
----------------- ------------------ ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Beginning balance...................................... $ 395,542 $ 265,113 $224,569
Mortgage-backed securities
purchased........................................... 248,917 251,004 88,490
Less: Principal repayments........................... (164,291) (117,048) (50,193)
Mortgage-backed securities sold................... (19,149) - -
(Amortization of
premium)....................................... (3,504) (1,804) (612)
Change in net unrealized gain
(loss) on mortgage-backed
securities available for sale................... (367) (1,723) 2,859
--------- --------- --------
Ending balance......................................... $ 457,148 $ 395,542 $265,113
========= ========= ========
</TABLE>
14
<PAGE>
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.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- -------------------------- --------------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
------------ ----------- ------------ ----------- ------------ -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed
securities:
FHLMC.................. $245,414 $245,559 $316,773 $317,735 $221,822 $223,884
FNMA................... 109,873 109,991 69,190 69,108 27,307 27,624
GNMA................... 97,714 98,172 2,800 2,931 3,561 3,763
3,378 3,426 5,643 5,768 9,564 9,842
-------- -------- -------- -------- -------- --------
Total mortgage-backed
securities............. $456,379 $457,148 $394,406 $395,542 $262,254 $265,113
======== ======== ======== ======== ======== ========
</TABLE>
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, 1997, the Bank had investment securities with an amortized cost of
$206.6 million, and a market value of $207.4 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.
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- ---------------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE
------------ ------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
U.S. Government and
agency obligations..... $204,992 $205,648 $175,003 $173,327 $112,956 $113,302
State and municipal
obligations............ 393 400 693 701 1,549 1,579
Equity
investments............ 1,170 1,309 --- --- --- ---
-------- -------- -------- -------- -------- --------
Total investment
securities............. $206,555 $207,357 $175,696 $174,028 $114,505 $114,881
======== ======== ======== ======== ======== ========
</TABLE>
15
<PAGE>
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, 1997.
<TABLE>
<CAPTION> AT DECEMBER 31, 1997
-----------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEAR TO TEN YEARS MORE THAN TEN YEARS
--------------------- -------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD
--------- -------- --------- -------- --------- -------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities:
U.S. Government and
agency obligations.............. $ 5,000 5.75% $ 85,000 6.31% $ 114,992 7.10% $ --- ---%
State and municipal
obligations (1)................. 60 9.66 197 9.27 136 8.71 --- ---
Equity investments............... 1,170 --- --- --- --- --- --- ---
--------- --------- --------- ---------
Total investment
securities....................... $ 6,230 4.71 $ 85,197 6.32 $ 115,128 7.10 $ --- ---
========= ========= ========= =========
Mortgage-backed
securities:
FHLMC........................... 12,898 5.55 29,428 6.42 40,823 6.76 162,265 6.52
FNMA............................ 836 8.66 4,016 6.31 52,326 6.61 52,695 6.21
GNMA............................ --- --- 205 8.00 1,433 8.96 96,076 7.62
CMOs............................ 519 6.27 2,227 8.98 632 6.28 --- ---
--------- --------- --------- ---------
Total mortgage-backed
securities....................... $ 14,253 5.76 $ 35,876 6.58 $ 95,214 6.71 $ 311,036 6.81
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
---------------------------------
WEIGHTED
AMORTIZED MARKET AVERAGE
COST VALUE YIELD
--------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Investment securities:
U.S. Government and
agency obligations.............. $ 204,992 $ 205,648 6.74%
State and municipal
obligations (1)................. 393 400 9.14
Equity investments............... 1,170 1,309 ---
--------- ---------
Total investment
securities....................... $ 206,555 $ 207,357 6.70
========= =========
Mortgage-backed
securities:
FHLMC........................... 245,414 245,559 6.50
FNMA............................ 109,873 109,991 6.42
GNMA............................ 97,714 98,172 7.64
CMOs............................ 3,378 3,426 8.06
--------- ---------
Total mortgage-backed
securities....................... $ 456,379 $ 457,148 6.73
========= =========
</TABLE>
__________________________
(1) Tax equivalent yield.
16
<PAGE>
SOURCES OF FUNDS
General. Deposits, loan repayments and prepayments, proceeds from sales of
- -------
loans, investment maturities, cash flows generated from operations and FHLB and
other 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, 1997, time deposits constituted 66.3% 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:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
------------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Net deposits (withdrawals)................................ $ 2,946 $(29,111) $23,097
Interest credited on deposit accounts..................... 39,088 37,283 36,041
------- -------- -------
Total increase in deposit accounts........................ $42,034 $ 8,172 $59,138
======= ======== =======
</TABLE>
At December 31, 1997, the Bank had $59.5 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
MATURITY PERIOD AMOUNT RATE
- ------------------------------------------------------- --------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less................................... $21,158 5.48%
Over three through six months.......................... 6,633 5.55
Over six through 12 months............................. 12,538 5.73
Over 12 months......................................... 19,175 6.20
-------
Total.................................................. $59,504 5.77%
=======
</TABLE>
17
<PAGE>
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.
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED 31,
--------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------- ------------------------------
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Money market deposit accounts.. $ 68,972 7.18% 2.94% $ 70,209 7.52% 2.90% $ 68,987 7.71% 2.93%
Savings accounts............... 168,733 17.56 2.30 175,060 18.75 2.28 178,973 20.00 2.53
NOW accounts................... 77,785 8.09 1.78 72,265 7.74 1.84 69,330 7.74 2.14
Non-interest-bearing accounts.. 8,115 .84 - 6,425 .69 -- 2,902 .32 --
-------- ------ -------- ------ -------- ------
Total......................... 323,605 33.67 2.25 323,959 34.70 2.27 320,192 35.77 2.49
-------- ------ -------- ------ -------- ------
Time deposits:
Six months or less............ 78,724 8.19 5.32 71,353 7.64 4.95 78,455 8.77 4.84
Over Six through 12 months.... 146,951 15.29 5.37 151,485 16.23 5.23 131,795 14.73 5.44
Over 12 through 24 months..... 178,440 18.57 5.55 150,085 16.08 5.49 123,825 13.83 5.59
Over 24 months................ 120,709 12.56 5.92 124,056 13.29 6.09 127,205 14.21 6.19
IRA/KEOGH..................... 112,602 11.72 5.84 112,641 12.06 5.86 113,564 12.69 6.39
-------- ------ -------- ------ -------- ------
Total time deposits.......... 637,425 66.33 5.60 609,620 65.30 5.55 574,844 64.23 5.70
-------- ------ -------- ------ -------- ------
Total average deposits...... $961,030 100.00% 4.47% $933,579 100.00% 4.44% $895,036 100.00% 4.59%
======== ====== ======== ====== ======== ======
</TABLE>
18
<PAGE>
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, 1998. 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, 1997, the Bank had
borrowed $20.4 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, 1997, the
Bank had borrowed $288.2 million through securities sold under agreements to
repurchase. (See note 11 to the consolidated financial statements in the 1997
Annual Report to Stockholders.)
SUBSIDIARY ACTIVITIES
The Bank owns two subsidiaries - Ocean Investment Services Corp. (formerly Dome
Financial Services, Inc.) and Ocean Federal Realty Inc.
Ocean Investment Services Corp. was originally organized in 1982 to engage in
the sale of all-savers life insurance. For the past several years the subsidiary
has been inactive, however, beginning in 1998, the Bank plans to sell non-
deposit investment products (annuities and mutual funds) to Bank customers
through this subsidiary, recognizing fee income from such sales.
Ocean Federal Realty Inc. was established in 1997 and is intended to qualify as
a real estate investment trust, which may, among other things, be utilized by
the Company to raise capital in the future. Upon formation of Ocean Federal
Realty Inc., the Bank transferred $668 million of mortgage loans to this
subsidiary.
PERSONNEL
As of December 31, 1997, the Bank had 210 full-time employees and 47 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
19
<PAGE>
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory
requirements and policies, whether by the 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, and no multiple savings and loan holding company may acquire
more than 5% of the voting stock of a company engaged in impermissible
activities.
The HOLA prohibits a savings and loan holding company, directly or indirectly,
or through one or more subsidiaries, from acquiring more than 5% of the voting
stock of another savings institution or holding company thereof, without prior
written approval of the OTS; or acquiring or retaining control of a depository
institution that is not insured by the FDIC. In evaluating applications by
holding companies to acquire savings institutions, the OTS must consider the
financial and managerial resources and future prospects of the company and
institution involved, the effect of the acquisition on the risk to the insurance
funds, the convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
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
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
20
<PAGE>
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, 1997, 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.
The following table presents the Bank's capital position at December 31, 1997
relative to fully phased-in regulatory requirements.
<TABLE>
<CAPTION>
EXCESS CAPITAL
-------------------------------
ACTUAL REQUIRED (DEFICIENCY) ACTUAL REQUIRED
CAPITAL CAPITAL AMOUNT PERCENT PERCENT
------------------ --------------- ------------------- ------------- -----------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
Tangible.............. $178,592 $22,491 $156,101 11.91% 1.50%
Core (Leverage)....... 178,592 44,982 133,610 11.91% 3.00%
Risk-based............ 184,970 49,525 135,445 29.88% 8.00%
</TABLE>
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
21
<PAGE>
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 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
approximately 6.5 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 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 1997 was 6.5 basis points and the premium
paid for this period was $482,000. A significant increase in SAIF insurance
premiums would likely have an adverse effect on the operating expenses and
results of operations of the Bank.
22
<PAGE>
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 Funds Act provides that the BIF and SAIF
- -------------------------------
will merge on January 1, 1999, if there are no more savings associations as of
that date. Various proposals to eliminate the federal thrift charter, create a
uniform financial institutions charter and abolish the OTS have been introduced
in Congress. Some bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date or they would
automatically become national banks. Under some proposals, 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. A more recent bill passed by the House
Banking Committee would allow savings institutions to continue to exercise
activities being conducted when they convert to a bank regardless of whether a
national bank could engage in the activity. 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 grandfathering would be lost
under certain circumstances such as a change in control of the Company. The Bank
is unable to predict whether such legislation would be enacted or the extent to
which legislation would restrict or disrupt its operations.
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,
1997, the Bank's limit on loans to one borrower as provided under the HOLA was
$26.8 million. At December 31, 1997, the Bank's largest aggregate outstanding
balance of loans to one borrower was $4.4 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, 1997, the Bank maintained 95% of its portfolio assets in qualified thrift
investments and, therefore, met the QTL test. Recent legislation has expanded
the extent to which education loans, credit card loans and small business loans
may be considered "qualified thrift investments."
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"
(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
23
<PAGE>
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, 1997, 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 4% 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. Monetary penalties may
be imposed for failure to meet the liquidity requirement. The Bank's liquidity
ratio for December 31, 1997 was 9.82%, which exceeded the applicable
requirement. The Bank has never been subject to monetary penalties for failure
to meet its liquidity requirement.
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, 1997 totaled $237,000.
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 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
24
<PAGE>
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.
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 for most of 1997 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 was
3%; and for accounts aggregating greater than $49.3 million, the reserve
requirement was $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. For 1998, the Federal Reserve Bond has decreased from
$49.3 to $47.8 million the amount of transaction accounts subject to the 3%
reserve requirement and increased the amount of exempt reservable balances from
$4.4 million to $4.7 million. 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 1997 taxable year, the Bank is subject to a maximum federal income tax
rate of 34.5%.
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
25
<PAGE>
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%.
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 was 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 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.
26
<PAGE>
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 is 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.
27
<PAGE>
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.
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 1997 Annual Report to Stockholders and is incorporated
herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The above-captioned information appears under "Selected Consolidated Financial
and Other Data of the Company" in the Registrant's 1997 Annual Report to
Stockholders on pages 11 and 12 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
1997 Annual Report to Stockholders on pages 13 through 21 and is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The above captioned information appears under "Management Discussion and
Analysis of Financial Condition and Results of Operations - Management of
Interest Rate Risk" in the Registrant's 1997 Annual Report to Stockholders on
pages 14 to 16.
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 and the
"Selected Consolidated Quarterly Financial Data (Unaudited)" appears in the
Registrant's 1997 Annual Report to Stockholders on pages 22 through 37 and are
incorporated herein by reference.
28
<PAGE>
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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 23 , 1998, at pages 5
through 7.
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 23, 1998, at pages 8 and 9
and pages 14 through 20 (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 23, 1998,
at pages 3 through 4 and 6 through 7.
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 23, 1998, at page 20.
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 1997 Annual Report to
Stockholders.
29
<PAGE>
<TABLE>
<CAPTION>
PAGE
<S> <C>
Independent Auditors' Report................................ 36
Consolidated Statements of Financial Condition at
December 31, 1997 and 1996................................ 22
Consolidated Statements of Income for the
Years Ended December 31, 1997, 1996 and 1995.............. 23
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1997, 1996 and 1995...... 24
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1997, 1996 and 1995.............. 25
Notes to Consolidated Financial Statements for the
Years Ended December 31, 1997, 1996 and 1995.............. 26-36
</TABLE>
The remaining information appearing in the 1997 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.
30
<PAGE>
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 previously)
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 Amended and Restated 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 1997 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by reference to "Part I -
Subsidiaries"
23.0 Consent of KPMG Peat Marwick LLP (filed herewith)
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 Annual Meeting of Shareholders of Ocean Financial Corp. to be
held on April 23, 1998.
31
<PAGE>
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 18, 1998
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 18, 1998
- --------------------------
John R. Garbarino
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
/s/ Michael J. Fitzpatrick March 18, 1998
- --------------------------
Michael J. Fitzpatrick
Executive Vice President and
Chief Financial Officer
(principal accounting and financial officer)
/s/ Michael E. Barrett March 18, 1998
- ---------------------------
Michael E. Barrett
Director
/s/ Thomas F. Curtin March 18, 1998
- --------------------
Thomas F. Curtin
Director
/s/ Carl Feltz, Jr. March 18, 1998
- --------------------
Carl Feltz, Jr.
Director
/s/ Robert E. Knemoller March 18, 1998
- ------------------------
Robert E. Knemoller
Director
32
<PAGE>
/s/ Donald E. McLaughlin March 18, 1998
- ------------------------
Donald E. McLaughlin
Director
/s/ Diane F. Rhine March 18, 1998
- ------------------------
Diane F. Rhine
Director
/s/ Frederick E. Schlosser March 18, 1998
- --------------------------
Frederick E. Schlosser
Director
/s/ James T. Snyder March 18, 1998
- -------------------
James T. Snyder
Director
33
<PAGE>
Exhibit 11
OCEAN FINANCIAL CORP.
STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE
FOR THE YEAR ENDED DECEMBER 31, 1997 AND FOR
THE PERIOD FROM JULY 2, 1996 TO DECEMBER 31, 1996
(dollars and shares in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the period from
Year Ended July 2, 1996 to
December 31, 1997 December 31, 1997
----------------- --------------------
<S> <C> <C>
Net income (loss) $13,825 $(6,612)
======= =======
Weighted average shares outstanding:
Weighted average shares issued net of Treasury shares 8,556 9,059
Less: Unallocated ESOP shares (580) (629)
Unallocated Incentive award shares (304) -
------- -------
Average basic shares outstanding 7,672 8,430
Add: Effect of dilutive securities:
Stock options 72 -
Incentive awards 75 -
------- --------
Average diluted shares outstanding 7,819 8,430
======= ========
Basic earnings (loss) per share $ 1.80 $(.78)
------- --------
Diluted earnings (loss) per share $ 1.77 $(.78)
======= ========
</TABLE>
<PAGE>
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.
<TABLE>
<CAPTION>
At December 31, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(dollars in thousands)
SELECTED FINANCIAL CONDITION DATA:
....................................................................................................................................
Total assets $1,510,947 $1,303,865 $1,036,445 $ 971,651 $ 937,214
....................................................................................................................................
Investment securities held to maturity - - - 127,451 126,999
....................................................................................................................................
Investment securities available for sale 207,357 174,028 114,881 - -
....................................................................................................................................
FHLB-NY stock 14,980 8,457 7,723 7,323 6,680
....................................................................................................................................
Mortgage-backed securities held to maturity - - - 224,569 241,188
....................................................................................................................................
Mortgage-backed securities available for sale 457,148 395,542 265,113 - -
....................................................................................................................................
Loans receivable, net 783,695 678,728 612,696 592,315 539,885
....................................................................................................................................
Mortgage loans held for sale - 727 1,894 - 963
....................................................................................................................................
Deposits 976,764 934,730 926,558 867,420 858,461
....................................................................................................................................
Federal Home Loan Bank borrowings 20,400 8,800 10,400 - -
....................................................................................................................................
Securities sold under agreements to repurchase 288,200 99,322 - - -
....................................................................................................................................
Stockholders' equity 215,544 252,789 92,351 82,334 72,605
....................................................................................................................................
<CAPTION>
For the Year Ended December 31, 1997 1996 1995 1994 1993
....................................................................................................................................
<S> <C> <C> <C> <C> <C>
(dollars in thousands except per share amounts)
SELECTED OPERATING DATA:
....................................................................................................................................
Interest income $ 98,656 $ 80,236 $ 70,210 $ 63,683 $ 64,853
....................................................................................................................................
Interest expense 55,608 43,857 40,004 32,373 33,975
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 43,048 36,379 30,206 31,310 30,878
....................................................................................................................................
Provision for loan losses 900 700 950 1,129 1,300
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 42,148 35,679 29,256 30,181 29,578
....................................................................................................................................
Other income 2,509 2,881 1,356 2,057 2,740
....................................................................................................................................
Operating expenses 23,145 39,206 18,006 17,104 16,626
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income taxes 21,512 (646) 12,606 15,134 15,692
....................................................................................................................................
Provision for income taxes 7,687 1,083 4,659 5,405 5,556
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 13,825 $ (1,729) $ 7,947 $ 9,729 $ 10,136
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share $ 1.80 $ (.78) N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share $ 1.77 $ (.78) N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Net income before non-recurring items (2) $ 13,825 $ 11,576 $ 7,947 $ 9,729 $ 10,136
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Earnings (loss) per share for 1996 is for the period from July 2, 1996 (date of
conversion) to December 31, 1996
Selected Consolidated Financial and Other Data (continued)
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 11 --
<PAGE>
<TABLE>
<CAPTION>
At or for the Year Ended December 31, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL RATIOS AND OTHER DATA (1):
....................................................................................................................................
PERFORMANCE RATIOS:
....................................................................................................................................
<S> <C> <C> <C> <C> <C>
Return on average assets 0.97% (.15%) 0.80% 1.02% 1.10%
....................................................................................................................................
Return on average assets, as adjusted (2) 0.97 1.00 0.80 1.02 1.10
....................................................................................................................................
Return on average stockholders' equity 6.00 (1.03) 9.44 12.54 14.85
....................................................................................................................................
Return on average stockholders' equity, as adjusted (2) 6.00 6.91 9.44 12.54 14.85
....................................................................................................................................
Average stockholders' equity to average assets 16.25 14.42 8.51 8.11 7.41
....................................................................................................................................
Stockholders' equity to total assets at end of year 14.27 19.39 8.91 8.47 7.75
....................................................................................................................................
Average interest rate spread (3) 2.39 2.61 2.79 3.07 3.20
....................................................................................................................................
Net interest margin (4) 3.12 3.22 3.13 3.34 3.44
....................................................................................................................................
Average interest-earning assets to average
interest-bearing liabilities 117.95 115.84 107.98 107.71 106.42
....................................................................................................................................
Operating expenses to average assets 1.63 3.37 1.82 1.79 1.81
....................................................................................................................................
Operating expenses to average assets, as adjusted (2) 1.63 1.73 1.82 1.79 1.81
....................................................................................................................................
Operating Efficiency Ratio (5) 50.80 99.86 57.05 51.26 49.46
....................................................................................................................................
Operating Efficiency Ratio, as adjusted (2)(5) 50.80 51.11 57.05 51.26 49.46
....................................................................................................................................
REGULATORY CAPITAL RATIOS (BANK ONLY):
....................................................................................................................................
Tangible capital 11.91 12.69 8.72 8.43 7.73
....................................................................................................................................
Core capital 11.91 12.69 8.72 8.43 7.73
....................................................................................................................................
Risk-based capital 29.88 32.04 21.34 20.34 18.59
....................................................................................................................................
ASSET QUALITY RATIOS:
....................................................................................................................................
Non-performing loans as a percent of total loans receivable (6)(7) 0.70 1.12 1.40 1.83 1.92
....................................................................................................................................
Non-performing assets as a percent of total assets (7) 0.45 0.71 0.97 1.29 1.45
....................................................................................................................................
Allowance for loan losses as a percent of total loans receivable (6) 0.83 0.88 0.97 0.94 1.01
....................................................................................................................................
Allowance for loan losses as a percent of total non-performing loans (7) 119.03 78.23 69.21 51.27 52.45
....................................................................................................................................
NUMBER OF FULL-SERVICE CUSTOMER FACILITIES 10 9 8 8 8
....................................................................................................................................
</TABLE>
(1) With the exception of end of year ratios, all ratios are based on average
daily balances for 1997, 1996 and 1995 and average monthly balances for 1994 and
1993.
(2) Performance ratios are calculated to exclude the effect of non-recurring
charges in 1996 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 12 --
<PAGE>
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 and 1997
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.
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.
With the significant increase in capital arising from the stock conversion, the
Company adopted a leverage strategy in late 1996 to improve returns on capital.
The strategy included the retention of most 30-year fixed rate mortgage loans
and the use of wholesale borrowings to fund purchases of investment and
mortgage-backed securities. The adoption of this strategy may increase the
Company's interest rate risk exposure. As noted below, management seeks to
carefully monitor and assess the Company's interest rate risk exposure while
actively managing the balance sheet composition.
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, a new branch opened in Lacey Township. In 1998, the
Company expects to open an additional branch office in Toms River during the
second quarter. A branch in Wall Township, in Southern Monmouth County, is
expected to open at year end. The Company is also evaluating additional office
sites within its existing market area.
Management also intends to diversify its retail product line. In 1998, the
Company expects to offer alternative investment products (annuities and mutual
funds) for sale through its retail branch network. The products will be
non-proprietary, sold through a third party vendor, and provide the Company with
fee income opportunities.
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, marketing 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 1997 Annual Report
-- 13 --
<PAGE>
Management of Interest Rate Risk
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises primarily from interest rate risk inherent in
its lending, investment and deposit taking activities. The Company's
profitability is affected by fluctuations in interest rates. A sudden and
substantial increase in interest rates may adversely impact the Company's
earnings to the extent that the interest rates borne by assets and liabilities
do not change at the same speed, to the same extent or on the same basis. To
that end, management actively monitors and manages its interest rate risk
exposure.
The principal 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 and throughout 1997, however, the
Company began retaining most of its 30-year fixed rate mortgage loan production
in order to improve yields and increase balance sheet leverage. Management felt
that the significant capital position of the Company resulting from the
Conversion, 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, 1997, 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 below, 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, 1997, 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 11% and 30%
annually. Mortgage-backed securities are projected to prepay at rates between
11% and 30% annually. Passbook accounts, negotiable order of withdrawal ("NOW")
and money market accounts are assumed to decay at 9.66%, 8.73%, 15.01%, 37.05%,
16.44%, 11.39% and 1.72%, 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 14 --
<PAGE>
<TABLE>
<CAPTION>
More than More than More than More than More than
3 Months 3 Months to 6 Months to 1 Year to 3 Years to 5 Years to More than
At December 31, 1997 or Less 6 Months 1 Year 3 Years 5 Years 10 Years 10 Years Total
....................................................................................................................................
(dollars in thousands)
INTEREST-EARNING ASSETS (1):
....................................................................................................................................
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning deposits and
short-term investments $ 1,603 $ -- $ -- $ -- $ -- $ -- $ -- $ 1,603
....................................................................................................................................
Investment securities 6,268 -- 60 50,198 35,014 115,817 -- 207,357
....................................................................................................................................
Loans receivable (2) 101,159 60,504 115,684 244,319 133,599 95,848 43,203 794,316
....................................................................................................................................
Mortgage-backed securities 135,993 60,868 83,405 69,770 52,216 34,088 20,808 457,148
....................................................................................................................................
FHLB stock 14,980 -- -- -- -- -- -- 14,980
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 260,003 121,372 199,149 364,287 220,829 245,753 64,011 1,475,404
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
....................................................................................................................................
Money market deposit accounts 6,568 5,933 10,202 25,191 11,175 7,742 1,168 67,979
....................................................................................................................................
Savings accounts 15,755 14,245 24,494 60,484 26,831 18,589 2,804 163,202
....................................................................................................................................
NOW accounts 7,655 6,918 11,894 29,360 13,027 9,026 1,363 79,243
....................................................................................................................................
Time deposits 138,589 115,995 185,153 147,872 56,734 10,097 -- 654,440
....................................................................................................................................
FHLB borrowings 20,400 -- -- -- -- -- -- 20,400
....................................................................................................................................
Securities sold under agreements
to repurchase 148,700 -- 50,000 24,500 30,000 35,000 -- 288,200
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 337,667 143,091 281,743 287,407 137,767 80,454 5,335 1,273,464
- ------------------------------------------------------------------------------------------------------------------------------------
Interest sensitivity gap (3) $ (77,664) $ (21,719) $ (82,594) $ 76,880 $ 83,062 $165,299 $ 58,676 $ 201,940
====================================================================================================================================
Cumulative interest sensitivity gap $ (77,664) $ (99,383) $(181,977) $(105,097) $ (22,035) $143,264 $201,940
====================================================================================================================================
Cumulative interest sensitivity gap
as a percent of total assets (5.14%) (6.58%) (12.04%) (6.95%) 1.46% 9.48% 13.36%
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative interest-earning assets
as a percent of cumulative
interest-bearing liabilities 77.00% 79.33% 76.13% 89.99% 98.14% 111.30% 115.86%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(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 1997 Annual Report
--15--
<PAGE>
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
Office of Thrift Supervision ("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, 1997,
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 $ 148,630 $(102,067) (40.7)% 10.9% (33.9)%
................................................................................
300 181,482 (69,215) (27.6) 12.9 (21.8)
................................................................................
200 213,613 (37,084) (14.8) 14.7 (10.9)
................................................................................
100 234,059 (16,638) (6.6) 15.8 (4.2)
................................................................................
Static 250,697 - - 16.5 -
................................................................................
(100) 255,243 4,546 1.8 16.5 -
................................................................................
(200) 256,799 6,102 2.4 16.3 (1.2)
................................................................................
(300) 258,282 7,585 3.0 16.1 (2.4)
................................................................................
(400) 258,579 7,882 3.1 15.8 (4.2)
................................................................................
(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 requires
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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 16 --
<PAGE>
The following table sets forth certain information relating to the Company at
December 31, 1997 and for each of the years ended December 31, 1997, 1996 and
1995. 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. The yields and costs include fees which are considered adjustments to
yields.
<TABLE>
<CAPTION>
At December 31,
.................................................................................................................
1997 1997
.................................................................................................................
Average Average
Yield/ Average Yield/ Average
Balance Cost Balance Interest Cost Balance
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets:
.................................................................................................................
Interest-earning assets:
.................................................................................................................
Interest earning deposits and
short-term investments $ 1,603 2.65% $ 2,852 $ 155 5.43% $ 4,872
.................................................................................................................
Investment securities (1) 207,357 6.70 196,650 13,302 6.76 148,378
.................................................................................................................
Loans receivable, net (2) 783,695 7.81 725,866 57,540 7.93 637,453
.................................................................................................................
Mortgage-backed securities (3) 457,148 6.73 442,500 26,907 6.08 331,669
.................................................................................................................
FHLB stock 14,980 7.05 11,271 752 6.67 8,323
- -----------------------------------------------------------------------------------------------------------------
Total interest-earning assets 1,464,783 7.30 1,379,139 98,656 7.15 1,130,695
.................................................................................................................
Non-interest-earning assets 46,164 38,829 31,810
- -----------------------------------------------------------------------------------------------------------------
Total assets $1,510,947 $1,417,968 $1,162,505
=================================================================================================================
Liabilities and Equity:
.................................................................................................................
Interest-bearing liabilities:
.................................................................................................................
Money market deposit accounts $ 67,979 2.90% $ 68,972 2,028 2.94% $ 70,209
.................................................................................................................
Savings accounts 163,202 2.28 168,733 3,877 2.30 175,060
.................................................................................................................
NOW accounts 77,994 1.84 77,785 1,388 1.78 72,265
.................................................................................................................
Time deposits 654,440 5.69 637,425 35,667 5.60 609,620
- -----------------------------------------------------------------------------------------------------------------
Total 963,615 4.60 952,915 42,960 4.51 927,154
.................................................................................................................
FHLB borrowings 20,400 6.38 7,207 414 5.74 39,135
.................................................................................................................
Securities sold under
agreements to repurchase 288,200 6.01 209,089 12,234 5.85 9,803
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,272,215 4.95 1,169,211 55,608 4.76 976,092
.................................................................................................................
Non-interest-bearing liabilities 23,188 18,395 18,778
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 1,295,403 1,187,606 994,870
.................................................................................................................
Stockholders' equity 215,544 230,362 167,635
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $1,510,947 $1,417,968 $1,162,505
=================================================================================================================
Net interest income $ 43,048
=================================================================================================================
Net interest rate spread (4) 2.35% 2.39%
=================================================================================================================
Net interest margin (5) 3.00% 3.12%
=================================================================================================================
Ratio of interest-earning assets
to interest-bearing liabilities 115.14% 117.95% 115.84%
=================================================================================================================
<CAPTION>
Years Ended December 31,
....................................................................................................
1996 1995
....................................................................................................
Average Average
Yield/ Average Yield/
Interest Cost Balance Interest Cost
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets:
....................................................................................................
Interest-earning assets:
....................................................................................................
Interest earning deposits and
short-term investments $ 251 5.15% $ 5,245 $ 331 6.31%
....................................................................................................
Investment securities (1) 9,710 6.54 126,792 7,166 5.65
....................................................................................................
Loans receivable, net (2) 50,324 7.89 612,431 48,323 7.89
....................................................................................................
Mortgage-backed securities (3) 19,413 5.85 214,348 13,799 6.44
....................................................................................................
FHLB stock 538 6.46 7,679 591 7.70
- ----------------------------------------------------------------------------------------------------
Total interest-earning assets 80,236 7.10 966,495 70,210 7.26
....................................................................................................
Non-interest-earning assets 22,212
- ----------------------------------------------------------------------------------------------------
Total assets $ 988,707
====================================================================================================
Liabilities and Equity:
....................................................................................................
Interest-bearing liabilities:
....................................................................................................
Money market deposit accounts 1,994 2.84% $ 68,987 2,083 3.02%
....................................................................................................
Savings accounts 4,069 2.32 178,973 4,537 2.54
....................................................................................................
NOW accounts 1,371 1.90 69,330 1,483 2.14
....................................................................................................
Time deposits 33,555 5.50 574,844 31,723 5.52
- ----------------------------------------------------------------------------------------------------
Total 40,989 4.42 892,134 39,826 4.46
....................................................................................................
FHLB borrowings 2,298 5.87 2,933 178 6.07
....................................................................................................
Securities sold under
agreements to repurchase 570 5.81 -- -- --
- ----------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 43,857 4.49 895,067 40,004 4.47
....................................................................................................
Non-interest-bearing liabilities 9,457
- ----------------------------------------------------------------------------------------------------
Total liabilities 904,524
....................................................................................................
Stockholders' equity 84,183
- ----------------------------------------------------------------------------------------------------
Total liabilities and equity $ 988,707
====================================================================================================
Net interest income $ 36,379 $ 30,206
====================================================================================================
Net interest rate spread (4) 2.61% 2.79%
====================================================================================================
Net interest margin (5) 3.22% 3.13%
====================================================================================================
Ratio of interest-earning assets
to interest-bearing liabilities 107.98%
====================================================================================================
</TABLE>
(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 1997 Annual Report
-- 17 --
<PAGE>
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.
<TABLE>
<CAPTION>
Year Ended December 31, 1997 Year Ended December 31, 1996
Compared to Compared to
Year Ended December 31, 1996 Year Ended December 31, 1995
---------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------------------------------------------------
Volume Rate Net Volume Rate Net
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
................................................................................................................................
Interest-earning deposits and short-term investments $ (109) $ 13 $ (96) $ (22) $ (58) $ (80)
................................................................................................................................
Investment securities 3,256 336 3,592 1,321 1,223 2,544
................................................................................................................................
Loans receivable, net 6,962 254 7,216 2,001 - 2,001
................................................................................................................................
Mortgage-backed securities 6,705 789 7,494 6,976 (1,362) 5,614
................................................................................................................................
FHLB stock 196 18 214 47 (100) (53)
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 17,010 1,410 18,420 10,323 (297) 10,026
- --------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
................................................................................................................................
Money market deposit accounts (35) 69 34 37 (126) (89)
................................................................................................................................
Savings accounts (155) (37) (192) (94) (374) (468)
................................................................................................................................
NOW accounts 104 (87) 17 61 (173) (112)
................................................................................................................................
Time deposits 1,510 602 2,112 1,945 (113) 1,832
- --------------------------------------------------------------------------------------------------------------------------------
Total 1,424 547 1,971 1,949 (786) 1,163
................................................................................................................................
FHLB borrowings (1,834) (50) (1,884) 2,126 (6) 2,120
................................................................................................................................
Securities sold under agreements to repurchase 11,660 4 11,664 570 - 570
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 11,250 501 11,751 4,645 (792) 3,853
- --------------------------------------------------------------------------------------------------------------------------------
Net change in net interest income $ 5,760 $ 909 $ 6,669 $ 5,678 $ 495 $ 6,173
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Comparison of Financial Condition at December 31, 1997 and December 31, 1996
Total assets at December 31, 1997 were $1.511 billion, an increase of $207.1
million, or 15.9%, compared to $1.304 billion at December 31, 1996.
Investment securities available for sale increased by $33.3 million, to a
balance of $207.3 million at December 31, 1997, compared to a balance of $174.0
million at December 31, 1996, and mortgage-backed securities available for sale
increased by $61.6 million, to $457.1 million at December 31, 1997, from $395.5
million at December 31, 1996. The increase in investment and mortgage-backed
securities available for sale was due to the continued deployment of a wholesale
leverage strategy adopted in late 1996, designed to improve returns on invested
capital. Wholesale leverage growth was funded through securities sold under
agreements to repurchase, which increased to $288.2 million at December 31, 1997
from $99.3 at December 31, 1996. The strategy primarily involves the purchase of
adjustable and fixed-rate mortgage-backed securities funded by short and
medium-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 $105.0 million, or 15.5%, to a
balance of $783.7 million at December 31, 1997, compared to a balance of $678.7
million at December 31, 1996. The increase was largely attributable to robust
residential loan growth in the Bank's market area, as well as commercial lending
initiatives which accounted for $14.4 million of this growth.
Total deposits at December 31, 1997 were $976.8 million, an increase of $42.1
million, compared to $934.7 million at December 31, 1996. Stockholders' equity
at December 31, 1997 was $215.5 million, compared to $252.8 million at December
31, 1996. The reduction was due to the award of 335,523 shares of common stock
to directors and officers of the Company and the Bank under the Company's 1997
Incentive Plan. The fair market value of the shares on February 4, 1997 (the
date of shareholder approval) was initially recorded as a reduction to
stockholders' equity and is being amortized to expense. Additionally, through
December 31, 1997, the Company has completed the repurchase of 1,206,264 shares,
or 13.3%, of outstanding common stock. These shares were held as treasury stock
at December 31, 1997.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 18 --
<PAGE>
Results of Operations
General
Net income increased to $13.8 million for the year ended December 31, 1997, as
compared to a net loss of $1.7 million for the year ended December 31, 1996.
Prior year amounts were adversely affected by a charge of $5.7 million ($3.7
million after tax) representing the Bank's share of a special assessment to
recapitalize the Savings Association Insurance Fund ("SAIF") of the FDIC.
Additionally, concurrent with the close of the Company's stock offering on July
2, 1996, the Company funded The Ocean Federal Foundation with a one-time
donation of 671,046 shares of common stock, resulting in a charge of $13.4
million ($9.7 million after tax).
Interest Income
Interest income for the year ended December 31, 1997 was $98.6 million, compared
to $80.2 million for the year ended December 31, 1996, an increase of $18.4
million, or 23.0%. 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, due to the investment, in 1997, of funds received from
wholesale borrowings. Also, the average balance of loans receivable increased
$88.4 million for the year ended December 31, 1997, as compared to the same
prior year period. The increase in interest income was further augmented by an
increase in the yield on average interest earning assets, which improved to
7.15% on average in 1997, from 7.10% on average in 1996.
Interest Expense
Interest expense for the year ended December 31, 1997 was $55.6 million,
compared to $43.9 million for the year ended December 31, 1996, an increase of
$11.7 million or 26.8%. The increase in interest expense was primarily the
result of an increase in the average outstanding balance of total borrowings, as
previously discussed, and a smaller average increase in deposits. The average
cost of interest-bearing liabilities also increased to 4.76% for the year ended
December 31, 1997, as compared to 4.49% for the same prior year period due to a
greater percentage increase in higher cost wholesale funding over retail deposit
funding.
Provision for Loan Losses
For the year ended December 31, 1997, the Company's provision for loan losses
was $900,000, compared to $700,000 for the same prior year period. The increase
was due to overall loan growth and the introduction of commercial business loans
which generally carry greater credit risk than the 1-4 family mortgage loans
which have been the Bank's historical focus.
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 collectability 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 $2.5 million for the year ended December 31, 1997, compared to
$2.9 million for the same prior year period. Income from the net gain (loss) on
sales of loans and securities decreased $410,000 for the year ended December 31,
1997, compared to the same prior year period. The decrease was due to the
recognition of a loss of $142,000 in 1997 on the sale of a mortgage-backed
security. Additionally, the Company sold $2.7 million of 30-year fixed rate
mortgage loans in 1997, a decrease of $21.5 million as compared to $24.2 million
sold in 1996. Management determined that the significant capital position of the
Company mitigated the additional interest rate risk associated with retaining
these mortgages.
Operating Expenses
Operating expenses were $23.1 million and $39.2 million for the year ended
December 31, 1997, a decrease of $16.1 million compared to the same prior year
period. The charitable donation to The Ocean Federal Foundation in the third
quarter of 1996 accounted for $13.4 million of the decrease. Additionally,
federal deposit insurance expense declined by $7.3 million for the year ended
December 31, 1997, compared to the same prior year period due to the special
SAIF assessment of $5.7 million recorded in the third quarter of 1996. As a
result of the special assessment insurance premiums on SAIF-insured deposits
declined to 6.5 basis points per $100 of deposits effective January 1, 1997, as
compared to 23 basis points in 1996.
The increase in compensation and employee benefits expense of $3.7 million for
the year ended December 31, 1997, as compared to the same prior year period, was
due to the expense associated with the amortization, beginning in February 1997,
of incentive stock awards and the higher expense associated with the Bank's
Employee Stock Ownership Plan as a result of the increase in the Company's stock
price over its initial $20 per share cost. The ESOP expense was partly offset by
eliminating matching contributions under the Bank's 401K Plan.
Equipment expense increased by $426,000 for the year ended December 31, 1997,
compared to the same prior year period due to the establishment of two new
branch offices and the upgrade of computer equipment. General and administrative
expenses increased by $386,000 for the year ended December 31, 1997, compared to
the same prior year period due to expenses associated with operating as a
publicly-owned holding company.
Provision for Income Taxes
Income tax expense was $7.7 million for the year ended December 31, 1997,
compared to $1.1 million for the year ended December 31, 1996 due to the
significant increase in income before income taxes.
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
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 19 --
<PAGE>
stock at the time of the donation. 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 SAIF. 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).
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 Federal Home Loan Bank ("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 FHLB 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.
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.
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.
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 1996 and for the next
successive five years (the carry forward 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. 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.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, principal and interest
payments on loans and mortgage-backed securities, 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, 1997, the Company had $20.4 million of
outstanding overnight borrowings from the FHLB, representing an increase from
$8.8 million at December 31, 1996. The Company utilizes the overnight line from
time to time to fund short-term liquidity needs. The Company also borrowed
$288.2 million at December 31, 1997 through securities sold under agreements to
repurchase, an increase from $99.3 million at December 31, 1996. 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, 1997, were principally
provided by principal payments on loans and mortgage-backed securities, deposit
flows, and borrowings through securities sold under agreements to repurchase.
The cash provided was principally used for investing activities, which included
the purchase of investment and mortgage-backed securities and the
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 20 --
<PAGE>
origination of loans. The Company also used funds to purchase outstanding common
stock, either to fund incentive awards or to hold as treasury stock. For the
year ended December 31, 1996, the cash needs of the Company were primarily
satisfied by investment maturities, principal payments on loans and
mortgage-backed securities, borrowings through securities sold under agreements
to repurchase and proceeds from common stock subscriptions. The cash was
principally utilized for loan originations and purchases of investment and
mortgage-backed securities.
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 4% (a decrease from 5% at December
31, 1996) 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, 1997 and
1996, the Bank's liquidity ratios were 9.8% and 17.5%, respectively, both in
excess of the minimum regulatory requirement.
At December 31, 1997, the Bank exceeded all of its regulatory capital
requirements with tangible capital of $178.6 million, or 11.9%, of total
adjusted assets, which is above the required level of $22.5 million or 1.5%;
core capital of $178.6 million or 11.9% of total adjusted assets, which is above
the required level of $45.0 million, or 3.0%; and risk-based capital of $185.0
million, or 29.9% of risk-weighted assets, which is above the required level of
$49.5 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 Year 2000
The Company is conducting a comprehensive review of its computer systems and
third party vendors to identify the systems that could be affected by the "Year
2000" issue. The Year 2000 problem is the result of computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's programs that have time-sensitive software may recognize a date
using "00" as the year 1900 rather than the Year 2000. This could result in
system failure or miscalculations. The Company is devoting the necessary
internal and external resources in the development of an implementation plan to
address Year 2000. Management anticipates that all Year 2000 initiatives and
testing will be completed in a timely manner and will meet all regulatory
milestones. Expenditures in future years are not expected to have a material
impact on the Company.
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
Statement of Financial Accounting Standards No. 129, "Disclosure of Information
about Capital Structure" (SFAS 129) was issued in February 1997. SFAS 129 is
effective for periods ending after December 15, 1997. SFAS 129 lists required
disclosures about capital structure that had been included in a number of
separate statements and opinions of authoritative accounting literature. As
such, the adoption of SFAS 129 is not expected to have a significant impact on
the disclosures in financial statements of the Company.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Under SFAS 130, comprehensive income is divided into net
income and other comprehensive income. Other comprehensive income includes items
previously recorded directly in equity, such as unrealized gains or losses on
securities available for sale. SFAS 130 is effective for interim and annual
periods beginning after December 15, 1997. Comparative financial statements
provided for earlier periods are required to be reclassified to reflect
application of the provisions of the Statement. The adoption of SFAS 130 is not
expected to have a significant impact on the Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131). SFAS 131 establishes standards for the way public business enterprises are
to report information about operating segments in annual financial statements
and requires those enterprises to report selected financial information about
operating segments in interim financial reports to shareholders. SFAS 131 is
effective for financial statements for periods beginning after December 15,
1997. The adoption of SFAS 131 is not expected to have a significant impact on
the Company.
Private Securities Litigation Reform Act Safe Harbor Statement
In addition to historical information, this annual report may include certain
forward looking statements based on current management expectations. The
Company's actual results could differ materially from those management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of
federal and state tax authorities, changes in interest rates, deposit flows, the
cost of funds, demand for loan products, demand for financial services,
competition, changes in the quality or composition of the Bank's loan and
investment portfolios, changes in accounting principles, policies or guidelines,
and other economic, competitive, governmental and technological factors
affecting the Company's operations, markets, products, services and prices.
Further description of the risks and uncertainties to the business are included
in Item 1, BUSINESS of the Company's 1997 Form 10-K.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 21 --
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
December 31, 1997 and 1996 1997 1996
....................................................................................................................................
(dollars in thousands, except per share amounts)
ASSETS
<S> <C> <C>
....................................................................................................................................
Cash and due from banks $ 2,225 $ 5,372
....................................................................................................................................
Investment securities available for sale (notes 4, 11 and 15) 207,357 174,028
....................................................................................................................................
Federal Home Loan Bank of New York stock, at cost 14,980 8,457
....................................................................................................................................
Mortgage-backed securities available for sale (notes 5, 11 and 15) 457,148 395,542
....................................................................................................................................
Loans receivable, net (notes 6 and 15) 783,695 678,728
....................................................................................................................................
Mortgage loans held for sale - 727
....................................................................................................................................
Interest and dividends receivable (note 7) 11,064 9,757
....................................................................................................................................
Real estate owned, net (note 9) 1,198 1,555
....................................................................................................................................
Premises and equipment, net (note 8) 14,279 14,100
....................................................................................................................................
Other assets (note 12) 19,001 15,599
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,510,947 $ 1,303,865
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
....................................................................................................................................
Deposits (note 10) $ 976,764 $ 934,730
....................................................................................................................................
Federal Home Loan Bank borrowings 20,400 8,800
....................................................................................................................................
Securities sold under agreements to repurchase (note 11) 288,200 99,322
....................................................................................................................................
Advances by borrowers for taxes and insurance 4,773 3,832
....................................................................................................................................
Other liabilities (notes 12 and 13) 5,266 4,392
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,295,403 1,051,076
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' Equity (notes 2, 3, 12, 13 and 14):
....................................................................................................................................
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 7,852,860 and 9,059,124 shares outstanding at December 31, 1997 and 1996,
respectively 91 91
....................................................................................................................................
Additional paid-in capital 177,223 176,812
....................................................................................................................................
Retained earnings-substantially restricted 97,577 88,552
....................................................................................................................................
Net unrealized gain (loss) on securities available for sale, net of tax 989 (335)
....................................................................................................................................
Less: Unallocated common stock held by Employee Stock Ownership Plan (10,903) (12,331)
....................................................................................................................................
Unearned Incentive Awards (7,897) -
....................................................................................................................................
Treasury stock (1,206,264 shares at December 31, 1997) (41,536)
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 215,544 252,789
- ------------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (note 15)
....................................................................................................................................
Total liabilities and stockholders' equity $ 1,510,947 $ 1,303,865
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 22 --
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
INTEREST INCOME:
<S> <C> <C> <C>
....................................................................................................................................
Loans $ 57,540 $ 50,324 $ 48,323
....................................................................................................................................
Mortgage-backed securities 26,907 19,413 13,799
....................................................................................................................................
Investment securities and other 14,209 10,499 8,088
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 98,656 80,236 70,210
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
....................................................................................................................................
Deposits (note 10) 42,960 40,989 39,826
....................................................................................................................................
Borrowed funds 12,648 2,868 178
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 55,608 43,857 40,004
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 43,048 36,379 30,206
....................................................................................................................................
Provision for loan losses (note 6) 900 700 950
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 42,148 35,679 29,256
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME:
....................................................................................................................................
Fees and service charges (note 6) 1,905 1,819 1,603
....................................................................................................................................
Net (loss) gain on sales of loans and securities available for sale
(notes 4 and 6) (132) 278 (340)
....................................................................................................................................
Net income from (cost of) other real estate operations 223 355 (41)
....................................................................................................................................
Other 513 429 134
- ------------------------------------------------------------------------------------------------------------------------------------
Total other income 2,509 2,881 1,356
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
....................................................................................................................................
Compensation and employee benefits (notes 13 and 14) 13,969 10,296 8,707
....................................................................................................................................
Occupancy (note 15) 1,919 1,882 1,721
....................................................................................................................................
Equipment 1,288 862 879
....................................................................................................................................
Marketing 684 818 836
....................................................................................................................................
Federal deposit insurance (note 18) 719 8,051 2,199
....................................................................................................................................
Data processing 1,243 941 737
....................................................................................................................................
General and administrative 3,323 2,937 2,927
....................................................................................................................................
Charitable donation (notes 2 and 12) - 13,419 -
- ------------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 23,145 39,206 18,006
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income taxes 21,512 (646) 12,606
....................................................................................................................................
Provision for income taxes (note 12) 7,687 1,083 4,659
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 13,825 $ (1,729) $ 7,947
====================================================================================================================================
Basic earnings (loss) per share $ 1.80 $ (.78) N/A
====================================================================================================================================
Diluted earnings (loss) per share $ 1.77 $ (.78) N/A
====================================================================================================================================
Average basic shares outstanding (note 1) 7,672 8,430 N/A
====================================================================================================================================
Average diluted shares outstanding (note 1) 7,819 8,430 N/A
====================================================================================================================================
</TABLE>
Earnings (loss) per share and shares outstanding for 1996 cover the period from
July 2, 1996 (date of conversion) to December 31, 1996
See accompanying notes to consolidated financial statements.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 23 --
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss)
On
Securities
Additional Available
Common Paid-In Retained For Sale,
For The Years Ended 31, 1997, 1996 and 1995 Stock Capital Earnings Net of Tax
- --------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ -- $ -- $ 82,334 $ --
..........................................................................................................................
Net income for the year ended December 31, 1995 -- -- 7,947 --
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- 2,070
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- 90,281 2,070
..........................................................................................................................
Sale of 8,388,078 shares of common stock
in conversion 84 163,216 -- --
..........................................................................................................................
Donation of 671,046 shares of common stock to the
Ocean Federal Foundation at par value 7 13,414 -- --
..........................................................................................................................
Acquisition of 671,046 shares of stock by ESOP -- -- -- --
..........................................................................................................................
Allocation of ESOP stock -- -- -- --
..........................................................................................................................
ESOP adjustment -- 182 -- --
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- (2,405)
..........................................................................................................................
Net loss for the year ended December 31, 1996 -- -- (1,729) --
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 91 176,812 88,552 (335)
..........................................................................................................................
Acquisition of 335,523 shares of common stock
for Incentive Awards -- (506) -- --
..........................................................................................................................
Earned Incentive Awards -- -- -- --
..........................................................................................................................
Purchase 1,206,264 shares of common stock -- -- -- --
..........................................................................................................................
Allocation of ESOP stock -- -- -- --
..........................................................................................................................
ESOP adjustment -- 917 -- --
..........................................................................................................................
Cash dividend - $.60 per share -- -- (4,800) --
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- 1,324
..........................................................................................................................
Net income for the year ended December 31, 1997 -- -- 13,825 --
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ 91 $ 177,223 $ 97,577 $ 989
==========================================================================================================================
<CAPTION>
Employee
Stock Unearned
Ownership Incentive Treasury
For The Years Ended 31, 1997, 1996 and 1995 Plan Awards Stock Total
- --------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ -- $ -- $ -- $ 82,334
..........................................................................................................................
Net income for the year ended December 31, 1995 -- -- -- 7,947
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- 2,070
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- -- 92,351
..........................................................................................................................
Sale of 8,388,078 shares of common stock
in conversion -- -- -- 163,300
..........................................................................................................................
Donation of 671,046 shares of common stock to the
Ocean Federal Foundation at par value -- -- -- 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
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- (2,405)
..........................................................................................................................
Net loss for the year ended December 31, 1996 -- -- -- (1,729)
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 (12,331) -- -- 252,789
..........................................................................................................................
Acquisition of 335,523 shares of common stock
for Incentive Awards -- (9,670) -- (10,176)
..........................................................................................................................
Earned Incentive Awards -- 1,773 -- 1,773
..........................................................................................................................
Purchase 1,206,264 shares of common stock -- -- (41,536) (41,536)
..........................................................................................................................
Allocation of ESOP stock 1,428 -- -- 1,428
..........................................................................................................................
ESOP adjustment -- -- -- 917
..........................................................................................................................
Cash dividend - $.60 per share -- -- -- (4,800)
..........................................................................................................................
Change in net unrealized gain (loss) on securities
available for sale, net of tax -- -- -- 1,324
..........................................................................................................................
Net income for the year ended December 31, 1997 -- -- -- 13,825
- --------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $(10,903) $(7,897) $(41,536) $ 215,544
==========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 24 --
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 13,825 $ (1,729) $ 7,947
....................................................................................................................................
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 1,354 760 810
....................................................................................................................................
Amortization of Incentive Awards 1,773 - -
....................................................................................................................................
Amortization of ESOP 1,428 1,090 -
....................................................................................................................................
ESOP adjustment 917 182 -
....................................................................................................................................
Amortization of servicing asset 197 204 106
....................................................................................................................................
Net premium amortization in excess of discount accretion on securities 3,498 1,761 585
....................................................................................................................................
Net accretion of deferred fees and discounts in excess of premium amortization on loans (382) (487) (535)
....................................................................................................................................
Provision for loan losses 900 700 950
....................................................................................................................................
Deferred taxes 818 (3,263) 385
....................................................................................................................................
Net gain on sales of real estate owned (457) (507) (256)
....................................................................................................................................
Net loss (gain) on sales of loans and securities available for sale 132 (278) 340
....................................................................................................................................
Proceeds from sales of mortgage loans held for sale 2,705 24,173 19,108
....................................................................................................................................
Mortgage loans originated for sale (2,008) (23,453) (21,264)
....................................................................................................................................
Increase in interest and dividends receivable (1,307) (2,277) (251)
....................................................................................................................................
Increase in other assets (5,154) (830) (4,160)
....................................................................................................................................
Increase in other liabilities 874 577 1,371
- ------------------------------------------------------------------------------------------------------------------------------------
Total adjustments 5,288 11,771 (2,811)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 19,113 10,042 5,136
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans receivable (107,948) (68,429) (23,588)
....................................................................................................................................
Proceeds from sales of investment and mortgage-backed securities available for sale 19,006 - 63,713
....................................................................................................................................
Purchase of investment securities available for sale (51,154) (105,006) (29,976)
....................................................................................................................................
Purchase of mortgage-backed securities available for sale (248,917) (251,004) (34,575)
....................................................................................................................................
Purchase of investment securities held to maturity - - (54,975)
....................................................................................................................................
Purchase of mortgage-backed securities held to maturity - - (53,915)
....................................................................................................................................
Proceeds from maturities of investment securities available for sale 20,300 43,858 -
....................................................................................................................................
Principal payments on mortgage-backed securities available for sale 164,291 117,048 -
....................................................................................................................................
Principal payments on mortgage-backed securities held to maturity - - 50,193
....................................................................................................................................
Proceeds from maturities of investment securities held to maturity - - 33,624
....................................................................................................................................
Purchases of Federal Home Loan Bank of New York stock (6,523) (734) (400)
....................................................................................................................................
Proceeds from sales of real estate owned 3,277 2,503 3,261
....................................................................................................................................
Purchases of premises and equipment (1,533) (7,219) (4,121)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (209,201) (268,983) (50,759)
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 42,034 8,172 59,138
....................................................................................................................................
Increase (decrease) increase in Federal Home Loan Bank borrowings 11,600 (1,600) (5,900)
....................................................................................................................................
Increase in securities sold under agreements to repurchase 188,878 99,322 -
....................................................................................................................................
Increase in advances by borrowers for taxes and insurance 941 511 168
....................................................................................................................................
Net proceeds of common stock issuance - 149,886 -
....................................................................................................................................
Purchase of Incentive Award shares (10,176) - -
....................................................................................................................................
Dividends paid (4,800) - -
....................................................................................................................................
Purchase of treasury stock (41,536) - -
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 186,941 256,291 53,406
- ------------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and due from banks (3,147) (2,650) 7,783
....................................................................................................................................
Cash and due from banks at beginning of year 5,372 8,022 239
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 2,225 $ 5,372 $ 8,022
====================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
....................................................................................................................................
Interest $ 54,863 $ 43,624 $ 39,849
....................................................................................................................................
Income taxes 7,246 4,231 3,873
....................................................................................................................................
Non cash investing activities:
....................................................................................................................................
Transfer of loans receivable to real estate owned 2,463 2,184 2,792
....................................................................................................................................
Transfer of investment and mortgage-backed securities
from held-to-maturity to available for sale - - 382,713
....................................................................................................................................
Mortgage loans securitized into mortgage-backed securities $ 2,025 $ 23,392 $ 17,180
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 25 --
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1996
(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
subsidiaries, Ocean Federal Realty, Inc. and Ocean Investment Services, Corp.
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 Company 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.
Loans Receivable
Loans receivable, other than loans held for sale, are stated at unpaid principal
balance, plus unamortized premiums less unearned discounts, 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.
Mortgage Loans Held for Sale
The Company may periodically sell all or part of its conforming loan
originations. 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 26 --
<PAGE>
Real Estate Owned
Real estate owned is carried at the lower of cost or 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.
Stock Based Compensation
Effective January 1, 1997, the Company adopted Statement of Financial Accounting
Standards No. 123, Accounting for Stock Based Compensation (SFAS 123) which
allows an entity to choose between the intrinsic value method, as defined in
Accounting Principles Board Opinion No. 25, and the fair value method of
accounting for stock based compensation described in SFAS 123. An entity using
the intrinsic value method must show the pro forma net income and earnings per
share as if the stock based compensation had been determined using the fair
value method. The Company has elected to account for stock based compensation
using the intrinsic value method under APB No. 25 and has recognized no
compensation expense under this method. The pro forma disclosures required by
SFAS 123 are included in note 14 - 1997 Incentive Plan.
Contributions
Contributions made are 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 are 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.
Earnings (Loss) Per Share
Effective December 31, 1997 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 128 "Earnings per Share". All prior share
amounts have been restated to conform with the provisions of this statement.
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding. Diluted earnings
(loss) per share is calculated by dividing net income (loss) by the weighted
average number of shares of common stock outstanding plus potential common
stock, utilizing the treasury stock method. All share amounts exclude
unallocated shares of stock held by the Employee Stock Ownership Plan (ESOP).
Loss per share for 1996 was computed on net loss and average shares outstanding
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
from, as no stock was outstanding.
The following reconciles shares outstanding for basic and diluted earnings per
share for the year ended December 31, 1997 (in thousands):
Weighted average shares net of Treasury shares 8,556
................................................................................
Less: Unallocated ESOP shares (580)
................................................................................
Unallocated incentive award shares (304)
- --------------------------------------------------------------------------------
Average basic shares outstanding 7,672
................................................................................
Add: Effect of dilutive securities:
Stock options 72
................................................................................
Incentive awards 75
- --------------------------------------------------------------------------------
Average diluted shares outstanding 7,819
================================================================================
(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 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.
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, 1997 was approximately $30.8 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
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 27 --
<PAGE>
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, 1997, 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,
1997 and 1996 the Bank was considered well-capitalized.
The following is a summary of the Bank's actual capital amounts and ratios as of
December 31, 1997 and 1996, compared to the OTS minimum capital adequacy
requirements and the OTS requirements for classification as a well-capitalized
institution (in thousands).
To be well
For capitalized
capital under prompt
adequacy corrective
Actual purposes action
- --------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------
As of December 31, 1997:
................................................................................
Tangible capital $178,592 11.9% $22,491 1.5% $ -- --%
................................................................................
Core capital 178,592 11.9 44,982 3.0 74,969 5.0
................................................................................
Tier 1 risk-based
capital 178,592 28.8 24,763 4.0 37,144 6.0
................................................................................
Risk-based capital 184,970 29.9 49,525 8.0 61,906 10.0
................................................................................
................................................................................
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
- --------------------------------------------------------------------------------
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 $91,865,000
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, 1997 and December 31, 1996 are as follows (in thousands):
December 31, 1997
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------
Investment Securities
Available for Sale:
................................................................................
United States
Government and
agency obligations $204,992 $ 948 $ (292) $205,648
................................................................................
State and municipal
obligations 393 7 -- 400
................................................................................
Equity investments 1,170 139 -- 1,309
- --------------------------------------------------------------------------------
$206,555 $1,094 $ (292) $207,357
================================================================================
December 31, 1996
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
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
================================================================================
The amortized cost and estimated market value of investment securities at
December 31, 1997 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.
December 31, 1997
- --------------------------------------------------------------------------------
Estimated
Amortized Market
Cost Value
- --------------------------------------------------------------------------------
Investment Securities
Available For Sale:
................................................................................
Due in one year or less $ 6,230 $ 6,328
................................................................................
Due after one year through five years 85,197 85,212
................................................................................
Due after five years through ten years 115,128 115,817
................................................................................
Due after 10 years -- --
- --------------------------------------------------------------------------------
$206,555 $207,357
================================================================================
Gross losses on the sale of investment securities available for sale of $587,000
were realized in 1995.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 28 --
<PAGE>
(5) Mortgage-Backed Securities
The amortized cost and estimated market value of mortgage-backed securities at
December 31, 1997 and December 31, 1996 are as follows (in thousands):
December 31, 1997
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-Backed Securities
Available for Sale:
................................................................................
FHLMC $ 245,414 $ 1,549 $ (1,404) $ 245,559
................................................................................
FNMA 109,873 719 (601) 109,991
................................................................................
GNMA 97,714 465 (7) 98,172
................................................................................
Collaterized mortgage
obligations 3,378 48 - 3,426
- --------------------------------------------------------------------------------
$ 456,379 $ 2,781 $ (2,012) $ 457,148
- --------------------------------------------------------------------------------
December 31, 1996
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
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 losses on the sale of mortgage-backed securities available for sale of
$142,000 were realized in 1997.
Collateralized mortgage obligations issued by FHLMC, FNMA and private interests
amounted to $2,274,000, $519,000 and $633,000, respectively at December 31, 1997
and $4,143,000, $697,000 and $928,000, respectively at December 31, 1996.
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, 1997 and 1996 follows (in
thousands):
December 31, 1997 1996
- --------------------------------------------------------------------------------
Real estate mortgage:
................................................................................
One to four-family $ 710,880 $ 626,857
................................................................................
Commercial real estate, multi-family and land 25,699 15,613
................................................................................
FHA insured & VA guaranteed 668 941
- --------------------------------------------------------------------------------
737,247 643,411
................................................................................
Real estate construction 8,748 9,287
................................................................................
Consumer 45,417 36,860
................................................................................
Commercial 2,904 21
- --------------------------------------------------------------------------------
Total loans 794,316 689,579
- --------------------------------------------------------------------------------
Loans in process (2,867) (3,517)
................................................................................
Deferred fees (1,133) (1,302)
................................................................................
Unearned discount (9) (11)
................................................................................
Allowance for loan losses (6,612) (6,021)
- --------------------------------------------------------------------------------
(10,621) (10,851)
- --------------------------------------------------------------------------------
$ 783,695 $ 678,728
- --------------------------------------------------------------------------------
At December 31, 1997, 1996 and 1995, loans in the amount of $5,554,000,
$7,697,000, and $8,671,000, 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 $278,000, $345,000 and $428,000 of
additional interest income would have been recognized for the years ended
December 31, 1997, 1996 and 1995, respectively. The Company was not committed to
lend additional funds on any nonaccrual loans at December 31, 1997.
An analysis of the allowance for loan losses for the years ended December 31,
1997, 1996 and 1995 is as follows (in thousands):
Year Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------
Balance at beginning of year $ 6,021 $ 6,001 $ 5,608
................................................................................
Provision charged to operations 900 700 950
................................................................................
Charge-offs (337) (692) (568)
................................................................................
Recoveries 28 12 11
- --------------------------------------------------------------------------------
Balance at end of year $ 6,612 $ 6,021 $ 6,001
- --------------------------------------------------------------------------------
At December 31, 1997, 1996 and 1995, the Company serviced loans for others in
the amount of $144,230,000, $152,717,000 and $143,115,000, respectively.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 29 --
<PAGE>
(7) Interest and Dividends Receivable
A summary of interest and dividends receivable at December 31, 1997 and 1996
follows (in thousands):
December 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Loans $ 4,018 $ 3,567
................................................................................
Investment securities 3,190 2,811
................................................................................
Mortgage-backed securities 3,856 3,379
- --------------------------------------------------------------------------------
$ 11,064 $ 9,757
- --------------------------------------------------------------------------------
(8) Premises and Equipment, Net
Premises and equipment at December 31, 1997 and 1996 are summarized as follows
(in thousands):
December 31, 1997 1996
- --------------------------------------------------------------------------------
Land $ 3,195 $ 3,195
................................................................................
Buildings and improvements 10,922 10,260
................................................................................
Leasehold improvements 1,322 1,101
................................................................................
Furniture and equipment 5,613 4,448
................................................................................
Automobiles 150 130
................................................................................
Construction in progress 181 735
- --------------------------------------------------------------------------------
Total 21,383 19,869
................................................................................
Accumulated depreciation and amortization (7,104) (5,769)
- --------------------------------------------------------------------------------
$ 14,279 $ 14,100
- --------------------------------------------------------------------------------
(9) Real Estate Owned, Net
An analysis of the allowance for losses on real estate owned for the years ended
December 31, 1997, 1996 and 1995 is as follows (in thousands):
Year Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------
Balance at beginning of year $ 402 $ 411 $ 476
................................................................................
Losses charged off (35) (9) (65)
- --------------------------------------------------------------------------------
Balance at end of year $ 367 $ 402 $ 411
- --------------------------------------------------------------------------------
(10) Deposits
Deposits, including accrued interest payable of $175,000 and $105,000 at
December 31, 1997 and 1996, respectively, are summarized as follows (in
thousands):
December 31, 1997 1996
- --------------------------------------------------------------------------------
Weighted Weighted
Average Average
Amount Cost Amount Cost
- --------------------------------------------------------------------------------
Non-interest bearing accounts $ 13,149 -% $ 6,354 -%
................................................................................
NOW accounts 77,994 1.84 71,168 1.84
................................................................................
Money market deposit accounts 67,979 2.90 70,021 2.90
................................................................................
Savings accounts 163,202 2.28 169,527 2.28
................................................................................
Time deposits 654,440 5.69 617,660 5.55
- --------------------------------------------------------------------------------
$976,764 4.52% $934,730 4.44%
- --------------------------------------------------------------------------------
Included in time deposits at December 31, 1997 and 1996, respectively, is
$59,504,000 and $43,841,000 in deposits of $100,000 and over.
Time deposits at December 31, 1997 mature as follows (in thousands):
December 31, 1997
- --------------------------------------------------------------------------------
1998 $ 439,777
................................................................................
1999 121,832
................................................................................
2000 26,039
................................................................................
2001 38,614
................................................................................
2002 18,119
................................................................................
Thereafter 10,059
- --------------------------------------------------------------------------------
$ 654,440
- --------------------------------------------------------------------------------
Interest expense on deposits for the years ended December 31, 1997, 1996 and
1995 was as follows (in thousands):
Year ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------
NOW accounts $ 1,388 $ 1,371 $ 1,483
................................................................................
Money market deposit accounts 2,028 1,994 2,083
................................................................................
Savings accounts 3,877 4,069 4,537
................................................................................
Time deposits 35,667 33,555 31,723
- --------------------------------------------------------------------------------
$ 42,960 $40,989 $39,826
- --------------------------------------------------------------------------------
(11) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are as follows (in thousands):
1997 1996
- --------------------------------------------------------------------------------
Balance at December 31 $ 288,200 $ 99,322
................................................................................
Average Balance 209,089 9,803
................................................................................
Maximum amount outstanding
at any month end 294,826 99,322
................................................................................
Average interest rate:
During the year 5.85% 5.81%
................................................................................
At December 31 6.01 5.69
- --------------------------------------------------------------------------------
At December 31, 1997, securities sold under agreements to repurchase matured as
follows: $198,700,000 in 1998; $24,500,000 in 1999; $30,000,000 in 2002; and
$35,000,000 in 2004. 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 $301,117,000 and $301,231,000,
respectively, at December 31, 1997 and $102,943,000 and $102,974,000,
respectively, at December 31, 1996. The securities underlying the agreements are
not under the Company's control.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 30 --
<PAGE>
(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 year
ended December 31, 1995, 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.
Retained earnings at December 31, 1997 includes 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, 1997 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, 1997, 1996 and
1995 consists of the following (in thousands):
Year Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------
Current:
Federal $ 6,648 $ 4,001 $ 3,936
................................................................................
State 221 345 338
- --------------------------------------------------------------------------------
Total Current 6,869 4,346 4,274
- --------------------------------------------------------------------------------
Deferred:
Federal 857 (2,992) 353
................................................................................
State (39) (271) 32
- --------------------------------------------------------------------------------
Total Deferred 818 (3,263) 385
- --------------------------------------------------------------------------------
$ 7,687 $ 1,083 $ 4,659
================================================================================
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,
1997, 1996 and 1995 is as follows (in thousands):
Year Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------
Income (loss) before provision
for income taxes $ 21,512 $ (646) $ 12,606
................................................................................
Applicable statutory
Federal income tax rate 34.5% 34.1% 34.1%
................................................................................
Computed "expected"
Federal income tax expense (benefit) $ 7,422 $ (220) $ 4,299
................................................................................
Increase (decrease) in Federal income
tax expense resulting from:
Valuation allowance - 1,166 -
................................................................................
ESOP adjustment 316 62 -
................................................................................
State income taxes net of Federal benefit 119 49 253
................................................................................
Other items, net (170) 26 107
- --------------------------------------------------------------------------------
$ 7,687 $ 1,083 $ 4,659
================================================================================
Effective tax rate 35.7% N/A 37.0%
================================================================================
Included in other assets at December 31, 1997 and 1996 is a net deferred tax
asset of $3,962,000 and $5,550,000, respectively. In addition, included in other
liabilities at December 31, 1997 and 1996 is a current tax payable of $259,000
and $409,000, 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, 1997 and
1996 are presented below (in thousands).
December 31, 1997 1996
- --------------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan and real estate
owned losses per books $ 2,430 $ 2,319
................................................................................
Reserve for uncollected interest 113 188
................................................................................
Deferred compensation 297 247
................................................................................
Accrued pension expense 194 191
................................................................................
Premises and equipment, differences in depreciation 286 202
................................................................................
Other reserves 173 199
................................................................................
Stock awards 652 -
................................................................................
Charitable donation 3,599 4,321
................................................................................
Unrealized loss on securities available for sale - 192
- --------------------------------------------------------------------------------
Total gross deferred tax assets 7,744 7,859
................................................................................
Less valuation allowance (1,166) (1,166)
- --------------------------------------------------------------------------------
Deferred tax assets, net 6,578 6,693
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Allowance for loan and real estate
owned losses for tax purposes (858) (842)
................................................................................
Unrealized gain on securities available for sale (578) -
................................................................................
Excess servicing on sale of mortgage loans (94) (95)
................................................................................
Investments, discount accretion (26) (24)
................................................................................
Deferred loan and commitment fees (371) (182)
................................................................................
Fair market value adjustment on loans available for sale (19) -
................................................................................
Undistributed income of real estate
investment trust subsidiary (670) -
- --------------------------------------------------------------------------------
Total deferred tax liabilities (2,616) (1,143)
- --------------------------------------------------------------------------------
Net deferred tax assets $ 3,962 $ 5,550
================================================================================
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 1997 and the succeeding four 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 31 --
<PAGE>
(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. Beginning April 1, 1997,
ESOP shares are first allocated to employees who also participate in the Bank's
Incentive Savings (401K) Plan in an amount equal to 50% of the first 6% of the
employee's contribution. During 1997, 3,345 shares were either released or
committed to be released under this formula. The remaining ESOP shares are
allocated among participants on the basis of compensation earned during the
year. 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 a fixed
interest rate of 8.25%. The Bank's obligation to make such contributions is
reduced to the extent of any dividends paid by the Company on unallocated shares
and any investment earnings realized on such dividends. As of December 31, 1997
and 1996, contributions to the ESOP, which were used to fund principal and
interest payments on the ESOP debt, totaled $2,133,000 and $1,666,000,
respectively. During 1997, $368,000 of dividends paid on unallocated ESOP shares
were used for debt service. At December 31, 1997 and 1996, the loan had an
outstanding balance of $11,184,000 and $12,302,000, respectively, and the ESOP
had unallocated shares of 543,942 and 615,314, respectively. At December 31,
1997 and 1996, the unallocated shares had a fair value of $20,262,000 and
$15,691,000, respectively. 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 years ended December 31, 1997 and 1996, the Bank recorded compensation
expense related to the ESOP of $2,345,000 and $1,272,000, respectively,
including $917,000 and $182,000, respectively, representing adjustments to
expense to reflect the increase in the average fair value of allocated shares in
excess of cost. As of December 31, 1997, 58,029 shares had been allocated to
participants and 69,075 shares were committed to be released.
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, 1997 and 1996 in the Company's consolidated
statements of financial condition (in thousands):
1997 1996
- --------------------------------------------------------------------------------
Actuarial present value of benefit obligations
- - accumulated benefit obligation:
Vested $(1,625) $(1,657)
................................................................................
Non-vested (106) (114)
- --------------------------------------------------------------------------------
Projected benefit obligation for service
rendered to date (1,731) (1,771)
................................................................................
Plan assets at fair value, primarily a group
annuity contract 1,456 1,476
- --------------------------------------------------------------------------------
Plan assets less than projected benefit obligation (275) (295)
................................................................................
Unrecognized net loss 120 165
................................................................................
Unrecognized net transition asset (311) (343)
- --------------------------------------------------------------------------------
Accrued pension cost (included in other liabilities) $ (466) $ (473)
================================================================================
The components of net pension expense for the years ended December 31, 1997,
1996 and 1995 are as follows (in thousands):
1997 1996 1995
- --------------------------------------------------------------------------------
Service cost - benefits earned during the year $ -- $ 98 $ 209
................................................................................
Interest cost on projected benefit obligation 113 136 137
................................................................................
Actual return on plan assets (81) (89) (79)
................................................................................
Net amortization and deferral (39) (42) (40)
- --------------------------------------------------------------------------------
Net pension (benefit) expense $ (7) $ 103 $ 227
================================================================================
Assumptions used to develop the
net periodic pension cost are:
................................................................................
Discount rate 6.51% 6.51% 8.00%
................................................................................
Expected long-term rate of return on assets 6.75 6.75 6.75
................................................................................
Rate of increase in compensation level N/A 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. Prior to July 1, 1996, the Bank contributed 75% of the first 6% of
the employee's contribution to the employee's account. From to July 1, 1996
through March 31, 1997, the Bank contributed 50% of the first 6% of the
employees contribution to the employee's account. Effective March 31, 1997, the
Bank eliminated their matching obligation under this plan. The Bank's
contributions under this plan were $53,000, $161,000 and $242,000 for the years
ended December 31, 1997, 1996 and 1995, 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 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
--32--
<PAGE>
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)1997 Incentive Plan
On February 4, 1997, a special meeting of the Company's shareholders ratified
the Ocean Financial Corp. 1997 Incentive Plan (the "Incentive Plan"). The
Incentive Plan authorizes the granting of options to purchase Common Stock,
option-related awards and awards of Common Stock. 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.
During 1997, the Company acquired 335,523 shares in the open market at a cost of
$10,176,000. At December 31, 1997, 312,676 of these shares have been awarded to
officers and directors. Such amounts represent deferred compensation and have
been accounted for as a reduction of stockholders' equity. Awards vest at the
rate of 20% per year except that the Company has determined that certain awards
are also contingent upon attainment of certain performance goals by the Company,
which performance goals would be established by a committee of outside directors
("Committee"). The first and second annual installments will vest on the first
and second anniversary dates 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. The Company recorded compensation expense relating to stock awards of
$1,773,000 for the year ended December 31, 1997.
Under the 1997 Incentive Plan, the Company is authorized to issue up to 838,807
shares, subject to option. All options expire 10 years from the date of grant
and vest at the rate of 20% per year.
The company accounts for stock option awards using the intrinsic value method
and has recognized no compensation expense in 1997. SFAS 123 permits the use of
the intrinsic value method; however, requires the Company to disclose the pro
forma net income and earnings per share as if the stock based compensation had
been accounted for using the fair value method. Had the compensation costs for
the Company's stock option plan been determined based on the fair value method,
the Company's net income and earnings per share would have been reduced to the
pro forma amounts indicated below (in thousands except per share data):
Net income:
................................................................................
As reported $ 13,825
................................................................................
Pro forma 13,000
................................................................................
Basic earnings per share:
................................................................................
As reported $ 1.80
................................................................................
Pro forma 1.69
................................................................................
Diluted earnings per share:
................................................................................
As reported $ 1.77
................................................................................
Pro forma 1.68
................................................................................
Weighted average fair value of an option share
granted during the year $ 8.16
- --------------------------------------------------------------------------------
The fair value of stock options granted by the Company was estimated through the
use of the Black-Scholes option pricing model applying the following
assumptions:
Risk-free interest rate 6.25%
................................................................................
Expected option life 6 years
................................................................................
Expected volatility 25%
................................................................................
Expected dividend yield 2.50%
- --------------------------------------------------------------------------------
A summary of option activity for the year ended December 31, 1997 follows:
Weighted
Number Average
of Shares Exercise Price
- --------------------------------------------------------------------------------
Outstanding at beginning of year - $ -
................................................................................
Granted 810,879 28.90
................................................................................
Exercised - -
................................................................................
Forfeited (27,178) 28.82
- --------------------------------------------------------------------------------
Outstanding at end of year 783,701 $ 28.91
================================================================================
At December 31, 1997
................................................................................
Options exercisible None
................................................................................
Range of exercise prices $28.82 - $37.12
................................................................................
Weighted average remaining contractual life 9.1 years
================================================================================
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 33 --
<PAGE>
(15)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, 1997, the following commitments and contingent liabilities
existed which are not reflected in the accompanying consolidated financial
statements (in thousands):
December 31, 1997
- --------------------------------------------------------------------------------
Unused consumer and construction
loan lines of credit (primarily floating-rate) $20,485
................................................................................
Unused commercial loan lines of credit
(primarily floating rate) 2,682
................................................................................
Other commitments to extend credit:
................................................................................
Fixed Rate 24,536
................................................................................
Adjustable Rate 17,371
................................................................................
Floating Rate 1,007
................................................................................
The Company's fixed-rate loan commitments expire within 90 days of issuance and
carried interest rates ranging from 6.625% to 7.75% at December 31, 1997.
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, 1998. 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, 1997, the Company is obligated under noncancellable operating
leases for premises and equipment. Rental expense under these leases aggregated
approximately $515,000, $822,000 and $791,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
The projected minimum rental commitments as of December 31, 1997 are as follows
(in thousands):
December 31 1997
- --------------------------------------------------------------------------------
1998 $ 472
................................................................................
1999 537
................................................................................
2000 403
................................................................................
2001 326
................................................................................
2002 235
................................................................................
Thereafter 1290
- --------------------------------------------------------------------------------
$3,263
================================================================================
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.
(16)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.
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 and
mortgage-backed securities.
Loans
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as residential mortgage,
construction, land, consumer and commercial. 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.
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 34 --
<PAGE>
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,
1997 and 1996 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, 1997 Value Value
- --------------------------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 2,225 $ 2,225
................................................................................
Investment securities available for sale 207,357 207,357
................................................................................
Mortgage-backed securities available for sale 457,148 457,148
................................................................................
Federal Home Loan Bank of New York stock 14,980 14,980
................................................................................
Loans receivable and mortgage loans held for sale 783,695 807,651
................................................................................
Financial Liabilities:
Deposits 976,764 978,631
................................................................................
Federal Home Loan Bank borrowings 20,400 20,400
................................................................................
Securities sold under agreements to repurchase $288,200 $288,547
================================================================================
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
================================================================================
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.
(17)Parent-Only Financial Information
The following condensed statements of financial condition at December 31, 1997
and 1996 and condensed statements of operations and cash flows for the year
ended December 31, 1997 and for the period from July 2, 1996 (date of
conversion) to December 31, 1996 for Ocean Financial Corp. (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 STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 1996
- --------------------------------------------------------------------------------
(in thousands)
ASSETS
Cash and due from banks $ 7 $ 7
................................................................................
Advances to subsidiary Bank 9,931 71,553
................................................................................
Investment securities 10,780 -
................................................................................
ESOP loan receivable 11,184 12,302
................................................................................
Investment in subsidiary Bank 181,470 166,147
................................................................................
Other assets 3,320 3,470
- --------------------------------------------------------------------------------
Total Assets $ 216,692 $ 253,479
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Taxes payable $ 1,148 $ 690
................................................................................
Stockholders' Equity 215,544 252,789
- --------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 216,692 $ 253,479
================================================================================
CONDENSED STATEMENTS OF OPERATIONS
For the
period from
Year Ended July 2, 1996
December to December
31, 1997 31, 1996
- --------------------------------------------------------------------------------
(in thousands)
Interest income - Investment securities $ 2,889 $ -
................................................................................
Interest income - Advances to subsidiary Bank 132 1,840
................................................................................
Interest income - ESOP loan receivable 1,015 547
- --------------------------------------------------------------------------------
Total interest income 4,036 2,387
................................................................................
Other income 2 -
................................................................................
Charitable donation - 13,419
................................................................................
Other operating expenses 383 152
- --------------------------------------------------------------------------------
Income (loss) before income taxes and equity
in undistributed earnings of subsidiary Bank 3,655 (11,184)
................................................................................
Provision (benefit) for income taxes 1,233 (2,755)
- --------------------------------------------------------------------------------
Income (loss) before equity in
undistributed earnings of subsidiary Bank 2,422 (8,429)
................................................................................
Equity in undistributed earnings of
subsidiary Bank 11,403 1,817
- --------------------------------------------------------------------------------
Net income (loss) $ 13,825 $ (6,612)
================================================================================
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 35 --
<PAGE>
CONDENSED STATEMENTS OF CASH FLOWS
For the
period from
Year ended July 2, 1996 to
December 31, December 31,
1997 1996
- --------------------------------------------------------------------------------
(in thousands)
Cash flows from operating activities:
Net income (loss) $ 13,825 $ (6,612)
................................................................................
Donation of 671,046 shares of common
stock to the Ocean Federal Foundation - 13,419
................................................................................
Decrease (increase) in advances to
subsidiary Bank 61,622 (71,553)
................................................................................
Equity in undistributed earnings of
subsidiary Bank (11,403) (1,817)
................................................................................
Decrease (increase) in other assets 289 (3,470)
................................................................................
Increase in taxes payable 458 690
................................................................................
Reduction in Incentive Awards 1,773 -
- --------------------------------------------------------------------------------
Net cash provided by (used in)
operating activities 66,564 (69,343)
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of investment securities
available for sale (71,170) -
................................................................................
Sale of investment securities
available for sale 60,000 -
................................................................................
Funding of ESOP loan receivable,
net of repayments 1,118 (12,302)
................................................................................
Payments for investments in subsidiary Bank - (81,650)
- --------------------------------------------------------------------------------
Net cash used in investing activities (10,052) (93,952)
- --------------------------------------------------------------------------------
Cash flows from financing activities:
Net proceeds of common stock issuance - 163,302
................................................................................
Dividends paid (4,800) -
................................................................................
Purchase of Incentive Award shares (10,176) -
................................................................................
Purchase of treasury stock (41,536) -
- --------------------------------------------------------------------------------
Net cash (used in) provided by
financing activities (56,512) 163,302
- --------------------------------------------------------------------------------
Net increase in cash and due from banks - 7
................................................................................
Cash and due from banks at beginning of period 7 -
- --------------------------------------------------------------------------------
Cash and due from banks at end of period $ 7 $ 7
================================================================================
(18)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 Saving 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 eliminated the substantial disparity between the amount that BIF and
SAIF member institutions had been paying for deposit insurance premiums.
Effective January 1, 1997, BIF members paid a portion of the FICO payment equal
to 1.3 basis points on BIF-insured deposits compared to 6.5 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 ranged 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.
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, 1997 and 1996, 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, 1997.
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, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Short Hills, NJ
January 23, 1998
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 36 --
<PAGE>
SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA
(Unaudited)
<TABLE>
<CAPTION>
Quarter ended Dec. 31 Sept. 30 June 30 March 31
....................................................................................................................................
(dollars in thousands, except per share data)
1997
<S> <C> <C> <C> <C>
....................................................................................................................................
Interest income $ 26,233 $ 25,568 $ 24,310 $ 22,545
....................................................................................................................................
Interest expense 15,407 14,658 13,510 12,033
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 10,826 10,910 10,800 10,512
....................................................................................................................................
Provision for loan losses 225 225 225 225
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 10,601 10,685 10,575 10,287
....................................................................................................................................
Other income 776 572 575 586
....................................................................................................................................
Operating expenses 6,116 5,724 5,845 5,460
- ------------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 5,261 5,533 5,305 5,413
....................................................................................................................................
Provision for income taxes 1,781 1,993 1,889 2,024
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 3,480 $ 3,540 $ 3,416 $ 3,389
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ .49 $ .48 $ .43 $ .41
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ .47 $ .47 $ .43 $ .41
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Dec. 31 Sept. 30 June 30 March 31
....................................................................................................................................
1996
<S> <C> <C> <C> <C>
....................................................................................................................................
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
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share $ .38 $ (1.16) N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share $ .38 $ (1.16) N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Ocean Financial Corp. and Subsidiary 1997 Annual Report
-- 37 --
<PAGE>
Exhibit 23
INDEPENDENT ACCOUNTANTS' CONSENT
--------------------------------
The Board of Directors
Ocean Financial Corp.:
We consent to incorporation by reference in the registration statement (No. 33-
34143) on Form S-8, pertaining to the Ocean Financial Corp. 1997 Incentive Plan,
and to the registration statement (No. 33-34145), on Form S-8, pertaining to the
Retirement Plan for Ocean Federal Savings Bank, of Ocean Financial Corp., of our
report dated January 23, 1998, relating to the consolidated statements of
financial condition of Ocean Financial Corp. and subsidiary as of December 31,
1997 and 1996 and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997, which report is incorporated by reference in the
December 31, 1997 Annual Report on Form 10-K of Ocean Financial Corp.
KPMG PEAT MARWICK LLP
Short Hills, New Jersey
March 25, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,225
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 664,505
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 783,695
<ALLOWANCE> 6,612
<TOTAL-ASSETS> 1,510,947
<DEPOSITS> 976,764
<SHORT-TERM> 308,600
<LIABILITIES-OTHER> 10,039
<LONG-TERM> 0
0
0
<COMMON> 91
<OTHER-SE> 215,453
<TOTAL-LIABILITIES-AND-EQUITY> 1,510,947
<INTEREST-LOAN> 57,540
<INTEREST-INVEST> 41,116
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 98,656
<INTEREST-DEPOSIT> 42,960
<INTEREST-EXPENSE> 55,608
<INTEREST-INCOME-NET> 43,048
<LOAN-LOSSES> 900
<SECURITIES-GAINS> (142)
<EXPENSE-OTHER> 23,145
<INCOME-PRETAX> 21,512
<INCOME-PRE-EXTRAORDINARY> 21,512
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,825
<EPS-PRIMARY> 1.80
<EPS-DILUTED> 1.77
<YIELD-ACTUAL> 7.15
<LOANS-NON> 5,554
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 6,021
<CHARGE-OFFS> 337
<RECOVERIES> 28
<ALLOWANCE-CLOSE> 6,612
<ALLOWANCE-DOMESTIC> 3,649
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,963
</TABLE>
