ITEM 1. BUSINESS - ----------------
FIRST SENTINEL BANCORP, INC.
First Sentinel Bancorp, Inc. ("First Sentinel" or the "Company") is a Delaware corporation organized in 1998 by First Savings Bank ("First Savings" or the "Bank") for the purpose of holding all of the capital stock of the Bank. At December 31, 2002, the Company had consolidated total assets of $2.3 billion and total stockholders' equity of $221.2 million. The Company is a unitary thrift holding company subject to regulation by the Office of Thrift Supervision ("OTS") and the Securities and Exchange Commission ("SEC").
The Company's executive offices are located at 1000 Woodbridge Center Drive, Woodbridge, New Jersey 07095. The Company's telephone number is (732) 726-9700.
FIRST SAVINGS BANK
First Savings is a New Jersey-chartered, capital stock savings bank headquartered in Woodbridge, New Jersey. First Savings has operated in its present market area since 1901.
The Bank's executive offices are located at 1000 Woodbridge Center Drive, Woodbridge, New Jersey 07095. The Bank's telephone number is (732)726-9700.
AVAILABLE INFORMATION
The Company's Internet address is WWW.FIRSTSENTINELBANCORP.COM. The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 78m(a) or 78o(d)) are made available free of charge on the Company's website.
BUSINESS STRATEGY
STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACT ARE FORWARD-LOOKING STATEMENTS, AS THAT TERM IS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS MAY BE CHARACTERIZED AS MANAGEMENT'S INTENTIONS, HOPES, BELIEFS, EXPECTATIONS OR PREDICTIONS OF THE FUTURE. IT IS IMPORTANT TO NOTE THAT SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE FUTURE RESULTS TO VARY MATERIALLY FROM CURRENT EXPECTATIONS INCLUDE, BUT ARE NOT LIMITED TO, CHANGES IN INTEREST RATES, ECONOMIC CONDITIONS, DEPOSIT AND LOAN GROWTH, REAL ESTATE VALUES, LOAN LOSS PROVISIONS, COMPETITION, CUSTOMER RETENTION, CHANGES IN ACCOUNTING PRINCIPLES, POLICIES OR GUIDELINES AND LEGISLATIVE AND REGULATORY CHANGES.
The Company's objectives are to enhance shareholder value by profitably meeting the needs of its customers and seeking controlled growth, while preserving asset quality and maintaining a strong capital position. The Company's strategy emphasizes customer service and convenience, and the Company attributes the loyalty of its customer base to its commitment to maintaining customer satisfaction. The Company attempts to set itself apart from its competitors by providing the type of personalized service not generally available from larger banks while offering a greater variety of products and services than is typically available from smaller depository institutions.
The Company's principal business, which is conducted through the Bank, is attracting retail deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, primarily in single-family residential mortgage loans, real estate construction loans, commercial real estate loans, home equity loans and lines of credit and multi-family residential mortgage loans. The Company maintains a significant portfolio of mortgage-backed securities and also invests in U.S. Government, federal agency and corporate debt securities and other marketable securities. The Company's revenues are derived principally from interest on its loan and mortgage-backed securities portfolios and interest and dividends on its investment securities. The Company's primary sources of funds are deposits, proceeds from principal and interest payments on loans and mortgage-backed securities; sales of loans, mortgage-backed and investment securities available for sale; maturities
of investment securities and short-term investments; advances from the Federal Home Loan Bank of New York ("FHLB-NY"), reverse repurchase agreements and other borrowed funds.
In an effort to enhance its long-term profitability and increase its market share, the Company has endeavored to expand its traditional thrift lending and securities investment strategy. Toward this end, the Bank continues to diversify and expand upon the products and services it offers by focusing on both lending and deposit services to small and medium-sized retail businesses. The Bank has increased its emphasis on the origination of commercial real estate, construction and commercial loans, as well as the marketing of its business checking accounts and other business-related services. To develop full-service relationships with commercial customers, the Bank provides merchant services, such as merchant credit card processing, express teller services and escrow management. The Bank has hired, and intends to continue hiring, additional personnel with expertise in commercial lending to facilitate growth in this area. The Bank has also increased loan volumes through the use of third-party correspondent lending. Purchased loans were primarily one-to-four family adjustable-rate mortgages, underwritten internally, with higher rates than those currently offered by the Bank. Third-party correspondent lending is expected to continue to play a minor role in the future operations of the Bank.
As part of the Company's asset/liability management strategy, and as a means of enhancing profitability, the Company also invests in investment and mortgage-backed securities. In recent years, the Company has utilized its ability to borrow as an alternative means of funding asset growth. The average balance of borrowings outstanding for the years ended December 31, 2002, 2001 and 2000 was $588.0 million, $495.7 million and $503.4 million, respectively. The Company will continue to evaluate leveraged growth opportunities as market conditions allow and manage its borrowing levels to mitigate interest rate risk and/or reduce funding costs.
The Company repurchased 2.6 million shares, or $36.0 million, of its common stock during 2002 as part of its ongoing capital management strategy. In December 2002, the Company completed a 5% stock repurchase program authorized in May 2002. In January 2003, the Board of Directors authorized a new 5% stock repurchase program under which an additional 1.4 million shares of the Company's stock may be repurchased. The Company's dividend payout ratio was 39.5%, 35.9%, 34.8%, 61.7% and 32.6% for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
The Company intends to actively seek additional expansion opportunities in the areas surrounding its current branch locations. Accordingly, the Company purchased an existing bank branch facility in Somerset, New Jersey, in December 2001. This new branch location opened in February 2002. In addition, the Company plans to relocate one branch and add two new retail locations in 2003.
MARKET AREA AND COMPETITION
The Company currently operates 23 branch offices in central New Jersey, 18 of which are located in Middlesex County, two in Monmouth County and one in each of Mercer, Somerset and Union Counties. The Company's deposit gathering base is concentrated in the communities surrounding its offices. The majority of the Company's loan originations are derived from northern and central New Jersey, which is a part of the New York City metropolitan area and which has historically benefited from having a large number of corporate headquarters and a concentration of financial services-related industries. The area also has a well-educated employment base and a large number of industrial, service and high-technology businesses. Relatively low unemployment levels and favorable interest rates have contributed to the appreciation in New Jersey's real estate market in recent years. Whether such appreciation will continue is dependent, in large part, upon the general economic condition of both New Jersey and the United States and other factors beyond the Company's control and, therefore, cannot be estimated.
The Company faces significant competition both in making loans and in attracting deposits. The State of New Jersey has a high density of financial institutions, many of which are branches of significantly larger institutions which have greater financial resources than the Company, and all of which are competitors of the Company to varying degrees. The Company's competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies and insurance companies. Its most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. The Company faces additional competition for deposits from short-term money market funds, other corporate and government securities funds and from other financial institutions such as brokerage firms and insurance companies.
ANALYSIS OF NET INTEREST INCOME
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.
AVERAGE BALANCE SHEET. The following table sets forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Average balances are derived from month-end balances.
(1) Loans receivable, net includes non-accrual loans.
(2) Includes federal funds sold and FHLB-NY stock. All securities are presented at amortized cost.
(3) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4) Net interest margin represents net interest income divided by average interest-earning assets.
RATE/VOLUME ANALYSIS
Net interest income can also be analyzed in terms of the impact of changing interest rates on interest-earning assets and interest-bearing liabilities and changing volume or amount of these assets and liabilities. The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (change in volume multiplied by prior rate), (ii) changes attributable to changes in rate (change in rate multiplied by prior volume), and (iii) the net change. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate.
LENDING ACTIVITIES
LOAN AND MORTGAGE-BACKED SECURITIES PORTFOLIO COMPOSITIONS. The Company's loan portfolio consists primarily of conventional first mortgage loans secured by one-to-four family residences and, to a lesser extent, multi-family residences and commercial real estate. At December 31, 2002, the Company's loan portfolio totaled $1.2 billion, of which $835.6 million, or 68.9% were one-to-four family residential mortgage loans. At that date, the Company's loan portfolio also included $110.8 million of home equity loans and lines of credit generally secured by second liens on one-to-four family residential properties, $77.1 million of net construction loans, $164.6 million of commercial real estate loans, and $12.7 million of multi-family residential mortgage loans, which represented 9.1%, 6.4%, 13.6% and 1.1%, respectively, of total loans receivable. Of the mortgage loan portfolio outstanding at December 31, 2002, 47.6% were fixed-rate loans and 52.4% were adjustable-rate mortgage ("ARM") loans. Other loans held by the Company, which consist of loans on deposit accounts, commercial, personal, and automobile loans, totaled $12.5 million, or 1.0% of total loans outstanding at December 31, 2002. The Company anticipates continued growth in construction, commercial and commercial real estate loans, both in amount and as a percentage of total loans receivable, in the foreseeable future due to its efforts to diversify the loan portfolio.
The majority of the loans originated by the Company are held for investment. In order to manage interest rate risk and diversify credit risk, however, the Company periodically sells 30-year, fixed-rate conforming loans to the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC"), FHLB-NY and institutional investors and generally retains servicing rights. All such loans are sold without recourse. At December 31, 2002, the Company's servicing portfolio totaled $106.1 million. The Company had $563,000 in loans held for sale at December 31, 2002.
The Company also invests in mortgage-backed securities and other mortgage-backed products such as collateralized mortgage obligations ("CMOs"). At December 31, 2002, mortgage-backed securities, including CMOs, were $790.6 million, or 35.0% of total assets, of which 67.6% were secured by ARM loans. The majority of the Company's mortgage-backed securities are insured or guaranteed by Freddie Mac, the Government National Mortgage Association ("GNMA"), or Fannie Mae ("FNMA"). At December 31, 2002, all mortgage-backed securities were classified as available for sale. Mortgage-backed securities available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions, or to provide liquidity to fund activities such as common stock repurchases or loan originations. The Company expects to classify all mortgage-backed security purchases as available for sale in the foreseeable future.
The following table sets forth the composition of the Company's loan and mortgage-backed securities portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated (dollars in thousands):
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(1) Includes $563,000, $5.5 million and $277,000 in mortgage loans held for sale at December 31, 2002, 2001 and 2000, respectively. No loans were classified as held for sale at December 31, 1999 or 1998.
(2) Net of loans in process of $62.1 million, $65.1 million, $19.2 million, $28.0 million and $41.8 million at December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
LOAN MATURITY AND REPRICING
The following table shows the maturity or period to repricing of the Company's loan portfolio at December 31, 2002. Loans that have adjustable rates are shown as being due in the period during which the interest rates are next subject to change. The table does not include prepayments or scheduled principal amortization.
(1) Excludes loans in process of $62.1 million.
The following table sets forth at December 31, 2002, the dollar amount of loans contractually due or repricing after December 31, 2003, and whether such loans have fixed interest rates or adjustable interest rates (in thousands):
ONE-TO-FOUR FAMILY MORTGAGE LOANS. The Company offers fixed and adjustable-rate first mortgage loans secured by one-to-four family residences in New Jersey. Typically, such residences are single family homes that serve as the primary residence of the owner. Loan originations are generally obtained from existing or past
customers, members of the local community, and referrals from attorneys, established builders, and realtors within the Company's market area. In addition, one-to-four family residential mortgage loans are also originated in the Company's market area through loan originators who are employees of the Company and are compensated on a commission basis. Originated mortgage loans in the Company's portfolio include due-on-sale clauses which provide the Company with the contractual right to deem the loan immediately due and payable in the event that the borrower transfers ownership of the property without the Company's consent.
At December 31, 2002, 68.9% of total loans receivable consisted of one-to-four family residential loans. The Company offers ARM loans with initial fixed-rate terms of either one, three, five, seven or ten years. After the initial fixed-rate term, the loan then converts into a one-year ARM. The Company's ARM loans may carry an initial interest rate which is less than the fully-indexed rate for the loan. The initial discounted rate is determined by the Company in accordance with market and competitive factors. The majority of the Company's ARM loans adjust by a maximum of 2.00% per year, with a lifetime cap on increases of up to 6.00%. ARM loans are originated for terms of up to 30 years. Interest rates charged on fixed-rate loans are competitively priced based on market conditions and the Company's cost of funds. The Company's fixed-rate mortgage loans currently are made for terms of 10 through 30 years.
Generally, ARM loans pose credit risks different than risks inherent in fixed-rate loans, primarily because as interest rates rise, the payments of the borrower rise, thereby increasing the potential for delinquency and default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. In order to minimize risks, borrowers of one-year ARM loans are qualified at the starting interest rate plus 2.00% or the fully-indexed rate, whichever is lower. The Company does not originate ARM loans which provide for negative amortization. The Company also offers Limited Documentation loans that do not require income verification but do require full asset verification.
The Company generally originates one-to-four family residential mortgage loans in amounts up to 97% of the appraised value or selling price of the mortgaged property, whichever is lower. The Company requires private mortgage insurance for all loans originated with loan-to-value ratios exceeding 80%. Generally, the minimum one-to-four family loan amount is $25,000, and the maximum loan amount is $1,000,000. The Company offers residential mortgage loans with origination fees ranging from 0.00% to 3.00%.
HOME EQUITY LOANS AND LINES OF CREDIT. The Company originates home equity loans secured by one-to-four family residences. These loans generally are originated as fixed-rate loans with terms from five to 15 years. Home equity loans are primarily made on owner-occupied, one-to-four family residences and to the Company's first mortgage customers. These loans are generally subject to a 80% loan-to-value limitation including any other outstanding mortgages or liens. In addition, the Company currently offers home equity loans for qualified borrowers with a loan-to-value ratio of up to 100%. The Company obtains private mortgage insurance for some of these types of loans, depending on the underwriting and first lien position. The Company also offers "Helping Hand" home equity loans for low income borrowers, with a maximum term of ten years, with loan-to-value ratios of up to 100% and a maximum loan amount of $20,000. Generally, the Company's minimum equity loan is $10,000 and the maximum equity loan is $500,000. As of December 31, 2002, the Company had $62.4 million in fixed-rate home equity loans outstanding.
The Company also offers a variable rate, home equity line of credit, which is a credit line based on the applicant's income and equity in the home. Generally, the credit line, when combined with the balance of the first mortgage lien, may not exceed 80% of the appraised value of the property at the time of the loan commitment. Home equity lines of credit are secured by a mortgage on the underlying real estate. The Company presently charges no origination fees for these loans. A borrower is required to make monthly payments of principal and interest, at a minimum of $100.00 plus interest, based upon a 20-year amortization period. The interest rate charged is the prime rate of interest (as published in THE WALL STREET JOURNAL) (the "prime rate") plus up to 0.25%. The Company also offers a credit line product based on a 15-year amortization and the interest rate charged is the prime rate. The Company offers a fixed 6-month introductory rate on both home equity line of credit products. The introductory rate is currently 3.99%. The Company offers an additional credit line product that allows for a loan-to-value ratio of up to 100%. Payments are based on 15 or 20-year amortization periods with interest rates varying between the prime rate plus 1.50% to the prime rate plus 1.75%. All home equity lines of credit are subject to a maximum annual
interest rate change of 2.00% with a 14.99% ceiling. The Company's home equity lines of credit outstanding at December 31, 2002 totaled $48.5 million, with additional available credit lines of $65.5 million.
CONSTRUCTION LENDING. At December 31, 2002, construction loans totaled $77.1 million, or 6.4% of the Company's total loans outstanding. Available credit lines totaled $62.1 million at December 31, 2002. Construction loans generally bear interest rates that float at margins of up to 1.5% above the prime rate, with the majority also having floor rates. The Company's construction loans typically have original principal balances that are larger than its one-to-four family mortgage loans, with the majority of the loans ranging from available lines of credit of $400,000 to $11.5 million. At December 31, 2002, the Company had 49 construction loans, 21 of which had principal outstanding of $1.0 million or more, with the largest outstanding loan balance being $9.9 million. At December 31, 2002, all of the Company's construction lending portfolio consisted of loans secured by property located in the State of New Jersey, primarily for the purpose of constructing one-to-four family homes.
The Company will originate construction loans on unimproved land in amounts up to 70% of the lower of the appraised value or the cost of the land. The Company also originates loans for site improvements and construction costs in amounts up to 75% of actual costs or sales price where contracts for sale have been executed. Generally, construction loans are offered for 12-month to 18-month terms with up to four six-month options to extend the original term. Typically, additional loan origination fees are charged for each extension granted however, these fees have been waived occasionally. The Company requires an appraisal of the property, credit reports, and financial statements on all principals and guarantors, among other items, on all construction loans.
Construction lending, by its nature, entails additional risks as compared with one-to-four family mortgage lending, attributable primarily to the fact that funds are advanced upon the security of the project under construction prior to its completion. As a result, construction lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower or guarantor to repay the loan. Because of these factors, the analysis of prospective construction loan projects requires an expertise that is different in significant respects from that which is required for residential mortgage lending. The Company addresses these risks through its underwriting procedures. See "Asset Quality" for further discussion.
COMMERCIAL REAL ESTATE. At December 31, 2002, the Company had 163 loans secured by commercial real estate, totaling $164.6 million, or 13.6% of the Company's total loan portfolio. Commercial real estate loans are generally originated in amounts up to 75% of the appraised value of the mortgaged property. The Company's commercial real estate loans are permanent loans secured by improved property such as office buildings, retail stores, small shopping centers, medical offices, small industrial facilities, warehouses, storage facilities and other non-residential buildings. The largest commercial real estate loan at December 31, 2002 had an outstanding balance of $7.6 million and was secured by a hotel. Substantially all commercial real estate loans in the Company's portfolio are secured by properties located within New Jersey.
The Company's commercial real estate loans are generally made for terms of up to 15 years. These loans typically are based upon a payout period of 10 to 25 years. To originate commercial real estate loans, the Company requires a security interest in personal property, standby assignment of rents and leases and some level of personal guarantees, if possible. The Company has established a $20.0 million maximum for any individual commercial real estate loan.
Loans secured by commercial real estate properties are generally larger and involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject, to a greater extent, to adverse conditions in the real estate market or the economy. The Company seeks to minimize these risks by limiting the number of such loans, lending only to established customers and borrowers otherwise known or recommended to the Company, generally restricting such loans to New Jersey, and obtaining personal guarantees, if possible.
MULTI-FAMILY MORTGAGE LOANS. The Company originates multi-family mortgage loans in its primary lending area. As of December 31, 2002, $12.7 million, or 1.1%, of the Company's total loan portfolio consisted of multi-family residential loans. At December 31, 2002, the Company had two multi-family loans with an outstanding
balance in excess of $1.7 million. Large multi-family loans such as these are originated using the Company's underwriting standards for commercial real estate loans.
OTHER LENDING. The Company also offers other loans, primarily commercial, personal, automobile, boat, motorcycle and motor home loans and loans secured by deposit accounts. At December 31, 2002, $12.5 million, or 1.0%, of the loan portfolio consisted of such other loans.
LOAN APPROVAL AUTHORITY AND UNDERWRITING. All loans secured by real estate must have the approval or ratification of the members of the Loan Committee, which consists of at least two outside directors and at least two officers engaged in the lending area. The Loan Committee meets at least monthly to review and ratify management's approval of loans made within the scope of its authority since the last committee meeting, and to approve mortgage loans made in excess of $750,000, but not greater than $1.0 million. Real estate loans in excess of $1.0 million require prior Board approval. Prior Board approval is also required for the origination of consumer and business loans in excess of $100,000 for unsecured loans, and $500,000 for secured loans.
One-to-four family residential mortgage loans are generally underwritten according to Freddie Mac guidelines, except as to loan amount and certain documentation. For all loans originated by the Company, upon receipt of a completed loan application from a prospective borrower, a credit report is requested, income, assets and certain other information are verified and, if necessary, additional financial information is requested. An appraisal of the real estate intended to secure the proposed loan is required, performed by independent appraisers designated and approved by the Board of Directors. It is the Company's policy to obtain appropriate insurance protections, including title and flood insurance, on all real estate first mortgage loans. Borrowers must also obtain hazard insurance prior to closing. Borrowers generally are required to advance funds for certain items such as real estate taxes, flood insurance and private mortgage insurance, when applicable.
LOAN SERVICING. The Company generally retains the servicing rights on loans it has sold. The Company receives fees for these servicing activities, which include collecting and remitting loan payments, inspecting the properties and making certain insurance and tax payments on behalf of the borrowers. The Company was servicing $106.1 million and $96.1 million of mortgage loans for others at December 31, 2002 and 2001, respectively. The Company received $204,000 and $193,000 in servicing fees for the years ended December 31, 2002 and 2001, respectively.
LOAN PURCHASES AND SALES. The Company is a Freddie Mac qualified servicer in good standing, and may sell any of its conforming loans originated, subject to Freddie Mac requirements, and retain the servicing rights. The Company may also sell loans to the FHLB-NY and institutional investors, and generally retains servicing rights. As a part of its asset/liability management, the Company will sell loans, on occasion, in order to reduce or minimize potential interest rate and credit risk. As of December 31, 2002, $563,000 of mortgage loans were classified as held for sale. Mortgage loans sold totaled $46.6 million for each of the years ended December 31, 2002 and 2001. Periodically, the Company may also purchase mortgage loans. The Company purchased $27.6 and $19.1 million in mortgage loans from third-party correspondents for the years ended December 31, 2002 and 2001, respectively. The Company underwrote the loans and verified documentation prior to purchase and received representations and warranties for a one year period, including repayment of remaining purchase premiums if a loan prepays within the first 12 months.
ASSET QUALITY
The following table sets forth information regarding non-accrual loans, loans delinquent 90 days or more, and real estate owned ("REO"). At December 31, 2002, REO totaled $72,000 and consisted of one residential property. It is the policy of the Company to cease accruing interest on loans 90 days or more past due with loan-to-value ratios in excess of 55% and to reverse all previously accrued interest. For the year ended December 31, 2002, the amount of additional interest income that would have been recognized on nonaccrual loans if such loans had continued to perform in accordance with their contractual terms was $118,000.
CLASSIFICATION OF ASSETS. The Company classifies loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the Company to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. Loans designated as special mention are generally loans that, while current in required payment, have exhibited some potential weaknesses that, if not corrected, could increase the level of risk in the future. Pursuant to the Company's internal guidelines, all one-to-four family residential mortgage loans with loan-to-value ratios in excess of 55% which are 90 days past due and all other loans which are 90 days past due are classified substandard, doubtful, or loss.
The Company's classified assets totaled $2.1 and $9.0 million at December 31, 2002 and 2001, respectively. At December 31, 2002, $1.2 million of classified loans were secured by residential properties. The majority of the remaining $900,000 in classified loans consisted of a $668,000 construction loan secured by a residential housing development with an estimated loan-to-value ratio of 66%.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the adequacy of the allowance, including an assessment of known and inherent
risks in the Bank's loan portfolio, review of individual loans for adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and consideration of current economic conditions. Such evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers the fair value of the underlying collateral, economic conditions, historical loan loss experience, and other factors that warrant recognition in providing for an adequate loan loss allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and valuation of real estate owned. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The Company recorded $1.3 million and $650,000 in provisions for loan losses for the years ended December 31, 2002 and 2001, respectively. The increase in the provision for loan losses was largely attributable to a $1.4 million charge against the allowance for loan losses related to a participation loan to an insurance premium financier. This charge-off was precipitated by alleged acts of fraud and/or misrepresentation. The Company has received payment in full settlement of the remaining loan balance and has no further exposure to this item. At December 31, 2002, the Company holds no other insurance premium financing loans, nor does it have any other loans similar to this loan wherein the primary collateral is a surety bond. The Company believes that the allowance for loan losses is adequate. At December 31, 2002, the total allowance was $12.8 million, which amounted to 1.06% of loans receivable, net of unearned and deferred fees, and 7.3 times non-performing loans. The Company will continue to monitor the level of its allowance for loan losses in order to maintain it at a level which management considers adequate to provide for probable loan losses.
The following table sets forth activity in the Company's allowance for loan losses for the periods indicated (in thousands):
The following tables set forth the Company's percentage of allowance for loan losses to total allowance for loan losses and the percent of loans to total loans in each of the categories listed at the dates indicated (dollars in thousands):
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which, in general, are passed from the mortgage originators, through intermediaries that pool and repackage the participation interest in the form of securities, to investors such as the Company. Such intermediaries may be private issuers, or agencies of the U.S. Government, including Freddie Mac, FNMA and GNMA, that guarantee the payment of principal and interest to investors.
Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a specified range and have varying maturities. The underlying pool of mortgages can be composed of either fixed-rate or ARM loans. Mortgage-
backed securities are generally referred to as mortgage participation certificates or pass-through certificates. As a result, the interest rate risk characteristics of the underlying pool of mortgages (e.g., fixed-rate or adjustable-rate) as well as prepayment, default and other risks associated with the underlying mortgages (see "Lending Activities") are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgage(s).
The actual maturity of a mortgage-backed security varies, depending on when the mortgagors repay or prepay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the security, thereby affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization or accretion of the premium or discount related to the mortgage-backed security. Premiums and discounts are amortized or accreted over the anticipated life of the loans. The prepayment assumptions used to determine the amortization or accretion period for premiums and discounts can significantly affect the yield calculation of the mortgage-backed security, and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayments of the underlying mortgages depend on many factors, including the type of mortgages, the coupon rates, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages, general levels of market interest rates, and general economic conditions. GNMA mortgage-backed securities that are backed by assumable Federal Housing Authority ("FHA") or Veterans Administration ("VA") loans generally have a longer life than conventional non-assumable loans underlying Freddie Mac and FNMA mortgage-backed securities. The difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is an important determinant in the rate of prepayments. During periods of falling mortgage interest rates, prepayments generally increase, as opposed to periods of increasing interest rates whereby prepayments generally decrease. If the interest rate of underlying mortgages significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities, both convertible and non-convertible.
The Company has significant investments in mortgage-backed securities and has utilized such investments to complement its mortgage lending activities. At December 31, 2002, mortgage-backed securities, net, totaled $790.6 million, or 35.0% of total assets. All such securities were classified as available for sale and carried at market value. The Company invests in a large variety of mortgage-backed securities, including ARM, balloon and fixed-rate mortgage-backed securities, the majority of which are directly insured or guaranteed by Freddie Mac, GNMA and FNMA. At December 31, 2002, the mortgage-backed securities portfolio had a weighted average interest rate of 5.39%. Fixed coupon rates ranged from 6.00% to 9.50% for GNMA, 5.50% to 9.00% for Freddie Mac, 5.50% to 7.00% for FNMA fixed-rate securities and 2.28% to 6.50% for fixed-rate CMOs. Adjustable-rate coupon ranges were as follows: 4.00% to 6.63% for GNMA ARM mortgage-backed securities; 4.35% to 7.13% for Freddie Mac ARM mortgage-backed securities; and 4.29% to 6.06% for FNMA ARM mortgage-backed securities.
Included in the total mortgage-backed securities portfolio are CMOs, which had a market value of $120.8 million at December 31, 2002. The Company generally purchases short-term, sequential or planned amortization class ("PAC") CMOs. CMOs are securities created by segregating or portioning cash flows from mortgage pass-through securities or from pools of mortgage loans. CMOs provide a broad range of mortgage investment vehicles by tailoring cash flows from mortgages to meet the varied risk and return preferences of investors. These securities enable the issuer to "carve up" the cash flows from the underlying securities and thereby create multiple classes of securities with different maturity and risk characteristics. The CMOs and other mortgage-backed securities in which the Company invests may have a multi-class structure ("Multi-Class Mortgage Securities"). Multi-Class Mortgage Securities issued by private issuers may be collateralized by pass-through securities guaranteed by GNMA or issued by FNMA or Freddie Mac, or they may be collateralized by whole loans or pass-through mortgage-backed securities of private issuers. Each class has a specified maturity or final distribution date. In one structure, payments of principal, including any principal prepayments, on the collateral are applied to the classes in the order of their respective stated maturities or final distribution dates, so that no payment of principal will be made on any class until all classes having an earlier stated maturity or final distribution date have been paid in full. In other structures, certain classes may pay concurrently, or one or more classes may have a priority with respect to payments on the underlying collateral up to a specified amount. The Company's funds have not and will not be invested in any class with residual characteristics. The weighted average life of CMOs at December 31, 2002, was 3.8 years. The stated weighted average contractual maturity of the Company's CMOs at December 31, 2002, was 17.0 years.
The Company only purchases CMOs and mortgage-backed securities that are rated "AA" or higher at the time of purchase. Prior to purchasing CMOs and periodically throughout their lives, individual securities are reviewed for suitability with respect to projected weighted average lives and price sensitivity. Generally, fixed-rate CMOs purchased have projected average durations of three years or less using current market prepayment assumptions prevalent at the time of purchase and projected average durations that do not exceed nine years in the event of a 300 basis point increase in market rates of interest. The Company receives a detailed analysis from the broker/dealer or from the Bloomberg System on each security.
The amortized cost and market value of mortgage-backed securities at December 31, 2002, by contractual maturity are shown below. Expected maturities will differ from contractual maturities due to prepayments (in thousands):
INVESTMENT ACTIVITIES
The Investment Policy of the Company, which is established by the Board of Directors and reviewed by the Investment Committee, is designed primarily to provide and maintain liquidity, to generate a favorable return on investments without incurring undue interest rate and credit risk and to complement the Company's lending activities. The Policy currently provides for held to maturity, available for sale and trading portfolios, although all securities are currently classified as available for sale.
New Jersey state-chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and loans on federal funds. Subject to various restrictions, state-chartered savings institutions may also invest a portion of their assets in commercial paper, corporate debt securities and asset-backed securities.
INVESTMENTS AVAILABLE FOR SALE. The Company maintains a portfolio of investments available for sale to minimize interest rate and market value risk. These investments, designated as available for sale at purchase, are marked to market in accordance with Statement of Financial Accounting Standard No. 115. The Company's Investment Policy designates what type of securities may be contained in the available for sale portfolio. This portfolio of available for sale investments is reviewed and priced at least monthly. As of December 31, 2002, the market value of investment securities available for sale was $114.2 million, with an amortized cost basis of $112.1 million, and was composed of U.S. Government and Agency securities, state and political obligations, corporate obligations and equity securities. The available for sale portfolio, excluding equity securities, had a weighted average contractual maturity of 9.0 years. A portion of the investment portfolio is comprised of callable agency notes, which have a variety of call options available to the issuer at predetermined dates. The investment portfolio's yield is enhanced by the addition of callable agency notes, due to the issuer's flexibility in repricing their funding source, while creating reinvestment risk to the Company. At December 31, 2002, $71.7 million, or 62.8% of the total investment portfolio was callable.
INVESTMENT PORTFOLIO. The following table sets forth certain information regarding the carrying and market values of the Company's investment portfolio at the dates indicated (in thousands):
The table below sets forth certain information regarding the contractual maturities, amortized costs, market values, and weighted average yields for the Company's investment portfolio at December 31, 2002. Investments in equity securities, which have no contractual maturities, are excluded from this table.
SOURCES OF FUNDS
GENERAL. The Company's primary source of funds are deposits; proceeds from principal and interest payments on loans and mortgage-backed securities; sales of loans, mortgage-backed securities and investments available for sale; maturities of investment securities and short-term investments; and advances from the FHLB-NY, reverse repurchase agreements and other borrowed funds.
DEPOSITS. The Company offers a variety of deposit accounts having a range of interest rates and terms. The Company's deposits principally consist of fixed-term fixed-rate certificates, passbook and statement savings, money market, Individual Retirement Accounts ("IRAs") and Negotiable Order of Withdrawal ("NOW") accounts. The flow of deposits is significantly influenced by general economic conditions, changes in money market and prevailing interest rates and competition. The Company's deposits are typically obtained from the areas in which its offices are located. The Company relies primarily on customer service and long-standing relationships to attract and retain these deposits. At December 31, 2002, $133.2 million, or 9.6%, of the Company's deposit balance consisted of IRAs. Also at that date, $277.1 million, or 20.0%, of the Company's deposit balance consisted of accounts with balances greater than or equal to $100,000. The Company does not currently accept brokered deposits.
At December 31, 2002, certificate accounts in amounts of $100,000 or more mature as follows (in thousands):
MATURITY PERIOD Amount --------------- ------------------- Three months or less ................ $ 29,551 Over 3 through 6 months ............. 16,740 Over 6 through 12 months ............ 11,419 Over 12 months ...................... 22,433 -------------------- Total ........................ $ 80,143 ====================
The following table sets forth the distribution of the Company's average accounts for the periods indicated and the weighted average nominal interest rates on each category of deposits presented (dollars in thousands):
BORROWINGS. The Company's policy has been to utilize borrowings as an alternate and/or less costly source of funds. The Company obtains advances from the FHLB-NY, which are collateralized by the capital stock of the FHLB-NY held by the Company and certain one-to-four family mortgage loans held by the Company. The Company also borrows funds via reverse repurchase agreements with the FHLB-NY and primary broker/dealers. Advances from the FHLB-NY are made pursuant to varying terms, including interest rate, maturity, amortization and call options. The maximum amount that the FHLB-NY will advance to member institutions, including the Bank, for purposes other than withdrawals, fluctuates from time to time in accordance with the policies of the FHLB-NY. The maximum amount of FHLB-NY advances permitted to a member institution generally is reduced by borrowings from any other source. At December 31, 2002, the Company's FHLB-NY advances totaled $140.7 million, representing 7.0% of total liabilities.
At December 31, 2002, borrowings from the FHLB-NY and approved primary broker/dealers collateralized by designated mortgage-backed and investment securities totaled $456.0 million, representing 22.7% of total liabilities.
The Company also had an available overnight line-of-credit with the FHLB-NY for a maximum of $50.0 million.
The following table sets forth certain information regarding the Company's borrowed funds on the dates indicated (dollars in thousands):
SUBSIDIARY ACTIVITIES
FSB FINANCIAL LLC FSB Financial LLC is a wholly-owned subsidiary of the Bank and provides a line of fixed and variable rate annuity products, along with mutual funds and term life insurance. For the year ended December 31, 2002, FSB Financial LLC had net income of $255,000.
1000 WOODBRIDGE CENTER DRIVE, INC. 1000 Woodbridge Center Drive, Inc. is a wholly-owned subsidiary of the Bank. 1000 Woodbridge Center Drive, Inc. is a real estate investment trust and the majority of the Bank's mortgage loan portfolio is held by this subsidiary. 1000 Woodbridge Center Drive, Inc. had net income of $36.1 million for the year ended December 31, 2002.
FIRST SENTINEL CAPITAL TRUST I AND FIRST SENTINEL CAPITAL TRUST II. These subsidiaries are special purpose business trusts established for the issuance of $25.0 million in preferred capital securities. Each is a wholly-owned subsidiary of the Company.
In addition, the Company has three wholly-owned subsidiaries which were inactive in 2002.
PERSONNEL
As of December 31, 2002, the Company had 292 full-time employees and 43 part-time employees. The employees are not represented by a collective bargaining unit, and the Company considers its relationship with its employees to be good.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a consolidated basis. The Company and the Bank will report their income on a calendar year basis using the accrual method of accounting and will be subject to federal income taxation in the same manner as other corporations with some exceptions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company or the Bank.
BAD DEBT RESERVE. Retained earnings at December 31, 2002 and 2001, included approximately $18.1 million for which no provision for income tax has been made. This amount represents an allocation of income to bad debt deductions for tax purposes only. Events that would result in taxation of these reserves include failure to qualify as a bank for tax purposes, distributions in complete or partial liquidation, stock redemptions, excess distributions to shareholders or a change in Federal tax law. At December 31, 2002 and 2001, the Company had an unrecognized tax liability of $6.5 million with respect to this reserve. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a "non-dividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 35% corporate income tax rate (exclusive of state and local taxes). The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserve.
CORPORATE ALTERNATIVE MINIMUM TAX. The Internal Revenue Code of 1986, as amended, imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating loss carryovers, of which the Company currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Company's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). The Company does not expect to be subject to the alternative minimum tax.
STATE AND LOCAL TAXATION
STATE OF NEW JERSEY. The Bank files a New Jersey income tax return. For New Jersey income tax purposes, savings institutions are presently taxed at a rate equal to 9% of taxable income. For this purpose, "taxable income" generally means federal taxable income, subject to certain adjustments (including the addition of net interest income on state and municipal obligations).
The Company is required to file a New Jersey income tax return because it is doing business in New Jersey. For New Jersey tax purposes, regular corporations are presently taxed at a rate equal to 9% of taxable income. For this purpose, "taxable income" generally means Federal taxable income subject to certain adjustments (including addition of interest income on state and municipal obligations).
New Jersey corporate taxpayers are subject to an alternative minimum assessment ("AMA") of up to $5.0 million. The AMA is computed on either gross receipts or gross profits, based on an ascending scale. AMA is payable when the calculated amount exceeds the normally computed Corporation Business Tax liability.
DELAWARE TAXATION. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with, and pay an annual franchise tax to, the State of Delaware.
REGULATION AND SUPERVISION
GENERAL
The Company, as holding company for the Bank, is required to file certain reports with, and otherwise comply with the rules and regulations of the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the activities of savings institutions, such as the Bank, are governed by the HOLA and the Federal Deposit Insurance Act, as amended (the "FDI Act"). The Company is also required to file certain reports with, and otherwise comply with, the rules and regulations of the Securities and Exchange Commission under the federal securities laws.
As a New Jersey chartered savings bank, the Bank is subject to extensive regulation, examination and supervision by the Commissioner of the New Jersey Department of Banking and Insurance (the "Commissioner") as its chartering agency, and by the Federal Deposit Insurance Corporation ("FDIC"), as the deposit insurer. The Bank's deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the Commissioner and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other depository institutions and opening or acquiring branch offices. The Commissioner and the FDIC conduct periodic examinations to assess the Bank's compliance with various regulatory requirements.
The regulation and supervision of the Company and the Bank establish a comprehensive framework of activities in which an institution can engage and are intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Commissioner, the FDIC, the OTS or through legislation, could have a material adverse impact on the Company, the Bank and their operations and stockholders. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein.
HOLDING COMPANY REGULATION
Federal law allows a state savings bank that qualifies as a "qualified thrift lender" ("QTL") to elect to be treated as a savings association for purposes of the savings and loan holding company provisions of the HOLA. Such election would result in its holding company being regulated as a savings and loan holding company by the OTS, rather than as a bank holding company by the Federal Reserve Board. The Bank made such election and received approval from the OTS to become a savings and loan holding company. The Company is regulated as a nondiversified unitary savings and loan holding company within the meaning of the HOLA. As such, the Company is registered with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. In addition, the OTS has enforcement authority over the Company. As a unitary savings and loan holding company, the Company generally is not restricted under existing laws as to the types of business activities in which it may engage, provided that the Bank continues to be a QTL. Under the QTL test, a savings association is required to maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) certain intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) on a monthly basis in at least 9 months out of each 12 month period. If First Savings fails the QTL test, First Sentinel Bancorp must convert to a bank holding company. Additionally, First Savings must wait five years before applying to the OTS to regain its status as a "qualified thrift lender." As of December 31, 2002, the Bank maintained 86.1% of its portfolio assets in qualified thrift investments and had more than 80% of its portfolio assets in qualified thrift investments for each of the 12 months ending December 31, 2002, thereby qualifying under the QTL test.
The Gramm-Leach Bliley Act ("Gramm-Leach") also restricts the powers of new unitary savings and loan association holding companies. Unitary savings and loan holding companies that are "grandfathered," i.e., unitary savings and loan holding companies in existence or with applications filed with the OTS on or before May 4, 1999, such as the Company, retain their authority under the prior law. All other unitary savings and loan holding companies are limited to financially related activities permissible for bank holding companies, as defined under
Gramm-Leach. Gramm-Leach also prohibits non-financial companies from acquiring grandfathered unitary savings and loan association holding companies.
Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the QTL test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would be subject to extensive limitations on the types of business activities in which it could engage. The HOLA limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"), subject to the prior approval of the OTS, and certain activities authorized by OTS regulation, and no multiple savings and loan holding company may acquire more than 5% of the voting stock of a company engaged in impermissible activities, except in certain limited circumstances.
The HOLA prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of the voting stock of another savings institution or holding company thereof, without prior written approval of the OTS or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
NEW JERSEY HOLDING COMPANY REGULATION. Under the New Jersey Banking Act, a company owning or controlling a savings bank is regulated as a bank holding company. The New Jersey Banking Act defines the terms "company" and "bank holding company" as such terms are defined under the BHC Act. Each bank holding company controlling a New Jersey chartered bank or savings bank is subject to examination by the Commissioner. The Commissioner regulates, among other things, the Bank's internal business procedures as well as its deposits, lending and investment activities. The Commissioner must approve changes to the Bank's Certificate of Incorporation, establishment or relocation of branch offices, mergers and the issuance of additional stock.
New Jersey law provides that, upon satisfaction of certain triggering conditions, as determined by the Commissioner, insured institutions or savings and loan holding companies located in a state which has reciprocal legislation in effect on substantially the same terms and conditions as stated under New Jersey law may acquire, or be acquired by New Jersey insured institutions or holding companies on either a regional or national basis. New Jersey law explicitly prohibits interstate branching.
FEDERAL BANKING REGULATION
CAPITAL REQUIREMENTS. FDIC regulations require SAIF-insured banks, such as the Bank, to maintain minimum levels of capital. The FDIC regulations define two Tiers, or classes, of capital.
Tier 1 capital is comprised of the sum of common stockholders' equity (excluding the net unrealized appreciation or depreciation, net of tax, from available-for-sale securities), non-cumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than qualifying servicing rights), and any net unrealized loss on marketable equity securities.
The components of Tier 2 capital currently include cumulative perpetual preferred stock, certain perpetual preferred stock for which the dividend rate may be reset periodically, mandatory convertible securities, subordinated debt, intermediate preferred stock and allowance for possible loan losses. Allowance for possible loan losses
includible in Tier 2 capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital that may be included in total capital cannot exceed 100% of Tier 1 capital.
The FDIC regulations establish a minimum leverage capital requirement for banks in the strongest financial and managerial condition, with a rating of 1 (the highest examination rating of the FDIC for banks) under the Uniform Financial Institutions Rating System, of not less than a ratio of 3.0% of Tier 1 capital to total assets. For all other banks, the minimum leverage capital requirement is 4.0%, unless a higher leverage capital ratio is warranted by particular circumstances or risk profile of the depository institution.
The FDIC regulations also require that savings banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of a ratio of total capital (which is defined as the sum of Tier 1 capital and Tier 2 capital) to risk-weighted assets of at least 8% and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted regulations to require an assessment of an institution's exposure to declines in the economic value of a bank's capital due to changes in interest rates when assessing the bank's capital adequacy. Under such a risk assessment, examiners will evaluate a bank's capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors. According to the agencies, applicable considerations include the quality of the bank's interest rate risk management process, the overall financial condition of the bank and the level of other risks at the bank for which capital is needed. Institutions with significant interest rate risk may be required to hold additional capital. The agencies also issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies' evaluation of interest rate risk in connection with capital adequacy. The Bank is in compliance with all minimum capital requirements.
The FDIC adopted a regulation, effective April 1, 2002, that established minimum regulatory capital requirements for equity investments in non-financial companies. The regulation applies a series of marginal capital charges that range from 8% to 25% depending upon the size of the aggregate equity investment portfolio of the banking organization relative to its Tier 1 capital. The capital charge would be applied by making a deduction, which would be based on the adjusted carrying value of the equity investment from the organization's Tier 1 capital. This new capital requirement has not had a material adverse effect upon the Company's operations. However, management will have to take this requirement into consideration should the Company, at some point in the future, decide to invest in non-financial companies.
ACTIVITY RESTRICTIONS ON STATE-CHARTERED BANKS. Section 24 of the FDI Act, which was added by the Federal Deposit Insurance Corporation Improvement Act of 1991, generally limits the activities and investments of state-chartered FDIC insured banks and their subsidiaries to those permissible for federally chartered national banks and their subsidiaries, unless such activities and investments are specifically exempted by Section 24 or consented to by the FDIC.
Section 24 provides an exception for investments by a bank in common and preferred stocks listed on a national securities exchange or the shares of registered investment companies if:
o the bank held such types of investments during the 14-month period from September 30, 1990 through November 26, 1991;
o the state in which the bank is chartered permitted such investments as of September 30, 1991; and
o the bank notifies the FDIC and obtains approval from the FDIC to make or retain such investments. Upon receiving such FDIC approval, an institution's investment in such equity securities will be subject to an aggregate limit up to the amount of its Tier 1 capital.
First Savings received approval from the FDIC to retain and acquire such equity investments subject to a maximum permissible investment equal to the lesser of 100% of First Savings' Tier 1 capital or the maximum permissible amount specified by the New Jersey Banking Act. Section 24 also provides an exception for majority
owned subsidiaries of a bank, but Section 24 limits the activities of such subsidiaries to those permissible for a national bank under Section 24 of the FDI Act and the FDIC regulations issued pursuant thereto, or as approved by the FDIC.
Before making a new investment or engaging in a new activity not permissible for a national bank or otherwise permissible under Section 24 of the FDIC regulations thereunder, an insured bank must seek approval from the FDIC to make such investment or engage in such activity. The FDIC will not approve the activity unless the bank meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the FDIC insurance funds.
PROMPT CORRECTIVE ACTION. Under the FDIC prompt corrective action regulations, the FDIC is required to take certain, and authorized to take other, supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a total risk-based capital of less than 8% or a leverage ratio or a Tier 1 capital ratio that is less than 4% is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the FDIC within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to the institution depending upon its category, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FDIC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Under the OTS regulations, generally, a federally chartered savings association is treated as well capitalized if its total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 6% or greater, and its leverage ratio is 5% or greater, and it is not subject to any written agreement, order or directive by the OTS to meet a specific capital level. As of December 31, 2002, First Sentinel was considered "well capitalized" by the OTS.
INSURANCE OF DEPOSIT ACCOUNTS. Deposits of the Bank are presently insured by SAIF. The FDIC maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends upon the categories to which it is assigned. Assessment rates for SAIF member institutions are determined semiannually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. The assessment rates for the Bank's SAIF-assessable deposits are zero basis points. If the FDIC determines that assessment rates should be increased, institutions in all risk categories could be affected. The FDIC has exercised this authority several times in the past and could raise insurance assessment rates in the future. SAIF-assessed deposits are also subject to assessments for payments on the bonds issued in the late 1980's by the Financing Corporation, or FICO, to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. The Bank's total expense in 2002 for the assessment for deposit insurance and the FICO payments was $234,000.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
STANDARDS FOR SAFETY AND SOUNDNESS. The FDI Act requires each federal banking agency to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, and compensation, fees and benefits and such other operational and managerial standards as the agency deems appropriate. The federal banking agencies have adopted final regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to implement these safety and soundness standards. The Guidelines set forth the safety
and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act ("CRA"), any insured depository institution, including First Savings, has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the FDIC, in connection with its examination of a savings bank, to assess the depository institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications for branch relocations, additional branches and acquisitions.
Among other things, current CRA regulations apply an evaluation system that rates an institution based on its actual performance in meeting community needs. In particular, the evaluation system focuses on three tests:
o a lending test, to evaluate the institution's record of making loans in its service areas;
o an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and
o a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices.
The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system and requires public disclosure of an institution's CRA rating. First Savings has received a "satisfactory" rating in its most recent CRA examination. In addition, the FDIC adopted regulations implementing the requirements under Gramm-Leach that insured depository institutions publicly disclose certain agreements that are in fulfillment of the CRA. The Bank has no such agreement in place at this time.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB system, which consists of twelve regional FHLBs, each subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The FHLB provides a central credit facility primarily for member thrift institutions as well as other entities involved in home mortgage lending. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLBs. It makes loans to members (i.e., advances) in accordance with policies and procedures, including collateral requirements, established by the respective boards of directors of the FHLBs. These policies and procedures are subject to the regulation and oversight of the FHFB. All long-term advances are required to provide funds for residential home financing. The FHFB has also established standards of community or investment service that members must meet to maintain access to such long-term advances. The Bank, as a member of the FHLB-NY, is currently required to purchase and hold shares of capital stock in that FHLB in an amount at least equal to the greater of (i) 1% of the aggregate principal amount of its unpaid mortgage loans, home purchase contracts and similar obligations at the beginning of each year; (ii) 0.3% of its assets; or (iii) 5% (or such greater fraction as established by the FHLB) of its advances from the FHLB as of December 31, 2002. The Company is in compliance with these requirements. Pursuant to regulations promulgated by the FHFB, as required by Gramm-Leach, the FHLB-NY has adopted a capital plan, which is expected to become effective during the second half of 2003, that will change the foregoing minimum stock ownership requirements for FHLB-NY stock. Under the new capital plan, each member of the FHLB-NY will have to maintain a minimum investment in FHLB-NY capital stock in an amount equal to the sum of (i) the greater of $1,000 or 0.20% of the member's mortgage-related assets and (ii) 4.50% of the dollar amount of any outstanding advances under such member's Advances, Collateral Pledge and Security Agreement with the FHLB-NY.
INSURANCE ACTIVITIES. The Bank is subject to regulations prohibiting depository institutions from conditioning the extension of credit to individuals upon either the purchase of an insurance product or annuity or an agreement by the consumer not to purchase an insurance product or annuity from an entity that is not affiliated with the depository institution. The regulations also require prior disclosure of this prohibition to potential insurance product or annuity customers.
PRIVACY STANDARDS. First Sentinel is subject to FDIC regulations implementing the privacy protection provisions of Gramm-Leach. These regulations require First Sentinel and First Savings to disclose their privacy policy, including identifying with whom they share "nonpublic personal information," to customers at the time of establishing the customer relationship and annually thereafter. The regulations also require First Sentinel and First Savings to provide their customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, First Sentinel and First Savings are required to provide their customers with the ability to "opt-out" of having First Sentinel and First Savings share their non-public personal information with unaffiliated third parties before they can disclose such information, subject to certain exceptions. The implementation of these regulations did not have a material adverse effect on the Company's operations.
INTERNET BANKING. Technological developments are dramatically altering the ways in which most companies, including financial institutions, conduct their business. The growth of the Internet is prompting banks to reconsider business strategies and adopt alternative distribution and marketing systems. The federal bank regulatory agencies have conducted seminars and published materials targeted to various aspects of internet banking, and have indicated their intention to reevaluate their regulations to ensure that they encourage banks' efficiency and competitiveness consistent with safe and sound banking practices. No assurance can be given that the federal bank regulatory agencies will not adopt new regulations that will materially affect First Savings' Internet operations or restrict any such further operations.
TRANSACTIONS WITH AFFILIATES OF FIRST SAVINGS. First Savings is subject to the affiliate and insider transaction rules set forth in Sections 23A, 23B, 22(g) and 22(h) of the Federal Reserve Act ("FRA"), and the regulations of the Federal Reserve Board ("FRB") promulgated thereunder. These provisions, among other things, prohibit or limit a savings banks from extending credit to, or entering into certain transactions with, its affiliates (which for First Savings would include First Sentinel) and principal stockholders, directors and executive officers of First Savings.
Effective April 1, 2003, the FRB is rescinding its interpretations of Sections 23A and 23B of the FRA and is replacing these interpretations with Regulation W. In addition, Regulation W makes various changes to existing law regarding Sections 23A and 23B, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B.
Under Regulation W, all transactions entered into on or before December 12, 2002, which either became subject to Sections 23A and 23B solely because of Regulation W, and all transactions covered by Sections 23A and 23B, the treatment of which will change solely because of Regulation W, will become subject to Regulation W on July 1, 2003. All other covered affiliate transactions become subject to Regulation W on April 1, 2003. The FRB expects each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W. We do not expect that the changes made by Regulation W will have a material adverse effect on the Company's business.
In addition, provisions of the BHCA prohibit extensions of credit to a bank's insiders and their related interests by any other institution that has a correspondent banking relationship with the bank, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features.
Section 402 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to loans advanced by an insured depository institution, such as First Savings, that are subject to the insider lending restrictions of Section 22(h) of the FRA.
Provisions of the New Jersey Banking Act impose conditions and limitations on the liabilities to a savings bank of its directors and executive officers and of corporations and partnerships controlled by such persons that are comparable in many respects to the conditions and limitations imposed on the loans and extensions of credit to insiders and their related interests under federal law and regulation, as discussed above. The New Jersey Banking Act also provides that a savings bank that is in compliance with the applicable federal laws and regulations is deemed to be in compliance with such provisions of the New Jersey Banking Act.
NEW JERSEY BANKING REGULATION
ACTIVITY POWERS. The Bank derives its lending, investment and other activity powers primarily from the applicable provisions of the New Jersey Banking Act and its related regulations. Under these laws and regulations, savings banks, including First Savings, generally may invest in:
(1) real estate mortgages; (2) consumer and commercial loans; (3) specific types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies; (4) certain types of corporate equity securities; and (5) certain other assets.
A savings bank may also invest pursuant to a "leeway" power that permits investments not otherwise permitted by the New Jersey Banking Act. Such investments must comply with a number of limitations on the individual and aggregate amounts of the investments. A savings bank may also exercise trust powers upon approval of the Department. New Jersey savings banks may also exercise any power authorized for federally chartered savings banks unless the Department determines otherwise. The exercise of these lending, investment and activity powers are limited by federal law and the related regulations.
LOANS-TO-ONE-BORROWER LIMITATIONS. With certain specified exceptions, a New Jersey chartered savings bank may not make loans or extend credit to a single borrower and to entities related to the borrower in an aggregate amount that would exceed 15% of the bank's capital funds. A savings bank may lend an additional 10% of the bank's capital funds if secured by collateral meeting the requirements of the New Jersey Banking Act. The Bank currently complies with applicable loans-to-one-borrower limitations.
DIVIDENDS. Under the New Jersey Banking Act, a stock savings bank may declare and pay a dividend on its capital stock only to the extent that the payment of the dividend would not impair the capital stock of the savings bank. In addition, a stock savings bank may not pay a dividend if the surplus of the savings bank would, after the payment of the dividend, be reduced unless after such reduction the surplus was 50% or more of the bank's capital stock.
MINIMUM CAPITAL REQUIREMENTS. Regulations of the Department impose on New Jersey chartered depository institutions, including the Bank, minimum capital requirements similar to those imposed by the FDIC on insured state banks.
EXAMINATION AND ENFORCEMENT. The New Jersey Department of Banking and Insurance may examine the Bank whenever it deems an examination advisable. The Commissioner will examine the Bank at least every two years. The Department may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any director, officer, attorney or employee of a savings bank engaged in an objectionable activity, after the Department has ordered the activity to be terminated, to show cause at a hearing before the Department why such person should not be removed.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for
accounts aggregating $42.1 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement was 3%; and for accounts aggregating greater than $42.1 million, the reserve requirement was $1.1 million plus 10% (subject to adjustment by the Federal Reserve Board) against that portion of total transaction accounts in excess of $42.1 million. The first $6.0 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) were exempted from the reserve requirements. The Bank maintained compliance with the foregoing requirements. Because required reserves must be maintained in the form of either vault cash, a non-interest bearing account at a Federal Reserve Bank or a pass-through accounts as defined by the Federal Reserve Board, the effect of this reserve requirement is to reduce the Bank's interest-earning assets.
THE USA PATRIOT ACT
In response to the events of September 11, 2001, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:
Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program. Interim final rules implementing Section 352 were issued by the Treasury Department on April 29, 2002. Such rules state that a financial institution is in compliance with Section 352 if it implements and maintains an anti-money laundering program that complies with the anti-money laundering regulations of its federal functional regulator. First Savings is in compliance with the FDIC's anti-money laundering regulations.
Section 326 of the Act authorizes the Secretary of the Department of Treasury, in conjunction with other bank regulators, to issue regulations that provide for minimum standards with respect to customer identification at the time new accounts are opened. On July 23, 2002, the FDIC and the other federal bank regulators jointly issued proposed rules to implement Section 326. The proposed rules require financial institutions to establish a program specifying procedures for obtaining identifying information from customers seeking to open new accounts. This identifying information would be essentially the same information currently obtained by most financial institutions for individual customers generally. A financial institution's program would also have to contain procedures to verify the identity of customers within a reasonable period of time, generally through the use of the same forms of identity verification currently in use, such as through driver's licenses, passports, credit reports and other similar means.
Section 312 of the Act requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. Interim rules under Section 312 were issued by the Treasury Department on July 23, 2002. The interim rules state that a due diligence program is reasonable if it comports with existing best practices standards for banks that maintain correspondent accounts for foreign banks and evidences good faith efforts to incorporate due diligence procedures for accounts posing increased risk of money laundering. In addition, an enhanced due diligence program is reasonable if it comports with best practices standards and focuses enhanced due diligence measures on those correspondent accounts posing a particularly high risk of money laundering based on the bank's overall assessment of the risk posed by the foreign correspondent bank. Finally, a private banking due diligence program must be reasonably designed to detect and report money laundering and the existence of proceeds of foreign corruption. Such a program is reasonable if it focuses on those private banking accounts that present a high risk of money
laundering.
Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.
Compliance with the regulations adopted under the USA PATRIOT Act is not expected to have a material adverse effect on the Company's operations.
Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.
DELAWARE CORPORATION LAW
The Company is incorporated under the laws of the State of Delaware, and is therefore subject to regulation by the State of Delaware. In addition, the rights of the Company's shareholders are governed by the Delaware General Corporation Law.
ITEM 2.
ITEM 2. PROPERTIES - -------------------
The Company conducts its business through its main office and 22 full service branch offices, all located in central New Jersey. The following table sets forth certain information concerning the main office and each branch office of the Company at December 31, 2002. The aggregate net book value of the Company's premises and equipment was $15.9 million at December 31, 2002.
(1) Includes an adjacent administrative building. (2) Acquired/leased in conjunction with the purchase of deposits.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal actions arising in the normal course of its business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on the Company's results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of stockholders during the quarter ended December 31, 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information contained in the section captioned "Market Information for Common Stock" on page 31 of the 2002 Annual Report to Stockholders ("2002 Annual Report") is incorporated herein by reference. At December 31, 2002, 28,422,028 shares of the Company's outstanding common stock were held of record by approximately 2,630 persons or entities, not including the number of persons or entities holding stock in nominee or stock name through various brokers or banks.
The information contained in the section captioned "Equity Compensation Plan Information" on page 25 of the Company's proxy statement for the 2003 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on March 28, 2003, ("2003 Proxy Statement") is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information contained in the section captioned "Consolidated Financial Highlights" on page 5 of the 2002 Annual Report is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Comparison of Operating Results" on pages 6 through 11 of the 2002 Annual Report is incorporated herein by reference.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Disclosure relating to market risk is included in "Management's Discussion and Analysis of Financial Condition and Comparison of Operating Results," on page 11 of the 2002 Annual Report and is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
The Company's consolidated financial statements, together with the report thereon by KPMG LLP, are found in the 2002 Annual Report on pages 12 through 30 and are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT OF THE REGISTRANT
The disclosures required by Item 10 are included under the captions "Who Our Directors and Executive Officers Are" on pages 6 through 8 of the 2003 Proxy Statement and "Section 16(a) Beneficial Ownership Reporting Compliance" on page 9 of the 2003 Proxy Statement and are incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The disclosures required by Item 11 are included on pages 9 through 25 of the 2003 Proxy Statement under the captions "Compensation of Directors and Executive Officers", (with the exception of the "Compensation Committee Report" and the "Stock Performance Graph"), "Compensation Committee Interlocks and Insider Participation" and "Equity Compensation Plan Information" and are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Disclosure relating to Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to the 2003 Proxy Statement under the captions "Equity Compensation Plan Information" on page 25, "Security Ownership of Certain Beneficial Owners" on page 4 and "Who Our Directors and Executive Officers Are" on page 6.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The disclosures required by Item 13 are included under the caption "Transactions With Certain Related Persons" on page 21 of the 2003 Proxy Statement and are incorporated herein by reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
a.) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Christopher Martin, the Company's Chief Executive Officer, and Thomas M. Lyons, the Company's Chief Financial Officer, conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended) as of March 27, 2003. Based upon their evaluation, they each found the Company's disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports that the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.
b.) CHANGES IN INTERNAL CONTROLS.
There were no significant changes in the Company's disclosure controls and procedures or internal controls for financial reporting or other factors that could significantly affect those controls subsequent to March 27, 2003, and the Company identified no significant deficiencies or material weaknesses requiring corrective action with respect to those controls.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial statements.
The Consolidated Financial Statements and Independent Auditors' Report for the year ended December 31, 2002, included in the 2002 Annual Report, listed below, are incorporated herein by reference.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND 2001 (2002 ANNUAL REPORT - PAGE 12). CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (2002 ANNUAL REPORT - PAGE 13). CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (2002 ANNUAL REPORT - PAGE 14). CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (2002 ANNUAL REPORT - PAGE 15). NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2002 ANNUAL REPORT - PAGES 16 THROUGH 29).
INDEPENDENT AUDITORS' REPORT (2002 ANNUAL REPORT - PAGE 30).
(2) Financial Statement Schedules.
All schedules have been omitted because the required information is either inapplicable or included in the Notes to Consolidated Financial Statements.
(3) Exhibits
The following exhibits are filed as part of this report.
a Previously filed and incorporated herein by reference to the December 31, 1998 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No. 000-23809) dated March 30, 1999.
b Previously filed and incorporated herein by reference to the Exhibits to the Registration Statement on Form S-1 (File No. 333-42757) of First Sentinel Bancorp, Inc. (formerly known as First Source Bancorp, Inc.) dated December 19, 1997, and all amendments thereto.
c Previously filed and incorporated herein by reference to the Exhibits to the Registration Statement on Form 8-A (File No. 000-23809) of First Sentinel Bancorp, Inc. dated December 20, 2001.
d Previously filed and incorporated herein by reference to the Proxy Statement for the 1999 Annual Meeting of Stockholders of First Sentinel Bancorp, Inc. (File No. 000-23809) filed on March 30, 1999.
e Previously filed and incorporated herein by reference to the December 31, 1999 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No. 000-23809) dated March 30, 2000.
f Previously filed and incorporated herein by reference to the December 31, 2000 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. (File No. 000-23809) dated March 30, 2001.
g Previously filed and incorporated herein by reference to the June 30, 2002 Quarterly Report on Form 10-Q of First Sentinel Bancorp, Inc. (File No. 000-23809) dated August 14, 2002.
h Filed herein as a component of Exhibit 13.0, under Note 1 of the Notes to Consolidated Financial Statements.
(b) Reports on Form 8-K.
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2003 FIRST SENTINEL BANCORP, INC.
/s/ CHRISTOPHER MARTIN ------------------ Christopher Martin President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
CERTIFICATION
I, Christopher Martin, certify that:
1. I have reviewed this annual report on Form 10-K of First Sentinel Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: MARCH 31, 2003 /S/ CHRISTOPHER MARTIN -------------- ---------------------- Christopher Martin President and Chief Executive Officer
CERTIFICATION
I, Thomas M. Lyons, certify that:
1. I have reviewed this annual report on Form 10-K of First Sentinel Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: MARCH 31, 2003 /S/ THOMAS M. LYONS -------------- ------------------- Thomas M. Lyons Chief Financial Officer