Item 1. Business
Reliance Bancorp, Inc. ("Reliance" or the "Company") is a Delaware corporation organized on November 16, 1993 at the direction of the Board of Directors of Reliance Federal Savings Bank (the "Bank") for the purpose of becoming a holding company to own all of the outstanding capital stock of the Bank upon its conversion from a mutual to a stock form of organization. The stock conversion was completed on March 31, 1994.
In addition to directing, planning and coordinating the business activities of the Bank, the Company invests primarily in U.S. Government securities, corporate debt and equity securities and repurchase agreements. In addition, the Company completed its acquisitions of Bank of Westbury, a Federal Savings Bank, in August 1995, Sunrise Bancorp Inc., in January 1996 and Continental Bank ("Continental"), a commercial bank, in October 1997.
General
The primary business of the Company is the operations of its wholly-owned subsidiary, the Bank. The Bank's principal business is attracting retail deposits from the general public and investing those deposits, together with funds generated from operations, principal repayments and borrowings, primarily in mortgage, multi-family, commercial, consumer (primarily home equity lines of credit, home equity loans, auto and guaranteed student loans), commercial real estate and construction loans. In the past, the Bank has also invested in loans secured by cooperative units ("co-op loans") but in recent years has discontinued its origination activities in this area. In addition, during periods in which the demand for loans which meet the Bank's underwriting, investment and interest rate risk standards is lower than the amount of funds available for investment, the Bank invests excess funding in mortgage-backed securities, securities issued by the U.S. Government and agencies thereof and other investments permitted by federal laws and regulations. The Bank's revenues are derived principally from interest on its loan and mortgage-backed securities portfolios. The Bank's primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed and investment securities, FHLB-NY advances and reverse repurchase agreements. The Bank also operates five Money Center check cashing operations which generate additional fee income for the Bank.
The information presented in the consolidated financial statements and in the Form 10-K reflect the financial condition and results of operations of the Company, as consolidated with the Bank, its wholly-owned subsidiary. At June 30, 1999, the Company had total assets of $2.5 billion.
Acquisition of Reliance Bancorp, Inc. by North Fork Bancorporation, Inc.
On August 30, 1999, the Company announced that it had signed a definitive Agreement and Plan of Merger, dated as of August 30, 1999 (the "Merger Agreement"), with North Fork Bancorporation, Inc., a Delaware corporation ("NFB"). NFB is the bank holding company parent of North Fork Bank and Trust Company, a New York State chartered stock commercial bank. The Merger Agreement provides, among other things, that Reliance will merge with and into NFB, with NFB being the surviving corporation ("Merger").
Pursuant to the Merger Agreement, each share of Reliance common stock, par value $0.01 per share ("Reliance Common Stock" or the "Company's Common Stock"), issued and outstanding immediately prior to the Effective Time will be converted into and become the right to receive 2.0 shares of NFB common stock, par value $2.50 per share ("NFB Common Stock"). The exchange ratio was based upon the price of NFB's stock utilizing its closing price on August 27, 1999 of $19.06 for a total value to Reliance shareholders of $38.12 per share.
The Merger will be structured as a tax-free reorganization and will be accounted under the purchase method of accounting. Consummation of the Merger is subject to the satisfaction of certain customary conditions, including approval of the Merger Agreement by the stockholders of Reliance and approval of the appropriate regulatory agencies. Following consummation of the Merger, the Bank will be merged with and into North Fork Bank and Trust Company. It is anticipated that the Merger will be completed in 2000.
Reliance has the right to terminate the Merger Agreement if should the closing price of NFB's shares decline beyond a specified price and index, unless NFB elects to increase the Merger Consideration to be received by Reliance's stockholders as set forth in the Merger Agreement.
The Merger Agreement also provides that options to purchase shares of Reliance Common Stock under Reliance's stock option plans that are outstanding at the Effective Time shall be converted into options to purchase shares of NFB Common Stock in accordance with the procedure set forth in the Merger Agreement. In connection with the Merger Agreement, Reliance granted to NFB a stock option pursuant to a Stock Option Agreement, dated as of August 30, 1999, which, under certain defined circumstances, would enable NFB to purchase up to 19.9% of Reliance's issued and outstanding shares of common stock. The Stock Option Agreement provides that the total profit receivable thereunder may not exceed $17.4 million plus reasonable out-of-pocket expenses.
Market Area and Competition
The Bank has been, and continues to be, a community-oriented savings institution offering a variety of financial services to meet the needs of the communities it serves. The Bank's deposit gathering area is primarily concentrated in the communities surrounding its full service banking offices in the New York City Borough of Queens and the New York State Counties of Nassau and Suffolk. The Bank's primary lending area extends beyond its deposit gathering area to the New York City Boroughs of Brooklyn, Staten Island, Manhattan and the Bronx and the New York State County of Westchester.
The greater New York metropolitan area has historically benefitted from having a large number of corporate headquarters and a diversity of financial service industries. The New York State counties of Nassau and Suffolk have also continued to benefit from a large and well-developed suburban market, well educated employment base and a diversity of industrial, service and high technology businesses. After a prolonged period of decline, which was marked by layoffs in the financial services and defense industries and corporate relocations and downsizings, the economy in the greater New York metropolitan area performed well during fiscal 1999. Durable goods, retail trade and the service sector are driving economic growth in the suburbs, while financial services and securities industries are responsible for growth in New York City. In addition, the pool of skilled labor, access to international markets and the growing media industry in the area have kept the region one of the most attractive in the country. The healthy economy has also benefitted the greater New York metropolitan area office market where the overall and class A office vacancy rates have significantly declined. This decline in the vacancy rate kept asking rents for all types of space on the upswing. The improved economic environment is also evident in the Long Island, New York area, which is experiencing a rebound in its residential, commercial and industrial real estate markets not seen in a number of years. The residential real estate market in the greater New York metropolitan area was also favorably impacted during fiscal year 1999 by increased demand for housing during the period of low unemployment and generally low stable interest rates.
The Bank faces significant competition both in making loans and in attracting deposits. The Bank's market area has a high density of financial institutions, many of which are branches of significantly larger institutions which have greater financial resources than the Bank, and all of which are competitors of the Bank to varying degrees. The Bank's competition for loans comes principally from commercial banks, savings banks, credit unions, savings and loan associations and mortgage banking companies. Its most direct competition for deposits has historically come from savings and loan associations, savings banks, commercial banks and credit unions. The Bank faces additional competition for deposits from short-term money market funds and other corporate and government securities funds, as well as from other financial institutions such as brokerage firms and insurance companies. Competition may also increase as a result of the lifting of federal restrictions on the interstate banking operations for financial institutions and the entrance of non-depository financial institutions into the industry through the formation and acquisition of thrift institutions.
Lending Activities
Portfolio Composition. The Bank offers a variety of loans to serve the credit needs of its communities. The Bank's loan portfolio is comprised primarily of first mortgage loans, most of which are underwritten to meet Federal Home Loan Mortgage Corporation ("FHLMC") or Federal National Mortgage Association ("FNMA") standards and guidelines and are secured by one- to four-family residences, including co-op loans and, to a lesser extent, by multi-family residences and commercial real estate. The Bank also emphasizes the origination of consumer loans in the form of its home equity lines of credit and home equity loans. The remainder of the Bank's loan portfolio, at June 30, 1999, consisted of a variety of commercial, consumer and other loans, primarily secured and unsecured commercial, guaranteed student loans, auto and loans on deposit accounts.
The types of loans that the Bank may originate are subject to federal laws and regulations. Interest rates charged by the Bank on loans are affected principally by the demand for such loans, the cost and supply of money available for lending purposes and rates offered by its competitors. General and economic conditions, monetary policies of the federal government including the Federal Reserve Board, legislative tax policies and governmental budgetary matters also affect interest rates charged by the Bank.
One- to Four-Family Residential Mortgage Lending. The Bank currently offers first mortgage loans secured by one- to four-family residences and condominiums located in the Bank's primary lending area. The Bank offers such loans as fixed rate mortgage loans and adjustable rate mortgage loans ("ARMs") with maturities ranging from five to 30 years. Loan originations are generally obtained from existing or past customers, members of the local communities served, or referrals from local real estate agents, attorneys and builders. The Bank's one- to four-family residential mortgage loans are generally underwritten according to guidelines of the FHLMC, FNMA and other governmental agencies. However, the Bank originates loans for its own portfolio with amounts in excess of the loan amounts specified by such guidelines.
At June 30, 1999, $440.1 million, or 44.8% of the Bank's total loan portfolio consisted of one- to four-family residential and co-op loans loans, of which $159.1 million, or 36.1%, were ARM loans. The Bank currently offers one-year ARM loans with terms of up to 30 years and loans with terms of up to 30 years which are fixed for three, five, seven and ten years and convert into one-year ARM loans at the end of the initial fixed period. These ARM loans may carry an initial interest rate which is less than the fully indexed rate for the loan. These ARM loans may be originated on a point or no-point basis (i.e., with or without a loan origination fee based on a percentage of the loan amount). The maximum loan amount for ARM loans offered by the Bank is currently $750,000 and the maximum loan-to-value ratio is 80.0% of the property's appraised value or sales price, whichever is lower, or over 80% if private mortgage insurance is obtained. Presently, the Bank's interest rates on ARM loans fluctuate based upon a spread above the weekly average yield of United States Treasury securities, adjusted to a constant maturity which corresponds to the adjustment period of the loan (the "U.S. Treasury constant maturity index") as published weekly by the Federal Reserve Board and are generally subject to limitations on interest rate increases and decreases and specified lifetime caps. The Bank's ARM loans typically carry an initial interest rate below the fully-indexed rate for the loan. However, to recognize the credit risks associated with ARM loans offered at initial discounts below market interest rates, the Bank generally underwrites its one-year ARM loans assuming a rate equal to 200 basis points over the initial discount rate. For ARM loans with longer adjustment periods, and therefore, less risk due to the longer period for the borrower's's income to adjust to anticipated higher future payments, the Bank underwrites the loans using the initial rate, which may be discounted. The volume and types of ARM loans originated by the Bank have been affected by such market factors as the level of interest rates, competition, consumer preferences and the availability of funds. During the past several years, demand for ARM loans has been weak due to a low interest rate environment and consumer preference for fixed rate loans. Accordingly, although the Bank will continue to offer ARM loans, there can be no assurance that the Bank will be able to originate a sufficient volume of ARM loans in the future to increase or maintain the proportion that these loans currently bear to total loans.
The Bank currently offers fixed rate mortgage loans with terms of 10 to 30 years, secured by one- to four-family residences and condominiums. The Bank also offers these loans on a point or no-point basis with the respective interest rates determined in accordance with prevailing market and competitive factors. Fixed rate mortgage loans
with terms exceeding 15 years are currently originated by the Bank for sale in the secondary market to the FHLMC, FNMA and other investors. The maximum loan amount for fixed rate loans offered by the Bank is currently $750,000. For fixed rate loans to be retained for the Bank's portfolio, the Bank's underwriting standards establish an 80.0% maximum loan-to-value ratio or over 80% if private mortgage insurance is obtained. Fixed rate loans which meet the eligibility requirements for sale to FHLMC or FNMA will be considered for amounts up to 95.0% of the appraised value or sales price, whichever is lower. Loan applications which meet the eligibility requirements of the State of New York Mortgage Agency ("SONYMA") Low Interest Rate Program will be considered for amounts up to 100.0% of the appraised value or sales price, whichever is lower. At June 30, 1999, $281.0 million, or 63.9%, of the Bank's one- to four-family residential mortgage loan portfolio consisted of fixed rate loans.
Multi-Family and Commercial Real Estate Lending. The Bank currently offers fixed rate loans and ARM loans (one, three, five, seven, ten and 15 year) secured by multi-family dwellings (five or more units) and commercial real estate (e.g., office buildings, retail stores, mixed use properties, shopping centers, etc.). The maximum loan amounts for multi-family and commercial real estate loans offered by the Bank are $5.0 million and $1.5 million, respectively. The Bank offers multi-family or commercial real estate loans with terms up to 15 years, and amortizations of up to 30 years for multi-family loans and 15 years for commercial real estate loans. The maximum loan-to-value ratios for multi-family and commercial real estate loans is 70.0% and 60.0%, respectively, of the property's appraised value or sales price, whichever is lower.
For fiscal 1999, originations of multi-family loans totalled $90.0 million as compared to $60.7 million in fiscal 1998 and $115.9 million in fiscal 1997. The Bank increased its emphasis on originations of 5 year ARM loans with terms of up to 15 years and amortizations up to 30 years. These ARM loans may carry an initial interest rate which is less than the fully indexed rate for the loan. These ARM loans are originated on a point basis and no-point basis. Presently, the Bank's interest rates on 5 year ARM loans fluctuate based upon a spread above the weekly average yield of United States Treasury securities, adjusted to a constant maturity of 5 years which corresponds to the adjustment period of the loan (the "U.S. Treasury constant maturity index for 5 years") as published weekly by the Federal Reserve Board.
During fiscal 1999, the Bank originated commercial real estate loans totalling $12.4 million as compared to $1.1 million for fiscal 1998 and $650,000 for fiscal 1997. Due to market conditions and the Bank's determination to originate such loans on a selective basis, the Bank's commercial real estate originations in recent periods have been relatively low in comparison to its other lending activities.
The Bank determines the interest rate and term of each multi-family or commercial real estate loan on a case-by-case basis and in accordance with prevailing market and competitive factors. In making its determination, the Bank will consider the financial resources and income level of the borrower, the borrower's experience in owning or managing similar property, the marketability of the property and the Bank's lending experience with the borrower, and the property's net operating income available for debt service.
At June 30, 1999, the Bank's multi-family loans, consisting of 295 loans, totalled $316.1 million, or 32.2% of the Bank's total loan portfolio. Commercial property loans, consisting of 89 loans, totalled $48.1 million, or 4.9% of the Bank's total loan portfolio. At June 30, 1999, all multi-family loans were current and performing in accordance with their terms. At June 30, 1999, the Bank had eight commercial real estate loans totalling $1.9 million which were not performing in accordance with their loan terms and are on non-accrual status.
Loans secured by commercial properties generally involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by commercial properties are often dependent on the 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. Additionally, the past declines in real estate values have been more pronounced with respect to commercial properties. The Bank seeks to minimize these risks by originating such loans on a selective basis.
Construction Lending. The Bank currently offers construction loans secured by one- to four-family, multi-family and commercial real estate properties on a selective basis. The Bank's construction loan originations in recent periods have primarily been made to finance the construction of one- to four-family residential properties. As of June 30, 1999, the Bank has outstanding commitments to fund construction loans in the amount of $8.8 million, of which $7.5 million, or 0.79% of total loans, has been disbursed.
Commercial Lending. A key management objective is to maintain the quality of the commercial loan portfolio, substantially all of which was acquired in the Continental Bank acquisition. This objective is achieved by maintaining high underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower. The portfolio strategies seek to avoid concentrations by industry or loan size in order to minimize credit exposure and to originate loans in markets with which it is familiar. At June 30, 1999, the Bank's commercial loans, consisting of 419 loans, totalled $44.9 million, or 4.6% of the Bank's total loan portfolio. Loans in this category are typically made to small and medium sized businesses and range between $25,000 and $5 million. The primary source of repayment is from the borrower's operating profits and cash flows. Based on underwriting standards, loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory or real property.
Consumer and Other Lending. The Bank currently offers three general types of consumer loans consisting of: (1) home equity lines of credit; (2) home equity loans; and (3) guaranteed student loans. The Bank offers adjustable rate home equity lines of credit secured by one- to four-family owner-occupied properties (including condominiums) which serve as the primary residence of the borrower. Co-op units do not qualify as security for such loans. The Bank's home equity line of credit loans include a standard home equity line of credit, which may be secured only by a first or second mortgage on the underlying property, and a mini-home equity line of credit, which may be secured by any recorded mortgage on the underlying property. Both are open end lines of credit available only to borrowers within the Bank's lending community. The maximum line of credit is presently $250,000 for the standard home equity line of credit and $50,000 for the mini-home equity line of credit. The maximum total debt permitted to encumber a property varies based upon the loan-to-value ratio. When the loan balance plus any prior liens is: (1) $400,000 or less, the maximum loan-to-value ratio is 80%; (2) greater than $400,000 but $500,000 or less, the maximum loan-to-value ratio is 70%; (3) greater than $500,000 but $650,000 or less, the maximum loan-to-value ratio is 65%; and (4) greater than $650,000 but $750,000 or less, the maximum loan-to-value ratio is 60%. For the standard home equity line of credit, borrowers may draw on their line for a period of 10 years and may pay interest only on a monthly basis. At the end of the 10 year period, borrowers must repay principal and interest at a 20-year amortization rate. For the mini-home equity line of credit, borrowers may draw on their line for a period of 5 years and may pay interest only on a monthly basis. Borrowers must then repay principal and interest at a 10- year amortization rate. Advances under each line of credit are accessed by the borrower drawing a personal check on his or her individual account set up specifically for the program. The account is separate and distinct from any other checking account held by the borrower.
The Bank also offers fixed rate home equity loans with terms ranging from one to 15 years. Such loans are secured by one- to four-family owner-occupied real property (including condominiums) which is the primary residence of the borrower. The loan is available only to borrowers within the Bank's lending community and co-op units do not qualify as security for such loans. The maximum loan amount is $50,000 and the maximum loan-to-value ratio is 80%.
The Bank's guaranteed student loans are made only under the Guaranteed Student Loan Program administered by the New York State Higher Education Services Corporation ("NYSHESC"). The Bank does not fix the amount, maturity, or interest rate for its Education Loans; however, such terms meet the maximums authorized by NYSHESC and therefore are guaranteed by NYSHESC. The Bank will not approve an Education Loan application for any course of study offered by any school with a default ratio above 15.0% on the most recent Cohort Default Rate Listing published by the United States Department of Education. Increased competition for guaranteed student loans in general has resulted in reduced origination activity by the Bank for such loans. At June 30, 1999, the Bank's guaranteed student loans totalled $12.7 million, or 1.3% of total loans.
Additionally, the Bank offers loans fully secured by its deposit accounts which, at June 30, 1999, totalled $5.2 million, or 0.53% of total loans. The Bank offered other consumer loans in the form of home improvement, auto, overdraft checking and boat loans; however, the Bank currently offers only auto and overdraft checking loans. At June 30, 1999, such loans totalled $1.4 million or 0.14% of total loans.
Loan Approval Procedures and Authority. Loan approval authority has been granted by the Board of Directors to the Bank's Mortgage Loan, Commercial Loan and Consumer Loan Committees. For all mortgage loans originated by the Bank, upon receipt of a completed loan application from a prospective borrower, a credit report is ordered, certain other information is verified and, if necessary, additional financial information is requested. An appraisal of the real estate intended to secure the proposed loan is required and is currently performed by Board approved independent fee appraisers. The Bank requires title insurance on all mortgage loans, except for certain consumer loans secured by real estate. Borrowers must also obtain hazard insurance and may be required to obtain flood insurance prior to closing. Borrowers generally are required to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which the Bank makes disbursements for items such as real estate taxes and private mortgage insurance premiums, if required.
Delinquent Loans and Foreclosed Assets
Loan Collection. When a borrower fails to make a required payment on a loan, the Bank takes a number of specific steps to induce the borrower to cure the delinquency and restore the loan to a current status.
The Bank's collection procedures applicable to mortgage loans include a computerized delinquency notice being sent at the time a payment is over 15 days past due, with a second notice being sent at the time payment becomes 30 days past due. A personal letter is generally sent after the 40th day of delinquency. In the event that payment is not received after the 60th day, a division supervisor will be notified. Such supervisor will then order an inspection of the property within the next week and assume control of the account within two weeks. If personal contact is made with the borrower during inspection or any time prior to foreclosure, the Bank will attempt to obtain full payment or work out a repayment schedule with the borrower to avoid foreclosure. Foreclosure notices are sent when a loan is 85-90 days delinquent. Foreclosure commences on the 91st day of delinquency. Most loan delinquencies are cured within 90 days and no legal action is taken.
The Bank's collection procedures applicable to home equity lines of credit are generally similar to those discussed above; however, if an agreeable resolution of the delinquency is not reached, a notice of intent to foreclose is generally sent after the 45th day of delinquency and the matter is generally transferred to the supervisor on the same day. As with mortgage loans, foreclosures for home equity lines of credit commence on the 91st day of delinquency.
With respect to delinquent payments on other loans (e.g., mini-home equity loans, automobile loans, etc.), delinquency letters are sent to borrowers at the end of 26 and 40 days. In the event such loans become delinquent 120 days or more, the account is charged off and legal action is pursued.
As part of the Bank's collection procedures applicable to commercial loans, telephone contact is initiated and continued until the delinquency is cured. If payment remains uncollected, a demand for satisfaction is sent by the 45th day. If contact is made with the borrower at any time prior to 90 days delinquent, the Bank attempts to obtain full payment or work out a repayment schedule with the borrower to avoid legal action. All loans more than 90 days delinquent are sent to an attorney for collection.
Non-Accrual Loans. The following table sets forth information regarding non-accrual loans and loans delinquent 90 days or more on which the Bank is accruing interest at the dates indicated. It is the Bank's policy to classify any loans, or any portion thereof, that have been determined to be uncollectible, in whole or in part, as non-accrual loans. With the exception of guaranteed student loans, the Bank also classifies as non-accrual loans all loans 90 days or more past due. When a loan is placed on non-accrual status, the Bank ceases the accrual of interest owed and previously accrued interest is charged against interest income. During the fiscal years ended June 30, 1999, 1998, and 1997, the amounts of additional interest income that would have been recorded on non-accrual loans, had they
been current, totalled $498,000, $799,000, and $573,000, respectively. These amounts were not included in the Bank's interest income for the respective periods.
Allowances for Losses on Loans, Investments in Real Estate and Real Estate Owned.
The Bank's allowance for loan losses is established and maintained through a provision for loan losses based on management's evaluation of the risk inherent in the Bank's loan portfolio and the condition of the local economy in the Bank's market areas. Such evaluation, which includes a review of all loans on which full collectibility is not reasonably assured, considers among other matters, the estimated fair market value of the underlying collateral, economic and regulatory conditions, and other factors that warrant recognition of an adequate loan loss allowance. The evaluation includes a system of ranges and percentages as a supplemental measure for reviewing the adequacy of the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the adequacy of the Bank's allowance for loan losses, future adjustments may be necessary if economic and other conditions differ from the economic and other conditions in the assumptions used in making the initial determinations which such adjustments could have an adverse impact on the earnings or financial condition of the Company.
General valuation allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. The Bank's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance Company ("FDIC"), both of which can order the establishment of additional general or specific loss allowances.
As a result of the declines in local and regional real estate market values and the significant losses experienced by many financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as part of the examination of the institutions by the OTS and the FDIC. While the Bank believes it has established an adequate allowance for loan losses, there can be no assurance that regulators, where reviewing the Bank's loan portfolio, will not request the Bank to materially increase its allowance for loan losses, thereby negatively affecting the Bank's financial condition and earnings.
Investment Activities
General
As part of the present investment policy, the Bank deploys a large portion of its investable funds into mortgage-backed securities, and to a lesser extent, U.S. Government and agency obligations, and state and municipal debt securities. The Company deploys a large portion of its investable funds into corporate debt and equity securities. The investment policy of the Bank and Company, which is approved by the Board of Directors and implemented by the Company's Investment Committee as authorized by the Board, is designed primarily to generate a favorable return for the Company without compromising the Company's business objectives or incurring undue interest rate or credit risk, and to provide and maintain liquidity for the Company.
The Investment Committee, which is comprised of the Company's President and Chief Executive Officer, Executive Vice President - Treasurer, Senior Vice President-Chief Financial Officer, and Vice President - Investment Officer, meets as needed but not less than on a monthly basis to monitor the Company's investment transactions, to establish future investment strategies and to set future spending parameters. The Board of Directors reviews the Company's investment policy on a quarterly basis and the Company's investment activity on a monthly basis. In establishing its investment strategies, the Committee considers the Company's business and growth plans, its interest rate sensitivity "gap" position, the local and national economic environment, the types of securities to be held and other factors.
Although federally-chartered savings institutions have authority to invest in various types of assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers acceptances, repurchase agreements, loans of federal funds, and, subject to certain limits, corporate securities, commercial paper and mutual funds, the Bank currently favors mortgage-backed securities over other types of securities due to the Bank's focus upon residential mortgage lending. The Bank and the Company currently do not purchase securities with the intention of trading such securities, nor does the Bank or the Company maintain trading portfolios.
Debt and Equity Securities
At June 30, 1999, the Bank's debt and equity securities portfolio classified held-to-maturity totalled $28.8 million. The debt and equity securities held-to-maturity portfolio consisted of $8.9 million in U.S. Government agency obligations, $390,000 in municipal obligations and $19.6 million of FHLB stock. At June 30, 1999, the Bank's debt and equity securities portfolio classified as available-for-sale totalled $112.1 million. The Bank's debt and equity securities available-for-sale portfolio consisted of $102.1 million in corporate debt securities and $10.0 million in U.S. Government agency obligations. The Bank's current investment policy does not permit the Bank to invest in non-investment grade bonds or high-risk mortgage derivatives.
At June 30, 1999, the Company's debt and equity securities available-for-sale portfolio totalled $10.1 million and consisted of $9.2 million of corporate debt securities and $877,000 of equity securities.
Mortgage-Backed Securities
The Bank invests in mortgage-backed securities, including Real Estate Mortgage Investment Conduits ("REMICs") and Collateralized Mortgage Obligations ("CMOs"), and utilizes such investments to complement its mortgage lending activities in periods of low loan demand for the types of mortgage loans the Bank originates to be held for investment in conformance with its underwriting standards and interest rate risk policies, namely, ARM loans and shorter-term fixed rate loans secured by one- to four-family properties and multi-family loans. Investments in mortgage-backed securities involve a risk that actual prepayments will exceed prepayments estimated over the life of the security which may result in a loss of any premium paid for such instruments thereby reducing the net yield on such securities. In addition, if interest rates increase, the market value of such securities may be adversely affected.
REMICs and CMOs are typically issued by a special purpose entity, which may be organized in a variety of legal forms, such as a trust, a corporation or a partnership. The entity aggregates pools of loans or pass-through securities, which are used to collateralize the mortgage-related securities. Once combined, the cash flows are divided into "tranches" or classes of individual securities, thereby creating more predictable average lives for each security than the underlying collateral. Accordingly, under this security structure, loan principal and interest payments are allocated to a mortgage-related securities class or classes structured to have priority until it has been paid off. It is the policy of the Bank to limit its privately issued REMICs and CMOs to non-high risk securities rated "AAA". As of June 30, 1999, the Bank's portfolio of REMICs totalled $684.3 million of which $246.4 million were agency issued and $437.9 million were private issued.
The Bank purchases mortgage-backed securities in order to: (i) generate positive interest rate spreads with minimal administrative expense; (ii) lower its credit risk as a result of the guarantees provided by FHLMC, FNMA, and GNMA; (iii) utilize these securities as collateral for borrowings; and (iv) increase the liquidity of the Bank. The Bank has primarily invested in mortgage-backed securities issued or sponsored by FNMA, FHLMC and GNMA and private issuers.
At June 30, 1999, mortgage-backed securities totalled $1.2 billion, or 48.6% of total assets, of which $255.9 million were classified as held-to-maturity and $935.0 million were classified as available-for-sale. The Bank increased its purchases of mortgage-backed securities available-for-sale as part of its leveraging strategy in order to improve its return on equity. At June 30, 1999, the mortgage-backed securities portfolio classified as available-for- sale had an unrealized loss of $15.8 million. The market value of all mortgage-backed securities totalled approximately $1.2 billion at June 30, 1999.
As of June 30, 1999, $381.3 million, or 32.0%, of the Bank's mortgage-backed securities portfolio carried adjustable rates repricing annually. The adjustable rate portfolio had a weighted average interest rate yield of 5.85% at June 30, 1999.
Sources of Funds
General. Deposits, loans and mortgage-backed securities principal and interest payments, FHLB-NY advances and reverse repurchase agreements are the primary sources of the Bank's funds for use in lending, investing and for other general purposes. The Bank utilizes borrowings as part of its asset/liability management strategy.
Deposits. The Bank offers a variety of deposit accounts having a range of interest rates and terms. The Bank presently offers passbook savings, demand deposit, NOW, money market, and certificate accounts. The flow of deposits is influenced significantly by general economic conditions, changes in prevailing interest rates, pricing of deposits and competition. The Bank's deposits are primarily obtained from areas surrounding its offices, and the Bank relies primarily on marketing new products, service and long-standing relationships with customers to attract and retain these deposits. The Bank does not use brokers to obtain deposits, nor does it offer a negotiated rate on large dollar deposits.
When management determines the levels of the Bank's deposit rates, consideration is given to local competition, U.S. Treasury securities offerings and the rates charged on other sources of funds. The Bank has maintained a high level of passbook, demand deposit and NOW accounts ("core deposits"), which has contributed to its low cost-of-funds. Passbook, demand deposits and NOW accounts represented 39.9% of total deposits at June 30, 1999 as compared to 36.9% of total deposits at June 30, 1998.
Borrowings. The Bank has utilized borrowed funds to grow, leveraging the Bank's capital and improving the return on equity. Borrowed funds, principally from the FHLB-NY and reverse repurchase agreements are utilized as a source of funding in order to take advantage of favorable rates of interest in comparison to its other sources of funds. The Bank's FHLB-NY advances are generally secured by a blanket lien against the Bank's mortgage portfolio, mortgage-backed and investment securities portfolios and the Bank's investment in the stock of the FHLB-NY. The
maximum amount that the FHLB-NY will advance for purposes other than for meeting withdrawals, fluctuates from time to time in accordance with the policies of the FHLB-NY. At June 30, 1999, total advances from the FHLB-NY were $338.7 million. The Bank has also entered into reverse repurchase agreements with nationally recognized primary securities dealers. Reverse repurchase agreements are accounted for as borrowings and are secured by the securities sold with agreements to repurchase. At June 30, 1999, borrowings under reverse repurchase agreements totalled $313.7 million.
The Company has utilized borrowed funds to obtain capital to improve Bank capital ratios and fund asset growth. On April 29, 1998, Reliance Capital Trust I, a trust formed under the laws of the State of Delaware (the " Capital Trust"), issued $50 million of 8.17% capital securities. The Holding Company is the owner of all the beneficial interests represented by common securities of the Trust. The Trust exists for the sole purpose of issuing the Trust securities (comprised of the capital securities and the common securities) and investing the proceeds thereof in the 8.17% junior subordinated deferrable interest debentures issued by the Holding Company on April 23, 1998 which are scheduled to mature on May 1, 2028. Interest on the capital securities is payable in semiannual installments, commencing on November 1, 1998. The Trust securities are subject to mandatory redemption (i) in whole, but not in part upon repayment in full, at the stated maturity of the junior subordinated debentures at a redemption price equal to the principal amount of, plus accrued interest on, the junior subordinated debentures,(ii) in whole, but not in part, at any time prior to May 1, 2008, contemporaneously with the occurrence and continuation of a special event, defined as a tax event or regulatory capital event, at a special event redemption price equal to the greater of 100% of the principal amount of the junior subordinated debentures or the sum of the present values of the principal amount and premium payable with respect to an optional redemption of the junior subordinated debentures on the initial optional repayment date to and including the initial optional prepayment date, discounted to the prepayment date plus accrued and unpaid interest thereon, and (iii) in whole or in part, on or after May 1, 2008, contemporaneously with the optional prepayment by the Corporation of the junior subordinated debentures at a redemption price equal to the optional prepayment price. Subject to prior required regulatory approval, the junior subordinated debentures are redeemable during the 12-month periods beginning on or after May 1, 2008 at 104.085% of the principal amounts outstanding, declining ratably each year thereafter to 100%, plus accrued and unpaid interest thereon to the date of redemption. Deferred issuance costs in the amount of $1.0 million, are being amortized over ten years and are included in Prepaid Expenses and Other Assets in the Company's Consolidated Statement of Condition as of June 30, 1999.
Subsidiary Activities
The Bank formed a number of subsidiaries in the mid-1980s to enter into real estate-development joint ventures for the development of properties located in the Bank's primary lending area, all of which are currently inactive. The Bank does not currently intend to form any new subsidiaries or use any currently inactive subsidiaries to enter into new real estate development projects. The Bank maintains the following active subsidiaries.
RFS Insurance Agency Inc. RFS Insurance was organized by the Bank on April 15, 1983 and currently offers the sale of non-deposit investment products (annuities and mutual funds) to Bank customers and recognizes fee income from such sales.
Reliance Preferred Funding Corp. Reliance Preferred Funding Corp. (the "Subsidiary") was organized by the Bank on April 4, 1997 for the purpose of engaging in a real estate investment trust ("REIT"). The purpose of the subsidiary is to enhance and strengthen the Bank's capital position. The Subsidiary is poised to raise capital expeditiously in the event that the Bank should need such capital (e.g., for a significant strategic transaction or combination). In addition to such possible increased capital resulting from any future public offering that the Subsidiary or the Bank may conduct, the Subsidiary affords the Bank certain tax benefits.
Personnel
As of June 30, 1999, the Bank had 344 full-time employees and 162 part-time employees. The employees are not represented by a collective bargaining unit and the Bank considers its relationship with its employees to be good.
FEDERAL, STATE AND LOCAL TAXATION
Federal Taxation
General. The Company and the Bank report their income on a calendar year basis using the accrual method of accounting and are subject to Federal income taxation in the same manner as other corporations. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Company and the Bank have not been audited by the Internal Revenue Service during the last five years.
Tax Bad Debt Reserves. Prior to the enactment of the Small Business Job Protection Act of 1996 (the "1996 Act"), on August 20, 1996, for federal income tax purposes, thrift institutions such as the Bank, were permitted under Section 593 of the Code ("IRC 593"), to establish tax reserves for bad debts and to make annual additions thereto, which additions could, within specified limitations, be deducted in arriving at taxable income. Similar deductions for additions to the Bank's bad debt reserves were permitted under the New York State Franchise Tax and the New York City Financial Corporation Tax. Under the 1996 Act, the Bank, as a "large bank" (one with assets having an adjusted base of more than $500 million), is unable to make additions to its tax bad debt reserves, is permitted to deduct bad debts only as they occur and is required to recapture the excess of the balance of its bad debt reserves (other than the supplemental reserve) as of December 31, 1995 over the balance of such reserves as of December 31, 1987 (or over a lesser amount if the Bank's loan portfolio decreased since December 31, 1987). However, under the 1996 Act, such recapture requirements were suspended for each of the two successive taxable years beginning January 1, 1996, in which the Bank originates a minimum amount of certain residential loans during such years that is not less than the average of the principal amounts of such loans made by the Bank during its six taxable years preceding January 1, 1996.
Distributions. To the extent that the Bank makes "nondividend distributions" to shareholders, such distributions will be considered to result in distributions from the Bank's base year reserve to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits will not constitute nondividend distributions and, therefore, will not be included in the Bank's income. The amount of additional taxable income created from a nondividend distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, approximately one and one-half times the nondividend distribution would be includable in gross income for federal income tax purposes, assuming a 35% federal corporate income tax rate.
Corporate Alternative Minimum Tax. In addition to the regular income tax, corporations generally are subject to an alternative minimum tax ("AMT") in an amount equal to 20% of alternative minimum taxable income ("AMTI") to the extent the AMT exceeds the corporation's regular tax. AMTI is regular taxable income as modified by certain adjustments and increased by certain tax preference items. AMTI includes an amount equal to three-quarters of the excess of adjusted current earnings over such specially computed AMTI. 90% of AMTI can be offset by net operating loss carryovers. The AMT is available as a credit against future regular income tax. The Company does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company and the Bank own more than 20% of the stock of a corporation distributing a dividend, 80% of any dividends received may be deducted.
State And Local Taxation
New York State Taxation. The Bank is subject to New York State Franchise Tax on net income or one of several alternative bases, whichever results in the highest tax. The Company and Bank will file a combined tax return in the same manner as other corporations with some exceptions, including the Bank's reserve for bad debts as discussed below. New York State passed legislation that incorporated the former provisions of IRC 593 into New York State tax law. The impact of this legislation enabled the Bank to defer the recapture of the New York State tax bad debt reserves that would have otherwise occurred as a result of the federal amendment to IRC 593. The legislation also enabled the Bank to continue to utilize the reserve method for computing its bad debt deduction. The following discussion of the reserve for bad debts is intended only as a summary and does not purport to be a comprehensive description of the New York State tax rules applicable to the Bank or the Company.
Bad Debt Deduction. Federally chartered savings banks, such as the Bank, which meet certain definition tests primarily relating to their assets and the nature of their business ("qualifying thrifts") are permitted to establish a reserve for bad debts and to make annual additions thereto, which additions may, within specified formula limits, be deducted in arriving at their taxable income. The Bank will be a qualifying thrift only if, among other requirements, at least 60% of its assets are assets described in Section 1453(h)(1) of the New York State Tax Law (the "60% Test"). The Bank presently satisfies the 60% Test. Although there can be no assurance that the Bank will satisfy the 60% Test in the future, management believes that this level of qualifying assets can be maintained by the Bank. The Bank's deduction for additions to its bad debt reserve with respect to qualifying loans may be computed using the experience method or a percentage equal to 32% of the Bank's taxable income, computed with certain modifications, without regard to the Bank's actual loss experience, and reduced by the amount of any addition permitted to the reserve for non-qualifying loans ("NYS Percentage of Taxable Income Method"). The Bank's deduction with respect to non-qualifying loans must be computed under the experience method which is based on the qualifying thrift's actual loss experience. Under the experience method, the amount of a reasonable addition, in general, equals the amount necessary to increase the balance of the bad debt reserve at the close of the taxable year to the greater of (i) the amount that bears the same ratio to loans outstanding at the close of the taxable year as the total net bad debts sustained during the current and five preceding taxable years bears to the sum of the loans outstanding at the close of those six years, or (ii) the balance of the bad debt reserve at the close of the base year (assuming that the loans outstanding have not declined since then). The "base year" for these purposes is the last taxable year beginning before the NYS percentage of income bad debt deduction was taken. Any deduction for the addition to the reserve for non-qualifying loans reduces the taxable addition to the reserve for qualifying real property loans calculated under the NYS Percentage of Taxable Income Method. Each year the Bank reviews the most favorable way to calculate the deduction attributable to an addition to the bad debt reserve. The amount of the addition to the reserve for losses on qualifying real property loans under the NYS Percentage of Taxable Income Method cannot exceed the amount necessary to increase the balance of the reserve for losses on qualifying real property loans at the close of the taxable year to 6% of the balance of the qualifying real property loans outstanding at the end of the taxable year. Also, if the qualifying thrift uses the NYS Percentage of Taxable Income Method, then the qualifying thrift's aggregate addition to its reserve for losses on qualifying real property loans cannot, when added to the addition to the reserve for losses on non-qualifying loans, exceed the amount by which (i) 12% of the amount that the total deposits or withdrawable accounts of depositors of the qualifying thrift at the close of the taxable year exceeded (ii) the sum of the qualifying thrift's surplus, undivided profits and reserves at the beginning of such year.
New York City Taxation. The Bank is also subject to the New York City Financial Corporation Tax calculated, subject to a New York City income and expense allocation, on a similar basis as the New York State Franchise Tax. In this connection, legislation was enacted regarding the use and treatment of tax bad debt reserves
that is substantially similar to the New York State legislation described above. A significant portion of the Bank's entire net income for New York City purposes is allocated outside the jurisdiction which has the effect of significantly reducing the New York City taxable income of the Bank.
Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.
REGULATION AND SUPERVISION General
The Bank is subject to extensive regulation, examination and supervision by the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The Bank is a member of the FHLB System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the 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 policies, whether by the OTS, the FDIC or through legislation, could have a material adverse impact on the Company, the Bank and their operations. The Company, as a savings and loan holding company, is required to file certain reports with, and otherwise comply with the rules and regulations of the OTS under the Home Owners' Loan Act, as amended (the "HOLA"), and of the Securities and Exchange Commission ("SEC") under the federal securities laws. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein.
The description of statutory provisions and regulations applicable to savings institutions set forth in this document do not purport to be a complete description of such statutes and regulations and their effects on the Bank.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are governed by HOLA and, in certain respects, the Federal Deposit Insurance Act ("FDI Act") and the regulations issued to implement those statutes. These laws and regulations delineate the nature and extent of the activities in which federal associations may engage. In particular, many types of lending authorities for federal associations, e.g., commercial, nonresidential real property and consumer loans, are limited to a specified percentage of the institution's capital assets.
Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the national bank limits on loans to one borrower. Unless an exception applies, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15.0% of the Bank's unimpaired capital and surplus. An additional amount may be lent, equal to 10.0% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion, but does not include real estate. At June 30, 1999, there were two borrowers each with aggregate loans totalling $13.1 million and $12.5 million, respectively. These loans represented the largest aggregate amount of loans to one borrower and were below the Bank's loans to one borrower limit of $25.8 million at such date. At June 30, 1999, both of these borrowers were current.
QTL Test. The HOLA requires savings institutions to meet a qualified thrift lender ("QTL") test. Under the QTL test, a savings bank is required to either maintain at least 65.0% of its "portfolio assets" (total assets less (i)
specified liquid assets up to 20.0% of total assets, (ii) intangibles, including goodwill, and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) on a monthly basis in 9 out of every 12 months.
A savings institution that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of June 30, 1999, the Bank maintained 90.3% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by a savings institution, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule effective in 1998 established three tiers of institutions, based primarily on an institution's capital level. An institution that exceeded all capital requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without approval of the OTS, make capital distributions during a calendar year equal to the greater of: (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half the excess capital over its capital requirements at the beginning of the calendar year; or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions required prior regulatory approval. At June 30, 1999, the Bank was a Tier 1 Bank. Effective April 1, 1999, the OTS's capital distribution regulation changed. Under the new regulation, an application to and the prior approval of the OTS will be required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment: of applications under OTS regulations (i.e., generally, safety and soundness, compliance and Community Reinvestment Act examination ratings in the two tope categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with OTS. If an application is not required, the institution must still provide prior notice to OTS of the capital distribution. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. At June 30, 1999, the Bank was a Tier 1 Bank.
Liquidity. The Bank is required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified United States Government, state or federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement may be changed from time to time by the OTS to any amount within the range of 4.0% to 10.0% depending upon economic conditions and the savings flows of member institutions, and is currently 4.0%. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's average liquidity for the year ended June 30, 1999 was 9.34% which exceeded the applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessment, paid on a semi-annual basis, is computed as a percentage upon the savings institution's total assets, including consolidated subsidiaries, as reported in the bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended June 30, 1999 totalled $366,000.
Branching. The OTS regulations authorize federally chartered savings associations to branch nationwide to the extent allowed by federal statute. This permits federal savings and loan associations with interstate networks to diversify more easily their loan portfolios and lines of business geographically. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as implemented by OTS regulations, a savings institution 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, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received a "satisfactory" CRA rating in its most recent examination.
Transactions with Related Parties. The Bank's authority to engage in certain transactions with related parties or "affiliates" (i.e., any company that controls or is under common control with an institution, including the Company and any non-savings institution subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of "covered transactions" (including extension of credit to, purchases of assets from or the issuance of a guarantee, acceptance or letter of credit on behalf of affiliate) with any individual affiliate to 10.0% of the capital and surplus of the savings institution and also limits the aggregate amount of transactions with all affiliates to 20.0% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B generally provides that certain transactions with affiliates, (including loan, asset sales or purchases, and any servicing, leases or other agreements) must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with nonaffiliated companies. Notwithstanding Sections 23A and 23B, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies under Section 4 (c) of the Bank Holding Company Act ("BHC Act"). Further, no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and principal shareholders (generally considered to be those owners controlling or having the power to vote ten percent or more of any class of the Company's stock) as well as entities controlled by such persons, are currently governed by Sections 22(g) and 22(h) of the FRA, and the Federal Reserve Board's ("FRB") Regulation O thereunder. Among other things, these regulations require such loans to be made on terms substantially the same as those offered to unaffiliated individuals and may not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Regulation O also places individual and aggregate limits on the amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has the authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") and a final rule to implement safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes
impaired. The standards set forth in the Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans when such plans are required. Most recently, the agencies adopted guidelines related to Year 2000 computer compliance.
Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital standard, a 4.0% (3% for the most highly rated institutions) leverage ratio (or core capital ratio) and an 8.0% risk-based capital standard. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital ratio (3% for institutions receiving the highest rating on the CAMEL financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The OTS regulations also require that, in meeting the tangible, leverage (core) and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk weighted assets of 4.0% and 8.0%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of Tier 1 (core) capital are equivalent to those discussed earlier under the 3.0% leverage ratio standard. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and allowance for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The OTS (and other federal banking agencies) has revised the risk-based capital standards to ensure that such standards take account of interest rate risk. The OTS regulations set forth the methodology for calculating an interest rate risk component that would be incorporated into the OTS risk-based capital regulations. A savings institutions with "above normal" interest rate risk exposure must deduct from total capital a portion of its capital to cover such interest rate risk for purposes of calculating their risk-based capital requirements. A savings institution's interest rate risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200-basis point increase or decrease in market interest rates (except when the 3-month Treasury bond equivalent yield falls below 4.0%, then the decrease will be equal to one-half of that Treasury rate) divided by the estimated economic value of the institution's assets, as calculated in accordance with guidelines set forth by the OTS. A savings institution whose measured interest rate risk exposure exceeds 2.0% must deduct an interest rate component in calculating its total capital under the risk-based capital rule. The interest rate risk component is an amount equal to one-half of the difference between the institution's measured interest rate risk and 2.0%, multiplied by the estimated economic value of the bank's assets. That dollar amount is deducted from an institution's total capital in calculating compliance with its risk-based capital requirement. For the present time, the OTS has deferred implementation of a capital deduction based on the interest-rate risk component. If the Bank had been subject to an interest-rate risk component as of June 30, 1999, the Bank would not have been subject to any deduction from capital as a result of its interest rate risk position.
At June 30, 1999, the Bank met each of its capital requirements. The following table sets forth in terms of dollars and percentages the OTS tangible, leverage and risk-based capital requirements, and the Bank's historical amounts and percentages at June 30, 1999.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution is considered "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core capital to total assets is at least 5%, and it is not subject to any order or directive by the OTS to meet a specific capital level. A savings institution generally is considered "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%, and its ratio of core capital to total assets is at least 4% (3% if the institution receives the highest CAMEL rating). A savings institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance on Deposit Accounts. The FDIC has established a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. Under the risk-based assessment system, the average assessment rate paid by institutions insured under the SAIF was increased. Under the risk- based assessment system, the FDIC assigns an institution to one of three capital categories based on the institution's financial information as of the reporting period ending seven months before the assessment period, consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized. The FDIC also assigns an institution to one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary federal regulator and information that the FDIC determines to be relevant to the institution's financial conditions and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution's state supervisor). An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. Under the risk-based assessment system, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. As a result of the recapitalization of the SAIF in 1996 after the enactment of the Deposit Funds Insurance Act of 1996, the FDIC reduced the assessment rates for deposit insurance for SAIF-assessable deposits for fiscal 1999
to a range of 0 to 27 basis points. The assessment rate for the Company's SAIF-assessable deposits for fiscal 1999 was 0 basis points. In addition, SAIF-assessable deposits are also subject to assessments for payments on the bonds issued in the late 1980s by the Financing Corporation (the "FICO" bonds) to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. The Company's total expense in fiscal 1999 for the assessment for deposit insurance and the FICO payments was $930,000.
Thrift Rechartering Legislation. The Funds Act provides that the Bank Insurance Fund (the "BIF") and SAIF will merge on January 1, 1999 if there are no more savings associations as of that date. That legislation also required that the Department of Treasury submit a report to Congress that makes recommendations regarding a common financial institutions charter, including whether the separate charters for thrifts and banks should be abolished. Various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter and abolish the OTS have been introduced in Congress. The bills would require federal savings institutions to convert to a national bank or some type of state charter by a specified date under some bills, or they would automatically become national banks. Under some proposals, converted federal thrifts would generally be required to conform their activities to those permitted for the charter selected and divestiture of nonconforming assets would be required over a two year period, subject to two possible one year extensions. State chartered thrifts would become subject to the same federal regulation as applies to state commercial banks. A more recent bill passed by the House of Representatives would not affect the federal thrift charter, but would subject unitary savings and loan holding companies to the same activities restrictions applicable to multiple savings and loan holding companies existing on or applied for by March 31, 1998 would be grandfathered. The Bank is unable to predict whether such legislation would be enacted or the extent to which the legislation would restrict or disrupt its operations.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in that FHLB in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. The Bank was in compliance with this requirement with an investment in FHLB stock at June 30, 1999, of $19.6 million. FHLB advances must be secured by specified types of collateral and all long-term advances may only be obtained for the purpose of providing funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. For the years ended June 30, 1999, 1998 and 1997, dividends from the FHLB to the Bank amounted to $1.3 million, $1.2 million and $820,000, respectively. If dividends were reduced, or interest on future FHLB advances increased, the Bank's net interest income would likely also be reduced. Further, there can be no assurance that the impact of FDICIA and the FIRREA on the FHLBs will not also cause a decrease in the value of the FHLB stock held by the Bank.
Federal Reserve System
The FRB regulations require savings institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The FRB regulations generally require that reserves be maintained against aggregate transaction accounts as follows: For accounts aggregating $46.5 million or less (subject to adjustment by the FRB) the reserve requirement is 3.0%; and for accounts greater than $46.5 million, the reserve requirement is $1.395 million plus 10.0% (subject to adjustment by the FRB between 8.0% and 14.0%) against that portion of total transaction accounts in excess of $46.5 million. The first $4.9 million of otherwise reservable balances (subject to adjustments by the FRB) are exempted from the reserve requirements. The Bank is
in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the FRB may be used to satisfy liquidity requirements imposed by the OTS.
Holding Company Regulation
The Company is a non-diversified unitary savings and loan holding company within the meaning of the HOLA, as amended. As such, the Company has 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 and its non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the holding company's subsidiary savings institution. The Bank must notify the OTS 30 days before declaring any dividend to the Company.
The HOLA prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5.0% 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.
As a unitary savings and loan holding company (i.e., one that controls only one thrift subsidiary), the Company generally will not be restricted under existing banking laws as to the types of business activities in which it may engage, provided that the Bank continues to be a QTL. See "Federal Savings Institution Regulation - QTL Test" for a discussion of the QTL requirements. Upon any non-supervisory acquisition by the Company of another savings association or savings bank that meets the QTL test and is deemed to be a savings institution by 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, subject to the prior approval of the OTS, and certain other activities authorized by OTS regulation, and no multiple savings and loan holding company may acquire more than 5.0% of the stock of a company engaged in impermissible activities.
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.
Federal law generally provides that no "person," acting directly or indirectly or through or in concert with one or more other persons, may acquire "control," as that term is defined in OTS regulations, of a federally-insured savings institution without giving at least 60 days written notice to the OTS and providing the OTS an opportunity to disapprove of the proposed acquisition. Such acquisitions of control may be disapproved if it is determined, among other things, that (i) the acquisition would substantially lessen competition; (ii) the financial condition of the acquiring person might jeopardize the financial stability of the savings institution or prejudice the interests of its depositors; or (iii) the competency, experience or integrity of the acquiring person or the proposed management personnel indicates that it would not be in the interest of the depositors or the public to permit the acquisition of control by such person.This requirement would apply to acquisitions of the Company's stock.
Thrift Rechartering Legislation. The Funds Act provides that the Bank Insurance Fund (the "BIF") and SAIF were to have merged on January 1, 1999 if there had been no more savings associations as of that date. That legislation also required that the Department of Treasury submit a report to Congress that makes recommendations regarding a common financial institutions charter, including whether the separate charters for thrifts and banks should be abolished. Various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter and abolish the OTS have been introduced in Congress. The bills would require federal savings institutions to convert to a national bank or some type of state charter by a specified date under some bills, or they would automatically become national banks. Under some proposals, converted federal thrifts would generally be required to conform their activities to those permitted for the charter selected and divestiture of nonconforming assets would be required over a two year period, subject to two possible one year extensions. State chartered thrifts would become subject to the same federal regulation as applies to state commercial banks. A more recent bill pending in a House of Representatives Senate Conference Committee would not affect the federal thrift charter, but would subject unitary savings and loan holding companies to the same activities restrictions applicable to multiple savings and loan holding companies under the legislation. Unitary holding companies existing on or applied for by March 4, 1999 would be grandfathered. The Bank is unable to predict whether such legislation would be enacted or the extent to which the legislation would restrict or disrupt its operations.
Federal Securities Laws
The Company's Common Stock is registered with the SEC under the Exchange Act of 1934, as amended (the "Exchange Act"). The Company and its officers and directors are subject to periodic reporting, proxy solicitation regulations, insider trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of 1933 (the "Securities Act") of shares of the Common Stock issued in the Conversion or pursuant to the Company's employee stock benefit plans does not cover the resale of such shares. Shares purchased or acquired by an affiliate of the Company will be subject to the resale restrictions of Rule 144 under the Securities Act. If the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate of the Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1.0% of the outstanding shares of the Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks. Shares acquired from the Company that are deemed to be restricted under the definition of that term in Rule 144, must be held for a period of at least one year before they may be publicly resold. A provision may be made in the future by the Company to permit affiliates to have their shares registered for sale under the Securities Act under certain circumstances.
STATISTICAL DATA
The detailed statistical data that follows is being presented in accordance with Guide 3, prescribed by the Securities and Exchange Commission. This data should be read in conjunction with the financial statements and related notes and the discussion included in the Management's Discussion and Analysis of Financial Condition and Results of Operations.
A. Mortgage and Other Loan Activities
The following table sets forth the Bank's loan originations, loan purchases, sales, and principal repayments for the periods indicated:
(1) For fiscal year 1998, mortgage loans, commercial loans and consumer loans include $26.1 million, $55.8 million and $706,000, respectively, of loans acquired from the Continental acquisition.
B. Loan Maturity and Repricing
The following table shows the maturity or period to repricing of the Bank's loan portfolio at June 30, 1999. 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. Prepayments and scheduled principal amortization on loans totalled $325.5, $290.0 million and $125.8 million, respectively, for the years ended June 30, 1999, 1998 and 1997.
- ------------------- (1) Leased property includes all option periods. (2) Drive-up facility. (3) The Bank owns one half of the property and leases the other half. (4) TheBank pays all real estate taxes on this property. 5) This branch was originally owned by the Bank. The Bank has subsequently sold the property and is now leasing it. The transaction is being treated as a capital lease (sale/leaseback). (6) The Bank owns the building and leases the land. Option to purchase the land at the end of the last lease option.
Item 3.
Item 3. Legal Proceedings
The Bank is involved in various legal actions arising in the ordinary course of its business which, in the aggregate, involve amounts which are believed by management to be not material to the financial condition of the Bank.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Item 5. Market for the Company's Common Equity and Related Stockholder Matters
The Company's common stock is traded on the Nasdaq National Market and quoted under the symbol "RELY". As of September 16, 1999, the Company had 1,500 stockholders of record, not including the number of persons or entities holding stock in nominee or street name through various brokers and banks.
Shares of the common stock were made available to qualified subscribers at $10.00 per share during the initial offering. The tables show the reported high and low sales prices of the common stock during fiscal 1999 and 1998.
--------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- High..........$38.50 $29.88 $31.63 $29.63 Low...........$23.88 $21.50 $28.00 $26.00
--------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- High..........$33.00 $36.88 $38.75 $42.25 Low...........$27.69 $30.00 $29.69 $36.75
On September 18, 1996, the Company's Board of Directors adopted a Stockholder Protection Rights Plan and declared a dividend of one preferred share purchase right ("Right") for each outstanding share of common stock of the Company. Each Right, initially, will entitle stockholders to buy a one one-hundredth interest in a share of a new series of preferred stock of the Company at an exercise price of $60.00, upon the occurrence of certain events described in the Plan. Initially, Rights will not be exercisable and will transfer with and only with the shares of common stock. The Rights will be exercisable and separately transferable ten business days after a person or group of persons acquires 10% or more of the common stock of Reliance Bancorp, Inc. ("Acquiring Person") or a person or group of persons announces a tender offer, the consummation of which would result in ownership by a person or group of persons of 10% or more of Company common stock. Subject to certain limitations, the Company's Board of Directors may reduce the 10% threshold.
If a person or group of persons becomes an Acquiring Person, each Right, unless redeemed by the Board of Directors at a price of $0.01 per Right, will entitle its holder (other than such person or member of such group) to purchase, at the then-current exercise price of the Right, a number of shares of common stock of Reliance Bancorp, Inc. having a market value equal to twice the exercise price of the Right. Alternatively, at any time after an Acquiring Person becomes such, but prior to the acquisition by such person of 50% or more of the Company's common stock, the Board of Directors may, at its option, direct the issuance of one share of common stock in exchange for each Right other than those held by the Acquiring Person.
The Rights dividend distribution was made to stockholders of record on October 3, 1996. The Rights will expire ten years later on October 3, 2006. The distribution of the Rights is not taxable to stockholders. Pursuant to the terms of the Stockholder Protection Rights Plan, the rights did not become exercisable upon execution of the Merger Agreement and will not become exercisable upon the completion of the transactions contemplated by the Merger agreement. The Rights Plan will expire upon consummation of the merger with North Fork.
Item 6.
Item 6. Selected Financial Data
Set forth below are the selected consolidated financial and other data of the Company. This financial data is derived in part from, and it should be read in conjunction with the Company's consolidated financial statements and related notes.
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(1) For purposes of these calculations, average stockholders' equity and average stockholders' tangible equity exclude the effect of changes in the unrealized appreciation (depreciation) on securities available-for-sale, net of taxes. (2) Calculation is based upon net interest income before provision for loan losses divided by average interest-earning assets. (3) Operating income represents total non-interest income less (plus) net gain (loss) on sale of securities and condemnation award on joint venture. (4) Non-performing loans consist of all loans 90 days or more past due and any other loans, or any portion thereof, that have been determined to be doubtful of collection. (5) Non-performing assets consist of non-performing loans and real estate owned.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
Reliance Bancorp, Inc. is a Delaware corporation organized on November 16, 1993 and is the holding company for Reliance Federal Savings Bank. On March 31, 1994, the Company issued 10,750,820 shares of common stock at $10.00 per share raising total net proceeds of $103.6 million of which $51.8 million was retained by the Company with the remaining net proceeds being used by the Company to purchase all of the outstanding stock of the Bank.
The Company is headquartered in Garden City, New York and its primary business currently consists of the operation of its wholly-owned subsidiary, the Bank. In addition to directing, planning and coordinating the business activities of the Bank, the Company currently invests primarily in U.S. Government securities, corporate debt securities and repurchase agreements. In addition, the Company completed the acquisitions of the Bank of Westbury, a Federal Savings Bank, in August 1995, Sunrise Bancorp, Inc., in January 1996 and Continental Bank, a commercial bank, in October 1997, which were all merged into the Bank.
The Bank's principal business is attracting retail deposits from the general public and investing those deposits, together with funds generated from operations, principal repayments and borrowings, primarily in mortgage, consumer, multi-family, commercial, commercial real estate, construction and guaranteed student loans. In connection with the acquisition of Continental Bank, the Bank now offers both secured and unsecured commercial loans. In addition, during periods in which the demand for loans which meet the Bank's underwriting and interest rate risk standards and policies is lower than the amount of funds available for investment, the Bank invests in mortgage-backed securities, securities issued by the U.S. Government and agencies thereof and other investments permitted by federal laws and regulations. The Bank also operates, as a result of the Continental Bank acquisition, five check cashing ("Money Centers") operations which result in additional fee income to the Bank.
The Company's results of operations are dependent primarily on interest income from its securities investments and earnings of the Bank. The Bank's results of operations are primarily dependent on its net interest income, which is the difference between the interest earned on its assets, primarily its loan and securities portfolios, and its cost of funds, which consists of the interest paid on its deposits and borrowings. The Bank's net income also is affected by its provision for loan losses as well as non-interest income, general and administrative expense, other non-interest expense, and income tax expense. General and administrative expense consists primarily of compensation and benefits, occupancy expenses, federal deposit insurance premiums, advertising expense and other general and administrative expenses. Other non-interest expense consists of real estate operations, net, amortization of excess of cost over the fair value of net assets acquired, and in fiscal 1997, a one-time pre-tax SAIF recapitalization charge. The earnings of the Company and Bank are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.
Financial Condition
As of June 30, 1999, total assets were $2.5 billion, a decrease of $34.0 million from June 30, 1998. Investment securities decreased $24.1 million, or 13.8%, from $175.1 million at June 30, 1998 to $151.0 million at June 30, 1999 as a result of sales and calls of debt securities.
Deposits decreased $78.9 million, or 4.8%, during the fiscal year ended June 30, 1999 as a result of a reduction in certificate of deposit products while borrowings increased $72.2 million, or 11.5%, from $630.2 million at June 30, 1998 to $702.4 million at June 30, 1999 as a result of additional FHLB advances.
Treasury stock increased from $24.0 million at June 30, 1998 to $50.6 million at June 30, 1999 as a result of 1.0 million shares repurchased net of stock options exercised during the fiscal year ended.
Non-performing assets
Non-performing loans totaled $6.6 million, or 0.67% of total loans at June 30, 1999 as compared to $9.3 million, or 0.95% of total loans, at June 30, 1998. Non-performing loans at June 30, 1999 were comprised of $4.0 million of loans secured by one- to four-family residences, $1.9 million of commercial real estate loans, $433,000 of commercial loans and $255,000 of guaranteed student and other loans.
For the fiscal year ended June 30, 1999, the Company's loan loss provision was $650,000 as compared to $1.7 million in the prior fiscal year. The Company decreased its provision for loan losses due to the lower level of non-performing loans and charge-offs. Net charge-offs were $471,000 for the fiscal year ended June 30, 1999 as compared to $636,000 in the fiscal year ended June 30, 1998. The Company's allowance for loan losses totalled $9.1 million at June 30, 1999 as compared to $8.9 million at June 30, 1998 which represents a ratio of allowance for loan losses to non-performing loans and to total loans of 139.08% and 0.93% at June 30, 1999 compared to 96.12% and 0.91% at June 30, 1998, respectively. Management believes the allowance for loan losses at June 30, 1999 is adequate and sufficient reserves are presently maintained to cover losses on loans.
Asset/Liability Management
One of the Bank's primary long-term financial objectives has been and will continue to be to monitor the sensitivity of its earnings to interest rate fluctuations by maintaining an appropriate matching of the maturities and interest rate repricing characteristics of its assets and liabilities in relation to the current and anticipated interest rate environment. In an effort to realize this objective and minimize the Bank's exposure to interest rate risk, the Bank emphasizes the origination of adjustable-rate mortgage ("ARM"), commercial and consumer loans, shorter-term fixed rate multi-family, mortgage, commercial and consumer loans and the purchase of shorter-term fixed rate and adjustable-rate mortgage-backed securities. However, there can be no assurances that the Bank will be able to originate adjustable-rate loans or acquire mortgage-backed securities with terms and characteristics which conform with the Bank's underwriting standards, investment criteria or interest rate risk policies.
The Company has attempted to limit its exposure to interest rate risk through the origination and purchase of adjustable-rate mortgage loans ("ARMs") and through purchases of adjustable-rate mortgage-backed and mortgage-related securities and fixed rate mortgage-backed and mortgage-related securities with short- and medium-term average lives. In the most recent fiscal year, the Bank has not been able to originate a significant amount of ARM's due to customer preference for fixed rate loans.
The actual duration of mortgage loans and mortgage-backed securities can be significantly impacted by changes in mortgage prepayment and market interest rates. Mortgage prepayment rates will vary due to a number of factors, including the regional economy in the area where the underlying mortgages were originated, seasonal factors, demographic variables and the assumability of the underlying mortgages. However, the largest determinants of prepayment rates are prevailing interest rates and related mortgage refinancing opportunities. Management monitors interest rate sensitivity so that adjustments in the asset and liability mix, when deemed appropriate, can be made on a timely basis.
At June 30, 1999, $922.2 million, or 39.5%, of the Bank's interest-earning assets consisted of adjustable-rate loans and mortgage-backed securities. The Bank's mortgage loan portfolio totalled $810.9 million, of which, $408.8 million, or 50.4%, were adjustable-rate loans and $402.1 million, or 49.6%, were fixed-rate loans. In addition, at June 30, 1999, the Bank's consumer loan portfolio totalled $127.3 million, of which, $99.6 million, or 78.2%, were adjustable-rate home equity lines of credit and guaranteed student loans and $27.7 million, or 21.8%, were fixed-rate home equity and other consumer loans. At June 30, 1999, the Bank's commercial loan portfolio totalled $44.9 million of which $32.5 million, or 72.3% were adjustable rate loans and $12.4 million, or 27.7% were fixed rate loans. At June 30, 1999, the mortgage-backed securities portfolio totalled $1.2 billion of which $935.0 million were classified as available-for-sale and $255.9 million was classified as held-to-maturity. Of the $935.0 million classified as available-for-sale, $327.4 million, or 27.5% of the total mortgage-backed portfolio, were adjustable-rate securities and $607.6 million, or 51.0%, were fixed-rate securities. Of the $255.9 million were classified as held-to-maturity,
$53.9 million, or 4.5% of the total mortgage-backed portfolio, were adjustable-rate securities and $202.0 million, or 17.0%, were fixed-rate securities. The Bank expects to continue to invest in shorter term fixed-rate and adjustable-rate mortgage-backed securities to reduce credit risk as well as minimize exposure to volatile interest rates. Recently, the Bank has purchased longer term fixed-rate higher yielding mortgage-backed securities to offset the prepayment risk of adjustable-rate securities during a falling interest rate environment. It should be noted that adjustable-rate loans and mortgage-backed securities backed by ARM loans initially bear rates of interest below that of comparable fixed rate loans or mortgage-backed securities backed by fixed rate loans. Accordingly, increased emphasis on adjustable-rate loans and mortgage-backed securities may, under certain interest rate conditions, result in the Bank's yield on interest-earning assets being lower than it could be if fixed rate loans were emphasized.
Market Risk and Interest Rate Sensitivity Analysis
The Company's primary component of market risk is interest rate volatility. The Company's net interest income, the primary component of its net income, is subject to substantial risk due to changes in interest rates or changes in market yield curves, particularly if there is a substantial variation in the timing between the repricing of the Company's assets and the liabilities which fund them. The Company seeks to manage this risk by monitoring and controlling the variation in repricing intervals between its assets and liabilities. To a lesser extent, the Company also monitors its interest rate sensitivity by analyzing the estimated changes in market value of its assets and liabilities assuming various interest rate scenarios. As previously discussed, there are a variety of factors which influence the repricing characteristics and market values of any given asset or liability. The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice, either by its contractual terms, or based upon certain assumptions made by management, within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice within that same time period. A gap is considered positive when the amount of interest rate sensitive assets maturing or repricing within a specific time frame exceeds the amount of interest rate sensitive liabilities maturing or repricing within that same time frame. Conversely, a gap is considered negative when the amount of interest rate sensitive liabilities maturing or repricing within a specific time frame exceeds the amount of interest rate sensitive assets maturing or repricing within that same time frame. In a rising interest rate environment, an institution with a negative gap would generally be expected, absent the effects of other factors, to experience a greater increase in the costs of its liabilities relative to the yields of its assets and thus a decrease in the institution's net interest income, whereas an institution with a positive gap would generally be expected to experience the opposite results. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.
Management monitors interest rate sensitivity so that adjustments in the asset and liability mix, when deemed appropriate, can be made on a timely basis. At June 30, 1999, the Company's interest-bearing liabilities maturing or repricing within one year exceeded net interest-earning assets maturing or repricing within the same time period by $100.1 million, representing a negative cumulative one-year gap of 4.08% of total assets. This compares to interest-bearing liabilities maturing or repricing within one year exceeding net interest-earning assets maturing or repricing within the same time period by $213.7 million, representing a negative cumulative one-year gap of 8.60% of total assets at June 30, 1998.
The following table ("the Gap table") sets forth the amount of interest-earning assets and interest-bearing liabilities outstanding at June 30, 1999, that are anticipated by the Company using certain assumptions based on its historical experience and other data available to management to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period was determined in accordance with the earlier of the term to repricing or the contractual terms of the asset or liability. Prepayment assumptions have been applied in estimating the repricing of the Company's mortgage loans and mortgage-backed securities. The estimated rates of prepayment assumed for loans and mortgage-backed securities are based upon coupon rates. The Company utilized deposit withdrawal assumptions for its deposit decay rate. For
passbook accounts, NOW accounts and money market accounts, such assumed rates were 8%, 15% and 18%, respectively. The assumptions used may not be indicative of future withdrawals of deposits or prepayments of loans and mortgage-backed securities. The Gap table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the actual repricing dates of various assets and liabilities are subject to customer discretion and competitive and other pressures. Callable features of certain assets and liabilities, in addition to the foregoing, may cause actual experience to vary from that indicated. Included in this table are $113.7 million of callable investment securities, classified according to their call dates. Of such securities, $18.9 million, $0.0, $18.0 million, $0.0, $0.0, and $76.8 million are callable in the "Up to One Year", "One to Two Years", "Two to Three Years", "Three to Four Years", "Four to Five Years", and "Over Five Years" categories, respectively. Also included in this table are $407.5 million of callable borrowings, classified according to their call dates. Of such borrowings, $244.0 million, $58.5 million, $0.0, $30.0 million, $25.0 million and $50.0 million are callable in the "Up to One Year", "One to Two Years", "Two to Three Years", "Three to Four Years", "Four to Five Years", and "Over Five Years" categories, respectively.
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(1) For purposes of the GAP analysis, mortgage and other loans are not reduced for the allowance for loan losses and non-performing loans. (2) For purposes of the GAP analysis, premiums, unearned discounts, deferred loan fees and purchase accounting adjustments are excluded. (3) Mortgage-backed and debt and equity securities were shown excluding the market value depreciation of $18.7 million on securities claassified as available-for-sale.
Certain shortcomings are inherent in the method of analysis presented in the Gap table. For example, although certain assets and liabilities may have similar contractual maturities or periods to repricing, they may react in different ways to changes in market interest rates. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Additionally, certain assets, such as ARMs, have contractual features which restrict changes in interest rates on a short-term basis and over the life of the asset. Finally, the ability of borrowers to service their ARMs or other loan obligations may decrease in the event of an interest rate increase. The Gap table reflects the estimates of management as to periods to repricing at a particular point in time. Among the factors considered are current trends and historical repricing experience with respect to similar products. For example, the Company has a number of deposit accounts, including savings, NOW accounts, and money market which, subject to certain regulatory exceptions not relevant here, may be withdrawn at any time. The Company, based upon its historical experience, assumes that while all customers in these account categories could withdraw their funds on any given day, they will not do so even if market interest rates change. As a result, different assumptions may be used at different points in time.
The Company's interest rate sensitivity is also monitored by management through analysis of the change in the net portfolio value ("NPV"). NPV is defined as the net present value of the expected future cash flows of an entity's assets and liabilities and, therefore, hypothetically represents the market value of an institution's net worth. Increases in the market value of assets will increase the NPV whereas decreases in market value of assets will decrease the NPV. Conversely, increases in the market value of liabilities will decrease NPV whereas decreases in the market value of liabilities will increase the NPV. The changes in market value of assets and liabilities due to changes in interest rates reflect the interest sensitivity of those assets and liabilities as their values are derived from the characteristics of the asset or liability (i.e. fixed rate, adjustable rate, caps, floors) relative to the interest rate environment. For example, in a rising interest rate environment the fair market value of a fixed rate asset will decline, whereas the fair market value of an adjustable rate asset, depending on its repricing characteristics, may not decline. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. This analysis, referred to in the NPV table, initially measures percentage changes from the value of projected NPV in a given rate scenario, and then measures interest rate sensitivity by the change in the NPV ratio, over a range of interest rate change scenarios. The OTS also produces a similar analysis using its own model based upon data submitted on the Bank's quarterly Thrift Financial Reports, the results of which may vary from the Company's internal model primarily because of differences in assumptions utilized between the Company's internal model and the OTS model, including estimated loan prepayment rates, reinvestment rates and deposit decay rates. For purposes of the NPV table, prepayment speeds and deposit decay rates similar to those used in the Gap table were used. The NPV table is based on simulations which utilize institution specific assumptions with regard to future cash flows, including customer options such as loan prepayments, period and lifetime caps, puts and calls, and deposit withdrawal estimates. The NPV table uses discount rates derived from various sources including, but not limited to, treasury yield curves, thrift retail certificate of deposit curves, national and local secondary mortgage markets, brokerage security pricing services and various alternative funding sources.
Specifically, for mortgage loans receivable, the discount rates used were based on market rates for new loans of similar type and purpose, adjusted, when necessary, for factors such as servicing cost, credit risk and term. The discount rates used for certificates of deposit and borrowings were based on rates which approximate the rates offered by the Company for deposits and borrowings of similar remaining maturities. The table calculates the NPV at a flat rate scenario by computing the present value of cash flows of interest earning assets less the present value of interest bearing liabilities. Certain assets, including fixed assets and real estate held for development, are assumed to remain at book value (net of valuation allowance) regardless of interest rate scenario. Other non-interest earning assets and non-interest bearing liabilities such as deferred fees, unamortized premiums, goodwill and accrued expenses and other liabilities are excluded from the NPV calculation. The following table sets forth the Bank's NPV as of June 30, 1999, as calculated by the Bank, for instantaneous and sustained changes in interest rates relative to the NPV in an unchanging interest rate environment.
Changes in Interest Portfolio Rates in Basis Net Portfolio Value Value of Assets ----------------------------- ------------------- Points $ $ % NPV % (Rate Shock) Amount Change Change Ratio Change ------------ ------ ------ ------ ----- ------ (Dollar in Thousands) 200.................. 102,338 (77,424) (43.1) 4.42 40.8 100.................. 148,675 (31,087) (17.3) 6.28 15.9 0.................... 179,762 7.47 (100)................ 215,043 35,281 19.6 8.76 (17.3) (200)................ 223,290 43,528 24.2 9.03 (20.9)
As with the Gap table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling of changes in NPV requires the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model assumes that the composition of the Company's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is immediate and is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. In addition, prepayment estimates and other assumptions within the model are subjective in nature, involve uncertainties and, therefore, cannot be determined with precision. Accordingly, although the NPV measurements in theory, may provide an indication of the Company's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide for a precise forecast of the effect of changes in market interest rates on the Company's net portfolio value and will differ from actual results.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.
The following table sets forth certain information relating to the Company's consolidated statements of condition and the consolidated statements of income for the years ended June 30, 1999, 1998, and 1997 and reflects the average yields on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the fiscal years shown. Average balances are derived from daily balances. The average balance of loans receivable includes loans on which the Bank has discontinued accruing interest. The yields and costs include fees, premiums and discounts which are considered adjustments to yields.
Comparison of Operating Results for the Years Ended June 30, 1999 and 1998
General. Net income for fiscal 1999 was $20.2 million as compared to $18.7 million for fiscal 1998.
Interest Income. Interest income increased $13.5 million, or 8.8%, from $153.8 million for fiscal 1998 to $167.3 million for fiscal 1999. The increase resulted primarily from a $303.0 million increase in average interest-earning assets from $2.0 billion for fiscal 1998 to $2.3 billion for fiscal 1999. The average yield on interest-earning assets decreased from 7.52% in fiscal 1998 to 7.13% in fiscal 1999. Interest income on mortgage-backed securities increased $11.8 million, or 17.5%, from $67.2 million for fiscal 1998 to $78.9 million for fiscal 1999, primarily due to an increase of $235.6 million, or 23.9%, in the average balance of these securities, offset by a 35 basis point decrease in the average yield on these securities from 6.81% for fiscal 1998 to 6.46% for fiscal 1999. Interest income on investment securities increased $3.9 million, or 60.5%, from $6.4 million in fiscal 1998 to $10.3 million in fiscal 1999, primarily due to an increase of $67.1 million in the average balance of investment securities, offset by a 66 basis point decrease in the average yield on investment securities from 7.29% for fiscal 1998 to 6.63% for fiscal 1999. The increase in the average balance of investment securities was primarily due to purchases of corporate debt securities.
Interest Expense. Interest expense for fiscal 1999 was $98.0 million, an increase of $11.2 million, or 12.9%, from $86.8 million in fiscal 1998. The increase is primarily the result of a $286.8 million, or 15.0%, increase in the average balance of interest-bearing liabilities from $1.9 billion for fiscal 1998 to $2.2 billion for fiscal 1999 offset by a 8 basis point decrease in the cost of interest-bearing liabilities from 4.54% for fiscal 1998 to 4.46% for fiscal 1999. The increase in the average balance of interest-bearing liabilities was primarily due to new certificates of deposits and additional borrowings. The decrease in the average yield of interest-bearing liabilities was primarily due to lower interest rate environment during the year which resulted in lower certificate of deposits and borrowing rates. Interest expense on total deposits decreased $1.5 million, or 2.3%, from $63.4 million for fiscal 1998 to $62.0 million for fiscal 1999, primarily as a result of a 24 basis point decrease in the average cost of such deposits from 4.21% in fiscal 1998 to 3.97% in fiscal 1999. The decrease in the average yield on deposits is primarily due to a reduction in passbook savings rates during the year and lower rates offered on certificates of deposits. Interest expense on borrowed funds increased $12.6 million, or 54.0%, from $23.4 million for fiscal 1998 to $36.0 million for fiscal 1999. The average balance of borrowed funds increased $232.7 million, or 57.7% to $636.1 million for fiscal 1999 as compared to $403.4 million for fiscal 1998. The increase in borrowings is attributable to additional leveraging of the balance sheet and the proceeds from the trust preferred securities. The Bank had been using borrowings to leverage its capital and fund asset growth.
Net Interest Income. Net interest income for fiscal 1999 increased $2.3 million, or 3.5%, from $67.0 million for fiscal 1998 to $69.3 million for fiscal 1999. The increase in net interest income primarily relates to growth in the average balances of interest-earning assets offset by a decrease in the net interest spread. Average interest-earning assets increased $303.0 million, or 14.8%, from $2.0 billion in fiscal 1998 to $2.3 billion in fiscal 1999 while average interest-bearing liabilities increased $286.8 million, or 15.0%, from $1.9 billion in fiscal 1998 to $2.2 billion in fiscal 1999. The net interest rate spread declined by 31 basis points from 2.98% for fiscal 1998 to 2.67% for fiscal 1999 as a result of reinvestment of funds into lower yielding interest-earning assets. As a result of further leveraging of the Bank's capital, the net interest margin decreased from 3.28% in fiscal 1998 to 2.95% in fiscal 1999.
Provision for Loan Losses. The provision for loan losses for fiscal 1999 was $650,000, a decease of $1.0 million or 60.6%, from $1.7 for fiscal 1998. When determining the provision for loan losses, management assesses the risk inherent in its loan portfolio based on information available to management at such time relating to trends in the national and local economies, trends in the real estate market and trends in the Company's level of non-performing loans, assets and net charge-offs. Management decreased the provision for loan losses for fiscal 1999 due to the lower level of non-performing loans and charge-offs. Non-performing loans decreased $2.7 million, or 29.5%, from $9.3 million at the end of fiscal 1998 to $6.6 million at the end of fiscal 1999 and net charge-offs decreased from $636,000 for fiscal 1998 to $471,000 for fiscal 1999. At June 30, 1999 and 1998, the allowance for loan losses was $9.1 million and $8.9 million, respectively, which represented 139.08% of non-performing loans and 0.93% of total loans at June 30, 1999 as compared to 96.12% of non-performing loans and 0.91% of total loans at June 30, 1998. Management believes that, based on information currently known to management, the provision for possible loan losses and the allowance for possible loan losses are currently reasonable and adequate to cover potential losses reasonably expected in the existing loan portfolio. While management estimates loan losses using the best available information, no assurance can be given that future additions to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding problem loans, identification of additional problem loans and other factors, both within and outside of management's control. If general economic conditions and real estate values within the Bank's primary lending area decline, the level of non-performing loans may increase resulting in larger provisions for loan losses which, in turn, would adversely affect net income.
Non-Interest Income. Non-interest income for fiscal 1999 increased $541,000, or 6.9%, from $7.9 million for fiscal 1998 to $8.4 million for fiscal 1999 due to increased fee income generated from the check cashing operations, prepayment penalties, ATM fees and deposit fee income offset by a condemnation award in the prior fiscal year.
Non-Interest Expense. Non-interest expense totalled $41.0 million for fiscal 1999 as compared to $39.7 million for fiscal 1998, an increase of $1.3 million, or 3.3%. For fiscal 1999, compensation and benefits expense increased to $20.4 million, an increase of $76,000, or 0.37%, from $20.3 million for fiscal 1998. The increase in compensation
and benefits expense is due to higher benefit expenses and normal salary adjustments. For fiscal 1999, ESOP and RRP expense was $3.1 million as compared to $3.7 million in the prior year, a decrease of $585,000, or 15.8%. Occupancy and equipment expense increased $533,000, or 8.2%, from $6.5 million for fiscal 1998 to $7.1 million for fiscal 1999 due to costs associated with the full year operation of two new banking offices and five check cashing facilities which were acquired from Continental Bank. Federal deposit premium expense increased $9,000, or 1.0%, from $921,000 million for fiscal 1998 to $930,000 for fiscal 1999. Other operating expenses increased $401,000, or 6.4%, from $6.3 million during fiscal 1998 to $6.7 million for fiscal 1999 primarily as a result of general expenses related to the full year operation of two new banking offices and five check cashing facilities.
For fiscal 1999, expenses related to real estate operations, net was $111,000, as compared to $218,000 in the prior fiscal year. The decrease is mainly the result of a lower provision for REO losses and lower expenses due to faster disposition of properties during the fiscal year ended June 30, 1999. During fiscal 1999, the Bank established a provision for REO losses of $34,500 as compared to $93,000 in the prior fiscal year period.
During fiscal 1999, the Bank recognized amortization of excess of cost over fair value of net assets acquired of $4.6 million as compared to $4.2 million in fiscal 1998. The amortization of cost over fair value of net assets acquired relates to the Company accounting for the acquisitions of Bank of Westbury, Sunrise Bancorp, Inc. and Continental Bank using the purchase method of accounting.
Income Tax Expense. Income tax expense increased $1.1 million, or 7.6%, from $14.8 million for fiscal 1998 to $15.9 million for fiscal 1999. The effective income tax rate was 44.2% for fiscal 1999 and 1998. The effective income tax rate is affected by certain tax benefits associated with the operations of a subsidiary of the Bank and by amortization of excess of cost over fair value of net assets acquired, which provides no tax benefit.
Comparison of Operating Results for the Years Ended June 30, 1998 and 1997.
General. Net income for fiscal 1998 was $18.7 million as compared to $10.9 million for fiscal 1997. Net income for fiscal 1997 reflects a one time pre-tax charge to income of $8.25 million for the Company's share of recapitalizing the Savings Association Insurance Fund ("SAIF"). The following discussion reflects the results of operations exclusive of the SAIF recapitalization charge.
General Comparison Exclusive of the SAIF Recapitalization Charge. Net income increased $3.0 million, or 18.8% from $15.7 million for fiscal 1997 to $18.7 million for fiscal 1998. Return on average equity increased to 10.42% for fiscal 1998 from 10.12% for fiscal 1997 and return on average tangible equity increased to 15.14% for fiscal 1998 from 14.56% for fiscal 1997. Diluted earnings per share rose to $1.99 for fiscal 1998 as compared to diluted earnings per share of $1.81 for fiscal 1997.
Interest Income. Interest income increased $20.5 million, or 15.4%, from $133.3 million for fiscal 1997 to $153.8 million for fiscal 1998. The increase resulted primarily from a $270.2 million increase in average interest-earning assets from $1.8 billion for fiscal 1997 to $2.0 billion for fiscal 1998 and from a slight increase in the average yield of interest-earning assets from 7.51% in fiscal 1997 to 7.52% in fiscal 1998. The increase in the average interest-earning assets was primarily due to assets acquired in the Continental Bank acquisition, increased purchases of mortgage-backed securities and increased originations of multi-family loans. Interest income on mortgage-backed securities increased $7.8 million, or 13.1%, from $59.4 million for fiscal 1997 to $67.2 million for fiscal 1998, primarily due to an increase of $136.5 million, or 16.1%, in the average balance of these securities, offset by an 18 basis point decrease in the average yield on these securities from 6.99% for fiscal 1997 to 6.81% for fiscal 1998. Interest income on mortgage loans increased $6.6 million, or 11.6% from $56.9 million in fiscal 1997 to $63.5 million in fiscal 1998, primarily due to an increase of $75.6 million in the average balance of mortgage loans, and a slight 7 basis point increase in the average yield on mortgage loans from 8.03% for fiscal 1997 to 8.10% for fiscal 1998. The increase in the average balance of mortgage loans was primarily due to loans acquired in the Continental Bank acquisition and increased originations of multi-family loans.
Interest Expense. Interest expense for fiscal 1998 was $86.8 million, an increase of $15.2 million, or 21.2%, from $71.6 million in fiscal 1997. The increase is primarily the result of a $241.5 million, or 14.5%, increase in the average balance of interest-bearing liabilities from $1.7 billion for fiscal 1997 to $1.9 billion for fiscal 1998 and from a 25 basis point increase in the cost of interest-bearing liabilities from 4.29% for fiscal 1997 to 4.54% for fiscal 1998. The increase in the average balance of interest-bearing liabilities was primarily due to deposits acquired in the Continental Bank acquisition, new certificate deposits and additional borrowings. Interest expense on total deposits increased $9.3 million, or 17.2%, from $54.1 million for fiscal 1997 to $63.4 million for fiscal 1998, primarily as a result of a $149.4 million, or 11.0%, increase in the average balance of deposits from $1.4 billion in fiscal 1997 to $1.5 billion in fiscal 1998 and a 23 basis point increase in the average cost of such deposits from 3.98% in fiscal 1997 to 4.21% in fiscal 1998. The average balance of certificate accounts increased $145.8 million, or 19.8%, from $737.0 million for fiscal 1997 to $882.8 million for fiscal 1998. In addition to the increase in the average balance of certificate accounts, the average balance of interest-bearing core deposits also increased $9.5 million, or 1.8%, from $522.0 million for fiscal 1997 to $531.5 million for fiscal 1998. The increase in average core deposits relates to deposits acquired from Continental Bank. Interest expense on borrowed funds increased $5.9 million, or 33.6%, from $17.5 million for fiscal 1997 to $23.4 million for fiscal 1998. The average balance of borrowed funds increased $92.0 million, or 29.6% to $403.4 million for fiscal 1998 as compared to $311.4 million for fiscal 1997. The increase in borrowings is attributable to additional leveraging of the balance sheet and the proceeds from the trust preferred securities. The Bank had been using borrowings to leverage its capital and fund asset growth.
Net Interest Income. Net interest income for fiscal 1998 increased $5.4 million, or 8.7%, from $61.6 million for fiscal 1997 to $67.0 million for fiscal 1998. The increase in net interest income primarily relates to the significant growth in the average balances of interest-earning assets offset by a decrease in the net interest spread. Average interest-earning assets increased $270.2 million, or 15.2%, from $1.8 billion in fiscal 1997 to $2.0 billion in fiscal 1998 while average interest-bearing liabilities increased $241.5 million, or 14.5%, from $1.7 billion in fiscal 1997 to $1.9 billion in fiscal 1998. The net interest rate spread declined by 24 basis points from 3.22% for fiscal 1997 to 2.98% for fiscal 1998 as a result of increased costs of interest bearing liabilities. As a result of further leveraging of the Bank's capital, the net interest margin decreased from 3.47% in fiscal 1997 to 3.28% in fiscal 1998. As a result of the Continental acquisition, the ratio of average interest-earning assets to interest-bearing liabilities increased slightly from 1.06X in fiscal 1997 to 1.07X in fiscal 1998.
Provision for Loan Losses. The provision for loan losses for fiscal 1998 was $1.65 million, an increase of $700,000, or 73.7%, from $950,000 for fiscal 1997. When determining the provision for loan losses, management assesses the risk inherent in its loan portfolio based on information available to management at such time relating to trends in the national and local economies, trends in the real estate market and trends in the Company's level of non-performing loans, assets and net charge-offs. Non-performing loans decreased from $14.7 million at the end of fiscal 1997 to $9.3 million at the end of fiscal 1998 and net charge-offs increased from $263,000 for fiscal 1997 to $636,000 for fiscal 1998. Management increased the provision for loan losses during fiscal 1998 due to its assessment of the loan portfolio and to increase loan loss coverage on non-performing loans. Additionally, during fiscal 1998, the Company increased its origination of multi-family loans and as a result of the Continental acquisition, the Company began to originate commercial loans. Multi-family loans and commercial loans may possess a greater credit risk than one- to four-family loans and require greater general reserve levels. Management believes that based upon information currently available, its allowance for loan losses is adequate to cover future loan losses. However, if general economic conditions and real estate values within the Bank's primary lending area decline, the level of non-performing loans may increase resulting in larger provisions for loan losses which, in turn, would adversely affect net income.
Non-Interest Income. Non-interest income for fiscal 1998 increased $4.4 million, or 130.3%, from $3.4 million for fiscal 1997 to $7.8 million for fiscal 1998, due to a gain from a condemnation award received from an inactive joint venture, fee income generated from the check cashing operations acquired from Continental Bank and increased deposit fee income.
Non-Interest Expense. Non-interest expense totalled $39.7 million for fiscal 1998 as compared to $43.0 million for fiscal 1997, a decrease of $3.3 million, or 7.8%. Included in non-interest expense for fiscal 1997 is the special SAIF
pre-tax charge of $8.25 million. Excluding the SAIF charge, non-interest expense increased $4.9 million, or 14.1%.The increase is mainly the result of banking office personnel, goodwill amortization and other expenses associated with the Continental Bank acquisition offset by a decrease in deposit insurance premiums. Due to the increased asset base and the operational efficiencies realized from the acquisition, the general and administrative expenses to average assets ratio improved from 1.66% for the fiscal year ended June 30, 1997 to 1.62% for fiscal 1998. For fiscal 1998, compensation and benefits expense increased to $20.3 million, an increase of $3.8 million, or 23.0%, from $16.5 million for fiscal 1997. The increase in compensation and benefits expense is due to the addition of banking office personnel from the Continental Bank acquisition, higher benefit expenses and normal salary adjustments. For fiscal 1998, ESOP and RRP expense was $3.7 million as compared to $2.5 million in the prior year, an increase of $1.2 million, or 46.9%. Occupancy and equipment expense increased $812,000, or 14.2%, from $5.7 million for fiscal 1997 to $6.5 million for fiscal 1998 due to costs associated with the operation of two new banking offices and five check cashing facilities. Federal deposit premium expense decreased $892,000, or 49.2%, from $1.8 million for fiscal 1997 to $921,000 for fiscal 1998 due to the reduction in SAIF. Other operating expenses increased $496,000, or 8.6%, from $5.8 million during fiscal 1997 to $6.3 million for fiscal 1998 primarily as a result of general expenses related to the addition of two new banking offices and five check cashing facilities.
For fiscal 1998, expenses related to real estate operations, net was $218,000, a decrease of $165,000, or 43.1%, from $383,000 in the prior year period. The decrease is the result of a lower provision for REO losses during the fiscal year ended June 30, 1998. During fiscal 1998, the Bank established a provision for REO losses of $93,000 as compared to $200,000 in the prior year period.
During fiscal 1998, the Bank recognized amortization of excess of cost over fair value of net assets acquired of $4.2 million as compared to $3.4 million in fiscal 1997. The amortization of cost over fair value of net assets acquired relates to the Company accounting for the acquisitions of Bank of Westbury, Sunrise Bancorp, Inc. and Continental Bank using the purchase method of accounting.
Income Tax Expense. Income tax expense increased $4.7 million, or 46.1%, from $10.1 million for fiscal 1997 to $14.8 million for fiscal 1998. The effective income tax rate was 44.2% for fiscal 1998 as compared to 48.1% for fiscal 1997. The decrease in the effective tax rate primarily relates to certain tax benefits associated with the operations of a subsidiary of the Bank, offset by an increase in amortization of excess of cost over fair value of net assets acquired, which provides no tax benefit.
Liquidity and Capital Resources
The Company's current primary sources of funds are principal and interest payments, sales of securities available-for- sale, borrowings and dividends from the Bank. Dividend payments to the Company from the Bank are subject to the profitability of the Bank and to applicable laws and regulations. During fiscal 1999, 1998 and 1997, the Bank made dividend payments of $13.0 million, $14.0 million and $6.7 million, respectively, to the Company.
On April 29, 1998, the Company completed a $50 million private placement of 8.17% capital securities (the "Capital Securities") due May 1, 2028. The securities were issued by the Company's recently formed unit, Reliance Capital Trust I. The securities were sold in an offering under Rule 144A and Regulation D of the Securities Act of 1933. Proceeds of the issue were invested by Reliance Capital Trust I in junior subordinated debentures issued by the Company. The Capital Securities are guaranteed by the Company. Net proceeds from the sale of the debentures were used for general corporate purposes.
The Company's liquidity is also available to, among other things, support future expansion of operations or diversification into other banking related business, pay dividends or repurchase its common stock. In this regard, the Company declared cash dividends of $6.5 million, $6.0 million and $4.9 million during fiscal years 1999, 1998 and 1997, respectively.
On November 6, 1998, the Company completed its seventh five percent stock repurchase plan purchasing 500,000 shares at an aggregate cost of $13.9 million. The Company also announced its eighth stock repurchase plan to repurchase up to 500,000 of the Company's outstanding shares. As of June 30, 1999, 146,207 shares under this program were repurchased at an aggregate cost of $4.1 million. During fiscal years 1999, 1998 and 1997, the Company repurchased total shares of 1,040,207, 460,973 and 442,182, respectively, at an aggregate cost of $27.9 million, $15.3 million and $8.1 million, respectively.
The Bank's primary sources of funds are deposits, principal and interest payments on loans, mortgage-backed securities and debt and equity securities, advances from the FHLB-NY and borrowings under reverse repurchase agreements and loan sales. While maturities and scheduled amortization of loans, mortgage-backed securities and debt securities are predictable sources of funds, deposit flows and mortgage prepayments are strongly influenced by changes in general interest rates, economic conditions and competition.
The Bank is required to maintain an average daily balance of liquid assets as a percentage of net withdrawable deposit accounts plus short-term borrowings as defined by OTS regulations. The minimum required liquidity is currently 4.0%. The Bank's liquidity ratio averaged 9.3% for the year ended June 30, 1999.
The Bank's most liquid assets are cash and short-term investments. The levels of the Bank's liquid assets are dependent on the Bank's operating, financing, lending and investing activities during any given period. At June 30, 1999, assets qualifying for liquidity, including cash, US government obligations and other eligible securities, totalled $201.4 million.
The primary investment activity of the Bank is the origination of mortgage, commercial and consumer and loans, and the purchase of mortgage loans and mortgage-backed securities. During the fiscal year ended June 30, 1999, the Bank originated and purchased mortgage loans, commercial and consumer loans in the amount of $175.8 million, $141.2 million and $41.7 million, respectively. During the fiscal year ended June 30, 1999, the Bank purchased $836.5 million of mortgage-backed securities of which $730.2 million and $106.3 million, respectively, were classified as available-for-sale and held-to-maturity and purchased as part of the Bank's growth strategy. These activities were funded primarily by deposits, principal repayments on loans and mortgage-backed securities and borrowings from the FHLB-NY, reverse repurchase agreements and proceeds from Capital Securities. At June 30, 1999, borrowings from the FHLB-NY and reverse repurchase agreements totalled $338.7 million and $313.7 million, respectively.
At June 30, 1999, the Bank had outstanding loan commitments of $45.2 million and commercial and consumer open lines of credit of $18.1 million and $52.0 million, respectively. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit which are scheduled to mature in one year or less from June 30, 1999 totalled $710.7 million. Management believes that a significant portion of such deposits will remain with the Bank.
At June 30, 1999, the Bank exceeded each of the OTS capital requirements. The Bank's tangible, core, and risked-based ratios were 6.78%, 6.78% and 17.14%, respectively. The Bank qualifies as "well capitalized" under the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvements Act of 1991.
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles ("GAAP"), which require the measurements of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or, to the same extent, as the price of goods and services.
Impact of New Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.133"). SFAS No. 133 establishes accounting and reporting standards forderivative instruments and for hedging activities. It requires that an entityrecognize all derivatives as either assets or liabilities in the statement offinancial condition and measure those instruments at fair value. The accountingfor changes in the fair value of a derivative (that is, unrealized gains andlosses) depends on the intended use of the derivative and the resulting designation. SFAS No. 133 is effective for fiscal quarters of fiscal years beginning after June 15, 1999 and does not require restatement of prior periods. In June 1999, the FASB issued SFAS No. 137, "Deferral of Effective Date of SFAS No. 133", which defers the adoption of SFAS No. 133 by one year. Management of the Company believes the implementation of SFAS No. 133 will not have a material impact on the Company's financial condition or results of operations.
Impact of the Year 2000 Issue
The Year 2000 Issue centers on the inability of computer systems to recognize the year 2000. Many existing computer programs and systems were originally programmed with six digit dates that provided only two digits to identify the calendar year in the date field, without considering the upcoming change in the century. With the impending millennium, these programs and computers will recognize "00" as the year 1900 rather than the year 2000. Like most financial service providers, the Company and its operations may be significantly affected by the Year 2000 Issue due to the nature of financial information. Software, hardware, and equipment both within and outside the Company's direct control and with whom the Company electronically or operationally interfaces (e.g. third party vendors providing data processing, information system management, maintenance of computer systems, and credit bureau information) are likely to be affected. Furthermore, if computer systems are not adequately changed to identify the Year 2000, many computer applications could fail or create erroneous results. As a result, many calculations which rely on the date field information, such as interest, payment or due dates and other operating functions, will generate results which could be significantly misstated, and the Company could experience a temporary inability to process transactions, send invoices or engage in similar normal business activities. In addition, under certain circumstances, failure to adequately address the Year 2000 Issue could adversely affect the viability of the Company's suppliers and creditors and the creditworthiness of its borrowers. Thus, if not adequately addressed, the Year 2000 Issue could result in a significant adverse impact on the Company's products, services and competitive condition.
The Company has adopted a "Year 2000 Policy" and is in the process of reviewing its internal systems. The Company completed testing of computer software programs and hardware to determine Year 2000 compliance. Further, the Company has purchased Year 2000 compliant software from EDS for use with the mainframe computer. The Company believes that with existing modifications to existing software and conversions to new software and hardware where necessary, the Year 2000 problem will be mitigated without causing a material adverse impact on the operations of the Company. The Company has completed testing and implementation of changes.
The Company has initiated formal written communications with all of its significant suppliers to determine the extent to which the Company is vulnerable to those third parties' failures to remediate their own Year 2000 Issue. Significant suppliers have been requested to certify that they are Year 2000 compliant or, if not, to provide their plans to become compliant. Management of the Company receives monthly updates as to which significant suppliers are Year 2000 compliant and follow-up with all significant suppliers is being conducted according to plan. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue will be mitigated without causing a material adverse impact on the operations of the Company. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have an impact on the operations of the Company. At this time, management does not believe that the impact and any resulting costs will be material.
Monitoring and managing the Year 2000 project will result in additional direct and indirect costs to the Company. Direct costs include potential charges by third party software vendors for product enhancements, costs involved in testing software products for Year 2000 compliance, and any resulting costs for developing and implementing contingency plans for critical software products which are not enhanced. Indirect costs will principally consist of the time devoted by existing employees in monitoring software vendor progress, testing enhanced software products and implementing any necessary contingency plans. The Company does not believe that such costs will have a material effect on results of operations. Both direct and indirect costs of addressing the Year 2000 Issue will be charged to earnings as incurred. Such costs have not been material to date, however the Company expects to incur approximately $200,000 in Year 2000 related expenses.
Presently, the Company has a formal contingency plan in the event that its computer software and hardware vendors are not Year 2000 compliant. Based upon discussions with the Company's computer software and hardware vendors, including its data processing vendors, such vendors have indicated that they have completed testing and will be Year 2000 compliant.
Private Securities Litigation Reform Act Safe Harbor Statement
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market area and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Company and its business, including additional factors that could materially affect the Company's financial results, is included in the Company's filings with the Securities and Exchange Commission.
The Company does not undertake -- and specifically disclaims any obligation -- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Information regarding management's discussion and analysis of financial condition and results of operations appears under Item 7 of this report.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See the information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset/Liability Management /Market Risk and Interest Rate Sensitivity Analysis" in Item 7 of this report.
Item 8.
Item 8.
Consolidated Financial Statements and Supplementary Data
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
[LOGO] Arthur Andersen LLP Independent Public Accountants 1345 Avenue of the Americas New York, NY 10105
To the Board of Directors and Stockholders of Reliance Bancorp, Inc.,
We have audited the accompanying consolidated statement of condition of Reliance Bancorp, Inc. and subsidiary as of June 30, 1999, and the related consolidated statements of income, changes in stockholders' equity, comprehensive income and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Reliance Bancorp, Inc. and subsidiary as of June 30, 1998, and for each of the years in the two year period then ended were audited by other auditors whose report dated July 23, 1998, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Reliance Bancorp, Inc. and subsidiary as of June 30, 1999, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP - --- ------------------- Arthur Andersen LLP New York, New York July 21, 1999 (except with respect to the matter discussed in Note 2, as to which the date is August 30, 1999)
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
[LOGO] KPMG LLP 1305 Walt Whitman Road Melville, NY 11747-4302
To the Board of Directors and Stockholders of Reliance Bancorp, Inc.,
We have audited the accompanying consolidated statement of condition of Reliance Bancorp, Inc. and subsidiary as of June 30, 1998, and the related consolidated statements of income, changes in stockholders' equity, comprehensive income and cash flows for each of the years in the two-year period ended June 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statementsare free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Reliance Bancorp, Inc. and subsidiary as of June 30, 1998, and the results of their operations and their cash flows for each of the years in the two-year period ended June 30, 1998, in conformity with generally accepted accounting principles.
/s/ KMPG LLP KPMG LLP July 23, 1998
Reliance Bancorp, Inc. and Subsidiary Consolidated Statements of Condition (In thousands, except share amounts)
See accompanying notes to consolidated financialstatements.
Reliance Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
The accounting and reporting policies of Reliance and subsidiary conform to generally accepted accounting principles and to general practice within the financial institution industry. The following is a description of the more significant policies which the Company follows in preparing and presenting its consolidated financial statements.
(a) Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Reliance Federal Savings Bank. All significant intercompany transactions and balances are eliminated in consolidation.
As more fully discussed in Note 3, Reliance Bancorp Inc., a Delaware corporation, was organized by the Bank for the purpose of acquiring all of the capital stock of the Bank pursuant to the conversion of the Bank from a federally chartered mutual savings bank to a federally chartered stock savings bank. The Company is subject to the financial reporting requirements of the Securities and Exchange Act of 1934, as amended.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and income and expense for the years presented. Estimates that are susceptible to change include primarily the determination of the allowances for losses on loans and the valuation of real estate acquired in connection with foreclosures.
(b) Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and repurchase agreements with an original term to maturity of less than three months.
(c) Securities Available-for-Sale The Company follows Statement of Financial Accounting Standards ("SFAS") No.115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 requires securities, including debt, equity and mortgage-backed securities, classified as available-for-sale to be recorded at estimated fair value with changes in unrealized gains or losses reported net of tax as a separate component in stockholders' equity.
Debt securities are classified as available-for-sale when management intends to hold the securities for indefinite periods of time or when the securities may be utilized for tactical asset/liability management strategy and may be sold from time to time to effectively manage interest rate exposure and resultant prepayment risk and liquidity needs. Premiums and discounts are amortized or accreted, respectively, using the level-yield method. Readily marketable equity securities are also classified as available-for-sale. Gains or losses on the sales of the securities are recognized when sold using the specific identification method.
(d) Debt and Equity Securities Held-to-Maturity Debt and equity securities classified as held-to-maturity are carried at cost unless there is a permanent impairment of value, at which time they are valued at the lower of cost or market value resulting in a new cost basis for the security. The debt securities are adjusted for amortization of premiums and accretion of discounts over the term of the security using the level-yield method. The Company currently has the ability and intent to hold the debt securities until maturity. Equity securities classified held-to-maturity are not readily marketable.
(e) Mortgage-Backed Securities Held-to-Maturity Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by the issuers of the securities. Mortgage-backed securities held-to-maturity are carried at current unpaid
principal balances, adjusted for unamortized premiums and unaccreted discounts. Premiums are amortized and discounts are accreted to income over the estimated life of the respective securities using the level-yield method. The Company currently has the ability and intent to hold the securities until maturity.
(f) Loans Loans are stated at the principal amount outstanding, less unearned discounts and net deferred loan origination fees, if applicable. Interest on loans is credited to income based on the principal amount outstanding during the period. Gains and losses on the sale of loans are determined using the specific identification method.
Interest on loans is recognized on the accrual basis. Loans are placed on nonaccrual status when principal or interest becomes 90 days or more past due for mortgage loans and commercial loans and 120 days past due for other loans, unless the obligation is both well secured and in the process of collection. Accrued interest receivable previously recognized is reserved when a loan is placed on nonaccrual status. Loans remain on nonaccrual status until principal and interest payments are current or the obligation is considered both well secured and in the process of collection. A loan is considered a troubled debt restructuring when changes, such as reduction in interest rates or deferral of interest or principal payments, are made to contractual terms due to a borrower's weakened financial condition.
The Company defers loan origination fees on multi-family loans, less certain direct costs, and subsequently recognizes them as an adjustment of the loan's yield over the contractual life of the loan using the level-yield method or, in the case of loans with below-market introductory rates, generally over the applicable introductory period, using the interest method.
The Company follows SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". Under SFAS No. 114 and SFAS No. 118, a loan is considered impaired when, based upon current information and events, it is probable that a creditor will be unable to collect all amounts due including principal and interest, according to the contractual terms of the loan agreement. These statements require that impaired loans that are within their scope be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or as a practical expedient, at the loan's current observable market price, or the fair value of the collateral if the loan is collateral dependent. The amount by which the recorded investment of an impaired loan exceeds the measurement value is recognized by creating a valuation allowance through a charge to the provision for loan losses. Interest income received on impaired loans is recognized on a cash basis.
(g) Allowance for Loan Losses A provision for loan losses charged to income is reflected as an addition to a valuation allowance which is netted against loans receivable. Management's periodic evaluation of the adequacy of the valuation allowance considers the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower's ability to repay, estimated value of the underlying collateral and the current real estate markets and economic condition in the Bank's lending areas. In addition, the Bank's regulators, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans and real estate. Accordingly, the Bank may be required to take certain charge-offs and recognize additions to the allowance based on the regulators' judgments concerning information available to them during their examination.
(h) Office Properties and Equipment Land is carried at cost. Buildings, leasehold improvements, furniture and fixtures and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line method over the estimated useful lives of the assets. The cost of leasehold improvements is being amortized using the straight-line method over the shorter of the term of the related leases or the estimated useful lives.
(i) Excess of Cost Over Fair Value of Net Assets Acquired The excess of cost over the fair value of net assets acquired in the acquisitions of the Bank of Westbury, Sunrise Bancorp, Inc. and Continental Bank is amortized using the straight line method over fifteen years. The excess of cost
over the fair value of net assets acquired is evaluated periodically by the Company for impairment in response to changes in circumstances or events.
(j) Real Estate Owned Real estate acquired through foreclosure is recorded at the lower of cost (unpaid loan balance plus foreclosure costs) or fair market value at the time of acquisition. The carrying value of individual properties is subsequently adjusted to the extent it exceeds estimated fair market value less costs to sell. Operating expenses of holding real estate, net of related income, are charged against income as incurred. Gains on sales of real estate are recognized when down payment and other requirements are met; otherwise such gains are deferred and recognized on the installment method of accounting. Losses on the disposition of real estate, including expenses incurred in connection with the disposition, are charged to income. A valuation allowance is maintained through provisions for real estate losses charged to income for any decrease in the fair value of property less costs to sell, which is netted against real estate owned.
(k) Taxes on Income The Company files a calendar-year Federal income tax return on a consolidated basis with its subsidiary.
The Company follows SFAS No. 109, "Accounting for Income Taxes" which requires the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
(l) Employee Benefits The Bank's pension plan is non-contributory and covers substantially all eligible employees. The plan conforms to the provisions of the Employee Retirement Income Security Act of 1974, as amended. The Bank's policy is to accrue for all pension costs and to fund the maximum amount allowable for tax purposes. In the interest of maintaining a comprehensive benefit package for employees, the Bank periodically evaluates the overall effectiveness and economic value of the pension plan. Based on an evaluation of the pension plan in fiscal 1998, the Bank concluded that future benefit accruals under the plan would cease, or "freeze" on May 31, 1998. In its stead, Reliance Federal Savings Bank 401(k) Retirement Savings Plan (the "401(k) Plan") was formed. Effective June 1, 1998, all Reliance Federal Savings Bank employees who are at least 21 years of age and have completed one year of service are eligible to participate in the 401(k) Plan.
Actuarial gains and losses that arise from changes in assumptions concerning future events, used in estimating pension costs, have been amortized over a period that reflects the long range nature of pension expense. However, as a result of the freezing of the plan, the Bank recognized a curtailment gain in fiscal 1998. (See Note 17).
The Company follows AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans" ("SOP 93-6") to account for the established Employee Stock Ownership Plan ("ESOP"). SOP 93-6 requires that compensation expense be recognized for shares committed to be released to directly compensate employees equal to the fair value of the shares committed. In addition, SOP 93-6 requires that leveraged ESOP debt and related interest expense be reflected in the employer's financial statements. The application of SOP 93-6 results in fluctuations in compensation expense as a result of changes in the fair value of the Company's common stock; however, such compensation expense fluctuations result in an offsetting adjustment to paid in capital. Therefore, total stockholders' equity is not affected.
The Bank follows SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 123 applies to all transactions in which an entity acquires goods or services by issuing equity instruments or by incurring liabilities where the payment amounts are based on the entity's common stock price, except for employee stock ownership plans. SFAS No. 123 established a fair value-based method of accounting for stock-based compensation arrangements with employees, rather than the intrinsic value-based method that is contained in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). SFAS No. 123 does not require an entity to adopt
the new fair value-based method for purposes of preparing its basic financial statements; an entity is allowed to continue to use the APB No. 25 method for preparing its basic financial statements. The Company has chosen to continue to use the APB No. 25 method, however, SFAS No. 123 requires presentation of pro forma net income and earnings per share information, in the notes to the financial statements, as if the fair value-based method had been adopted.
(m) Treasury Stock Repurchases of common stock are recorded as treasury stock at cost.
(n) Comprehensive Income The Company follows Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 requires that all items that are components of "comprehensive income" be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income is defined as "the change in equity [net assets] of a business enterprise during a period from transactions and other events and circumstances from nonowner sources." It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company adopted the provisions of SFAS No. 130 during the first quarter of fiscal 1999 and as such was required to (a) classify items of other comprehensive income by their nature in a financial statement; (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section in the statement of financial condition and (c) reclassify prior periods presented. As the requirements of SFAS No. 130 are disclosure-related, its implementation had no impact on the Company's financial condition or results of operations.
(o) Earnings Per Share The Company follows SFAS No. 128, "Earnings per Share" which specifies the computation, presentation and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock. This statement simplifies the standard for computing EPS previously found in Accounting Principles Board Opinion No. 15 ("APB No. 15"). It replaces the presentation of primary EPS with a presentation of basic EPS and the presentation of fully diluted EPS with a presentation of diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period, adjusted for the unallocated portion of shares held by the ESOP in accordance with SOP 93-6. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Potential common stock due to the dilutive effect of stock options is computed using the treasury stock method. SFAS No. 128 was effective for financial statements issued for periods ending after December 15, 1997 and requires the restatement of all prior-period EPS data presented. The Company adopted SFAS No. 128 effective December 31, 1997.
(p) Segment Reporting During fiscal 1999, the Company adopted Statement of Financial Accounting Standards No.131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires public companies to report certain financial information about significant revenue-producing segments of the business for which such information is available and utilized by the chief operating decision maker. Specific information to be reported for individual operating segments includes a measure of profit and loss, certain revenue and expense items, and total assets. As a community-oriented financial institution, substantially all of the Company's operations involve the delivery of loan and deposit products to customers. Management makes operating decisions and assesses performance base on an ongoing review of these community banking operations, which constitute the Company's only operating segment for financial reporting purposes under SFAS No.131.
2. Subsequent Event
Acquisition of Reliance Bancorp, Inc. by North Fork Bancorporation, Inc.
On August 30, 1999, the Company announced that it had signed a definitive Agreement and Plan of Merger, dated as of August 30, 1999, with North Fork Bancorporation, Inc. NFB is the bank holding company parent of North Fork
Bank and Trust Company, a New York State chartered stock commercial bank. The Merger Agreement provides, among other things, that Reliance will merge with and into NFB, with NFB being the surviving corporation.
Pursuant to the Merger Agreement, each share of Reliance common stock, par value $0.01 per share, issued and outstanding immediately prior to the Effective Time will be converted into and become the right to receive 2.0 shares of NFB common stock, par value $2.50 per share.
The Merger will be structured as a tax-free reorganization and will be accounted under the purchase method of accounting. Consummation of the Merger is subject to the satisfaction of certain customary conditions, including approval of the Merger Agreement by the stockholders of Reliance and approval of the appropriate regulatory agencies. Following consummation of the Merger, the Bank will be merged with and into North Fork Bank and Trust Company. It is anticipated that the Merger will be completed in 2000.
Reliance has the right to terminate the Merger Agreement if the closing price of NFB's shares decline beyond a specified price and index, unless NFB elects to increase the Merger Consideration to be received by Reliance's stockholders as set forth in the Merger Agreement.
The Merger Agreement also provides that options to purchase shares of Reliance Common Stock under Reliance's stock option plans that are outstanding at the Effective Time shall be converted into options to purchase shares of NFB Common Stock in accordance with the procedure set forth in the Merger Agreement. In connection with the Merger Agreement, Reliance granted to NFB a stock option pursuant to a Stock Option Agreement, dated as of August 30, 1999, which, under certain defined circumstances, would enable NFB to purchase up to 19.9% of Reliance's issued and outstanding shares of common stock. The Stock Option Agreement provides that the total profit receivable thereunder may not exceed $17.4 million plus reasonable out-of-pocket expenses.
3. Stock Form of Ownership
On September 16, 1993, the Board of Directors of the Bank adopted a Plan of Conversion to convert from a federally chartered mutual savings bank to a federally chartered stock savings bank with the concurrent formation of a holding company. As part of the conversion, the Company was incorporated under Delaware law on November 16, 1993. The Company completed its initial public offering on March 31, 1994 and issued 10,750,820 shares of common stock resulting in net proceeds of approximately $103.6 million. The Company retained $51.8 million of the net proceeds and used the remaining net proceeds to purchase all of the outstanding stock of the Bank. The financial position and results of operations of the Company as of and for the year ended June 30, 1999, 1998 and 1997 are presented in Note 22.
On November 6, 1998, the Company completed its seventh five percent stock repurchase plan purchasing 500,000 shares at an aggregate cost of $13.9 million. The Company also announced its eighth stock repurchase plan to repurchase up to 500,000 of the Company's outstanding shares. As of June 30, 1999, 146,207 shares under this program were repurchased at an aggregate cost of $4.1 million. During fiscal years 1999, 1998 and 1997, the Company repurchased total shares of 1,040,207, 460,973 and 442,182, respectively, at an aggregate cost of $27.9 million, $15.3 million and $8.1 million, respectively.
At the time of the conversion, the Bank established a liquidation account with a balance equal to its retained earnings reflected in its statement of condition. The balance in the liquidation account at June 30, 1999 and 1998 was approximately $18.3 million and $21.4 million, respectively. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after the conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held.
The Company may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause stockholders' equity to be reduced below applicable regulatory capital maintenance requirements, the amount required for the liquidation account, or if such declaration and payment would otherwise violate regulatory requirements. During fiscal 1999, the Company declared cash dividends totalling $6.5 million.
4. Acquisition
Acquisition of Continental Bank
On October 17, 1997, the Company completed the acquisition of Continental Bank ("Continental"), a commercial bank with two full service banking offices located in Nassau and Suffolk counties in Long Island, New York, a commercial lending facility and five check cashing facilities ("Money Centers") in Manhattan. The transaction was accounted for as a purchase. Under the terms of the merger, Reliance issued 1.10 shares (1,013,909 shares) of its common stock for each outstanding common share of Continental. The cost of the acquisition was approximately $24.4 million. Assets acquired in the transaction, principally loans and mortgage-backed securities aggregated $177.8 million and liabilities assumed, substantially all deposits and borrowings, aggregated $171.1 million. The excess of cost over fair value of net assets acquired in the transaction was $17.7 million, which is being amortized on a straight line basis over 15 years.
5. Money Market Investments
Money market investments generally have original maturities of three months or less, and at 1998 consist solely of securities purchased under agreements to resell (repurchase agreements). There were no money market investments at June 30,1999. These agreements represent short-term loans and are reflected as an asset in the consolidated statements of condition. The same securities are to be resold at maturity of the repurchase agreements.
Securities purchased under repurchase agreements averaged $1.4 million for the year ended June 30, 1999 and $4.5 million for the year ended June 30, 1998. The maximum amount of such agreements outstanding at any month-end during the fiscal year ended June 30, 1999 and 1998 was $8.0 million and $23.0 million, respectively.
6. Debt and Equity Securities
A summary of the amortized cost and estimated market values of debt and equity securities are as follows:
At June 30, 1999 and 1998, the Company had commitments to sell loans of $2.2 million and $3.7 million, respectively. At June 30, 1999 and 1998, the Company had no commitments to purchase loans.
The principal balance of loans in arrears three months or more:
June 30, ------------------------------------- 1999 1998 ---------------- ----------------- No. of No. of loans Amount loans Amount ----- ------ ----- ------ (Dollars in thousands) One- to four-family Mortgages............ 44 $3,693 70 $6,256 Consumer and Other Loans................. 59 564 62 517 Commercial Real Estate................... 8 1,868 7 1,962 Commercial............................... 10 433 9 567 --- ----- --- ---- 121 $6,558 148 $9,302 === ===== === =====
Interest income that would have been recorded under the original terms of loans classified as non-accrual and interest income actually recognized are as follows: Year Ended June 30, ----------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Interest Income that would have been Recorded... $792 $1,159 $838 Interest Income Recognized...................... (294) (360) (265) ----- ----- ---- Interest Income Foregone........................ $498 $ 799 $573 === === ===
In accordance with SFAS No. 114, the Company deems certain loans impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. SFAS No. 114 generally does not apply to large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, such as one- to four-family mortgage loans and consumer loans. Loans individually reviewed for impairment by the Company are limited to multi-family loans, commercial loans, construction and land loans, loans modified in a troubled debt restructuring and selected large one- to four-family loans. Examples of measurement techniques utilized by the Company include present value of expected future cash flows, the loan's market price if one exists, and the estimated fair value of the collateral.
At June 30, 1999, 1998 and 1997 the Company had seven, four and four impaired commercial real estate loans totalling $1.6 million, $1.9 million and $2.9 million, respectively, with no related allowance. The Company had 10 impaired commercial loans totalling $433,000 and $567,000, respectively, at June 30, 1999 and 1998 and no impaired commercial loans at June 30, 1997, with no related allowances. The Company's average recorded investment in impaired loans for the years ended June 30, 1999, 1998 and 1997 was $2.5 million, $2.5 million and $1.9 million, respectively. The Company did not recognize any interest income on impaired loans for the years ended June 30, 1999, 1998 and 1997.
The Bank generally originates fixed rate loans with terms greater than 15 years for sale to FHLMC, FNMA or other secondary market investors. At June 30, 1999 and 1998, there were no fixed rate loans classified as held for sale.
Included in mortgage loans at June 30, 1999 and 1998 are $408.8 million and $425.2 million, respectively, of adjustable rate mortgage loans.
Proceeds from the sale of first mortgage loans were $28.2 million, $8.5 million and $7.3 million during the fiscal years ended June 30, 1999, 1998 and 1997, respectively. Gross realized gains and losses resulting from sale of first mortgage loans were as follows: Year Ended June 30, -------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Gross Realized Gains............ $144 $ 44 $ 31 Gross Realized Losses........... (10) -- (3) ---- --- ---- $134 $ 44 $ 28 === === ===
The Bank services mortgage loans for investors which are not included in the accompanying consolidated statements of condition. A summary of the principal balances, custodial escrow, servicing income and number of loans serviced for others by the Bank are as follows: Year Ended June 30, ------------------------- 1999 1998 1997 ---- ---- ---- (Dollars in thousands) Principal Balances............................... $298,635 $355,149 $410,229 ======= ======= ======= Custodial Escrow................................. $ 3,242 $ 4,290 $ 4,493 ===== ===== ===== Servicing Income (Excludes MSR Amortization)..... $ 959 $ 1,183 $ 1,399 === ===== ===== Number of Loans.................................. 5,186 6,085 6,842 ===== ===== =====
Fees earned for servicing loans are reported as income when the related mortgage payments are collected. Mortgage Servicing Rights ("MSRs") are amortized as a reduction to loan service fee income on a method that approximates the level-yield basis over the estimated remaining life of the underlying mortgage loans. MSRs are carried at fair value and impairment, if any, is recognized through a valuation allowance. For the year ended June 30, 1999 and 1998, no impairment existed in the MSRs and as a result, no valuation allowance was required.
MSR activity is summarized as follows: Year Ended June 30, -------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Balance at Beginning of the Year......... $2,317 $3,046 $3,905 Amortization............................. (803) (729) (859) ------ ----- ------ Balance at End of the Year............... $1,514 $2,317 $3,046 ===== ===== =====
9. Allowance for Loan Losses
Activity in the allowance for loan losses is summarized as follows:
Year Ended June 30, --------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Balance at Beginning of the Year........... $8,941 $5,182 $4,495 Provision for Loan Losses.................. 650 1,650 950 Allowances of Acquired Institutions........ -- 2,745 -- Charge-offs................................ (513) (773) (306) Recoveries................................. 42 137 43 ----- ----- ----- Balance at End of the Year................. $9,120 $8,941 $5,182 ===== ===== =====
10. Real Estate Owned
Real estate owned, net is summarized as follows:
June 30, ------------------ 1999 1998 ---- ---- (In thousands) One- to four-family Residences................... $185 $505 Co-ops........................................... 63 73 Commercial....................................... -- 300 Allowance for Losses on Real Estate Owned........ (71) (123) ---- ---- $177 $755 ==== ====
Results of operating real estate owned for the years ended June 30, 1999, 1998 and 1997 are summarized as follows:
Year Ended June 30, -------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Net Gain on Sale on Real Estate Owned....... $ 84 $ 146 $ 56 Net Expenses of Holding Property............ (160) (271) (239) Provision for Losses........................ (35) (93) (200) ----- ----- ----- $(111) $(218) $(383)
Activity in the allowance for losses in real estate owned is summarized as follows: Year Ended June 30, --------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Balance at Beginning of the Year............. $123 $334 $768 Provision for Losses......................... 35 93 200 Charge-offs.................................. (87) (304) (634) ---- ----- ----- Balance at End of the Year................... $ 71 $123 $334 == === ===
11. Accrued Interest Receivable
Accrued interest receivable, net is summarized as follows:
June 30, ---------------- 1999 1998 ---- ---- (In thousands) Debt Securities........................................ $ 932 $1,708 Mortgage-Backed Securities............................. 6,533 7,137 Loans Receivable, Net of Reserves for Uncollectible Interest of $1,078 and $1,293, respectively.......... 5,630 6,113 ------ ------ $13,095 $14,958 ====== ====== 12. Office Properties and Equipment
A summary of office properties and equipment, net is as follows:
June 30, ---------------- 1999 1998 ---- ---- (In thousands) Land................................................... $ 4,489 $ 4,489 Buildings.............................................. 10,943 10,477 Furniture, Fixtures and Equipment...................... 15,852 13,853 Leasehold Improvements................................. 4,649 4,407 Capital Lease.......................................... 1,470 1,470 ------ ------
Office Properties and Equipment, at Cost............... 34,403 34,696 Accumulated Depreciation and Amortization.............. (21,035) (19,260) --------- ------- $16,368 $15,436
In October 1989, the Bank sold a building used for a branch operation located in Jamaica, New York for approximately $2.3 million, and subsequently leased back a portion of the building to conduct the branch operation. The Bank received approximately $2.0 million in cash from the transaction, after expenses of the sale, which generated a gain of approximately $1.1 million. The gain has been deferred and is being amortized over the twelve-year lease period. Deferred gain on sale amounted to approximately $217,000 and $311,000 at June 30, 1999 and 1998, respectively, and is included in accrued expenses and other liabilities. The leaseback is recorded as a capital lease in the amount of $1.5 million at June 30, 1999 and 1998 (refer to the above table) and the related obligation under capital leases of $387,000 and $535,000, respectively, at June 30, 1999 and 1998 is reflected in accrued expenses and other liabilities.
Depreciation and amortization of office properties and equipment, included in occupancy and equipment expense, was approximately, $1.8 million, $1.6 million and $1.4 million for the fiscal years ended June 30, 1999, 1998 and 1997, respectively.
13. Deposits
Deposits are summarized as follows:
The components of net pension expense are as follows: Year Ended June 30, ------------------------ 1999 1998 1997 ---- ---- ---- (In thousands) Service Cost-benefits Earned during the Year...... $ -- $ 627 $ 327 Interest Cost on Projected Benefit Obligation..... 358 710 627 Net Amortization and Deferral..................... (61) 20 (290) Actual Return on Plan Assets...................... (398) (710) (482) Curtailment Gain Recognized....................... -- (739) -- Settlement Loss Recognized........................ -- 117 -- ---- --- ---- Net Pension Expense............................... $(101) $25 $182 ===== == ===
Year Ended June 30, ------------------------- 1999 1998 1997 ---- ---- ---- Assumptions Used: Weighted Average Discount Rate................. 7.0% 7.0% 7.0% Rate of Increase in Compensation Levels........ 5.0% 5.0% 5.0% Expected Long-term Rate of Return on Assets.... 8.0% 8.0% 9.0%
Based on an evaluation of the pension plan in fiscal 1998, the Bank concluded that future benefit accruals under the plan would cease, or "freeze" on May 31, 1998. In connection with the freezing of the Plan, the Bank recognized a curtailment gain of approximately $739,000 and a settlement loss of approximately $117,000 as of May 31, 1998.
In connection with the acquisitions of Bank of Westbury, Sunrise Bancorp, Inc. and Continental Bank, their respective pension plans were terminated and are not included in the above tables. All former employees of Bank of Westbury and Sunrise Bancorp, Inc. remaining in the employment of the Company were eligible to participate in the Company's pension plan effective June 1, 1997. However, as a result of the pension plan's eligibility requirements and the freezing of the pension plan on May 31, 1998, no Continental employees were eligible to participate in the plan.
Reliance Federal Savings Bank 401(k) Retirement Plan
Effective June 1, 1998, employees of the Bank who are at least 21 years of age and have completed one year of service are eligible to participate in the Reliance Federal Savings Bank 401(k) Retirement Plan (the "401(k) Plan"). Eligible employees may make pre-tax contributions equal to the lesser of ten percent of their annual compensation or the amount permitted by law. As a base amount, the Bank will make contributions (on account for eligible employees) equal to two percent of all eligible employees earnings regardless of whether employees make contributions on their own behalf. Additionally, the Bank will make matching contributions equal to 75% of employee contributions that do not exceed four percent of their annual earnings. Employees are immediately vested in their own contributions and after five years of service they will be vested in the Bank's base and matching contributions. During fiscal 1999 and 1998, the Bank incurred $420,000 and $40,000, respectively, in 401(k) Plan costs.
18. Stock Benefit Plans
The following are the stock based benefit plans maintained by the Company:
Stock Option Plan The Company maintains the Reliance Bancorp, Inc. 1994 Incentive Stock Option Plan and the Reliance Bancorp, Inc. 1996 Incentive Stock Option Plans Amended and Restated as of February 19, 1997 (the "Stock Option Plans"). Under the Stock Option Plans, stock options (which expire ten years from the date of grant) have been granted to the executive officers and officers of the Company and its affiliate, the Bank. Each option entitles the holder to purchase one share of the Company's common stock at an exercise price equal to the fair market value of the stock at the date of grant. Options will be exercisable in whole or in part over the vesting period. However, all options become 100% exercisable in the event that the employee terminates his employment due to death, disability, normal retirement, or in the event of a change in control of the Bank or the Company. Simultaneous with the grant of these options, the Personnel Committee of the Board of Directors granted "Limited Rights" with respect to the shares covered by the options. Limited Rights granted are subject to terms and conditions and can be exercised only in the event of a change in control of the Company. Upon exercise of a limited right, the holder shall receive from the Company a cash payment equal to the difference between the exercise price of the option and the fair market value of the underlying shares of common stock.
Stock Option Plan for Outside Directors The Company maintains the Amended and Restated Reliance Bancorp, Inc. 1994 and 1996 Stock Option Plans for Outside Directors (the "Directors' Option Plans"). Each member of the Board of Directors who is not an officer or employee of the Company or the Bank is granted non-statutory options to purchase shares of the Company's common stock. Members of the Board of Directors of the Company are granted options to purchase shares of the common stock of the Company at an exercise price equal to the fair market value of the stock at the date of grant. All of the
options granted under the Directors' Option Plan become exercisable over the vesting period and expire upon the earlier of 10 years following the date of grant or one year following the date the optionee ceases to be a director.
Had compensation cost for the Company's three stock-based compensation plans been determined consistent with SFAS No. 123 for awards made after July 1, 1995, the Company's net income per common share would have been reduced to the pro forma amounts indicated below for the years ended June 30:
1999 1998 1997 -------- -------- ------ (Dollars in thousands, except per share data)
Net Income As Reported $20,151 $ 18,729 $ 10,936 Pro forma 19,681 18,492 8,672
Net Income per Common Share: Basic As Reported $ 2.38 $ 2.11 $ 1.32 Pro forma $ 2.32 $ 2.08 1.04
Diluted As Reported $ 2.26 $ 1.99 $ 1.25 Pro forma $ 2.21 $ 1.96 0.99
The fair values of the share grants were estimated on the date of grant using the Black-Scholes option - pricing model using the following assumptions in fiscal 1999, 1998 and 1997: dividend yield of 3.00% for all years; expected volatility of 29.14% for fiscal 1999, 22.05% for fiscal 1998 and 16.64% for fiscal 1997; risk-free interest rates of 6.25% for all years; and expected option lives of 6 years for all years.
Employees Stock Ownership Plan ("ESOP")
The Bank has established an ESOP for eligible employees. Full-time employees employed with the Bank as of January 1, 1993, and full-time employees of the Company or the Bank employed after such date who have been credited with at least 1,000 hours during a twelve-month period and who have attained age 21 are eligible to participate.
The ESOP borrowed $8.3 million from the Company and used the funds to purchase 828,000 shares of the Company's common stock issued in the Conversion. The loan is repaid principally from the Bank's discretionary contributions to the ESOP over a 10 year period. At June 30, 1999 and 1998, the loan had an outstanding balance of $4.0 million and $4.8 million, respectively, and an interest rate of 7.75% and 8.50%, respectively. Interest expense for the obligation was $348,000, $441,000 and $502,000, respectively, for the year ended June 30, 1999, 1998 and 1997. Shares purchased with the loan proceeds are held in a suspense account for allocation among participants as the loan is paid. Contributions to the ESOP and shares released from the loan collateral in an amount proportional to the repayment of the ESOP loan is allocated among participants on the basis of compensation, as described in the plan, in the year of allocation. Benefits generally become 100% vested after five years of credited service. However, in the event of a change in control, as defined in the plan, any unvested portion of benefits shall vest immediately. Forfeitures are reallocated among participating employees, in the same proportion as contributions. Benefits are payable upon death, retirement, disability, or separation from service based on vesting status and share allocations made.
As of June 30, 1999, 366,019 shares remaining in the ESOP were allocated to participants and 41,400 shares were committed to be released. As shares are released from collateral, the shares become outstanding for earnings per share computations. As of June 30, 1999 and 1998, the fair market value of the 372,600 and 455,400 unallocated shares, respectively, was $10.3 million and $17.4 million, respectively.
Recognition and Retention Plans and Trusts ("RRPs") The Bank maintains the Reliance Federal Savings Bank Recognition and Retention Plan for Officers and Employees and the Amended and Restated Reliance Federal Savings Bank 1994 Recognition and Retention Plan for Outside Directors (the "RRPs"). The purpose of the RRPs is to provide executive officers, officers, and directors of the Bank with a proprietary interest in the Company in a manner designed to encourage such persons to remain with the Bank. The RRPs acquired an aggregate of 414,000 shares of the Company's common stock in the Conversion of which 412,447 shares have been awarded to Officers and Directors (327,715 at the time of the Conversion and 84,732 thereafter). Such amounts represent deferred compensation and have been accounted for as a reduction of stockholders' equity. Awards vest at a rate of 20% per year for directors and officers, commencing one year from the date of award. Awards become 100% vested upon termination of employment due to death, disability, or following a change in control of the Bank or the Company.
The Company recorded compensation expenses for the ESOP and RRP of $3.1 million, $3.7 million and $2.5 million, respectively, for the years ended June 30, 1999, 1998 and 1997.
19. Earnings Per Share
The Company follows SFAS No. 128, "Earnings Per Share", which establishes new standards for computing and presenting earnings per share ("EPS"). All earnings per share amounts have been restated to conform to the new requirements.
Basis EPS is computed by dividing net income by the weighted average number of common shares outstanding. The weighted average number of common shares outstanding includes the average number of shares of common stock outstanding adjusted for the weighted average number of unallocated shares held by the ESOP.
Diluted EPS is computed by dividing net income by the weighted average number of common shares and common equivalent shares outstanding during the year. For the diluted EPS calculation, the weighted average number of common shares and common equivalent shares outstanding include the average number of shares of common stock outstanding adjusted for the weighted average number of unallocated shares held by the ESOP and the dilutive effect
of unexercised stock options using the treasury stock method. When applying the treasury stock method, the Company's average stock price is utilized, and the Company adds to the proceeds the tax benefit that would have been credited to additional paid-in capital assuming exercise of non-qualified stock options.
The computation of basis and diluted EPS for the fiscal years ended June 30, 1999, 1998 and 1997 are presented in the following table:
- ----------------------------- (1) Consists of payments under the Bank's Incentive Compensation Plan. (2) For fiscal years 1999, 1998 and 1997, there were no (a) perquisites over the lesser of $50,000 or 10% of the individual's total salary and bonus for the year; (b) payments of above-market preferential earnings on deferred compensation; (c) payments of earnings with respect to long-term incentive plans prior to settlement or maturation; (d) tax payment reimbursements; or (e) preferential discounts on stock. (footnotes continued on next page)
(3) Includes stock options granted under the 1996 Stock Option Plan. Each stock option was granted in tandem with a limited rights, which is exercisable only in the event of a change in control of the Company. (4) The Bank did not make any payment of long-term incentive plans in fiscal 1999, 1998 and 1997. (5) For fiscal year 1999 amount includes SERP contributions for Messrs. R.A. Nielsen and Sauvigne for the reduction of benefits related to the Bank's ESOP.
Employment Agreements. The Bank and the Company have entered into employment agreements with Messrs. R.A. Nielsen, Sauvigne, Lavelle, Hagan and Traxler. These employment agreements are intended to ensure that the Bank and the Company will be able to maintain a stable and competent management base. The continued success of the Bank and the Company depends to a significant degree on the skills and competence of these individuals.
The Company employment agreements provide for five-year terms for Messrs. R.A. Nielsen and Sauvigne and two-year terms for Messrs. Lavelle, Hagan and Traxler, except that the term is three years with respect to the obligation to make payments based on termination of employment after a change in control as discussed below. The Bank agreements provide for a three year term for Messrs. R.A. Nielsen and Sauvigne and two year terms for Messrs. Lavelle, Hagan and Traxler. The Bank agreements further provide that commencing on July 1, 1999 and continuing on July 1 of each year thereafter, the Board of Directors of the Bank may, with the consent of the respective employees, extend the employment agreements with the Company and the Bank for an additional year, such that the remaining terms of the respective agreements shall be the amount of the original term unless written notice of non-renewal is given by the Board of Directors after conducting a performance evaluation of the executive. The employment agreements with the Company provide for automatic daily extensions such that the remaining terms shall be the amount of the original term unless written notice of non-renewal is given by the Board of Directors or the employee. In such case, the term shall end on the second anniversary of the date of written notice. The Company and Bank employment agreements provide that Messrs. R.A. Nielsen, Sauvigne, Lavelle, Hagan and Traxler will receive annual base salaries of $500,000, $250,000, $150,000, $160,000, and $118,000, respectively, which will be reviewed annually by the Board. In addition to the base salary, the Company and Bank employment agreements provide for, among other things, disability payments, participation in retirement plans, stock benefit plans and other compensation plans applicable to executive personnel from time to time. The Company and Bank employment agreements provide for termination by the Bank or the Company for "cause", as defined in such agreements, at any time. In the event the Bank or the Company chooses to terminate the executive's employment for reasons other than a change in control, retirement or for cause or in the event of the executive's resignation from the Bank and the Company subsequent to: (i) the failure to re-elect the executive to his current offices or the extent this executive serves as a director of the Company, failure to renominate or reelect the executive as a director; (ii) a material adverse change in the executive's functions, duties or responsibilities, or relocation of his principal place of employment, by more than 30 miles, or a material reduction in benefits or perquisites; (iii) liquidation or dissolution of the Bank or the Company; or (iv) a breach of the agreement by the Bank or the Company, the executive or, in the event of death, his beneficiary, would be entitled to receive an aggregate payment amount equal to the amount of the remaining payments (or benefits) that the executive would have earned if he had continued his employment with the Bank or Company during the remaining unexpired term of the agreement based on the executive's defined base salary on the date the executive was terminated. Additionally, the Company employment agreement of Messrs. R.A. Nielsen and Sauvigne provide that in the event of their termination of employment, the Company or any of its subsidiaries amend any employee benefit plan maintained by the Company or any of its subsidiaries such that it reduces the benefits payable to the executives, the Company will provide the executive with an economic benefit equal to the amount of any such reduction on an annual basis.
Under the terms of the Company employment agreements, if termination of employment, whether voluntary or involuntary, follows a "change in control" of the Bank or the Company, as defined in the employment agreements, the executive or, in the event of death, his beneficiary, would be entitled to an aggregate payment equal to the greater of (1) the payments due under the remaining term of the agreement, (2) five times the average annual compensation with respect to Messrs. R.A. Nielsen and Sauvigne or (3) three times the average compensation with respect to Messrs. Lavelle, Hagan and Traxler. Such average annual compensation will be determined, in the case of the Bank employment agreements, over the five most recent taxable years, and, in the case of the Company employment agreements, for the three or two preceding taxable years, whichever is applicable to the term of the respective employment agreement. Such average annual compensation shall include any commissions, bonuses, pension and profit sharing plan benefits, severance payments, retirement benefits, director or committee fees and fringe benefits paid or to be paid to the executive in any such years. The Bank and the Company would also continue the executive's life, health, and disability coverage and any dependent that is currently covered by such plans, for the remaining unexpired term of the agreements to the extent allowed by the plans or policies maintained by the Company or Bank from time to time. Payments to the executive under the Bank's employment agreements will be guaranteed by the Company in the event that payments or benefits are not paid by the Bank. The agreements also provide that the Bank and the Company shall indemnify the executive to the fullest extent allowable under federal and Delaware law, respectively.
In addition, upon a change in control, certain awards of Common Stock and options to purchase Common Stock made to each of the executives under the Company's and Bank's various non-qualified stock based benefit plans would vest immediately. If any amounts payable in connection with any change in control are determined to be "excess parachute payments" under Section 280G of the code resulting in the imposition of the 20% excise tax on such payments under Section 4999 of the code, each officer will receive from the Company an additional amount such that the effect of the imposition of that excise tax is effectively eliminated.
The following table provides certain information with respect to the number of shares of Common Stock represented by outstanding stock options granted under the 1994 Stock Option Plan and the 1996 Stock Option Plan held by the Named Executive Officers as of June 30, 1999. Also reported are the values for "in-the-money" options which represent the positive spread between the exercise price of any such existing stock options and the year-end price of the Common Stock. There were no options exercised by any of the Named Executive Officers in Fiscal Year 1999.
FISCAL YEAR END OPTION VALUES
Number of Securities Value of Unexercised Underlying Unexercised In-the-Money Options Options at June 30, 1999 at June 30, 1999 Exercisable Exercisable Name (#) ($)(1) ------ ----- ------ Raymond A. Nielsen 143,448 2,219,902 Gerald M. Sauvigne 89,088 1,261,807 Joseph F. Lavelle 39,087 492,462 Paul D. Hagan 45,087 598,212 John F. Traxler 51,357 744,084
(1) Market Value of underlying securities at fiscal year-end ($27.625) minus the exercise or base prices of $10.00, $15.75, $19.375 and $38.00 per share.
Pension Plan. The Bank maintains the Reliance Federal Savings Bank Retirement Plan (the "Pension Plan"), for the benefit of the employees of the Bank. The Pension is a noncontributory defined benefit pension plan. All employees over the age of 21 who have worked 1,000 hours at the Bank for a twelve month period are eligible to participate in the Pension Plan. The Bank annually contributes an amount to the Pension Plan necessary to satisfy the actuarially determined minimum funding requirements in accordance with ERISA.
Upon the attainment of normal retirement age (age 65), a participant is entitled to a retirement benefit in an amount equal to 50.0% of the participant's average annual base wage (determined by using the participant's earnings for the highest five complete consecutive plan years out of the last ten plan years of a participant's employment) multiplied by a ratio, the numerator of which is the number of months of the participant's service, and the denominator of which is 240. Under the Pension Plan, benefits are also payable for termination due to early retirement or death of a married participant. Benefits become vested after a participant completes five years of service. In the case of death, or early retirement occurring on or after attainment of age 60, but after the completion of five years of service, benefits are reduced if they commence prior to age 65.
Based on an evaluation of the pension plan in fiscal 1998, the Bank concluded that future benefit accruals under the plan would cease, or "freeze" on May 31, 1998.
401(k) Plan. The Bank maintains the Reliance Federal Savings Bank 401(k) Retirement Savings Plan (the "401(k) Plan"), a tax-qualified defined contributions plan governed by Section 401(k) of the Internal Revenue Code. The 401(k) Plan allows salaried employees to make pre-tax salary contributions, limited to 10% of compensation, with a maximum of $10,000 per year. The Bank contributes 2% per employee and matches seventy-five percent of employee contributions up to 4%, subject to a maximum total employer contribution of 5% of employee compensation. Employees are fully vested in their contributions and become vested in the Bank's contributions after the completion of five years of service. Employees select the investments made with their account balances from a fixed menu of options.
Supplemental Executives' Retirement Plan. The Bank maintains the Reliance Federal Savings Bank Supplemental Executives' Retirement Plan (the "SERP"), which is intended to provide an additional retirement benefit to designated executives who are participants in the Bank's tax qualified plans, and whose benefits under such plans are reduced due to the limitations imposed by Section 415 of the Code on the maximum annual benefits and contributions that may be made with regard to such plans and the limitations imposed by Section 401(a)(17) of the Code on the maximum amount of compensation that may be taken into account in determining benefits and contributions with respect to such plans. The SERP is intended to provide a benefit equal to the benefit the participant would have received under the applicable tax qualified plans if the Code's limitations did not apply and the amounts such individuals will actually receive with the application of the Code's limitations.
The following table sets forth the estimated annual benefits payable under the Pension Plan and SERP described above upon retirement at age 65 in calendar year 1999, expressed in the form of a 10-year certain and continuous annuity, for the average annual earnings and years of service classifications specified.
Creditable Years of Service at Age 65 --------------------------------------------------------- Average Annual Earnings(1)(2) 15 20 25 30 35 ---- ---- ---- ---- ----
$25,000 $ 9,375 $ 12,500 $ 12,500 $ 12,500 $ 12,500 50,000 18,750 25,000 25,000 25,000 25,000 100,000 37,500 50,000 50,000 50,000 50,000 150,000 56,250 75,000 75,000 75,000 75,000 200,000 75,000 100,000 100,000 100,000 100,000 250,000 93,750 125,000 125,000 125,000 125,000 300,000 112,500 150,000 150,000 150,000 150,000 350,000 131,250 175,000 175,000 175,000 175,000 400,000 150,000 200,000 200,000 200,000 200,000 450,000 171,000 225,000 225,000 225,000 225,000 510,000 191,250 255,000 255,000 255,000 255,000 570,000 213,750 285,000 285,000 285,000 285,000
(1) The covered salary under the Pension Plan is the amounts shown in the column entitled "Salary" in the Summary Compensation Table and does not include amounts shown in the column entitled "Bonus" in such table. (2) The benefits listed in the retirement benefit table are not subject to Social Security or other offset amounts.
The following table sets forth the years of certified service (i.e., benefit service) as of the fiscal year ended June 30, 1999, for each of the individuals named in the Summary Compensation Table.
Credited Service ---------------- Years Months ----- ------ Raymond A. Nielsen................. 29 0 Gerald M. Sauvigne................. 21 10 Joseph F. Lavelle.................. 30 5 Paul D. Hagan...................... 5 8 John F. Traxler.................... 26 4
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as to those persons who are beneficial owners of more than 5% of the Company's outstanding shares of Common Stock on the Record Date based solely upon disclosure in certain reports received by the Company regarding such ownership filed with the Company and with the Securities and Exchange Commission, in accordance with Sections 13(d) or 13(g) of the Securities Exchange Act of 1934, as amended, ("Exchange Act") by such persons and groups. Other than those persons listed below, the Company is not aware of any person or group, as such term is defined in the Exchange Act, that owns more than 5% of the Company's Common Stock as of the Record Date.