-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J+mzHk5UVpa9lsoPkY+wS+XvWSdySTqcu72Nl7mIqVhxL81G60o4iRdKTZtO+mgg jf3H3XvhD1RA1rtbQN6wWQ== 0000928385-99-000323.txt : 19990212 0000928385-99-000323.hdr.sgml : 19990212 ACCESSION NUMBER: 0000928385-99-000323 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990211 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROVIDENT BANCORP INC/NY/ CENTRAL INDEX KEY: 0001070154 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 000000000 FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-25233 FILM NUMBER: 99532012 BUSINESS ADDRESS: STREET 1: 400 RELLA BLVD CITY: MONTEBELLO STATE: NY ZIP: 10901 BUSINESS PHONE: 9143698040 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from _________ to ________ Commission File Number: 0-25233 PROVIDENT BANCORP, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) Federal To be applied for ------------------------------- ------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) Number) 400 Rella Boulevard, Montebello, New York 10901 ----------------------------------------- ---------- (Address of Principal Executive Office) (Zip Code) (914) 369-8040 --------------------------------------------------- (Registrant's Telephone Number including area code) Securities Registered Pursuant to Section 12(b) of the Act: None ---- Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $0.10 per share --------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file reports) and (2) has been subject to such requirements for the past 90 days. (1) YES ___X___ NO _______ (1) YES _______ NO ___X___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B 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 amendments to this Form 10-KSB. [_] The registrant's revenues for the fiscal year ended September 30, 1998 were $51.0 million. As of January 14, 1999, there were issued and outstanding 8,280,000 shares of the Registrant's Common Stock. The aggregate value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of the Common Stock as of January 29, 1999 ($12.19) was $42.1 million. DOCUMENTS INCORPORATED BY REFERENCE None PART I ------ ITEM 1. Business - ------- -------- Provident Bancorp, Inc. Provident Bancorp, Inc. (the "Company") is a Federally-chartered corporation that was organized on January 7, 1999 at the direction of the Board of Directors of Provident Bank (the "Bank") for the purpose of acquiring all of the capital stock of the Bank upon completion of the Bank's reorganization into the mutual holding company structure. The initial public offering of common stock by the Company in connection with the reorganization was consummated on January 7, 1999, and accordingly, had not been consummated by September 30, 1998, the end of the 12-month period for which this Annual Report on Form 10-K is filed. Prior to the consummation of the reorganization and the initial stock offering, the Company had not issued any stock, had no assets and no liabilities, and had not conducted operations other than of an organizational nature. Following consummation of the reorganization and initial stock offering, the Company's only significant assets are 100% of the shares of the Bank's outstanding common stock and up to 50% of the net proceeds of the Company's initial public stock offering. The Company does not intend to employ any persons other than certain officers who are currently officers of the Bank, but will utilize the support staff of the Bank from time to time. Additional employees will be hired as appropriate to the extent the Company expands its business in the future. The directors and executive officers of the Company are set forth below. The Company's offices are located at the executive offices of the Bank at 400 Rella Boulevard, Montebello, New York. Its telephone number is (914) 369- 8040. Filed herewith as Exhibits 99.1 and 99.2 for informational purposes only are the consolidated financial statements of the Bank and its subsidiaries, and management's discussion and analysis of such consolidated financial statements, as of September 30, 1998 and 1997 and for the years ended September 30, 1998, 1997 and 1996. Directors and Executive Officers of the Company The following individuals serve as directors and executive officers of the Company:
Age at Current Name September 30, 1998 Position Director Since Term Expires - ---- ------------------ -------- -------------- ------------ Directors: William F. Helmer 64 Chairman of the Board 1974 2001 George Strayton 54 President, Chief Executive 1991 2002 Officer and Director Dennis L. Coyle 62 Vice Chairman 1984 2002 Murray L. Korn 74 Director 1966 2000 Dr. Donald T. McNelis 66 Director 1987 2000 Richard A. Nozell 64 Director 1990 2000 William R. Sichol, Jr. 58 Director 1990 2001 Wilbur C. Ward 72 Director 1990 2002 F. Gary Zeh 60 Director 1979 2001 Executive Officers who are Not Directors: Daniel G. Rothstein 51 Executive Vice President, Chief Credit Officer and Regulatory Counsel Robert J. Sansky 51 Executive Vice President and Director of Human Resources Katherine A. Dering 50 Senior Vice President and Chief Financial Officer Stephen G. Dormer 47 Senior Vice President and Director of Business Activity John F. Fitzpatrick 46 Senior Vice President and Director of Support Services
The business experience for the past five years for each of the Company's directors and executive officers is as follows: William F. Helmer has served as the Chairman of the Board of Directors of the Bank since 1994, and is the President of Helmer-Cronin Construction, Inc., a construction company. George Strayton has been employed by the Bank since 1982, and was named President and Chief Executive Officer of the Bank in 1986. Dennis L. Coyle has served as Vice Chairman of the Board of Directors of the Bank since 1994. Mr. Coyle is the owner of the Coyle Insurance Agency, the owner and President of Delco Realty and the owner of Dennis L. Coyle Rental Properties. Murray L. Korn was the Senior and Managing Partner of Korn, Rosenbaum, Phillips and Jauntig, an accounting firm, prior to his retirement in 1986. Mr. Korn also served as Chairman of the Board of Directors of the Bank from 1984 until his retirement from that position in 1994. Dr. Donald T. McNelis served as President of St. Thomas Aquinas College in Sparkill, New York from 1974 until his retirement in 1995. Richard A. Nozell is the owner of Richard Nozell Building Construction, and serves as a general building contractor. 2 William R. Sichol, Jr. is a principal of Sichol & Hicks, P.C., a private law firm. Wilbur C. Ward is currently retired. Prior to his retirement, Mr. Ward was the President of Ward Bulldozers. F. Gary Zeh is the President of Haverstraw Transit Inc., a bus contracting company, and President and Owner of Quality Bus Sales and Service. Daniel G. Rothstein has been employed by the Bank since 1983, and was named Executive Vice President of the Bank in 1989. Mr. Rothstein has served as the Bank's Chief Credit Officer and Regulatory Counsel since 1996. Robert J. Sansky has been employed by the Bank since 1985, and was named Executive Vice President in 1989. Mr. Sansky has served as the Bank's Director of Human Resources since 1995. Katherine A. Dering has served as the Bank's Chief Financial Officer since 1994. Ms. Dering previously served as the Chief Financial Officer of a community bank located in Connecticut. Stephen G. Dormer has served as Senior Vice President and Director of Business Development of the Bank since 1996, and was previously Senior Vice President and Manager of the Bank's Commercial Loan Department from 1994 until 1996. Prior to joining the Bank in 1994, Mr. Dormer was Senior Vice President of a commercial bank located in New Jersey. John F. Fitzpatrick has been employed by the Bank since 1986, and was named Senior Vice President and Director of Support Services in 1997. ITEM 2. Properties - ------- ---------- The Company conducts its business through its office at 400 Rella Boulevard, Montebello, New York 10901. ITEM 3. Legal Proceedings - ------- ----------------- The Bank is a defendant in a lawsuit, Patrick Gawrysiak a/k/a Patrick Gray ------------------------------------ v. Provident Bank, brought by a prospective purchaser of REO property, alleging - ----------------- breach of contract, negligence, consumer fraud and civil conspiracy. The plaintiff brought the lawsuit in the Superior Court of New Jersey, Bergen County Law Division, and is seeking compensatory damages of $500,000, exemplary damages of $1.0 million, "nominal" damages of $1.0 million and punitive damages of $1.0 million. Although there can be no certainty as to the outcome of this matter, management believes the claim is baseless and has retained counsel to vigorously contest the claim. The Company is not involved in any other pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which, in the aggregate, involved amounts which are believed by management to be immaterial to the financial condition and operations of the Company. ITEM 4. Submission of Matters to a Vote of Security Holders - ------- --------------------------------------------------- No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year under report. 3 PART II ITEM 5. Market for Company's Common Stock and Related Security Holder Matters - ------- --------------------------------------------------------------------- (a) The common stock of the Company is quoted on the Nasdaq National Market under the symbol "PBCP". As of September 30, 1998, the date for which this report is filed, the Company had not issued shares and there had been no trading in the common stock of the Company. (b) The effective date of the Securities Act registration statement for which use of proceeds information is being disclosed herein was November 12, 1998; the commission file number assigned to the registration statement was 333- 63593. The offering commenced on or about November 12, 1998 and continued through December 17, 1998. The offering was managed on a best efforts basis by Ryan, Beck & Co., Inc. as marketing agent. The securities registered were the common stock, par value $0.10 per share, of the Company. In the registration statement, 4,007,175 shares of such common stock were registered at an aggregate price of $40,071,750. In the Reorganization, 8,280,000 shares of common stock were issued, of which 3,864,000 shares were sold to the public, and 4,416,000 shares were issued to Provident Bancorp, MHC, the mutual holding company formed in the Reorganization. Because the effective date of the registration statement was subsequent to September 30, 1998, the ending date of the reporting period for this report, the amount of expenses incurred and the amount of net offering proceeds will be reported in the Company's next periodic report filed pursuant to section 13(a) and 15(b) of the Securities Exchange Act of 1934. However, the total expenses of the reorganization and offering are not expected to exceed $1.3 million. ITEM 6. Selected Financial Data - ------- ----------------------- None. As of September 30, 1998, the Company had not issued any stock, had no assets and no liabilities and had not conducted operations other than of an organizational nature. ITEM 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations --------------------- None. As of September 30, 1998, the Company had not issued any stock, had no assets and no liabilities and had not conducted operations other than of an organizational nature. See Exhibit 99.2 for management's discussion and analysis of the Bank's financial condition and results of operations through September 30, 1998. ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk - -------- ---------------------------------------------------------- Not applicable. Information with respect to the Bank is included in Exhibit 99.2. ITEM 8. Financial Statements and Supplementary Data - ------- ------------------------------------------- None. As of September 30, 1998, the Company had not issued any stock, had no assets and no liabilities and had not conducted operations other than of an organizational nature. See Exhibit 99.1 for the Bank's consolidated financial statements as of September 30, 1998 and 1997, and for each of the years in the three-year period ended September 30, 1998. ITEM 9. Changes in and Disagreements with Accountants on Accounting and - ------- --------------------------------------------------------------- Financial Disclosure -------------------- Not applicable. 4 PART III -------- ITEM 10. Directors and Executive Officers of the Company - -------- ----------------------------------------------- See "Business--Directors and Executive Officers of the Registrant" for information concerning the Company's directors and executive officers. ITEM 11. Executive Compensation - -------- ---------------------- No compensation has been paid by the Company to the executive officers or directors of the Company. ITEM 12. Security Ownership of Certain Beneficial Owners and Management - -------- -------------------------------------------------------------- Not applicable. ITEM 13. Certain Relationships and Related Transactions - -------- ---------------------------------------------- Not applicable. PART IV ------- ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------- ---------------------------------------------------------------- The exhibits and financial statement schedules filed as a part of this Form 10-K are as follows: (a)(3) Exhibits -------- 99.1 Consolidated Financial Statements of Provident Bank and subsidiaries as of September 30, 1998 and 1997 and for the years ended September 30, 1998, 1997 and 1996, with Independent Auditors' Report thereon. 99.2 Management's discussion and analysis of the Consolidated Financial Statements. (b) Reports on Form 8-K ------------------- The Company did not file a Current Report on Form 8-K during the fourth quarter of the fiscal year ended September 30, 1998. 5 Signatures Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Provident Bancorp, Inc. Date: February 8, 1999 By: George Strayton --------------- George Strayton President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange 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: George Strayton By: Katherine A. Dering ---------------------------------- ----------------------------------- George Strayton Katherine A. Dering President, Chief Executive Officer Senior Vice President and and Director (Principal Executive Chief Financial Officer Officer) (Principal Financial and Accounting Officer) Date: February 8, 1999 Date: February 8, 1999 By: William F. Helmer By: Dennis L. Coyle ---------------------------------- ----------------------------------- William F. Helmer Dennis L. Coyle Chairman of the Board Vice Chairman of the Board Date: February 8, 1999 Date: February 8, 1999 By: Murray L. Korn By: William R. Sichol, Jr. ---------------------------------- ----------------------------------- Murray L. Korn William R. Sichol, Jr. Director Director Date: February 8, 1999 Date: February 8, 1999 By: Donald T. McNelis By: Wilbur C. Ward ---------------------------------- ----------------------------------- Donald T. McNelis Wilbur C. Ward Director Director Date: February 8, 1999 Date: February 8, 1999 By: Richard A. Nozell By: F. Gary Zeh ---------------------------------- ----------------------------------- Richard A. Nozell F. Gary Zeh Director Director Date: February 8, 1999 Date: February 8, 1999 6 EX-27 2 EXHIBIT 27
9 1,000 YEAR SEP-30-1998 SEP-30-1998 7,600 0 0 0 98,000 98,400 99,700 468,600 4,900 691,100 573,200 49,900 6,900 0 0 0 0 55,200 691,100 35,000 12,900 0 47,900 19,200 20,900 27,100 1,700 25,300 21,800 6,600 6,600 0 0 4,200 0 0 7.57 6,100 0 0 0 3,800 700 100 4,900 4,900 0 0
EX-99.1 3 EXHIBIT 99.1 Exhibit 99.1 PROVIDENT BANK Consolidated Financial Statements September 30, 1998, 1997 and 1996 [PEAT MARWICK LLP LETTERHEAD APPEARS HERE] Independent Auditors' Report The Board of Directors Provident Bank: We have audited the accompanying consolidated statements of financial condition of Provident Bank and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of income, changes in equity, and cash flows for each of the years in the three-year period ended September 30, 1998. These consolidated financial statements are the responsibility of the Bank'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 Provident Bank and subsidiaries as of September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1998 in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP November 25, 1998 PROVIDENT BANK Consolidated Statements of Financial Condition September 30, 1998 and 1997 (In thousands)
1998 1997 -------- -------- Assets Cash and due from banks $ 7,572 $ 9,191 Investment securities (Note 2): Held to maturity, at amortized cost (fair value of $19,262 in 1998 and $22,091 in 1997) 19,176 22,195 Available for sale, at fair value (amortized cost of $47,163 in 1998 and $48,290 in 1997) 48,071 48,517 --------- --------- Total investment securities 67,247 70,712 --------- --------- Mortgage-backed securities (Note 3): Held to maturity, at amortized cost (fair value of $80,410 in 1998 and $104,624 in 1997) 79,226 104,071 Available for sale, at fair value (amortized cost of $49,303 in 1998 and $35,785 in 1997) 49,912 36,153 --------- --------- Total mortgage-backed securities 129,138 140,224 --------- --------- Loans receivable, net of allowance for loan losses of $4,906 in 1998 and $3,779 in 1997 (Note 4) 463,667 404,497 Accrued interest receivable, net (Note 5) 4,087 4,262 Federal Home Loan Bank stock, at cost (Note 9) 3,690 3,641 Premises and equipment, net (Note 6) 7,058 7,047 Real estate owned, net (Note 7) 366 186 Deferred income taxes (Note 10) 2,477 1,783 Other assets (Note 8) 5,766 7,199 --------- --------- Total assets $ 691,068 $ 648,742 ========= ========= Liabilities and Equity Liabilities: Deposits (Note 8) $ 573,174 $ 546,846 Borrowings (Note 9) 38,646 24,000 Bank overdraft 11,285 17,623 Mortgage escrow funds (Note 4) 5,887 4,559 Other liabilities 6,876 5,315 --------- --------- Total liabilities 635,868 598,343 --------- --------- Commitments and contingencies (Notes 13 and 14) Equity (Note 11): Retained earnings 54,291 50,049 Net unrealized gain on securities available for sale, net of income taxes of $608 in 1998 and $245 in 1997 909 350 --------- --------- Total equity 55,200 50,399 --------- --------- Total liabilities and equity $ 691,068 $ 648,742 ========= =========
See accompanying notes to consolidated financial statements. 2 PROVIDENT BANK Consolidated Statements of Income Years ended September 30, 1998, 1997 and 1996 (In thousands)
1998 1997 1996 ------------ ---------- ------------ Interest and dividend income: Interest and fees on loans $ 35,032 $ 32,544 $ 29,210 Interest on mortgage-backed securities 8,822 9,398 9,008 Interest and dividends on investment securities and other earning assets 4,094 4,613 4,348 -------- -------- -------- Total interest and dividend income 47,948 46,555 42,566 -------- -------- -------- Interest expense: Deposits (Note 8) 19,155 18,692 17,113 Borrowings 1,725 1,487 1,472 -------- -------- -------- Total interest expense 20,880 20,179 18,585 -------- -------- -------- Net interest income 27,068 26,376 23,981 Provision for loan losses (Note 4) 1,737 1,058 911 -------- -------- -------- Net interest income after provision for loan loss 25,331 25,318 23,070 -------- -------- -------- Non-interest income: Loan servicing 579 583 648 Banking service fees and other income 2,501 2,128 1,803 -------- -------- -------- Total non-interest income 3,080 2,711 2,451 -------- -------- -------- Non-interest expense: Compensation and employee benefits (Note 12) 10,506 9,915 9,063 Occupancy and office operations (Notes 6 and 13) 3,141 3,167 2,936 Advertising and promotion 1,146 1,038 1,251 Federal deposit insurance costs, including a special assessment of $3,298 in 1996 (Note 11) 319 409 4,373 Data processing 845 580 573 Foreclosed real estate expense (income), net (Note 77 (40) 441 Amortization of branch purchase premiums (Note 8) 1,630 1,506 691 Other 4,159 4,027 3,406 ------- ------- ------- Total non-interest expense 21,823 20,602 22,734 ------- ------- ------- Income before income tax expense 6,588 7,427 2,787 Income tax expense (Note 10) 2,346 2,829 690 ------- ------- ------- Net income $ 4,242 $ 4,598 $ 2,097 ======== ======== ========
See accompanying notes to consolidated financial statements. 3 PROVIDENT BANK Consolidated Statements of Changes in Equity Years ended September 30, 1998, 1997 and 1996 (In thousands)
Net Unrealized Retained Gain on Total Earnings Securities Equity ------------ ---------- ------------ Balance at September 30, 1995 $ 43,354 $ 474 $ 43,828 Net income for the year 2,097 -- 2,097 Decrease in net unrealized gain on securities available for sale, net of income taxes of $271 -- (389) (389) -------- ------ -------- Balance at September 30, 1996 45,451 85 45,536 Net income for the year 4,598 -- 4,598 Increase in net unrealized gain on securities available for sale, net of income taxes of $185 -- 265 265 -------- ------ -------- Balance at September 30, 1997 50,049 350 50,399 Net income for the year 4,242 -- 4,242 Increase in net unrealized gain on securities available for sale, net of income taxes of $363 -- 559 559 ======== ====== ======== Balance at September 30, 1998 $ 54,291 $ 909 $ 55,200 ======== ====== ========
See accompanying notes to consolidated financial statements. 4 PROVIDENT BANK Consolidated Statements of Cash Flows Years ended September 30, 1998, 1997 and 1996 (In thousands)
1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 4,242 $ 4,598 $ 2,097 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization of premiums and discounts on securities 250 177 184 Depreciation and amortization of premises and equipment 1,390 1,462 1,297 Provision for loan losses 1,737 1,058 911 Amortization of branch purchase premiums 1,630 1,506 691 Originations of loans held for sale (20,402) (197) (433) Proceeds from sales of loans held for sale 17,163 197 433 Deferred income tax (benefit) expense (1,057) 496 (2,551) Net changes in accrued interest receivable and payable 675 (245) 13 Net increase (decrease) in other liabilities 1,061 (2,881) 4,947 Other adjustments, net (402) (175) (790) --------- --------- --------- Net cash provided by operating activities 6,287 5,996 6,799 --------- --------- --------- Cash flows from investing activities: Purchases of securities: Investment securities held to maturity (2,977) (4,999) (13,277) Investment securities available for sale (20,012) (8,204) (29,122) Mortgage-backed securities held to maturity (12,398) (10,071) (56,666) Mortgage-backed securities available for sale (23,108) (2,000) (15,604) Proceeds from maturities, calls and principal payments: Investment securities held to maturity 6,043 5,012 29,021 Investment securities available for sale 15,000 7,000 3,000 Mortgage-backed securities held to maturity 37,034 18,667 17,933 Mortgage-backed securities available for sale 9,645 7,730 10,517 Proceeds from sales of investment securities available for sale 6,007 -- -- Loan originations, net of principal repayments (58,105) (36,829) (39,814) Branch purchase premiums paid -- -- (7,532) Purchases of Federal Home Loan Bank stock (49) (430) (242) Proceeds from sales of real estate owned 451 2,029 200 Purchases of premises and equipment (1,565) (1,260) (3,775) Proceeds from sales of premises and equipment 164 292 192 --------- --------- --------- Net cash used in investing activities (43,870) (23,063) (105,169) --------- --------- ---------
(Continued) 5 PROVIDENT BANK Consolidated Statements of Cash Flows Years ended September 30, 1998, 1997 and 1996 (In thousands)
1998 1997 1996 ----------- ------------ ----------- Cash flows from financing activities: Net increase in deposits, including an increase of $104,477 in 1996 from branch purchases $ 26,328 $ 1,560 $ 101,619 Net increase (decrease) in borrowings 14,646 11,000 (900) Net (decrease) increase in bank overdraft (6,338) 466 1,970 Net increase (decrease) in mortgage escrow funds 1,328 (437) (1,497) --------- --------- --------- Net cash provided by financing activities 35,964 12,589 101,192 --------- --------- --------- Net (decrease) increase in cash and cash equivalents (1,619) (4,478) 2,822 Cash and cash equivalents at beginning of year 9,191 13,669 10,847 -------- --------- --------- Cash and cash equivalents at end of year $ 7,572 $ 9,191 13,669 ======== ========= ========= Supplemental information: Interest paid $ 20,380 $ 20,100 $ 18,758 Income taxes paid 3,539 1,808 3,140 Non-cash investing activities: Transfers of loans receivable to real estate owned 597 715 1,362 Transfer of mortgage-backed securities from held to maturity to available for sale -- -- 6,519 ======== ========= =========
See accompanying notes to consolidated financial statements. 6 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (1) Summary of Significant Accounting Policies Provident Bank (the "Bank") is a community bank that offers financial services to individuals and businesses primarily in Rockland County, New York and its contiguous communities. The Bank's principal business is accepting deposits and, together with funds generated from operations and borrowings, investing in various types of loans and securities. The Bank's deposits are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") and, as a federally-chartered savings bank, its primary regulator is the Office of Thrift Supervision ("OTS"). As discussed in Note 18, the Bank's Board of Directors has adopted a Plan of Reorganization and Stock Issuance Plan pursuant to which the Bank will convert from mutual to stock form of ownership under a two-tier mutual holding company structure and shares of common stock will be sold in an initial public offering. Basis of Financial Statement Presentation The consolidated financial statements include the accounts of the Bank and its wholly-owned subsidiaries -- Provest Services Corp. I which became active in fiscal 1996 and invests in a low-income housing partnership, and Provest Services Corp. II which became active in fiscal 1997 and has engaged a third-party provider to sell mutual funds and annuities to the Bank's customers. Financial statement amounts for these subsidiaries have been insignificant. Intercompany transactions and balances are eliminated in consolidation. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense. A material estimate that is particularly susceptible to near- term change is the allowance for loan losses, which is discussed below. For purposes of reporting cash flows, cash equivalents consist of overnight Federal funds sold (if any). Securities Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," requires entities to classify securities among three categories -- held to maturity, trading, and available for sale. Management determines the appropriate classification of the Bank's securities at the time of purchase. Held-to-maturity securities are limited to those debt securities for which management has the intent and the Bank has the ability to hold to maturity. These securities are reported at amortized cost. (Continued) 7 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Trading securities are those debt and equity securities bought and held principally for the purpose of selling them in the near term. These securities are reported at fair value, with unrealized gains and losses included in earnings. The Bank does not engage in security trading activities. All other debt and equity securities are classified as available for sale. These securities are reported at fair value, with unrealized gains and losses (net of the related income tax effect) excluded from earnings and reported in a separate component of equity. Available-for-sale securities include securities that management intends to hold for an indefinite period of time, such as securities to be used as part of the Bank's asset/liability management strategy or securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase capital, or similar factors. Federal Home Loan Bank stock is a non-marketable security held in accordance with regulatory requirements and, accordingly, is carried at cost. Premiums and discounts on debt securities are recognized in interest income on a level-yield basis over the period to maturity. The cost of securities sold is determined using the specific identification method. Unrealized losses are charged to earnings when the decline in fair value of a security is judged to be other than temporary. Loans and Allowance for Loan Losses Loans, other than those classified as held for sale, are carried at amortized cost less the allowance for loan losses. Mortgage loans originated and held for sale in the secondary market are carried at the lower of aggregate cost or estimated market value. Market value is estimated based on outstanding investor commitments or, in the absence of such commitments, based on current investor yield requirements. Net unrealized losses, if any, are recognized in a valuation allowance by a charge to earnings. In accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures," the Bank considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all principal and interest due according to the contractual terms of the loan. SFAS No. 114 permits creditors to measure and report impaired loans based on one of three approaches -- the present value of expected future cash flows discounted at the loan's effective interest rate; the loan's observable market price; or the fair value of the collateral if the loan is collateral dependent. If the approach used results in a measurement that is less than the recorded investment in an impaired loan, an impairment loss is recognized as part of the allowance for loan losses. SFAS No. 118 allows creditors to continue to use existing methods for recognizing interest income on impaired loans. The adoption of these statements did not affect the Bank's overall allowance for loan losses or income recognition policies. (Continued) 8 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The allowance for loan losses is established through provisions for losses charged to earnings. Loan losses are charged against the allowance when management believes that the collection of principal is unlikely. Recoveries of loans previously charged-off are credited to the allowance when realized. The allowance for loan losses is an amount that management believes will be adequate to absorb probable losses on existing loans that may become uncollectible, based on evaluations of the collectibility of the loans. Management's evaluations, which are subject to periodic review by the Bank's regulators, take into consideration such factors as the Bank's past loan loss experience, changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and collateral values, and current economic conditions that may affect the borrowers' ability to pay. Future adjustments to the allowance for loan losses may be necessary based on changes in economic and real estate market conditions, further information obtained regarding known problem loans, regulatory examinations, the identification of additional problem loans, and other factors. Interest and Fees on Loans A loan is placed on non-accrual status when management has determined that the borrower may be unable to meet contractual principal or interest obligations, or when interest and principal is 90 days or more past due. Accrual of interest ceases and, in general, uncollected past due interest (including interest applicable to prior years, if any) is reversed and charged against current income. Interest payments received on non-accrual loans (including impaired loans under SFAS No. 114, as amended by SFAS No. 118) are not recognized as income unless warranted based on the borrower's financial condition and payment record. Interest on loans that have been restructured is accrued in accordance with the renegotiated terms. The Bank defers non-refundable loan origination and commitment fees and certain direct loan origination costs, and amortizes the net amount as an adjustment of the yield over the contractual term of the loan. If a loan is prepaid or sold, the net deferred amount is recognized in income at that time. Real Estate Owned Real estate properties acquired through loan foreclosure are recorded initially at estimated fair value less expected sales costs, with any resulting writedown charged against the allowance for loan losses. Subsequent valuations are periodically performed by management, and the carrying value of a real estate owned property is adjusted by a charge to expense to reflect any subsequent declines in estimated fair value. Fair value estimates are based on recent appraisals and other available information. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized. Gains and losses on sales of real estate owned are recognized upon disposition. (Continued) 9 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Premises and Equipment Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets ranging from 3 to 40 years. Leasehold improvements are amortized on a straight-line basis over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized. Branch Purchase Premiums Premiums attributable to the acquisition of core deposits in branch purchase transactions are amortized using the straight-line method over periods not exceeding the estimated average remaining life of the acquired customer base (initial five-year periods for the Bank's 1996 branch purchases). The weighted average remaining amortization period for these premiums was approximately 2.2 years at September 30, 1998. The unamortized premiums are reviewed for impairment if events or changes in circumstances indicate that the carrying amount may not be fully recoverable. Transfers and Servicing of Financial Assets SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," establishes financial reporting standards for a broad range of transactions including sales of loans with servicing retained, loan securitizations, loan participations, repurchase agreements, securities lending and in-substance defeasances of debt. Among other things, the standard requires recognition of servicing rights as an asset when loans are sold with servicing retained. SFAS No. 125 is generally effective for transactions entered into on or after January 1, 1997 and superseded SFAS No. 122, "Accounting for Mortgage Servicing Rights," which became effective for the Bank on October 1, 1996. In accordance with these standards, the Bank recognizes mortgage servicing rights as an asset when loans are sold with servicing retained, by allocating the cost of an originated mortgage loan between the loan and the servicing right based on estimated relative fair values. The cost allocated to the servicing right is capitalized as a separate asset which is amortized thereafter in proportion to, and over the period of, estimated net servicing income. Asset recognition of servicing rights on sales of originated loans was not permitted under previous accounting standards. Capitalized mortgage servicing rights are assessed for impairment based on the fair value of those rights, and any impairment loss is recognized in a valuation allowance by charges to income. SFAS No. 125 has not had a significant impact on the Bank's consolidated financial statements through September 30, 1998. (Continued) 10 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Income Taxes In accordance with SFAS No. 109, "Accounting for Income Taxes", deferred taxes are recognized for the estimated future tax effects attributable to "temporary differences" between the financial statement carrying amounts and the tax bases of existing assets and liabilities. A deferred tax liability is recognized for all temporary differences that will result in future taxable income. A deferred tax asset is recognized for all temporary differences that will result in future tax deductions, subject to reduction of the asset by a valuation allowance in certain circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management's judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax laws or rates is recognized in income tax expense in the period that includes the enactment date of the change. Interest Rate Cap Agreements The Bank uses the accrual method of accounting for interest rate cap agreements entered into for interest rate risk management purposes. Interest payments (if any) due from the counterparties are recognized in the consolidated statements of income as an adjustment to interest income or expense on the assets or liabilities designated in the Bank's interest rate risk management strategy. Premiums paid by the Bank at inception of the agreements are included in other assets and amortized on a straight-line basis as an adjustment to interest income or expense over the term of the agreements. (Continued) 11 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (2) Investment Securities The following are summaries of investment securities at September 30, 1998 and 1997:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ----------- --------- September 30, 1998 - ------------------ Securities Held to Maturity U.S. Government and Agency securities due: Within one year $ 9,486 $ 23 $ -- $ 9,509 After one year, but within five years 8,983 63 -- 9,046 Municipal and other securities 707 -- -- 707 --------- -------- -------- -------- 19,176 86 -- 19,262 --------- -------- -------- -------- Securities Available for Sale U.S. Government and Agency securities due: Within one year 10,017 41 -- 10,058 After one year, but within five years 33,130 637 -- 33,767 Corporate debt securities 1,999 -- (2) 1,997 Equity securities 2,017 242 (10) 2,249 --------- -------- -------- -------- 47,163 920 (12) 48,071 --------- -------- -------- -------- Total investment securities $ 66,339 $ 1,006 $ (12) $ 67,333 ========= ======== ======== ======== September 30, 1997 - ------------------ Securities Held to Maturity U.S. Government and Agency securities due: Within one year $ 1,025 $ 2 $ -- $ 1,027 After one year, but within five years 20,448 1 (106) 20,343 Municipal and other securities 722 -- (1) 721 --------- -------- -------- -------- 22,195 3 (107) 22,091 --------- -------- -------- -------- Securities Available for Sale U.S. Government and Agency securities due: Within one year 16,028 49 -- 16,077 After one year, but within five years 27,238 128 (108) 27,258 Corporate debt securities 3,007 1 (3) 3,005 Equity securities 2,017 182 (22) 2,177 --------- -------- -------- -------- 48,290 360 (133) 48,517 --------- -------- -------- -------- Total investment securities $ 70,485 $ 363 $ (240) $ 70,608 ========= ======== ======== ========
(Continued) 12 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Equity securities available for sale at September 30, 1998 and 1997 consist of Freddie Mac and Fannie Mae preferred stock. The following is an analysis, by type of interest rate, of the amortized cost and weighted average yield of the debt securities in the Bank's investment securities portfolio:
Fixed Adjustable Rate Rate Total ------- ------- ------ September 30, 1998 Amortized cost $61,800 $2,522 $64,322 Weighted average yield 5.81% 4.46% 5.76% September 30, 1997 Amortized cost $65,950 $2,518 $68,468 Weighted average yield 6.08% 5.65% 6.06%
Proceeds from sales of investment securities available for sale were $6,007 in the year ended September 30, 1998, resulting in gross realized gains of $10 which are included in other non-interest income. There were no sales of investment securities in the years ended September 30, 1997 and 1996. U.S. Government securities with a carrying value of $2,240 and $1,350 were pledged as collateral for public deposits and other purposes at September 30, 1998 and 1997, respectively. (3) Mortgage-Backed Securities The Bank's mortgage-backed securities are principally Freddie Mac participation certificates, and pass-through certificates guaranteed by Fannie Mae or Ginnie Mae. Certain Freddie Mac and Fannie Mae collateralized mortgage obligations are also held in the portfolio. The Bank's other mortgage-backed securities are primarily Small Business Administration participation certificates. Mortgage-backed securities are collateralized by one- to four-family residential loans which contractually may be prepaid. (Continued) 13 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The following are summaries of mortgage-backed securities at September 30, 1998 and 1997:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------- ------- ------- ---------- September 30, 1998 - ------------------ Securities Held to Maturity Freddie Mac $ 36,048 $ 724 $ -- $ 36,772 Fannie Mae 34,496 304 (27) 34,773 Ginnie Mae 6,511 90 -- 6,601 Other 2,171 93 -- 2,264 -------- ------- ------- -------- 79,226 1,211 (27) 80,410 -------- ------- ------- -------- Securities Available for Sale Freddie Mac 19,792 341 (30) 20,103 Fannie Mae 26,344 280 -- 26,624 Other 3,167 18 -- 3,185 -------- ------- ------- -------- 49,303 639 (30) 49,912 -------- ------- ------- -------- Total mortgage-backed securities $128,529 $ 1,850 $ (57) $130,322 ======== ======= ======= ======== September 30, 1997 - ------------------ Securities Held to Maturity Freddie Mac $ 55,950 $ 436 $ (59) $ 56,327 Fannie Mae 37,928 121 (148) 37,901 Ginnie Mae 7,971 143 -- 8,114 Other 2,222 60 -- 2,282 -------- ------- ------- ------- 104,071 760 (207) 104,624 -------- ------- ------- ------- Securities Available for Sale Freddie Mac 10,289 224 (5) 10,508 Fannie Mae 20,912 219 (53) 21,078 Other 4,584 -- (17) 4,567 35,785 443 (75) 36,153 -------- ------- ------- ------- Total mortgage-backed securities $139,856 $ 1,203 $ (282) $140,777 ======== ======= ======= ========
(Continued) 14 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The following is an analysis, by type of interest rate, of the amortized cost portfolio:
Fixed Adjustable Rate Rate Total -------- ---------- --------- September 30, 1998 Amortized cost $88,349 $40,180 $128,529 Weighted average yield 6.53% 6.54% 6.53% September 30, 1997 Amortized cost $86,702 $53,154 $139,856 Weighted average yield 6.65% 6.66% 6.65%
In November 1995, the Financial Accounting Standards Board ("FASB") issued a special report concerning SFAS No. 115 which provided an opportunity to reclassify debt securities from the held-to-maturity category to the available- for-sale category prior to December 31, 1995, without calling into question the intent to hold other debt securities to maturity. On December 19, 1995, the Bank reclassified mortgage-backed securities with an amortized cost of $6,519 and a fair value of $6,582 from the held-to-maturity category to the available-for- sale category. An after-tax net unrealized gain of $37 was recorded as an increase in equity at the time of transfer. There were no sales of mortgage-backed securities in the years ended September 30, 1998, 1997 and 1996. (Continued) 15 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (4) Loans Receivable Loans receivable are summarized as follows at September 30:
1998 1997 -------- -------- First mortgage loans: One- to four-family residential: Fixed rate $207,939 $158,596 Adjustable rate 82,289 83,299 Multi-family residential 7,007 7,358 Commercial real estate 64,853 55,747 Construction and land 27,271 31,740 -------- -------- 389,359 336,740 -------- -------- Other loans: Home equity lines of credit 26,216 31,456 Homeowner loans 26,658 18,678 Other consumer loans 8,918 10,670 Commercial business loans 27,081 21,651 -------- -------- 88,873 82,455 -------- -------- Total loans receivable 478,232 419,195 Loans in process (10,500) (11,424) Allowance for loan losses (4,906) (3,779) Deferred loan origination costs, net 841 505 -------- -------- Total loans receivable, net $463,667 $404,497 ======== -=======
The Bank originates mortgage loans secured by existing one- to four-family residential properties. The Bank also originates multi-family and commercial real estate loans, construction and land loans, consumer loans and commercial business loans. A substantial portion of the loan portfolio is secured by residential and commercial real estate located in Rockland County, New York. The ability of the Bank's borrowers to make principal and interest payments is dependent upon, among other things, the level of overall economic activity and the real estate market conditions prevailing within the Bank's concentrated lending area. The Bank originated commercial real estate loans and construction and land loans totaling $ 33,267, $23,884 and $32,371 in the years ended September 30, 1998, 1997 and 1996, respectively. These loans are considered by management to be of somewhat greater credit risk than loans to fund the (Continued) 16 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) purchase of a primary residence due to the generally larger loan amounts and dependency on income production or sale of the real estate. Substantially all of these loans are collateralized by real estate located in the Bank's primary market area. The principal balances of non-accrual loans were as follows at September 30:
1998 1997 ------ ------ First mortgage loans: One- to four-family $2,965 $2,549 Construction and land 1,256 276 Commercial real estate 871 1,375 Consumer loans 647 234 Commercial business loans 368 243 ------ ------ Total non-accrual loans $6,107 $4,677 ====== ======
The allowance for uncollected interest, representing the amount of interest on non-accrual loans that has not been recognized in interest income, was $531 and $433 at September 30, 1998 and 1997, respectively. Gross interest income that would have been recorded, if the non-accrual loans at September 30, 1998 and 1997 had remained on accrual status throughout the period, amounted to $698 in fiscal 1998 and $411 in fiscal 1997. Interest income actually recognized on such loans totaled $310 and $147 for the years ended September 30, 1998 and 1997, respectively. SFAS No. 114, as amended by SFAS No. 118, applies to loans that are individually evaluated for collectibility in accordance with the Bank's ongoing loan review procedures (principally commercial real estate loans, construction and land loans, and commercial business loans). The standard does not generally apply to smaller-balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and consumer loans. The Bank's recorded investment in impaired loans, as defined by SFAS No. 114, is summarized as follows at September 30:
1998 1997 ------ ------ Loans with an allowance for loan impairment under SFAS No. 114 of $168 in 1997 $ -- $ 615 Loans for which an allowance for loan impairment was not required 2,495 1,279 ------ ------ Total impaired loans $2,495 $1,894 ====== ======
(Continued) 17 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Substantially of all of these impaired loans were collateral-dependent loans measured based on the fair value of the collateral in accordance with SFAS No. 114. The Bank determines the need for an allowance for loan impairment under SFAS No. 114 on a loan-by-loan basis. The Bank's recorded investment in impaired loans averaged $2,909, $2,210 and $3,663 in the years ended September 30, 1998, 1997 and 1996, respectively. Activity in the allowance for loan losses is summarized as follows for the years ended September 30:
1998 1997 1996 ------ ------ ------- Balance at beginning of year $3,779 $3,357 $ 3,472 Provision for losses 1,737 1,058 911 Charge-offs (665) (759) (1,076) Recoveries 55 123 50 ------ ------ ------- Balance at end of year $4,906 $3,779 $ 3,357 ====== ====== =======
Certain residential mortgage loans originated by the Bank are sold in the secondary market. Other non-interest income for the year ended September 30, 1998 includes a net gain of $170 on sales of residential mortgage loans held for sale (net gains in fiscal 1997 and 1996 were insignificant). Fixed-rate residential mortgage loans include loans held for sale with a carrying value of $3,885 at September 30, 1998 and $486 at September 30, 1997, which approximated market value at those dates. Other assets at September 30, 1998 include capitalized mortgage servicing rights with an amortized cost of $157, which approximated fair value. The Bank generally retains the servicing rights on loans sold. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and, if necessary, processing foreclosures. Loans serviced for others totaled approximately $120,700, $127,600 and $143,000 at September 30, 1998, 1997 and 1996, respectively. These amounts include loans sold with recourse ($2,700 at September 30, 1998) for which management does not expect the Bank to incur any significant losses. Loan servicing income includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. Mortgage escrow funds include amounts held in connection with loans serviced for others of $2,017 and $1,873 at September 30, 1998 and 1997, respectively. (Continued) 18 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (5) Accrued Interest Receivable The components of accrued interest receivable were as follows at September 30:
1998 1997 ------ ------ Loans receivable $3,023 $2,933 Allowance for uncollected interest (531) (433) ------ ------ 2,492 2,500 Investment securities 794 868 Mortgage-backed securities 801 894 ------ ------ Total accrued interest receivable, net $4,087 $4,262 ====== ======
(6) Premises and Equipment Premises and equipment are summarized as follows at September 30:
1998 1997 ------- ------- Land and land improvements $ 1,088 $ 1,082 Buildings 3,504 3,348 Leasehold improvements 2,809 2,642 Furniture and fixtures 6,733 5,820 ------- ------- 14,134 12,892 Accumulated depreciation and amortization (7,076) (5,845) ------- ------- Total premises and equipment, net $ 7,058 $ 7,047 ======= =======
Depreciation and amortization expense, which is included in occupancy and office operations expense, amounted to $1,390, $1,462 and $1,297 in the years ended September 30, 1998, 1997 and 1996, respectively. (Continued) 19 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (7) Real Estate Owned Real estate owned consisted of the following at September 30:
1998 1997 ------ ------ One- to four-family properties $ 92 $ 212 Commercial properties 274 -- Allowance for losses -- (26) ----- ----- Real estate owned, net $ 366 $ 186 ===== =====
Activity in the allowance for losses on real estate owned is summarized as follows for the years ended September 30:
1998 1997 1996 ----- ----- ----- Balance at beginning of year $ 26 $ 50 $ -- Provision for losses -- 75 64 Losses charged to allowance (26) (99) (14) ----- ----- ----- Balance at end of year $ -- $ 26 $ 50 ===== ===== =====
Foreclosed real estate expense (income) consisted of the following for the years ended September 30:
1998 1997 1996 ------ ------ ------ Holding costs $ 111 $ 164 $ 382 Provision for losses -- 75 64 Income from operations -- (11) (4) Net gain on sales of properties (34) (268) (1) ------ ------ ------ Expense (income), net $ 77 $ (40) $ 441 ====== ====== =====
(Continued) 20 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (8) Deposits Deposit accounts and weighted average interest rates are summarized as follows at September 30:
1998 1997 ------------------- -------------------- Amount Rate Amount Rate --------- ------ ---------- ------ Demand deposits $ 50,330 --% $ 49,221 --% NOW deposits 41,738 1.22 32,985 1.25 Savings deposits 155,934 1.99 153,171 2.25 Money market deposits 76,010 2.65 75,339 2.96 Certificates of deposit 249,162 5.15 236,130 5.31 --------- ----- ---------- ----- Total deposits $ 573,174 3.22% $ 546,846 3.40% ========= ===== ========== =====
Certificates of deposit at September 30 had remaining periods to contractual maturity as follows:
1998 1997 ---------- ---------- Remaining period to maturity: Less than one year $ 200,037 $ 185,557 One to two years 37,675 24,075 Two to three years 6,438 19,086 Over three years 5,012 7,412 ---------- ---------- Total certificates of deposit $ 249,162 $ 236,130 ========== ==========
Certificate of deposit accounts with a denomination of $100 or more totaled $27,430 and $25,137 at September 30, 1998 and 1997, respectively. The FDIC generally insures depositor accounts up to $100, as defined in the applicable regulations. The Bank purchased two branch offices in separate transactions consummated in March and May 1996. In these transactions, the Bank assumed deposit liabilities of $104,477; received cash of $96,165 and other assets of $780; and recorded a core deposit purchase premium of $7,532. Premium amortization charged to expense amounted to $1,630, $1,506 and $691 in the years ended September 30, 1998, 1997 and 1996, respectively. Unamortized premiums of $3,665 and $5,280 are included in other assets at September 30, 1998 and 1997, respectively. (Continued) 21 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Interest expense on deposits is summarized as follows for the years ended September 30:
1998 1997 1996 ----------- ----------- ----------- Savings deposits $ 3,485 $ 3,670 $ 3,592 Money market and NOW deposits 2,899 2,675 2,480 Certificates of deposit 12,771 12,347 11,041 ----------- ----------- ----------- Total interest expense $ 19,155 $ 18,692 $ 17,113 =========== =========== ===========
(9) Borrowings The Bank's borrowings at September 30 consist of Federal Home Loan Bank ("FHLB") advances with weighted average interest rates and remaining periods to maturity as follows:
1998 1997 ---------------------- --------------------- Amount Rate Amount Rate ----------- ------ ---------- ------ Remaining period to maturity: Less than one year $ 8,000 6.00% $ -- -- % One to two years 10,000 6.20 11,000 7.16 Two to three years 5,000 6.35 3,000 6.58 Three to four years 4,750 5.20 5,000 6.12 Four to five years 10,896 5.91 5,000 6.28 ----------- ----- ---------- ------ Total borrowings $ 38,646 5.97% $ 24,000 6.69% =========== ===== ========== ======
As a member of the FHLB of New York, the Bank may have outstanding FHLB borrowings of up to 30% of its total assets, or approximately $207,300 at September 30, 1998, in a combination of term advances and overnight funds. The Bank's unused FHLB borrowing capacity was approximately $168,600 at September 30, 1998. Borrowings are secured by the Bank's investment in FHLB stock and by a blanket security agreement. This agreement requires the Bank to maintain as collateral certain qualifying assets (principally securities and residential mortgage loans) not otherwise pledged. The Bank satisfied this collateral requirement at September 30, 1998 and 1997. (Continued) 22 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (10) Income Taxes Income tax expense consists of the following components for the years ended September 30:
1998 1997 1996 -------- -------- -------- Current tax expense: Federal $ 2,765 $ 1,898 $ 2,743 State 638 435 498 -------- -------- -------- 3,403 2,333 3,241 -------- -------- -------- Deferred tax (benefit) expense: Federal (787) 356 (1,662) State (270) 140 (889) -------- -------- -------- (1,057) 496 (2,551) -------- -------- -------- Total income tax expense $ 2,346 $ 2,829 $ 690 ======== ======== ========
The Bank's actual income tax expense amounts for the years ended September 30 differ from the amounts determined by applying the statutory Federal income tax rate to income before income taxes for the following reasons:
1998 1997 1996 --------------------- -------------------- ------------------- Amount Percent Amount Percent Amount Percent --------- -------- -------- -------- ------- -------- Tax at Federal statutory rate $ 2,240 34.0% $ 2,525 34.0% $ 948 34.0% State income taxes, net of Federal tax effect 243 3.7 380 5.1 (258) (9.2) Low-income housing tax credits (71) (1.1) (63) (0.8) -- -- Other, net (66) (1.0) (13) (0.2) -- -- -------- ------- --------- -------- ------- -------- Actual income tax expense $ 2,346 35.6% $ 2,829 38.1% $ 690 24.8% ======== ======= ========= ======== ======= ========
(Continued) 23 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Deferred tax assets and liabilities have been recognized for temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The sources of these temporary differences and their deferred tax effects are as follows at September 30:
1998 1997 -------- -------- Deferred tax assets: Allowance for loan losses $ 2,019 $ 1,470 Deposit premium amortization 1,052 594 Deferred compensation 869 789 Depreciation of premises and equipment 134 122 Other 81 65 -------- -------- Total deferred tax assets 4,155 3,040 -------- -------- Deferred tax liabilities: Federal tax bad debt reserve in excess of base-year amount 444 444 Prepaid pension expense 357 355 Deferred loan origination costs, net 269 213 Net unrealized gain on securities available for sale 608 245 -------- -------- Total deferred tax liabilities 1,678 1,257 -------- -------- Net deferred tax asset $ 2,477 $ 1,783 ======== ========
Based on recent historical and anticipated future pre-tax earnings, management believes it is more likely than not that the Bank will realize its deferred tax assets. As a savings 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 were determined using methods based on loss experience or a percentage of taxable income. Tax bad debt reserves represent 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. (Continued) 24 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Certain amendments to the Federal and New York State tax laws regarding bad debt deductions were enacted in the quarter ended September 30, 1996. The Federal amendments eliminated the percentage-of-taxable-income method for tax years beginning after December 31, 1995 and imposed a requirement to recapture into taxable income (over a six-year period) the bad debt reserves in excess of the base-year amounts. The Bank previously established, and has continued to maintain, a deferred tax liability with respect to such excess Federal reserves. The New York State amendments redesignated all then-existing State bad debt reserves as the base-year amount and provide for future additions to that base-year reserve using the percentage-of-taxable-income method. These changes effectively eliminated the Bank's excess New York State reserves for which a deferred tax liability had been recognized and, accordingly, such liability was reversed in the quarter ended September 30, 1996 and a $500 reduction in income tax expense was recognized. The Bank's Federal and State base-year reserves were approximately $4,600 and $25,300, respectively, at September 30, 1998 ($4,600 and $22,800, respectively, at September 30, 1997). In accordance with SFAS No. 109, deferred tax liabilities have not been recognized with respect to these reserves, since the Bank does not expect that these amounts will become taxable in the foreseeable future. Under the tax laws as amended, events that would result in taxation of certain of these reserves include failure to maintain a specified qualifying-assets ratio or meet other thrift definition tests for New York State tax purposes. At September 30, 1998 and 1997, the Bank's unrecognized deferred tax liabilities with respect to its base-year reserves totaled approximately $3,300 and $3,200, respectively. (11) Regulatory Matters Capital Requirements OTS regulations require savings institutions to maintain a minimum ratio of tangible capital to total adjusted assets of 1.5%; a minimum ratio of Tier 1 (core) capital to total adjusted assets of 3.0%; and a minimum ratio of total (core and supplementary) capital to risk-weighted assets of 8.0%. Under its prompt corrective action regulations, the OTS is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized institution. Such actions could have a direct material effect on the institution's financial statements. The regulations establish a framework for the classification of savings institutions into five categories -- well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Generally, an institution is considered well capitalized if it has a Tier 1 (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%. (Continued) 25 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the OTS about capital components, risk weightings and other factors. Management believes that, as of September 30, 1998 and 1997, the Bank met all capital adequacy requirements to which it was 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 actual capital amounts and ratios, compared to the OTS minimum capital adequacy requirements and the OTS requirements for classification as a well-capitalized institution:
OTS Requirements ---------------------------------------- Minimum Capital Classification Bank Actual Adequacy as Well Capitalized ------------------- ------------------ -------------------- Amount Ratio Amount Ratio Amount Ratio --------- -------- --------- ------- ---------- -------- September 30, 1998 Tangible capital $ 50,626 7.4% $ 10,301 1.5% $ -- --% Tier 1 (core) capital 50,626 7.4 20,601 3.0 34,335 5.0 Risk-based capital: Tier 1 50,626 12.9 -- -- 23,472 6.0 Total 55,532 14.2 31,296 8.0 39,120 10.0 ========= ====== ========= ===== ========== ====== September 30, 1997 Tangible capital $ 44,769 7.0% $ 9,650 1.5% $ -- --% Tier 1 (core) capital 44,769 7.0 19,299 3.0 32,165 5.0 Risk-based capital: Tier 1 44,769 12.7 -- -- 21,168 6.0 Total 48,336 13.7 28,224 8.0 35,280 10.0 ========= ====== ========= ===== ========== ======
(Continued) 26 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The following is a reconciliation of the Bank's equity under generally accepted accounting principles and its regulatory capital amounts at September 30:
1998 1997 ---------- ---------- Equity under generally accepted accounting principles $ 55,200 $ 50,399 Core deposit purchase premiums (3,665) (5,280) Net unrealized gain on securities available for sale, net of income taxes (909) (350) ---------- ---------- Tangible capital, Tier 1 (core) capital and Tier 1 risk-based capital 50,626 44,769 Allowance for loan losses includable in total risk-based capital 4,906 3,567 ---------- ---------- Total risk-based capital $ 55,532 $ 48,336 ========== ==========
SAIF Special Assessment The Deposit Insurance Funds Act of 1996 (the "Act") was signed into law on September 30, 1996. Among other things, the Act required depository institutions to pay a one-time special assessment of 65.7 basis points on their SAIF-assessable deposits, in order to recapitalize the SAIF to the reserve level required by law. The Bank's consolidated financial statements for the year ended September 30, 1996 reflect a separate expense charge of $3,298 for this special assessment. (12) Employee Benefits Pension Plans The Bank has a noncontributory defined benefit pension plan covering substantially all of its employees. Employees who are twenty-one years of age or older and have worked for the Bank for one year are eligible to participate in the plan. The Bank's funding policy is to contribute annually an amount sufficient to meet statutory minimum funding requirements, but not in excess of the maximum amount deductible for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. (Continued) 27 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The following is a reconciliation of the funded status of the plan and the prepaid pension costs recognized in the consolidated statements of financial condition at September 30:
1998 1997 -------- -------- Accumulated benefit obligation, including vested benefits of $3,674 in 1998 and $2,768 in 1997 $ 4,097 $ 3,099 ======== ======== Projected benefit obligation for service rendered to date $ 5,471 $ 4,411 Plan assets at fair value 5,312 4,906 -------- -------- Plan assets (less than) greater than projected benefit obligation (159) 495 Transition obligation 164 190 Unrecognized prior service cost (124) (138) Unrecognized net loss 992 319 -------- -------- Prepaid pension cost $ 873 $ 866 ======== ========
Pension plan assets at September 30, 1998 and 1997 were invested principally in a managed growth fund and certificates of deposit with the Bank. The components of the net periodic pension expense were as follows for the years ended September 30:
1998 1997 1996 -------- -------- -------- Service cost (benefits earned during the year) $ 427 $ 348 $ 292 Interest cost on projected benefit obligation 367 329 273 Return on plan assets (411) (306) (227) Amortization: Transition obligation 26 26 26 Unrecognized prior service cost (14) (14) (14) Unrecognized net loss -- 21 7 -------- -------- -------- Net periodic pension expense $ 395 $ 404 $ 357 ======== ======== ========
The actuarial present values of the projected benefit obligation were determined using discount rates of 7.00% and 7.75% at September 30, 1998 and 1997, respectively, and a rate of increase in future compensation of 6.0% at both dates. The expected long-term rate of return on plan assets was 8.0%, 8.0% and 7.5% for the years ended September 30, 1998, 1997 and 1996, respectively. (Continued) 28 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The Bank also has established a non-qualified Supplemental Executive Retirement Plan to provide certain executives with supplemental retirement benefits in addition to the benefits provided by the pension plan. The periodic pension expense related to the supplemental plan amounted to $46, $40 and $34 in the years ended September 30, 1998, 1997 and 1996, respectively. The actuarial present value of the accumulated benefit obligation was approximately $98 at September 30, 1998, all of which is unfunded. This amount was determined using a discount rate of 7.0% and a rate of increase in future compensation of 4.5%. Other Postretirement Benefits The Bank's postretirement health care plan, which is unfunded, provides optional medical, dental and life insurance benefits to retirees. The Bank adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", effective October 1, 1995. SFAS No. 106 requires accrual of the cost of postretirement benefits over the years in which employees provide services to the date of their full eligibility for such benefits. In accordance with SFAS No. 106, the Bank elected to amortize the transition obligation for accumulated benefits (which amounted to $237 at the adoption date) as an expense over a 20-year period. The total periodic expense recognized under SFAS No. 106 amounted to $38, $37 and $42 in the years ended September 30, 1998, 1997 and 1996, respectively. 401(k) Savings Plan The Bank also sponsors a defined contribution plan established under Section 401(k) of the Internal Revenue Code, pursuant to which eligible employees may elect to contribute up to 10% of their compensation. The Bank makes contributions equal to 100% of the participant's contributions up to a maximum contribution equal to 6% of the participant's compensation. Voluntary and matching contributions are invested, in accordance with the participant's direction, in one or a number of investment options. Compensation and employee benefits expense includes 401(k) savings plan expense of $315, $276 and $234 in the years ended September 30, 1998, 1997 and 1996, respectively. (13) Commitments and Contingencies Certain premises and equipment are leased under operating leases with terms expiring through 2025. The Bank has the option to renew certain of these leases for terms of up to five years. Future minimum rental payments due under non-cancelable operating leases with initial or remaining terms of more than one year at September 30, 1998 are $825 for fiscal 1999; $765 for fiscal 2000; $785 for fiscal 2001; $802 for fiscal 2002; $835 for fiscal 2003; and $6,981 for later years. Net rent expense, which is included in occupancy and office operations expense, amounted to $931, $951 and $941 in the years ended September 30, 1998, 1997 and 1996, respectively. (Continued) 29 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The Bank is a defendant in certain claims and legal actions arising in the ordinary course of business. Management, after consultation with legal counsel, does not anticipate losses on any of these claims or actions which would have a material adverse effect on the Bank's consolidated financial statements. (14) Off-Balance-Sheet Financial Instruments In the normal course of business, the Bank is a party to off-balance-sheet financial instruments that involve, to varying degrees, elements of credit risk and interest rate risk in addition to the amounts recognized in the consolidated financial statements. The contractual or notional amounts of these instruments, which reflect the extent of the Bank's involvement in particular classes of off-balance-sheet financial instruments, are summarized as follows at September 30:
1998 1997 ------- ------- Lending-Related Instruments: Commitments to extend credit: Fixed-rate loans $38,895 $ 8,610 Adjustable-rate loans 11,584 14,503 Unused lines of credit 27,373 25,883 Standby letters of credit 4,952 4,222 Forward commitments to sell loans 6,500 -- Interest Rate Risk Management: Interest rate cap agreement 20,000 -- ======= ======
Lending-Related Instruments The contractual amounts of the commitments to extend credit, unused lines of credit and standby letters of credit represent the Bank's maximum potential exposure to credit loss, assuming (i) the instruments are fully funded at a later date, (ii) the borrower does not meet the contractual payment obligations and (iii) any collateral or other security proves to be worthless. The contractual amounts of these instruments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. Substantially all of these lending-related instruments have been entered into with customers located in the Bank's primary market area described in Note 4. (Continued) 30 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) Commitments to extend credit are legally-binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments have fixed expiration dates (generally ranging up to 45 days) or other termination clauses, and may require payment of a fee by the customer. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral, if any, obtained by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include mortgages on residential and commercial real estate, deposit accounts with the Bank, and other property. The Bank's fixed-rate loan commitments at September 30, 1998 provide for interest rates ranging from 6.25% to 9.63%. Unused lines of credit are legally-binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates or other termination clauses. The amount of collateral obtained, if deemed necessary by the Bank, is based on management's credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Bank to assure the performance of financial obligations of a customer to a third party. These commitments are primarily issued in favor of local municipalities to support the obligor's completion of real estate development projects. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In order to limit the interest rate and market risk associated with loans held for sale and commitments to originate loans held for sale, the Bank enters into mandatory forward commitments to sell loans in the secondary mortgage market. Risks associated with forward commitments to sell mortgage loans include the possible inability of the counterparties to meet the contract terms, or of the Bank to originate loans to fulfill the contracts. If the Bank is unable to fulfill a contract, it could purchase securities in the open market to deliver against the contract. The Bank controls its counterparty risk by entering into these agreements only with highly-rated counterparties. Interest Rate Cap Agreement At September 30, 1998, the Bank was a party to an interest rate cap agreement with a notional amount of $20,000 and a five-year term ending in March 2003. This agreement was entered into to reduce the Bank's exposure to potential increases in interest rates on a portion of its certificate of deposit accounts. The counterparty in the transaction has agreed to make interest payments to the Bank, based on the notional amount, to the extent that the three-month LIBOR rate exceeds 6.50% over the term of the cap agreement. No payments were due from the counterparty through September 30, 1998. The carrying amount of the cap agreement at September 30, 1998 represented the unamortized premium of $270, which is included in other assets. Premium amortization of $36 is included in deposit interest expense for the year ended September 30, 1998. The estimated fair value of the interest rate cap agreement at September 30, 1998 was approximately $180, representing the estimated amount the Bank would receive to terminate the contract at that date. (Continued) 31 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (15) Related Party Transactions The Bank was indebted to its directors for deferred directors fees (and accrued interest thereon) totaling $2,018 and $1,859 at September 30, 1998 and 1997, respectively. The interest rates on these amounts were 6.53% and 6.64% at the respective dates. The Bank has had, and expects to have in the future, banking transactions in the ordinary course of business with its directors, senior officers and their affiliates. Loans are made to these individuals on the same terms as those prevailing for comparable transactions with other borrowers and do not involve more than normal collection risk. Loans receivable from related parties totaled $369 and $426 at September 30, 1998 and 1997, respectively. Repayments on related party loans were $57 and $30 in the years ended September 30, 1998 and 1997. No new loans were granted and such related parties during these periods. (16) Fair Values of Financial Instruments SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires disclosure of fair value information for those financial instruments for which it is practicable to estimate fair value, whether or not such financial instruments are recognized in the consolidated statements of financial condition. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. Quoted market prices are used to estimate fair values when those prices are available. However, active markets do not exist for many types of financial instruments. Consequently, fair values for these instruments must be estimated by management using techniques such as discounted cash flow analysis and comparison to similar instruments. These estimates are highly subjective and require judgments regarding significant matters, such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near-term changes. Fair values disclosed in accordance with SFAS No. 107 do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect possible tax ramifications or estimated transaction costs. (Continued) 32 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) The following is a summary of the carrying amounts and estimated fair values of financial assets and liabilities at September 30 (none of which were held for trading purposes):
1998 1997 -------------------------- -------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------------ ------------ ------------ ------------ Financial assets: Cash and due from banks $ 7,572 $ 7,572 $ 9,191 $ 9,191 Investment securities 67,247 67,333 70,712 70,608 Mortgage-backed securities 129,138 130,322 140,224 140,777 Loans receivable 463,667 466,020 404,497 410,382 Accrued interest receivable 4,087 4,087 4,262 4,262 Federal Home Loan Bank stock 3,690 3,690 3,641 3,641 ============ ============ ============ ============ Financial liabilities: Deposits $ 573,174 $ 575,822 $ 546,846 $ 547,557 Borrowings 38,646 39,564 24,000 24,071 Bank overdraft 11,285 11,285 17,623 17,623 Mortgage escrow funds 5,887 5,887 4,559 4,559 ============ ============ ============ ============
The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Investment Securities and Mortgage-backed Securities Fair values were estimated for portfolios of loans with similar financial characteristics. For valuation purposes, the total loan portfolio was segregated into performing and non-performing categories. Performing loans were segregated by adjustable-rate and fixed-rate loans; fixed-rate loans were further segmented by type, such as residential mortgage, commercial mortgage, commercial business and consumer loans. Residential loans were also segmented by maturity. Fair values were estimated by discounting scheduled future cash flows through estimated maturity using a discount rate equivalent to the rate at which the Bank would currently make loans which are similar with regard to collateral, maturity and the type of borrower. The discounted value of the cash flows was reduced by a credit risk adjustment based on loan categories. Based on the current composition of the Bank's loan portfolio, as well as both past experience and current economic (Continued) 33 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) conditions and trends, the future cash flows were adjusted by prepayment assumptions which shortened the estimated remaining time to maturity and therefore impacted the fair value estimates. Estimated fair values of loans held for sale were based on contractual sale prices for loans covered by forward sale commitments. Any remaining loans held for sale were valued based on current secondary market prices and yields. Deposits In accordance with SFAS No. 107, deposits with no stated maturity (such as savings, demand and money market deposits) were assigned fair values equal to the carrying amounts payable on demand. Certificates of deposit were segregated by account type and original term, and fair values were estimated based on the discounted value of contractual cash flows. The discount rate for each account grouping was equivalent to the then-current rate offered by the Bank for deposits of similar type and maturity. These fair values do not include the value of core deposit relationships which comprise a significant portion of the Bank's deposit base. Management believes that the Bank's core deposit relationships provide a relatively stable, low-cost funding source which has a substantial unrecognized value separate from the deposit balances. Borrowings Estimated fair values of FHLB advances were based on the discounted value of contractual cash flows. A discount rate was utilized for each outstanding advance equivalent to the then-current rate offered by the FHLB on borrowings of similar type and maturity. Other Financial Instruments The other financial assets and liabilities listed in the preceding table have estimated fair values that approximate the respective carrying amounts because the instruments are payable on demand or have short-term maturities and present relatively low credit risk and interest rate risk. The carrying amount and estimated fair value of the Bank's interest rate cap agreement at September 30, 1998 is set forth in Note 14. The fair values of the Bank's lending-related off-balance-sheet financial instruments described in Note 14 were estimated based on the interest rates and fees currently charged to enter into similar agreements, considering the remaining terms of the agreements and the present credit worthiness of the counterparties. At September 30, 1998 and 1997, the estimated fair values of these instruments approximated the related carrying amounts which were not significant. 34 (17) Accounting Standards In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income (and its components) in financial statements. The standard does not, however, specify when to recognize or how to measure items that make up comprehensive income. Comprehensive income represents net income and certain amounts reported directly in equity, such as the net unrealized gain or loss on available-for-sale securities. While SFAS No. 130 does not require a specific reporting format, it does require that an enterprise display in the financial statements an amount representing total comprehensive income for the period. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997 and, accordingly, will be adopted by the Bank in the fiscal year beginning October 1, 1998. Management does not anticipate that the adoption of this standard will significantly affect the Bank's financial reporting. In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which standardizes the disclosure requirements for pensions and other postretirement benefits; requires additional information on changes in the benefit obligations and fair values of plan assets; and eliminates certain present disclosure requirements. The standard does not change the recognition or measurement requirements for postretirement benefits. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997 and, accordingly, will be adopted by the Bank in the fiscal year beginning October 1, 1998. Management does not anticipate that the adoption of this standard will significantly affect the Bank's financial reporting. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires entities to recognize all derivatives as either assets or liabilities in the statement of financial condition at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value hedge, a cash flow hedge, or a foreign currency hedge. A specific accounting treatment applies to each type of hedge. Entities may reclassify securities from the held-to-maturity category to the available-for-sale category at the time of adopting SFAS No. 133. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999, although early adoption is permitted. The Bank has not yet selected an adoption date or decided whether it will reclassify securities between categories. The Bank has engaged in limited derivatives and hedging activities covered by the new standard and, accordingly, SFAS No. 133 is not expected to have a material impact on the Bank's consolidated financial statements. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage- Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." SFAS No. 134 provides for the classification of such retained securities as held to maturity, available for sale, or trading in accordance with SFAS No. 115. Prior accounting standards limited the classification of these securities to the trading category. SFAS No. 134 is effective for the first fiscal quarter beginning after December 15, 1998 and is not expected to have a material impact on the Bank's consolidated financial statements. (Continued) 35 PROVIDENT BANK Notes to Consolidated Financial Statements September 30, 1998, 1997 and 1996 (Dollars in thousands) (18) Mutual Holding Company Reorganization and Offering On April 23, 1998, the Board of Directors of the Bank adopted a Plan of Reorganization and Stock Issuance Plan ("the Plan") pursuant to which the Bank will convert from mutual to stock form of ownership under a two-tier mutual holding company structure and shares of common stock will be sold in an initial public offering. As part of the Plan, the Bank will establish a federally-chartered mutual holding company known as Provident Bancorp, MHC (the "Mutual Holding Company") and a capital stock holding company known as Provident Bancorp, Inc. (the "Company"). The Bank will become a federally- chartered capital stock savings bank, wholly owned by the Company. The Company plans to offer for sale 46.7% of its common shares in a subscription offering (the "Offering") initially to eligible Bank depositors; tax-qualified employee benefit plans of the Bank; certain other Bank depositors and borrowers; and employees, officers and directors of the Bank. Any shares of common stock not sold in the Offering will be offered to certain members of the general public in a community offering, with preference given to natural persons residing in Rockland County, New York. The Mutual Holding Company will own the remaining 53.3% of the Company's issued common shares. Following the completion of the reorganization, all depositors who had liquidation rights with respect to the Bank as of the effective date of the reorganization will continue to have such rights solely with respect to the Mutual Holding Company so long as they continue to hold deposit accounts with the Bank. In addition, all persons who become depositors of the Bank subsequent to the reorganization will have such liquidation rights with respect to the Mutual Holding Company. The Bank will be subject to OTS regulations concerning capital distributions it makes to the Company subsequent to the reorganization and Offering. The Bank may not declare or pay cash dividends on or repurchase any of its common stock if the effect thereof would cause its stockholders' equity to be reduced below applicable regulatory capital requirements. The OTS regulations applicable to institutions (such as the Bank) that meet their regulatory capital requirements, generally limit dividend payments in any year to the greater of (i) 100% of year-to-date net income plus an amount that would reduce surplus capital by one half or (ii) 75% of net income for the most recent four quarters. Surplus capital is the excess of actual capital at the beginning of the year over the institution's minimum regulatory capital requirement. Offering costs will be deferred and reduce the proceeds from the shares sold in the Offering. If the Offering is not completed, these costs will be charged to expense. At September 30, 1998, offering costs of $192 had been incurred and are included in other assets. 36 EX-99.2 4 EXHIBIT 99.2 Exhibit 99.2 General - ------- Provident Bank (the "Bank") is a federally chartered thrift institution operating as a community bank and conducting business primarily in Rockland County, New York. On January 7, 1999, the Bank completed its reorganization into a mutual holding company structure, and Provident Bancorp, Inc., the Bank's holding company (the "Company") issued 3,864,000 shares of common stock to the public and 4,416,000 shares to Provident Bancorp, MHC. As a result of the stock offering, the Company raised net proceeds of approximately $37.4 million, prior to the purchase of stock by the Bank's ESOP. The ESOP, which did not purchase shares in the offering, has been authorized to purchase 8% of the shares issued to the public, or approximately 309,100 shares. The reorganization and stock offering were completed subsequent to September 30, 1998, which was the Bank's last fiscal year end. Therefore, the financial statements included in this Form 10-K, and the management's discussion and analysis which follows, are for the Bank only. This financial information should be read in conjunction with the Company's Prospectus, dated November 12, 1998. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements This annual report on Form 10-K contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believe", "anticipates", "plans", "expects" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company's actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, the Bank's continued ability to originate quality loans, fluctuations in interest rates, real estate conditions in the Bank's lending areas, general and local economic conditions, unanticipated Year 2000 issues, the Bank's continued ability to attract and retain deposits, the Company's ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Management of Market Risk Qualitative Analysis. Like other financial institutions, the Bank's most significant form of market risk is interest rate risk. The general objective of the Bank's interest rate risk management is to determine the appropriate level of risk given the Bank's business strategy, and then manage that risk in a manner that is consistent with the Bank's policy to reduce the exposure of the Bank's net interest income to changes in market interest rates. The Bank's asset/liability management committee ("ALCO"), which consists of senior management, evaluates the interest rate risk inherent in certain assets and liabilities, the Bank's operating environment, and capital and liquidity requirements, and modifies lending, investing and deposit gathering strategies accordingly. A committee of the Board of Directors reviews the ALCO's activities and strategies, the effect of those strategies on the Bank's net interest margin, and the effect that changes in market interest rates would have on the value of the Bank's loan and securities portfolios. The Bank actively evaluates interest rate risk concerns in connection with its lending, investing, and deposit gathering activities. The Bank emphasizes the origination of residential monthly and bi-weekly fixed-rate mortgage loans, residential and commercial adjustable-rate mortgage ("ARM") loans, and consumer loans. Depending on market interest rates and the Bank's capital and liquidity position, the Bank may retain all of its newly originated fixed-rate, fixed-term residential mortgage loans or may decide to sell all or a portion of such longer-term loans on a servicing-retained basis. The Bank also invests in short-term securities, which generally have lower yields compared to longer-term investments. Shortening the maturities of the Bank's interest-earning assets by increasing investments in shorter- term loans and securities helps to better match the maturities and interest rates of the Bank's assets and liabilities, thereby reducing the exposure of the Bank's net interest income to changes in market interest rates. These strategies may adversely impact net interest income due to lower initial yields on these investments in comparison to longer term, fixed-rate loans and investments. The Bank has also purchased interest rate caps to synthetically extend the duration of its portfolio of short-term certificates of deposit. The counterparty in the transaction has agreed to make interest payments to the Bank, based on a $20 million notional amount, to the extent that the three-month LIBOR rate exceeds 6.5% over the term of the cap agreement, which has a five year term ending in March 2003. By purchasing shorter term assets and extending the duration of its liabilities, management believes that the corresponding reduction in interest rate risk will enhance long-term profitability. Quantitative Analysis. The Bank monitors interest rate sensitivity primarily through the use of a model that simulates net interest income under varying interest rate assumptions. The Bank also evaluates this sensitivity through a net portfolio value model that estimates the change in the Bank's net portfolio value ("NPV") over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. Both models assume estimated loan prepayment rates, reinvestment rates and deposit decay rates which management believes are most likely based on historical experience during prior interest rate changes. The table below sets forth, as of September 30, 1998, the estimated changes in the Bank's NPV and its net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve.
NPV Net Interest Income -------------------------------- -------------------------------------------- Estimated Increase Increase (Decrease) in Change in (Decrease) in NPV Estimated Estimated Net Interest Income Interest Rates Estimated ------------------ Net Interest ----------------------------- (basis points) NPV Amount Percent Income Amount Percent -------------- --------- -------- ------- ------------ -------- ------- (Dollars in Thousands) +300 $54,461 $(19,385) (26)% $23,141 $(116) -% +200 61,811 (12,037) (16) 23,318 60 - +100 67,830 (6,019) (8) 23,288 30 - 0 73,849 - - 23,257 - - -100 76,674 2,821 4 23,038 (219) (1) -200 79,498 5,649 8 22,818 (440) (2) -300 79,460 5,612 8 22,576 (681) (3)
The table indicates that at September 30, 1998, in the event of an abrupt 200 basis point decrease in interest rates, the Bank would be expected to experience an 8% increase in NPV and a 2% decline in net interest income. In the event of an abrupt 200 basis point increase in interest rates, the Bank would be expected to experience a 16% decrease in NPV and see a negligible change in net interest income. Since September 30, 1998, there have been no significant changes in the Bank's interest rate risk exposures or how those exposures would be managed, although the Bank's NPV increased significantly as a result of its receipt (and reinvestment) of a portion of the proceeds from the stock offering. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not reflect any actions management may undertake in response to changes in interest rates. Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The NPV table presented above assumes that the composition of the Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured. It also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the NPV table provides an indication of the Bank's sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Bank's net interest income and will differ from actual results. Analysis of Net Interest Income Net interest income is the difference between interest income on interest- earning assets and interest expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them, respectively. The following tables set forth average balance sheets, average yields and costs, and certain other information for the years ended September 30, 1998, 1997 and 1996. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are monthly average balances which, in the opinion of management, are not materially different from daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums which are included in interest income.
Years Ended September 30, ----------------------------------------------------------------------------------------------- 1998 1997 1996 ------------------------------- ------------------------------- ------------------------------- Average Average Average Outstanding Average Outstanding Average Outstanding Average Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate ----------- -------- ---------- ----------- -------- ---------- ----------- -------- ---------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $428.460 $35,032 8.18% $385,355 $32,544 8.45% $348,155 $29,210 8.39% Mortgage-backed securities (2) 136,011 8,822 6.49 144,252 9,398 6.52 137,772 9,008 6.54 Investment securities (2) 64,177 3,791 5.91 71,826 4,385 6.11 66,554 4,020 6.04 Other 4,345 303 6.97 3,526 228 6.47 5,681 328 5.77 -------- ------- -------- ------- -------- ------- Total interest-earning assets 632,993 47,948 7.57 604,959 46,555 7.70 558,162 42,566 7.63 ------- ------- ------- Non-interest-earning assets 30,254 31,861 24,009 -------- -------- -------- Total assets $663,247 $636,820 $582,171 ======== ======== ======== Interest-bearing liabilities: Savings deposits (3) $166,529 3,697 2.22 $164,726 3,670 2.23 $161,215 3,592 2.23 Money market and NOW deposits 114,542 2,687 2.35 109,289 2,675 2.45 99,344 2,480 2.50 Certificates of deposit 240,987 12,771 5.30 237,262 12,347 5.20 212,476 11,041 5.20 Borrowings 28,816 1,725 5.99 23,730 1,487 6.27 22,686 1,472 6.49 -------- ------- -------- ------- -------- ------- Total interest-bearing liabilities 550,874 20,880 3.79 535,007 20,179 3.78 495,721 18,585 3.75 ------- ------- ------- Non-interest-bearing liabilities 58,995 53,489 40,880 -------- -------- -------- Total liabilities 609,829 588,496 536,601 Equity 53,418 48,324 45,570 -------- -------- -------- Total liabilities and equity $663,247 $636,820 $582,171 ======== ======== ======== Net interest income $27,068 $26,376 $23,981 ======= ======= ======= Net interest rate spread (4) 3.78% 3.92% 3.88% Net interest-earning assets (5) $82,119 $69,952 $62,441 ======== ======== ======== Net interest margin (6) 4.28% 4.36% 4.30% Ratio of interest-earning assets To interest-bearing liabilities 114.91% 113.07% 112.60%
____________________________________ (1) Balances include the effect of net deferred loan origination fees and costs, loans in process and the allowance for loan losses. (2) Average outstanding balances are based on amortized cost. (3) Includes club accounts and interest-bearing mortgage escrow balances. (4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. (5) Net earning assets represents total interest-earning assets less total interest-bearing liabilities. (6) Net interest margin represents net interest income divided by average total interest-earning assets. The following table presents the dollar amount of changes in interest income and interest expense for the major categories of the Bank's interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). 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.
Year Ended September 30, ---------------------------------------------------------------------------- 1998 vs. 1997 1997 vs. 1996 -------------------------------------- ---------------------------------- Increase(Decrease) Increase(Decrease) Due to Total Due to Total ------------------ Increase ------------------ Increase Volume Rate (Decrease) Volume Rate (Decrease) ------ ------- ---------- ------ ---- ---------- (In Thousands) Interest-earning assets: Loans receivable...................... $3,550 $(1,062) $2,488 $3,141 $193 $3,334 Mortgage-backed securities............ (535) (41) (576) 422 (32) 390 Investment securities................. (456) (138) (594) 322 43 365 Other................................. 56 19 75 (135) 35 (100) ------ ------- ------ ------ ---- ------ Total interest-earning assets....... 2,615 (1,222) 1,393 3,750 239 3,989 ------ ------- ------ ------ ---- ------ Interest-bearing liabilities: Savings deposits...................... 40 (13) 27 78 - 78 Money market and NOW deposits............................ 125 (113) 12 244 (49) 195 Certificates of deposit............... 196 228 424 1,290 16 1,306 Borrowings............................ 307 (69) 238 65 (51) 15 ------ ------- ------ ------ ---- ------ Total interest-bearing liabilities.. 668 33 701 1,678 (84) 1,594 ------ ------- ------ ------ ---- ------ Change in net interest income......... $1,947 $(1,255) $ 692 $2,072 $323 $2,395 ====== ======= ====== ====== ==== ======
Comparison of Financial Condition at September 30, 1998 and September 30, 1997 Total assets increased by $42.4 million, or 6.5%, to $691.1 million at September 30, 1998 from $648.7 million at September 30, 1997. The growth in assets was primarily attributable to a $59.2 million increase in loans receivable, partially offset by decreases of $11.1 million in mortgage-backed securities and $3.5 million in investment securities, as the Bank's asset mix continued to shift from securities into loans. Asset growth was funded primarily from deposit inflows through the Bank's existing branch network. Investment securities at September 30, 1998 totaled $67.2 million, a decrease of $3.5 million from $70.7 million at September 30, 1997. Mortgage-backed securities at September 30, 1998 totaled $129.1 million, a decrease of $11.1million from September 30, 1997. One- to four- family residential mortgage loans increased by $48.3 million to $290.2 million at September 30, 1998 from $241.9 million at September 30, 1997, reflecting the continuation of the strong market for new mortgage loans and loan refinancings. The increase consisted of a $49.3 million increase in fixed-rate loans partially offset by a $1.0 million decline in adjustable-rate loans, as borrowers preferred fixed-rate mortgage loans in the current low interest rate environment. Due to the significant increase in loan refinancings, the Bank reentered the secondary mortgage sales market after an absence of three years by selling substantially all of its 30 year fixed-rate loans originated between December 1, 1997 and September 30, 1998. On a combined basis, total outstanding balances in the Bank's commercial loan categories (commercial mortgages, multi-family mortgages, construction loans to builders and business loans) increased by $10.6 million, or 10.1%, to $115.7 million at September 30, 1998 from $105.1 million at September 30, 1997. Other assets of the Bank decreased to $5.8 million at September 30, 1998 from $7.2 million at September 30, 1997, primarily due to $1.6 million in amortization of core deposit purchase premiums. Total deposits at September 30, 1998 were $573.2 million, an increase of $26.4 million, or 4.8%, from $546.8 million at September 30, 1997. The increase was partly due to growth in the Bank's demand and NOW accounts, which increased by $9.9 million to $92.1 million at September 30, 1998 from $82.2 million at September 30, 1997, largely as a result of the Bank's promotion of its "Select" and "Select Plus" checking account products. The Bank's passbook savings accounts, certificates of deposit and money market accounts grew to $155.9 million, $249.2 million and $76.0 million, respectively, at September 30, 1998, representing increases of $2.7 million, $13.1 million and $671,000, respectively, over the period. FHLB borrowings at September 30, 1998 were $38.6 million, an increase of $14.6 million from $24.0 million at September 30, 1997. Mortgage escrow funds increased by $1.3 million to $5.9 million at September 30, 1998 from $4.6 million at September 30, 1997, while the bank overdraft liability decreased by $6.3 million to $11.3 million at September 30, 1998 from $17.6 million at September 30, 1997. Total equity increased to $55.2 million at September 30, 1998 from $50.4 million at September 30, 1997, reflecting net income of $4.2 million and a $559,000 increase in the after-tax net unrealized gain on securities available for sale. Comparison of Operating Results for the Years Ended September 30, 1998 and September 30, 1997 General. Net income for the fiscal year ended September 30, 1998 was $4.2 million, a decrease of $356,000, or 7.7 %, from net income of $4.6 million for the fiscal year ended September 30, 1997. The decrease was due primarily to increases in the provision for loan losses and non-interest expense, partially offset by an increase in net interest income and a decrease in income tax expense. Interest Income. Interest income increased by $1.4 million, or 3.0%, to $48.0 million for the fiscal year ended September 30, 1998 from $46.7 million for the fiscal year ended September 30, 1997. The increase was due primarily to an increase in average interest-earning assets. The impact of declining yields and spreads was partially offset by a change in asset mix. Loan balances increased while investment and mortgage-backed securities declined. The effect of a $2.5 million increase in income from loans was partially offset by a $576,000 decrease in income from mortgage-backed securities and a $519,000 decrease in income from investment securities and other interest-earning assets. The increase in income from loans was attributable to a $43.1 million increase in the average balance of loans to $428.5 million from $385.4 million, partially offset by a 27 basis point decrease in the average yield on loans to 8.18% from 8.45%. The increase in average loans resulted primarily from the origination of one- to four- family mortgage loans. The decrease in the average yield on loans reflects declining market interest rates, as the Bank originated new one- to four-family loans with yields lower than the average yield on the existing loan portfolio. The decrease in income from mortgage-backed securities was attributable almost entirely to an $8.3 million decrease in the average balance of mortgage-backed securities to $136.0 million from $144.3 million, as the average yield on mortgage-backed securities remained essentially unchanged. The decrease in income from investment securities was attributable to a $7.6 million decrease in the average balance of investment securities to $64.2 million from $71.8 million, combined with a 20 basis point decrease in the average yield on investment securities to 5.91% from 6.11%. Interest Expense. Interest expense increased by $701,000, or 3.5%, to $20.9 million for the fiscal year ended September 30, 1998 from $20.2 million for the fiscal year ended September 30, 1997. This increase was due primarily to a $15.9 million increase in the average balance of interest-bearing liabilities in the 1998 period compared to the 1997 period. The increase in overall interest expense resulted primarily from a $424,000 increase in interest expense on certificates of deposit and a $238,000 increase in interest expense on borrowings. The increase attributable to certificates of deposit resulted from a $3.7 million increase in the average balance of certificates of deposit to $241.0 million in fiscal 1998 from $237.3 million in fiscal 1997, combined with a 10 basis point increase in the average cost of certificates of deposit to 5.30% from 5.20%. The increase attributable to borrowings resulted from a $5.1 million increase in the average balance of borrowings to $28.8 million for the fiscal year ended September 30, 1998 from $23.7 million for the fiscal year ended September 30, 1997, which was partially offset by a 28 basis point decrease in the average cost of borrowings to 5.99% from 6.27%. Net Interest Income. For the fiscal years ended September 30, 1998 and 1997, net interest income was $27.1 million and $26.4 million, respectively. The $692,000 increase in net interest income was primarily attributable to a $12.2 million increase in net interest- earning assets (interest-earning assets less interest-bearing liabilities), partially offset by a 14 basis point decline in the net interest rate spread to 3.78% from 3.92%. The Bank's net interest margin decreased to 4.28% in the fiscal year ended September 30, 1998 from 4.36% in the fiscal year ended September 30, 1997. Provision for Loan Losses. The Bank records provisions for loan losses, which are charged to earnings, in order to maintain the allowance for loan losses at a level which is considered appropriate to absorb probable loan losses inherent in the existing portfolio. In determining the appropriate level of the allowance for loan losses, management considers past and anticipated loss experience, evaluations of real estate collateral, current and anticipated economic conditions, volume and type of lending, and the levels of non- performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates. Management of the Bank assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses in order to maintain the adequacy of the allowance. The Bank's provision for loan losses increased by $679,000 to $1.7 million for the fiscal year ended September 30, 1998 from $1.1 million for the fiscal year ended September 30, 1997. The increased provision reflects continued loan portfolio growth, including commercial real estate and commercial business loans, as well as an increase in non-performing loans to $6.1 million at September 30, 1998 from $4.7 million at September 30, 1997. Non-Interest Income. Non-interest income increased by $369,000, or 13.6%, to $3.1 million for the fiscal year ended September 30, 1998 from $2.7 million for the fiscal year ended September 30, 1997. This reflects a $164,000 increase in the gain on sale of loans to $170,000 in fiscal 1998 from $6,000 in fiscal 1997, primarily from a higher volume of loan sales, as the Bank sold newly originated, longer term fixed-rate mortgage loans as part of its interest rate risk management. In addition, deposit-related fees and charges increased $137,000, or 6.7%, to $2.2 million for the fiscal year ended September 30, 1998 from $2.0 million for the fiscal year ended September 30, 1997. Non-Interest Expense. Non-interest expense increased by $1.2 million, or 5.9%, to $21.8 million for the fiscal year ended September 30, 1998 from $20.6 million for the fiscal year ended September 30, 1997. Compensation and employee benefits increased by $591,000 to $10.5 million from $9.9 million primarily due to a $335,000, or 4.9%, increase in salaries for Bank officers and staff, and a $90,000 increase in medical and disability insurance. In addition, there was a charge of approximately $190,000 related to the early termination of a long-term incentive plan for senior officers and directors. The increase in non-interest expense also reflects $340,000 in conversion-related expenses associated with the new core processing system and an increase of $160,000 in legal expenses. Income Taxes. Income tax expense was $2.3 million for the fiscal year ended September 30, 1998 compared to $2.8 million for fiscal 1997, representing effective tax rates of 35.6% and 38.1%, respectively. Comparison of Operating Results for the Years Ended September 30, 1997 and September 30, 1996 General. Net income for the fiscal year ended September 30, 1997 was $4.6 million, an increase of $2.5 million, or 119.3%, from net income of $2.1 million for the fiscal year ended September 30, 1996. The increase was due primarily to a $3.3 million special assessment during fiscal 1996 to recapitalize the Savings Association Insurance Fund ("SAIF"). The after-tax impact of this one- time assessment was a $2.0 million reduction of net income in fiscal 1996. The remaining increase in net income was due to higher net interest income and non- interest income, partially offset by increases in non-interest expenses and income tax expense. Interest Income. Interest income increased by $4.0 million, or 9.4%, to $46.7 million for the year ended September 30, 1997 from $42.6 million for the year ended September 30, 1996. The increase was primarily due to a $3.3 million increase in income from loans, a $390,000 increase in income from mortgage- backed securities and a $365,000 increase in income from investment securities. The increase in income from loans was attributable to a $37.2 million increase in the average balance of loans to $385.4 million from $348.2 million, and a 6 basis point increase in the average yield on loans from 8.39% to 8.45%. In fiscal 1997, the Bank continued its focus on increasing the loan portfolio by reinvesting the proceeds from branch purchases and from repayments on investment and mortgage-backed securities into loans. The increase in income from investment securities was attributable to a $5.2 million increase in the average balance of investment securities to $71.8 million from $66.6 million, and a 7 basis point increase in the average yield on investment securities to 6.11% from 6.04%. The increase in income from mortgage-backed securities was attributable to a $6.5 million increase in the average balance of mortgage-backed securities to $144.3 million from $137.8 million, which was partially offset by a 2 basis point decrease in the average yield on mortgage- backed securities to 6.52% from 6.54%. Average balances for securities were higher in fiscal 1997 than fiscal 1996 because securities purchased during fiscal 1996 were held for the entire 1997 fiscal year. Interest Expense. Interest expense increased by $1.6 million, or 8.6%, to $20.2 million for the fiscal year ended September 30, 1997 from $18.6 million for the fiscal year ended September 30, 1996. Overall, the average balance of interest-bearing liabilities increased by $39.3 million in fiscal 1997, and the average rate paid on these liabilities increased 3 basis points to 3.78% in fiscal 1997 from 3.75% in fiscal 1996. The increase in interest expense resulted primarily from a $1.3 million increase in interest expense on certificates of deposit and a $195,000 increase in interest expense on money market and NOW accounts. The increase attributable to certificates of deposit resulted from a $24.8 million increase in the average balance of certificates of deposit to $237.3 million in fiscal 1997 from $212.5 million in fiscal 1996. The increase in interest expense attributable to money market and NOW accounts was due to a $10.0 million increase in the average balance of these accounts to $109.3 million in fiscal year 1997 from $99.3 million in fiscal 1996. This increase was partially offset by a 5 basis point decrease in the average cost of money market and NOW accounts to 2.45% from 2.50%. The average balance in savings deposits increased by $3.5 million to $164.7 million in fiscal 1997 from $161.2 million in fiscal 1996, resulting in a $78,000 increase in interest expense for fiscal 1997. Net Interest Income. Net interest income increased $2.4 million, or 10.0%, to $26.4 million in fiscal 1997 from $24.0 million in fiscal 1996. The increase was attributable to a $7.5 million increase in net earning assets and a 6 basis point increase in the net interest margin to 4.36% in fiscal 1997 from 4.30% in fiscal 1996. The net interest rate spread increased 4 basis points to 3.92% in fiscal 1997 from 3.88% in fiscal 1996. Provision for Loan Losses. The Bank's provision for loan losses increased by $147,000 to $1.1 million for the year ended September 30, 1997 from $911,000 for the year ended September 30, 1996. The increase in the provision reflects management's evaluation of changes in the level of losses inherent in the loan portfolio as a result of ongoing portfolio growth and changes in the portfolio mix. The allowance for loan losses represented 0.93% of net loans receivable at September 30, 1997, compared to 0.91% at September 30, 1996. Non-Interest Income. Non-interest income was $2.7 million for the year ended September 30, 1997, a $260,000, or 10.6%, increase from $2.5 million for the year ended September 30, 1996. Income from bank services and fees on deposit accounts increased by $325,000 to $2.1 million for the fiscal year ended September 30, 1997, from $1.8 million in fiscal 1996 primarily reflecting higher transaction volume. Income from loan servicing decreased $65,000 for the year ended September 30, 1997 to $583,000 from $648,000 for fiscal 1996, as the balance of loans serviced for others declined due to refinancing trends and the Bank's decision to retain most loans originated during that period. Non-Interest Expense. Non-interest expense decreased by $2.1 million, or 9.4%, to $20.6 million for the year ended September 30, 1997 from $22.7 million for the year ended September 30, 1996. The decrease was due primarily to a non- recurring $3.3 million special assessment to recapitalize the SAIF during the year ended September 30, 1996. This was partially offset by an $852,000 increase in compensation and employee benefits, an $815,000 increase in amortization of branch purchase premiums, a $621,000 increase in other expenses and a $231,000 increase in occupancy and office expenses. Decreases in non- interest expense for the year ended September 30, 1997 compared to the year ended September 30, 1996 include a $213,000 decrease in advertising and promotion expense, and a $481,000 decrease in expenses for foreclosed real estate. Increases in compensation and employee benefits, amortization of branch purchase premiums, occupancy and other expenses in fiscal 1997 reflect the first full year of operating costs related to two purchased branches which were operated by the Bank for only four and six months, respectively, in fiscal 1996. Income Taxes. Income tax expense was $2.8 million for the year ended September 30, 1997 compared to $690,000 for the year ended September 30, 1996, representing effective tax rates of 38.1% in fiscal 1997 and 24.8% in fiscal 1996. The lower effective tax rate in fiscal 1996 primarily reflects the recognition of a deferred tax benefit due to an amendment in New York State tax law concerning tax bad debt reserves. See Note 10 of the Notes to Consolidated Financial Statements, included as an exhibit to this report. Liquidity and Capital Resources The objective of the Bank's liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses the Bank's ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise. The Bank's primary sources of funds are deposits, proceeds from principal and interest payments on loans and securities, and to a lesser extent, borrowings and proceeds from the sale of fixed-rate mortgage loans in the secondary mortgage market. While maturities and scheduled amortization of loans and securities, and proceeds from borrowings are predictable sources of funds, other funding sources such as deposit inflows, mortgage prepayments and mortgage loan sales are greatly influenced by market interest rates, economic conditions and competition. The Bank's primary investing activities are the origination of both residential one- to four-family and commercial real estate loans, and the purchase of investment securities and mortgage-backed securities. During the years ended September 30, 1998, 1997 and 1996, the Bank's loan originations net of principal repayments were $58.1 million, $36.8 million and $39.8 million, respectively. Purchases of mortgage-backed securities totaled $35.5 million, $12.1 million and $72.3 million for the years ended September 30, 1998, 1997 and 1996, respectively. Purchases of investment securities totaled $23.0 million, $13.2 million and $42.4 million for the years ended September 30, 1998, 1997 and 1996, respectively. These activities were funded primarily by deposit growth and by principal repayments on loans and securities. Loan sales totaling $17.2 million provided an additional source of liquidity during the year ended September 30, 1998. Loan origination commitments totaled $50.5 million at September 30, 1998, comprised of $11.6 million at adjustable or variable rates and $38.9 million at fixed rates. In addition, commitments to sell fixed rate residential loans totaled $6.5 million at the same date. The Bank anticipates that it will have sufficient funds available to meet current loan commitments. Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by local competitors, and other factors. The net increase in total deposits was $26.3 million, $1.6 million and $101.6 million for the years ended September 30, 1998, 1997 and 1996, respectively. The deposit increase in fiscal 1996 was primarily associated with two branch purchase transactions in which the Bank assumed deposit liabilities totaling $104.5 million. Certificates of deposit that are scheduled to mature in one year or less from September 30, 1998 totaled $200.0 million. Based upon its prior experience and current pricing strategy, the Bank believes that a significant portion of such deposits will remain with the Bank. The Bank monitors its liquidity position on a daily basis. Excess short- term liquidity if any, is usually invested in overnight federal funds sold. The Bank generally remains fully invested and utilizes additional sources of funds through FHLB advances, which amounted to $38.6 million at September 30, 1998. At September 30, 1998, the Bank exceeded all of its regulatory capital requirements with a leverage capital level of $50.6 million, or 7.4% of adjusted assets (which is above the required level of $20.6 million, or 3.0%) and a risk- based capital level of $55.5 million, or 14.2% of risk-weighted assets (which is above the required level of $31.3 million, or 8.0%). See Note 11 of the Notes to Consolidated Financial Statements included as an exhibit to this report. Year 2000 Considerations The following information constitutes "Year 2000 Readiness Disclosure" under the Year 2000 Information and Readiness Disclosure Act. The Bank, like all companies that utilize computer technology, is facing the significant challenge of ensuring that its computer systems will be able to process time-sensitive data accurately beyond the Year 1999 (referred to as the "Year 2000", or the "Y2K" issue). The Year 2000 issue has arisen since many existing computer programs use two digits rather than four in date fields that define the year. Such computer programs may recognize a date field using "00" as the Year 1900 rather than the Year 2000. Software, hardware and equipment both within and outside the Bank's direct control (and with which the Bank interfaces either electronically or operationally), are likely to be affected by the Year 2000 issue. The Bank has conducted a comprehensive review of its computer systems to identify systems that could be affected by the Year 2000 issue, and has developed an implementation plan (including establishing priorities for mission- critical applications) to modify or replace the affected systems and test them for Year 2000 compliance. The Bank's plan includes actions to identify Year 2000 issues attributable to its own systems as well as those of third parties who supply products and services to the Bank, or who have material business relationships with the Bank. The Bank realizes that the Year 2000 issue extends beyond the computer systems associated with its operations. The Bank has identified and begun a process of quantifying external risks posed by the Y2K problem. The Bank's Year 2000 plan addresses each of these factors and, in cases where risks may be high, the Bank has begun to take action to protect its interests, including establishing contingency plans to be activated in the event of system failures. In addition to its internal efforts, the Bank has employed the services of an outside firm to help it with this planning effort. Although no guaranty can be given that all internal systems and/or third parties will be prepared for the Year 2000 issue, the actions being taken by the Bank in response to Year 2000 issues are consistent with the guidelines set forth in policy statements issued by the bank regulatory agencies. The Bank has identified six mission-critical systems including its "core" data processing system for loans, deposits and the general ledger. In November 1998, the Bank converted to a new core system which it believes will enhance the quality of its information technology and result in improved customer service. Like the Bank's prior core system, the new system is maintained by a third-party vendor. Because other users of the Bank's new core system have already tested the applications at their sites, the Bank has secured approval to conduct proxy testing of its core system. Proxy testing limits the number of dates for which testing is required, and limits the number of tests which must be performed; however, the Bank intends to conduct its own testing of the core system. The Bank anticipates that it will complete this testing by March 31, 1999 and a detailed report of testing results will be produced. These results will be validated for accuracy by internal bank staff as well. The Bank is currently in the process of seeking assurances from third parties with whom it does business, either as to their current Year 2000 compliance or assurance that they are in the process of complying with the Year 2000 issue. For example, the Bank exchanges data with a number of other entities, such as credit bureaus, the Federal Reserve Bank, and governmental sponsored enterprises. The failure of these entities to adequately address the Year 2000 issue could adversely affect the Bank's ability to conduct its business. The risk also exists that some of the Bank's commercial borrowers may not be prepared for Year 2000 issues and may suffer financial harm as a result. This, in turn, represents risk to the Bank regarding the repayment of loans from those commercial customers. The Bank has surveyed its existing commercial customers with aggregate outstanding loan balances of $250,000 or more regarding their Year 2000 preparedness, and is now conducting follow-up interviews with its larger commercial borrowers to determine their readiness. Thus, while the Bank does not yet have specific financial data regarding the potential effect of the Year 2000 issues on its commercial customers, the Bank recognizes this as a risk and will continue to seek evidence of preparedness from its major borrowers. The Bank also has begun a process to assess Year 2000 readiness as a component of its risk evaluation for new commercial borrowers. While the Bank expects to complete its Year 2000 plan on a timely basis, there can be no assurance that its own systems or the systems of other companies will be completed in a timely fashion. Contingency plans are being developed for its in-house sytems on a department-by-department basis in anticipation of the possibility of unplanned system difficulties. It is expected that most of these plans will provide for some type of manual record keeping and reporting procedures, and will be completed by June 30, 1999 as part of the Bank's overall contingency planning process. In preparing its contingency plan, the Bank has categorized potential events as "uncontrollable" and "controllable". Uncontrollable events, such as loss of the global power grid and telephone service failures, will affect all companies, government and customers. These global events cannot be remedied by anyone other than the appropriate responsible party, but require the preparation of a business resumption contingency plan. The Bank has documented pre-determined actions to help it resume normal operations in the event of failure of any mission-critical service and product, as specified in the Bank's Year 2000 inventory list. For example, the Bank is ensuring the availability of cash to meet potential depositor demand due to concerns about the availability of funds after December 31, 1999. As part of its contingency planning process, the Bank will conduct a business impact analysis to identify potential disruption and the effect such disruption could have on business operations should a service provider or software vendor be unable to restore systems and/or business operations. The Bank will establish a recovery program that identifies participants, processes and equipment that might be necessary for the Bank to function adequately. The basic priorities for restoring service will be based on the essential application processing required to ensure that the Bank can continue to serve its customers. The Bank will also institute a resumption tracking system for critical operations to ensure that appropriate pre-determined actions are identified. The tracking system will also identify any required resources (equipment, personnel etc.) needed to restore operations. Monitoring and managing the Year 2000 issue will result in additional direct and indirect costs for the Bank. Direct costs include potential charges by third-party software vendors for product enhancements, costs involved in testing software products for Year 2000 compliance, and any resulting costs for developing and implementing contingency plans for critical software products which are not enhanced. Indirect costs will principally consist of the time devoted by existing employees in monitoring software vendor progress, testing enhanced software products, and implementing any necessary contingency plans. The Bank's direct and indirect costs of addressing the Y2K issue are charged to expense as incurred, except for costs incurred in the purchase of new software or hardware, which are capitalized. To date, costs incurred primarily relate to the dedication of internal resources employed in the assessment and development of the Bank's Year 2000 plan, as well as the testing of hardware and software owned or licensed for its personal computers. Based on knowledge as of the date hereof, total direct and indirect Year 2000 costs are not expected to exceed $500,000, of which less than $200,000 was incurred through September 30, 1998. -----END PRIVACY-ENHANCED MESSAGE-----