SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number 0-25994
SFS BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 22-3366295
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization Identification Number)
251-263 State Street, Schenectady, New York 12305
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (518) 395-2300
----------------------------------
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-K. [X]
The issuer's revenues for the fiscal year ended December 31, 1998 were
$15,213,000.
<PAGE>
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, computed by reference to the average of the bid and asked price
of such stock as of March 5, 1999 was $19.0 million. (The exclusion from such
amount of the market value of the shares owned by any person shall not be deemed
an admission by the Registrant that such person is an affiliate of the
Registrant.)
As of March 1, 1999, the Registrant had 1,208,472 shares of Common Stock
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of Form 10-KSB - Annual Report to Stockholders for the fiscal year
ended December 31, 1998.
Part III of Form 10-KSB - Portions of The Proxy Statement for Annual Meeting
of Stockholders to be held in 1999.
<PAGE>
PART I
Item 1 Description of Business
Forward Looking Statements
When used in this Form 10-KSB or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be",
"will allow", "intends to", "will likely result", "are expected to", "will
continue", "is anticipated", "estimate", "project", or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
to advise readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any
obligation, to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
General
SFS Bancorp, Inc. (the "Holding Company" or "SFS Bancorp"), a Delaware
corporation, was organized to act as the holding company for Schenectady Federal
Savings Bank ("Schenectady Federal" or the "Bank") upon completion of the Bank's
conversion from the mutual to the stock form of organization (the "Conversion").
Collectively, these entities are referred to herein as the Company. The Holding
Company received approval from the Office of Thrift Supervision (the "OTS") to
acquire all of the common stock of the Bank to be outstanding upon completion of
the Conversion. The Conversion was completed on June 29, 1995. All references to
the Company, unless otherwise indicated, at or before June 29, 1995 refer to the
Bank and its subsidiary on a consolidated basis. The Holding Company's Common
Stock is quoted on the National Association of Securities Dealers Automated
Quotations ("Nasdaq") "National Market System under the symbol "SFED".
At December 31, 1998, the Company had total assets of $178.2 million,
deposits of $150.6 million, and stockholders' equity of $23.6 million.
1
<PAGE>
The executive offices of the Company are located at 251-263 State
Street, Schenectady, New York 12305, and its telephone number at that address is
(518) 395-2300.
The Holding Company and the Bank are subject to comprehensive
regulation, examination and supervision by the Office of Thrift Supervision,
Department of the Treasury ("OTS") and by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is a member of the Federal Home Loan Bank
("FHLB") System and its deposits are backed by the full faith and credit of the
United States Government and are insured by the Savings Association Insurance
Fund ("SAIF") to the maximum extent permitted by the FDIC. See "Regulation."
The Bank, the Holding Company's only operating subsidiary, was
originally chartered in 1889 as a state-chartered financial institution. In
1981, the Bank converted to a federally chartered mutual savings and loan
association. Schenectady Federal's business involves attracting deposits from
the general public and using such deposits to fund one- to four-family
residential mortgage, home equity and, to a much lesser extent, consumer and
other loans in its market area. At December 31, 1998, $135.6 million, or 96.0%
of the Bank's total loan portfolio consisted of residential mortgage loans,
including home equity loans. The Bank also invests in mortgage-backed
securities, investment securities (consisting primarily of U.S. agency
obligations) and other permissible investments. At December 31, 1998, the Bank
had $9.8 million of mortgage-backed securities, representing 5.5% of total
assets, and $18.8 million of other investment securities (including $17.0
million of securities available-for-sale, at fair value), representing 10.6% of
total assets.
The Bank has sought to enhance its net income through the adoption of a
strategy designed to maintain capital in excess of regulatory requirements,
limit loan delinquencies and manage the Bank's vulnerability to changes in
interest rates. This strategy involves (i) emphasizing, subject to market
conditions, the acquisition of adjustable rate one- to four-family mortgage
loans ("ARMs") and fixed rate one- to four-family mortgage loans, (ii)
emphasizing the origination of home equity loans (most of which carry floating
rates of interest), (iii) maintaining a substantial portfolio of mortgage-backed
and investment securities and other short- and medium-term investments, and (iv)
using customer service and marketing efforts to build and maintain a substantial
level of core deposits.
Schenectady Federal is a community-oriented financial institution
offering a variety of financial services to meet the needs of the communities it
serves. The Bank attracts retail deposits from the general public and invests
those funds primarily in first mortgages on owner-occupied, one-to-four family
residences, as well as in home equity loans generally secured by junior liens on
the borrower's home. To a lesser extent, the Bank also originates consumer and
other loans in its market area. See "Lending Activities." The Bank also invests
in mortgage-backed securities, investment securities and other permissible
assets. See "Investment Activities."
2
<PAGE>
Market Area
Schenectady Federal conducts business in Schenectady County through its
main office located at 251-263 State Street in Schenectady, New York and three
branch offices located in the Mayfair Shopping Center in Glenville, New York and
in the Bellevue and Upper Union Street areas of Schenectady, New York.
Schenectady County is part of the four-county Capital District Region which also
includes the counties of Saratoga, Albany and Rensselaer. Schenectady Federal's
primary market area for deposits consists of communities within Schenectady
County, while the Bank's primary market area for lending extends to Albany,
Rensselaer and Saratoga Counties and, to a lesser extent, Warren and Washington
Counties.
In 1998, the population of Schenectady County was approximately 150,000
essentially unchanged from population levels in 1985. The unemployment rate for
Schenectady County was 3.1% and 4.2% in December 1998 and 1997, respectively.
Primary industries in the Bank's market area are manufacturing and
service industries. State and local government and wholesale and retail trade
account for a noteworthy percentage of employment. Major employers include
General Electric, KAPL, Inc., a research laboratory, the County of Schenectady,
Ellis and St. Clare's Hospitals, Union College, Schenectady International, Inc.
and Golub Corporation.
Lending Activities
General. Historically, the Bank originated 30-year, fixed-rate mortgage
loans secured by one- to four-family residences. During the 1990s, in order to
reduce its vulnerability to changes in interest rates, the Bank has emphasized
the acquisition, origination and retention of mortgage loans and home equity
loans with periodic repricing. The Bank also offers consumer loans and to a
lesser extent commercial real estate mortgage loans.
3
<PAGE>
Loan Portfolio Composition. The following table sets forth certain
information concerning the composition of the Bank's loan portfolio in dollar
amounts and in percentages (before deductions for loans in process, deferred
fees and discounts and allowances for losses) as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- -----------------------
Amount Percent Amount Percent Amount Percent
------------ ---------- ----------- --------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate Loans:
One- to four-family .......................... $116,033 82.12% $105,077 78.07% $ 91,161 76.53%
Multi-family ................................ 1,363 0.97 1,981 1.47 1,568 1.32
Commercial .................................. 3,551 2.51 4,149 3.08 2,964 2.49
Home Equity .................................. 19,570 13.85 22,658 16.84 22,904 19.23
-------- ------ -------- ------- -------- ------
Total real estate loans ................... 140,517 99.45 133,865 99.46 118,597 99.57
-------- ------ -------- ------ -------- ------
Other Loans:
Consumer:
Loans on savings accounts ................... 473 .34 573 .43 478 .40
Education ................................... 2 -- 3 -- 4 --
Personal .................................... 40 .03 33 .03 34 .03
Automobile .................................. 241 .17 110 .08 -- --
Home improvement ............................ -- -- 2 -- 3 --
-------- ------ -------- ------ -------- ------
Total consumer loans ...................... 756 .54 721 .54 519 .43
Commercial business loans ..................... 20 .01 -- -- 4 --
-------- ------ -------- ------ -------- ------
Total other loans ......................... 776 .55 721 .54 523 .43
-------- ------ ---------- ------ -------- ------
Total loans ............................... 141,293 100.00% 134,586 100.00% 119,120 100.00%
====== ====== ======
Less:
Deferred fees and discounts .................. 130 22 23
Allowance for losses ......................... 953 778 642
----------- --------- --------
Total loans receivable, net ............. $ 140,210 $133,786 $118,455
=========== ========= ========
</TABLE>
4
<PAGE>
The following table shows the composition of the Bank's loan
portfolio by fixed and adjustable or floating rate at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- -----------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed-Rate Loans:
Real estate:
One- to four-family ....................... $ 51,556 36.49% $ 31,454 23.37% $ 20,615 17.31%
Multi-family .............................. 323 .23 213 .16 242 .20
Commercial ................................ 2,395 1.69 2,335 1.73 1,533 1.29
Home equity .............................. 4,176 2.96 4,656 3.46 4,334 3.64
-------- ------ -------- ------ -------- ------
Total fixed-rate real estate loans ..... 58,450 41.37 38,658 28.72 26,724 22.44
Consumer ................................... 756 .54 721 .54 515 .43
Commercial business ........................ -- -- -- -- 4 --
-------- ------ -------- ------ -------- ------
Total fixed-rate loans ................. 59,206 41.91 39,379 29.26 27,243 22.87
-------- ------ -------- ------ -------- ------
Adjustable-Rate Loans:
Real estate:
One- to four-family ....................... 64,477 45.63 73,623 54.70 70,546 59.22
Multi-family .............................. 1,040 .74 1,768 1.31 1,326 1.11
Commercial ................................ 1,156 .82 1,814 1.35 1,431 1.20
Home equity ............................... 15,394 10.89 18,002 13.38 18,570 15.59
-------- ------ -------- ------ -------- ------
Total adjustable-rate real estate loans 82,067 58.08 95,207 70.74 91,873 77.13
Consumer ................................... -- -- -- -- 4 --
Commercial business ........................ 20 .01 -- -- -- --
-------- ------ -------- ------ -------- ------
Total adjustable-rate loans ............ 82,087 58.09 95,207 70.74 91,877 77.13
-------- ------ -------- ------ -------- ------
Total loans ........................... 141,293 100.00% 134,586 100.00% 119,120 100.00%
====== ====== =======
Less:
Deferred fees and discounts ................ 130 22 23
Allowance for loan losses .................. 953 778 642
-------- --------- --------
Total loans receivable, net ............. $140,210 $ 133,786 $118,455
======== ========= ========
</TABLE>
5
<PAGE>
The following schedule illustrates the interest rate sensitivity of the
Bank's loan portfolio at December 31, 1998. Loans which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
------------------------------------------------------------------------ ----------------------
Multi-family and
One-to four-family Commercial Home Equity Consumer
--------------------- ----------------------- ---------------------- ----------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ---- ------ ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Due During Years
Ending December 31,
1999 ............. $ 34 7.53% $ 115 8.61% $ 228 9.18% $ 282 8.98%
2000 ............. 75 8.11 -- -- 1,591 8.88 198 7.56
2001 ............. 270 7.93 66 9.50 2,164 8.67 84 7.49
2002 to 2003 ..... 1,419 7.53 1,581 9.48 3,260 8.73 192 7.94
2004 to 2023 ..... 42,376 7.51 3,152 9.62 12,327 8.18 -- --
2024 and following 71,859 7.19 -- -- -- -- -- --
-------- --------- -------- -------
$116,033 $ 4,914 $ 19,570 $ 756
======== ========= ======== =======
<CAPTION>
Commercial
Business Total
------------------------- -------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------------ ------------ ------------ ------------
<S> <C> <C> <C>
Due During Years
Ending December 31,
1999 ........... $ -- -- $ 659 8.91%
2000 ........... 20 8.75 1,884 8.71
2001 ........... -- -- 2,584 8.58
2002 to 2003 ..... -- -- 6,452 8.62
2004 to 2023 ..... -- -- 57,855 7.77
2024 and following -- -- 71,859 7.19
------ -----------
$ 20 $ 141,293
====== ===========
</TABLE>
The total amount of loans due after December 31, 1998 which
have predetermined interest rates is $59.2 million, while the total
amount of loans due after such date which have floating or adjustable
interest rates is $82.1 million.
6
<PAGE>
Pursuant to Federal law, the aggregate amount of loans that the Bank is
permitted to make to any one borrower is generally limited to 15% of unimpaired
capital and surplus (25% if the security for such loan has a "readily
ascertainable" value or 30% for certain residential development loans). At
December 31, 1998, based on the above, the Bank's loans-to-one borrower limit
was approximately $3.1 million. On the same date, the Bank had no borrowers with
outstanding balances in excess of this amount. The Bank's largest lending
relationship at December 31, 1998 was two loans to one borrower totaling
$760,000. One loan in the amount of $532,000 was secured by a five building, 20
unit apartment complex located in Saratoga Springs, New York. The second loan in
the amount of $228,000 was secured by a commercial property located in
Schenectady, New York. Both loans were performing in accordance with their terms
at December 31, 1998.
The Bank's lending is subject to its written underwriting standards and
to loan origination procedures. Decisions on loan applications are made on the
basis of detailed applications and property valuations (consistent with the
Bank's appraisal policy) by the Bank's independent appraisers. The loan
applications are designed primarily to determine the borrower's ability to repay
and the more significant items on the application are verified through use of
credit reports, financial statements, tax returns and/or confirmations.
Under the Bank's loan policy, the individual processing an application
is responsible for ensuring that all documentation is obtained prior to the
submission of the application to a loan officer for approval. In addition, the
loan officer verifies that the application meets the Bank's underwriting
guidelines described below.
All secured loans over $500,000, or unsecured loans over $100,000, must
be approved by the Bank's Board of Directors. The Bank's Loan Committee,
consisting of officers Giaquinto, Schlansker, Ammian, and Krywinski, has
authority to approve secured loans up to $500,000 and unsecured loans up to
$100,000. Any three of these individuals acting as a group can approve a loan
within the authority of the Loan Committee. Various officers of the Bank have
individual secured loan approval authority ranging from $10,000 to $300,000.
Authorization for unsecured loans range from $500 to $5,000.
Generally, the Bank requires title insurance or updated abstracts on
its mortgage loans as well as fire and extended coverage casualty insurance in
amounts at least equal to the principal amount of the loan or the value of
improvements on the property, depending on the type of loan. The Bank also
requires flood insurance to protect the property securing its interest when the
property is located in a flood plain.
7
<PAGE>
One- to Four-Family Residential Real Estate Lending. The cornerstone of
the Bank's lending program is the origination of loans secured by mortgages on
owner-occupied one- to four-family residences. At December 31, 1998, $135.6
million, or 96.0% of the Bank's loan portfolio consisted of mortgage loans
(including home equity loans) on one- to four-family residences. Substantially
all of the residential loans originated by Schenectady Federal are secured by
properties located in the Bank's primary lending area. Included in the mortgage
loan portfolio at December 31, 1998, the Bank also had $4.0 million of purchased
one- to four-family loans serviced by others, which were primarily secured by
properties located outside its market area. A majority of the mortgage loans
originated by the Bank are retained and serviced by it. No loans have been
purchased by the Bank and serviced by others since 1990.
The Bank offers conventional fixed-rate loans with terms ranging
between 10 and 30 years. The interest rate on such loans is generally based on
the FHLMC delivery rates as well as competitive factors.
In addition to fixed rate loans, the Bank offers one-year ARMs at a
margin (generally 300 basis points) over the yield on the Average Monthly One
Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARM
loans currently offered by the Bank generally provide for a 200 basis point
annual interest rate change cap and a lifetime cap of 600 basis points over the
initial rate. The Bank's loans typically do not contain floors. Initial interest
rates offered on the Bank's ARMs may be 100 to 350 basis points below the fully
indexed rate, and borrowers are qualified at that initial rate plus 200 basis
points. As a result, the risk of default on these loans may increase as interest
rates increase. See "Asset Quality-Non-Performing Assets." The Bankalso offers
five year/one year and three year/one year ARM products where the rate is fixed
for the first three or five years. After the initial fixed term, the mortgage
has the same characteristics as a one-year ARM. The Bank's ARMs do not permit
negative amortization of principal, do not contain prepayment penalties and are
not convertible into fixed-rate loans. In the past, the Bank offered one-year
ARMs with a margin 200 to 300 basis points over a specified index and an average
annual cap of 600 basis points. At December 31, 1998, one- to four-family ARMs
totaled $64.5 million, or 45.6% of the Bank's total loan portfolio.
In underwriting one- to four-family residential real estate loans, the
Bank evaluates both the borrower's ability to make principal, interest and
escrow payments, the value of the property that will secure the loan and debt to
income ratios. Schenectady Federal originates residential mortgage loans with
loan-to-value ratios of up to 95% for owner-occupied homes. However, private
mortgage insurance is required on loans with loan-to-value ratios greater than
80% to reduce the Bank's exposure. The Bank generally seeks to underwrite its
loans in accordance with secondary market standards.
The Bank's residential mortgage loans customarily include due-on-sale
clauses giving the Bank the right to declare the loan immediately due and
payable in the event that, among other things, the borrower sells or otherwise
disposes of the property subject to the mortgage and the loan is not repaid.
8
<PAGE>
The Bank also originates home equity loans and lines of credit secured
by a lien on the borrower's residence. The Bank's home equity loans are
generally limited to $100,000. The Bank uses the same underwriting standards for
home equity loans as it uses for one- to four-family residential mortgage loans.
The Bank's home equity loans are originated in amounts which, together with the
amount of the first mortgage, do not exceed 80% of the appraised value of the
property securing the loan. The interest rates for home equity loans and lines
of credit float with the prime rate or, in the case of loans (but not lines of
credit) are fixed. The Bank writes home equity loans for terms of up to 25
years. At December 31, 1998, the Bank had $19.6 million of home equity loans and
an additional $9.7 million of additional funds committed, but undrawn, under
home equity lines of credit.
Commercial Real Estate and Multi-Family Lending. The Bank actively
originates and purchases permanent commercial real estate and multi-family
loans. At December 31, 1998, the Bank had $3.6 million in commercial real estate
loans, representing 2.5% of the Bank's total loan portfolio, and $1.4 million in
multi-family loans, or 1.0% of the Bank's total loan portfolio.
The Bank's commercial real estate and multi-family loan portfolio
includes loans secured by motels, apartment buildings, small office buildings,
and other non-residential building properties, as well as participation
interests therein.
The Bank's permanent commercial real estate and multi-family loans
generally carried a maximum term of 25 years. These loans were generally written
in amounts of up to 75% of the lesser of the appraised value of the property or
the purchase price and had a projected debt service coverage ratio of at least
1.2%. Commercial real estate loans originated during 1998 possess maturity dates
between five and ten years. Those loans maturing in ten years have been
originated to reprice in five years.
Multi-family and commercial real estate loans generally present a
higher level of risk than loans secured by one- to four-family residences. This
greater risk is due to several factors, including the concentration of principal
in a limited number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty of
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by multi-family and commercial real estate is typically dependent
upon the successful operation of the related real estate project. If the cash
flow from the project is reduced (for example, if leases are not obtained or
renewed), the borrower's ability to repay the loan may be impaired. On December
31, 1998, the Bank had one commercial real estate loan totaling $185,000 that
was non-performing. See "Asset Quality-Non-Performing Assets." Since 1991, the
Bank has focused its primary efforts on residential lending.
Consumer Lending. The Bank originates a variety of consumer loans,
including automobile, home improvement, deposit account and other loans for
household and personal purposes. At December 31, 1998, consumer loans totaled
$756,000 or .5% of total loans outstanding.
Consumer loan terms vary according to the type of loan and value of
collateral, length of contract and creditworthiness of the borrower. The Bank's
consumer loans are made at fixed interest rates, with terms of up to 20 years
for secured loans and on a demand basis for unsecured loans.
9
<PAGE>
The underwriting standards employed by the Bank for consumer loans
include a determination of the applicant's payment history on other debts and
the ability to meet existing obligations and payments on the proposed loan.
Although creditworthiness of the applicant is of primary consideration, the
underwriting process also includes a comparison of the value of the security, if
any, in relation to the proposed loan amount. Consumer loans may entail greater
credit risk than do residential mortgage loans, particularly in the case of
consumer loans which are unsecured or are secured by rapidly depreciable assets,
such as automobiles. In such cases, any repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment of the outstanding
loan balance as a result of the greater likelihood of damage, loss or
depreciation. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
affected by adverse personal circumstances. Furthermore, the application of
various federal and state laws, including bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans. During 1998, the Bank
recovered $20,000 on consumer loans previously charged off. There can be no
assurance that delinquencies will not develop in the future.
Originations, Purchases and Sales of Loans and Mortgage-Backed Securities
Loan applications are taken in all branch offices and approved in the
main office of the Bank. Prior to 1994, most of Schenectady Federal's originated
loans were generated by Schenectady Federal's staff of salaried loan officers.
Beginning in 1994, the Bank began to originate a significant amount of loans
through local mortgage brokers which generally retained a 100 basis point
origination fee as their compensation. Also during 1994, the Bank purchased
loans on a servicing released basis which were originated by a mortgage banker
for the Bank. All such loans were originated in accordance with the Bank's
normal underwriting standards. The Bank believes that its utilization of
mortgage brokers has had a favorable impact on loan originations. However, in
the event the Bank's relationship with these mortgage brokers were terminated in
the future, loan originations and results of operations could be adversely
affected.
While the Bank originates both fixed and adjustable-rate loans, its
ability to originate loans is dependent upon the relative customer demand for
loans in its market. Demand is affected by the interest rate environment. During
1996 and 1997, the Bank's volume of ARMs exceeded its volume of fixed rate
loans. During 1998, the Bank's volume of fixed rate loans exceeded its volume of
ARMs.
Historically, the Bank retained most of the fixed rate one- to
four-family residential loans in its portfolio. In order to reduce its
vulnerability to changes in interest rates, commencing in 1992 and ending 1994,
the Bank sold most of the fixed rate residential loans it originated or
otherwise acquired with maturities in excess of 15 years, except where the
interest rate equaled or exceeded a specified rate (as designated from time to
time by management) based on its portfolio objectives and alternative investment
opportunities. When loans are sold, the Bank typically retains the
responsibility for collecting and remitting loan payments, making certain that
real estate tax payments are made on behalf of borrowers, and otherwise
servicing the loans. The servicing fee is recognized as income over the life of
the loans. At December 31, 1998, the Bank serviced $2.4 million of mortgage
loans for others. The Bank did not sell loans during 1996, 1997 and 1998. The
bank may consider selling fixed rate loans in the future.
10
<PAGE>
The following table shows the loan and mortgage-backed securities
origination, purchase, sale and repayment activities of the Bank for the periods
indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C>
LOANS:
Originations by type:
- ---------------------
Adjustable rate:
Real estate - one- to-four-family $ 10,706(1) $ 13,186(1) $ 20,894 (1)
- home equity ....... 5,036 5,705 5,174
- commercial ........ 333 927 --
Non-real estate - consumer ...... 170 -- --
-------- -------- --------
Total adjustable-rate...... 16,245 19,818 26,068
Fixed rate:
Real estate - one- to-four-family 16,785(2) 9,930(2) 1,606(2)
- home equity ...... 1010 515 737
- commercial ....... 320 1,318 198
Non-real estate - consumer ...... 748 293 16
-------- -------- --------
Total fixed-rate ......... 18,863 12,056 2,557
-------- -------- --------
Total loans originated..... 35,108 31,874 28,625
Purchases:
- ----------
Real estate - one-to-four-family 2,365 3,550 6,973
-------- -------- --------
Sales and Repayments:
- ---------------------
Real estate - one- to-four-family -- -- --
Non-real estate - consumer ...... -- -- --
-------- -------- --------
Total sales ............... -- -- --
Principal repayments ............ 30,766 19,958 17,998
-------- -------- --------
Total reductions .......... 30,766 19,958 17,998
-------- -------- --------
Net increase ............. $ 6,707 $ 15,466 $ 17,600
======== ======== ========
MORTGAGE-BACKED SECURITIES:
- ---------------------------
Purchases:
Mortgage-backed securities ....... $ -- $ -- $ --
Principal repayments ............. 7,157 3,468 3,984
-------- -------- --------
Net increase (decrease) ....... $ (7,157) $ (3,468) $ (3,984)
======== ======== ========
</TABLE>
<PAGE>
(1) Includes $10,124, $12,672 and $19,573 of loans originated through
brokers in 1998, 1997 and 1996, respectively.
(2) Includes $12,007, $8,511 and $162 of loans originated through
brokers in 1998, 1997 and 1996, respectively.
11
<PAGE>
Asset Quality
Delinquency Procedures. When a borrower fails to make a required
payment on a loan, the Bank attempts to cure the delinquency by contacting the
borrower. A late notice is sent on all loans over 16 days delinquent. Additional
written and verbal contacts may be made with the borrower between 30 and 60 days
after the due date. If the loan is contractually delinquent 90 days, the Bank
usually sends a 30-day demand letter to the borrower and, after the loan is
contractually delinquent 120 days, institutes appropriate action to foreclose on
the property. If foreclosed, the property is sold at auction and may be
purchased by the Bank. Delinquent consumer loans are generally handled in a
similar manner. The Bank's procedures for repossession and sale of consumer
collateral are subject to various requirements under New York consumer
protection laws.
Real estate acquired by Schenectady Federal as a result of foreclosure,
by deed in lieu of foreclosure or by in-substance foreclosure is classified as
real estate owned until it is sold. When property is acquired or expected to be
acquired by foreclosure, deed in lieu of foreclosure, it is recorded at the
lower of cost or estimated fair value, less the estimated cost of disposition.
After acquisition, all costs incurred in maintaining the property are expensed.
Costs relating to the development and improvement of the property, however, are
capitalized to the extent of fair value less disposition cost.
The following table sets forth the Bank's loan delinquencies by type,
by amount and by percentage of type at December 31, 1998.
<TABLE>
<CAPTION>
Loans Delinquent For:
-------------------------------------------------------------------------------------------
60-89 Days 90 Days and Over Total Delinquent Loans
------------------------------ -------------------------- -----------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ ------- ------ ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family 9 $ 745 .64% 10 $ 440 .38% 19 $1,185 1.02%
.38
Multi-family ...... -- -- -- -- -- -- -- --
Commercial ........ -- -- -- 1 185 5.21 1 185 5.21
Home equity ....... -- -- -- 6 235 1.20 6 235 1.20
Consumer ............ -- -- -- -- -- -- -- -- --
Commercial business . -- -- -- -- -- -- -- -- --
--- ------ ---- --- ------ ---- --- ------ ----
Total ............... 9 $ 745 .53% 17 $ 860 .61% 26 $1,566 1.11%
=== ====== ==== === ====== ==== === ====== ====
</TABLE>
12
<PAGE>
Classification of Assets. Federal regulations require that each savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of savings institutions, OTS and FDIC examiners have authority
to identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets: substandard, doubtful and
loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the Bank will sustain some loss
if the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets, with the additional characteristics that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset on the balance sheet of the institution is not
warranted. Assets classified as substandard or doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as loss, the institution must either establish specific
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss, or charge off such amount. If an institution does not agree
with an examiner's classification of an asset, it may appeal this determination
to the District Director of the OTS. On the basis of management's review of its
assets, at December 31, 1998, the Bank had classified a total of $1.1 million of
its loans and other assets as follows:
<TABLE>
<CAPTION>
Commercial Real
One- to Four- Estate and Consumer
Family Multi-Family and Other Total
------ ------------ --------- -----
(In Thousands)
<S> <C> <C> <C> <C>
Substandard ............. $632 $390 $109 $1,131
Doubtful .................. --- --- --- ---
Loss ...................... --- --- --- ---
---- ---- ---- ------
Total ................. $632 $390 $109 $1,131
==== ==== ==== ======
</TABLE>
Schenectady Federal's classified assets consist of the non-performing
loans and loans and other assets of concern discussed herein. As of the date
hereof, these asset classifications are generally consistent with those of the
OTS and FDIC.
13
<PAGE>
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Bank's loan portfolio. Loans are
placed on non-accrual status when the collection of principal and/or interest
become doubtful. Restructured loans consist of troubled debt restructurings
(which involve forgiving a portion of interest or principal on any loans or
making loans at a rate materially less than that of market rates). Foreclosed
assets include assets acquired in settlement of loans.
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997 1996
---- ---- -----
(Dollars in Thousands)
<S> <C> <C> <C>
Non-accruing loans:
One- to four-family ................................... $ 431 $ 472 $ 25
Home equity ........................................... 109 165 18
Multi-family ......................................... -- -- --
Commercial real estate ................................ 185 691 756
Consumer ............................................. -- -- 2
Commercial business .................................. -- -- --
------ ------ ------
Total ................................................... 725 1,328 801
------ ------ ------
Accruing loans delinquent 90 days or more:
One- to four-family ................................... 135 19 32
Home equity ........................................... -- -- --
Multi-family .......................................... -- -- --
Commercial real estate ................................ -- -- --
Consumer .............................................. -- -- --
Commercial business ................................... -- -- --
------ ------ ------
Total ................................................... 135 19 32
------ ------ ------
Restructured loans:
One- to four-family ................................... -- -- --
Home equity .......................................... -- -- --
Multi-family ......................................... -- -- --
Commercial real estate ............................... -- -- --
Consumer ............................................. -- -- --
Commercial business .................................. -- -- --
------ ------ ------
Total ................................................... -- -- --
------ ------ ------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Foreclosed assets:
One- to four-family ................................... 67 -- 94
Home equity ........................................... -- 27 --
Multi-family .......................................... -- -- --
Commercial real estate ................................ 204 84 84
Consumer .............................................. -- -- --
Commercial business ................................... -- -- --
------ ------ ------
Total ................................................ 271 111 178
------ ------ ------
Total non-performing assets ............................. $1,131 $1,458 $1,011
====== ====== ======
Total as a percentage of total assets ................... .64% .84% .61%
====== ====== ======
Total non-performing loans .............................. $ 860 $1,347 $ 833
====== ====== ======
Total as a percentage of total loans receivable, net .... .61% 1.01% .70%
====== ====== ======
</TABLE>
14
<PAGE>
For the year ended December 31, 1998 gross interest income which would have
been recorded had the non-accruing loans been current in accordance with their
original terms amounted to $36,000. The amount that was included in interest
income on such loans was approximately $51,000.
Other Loans of Concern. In addition to the non-performing assets set forth
in the table above, as of December 31, 1998 there were no loans with respect to
which known information about the possible credit problems of the borrowers or
the cash flows of the security properties have caused management to have
concerns as to the ability of the borrowers to comply with present loan
repayment terms and which may result in the future inclusion of such items in
the non-performing asset categories.
15
<PAGE>
Management has considered the Bank's non-performing and "of concern" assets
in establishing its allowance for loan losses.
Allowance for Loan Losses. The following table sets forth an analysis
of the Bank's allowance for loan losses.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1998 1997 1996
----- ----- ----
(Dollars in Thousands)
<S> <C> <C> <C>
Balance at beginning of period ........................... $ 778 $ 642 $ 572
Charge-offs:
One- to four-family .................................... 21 16 44
Home equity ........................................... -- 7 41
Multi-family .......................................... 24 -- --
Commercial real estate ................................ -- -- --
Consumer .............................................. -- 3 2
Commercial business ................................... -- -- --
------ ----- -----
Total ............................................. 45 26 87
------ ----- -----
Recoveries:
One- to four-family ................................... -- -- --
Home equity ........................................... -- -- --
Multi-family .......................................... -- -- --
Commercial real estate ................................ 80 -- --
Consumer .............................................. 20 42 37
Commercial business ................................... -- -- --
----- ----- -----
Total ............................................ 100 42 37
----- ----- -----
Net charge-offs (recoveries) ............................. (55) (16) 50
Additions charged to operations ......................... 120 120 120
===== ===== =====
Balance at end of period ................................. $ 953 $ 778 $ 642
====== ===== =====
Ratio of net charge-offs (recoveries) to average
loans outstanding ....................................... (.04)% (.01)% .04%
===== ===== =====
Ratio of net charge-offs
(recoveries) to non-performing loans .................... (6.40)% (1.19)% 6.00%
====== ====== =====
Allowance for loan losses to non-performing loans ........ 110.76% 57.76% 77.07%
====== ====== ======
Allowance for loan losses to total loans at end of period .67% .58% .54%
====== ====== ======
</TABLE>
16
<PAGE>
The distribution of the Bank's allowance for loan losses at the dates
indicated is summarized as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------------
1998 1997 1996
--------------------- -------------------------- --------------------------
Percent Percent Percent
of Loans of Loans of Loans
in Each in Each in Each
Category Category Category
of Total of Total of Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
One-to-four family .. $274 82.12 $239 78.07 $141 76.53
Multi-family ......... 14 .97 20 1.47 16 1.32
Commercial real estate 61 2.51 143 3.08 143 2.49
Home equity .......... 84 13.85 68 16.84 60 19.23
Consumer ............. 8 .54 7 .54 5 .43
Commercial business .. -- .01 -- -- -- --
Unallocated .......... 512 -- 301 -- 277 --
---- ------ ---- ------ ---- ------
Total ...... $953 100.00% $778 100.00% $642 100.00%
==== ====== ==== ====== ==== ======
</TABLE>
The allowance for loan losses is established through a provision for
loan losses charged to earnings based on management's evaluation of the risk
inherent in the loan portfolio. The allowance is established as an amount that
management believes will be adequate to absorb losses on existing loans, based
on evaluations of the collectibility of loans and prior loan loss experience.
Management's evaluation of the adequacy of the allowance takes into
consideration such factors as the historical loan loss experience, changes in
the nature and volume of the loan portfolio, overall portfolio quality, review
of specific problem loans and current economic conditions that may affect
borrowers' ability to pay.
While management believes that it uses the best information available
to determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses, and net earnings could
be significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination. No portion of the allowance
is restricted to any loan or group of loans, and the entire allowance is
available to absorb realized losses. The amount and timing of realized losses
and future allowance allocations may vary from current estimates.
Investment Activities
The Bank utilizes investment and mortgage-backed securities in
virtually all aspects of its asset/liability management strategy. In making
investment decisions, the Investment Committee considers, among other things,
the Bank's yield and interest rate objectives, its interest rate and credit risk
position and its liquidity and cash flow.
17
<PAGE>
Schenectady Federal must maintain minimum levels of investments that
qualify as liquid assets under OTS regulations. Liquidity may increase or
decrease depending upon the availability of funds and comparative yields on
investments in relation to the return on loans. Cash flow projections are
regularly reviewed and updated to assure that adequate liquidity is maintained.
The Bank's level of liquidity is a result of management's asset/liability
strategy.
Investment Securities. Federally chartered savings institutions have
the authority to invest in various types of investment securities, including
United States Treasury obligations, securities of various federal agencies,
certain certificates of deposit of insured banks and savings institutions,
certain bankers' acceptances, repurchase agreements and federal funds. Subject
to various restrictions, federally chartered savings institutions may also
invest their assets in commercial paper, investment grade corporate debt
securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly.
To date, the Bank's investment strategy has been directed toward
high-quality assets (primarily government and agency obligations) with varying
terms to maturity. At December 31, 1998, the Bank did not own any investment
securities of a single issuer which exceeded 10% of the Bank's equity, other
than U.S. government or federal agency obligations.
The Bank invests its liquid assets primarily in interest-earning
overnight deposits. Other investments include primarily high grade medium-term
(up to five years) U.S. government securities and agency obligations. For the
year ended December 31, 1998, the Bank had an average outstanding balance of
$13.7 million in investment securities (including $9.0 million of securities
available for sale) with an average yield of 6.53%.
18
<PAGE>
The following table sets forth the composition of the Bank's securities
portfolio at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------
1998 1997 1996
--------------------------- -------------------------- -------------------
Book % of Book % of Book % of
Value Total Value Total Value Total
----------- ---------- --------- ---------- ---------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale (at fair value):
Federal agency obligations ..................... $12,874 57.88% $ 4,067 $ 22.96% -- --%
Corporate bonds ............................... 4,080 18.34 -- -- -- --
Mutual funds .................................. -- -- -- -- 1,990 9.68
Investment securities (at amortized cost):
U.S. government obligations .................... -- -- 1,992 11.24 3,980 19.37
Federal agency obligations...................... 1,086 4.88 9,945 56.13 9,481 46.13
Time deposits at other bank .................... 699 3.14 -- -- -- --
Municipal bonds ................................ 67 .30 76 .43 84 .41
Corporate bonds ................................ -- -- -- -- 2,201 10.71
Mutual funds ................................... -- -- -- -- -- --
------- ------ ---------- ------ ---------- ------
Subtotal ......................................... 18,806 84.54 16,080 90.76 17,736 86.30
FHLB stock ....................................... 1,338 6.02 1,338 7.55 1,215 5.91
------- ------ ---------- ------ ---------- ------
Total investment securities and FHLB stock ..... $20,144 90.56% $ 17,418 98.31% $ 18,951 92.21%
======= ====== ========== ====== ========== ======
Average remaining life of securities excluding
FHLB stock and mutual funds ..................... 5.0 years 5.1 years 3.6 years
Other interest-earning assets:
Federal funds sold ............................. 2,100 9.44 300 1.69 1,600 7.79
------- ------ ---------- ------ ---------- ------
Total ...................................... $22,244 100.00% $ 17,718 100.00% $ 20,551 100.00%
======= ====== ========== ====== ========== ======
Average remaining life or term to repricing of
securities and other interest-earning assets,
excluding FHLB stock and mutual funds ........... 4.5 years 5.0 years 3.3 years
</TABLE>
19
<PAGE>
The composition and maturities of the securities portfolio, excluding
FHLB stock and federal funds sold, are indicated in the following table.
<TABLE>
<CAPTION>
December 31, 1998
------------------------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over No Stated
1 Year Years Years 10 Years Maturity Total Securities
--------- ------ ------- -------- -------- ----- ----------
Book Book Book Book Book Book Market
Value Value Value Value Value Value Value
----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
Federal agency obligations .......... $ -- $10,875 $ 1,999 $ -- $ -- $12,874 $ 12,874
Corporate bonds ..................... -- 3,040 1,040 -- -- 4,080 4,080
----- ------- ------- ----- ----- ------- --------
Total securities available for sale -- 13,915 3,039 -- -- 16,954 16,954
----- ------- ------- ----- ----- ------- --------
Investment securities:
U.S. government securities .......... -- -- -- -- -- -- --
Federal agency obligations .......... -- 38 1,048 -- -- 1,086 1,086
Time deposits at other banks ....... 99 600 -- -- -- 699 699
Municipal bonds .................... -- -- 67 -- -- 67 67
Corporate bonds .................... -- -- -- -- -- -- --
----- ------- ------- ----- ----- ------- --------
Total investment securities ........ 99 638 1,115 -- -- 1,852 1,852
----- ------- ------- ----- ----- ------- --------
Total securities ...................... $ 99 $14,553 $ 4,154 $ $ $18,806 $ 18,806
===== ======= ======= ===== ===== ======= ========
Weighted average yield ................ 5.35% 6.00% 6.65% -- ---% 6.14%
</TABLE>
Mortgage-Backed Securities. In order to supplement loan production and
achieve its asset/liability management goals, the Bank invests in
mortgage-backed securities. All of the mortgage-backed securities owned by the
Bank are issued, insured or guaranteed either directly or indirectly by a
federal agency or are rated "AA" or higher. At December 31, 1998, Schenectady
Federal had $9.8 million of mortgage-backed securities, all of which are held
for investment purposes.
Consistent with its asset/liability management strategy over the last
several years, a majority of the mortgage-backed securities acquired by the Bank
have had short or intermediate effective terms to maturity or, to a lesser
extent, adjustable interest rates. In particular, virtually all of the
mortgage-backed securities purchased by the Bank since 1992 have carried five
and seven year balloon terms.
20
<PAGE>
The following table sets forth the contractual maturities
of the Bank's mortgage-backed securities at December 31, 1998.
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 10 to 20 Over Total Mortgage-Backed
1 Year Years Years Years 20 Years Securities
--------- ------ ------- -------- -------- ---------------------
Book Book Book Book Book Book Market
Value Value Value Value Value Value Value
----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Mortgage Backed Securities
Held for
Investment:
Government National Mortgage
Association ................. $ -- $ 59 $ 542 $ 927 $ -- $1,528 $1,623
Federal National Mortgage
Association ................. -- 2,056 -- 94 514 2,664 2,661
Federal Home Loan Mortgage
Corporation ................. 962 3,329 103 190 1,033 5,617 5,622
------ ------ ------ ------ ------ ------ ------
Total mortgage-backed securities $ 962 $5,444 $ 645 $1,211 $1,547 $9,809 $9,906
====== ====== ====== ====== ====== ====== ======
Weighted average yield ......... 6.50% 5.78% 8.29% 9.02% 6.60% 6.55%
====== ====== ====== ====== ====== ======
</TABLE>
Sources of Funds
General. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and funds provided from
operations.
Deposits. Schenectady Federal offers a variety of deposits accounts
having a wide range of interest rates and terms. The Bank's deposits consist of
passbook, NOW, money market, noninterest bearing checking and certificate
accounts. The Bank relies primarily on competitive pricing policies and customer
service to attract and retain these deposits.
The variety of deposit accounts offered by the Bank has allowed it to
be competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As customers have become more interest rate conscious, the Bank
has become more susceptible to short-term fluctuations in deposit flows. The
Bank manages the pricing of its deposits in keeping with its asset/liability
management, profitability and growth objectives.
21
<PAGE>
Based on its experience, the Bank believes that a substantial portion
of its passbook and NOW accounts are relatively stable sources of deposits and
has used customer service and marketing initiatives in an effort to increase the
volume of such deposits. However, the ability of the Bank to attract and
maintain these accounts (as well as certificate accounts) has been and will be
affected by market conditions. During 1998, the Bank experienced a decline in
the balance of certificate accounts (much of which is believed to have
transferred into non-certificate accounts) as a result of local competition and
the rates paid on these deposits. The Bank has been and will continue to be
significantly affected by market conditions.
The following table sets forth the savings flows at the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------
1998 1997 1996
-------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Opening Balance $ 150,469 $ 140,616 $ 139,671
Deposits 266,140 249,343 237,180
Withdrawals (272,926) (246,113) (242,412)
Interest credited 6,895 6,623 6,177
---------- --------- ---------
Ending balance $ 150,578 $ 150,469 $ 140,616
========== ========= =========
Net increase $ 109 $ 9,853 $ 945
========== ========= ==========
Percent increase .07% 7.01% .68%
========== ========== =========
</TABLE>
22
<PAGE>
The following table sets forth the dollar amount of deposits in the
various types of deposit programs offered by the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------
1998 1997 1996
---------------------- ------------------------- ----------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Transaction and Savings Deposits:(1)
Noninterest-bearing Checking Accounts $ 2,103 1.39% $ 2,265 1.51% $ 1,392 .99%
Savings Accounts 2.50% .............. 36,394 24.17 36,681 24.38 37,152 26.42
NOW Accounts 1.25% .................. 10,867 7.22 9,163 6.09 9,104 6.47
Money Market Accounts 2.60%-4.30% ... 8,263 5.49 7,619 5.06 6,074 4.32
-------- ------ -------- ------- -------- ------
Total Non-Certificate Accounts ...... 57,627 38.27 55,728 37.04 53,722 38.20
-------- ------ -------- ------- -------- ------
Certificates of Deposit:
3.00 - 3.99% ....................... 1,047 .70 -- -- -- --
4.00 - 4.99% ....................... 20,367 13.53 801 .53 23,244 16.53
5.00 - 5.99% ....................... 66,818 44.37 84,451 56.12 50,815 36.14
6.00 - 6.99% ....................... 4,719 3.13 9,489 6.31 12,835 9.13
-------- ------- -------- ------ ------- -------
Total Certificates of Deposit ...... 92,951 61.73 94,741 62.96 86,894 61.80
-------- ------- -------- ------ -------- -------
Total Deposits ...................... $150,578 100.00% $150,469 100.00% $140,616 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
- ------------------------
(1) Reflects rates paid on transaction and savings deposits at December 31,
1998. 23
23
<PAGE>
The following table shows rate and maturity information for the Bank's
certificates of deposit as of December 31, 1998.
<TABLE>
<CAPTION>
3.00- 5.00- Percent
4.99% 6.99% Total of Total
--------- --------- --------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Certificates of deposit
maturing in quarter ending:
---------------------------
March 31, 1999 . . . . . . . . . . . $1,509 $17,187 $18,696 20.11%
June 30, 1999 . . . . . . . . . . . . 6,668 15,561 22,229 23.91
September 30, 1999 . . . . . . . . . 244 14,735 14,979 16.12
December 31, 1999 . . . . . . . . . 7,073 5,120 12,194 13.12
March 31, 2000 . . . . . . . . . . . 756 4,862 5,618 6.04
June 30, 2000 . . . . . . . . . . . . 3,807 1,750 5,556 5.98
September 30, 2000 . . . . . . . . . 493 1,650 2,143 2.31
December 31, 2000 . . . . . . . . . 154 1,658 1,812 1.95
March 31, 2001 . . . . . . . . . . . --- 1,196 1,196 1.29
June 30, 2001 . . . . . . . . . . . . 256 658 914 0.98
September 30, 2001 . . . . . . . . . --- 634 634 0.68
December 31, 2001 . . . . . . . . . 290 569 859 0.92
Thereafter . . . . . . . . . . . . . . 164 5,957 6,121 6.59
-------- --------- ------ ------
Total . . . . . . . . . . . . . . . $ 21,414 $ 71,537 $92,951 100.00%
======= ========= ======= ======
Percent of total . . . . . . . . . . 23.04% 79.96%
======== =========
</TABLE>
The following table indicates the amount of the Bank's "jumbo" and
other certificates of deposit as of December 31, 1998.
<TABLE>
<CAPTION>
Maturity
--------------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 Months Total
------- -------- ------- ------- -------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit less than $100,000 $16,483 $20,390 $23,903 $23,292 $84,068
Certificates of deposit of $100,000 or more 2,213 1,839 3,270 1,561 8,883
------- ------- ------- ------- -------
Total certificates of deposit $18,696 $22,229 $27,173 $24,853 $92,951
======= ======= ======= ======= =======
</TABLE>
Borrowings. Schenectady Federal's other available sources of funds
include advances from the FHLB of New York and other borrowings. As a member of
the FHLB of New York, the Bank is required to own capital stock in the FHLB of
New York and is authorized to apply for advances from the FHLB of New York. Each
FHLB credit program has its own interest rate, which may be fixed or variable,
24
<PAGE>
and range of maturities. The FHLB of New York may prescribe the acceptable uses
for these advances, as well as limitations on the size of the advances and
repayment provisions. At December 31, 1998, the Bank had $700,000 of FHLB
advances outstanding. On such date, the Bank had a collateral pledge arrangement
with FHLB of New York pursuant to which the Bank may borrow up to $53.4 million
for liquidity purposes.
During the fiscal years ended December 31, 1998, 1997 and 1996, the
Bank had average FHLB advances or other borrowings outstanding totaling
approximately $139,000, $16,000 and $1,000, respectively.
Competition
Schenectady Federal faces strong competition both in originating real
estate loans and in attracting deposits. Competition in originating loans comes
primarily from mortgage bankers, commercial banks which have received a
reduction in deposit insurance premiums, credit unions and other savings
institutions, which also make loans secured by real estate located in the Bank's
market area. The Bank competes for loans principally on the basis of the
interest rates and loan fees it charges, the types of loans it originates and
the quality of services it provides to borrowers.
Competition for deposits is principally from money market and mutual
funds, securities firms, commercial banks, credit unions and other savings
institutions located in the same communities. The ability of the Bank to attract
and retain deposits depends on its ability to provide an investment opportunity
that satisfies the requirements of investors as to rate of return, liquidity,
risk, convenient locations and other factors. The Bank competes for these
deposits by offering a variety of deposit accounts at competitive rates,
convenient business hours and a customer oriented staff.
Employees
At December 31, 1998, the Bank had a total of 49 full-time and 8
part-time employees. None of the Bank's employees are represented by any
collective bargaining. Management considers its employee relations to be good.
Subsidiary Activities
As a federally chartered savings and loan association, Schenectady
Federal is permitted by OTS regulations to invest up to 2% of its assets in the
stock of, or loans to, service corporation subsidiaries, and may invest an
additional 1% of its assets in service corporations where such additional funds
are used for inner-city or community development purposes. At December 31, 1998
Schenectady Federal's investment in its service corporation totaled $27,000. In
addition to investments in service corporations, federal institutions are
permitted to invest an unlimited amount in operating subsidiaries engaged solely
in activities which a federal savings association may engage in directly.
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At December 31, 1998, Schenectady Federal had one wholly owned service
corporation, SSLA Services Corp. ("SSLA"). The corporation was formed in 1983 to
sell insurance products. In 1994, SSLA was authorized to sell mutual funds. For
the year ended December 31, 1998, SSLA sold mutual funds totaling $892,000 and
annuities totaling $1.7 million. No assurance can be made that a material amount
of mutual fund and/or annuity sales will occur in the future. For the fiscal
year ended December 31, 1998, SSLA had net income of $19,000. For the fiscal
year ended December 31, 1997, SSLA had a net loss of $9,000. For the fiscal year
ending December 31, 1996, SSLA had net income of $8,000.
REGULATION
General
Schenectady Federal is currently a federally chartered savings bank,
the deposits of which are federally insured and backed by the full faith and
credit of the United States Government. Accordingly, Schenectady Federal is
subject to broad federal regulation and oversight extending to all its
operations. Schenectady Federal is a member of the FHLB of New York and is
subject to certain limited regulation by the Federal Reserve Board. As the
savings and loan holding company of Schenectady Federal, the Holding Company
also is subject to federal regulation and oversight. The purpose of the
regulation of the Holding Company and other holding companies is to protect the
subsidiary savings bank. Schenectady Federal is a member of the SAIF and the
deposits of Schenectady Federal are insured by the FDIC. As a result, the FDIC
has certain regulatory and examination authority over Schenectady Federal.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
Federal Regulation of Savings Bank
The OTS has extensive authority over the operations of savings banks.
As part of this authority, Schenectady Federal is required to file periodic
reports with the OTS and is subject to periodic examinations by the OTS and the
FDIC. The last regular OTS examination of Schenectady Federal was as of May
1998. Under agency scheduling guidelines, it is likely that another examination
will be initiated in the near future. When these examinations are conducted by
the OTS and the FDIC, the examiners may require Schenectady Federal to provide
for higher general or specific loan loss reserves. All savings banks are subject
to a semi-annual assessment, based upon the savings bank's total assets, to fund
the operations of the OTS. Schenectady Federal's OTS assessment for the fiscal
year ended December 31, 1998 was $52,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including Schenectady Federal and the
Holding Company. This enforcement authority includes, among other things, the
ability to assess civil money penalties, to issue cease-and-desist or removal
orders and to initiate injunctive actions. In general, these enforcement actions
may be initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
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In addition, the investment, lending and branching authority of
Schenectady Federal is prescribed by federal laws and regulations, and it is
prohibited from engaging in any activities not permitted by such laws and
regulations. For instance, no savings institution may invest in non-investment
grade corporate debt securities. In addition, the permissible level of
investment by federal savings banks in loans secured by non-residential real
property may not exceed 400% of total capital, except with approval of the OTS.
Federal savings banks are also generally authorized to branch nationwide.
Schenectady Federal is in compliance with the noted restrictions.
Schenectady Federal's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At December 31, 1998, Schenectady Federal's
lending limit under this restriction was $3.1 million. Schenectady Federal is in
compliance with the loans-to-one borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on matters such as loan
underwriting and documentation, internal controls and audit systems, interest
rate risk exposure and compensation and other employee benefits. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The OTS and other federal banking
agencies have also proposed additional guidelines on asset quality and earnings
standards. No assurance can be given as whether or in what form the proposed
regulations will be adopted.
Insurance of Accounts and Regulation by the FDIC
Schenectady Federal is a member of the SAIF, which is administered by
the FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action, and may terminate the deposit insurance if it determines that the
institution has engaged or is engaging in unsafe or unsound practices or is in
an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system, under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums, ranging from 0% to .31% of
deposits, based upon their level of capital and supervisory evaluation. Under
the system, institutions classified as well capitalized (i.e., a core capital
ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets
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("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of
at least 10%) and considered healthy pay the lowest premium while institutions
that are less than adequately capitalized (i.e., core or Tier 1 risk-based
capital ratios of less than 4% or a risk-based capital ratio of less than 8%)
and considered of substantial supervisory concern pay the highest premium. Risk
classification of all insured institutions will be made by the FDIC for each
semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
Prior to the enactment of legislation, a portion of the SAIF assessment
imposed on savings institutions was used to repay obligations issued by a
federally chartered corporation to provide financing ("FICO") for resolving the
thrift crisis in the 1980s. Although the FDIC has proposed that the SAIF
assessment be equalized with the BIF assessment schedule, effective October 1,
1996, SAIF-insured institutions will continue to be subject to a FICO assessment
as a result of this continuing obligation. Although legislation also now
requires assessments to be made on BIF-assessable deposits for this purpose,
effective January 1, 1997, that assessment was limited to 20% of the rate
imposed on SAIF assessable deposits until the earlier of December 31, 1999 or
when no savings institution continues to exist, thereby imposing a greater
burden on SAIF member institutions such as Schenectady Federal. Thereafter,
however, assessments on BIF-member institutions will be made on the same basis
as SAIF-member institutions. The rates to be established by the FDIC to
implement this requirement for all FDIC-insured institutions is uncertain at
this time, but are anticipated to be about a 6.5 basis points assessment on SAIF
deposits and 1.5 basis points on BIF deposits until BIF insured institutions
participate fully in the assessment.
Regulatory Capital Requirements
Federally insured savings banks, such as Schenectady Federal, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings institutions. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual institutions on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income and certain
noncumulative perpetual preferred stock and retained income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with
the requirement. At December 31, 1998, Schenectady Federal had no intangible
assets which were required to be deducted from tangible capital.
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The OTS regulations establish special capitalization requirements for
savings institutions that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the institution's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. The subsidiaries of Schenectady Federal are includable
subsidiaries.
At December 31, 1998, Schenectady Federal had tangible capital of $20.5
million, or 11.50% of adjusted total assets, which is approximately $17.8
million above the minimum requirement of 1.5% of adjusted total assets in effect
on that date.
The capital standards also require core capital equal to at least 3.0%
of adjusted total assets (as defined by regulation). Core capital generally
consists of tangible capital plus certain intangible assets, including a limited
amount of purchased credit card relationships. As a result of the prompt
corrective action provisions of FDICIA discussed below, however, a savings
institution must maintain a core capital ratio of at least 4.0% to be considered
adequately capitalized unless its supervisory condition is such to allow it to
maintain a 3.0% ratio. At December 31, 1998, Schenectady Federal had no
intangibles which were subject to these tests.
At December 31, 1998, Schenectady Federal had core capital equal to
$20.5 million, or 11.50% of adjusted total assets, which is $15.2 million above
the minimum leverage ratio requirement of 3.0% as in effect on that date.
The OTS risk-based requirement requires savings institutions to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings institution to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At December 31, 1998, Schenectady
Federal had $953,000 of general loss reserves, which was less than 1.25% of
risk-weighted assets and was included in capital.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. Schenectady Federal had
no such exclusions from capital and assets at December 31, 1998.
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In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 50% for prudently underwritten
permanent one- to four-family first lien mortgage loans not more than 90 days
delinquent and having a loan to value ratio of not more than 80% at origination
unless insured to such ratio by an insurer approved by the FNMA or the FHLMC.
The OTS has adopted a final rule that requires every savings
institution with more than normal interest rate risk exposure to deduct from its
total capital, for purposes of determining compliance with such requirement, an
amount equal to 50% of its interest-rate risk exposure multiplied by the present
value of its assets. This exposure is a measure of the potential decline in the
net portfolio value of a savings institution, greater than 2% of the present
value of its assets, based upon a hypothetical 200 basis point increase or
decrease in interest rates (whichever results in a greater decline). Net
portfolio value is the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts. The rule provides for a two quarter
lag between calculating interest rate risk and recognizing any deduction from
capital. The rule will not become effective until the OTS evaluates the process
by which savings institutions may appeal an interest rate risk deduction
determination. It is uncertain when this evaluation may be completed. Any
savings institution with less than $300 million in assets and a total capital
ratio in excess of 12% is exempt from this requirement unless the OTS determines
otherwise.
On December 31, 1998, Schenectady Federal had total capital of $21.4
million (including $20.5 million in core capital and $953,000 in qualifying
supplementary capital) and risk-weighted assets of $94.7 million; or total
capital of 22.6% of risk-weighted assets. This amount was $13.9 million above
the 8.0% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings institutions that fail to meet
capital requirements. The OTS is generally required to take action to restrict
the activities of an "undercapitalized association" (generally defined to be one
with less than either a 4% core ratio, a 4% Tier 1 risked-based capital ratio or
an 8% risk-based capital ratio). Any such institution must submit a capital
restoration plan and until such plan is approved by the OTS may not increase its
assets, acquire another institution, establish a branch or engage in any new
activities, and generally may not make capital distributions. The OTS is
authorized to impose the additional restrictions that are applicable to
significantly undercapitalized institutions.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized institution must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings institution that fails to comply with its capital plan or
is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more of additional specified actions and operating
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restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the institution. An institution that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized institutions. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings institution, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized institution is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver.
The OTS is also generally authorized to reclassify an institution into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on
Schenectady Federal may have a substantial adverse effect on Schenectady
Federal's operations and profitability. Holding Company shareholders do not have
preemptive rights, and therefore if the Holding Company is directed by the OTS
or the FDIC to issue additional shares of Common Stock, such issuance may result
in the dilution in the percentage of ownership of the Holding Company.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions or requirements on
institutions with respect to their ability to pay dividends or make other
distributions of capital which include dividends, stock redemptions or
repurchases cash-out mergers and other transactions charged to the capital
account. OTS regulations prohibit an institution from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
capital of the institution would be reduced below the amount required to be
maintained for the liquidation account established in connection with its mutual
to stock conversion.
Generally, savings banks, such as Schenectady Federal, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the institution's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of its net income for the most recent four quarter period.
However, an institution deemed to be in need of more than normal supervision by
the OTS may have its dividend authority restricted by the OTS. Schenectady
Federal may pay dividends in accordance with this general authority.
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings institution may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMEL 1 or 2 rating, is not of
supervisory concern (as defined by regulation) and would remain adequately
capitalized (as defined in the OTS prompt corrective action regulations)
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following the proposed distribution. Savings banks that would remain adequately
capitalized following the proposed distribution but do not meet the other noted
requirements must notify the OTS 30 days prior to declaring a capital
distribution. The OTS stated it will generally regard as permissible that amount
of capital distributions that do not exceed 50% of the institution's excess
regulatory capital plus net income to date during the calendar year. A savings
institution may not make a capital distribution without prior approval of the
OTS and the FDIC if it is undercapitalized before, or as a result of, such a
distribution. As under the current rule, the OTS may object to a capital
distribution if it would constitute an unsafe or unsound practice. No assurance
may be given as to whether or in what form the regulations may be adopted.
Savings institutions proposing to make any capital distribution need
only submit written notice to the OTS 30 days prior to such distribution.
Savings institutions that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution, however, must
obtain OTS approval prior to making such distribution. The OTS may object to the
distribution during the 30-day notice period based on safety and soundness
concerns. See "Regulatory Capital Requirements."
Liquidity
All savings banks, including Schenectady Federal, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what Schenectady
Federal includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operation Liquidity and Capital Resources."
This liquid asset ratio requirement may vary from time to time (between 4% and
10%) depending upon economic conditions and savings flows of all savings
institutions. At the present time, the minimum liquid asset ratio is 4%. For the
year ended December 31, 1998, Schenectady Federal was in compliance with this
requirement, with an overall average daily liquid asset ratio of 20.9%.
Accounting
An OTS policy statement applicable to all savings institutions
clarifies and re-emphasizes that the investment activities of a savings
institutions must be in compliance with approved and documented investment
policies and strategies, and must be accounted for in accordance with GAAP.
Under the policy statement, management must support its classification of and
accounting for loans and securities (i.e., whether held for investment, sale or
trading) with appropriate documentation. Schenectady Federal is in compliance
with these amended rules.
The OTS has adopted an amendment to its accounting regulations, which
may be made more stringent than GAAP by the OTS, to require that transactions be
reported in a manner that best reflects their underlying economic substance and
inherent risk and that financial reports must incorporate any other accounting
regulations or orders prescribed by the OTS.
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Qualified Thrift Lender Test
All savings banks, including Schenectady Federal, are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings institution to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. Such assets
primarily consist of residential housing related loans and investments. At
December 31, 1998, Schenectady Federal met the test and has always met the test
since its effectiveness.
Any savings institution that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an institution does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the Bank Insurance Fund. If such an institution has not yet requalified or
converted to a national bank, its new investments and activities are limited to
those permissible for both a savings institution and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
institution is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such institution
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
institution that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "Holding Company Regulation."
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of
Schenectady Federal, to assess the institution's record of meeting the credit
needs of its community and to take such record into account in its evaluation of
certain applications, such as a merger or the establishment of a branch, by the
Bank. An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
The federal banking agencies, including the OTS, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, the Bank may be required to devote additional funds for
investment and lending in its local community. The Bank was examined for CRA
compliance in September 1997 and received a rating of satisfactory.
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Transactions with Affiliates
Generally, transactions between a savings institutions or its
subsidiaries and its affiliates are required to be on terms as favorable to the
institution as transactions with non-affiliates. In addition, certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of
the institution's capital. Affiliates of Schenectady Federal include the Holding
Company and any company which is under common control with Schenectady Federal.
In addition, a savings institution may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of most affiliates. Schenectady Federal's subsidiaries are not deemed
affiliates, however; the OTS has the discretion to treat subsidiaries of savings
institutions as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation
The Holding Company is a unitary savings and loan holding company
subject to regulatory oversight by the OTS. As such, the Holding Company is
required to register and file reports and is subject to regulation and
examination by the OTS. In addition, the OTS has enforcement authority over the
Holding Company and its non-savings association subsidiaries which also permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the subsidiary savings institutions.
As a unitary savings and loan holding company, the Holding Company
generally is not subject to activity restrictions. If the Holding Company
acquires control of another savings institution as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
the Holding Company and any of its subsidiaries (other than Schenectady Federal
or any other SAIF-insured savings association) would become subject to such
restrictions unless such other associations each qualify as a QTL and were
acquired in a supervisory acquisition.
If Schenectady Federal fails the QTL test, the Holding Company must
obtain the approval of the OTS prior to continuing after such failure, directly
or through its other subsidiaries, any business activity other than those
approved for multiple savings and loan holding companies or their subsidiaries.
In addition, within one year of such failure the Holding Company must register
as, and will become subject to, the restrictions applicable to bank holding
companies. The activities authorized for a bank holding company are more limited
than are the activities authorized for a unitary or multiple savings and loan
holding company. See "Qualified Thrift Lender Test."
The Holding Company must obtain approval from the OTS before acquiring
control of any other SAIF-insured institution. Such acquisitions are generally
prohibited if they result in a multiple savings and loan holding company
controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings institution.
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Federal Securities Law
The stock of the Holding Company is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Holding
Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.
Holding Company stock held by persons who are affiliates (generally
officers, directors and principal stockholders) of the Holding Company may not
be resold without registration or unless sold in accordance with certain resale
restrictions. If the Holding Company meets specified current public information
requirements, each affiliate of the Holding Company is able to sell in the
public market, without registration, a limited number of shares in any
three-month period.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking accounts).
At December 31, 1998, Schenectady Federal was in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements that
may be imposed by the OTS. See " Liquidity."
Savings institutions are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
institutions to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
Schenectady Federal is a member of the FHLB of New York, which is one
of 12 regional FHLBs, that administers the home financing credit function of
savings institutions. Each FHLB serves as a reserve or central bank for its
members within its assigned region. It is funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures established
by the board of directors of the FHLB, which are subject to the oversight of the
Federal Housing Finance Board. All advances from the FHLB are required to be
fully secured by sufficient collateral as determined by the FHLB. In addition,
all long-term advances are required to provide funds for residential home
financing.
As a member, Schenectady Federal is required to purchase and maintain
stock in the FHLB of New York. At December 31, 1998, Schenectady Federal had
$1.3 million in FHLB stock, which was in compliance with this requirement. In
past years, Schenectady Federal has received substantial dividends on its FHLB
stock. Over the past five calendar years such dividends have averaged 7.1% and
7.25% in 1998. For the year ended December 31, 1998, dividends paid by the FHLB
of New York to Schenectady Federal totaled $97,000, which constitute a $10,000
increase from the amount of dividends received in 1997.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings institutions and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
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advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of Schenectady Federal's FHLB stock may result in a
corresponding reduction in Schenectady Federal's capital.
Federal and State Taxation
Federal Taxation. Savings institutions such as the Bank that meet
certain definitional tests relating to the composition of assets and other
conditions prescribed by the Internal Revenue Code of 1986, as amended (the
"Code"), are permitted to establish reserves for bad debts and to make annual
additions thereto which may, within specified formula limits, be taken as a
deduction in computing taxable income for federal income tax purposes. The
amount of the bad debt reserve deduction is computed under the experience
method. Under the experience method, the bad debt reserve deduction is an amount
determined under a formula based generally upon the bad debts actually sustained
by the savings institution over a period of years.
In August 1996, federal legislation was enacted that changed the manner
in which the bad debt deduction is calculated by thrift institutions, including
the Bank. Formerly the Bank had been allowed to calculate its deduction under
the experience or percentage of taxable income methods and deduct the higher
amount. The percentage of taxable income method was repealed effective for the
1996 tax year. The legislation effectively requires thrifts to account for bad
debts for federal income tax purposes on the same basis as commercial banks for
tax years beginning after December 31, 1995.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to an alternative minimum
tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on
alternative minimum taxable income, which is the sum of a corporation's regular
taxable income (with certain adjustments) and tax preference items, less any
available exemption. The alternative minimum tax is imposed to the extent it
exceeds the corporation's regular income tax and net operating losses can offset
no more than 90% of alternative minimum taxable income. For taxable years
beginning after 1986 and before 1996, corporations, including savings
institutions such as the Bank, were also subject to an environmental tax equal
to 0.12% of the excess of alternative minimum taxable income for the taxable
year (determined without regard to net operating losses and the deduction for
the environmental tax) over $2 million.
To the extent prior years earnings appropriated to a savings
association's bad debt reserves for "qualifying real property loans" and
deducted for federal income tax purposes exceed the allowable amount of such
reserves computed under the experience method and to the extent of the
association's supplemental reserves for losses on loans ("Excess"), such Excess
may not, without adverse tax consequences, be utilized for the payment of cash
dividends or other distributions to a shareholder (including distributions on
redemption, dissolution or liquidation) or for any other purpose (except to
absorb bad debt losses). As of December 31, 1998, the Bank's Excess for tax
purposes totaled approximately $4.6 million.
The Bank and its subsidiaries file consolidated federal income tax
returns on a fiscal year basis using the accrual method of accounting. The
Holding Company intends to file consolidated federal income tax returns with the
Bank and its subsidiaries.
37
<PAGE>
The Bank and its consolidated subsidiaries have been audited by the IRS
with respect to consolidated federal income tax returns through December 31,
1985. With respect to years examined by the IRS, either all deficiencies have
been satisfied or sufficient reserves have been established to satisfy asserted
deficiencies. In the opinion of management, any examination of still open
returns (including returns of subsidiaries and predecessors of, or entities
merged into, the Bank) would not result in a deficiency which could have a
material adverse effect on the financial condition of the Bank and its
consolidated subsidiaries.
New York Taxation. The Bank and its subsidiaries that operate in New
York are subject to New York state taxation. The Bank is subject to the New York
State Franchise Tax on Banking Corporations in an annual amount equal to the
greater of (i) 9% of the Bank's "entire net income" allocable to New York State
during the taxable year, or (ii) the applicable alternative minimum tax. The
alternative minimum tax is generally the greater of (a) 0.01% of the value of
the Bank's assets allocable to New York State with certain modifications, (b) 3%
of the Bank's "alternative entire net income" allocable to New York State, or
(c) $250. Entire net income is similar to federal taxable income, subject to
certain modifications (including the fact that net operating losses cannot be
carried back or carried forward) and alternative entire net income is equal to
entire net income without certain modifications.
Delaware Taxation. As a Delaware holding company, the Holding Company is
exempted from Delaware corporate income tax but is required to file an annual
report with and pay an annual fee to the State of Delaware. The Holding Company
is also subject to an annual franchise tax imposed by the State of Delaware.
37
<PAGE>
Executive Officers of the Company
The executive officers of the Company, each of whom is currently an
executive officer of the Bank, are identified below. The executive officers of
the Company are elected annually by the Company's Board of Directors.
<TABLE>
<CAPTION>
Name Age(1) Position With Company
---- ------ ------------------------------------------------------------
<S> <C> <C>
Joseph H. Giaquinto 59 Chairman of the Board, President and Chief Executive Officer
David J. Jurczynski 39 Senior Vice President, Treasurer and Chief Financial Officer
Richard D. Ammian 51 Senior Vice President and Corporate Secretary
</TABLE>
(1) As of December 31, 1998
Executive Officers of the Company
Joseph H. Giaquinto. Mr. Giaquinto, age 59, is Chairman of the Board,
President and Chief Executive Officer of the Bank and the Holding Company. Mr.
Giaquinto began his career with Schenectady Federal in 1961 and has served in a
variety of positions including his current positions since 1984.
Richard D. Ammian. Mr. Ammian, age 51, is Senior Vice President of
Administration and Marketing and Corporate Secretary. In that capacity, Mr.
Ammian is responsible for human resources, employee benefits, marketing and
property management functions of the Bank. Mr. Ammian joined the Bank in 1978
and held various positions with the Bank until his promotion to his current
positions in 1988. Mr. Ammian serves as a director of the Bank and the Holding
Company.
David J. Jurczynski. Mr. Jurczynski, age 39, is Senior Vice President,
Treasurer, and Chief Financial Officer of the Bank. Mr. Jurczynski was appointed
to the position in October 1996. From 1990 to 1996, Mr. Jurczynski was Vice
President and Treasurer of Cohoes Savings Bank. Mr. Jurczynski is a certified
public accountant.
38
<PAGE>
Item 2. Properties
----------
The following table sets forth information concerning the main office and
each branch office of the Bank at December 31, 1998. At December 31, 1998, the
Bank's premises had an aggregate net book value of approximately $1.6 million.
<TABLE>
<CAPTION>
Year Owned or Net Book Value
Location Acquired Leased December 31, 1998
-------- -------- ------ -----------------
(In thousands)
<S> <C> <C> <C>
Main Office:
251-263 State Street 1959 Owned $685
Schenectady, New York
Full Service Branches:
262 Saratoga Road 1981 Leased $ 14
Scotia, New York (expires 2006)
2526-2528 Broadway 1977 Owned $352
Schenectady, New York
1624 Union Street 1997 Owned $542
Schenectady, New York
</TABLE>
The Bank believes that its current facilities are adequate to meet the
present and foreseeable future needs of the Bank and the Holding Company. The
Bank may look to open new branches when and if the prospective market is deemed
to provide an opportunity to the Bank.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data processing
and computer equipment utilized by the Bank at December 31, 1998 was
approximately $179,000.
Item 3. Legal Proceedings
-----------------
The Holding Company and the Bank are involved as plaintiff or defendant in
various legal actions arising in the normal course of its business. While the
ultimate outcome of these proceedings cannot be predicted with certainty, it is
the opinion of management, after consultation with counsel representing the
Holding Company and the Bank in the proceedings, that the resolution of these
proceedings should not have a material effect on Company's consolidated
financial position, results of operations or liquidity.
Item 4. Submission of Matters to a Vote of Securities Holders
-----------------------------------------------------
No matters were submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
1998.
39
<PAGE>
PART II
Item 5. Market for Common Equity and Related
Stockholder Matters
-------------------
Page 56 of the Company's 1998 Annual Report to Stockholders is herein
incorporated by reference.
Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations
-----------------------------------
Pages 4 through 19 of the Company's 1998 Annual Report to Stockholders is
herein incorporated by reference.
Item 7. Financial Statements
--------------------
The following information appearing in the Company's Annual Report to
Stockholders for the year ended December 31, 1998, is incorporated by reference
in this Annual Report on Form 10-KSB as Exhibit 13.
Pages in
Annual Report Section Annual Report
- --------------------------------------------------------------------------------
Selected Consolidated Financial Information.................... 2 - 3
Management's Discussion and Analysis of Financial Condition
and Results of Operation.................................... 4 - 19
Independent Auditors' Report................................... 20
Consolidated Balance Sheets as of
December 31, 1998 and 1997.................................. 21
Consolidated Statements of Income for the Years
Ended December 31, 1998, 1997 and 1996...................... 22
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996........ 23
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1998, 1997 and 1996................ 24 - 25
Notes to Consolidated Financial Statements .................... 26 - 55
40
<PAGE>
With the exception of the aforementioned information, the Company's
Annual Report to Stockholders for the year ended December 31, 1998, is not
deemed filed as part of this Annual Report on Form 10-KSB.
Item 8. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure
-----------------------------------
None.
41
<PAGE>
PART III
Item 9. Directors, Promoters and Control Persons; Compliance With
Section 16(a) of the Exchange Act
---------------------------------
Directors
- ---------
Information concerning directors of the Company is incorporated herein
by reference from the Company's definitive Proxy Statement for the Annual
Meeting of Stockholders for the fiscal year ended December 31, 1998, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
Executive Officers
- ------------------
Information regarding the business experience of the executive officers
of the Company and the Bank contained in Part I of this 10-KSB is incorporated
herein by reference.
Item 10. Executive Compensation
----------------------
Information concerning executive compensation is incorporated herein by
reference from the Company's definitive Proxy Statement for the fiscal year
ended December 31, 1998, a copy of which will be filed not later than 120 days
after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the Company's definitive
Proxy Statement for the fiscal year ended December 31, 1998, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
Item 12. Certain Relationships and Related Transactions
----------------------------------------------
Information concerning certain relationships and transactions is
incorporated herein by reference from the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders for the fiscal year ended December 31,
1998, a copy of which will be filed not later than 120 days after the close of
the fiscal year.
42
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits:
Reference to
Prior Filing
or Exhibit
Regulation Number
S-B Exhibit Attached
Number Document Hereto
------ -------- ------
2 Plan of acquisition, reorganization
arrangement, liquidation or succession . . . . . . . . None
3 Articles of Incorporation and Bylaws . . . . . . . . . . *
4 Instruments defining the rights of security holders,
including indentures:
Common Stock Certificate . . . . . . . . . . . . . . *
9 Voting trust agreement . . . . . . . . . . . . . . . . None
10 Material Contracts
10.1 1996 Stock Option and Incentive Plan . . . . . . . . *
10.2 1996 Management Recognition Plan . . . . . . . . *
10.3 Employment Agreement with Joseph H. Giaquinto . . **
10.4 Employment Agreement with Richard D. Ammian . . **
10.5 Employment Agreement with David J. Jurczynski . . **
10.6 Severance Agreement with Michael J. Krywinski . . **
10.7 Severance Agreement with William Pezzula . . . . . **
10.8 Change of Control Benefit Plan . . . . . . . . . . . **
11 Statement re: computation of per
share earnings . . . . . . . . . . . . . . . . . . . . None
12 Statement re: computation of ratios . . . . . . . . . . None
13 Annual Report to Security Holders . . . . . . . . . . . 13
16 Letter on change in certifying
accountant . . . . . . . . . . . . . . . . . . . . . . None
18 Letter on change in accounting
principles . . . . . . . . . . . . . . . . . . . . . . None
21 Subsidiaries of Registrant . . . . . . . . . . . . . . . 21
22 Published report regarding matters
submitted to vote of security holders . . . . . . . . . None
23 Consent of Experts and Counsel . . . . . . . . . . . 23
24 Power of Attorney . . . . . . . . . . . . . . . . . . None
27 Financial Data Schedule . . . . . . . . . . . . . . . . None
28 Information from reports furnished to
state insurance regulatory authorities . . . . . . . . None
99 Additional exhibits . . . . . . . . . . . . . . . . . . None
--------------------
* Filed as exhibits to the Company's S-1 registration statement filed on
March 17, 1995, (File No.33-90422) pursuant to Section 5 of the Securities Act
of 1933. All of such previously filed documents are hereby incorporated herein
by reference in accordance with Item 601 of Regulation S-B.
** Filed as exhibits to the Company's Annual Report on 10-KSB for the
fiscal year ended December 31, 1997 under the Securities Exchange Act of 1934,
filed with the SEC on March 31, 1998, and incorporated herein by reference in
accordance with Item 601 of Regulation S-B.
43
<PAGE>
(b) Reports on Form 8-K:
On October 29, 1998, Form 8-K was filed in connection with the
announced execution of a termination agreement between SFS Bancorp, Inc. and
Cohoes Savings Bank. On October 23, 1998, SFS Bancorp, Inc. and Cohoes Savings
Bank jointly announced the execution of a Termination Agreement dated October
23, 1998 (the "Termination Agreement"), which terminated the definitive
agreement dated as of July 31, 1998 by and between the Company and Cohoes (the
"Merger Agreement"). Under the terms of the Merger Agreement, the Company was to
have merged into a newly-formed holding company of Cohoes to be organized in
connection with Cohoes' conversion from a mutual to a stock institution (the
"Merger"). The Merger was terminated after Cohoes determined that due to the
recent significant decline in the market values of publicly held thrift
institutions, including institutions undertaking mutual-to-stock conversions,
and regulatory concerns regarding the amount of stock that SFS Bancorp, Inc.
shareholders would receive in the Merger, that the Merger was no longer feasible
and could adversely affect the Cohoes conversion. Pursuant to the Termination
Agreement, Cohoes has paid the Company a termination fee of $2 million. No
financial statements were required to be filed with the Form 8-K.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SFS BANCORP, INC.
Date: March 31, 1999 By: /s/ Joseph H. Giaquinto
--------------- ------------------------
Joseph H. Giaquinto (Duly
Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Joseph H. Giaquinto By: /s/ John F. Assini, M.D.
----------------------- ------------------------
Joseph H. Giaquinto, Chairman of the John F. Assini, M.D.
Board, President and Chief Executive Vice Chairman of the Board
Officer (Principal Executive and
Operating Officer)
Date: March 31, 1999 Date: March 31, 1999
-------------- --------------
By: /s/ Richard D. Ammian By: /s/ Gerald I. Klein
--------------------- -------------------
Richard D. Ammian, Director Gerald I. Klein, Director
Date: March 31, 1999 Date: March 31, 1999
-------------- --------------
By: /s/ Robert A. Schlansker By: /s/ David J. Jurczynski
------------------------ -----------------------
Robert A. Schlansker, Director David J. Jurczynski
Senior Vice President, Treasurer
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: March 31, 1999 Date: March 31, 1999
-------------- --------------
1998 ANNUAL REPORT
[LOGO]
SFS BANCORP, INC.
Schenectady, New York
<PAGE>
TABLE OF CONTENTS
President's Message ............................................ 1
Selected Consolidated Financial Information ..................... 2
Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 4
Independent Auditors' Report ................................... 20
Consolidated Financial Statements ............................... 21
Corporate Information ........................................... 56
<PAGE>
PRESIDENT'S MESSAGE
-------------------
Dear Fellow Stockholders:
On behalf of the Board of Directors, Officers and Employees of SFS
Bancorp, Inc. (SFS) and its wholly owned subsidiary, Schenectady Federal Savings
Bank (the "Bank"), we are pleased to present to you our Annual Report for 1998.
Undoubtedly the most noteworthy event during 1998 was the announced
merger of SFS Bancorp, Inc. with and into Cohoes Bancorp, Inc. (Cohoes) a newly
formed holding company of Cohoes Savings Bank. The merger was perceived by
management and the Board of SFS as an opportunity to maximize value for our
shareholders. The merger was terminated when Cohoes notified SFS in October that
the merger was no longer feasible due to the significant decline in the market
values of publicly held thrift institutions and institutions converting from
mutual to stock, as well as, regulatory concerns regarding the pricing of the
transaction. As a result, SFS received a termination fee of $2,000,000 during
the fourth quarter of 1998.
Net income for 1998 was $2,115,000 compared to $1,068,000 for 1997. The
increase of $1,047,000 was primarily attributable to the termination fee which
was partially offset by one-time merger related expenses of $355,000. Excluding
the termination fee and one-time merger related expenses, net income increased
by approximately $60,000 to $1,128,000 or 5.6% from 1997 levels. The focus on
core banking products and net interest income provided the basis for the
increase in the net income exclusive of the termination fee and one-time merger
related expenses. SFS will continue to focus on core banking products and
services as a means of improving net income and enhancing the value of our
franchise.
In 1998, the Bank again reaffirmed its commitment to meeting the credit
needs of our community through mortgage and consumer lending. Net loans
increased $6.4 million during 1998 to $140.2 million at year-end 1998. The
increase was primarily the result of originations of local residential mortgage
loans which the Bank continues to own and service. This continues our ongoing
policy of generating high asset quality investments. Non-performing loans
decreased $487,000 or 36.2% during 1998 to $860,000 or approximately 0.6% of
total assets at year end 1998.
Our management team has been working diligently on the much-publicized
Year 2000 data processing issue. We have developed a comprehensive plan
including contingency and business resumption issues that addresses the
sensitivity of processes affected by the century date change. We do not expect
that the cost of fully complying with this issue will have a material impact on
our earnings in 1999. All mission critical systems have been modified and all
have been tested and deemed to be compliant. We expect to be fully compliant
long before the change to the new millennium.
As always, please be assured that your Board of Directors and
management team remain committed to explore capital management and other
strategies that will result in maximizing value for our shareholders. Thank you
for your continued support and confidence in SFS Bancorp, Inc.
Sincerely,
/s/Joseph H. Giaquinto
----------------------
Joseph H. Giaquinto
Chairman of the Board, President
and Chief Executive Officer
<PAGE>
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data
Total assets . . . . . . . . . . . . . . . $178,167 $174,428 $164,888 $166,529 $150,837
Cash and cash equivalents . . . . . . . . 3,812 2,176 2,896 10,453 6,468
Securities available for sale . . . . . . . 16,954 4,067 1,990 7,976 7,776
Investment securities . . . . . . . . . . 11,661 28,979 36,180 43,076 38,893
FHLB stock . . . . . . . . . . . . . . . 1,338 1,338 1,215 1,117 1,123
Loans receivable, net . . . . . . . . . . 140,210 133,786 118,455 100,921 93,703
Real estate owned . . . . . . . . . . . . 271 111 178 200 204
Deposits . . . . . . . . . . . . . . . . . 150,578 150,469 140,616 139,671 138,299
Advance payments by borrowers
for taxes and insurance . . . . . . . . 1,425 1,281 1,160 1,402 1,270
Stockholders' equity . . . . . . . . . . . 23,610 21,431 21,671 24,261 10,046
<CAPTION>
December 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Selected Operations Data
Total interest income . . . . . . . . . . $ 12,751 $ 12,368 $ 11,867 $ 11,523 $ 9,849
Total interest expense . . . . . . . . . . 6,902 6,623 6,187 6,236 5,077
----------- ----------- ----------- ----------- ----------
Net interest income . . . . . . . . . . . 5,849 5,745 5,680 5,287 4,772
Provision for loan losses . . . . . . . . . 120 120 120 370 120
----------- ----------- ----------- ----------- ----------
Net interest income after
provision for loan losses . . . . . . . . 5,729 5,625 5,560 4,917 4,652
Noninterest income . . . . . . . . . . . 2,462 423 333 280 137
Noninterest expense . . . . . . . . . . . 4,638 4,288 5,169 3,986 4,063
----------- ----------- ----------- ----------- ----------
Income before taxes . . . . . . . . . . . 3,553 1,760 724 1,211 726
Income tax expense (benefit) . . . . . . . 1,438 692 (106) 356 215
=========== =========== =========== =========== ==========
Net income . . . . . . . . . . . . . . . $ 2,115 $ 1,068 $ 830 $ 855 $ 511
=========== =========== =========== =========== ===========
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL INFORMATION, continued
Year Ended December 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data
Performance Ratios:
-------------------
Return on assets (ratio of net income to
average total assets. . . . . . . . .. . . . . . . . . 1.20% 0.63% 0.50% 0.53% 0.34%
Net interest rate spread . . . . . . . . . . . . . . . . 2.88 2.96 2.95 2.93 3.06
Net interest margin . . . . . . . . . . . . . . . . . . . 3.40 3.46 3.51 3.36 3.26
. . . . .
Ratio of noninterest expense to average total assets . . 2.63 2.51 3.13 2.48 2.72
Ratio of net interest income to noninterest expense . . . 126.11 133.97 109.89 131.29 116.50
Return on equity (ratio of net income to average
equity) . . . . . . . . . . . . . . . . . . . . . . . 9.74 5.04 3.73 5.07 5.31
. . . . . . .
Liquidity ratio at end of year . . . . . . . . . . . . 19.24 19.72 22.58 32.45 19.57
Efficiency ratio . . . . . . . . . . . . . . . . . . . . 67.87 69.52 85.96 71.60 82.77
Asset Quality Ratios:
---------------------
Non-performing assets to total assets, at end of year . . 0.64 0.84 0.61 0.62 1.93
Allowance for loan losses to non-performing loans,
at year end . . . . . . . . . . . . . . . . . . . . . 110.76 57.78 77.07 68.18 31.79
Allowance for loan losses to total loans . . . . . . . . 0.67 0.58 0.54 0.56 0.91
Capital Ratios:
---------------
Stockholders' equity to total assets at end of year . . . 13.25 12.29 13.14 14.57 6.66
Average stockholders' equity to average total assets . . 12.31 12.43 13.48 10.50 6.43
Ratio of average interest-earning assets to average
interest-bearing liabilities. . . . . . . . . . . . . . 112.84 112.68 114.72 110.84 105.75
Number of full service offices . . . . . . . . . . . . . 4 4 3 3 3
</TABLE>
3
<PAGE>
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Management's discussion and analysis of the consolidated financial
condition and the results of operations is intended to assist in understanding
the consolidated financial condition and results of operations of the Company.
The information contained in this section should be read in conjunction with the
consolidated financial statements and accompanying notes thereto.
SFS Bancorp, Inc. (the "Parent Company") is the holding company for
Schenectady Federal Savings Bank and its subsidiary (the "Bank"), a federally
chartered stock savings bank. Collectively, these entities are referred to
herein as the "Company." On June 29, 1995, the Bank completed its conversion
from a federal mutual savings and loan association to a federal stock savings
bank. On that date, the Parent Company issued and sold 1,495,000 shares of its
common stock at $10.00 per share in connection with the conversion. Net proceeds
to the Parent Company were $14.2 million after reflecting conversion expenses of
$750,000. The Parent Company used $7.1 million of the net proceeds to acquire
all of the issued and outstanding stock of the Bank.
Forward Looking Statements
When used in this Annual Report or future filings by the Company with
the Securities and Exchange Commission, in the Company's press releases or other
public or other shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be",
"will allow", "intends to", "will likely result", "are expected to", "will
continue", "is anticipated", "estimate", "project", or similar expressions are
intended to identify "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
to advise readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any
obligation, to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
4
<PAGE>
Business Strategy
The primary goal of management is to improve the Company's
profitability and enhance its net worth while minimizing risk. The Company's
profitability is dependent primarily on its net interest income, which is the
difference between interest earned on its loans and investments and the interest
paid on interest-bearing liabilities. The Company's profitability is also
affected by the generation of recurring noninterest income, which primarily
consists of fees and service charges. Net interest income is determined by (i)
the difference between the yield earned on interest-earning assets and rates
paid on interest-bearing liabilities ("interest rate spread") and (ii) the
relative amounts of interest-earning assets and interest-bearing liabilities.
The Company's interest rate spread is affected by regulatory, economic and
competitive factors that influence interest rates, loan demand and deposit
flows. In addition, net income is affected by the level of noninterest expense
and provision for loan losses.
The operations of financial institutions, including the Company, are
significantly affected by prevailing economic conditions, competition and the
monetary and fiscal policies of governmental agencies. Lending activities are
influenced by the demand for the supply of housing, competition among lenders,
the level of interest rates and the availability of funds. Deposit flows and
cost of funds are influenced by prevailing market rates of interest primarily on
competing investments, account maturities and the level of personal income and
savings in the Company's market area.
Management strives to operate as a conservative, well-capitalized,
profitable community bank dedicated to financing home ownership and other
consumer needs, and to provide quality service to its customers. The Company
believes it successfully implements this strategy by:
Emphasizing One-to-Four Family Lending. Historically, the Company has
been predominantly a one-to-four family residential lender. One-to-four family
residential loans constituted 96.0% and 94.9% of total gross loans at December
31, 1998 and 1997, respectively.
Maintaining Asset Quality. The Company places strong emphasis on
achieving a high degree of asset quality maintained through sound underwriting,
constant monitoring and effective collection techniques. The Company's ratio of
non-performing assets to total assets was 0.6% and 0.8% as of December 31, 1998
and 1997, respectively.
Managing Interest Rate Risk. In order to reduce the impact on the
Company's net interest income due to changes in interest rates, the Company's
management has adopted a strategy that has been designed to maintain the
interest rate sensitivity of its assets and liabilities. The primary elements of
this strategy involve emphasizing the origination of adjustable and floating
rate loans and maintaining a short- and medium-term investment portfolio. The
level of adjustable or floating rate loans included in total loans was 56.3% as
of December 31, 1998. Additionally, 20.2% of the Company's interest-earning
assets carried remaining terms of five years or less.
5
<PAGE>
The Company's management believes that a portion of passbook,
transaction and other non-certificate accounts representing core deposits can
have a lower cost and be more resistant to interest rate changes than
certificate accounts. Accordingly, the Company has used customer service and
marketing initiatives to maintain and expand its core deposits. While the
Company believes that a portion of these non-certificate accounts are interest
rate sensitive and may flow to other investments if interest rate differential
between certificate and non-certificate accounts continue, the Company believes
that a significant portion of the balance of these accounts represent core
deposits. At December 31, 1998, 38.3% of the Company's total deposits consisted
of passbook, transaction and other non-certificate accounts.
Asset/Liability Management
The principal financial objective of the Company's interest rate risk
management is to achieve long-term profitability while limiting its exposure to
fluctuating interest rates. The Company has sought to reduce exposure of its
earnings to changes in market interest rates by managing the mismatch between
assets and liability maturities and interest rates. The principal element in
achieving this objective is to increase the interest-rate sensitivity of the
Company's assets by holding loans with interest rates subject to periodic
adjustment to market conditions. In addition, the Company maintains an
investment portfolio which primarily consists of securities that mature within
five years. The Company relies on retail deposits as its primary source of
funds. Management believes retail deposits, compared to brokered deposits, limit
the effects of interest rate fluctuation because they generally represent a more
stable source of funds. As part of its interest rate risk strategy, the Company
promotes transaction accounts and certificates of deposit with terms up to five
years.
The following table is provided by the OTS and sets forth as of
December 31, 1998 the Company's interest rate risk as measured by changes in its
net portfolio value ("NPV") (i.e. the present value of the expected cash flow
from assets, liabilities and off-balance sheet contracts) for instantaneous and
sustained parallel shifts in the yield curve, in 100 basis point increments, up
and down 400 basis points.
<TABLE>
<CAPTION>
Change in
Interest Rate $ Amount $ Change % Change
------------- -------- -------- --------
(Basis Points) (Dollars in Thousands)
<S> <C> <C> <C>
+400 $15,305 $(9,223) (38)%
+300 18,141 (6,387) (26)
+200 20,726 (3,802) (15)
+100 22,848 (1,680) (7)
0 24,528 -- --
-100 26,038 1,510 6
-200 27,376 2,848 12
-300 29,082 4,554 19
-400 30,678 6,150 25
</TABLE>
6
<PAGE>
As with any method of measuring interest rate risk, certain
shortcomings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods to reprice, they may react in different degrees to changes
in market interest rates. Also, the interest rates on certain types of asset and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Additionally, certain assets, such as ARM loans, have features which restrict
changes in interest rates on a short-term basis and over the life of the asset.
Further, in the event of a change in interest rates, expected rates of
prepayment on loans and early withdrawals from certificates could likely deviate
significantly from those assumed in calculating the table. It is also possible
as a result of an interest rate increase, the increased mortgage payments
required of ARM borrowers could result in an increase in delinquencies and
defaults. Accordingly, the data presented in the table above should not be
relied upon as indicative of actual results in the event of changes in interest
rates. Furthermore, the NPV presented in the table is not intended to represent
the fair market value of the Company.
Financial Condition
Total assets increased $3.7 million (2.1%) to $178.2 million at
December 31, 1998 from $174.4 million at December 31, 1997. This increase
consisted primarily of an increase in loans receivable, net of $6.3 million
(4.8%) to $140.2 million at December 31, 1998 and an increase in securities
available for sale of $12.9 million (316.9%) to $17.0 million at December 31,
1998. These increases were offset by a decrease in investment securities of
$17.3 million (59.8%) to $11.7 million at December 31, 1998. The change in the
composition of the investment portfolio classifications from held to maturity to
available for sale will provide management the flexibility to entertain
strategies to maximize the return of the combined portfolios.
Total liabilities were $154.6 million at December 31, 1998 representing
an increase of $1.6 million (1.0%) from December 31, 1997. The increase was
attributable to marginal increases in total deposits and advance payments by
borrowers for taxes and insurance combined with long-term borrowings which were
$700,000 at December 31, 1998. There were no long-term borrowings as of December
31, 1997.
Stockholders' equity increased $2.2 million (10.2%) to $23.6 million at
December 31, 1998 as compared to $21.4 million at December 31, 1997. Retained
earnings increased by $1.7 million as a result of net income of the Company for
the year ended December 31, 1998 of $2.1 million offset by the declaration and
payment of dividends of $387,000.
Non-performing assets totaled $1.1 million and $1.5 million at December
31, 1998 and 1997, respectively. The decrease in non-performing assets of
$400,000 (25.1%) is primarily attributable to principal paydowns received on the
Bank's largest non-performing loan. In addition to the principal payments
received on this loan, the Bank recovered approximately $56,000 on a previously
charged off portion of this loan relationship. The remaining portion of this
loan is considered adequately collateralized and payments have remained current.
All remaining loans classified as non-performing are secured by one-to-four
family residential
7
<PAGE>
properties. The decrease in non-performing loans was offset by an increase in
real estate owned. All assets in other real estate are recorded at the net
realizable value. The ratio of allowance for loan losses to non-performing loans
was 110.76% at December 31, 1998, compared with 57.78% at December 31, 1997. The
ratio of non-performing assets to total assets was .64% at December 31, 1998
compared with .84% at December 31, 1997.
Analysis of Net Interest Income
Net interest income represents the difference between interest earned
on interest-earning assets and interest paid on interest-bearing liabilities.
Net interest income depends on the volumes of interest-earning assets and
interest-bearing liabilities and the interest rate earned or paid on them.
The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. No tax equivalent adjustments were made.
Nonaccruing loans have been included in the table as loans.
8
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997
-------------------------------------- ------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate
-------- --------- ------- -------- ------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Loans receivable, net(1) . . . . . . . . . $139,445 $ 10,693 7.67% $124,994 $ 9,757 7.81%
Mortgage-backed securities . . . . . . . 13,700 850 6.20 18,807 1,189 6.32
Securities available for sale. . . . . . . 8,988 562 6.25 4,368 286 6.55
Investment securities . . . . . . . . . . 4,755 335 7.05 13,779 896 6.50
Other interest-earning assets
including cash equivalents . . . . . . . 4,042 214 5.29 2,845 153 5.38
FHLB stock . . . . . . . . . . . . . . 1,338 97 7.25 1,322 87 6.58
-------- --------- -------- -------
Total interest-earning assets . . . . $172,268 12,751 7.40 $166,115 12,368 7.45
======== --------- ======== -------
Interest-Bearing Liabilities:
Savings accounts . . . . . . . . . . . . 36,460 1,069 2.93 36,982 1,113 3.01
Money market accounts . . . . . . . . . 7,618 249 3.27 7,197 251 3.49
Demand and NOW accounts(2) . . . . . . . . 11,539 158 1.37 10,660 159 1.49
Certificate accounts. . . . . . . . . . . 95,526 5,390 5.64 91,420 5,075 5.55
Long term borrowings . . . . . . . . 139 7 5.04 -- -- --
Escrow . . . . . . . . . . . . . . . . . 1,378 29 2.10 1,162 25 2.15
-------- --------- -------- -------
Total interest-bearing liabilities . . $152,660 6,902 4.52 $147,421 6,623 4.49
======== --------- ------ ======== ------- ------
Net interest income . . . . . . . . . . . $ 5,849 $ 5,745
========= =======
Net interest rate spread . . . . . . . . 2.88% 2.96%
==== ====
Net earning assets . . . . . . . . . . . . $ 19,608 $ 18,694
======== =========
Net yield on average interest-
earning assets . . . . . . . . . . . . . 3.40% 3.46%
==== ====
Average interest-earning assets to
average interest-bearing liabilities . . 1.13 1.13
==== ====
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1996
-------------------------------------
Average Interest
Outstanding Earned/ Yield/
Balance Paid Rate
-------- ------- ------
(Dollars in Thousands)
<S> <C> <C> <C>
Interest-Earning Assets:
Loans receivable, net(1) . . . . . . . . . $111,524 $ 8,758 7.85%
Mortgage-backed securities . . . . . . . 22,403 1,418 6.33
Securities available for sale. . . . . . . 5,169 307 5.94
Investment securities . . . . . . . . . . 16,698 1,059 6.34
Other interest-earning assets
including cash equivalents . . . . . . . 4,698 247 5.26
FHLB stock . . . . . . . . . . . . . . 1,204 78 6.48
-------- -------
Total interest-earning assets . . . . $161,696 11,867 7.34
======== -------
Interest-Bearing Liabilities:
Savings accounts . . . . . . . . . . . . 38,857 1,173 3.02
Money market accounts . . . . . . . . . 5,195 161 3.10
Demand and NOW accounts(2) . . . . . . . . 10,102 148 1.47
Certificate accounts. . . . . . . . . . . 85,642 4,680 5.46
Long term borrowings . . . . . . . . -- -- --
Escrow . . . . . . . . . . . . . . . . . 1,155 25 2.16
-------- -------
Total interest-bearing liabilities . . 140,951 6,187 4.39
======== ------- ------
Net interest income . . . . . . . . . . . $ 5,680
=======
Net interest rate spread . . . . . . . . 2.95%
======
Net earning assets . . . . . . . . . . . . $ 20,745
========
Net yield on average interest-
earning assets . . . . . . . . . . . . . 3.51%
======
Average interest-earning assets to
average interest-bearing liabilities . . 1.15
=========
</TABLE>
(1) Calculated net of deferred loan fees.
(2) Includes noninterest-bearing demand accounts.
9
<PAGE>
Rate/Volume Analysis
The following schedule presents the dollar amount of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. It distinguishes between the increase
(decrease) related to outstanding balances and that due to the changes in
interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume). For purposes
of this table, changes attributable to both rate and volume, which cannot be
segregated have been allocated proportionately to the change due to volume and
the change due to rate.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
-------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------- --------------------
Total Total
Increase Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net . . . . . . . . . $1,105 $ (169) $ 936 $1,051 $ (52) $ 999
Mortgage-backed securities . . . . . . (317) (22) (339) (227) (2) (229)
Securities available for sale . . . . . 289 (13) 276 (51) 30 (21)
Investment securities . . . . . . . . . (643) 82 (561) (190) 27 (163)
Other interest-earning assets . . . . . 63 (2) 61 (100) 6 (94)
FHLB stock . . . . . . . . . . . . . 1 9 10 8 1 9
------- ------- ------- ------ ------ -------
Total interest-earning assets . . . . . $ 498 $ (115) $ 383 $ 491 $ 10 $ 501
======= ======= ======= ====== ====== =======
Interest-bearing liabilities:
Savings accounts . . . . . . . . . . . $ (16) $ (28) $ (44) $ (56) $ (4) $ (60)
Money market accounts . . . . . . . . 14 (16) (2) 74 16 90
Demand and NOW accounts . . . . . 13 (14) (1) 8 3 11
Certificate accounts . . . . . . . . . 231 84 315 320 75 395
Long-term borrowings . . . . . . . . . 7 0 7 0 0 0
Escrow . . . . . . . . . . . . . . . . . 5 (1) 4 0 0 0
--------- -------- ------- ------- ------- -------
Total interest-bearing liabilities . . $ 254 $ 25 $ 279 $ 346 $ 90 $ 436
========= ========= ======== ======= ======= =======
Net interest income $ 104 $ 65
======== =======
</TABLE>
10
<PAGE>
Results of Operations
General. The Company's results of operations depend primarily on net
interest income, noninterest expense, and to a lesser extent, income taxes and
noninterest income. Net interest income is a function of the volume of
interest-earning assets and interest-bearing liabilities and the interest rates
earned or paid on such assets and liabilities, respectively. Noninterest expense
consists primarily of general and administrative expenses. The Company's
noninterest income consists primarily of fees charged on deposit accounts, and
other loan charges which help to offset the cost associated with establishing
and maintaining these deposit and loan accounts.
Comparison of Operating Results for Years Ended December 31, 1998 and 1997
Net Income. The Company reported net income of $2,115,000 for the year
ended December 31, 1998, as compared to $1,068,000 for the year ended December
31, 1997. As discussed below, the increase in net income of $1,047,000 or 98.0%,
was due to an increase in noninterest income of $2,039,000 and an increase in
net interest income of $104,000. These increases were partially offset by an
increase in noninterest expense of $350,000 and an increase in income tax
expense of $746,000.
Interest Income. Interest income increased by $383,000, or 3.1% from
$12.4 million in 1997 to $12.8 million in 1998. This increase was due to an
increase in the balance of average interest-earning assets offset by a decrease
in the yield earned. Average interest-earning assets increased from $166.1
million in 1997 to $172.3 million in 1998. The yield on the Company's
interest-earning assets decreased from 7.45% for the year ended December 31,
1997 to 7.40% for the year ended December 31, 1998 as a result of the general
decrease in the market rates of interest on both loans and investment
securities.
Interest Expense. Interest expense increased by $279,000 or 4.2% to
$6.9 million for the year ended December 31, 1998. The increase was a result of
an increase in the balance of average interest-bearing liabilities of $5.2
million, or 3.6% to $152.7 million. The average rate paid for the year ended
December 31, 1998 was 4.52% as compared to 4.49% in 1997. The average balance of
all deposit products increased from 1997 to 1998 except savings accounts which
decreased on average $522,000 (1.4%). The increase in the various deposit
products was due in part to the opening of a new branch in March 1997 along with
continued competitive pricing and to a lesser extent the flow from savings
accounts to higher paying certificate accounts. The increase in the average rate
paid can be attributable to the composition of the deposit structure whereby
certificate accounts represented a greater percentage of total deposits in 1998
compared to 1997. The competitive rate environment that prevailed during 1998
and 1997 also affected the average rate paid.
Net Interest Income. Net interest income increased $104,000 or 1.8% to
$5.8 million in 1998 due principally to the relative increase of the loans
receivable, net portfolio in relation to total interest earning assets from 1997
to 1998. The percentage of average loans receivable, net to total average
interest earning assets increased from 75.2% in 1997 to 80.9% in 1998.
11
<PAGE>
Provision For Loan Losses. The provision for loan losses amounted to
$120,000 for 1998 and 1997, respectively. When determining the level of
provision for loan losses, management considers historical charge off ratios as
well as the then current regulatory and the general economic environment. The
Company's ability to collect on numerous loans previously charged off continued
throughout 1998 and 1997. As a result of successful collection efforts, total
recoveries exceeded total charge offs by $55,000 in 1998 and $16,000 in 1997.
The Company will continue to monitor and modify its allowance for loan losses as
conditions dictate. Although the Company maintains its allowance for loan losses
at a level it considers adequate to provide for probable losses in the present
portfolio, there can be no assurance that such losses will not exceed the
estimated amounts or that additional provisions for loan losses will not be
required in future periods.
Noninterest Income. Total noninterest income increased by $2,039,000,
or 482.0% from $423,000 in 1997 to $2,462,000 in 1998. The increase was
principally attributable to a $2,000,000 fee resulting from the termination of
the definitive agreement pursuant to which the Company was to merge with Cohoes
Bancorp, Inc. (Cohoes), a newly-formed holding company organized in connection
with Cohoes Savings Bank's conversion from a mutual to a stock institution.
Cohoes had advised the Company that the transaction was no longer feasible due
to significant declines in market values of publicly traded thrift institutions
and institutions undertaking mutual-to-stock conversions. Despite the best
efforts of both parties, revised terms acceptable to everyone could not be
agreed upon.
Noninterest Expense. Noninterest expense increased by $350,000, or 8.2%
from $4.3 million in 1997 to $4.6 million in 1998. The increase is primarily
attributable to the professional services and other expenses incurred totaling
$355,000 associated with the terminated merger as described above. Compensation
and benefits increased $52,000 (2.0%) from 1997 to 1998. The increase was a
result of annual merit increases and increased employee benefits partially due
to an increase in the Employee Stock Ownership Plan (ESOP) expense offset by a
reduction in the number of employees. Data processing fees increased $20,000
(11.4%) during 1998 to $195,000 due in part to incremental expenses related to
the Company's efforts to comply with the Year 2000 data processing issue.
Advertising and business promotion decreased $34,000 (39.5%) as a result of
expenses incurred in 1997 for the opening of a new branch. FDIC premiums
increased $18,000 (24.3%) to $92,000 as a result of the SAIF insurance premium
refunded the Bank in the first quarter of 1997 which had been paid in the fourth
quarter of 1996 subsequent to the capitalization of SAIF. Other expenses
decreased $44,000 (10.1%) to $390,000 in 1998 due in part to reduced servicing
expenses as the serviced mortgage portfolio decreases and reduced premiums on
insurance policies that were put out to bid. Office occupancy and equipment
expenses and professional service fees remained relatively stable during 1998 as
compared with 1997. As a result of the merger related expenses, the ratio of
noninterest expense to average assets increased from 2.51% for 1997 to 2.63% for
1998.
Income Tax Expense. Income tax expense increased $746,000 from $692,000
in 1997 to $1,438,000 in 1998. Income before taxes increased $1,793,000 (101.9%)
to $3,553,000 as a
12
<PAGE>
result of the recognition of fees associated with the failed merger net of
related expenses as described above. The effective tax rates for 1998 and 1997
were 40.5% and 39.3%, respectively. The increase was primarily attributable to
an increase in the nondeductible portion of the compensation expense of the
Company's ESOP.
Comparison of Operating Results for the Years Ended December 31, 1997 and 1996
Net Income. The Company reported net income of $1,068,000 for the year
ended December 31, 1997, as compared to $830,000 for the year ended December 31,
1996. As discussed below, the increase in net income of $238,000 or 28.7%, was
due to a decrease in noninterest expense of $881,000, an increase in noninterest
income of $90,000 and an increase in net interest income of $65,000. These
increases were partially offset by an increase in income tax expense of
$798,000.
Interest Income. Interest income increased by $501,000, or 4.2% from
$11.9 million in 1996 to $12.4 million in 1997. This increase was due to an
increase in both the balance of average interest-earning assets and the yield
earned. Average interest-earning assets increased from $161.7 million in 1996 to
$166.1 million in 1997. The yield on the Company's interest-earning assets
increased from 7.34% for the year ended December 31, 1996 to 7.45% for the year
ended December 31, 1997 as a result of the Company's ability to originate and
purchase loans and therefore affect the overall composition of interest earning
assets. The yield was also affected by the general increase in the market rates
of interest.
Interest Expense. Interest expense increased by $436,000 or 7.0% to
$6.6 million for the year ended December 31, 1997. The increase was a result of
an increase in the balance of average interest-bearing liabilities of $6.5
million, or 4.6% to $147.4 million. The average rate paid for the year ended
December 31, 1997 was 4.49% as compared to 4.39% in 1996. The mix within the
deposit structure changed as the average balance of certificate and money market
account balances grew a combined $7.8 million (8.6%) while savings accounts
declined $1.9 million (4.8%). The change in the deposit mix was due in part to
the opening of the new branch which had higher promotional certificate rates and
to a lesser extent the flow from savings accounts to higher paying certificate
accounts. The average rate paid was a reflection of the general interest rate
and competitive environment that prevailed during 1997 and 1996.
Net Interest Income. Net interest income increased $65,000, or 1.1% to
$5.7 million in 1997 due principally to the relative increase of the loans
receivable, net portfolio in relation to total interest earning assets from 1996
to 1997. The percentage of average loans receivable, net to total average
interest earning assets increased from 69.0% in 1996 to 75.2% in 1997.
Provision For Loan Losses. The provision for loan losses amounted to
$120,000 for 1997 and 1996, respectively. When determining the level of
provision for loan losses, management considers historical charge off ratios as
well as the then current regulatory and the general economic environment. Net
charge-offs decreased from $50,000 in 1996 to a $16,000 net recovery in 1997 due
to the Company's ability to collect on numerous loans previously
13
<PAGE>
charged off combined with a decrease in charge offs in 1997. The Company will
continue to monitor and modify its allowance for loan losses as conditions
dictate. Although the Company maintains its allowance for loan losses at a level
it considers adequate to provide for probable losses in the present portfolio,
there can be no assurance that such losses will not exceed the estimated amounts
or that additional provisions for loan losses will not be required in future
periods.
Noninterest Income. Total noninterest income increased by $90,000, or
27.0% from $333,000 in 1996 to $423,000 in 1997. The increase was principally
attributable to an increase of $48,000 in net gain on security transactions
combined with increases in other loan charges and Bank fees and service charges.
Noninterest Expense. Noninterest expense decreased by $881,000, or
17.0% from $5.2 million in 1996 to $4.3 million in 1997. The decrease is
primarily attributable to the special one-time SAIF assessment in 1996 which
totaled $930,000 and an ongoing reduction in the FDIC insurance premiums
subsequent to the special assessment. Compensation and benefits increased
$188,000 (7.7%) from 1996 to 1997. The increase was a result of increased retail
staff due to the opening of a new branch in March 1997, annual merit increases,
and increased employee benefits partially due to the increases in the ESOP
expense. Office occupancy and equipment expense increased $98,000, or 18.8% as a
result of increases in depreciation, property taxes and utilities associated
with the opening of the new branch. Advertising and business promotion,
professional service fees, data processing fees, and other expense remained
relatively stable during 1997 as compared with 1996. The ratio of noninterest
expense to average assets decreased from 3.13% for 1996 to 2.51% for 1997.
Income Tax Expense. Income tax expense increased from a benefit of
$106,000 in 1996 to an expense of $692,000 in 1997. The effective tax rate for
1997 was 39.3%. The income tax benefit recognized in 1996 primarily reflects a
reduction of the deferred tax asset valuation reserve which reduced the tax
effect on pre-tax income. The reduction in the deferred valuation allowance
during 1996 was primarily the result of the expected realization of certain
deferred items which were previously considered uncertain. There were no
comparable reductions in the deferred tax asset valuation reserve during 1997.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, proceeds from
principal and interest payment on loans, the maturity of and interest income on
investment securities, proceeds from the sale of securities available for sale
and advances from the FHLB of New York. While maturities and scheduled
amortization of loans and securities are a predictable source of funds, deposit
flows, mortgage prepayments and loan sales are greatly influenced by general
interest rates, economic conditions and competition.
The Company must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to support loan growth and deposit withdrawals,
to satisfy financial
14
<PAGE>
commitments and to take advantage of investment opportunities. The Company
generally maintains sufficient cash and overnight deposits to meet short-term
liquidity needs. At December 31, 1998, cash and cash equivalents totaled $3.8
million, or 2.1% of total assets. In addition, the Company maintains a credit
facility with the FHLB of New York, which provides for immediately available
advances. As of December 31, 1998, there was $700,000 advanced under this credit
facility. Depending on market conditions and the pricing of deposit products and
FHLB borrowings, the Company may continue to rely on FHLB borrowings for its
liquidity needs.
The Company is required to maintain minimum levels of liquid assets as
defined by OTS regulations. This requirement, which may be varied by the OTS
depending upon economic conditions and deposit flows, is based upon a percentage
of deposits and short-term borrowings. The required minimum liquidity ratio is
currently 4.0% and for the month of December 1998, the Bank exceeded that,
maintaining an average liquidity ratio of 19.24%.
The primary investing activities of the Company are the origination and
purchase of mortgage loans and the purchase of securities. During the years
ended December 31, 1998, 1997 and 1996, the Company's mortgage loan originations
and purchases totaled $36.7 million, $35.4 million, and $31.4 million,
respectively. The Company purchased securities available for sale of $16.9 and
$6.1 million for the years ended December 31, 1998 and 1997, respectively. The
Company did not purchase any securities available for sale during 1996. The
Company purchased investment securities during the years ended December 31,
1998, 1997 and 1996 of $699,000, $1.7 million and $6.0 million, respectively.
The primary financing activity of the Company is the attraction of
deposits and the repurchase of the Company's shares. During the years ended
December 31, 1998, 1997, and 1996, the Company experienced a net increase in
deposits of $109,000, $9.9 million, and $945,000, respectively. During the year
ended December 31, 1997, the Company repurchased 77,475 shares. During the year
ended December 31, 1996, the Company repurchased 269,750 shares of which 53,222
shares were used to fund the RRP. The average price of treasury shares purchased
was $19.68 totaling $1.5 million for 1997 and $12.68 totaling $3.5 million for
1996. The average price paid was approximately 111.0% and 74.4% of the Company's
book value per share at December 31, 1997 and 1996, respectively. The Company
did not repurchase shares during 1998. The Office of Thrift Supervision (OTS)
restricts the number of shares which may be repurchased during the three year
period following conversion. Generally, only 5% of shares outstanding may be
repurchased annually during the first three years following conversion. However,
the OTS has allowed additional share repurchases of 5% annually based on
extenuating facts and circumstances. As of June 29, 1998, the OTS no longer
restricts the amount of shares the Company may elect to repurchase.
At December 31, 1998, the Bank's capital exceeded each of the capital
requirements of the OTS. At December 31, 1998, the Bank's tangible and core
capital levels were both $20.5 million (11.50% of total adjusted assets) and its
risk-based capital level was $21.4 million (22.65% of total risk-weighted
assets). The current minimum regulatory capital ratio
15
<PAGE>
requirements are 1.5% for tangible capital, 3.0% for core capital and 8.0% for
risk-weighted capital.
The Company anticipates that it will have sufficient funds available to
meet its current commitments. At December 31, 1998, the Company had commitments
to originate loans of $2.1 million as well as undrawn commitments of $10.2
million on home equity and other lines of credit. Certificates of deposits which
are scheduled to mature in one year or less at December 31, 1998 totaled $68.1
million. Management believes that a significant portion of these deposits will
remain with the Company.
Impact of Inflation and Changing Prices
The consolidated financial statements and related financial data
presented herein have been prepared in accordance with generally accepted
accounting principles ("GAAP"), which generally requires the measurement of
financial position and operating results in terms of historical dollars, without
considering the change in the relative purchasing power of money over time due
to inflation. The primary impact of inflation is reflected in the increased cost
of the Company's operations. Unlike most industrial companies, virtually all the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than do general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services.
Impact of Recent Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. This Statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. Management is currently
evaluating the impact of this Statement on the Company's consolidated financial
statements.
Impact of the Year 2000
General. The Year 2000 ("Y2K") issue confronting the Company and its suppliers,
customers, customers' suppliers and competitors centers on the inability of
computer systems to recognize the year 2000. Many existing computer programs and
systems originally were programmed with six digit dates that provided only two
digits to identify the calendar year in the date field. With the impending new
millennium, these programs and computers will recognize "00" as the year 1900
rather than the year 2000.
16
<PAGE>
Financial institution regulators recently have increased their focus upon Y2K
compliance issues and have issued guidance concerning the responsibilities of
senior management and directors. The Federal Financial Institutions Examination
Council ("FFIEC") has issued several interagency statements on Y2K Project
Management Awareness. These statements require financial institutions to, among
other things, examine the Y2K implications of their reliance on vendors and with
respect to data exchange and the potential impact of the Y2K issue on their
customers, suppliers and borrowers. These statements also require each federally
regulated financial institution to survey its exposure, measure its risk and
prepare a plan to address the Y2K issue. In addition, the federal banking
regulators have issued safety and soundness guidelines to be followed by insured
depository institutions, such as the Bank, to assure resolution of any Y2K
problems. The federal banking agencies have assessed that Y2K testing and
certification is a key safety and soundness issue in conjunction with regulatory
exams and, thus, that an institution's failure to address appropriately the Y2K
issue could result in supervisory action, including the reduction of the
institution's supervisory ratings, the denial of applications for approval of
mergers or acquisitions or the imposition of civil money penalties.
Risks. Like most financial services providers, the Company and its operations
may be significantly affected by the Y2K issue due to its dependence on
technology and date-sensitive data. Computer software and hardware and other
equipment, both within and outside the Company's direct control, and third
parties with whom the Company electronically or operationally interfaces
(including without limitation its customers and third party vendors) are likely
to be affected. If computer systems are not modified in order to be able to
identify the year 2000, many computer applications could fail or create
erroneous results. As a result, many calculations which rely on date field
information, such as interest, payment or due dates and other operating
functions, could generate results which are significantly misstated, and the
Company could experience an inability to process transactions, prepare
statements or engage in similar normal business activities. Likewise, under
certain circumstances, a failure to adequately address the Y2K issue could
adversely affect the viability of the Company's suppliers and creditors and the
creditworthiness of its borrowers. Thus, if not adequately addressed, the Y2K
issue could result in a significant adverse impact on the Company's operations
and, in turn, its financial condition and results of operations.
State of Readiness. During May 1998, the Company formally approved its plan to
address the Y2K issue. Since that time the Company has taken the following
steps:
- - Established senior management advisory and review responsibilities;
- - Completed a Company-wide inventory of applications and system software;
- - Implemented a tracking database for applications and vendor software created
by regulators;
- - Developed compliance plans and schedules for all lines of business;
- - Begun computer application testing;
- - Initiated vendor compliance verification;
- - Contacted all vendors with whom the Company interacts to determine their state
of readiness;
17
<PAGE>
- - Begun awareness and education activities for employees through existing
internal communication channels; and
- - Developed a process to respond to customer inquires as well as help educate
customers on the Y2K issue.
The following paragraphs summarize the phases of the Company's Y2K plan:
1. Awareness Phase. The Company formally established a Y2K plan headed by a
senior manager, and a Y2K committee was assembled for management of the project.
The project committee created a plan of action that includes milestones, budget
estimates, strategies, and methodologies to track and report the status of the
project. Members of the project committee also attended conferences and
information sharing sessions to gain more insight into the Y2K issue and
potential strategies for addressing it. This phase is substantially complete.
2. Assessment Phase. The Company's strategies were further developed with
respect to how the objectives of the Y2K plan would be achieved, and a Y2K
business risk assessment was made to quantify the extent of the Company's Y2K
exposure. A corporate inventory (which is periodically updated as new technology
is acquired and as systems progress through subsequent phases) was developed to
identify and monitor Y2K readiness for information systems (hardware, software,
utilities, and vendors) as well as environmental systems (security systems,
facilities, etc.). Systems were prioritized based on business impact and
available alternatives. Mission critical systems supplied by vendors were
researched to determine Y2K readiness. If Y2K-ready versions were not available,
the Company began identifying functional replacements which were either
upgradeable to currently Y2K-ready, and a formal plan was developed to repair,
upgrade or replace all mission critical systems. This phase is substantially
complete.
Beginning in 1997 and throughout 1998, the Company began Y2K evaluation of all
commercial borrowers at the time of the annual review of their loans. All
commercial customers were evaluated for Y2K exposure by the Internal Loan Review
Committee using a questionnaire developed by the Company's Y2K committee and an
assessment as to the borrower's reliance on data processing and the risk to the
overall viability of the business. As part of the current credit approval
process, all new and renewed loans are evaluated for Y2K risk. While the Company
will continue to monitor the progress being made by its commercial customers in
addressing their own Y2K issues, to date the Company is generally satisfied with
customers' responses and their progress in addressing their Y2K risk. The
Company's primary assets are residential mortgage loans which have been assessed
with minimal risk as it relates to Y2K and the impact on the creditworthiness of
these loans individually or as a whole.
3. Conversion/Renovation Phase. The Company's corporate inventory revealed that
upgrades are available for all vendor-supplied mission critical systems. All
mission critical applications and the majority of other applications which are
deemed Y2K-ready have been received and placed into production and have entered
the validation process.
18
<PAGE>
4. Validation/Implementation Phase. This phase is designed to test the ability
of hardware and software to accurately process date sensitive data. The Company
currently is in the process of validation testing of each mission critical
applications. The Company's Y2K test environment, periodically supplied by its
service bureau data center, is virtually insulated from production and
development environments. The Company has reassigned internal personnel
responsibilities in anticipation of the increased work efforts and has increased
staff to support normal business activities. The Company's validation phase was
substantially completed during 1998 for all mission critical systems except for
the accounting general ledger system which will undergo validation testing in
the first quarter of 1999. During the validation testing process to date, no
significant Y2K problems have been identified relating to any modified or
upgraded mission critical systems.
Company's Resources Invested. The Company's Y2K committee has been assigned the
task of ensuring that all systems across the Company are identified, analyzed
for Y2K compliance, corrected if necessary, tested, and changes put into
service. The Y2K committee members represent all functional areas of the
Company, including retail banking, data processing, loan administration,
accounting, operations, compliance, internal audit, human resources, and
marketing. The committee is headed by a senior vice president who reports
directly to the Company's chief executive officer. The Company's Board of
Directors oversees the Y2K plan and provides guidance and resources to the
project committee. The Board is updated periodically as to the progress of the
committee.
The Company is expensing all costs associated with required system changes as
those projects are incurred, and such costs are being funded through operating
cash flow. Expenditures incurred for hardware upgrades are being capitalized and
depreciated in accordance with the Company's policies. The total expenditures
associated with the Y2K conversion project, exclusive of internal costs, are
estimated to be approximately $100,000. As of December 31, 1998, the Company
incurred or was contractually committed for services, equipment and software
totaling approximately $73,000 for the Y2K conversion project. The Company does
not expect significant increases in future data processing costs related to Y2K
compliance above the aforementioned estimate.
Contingency Plans. Virtually all the Company's mission critical systems are
dependent on third party vendors or service providers. Therefore, contingency
plans include selecting a new vendor or service provider and converting to their
system. In the event a current vendor's system fails during validation testing
and it is determined that the vendor is unable or unwilling to correct the
failure, the Company will convert to a new system from a list of prospective
vendors. In each case, realistic trigger dates have been established to allow
for orderly and successful conversion. The Board of Directors approved a formal
contingency and business resumption plan in December 1998.
19
<PAGE>
SFS Bancorp, Inc. and Subsidiary
Consolidated Financial Statements
As of December 31, 1998 and 1997
and for each of the years in the three-year period
ended December 31, 1998
(With Independent Auditors' Report Thereon)
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
SFS Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of SFS Bancorp,
Inc. and subsidiary (the Company) as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SFS Bancorp, Inc.
and subsidiary as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/KPMG LLP
- -----------
KPMG LLP
January 22, 1999
20
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1998 and 1997
1998 1997
--------- -------
Assets (in thousands, except share data)
<S> <C> <C>
Cash and due from banks ........................................... $ 1,712 1,876
Federal funds sold ................................................ 2,100 300
--------- -------
Total cash and cash equivalents .......................... 3,812 2,176
Securities available for sale, at fair value (note 5) ............. 16,954 4,067
Investment securities (estimated fair value of $11,758 and $29,095,
at December 31, 1998 and 1997, respectively) (note 6) ........ 11,661 28,979
Stock in Federal Home Loan Bank of New York, at cost .............. 1,338 1,338
Loans receivable, net (note 7) .................................... 140,210 133,786
Accrued interest receivable (note 8) .............................. 1,133 1,130
Premises and equipment, net (note 9) .............................. 2,191 2,242
Real estate owned (note 10) ....................................... 271 111
Prepaid expenses and other assets ................................. 597 599
--------- -------
Total assets ............................................. $ 178,167 174,428
========= =======
Liabilities and Stockholders' Equity
Liabilities:
Due to depositors (note 11):
Non-interest bearing ....................................... 2,103 2,265
Interest bearing ........................................... 148,475 148,204
--------- -------
Total deposits ........................................... 150,578 150,469
--------- -------
Advance payments by borrowers for taxes and insurance ......... 1,425 1,281
Long-term borrowings (note 13) ................................ 700 --
Accrued expenses and other liabilities ........................ 1,854 1,247
--------- -------
Total liabilities ........................................ 154,557 152,997
--------- -------
Commitments and contingent liabilities (notes 12 and 17)
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 500,000 shares .... -- --
Common stock, $.01 par value, authorized 2,500,000 shares;
1,495,000 shares issued at December 31, 1998 and 1997 ...... 15 15
Additional paid-in capital .................................... 14,576 14,365
Retained earnings, substantially restricted ................... 14,150 12,422
Treasury stock, at cost (286,528 shares at December 31, 1998
and 1997) .................................................. (4,089) (4,089)
Common stock acquired by employee stock ownership plan
(ESOP) ..................................................... (718) (837)
Unearned recognition and retention plan (RRP) ................. (318) (455)
Accumulated other comprehensive income ........................ (6) 10
--------- -------
Total stockholders' equity ............................... 23,610 21,431
--------- -------
Total liabilities and stockholders' equity ............... $ 178,167 174,428
========= =======
</TABLE>
See accompanying notes to consolidated financial statements
21
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
------- ------- -------
(in thousands, except for per share amounts)
<S> <C> <C> <C>
Interest income:
Loans .................................................. $10,693 9,757 8,758
Investment securities .................................. 1,185 2,085 2,477
Securities available for sale .......................... 562 286 307
Federal funds sold and cash deposits ................... 214 153 247
Stock in Federal Home Loan Bank of New York ............ 97 87 78
------- ------- -------
Total interest income ............................... 12,751 12,368 11,867
Interest expense:
Deposits (note 11) ..................................... 6,895 6,623 6,187
Borrowings ............................................. 7 -- --
------- ------- -------
Total interest expense .............................. 6,902 6,623 6,187
Net interest income ................................. 5,849 5,745 5,680
Provision for loan losses (note 7) ......................... 120 120 120
------- ------- -------
Net interest income after provision for loan losses . 5,729 5,625 5,560
------- ------- -------
Noninterest income:
Bank fees and service charges .......................... 176 160 138
Net gain on security transactions ...................... -- 56 8
Termination fee related to merger (note 2) ............. 2,000 -- --
Other income ........................................... 286 207 187
------- ------- -------
Total noninterest income ............................ 2,462 423 333
------- ------- -------
Noninterest expense:
Compensation and benefits .............................. 2,683 2,631 2,443
Office occupancy and equipment expenses ................ 610 620 522
Professional service fees .............................. 261 268 241
Data processing fees ................................... 195 175 166
Advertising and business promotion ..................... 52 86 108
Federal deposit insurance premiums ..................... 92 74 322
Federal deposit insurance special SAIF assessment ...... -- -- 930
Expenses related to terminated merger (note 2) ......... 355 -- --
Other expense .......................................... 390 434 437
------- ------- -------
Total noninterest expense ........................... 4,638 4,288 5,169
------- ------- -------
Income before taxes ................................. 3,553 1,760 724
Income tax expense (benefit) (note 12) ..................... 1,438 692 (106)
------- ------- -------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
For the years ended December 31, 1998, 1997 and 1996
(continued)
1998 1997 1996
------- ------- -------
(in thousands, except for per share amounts)
<S> <C> <C> <C>
Net income ................................................. $ 2,115 1,068 830
======= ======= =======
Basic earnings per share ................................... $ 1.94 0.96 0.68
======= ======= =======
Diluted earnings per share ................................. $ 1.83 0.93 0.67
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements
22
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996
Retained
Additional earnings Treasury
Shares Common paid-in substantially stock,
issued stock capital restricted at cost
------ ----- ------- ---------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ................................. 1,495,000 $ 15 14,221 11,013 --
Comprehensive income:
Net income ................................................ -- -- -- 830 --
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $37) ....................... -- -- -- -- --
Reclassification adjustment for net gains realized in net
income during the year (pre-tax $8) ................. -- -- -- -- --
Other comprehensive income ................................
Comprehensive income .........................................
Purchases of common stock (269,750 shares) ................... -- -- -- -- (3,418)
Grant of restricted stock under RRP (45,747 shares) .......... -- -- -- -- 578
Amortization of unearned RRP compensation .................... -- -- -- -- --
Cash dividends declared on common stock ...................... -- -- -- (156) --
Allocation of ESOP stock (11,960 shares) ..................... -- -- 39 -- --
--------- ------- ------ ------ ------
Balance at December 31, 1996 ................................. 1,495,000 15 14,260 11,687 (2,840)
Comprehensive income:
Net income ................................................ -- -- -- 1,068 --
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $3) ........................ -- -- -- -- --
Reclassification adjustment for net gains realized in net
income during the year (pretax $56) ................. -- -- -- -- --
Other comprehensive income ................................
Comprehensive income .........................................
Purchases of common stock (77,475 shares) .................... -- -- -- -- (1,486)
Grants of restricted stock under RRP (7,475 shares) .......... -- -- -- -- 143
Amortization of unearned RRP compensation .................... -- -- -- -- --
Cash dividends declared on common stock ...................... -- -- -- (333) --
Exercise of stock options (7,475 shares) ..................... -- -- -- -- 94
Allocation of ESOP stock (11,960 shares) ..................... -- -- 105 -- --
--------- ------- ------ ------ ------
Balance at December 31, 1997 ................................. 1,495,000 15 14,365 12,422 (4,089)
Comprehensive income:
Net income ................................................ -- -- -- 2,115 --
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $26) ....................... -- -- -- -- --
Comprehensive income .........................................
Amortization of unearned RRP compensation .................... -- -- -- -- --
Tax benefit related to vested RRP shares ..................... -- -- 49 -- --
Cash dividends declared on common stock ...................... -- -- -- (387) --
Allocation of ESOP stock (11,960 shares) ..................... -- -- 162 -- --
--------- ------- ------ ------ ------
Balance at December 31, 1998 ................................. 1,495,000 $ 15 14,576 14,150 (4,089)
========= ======= ====== ====== ======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Common Unearned other
stock recognition compre- Compre-
acquired and retention hensive sive
by ESOP plan income income Total
------- ---- ------ ------ -----
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ................................. (1,076) -- 88 24,261
Comprehensive income:
Net income ................................................ -- -- -- $ 830 830
-------
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $37) ....................... -- -- -- (37)
Reclassification adjustment for net gains realized in net
income during the year (pre-tax $8) ................. -- -- -- (5)
-------
Other comprehensive income ................................ (42) (42) (42)
-------
Comprehensive income ......................................... $ 788
=======
Purchases of common stock (269,750 shares) ................... -- -- -- (3,418)
Grant of restricted stock under RRP (45,747 shares) .......... -- (578) -- --
Amortization of unearned RRP compensation .................... -- 38 -- 38
Cash dividends declared on common stock ...................... -- -- -- (156)
Allocation of ESOP stock (11,960 shares) ..................... 119 -- -- 158
------ ----- ---- -------
Balance at December 31, 1996 ................................. (957) (540) 46 21,671
Comprehensive income:
Net income ................................................ -- -- -- 1,068 1,068
-------
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $3) ........................ -- -- -- (2)
Reclassification adjustment for net gains realized in net
income during the year (pretax $56) ................. -- -- -- (34)
-------
Other comprehensive income ................................ (36) (36) (36)
-------
Comprehensive income ......................................... $ 1,032
=======
Purchases of common stock (77,475 shares) .................... -- -- -- (1,486)
Grants of restricted stock under RRP (7,475 shares) .......... -- (143) -- --
Amortization of unearned RRP compensation .................... -- 228 -- 228
Cash dividends declared on common stock ...................... -- -- -- (333)
Exercise of stock options (7,475 shares) ..................... -- -- -- 94
Allocation of ESOP stock (11,960 shares) ..................... 120 -- -- 225
------ ----- ---- -------
Balance at December 31, 1997 ................................. (837) (455) 10 21,431
Comprehensive income:
Net income ................................................ -- -- -- 2,115 2,115
-------
Other comprehensive income, net of taxes:
Unrealized net holding losses arising
during the year (pre-tax $26) ....................... -- -- (16) (16) (16)
-------
Comprehensive income ......................................... $ 2,099
=======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Common Unearned other
stock recognition compre- Compre-
acquired and retention hensive sive
by ESOP plan income income Total
------- ---- ------ ------ -----
<S> <C> <C> <C> <C> <C>
Amortization of unearned RRP compensation .................... -- 137 -- 137
Tax benefit related to vested RRP shares ..................... -- -- -- 49
Cash dividends declared on common stock ...................... -- -- -- (387)
Allocation of ESOP stock (11,960 shares) ..................... 119 -- -- 281
------ ----- ---- -------
Balance at December 31, 1998 ................................. (718) (318) (6) 23,610
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Increase (decrease) in cash and cash equivalents:
Reconciliation of net income to net cash provided
by operating activities:
Net income ............................................ $ 2,115 1,068 830
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation .................................... 204 190 140
Net accretion on investment securities .......... (74) (75) (12)
Net amortization on securities available for sale 3 -- --
ESOP compensation expense ....................... 281 225 158
Amortization of RRP ............................. 137 228 38
Provision for loan losses ....................... 120 120 120
Real estate owned writedown ..................... -- -- 7
Loss on sale of real estate owned ............... -- 3 --
Gain on sales of securities available for sale .. -- (56) (8)
(Increase) decrease in accrued interest
receivable .................................... (3) 7 24
Decrease (increase) in prepaid expenses
and other assets .............................. 2 317 (705)
Increase (decrease) in accrued expenses
and other liabilities ......................... 666 (200) 246
-------- -------- --------
Net cash provided by operating
activities .............................. 3,451 1,827 838
-------- -------- --------
Cash flows from investing activities:
Proceeds from maturities and paydowns of
investment securities ................................... 18,091 8,976 12,908
Proceeds from the sales and calls of securities
available for sale ..................................... 4,000 4,000 5,952
Purchases of investment securities ......................... (699) (1,700) (6,000)
Purchases of securities available for sale ................. (16,916) (6,051) --
Purchases of FHLB stock .................................... -- (123) (98)
Net increase in loans made to customers .................... (4,366) (11,923) (10,859)
Capital expenditures, net of disposals ..................... (153) (511) (647)
Purchases of loans receivable .............................. (2,365) (3,550) (6,973)
Proceeds from the sales of real estate owned ............... 27 86 193
-------- -------- --------
Net cash used by investing activities ...... (2,381) (10,796) (5,524)
-------- -------- --------
</TABLE>
(Continued)
24
<PAGE>
<TABLE>
<CAPTION>
SFS BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in deposits ............................. $ 109 9,853 945
Net increase (decrease) in advance payments
by borrowers for property taxes and insurance .... 144 121 (242)
Purchases of common stock for treasury ............... -- (1,486) (3,418)
Cash dividends paid .................................. (387) (333) (156)
Proceeds from exercise of stock options .............. -- 94 --
Proceeds from FHLB advances .......................... 700 -- --
------- ------- -------
Net cash provided (used) in financing
activities ........................ 566 8,249 (2,871)
------- ------- -------
Net increase (decrease) in cash and cash equivalents ..... 1,636 (720) (7,557)
Cash and cash equivalents at beginning of year ........... 2,176 2,896 10,453
------- ------- -------
Cash and cash equivalents at end of year ................. $ 3,812 2,176 2,896
======= ======= =======
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest paid ..................................... $ 6,895 6,623 6,187
======= ======= =======
Taxes paid ........................................ $ 854 538 509
======= ======= =======
Supplemental schedule of noncash investing activities:
Transfer of loans to other real estate owned ......... $ 187 22 178
======= ======= =======
Adjustment of securities available for sale to fair value,
net of increase in deferred tax asset of $10 in 1998
and increase in deferred tax liability of $6 in 1997 . $ (16) (36) (42)
======= ======= =======
Deferred tax benefit related to vested RRP shares ........ $ 49 -- --
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Summary of Significant Accounting Policies
SFS Bancorp, Inc. (the Holding Company) was incorporated under Delaware
law in March, 1995 as a holding company to purchase 100% of the common
stock of Schenectady Federal Savings Bank and subsidiary (the Bank). The
Bank converted from a mutual form to a stock form institution, and the
Holding Company completed its initial public offering on June 29, 1995,
at which time the Holding Company purchased all of the outstanding stock
of the Bank. To date, the principal operations of SFS Bancorp, Inc. and
subsidiary (the Company) have been those of the Bank.
The following is a description of the more significant policies which the
Company follows in preparing and presenting its consolidated financial
statements:
(a) Basis of Presentation
The accompanying consolidated financial statements include the
accounts of the Holding Company, its wholly owned subsidiary the
Bank, and the Bank's wholly owned subsidiary. All significant
intercompany transactions and balances are eliminated in
consolidation. The accounting and reporting policies of the
Company conform in all material respects to generally accepted
accounting principles and to general practice within the thrift
industry. In the "Parent Company Financial Information" (note 19),
the investment in the wholly owned subsidiary is carried under the
equity method of accounting.
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates.
Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination of
the allowance for loan losses and the valuation of real estate
acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for
loan losses and the valuation of real estate owned, management
obtained appraisals for significant properties.
<PAGE>
(b) Business
A substantial portion of the Company's assets are loans secured by
real estate in the upstate New York area. In addition, a
substantial portion of the real estate owned is located in those
same markets. Accordingly, the ultimate collectibility of a
substantial portion of the Bank's loan portfolio and the recovery
of a substantial portion of the carrying amount of real estate
owned are dependent upon market conditions in the upstate New York
region.
26 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Management believes that the allowance for loan losses is adequate
and that real estate owned is properly valued. While management
uses available information to recognize losses on loans and real
estate owned, future additions to the allowance or writedowns on
real estate owned may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require
the Bank to recognize additions to the allowance or writedowns on
real estate owned based on their judgments about information
available to them at the time of their examination which may not
be currently available to management.
(c) Cash Equivalents
For purposes of the consolidated statements of cash flows, the
Company considers all cash and due from banks and federal funds
sold to be cash equivalents.
(d) Securities Available for Sale, Investment Securities and Federal
Home Loan Bank of New York Stock
Management determines the appropriate classification of securities
at the time of purchase. If management has the positive intent and
ability to hold debt securities to maturity, they are classified
as investment securities and are stated at amortized cost. All
other debt and marketable equity securities are classified as
securities available for sale and are reported at fair value, with
net unrealized gains or losses reported as a separate component of
stockholders' equity, net of estimated income taxes. The Company
does not maintain a trading portfolio.
Realized gains and losses on the sale of securities are based on
the net proceeds and the amortized cost of the securities sold,
using the specific identification method. The cost of securities
is adjusted for amortization of premium and accretion of discount,
which is calculated on an effective interest method.
Mortgage backed securities, which are guaranteed by the Government
National Mortgage Association ("GNMA"), the Federal Home Loan
Mortgage Corporation ("FHLMC"), or the Federal National Mortgage
Association ("FNMA"), represent participating interests in direct
pass-through pools of long-term first mortgage loans originated
and serviced by the issuers of the securities.
Unrealized losses on securities are charged to earnings when the
decline in fair value of a security is judged to be other than
temporary.
Non-marketable equity securities, such as Federal Home Loan Bank
of New York stock, are stated at cost. The investment in Federal
Home Bank of New York stock is required for membership.
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(e) Loans Receivable
Loans receivable are stated at unpaid principal amount, net of
unearned discount, unamortized premiums, deferred loan fees and
the allowance for loan losses. Premiums and discounts on related
loans are amortized into income using a method that approximates
the level-yield method. Loan origination fees net of certain
related costs are generally amortized into income over the
estimated term of the loan using the interest method of
amortization. Interest income on loans is not recognized when
considered doubtful of collection by management.
Loans considered doubtful of collection by management are placed
on a nonaccrual status for the recording of interest. Generally
loans past due 90 days or more as to principal or interest are
placed on nonaccrual status except for certain loans which, in
management's judgment, are adequately secured and for which
collection is probable. Previously accrued income that has not
been collected is reversed from current income. Thereafter, the
application of payments received (principal or interest) is
dependent on the expectation of ultimate repayment of the loan. If
ultimate repayment of the loan is expected, any payments received
are applied in accordance with contractual terms. If ultimate
repayment of principal is not expected or management judges it to
be prudent, any payment received on a nonaccrual loan is applied
to principal until ultimate repayment becomes expected. Loans are
removed from nonaccrual status when they become current as to
principal and interest and when, in the opinion of management, the
loans are estimated to be fully collectible as to principal and
interest. Amortization of related deferred fees is suspended when
a loan is placed on nonaccrual status.
The allowance for loan losses is maintained at a level deemed
appropriate by management based on an evaluation of the known and
inherent risks in the present portfolio, the level of
non-performing loans, past loan loss experience, estimated value
of underlying collateral, and current and prospective economic
conditions. The allowance is increased by provisions for loan
losses charged to operations.
Impaired loans are identified and measured in accordance with SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan," and
SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -
Income Recognition and Disclosures." A loan is considered impaired
when it is probable that the borrower will be unable to repay the
loan according to the original contractual terms of the loan
agreement, or the loan is restructured in a troubled debt
restructuring subsequent to January 1, 1995. These standards are
applicable principally to commercial and commercial real estate
loans, however, certain provisions related to restructured loans
are applicable to all loan types.
<PAGE>
Under these Statements the allowance for loan losses related to
impaired loans is based on discounted cash flows using the loan's
initial effective interest rate or the fair value of the
collateral for certain loans where repayment of the loan is
expected to be provided solely by the underlying collateral
(collateral dependent loans). The Company's impaired loans are
generally collateral dependent. The Company considers estimated
costs to sell on a discounted basis when determining the fair
value of collateral in the measurement of impairment if these
costs are expected to reduce the cash flows available to repay or
otherwise satisfy the loans.
28 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
As a matter of policy, the Company generally places impaired loans
on nonaccrual status and recognizes interest income on such loans
only on a cash basis. In some instances, all monies received from
the borrower, or from the proceeds of collateral, are applied
directly to reduce the principal balance of the loan, and no
interest income is recognized until the principal balance of the
impaired loan is paid in full or is no longer considered impaired.
(f) Real Estate Owned
Included in real estate owned are assets received from
foreclosures and in-substance foreclosures. In accordance with
SFAS No. 114, a loan is classified as an in-substance foreclosure
when the Company has taken possession of the collateral regardless
of whether formal foreclosure proceedings have taken place.
Foreclosed assets, including in-substance foreclosures, are
recorded on an individual asset basis at net realizable value
which is the lower of fair value minus estimated costs to sell or
"cost" (defined as the fair value at initial foreclosure). When a
property is acquired or identified as in-substance foreclosure,
the excess of the loan balance over fair value is charged to the
allowance for loan losses. Subsequent writedowns to carry the
property at fair value are included in noninterest expense. Costs
incurred to develop or improve properties are capitalized, while
holding costs are charged to expense.
(g) Premises and Equipment, Net
Premises and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is computed on the
straight-line or accelerated method over the estimated useful
lives of the related assets. Useful lives are 20 to 50 years for
banking house and 3 to 15 years for furniture, fixtures, and
office equipment.
(h) Pension Plan
The Company has a defined benefit pension plan covering all full
time employees meeting age and service requirements. This plan is
accounted for in accordance with SFAS No. 87, "Employers'
Accounting for Pensions."
(i) Income Taxes
Income taxes are provided on income reported in the consolidated
statements of income regardless of when such taxes are payable.
The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes." SFAS No. 109 requires the
asset and liability method of accounting for income taxes. Under
the asset and liability method of SFAS No. 109, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between financial
statement carrying amounts of existing assets and liabilities and
<PAGE>
their respective tax basis. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the
enactment date. The Company's policy is that deferred tax assets
are reduced by a valuation reserve if, based on the weight of
available evidence, it is more likely than not that some or all of
the deferred tax assets will not be realized.
29 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(j) Stock Based Compensation Plans
Compensation expense in connection with the Company's Employee
Stock Ownership Plan (ESOP) is recorded in accordance with the
American Institute of Certified Public Accountants' Statement of
Position No. 93-6, "Employers' Accounting for Employee Stock
Ownership Plans."
The Company accounts for its stock option plans in accordance with
the provisions of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees." Accordingly,
compensation expense is recognized only if the exercise price of
the option is less than the fair value of the underlying stock at
the grant date. SFAS No. 123, "Accounting for Stock-Based
Compensation," encourages entities to recognize the fair value of
all stock-based awards on the date of grant as compensation
expense over the vesting period. Alternatively, SFAS No. 123
allows entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma disclosures of net income and
earnings per share as if the fair-value-based method defined in
SFAS No. 123 had been applied. The Company has elected to continue
to apply the provisions of APB Opinion No. 25 and provide the pro
forma disclosures required by SFAS No. 123.
The Company's Recognition and Retention Plan ("RRP") is also
accounted for in accordance with APB Opinion No. 25. The fair
value of the shares awarded, measured as of the grant date, is
recognized as unearned compensation (a deduction from
stockholders' equity) and amortized to compensation expense as the
shares become vested. Any excess of the cost to fund purchases of
RRP shares over the grant-date fair value is charged to
stockholders' equity.
(k) Earnings per Share
On December 31, 1997, the Company adopted SFAS No. 128, "Earnings
per Share," which establishes standards for computing and
presenting earnings per share. SFAS No. 128 requires dual
presentation of basic and diluted earnings per share on the face
of the income statement for all entities with a complex capital
structure. Basic earnings per share excludes dilution and is
computed by dividing income available to common stockholders by
the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution
that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of
the entity. All earnings per share data reflect the adoption of
SFAS No. 128. Unallocated ESOP shares are not included in the
weighted average number of common shares outstanding for either
the basic or diluted earnings per share calculations.
<PAGE>
(l) Segment Reporting
During 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." This Statement
requires the Company to report financial and other information
about operating segments meeting certain quantitative and other
requirements as defined by this Statement.
The Company's operations are solely in the financial services
industry and include the provision of traditional banking
services. The Company operates solely in the geographical region
of Upstate New York. In the opinion of the Company's management,
the Company does not have any reportable segments as defined by
SFAS No. 131.
30 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(m) Reclassifications
Amounts in the prior years' financial statements are reclassified
whenever necessary, in order to conform to the presentation in the
current year's financial statements.
(2) Terminated Merger
On October 23, 1998, the Company and Cohoes Savings Bank (Cohoes)
announced the termination of a definitive agreement entered into on July
31, 1998, pursuant to which the Company was to merge into Cohoes Bancorp,
Inc., a newly-formed holding company of Cohoes organized in connection
with Cohoes' conversion from a mutual to a stock institution. Cohoes
advised the Company that the merger was not feasible because of a
significant decline in the market values of publicly held thrift
institutions and institutions undertaking mutual-to-stock conversions,
and regulatory concerns regarding the pricing of the merger. Despite the
best efforts of both parties, revised terms acceptable to everyone could
not be agreed upon. Pursuant to the definitive agreement, Cohoes paid the
Company a termination fee of $2 million. The Company recognized
professional and other expenses associated with the terminated merger
totaling $355,000.
(3) Earnings Per Share
The following is a reconciliation of net income and weighted average
shares for the basic and diluted earnings per share (EPS) calculations
for the years ended December 31:
<TABLE>
<CAPTION>
(in thousands except share and per share information)
1998
-----------------------------------------------
Weighted
Average Per-Share
Net Income Shares Amount
--------- --------- ----------
<S> <C> <C> <C>
Basic EPS $ 2,115 1,092,029 $ 1.94
==========
Dilutive effect of potential common shares related
to stock based compensation plans - 61,410
--------- ---------
Diluted EPS $ 2,115 1,153,439 $ 1.83
========= ========= ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1997
------------------------------------------------
Weighted
Average Per-Share
Net Income Shares Amount
--------- --------- ----------
<S> <C> <C> <C>
Basic EPS $ 1,068 1,108,094 $ .96
==========
Dilutive effect of potential common shares related
to stock based compensation plans - 46,231
--------- ---------
Diluted EPS $ 1,068 1,154,325 $ .93
========= ========= ==========
</TABLE>
31 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
1996
-----------------------------------------------
Weighted
Average Per-Share
Net Income Shares Amount
--------- --------- ----------
<S> <C> <C> <C>
Basic EPS $ 830 1,224,703 $ .68
==========
Dilutive effect of potential common shares related
to stock based compensation plans - 10,128
---------- ---------
Diluted EPS $ 830 1,234,831 $ .67
========== ========= ==========
</TABLE>
(4) Reserve Requirements
The Company is required to maintain certain reserves of cash and/or
deposits with the Federal Reserve Bank. The amount of this reserve
requirement, included in cash and due from banks, was approximately
$202,000 and $164,000 at December 31, 1998 and 1997, respectively.
The Company is also required to maintain certain levels of stock in the
Federal Home Loan Bank of New York.
(5) Securities Available for Sale
The amortized cost and estimated fair value are as follows at December
31:
<TABLE>
<CAPTION>
1998
------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
U.S. Government securities and agencies $ 4,084 6 10 4,080
Corporate bonds ....................... 12,880 19 25 12,874
------- ------- ------- -------
Total securities available for sale $16,964 25 35 16,954
======= ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1997
------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
U.S. Government securities and agencies $4,051 16 - 4,067
------ ------ --------- ------
Total securities available for sale $4,051 16 - 4,067
====== ====== ========= ======
</TABLE>
There were no sales of securities available for sale during 1998.
Proceeds from the sale of securities available for sale were
approximately $2.0 million and 6.0 million during 1997 and 1996,
respectively. During 1997, sales of securities available for sale
resulted in gross realized gains of $56,000. During 1996, sales of
securities available for sale resulted in gross realized gains of $44,000
and gross realized losses of $36,000.
32 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The amortized cost and estimated fair value of securities available for
sale at December 31, 1998, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because
certain issuers may have the right to call obligations with or without
call penalties.
December 31, 1998
Amortized Estimated
Cost Fair Value
------- -------
(in thousands)
Due within one year .................... $ 996 998
Due one to five years .................. 12,926 12,917
Due five years to ten years ............ 3,042 3,039
------- -------
Total securities available for sale $16,964 16,954
======= =======
(6) Investment Securities
The amortized cost and estimated fair values of investment securities are
as follows at December 31:
<TABLE>
<CAPTION>
1998
----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C>
Mortgage backed securities ............ $ 9,809 104 (7) 9,906
U.S. Government securities and agencies 1,086 -- -- 1,086
Time deposits held at other banks ..... 699 -- -- 699
States and political subdivisions ..... 67 -- -- 67
------- ------- ------- -------
Total investment securities .......... $11,661 104 (7) 11,758
======= ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1997
----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C>
Mortgage backed securities ............ $16,966 194 (84) 17,076
U.S. Government securities and agencies 11,937 24 (18) 11,943
States and political subdivisions ..... 76 -- -- 76
------- ------- ------- -------
Total investment securities .......... $28,979 218 (102) 29,095
======= ======= ======= =======
</TABLE>
There were no sales of investment securities during 1998, 1997 or 1996.
33 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The amortized cost and estimated fair value of investment securities at
December 31, 1998, by contractual maturity, are shown below (mortgage
backed securities are included by final contractual maturity). Expected
maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
------- -------
(in thousands)
<S> <C> <C>
Due within one year .......................... $ 1,061 1,059
Due one year to five years ................... 6,082 6,078
Due five years to ten years .................. 1,760 1,794
Due after ten years .......................... 2,758 2,827
------- -------
Total investment securities ............. $11,661 11,758
======= =======
</TABLE>
(7) Loans Receivable, Net
A summary of loans receivable is as follows at December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
(in thousands)
<S> <C> <C>
Loans secured by real estate:
Residential:
Conventional ................................ $112,568 100,277
Home equity ................................. 19,570 22,658
FHA insured ................................. 2,107 2,772
VA guaranteed ............................... 1,358 2,028
Commercial and multi family ..................... 4,914 6,130
-------- --------
140,517 133,865
-------- --------
Other loans:
Loans on savings accounts ....................... 473 573
Autos ........................................... 241 110
Other ........................................... 62 38
-------- --------
776 721
-------- --------
Less:
Unearned discount and net deferred loan fees .... 130 22
Allowance for loan losses ....................... 953 778
-------- --------
1,083 800
-------- --------
Loans receivable, net ......................... $140,210 133,786
======== ========
</TABLE>
<PAGE>
Not included in the Company's loans receivable are real estate mortgages
serviced by the Bank for other institutions of approximately $2.4 and
$3.5 million at December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997, the recorded investment in loans that were
considered to be impaired under SFAS No. 114 totaled approximately
$185,000 and $691,000, respectively. The amount in both years represents
one impaired loan that, as a result of charge-offs of approximately
$202,000, did not require an allowance for credit losses determined in
accordance with SFAS No. 114. The average recorded investment in impaired
loans during the years ended December 31, 1998, 1997 and 1996 was
approximately $485,000, $718,000 and $744,000, respectively.
34 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table sets forth the information with regard to
non-performing loans at December 31:
<TABLE>
<CAPTION>
1998 1997
----- -----
(in thousands)
<S> <C> <C>
Loans on a nonaccrual status ......................... $ 725 1,328
Loans contractually past due 90 days or more
and still accruing interest ..................... 135 19
Restructured loans ................................... -- --
----- -----
Total non-performing loans ................ $ 860 1,347
===== =====
</TABLE>
Interest on nonaccrual loans of approximately $36,000, $89,000, and
$81,000 would have been earned in accordance with the original
contractual terms of the loans in 1998, 1997 and 1996, respectively.
Approximately $51,000, $0, and $74,000 of interest was collected and
recognized as income in 1998, 1997 and 1996, respectively, on both
nonaccrual and impaired loans.
Certain directors and executive officers of the Company were customers of
and had other transactions with the Company in the ordinary course of
business. Loans to these parties were made in the ordinary course of
business at the Company's normal credit terms, including interest rate
and collateralization. The aggregate of such loans totaled approximately
$125,000 and $127,000 at December 31, 1998 and 1997, respectively. There
were advances to the directors and executive officers during the year
ended December 31, 1998 of approximately $4,000. Total payments made on
these loans were approximately $6,000 during 1998.
Changes in the allowance for loan losses were as follows for the years
ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
(in thousands)
<S> <C> <C> <C>
Balance, beginning of year ............... $ 778 642 572
Provision charged to operations .......... 120 120 120
Loans charged off ........................ (45) (26) (87)
Recoveries on loans previously charged off 100 42 37
----- ----- -----
Balance, end of year ..................... $ 953 778 642
===== ===== =====
</TABLE>
<PAGE>
(8) Accrued Interest Receivable
A summary of accrued interest receivable by type was as follows at
December 31:
<TABLE>
<CAPTION>
1998 1997
(in thousands)
<S> <C> <C>
Loans ............................................ $ 774 766
Securities available for sale .................... 246 68
Investment securities ............................ 113 296
------ ------
Total accrued interest receivable .......... $1,133 1,130
====== ======
</TABLE>
35 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(9) Premises and Equipment, Net
Premises and equipment are summarized by major classification as follows
at December 31:
1998 1997
------ ------
(in thousands)
Land ................................................. $ 338 338
Leasehold improvements ............................... 241 241
Office buildings ..................................... 2,559 2,550
Furniture, fixtures and equipment .................... 1,278 1,135
------ ------
Total .......................................... 4,416 4,264
Less accumulated depreciation and amortization ....... 2,225 2,022
------ ------
Premises and equipment, net .................... $2,191 2,242
====== ======
Depreciation expense included in office occupancy and equipment expense
amounted to approximately $204,000, $190,000, and $140,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
(10) Real Estate Owned
A summary of real estate acquired through foreclosure by the Company or
classified as in-substance foreclosure is as follows at December 31:
1998 1997
---- ----
(in thousands)
Residential (1 - 4 family) ..................... $ 67 26
Commercial property ............................ 204 85
---- ----
Total real estate owned .................. $271 111
==== ====
<PAGE>
(11) Due to Depositors
Due to depositors account balances are summarized as follows at December
31:
<TABLE>
<CAPTION>
Stated
rate 1998 1997
------------ --------- ------
(in thousands)
<S> <C> <C> <C>
Savings deposit accounts:
Passbook and statement deposit accounts 2.50% $ 36,394 36,681
Money market deposit accounts 2.60 - 4.30 8,263 7,619
--------- ------
44,657 44,300
Time deposit accounts:
3.00 - 3.99 1,047 -
4.00 - 4.99 20,367 801
5.00 - 5.99 66,818 84,451
6.00 - 6.99 4,719 9,489
--------- ------
92,951 94,741
NOW deposit accounts 1.25 10,867 9,163
Demand deposit accounts 0 2,103 2,265
--------- -------
Total deposits $ 150,578 150,469
========= =======
</TABLE>
36 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The approximate amount of contractual maturities of time deposit accounts
at December 31, 1998 are as follows:
Year ended December 31, (in thousands)
1999 $ 68,098
2000 15,129
2001 3,603
2002 2,930
2003 3,191
---------
$ 92,951
=========
At December 31, 1998 and 1997, the aggregate amount of time deposit
accounts with balances equal to or in excess of $100,000 was
approximately $8.9 million and $8.4 million, respectively.
Interest expense on deposits and advance payments by borrowers for
property taxes and insurance is summarized as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(in thousands)
<S> <C> <C> <C>
Passbook and statement savings ..... $1,069 1,113 1,173
Money market accounts .............. 249 251 161
Time deposits ...................... 5,390 5,075 4,680
NOW accounts ....................... 158 159 148
Escrow balances .................... 29 25 25
------ ------ ------
Total interest on deposits and
advance payments by
borrowers for property taxes
and insurance .............. $6,895 6,623 6,187
====== ====== ======
Weighted average interest rates .... 4.18% 4.59% 4.37%
====== ====== ======
</TABLE>
<PAGE>
(12) Income Taxes
The following is a summary of the components of income tax expense for
the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Current tax expense:
Federal ................... $ 1,250 583 372
State ..................... 280 121 76
Deferred benefit .......... (92) (12) (554)
------- ------- -------
Income tax expense (benefit) ... $ 1,438 692 (106)
======= ======= =======
</TABLE>
37 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The provision for income taxes is less than the amount computed by
applying the U.S. Federal income tax rate of 34% to income before taxes
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- -------------------- -------------------
% of % of % of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
------ ------ ------ ------ ------ ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tax expense at statutory rate $ 1,208 34.0% $ 598 34.0% $ 246 34.0%
State income tax, net of federal tax
benefit 172 4.9 105 5.9 45 6.2
Change in beginning of year
balance of the valuation
allowance for deferred tax assets - - - - (396) (54.7)
Other, net 58 1.6 (11) (.6) (1) (.1)
------- ---- ------- ---- -------- -----
$ 1,438 40.5% $ 692 39.3% $ (106) (14.6)%
======= ==== ======= ==== ======== =====
</TABLE>
The tax effects of significant temporary differences that give rise to
the deferred tax assets and liabilities were as follows at December 31:
<PAGE>
<TABLE>
<CAPTION>
1998 1997
----- -----
(in thousands)
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses ..................... $ 410 334
Deferred compensation and pension costs ....... 448 430
Recognition and retention plan expense ........ 59 52
Securities basis adjustment ................... 22 22
----- -----
Total gross deferred tax assets ........... 939 838
Less valuation allowance .................. (96) (96)
----- -----
Net deferred tax assets ................... 843 742
----- -----
Deferred tax liabilities:
Depreciation differences ...................... 71 72
Accretion of discount on securities ........... 54 53
Other items ................................... 60 51
----- -----
Total gross deferred tax liabilities ...... 185 176
----- -----
Net deferred tax asset at year-end ........ 658 566
Net deferred tax asset at beginning of year 566 554
----- -----
Deferred tax benefit for the years ended .. $ 92 12
===== =====
</TABLE>
In addition to the deferred tax amounts described above, the Company also
had a deferred tax asset of approximately $4,000 at December 31, 1998 and
a deferred tax liability of approximately $6,000 at December 31, 1997,
related to the net unrealized gains on securities available for sale.
38 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The valuation allowance for deferred tax assets as of December 31, 1998
and 1997 was $96,000. During the year ended December 31, 1996, the
valuation allowance was reduced by $396,000. This reduction was primarily
the result of the expected realization of certain deferred items which
were previously considered to be uncertain. In evaluating the valuation
allowance the Company takes into consideration the nature and timing of
the deferred tax asset items as well as the amount of available open tax
carrybacks. The Company has reserved a portion of its New York State
deferred tax asset, which is a significant component of deferred tax
assets, due to the lack of carryback and carryforward provisions
available in New York State. Any changes in the deferred tax asset
valuation allowance is based upon the Company's continuing evaluation of
the level of such allowance and the realizability of the temporary
differences creating the deferred tax asset. Based on recent historical
and anticipated future pre-tax earnings, management believes it is more
likely than not that the Company will realize its net deferred tax
assets.
As a thrift institution, the Bank is subject to special provisions in the
Federal and New York State tax laws regarding its allowable tax bad debt
deductions and related tax bad debt reserves. These deductions
historically have been determined using methods based on loss experience
or a percentage of taxable income. Tax bad debt reserves are maintained
equal to the excess of allowable deductions over actual bad debt losses
and other reserve reductions. These reserves consist of a defined
base-year amount, plus additional amounts ("excess reserves") accumulated
after the base year. SFAS No. 109 requires recognition of deferred tax
liabilities with respect to such excess reserves, as well as any portion
of the base-year amount which is expected to become taxable (or
"recaptured") in the foreseeable future.
Certain amendments to the Federal and New York State tax laws regarding
bad debt deductions were enacted in July and August 1996. The Federal
amendments include elimination of the percentage of taxable income method
for tax years beginning after December 31, 1995, and imposition of a
requirement to recapture into taxable income (over a period of
approximately six years) the bad debt reserves in excess of the base-year
amounts. The Bank previously established, and will continue to maintain,
a deferred tax liability with respect to such excess Federal reserves.
The New York State amendments redesignate the Bank's state bad debt
reserves at December 31, 1995 as the base-year amount and also provide
for future additions to the base-year reserve using the percentage of
taxable income method.
In accordance with SFAS No. 109, a deferred tax liability has not been
recognized at both December 31, 1998 and 1997 with respect to the
base-year reserve of $4.6 million, since the Bank does not expect that
this amount will become taxable in the foreseeable future. Under New York
State tax law, as amended, events that would result in taxation of this
reserve include the failure of the Bank to maintain a specified
qualifying assets ratio or meet other thrift definition tests for tax
purposes. The unrecognized deferred tax liability at both December 31,
1998 and 1997 with respect to the base-year reserve was approximately
$1.8 million.
39 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(13) Borrowings
(a) Line of Credit
The Company has an overnight line of credit and a one-month
overnight repricing line of credit with the Federal Home Loan Bank
of New York as of December 31, 1998 totaling approximately $17.4
million. The interest rate may fluctuate based on existing market
conditions and customers' demands for credit. There were no
amounts outstanding under this line of credit at December 31, 1998
or 1997.
(b) Long-Term Borrowings
The Company utilizes long-term borrowings as a source of funds for
its asset growth and asset/liability management. Collateralized
advances are available from the FHLB provided certain standards
related to creditworthiness have been met. Long-term borrowings
from the FHLB as of December 31, 1998 had a weighted average rate
of 4.98%. The Company had no long-term borrowings in 1997. The
Company has pledged mortgage loans and FHLB stock as collateral on
these borrowings. The maturity of advances as of December 31, 1998
is as follows:
Amount
-----------
(in thousands)
Due in 1999 $ 100
Due in 2000 200
Due in 2001 300
Due in 2002 -
Due in 2003 100
-----------
Total $ 700
===========
(14) Employee Benefit Plans
(a) Pension Plan
The Company's defined benefit, non-contributory, pension plan (the
"Plan") covers all full time employees meeting age and service
requirements. The benefit formula is equal to 2% of three year
average base earnings multiplied by the number of years of
credited service up to 30 years. Benefits contemplated by the Plan
are being funded under a group annuity contract with an insurance
company.
40 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table sets forth the Plan's change in benefit
obligation, the change in plan assets and reconciliation of funded
status at December 31:
<TABLE>
<CAPTION>
1998 1997
------- -------
(in thousands)
<S> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of year ...... $ 4,662 3,936
Service cost ................................. 179 171
Interest cost ................................ 284 288
Actuarial (gain)/loss ........................ (190) 331
Benefits paid ................................ (65) (64)
------- -------
Benefit obligations at end of year ...... 4,870 4,662
------- -------
Change in plan assets:
Fair value of plan assets at beginning of year 3,636 3,190
Actual return on plan assets ................. 322 295
Employer contribution ........................ 211 215
Benefits paid ................................ (65) (64)
------- -------
Fair value of plan assets at end of year 4,104 3,636
------- -------
Reconciliation of funded status:
Funded status ................................ (766) (1,026)
Unrecognized net actuarial loss .............. 488 704
Unrecognized prior service cost .............. 1 2
Unrecognized net transition asset ............ 223 246
------- -------
Accrued pension cost .................... $ (54) (74)
======= =======
</TABLE>
<PAGE>
Net pension cost for 1998, 1997 and 1996 included the following
components:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
(in thousands)
<S> <C> <C> <C>
Service cost - benefits earned during the period $ 179 171 171
Interest cost on projected benefit obligations . 285 288 265
Actual return on plan assets ................... (296) (295) (171)
Net amortization and deferral .................. 23 26 (67)
----- ----- -----
Net periodic pension cost ...................... $ 191 190 198
===== ===== =====
</TABLE>
<PAGE>
Significant assumptions used in determining pension expense of the
Plan are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Discount rate 6.50% 7.0% 7.5%
Expected long-term rate of return 8.00% 9.0% 9.0%
Compensation increase rate 5.00% 6.0% 6.0%
</TABLE>
41 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(b) Executive Supplemental Retirement Plan
The Company maintains an executive supplemental retirement plan
for key management personnel. An expense of approximately $61,000,
$72,000, and $72,000 was recorded in 1998, 1997 and 1996,
respectively.
(c) 401(k) Savings Plan
The Company maintains a defined contribution 401(k) savings plan,
covering all full time employees who have attained age 21 and have
completed one year of employment. The Company matches 50% of
employee contributions that are less than or equal to 6% of the
employee's salary. Total expense recorded during 1998, 1997 and
1996 was approximately $32,000, $27,000, and $23,000,
respectively.
(15) Stock-Based Compensation Plans
(a) Employee Stock Ownership Plan
The Company established an employee stock ownership plan (ESOP) to
provide substantially all employees of the Company the opportunity
to also become stockholders. The ESOP borrowed $1,196,000 from the
Holding Company and used the funds to purchase 119,600 shares of
the common stock of the Company issued during the Company's
initial public offering. The loan will be repaid principally from
the Bank's discretionary contributions to the ESOP over a period
of ten years. At December 31, 1998 and 1997, the loan had an
outstanding balance of $717,600 and $837,200, respectively, and an
interest rate of 7.31%. Both the loan obligation and the unearned
compensation are reduced by the amount of loan repayments made by
the ESOP. Shares purchased with the loan proceeds are held in a
suspense account for allocation among participants as the loan is
repaid. Contributions to the ESOP and shares released from the
suspense account are allocated among participants on the basis of
compensation in the year of allocation.
Unallocated ESOP shares are pledged as collateral on the loan and
are reported in stockholders' equity. As shares are released from
collateral, the Company reports compensation expense equal to the
current market price of the shares, and the shares become
outstanding for earnings per share computations. Unallocated ESOP
shares are not included in the earnings per share computations.
The Company recorded approximately $281,000, $225,000 and $158,000
of compensation expense under the ESOP in 1998, 1997 and 1996,
respectively.
<PAGE>
The ESOP shares as of December 31, 1998 were as follows:
Allocated shares 35,880
Shares released for allocation 11,960
Unallocated shares 71,760
----------
119,600
Market value of unallocated shares at ----------
December 31, 1998 $1,525,000
==========
42 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(b) Stock Option Plan
On January 16, 1996, the Company's stockholders approved the SFS
Bancorp, Inc. 1996 Stock Option and Incentive Plan (Stock Option
Plan). The primary objective of the Stock Option Plan is to
provide officers and directors with a proprietary interest in the
Company and as an incentive to encourage such persons to remain
with the Company.
Under the Stock Option Plan, 149,500 shares of authorized but
unissued stock are reserved for issuance upon option exercises.
The Company also has the alternative to fund the stock option plan
with treasury stock. Options under the plan may be either
non-qualified stock options or incentive stock options. Each
option entitles the holder to purchase one share of common stock
at an exercise price equal to the fair market value on the date of
grant. Options expire no later than ten years following the date
of grant.
In January, 1996, 133,054 options were awarded at an exercise
price of $12.63 per share; in January, 1997, 7,475 options were
awarded at an exercise price of $14.75 per share; and in October,
1997 11,212 options were awarded at an exercise price of $22.03
per share. These shares have a ten-year term and vest at a rate of
20% per year from their respective grant dates. There were no
options awarded during 1998.
A summary of the status of the Company's stock option plans as of
December 31, 1998, 1997 and 1996 and changes during the years
ended on those dates is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- --------------------- ----------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options:
Outstanding at January 1 125,579 $ 13.59 114,367 $ 12.63 - $ -
Granted - - 18,687 19.12 133,054 12.63
Exercised - - (7,475) 12.63 - -
Forfeited - - - - (18,687) -
Outstanding at year-end 125,579 13.59 125,579 13.59 114,367 12.63
Exercisable at year-end 46,496 12.63 21,379 12.63 - 12.63
Estimated weighted-average
fair value of options
granted during
the year $ 6.29 $ 4.08
====== ======
</TABLE>
43 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
SFAS No. 123 requires Companies not using a fair value based
method of accounting for employee stock options or similar plans,
to provide pro forma disclosure of net income and earnings per
share as if that method of accounting had been applied. The fair
value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1997 and 1996:
<TABLE>
<CAPTION>
October January January
1997 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Dividend yield 1.3% 1.9% 1.7%
Expected volatility 22.0% 22.0% 25.0%
Risk-free interest rate 6.0% 6.5% 5.6%
Expected life 7 years 7 years 7 years
</TABLE>
Had the Company recorded compensation cost based on the fair value
at grant date for its stock options under SFAS No. 123, the
company's consolidated net income and basic and diluted earnings
per share would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
(in thousands except per share data)
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income:
As reported $ 2,115 1,068 830
Pro forma 2,009 976 744
Basic earnings per share:
As reported 1.94 .96 .68
Pro forma 1.84 .88 .61
Diluted earnings per share:
As reported 1.83 .93 .67
Pro forma 1.74 .86 .62
</TABLE>
Because the Company's employee stock options have characteristics
significantly different from those of traded options for which the
Black-Scholes model was developed, and because changes in the
subjective input assumptions can materially affect the fair value
estimate, the existing models, in management's opinion, do not
necessarily provide a reliable single measure of the fair value of
its employee stock options.
<PAGE>
(c) Recognition and Retention Plan
On January 16, 1996, the Company's stockholders approved the SFS
Bancorp, Inc. Recognition and Retention Plan (RRP). The purpose of
the plan is to promote the long-term interests of the Company and
its shareholders by providing a stock based compensation program
to attract and retain officers and directors. Under the RRP,
59,800 shares of authorized but unissued shares are reserved for
issuance under the plan. The Company also has the alternative to
fund the RRP with treasury stock.
During 1997 and 1996, 7,475 shares and 53,222 shares,
respectively, were awarded under the RRP. There were no shares
awarded during 1998. During 1996, 7,475 shares were forfeited
under the RRP. A total of 10,047 shares, 8,552 shares and 8,691
shares vested under the RRP during 1998, 1997 and 1996,
respectively.
44 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(16) Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments"
requires the Company to disclose estimated fair values for its financial
instruments. SFAS No. 107 defined fair value of financial instruments as
the amount at which the instrument could be exchanged in a current
transaction between willing parties other than in a forced or liquidation
sale. SFAS No. 107 defines a financial instrument as cash, evidence of
ownership interest in an entity, or a contract that imposes on one entity
a contractual obligation to deliver cash or another financial instrument
to a second entity or to exchange other financial instruments on
potentially unfavorable terms with a second entity and conveys to that
second entity a contractual right to receive cash or another financial
instrument from the first entity or to exchange other financial
instruments on potentially favorable terms with the first entity.
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Company's entire
holdings of a particular financial instrument. Because no ready market
exists for a significant portion of the Company's financial instruments,
fair value estimates are based on judgments regarding future expected net
cash flows, 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- and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. Significant assets and
liabilities that are not considered financial assets or liabilities
include the deferred tax asset and office premises and equipment. In
addition, tax ramifications related to the realization of the unrealized
gains and losses, which can have a significant effect on fair value
estimates, have not have been considered in the estimates of fair value
under SFAS No. 107.
In addition there are significant intangible assets that SFAS No. 107
does not recognize, such as the value of "core deposits", the Company's
branch network and other items generally referred to as "goodwill."
45 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following tables present the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1998 and
1997:
<TABLE>
<CAPTION>
1998
-------------------------
(in thousands)
Carrying Estimated
Amount Fair Value
-------- --------
<S> <C> <C>
Financial assets:
Cash and cash equivalents ..................................... $ 3,812 3,812
Securities available for sale ................................. 16,954 16,954
Investment securities ......................................... 11,661 11,758
Stock in Federal Home Loan Bank ............................... 1,338 1,338
Loans ......................................................... 141,293 142,848
Less: allowance for loan losses .......................... 953 --
unearned discount, and deferred loan fees, net ..... 130 --
-------- --------
Net loans ............................................. 140,210 142,848
Accrued interest receivable ................................... 1,133 1,133
Financial liabilities:
Savings, now, and demand deposit accounts ..................... 57,627 57,627
Time deposit accounts ......................................... 92,951 93,936
Advance payments by borrowers for property taxes
and insurance ............................................. 1,425 1,425
Long-term borrowings .......................................... 700 694
Accrued interest on depositors accounts ....................... 6 6
<CAPTION>
1997
-------------------------
(in thousands)
Carrying Estimated
Amount Fair Value
-------- --------
<S> <C> <C>
Financial assets:
Cash and cash equivalents ..................................... $ 2,176 2,176
Securities available for sale ................................. 4,067 4,067
Investment securities ......................................... 28,979 29,095
Stock in Federal Home Loan Bank ............................... 1,338 1,338
Loans ......................................................... 134,586 135,886
Less: allowance for loan losses .......................... 778 --
unearned discount, and deferred loan fees, net ..... 22 --
-------- --------
Net loans ............................................. 133,786 135,886
Accrued interest receivable ................................... 1,130 1,130
Financial liabilities:
Savings, now, and demand deposit accounts ..................... 55,728 55,728
Time deposit accounts ......................................... 94,741 94,880
Advance payments by borrowers for property taxes
and insurance ............................................. 1,281 1,281
Accrued interest on depositors accounts ....................... 7 7
</TABLE>
46 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Financial Instruments with Carrying Amount Equal to Fair Value
--------------------------------------------------------------
The carrying amount of cash and cash equivalents, stock in Federal Home
Loan Bank, accrued interest receivable, accrued interest payable, and
advance payments by borrowers for property taxes and insurance is
considered to be equal to fair value as a result of their short-term
nature.
Securities
----------
The fair value of securities available for sale and investment securities
is estimated based on bid prices published in financial newspapers and
bid quotations received from either quotation services or securities
dealers.
Loans
-----
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as one- to
four-family, commercial real estate, consumer and commercial loans. Each
loan category is further segmented into fixed and adjustable rate
interest terms and by performing and nonperforming categories.
The fair value of performing loans is calculated by discounting scheduled
cash flows through the estimated maturity using estimated market discount
rates that reflect the credit and interest rate risk inherent in the
loan. The estimate of maturity is based on the contractual term of the
loans to maturity, adjusted for estimated prepayments.
Fair value for nonperforming loans is based on recent external appraisals
and discounting of cash flows. Estimated cash flows are discounted using
a rate commensurate with the risk associated with the estimated cash
flows. Assumptions regarding credit risk, cash flows, and discount rates
are judgmentally determined using available market information and
specific borrower information.
Deposit Liabilities
-------------------
Under SFAS No. 107, the fair value of deposits with no stated maturity,
such as noninterest-bearing demand deposits, savings deposits, NOW
deposits and money market deposits, must be stated at the amount payable
on demand as of December 31, 1998 and 1997. 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. The fair value
estimates of deposit liabilities in the foregoing table do not include
the benefit that results from the low cost funding provided by the
deposit liabilities compared to the cost of borrowing funds in the
market.
Long-Term Borrowings
--------------------
The fair value of the Company's long-term borrowings is estimated based
on the quoted market prices for the same or similar issues.
<PAGE>
Commitments to Extend Credit and Standby Letters of Credit
----------------------------------------------------------
The fair value of commitments to extend credit is estimated using the
fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed rate loan commitments,
fair value also considers the difference between current level of
interest rates and the committed rates. Based on an analysis of the
foregoing factors, the fair value of these items approximates their
carrying value at December 31, 1998 and 1997.
47 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(17) Commitments and Contingent Liabilities
(a) Off-Balance Sheet Financing and Concentrations of Credit
The Company is a party to certain financial instruments with
off-balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial instruments
are limited to commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk in excess of
the amount recognized on the statement of financial condition. The
contract amounts of these instruments reflect the extent of
involvement by the Company.
The Company's exposure to credit loss in the event of
nonperformance by the other party to the commitment to extend
credit is represented by the contractual notional amount of those
instruments. The Company uses the same credit policies in making
commitments as it does for on-balance sheet instruments.
Contract amounts of financial instruments that represent credit
risk as of December 31, 1998 and 1997 at fixed and variable
interest rates are as follows:
1998
-------------------------------------
Fixed Variable Total
------- ------- -------
(in thousands)
Financial instruments whose
contract amounts represent
credit risk:
Conventional mortgage loans ..... $ 1,823 248 2,071
Home equity ..................... -- 9,733 9,733
Commercial loans ................ 359 -- 359
Overdraft loans ................. 154 -- 154
------- ------- -------
$ 2,336 9,981 12,317
======= ======= =======
1997
-------------------------------------
Fixed Variable Total
------- ------- -------
(in thousands)
Financial instruments whose
contract amounts represent
credit risk:
Conventional mortgage loans ..... $ 921 2,296 3,217
Home equity ..................... -- 10,279 10,279
Commercial loans ................ 257 -- 257
Overdraft loans ................. 135 -- 135
------- ------- -------
$ 1,313 12,575 13,888
======= ======= =======
48 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The range of interest rates on fixed rate commitments was 6.50% to
18.00% at December 31, 1998 and 7.13% to 18.00% at December 31,
1997. The Company offers various adjustable rate mortgage (ARM)
products on 1-4 family residential dwellings. The principal
one-year ARM offered as of December 31, 1998 and 1997 has a 2.00%
annual interest rate adjustment cap, and uses the weekly average
from the one-year Treasury Constant Maturity Series, plus a margin
of 3.00%, as an index for rate adjustments. The lifetime rate
ceiling for the one-year ARM product at December 31, 1998 and 1997
was 6.00% above the initial rate. The Company also offers 3/1 and
5/1 ARM products where the rate is fixed for the first 3 and 5
years, respectively. After the initial fixed term, the mortgage
has the same characteristics as a one-year ARM. The other ARM
product offered at December 31, 1998 and 1997, was a jumbo ARM
with a lifetime ceiling of 6.00% above the initial rate. The
Company does not originate loans which provide for negative
amortization. Mortgage loan terms vary from 10 to 30 years.
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since
many of the commitments are expected to expire without being fully
drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral, if any, required by the Company upon the extension of
credit is based on management's credit evaluation of the customer.
Mortgage and construction loan commitments are secured by a first
or second lien on real estate. Typically, overdraft loans do not
require collateral.
The Company does not engage in investments in futures contracts,
forwards, swaps, option contracts or other derivative investments
with similar characteristics.
(b) Lease Commitments
The Company leases a branch facility under a noncancelable
operating lease expiring in 2006. Total expenses under this lease
for the years ended December 31, 1998, 1997 and 1996 were
approximately $52,000, $53,000, and $45,000, respectively. A
summary of the future minimum commitments required under the
noncancelable facility lease are as follows:
Years ending December 31: (in thousands)
1999 $ 52
2000 52
2001 52
2002 52
2003 52
Thereafter 151
------------
$ 411
============
49 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(18) Dividend Restrictions and Regulatory Capital Requirements
(a) Dividend Restrictions
In connection with the Company's initial public offering, the Bank
established a liquidation account for the benefit of eligible
depositors who continue to maintain their deposit accounts in the
Bank after conversion. In the unlikely event of a complete
liquidation of the Bank, each eligible depositor will be entitled
to receive a liquidation distribution from the liquidation
account, in the proportionate amount of the then current adjusted
balance for deposit accounts held, before distribution may be made
with respect to the Bank's capital stock. The Bank may not declare
or pay a cash dividend to the Holding Company on, or repurchase
any of, its capital stock if the effect thereof would cause the
retained earnings of the Bank to be reduced below the amount
required for the liquidation account. Except for such
restrictions, the existence of the liquidation account does not
restrict the use or application of retained earnings.
The Bank's capital exceeds all of the fully phased-in capital
regulatory requirements. The Office of Thrift Supervision (OTS)
regulations provide that an institution that exceeds all fully
phased-in capital requirements before and after a proposed capital
distribution could, after prior notice but without the approval by
the OTS, make capital distributions during the calendar year of up
to 100% of its net income to date during the calendar year plus
the amount that would reduce by one-half its "surplus capital
ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year. Any
additional capital distributions would require prior regulatory
approval. At December 31, 1998, the maximum amount that could have
been paid by the Bank to the Holding Company was approximately
$8.1 million.
The Holding Company's ability to pay dividends to its stockholders
is dependent on the ability of the Bank to pay dividends to the
Holding Company.
(b) Regulatory Capital Requirements
OTS regulations require savings institutions to maintain minimum
levels of regulatory capital. Under the regulations in effect at
December 31, 1998, 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%.
<PAGE>
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 an 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 considered well capitalized if it has a Tier 1 (core)
capital ratio of at least 5.0%; a Tier 1 risk-based capital ratio
of at least 6.0%; and a total risk-based capital ratio of at least
10.0%.
50 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
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 December 31, 1998, the Bank meets
all capital adequacy requirements to which it is subject. Further,
the most recent OTS notification categorized the Bank as a well
capitalized institution under the prompt corrective action
regulations. There have been no conditions or events since that
notification that management believes have changed the Bank's
capital classification.
The following is a summary of the Bank's and Company's actual
capital amounts and ratios, compared to the OTS minimum capital
adequacy requirements and the OTS requirements for classification
as a well capitalized institution, at December 31:
<TABLE>
<CAPTION>
1998
-------------------------------------------------------------------------
Minimum Capital Classification
Actual Adequacy as Well Capitalized
---------------------- --------------- -------------------
Amount Ratio Ratio Ratio
------ ----- ----- -----
<S> <C> <C> <C>
Bank
----
Tangible capital $ 20,496 11.50% 1.50% -
Tier 1 (core) capital 20,496 11.50 3.00 5.00%
Risk-based capital:
Tier 1 20,496 21.64 - 6.00
Total 21,449 22.65 8.00 10.00
<CAPTION>
Actual
----------------------
Amount Ratio
------ -----
<S> <C> <C>
Consolidated
------------
Tangible capital $ 23,604 13.25%
Tier 1 (core) capital 23,604 13.25
Risk-based capital:
Tier 1 23,604 24.93
Total 24,557 25.93
</TABLE>
51 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
1997
-------------------------------------------------------------------------
Minimum Capital Classification
Actual Adequacy as Well Capitalized
---------------------- --------------- -------------------
Amount Ratio Ratio Ratio
------ ----- ----- -----
<S> <C> <C> <C>
Bank
----
Tangible capital $ 18,977 10.88% 1.50% -
Tier 1 (core) capital 18,977 10.88 3.00 5.00
Risk-based capital:
Tier 1 18,977 20.33 - 6.00
Total 19,755 21.16 8.00 10.00
<CAPTION>
Actual
----------------------
Amount Ratio
------ -----
Consolidated
------------
Tangible capital $ 21,421 12.28%
Tier 1 (core) capital 21,421 12.28
Risk-based capital:
Tier 1 21,421 22.95
Total 22,199 23.78
</TABLE>
52 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(19) Parent Company Financial Information
SFS Bancorp, Inc. was organized to serve as the holding company for the
Bank and began operations on June 29, 1995 in conjunction with the Bank's
mutual-to-stock conversion and the Holding Company's initial public
offering of its common stock.
<TABLE>
<CAPTION>
Balance Sheets
as of December 31, 1998 and 1997
1998 1997
--------- --------
Assets (in thousands, except share data)
<S> <C> <C>
Cash and cash equivalents ........................................ $ 79 76
Loan receivable from subsidiary .................................. 3,618 2,337
Equity in net assets of subsidiary ............................... 20,502 18,987
Other assets ..................................................... -- 60
--------- --------
Total assets ............................................ $ 24,199 21,460
========= ========
Liabilities and Stockholders' Equity
Liabilities:
Other liabilities ........................................... $ 589 29
--------- --------
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 500,000
shares -
Common stock, $.01 par value, authorized 2,500,000 shares;
1,495,000 shares issued at December 31,
1998 and 1997 ........................................... 15 15
Additional paid-in capital .................................. 14,576 14,365
Retained earnings, substantially restricted ................. 14,150 12,422
Treasury stock, at cost (286,528 shares at
December 31, 1998 and 1997) ............................. (4,089) (4,089)
Common stock acquired by employee stock ownership plan (ESOP) (718) (837)
Unearned recognition and retention plan (RRP) ............... (318) (455)
Accumulated other comprehensive income ...................... (6) 10
--------- --------
Total stockholders' equity .......................... 23,610 21,431
--------- --------
Total liabilities and stockholders' equity .......... $ 24,199 21,460
========= ========
</TABLE>
53 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
Statements of Income
For the years ended December 31, 1998 and 1997
1998 1997 1996
------ ------- ------
(in thousands)
<S> <C> <C> <C>
Interest income ....................... $ 180 245 384
Interest expense ...................... -- -- --
------ ------ ------
Net interest income .............. 180 245 384
Non interest income (note 2) .......... 2,000 -- --
Noninterest expense ................... 738 115 104
------ ------ ------
Income before income taxes and
equity in undistributed
earnings of subsidiary ............. 1,442 130 280
Income tax expense .................... 576 52 112
------ ------ ------
Income before equity in
undistributed earnings of subsidiary 866 78 168
Equity in undistributed earnings
of subsidiary (for the years
ended December 31,
1998 and 1997) ..................... 1,249 990 662
------ ------ ------
Net income ............................ $2,115 1,068 830
====== ====== ======
</TABLE>
54 (Continued)
<PAGE>
SFS BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
Statements of Cash Flows
For the years ended December 31, 1998 and 1997
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ................................ $ 2,115 1,068 830
Adjustment to reconcile net
income to net cash provided
by operating activities:
Equity in undistributed
earnings of subsidiary ............ (1,249) (990) (662)
Decrease (increase) in other assets . 60 (2) (17)
Increase (decrease) in liabilities .. 608 (19) 27
Amortization of RRP ................. 137 228 38
------- ------- -------
Net cash provided by
operating activities ........ 1,671 285 216
------- ------- -------
Cash flows from investing activities:
Net (increase) decrease in
loan receivable from subsidiary ........ (1,281) 1,420 3,319
------- ------- -------
Net cash provided (used)
in investing activities ............. (1,281) 1,420 3,319
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock ................ -- (1,486) (3,418)
Cash dividends paid ....................... (387) (333) (156)
Proceeds from exercise of stock option .... -- 94 --
------- ------- -------
Net cash used from financing activities (387) (1,725) (3,574)
------- ------- -------
Net increase (decrease) in cash
and cash equivalents ...................... 3 (20) (39)
Cash and cash equivalents:
Beginning of period ....................... 76 96 135
------- ------- -------
End of period ............................. $ 79 76 96
======= ======= =======
</TABLE>
These financial statements should be read in conjunction with the
Company's consolidated financial statements and notes thereto.
55
<PAGE>
CORPORATE INFORMATION
================================================================================
Annual Meeting
The annual meeting of SFS Bancorp, Inc. will be held on April 14, 1999
at 10:00 a.m. at the Main Office of the Company at 251-263 State Street in
Schenectady, New York.
Market Information
SFS Bancorp, Inc. Common Stock is traded on the Nasdaq National System
under the symbol "SFED." SFS Bancorp, Inc. Common Stock was issued at $10.00 per
share in connection with the conversion of Schenectady Federal from mutual to
stock form on June 29, 1995. At March 5, 1999 there were approximately 276
holders of record and approximately 551 additional beneficial shareholders of
SFS Bancorp, Inc. Common Stock and 1,495,000 shares of common stock issued and
1,208,472 shares outstanding.
PRICE RANGE OF COMMON STOCK
The table below shows the range of high and low bid prices for the
Company's Common Stock. The information set forth in the table below was
provided by the Nasdaq. Such information reflects interdealer prices, without
retail mark-up, mark-down or commission and may not represent actual
transactions.
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------- --------------------------------------------
High Low High Low
<S> <C> <C> <C> <C> <C>
First Quarter $28.00 $20.75 First Quarter $18.125 $14.75
Second Quarter $26.25 $21.00 Second Quarter $17.50 $16.00
Third Quarter $29.00 $19.75 Third Quarter $23.25 $16.875
Fourth Quarter $27.25 $20.25 Fourth Quarter $28.00 $21.50
</TABLE>
During 1998, the Company declared dividends totaling $387,000 or $0.32
per share on its Common Stock. Dividend payment decisions are made with
consideration of a variety of factors including earnings, financial condition,
market considerations and regulatory restrictions. Restrictions on dividend
payments are described in Note 18 of the Notes to Consolidated Financial
Statements included in this Annual Report.
56
<PAGE>
Annual Report on Form 10-KSB and Other Investor Information
SFS Bancorp, Inc. will furnish at no charge to any stockholder a copy
of SFS Bancorp, Inc.'s Annual Report on Form 10-KSB for the year ended December
31, 1998 and the exhibits thereto required to be filed with the Securities and
Exchange Commission by writing to:
David J. Jurczynski, Chief Financial Officer
SFS Bancorp, Inc.
251-263 State Street
Schenectady, New York 12305
Transfer Agent and Registrar Independent Auditors
Registrar and Transfer Company KPMG LLP
10 Commerce Drive 515 Broadway
Cranford, NJ 07016 Albany, NY 12207
Special Counsel
Silver Freedman & Taff, L.L.P.
1100 New York Avenue, N.W.
7th Floor, East Tower
Washington, D.C. 20005
BOARD OF DIRECTORS OF SFS BANCORP, INC. AND SCHENECTADY FEDERAL SAVINGS BANK
Joseph H. Giaquinto, Chairman Gerald I. Klein
John F. Assini, M.D., Vice Chairman Robert A. Schlansker
Richard D. Ammian
OFFICERS OF SFS BANCORP, INC. AND SCHENECTADY FEDERAL SAVINGS BANK
Joseph H. Giaquinto Richard D. Ammian
President and Chief Executive Officer Senior Vice President and Secretary
David J. Jurczynski Michael Krywinski
Senior Vice President, Treasurer Vice President
and Chief Financial Officer
William Pezzula
Vice President
57
<TABLE>
<CAPTION>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
State of
Percentage of Incorporation
Parent Subsidiary Ownership or Organization
------ ---------- --------- ---------------
<S> <C> <C> <C>
SFS Bancorp, Inc. Schenectady Federal Savings Bank 100% Federal
Schenectady Federal Savings Bank SSLA Service Corp. 100% New York
</TABLE>
[LETTERHEAD KPMG LLP]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
SFS Bancorp, Inc.:
We consent to incorporation by reference in the following registration
statements of SFS Bancorp, Inc.:
No. 333-05789 on Form S-8, and
No. 333-05831 on Form S-8
of our report dated January 22, 1999, relating to the consolidated balance
sheets of SFS Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and
the related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
1998, which report appears in the December 31, 1998 Annual Report on Form 10-KSB
of SFS Bancorp, Inc.
/s/KPMG LLP
- -----------
KPMG LLP
Albany, New York
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
The Schedule contains Summary Financial information extracted from the
Annul Report on Form 10-K SB for The Fiscal Year Ended December 31, 1998 and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 1,712 1,876
<INT-BEARING-DEPOSITS> 0 0
<FED-FUNDS-SOLD> 2,100 300
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 16,954 4,067
<INVESTMENTS-CARRYING> 11,661 28,979
<INVESTMENTS-MARKET> 11,758 29,095
<LOANS> 141,163 134,564
<ALLOWANCE> 953 778
<TOTAL-ASSETS> 178,167 174,428
<DEPOSITS> 150,578 150,469
<SHORT-TERM> 0 0
<LIABILITIES-OTHER> 3,279 2,528
<LONG-TERM> 700 0
0 0
0 0
<COMMON> 15 15
<OTHER-SE> 23,595 21,416
<TOTAL-LIABILITIES-AND-EQUITY> 178,167 174,428
<INTEREST-LOAN> 10,693 9,757
<INTEREST-INVEST> 1,747 2,371
<INTEREST-OTHER> 311 240
<INTEREST-TOTAL> 12,751 12,368
<INTEREST-DEPOSIT> 6,895 6,623
<INTEREST-EXPENSE> 6,902 6,623
<INTEREST-INCOME-NET> 5,849 5,745
<LOAN-LOSSES> 120 120
<SECURITIES-GAINS> 0 56
<EXPENSE-OTHER> 4,638 4,288
<INCOME-PRETAX> 3,553 1,760
<INCOME-PRE-EXTRAORDINARY> 3,553 1,760
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 2,115 1,068
<EPS-PRIMARY> 1.94 .96
<EPS-DILUTED> 1.83 .93
<YIELD-ACTUAL> 3.40 3.46
<LOANS-NON> 725 1,328
<LOANS-PAST> 135 19
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 778 642
<CHARGE-OFFS> 45 26
<RECOVERIES> 100 42
<ALLOWANCE-CLOSE> 953 778
<ALLOWANCE-DOMESTIC> 441 477
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 512 301
</TABLE>
