FIRST STATE FINANCIAL SERVICES, INC.
First State Financial Services, Inc. (First State) is a Delaware
corporation which acquired all of the stock of First DeWitt Savings
and Loan Association upon its conversion from a New Jersey state
chartered mutual savings and loan association to a stock association.
This conversion was completed on December 29, 1987. On March 1, 1993,
First DeWitt Savings and Loan Association converted to a federal
savings bank charter and on August 1, 1994, this institution became
known as First DeWitt Bank. The information and consolidated
financial statements in this annual report of First State relate
primarily to its wholly-owned subsidiary, First DeWitt Bank, through
which First State conducts its principal business activities.
First DeWitt Bank is regulated by the Office of Thrift
Supervision and is a member of the Federal Home Loan Bank of New York.
The Bank's primary business consists of attracting deposits from the
general public and originating first mortgage loans secured by
residential properties, consumer and home equity loans and commercial
and construction mortgage loans. First DeWitt conducts its business
through 14 full-service offices in five counties in New Jersey. First
DeWitt's deposits are insured by the FDIC.
The common stock of First State Financial Services, Inc. is
traded on the over-the-counter market and quoted by the National
Association of Security Dealers Automatic Quotation (NASDAQ) National
Market System under the symbol "FSFI."
Contents:
Chairman's Message 2
Business Description 3
Selected Consolidated Financial and Other Data 4
Management's Discussion and Analysis 5
Consolidated Financial Statements 16
Stockholder Information 45
Officers and Directors 46
To Our Shareholders:
The year 1996 proved to be both a challenging and rewarding year
for the shareholders of First State Financial Services, Inc. In terms
of earnings, the company was faced with the negative impact of the one-
time Savings Association Insurance Fund ("SAIF") special assessment as
well as the need to provide for the potential of further deterioration
in the value of certain loans and other real estate owned. On the
positive side, the company signed a merger agreement with Sovereign
Bancorp of Wyomissing, Pennsylvania (amended November 26, 1996)
whereby shareholders would exchange their shares in a tax-deferred
transaction for a minimum value (subject to certain contingencies)
equal to $14.75. Let me take a moment to expand on both these
challenges and rewards.
For the full year ended September 30, 1996, the company reported
a loss of $5.6 million, or $1.40 per share, compared to earnings
during the comparable period last year of $4.0 million, or $1.01 per
share. On a pretax basis, the loss equaled $7.3 million. The SAIF
special assessment of $3.1 million accounted for 42.7% of the total
pretax loss. The other factors contributing to the loss included a
provision for loan losses of $8.9 million, compared to $1.7 million
last year, and problem asset expenses of $3.7 million, compared to
$1.6 million in 1995. On the positive side of the income statement,
net interest income advanced 11.5% to $25.2 million. In terms of the
balance sheet, total assets declined 4.2% to $610.4 million, while
loans receivable advanced 4.2% to $480.9 million. Deposits declined
slightly by 2.4% to $554.3 million. Total shareholder equity at
September 30, 1996, equaled $35.2 million, or 5.8% of total assets.
In terms of the rewards for shareholders, I am pleased to report
that your company executed a Definitive Agreement dated June 24, 1996,
amended on November 26, 1996, under which we would be acquired by
Sovereign Bancorp. Shareholders in our company would receive the
greater of $14.75 in Sovereign common stock or 1.225 shares of
Sovereign common stock for each outstanding share of First State.
Your company retains the right to terminate the Definitive Agreement
if the average price of Sovereign is below $8.00. As of the date of
this letter, Sovereign was selling at approximately $13 per share of
common stock. Substantially more information contained in a proxy in
preparation for a shareholders' meeting will be mailed shortly to all
holders of our company stock. Assuming regulatory and shareholder
approvals are obtained in due course, it is anticipated that the
merger will be consummated before March 31, 1997. The senior
management of your company believes that the Merger Agreement with
Sovereign, which was unanimously approved by the Board of Directors of
your company, is in the best interests of shareholders.
With the pending merger, this letter to shareholders is likely to
be my last chance to communicate with you. On a personal note, I
would like to take this opportunity to thank all of our shareholders
for your support during the past nine years. Also, I wish to thank our
dedicated employees for their loyal cooperation during my tenure here
at First State. With best wishes for the future, I am
Sincerely yours,
/s/ Michael J. Quigley,III
Michael J. Quigley, III
Chairman, President and
Chief Executive Officer
Business Description
First State Financial Services, Inc. (First State) conducts its
principal business activity through First DeWitt Bank (First DeWitt or
the Bank). The principal business of the Bank is attracting deposits
from the general public and originating residential mortgage loans,
consumer loans, home equity loans, and commercial and construction
mortgage loans. The Bank conducts its business through six full-
service offices in Essex County, three full-service offices in each of
Ocean and Monmouth counties, and one full service office in each of
Morris and Sussex counties, New Jersey.
The Bank has a number of different deposit programs designed to
attract both short-term and long-term deposits. These programs
include passbook, statement savings and club accounts, commercial
checking, checking accounts, NOW accounts, money market checking and
passbook accounts, IRA, SEPP and Keogh retirement accounts,
certificate accounts and jumbo certificates in denominations of
$100,000 or more. The principal methods used to attract deposit
accounts include offering a wide variety of services and accounts,
competitive interest rates, and convenient hours and locations.
The Bank originates fixed-rate loans and ARMs on single family
and multi-family residential properties for terms generally ranging
from 5 to 30 years. These loans are generally originated in
accordance with Federal Home Loan Mortgage Corporation and Federal
National Mortgage Association standards which enable the Bank to sell
or securitize these loans in the secondary mortgage market. A wide
variety of consumer loan programs are offered by the Bank including
automobile loans, loans secured by passbook or certificate accounts,
home improvement loans, home equity lines of credit, personal loans,
and student loans guaranteed by the State of New Jersey. The Bank
also offers credit card programs, construction loans, and loans for
commercial purposes to businesses and individuals.
Revenues of the Bank are derived principally from interest earned
on loans, fees charged in connection with loans and banking services,
and interest and dividends from investment securities. The Bank's
primary sources of funds are deposit inflows, interest and principal
repayments on loans outstanding, prepayment of loan balances, proceeds
from the sales and maturities of loans, mortgage-backed securities,
investment securities and short-term investments, and borrowings.
First State's other wholly-owned subsidiary, First State
Investment Services, Inc., was organized primarily to offer
professional financial services and new investment alternatives, such
as tax deferred annuities, mutual funds, etc., to the Bank's
customers.
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Selected Financial Data
As of and for the Year Ended September 30,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share amounts)
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Total Assets $ 610,417 $ 637,020 $ 553,483 $ 476,370 $ 470,520
========== ========== ========== ========== ==========
Loans receivable:
Net mortgage loans (1) 406,982 441,455 374,412 312,578 299,597
Net consumer and commercial loans 83,055 87,412 72,002 64,042 57,551
---------- ---------- ---------- ---------- ----------
Total loans receivable 490,037 528,867 446,414 376,620 357,148
Mortgage-backed securities 31,024 18,961 18,751 25,837 30,607
---------- ---------- ---------- ---------- ----------
Total loans receivable and
mortgage-backed securities $ 521,061 $ 547,828 $ 465,165 $ 402,457 $ 387,755
========== ========== ========== ========== ==========
Total investment securities and FHLB stock $ 37,513 $ 36,403 $ 40,413 $ 28,331 $ 33,421
Excess of cost over fair value of net assets
required 2,149 2,349 2,777 3,311 3,845
Deposits 554,320 567,710 479,364 432,012 428,402
Borrowed money 5,928 23,105 31,738 5,680 5,846
Retained income, substantially restricted 14,183 20,693 17,453 14,431 11,906
Total stockholder's equity 35,236 41,592 37,973 34,179 31,490
OPERATING DATA:
Interest income $ 49,239 $ 44,349 $ 34,935 $ 34,624 $ 36,479
Interest expense 24,054 21,765 13,448 15,401 20,474
---------- ---------- ---------- ---------- ----------
Net interest income 25,185 22,584 21,487 19,223 16,005
Provision for loan losses 8,900 1,650 1,892 2,440 2,677
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for loan losses 16,285 20,934 19,595 16,783 13,328
---------- ---------- ---------- ---------- ----------
Other income 17,480 6,368 4,150 4,205 3,881
---------- ---------- ---------- ---------- ----------
Operating expenses 41,022 22,172 18,881 18,448 16,997
---------- ---------- ---------- ---------- ----------
Income (loss) before income tax
expense (benefit) (7,257) 5,130 4,864 2,540 212
Income tax expense (benefit) (1,608) 1,132 1,363 15 (504)
Extraordinary item - - - - -
---------- ---------- ---------- ---------- ----------
Net income (loss) $ (5,649) $ 3,998 $ 3,501 $ 2,525 $ 716
========== ========== ========== ========== ==========
Net income (loss) per share $ (1.40) $ 1.01 $ 0.91 $ 0.65 $ .19
SELECTED OTHER DATA:
Return on average assets (0.90)% 0.67% 0.70% 0.53% 0.15%
Return on average equity (13.51) 10.27 9.62 7.56 2.28
Average equity to average assets 6.69 6.56 7.27 6.99 6.70
Interest rate spread(2) 4.41 4.25 4.72 4.50 3.94
Net yield on average interest-earning assets(3) 4.38 4.18 4.73 4.46 3.82
Average interest-earning assets to
average interest-bearing liabilities 0.99X 0.98x 1.01x 0.99x 0.98x
Book value per share of common stock
outstanding $ 8.97 $ 10.71 $ 9.89 $ 8.86 $ 8.17
Dividends paid per share of common stock
outstanding $ 0.22 $ 0.21 $ 0.12 $ - $ -
Dividend payout ratio N/M 20.79% 13.19% 0.00% 0.00%
Number of full service offices 14 12 12 12 11
(1)Includes construction and land development loans of $17.6 million, $23.0 million, $19.7 million, $11.3 million,
and $19.1 million, at September 30, 1996, 1995, 1994, 1993, and 1992, respectively. Also includes mortgage
loans held for resale of $9.1 million, $67.2 million,$3.1 million, $10.9 million, and $10.2 million at
September 30, 1996, 1995, 1994, 1993, and 1992, respectively.
(2)Represents the average yield earned on interest-earning assets less the
average cost of interest-bearing liabilities.
(3)Represents net interest income as a percentage of average interest-earning
assets.
</TABLE>
MANAGEMENT'S DISCUSSION and ANALYSIS
Introduction
First State Financial Services, Inc. (First State) conducts its
principal business activity through First DeWitt Bank, (the Bank), a
wholly-owned subsidiary.
On June 24, 1996, the Corporation signed a definitive merger
agreement providing for the acquisition of all of the outstanding
stock of First State Financial Services, Inc. by Sovereign Bancorp,
Inc. (Sovereign). This merger agreement was amended by an agreement
(the "amendment") signed by both parties on November 26, 1996. The
amendment calls for First State shareholders to receive between 1.225
and 1.84 shares of Sovereign's common stock under a floating exchange
ratio for each share of First State common stock if Sovereign's
average closing price as defined in the amendment (the "Sovereign
Market Value") is greater than or equal to $8.00 but less than or
equal to $12.04. Within this range, the exchange ratio will be $14.75
divided by the Sovereign Market Value. If the Sovereign Market Value
is greater than $12.04, the exchange ratio will be 1.225. If the
Sovereign Market Value falls below $8.00, the agreement may be
terminated by First State unless certain conditions are met. In a
related agreement, Sovereign was given an option to purchase up to
783,000 shares of First State's issued and outstanding common stock if
certain conditions occur. The merger is subject to certain
conditions, including approval by First State's shareholders and
various regulatory authorities, and is expected to be completed by the
first calendar quarter of 1997.
On a consolidated basis, at September 30, 1996, First State had
total assets of $610.4 million. This represented a decrease in assets
of $26.6 million, or 4.2%, from September 30, 1995. The principal
asset decreases were in mortgage loans held for resale, investments
available for sale, and real estate owned. These decreases were
partially offset by increases in loans receivable, mortgage backed
securities and investment securities. Total liabilities were $575.2
million at September 30, 1996 and this represents a decrease of $20.2
million, or 3.4%, from September 30, 1995. The principal decreases
were in deposits and borrowings, partially offset by an increase in
other liabilities. Total stockholders' equity amounted to $35.2
million at September 30, 1996 and this was a decrease of $6.4 million
from September 30, 1995. This decrease was primarily due to a net
loss of $5.6 million for the year ended September 30, 1996.
First State recorded a net loss for the year ended September 30,
1996 of $5.6 million, or $1.40 per share, compared to a net income of
$4.0 million for the year ended September 30, 1995, or $1.01 per
share. Provisions for loan losses of $8.9 million, provisions for
writedowns of real estate owned of $3.0 million and the special one-
time assessment of $3.1 million, charged by the Federal Deposit
Insurance Corporation for the Savings Association Insurance Fund
("SAIF"), were the principal causes of the loss in the current fiscal
year.
Net income is primarily dependent upon net interest income, which
represents the difference between interest income on interest earning
assets and the cost of interest bearing liabilities. Earnings could be
affected by interest rate fluctuations to the extent that interest
bearing liabilities mature or reprice more rapidly than interest
earning assets. Such asset/liability structure may result in lower
net interest income during periods of rising interest rates and may be
beneficial in times of declining interest rates. The net interest
rate spread for fiscal 1996 was 4.41% compared to 4.25% for fiscal
1995. Net income, which is affected by interest rate spread, is also
affected by lack of income from nonperforming assets, gains or losses
on sales of loans and securities, provision for loan losses, other
income, operating expenses, and income taxes.
Both First State's and the Bank's capital positions remain
strong, however, they were severely impacted by the loan loss
provisions, writedowns of real estate owned and SAIF assessment that
occurred over the year. At September 30, 1996, the Bank's capital
position exceeded all regulatory requirements and was categorized as
"adequately capitalized" under the Prompt Corrective Actions
provisions of the Federal Deposit Insurance Corporation Improvement
Act of 1991.
First State's stock price reached record highs in 1996. At
September 30, 1996, the stock closed at $13.375 per share. This
compares to a stock price of $12.75 at September 30, 1995 and a $5.50
stock price in December, 1987 when First State became a public
corporation.
First DeWitt Bank continued to expand it franchise. During
fiscal 1996, the Bank opened a branch office in Ocean County, New
Jersey, and a branch office in Wall Township, New Jersey. The new
offices brought the Bank's total number of offices in its "southern
region" to six and the overall branch office total to fourteen.
Deposits at these offices presently exceed $22.9 million.
The discussion herein reflects the financial condition and
results of operations of First State and should be reviewed in
conjunction with the consolidated financial statements and related
notes to consolidated financial statements included in this report.
Financial Condition
Total assets of First State were $610.4 million at September 30,
1996. This was a net decrease of $26.6 million from September 30,
1995. The principal decreases in assets were in mortgage loans held
for resale of $58.1 million, (due to sales), in investments available
for sale of $2.3 million, (due to sales), and in real estate owned of
$4.5 million, (due to sales and writedowns (see below)). Included in
mortgage loans held for resale at September 30, 1995, was a portfolio
of loans that totaled $60.8 million. These loans were sold during the
quarter ended December 31, 1995. Cash generated from the mortgage
loan sales, investment security sales, and real estate owned disposals
was mainly used to fund new loan originations, repay borrowings and
brokered certificates of deposit, and also to purchase other
securities.
The principal increases in assets were in loans receivable of
$19.3 million, mortgage-backed-securities of $12.1 million, in
investment securities of $3.8 million and in other assets of $3.2
million. Net loans receivable consisted of first mortgage loans of
$407.0 million, consumer loans totaling $46.7 million, and commercial
loans totaling $36.3 million. The Bank originated $107.4 million in
mortgage loans during the fiscal year. This compares with loan
originations of $129.1 million during fiscal 1995. The continued
strong performance was mainly attributable to the Bank's loan
soliciting operations. The Bank offers many loan products structured
so that they are attractive to borrowers and effectively compete with
mortgage banking companies and other lending institutions. A decrease
in market interest rates in the later months of the fiscal year
significantly slowed borrowers' requests for adjustable rate mortgage
loans. The Bank alternatively invested in adjustable rate or short
term mortgage-backed securities and investment securities. The $3.2
million increase in other assets was mainly due to an increase of $2.0
million in the deferred tax asset (caused by the increase in
provisions for loan losses, real estate writedowns and special SAIF
assessment) and the net capitalization of $471,000 in originated
mortgage servicing rights.
Problem assets at September 30, 1996 totaled $25.3 million and
consisted of $19.9 million in nonaccrual loans, $4.0 million in real
estate owned, and $1.4 million in current restructured loans.
Comparable figures at September 30, 1995 were total problem assets of
$30.5 consisting of nonaccrual loans of $18.5 million, real estate
owned of $8.6 million, and current restructured loans of $3.5 million.
Although the overall decrease in problem assets amounted to $5.2
million for the year, nonaccrual loans increased by $1.4 million. The
increase in nonaccrual loans was mainly due to one loan relationship
where the borrowers are experiencing financial difficulties. Although
the loan is reserved based upon the estimated fair value of the
underlying collateral, management is cooperating with the borrowers
who believe they can work out of their financial difficulties. The
borrowers are currently making payments which are in excess of their
normal required monthly payments. Two nonaccrual loans, totaling $3.1
million, have been repaid subsequent to September 30, 1996.
The allowance for loan losses at September 30, 1996 was $12.3
million or 61.9% of nonaccrual loans. The allowance for loan losses
at September 30, 1995 was $6.1 million or 32.9% of nonaccrual loans.
Provisions for loan losses during fiscal 1996 totaled $8.9 million,
recoveries were $141,000 and charges against the reserve were $2.8
million. This compares with provisions for loan losses of $1.7 million
during fiscal 1995, recoveries of $72,000 and charges against the
reserve of $2.0 million. The Bank's Loan Review Committee analyzes the
loan portfolio on a quarterly basis for classification of problem and
potential problem loans. The analysis of classified loans considers
such factors as the borrower's ability to repay, value of underlying
collateral, loan delinquency experience, level of allowance for loan
losses, and other matters which warrant consideration. The Loan
Review Committee also reviews the allocation of loss reserves to
loans. On April 30, 1996, the Board of Directors of First State
authorized a strategic restructuring of the operations of First State
with the goal of increasing profitability and substantially enhancing
shareholder value. This restructuring was partially in response to an
increase in nonaccrual loans that occurred over the quarter ended
March 31, 1996. One of the key elements of this restructuring was to
liquidate substantially all nonperforming assets by March 31, 1997.
The valuations of First State's problem assets were affected by this
timetable. Estimates of the carrying values necessary to dispose of
the problem assets by March 31, 1997, were formulated over the quarter
ended June 30, 1996 and resulted in a provision for loan losses for
the quarter of $4.4 million (as well as a provision for writedowns of
real estate owned of $1.3 million). Updated appraisals for several
problem assets were received over the quarter ended September 30,
1996. In addition, First State's historical loss experience on loans
necessitated an increase in overall general valuation allowance
levels. The asset values contained in the updated appraisals as well
as the increased general valuation allowance levels required a
provision for loan losses of $3.3 million and a provision for the
writedowns of real estate owned of $1.3 million for the quarter ended
September 30, 1996.
Management is constantly monitoring the loan portfolio and is
concentrating on workouts of the Bank's troubled loans. Management
believes that the present allowance for loan losses is adequate in
light of management's assessment of the risk inherent in the
portfolio. However, while management uses its best judgment in
providing for possible loan losses, management recognizes that
additional problems could develop and that future adjustments may be
necessary.
Real estate owned totaled $4.0 million at September 30, 1996
compared to $8.6 million at September 30, 1995. Dispositions of real
estate owned properties amounted to $3.7 million during 1996. Real
estate owned is carried on the Bank's books at fair value less
estimated costs to sell. Provisions for the writedown of real estate
owned totaled $3.0 million for the year ended September 30, 1996
compared to $900,000 for the year ended September 30, 1995. These
provisions were affected by the strategic restructuring announced by
the Board of Directors on April 30, 1996. These effects are
elaborated on in the discussion of the allowance for loan losses,
above. Management recognizes that future adjustments may be necessary
if the real estate values decline.
Total liabilities of First State were $575.2 million at September
30, 1996, reflecting a net decrease of $20.2 million from September
30, 1995. The principal changes were a decrease in deposits of $13.4
million, a decrease in borrowed money of $17.2 million, and offset by
an increase in other liabilities of $11.0 million. Funds obtained
from the sales of loans were mainly used to repay borrowings and
brokered certificates of deposit. The Bank aggressively marketed
certificate of deposit accounts and also continued to concentrate its
efforts on attracting checking account depositors. As a result of
these efforts, savings and checking deposits and certificates of
deposit, other than negotiated certificates of deposit, increased
$13.0 million during the year. Fiscal 1996 was a difficult year for
obtaining new deposits because depositors and investors found the
returns on mutual funds and stocks to be more attractive than those of
deposits. The increase in other liabilities was partially due to the
liability recorded for the SAIF Special Assessment of $3.1 million at
September 30, 1996, in addition to several suspense items. These
suspense items were comprised of a certified check for $5.0 million
and $2.2 million due to the Federal Reserve Bank for customer checks
that were not charged on September 30, 1996. Both of these suspense
items cleared on October 1, 1996.
First State's stockholders' equity decreased $6.4 million during
the year bringing total equity to $35.2 million at September 30, 1996.
The net decrease was attributable to a net loss for the year of $5.6
million, a decrease of $861,000 due to the payment of dividends, a
decrease of $139,000 due to the change in net unrealized loss on
securities classified as available for sale and an increase of
$293,000 due to the issuance of additional shares of common stock
under existing option plans. Future declaration of cash dividends by
First State will depend upon dividend payments by the Bank to First
State, which is its primary source of income and which is subject to
regulatory restrictions. For further information regarding dividends,
see Note 16 to the Consolidated Financial Statements. The Bank is
categorized as "adequately capitalized" under the Federal Deposit
Insurance Corporation Improvement Act of 1991 definitions.
RESULTS OF OPERATIONS
A comparison of years ended September 30, 1996 and September 30, 1995
is discussed below.
General
First State Financial Services, Inc. recorded a net loss of $5.6
million for the year ended September 30, 1996. This compares to net
income of $4.0 million for the year ended September 30, 1995. The net
loss in 1996 was mainly due to provisions for loan losses of $8.9
million, provisions for writedowns of real estate owned totaling $3.0
million and a special one-time SAIF assessment charge of $3.1 million.
Interest Income
Interest income totaled $49.2 million reflecting an increase of
$4.9 million during 1996. The increase in the Bank's interest income
in 1996 was mainly attributable to the increase in interest on
consumer and commercial loans of $4.8 million which was primarily due
to the increase in the size of the Bank's consumer and commercial loan
portfolios. The average balance of those portfolios was $106.0
million in 1996 compared to $78.3 in 1995. Interest on mortgage loans
decreased $790,000 in 1996 and the decrease was mainly due to the sale
of mortgage loans of $81.9 million. The average yield on all loan
portfolios was 8.89% in 1996 compared to 8.40% in 1995. At September
30, 1996, the loan portfolios consisted of mortgage loans of $407.0
million (which includes $215.0 million in adjustable rate mortgages),
consumer loans of $46.7 million, and commercial loans of $36.3
million. The Bank utilizes the services of loan solicitors for
mortgage loan production. The Bank has aggressively marketed
adjustable rate loans because of their interest rate sensitivity in a
rising interest rate environment. If nonaccrual loans had been
current in accordance with their original terms, total interest income
would have been increased by approximately $1.7 million in 1996 and
approximately $1.5 million in 1995. The Bank invests its funds
primarily in loans. It will invest in mortgage-backed or other
securities when loan demand is slow or when security investments are a
better alternative. There was a net increase in the Bank's mortgage-
backed securities portfolio of $12.1 million during 1996 bringing the
total to $31.0 million at September 30, 1996. Interest income on such
securities increased $705,000 in 1996. The investment securities
portfolio and investment securities available for sale totaled $34.1
million at September 30, 1996, an increase of $1.4 million during
1996. The average yield on all interest-earning assets was 8.56% in
1996 compared to 8.21% in 1995.
Interest Expense
Interest expense increased $2.3 million to $24.1 million during
1996. The increase was mainly attributable to increased average
deposits and to higher interest rates paid on certificate accounts,
particularly jumbo and brokered certificates of deposit. The average
balance of deposits in 1996 was $561.7 million compared to $532.1
million in 1995. The average cost of deposits in 1996 was 4.09%
compared to 3.88% in 1995. The Bank continues to concentrate its
efforts to attract checking accounts, money market demand accounts,
and NOW accounts. Accounts of this type are generally less interest
rate sensitive than certificates of deposits and other savings
deposits. In addition to providing opportunities to generate service
fees, checking accounts present opportunities to develop solid core
depositor relationships. At September 30, 1996, the Bank had $101.5
million in commercial checking, NOW, and money market checking
accounts. This compares to $90.9 million in similar accounts at
September 30, 1995. Interest expense on borrowings decreased $22,000
in 1996. Average borrowings were $18.1 million during 1996 compared
to $18.0 million in 1995. The average interest rate on all interest-
bearing liabilities was 4.15% for 1996 compared to 3.96% for 1995.
Net Interest Income
Net interest income, which represents the difference between
total interest earned on assets and total interest paid on deposits
and borrowings supporting those assets, increased $2.6 million to
$25.2 million in 1996 from $22.6 million in 1995. The components of
net interest income are discussed above in more detail. The average
balance of interest-earning assets was $575.1 million, yielding 8.56%
in 1996, compared to $540.7, yielding 8.21% in 1995. The average
balance of interest-bearing liabilities was $579.7 million in 1996 and
cost 4.15%, compared to $550.2 million costing 3.96% in 1995.
The following table sets forth, for the periods indicated,
information regarding: (i) First State's average balance sheet; (ii)
the dollar amounts of income from interest-earning assets and the
resulting average yields; (iii) the total dollar amounts of interest
expense on interest-bearing liabilities and the resulting average
costs; (iv) net interest income; (v) interest rate spread; (vi) net
yield earned on interest-earning assets; and (vii) the ratio of total
interest-earning assets to total interest-bearing liabilities.
Average balances were calculated on a daily basis (except for the
balance adjustments relating to the pooling of Ocean Independent Bank
in 1994, which were annualized).
<TABLE>
<CAPTION>
Year Ended September 30,
1996 1995 1994
--------------------------- ---------------------------- -----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
--------- -------- ------- --------- -------- ---- --------- -------- ----
Assets:
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans (1) $ 504,374 $ 44,862 8.89% $ 486,641 $ 40,876 8.40% $ 391,701 $ 31,102 7.94%
Mortgage-Backed Securities 29,223 1,943 6.65 17,807 1,238 6.95 21,996 1,587 7.21
Investment securities 18,063 1,072 5.93 23,216 1,387 5.97 13,220 790 5.98
Investments available for sale 14,634 838 5.73 8,588 525 6.11 20,487 1,104 5.39
Federal Funds 5,121 282 5.51 1,010 67 6.63 3,516 79 2.25
Investments required by law 3,694 241 6.52 3,393 256 7.54 3,097 273 8.81
--------- -------- ----- --------- -------- ---- --------- -------- ----
Total interest-earning assets 575,109 49,238 8.56 540,655 44,349 8.21 454,017 34,935 7.70
Non-interest-earning assets 49,910 -------- ----- 52,448 44,294
--------- --------- -------- ---- --------- -------- ----
$ 625,019 $ 593,103 $ 498,311
========= --------- -------- ---- --------- -------- ----
Liabilities and
Stockholders' Equity:
Interest-bearing liabilities:
NOW and money mkt deposits 95,065 1,877 1.97 86,220 1,742 2.02 75,614 1,450 1.92
Passbook accounts 140,516 3,394 2.42 150,938 3,727 2.47 173,227 4,398 2.54
Certificate accounts 326,069 17,694 5.43 294,987 15,185 5.15 195,777 7,239 3.70
Borrowed Money 18,079 1,089 6.02 18,028 1,111 6.16 7,048 361 5.12
--------- -------- ----- --------- -------- ---- --------- -------- ----
Total interest-bearing liabilities $ 579,729 24,054 4.15 $ 550,173 21,765 3.96 $ 451,666 13,448 2.98
Non-interest bearing liabilities 3,485 -------- ----- 4,013 10,259
--------- --------- ---------
583,214 554,186 461,925
Stockholders' equity 41,805 38,917 36,386
--------- --------- ---------
Total liabilities and
stockholders' equity $ 625,019 $ 593,103 $ 498,311
========= ========= =========
Net interest income,
interest rate spread $ 25,184 4.41% 22,584 4.25% $ 21,487 4.72%
======== ===== ======== ===== ======== =====
Net interest-earning assets
(liabilities),net yield on
interest-earning assets $ (4,620) 4.38% $ (9,518) 4.18% $ 2,351 4.73%
========== ========== =========
Ratio of interest-earning assets to
interest-bearing liabilities .99x .98x 1.01x
(1) Includes non-accrual loans
</TABLE>
Provision for Loan Losses
Provisions for loan losses totaled $8.9 million during 1996 and
$1.7 million in 1995. The related allowance for loan losses totaled
$12.3 million at September 30, 1996. This compares to a $6.1 million
allowance for loan losses at September 30, 1995. Substantially all of
the nonaccrual loans are secured by first mortgage liens on real
property. See "Financial Condition" section for information regarding
factors which influence management's judgment in determining the
amount of additions to the loan loss allowance and increases during
the year.
Although management considers the allowance for loan losses to be
adequate, management recognizes that additional problems could develop
and lead to additional loss provisions and asset write-downs.
Other Income
Total other income increased $11.1 million to $17.5 million in
1996. The increased income was mainly attributable to increases in
income from loan fees and other loan charges of $9.9 million and
increases in net gains on the sales of loans of $982,000. The
increase in income from loan fees and other loan charges was directly
attributable to the Bank's credit card portfolio. First State
obtained a serviced credit card portfolio through the merger with
Ocean Independent Bank in October, 1994. The effect of the accounting
for the credit card portfolio has caused increases in the areas of
consumer loan interest, loan fees and other loan charges, and loan
processing expenses. Details regarding First State's serviced credit
card portfolio are discussed below. The sales of $80.6 million of
mortgage loans from the available for sale portfolio generated a net
gain on sales of loans of $1.1 million. The Bank maintains an
investment securities available for sale portfolio and anticipates
periodic sales of such securities. Net gains on such sales totaled
$69,000 in 1996. Management intends to continue its efforts in
acquiring checking accounts and to increase other branch service fee
income through the marketing of its broad range of banking services.
Income from service charges on deposit accounts totaled $1.9 million
in 1996 as compared to $1.8 million in 1995.
Operating Expenses
Operating expenses increased $18.9 million to $41.0 million in
1996. The principal increases were in loan processing expenses of
$12.8 million, in the SAIF special assessment of $3.1 million, in
problem asset expenses, inclusive of real estate owned writedowns, of
$2.1 million, and in compensation and employee benefits of $1.1
million. Substantially all of the increase in loan processing
expenses was due to the accounting for credit card expenses. Details
regarding First State's serviced credit card portfolio are discussed
separately below. The increase in problem asset expenses was mainly
due to writedowns of the carrying values of the properties. The
writedowns were in accordance with the Bank's announced intent to
liquidate substantially all of its problem assets and updated
appraisals regarding the current value of the properties. The
increase in compensation and employee benefits was mainly due to the
continually rising cost of employee benefits, a cost of living
increase, an increase in expense associated with deferred compensation
and the employment of personnel to staff the two new branch offices
opened during the period. Employee benefit plans are discussed in
footnote 11 of the consolidated financial statements. Premises and
occupancy costs increased by $317,000 to $2.3 million for 1996. This
increase is due primarily to the operations of two new branch offices
and high costs incurred in 1996 for snow removal. The types of other
expenses together with a comparison of the prior two years are shown
in Note 9 to the Consolidated Financial Statements.
A one-time special assessment of $3.1 million was levied on September
30, 1996 in connection with legislation enacted to recapitalize the
Savings Association Insurance Fund ("SAIF"). The assessment was
recorded on First State's financial statements as of September 30,
1996 and severely impacted earnings for the quarter. Congress passed
the legislation requiring a one-time charge to SAIF insured
institutions in order to recapitalize and fully fund the SAIF deposit
insurance fund. As a result of fully funding the SAIF, First DeWitt's
premium to SAIF will decrease significantly from the current .26
percent of insured deposits as of January 1, 1997.
The Corporation acquired a serviced credit card portfolio through the
acquisition of Ocean Independent Bank in October, 1994. The
arrangement with the servicer of the portfolio, Applied Card Systems
(ACS) of Wilmington, Delaware, provides the Corporation with a
guaranteed net return based on the outstanding receivables associated
with the serviced portfolio. The return that is guaranteed to the
Corporation is net of all costs, including credit loss and cost of
funds. First State records all interest income associated with the
portfolio in the "Interest on consumer and commercial loans" caption
and all fees associated with portfolio are recorded in the "Loan fees
and other loan charges" caption. The difference between the amounts
received for the two captions above and the net return guaranteed to
the Corporation is considered "credit card expenses" that represent
the fees paid to ACS for their servicing of the portfolio. This
amount is recorded in the "Loan expenses" caption. The Corporation's
business with ACS had expanded and this growth caused an increase in
all three income statement captions. The detailed effect of the
serviced credit card portfolio on the income statement for the years
ended September 30, 1996 and 1995 are presented below.
12 Months 12 Months
Ended Ended
9/30/96 9/30/95
--------- ---------
Income Statement Caption (in thousands)
Interest on consumer and $ 6,056 $ 2,281
commercial loans
Loan fees and other loan charges 12,691 2,291
--------- ---------
Total credit card income 18,747 5,272
Loan expenses 17,260 4,600
--------- ---------
Net credit card income (pre tax) $ 1,487 $ 672
========= =========
Net credit card income (after $ 907 $ 410
tax) ========= =========
The total credit card receivables outstanding that were serviced by
ACS totaled $16.6 million at September 30, 1996. Total credit card
receivables serviced by ACS reached a high of $74.6 million over the
year. On August 15, 1996, the Corporation entered into an agreement
to sell the credit card portfolio. Between August 15 and September
30, 1996, $59.6 million in credit card receivables were sold at par.
Substantially all of the remaining credit card portfolio was sold at
par subsequent to September 30, 1996. Due to the sale of this
portfolio, decreases in the "Interest on consumer and commercial
loans" caption, the "Loan fees and other loan charges" caption and the
"Loan processing expenses" caption are expected in fiscal 1997. This
sale is also expected to negatively impact the Corporation's interest
rate spread in 1997.
Income Tax Expense
The Corporation recorded a tax benefit of $1.6 million for the
year ended September 30, 1996. This benefit was due to the pre-tax
loss on operations of $7.3 million. The Corporation recorded income
tax expense of $1.1 million for the year ended September 30, 1995, due
to pre-tax income of $5.1 million. The acquisition of Ocean
Independent Bank ("Ocean") on October 21, 1994, warranted a reduction
of the valuation allowance associated with the adoption of Statement
of Financial Accounting Standards 109 "Accounting for Income Taxes".
This reduction of the valuation allowance had the effect of reducing
income tax expense for First State in 1995. See Note 10 to the
Consolidated Financial Statements for additional discussion of income
taxes, including a reconciliation of the "expected" income tax benefit
or expense to the amount recorded on the Corporation's financial
statements.
RESULTS OF OPERATIONS
A comparison of years ended September 30, 1995 and September 30, 1994
is discussed below.
General
First State Financial Services, Inc. recorded net income of $4.0
million for the year ended September 30, 1995. This compares to net
income of $3.5 million for the year ended September 30, 1994 and
represents a 14.2% increase over 1994. The improved performance in
1995 is primarily attributable to increases in net interest income and
loan fees and other loan charges.
Interest Income
Interest income totaled $44.3 million reflecting an increase of
$9.4 million during 1995. The increase in the Bank's interest income
in 1995 was mainly attributable to the increase in the size of the
Bank's loan portfolios and also to the increased average interest
yield of the portfolios. The average balance of the loan portfolios
was $486.6 million in 1995 compared to $391.7 in 1994. The average
yield on the loan portfolios was 8.40% in 1995 compared to 7.94% in
1994. At September 30, 1995, the loan portfolios consisted of
mortgage loans of $441.5 million (which includes $228.5 million in
adjustable rate mortgages), consumer loans of $53.0 million, and
commercial loans of $34.4 million. The Bank utilizes the services of
loan solicitors for mortgage loan production. The Bank has
aggressively marketed adjustable rate loans because of their interest
rate sensitivity in a rising interest rate environment. The Bank
intends to continue its emphasis on attracting adjustable rate loans.
Long-term, fixed-rate mortgage loans will be originated with the
intent, in most cases, of selling them. The Bank will also continue
its efforts to attract consumer and commercial loans by structuring
products attractive to borrowers and effectively marketing the
products. If nonaccrual loans had been current in accordance with
their original terms, total interest income would have been increased
by approximately $1.5 million in 1995 and approximately $899,000 in
1994. The Bank invests its funds primarily in loans. It will invest
in mortgage-backed or other securities when loan demand is slow or
when security investments are a better alternative. The average yield
on all interest-earning assets was 8.21% in 1995 compared to 7.70% in
1994.
Interest Expense
Interest expense increased $8.3 million to $21.8 million during
1995. The increase was mainly attributable to increased deposits and
to higher interest rates paid on deposits. The average balance of
deposits in 1995 was $532.1 million compared to $444.6 million in
1994. The average cost of deposits in 1995 was 3.88% compared to
2.94% in 1994. General market interest rates began to trend upward in
1994 and continued increasing through June, 1995. Interest rates began
to trend downward after that date and should have a lowering effect on
the interest rates paid on deposits going forward. The Bank will
continue to concentrate its efforts to attract checking accounts,
money market demand accounts, and NOW accounts. Accounts of this type
are generally less interest rate sensitive than certificates of
deposits and other savings deposits. In addition to providing
opportunities to generate service fees, checking accounts present
opportunities to develop solid core depositor relationships. At
September 30, 1995, the Bank had $90.9 million in commercial checking,
NOW, and money market checking accounts. This compares to $83.8
million in similar accounts at September 30, 1994. Interest expense
on borrowings increased $750,000 in 1995 and was mainly due to
increased borrowings during the year. Average borrowings were $18.0
million during 1995 compared to $7.0 million in 1994. The average
interest rate on all interest-bearing liabilities was 3.96% for 1995
compared to 2.98% for 1994. Rising interest rates will also increase
the cost of borrowing going forward.
Net Interest Income
Net interest income, which represents the difference between
total interest earned on assets and total interest paid on deposits
and borrowings supporting those assets, increased $1.1 million to
$22.6 million in 1995 from $21.5 million in 1994. The components of
net interest income are discussed above in more detail. The average
balance of interest-earning assets was $540.7 million, yielding 8.21%
in 1995, compared to $454.0, yielding 7.70% in 1994. The average
balance of interest-bearing liabilities was $550.2 million in 1995 and
cost 3.96%, compared to $451.7 million costing 2.98% in 1994.
The following table sets forth, for the periods indicated,
information regarding: (i) First State's average balance sheet; (ii)
the dollar amounts of income from interest-earning assets and the
resulting average yields; (iii) the total dollar amounts of interest
expense on interest-bearing liabilities and the resulting average
costs; (iv) net interest income; (v) interest rate spread; (vi) net
yield earned on interest-earning assets; and (vii) the ratio of total
interest-earning assets to total interest-bearing liabilities.
Average balances were calculated on a daily basis (except for the
balance adjustments due to Ocean in 1994 and 1993, which were
annualized).
Provision for Loan Losses
Provisions for loan losses totaled $1.7 million during 1995 and
$1.9 million in 1994. The related allowance for loan losses totaled
$6.1 million at September 30, 1995. This compares to a $6.4 million
allowance for loan losses at September 30, 1994. Substantially all of
the nonaccrual loans are secured by first mortgage liens on real
property. See "Financial Condition" section for information regarding
factors which influence management's judgment in determining the
amount of additions to the loan loss allowance.
Although management considers the allowance for loan losses to be
adequate, management recognizes that additional problems could develop
and lead to additional loss provisions and asset write-downs.
Other Income
Total other income increased $2.2 million to $6.4 million in
1995. Increased income from loan fees and other loan charges of $2.1
million substantially accounted for the increase. The increase was due
to the increase in mortgage activity discussed earlier and also from
the Bank's credit card programs. The Bank expects to continue to
expand it's activities in these areas. Service charges on deposit
accounts increased $198,000 in 1995. Management continued to make a
concerted effort to expand the Bank's checking account business in
1995 and, as mentioned earlier, increased those accounts by
approximately $7.5 million in 1995. Management intends to continue its
efforts in acquiring checking accounts and to increase other branch
service fee income through the marketing of its broad range of banking
services. The net gain on sales of loans decreased $386,000 and was
due to decreased sales activity. Loans sold in 1995 totaled $6.9
million compared to $26.4 million in 1994. The net loss on sale of
investment securities in 1995 of $125,000 was due to the sale of
securities carried on Ocean Independent Bank's books as available-for-
sale at the time of merger. The increase in other income was mainly
due to the increase in the cash surrender value of life insurance
policies covering the Bank's senior officers.
Operating Expenses
Operating expenses increased $3.3 million to $22.2 million in
1995. The principal increase was in loan expenses of $3.2 million.
The principal decrease was in compensation and employee benefits of
$286,000. The decrease, as anticipated, was mainly due to savings
attained by consolidating Ocean Independent Bank's operations into
First DeWitt's operations. Medical insurance expense was also reduced
by switching to a managed care program. The increase in loan expenses
was partially due to mortgage lending but primarily due to credit card
activities. The expenses incurred in connection with the credit card
programs were more than offset by interest income and fee income
generated from the programs. The types of other expenses together
with a comparison of the prior two years are shown in Note 9 to the
Consolidated Financial Statements.
Problem asset expenses, inclusive of real estate writedowns
totaled $1.6 million in 1995 compared to $1.5 million in 1994. These
expenses can be expected to be reduced with a decreased level of
problem assets. Management is constantly pursuing various avenues of
problem asset disposal.
Income Tax Expense
Income tax expense of $1.1 million incurred in 1995 and income
tax expense of $1.4 million incurred in 1994 was due to the generation
of taxable income. Taxable income was reduced because of allowable
deductions for increases in specific loan and REO reserves and charge-
offs. In addition, First State adopted the Statement of Financial
Accounting Standards 109 "Accounting for Income Taxes" ("FAS 109"),
effective October 1, 1992. FAS 109 had the effect of significantly
reducing income tax expense for the year ended September 30, 1993, and
affected the 1994 period to a much lesser extent. The acquisition of
Ocean on October 21, 1994, warranted a reduction of the valuation
allowance associated with FAS 109. This reduction of the valuation
allowance had the effect of reducing income tax expense for First
State in 1995. See Note 10 to the Consolidated Financial Statements
for additional discussion of income taxes.
LIQUIDITY and CAPITAL RESOURCES
First State's principal sources of funds are dividends from its
subsidiaries and funds provided from operations. The Bank's principal
sources of funds are from deposits; scheduled loan amortization
payments; sales and prepayments of loan principal; sales and
maturities of mortgage-backed securities, sales and maturities of
investment securities and short-term investments; borrowings and funds
provided from operations.
The financing activities section of the Consolidated Statement of
Cash Flows reflects a net decrease in deposits of $13.4 million during
1995. The decrease consisted of $36.4 million in net withdrawals
offset by $23.0 million in interest credited to deposit accounts. The
decrease was mainly due to the withdrawal of brokered certificates and
jumbo accounts. The Bank utilized the cash flow from loan sales to,
among other things, reduce its position in these high cost deposits.
These funds were also used to repay borrowings, see below. In fiscal
1995, total deposits increased by $88.3 million. Net borrowings
decreased $17.2 million in 1996 compared to a net decrease in
borrowings of $13.6 million in 1995. Deposits are mainly used to fund
loans in conjunction with the Bank's investing activities. Management
will utilize borrowings when it is opportunistic to originate loans
and internally generated funds are insufficient to fund the loans. In
1995, new deposits and internally generated funds were in excess of
loan demand and resulted in the Bank repaying borrowings.
In the investing activities section of the Statement of Cash Flows, a
net increase in loans receivable of $90.8 million is reported for
fiscal 1996, compared to $82.8 million in 1995. Loans originated in
1996 totaled $233.4 million compared to $179.8 million in 1995. Loan
repayments and proceeds from sales of loans provided a substantial
portion of the funds for the origination of loans in both periods.
Such sources of funds provided $264.1 million in 1995 and $101.4
million in the 1995 period. Deposit funds, borrowings and funds
obtained through normal operations were also utilized to fund the
origination of loans. The Bank actively solicits loans through the
marketing of several competitive loan programs and has successfully
utilized the services of loan solicitors for the origination of loans.
In the operating activities section of the Statement of Cash Flows,
origination of loans held for resale totaled $21.4 million in 1996 and
$10.3 million in 1995. Proceeds from the sales of such loans were
$81.9 million in 1996 and $7.0 million in 1995. The 1996 sales were
primarily due to the sale of $67.2 million in mortgage loans
classified as Mortgage loans held for resale at September 30, 1995.
The Bank also sold $59.6 million in credit card receivables in 1996.
The Bank's emphasis is on attracting adjustable rate loans. Long-
term, fixed-rate mortgage loans are originated with the intent, in
most cases, of selling them. In 1996, the Bank purchased a total of
$16.4 million in mortgage-backed securities (including $1.2 million in
mortgage-backed securities available for sale) and received $4.3
million from sales and from prepayments of those securities. In 1995,
purchases of mortgage-backed securities only exceeded sales and
prepayments by $114,000. The statement of cash flows discloses that in
1996 $3.4 million in investment securities matured and that $14.1
million was reinvested in new investment securities. Proceeds from the
sales of investment securities available for sale portfolio exceeded
purchases of securities for this portfolio by $9.2 million. A net non
cash transfer of $6.9 million significantly effected the ending
balances of these portfolios. In 1995, the Bank purchased $8.3
million in investment securities while $9.4 million of investment
securities matured. The Bank also saw sales of investment securities
available for sale exceeding purchases by $3.6 million in 1995. Cash
funds received from the disposition of real estate properties owned
amounted to $3.7 million in 1996 and $3.2 in 1995.
The Bank is required to maintain minimum levels of liquid assets
as defined by the Office of Thrift Supervision (OTS) regulations, such
as United States Government and federal agency securities. This
requirement, which may be varied by OTS, is based upon a percentage of
deposits and short-term borrowings. The required ratio is currently
5.00%. The Bank's ratio was 5.13% at September 30, 1996. The Bank
anticipates maintaining its liquidity at or above the level required
by regulatory agencies.
At September 30, 1996 the Bank had $9.9 million in outstanding
commitments to originate or purchase loans and $28.8 million in unused
lines of credit primarily available under home equity loan credit
lines. The Bank also had commitments to sell $4.8 million in mortgage
loans. These commitments to sell loans primarily consisted of "best
effort" commitments with minimal detrimental effects if they are not
filled. The Bank had no material commitments for capital expenditures
at September 30, 1996. Management intends to fund the total loan
commitment through new savings deposits and internal sources. Any
shortfall in obtaining the funds internally will be acquired by
additional borrowings. As a member of the Federal Home Loan Bank
(FHLB) system, the Bank may borrow from the FHLB of New York. The
Bank maintains a $63.3 million line of credit with the FHLB. The Bank
had $600,000 in borrowings against the line of credit with the FHLB of
New York at September 30, 1996.
Asset / Liability Management
The Bank's asset/liability management strategy is directed at
shortening the repricing intervals and maturities of interest-earning
assets in order to better match the corresponding repricing intervals
and maturities of interest-bearing liabilities while maintaining an
adequate spread and asset quality. The Bank has emphasized the
origination of adjustable rate mortgage ("ARM") loans, short-term
consumer loans, and commercial loans. This strategy has reduced the
Bank's level of interest-rate risk.
The ability of the Bank to match the maturity of interest-earning
assets and interest-bearing liabilities may be analyzed by examining
the extent to which such assets and liabilities are "interest-rate
sensitive." 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 interest-earning assets maturing or
repricing within a specific time period and interest-bearing
liabilities maturing or repricing within that time period.
The following table presents a static gap analysis of the Bank's
current interest rate sensitivity. Assets and liabilities are
distributed in the table to reflect expected cash flow and repricing
characteristics as of September 30, 1996. The table shows the Bank to
be in a liability sensitive gap position over a 12-month time frame
with a cumulative negative, one-year gap of $99.8 million. The
cumulative one-year gap equals 16.3% of total assets.
Static gap analysis describes interest rate sensitivity at one
point in time. However, it does not capture the inherent dynamics of
the balance sheet or the influence of prospective interest rate
changes. Because of this limitation, the Bank employs simulation
models that measure the dynamics of future cash flows, balance sheet
changes and the impact on revenue of diverse interest rate scenarios.
<TABLE>
<CAPTION>
Gap Analysis at September 30, 1996
---------------------------------------------------------------------------
Within Within Within
Within 6 Months 1 Year to 2 years After
6 months to a Year 2 Years to 5 Years 5 years Total
---------- ---------- ---------- ---------- ---------- ----------
( Dollars in thousands )
<S> <C> <C> <C> <C> <C> <C>
Interest- earnings assets:
Mortgage loans (2) (3) $ 122,025 $ 53,920 $ 58,793 $ 124,618 $ 57,993 $ 417,349
Mortgage-backed securities 17,526 3,472 3,096 4,570 2,360 31,024
Consumer and commercial loans (3) 54,431 2,816 3,699 6,659 18,363 85,968
Investment securities 12,602(1) 1,555 - 1,393 12,497 28,047
Investment securities available for sale 1,256 - 8,210 - - 9,466
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets $ 207,840 $ 61,763 $ 73,798 $ 137,240 $ 91,213 $ 571,854
========== ========== ========== ========== ========== ==========
Interest-bearing liabilities:
NOW accounts (4) $ 8,687 $ 7,702 $ 12,827 $ 23,293 $ - $ 52,509
Non-interest demand accounts (4) 4,861 4,403 7,334 13,320 - 29,918
Money market demand accounts (4) 3,206 2,932 5,134 7,798 - 19,070
Savings and club accounts (4) 26,437 21,759 36,710 47,106 - 132,012
Certificate accounts 181,047 107,761 14,261 10,792 6,522 320,383
Borrowed money 600 - 2,000 3,000 328 5,928
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities $ 224,838 $ 144,557 $ 78,266 $ 105,309 $ 6,850 $ 559,820
========== ========== ========== ========== ========== ==========
Rate sensitivity gap per period (4) $ (16,998) $ (82,794) $ (4,468) $ 31,931 $ 84,363 $ 12,034
========== ========== ========== ========== ========== ==========
Cumulative interest rate sensitivity gap (4) $ (16,998) $ (99,792) $(104,260) $ (72,329) $ 12,034
========== ========== ========== ========== ==========
Interest rate sensitivity gap as a
percentage of total assets (4) (2.78)% (16.31)% (17.04)% (11.82)% 1.97%
Cumulative percentage of interest-sensitive
assets to interest-sensitive liabilities 92.44% 72.99% 76.71% 86.92% 102.15%
(1) Includes $3.4 million stock in FHLB of New York.
(2) Includes loans held for resale and net of loans in process.
(3) Includes non-accrual loans.
(4) If all NOW, non-interest demand, money market, savings and club accounts were to reprice within 6 months
or less, the one year cumulative rate sensitivity gap would have been $(253,314) or 51.56%.
</TABLE>
Impact of Inflation
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a
result, interest rates have a more significant impact on a financial
institution's performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services
as measured by the consumer price index.
FIRST STATE FINANCIAL SERVICES. INC.
INDEPENDENT AUDITORS' REPORT
The Board of Directors
First State Financial Services, Inc.
We have audited the accompanying consolidated balance
sheets of First State Financial Services, Inc. and
subsidiaries as of September 30, 1996 and 1995, the related
consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the years
in the three-year period ended September 30, 1996. These
consolidated financial statements are the responsibility of
the Corporation'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 First State Financial Services,
Inc. and subsidiaries at September 30, 1996 and 1995 and the
results of their operations, and their cash flows for each
of the years in the three-year period ended September 30,
1996, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Short Hills, New Jersey
November 26, 1996
<TABLE>
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Balance Sheets
<CAPTION>
September 30,
-----------------------
1996 1995
---------- ----------
(in thousands)
<S> <C> <C>
ASSETS
Cash on hand and in banks $ 12,395 $ 11,792
Investment securities available for sale (note 3) 9,466 11,799
Investment securities, market value of $24,355 and
$20,657 at September 30, 1996 and 1995 (note 3) 24,643 20,889
Stock in FHLB of New York, at cost 3,404 3,715
Loans receivable, net (note 4) 480,931 461,648
Mortgage loans held for resale, market value of
$9,106 and $67,642 at September 30, 1996 and 1995 9,106 67,219
Mortgage-backed securities, market value of $30,560
and $19,002 at September 30, 1996 and 1995
(notes 3 and 6) 31,024 18,961
Accrued interest receivable (note 8) 3,942 4,046
Office properties and equipment, net (note 7) 10,171 10,523
Real estate owned 4,045 8,564
Cost in excess of fair value of net assets acquired 2,149 2,349
Cash surrender value of life insurance (note 11) 11,978 11,582
Other assets 7,163 3,933
---------- ----------
$ 610,417 $ 637,020
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 5) $ 554,320 $ 567,710
Borrowed money (note 6) 5,928 23,105
Advance payments by borrowers for taxes and
insurance 2,614 3,253
Accrued expenses and other liabilities 12,319 1,360
---------- ----------
Total liabilities 575,181 595,428
---------- ----------
Stockholders' Equity (note 14 and note 16):
Preferred stock, $.01 par value, 2 million
shares authorized; none issued - -
Common stock, $.01 par value, 8 million
shares authorized;3,938,815 issued,
3,929,455 outstanding in 1996 and 3,883,765
issued, 3,874,405 outstanding in 1995 39 39
Additional paid-in capital 21,242 20,949
Net unrealized loss on securities
available for sale (228) (89)
Retained income, substantially restricted
(notes 10 and 16) 14,183 20,693
---------- ----------
Total stockholders' equity 35,236 41,592
Commitments and Contingencies (note 12) ---------- ----------
$ 610,417 $ 637,020
========== ==========
See accompanying notes to the consolidated
financial statements
</TABLE>
<TABLE>
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Operations
(In thousands, except per share amounts)
<CAPTION>
Year Ended September 30,
-------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Interest on mortgage loans (note 4) 31,948 32,738 25,217
Interest on consumer and commercial loans 12,914 8,138 5,885
Interest on mortgage-backed securities 1,943 1,238 1,587
Interest on investments available for sale 839 525 1,104
Interest on investment securities 1,595 1,710 1,142
-------- -------- --------
Total interest income 49,239 44,349 34,935
-------- -------- --------
Interest expense:
Interest on deposits (note 5) 22,965 20,654 13,087
Interest on borrowed money 1,089 1,111 361
-------- -------- --------
Total interest expense 24,054 21,765 13,448
-------- -------- --------
Net interest income 25,185 22,584 21,487
Provision for loan losses (note 4) 8,900 1,650 1,892
-------- -------- --------
Net interest income after
provision for loan losses 16,285 20,934 19,595
-------- -------- --------
Other income:
Loan fees and other loan charges 13,591 3,725 1,589
Service charges on deposit accounts 1,874 1,784 1,586
Net gain on sales of loans 1,070 88 474
Net gain (loss) on sales of investments 69 (125) 82
Other 876 896 419
-------- -------- --------
Total other income 17,480 6,368 4,150
-------- -------- --------
Operating expenses:
Compensation and employee benefits (note 11) 8,457 7,362 7,648
Premises and occupancy expense, net 2,324 2,007 2,046
Amortization of cost of intangible assets 200 427 536
Loan expenses 17,270 4,491 1,254
Data processing 1,250 1,100 1,036
Advertising and promotion 642 812 724
Federal insurance premiums 1,261 1,234 1,097
SAIF special assessment (note 16) 3,096 - -
Problem asset expenses, inclusive of
real estate owned writedowns 3,671 1,615 1,456
Other expenses (note 9) 2,851 3,124 3,084
-------- -------- --------
Total operating expenses 41,022 22,172 18,881
-------- -------- --------
Income (loss) before income tax
expense (benefit) (7,257) 5,130 4,864
Income tax expense (benefit) (note 10) (1,608) 1,132 1,363
-------- -------- --------
Net income (loss) $(5,649) $ 3,998 $ 3,501
======== ======== ========
Net income (loss) per share $ (1.40) $ 1.01 $ 0.91
======== ======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)
<CAPTION> Common Stock
Net Unrealized Acquired by
Retained Loss on Employees
Additional Income Securities Stock
Common Paid-In Substantially Available Ownership
Stock Capital Restricted for Sale Plan Total
------- --------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1993 $ 38 $ 20,869 $ 14,431 $ - $(1,159) $ 34,179
Distributions of Employee Stock
Ownership Plan Stock - 210,798 shares 1,159 1,159
Cash dividends declared and paid (476) (476)
Change in net unrealized loss on securities
classified as available for sale (278) (278)
Net income for the year 3,501 3,501
Stock cancellation upon Ocean
merger-18,302 shares (109) (109)
Adjustment for the pooling of a company
with a different year end (3) (3)
------- --------- --------- -------- -------- ---------
Balance at September 30, 1994 $ 38 $ 20,760 $ 17,453 $ (278) $ - $ 37,973
Cash dividends declared and paid (758) (758)
Issuance of common stock under stock
option plans (note 14) -46,142 shares 1 189 190
Change in net unrealized loss on securities
classified as available for sale 189 189
Net income for the year 3,998 3,998
------- --------- --------- -------- -------- ---------
Balance at September 30, 1995 $ 39 $ 20,949 $ 20,693 $ (89) $ - $ 41,592
Cash dividends declared and paid (861) (861)
Issuance of common stock under stock
option plans (note 14) -55,050 shares - 293 293
Change in net unrealized loss on securities
classified as available for sale (139) (139)
Net loss for the year (5,649) (5,649)
------- --------- --------- -------- -------- ---------
Balance at September 30, 1996 $ 39 $ 21,242 $ 14,183 $ (228) $ - $ 35,236
======= ========= ========= ======== ======== =========
See accompanying notes to the consolidated financial statements
</TABLE>
<TABLE>
FIRST STATE FINANCIAL SERVICES, INC.
Consolidated Statements of Cash Flows
(In thousands, except per share amounts)
<CAPTION>
Year ended September 30,
-------------------------------
1996 1995 1994
---------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (5,649) $ 3,998 $ 3,501
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of intangible assets 200 428 534
Depreciation 1,263 962 1,087
Net accretion of loan fees and discounts (255) (376) (382)
Net amortization and (accretion) of investment
premium and discount 67 (96) (733)
Net amortization and (accretion) of MBS
premium and discount 34 58 (102)
Decrease (increase) in interest receivable 104 (935) (598)
Proceeds from sales of loans held for resale 81,856 7,012 26,864
Proceeds from sales of credit cards receivable 59,635 - -
Origination of loans held for resale (21,414) (10,278) (7,962)
Net gain on sale of real estate owned (261) (19) -
Net gain on sale of loans (1,070) (88) (474)
Net (gain) loss on sale of investments (69) 125 (82)
Provision for losses on loans 8,900 1,650 1,892
Provision for writedowns of real estate owned 3,000 900 700
Increase in cash surrender value of life insurance (396) (572) (11,010)
(Increase) decrease in other assets (3,230) 734 (192)
Increase (decrease) in other liabilities 10,959 (260) 908
---------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 133,674 3,243 13,951
---------- --------- ---------
INVESTING ACTIVITIES
Net increase in loans receivable (90,760) (82,753) (91,881)
Mortgage loans purchased - (292) -
Purchase of mortgage-backed securities (15,174) (5,809) (5,048)
Purchase of mortgage-backed securities
available for sale (1,241) - -
Proceeds from sales of mortgage-backed securities - 1,630 5,207
Proceeds from sales of mortgage-backed securities
available for sale 1,224 - -
Principal payments on mortgage-backed securities 3,094 4,065 7,029
Proceeds from dispositions of real estate owned 3,718 3,231 6,935
Office properties and equipment expenditures (911) (1,167) (669)
Purchase of investment securities (14,132) (8,297) (14,901)
Purchase of investment securities available
for sale (30,588) (12,934) (1,427)
Proceeds from sale of investment securities
available for sale 39,746 16,538 4,704
Redemption (purchase) of Federal Home Loan Bank Stock 311 (710) 414
Proceeds from maturities of investment securities 3,416 9,419 -
---------- --------- ---------
NET CASH USED BY INVESTING ACTIVITIES (101,297) (77,079) (89,637)
---------- --------- ---------
FINANCING ACTIVITIES
Net (decrease) increase in deposits (13,390) 88,346 47,352
Dividends paid on common stock (861) (758) (476)
Principal repayments of borrowings (17,177) (13,633) (1,176)
Additional borrowings - 5,000 27,234
Net (decrease) increase in advance payments by
borrowers for taxes and insurance (639) 465 160
Common stock issued 293 190 -
Adjustment for the pooling of a company with a
different year-end - - (173)
---------- --------- ---------
NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (31,774) 79,610 72,921
---------- --------- ---------
Increase (decrease) in cash and cash equivalents 603 5,774 (2,765)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 11,792 6,018 8,783
---------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 12,395 $ 11,792 $ 6,018
========== ========= =========
CASH PAID DURING THE YEAR FOR:
Interest $ 24,165 $ 21,467 $ 13,346
Income taxes $ 375 $ 2,213 $ 1,235
NON-CASH TRANSFERS:
Loans classified as Real Estate Owned $ 1,938 $ 2,672 $ 2,319
Transfer of investment securities held to maturity
to investment securities available for sale $ 8,454 $ 2,300 -
Transfer of investment securities available for
sale to investment securities held to maturity $ 1,559 - -
Transfer of mortgage-backed securities held to maturity
to mortgage-backed securitiess available for sale $ 627 - -
Transfer of mortgage-backed securities available for
sale to mortgage-backed securities held to
maturity $ 644 - -
Reclassification of Loans rec. to mortgage
loans held for resale - $ 60,770 -
Cancellation of common shares in conjunction
with Ocean merger - - $ 109
Release of ESOP stock - - $ 1,159
See accompanying notes to consolidated financial statements.
</TABLE>
FIRST STATE FINANCIAL SERVICES, INC.
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The following is a description of the more significant accounting
policies used in preparation of the accompanying consolidated
financial statements.
Principles of Consolidation
The consolidated financial statements are comprised of the accounts of
First State Financial Services, Inc. (First State and/or the
Corporation), its wholly owned subsidiaries, First DeWitt Bank, (First
DeWitt or the Bank), and First State Investment Services, Inc. (FSIS);
and First DeWitt's wholly owned subsidiaries, Cedar Grove Service
Corporation (CGSC), Ridge (Caldwell) Associates (Ridge) and Southport
(Wall) Associates (Southport). All intercompany accounts and
transactions have been eliminated in consolidation.
Business
First State conducts its principal business activity through First
DeWitt Bank. First DeWitt provides a full range of banking services
to individual and corporate customers through branch offices in New
Jersey. First DeWitt is subject to competition from other financial
institutions and is subject to the regulations of certain federal
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 ("GAAP"). 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 balance sheet date. Actual results could
differ significantly from those estimates.
Material estimates that are particularly susceptible to significant
change in the next accounting cycle relate to the determination of the
allowance for loan losses and the current valuation of real estate
acquired in connection with foreclosures or in satisfaction of loans.
In connection with the determination of these allowances and the
valuation of real estate owned, management obtains independent
appraisals for significant properties.
Cash and Cash Equivalents
The caption of cash and cash equivalents used in the statements of
cash flows includes the balance sheet caption cash on hand and in
banks.
Investments, Investments Available for Sale and Mortgage-backed
Securities
Investment securities and mortgage-backed securities are carried at
amortized cost. Investment securities available for sale are carried
at market value. They are adjusted for unamortized premiums and
unearned discounts which are recognized as interest income over the
terms of the securities for investments and the estimated remaining
lives based on anticipated prepayments for mortgage-backed securities
using a method which approximates the level-yield interest method.
Investment and mortgage-backed securities are carried at cost because
First State intends and has the ability to hold them to maturity.
Gains or losses on the sale of securities are determined using the
specific identification method and are recognized upon realization.
Under Statement of Accounting Standards No. 115 "Accounting for
Certain Investments in Debt and Equity Securities" (SFAS 115), debt
securities to be held for indefinite periods of time and not intended
to be held to maturity, as well as marketable equity securities, are
classified as available for sale. Investment securities available for
sale are carried at fair value and unrealized gains and losses, net of
related tax effect, on such securities are excluded from earnings but
are included in stockholders' equity.
First DeWitt, as a member of the FHLB of N.Y., is required to hold
shares of capital stock in the FHLB of N.Y. in an amount equal to 1%
of the outstanding balance of residential mortgage loans and similar
obligations or 5% of its outstanding advances from the FHLB of N.Y.,
whichever is greater. First DeWitt complied with this requirement as
of September 30, 1996.
Loans
Loans are stated at their principal amounts outstanding net of
unearned income. Interest is accrued monthly as earned, except when a
loan becomes 90 days or more past due or collection becomes uncertain,
in which case the accrual of income is discontinued. Any accrued but
unpaid interest on such loans is reversed against current earnings.
These loans are classified as nonaccrual and interest income is only
recognized subsequently in the period collected. Loans are returned
to an accrual status when all past due amounts have been collected and
factors indicating doubtful collectability on a timely basis no longer
exists.
Discounts on loans purchased are accreted to income over the expected
lives of such loans using a method that approximates the level-yield
interest method of accounting.
Loan origination fees and certain direct loan origination costs are
deferred and amortized into income using a method which approximates
the level-yield interest method over the estimated lives of the
related loans as an adjustment to the related loan yields.
Mortgage Loans Held for Resale
First DeWitt from time to time sells its fixed rate conforming loan
originations and retains all other types of loan originations for its
loan portfolio. Mortgage loans intended for sale are carried at the
lower of cost or market using the aggregate method. Valuation
adjustments, if applicable, are reflected in current operations.
Gains and losses on sales are recorded using the specific
identification method.
Allowance for Loan Losses
Provisions for losses on loans are charged to operations based upon
periodic review and management's assessment of the risk inherent in
the loan portfolio in relation to the level of the allowance for loan
losses, loan loss experience, changes in the nature and volume of the
loan portfolio, estimated value of the collateral underlying the loan
agreements, economic conditions and other matters which warrant
consideration.
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 their market area. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowance for losses on
loans. Such agencies may require the Corporation to recognize
additions to the allowance based on their judgments about information
available to them at the time of their examination.
On October 1, 1995, First State adopted Statement of Accounting
Standards No. 114, "Accounting by Creditors for the Impairment of a
Loan", as amended by SFAS 118, "Accounting by Creditors for the
Impairment of a Loan-Income Recognition and Disclosures. As defined
by these statements, a loan is considered impaired when, based on
current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms
of the loan agreement. As a result, certain impaired loans are
reported at the present value of expected future cash flows discounted
at the loan's effective interest rate or the fair value of the
collateral if the loan is collateral dependent. The adoption of these
statements did not impact the Corporation's operating results or total
allowances for loan losses.
Office Properties and Equipment
Office properties and equipment are stated at cost less accumulated
depreciation. Depreciation of office properties and equipment is
accumulated on a straight-line basis over their estimated useful lives
of three to forty years.
Real Estate Owned
Real estate acquired through foreclosure or by deed in lieu of
foreclosure, is recorded at the lower of cost or fair value less
estimated costs to sell. An allowance for REO losses is maintained
for subsequent declines in fair value. Gains and losses from sales
are recognized as incurred. Carrying costs are generally expensed as
incurred.
Cost in Excess of Fair Value of Net Assets Acquired
Costs in excess of fair value of net assets acquired in business
combinations are being amortized on a straight-line basis over periods
of either 10 or 25 years. The remaining balance at September 30,
1996, is being amortized over 25 years.
Income Taxes
The Corporation and the Bank file a consolidated Federal income tax
return. State income tax returns are filed on a separate basis.
Loan Servicing
The Bank services real estate loans for investors which are not
included in the accompanying consolidated balance sheets. Fees earned
for servicing loans are reported as income when the related mortgage
loan payments are collected. Loan servicing costs are charged to
expense as incurred.
Originated Mortgage Servicing Rights
Effective October 1, 1995, First State adopted Statement of Accounting
Standards No. 122, "Accounting for Mortgage Servicing Rights" (SFAS
122). SFAS 122 requires that a mortgage banking enterprise recognize
as separate assets the rights to service mortgage loans for others
that have been acquired through either the purchase or origination of
a loan. A mortgage banking enterprise that sells or securitizes those
loans with servicing rights retained should allocate the total cost of
the mortgage loans to the mortgage servicing rights and the loans
based on their relative fair values.
The fair value of capitalized originated mortgage servicing rights is
determined based on the estimated discounted net cash flows to be
received. Originated mortgage servicing rights are amortized in
proportion to and over the period of estimated net loan servicing
income. These capitalized mortgage servicing rights are periodically
reviewed for impairment based on the fair value of those rights.
First State capitalized $535,000 of originated mortgage servicing
rights during the year ended September 30, 1996.
Net Income Per Share
Net income per share is computed by dividing net income by the average
number of common shares outstanding during the period. Shares
exercisable under stock option plans have been included in the
calculation of primary earnings per share using the treasury stock
method for periods in which this calculation was dilutive.
Financial Statement Presentation
Certain amounts in the 1995 and 1994 consolidated financial statements
have been reclassified to comply with the 1996 presentation.
(2) Merger Agreement and Business Combinations
On June 24, 1996, the Corporation signed a definitive merger agreement
providing for the acquisition of all of the outstanding stock of First
State Financial Services, Inc. by Sovereign Bancorp, Inc. (Sovereign).
This merger agreement was amended by an agreement (the "amendment")
signed by both parties on November 26, 1996. The amendment calls for
First State shareholders to receive between 1.225 and 1.84 shares of
Sovereign's common stock under a floating exchange ratio for each
share of First State common stock if Sovereign's average closing price
as defined in the amendment (the "Sovereign Market Value") is greater
than or equal to $8.00 but less than or equal to $12.04. Within this
range, the exchange ratio will be $14.75 divided by the Sovereign
Market Value. If the Sovereign Market Value is greater than $12.04,
the exchange ratio will be 1.225. If the Sovereign Market Value falls
below $8.00, the agreement may be terminated by First State unless
certain conditions are met. In a related agreement, Sovereign was
given an option to purchase up to 783,000 shares of First State's
issued and outstanding common stock if certain conditions occur. The
merger is subject to certain conditions, including approval by First
State's shareholders and various regulatory authorities and is expected
to be completed by the first calendar quarter of 1997.
On October 21, 1994, the Corporation issued approximately 678,000
shares of its common stock for all the outstanding stock of Ocean
Independent Bank, a New Jersey chartered bank located in Ocean, New
Jersey (Ocean). This business combination was accounted for as a
pooling-of-interests combination and, accordingly, the Corporation's
historical consolidated financial statements have been restated to
include the accounts and results of operations of Ocean for all years
presented. The results of operation of the Corporation and Ocean for
the year ended September 30, 1994 prior to restatement is as follows:
Year ended September 30, 1994
(in thousands)
The Corporation:
Net Interest Income $ 19,058
Net Income 3,189
Ocean:
Net Interest Income 2,429
Net Income 312
Combined:
Net Interest Income 21,487
Net Income 3,501
Prior to the combination, Ocean's fiscal year ended December 31. In
recording the pooling-of-interests combination, Ocean's unaudited
financial statements for the twelve months ended September 30, 1994
were combined with the Corporation's financial statements for the same
period. In addition, Ocean's financial statements for the years ended
December 31, 1993 and 1992 were combined with the Corporation's
financial statements for the years ended September 30, 1993 and 1992.
Ocean's unaudited results of operation for the three months ended
December 31, 1993, included net interest income of $649,000 and net
income of $3,000. An adjustment has been made to stockholders' equity
to eliminate the effect of including Ocean's results of operations for
the three months ended December 31, 1994 in both the year ended
September 30, 1994 and the year ended September 30, 1993.
<TABLE>
<CAPTION>
(3) Investment Securities Available for Sale, Investments and Mortgage-Backed Securities
The amortized costs, gross unrealized gains and losses and estimated market values of investment
debt securities are as follows:
September 30, 1996
--------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ------------ ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Held to Maturity Portfolio:
Investment Securities
US Treasury Securities $ 847 $ 6 $ - $ 853
US Government & Agency Obligations 9,310 8 (146) 9,172
Municipal Obligations 14,486 86 (242) 14,330
---------- ------------ ------------ ---------
24,643 100 (388) 24,355
---------- ------------ ------------ ---------
Mortgage-Backed Securities
GNMA 6,839 31 (163) 6,707
FNMA 7,102 61 (106) 7,057
FHLMC 14,997 63 (314) 14,746
FHA 2,086 - (36) 2,050
---------- ------------ ------------ ---------
31,024 155 (619) 30,560
---------- ------------ ------------ ---------
$ 55,667 $ 255 $ (1,007) $ 54,915
========== ============ ============ =========
Available for Sale Portfolio:
Investment Securities
US Treasury Securities $ 750 $ - $ (7) $ 743
Municipal Obligations 7,720 - (248) 7,472
Other Investments 3 11 - 14
---------- ------------ ------------ ---------
8,473 11 (255) 8,229
---------- ------------ ------------ ---------
Mutual Funds
US Government Securities 250 - - 231
Adjustable Rate Mortgages 582 - - 579
Commercial Paper 427 - - 427
---------- ------------ ------------ ---------
1,259 - (22) 1,237
---------- ------------ ------------ ---------
$ 9,732 $ 11 $ (277) $ 9,466
========== ============ ============ =========
</TABLE>
<TABLE>
<CAPTION>
September 30, 1995
--------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ------------ ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Held to Maturity Portfolio:
Investment Securities
US Treasury Securities $ 1,256 $ 12 $ - $ 1,268
US Government & Agency Obligations 9,647 10 (171) 9,486
Municipal Obligations 9,986 75 (158) 9,903
---------- ------------ ------------ ---------
20,889 97 (329) 20,657
---------- ------------ ------------ ---------
Mortgage-Backed Securities
GNMA 3,873 39 (6) 3,906
FNMA 6,396 120 (79) 6,437
FHLMC 8,692 88 (121) 8,659
---------- ------------ ------------ ---------
18,961 247 (206) 19,002
---------- ------------ ------------ ---------
$ 39,850 $ 344 $ (535) $ 39,659
========== ============ ============ =========
Available for Sale Portfolio:
Investment Securities
US Treasury Securities $ 1,007 $ - $ (6) $ 1,001
Municipal Obligations 2,728 6 (17) 2,717
Other Investments 28 6 - 34
---------- ------------ ------------ ---------
3,763 12 (23) 3,752
---------- ------------ ------------ ---------
Mutual Funds
US Government Securities 236 - (15) 221
Adjustable Rate Mortgages 7,475 - (68) 7,407
Commercial Paper 419 - - 419
---------- ------------ ------------ ---------
8,130 - (83) 8,047
---------- ------------ ------------ ---------
$ 11,893 $ 12 $ (106) $ 11,799
========== ============ ============ =========
</TABLE>
The amortized cost and estimated market value of investment debt securities at
September 30,1996, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without penalties. The
contractual maturities of mortgage-backed securities generally exceeds twenty
years; however, the effective lives are expected to be less due to anticipated
prepayments.
<TABLE>
<CAPTION>
Estimated
Amortized Market Average
Cost Value Yield(a)
--------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Held to Maturity Portfolio:
Investment Securities
Due in one year or less $ 2,055 $ 2,057 6.11 %
Due after one year through five years 7,597 7,562 6.01
Due after five years through ten years 3,030 2,948 6.72
Due after ten years 11,961 11,788 7.81
--------- --------- ---------
24,643 24,355 6.98
Mortgage-Backed Securities 31,024 30,560 6.78
--------- --------- ---------
$ 55,667 $ 54,915 6.85 %
========= ========= =========
Available for Sale Portfolio:
Investment Securities
Due in one year or less $ - $ - - %
Due after one year through five years 750 743 5.03
Due after five years through ten years 419 408 6.76
Due after ten years 7,304 7,078 7.47
--------- --------- ---------
8,473 8,229 7.22
Mutual Funds
Due in one year or less 1,259 1,237 5.74
--------- --------- ---------
$ 9,732 $ 9,466 7.03 %
========= ========= =========
(a) Tax equivalent yields
</TABLE>
The carrying value of investment securities pledged as required for public
funds and deposits amounted to $2.6 million at September 30,1996. In
addition, certain investment and mortgage-backed securities are pledged
as collateral under various borrowing agreements.
See note 6.
Pursuant to the provisions and implementation guidance contained within the
Financial Accounting Standards Board's special report "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities", on November 15, 1995, the Corporation reassessed the
classification of all securities within its portfolio and transferred $9.1
million from its held-to-maturity investment portfolio to its available-
for-sale portfolio. These securities had a market value of $9.2 million
which resulted in the Corporation recording an unrealized gain on securities
available-for-sale, net of tax, within stockholders' equity of $87,000.
Gross gains (losses) realized on sales of investment securities and mortgage-
backed securities for the years ended September 30, 1996, 1995, and 1994 were
as follows:
1996 1995 1994
-------- ------- -------
(in thousands)
Gross gains $ 177 $ 32 $ 137
Gross losses (108) (157) (55)
-------- ------- -------
Net gain (loss) on sales of investments $ 69 $ (125) $ 82
======== ======= =======
Cash proceeds from sales transactions approximated $41.0 million, $18.2 mllion
and $9.9 million for the years ended September 30, 1996, 1995, and 1994,
respectively.
(4) Loans Receivable, Net
Loans receivable, net consists of the following:
<TABLE>
<CAPTION>
September 30,
--------------------------
1996 1995
----------- -----------
(in thousands)
<S> <C> <C>
First Mortgage loans:
Conventional $ 380,530 $ 351,416
Partially guaranteed by VA or insured by FHA 1,889 2,377
Participation in conventional loans 13,539 10,093
Loans for land and construction 17,624 23,031
----------- -----------
413,582 386,917
----------- -----------
Commercial loans 38,289 35,470
Property improvement loans 26,503 28,847
Credit card receivable 17,079 19,729
Guaranteed stucdent loans 306 658
Loans secured by deposits 1,263 1,122
Other loans 2,528 3,022
----------- -----------
85,968 88,848
----------- -----------
Less:
Allowance for loan losses 12,284 6,082
Deferred loan fees 847 350
Net unearned discounts 10 22
Loans in process 5,478 7,663
----------- -----------
18,619 14,117
----------- -----------
$ 480,931 $ 461,648
=========== ===========
</TABLE>
First DeWitt has granted loans to officers, directors, and to
associates. Related party loans are made on substantially the same
terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with unrelated persons and do not
involve more than the normal risk of collectibilty The aggregate
dollar amount of these loans was $10.6 million and $4.3 million at
September 30,1996 and 1995, respectively.
The following table presents information concerning loans accounted
for on a nonaccrual basis and loans whose terms have been restructured
to provide a reduction of interest rate charged to the borrower:
September 30,
----------------------------------------
1996 1995
----------------- -----------------
No. Amount No. Amount
(in thousands)
Nonaccrual loans 113 $ 19,859 159 $ 18,503
Current restructured loans 1 1,416 3 3,476
----- ---------- ----- ----------
Total 114 $ 21,275 162 $ 21,979
===== ========== ===== ==========
There were approximately $2.4 million and $1.1 million in loans that
were 90 days or more past due in principal repayments while
maintaining current interest payments at September 30, 1996 and 1995,
respectively. If the total nonaccrual loans had been current and
performing in accordance with their original terms, total interest
income would have been increased by approximately $1.7 million, $1.5
million, and $899,000 for the years ended September 30, 1996, 1995
and 1994, respectively.
At September 30,1996, the impaired loan portfolio was primarily
collateral dependent as defined under SFAS 114 and totaled $14.6
million for which general and specific allocations to the allowance
for loan losses of $6.4 million were identified. The average balance
of impaired loans during 1996 was approximately $12.1 million. The
amount of cash basis interest income that was recognized on impaired
loans during 1996 was $407,000.
The following is an analysis of the allowance for loan losses:
Year ended September 30,
-------------------------------
1996 1995 1994
---------- --------- ---------
(in thousands)
Balance, beginning of period $ 6,082 $ 6,351 $ 8,111
Adjustment for the pooling of a company
with a different year-end - - 170
Provisions charged to operations 8,900 1,650 1,722
Recoveries 141 72 409
Losses charged against the allowance (2,839) (1,991) (4,061)
---------- --------- ---------
Balance, end of period $ 12,284 $ 6,082 $ 6,351
========== ========= =========
First DeWitt services real estate loans for investors which are not
included in the accompanying consolidated balance sheets. The total
of such loans serviced amounted to approximately $166.8 million,
$113.4 million, and $115.2 million at September 30, 1996, 1995, and
1994, respectively. Servicing income generated from these loans
amounted to $562,000, $390,000, and $351,000 for the years ended
September 30, 1996, 1995 and 1994, respectively.
As discussed in note (1), the Corporation prospectively adopted SFAS
122 on October 1, 1995. The Corporation capitalized originated
mortgage servicing rights of $535,000 during the year ended September
30, 1996. Amortization of originated mortgage servicing rights for
the year ended September 30, 1996 was $63,000.
(5) Deposits
Savings deposits are comprised of the following:
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------
1996 1995
----------------------------- -------------------------------
Rate Amount % Rate Amount %
---------- --------- ------- ---------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance by type of account
and interest rate:
Commercial Checking -% $ 23,651 4.27% -% $ 19,563 3.45 %
Personal Checking 2.47 58,776 10.60 2.47 50,075 8.82
Money Market Checking 2.52 19,070 3.44 2.52 21,268 3.75
Money Market Passbook 2.52-4.89 32,426 5.85 2.52-3.93 31,898 5.62
Savings 2.13 97,361 17.56 2.37 108,240 19.06
Club 2.13 2,225 0.40 2.37 2,064 0.36
--------- ------- --------- -------
233,509 42.12 233,108 41.06
--------- ------- --------- -------
Certificates:
Regular 3.40-5.84(a) 279,350 50.40 3.20-5.51 266,754 46.99
Negotiable 4.35-7.68(a) 41,033 7.40 5.50-7.68 67,464 11.88
--------- ------- --------- -------
320,383 57.80 334,218 58.87
--------- ------- --------- -------
Accrued interest payable 428 0.08 384 0.07
--------- ------- --------- -------
$ 554,320 100.00% $ 567,710 100.00%
========= ======= ========= =======
</TABLE>
(a) At September 30,1996, the weighted average interest rates for regular and
negotiable certificates were 5.32% and 5.87%, respectively.
1996 1995
------------------ ------------------
Amount % Amount %
---------- ------- ---------- -------
(dollars in thousands)
Contractual maturity of
certificate accounts:
Within one year $ 288,982 90.20% $ 298,070 89.18%
One to two years 14,089 4.40 18,553 5.56
Two to three years 4,702 1.47 5,627 1.68
Three to Five Years 6,111 1.91 4,853 1.45
Over Five Years 6,499 2.02 7,115 2.13
---------- ------- ---------- -------
$ 320,383 100.00% $ 334,218 100.00%
========== ======= ========== =======
Interest expense on deposits is comprised of
the following:
Year Ended September 30,
-----------------------------------
1996 1995 1994
--------- --------- ---------
(Dollars in thousands)
Personal and money market
checking accounts $ 1,877 $ 1,742 $ 1,450
Savings, money market passbook
and certificate accounts. 21,088 18,912 11,637
--------- --------- ---------
$ 22,965 $ 20,654 $ 13,087
========= ========= =========
(6) Borrowed Money
Notes payable and other borrowings are as follows:
September 30,
Interest --------------------
Due Date Rate 1996 1995
-------------- -------- --------- ---------
(dollars in thousands)
FHLB of N.Y. (a)(d) Mar. 3, 2008 6.56% $ 128 $ 130
FHLB of N.Y. (b)(d) Sept. 11, 2006 8.16 200 200
FHLB of N.Y. (b)(d) May 25, 2000 6.63 3,000 3,000
FHLB of N.Y. (b)(d) Jan . 30, 1998 7.97 2,000 2,000
FHLB of N.Y. (c)(d) Demand 6.13 600 -
FHLB of N.Y. (c)(d) Demand 6.63 - 17,775
--------- ---------
$ 5,928 $ 23,105
========= =========
(a) These borrowings require periodic amortization.
(b) These borrowings do not require periodic amortization.
(c) The Corporation maintains a $63.3 million line of credit.
(d) First DeWitt maintains a blanket collateral agreement with FHLB
for the above borrowings. The amortized cost of mortgage-backed
securities, investments, and mortgage loans pledged toward this
agreement at September 30,1996 was $28.0 million, $8.1 million and
$25.5 million, respectively. The maximum borrowings outstanding
cannot exceed 90% of the amounts pledged.
(7) Office Properties and Equipment
Office properties and equipment are summarized as follows:
September 30,
----------------------
1996 1995
---------- ---------
(in thousands)
At cost:
Land $ 1,584 $ 1,563
Buildings and improvements 9,138 9,076
Furniture, equipment and automobiles 7,888 7,111
---------- ---------
18,610 17,750
Less accumulated depreciation 8,439 7,227
---------- ---------
$ 10,171 $ 10,523
========== =========
(8) Accrued Interest Receivable
A breakdown of accrued interest receivable on assets follows:
September 30,
--------------------
1996 1995
-------- --------
(in thousands)
Mortgage and other loans $ 5,140 $ 5,292
Mortgage-backed securities 212 122
Investments 579 495
-------- --------
5,931 5,909
Reserve for uncollectible interest (1,989) (1,863)
-------- --------
$ 3,942 $ 4,046
======== ========
(9) Other Expenses
Other expenses include the following:
Year ended September 30,
--------------------------------
1996 1995 1994
-------- -------- --------
(in thousands)
Telephone, postage and supplies $ 687 $ 669 $ 559
Insurance and bond premium 328 457 425
Legal expenses 314 256 215
Branch operations expense 304 276 223
Examination and audit services expense 317 315 445
Other employee expense 217 280 246
Other 684 871 971
-------- -------- --------
$ 2,851 $ 3,124 $ 3,084
======== ======== ========
(10) Income Taxes
Income tax expense (benefit) is made up of the following components:
Year ended September 30,
---------------------------------
1996 1995 1994
--------- -------- --------
(in thousands)
Current tax expense:
Federal $ 336 $ 1,575 $ 1,550
State - 147 142
--------- -------- --------
336 1,722 1,692
--------- -------- --------
Deferred federal tax benefit (1,944) (590) (329)
--------- -------- --------
Total income tax expense (benefit) $ (1,608) $ 1,132 $ 1,363
========= ======== ========
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
September 30, 1996 and 1995 are as follows:
1996 1995
-------- --------
Deferred tax assets:
Allowance for losses on loans
and real estate owned per books $ 3,633 $ 1,850
Loan origination fees deferred
for book purposes 177 126
Accrued SAIF special assessment 1,115 -
Reserve for uncollected interest 426 476
Other, net 344 89
Net operating loss carryforwards 417 564
-------- --------
Total gross deferred tax assets 6,112 3,105
-------- --------
Less valuation allowance 1,106 281
-------- --------
5,006 2,824
-------- --------
Deferred tax liabilities:
Depreciation 867 862
Tax reserve for bad-debt 174 -
-------- --------
Total gross deferred tax liability 1,041 862
-------- --------
$ 3,965 $ 1,962
======== ========
A reconciliation of income tax expense (benefit) per consolidated
financial statements and the "expected" income tax expense (benefit)
follows:
Year ended September 30,
------------------------
1996 1995
-------- --------
(in thousands)
Expected income tax expense (benefit) $(2,467) $ 1,744
Amortization of excess cost over fair
value of net assets acquired 68 145
State tax, net of Federal benefit - 33
Increase in cash surrender value of
insurance policies (135) (227)
Interest income exclusion (241) (265)
Other, net 342 104
Change in the beginning-of-the-year
balance of the valuation allowance
for deferred tax assets allocated
as income tax expense 825 (402)
Income tax expense (benefit) per -------- --------
consolidated financial statements $(1,608) $ 1,132
======== ========
The valuation allowance for deferred assets as of October 1, 1995 was
$281,000. The net change in the total valuation allowance for the
year ended September 30, 1996 was an increase of $825,000. Included
in deferred tax assets "Other, net" is an asset related to the
unrealized loss on securities available for sale, in the amounts of
$89,000 and $30,000 for 1996 and 1995, respectively.
The Corporation will need to generate future taxable income, in order
to fully realize the deferred tax asset. Management believes it is
more likely than not that the Corporation will realize the benefit of
net deductible temporary differences and that such net deductible
temporary differences will reverse during periods in which the
Corporation generates net taxable income. The net deferred tax asset
is predicated on the Corporation generating sufficient taxable income
to utilize the deferred tax assets. There can be no assurance,
however, that the Corporation will generate any earnings or any
specific level of continuing earnings.
The Congress in August of 1996, repealed, for tax purposes, the
percentage of taxable income bad debt reserve method. Pursuant to
SFAS 109, retained income at September 30, 1996 includes approximately
$10.0 million for which no provision for income tax has been made.
This amount represents an allocation of income to bad-debt deductions
for tax purposes only. Events that would result in taxation of these
reserves include failure to qualify as a bank for tax purposes,
distributions in complete or partial liquidation, and excess
distributions to shareholders. The Corporation at September 30, 1996
had an unrecognized deferred tax liability of $3.6 million with
respect to this reserve.
(11) Employee Benefit Plans
The Corporation has a noncontributory defined benefit pension plan.
The plan covers all employees provided they are at least 21 years of
age and have worked a minimum of 1000 hours in the plan year.
Benefits are generally based on years of service and the employee's
compensation during the last 5 years of employment. In 1995, the Bank
froze all future benefit accruals to participants in the pension plan.
Accordingly, 1996 net periodic pension cost and the projected benefit
obligation reflect the effects of the plan curtailment.
The following table sets forth the plan's funded status:
September 30,
-------------------
1996 1995
------- -------
(in thousands)
Plan assets at fair value, primarily
investment rated bonds and
mortgages with call protection $3,126 $2,337
------- -------
Actuarial present value of benefit obligations:
Accumulated benefit obligation for service
rendered to date, including vested benefits
of $2,791 and $2,860, respectively 3,066 3,106
Additional future benefits based on estimated
salary levels - 301
------- -------
Projected benefit obligation 3,066 3,407
------- -------
Excess of projected benefit obligation over
plan assets 60 (1,070)
Unrecognized net transition asset being
recognized over 20.5 and 21.5 years, respectively (9) (9)
Unrecognized prior service cost - 843
Unrecognized net gain (398) (37)
Additional minimum balance sheet liability - (496)
------- -------
Accrued pension cost included in other
(assets) liabilities $ (347) $ (769)
======= =======
Year ended September 30,
------------------------
1996 1995 1994
------ ------ -------
(in thousands)
Net periodic pension cost included the
following components:
Service cost-benefits earned during the
period $ - $ 273 $ 265
Interest cost on projected benefit 244 226 202
obligation
Actual return on plan assets (586) (112) (43)
Net amortization and deferral 361 10 (72)
Curtailments loss 542 - -
------ ------ -------
Total net periodic pension cost $ 561 $ 397 $ 352
Annual pension contributions are made by the Bank in accordance with
the requirements of the Employee Retirement Income Security Act of
1974. The weighted average discount rate of 7.5% in 1996, 1995 and
1994, and the rate of increase in future compensation levels of 5.5%
in 1995 and 1994 were used in determining the actuarial present value
of benefit obligations. The expected long-term rate of return on
assets was 9.0% for 1996, 1995 and 1994.
First DeWitt has established an Employee Stock Ownership Plan
("ESOP"). This plan covers all employees included in the pension
benefit plan except the President and Chief Executive Officer. The
ESOP, which is a tax-qualified employee benefit plan, became effective
upon conversion. At September 30, 1996, the ESOP held, in
trust, 171,302 shares of the Corporation's common stock.
First DeWitt has established a qualified defined contribution 401(k)
Thrift Plan (the Plan) under Section 401(k) of the Internal Revenue
Code. Substantially all employees are eligible for participation
after one year of credited service, as defined, provided they have
attained age 21. Under the Plan, employee contributions are partially
matched by the Corporation. All employee and employer matching
contributions and income thereon are fully vested at all times. Total
401(k) expense was $111,000, $82,000 and $75,000 for the years ended
September 30, 1996, 1995 and 1994, respectively.
As of October 1, 1994, the Bank adopted deferred compensation plans
for the benefit of certain executive officers. Under the plans, the
Bank agrees (i) in return for the participants relinquishing the right
to a portion of their current compensation and (ii) as a supplemental
retirement benefit, to pay certain officers retirement benefits in a
lump sum or in the form of monthly payments of up to 240 months. The
Bank will accrue on the books the present value of the benefits, so
the amounts required will be provided at normal retirement dates and
thereafter. Full retirement benefits are immediately payable to the
participant's beneficiary if death of the participant occurs prior to
retirement. The Bank incurred $666,000 and $198,000 of expense
relating to these plans during the years ended September 30, 1996 and
1995, respectively.
In conjunction with the formation of these plans, the Bank purchased
life insurance on the participants. The cash surrender value of that
insurance was approximately $12.0 million and $11.6 million at
September 30, 1996 and 1995, respectively.
(12) Commitments and Contingencies
Certain bank facilities are occupied under non-cancelable long term
operating leases which expire at various dates through 2007. Certain
lease agreements provide for renewal options and increases in rental
payments based upon increases in the consumer price index. Minimum
aggregate lease payments for the remainder of the lease terms are as
follows:
September 30, (in thousands)
------------- --------------
1997 $ 253
1998 246
1999 247
2000 258
2001 163
Thereafter 465
--------------
Total lease commitments $ 1,632
==============
Net premises and occupancy expenses for 1996, 1995, and 1994 includes
approximately $239,800, $137,000 and $148,200, respectively, of rental
expenses for bank facilities.
In the ordinary course of business, to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest
rates, the Bank is a party to various financial instruments which are
not reflected in the consolidated financial statements. These
instruments consist of commitments to extend credit and unused lines
of credit available under consumer loan credit lines and involve
elements of credit and interest rate risk in excess of the amounts
recognized in the consolidated financial statements. The Bank uses
the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. The amount
of collateral obtained, if deemed necessary upon extension of credit,
is based upon management's credit evaluation of the counterparty.
Loan commitments outstanding at September 30, 1996 and 1995 totaled
$9.9 million and $17.3 million, respectively. The loan commitments
outstanding at September 30, 1996 consist of variable rate commitments
approximating $6.7 million and fixed rate commitments approximating
$3.2 million. The later commitments had rates primarily from 6.63% to
8.75%. Unused line of credit available under credit lines aggregated
$28.8 million and $34.6 million at September 30, 1996 and 1995. These
off-balance sheet commitments generally have fixed expiration dates or
other termination clauses.
In addition, the Bank had commitments to sell mortgage loans
outstanding at September 30, 1996 totaling $4.8 million with interest
rates ranging from 6.50% to 8.75%. At September 30, 1995, there were
similar commitments to sell mortgage loans outstanding totaling $34.7
million.
The Bank grants residential, consumer, construction and commercial
loans secured generally by real estate to customers located primarily
in New Jersey. Accordingly, as with most financial institutions in
the market area, the ultimate collectability of a substantial portion
of the loan portfolio and recoverability of in-substance foreclosed
loans and real estate acquired by foreclosure are susceptible to
changes in market conditions.
In the normal course of business, First State may be party to various
outstanding legal proceedings and claims. In the opinion of
management, the disposition of such legal proceedings and claims will
not materially affect First State's consolidated financial statements.
(13) Selected Quarterly Financial Data (unaudited)
Quarterly results from 1996 and 1995 are shown below (in thousands,
except per share amounts):
1996
----------------------------------------
First Second Third Fourth
-------- -------- -------- --------
Interest income 11,844 11,601 13,050 12,744
Net interest income 5,905 5,880 6,928 6,472
Provisions for loan losses 300 900 4,400 3,300
Income (loss) before income taxes 2,263 439 (3,503) (6,456)
Net income (loss) 1,505 308 (2,809) (4,653)
Net income (loss) per share 0.36 0.08 (0.69) (1.15)
1995
----------------------------------------
First Second Third Fourth
-------- -------- -------- --------
Interest income 10,151 10,907 11,450 11,841
Net interest income 5,569 5,669 5,724 5,622
Provisions for loan losses 200 300 600 550
Income before income taxes 1,476 1,487 1,332 835
Net income 961 988 958 1,091
Net income per share 0.25 0.25 0.24 0.27
(14) Stock Option Plans
The Corporation has various stock option plans which have been
approved by the Corporation's stockholders. The table below details
their status at September 30, 1996.
<TABLE>
<CAPTION>
STOCK OPTIONS STOCK AWARDS
------------------------------------- ---------------
Total Wht. Total
Shares Avg. Options Shares
Plan Outstanding Issued Vested Price Exercised Issued Vested Unissued
- ----------------------- ------------- -------- ------- ------- --------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
The 1987 Plan 190,700(a) 190,700 190,700 $ 5.50 44,250 N/A N/A -
The 1993 Directors Plan 50,800 50,800 12,700 $ 6.98 12,700 - - -
The 1993 Plan:
1995 Distribution 254,000 48,700 19,480 $ 7.25 - 11,700 4,680
1996 Distribution 75,600 15,120 $ 13.25 - 17,100 3,420 95,500
(a) Options that have expired under this plan total 82,550.
</TABLE>
On October 14, 1994, Ocean Independent Bank issued shares under an
existing stock option plan that converted to 15,443 shares of First
State common stock.
(15) Condensed Financial Information of Parent Company
September 30,
---------------------
1996 1995
--------- ---------
Balance Sheets (in thousands)
Assets
Cash $ 59 $ 220
Investments securities available for sale 1,007 964
Investment securities - 410
Loans receivable 207 217
Investments in subsidiaries 33,965 39,779
Other assets - 2
--------- ---------
Total assets $ 35,238 $ 41,592
========= =========
Liabilities and Stockholders' equity
Other liabilities 2 -
Stockholders' equity 35,236 41,592
--------- ---------
Total stockholders' equity $ 35,238 $ 41,592
========= =========
Years ended September 30,
-----------------------------
1996 1995 1994
--------- -------- --------
Statement of Operations: (dollars in thousands)
Dividends from subsidiary $ - $ 1,000 $ 1,250
Other income 76 76 31
--------- -------- --------
Total income 76 1,076 1,281
Operating expenses 109 276 274
Income (loss) before income taxes and
equity in undistributed earnings of
subsidiaries (33) 800 1,007
Income tax benefit (58) (384) -
--------- -------- --------
Income before equity in undistributed
earnings of subsidiaries 25 1,184 1,007
Equity in undistributed earnings (losses)
of subsidiaries (5,674) 2,814 2,494
--------- -------- --------
Net income (loss) $ (5,649) $ 3,998 $ 3,501
========= ======== ========
<TABLE>
<CAPTION>
Years ended September 30,
----------------------------
1996 1995 1994
--------- -------- --------
(in thousands)
<S> <C> <C> <C>
Statement of Cash Flows:
Operating activities:
Net income (loss) $ (5,649) $ 3,998 $ 3,501
Net accretion of investment discount - (29) -
Provision for losses on loans - 50 -
Decrease in other assets 2 218 100
Increase in other liabilities 2 - -
--------- -------- --------
Net cash (used) provided by operating activities (5,645) 4,237 3,601
--------- -------- --------
Investing activities:
Decrease (increase) in investment in subsidiaries 5,675 (2,845) (2,417)
Proceeds from loan repayments 10 8 20
Origination of loans receivable - (44) (154)
Purchase of investment securities available for sale (473) (454) (510)
Purchase of investment securities - (1,097) -
Proceeds from sale ofinvestment securities available
for sale 430 - -
Proceeds from maturities of investment securities 410 716 -
--------- -------- --------
Net cash provided (used) by investing activities 6,052 (3,716) (3,061)
--------- -------- --------
Financing activities:
Dividends paid on common stock (861) (758) (476)
Common stock issued 293 190 -
--------- -------- --------
Net cash used by financing activities (568) (568) (476)
--------- -------- --------
(Decrease) increase in cash (161) (47) 64
Cash at beginning of year 220 267 203
--------- -------- --------
cash at end of year $ 59 $ 220 $ 267
========= ======== ========
NON-CASH TRANSFERS:
Release of Employee Stock Ownership Plan stock $ - $ - $ 1,159
Cancellation of common shares in conjunction with
merger $ - $ - $ 109
</TABLE>
(16) Stockholders' Equity and Regulatory Matters
Subject to applicable law, the Board of Directors of the Bank and of
the Corporation may each provide for the payment of dividends.
Future declaration of cash dividends by First State will depend upon
dividend payments by the Bank to the Corporation, which is its primary
source of income. Under Office of Thrift Supervision ("OTS")
regulations, if the Bank satisfies all applicable capital
requirements, the Bank is permitted to pay cash dividends during a
calendar year in an amount equal to 100% of its net income to date
during that calendar year plus 50% of the amount by which its capital
exceeds its capital requirements at the beginning of the year. The
Bank is required to give 30 days' prior notice to the OTS of the
intention to pay a dividend, and the OTS may prohibit the payment of
the dividend.
Earnings allocated to bad debt reserves for losses and deducted for
federal income tax purposes are not available for dividends or other
distributions with respect to the Bank's capital stock without the
payment of tax at the then current income tax rate on approximately
150% of the amount so used, assuming a 34% corporate income tax rate.
At the time of conversion from mutual to stock form, a liquidation
account was established in an amount equal to the Bank's retained
income at December 31, 1986. The liquidation account was established
for the benefit of eligible account holders who continue to maintain
their accounts at First DeWitt after conversion. The liquidation
account will be reduced annually to the extent that eligible account
holders have reduced their eligible deposits. Subsequent increases
will not restore an eligible account holder's interest in the
liquidation account. In the event of a complete liquidation, each
eligible account holder will be entitled to receive a distribution
from the liquidation account in a proportionate amount to the current
adjusted eligible account balances then held. The balance of the
liquidation account at September 30, 1996 was $69,000 ($1.7 million
at September 30,1995).
OTS regulations require savings institutions to maintain minimum
levels of regulatory capital. Under the regulations in effect at
September 30, 1996, the Bank was required to maintain a minimum ratio
of tangible capital to total adjusted assets of 1.5%; a minimum ratio
of Tier 1 (core) capital to total adjusted assets of 3.0%; and a
minimum ratio of total (core and supplementary) capital to risk-
weighted assets of 8.0%.
Under its prompt corrective action regulations, the OTS is required to
take certain supervisory actions (and may take additional
discretionary actions) with respect to an undercapitalized
institution. Such actions could have a direct material effect on the
institution's financial statements. The regulations establish a
framework for the classification of savings institutions into five
categories: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized. Generally, an institution is considered adequately
capitalized if it has a Tier 1 (core) capital ratio of at least 3.0%;
a Tier 1 risk-based capital ratio of at least 4.0%; and a total risk-
based capital ratio of at least 8.0%. Under the framework, the Bank's
capital levels do not allow the Bank to accept brokered deposits
without prior approval from regulators.
The foregoing capital ratios are based in part on specific
quantitative measures of assets, liabilities and certain off-balance
sheet items as calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative
judgments by the OTS about capital components, risk weightings, and
other factors.
Management believes that, as of September 30, 1996, the Bank meets all
capital adequacy requirements to which it is subject. The following
is a summary of the Bank's actual capital amounts and ratios as of
September 30, 1996 and 1995, compared to the OTS minimum capital
adequacy requirements and the OTS requirements for classification as a
well-capitalized institution.
<TABLE>
<CAPTION>
To Be Well
Capitalized
Under
Prompt
Minimum Corrective
Capital Action
Actual Requirements Provisions:
-------------- -------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------ ------ ------ ------ ------ -------
( in thousands )
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1996:
Tangible Capital 31,954 5.24% 9,143 1.50% 9,143 1.50%
Core Capital 31,954 5.24% 18,285 3.00% 30,474 5.00%
Tier 1 Risk-Based Capital 31,954 8.14% 15,710 4.00% 23,565 6.00%
Risk-Based Capital 36,921 9.40% 31,419 8.00% 39,274 10.00%
As of September 30, 1995:
Tangible Capital 37,404 5.87% 9,563 1.50% 9,563 1.50%
Core Capital 37,404 5.87% 19,126 3.00% 31,877 5.00%
Tier 1 Risk-Based Capital 37,404 9.27% 16,137 4.00% 24,205 6.00%
Risk-Based Capital 42,448 10.52% 32,273 8.00% 40,341 10.00%
</TABLE>
SAIF Special Assessment
The Deposit Insurance Funds Act of 1996 (the "Act") was signed into
law on September 30, 1996. Among other things, the Act requires
depository institutions to pay a one-time special assessment of 65.7
basis points on their SAIF-assessable deposits, in order to
recapitalize the SAIF to the reserve level required by law. The
Corporation's financial statements for the year ended September 30,
1996 reflect a separate charge of $3.1 million this special
assessment.
(17) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures
about Fair Value of Financial Instruments" (Statement 107), requires
disclosure of estimated fair value for financial instruments. Fair
value estimates, methods and assumption are set forth below for the
Bank's financial instruments for which it is practical to estimate
those values.
Cash on hand and in banks
For cash on hand and in banks the carrying amount approximates fair
value.
Investments Available for Sale, Investments and Mortgage-backed
Securities
The fair value of investments available for sale, investments and
mortgage-backed securities, were based on quoted market prices or
dealer quotes, if available. If a quoted market price or dealer quote
was not available, fair value was estimated using quoted market prices
of similar securities.
Stock in Federal Home Loan Bank of New York
The fair value for FHLB 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 Bank is required to maintain a minimum balance
based upon the unpaid principal of home mortgage loans and similar
obligations.
Loans, Receivable
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans were segregated by type. Each loan
category was further segmented into fixed and adjustable rate interest
terms.
The fair value of loans is estimated by discounting the future cash
flows and prepayments using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the
same remaining terms.
Cash surrender value of life insurance
The fair value of the cash surrender value of life insurance is the
approximate cash value at September 30, 1996 and 1995.
Deposit Liabilities
The fair value of deposits with no stated maturity, such as passbook,
NOW, money market and commercial deposit accounts, is equal to the
amount payable on demand as of September 30,1996 and 1995. 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.
Borrowed Money
The fair value of borrowed money is the carrying value for short-term
obligations while long-term borrowing fair values are estimated using
rates available on borrowings with similar terms and maturities.
The estimated fair values of the Bank's financial instruments as of
September 30, 1996 and 1995 are presented in the following table.
Since the fair value of off-balance-sheet commitments approximates
book value, these disclosures are not included.
<TABLE>
<CAPTION>
1996 1995
------------------- -------------------
Book Fair Book Fair
Value Value Value Value
--------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash on hand and in banks $ 12,395 $ 12,395 $ 11,792 $ 11,792
Investment securities 24,643 24,355 20,889 20,657
Investment securities,available for sale 9,466 9,466 11,799 11,799
Mortgage-backed securities 31,024 30,560 18,961 19,002
Federal Home Loan Bank of New York stock 3,404 3,404 3,715 3,715
Loans receivable, net 480,931 486,529 461,648 465,742
Mortgage loans held for resale 9,106 9,106 67,219 67,642
Cash surrender value of life insurance 11,978 11,978 11,582 11,582
--------- --------- --------- ---------
Financial liabilities:
Deposits $554,320 $553,205 $567,710 $567,126
Borrowed money 5,928 5,997 23,105 23,159
--------- --------- --------- ---------
</TABLE>
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 Bank's entire
holdings of a particular financial instrument. Because no market
exists for a significant portion of the Bank'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 on-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. 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.
(18) Recent Accounting Pronouncements
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123). This statement establishes
financial accounting and reporting standards for stock-based employee
compensation plans. SFAS 123 encourages all entities to adopt the
"fair value base method" of accounting for employee stock compensation
plans. However, SFAS 123 also allows an entity to continue to measure
compensation cost under such plans using the "intrinsic value based
method." Under the fair value based method, compensation cost is
measured at the grant date based on the value of the award and is
recognized over the service period, usually the vesting period. Fair
value is determined using an option pricing model that takes into
account the stock price at the grant date, the exercise price, the
expected life of the option, the volatility of the underlying stock
and the expected dividends on it, and the risk-free interest rate over
the expected life of the option. Under the intrinsic value based
method, compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date or other measurement date over
the amount an employee must pay to acquire the stock. Most stock
plans have no intrinsic value at date of grant, and under previous
accounting guidance, no compensation cost was to be recognized.
The accounting requirements of this statement are effective for
transactions entered into in fiscal years that begin after December
15, 1995. The Bank intends to continue accounting for compensation
costs under the intrinsic value based method and will provide pro
forma disclosures for all awards granted after October 1, 1995. Such
disclosures include net income and earnings per share after the fair
value based method of accounting has been applied.
In June 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS 125). SFAS 125 amends portions of SFAS 115, and
extends to all servicing assets and liabilities, the accounting
standards for mortgage servicing rights now governed by SFAS 65, and
SFAS 122. The statement provides consistent standards for
distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. Those standards are based upon
consistent application of a financial components approach that focuses
on control. The statement also defines accounting treatment for
servicing assets and other retained interests in the assets that are
transferred. SFAS 125 is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after
December 31, 1996 and is to be applied prospectively. The Bank does
not expect the adoption of SFAS 125 to have material effect on its
future financial position or results of operations.
FIRST STATE FINANCIAL SERVICES, INC.
Stockholder Information
Executive Offices
1120 Bloomfield Avenue, CN 2449
West Caldwell, New Jersey 07007-2449
Market Information for Common Stock
The common stock is traded over-the-counter and is quoted on
NASDAQ National Market System under the symbol "FSFI." At
October 29, 1996 there were 1,073 holders of record of First
State's common stock, as reported on the NASDAQ National Market
System, as well as information regarding dividends declared
during such periods.
Fiscal 1996 High Low
Quarter ended September 30, 1996 $ 13.375 $ 12.500
Quarter ended June 30, 1996 13.625 10.000
Quarter ended March 31, 1996 13.375 11.750
Quarter ended December 31, 1995 14.375 12.875
Fiscal 1995 High Low
Quarter ended September 30, 1995 $ 13.250 $ 12.125
Quarter ended June 30, 1995 12.250 9.250
Quarter ended March 31, 1995 9.500 6.750
Quarter ended December 31, 1994 8.750 6.625
Stockholder Relations
Stockholders are encouraged to contact the Secretary with any
questions or comments about their investments. A copy of the
Annual Report or Form 10-K for the year ended September 1996, as
filed with the Securities and Exchange Commission, will be
furnished without charge to stockholders as of the record date
upon written request to the Secretary.
Direct Inquiries to:
Marie G. Martino, Secretary
First State Financial Services, Inc.
1120 Bloomfield Avenue, CN 2449
West Caldwell, New Jersey 07007-2449
(201) 575-5800
Registrar and Transfer Agent Independent Auditors
Registrar and Transfer Company KPMG Peat
Marwick LLP
10 Commerce Drive 150 John F. Kennedy
Parkway
Cranford, New Jersey 07016 Short Hills,
New Jersey 07078
Attorneys
Gaccione, Pomaco and Beck Luse Lehman Gorman
Pomerenk & Schick
523 Union Avenue 5335 Wisconsin Avenue, N.W.
Belleville, New Jersey 07109 Washington, DC 20015
FIRST STATE FINANCIAL SERVICES, INC.
Officers and Directors
OFFICERS-FIRST STATE FINANCIAL SERVICES, INC
Michael J. Quigley, III John M. Fields, Jr.
Chairman, President, and Chief Vice President
Executive Officer
Emil J. Butchko John H. Isemann
Vice President and Treasurer Vice President
Marie G. Martino John A. Rogers
Secretary Vice President
DIRECTORS-FIRST STATE FINANCIAL SERVICES, INC.
Henry F. Albinson Walter J. Davis
Attorney, Bloomfield Retired: Former Governmant
Relations Manager, AT&T
Frank H. Bridge Marie G. Martino
President, F.H. Bridge & Secretary, First State
Associates Financial Services, Inc.
Vice President and Secretary,
First DeWitt Bank
June D. Castano
Writer/Editor-International Renew Michael J. Quigley, III
Chairman, President, and Chief
Executive Officer
Patrick N. Ciccone, M.D.
Physician Ralph M. Riefolo
President, Riefolo Construction Co.
Theodore F. Cox
Retired: Former President of
Cedar Grove Garden Center, Inc.
OFFICERS-FIRST DeWITT BANK
Michael J. Quigley, III John M. Fields, Jr.
Chairman of the Board, Vice President and Controller
President and Chief
Executive Officer
John H. Isemann
Emil J. Butchko Vice President, Mortgage Loan
Senior Vice President and Officer
Treasurer
Richard O. Lindsey
John A, Rogers Vice President, Commercial Loan
Senior Vice President Officer
Marie G. Martino
Robert H. Blum Vice President and Secretary
Vice President, Consumer Loan
Officer
Henrik Tvedt, Jr.
Joseph J. Burghardt Vice President
Vice President, Commercial
Mortgage Officer
Alan M. Chadrijian
Vice President, Commercial Loan
Officer
DIRECTOR-FIRST DeWITT BANK
Henry F. Albinson Walter J. Davis
Attorney, Bloomfield Retired: Former Governmant
Relations Manager, AT&T
Frank H. Bridge Terence J. Gunning
President, F.H. Bridge & Chief Operating Offier, Accudart
Associates
June D. Castano Michael J. Quigley, III
Writer/Editor, International Renew Chairman, President, and Chief
Executive Officer
Patrick N. Ciccone, M.D. Ralph M. Riefolo
Physician President, Riefolo Construction Co.
Theodore F. Cox Jerold L. Zaro, Esq.
Retired: Former President of Partner and President, Ansell
Cedar Grove Garden Center, Inc. Zaro Bennett & Grimm
Gary J. Davis
Managing Partner, McQueeny,
Davis, Kohm & Partners, Inc.
FIRST STATE FINANCIAL SERVICES, INC.
Branch Location Guide
Number for all offices:
1-800-537-0079
BANKING OFFICES:
Essex County Morris County
463 Washington Avenue 1980 Route 10 West
Belleville,NJ 07109 Morris Plains, NJ 07950
667 Bloomfield Avenue
Bloomfield, NJ 07003
60 Belleville Avenue Ocean County
Bloomfield, NJ 07003
2518 Old Hooper Avenue
1072 Broad Street Brick, NJ 08723
Bloomfield, NJ 07003
1161 Burnt Tavern Road
532 Pompton Avenue Brick, NJ 08724
Cedar Grove, NJ 07009
730 Jamaica Boulevard
1120 Bloomfield Avenue, CN2449 Toms River, NJ 08757
West Caldwell, NJ 07007-2449
Sussex County
Monmouth County 110 River Styx Road
Hopatcong, NJ 07843
4 Main Street
Englishtown, NJ 07726
901 West Park Avenue
Ocean, NJ 07712
2500 Belmar Boulevard
Wall, NJ 07719
All of our offices are a part of
the MAC 24-hour banking network.
