10-K 1 d277078d10k.htm FORM 10-K FORM 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number: 001-11713

 

 

OceanFirst Financial Corp.

(Exact name of registrant as specified in its charter)

 

DELAWARE   22-3412577

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

975 Hooper Avenue, Toms River, New Jersey 08753

(Address of principal executive offices)

Registrant’s telephone number, including area code: (732) 240-4500

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share

(Title of class)

The Nasdaq Global Select Market

(Name of each exchange on which registered)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, i.e., persons other than the directors and executive officers of the registrant, was $231,947,000 based upon the closing price of such common equity as of the last business day of the registrant’s most recently completed second fiscal quarter.

The number of shares outstanding of the registrant’s Common Stock as of March 9, 2012 was 18,570,668.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

 


Table of Contents

INDEX

 

          PAGE  

PART I

  

Item 1.

   Business      1   

Item 1A.

   Risk Factors      31   

Item 1B.

   Unresolved Staff Comments      36   

Item 2.

   Properties      36   

Item 3.

   Legal Proceedings      36   

Item 4.

   Mine Safety Disclosures      36   

PART II

  

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      37   

Item 6.

   Selected Financial Data      39   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      41   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      54   

Item 8.

   Financial Statements and Supplementary Data      58   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      101   

Item 9A.

   Controls and Procedures      101   

Item 9B.

   Other Information      102   

PART III

  

Item 10.

   Directors, Executive Officers and Corporate Governance      102   

Item 11.

   Executive Compensation      102   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      102   

Item 13.

   Certain Relationships and Related Transactions and Director Independence      103   

Item 14.

   Principal Accountant Fees and Services      103   

PART IV

  

Item 15.

   Exhibits and Financial Statement Schedules      103   

Signatures

     106   


Table of Contents

PART I

 

Item 1. Business

General

OceanFirst Financial Corp. (the “Company”) was incorporated under Delaware law and has served as the holding company for OceanFirst Bank (the “Bank”) since the Bank’s conversion from mutual to stock form in 1996. At December 31, 2011, the Company had consolidated total assets of $2.3 billion and total stockholders’ equity of $216.8 million. The Company is a savings and loan holding company subject to regulation by the Board of Governors of the Federal Reserve System (the “FRB”) and the Securities and Exchange Commission (“SEC”). The Bank is subject to regulation and supervision by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”). Currently, the Company does not transact any material business other than through its subsidiary, the Bank.

The Bank was originally founded as a state-chartered building and loan association in 1902, and converted to a Federal savings and loan association in 1945 and then a Federally-chartered mutual savings bank in 1989. The Bank’s principal business has been and continues to be attracting deposits from the general public in the communities surrounding its branch offices and investing those deposits primarily in single-family, owner-occupied residential mortgage loans and, more recently, in commercial real estate loans. The Bank also invests in other types of loans, including multi-family, construction, consumer and commercial loans. In addition, the Bank invests in mortgage-backed securities (“MBS”), securities issued by the U.S. Government and agencies thereof, corporate securities and other investments permitted by applicable law and regulations. The Bank periodically sells part of its mortgage loan production in order to manage interest rate risk and liquidity. Presently, servicing rights are retained in connection with most loan sales. The Bank’s revenues are derived principally from interest on its loans, and to a lesser extent, interest on its investment and mortgage-backed securities. The Bank also receives income from fees and service charges on loan and deposit products, and from the sale of trust and asset management services and alternative investment products, e.g., mutual funds, annuities and life insurance. The Bank’s primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, proceeds from the sale of loans, Federal Home Loan Bank (“FHLB”) advances and other borrowings and to a lesser extent, investment maturities.

The Company’s website address is www.oceanfirst.com. The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are available free of charge through its website, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. The Company’s website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

In addition to historical information, this Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Reform Act of 1995 which are based on certain assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “will,” “should,” “may,” “view,” “opportunity,” “potential,” or similar expressions or expressions of confidence. 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 its subsidiaries include, but are not limited to, those items discussed under Item 1A. Risk Factors herein and the following: changes in interest rates, general economic conditions, levels of unemployment in the Bank’s lending area, real estate market values in the Bank’s lending area, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury and the FRB, 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

 

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risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. 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.

Market Area and Competition

The Bank is a community-oriented financial institution, offering a wide variety of financial services to meet the needs of the communities it serves. The Bank conducts its business through an administrative and branch office located in Toms River, New Jersey, and twenty-three additional branch offices. Nineteen of the offices are located in Ocean County, four are located in Monmouth County, and one is located in Middlesex County, New Jersey. The Bank’s deposit gathering base is concentrated in the communities surrounding its offices while lending activities are concentrated in the sub-markets served by its branch office network. The Bank also maintains a trust and wealth management office in Manchester, New Jersey.

The Bank is the oldest and largest community-based financial institution headquartered in Ocean County, New Jersey, which is located along the central New Jersey shore. Ocean County is the fastest growing population area in New Jersey and has a significant number of retired residents who have traditionally provided the Bank with a stable source of deposit funds. The economy in the Bank’s primary market area is based upon a mixture of service and retail trade. Other employment is provided by a variety of wholesale trade, manufacturing, Federal, state and local government, hospitals and utilities. The area is also home to commuters working in New Jersey suburban areas around New York and Philadelphia. Based upon sales data for 2011 from the Ocean and Monmouth Counties Multiple Listing Service, home values in the Company’s primary market area have declined by approximately 19% from the peak of the market in 2006. The unemployment rate in Ocean County of 9.8% has generally trended above the state and national rate in 2011 while the unemployment rate in Monmouth County of 8.5% has generally trended below the state and comparable to the national rate.

The Bank faces significant competition both in making loans and in attracting deposits. The State of New Jersey has a high density of financial institutions. Many of the Bank’s competitors are branches of significantly larger institutions headquartered out-of-market which have greater financial resources than the Bank. The Bank’s competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies and insurance companies. Its most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions although the Bank also faces competition for deposits from short-term money market funds, other corporate and government securities funds, internet-only providers and from other financial service institutions such as brokerage firms and insurance companies.

Lending Activities

Loan Portfolio Composition. The Bank’s loan portfolio consists primarily of conventional first mortgage loans secured by one-to-four family residences. At December 31, 2011, the Bank had total loans outstanding of $1.589 billion, of which $882.6 million or 55.6% of total loans were one-to-four family, residential mortgage loans. The remainder of the portfolio consisted of $460.7 million of commercial real estate, multi-family and land loans, or 29.0% of total loans; $6.7 million of residential construction loans, or 0.4% of total loans; $192.9 million of consumer loans, primarily home equity loans and lines of credit, or 12.1% of total loans; and $45.9 million of commercial loans, or 2.9% of total loans. Included in total loans are $9.3 million in loans held for sale at December 31, 2011. At that same date, 43.6% of the Bank’s total loans had adjustable interest rates. The Bank has generally sold much of its 30-year fixed-rate one-to-four family loans into the secondary market primarily to manage interest rate risk.

 

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The types of loans that the Bank may originate are subject to Federal and state law and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the Federal government, including the FRB, and legislative tax policies.

The following table sets forth the composition of the Bank’s loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.

 

     At December 31,  
     2011     2010     2009     2008     2007  
     Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
 
                             (Dollars in thousands)                    

Real estate:

                

One-to-four family

   $ 882,550        55.55   $ 955,063        56.63   $ 954,736        57.92   $ 1,039,375        62.52   $ 1,084,687        64.20

Commercial real estate,

multi-family and land

     460,725        29.00        435,127        25.80        396,883        24.08        329,844        19.84        326,707        19.33   

Residential construction

     6,657        .42        13,748        .82        9,241        .56        10,561        .65        10,816        .64   

Consumer (1)

     192,918        12.14        205,725        12.20        217,290        13.18        222,797        13.40        213,282        12.62   

Commercial

     45,889        2.89        76,692        4.55        70,214        4.26        59,760        3.59        54,279        3.21   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

     1,588,739        100.00     1,686,355        100.00     1,648,364        100.00     1,662,337        100.00     1,689,771        100.00
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Loans in process

     (2,559       (4,055       (3,466       (3,586       (2,452  

Deferred origination costs, net

     4,366          4,862          4,767          5,195          5,140     

Allowance for loan losses

     (18,230       (19,700       (14,723       (11,665       (10,468  
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans, net

     1,572,316          1,667,462          1,634,942          1,652,281          1,681,991     

Less:

                    

Mortgage loans held for sale

     9,297          6,674          5,658          3,903          6,072     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Loans receivable, net

   $ 1,563,019        $ 1,660,788        $ 1,629,284        $ 1,648,378        $ 1,675,919     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans:

                    

Adjustable rate

   $ 692,332        43.58   $ 816,058        48.39   $ 839,285        50.93   $ 906,674        54.54   $ 924,117        54.69

Fixed rate

     896,407        56.42        870,297        51.61        809,079        49.07        755,663        45.46        765,654        45.31   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 1,588,739        100.00   $ 1,686,355        100.00   $ 1,648,364        100.00   $ 1,662,337        100.00   $ 1,689,771        100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Consists primarily of home equity loans and lines of credit, and to a lesser extent, loans on savings accounts, overdraft lines of credit and automobile loans.

 

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Loan Maturity. The following table shows the contractual maturity of the Bank’s total loans at December 31, 2011. The table does not include principal repayments. Principal repayments, including prepayments on total loans were $476.4 million, $477.5 million and $480.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.

 

     At December 31, 2011  
     One-to-
four
family
     Commercial
real estate,
multi-family
and land
     Residential
construction
     Consumer      Commercial      Total
Loans
Receivable
 
     (In thousands)  

One year or less

   $ 278       $ 53,243       $ 6,657       $ 1,448       $ 24,389       $ 86,015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

After one year:

                 

More than one year to three years

     4,179         145,221         —           2,873         11,122         163,395   

More than three years to five years

     7,276         136,823         —           5,779         5,509         155,387   

More than five years to ten years

     71,433         113,001         —           31,031         4,869         220,334   

More than ten years to twenty years

     154,090         10,703         —           150,902         —           315,695   

More than twenty years

     645,294         1,734         —           885         —           647,913   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total due after December 31, 2012

     882,272         407,482         —           191,470         21,500         1,502,724   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amount due

   $ 882,550       $ 460,725       $ 6,657       $ 192,918       $ 45,889         1,588,739   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Loans in process

                    (2,559

Deferred origination costs, net

                    4,366   

Allowance for loan losses

                    (18,230
                 

 

 

 

Total loans, net

                    1,572,316   

Less: Mortgage loans held for sale

                    9,297   
                 

 

 

 

Loans receivable, net

                  $ 1,563,019   
                 

 

 

 

 

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The following table sets forth at December 31, 2011, the dollar amount of total loans receivable contractually due after December 31, 2012, and whether such loans have fixed interest rates or adjustable interest rates.

 

     Due After December 31, 2012  
     Fixed      Adjustable      Total  
            (In thousands)         

Real estate loans:

        

One-to-four family

   $ 468,160       $ 414,112       $ 882,272   

Commercial real estate, multi-family and land

     304,965         102,517         407,482   

Consumer

     81,670         109,800         191,470   

Commercial

     12,217         9,283         21,500   
  

 

 

    

 

 

    

 

 

 

Total loans receivable

   $ 867,012       $ 635,712       $ 1,502,724   
  

 

 

    

 

 

    

 

 

 

Origination, Sale and Servicing of Loans. The Bank’s residential mortgage lending activities are conducted primarily by commissioned loan representatives in the exclusive employment of the Bank. The Bank originates both adjustable-rate and fixed-rate loans. The type of loan originated is dependent upon the relative customer demand for fixed-rate or adjustable-rate mortgage (“ARM”) loans, which is affected by the current and expected future level of interest rates.

The Bank periodically sells part of its mortgage production in order to manage interest rate risk and liquidity. At December 31, 2011, there were $9.3 million in loans categorized as held for sale which are recorded at the lower of cost or fair market value.

The following table sets forth the Bank’s loan originations, purchases, sales, principal repayments and loan activity, including loans held for sale, for the periods indicated.

 

     For the Year December 31,  
     2011      2010      2009  
     (In thousands)  

Total loans:

        

Beginning balance

   $ 1,686,355       $ 1,648,364       $ 1,662,337   
  

 

 

    

 

 

    

 

 

 

Loans originated:

        

One-to-four family

     240,640         381,296         418,446   

Commercial real estate, multi-family and land

     90,144         91,140         114,036   

Residential construction

     3,841         5,539         4,817   

Consumer

     74,175         76,846         64,175   

Commercial

     100,142         124,630         99,868   
  

 

 

    

 

 

    

 

 

 

Total loans originated

     508,942         679,451         701,342   
  

 

 

    

 

 

    

 

 

 

Total

     2,195,297         2,327,815         2,363,679   

Less:

        

Principal repayments

     469,902         477,536         480,174   

Sales of loans

     133,739         162,481         232,765   

Transfer to REO

     2,917         1,443         2,376   
  

 

 

    

 

 

    

 

 

 

Total loans

   $ 1,588,739       $ 1,686,355       $ 1,648,364   
  

 

 

    

 

 

    

 

 

 

One-to-Four Family Mortgage Lending. The Bank offers fixed-rate, regular amortizing adjustable-rate and interest-only mortgage loans secured by one-to-four family residences with maturities up to 30 years. The majority of such loans are secured by property located in the Bank’s primary market area. Loan originations are typically generated by commissioned loan representatives in the exclusive employment of the Bank and their contacts within the local real estate industry, members of the local communities and the Bank’s existing or past customers.

 

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At December 31, 2011, the Bank’s total loans outstanding were $1.589 billion, of which $882.6 million, or 55.6%, were one-to-four family residential mortgage loans, primarily single family and owner occupied. To a lesser extent and included in this activity are residential mortgage loans secured by seasonal second homes and non-owner occupied investment properties. The average size of the Bank’s one-to-four family mortgage loan was approximately $184,000 at December 31, 2011. The Bank currently offers a number of ARM loan programs with interest rates which adjust every one, three, five or ten years. The Bank’s ARM loans generally provide for periodic caps of 2% or 3% and an overall cap of 6% on the increase or decrease in the interest rate at any adjustment date and over the life of the loan. The interest rate on these loans is indexed to the applicable one-, three-, five- or ten-year U.S. Treasury constant maturity yield, with a repricing margin which ranges generally from 2.75% to 3.50% above the index. The Bank also offers three-, five-, seven- and ten-year ARM loans which operate as fixed-rate loans for the first three, five, seven or ten years and then convert to one-year ARM loans for the remainder of the term. The ARM loans are then indexed to a margin of generally 2.75% to 3.50% above the one-year U.S. Treasury constant maturity yield.

Generally, ARM loans pose credit risks different than risks inherent in fixed-rate loans, primarily because as interest rates rise, the payments of the borrower rise, thereby increasing the potential for delinquency and default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. In order to minimize risks, borrowers of one-year ARM loans with a loan-to-value ratio of 75% or less are qualified at the fully-indexed rate (the applicable U.S. Treasury index plus the margin, rounded up to the nearest one-eighth of one percent), and borrowers of one-year ARM loans with a loan-to-value ratio over 75% are qualified at the higher of the fully-indexed rate or the initial rate plus the 2% annual interest rate cap. The Bank does not originate ARM loans which provide for negative amortization. The Bank does offer interest-only ARM loans in which the borrower makes only interest payments for the first five, seven or ten years of the mortgage loan term and then convert to a fully-amortizing loan until maturity. Borrowers for interest-only ARM loans are qualified at the fully-amortized payment. The interest-only feature will result in future increases in the borrower’s loan repayment when the contractually required payments increase due to the required amortization of the principal amount. These payment increases could affect a borrower’s ability to repay the loan. The amount of interest-only, one-to-four family mortgage loans at December 31, 2011 and 2010 was $54.9 million and $80.1 million, respectively, or 6.2% and 8.4%, respectively, of total one-to-four family mortgages.

The Bank’s fixed-rate mortgage loans currently are made for terms from 10 to 30 years. The Bank may periodically sell some of the fixed-rate residential mortgage loans that it originates. The Bank retains the servicing on most loans sold. The Bank generally retains for its portfolio shorter-term, fixed-rate loans and certain longer-term, fixed-rate loans, generally consisting of loans to officers, directors or employees of the Bank. The Bank may retain a portion of its longer-term fixed-rate loans after considering volume and yield and after evaluating interest rate risk and capital management considerations. The retention of fixed-rate mortgage loans may increase the level of interest rate risk exposure of the Bank, as the rates on these loans will not adjust during periods of rising interest rates and the loans can be subject to substantial increases in prepayments during periods of falling interest rates. During the past three years, the Bank has generally sold much of its 30-year fixed-rate one-to-four family loans into the secondary market primarily to manage interest rate risk considerations.

The Bank’s policy is to originate one-to-four family residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan and up to 95% of the appraised value or selling price if private mortgage insurance is obtained. Appraisals are obtained for loans secured by real estate properties. The weighted average loan-to-value ratio of the Bank’s one-to-four family mortgage loans was 57% at December 31, 2011 based on appraisal values at the time of origination. In recent years, a decline in real estate values in the Bank’s lending area has reduced the collateral value supporting the Bank’s loans although the Bank believes that most borrowers continue to have adequate collateral to support their outstanding loan balance. Title insurance is required for all first mortgage loans. Mortgage loans originated by the Bank include due-on-sale clauses which provide the Bank with the contractual right to declare the loan immediately due and payable in the event the borrower

 

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transfers ownership of the property without the Bank’s consent. Due-on-sale clauses are an important means of adjusting the rates on the Bank’s fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses.

The Bank currently obtains full verification of income on residential borrowers, however, it previously originated stated income loans on a limited basis through November 2010. The Bank previously offered stated income loans only to self-employed borrowers for purposes of financing primary residences and second home properties. The amount of stated income loans at December 31, 2011 and 2010 was $54.1 million and $62.7 million, respectively, or 6.1% and 6.6%, respectively, of total one-to-four family mortgages.

Commercial Real Estate, Multi-Family and Land Lending. The Bank originates commercial real estate loans that are secured by properties, or properties under construction, generally used for business purposes such as small office buildings or retail facilities. A substantial majority of the Bank’s commercial real estate loans are located in the Bank’s primary market area. The Bank’s underwriting procedures provide that commercial real estate loans may be made in amounts up to 80% of the appraised value of the property. The Bank currently originates commercial real estate loans with terms of up to ten years and amortization schedules up to twenty-five years with fixed or adjustable rates. The loans typically contain prepayment penalties over the initial three to five years. In reaching its decision on whether to make a commercial real estate loan, the Bank considers the net operating income of the property and the borrower’s expertise, credit history, profitability and the term and quantity of leases. The Bank has generally required that the properties securing commercial real estate loans have debt service coverage ratios of at least 130%. The Bank generally requires the personal guarantee of the principal for commercial real estate loans. The Bank’s commercial real estate loan portfolio at December 31, 2011 was $460.7 million, or 29.0% of total loans. The largest commercial real estate loan in the Bank’s portfolio at December 31, 2011 was a performing loan for which the Bank had an outstanding carrying balance of $18.1 million secured by a first mortgage on dormitories at a major university in the Bank’s lending area. The average size of the Bank’s commercial real estate loans at December 31, 2011 was approximately $757,000.

The commercial real estate portfolio includes loans for the construction of commercial properties. Typically, these loans are underwritten based upon commercial leases in place prior to funding. In many cases, commercial construction loans are extended to owners that intend to occupy the property for business operations, in which case the loan is based upon the financial capacity of the related business and the owner of the business. At December 31, 2011, the Bank had an outstanding balance in commercial construction loans of $12.2 million.

The Bank also originates multi-family mortgage loans and land loans on a limited basis. The Bank’s multi-family loans and land loans at December 31, 2011 totaled $20.6 million and $8.3 million, respectively.

Loans secured by multi-family residential properties are generally larger and may involve a greater degree of risk than one-to-four family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting policies, which require such loans to be qualified at origination on the basis of the property’s income and debt coverage ratio.

Residential Construction Lending. At December 31, 2011, residential construction loans totaled $6.7 million, or 0.4%, of the Bank’s total loans outstanding. The Bank originates residential construction loans primarily on a construction/permanent basis with such loans converting to an amortizing loan following the completion of the construction phase. Most of the Bank’s residential construction loans are made to individuals building their primary residence, while, to a lesser extent, loans are made to finance a second home or to developers known to the Bank in order to build single-family houses for sale, which loans become due and payable over terms generally not exceeding 12 months.

 

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Construction lending, by its nature, entails additional risks compared to one-to-four family mortgage lending, attributable primarily to the fact that funds are advanced based upon a security interest in a project which is not yet complete. The Bank addresses these risks through its underwriting policies and procedures and its experienced staff.

Consumer Loans. The Bank also offers consumer loans. At December 31, 2011, the Bank’s consumer loans totaled $192.9 million, or 12.1% of the Bank’s total loan portfolio. Of the total consumer loan portfolio, home equity lines of credit comprised $110.7 million, or 57.4%; home equity loans comprised $81.6 million, or 42.3%; automobile and overdraft line of credit loans totaled $403,000 or 0.2%; and loans on savings accounts totaled $256,000, or 0.1%.

The Bank originates home equity loans typically secured by second liens on one-to-four family residences. These loans are originated as fixed-rate loans with terms ranging from 5 to 20 years. Home equity loans are typically made on owner-occupied, one-to-four family residences and generally to Bank customers. Generally, these loans are subject to an 80% loan-to-value limitation, including any other outstanding mortgages or liens. The Bank also offers a variable-rate home equity line of credit which extends a credit line based on the applicant’s income and equity in the home. Generally, the credit line, when combined with the balance of the first mortgage lien, may not exceed 80% of the appraised value of the property at the time of the loan commitment. Home equity lines of credit are secured by a mortgage on the underlying real estate. The Bank presently charges no origination fees for these loans, but may in the future charge origination fees for its home equity lines of credit. The Bank does, however, charge early termination fees should a line of credit be closed within three years of origination. A borrower is required to make monthly payments of principal and interest, at a minimum of $50, based upon a 10, 15 or 20 year amortization period. The Bank also offers home equity lines of credit which require the payment of interest only during the first five years with fully amortizing payments thereafter. Generally, the adjustable rate of interest charged is based upon the prime rate of interest (as published in the Wall Street Journal), although the range of interest rates charged may vary from 1.0% below prime to 1.5% over prime. The Bank currently maintains a 4.0% floor rate on new originations. The loans have an 18% lifetime cap on interest rate adjustments.

Commercial Lending. At December 31, 2011, commercial loans totaled $45.9 million, or 2.9% of the Bank’s total loans outstanding. The Bank originates commercial loans and lines of credit (including for working capital; fixed asset purchases; and acquisition, receivable and inventory financing) primarily in the Bank’s market area. In underwriting commercial loans and credit lines, the Bank will review and analyze financial history and capacity, collateral value, strength and character of the principals, and general payment history of the borrower and principals in coming to a credit decision. The Bank generally requires the personal guarantee of the principal borrowers for all commercial loans.

A well-defined credit policy has been approved by the Bank’s Board of Directors (the “Board”). This policy discourages high risk credits, while focusing on quality underwriting, sound financial strength and close monitoring. Commercial business lending, both secured and unsecured, is generally considered to involve a higher degree of risk than secured residential real estate lending. Risk of loss on a commercial business loan is dependent largely on the borrower’s ability to remain financially able to repay the loan from ongoing operations. If the Bank’s estimate of the borrower’s financial ability is inaccurate, the Bank may be confronted with a loss of principal on the loan. The Bank’s largest commercial loan at December 31, 2011 had an outstanding balance of $3.5 million although the average size of the Bank’s commercial loans at December 31, 2011 was approximately $185,000.

Loan Approval Procedures and Authority. The Board establishes the loan approval policies of the Bank based on total exposure to the individual borrower. The Board has authorized the approval of loans by various officers of the Bank or a Management Credit Committee, on a scale which requires approval by personnel with progressively higher levels of responsibility as the loan amount increases. New borrowers with a total exposure in excess of $3.0 million and existing borrowers with a total exposure in excess of $5.0 million require approval by the Management Credit Committee. A minimum of two employees’

 

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signatures are required to approve residential loans over the conforming loan limits of the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”). Pursuant to applicable regulations, loans to one borrower generally cannot exceed 15% of the Bank’s unimpaired capital, which at December 31, 2011 amounted to $32.6 million. At December 31, 2011, the Bank’s maximum loan exposure to a single borrower and related interests was $18.1 million. This previously mentioned performing loan is secured by a first mortgage on a dormitory at a major university in the Bank’s lending area.

Loan Servicing. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, making inspections as required of mortgaged premises, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. The Bank also services mortgage loans for others. All of the loans currently being serviced for others are loans which have been sold by the Bank or Columbia Home Loans, LLC (“Columbia”) the Bank’s mortgage company which was shuttered in 2007. At December 31, 2011, the Bank was servicing $878.5 million of loans for others. At December 31, 2011, 2010 and 2009, the balance of mortgage servicing rights totaled $4.8 million, $5.7 million and $6.5 million, respectively. For the years ended December 31, 2011, 2010 and 2009, loan servicing income (loss), net of related amortization totaled $427,000, $292,000 and $(18,000), respectively. The Bank evaluates mortgage servicing rights for impairment on a quarterly basis. No impairment was recognized for the years ended December 31, 2011 and 2010. For the year ended December 31, 2009, the Company recognized an impairment to the loan servicing asset of $263,000. The valuation of mortgage servicing rights is determined through a discounted analysis of future cash flows, incorporating numerous assumptions which are subject to significant change in the near term. Generally, a decline in market interest rates will cause expected prepayment speeds to increase resulting in a lower valuation for mortgage servicing rights and ultimately lower future servicing fee income.

Delinquencies and Classified Assets. Management and the Board perform a monthly review of all delinquent loan totals which includes loans sixty days or more past due, and the detail of each loan thirty days or more past due that was originated within the past year. In addition, the Chief Risk Officer compiles a quarterly list of all criticized and classified loans and a narrative report of classified commercial, commercial real estate, multi-family, land and construction loans. The steps taken by the Bank with respect to delinquencies vary depending on the nature of the loan and period of delinquency. When a borrower fails to make a required payment on a loan, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. The Bank generally sends the borrower a written notice of non-payment after the loan is first past due. In the event payment is not then received, additional letters and phone calls generally are made. In the case of residential mortgage loans, the Bank may offer to modify the terms or take other forbearance actions which afford the borrower an opportunity to remain in their home and satisfy the loan terms. If the loan is still not brought current and it becomes necessary for the Bank to take legal action, which typically occurs after a loan is delinquent at least 90 days or more, the Bank will commence litigation to realize on the collateral, including foreclosure proceedings against any real property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or an acceptable workout accommodation is not agreed upon before the foreclosure sale, the real property securing the loan generally is sold at foreclosure although foreclosure timelines in New Jersey have increased significantly over the past few years. The Bank utilized the HOPE NOW loan modification reporting standards through its end date of September 30, 2011, as well as the President’s Homeowner Affordability and Stability Plan and other plans to mitigate foreclosure actions. HOPE NOW was an alliance between counselors, mortgage market participants and mortgage servicers to create a unified, coordinated plan to reach and help as many homeowners as possible. The goal of the Homeowner Affordability and Stability Plan and other plans is to incent lenders to engage in sustainable mortgage modifications. The plan provides lenders with incentives to reduce rates on mortgages to a specified affordability level. The plan also provides access to low cost refinancing for responsible homeowners affected by falling home prices.

The Bank’s internal Asset Classification Committee, which is chaired by the Chief Risk Officer, reviews

 

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and classifies the Bank’s assets quarterly and reports the results of its review to the Board. The Bank classifies assets in accordance with certain regulatory guidelines. At December 31, 2011, the Bank had $88.1 million of assets, including all REO, classified as “Substandard,” $74,600 of assets classified as “Doubtful” and no assets classified as “Loss.” At December 31, 2010, the Bank had $90.0 million of assets classified as “Substandard,” $1.5 million classified as “Doubtful” and no assets classified as “Loss.” Loans and other assets may also be placed on a watch list as “Special Mention” assets. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “Special Mention.” Special Mention assets totaled $11.5 million at December 31, 2011, as compared to $15.5 million at December 31, 2010. Loans are classified as Special Mention due to past delinquencies or other identifiable weaknesses. The largest Special Mention loan relationship is comprised of several commercial real estate loans to a real estate management and investment company totaling $1.3 million. The loans are current as to payments and are secured by residential and commercial properties and personal guarantees. The largest Substandard loan relationship is comprised of several credit facilities to a building supply company with an aggregate balance of $8.6 million which was current as to payments but criticized due to poor, but improving, operating results. In addition to loan classifications, the Company classified investment securities with an amortized cost of $25.0 million and a carrying value of $17.8 million as Substandard, which represents the amount of investment securities with a credit rating below investment grade from one of the internationally-recognized credit rating services.

Non-Accrual Loans and REO. The following table sets forth information regarding non-accrual loans and REO. It is the policy of the Bank to cease accruing interest on loans 90 days or more past due or in the process of foreclosure. For the years ended December 31, 2011, 2010, 2009, 2008 and 2007, respectively, the amount of interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $2,125,000, $1,467,000, $1,441,000, $913,000 and $210,000.

 

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     December 31,  
     2011     2010     2009     2008     2007  
     (Dollars in thousands)  

Non-accrual loans:

          

Real estate:

          

One-to-four family

   $ 29,193      $ 26,577      $ 19,142      $ 8,696      $ 6,620   

Commercial real estate, multi-family and land

     10,552        5,849        5,152        5,527        1,040   

Residential construction

     43        368        368        —          —     

Consumer

     3,653        4,626        3,031        1,435        586   

Commercial

     567        117        627        385        495   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     44,008        37,537        28,320        16,043        8,741   

REO, net (1)

     1,970        2,295        2,613        1,141        438   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 45,978      $ 39,832      $ 30,933      $ 17,184      $ 9,179   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses as a percent of total loans receivable (2)

     1.15     1.17     .89     .70     .62

Allowance for loan losses as a percent of total non-performing loans (3)

     41.42        52.48        51.99        72.71        119.76   

Non-performing loans as a percent of total loans receivable (2)(3)

     2.77        2.23        1.72        .97        .52   

Non-performing assets as a percent of total assets (3)

     2.00        1.77        1.52        .92        .48   

 

(1) REO balances are shown net of related loss allowances.
(2) Total loans includes loans receivable and mortgage loans held for sale.
(3) Non-performing assets consist of non-performing loans and REO. Non-performing loans consist of all loans 90 days or more past due and other loans in the process of foreclosure.

The Company’s non-performing loans totaled $44.0 million at December 31, 2011, a $6.5 million increase from $37.5 million at December 31, 2010. Included in the non-performing loan total at December 31, 2011 was $14.5 million of troubled debt restructured loans, as compared to $3.3 million of troubled debt restructured loans at December 31, 2010. The increase in non-performing and troubled debt restructured loans was primarily due to the second quarter addition of one large loan relationship secured by commercial real estate with an outstanding balance of $6.4 million. The loans are collateralized by commercial and residential real estate, all business assets and also carry a personal guarantee. An appraisal performed in May 2011 values the real estate collateral at $8.7 million. In November 2011, the Company entered into a troubled-debt restructuring with the borrower which capitalized delinquent interest and reduced the interest rate in exchange for additional collateral. Non-performing loans are concentrated in one-to-four family loans which comprise 66.3% of the total. At December 31, 2011, the average weighted loan-to-value ratio of non-performing one-to-four family loans was 63% using appraisal values at time of origination and 82% using updated appraisal values. Appraisals are obtained for all non-performing loans secured by real estate and subsequently updated annually if the loan remains delinquent for an extended period. At December 31, 2011, the average weighted loan-to-value ratio of the total one-to-four family loan portfolio was 57% using appraisal values at time of origination. Based upon sales data for 2011 from the Ocean and Monmouth Counties Multiple Listing Service, home values in the Company’s primary market area have declined by approximately 19% from the peak of the market in 2006. Individual home values may move more or less than the average based upon the specific characteristics of the property. There can be no assurance that home values will not decline further, possibly resulting in losses to the Company. The largest non-performing one-to-four family loan is a loan for $2.8 million. The loan is secured by a first mortgage on a property with an August 2011 appraised

 

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value of $3.4 million. The Company’s non-performing loans remain at elevated levels partly due to the extended foreclosure process in the State of New Jersey. This protracted foreclosure process delays the Company’s ability to resolve non-performing loans through sale of the underlying collateral. Of the non-performing one-to-four family loans, 70% were originated by alternative Bank delivery channels which have since been shuttered.

Allowance for Loan Losses. The allowance for loan losses is a valuation account that reflects probable incurred losses in the loan portfolio. The adequacy of the allowance for loan losses is based on management’s evaluation of the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and current economic conditions. Additions to the allowance arise from charges to operations through the provision for loan losses or from the recovery of amounts previously charged-off. The allowance is reduced by loan charge-offs. The Company modified its charge-off policy in 2011 as described below.

The allowance for loan losses is maintained at an amount management considers sufficient to provide for probable losses. The analysis considers known and inherent risks in the loan portfolio resulting from management’s continuing review of the factors underlying the quality of the loan portfolio. These factors include delinquency status, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and the determination of the existence and realizable value of the collateral and guarantees securing the loan.

The Bank’s allowance for loan losses includes specific allowances and a general allowance, each updated on a quarterly basis. A specific allowance is determined for all loans which meet the definition of an impaired loan where the value of the underlying collateral can reasonably be evaluated and where the Company has not already taken an interim charge-off. These are generally loans which are secured by real estate. The Bank obtains an updated appraisal for all impaired loans secured by real estate and collateral dependent residential mortgage loans greater than 90 days delinquent. The appraisal is subsequently updated annually if the loan remains delinquent for an extended period. The specific allowance, or general reserve allocation for collateral dependent residential mortgage loans, represents the difference between the Bank’s recorded investment in the loan, net of any interim charge-off, and the fair value of the collateral, less estimated disposal costs. A general allowance is determined for all other classified and non-classified loans. In determining the level of the general allowance, the Bank segments the loan portfolio into various loan segments and classes as follows:

 

Loan Portfolio Segment

      

Loan Class

    
Residential real estate:   -    Loans originated by Bank   
  -    Loans originated by mortgage company   
  -    Loans originated by mortgage company – non-prime
  -    Residential construction   
Commercial real estate:   -    Commercial   
  -    Construction and land   
Consumer:   -    Consumer   
Commercial:   -    Commercial   

The mortgage company was shuttered by the Bank in 2007.

The loan portfolio is further segmented by delinquency status and risk rating (special mention, substandard and doubtful). An estimated loss factor is then applied to each risk tranche. If a loan secured by real estate becomes 90 days delinquent, the Bank obtains an updated appraisal which is subsequently updated annually as foreclosure timelines have recently increased significantly. For these loans, the estimated loss represents the difference between the Bank’s recorded investment in the loan and the fair value of the collateral, less estimated selling costs. For loans 90 days delinquent not secured by real estate, the Bank evaluates the fair value of the collateral and the personal guarantees, if any, and

 

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identifies an estimated loss for the difference between the Bank’s recorded investment in the loan and the fair value of the collateral, less estimated selling costs. For loans which are not 90 days delinquent, a historical loss rate is determined for each loan segment. To determine the loss rate, the Bank utilizes a rolling four quarter average of loan losses as a percent of loan principal adjusted for the estimated probability of default. The historical loss rate is adjusted for certain environmental factors including current economic conditions, regulatory environment, local competition, lending personnel, loan policies and underwriting standards, loan review system, delinquency trends, loss trends, nature and volume of the loan portfolio and concentrations of credit. Existing economic conditions which the Bank considered to estimate the allowance for loan losses include local trends in economic growth, unemployment and real estate values.

During the fourth quarter of 2011, the Company modified its charge-off policy on problem loans secured by real estate. Historically, the Company established specific valuation reserves for estimated losses for problem real estate related loans when the loans were deemed uncollectible. The specific valuation reserves were based upon the estimated fair value of the underlying collateral, less costs to sell. The actual loan charge-off was not recorded until the foreclosure process was complete. Under the modified policy, losses on loans secured by real estate are charged-off in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 120 days delinquent and a recent appraisal is received which reflects a collateral shortfall. The modification to the charge-off policy resulted in additional charge-offs in the fourth quarter 2011 of $5.7 million. All of these charge-offs were timely identified in previous periods in the Company’s allowance for loan losses process as a specific valuation reserve and were included in the Company’s loss experience as part of the evaluation of the allowance for loan losses. Accordingly, the additional charge-offs did not affect the Company’s provision for loan losses or net income for 2011. Without the additional charge-offs of $5.7 million recorded in the fourth quarter of 2011, the Company would have reported the following as of and for the year ended December 31, 2011: total charge-offs of $3.6 million; allowance for loan losses of $23.9 million; total non-performing loans of $49.7 million; allowance for loan losses as percent of total loans receivable of 1.50%; allowance for loan losses as percent of total non-performing loans of 48.12%; non-performing loans as a percent of total loans receivable of 3.12% ; and non-performing assets as a percent of total assets of 2.24%.

An overwhelming percentage of the Bank’s loan portfolio, 97.1%, is secured by real estate whether one-to-four family, consumer or commercial. Additionally, most of the Bank’s borrowers are located in Ocean and Monmouth Counties, New Jersey and the surrounding area. These concentrations may adversely affect the Bank’s loan loss experience should local real estate values decline further or should the markets served continue to experience difficult economic conditions including increased unemployment. See “Risk Factors – A continued downturn in the local economy or in local real estate values could hurt profits.”

Management believes the primary risk characteristics for each portfolio segment are a continued decline in the economy generally, including elevated levels of unemployment, a further decline in real estate market values and possible increases in interest rates. Any one or a combination of these events may adversely affect the borrowers’ ability to repay the loans, resulting in increased delinquencies, loan charge-offs and future levels of provisions. Accordingly, the Bank has provided for loan losses at the current level to address the current risk in the loan portfolio.

Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions in the Company’s market area. In addition, various regulatory agencies, as an integral part of their routine examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.

As of December 31, 2011 and 2010, the Bank’s allowance for loan losses was 1.15% and 1.17% respectively, of total loans. The Bank’s allowance for loan losses at December 31, 2011 was reduced by

 

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the $5.7 million in charge-offs relating to the Company’s decision to modify its charge-off policy as described above. The Bank had non-accrual loans of $44.0 million and $37.5 million at December 31, 2011 and 2010, respectively. The Bank will continue to monitor its allowance for loan losses as conditions dictate.

The following table sets forth activity in the Bank’s allowance for loan losses for the periods set forth in the table.

 

     At or for the Year Ended  
     2011     2010     2009     2008     2007  
     (Dollars in thousands)  

Balance at beginning of year

   $ 19,700      $ 14,723      $ 11,665      $ 10,468      $ 10,238   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Charge-offs:

          

Residential real estate

     4,643        1,959        1,603        884        107   

Commercial real estate

     2,301        324        885        —          —     

Consumer

     1,982        736        105        —          —     

Commercial

     323        257        95        —          370   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     9,249        3,276        2,688        884        477   

Recoveries

     29        253        46        306        7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     9,220        3,023        2,642        578        470   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     7,750        8,000        5,700        1,775        700   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 18,230      $ 19,700      $ 14,723      $ 11,665      $ 10,468   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs during the year to average net loans outstanding during the year

     .57     .18     .16     .03     .03
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The increase in charge-offs during 2011 was primarily due to the Company’s decision to modify its charge-off policy as described above.

 

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The following table sets forth the Bank’s percent of allowance for loan losses to total allowance and the percent of loans to total loans in each of the categories listed at the dates indicated (Dollars in thousands).

 

    At December 31,  
    2011     2010     2009     2008     2007  
    Amount     Percent of
Allowance
to Total
Allowance
    Percent
of Loans
in Each
Category

to Total
Loans
    Amount     Percent of
Allowance
to Total
Allowance
    Percent
of Loans
in Each
Category

to Total
Loans
    Amount     Percent of
Allowance

to Total
Allowance
    Percent
of Loans
in Each
Category

to Total
Loans
    Amount     Percent of
Allowance
to Total
Allowance
    Percent
of Loans
in Each
Category

to Total
Loans
    Amount     Percent of
Allowance
to Total
Allowance
    Percent
of Loans
in Each
Category
to Total
Loans
 

Residential real estate

  $ 5,370        29.46     55.97   $ 5,977        30.34     57.45   $ 3,654        24.82     58.48   $ 3,245        27.82     63.17   $ 2,301        21.98     64.84

Commercial real estate

    8,474        46.48        29.00        6,837        34.71        25.80        5,043        34.25        24.08        3,580        30.69        19.84        3,547        33.88        19.33   

Consumer

    1,461        8.01        12.14        3,264        16.57        12.20        2,998        20.36        13.18        1,924        16.49        13.40        1,587        15.16        12.62   

Commercial

    900        4.94        2.89        962        4.88        4.55        1,725        11.72        4.26        1,442        12.36        3.59        1,329        12.70        3.21   

Unallocated

    2,025        11.11        —          2,660        13.50        —          1,303        8.85        —          1,474        12.64        —          1,704        16.28        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 18,230        100.00     100.00   $ 19,700        100.00     100.00   $ 14,723        100.00     100.00   $ 11,665        100.00     100.00   $ 10,468        100.00     100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Reserve for Repurchased Loans. At December 31, 2011 and 2010, the Company maintained a reserve for repurchased loans of $705,000 and $809,000, respectively, related to potential losses on loans sold which may have to be repurchased due to a violation of a representation or warranty. The decrease from the prior year was due to a settlement of one repurchase request. Provisions for losses are charged to gain on sale of loans and credited to the reserve while actual losses are charged to the reserve. There were no loans repurchased for the years ended December 31, 2011, 2010 and 2009. Losses were $104,000, $10,000 and $79,000, respectively, for the years ended December 31, 2011, 2010 and 2009. Included in the losses on loans repurchased are cash settlements in lieu of repurchases. At December 31, 2011, there were four outstanding loan repurchase requests on loans with a total principal balance of $1.2 million, which the Company is disputing.

In order to estimate an appropriate reserve for repurchased loans, the Company considers recent and historical experience, product type and volume of recent whole loan sales and the general economic environment.

The method used to calculate the reserve for repurchased loans can generally be described as: volume of loans multiplied by the estimated percentage of loans returned for repurchase multiplied by the estimated loss percentage on loans repurchased.

The material assumptions relied on to determine the reserve for repurchased loans are further described below.

A specific reserve was established for projected losses on outstanding repurchase requests. The specific reserve was based on the estimated fair market value of the underlying collateral modified by the likelihood of payment which was estimated based on historical experience.

The Company segmented its volume of sold loans into two portfolios, Bank originated loans and loans originated by Columbia. Each of these portfolios was further segmented by investor type, between loans sold to Government Sponsored Enterprises (“GSE”) such as FHLMC and FNMA and loans sold to non-GSE investors. Based on actual loan repurchase experience, the Company determined that loans originated by Columbia had significantly more repurchase requests than loans originated by the Bank. Based on this data, the Company considered the population of loans subject to repurchase as Columbia loans originated from January 1, 2005 through its shuttering in 2007 and Bank loans originated in the past five years. The volume of loan originations by Columbia is net of loan volume covered by a prior settlement with the loan investor, as the risk of future repurchases from these loans has been mitigated. Loan balances were assumed to decay, or run-off, at the rate of 12.5% per year.

The Company then applied a return factor to the remaining loan sale volume as determined above. The return factor was determined based on the Company’s actual experience for repurchase requests and is equal to the amount of repurchase requests divided by the amount of loans sold.

The calculated return factors were as follows:

 

     Non-GSE Exposure     GSE Exposure  
     At December 31,  
     2011     2010     2009     2011     2010     2009  

Bank

     .16     .13     .11     .00     .00     .00

Columbia

     .49     .97     .10     .26     .81     .36

The Company experienced substantial repurchase request volume for Columbia in 2007 which decreased significantly throughout 2008 and through 2011. As a result of this trend, the Company gave more weight to its more recent experience and less weight to earlier experience.

Finally, to establish the reserve for repurchased loans, estimated loss factors were applied to the estimated amount of repurchase requests. The Company calculated an actual loss experience on prior repurchase requests of 15.7%, 16.0% and 15.0%, respectively, at December 31, 2011, 2010 and 2009, although the actual loss factor was modified to consider several economic factors which were likely to adversely

 

16


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impact the Company’s loss experience. These factors included continued weakness in the housing market; a nationwide recession with significant decline in employment; and, increasing delinquency and foreclosure rates on single family mortgage loans. Additionally, both FNMA and FHLMC and investors in mortgage-backed securities pools continue to carefully examine loan documentation on loans sold to these agencies and investors by loan originators, such as the Bank, with a goal of putting an increasing amount of delinquent loans back to the originator. After adjustments, the final estimated loss factors at December 31, 2011, 2010 and 2009 were 26.2%, 26.5% and 18.25%, respectively, for the Bank and 41.2%, 29.0% and 18.0%, respectively, for Columbia.

Management believes that the Bank has established and maintained the reserve for repurchased loans at adequate levels, however, future adjustments to the reserve may be necessary due to economic, operating or other conditions beyond the Bank’s control.

Investment Activities

Federally-chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various Federal agencies, certificates of deposit of insured banks and savings institutions, bankers’ acceptances, repurchase agreements and Federal funds. Subject to various restrictions, Federally-chartered savings institutions may also invest in commercial paper, investment-grade corporate debt securities and mutual funds whose assets conform to the investments that a Federally-chartered savings institution is otherwise authorized to make directly.

The investment policy of the Bank as established by the Board attempts to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Bank’s lending activities. Specifically, the Bank’s policies generally limit investments to government and Federal agency-backed securities and other non-government guaranteed securities, including corporate debt obligations that are investment grade at purchase. The Bank’s policies provide that all investment purchases must be approved by two officers (any two of the Senior Vice President/Treasurer, the Executive Vice President/Chief Financial Officer, and the President/Chief Operating Officer) and must be ratified by the Board. The Company’s investment policy mirrors that of the Bank except that it allows for the purchase of equity securities in limited amounts.

Management determines the appropriate classification of securities at the time of purchase. If the Bank has the intent and the ability at the time of purchase to hold securities until maturity, they may be classified as held to maturity. Investment and mortgage-backed securities identified as held to maturity are carried at cost, adjusted for amortization of premium and accretion of discount, which are recognized as adjustments to interest income. Securities to be held for indefinite periods of time, but not necessarily to maturity are classified as available for sale. Securities available for sale include securities that management intends to use as part of its asset/liability management strategy. Such securities are carried at fair value and unrealized gains and losses, net of related tax effect, are excluded from earnings, but are included as a separate component of stockholders’ equity. At December 31, 2011, all of the Bank’s investment and mortgage-backed securities were classified as available for sale.

Mortgage-backed Securities. Mortgage-backed securities represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which, in general, are passed from the mortgage originators, through intermediaries that pool and repackage the participation interests in the form of securities, to investors such as the Bank. Such intermediaries may be private issuers, or agencies including FHLMC, FNMA and the Government National Mortgage Association (“GNMA”) that guarantee the payment of principal and interest to investors. Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a certain range and with varying maturities. The underlying pool of mortgages can be composed of either fixed-rate or ARM loans.

The actual maturity of a mortgage-backed security varies, depending on when the mortgagors repay or

 

17


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prepay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the security, thereby affecting its yield to maturity and the related market value of the mortgage-backed security. The prepayments of the underlying mortgages depend on many factors, including the type of mortgages, the coupon rates, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages, the general levels of market interest rates, and general economic conditions. GNMA mortgage-backed securities that are backed by assumable Federal Housing Administration (“FHA”) or Department of Veterans Affairs (“VA”) loans generally have a longer life than conventional non-assumable loans underlying FHLMC and FNMA mortgage-backed securities. During periods of falling mortgage interest rates, prepayments generally increase, as opposed to periods of increasing interest rates when prepayments generally decrease. If the interest rate of underlying mortgages significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities. As indicated in the table below, prepayments on mortgage-backed securities have increased due to the low interest rate environment.

The Bank has investments in mortgage-backed securities and has utilized such investments to complement its lending activities. The Bank invests in a large variety of mortgage-backed securities, including ARM, balloon and fixed-rate securities. At December 31, 2011, mortgage-backed securities totaled $364.9 million, or 15.9% of total assets, and all were directly insured or guaranteed by either FHLMC, FNMA or GNMA.

 

18


Table of Contents

The following table sets forth the Bank’s mortgage-backed securities activities for the periods indicated.

 

     For the Year Ended December 31,  
     2011     2010     2009  
     (In thousands)  

Beginning balance

   $ 341,175      $ 213,622      $ 40,801   

Mortgage-backed securities purchased

     106,746        193,001        197,349   

Less: Principal repayments

     (85,839     (69,024     (24,380

Amortization of premium

     (1,689     (1,680     (577

Change in net unrealized gain on mortgage-backed securities available for sale

     4,538        5,256        429   
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 364,931      $ 341,175      $ 213,622   
  

 

 

   

 

 

   

 

 

 

The following table sets forth certain information regarding the amortized cost and market value of the Bank’s mortgage-backed securities at the dates indicated.

 

     At December 31,  
     2011      2010      2009  
     Amortized
Cost
     Estimated
Market
Value
     Amortized
Cost
     Estimated
Market
Value
     Amortized
Cost
     Estimated
Market
Value
 
     (In thousands)  

Mortgage-backed securities:

                 

FHLMC

   $ 74,155       $ 75,057       $ 19,225       $ 19,598       $ 12,423       $ 12,865   

FNMA

     279,414         288,762         315,024         320,368         199,381         199,413   

GNMA

     935         1,112         1,037         1,209         1,185         1,344   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

   $ 354,504       $ 364,931       $ 335,286       $ 341,175       $ 212,989       $ 213,622   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Investment Securities. At December 31, 2011, the carrying value of the Bank’s investment securities totaled $165.3 million, and consisted of $102.8 million of U.S. agency obligations, $39.4 million of corporate debt securities, $18.5 million of state and municipal obligations and $4.5 million of equity investments. Each of the U.S. agency obligations are rated AA+ by Standard and Poor’s and Aaa by Moody’s. The state and municipal obligations are issued by government entities in the State of New Jersey with current credit ratings that are considered investment grade ranging from a high of AA+ to a low of Baa1. The corporate debt securities are issued by other financial institutions and consist of eleven issues with an amortized cost of $5.0 million each spread between eight issuers. Credit ratings range from a high of A2 to a low of BB+ as rated by one of the internationally-recognized credit rating services. These floating-rate securities were purchased during the period May 1998 to September 1998 and have paid coupon interest continuously since issuance. Floating-rate debt securities such as these pay a fixed interest rate spread over 90 day LIBOR. Following the purchase of these securities, the required spread increased for these types of securities causing a decline in the market price. The Company concluded that unrealized losses on available for sale securities were only temporarily impaired at December 31, 2011. In concluding that the impairments were only temporary, the Company considered several factors in its analysis. The Company noted that each issuer made all the contractually due payments when required. There were no defaults on principal or interest payments and no interest payments were deferred. All of the financial institutions were also considered well-capitalized. Based on management’s analysis of each individual security, the issuers appear to have the ability to meet debt service requirements for the foreseeable future. Furthermore, although these investment securities are available for sale, the Company does not have the intent to sell these securities and it is more likely than not that the Company will not be required to sell the securities. The Company has held the securities continuously since 1998 and expects to receive its full principal at maturity in 2028 or prior if called by issuer. The Company has historically not actively sold investment securities and has not utilized the securities portfolio as a source of liquidity. The Company’s long range liquidity plans indicate adequate sources of liquidity outside the securities portfolio.

The following table sets forth certain information regarding the amortized cost and estimated market value of the Company’s investment securities at the dates indicated.

 

     At December 31,  
     2011      2010      2009  
     Amortized
Cost
     Estimated
Market
Value
     Amortized
Cost
     Estimated
Market
Value
     Amortized
Cost
     Estimated
Market
Value
 
     (In thousands)  

Investment securities:

                 

U.S. agency obligations

   $ 102,059       $ 102,776       $ 41,146       $ 41,132       $ 301       $ 306   

State and municipal obligations

     18,526         18,544         10,690         10,615         300         300   

Corporate debt securities

     55,000         39,449         55,000         39,856         55,000         36,369   

Equity investments

     4,294         4,510         370         315         370         292   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 179,879       $ 165,279       $ 107,206       $ 91,918       $ 55,971       $ 37,267   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The table below sets forth certain information regarding the amortized cost, weighted average yields and contractual maturities, excluding scheduled principal amortization, of the Bank’s investment and mortgage-backed securities, excluding equity securities, as of December 31, 2011. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     At December 31, 2011  
                             Total  
     One Year
or Less
Amortized
Cost
    More than
One Year
to Five
Years
Amortized
Cost
    More than
Five
Years to
Ten Years
Amortized
Cost
    More than
Ten Years
Amortized
Cost
    Amortized
Cost
    Estimated
Market
Value
 
     (Dollars in thousands)  

Investment securities:

            

U.S. agency obligations

   $ 15,383      $ 86,676      $ —        $ —        $ 102,059      $ 102,776   

State and municipal obligations (1)

     12,544        5,982        —          —          18,526        18,544   

Corporate debt securities (2)

     —          —          —          55,000        55,000        39,449   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

   $ 27,927      $ 92,658      $ —        $ 55,000      $ 175,585      $ 160,769   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield

     0.97     1.01     —       1.05     1.02  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Mortgage-backed securities:

            

FHLMC

   $ —        $ —        $ 5,005      $ 69,150      $ 74,155      $ 75,057   

FNMA

     —          1        —          279,413        279,414        288,762   

GNMA

     1        3        —          931        935        1,112   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total mortgage-backed securities

   $ 1      $ 4      $ 5,005      $ 349,494      $ 354,504      $ 364,931   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield

     %(3)      %(3)      1.54     2.96     2.94  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

(1) State and municipal obligations are reported at tax equivalent yield.
(2) All of the Bank’s corporate debt securities carry interest rates which adjust to a spread over LIBOR on a quarterly basis.
(3) Not meaningful.

 

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Table of Contents

Sources of Funds

General. Deposits, loans and mortgage-backed securities repayments and prepayments, proceeds from sales of loans, investment maturities, cash flows generated from operations and FHLB advances and other borrowings are the primary sources of the Bank’s funds for use in lending, investing and for other general purposes.

Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms to retail, government and business customers. The Bank’s deposits consist of money market accounts, savings accounts, interest-bearing checking accounts, non-interest-bearing accounts and time deposits. For the years ended December 31, 2011 and 2010, time deposits constituted 16.2% and 19.5%, respectively, of total average deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Bank’s deposits are obtained predominantly from the areas in which its branch offices are located. The Bank relies on its community-banking focus, stressing customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank’s ability to attract and retain deposits. The Bank does not currently use brokers to obtain deposits.

At December 31, 2011, the Bank had $77.1 million in time deposits in amounts of $100,000 or more maturing as follows:

 

Maturity Period

   Amount      Weighted
Average
Rate
 
     (Dollars in thousands)  

Three months or less

   $ 26,853         .92

Over three through six months

     11,977         1.80   

Over six through 12 months

     10,722         1.82   

Over 12 months

     27,501         3.33   
  

 

 

    

 

 

 

Total

   $ 77,053         2.04
  

 

 

    

 

 

 

 

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The following table sets forth the distribution of the Bank’s average deposit accounts and the average rate paid on those deposits for the periods indicated.

 

     For the Year Ended December 31,  
     2011     2010     2009  
     Average
Balance
     Percent
of Total
Average
Deposits
    Average
Rate
Paid
    Average
Balance
     Percent
of Total
Average
Deposits
    Average
Rate
Paid
    Average
Balance
     Percent
of Total
Average
Deposits
    Average
Rate
Paid
 
     (Dollars in thousands)  

Money market deposit accounts

   $ 116,295         6.93     .39   $ 104,833         6.83     .57   $ 91,695         6.76     .74

Savings accounts

     221,311         13.20        .22        241,762         15.75        .72        223,230         16.46        .88   

Interest-bearing checking accounts

     924,789         55.14        .50        761,854         49.65        .84        588,923         43.41        1.20   

Non-interest-bearing accounts

     142,478         8.50        —          127,535         8.31        —          110,740         8.16        —     

Time deposits

     272,198         16.23        1.78        298,534         19.46        1.87        341,999         25.21        2.43   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total average deposits

   $ 1,677,071         100.00     .62   $ 1,534,518         100.00     .93   $ 1,356,587         100.00     1.33
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Borrowings. From time to time the Bank has obtained advances from the Federal Home Loan Bank of New York (“FHLB-NY”) for cash management purposes or as an alternative to retail deposit funds and may do so in the future as part of its operating strategy. FHLB-NY term advances may also be used to acquire certain other assets as may be deemed appropriate for investment purposes. Advances are collateralized primarily by certain of the Bank’s mortgage loans and investment and mortgage-backed securities and secondarily by the Bank’s investment in capital stock of the FHLB-NY. The maximum amount that the FHLB-NY will advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the FHLB-NY. At December 31, 2011, the Bank had $266.0 million in outstanding advances from the FHLB-NY.

The Bank also borrows funds using securities sold under agreements to repurchase. Under this form of borrowing specific U.S. Government agency and/or mortgage-backed securities are pledged as collateral to secure the borrowing. These pledged securities are held by a third party custodian. At December 31, 2011, the Bank had borrowed $66.1 million through securities sold under agreements to repurchase.

The Bank can also borrow from the Federal Reserve Bank of Philadelphia (“Reserve Bank”) under the primary credit program. Primary credit is available on a short-term basis, typically overnight, at a rate above the Federal Open Market Committee’s Federal funds target rate. All extensions of credit by the Reserve Bank must be secured. At December 31, 2011, the Bank had no borrowings outstanding with the Reserve Bank.

Subsidiary Activities

At December 31, 2011, the Bank owned four subsidiaries – OceanFirst Services, LLC, OceanFirst REIT Holdings, Inc., 975 Holdings, LLC and Columbia (inactive).

OceanFirst Services, LLC was originally organized in 1982. In 1998, the Bank began to sell non-deposit investment products (annuities, mutual funds and insurance) through a third-party marketing firm to Bank customers through this subsidiary, recognizing fee income from such sales. OFB Reinsurance, Ltd. was established in 2002 as a subsidiary of OceanFirst Services, LLC to reinsure a percentage of the private mortgage insurance (“PMI”) risks on one-to-four family residential mortgages originated by the Bank and Columbia.

OceanFirst REIT Holdings, Inc. was established in 2007 and acts as the holding company for OceanFirst Realty Corp. OceanFirst Realty Corp. was established in 1997 and invests in qualifying mortgage loans and is intended to qualify as a real estate investment trust, which may, among other things, be utilized by the Company to raise capital in the future.

975 Holdings, LLC was established in 2010 as a wholly-owned service corporation of the Bank for the purpose of taking legal possession of certain repossessed collateral for resale to third parties.

Columbia was a mortgage banking company acquired by the Bank in 2000 which was shuttered in 2007 and is now inactive.

Personnel

As of December 31, 2011, the Bank had 337 full-time employees and 78 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.

 

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Table of Contents

REGULATION AND SUPERVISION

General

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted. Under the Dodd-Frank Act the Office of Thrift Supervision (“OTS”), which had been the primary federal regulator for the Company and the Bank, ceased to exist in July of 2011. At that time, the OCC, which is the primary federal regulator for national banks, became the primary federal regulator for federal thrifts such as the Bank. Additionally, the FRB will now supervise and regulate all savings and loan holding companies that were formerly regulated by the OTS, including the Company.

As a savings and loan holding company, the Company is required by Federal law to file reports with, and comply with the rules and regulations of the FRB. The Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary Federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the FDIC. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to consummating certain transactions such as mergers with, or acquisitions of, other insured depository institutions. The OCC and/or the FDIC conduct periodic examinations 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 and to ensure the safe and sound operation of the Bank. 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.

The Dodd-Frank Act. The Dodd-Frank Act significantly changed the bank regulatory structure and affects the lending, deposit, investment, compliance and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

The Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Company’s interest expense. The Dodd-Frank Act also broadened the base for Federal Deposit Insurance Corporation insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.

The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.

The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Savings institutions such as the Bank with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulators (the OCC in the case of the Bank), although the CFPB will have back-up authority over such institutions. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. The Dodd-Frank Act also directed the FRB to issue rules to limit debit-card interchange fees (the fees that issuing banks charge merchants each time a consumer uses a debit card) collected by banks with assets of $10 billion or more. On June 29, 2011, the FRB issued a final rule which would cap an issuer’s debit-card interchange base fee at twenty-one cents ($0.21) per transaction and allow an additional 5 basis point charge per transaction to cover fraud losses. The FRB also issued an interim final rule that allows a

 

25


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fraud-prevention adjustment of one cent ($0.01) per transaction conditioned upon an issuer adopting effective fraud prevention policies and procedures. The Bank’s average interchange fee per transaction is forty cents ($0.40). The Dodd-Frank Act exempts from the FRB’s rule banks with assets less than $10 billion, such as the Bank. Although exempt from the rule, market forces may result in reduced fees charged by all issuers, regardless of asset size, which may result in reduced revenues for the Bank. For the year ended December 31, 2011, the Bank’s revenues from interchange fees were $2.0 million, as compared to $1.8 million in 2010. The rules were effective October 1, 2011.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and allow greater access by shareholders to the company’s proxy material by authorizing the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal banking agencies to promulgate rules prohibiting excessive compensation paid to bank executives, regardless of whether the company is publicly traded. These rules require each bank with assets greater than $1 billion, such as the Bank, to make annual confidential disclosures to its primary Federal regulator detailing incentive compensation plans. The rules prohibit incentive-based compensation that would encourage inappropriate risks by providing excessive compensation or that would expose the bank to inappropriate risks by providing compensation that could lead to a material financial loss.

It is still uncertain how full implementation of and promulgation of rules under the Dodd-Frank Act, will affect the Bank. As the OCC and the FRB now regulate and supervise savings associations and savings and loan holding companies, existing regulations may be repealed or modified. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company, is subject to change and is qualified in its entirety by reference to the actual laws and regulations involved.

Holding Company Regulation

The Company is a nondiversified unitary savings and loan holding company within the meaning of Federal law. Generally, a unitary savings and loan holding company, such as the Company, is not restricted as to the types of business activities in which it may engage, provided that the Bank continues to be a qualified thrift lender (“QTL”). See “Federal Savings Institution Regulation - QTL Test.” The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, such as the Company, so long as the Bank continues to comply with the QTL test. The Company qualifies for the grandfather provision. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the QTL test and is deemed to be a savings institution, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act.

A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company without prior written approval of the FRB and from 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 FRB considers the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors.

Holding Company Capital Requirements. Under the Dodd-Frank Act, the FRB is authorized and directed to establish capital requirements for savings and loan holding companies. These capital requirements must be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Savings and loan holding companies will also be required to serve as a source of financial strength for their depository institution subsidiaries. Within five years after enactment, the Dodd-Frank Act requires the FRB to apply to savings and loan holding companies, consolidated capital requirements that are no less stringent than those applied to depository institutions as of May 19, 2009. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank or savings and loan holding company with less than $15 billion in assets, like the Company.

 

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The FRB has stated that it is considering applying the same consolidated risk-based and leverage capital requirements to savings and loan holding companies as those applied to bank holding companies under Basel III, to the extent reasonable and feasible taking into consideration the unique characteristics of savings and loan holding companies and requirements of the Home Owners Loan Act. The FRB expects these rules to be finalized in 2012 and for implementation to begin in 2013.

Acquisition of the Company. Under the Federal Change in Bank Control Act (“CBCA”) and applicable regulations, a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company’s outstanding voting stock, unless the FRB has found that the acquisition will not result in a change of control of the Company. Under CBCA, the FRB has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

Federal Savings Institution Regulation

Business Activities. The activities of Federal savings institutions are governed by Federal law and regulations. These laws and regulations delineate the nature and extent of the activities in which Federal savings banks may engage. In particular, many types of lending authority for Federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, are limited to a specified percentage of the institution’s capital or assets.

Capital Requirements. Capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the regulatory examination rating system and which are not experiencing significant growth) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish minimum capital standards. The regulations also require that, in meeting the tangible, leverage 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 core and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance-sheet activities, are multiplied by a risk-weight factor of 0% to 100%, assigned by the regulations based on the risks believed inherent in the type of asset. 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 components of supplementary capital currently include certain capital instruments that do not qualify as core capital, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available for sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OCC has authority to establish individual minimum capital requirements in cases where it is determined that a particular institution’s capital level is or may become, inadequate in light of the circumstances involved.

The following table presents the Bank’s capital position at December 31, 2011. The Bank met each of its capital requirements at that date.

 

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                        Capital  
     Actual
Capital
     Required
Capital
   Excess
Amount
     Actual
Percent
    Required
Percent
 
     (Dollars in thousands)               

Tangible

   $ 217,022       $34,593    $ 182,429         9.41     1.50

Core (Leverage)

     217,022       92,247      124,775         9.41        4.00   

Risk-based

     230,825       112,595      118,230         16.40        8.00   

Prompt Corrective Regulatory Action. Under federal law, each federal banking agency has implemented a system of prompt corrective action for institutions that it regulates. Under OCC regulations, an institution shall be deemed to be: (i) well-capitalized if it has total risk-based capital of 10.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a Tier 1 leverage capital ratio of 5.0% or more and if it is not subject to any written agreement, order or capital directive to meet and maintain a specific capital level for any capital measure; (ii) adequately capitalized if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more, a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and if it does not meet the definition of well-capitalized; (iii) undercapitalized if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% in certain circumstances); (iv) significantly undercapitalized if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less than 3.0%; and (v) critically undercapitalized if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. For purposes of these regulations, “core capital”, discussed above, constitutes Tier 1 capital. Federal law authorizes the OCC to reclassify a well-capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category. (The OCC may not reclassify a significantly undercapitalized institution as critically undercapitalized.)

Insurance of Deposit Accounts. Deposit accounts at the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC. The Bank’s deposits, therefore, are subject to FDIC deposit insurance assessments and the FDIC has adopted a risk-based system for determining deposit insurance assessments.

Federal law requires that the designated reserve ratio for the DIF be established by the FDIC at 1.15% to 1.50% of estimated insured deposits. If this reserve ratio drops below 1.15% or the FDIC expects that it will do so within six months, the FDIC must, within 90 days, establish and implement a plan to restore the designated reserve ratio to 1.15% of estimated insured deposits within five years (absent extraordinary circumstances).

Recent bank failures coupled with deteriorating economic conditions have significantly reduced the DIF’s reserve ratio. As a result of this reduced reserve ratio, on October 16, 2008, the FDIC published a proposed rule that would restore the reserve ratio to its required level of 1.15 percent within five years. On February 27, 2009, the FDIC took action to extend the restoration plan horizon to seven years.

The amended restoration plan was accompanied by a final rule that set assessment rates and made adjustments that improved how the assessment system differentiates for risk. At the time, most banks were in the best risk category and paid anywhere from 12 to 14 cents per $100 of deposits for insurance. Under the final rule, banks in this category paid initial base rates ranging from 12 to 16 cents per $100 on an annual basis, beginning on April 1, 2009.

In 2009 the FDIC announced increased assessments and charged a 10 basis point emergency special assessment, which was collected on September 30, 2009. The Company recorded an expense of $869,000 for the year ended December 31, 2009 to reflect the special assessment. The interim rule would also permit the FDIC to impose an emergency special assessment after June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance. These actions significantly increased the Company’s non-interest expense in 2009.

In addition, in 2009 the FDIC required insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The prepayment of assessments would ensure that the deposit insurance system remains directly funded by depository institutions and preserves the FDIC’s ability to borrow from the Treasury

 

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for emergency situations. The prepayment of $7.4 million was collected on December 30, 2009 and was recorded as a prepaid expense on the Company’s statement of financial condition. The prepaid expense is periodically amortized into operating expense through 2012.

On February 7, 2011 the FDIC Board approved a final rule that changes the assessment base from domestic deposits to average assets minus average tangible equity, adopts a new large-bank pricing assessment scheme, and sets a target size for the Deposit Insurance Fund. The changes were effective beginning with the second quarter of 2011. The rule finalizes a target size for the Deposit Insurance Fund at 2% of insured deposits. It also implements a lower assessment rate schedule when the fund reaches 1.15% (so that the average rate over time should be about 8.5 basis points) and, in lieu of dividends, provides for a lower rate schedule when the reserve ratio reaches 2% and 2.5%. The rule lowers overall assessment rates in order to generate the same approximate amount of revenue under the new larger base as was raised under the old base. The assessment rates in total would be between 2.5 and 9 basis points on the broader base for banks in the lowest risk category, and 30 to 45 basis points for banks in the highest risk category.

Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. In addition, all non-interest-bearing deposit accounts will receive unlimited insurance until December 31, 2012.

The FDIC may terminate the insurance of an institution’s deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

Under the Deposit Insurance Funds Act of 1996 (“Funds Act”), the assessment base for the payments on bonds issued in the late 1980’s by the Financing Corporation (“FICO”) to recapitalize the now defunct Federal Savings and Loan Insurance Corporation was expanded to include, beginning January 1, 1997, the deposits of certain insured institutions, including the Bank. The bonds issued by FICO are due to mature in 2017 through 2019. The FICO payments are in addition to the deposit insurance assessment.

The total expense incurred in 2011 and 2010 for the deposit insurance assessment and the FICO payments was $2.1 million and $2.3 million, respectively.

Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Subject to certain exceptions, a savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. At December 31, 2011, the Bank’s limit on loans to one borrower was $32.6 million. At December 31, 2011, the Bank’s maximum loan exposure to a single borrower was $18.1 million.

Qualified Thrift Lender Test. The Home Owners Loan Act requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least nine months out of each 12 month period. Additionally, education loans, credit card loans and small business loans may be considered “qualified thrift investments.” Any institution which fails to meet the qualified thrift lender test will be subject to certain limitations on its activity.

A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 2011, the Bank met the qualified thrift lender test.

Limitation on Capital Distributions. Applicable regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the approval of the OCC, is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under the regulations (i.e., generally, examination ratings in the two top 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

 

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agreement with the OCC. If an application is not required, the institution must still provide prior notice to the FRB of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank’s capital fell below its regulatory requirements or the FRB or OCC 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 FRB or OCC could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the FRB or OCC determine that such distribution would constitute an unsafe or unsound practice. If the FRB or OCC objects to the Bank’s notice to pay a dividend to the Company, the Company may not have the liquidity necessary to pay a dividend in the future, pay a dividend at the same rate as historically paid, be able to repurchase stock, or to meet current debt obligations. In addition, capital requirements made applicable to the Company as a result of the Dodd-Frank Act may limit the Company’s ability to pay dividends or repurchase stock in the future.

Assessments. Savings institutions are required to pay assessments to fund regulatory operations. The assessments, paid on a semi-annual basis, are based upon the institution’s total assets, including consolidated subsidiaries as reported in the Bank’s latest quarterly regulatory report, as well as the institution’s regulatory rating and complexity component. The assessments paid by the Bank for the fiscal year ended December 31, 2011 totaled $466,000.

Transactions with Related Parties. The Bank’s authority to engage in transactions with “affiliates” (e.g., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by Federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% 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 Federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.

Federal Home Loan Bank System

The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional FHLBs. Each FHLB provides member institutions with a central credit facility. The Bank, as a member of the FHLB-NY is required to acquire and hold shares of capital stock in that FHLB in an amount at least equal to 0.20% of mortgage related assets and 4.5% of the specified value of certain transactions with the FHLB. The Bank was in compliance with this requirement with an investment in FHLB-NY stock at December 31, 2011 of $18.2 million.

The FHLBs are required to provide funds for the previous 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 FHLB imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, the Bank’s net interest income would likely also be reduced.

Federal Reserve System

The Federal Reserve Board regulations require depository institutions to maintain reserves against their transaction accounts (primarily interest-bearing checking and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $58.8 million; a 10% reserve ratio is applied above $58.8 million. The first $10.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempt from the reserve requirements. The amounts are adjusted annually. The Bank complies with the foregoing requirements. For 2012, the Federal Reserve Board has set the 3% reserve limit at $11.5 million and the exemption of $71.0 million.

 

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FEDERAL AND STATE 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 with some exceptions, including particularly the Bank’s reserve for bad debts discussed below. 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 Bank has not been audited by the IRS in over 10 years. For its 2011 taxable year, the Bank is subject to a maximum Federal income tax rate of 35%.

Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”) imposes a tax on alternative minimum taxable income (“AMTI”) at a rate of 20%. The excess of the bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating loss carryovers of which the Bank currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Bank’s adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). The Bank does not expect to be subject to the AMTI.

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 or the Bank own more than 20% of the stock of a corporation distributing a dividend then 80% of any dividends received may be deducted.

State and Local Taxation

New Jersey Taxation. The Bank files New Jersey income tax returns. For New Jersey income tax purposes, the Bank is subject to a tax rate of 9% of taxable income. For this purpose, “taxable income” generally means Federal taxable income, subject to certain adjustments (including addition of interest income on State and municipal obligations).

The Company is required to file a New Jersey income tax return because it does business in New Jersey. For New Jersey tax purposes, regular corporations are presently taxed at a rate equal to 9% of taxable income. However, if the Company meets certain requirements, it may be eligible to elect to be taxed as a New Jersey Investment Company at a tax rate presently equal to 3.60% (40% of 9%) of taxable income.

OceanFirst REIT Holdings, Inc. files a New Jersey income tax return which includes income earned by OceanFirst REIT Holdings, Inc. and by OceanFirst Realty Corp. OceanFirst REIT Holdings, Inc. qualifies as a New Jersey Investment Company and is taxed at a rate presently equal to 3.60% of taxable income.

New York Taxation. The Bank, through Columbia, is subject to New York State income tax. The tax is measured by “entire net income” which is Federal taxable income with adjustments.

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.

 

Item 1A. Risk Factors

The nationwide recession and difficult market conditions have adversely affected the industry. The Bank is exposed to general economic conditions and downturns in the U.S. housing market. Dramatic declines in the national housing market in recent years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional and community financial institutions such as the Company. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of

 

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commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The continuing economic pressure on consumers and lack of confidence in the financial markets may adversely affect the Company’s business, financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the Company and others in the financial institutions industry. In particular, the Company may face the following risks in connection with these events:

 

   

The Company’s stock price could be negatively impacted by these events and could remain under pressure until a market recovery is under way.

 

   

Increased regulation of the industry. Compliance with such regulation may increase costs and limit the Company’s ability to pursue business opportunities.

 

   

The process used to estimate losses inherent in the Company’s credit exposure requires subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of borrowers to repay their loans. A continued deterioration in economic conditions may adversely affect future earnings.

 

   

Increased levels of nonperforming loans and loan losses may negatively impact earnings.

 

   

The Company may be required to pay significantly higher FDIC deposit insurance premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

 

   

A further deterioration in consumer confidence in financial institutions which could lead to declines in deposit totals and impact liquidity.

A continuation or worsening of current financial market or economic conditions could materially and adversely affect the Company’s business, financial condition, results of operations, access to credit or the trading price of the Company’s common stock.

A continued downturn in the local economy or in local real estate values could hurt profits. Most of the Bank’s loans are secured by real estate or are made to businesses in Ocean and Monmouth Counties, New Jersey and the surrounding area. As a result of this concentration, a downturn in the local economy could cause significant increases in nonperforming loans, which could hurt profits. Prior to 2007 there was a significant increase in real estate values in the Bank’s market area. Since that time, there has been a weakening in the local economy with rising unemployment coupled with declining real estate values and increases in non-performing mortgage loans, particularly residential loans. Based upon sales data for 2011 from the Ocean and Monmouth Counties Multiple Listing Service, home values in the Company’s primary market area have declined by approximately 19% from the peak of the market in 2006. A further decline in real estate values could cause additional residential and commercial mortgage loans to become inadequately collateralized, which could expose the Bank to a greater risk of loss.

Changes in interest rates or a prolonged period of low interest rates could adversely affect results of operations and financial condition. The Bank’s ability to make a profit largely depends on net interest income, which could be negatively affected by changes in interest rates. The interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities are generally fixed for a contractual period of time. Interest-bearing liabilities generally have shorter contractual maturities than interest-earning assets. This imbalance can create significant earnings volatility, because market interest rates change over time. In a period of rising interest rates, the interest income earned on interest-earning assets may not increase as rapidly as the interest paid on interest-bearing liabilities.

In addition, changes in interest rates can affect the average life of loans and mortgage-backed securities. A reduction in interest rates causes increased prepayments of loans and mortgage-backed securities as borrowers refinance their debt to reduce their borrowing costs. This creates reinvestment risk, which is the risk that the Bank may not be able to reinvest the funds from faster prepayments at rates that are comparable to the rates earned on the prepaid loans or securities. Conversely, an increase in interest rates generally reduces prepayments. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable-rate loans.

Changes in interest rates also affect the current market value of the interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. Unrealized net losses on securities available for sale are reported as a separate component of equity. To the extent interest rates increase and the value of the available for sale portfolio decreases, stockholders’ equity will be adversely affected.

 

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In January 2012 the Federal Reserve Open Market Committee announced their expectation to maintain short-term interest rates at low levels through mid 2014. The continuation of the current low interest rate environment will likely adversely affect the Company’s net interest margin and net interest income for 2012.

The Company and the Bank operate in a highly regulated environment and may be adversely affected by changes in laws and regulations. The Company is subject to examination and regulation by the FRB. The Bank is subject to extensive regulation, supervision and examination by the OCC, its primary federal regulator, and by the FDIC, as insurer of deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of assets and determination of the level of the allowance for loan losses. The purpose of the laws and regulations that govern the Company and the Bank’s operations are designed for the protection of depositors and the public, but not the Company’s stockholders.

In July of 2010, the Dodd-Frank Act was enacted. The Dodd-Frank Act is a broad legislative initiative that will significantly change the current bank regulatory structure and affect the operating activities of financial institutions and their holding companies. Under the Dodd-Frank Act the OTS, which had been the primary federal regulator for the Company and the Bank, ceased to exist in July of 2011. At that time the OCC, which is the primary federal regulator for national banks, became the primary federal regulator for federal thrifts such as the Bank. The FRB now supervises and regulates all savings and loan holding companies that were formerly regulated by the OTS, including the Company. In addition, the Dodd-Frank Act creates the CFPB with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Dodd-Frank Act also directed the FRB to issue rules to limit debit-card interchange fees, (the fees that issuing banks charge merchants each time a consumer uses a debit card) collected by banks with assets of $10 billion or more. On June 29, 2011, the FRB issued a final rule which would cap an issuer’s debit-card interchange base fee at twenty-one cents ($0.21) per transaction and allow an additional 5 basis point charge per transaction to cover fraud losses. The FRB also issued an interim final rule that allows a fraud-prevention adjustment of one cent ($0.01) per transaction conditioned upon an issuer adopting effective fraud prevention policies and procedures. The Bank’s average interchange fee per transaction is forty cents ($0.40). The Dodd-Frank Act exempts from the FRB’s rule banks with assets less than $10 billion, such as the Bank. Although exempt from this rule, market forces may result in reduced fees charged by all issuers, regardless of asset size, which may result in reduced revenues for the Bank. For the year ended December 31, 2011, the Bank’s revenues from interchange fees were $2.0 million, as compared to $1.8 million in 2010. The rules were effective October 1, 2011. Also, effective July 21, 2011 is a provision of the Dodd-Frank Act that eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. It is difficult to predict at this time what specific impact the Dodd-Frank Act, the yet to be adopted implementing rules and regulations, the change in the Company’s and the Bank’s regulators, or any other changes or law or regulation, will have on the Company and the Bank. However, it is expected that at a minimum they will increase the Company’s operating and compliance costs and could also increase interest expense and decrease revenue.

The recently publicized foreclosure issues affecting the nation’s largest mortgage loan servicers could impact the Bank’s foreclosure process. Several of the nation’s largest mortgage loan servicers have experienced highly publicized issues with respect to their foreclosure processes. As a result, some of these servicers have experienced moratoriums on their foreclosures and have been the subject of state attorney general scrutiny and consumer lawsuits, although the largest mortgage loan servicers have recently reached a settlement with the states. In light of these issues, the Bank has reviewed its foreclosure policies and procedures and has not found it necessary to interrupt any foreclosures. Over the past few years, foreclosure timelines have increased significantly due to, among other reasons, delays associated with the significant increase in the number of foreclosure cases. These delays were the result of the economic crisis, additional consumer protection initiatives related to the foreclosure process, increased documentary requirements and judicial scrutiny, and, both voluntary and mandatory programs under which lenders may consider loan modifications or other alternatives to foreclosure. These issues and the potential legal and regulatory responses could impact the foreclosure process and timing to completion of foreclosures for residential mortgage lenders, including the Bank, which might result in a material adverse effect on collateral values and the Bank’s ability to minimize its losses.

 

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Continued capital and credit market volatility may adversely affect the Company’s ability to access capital and may have a material adverse effect on the Company’s business, financial condition and results of operations. The capital and credit markets have been experiencing volatility and disruption in recent years. The markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the Company will not experience an adverse effect on its ability to access capital, which might result in a material adverse effect upon the Company’s business, financial condition or results of operations.

Changes in the fair value of securities may reduce stockholder’s equity and net income. At December 31, 2011, the Company maintained a securities portfolio of $530.2 million all of which was classified as available for sale. The estimated fair value of the available for sale securities portfolio may increase or decrease depending on the credit quality of the underlying issuer, market liquidity, changes in interest rates and other factors. Stockholder’s equity is increased or decreased by the amount of the change in the unrealized gain or loss (difference between the estimated fair value and the amortized cost) of the available for sale securities portfolio, net of the related tax expense or benefit, under the category of accumulated other comprehensive income/loss. Therefore, a decline in the estimated fair value of this portfolio will result in a decline in reported stockholder’s equity, as well as book value per common share. The decrease will occur even though the securities are not sold.

The Company conducts a periodic review and evaluation of the securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. Factors which are considered in the analysis include, but are not limited to, the severity and duration of the decline in fair value of the security, the financial condition and near-term prospects of the issuer, whether the decline appears to be related to issuer conditions or general market or industry conditions, the intent and ability to retain the security for a period of time sufficient to allow for any anticipated recovery in fair value and the likelihood of any near-term fair value recovery. If such decline is deemed to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of non-interest income.

At December 31, 2011, the securities available for sale portfolio included corporate debt securities issued by national and regional banks. The portfolio consisted of eleven $5.0 million issues spread among eight issuers. At December 31, 2011, the securities had a book value of $55.0 million and an estimated fair value of $39.4 million. The Company may be required to recognize an other-than-temporary impairment charge related to these securities if circumstances change.

Increased emphasis on commercial lending, or the Bank’s offering of alternative credit products, may expose the Bank to increased lending risks. At December 31, 2011, $506.6 million, or 31.9%, of the Bank’s total loans consisted of commercial real estate, multi-family and land loans, and commercial business loans. This portfolio has grown in recent years and the Bank intends to continue to emphasize these types of lending. These types of loans generally expose a lender to greater risk of non-payment and loss than one-to-four family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Also, many of the Bank’s commercial borrowers have more than one loan outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Bank to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. In addition, even within its residential loan portfolio, the Bank offers several alternative credit products, including one-to-four family loans with interest-only payment requirements for the first five, seven or ten years of the mortgage loan term. As a result, borrowers will face substantial increases in loan payment amounts as these loans begin to amortize. These loans expose the Bank to greater risk than traditional, fully amortizing one-to-four family residential mortgage loans.

The Company’s allowance for loan losses may be inadequate, which could hurt the Company’s earnings. The Company’s allowance for loan losses may prove to be inadequate to cover actual loan losses and if the Company is required to increase its allowance, current earnings may be reduced. When borrowers default and do not repay the loans that the Bank makes to them, the Company may lose money. The Company’s experience shows that some borrowers either will not pay on time or will not pay at all, which will require the Company to cancel or “charge-off” the defaulted loan or loans. The Company provides for losses by reserving what it believes to be an adequate amount to absorb any probable incurred losses. A “charge-off” reduces the Company’s reserve for possible loan losses. If the Company’s reserves were insufficient, it would be required to record a larger reserve, which would reduce earnings for that period.

The Bank or Columbia may be required to repurchase mortgage loans for a breach of representations and warranties, which could harm the Company’s earnings. The Bank and Columbia each entered into loan sale agreements with investors in the normal course of business. The loan sale agreements generally required the repurchase of certain loans previously sold in the

 

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event of a violation of various representations and warranties customary to the mortgage banking industry. Repurchase demands accelerated industry-wide in recent years. Additionally, FNMA, FHLMC and investors carefully examine loan documentation with the goal of increasing the amount of repurchases by the loan originator. The repurchased mortgage loans could typically only be resold at a significant discount to the unpaid principal balance. The Company maintains a reserve for repurchased loans, however, if repurchase activity is significant, the reserve may need to be increased to cover actual losses which could harm future earnings.

The Company’s mortgage servicing rights may become impaired which could hurt profits. Mortgage servicing rights are carried at the lower of cost or fair value. Any impairment is recognized as a reduction to servicing fee income. In the event that loan prepayments continue to increase due to increased loan refinancing, the fair value of mortgage servicing rights would likely decline.

The Company’s inability to achieve profitability on new branches may negatively affect earnings. The Bank has expanded its presence within the market area through de novo branching and continually evaluates opportunities for new branches. The profitability of this expansion strategy will depend on whether the income from the new branches will offset the increased expenses resulting from operating these branches. It is expected to take a period of time before these branches or any branches to open can become profitable. During this period, the expense of operating these branches may negatively affect net income.

Competition from other banks and financial institutions in originating loans, attracting deposits and providing various financial services may adversely affect profitability and liquidity. The Company has substantial competition in originating loans, both commercial and consumer, in its market area. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of these competitors enjoy advantages, including greater financial resources and access to capital, stronger regulatory ratios and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce the Company’s net income by decreasing the number and size of loans that the Bank originates and the interest rates charged on these loans.

In attracting business and consumer deposits, the Company faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of its competitors enjoy advantages, including greater financial resources and access to capital, stronger regulatory ratios, stronger asset quality and performance, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than the Company, which could decrease the deposits that the Company attracts or require the Company to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could materially adversely affect the Company’s ability to generate the funds necessary for lending operations. As a result, the Company may need to seek other sources of funds that may be more expensive to obtain which could increase the cost of funds.

The Company must continue to attract and retain qualified personnel and maintain cost controls and asset quality. The Company’s ability to manage growth successfully will depend on its ability to continue to attract and retain management experienced in banking and financial services and familiar with the communities in its market area. As the Company grows, the Company must be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about local market areas to implement the Company’s operating strategy. The unexpected loss of service of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could adversely affect the Company. If the Company grows too quickly and is not able to attract qualified personnel and maintain cost controls and asset quality, this continued growth could adversely affect the Company.

 

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The Bank’s ability to originate mortgage loans for portfolio has been adversely affected by the increased competition resulting from the unprecedented involvement of the U.S. government and GSEs in the residential mortgage market. Over the past few years, the Bank has faced increased competition for mortgage loans due to the unprecedented involvement of the GSEs in the mortgage market as a result of the recent economic crisis, which has caused the interest rate for thirty-year fixed-rate mortgage loans that conform to GSE guidelines to remain artificially low The Bank expects that one-to-four family mortgage loan prepayments will remain at elevated levels and will continue to outpace the production of loans to be held for portfolio. As a result of these factors, it may be difficult for the Bank to grow the residential mortgage loan portfolio, which could have a materially adverse impact on the Bank’s earnings.

On February 11, 2011, the Administration released its report on restructuring FNMA and FHLMC and on further reforming the mortgage and securitization markets. The report details the Administration’s intent to “wind down FNMA and FHLMC and shrink the government’s current footprint in housing finance.” Specifically, the proposal will increase GSE pricing, reduce conforming loan limits by allowing temporary higher limits to reset downward as of October 1, 2011, phase in a minimum 10% down payment requirement for borrowers, and shrink the GSE’s investment portfolio at a rate of not less than 10% per year. It is unsure at this time whether the Administration’s proposal, or any other proposed reform, affecting the GSEs will be enacted, and if so, the final form and impact on the Bank.

There is no guaranty that the Company will be able to continue to pay a dividend or, if continued, will be able to pay a dividend at the current rate. The Board of Directors of the Company determines at its discretion if, when and the amount of dividends that may be paid on the common stock. In making such determination, the Board of Directors takes into account various factors including economic conditions, earnings, liquidity needs, the financial condition of the Company, applicable state law, regulatory requirements and other factors deemed relevant by the Board of Directors. Although the Company has a history of paying a quarterly dividend on its common stock, there is no guaranty that such dividends will continue to be paid in the future, particularly in the event of changes in those factors which may affect the Board of Directors’ determination to pay a dividend.

 

Item 1B. Unresolved Staff Comments

None

 

Item 2. Properties

The Bank conducts its business through its administrative office, which includes a branch office, and 23 other full service offices located in Ocean, Monmouth and Middlesex Counties, and through a trust and wealth management office.

 

Item 3. Legal Proceedings

The Company and the Bank are not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such other routine legal proceedings in the aggregate are believed by management to be immaterial to the Company’s financial condition or results of operations.

 

Item 4. Mine Safety Disclosures

Not Applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information for Common Stock

OceanFirst Financial Corp.’s common stock is traded on the Nasdaq Stock Market under the symbol OCFC. The table below shows the reported high and low daily closing prices of the common stock during the periods indicated in 2011 and 2010.

2011

 

     First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 

High

   $ 14.02       $ 14.50       $ 13.84       $ 13.83   

Low

     12.68         12.41         11.07         11.42   

2010

 

     First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 

High

   $ 11.58       $ 13.39       $ 13.17       $ 13.35   

Low

     9.84         11.46         11.09         11.89   

As of December 31, 2011, the Company had approximately 2,700 shareholders, including the number of persons or entities holding stock in nominee or street name through various brokers and banks.

Stock Performance Graph

The following graph shows a comparison of total stockholder return on OceanFirst Financial Corp.’s common stock, based on the market price of the Company’s common stock with the cumulative total return of companies in the Nasdaq Composite Index and the SNL Thrift Index for the period December 31, 2006 through December 31, 2011. The graph may not be indicative of possible future performance of the Company’s common stock. Cumulative return assumes the reinvestment of dividends and is expressed in dollars based on an initial investment of $100.

 

LOGO

 

     12/31/06      12/31/07      12/31/08      12/31/09      12/31/10      12/31/11  

OceanFirst Financial Corp.

     100.00         72.23         79.58         57.87         68.68         72.22   

Nasdaq Composite Index

     100.00         110.66         66.42         96.54         114.06         113.16   

SNL Thrift Index

     100.00         59.99         38.18         35.60         37.20         31.30   

For the years ended December 31, 2011 and 2010, the Company paid an annual cash dividend of $.48 per share.

 

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On October 31, 2011, the Company announced its intention to repurchase up to 942,306 shares or 5% of its outstanding common stock. Information regarding the Company’s common stock repurchases for the three month period ended December 31, 2011 is as follows:

 

Period

   Total
Number  of

Shares
Purchased
     Average Price
Paid per  Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced  Plans or
Programs
     Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
 

October 1, 2011 through October 31, 2011

     —           —           —           942,306   

November 1, 2011 through November 30, 2011

     68,000         13.19         68,000         874,306   

December 1, 2011 through December 31, 2011

     97,154         12.86         97,154         777,152   

 

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Item 6. Selected Financial Data

The selected consolidated financial and other data of the Company set forth below is derived in part from, and should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere in this Annual Report.

 

     At December 31,  
     2011      2010      2009      2008      2007  
(dollars in thousands)                                   

Selected Financial Condition Data:

              

Total assets

   $ 2,302,094       $ 2,251,330       $ 2,030,028       $ 1,857,946       $ 1,927,499   

Investment securities available for sale

     165,279         91,918         37,267         34,364         57,625   

Federal Home Loan Bank of New York stock

     18,160         16,928         19,434         20,910         22,941   

Mortgage-backed securities available for sale

     364,931         341,175         213,622         40,801         54,137   

Loans receivable, net

     1,563,019         1,660,788         1,629,284         1,648,378         1,675,919   

Mortgage loans held for sale

     9,297         6,674         5,658         3,903         6,072   

Deposits

     1,706,083         1,663,968         1,364,199         1,274,132         1,283,790   

Federal Home Loan Bank advances

     266,000         265,000         333,000         359,900         393,000   

Securities sold under agreements to repurchase and other borrowings

     93,601         95,364         92,073         89,922         109,307   

Stockholders’ equity

     216,849         201,251         183,536         119,783         124,306   
     For the Year Ended December 31,  
     2011      2010      2009      2008      2007  
(dollars in thousands; except per share amounts)                                   

Selected Operating Data:

              

Interest income

   $ 95,387       $ 101,367       $ 95,861       $ 103,405       $ 114,964   

Interest expense

     18,060         24,253         30,398         45,382         62,040   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     77,327         77,114         65,463         58,023         52,924   

Provision for loan losses

     7,750         8,000         5,700         1,775         700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     69,577         69,114         59,763         56,248         52,224   

Other income

     15,301         15,312         15,589         12,823         2,531   

Operating expenses

     52,664         53,647         50,544         47,447         53,820   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before provision (benefit) for income taxes

     32,214         30,779         24,808         21,624         935   

Provision (benefit) for income taxes

     11,473         10,401         9,155         6,860         (140
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

     20,741         20,378         15,653         14,764         1,075   

Dividends on preferred stock and discount accretion

     —           —           3,170         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income available to common stockholders

   $ 20,741       $ 20,378       $ 12,483       $ 14,764       $ 1,075   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 1.14       $ 1.12       $ .98       $ 1.27       $ .09   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share

   $ 1.14       $ 1.12       $ .98       $ 1.26       $ .09   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     At or For the Year Ended December 31,  
     2011     2010     2009     2008     2007  

Selected Financial Ratios and Other Data (1):

          

Performance Ratios:

          

Return on average assets

     .91     .93     .82     .78     .05

Return on average stockholders’ equity

     9.88        10.62        9.35        11.98        .86   

Stockholders’ equity to total assets

     9.42        8.94        9.04        6.45        6.45   

Tangible equity to tangible assets

     9.42        8.94        9.04        6.45        6.45   

Average interest rate spread (2)

     3.48        3.56        3.42        3.00        2.50   

Net interest margin (3)

     3.59        3.69        3.63        3.24        2.79   

Average interest-earning assets to average interest-bearing liabilities

     113.15        111.99        112.36        109.47        108.96   

Operating expenses to average assets

     2.32        2.44        2.66        2.52        2.70   

Efficiency ratio (4)

     56.86        58.04        62.36        66.97        97.05   

Asset Quality Ratios:

          

Non-performing loans as a percent of total loans receivable (5)(6)(7)

     2.77        2.23        1.72        .97        .52   

Non-performing assets as a percent of total assets (6)(7)

     2.00        1.77        1.52        .92        .48   

Allowance for loan losses as a percent of total loans receivable (5)(7)

     1.15        1.17        .89        .70        .62   

Allowance for loan losses as a percent of total

non-performing loans (6)(7)

     41.42        52.48        51.99        72.71        119.76   

Per Share Data:

          

Cash dividends per common share

   $ .48      $ .48      $ .80      $ .80      $ .80   

Stockholders’ equity per common share at end of period

     11.61        10.69        9.75        9.69        10.07   

Tangible stockholders’ equity per common share at end of period

     11.61        10.69        9.75        9.69        10.07   

Number of full-service customer facilities:

     24        23        23        23        20   

 

(1) With the exception of end of year ratios, all ratios are based on average daily balances.
(2) The average interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(3) The net interest margin represents net interest income as a percentage of average interest-earning assets.
(4) Efficiency ratio represents the ratio of operating expenses to the aggregate of other income and net interest income.
(5) Total loans receivable includes loans receivable and loans held for sale.
(6) Non-performing assets consist of non-performing loans and real estate acquired through foreclosure. Non-performing loans consist of all loans 90 days or more past due and other loans in the process of foreclosure. It is the Company’s policy to cease accruing interest on all such loans.
(7) As discussed in the section “Allowance for Loan Losses”, during the fourth quarter of 2011, the Company modified its charge-off policy on problem loans secured by real estate. Without the additional charge-off of $5.7 million recorded in 2011, the Company would have reported the following as of December 31, 2011: non-performing loans as a percent of total loans receivable of 3.12%; non-performing assets as a percent of total assets of 2.24%; allowance for loan losses as a percent of total loans receivable of 1.50%; and allowance for loan losses as a percent of total non-performing loans of 48.12%.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

OceanFirst Financial Corp. has been the holding company for OceanFirst Bank since it acquired the stock of the Bank upon the Bank’s conversion from a Federally-chartered mutual savings bank to a Federally-chartered capital stock savings bank in 1996 (the “Conversion”).

The Company conducts business primarily through its ownership of the Bank which operates its administrative/branch office located in Toms River and twenty-three other branch offices. Nineteen of the offices are located in Ocean County, New Jersey, with four branches in Monmouth County and one in Middlesex County. The Bank also operates a trust and wealth management office in Manchester, New Jersey.

The Company’s results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on the Company’s interest-earning assets, such as loans and investments, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income such as income from loan sales, reverse mortgage loan originations, loan servicing, merchant check card services, deposit account services, the sale of alternative investments, trust and asset management services and other fees. The Company’s operating expenses primarily consist of compensation and employee benefits, occupancy and equipment, federal deposit insurance, data processing, marketing, and other general and administrative expenses. The Company’s results of operations are also significantly affected by competition, general economic conditions including levels of unemployment and real estate values as well as changes in market interest rates, government policies and actions of regulatory agencies.

Strategy

The Company operates as a consumer-oriented bank, with a strong focus on its local community. The Bank is the oldest and largest community-based financial institution headquartered in Ocean County, New Jersey. The Bank competes with larger and out-of-market financial service providers through its local focus and the delivery of superior service. The Bank also competes with smaller in-market financial service providers by offering a broad array of products.

The Company’s strategy has been to consistently grow profitability while limiting credit and interest rate risk exposure. To accomplish these objectives, the Bank has sought to (1) grow commercial loans receivable through the offering of commercial lending services to local businesses; (2) grow core deposits (defined as all deposits other than time deposits) through product offerings appealing to a broadened customer base and de novo branch expansion; and (3) increase non-interest income by expanding the menu of fee-based products and services.

With industry consolidation eliminating most locally-headquartered competitors, concurrent with the conversion, the Company perceived an opportunity to fill a void for locally-delivered commercial loan and deposit services. As such, the Bank assembled an experienced team of business banking professionals responsible for offering commercial loan and deposit services and merchant check card services to local businesses. As a result of this initiative, commercial loans represented 31.9% of the Bank’s total loans at December 31, 2011 as compared to 19.9% at December 31, 2006 and only 3.6% at December 31, 1997. Despite the Bank’s focus, commercial loan balances declined by $5.2 million, or 1.0%, in 2011, due to tepid loan demand in the weak economy and prepayments of certain loan relationships. Commercial loan products entail a higher degree of credit risk than is involved in one-to-four family residential mortgage lending activity. As a consequence, management continues to employ a well-defined credit policy focusing on quality underwriting and close management and Board monitoring.

The Bank seeks to increase core deposit market share in its primary market area by expanding the branch network and improving market penetration. Over the past sixteen years through December 31, 2011, the Bank has opened sixteen branch offices, twelve in Ocean County and four in Monmouth County. The Bank is continually evaluating additional office sites within its existing market area. The Bank opened its twenty-fourth branch office in late 2011. The branch is located within a senior housing development, Harrogate, in Lakewood, New Jersey and maintains limited hours for residents and employees of the retirement community. The Bank currently plans to open an additional branch office in Jackson, New Jersey in late 2012 or early 2013.

Core account development has benefited from Bank efforts to attract business deposits in conjunction with its commercial

 

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lending operations and from an expanded mix of retail core account products. Additionally, marketing and incentive plans have focused on core account growth. As a result of these efforts the Bank’s core deposit ratio has grown to 84.2% at December 31, 2011 as compared to 60.5% at December 31, 2006 and only 33.0% at December 31, 1997. Core deposits are generally considered a less expensive and more stable funding source than certificates of deposit.

Management continues to diversify the Bank’s product line in order to enhance non-interest income. The Bank offers alternative investment products (annuities, mutual funds and life insurance) for sale through its retail branch network. The products are non-proprietary, sold through a third party vendor, and provide the Bank with fee income opportunities. In early 2005, the alternative investment program was expanded to add Licensed Bank Employees which allows the Bank to capture more of the revenue associated with the sale of investment products. The Bank offers trust and asset management services and has also expanded the non-interest income received from business relationships by offering fee based products, including merchant services. As a result of these initiatives, income from fees and service charges has increased to $11.4 million for the year ended December 31, 2011 as compared to $10.5 million for the year ended December 31, 2006 and only $1.4 million for the year ended December 31, 1997. The Bank also offers reverse mortgage loans which are sold into the secondary market. The gain on sale from selling reverse mortgages is included in the net gain on sales of loans available for sale.

In addition to the objectives described above, in 2011 the Company determined to more actively manage its capital position to improve return on equity. In the fourth quarter of 2011, the Company announced its intention to repurchase up to 942,306 shares, or 5%, of its outstanding common stock. Through December 31, 2011, the Company had repurchased 165,154 shares of common stock for $2.1 million.

Summary

Interest-earning assets, both loans and securities, are generally priced against longer-term indices, while interest-bearing liabilities, primarily deposits and borrowings, are generally priced against shorter-term indices. In 2011, the Company’s net interest margin has contracted as compared to prior year periods. Due to the low interest rate environment, high loan refinance volume has caused yields on loans and mortgage-backed securities to trend downward. At the same time, the Company’s asset mix has shifted as higher-yielding loans have decreased due to weak demand, prepayments and the sale of newly originated 30-year fixed-rate one-to-four family loans, while lower-yielding interest-earning deposits and securities have increased. Management expects the low interest rate environment to continue beyond 2012, resulting in further pressure on the net interest margin. In addition to the interest rate environment, the Company is dependent upon national and local economic conditions. The overall economy remains weak with continued high unemployment coupled with concern surrounding the housing market. These conditions have had an adverse impact on the Company’s results of operations.

Highlights of the Company’s financial results for the year ended December 31, 2011 were as follows:

Total assets increased to $2.302 billion at December 31, 2011, from $2.251 billion at December 31, 2010. Loans receivable, net decreased $97.8 million, or 5.9%, at December 31, 2011, as compared to December 31, 2010 primarily due to weak demand, prepayments resulting from the low interest rate environment and the sale of newly originated 30-year fixed-rate one-to-four family loans. Investment securities available for sale increased by $73.4 million, or 79.8%, to $165.3 million at December 31, 2011, from $91.9 million at December 31, 2010.

Deposits increased by $42.1 million, or 2.5%, at December 31, 2011, as compared to December 31, 2010. An increase of $58.3 million in core deposits (i.e. all deposits excluding time deposits) was partly offset by a decline in time deposits, which decreased $16.2 million. At December 31, 2011, core deposits, a key focus for the Company, represented 84.2% of total deposits.

For the year ended December 31, 2011, net income increased to $20.7 million, or $1.14 per diluted share, as compared to net income of $20.4 million, or $1.12 per diluted share for the prior year. For the year ended December 31, 2010, diluted earnings per share included $922,000, or $.05 per share, relating to the reduction in the state tax valuation allowance.

Net interest income for the year ended December 31, 2011 increased to $77.3 million, as compared to $77.1 million in the prior year, reflecting greater average interest-earning assets partly offset by a decrease in the net interest margin to 3.59% for the year ended December 31, 2011 as compared to 3.69% in the prior year.

The provision for loan losses decreased to $7.8 million for the year ended December 31, 2011 as compared to $8.0 million for the prior year. The Company’s non-performing loans totaled $44.0 million at December 31, 2011, an increase from $37.5 million at December 31, 2010 primarily due to the second quarter addition of one large commercial real estate relationship and an increase in non-performing one-to-four family loans.

 

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The Company remains well-capitalized with a tangible common equity ratio of 9.42%. Return on average stockholders’ equity was 9.88%, for the year ended December 31, 2011, as compared to 10.62%, for the prior year as the Company continued to build equity.

Critical Accounting Policies

Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2011 contains a summary of significant accounting policies. Various elements of these accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Certain assets are carried in the consolidated statements of financial condition at fair value or the lower of cost or fair value. Policies with respect to the methodologies used to determine the allowance for loan losses, the reserve for repurchased loans, the valuation of Mortgage Servicing Rights and judgments regarding securities impairment are the most critical accounting policies because they are important to the presentation of the Company’s financial condition and results of operations, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions and estimates could result in material differences in the results of operations or financial condition. These critical accounting policies and their application are reviewed periodically and, at least annually, with the Audit Committee of the Board of Directors.

Allowance for Loan Losses

The allowance for loan losses is a valuation account that reflects probable incurred losses in the loan portfolio based on management’s evaluation of the risks inherent in the Bank’s loan portfolio and the general economy. The Bank maintains the allowance for loan losses through provisions for loan losses that are charged to income. Charge-offs against the allowance for loan losses are taken on loans where management determines that the collection of loan principal is unlikely. Recoveries made on loans that have been charged-off are credited to the allowance for loan losses when payment is received. The allowance for loan losses is maintained at an amount management considers sufficient to provide for probable losses based on evaluating known and inherent risks in the loan portfolio resulting from management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and the determination of the existence and realizable value of the collateral and guarantees securing the loan. The Company modified its charge-off policy in 2011 as discussed below.

The Bank’s allowance for loan losses includes specific allowances and a general allowance, each updated on a quarterly basis. A specific allowance is determined for all loans which meet the definition of an impaired loan where the value of the underlying collateral can reasonably be evaluated and where the Company has not already taken an interim charge-off. These are generally loans which are secured by real estate. The Bank obtains an updated appraisal for all impaired loans secured by real estate and collateral dependent residential mortgage loans greater than 90 days delinquent. The specific allowance, or general reserve allocation for collateral dependent residential mortgage loans, represents the difference between the Bank’s recorded investment in the loan, net of any interim charge-offs, and the fair value of the collateral, less estimated disposal costs. A general allowance is determined for all other classified and non-classified loans. In determining the level of the general allowance, the Bank segments the loan portfolio into various loan segments and classes. The loan portfolio is further segmented by delinquency status and risk rating. An estimated loss factor is then applied to each risk tranche. If a loan secured by real estate becomes 90 days delinquent, the Bank obtains an updated appraisal which is subsequently updated annually as foreclosure timelines have recently increased significantly. For these loans, the estimated loss represents the difference between the Bank’s recorded investment in the loan and the fair value of the collateral, less estimated selling costs. For loans 90 days delinquent not secured by real estate, the Bank evaluates the fair value of the collateral and personal guarantees, if any, and identifies an estimated loss for the difference between the Bank’s recorded investment in the loan and the fair value of the collateral, less estimated selling costs. For loans which are not 90 days delinquent a historical loss rate is determined for each loan segment. To determine the loss rate, the Bank utilizes a rolling four quarter average of loan losses as a percent of loan principal adjusted for the estimated probability of default. The historical loss rate is adjusted for certain environmental factors including current economic conditions, regulatory environment, local competition, lending personnel, loan policies and underwriting standards, loan review system, delinquency trends, loss trends, nature and volume of the loan portfolio and concentrations of credit.

 

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During the fourth quarter of 2011, the Company modified its charge-off policy on problem loans secured by real estate. Historically, the Company established specific valuation reserves for estimated losses for problem real estate related loans when the loans were deemed uncollectible. The specific valuation reserves were based upon the estimated fair value of the underlying collateral, less costs to sell. The actual loan charge-off was not recorded until the foreclosure process was complete. Under the modified policy, losses on loans secured by real estate are charged-off in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 120 days delinquent and a recent appraisal is received which reflects a collateral shortfall. The modification to the charge-off policy resulted in additional charge-offs in the fourth quarter of 2011 of $5.7 million. All of these charge-offs were timely identified in previous periods in the Company’s allowance for loan losses process as a specific valuation reserve and were included in the Company’s loss experience as part of the evaluation of the allowance for loan losses. Accordingly, the additional charge-offs did not affect the Company’s provision for loan losses or net income for 2011. Without the additional charge-offs of $5.7 million recorded in the fourth quarter of 2011, the Company would have reported the following as of and for the year ended December 31, 2011: total charge-offs of $3.6 million; allowance for loan losses of $23.9 million; total non-performing loans of $49.7 million; allowance for loan losses as percent of total loans receivable of 1.50%; allowance for loan losses as percent of total non-performing loans of 48.12%; non-performing loans as a percent of total loans receivable of 3.12%; and non-performing assets as a percent of total assets of 2.24%.

An overwhelming percentage of the Bank’s loan portfolio, 97.1%, is secured by real estate whether one-to-four family, consumer or commercial. Additionally, most of the Bank’s borrowers are located in Ocean and Monmouth Counties, New Jersey and the surrounding area. These concentrations may adversely affect the Bank’s loan loss experience should real estate values decline further or should the markets served continue to experience difficult economic conditions including increased unemployment.

Management believes the primary risk characteristics for each portfolio segment are a continued decline in the economy generally, including sustained unemployment, a decline in real estate market values and possible increases in interest rates. Any one or a combination of these events may adversely affect the borrowers’ ability to repay the loans, resulting in increased delinquencies, loan losses and future levels of provisions. Accordingly, the Bank has provided for loan losses at the current level to address the current risk in the loan portfolio.

Although management believes that the Bank has established and maintained the allowance for loan losses at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. In addition, various regulatory agencies, as part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to make additional provisions for loan losses based upon information available to them at the time of their examination. Although management uses what it believes to be the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond the Bank’s control.

Reserve for Repurchased Loans

The reserve for repurchased loans relates to potential losses on loans sold which may have to be repurchased due to an early payment default, or a violation of representations and warranties. Provisions for losses are charged to gain on sale of loans and credited to the reserve, which is part of other liabilities, while actual losses are charged to the reserve. In order to estimate an appropriate reserve for repurchased loans, the Bank considers recent and historical experience, product type and volume of recent whole loan sales and the general economic environment. Management believes that the Bank has established and maintained the reserve for repurchased loans at adequate levels, however, future adjustments to the reserve may be necessary due to economic, operating or other conditions beyond the Bank’s control.

 

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Valuation of Mortgage Servicing Rights (“MSR”)

The estimated origination and servicing costs of mortgage loans sold in which servicing rights are retained is allocated between the loans and the servicing rights based on their estimated fair values at the time of the loan sale. Servicing assets are carried at the lower of cost or fair value and are amortized in proportion to, and over the period of, net servicing income. The estimated fair value of MSR is determined through a discounted analysis of future cash flows, incorporating numerous assumptions including servicing income, servicing costs, market discount rates, prepayment speeds and default rates. Impairment of the MSR is assessed on the fair value of those rights with any impairment recognized as a component of loan servicing fee income.

The fair value of MSR is sensitive to changes in assumptions. Fluctuations in prepayment speed assumptions have the most significant impact on the fair value of MSR. In the event that loan prepayments continue to increase due to increased loan refinancing, the fair value of MSR would likely decline. In the event that loan prepayment activities decrease due to a decline in loan refinancing, the fair value of MSR would likely increase. Additionally, due to the economic downturn, default rates and servicing costs may increase in future periods which would result in a decline in the fair value of MSR. Any measurement of MSR is limited by the existing conditions and assumptions utilized at a particular point in time, and would not necessarily be appropriate if applied at a different point in time.

Impairment of Securities

On a quarterly basis the Company evaluates whether any securities are other-than-temporarily impaired. In making this determination, the Company considers the extent and duration of the impairment, the nature and financial health of the issuer, the ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value and other factors relevant to specific securities, such as the credit risk of the issuer and whether a guarantee or insurance applies to the security. If a security is determined to be other-than-temporarily impaired, the impairment is charged to income during the period the impairment is found to exist, resulting in a reduction to earnings for that period. During 2011, the Company recognized an other-than-temporary impairment loss on equity securities of $148,000.

As of December 31, 2011, the Company concluded that any remaining unrealized losses in the securities available for sale portfolios were temporary in nature because they were primarily related to market interest rates, market illiquidity and wider credit spreads for these types of securities. Additionally, the Company does not intend to sell the securities and it is more likely than not that the Company will not be required to sell the securities before recovery of their amortized cost. Future events that could materially change this conclusion and require an impairment loss to be charged to operations include a change in the credit quality of the issuers or a determination that a market recovery in the foreseeable future is unlikely.

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.

The following table sets forth certain information relating to the Company for each of the years ended December 31, 2011, 2010 and 2009. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown except where noted otherwise. Average balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to yields.

 

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    Years Ended December 31,  
    2011     2010     2009  
(dollars in thousands)   Average
Balance
    Interest     Average
Yield/
Cost
    Average
Balance
    Interest     Average
Yield/
Cost
    Average
Balance
    Interest     Average
Yield/
Cost
 

Assets:

                 

Interest-earning assets:

                 

Interest-earning deposits and short-term investments

  $ 34,939      $ 70        .20   $ 11,252      $ 28        .25   $ —        $ —          —  

Investment securities (1)

    148,055        1,432        .97        65,595        628        .96        55,859        888        1.59   

FHLB-NY stock

    17,984        831        4.62        20,838        1,028        4.93        16,435        866        5.27   

Mortgage-backed securities (1)

    336,807        10,060        2.99        336,286        11,503        3.42        91,660        3,512        3.83   

Loans receivable, net (2)

    1,616,360        82,994        5.13        1,653,367        88,180        5.33        1,639,992        90,595        5.52   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    2,154,145        95,387        4.43        2,087,338        101,367        4.86        1,803,946        95,861        5.31   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Non-interest-earning assets

    117,010            113,689            94,397       
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 2,271,155          $ 2,201,027          $ 1,898,343       
 

 

 

       

 

 

       

 

 

     

Liabilities and Equity:

                 

Interest-bearing liabilities:

                 

Money market deposit accounts

  $ 116,295        454        .39   $ 104,833        597        .57   $ 91,695        678        .74

Savings accounts

    221,311        481        .22        241,762        1,732        .72        223,230        1,975        .88   

Interest-bearing checking accounts

    924,789        4,624        .50        761,854        6,418        .84        588,923        7,056        1.20   

Time deposits

    272,198        4,842        1.78        298,534        5,593        1.87        341,999        8,323        2.43   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,534,593        10,401        .68        1,406,983        14,340        1.02        1,245,847        18,032        1.45   

FHLB advances

    270,741        6,572        2.43        358,352        8,629        2.41        263,896        10,849        4.11   

Securities sold under agreements to repurchase

    70,982        283        .40        70,983        434        .61        68,272        589        .86   

Other borrowings

    27,500        804        2.92        27,500        850        3.09        27,500        928        3.37   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    1,903,816        18,060        .95        1,863,818        24,253        1.30        1,605,515        30,398        1.89   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Non-interest-bearing deposits

    142,478            127,535            110,740       

Non-interest-bearing liabilities

    14,919            17,764            14,691       
 

 

 

       

 

 

       

 

 

     

Total liabilities

    2,061,213            2,009,117            1,730,946       

Stockholders’ equity

    209,942            191,910            167,397       
 

 

 

       

 

 

       

 

 

     

Total liabilities and equity

  $ 2,271,155          $ 2,201,027          $ 1,898,343       
 

 

 

       

 

 

       

 

 

     

Net interest income

    $ 77,327          $ 77,114          $ 65,463     
   

 

 

       

 

 

       

 

 

   

Net interest rate spread (3)

        3.48         3.56         3.42
     

 

 

       

 

 

       

 

 

 

Net interest margin (4)

        3.59         3.69         3.63
     

 

 

       

 

 

       

 

 

 

Ratio of interest-earning assets to interest-bearing liabilities

    113.15         111.99         112.36    
 

 

 

       

 

 

       

 

 

     

 

(1) Amounts are recorded at average amortized cost.
(2) Amount is net of deferred loan fees, undisbursed loan funds, discounts and premiums and estimated loan loss allowances and includes loans held for sale and non-performing loans.
(3) Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
(4) Net interest margin represents net interest income divided by average interest-earning assets.

Rate Volume Analysis

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

 

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     Year Ended December 31, 2011
Compared to

Year Ended December 31, 2010
    Year Ended December 31, 2010
Compared to

Year Ended December 31, 2009
 
    

Increase (Decrease)

Due to

   

Increase (Decrease)

Due to

 
(in thousands)    Volume     Rate     Net     Volume     Rate     Net  

Interest-earning assets:

            

Interest-earning deposits and short-term investments

   $ 42      $ —        $ 42      $ 28      $ —        $ 28   

Investment securities

     797        7        804        136        (396     (260

FHLB-NY stock

     (135     (62     (197     221        (59     162   

Mortgage-backed securities

     18        (1,461     (1,443     8,405        (414     7,991   

Loans receivable, net

     (1,938     (3,248     (5,186     731        (3,146     (2,415
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     (1,216     (4,764     (5,980     9,521        (4,015     5,506   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Money market deposit accounts

     60        (203     (143     89        (170     (81

Savings accounts

     (136     (1,115     (1,251     148        (391     (243

Interest-bearing checking accounts

     1,171        (2,965     (1,794     1,782        (2,420     (638

Time deposits

     (486     (265     (751     (970     (1,760     (2,730
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     609        (4,548     (3,939     1,049        (4,741     (3,692

FHLB advances

     (2,128     71        (2,057     3,133        (5,353     (2,220

Securities sold under agreements to repurchase

     —          (151     (151     22        (177     (155

Other borrowings

     —          (46     (46     —          (78     (78
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     (1,519     (4,674     (6,193     4,204        (10,349     (6,145
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in net interest income

   $ 303      $ (90   $ 213      $ 5,317      $ 6,334      $ 11,651   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Financial Condition at December 31, 2011 and December 31, 2010

Total assets at December 31, 2011 were $2.302 billion, an increase of $50.8 million, or 2.3%, compared to $2.251 billion at December 31, 2010.

Cash and due from banks increased by $46.1 million, to $77.5 million at December 31, 2011, as compared to $31.5 million at December 31, 2010. Investment securities available for sale increased $73.4 million, or 79.8%, to $165.3 million at December 31, 2011, as compared to $91.9 million at December 31, 2010, due to purchases of government agency securities. The increases in cash and due from banks and investment securities available for sale were attributable to the reduction in loans and the increase in deposits as described below.

Loans receivable, net decreased by $97.8 million, or 5.9%, to a balance of $1.563 billion at December 31, 2011, as compared to a balance of $1.661 billion at December 31, 2010, primarily due to weak demand, prepayments resulting from the low interest rate environment, and sales of newly originated 30-year fixed-rate one-to-four family loans.

Total deposits increased $42.1 million, or 2.5%, to $1.706 billion at December 30, 2011, from $1.664 billion at December 31, 2010. An increase of $58.3 million in core deposits (i.e. all deposits excluding time deposits) was partly offset by a decline in time deposits of $16.2 million.

Stockholders’ equity at December 31, 2011 increased by 7.8%, to $216.8 million, as compared to $201.3 million at December 31, 2010, primarily due to net income and a reduction in accumulated other comprehensive loss partly offset by the cash dividend on common stock and by the repurchase of 165,154 shares of common stock for $2.1 million.

 

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Comparison of Operating Results for the Years Ended December 31, 2011 and December 31, 2010

General

Net income for year ended December 31, 2011 increased to $20.7 million, as compared to net income of $20.4 million for the prior year. On a per share basis, diluted earnings per share increased 1.8%, to $1.14, for the year ended December 31, 2011, as compared to $1.12 for the prior year. For the year ended December 31, 2010, diluted earnings per share included $922,000, or $.05 per share, relating to the reduction in the state tax valuation allowance.

Interest Income

Interest income for the year ended December 31, 2011 was $95.4 million as compared to $101.4 million for the year ended December 31, 2010. The yield on interest-earning assets declined to 4.43% for the year ended December 31, 2011, as compared to 4.86% for the prior year. This decline was due to a change in the mix of average interest-earning assets from higher-yielding loans receivable into lower-yielding interest-earning deposits and investment securities, as well as the continued low interest rate environment, which caused asset yields to decline. The low interest rate environment also caused high loan refinance volume which resulted in yields on loans and mortgage-backed securities to trend downward. Average interest-earning assets increased by $66.8 million, or 3.2%, for the year ended December 31, 2011, as compared to the prior year. The increase in average interest-earning assets was primarily due to an increase in average investment securities of $82.5 million for the year ended December 31, 2011 as compared to the prior year and an increase in average interest-earning deposits and short-term investments of $23.7 million. These increases were offset by a decrease in average loans receivable, net, of $37.0 million.

Interest Expense

Interest expense for year ended December 31, 2011 was $18.1 million compared to $24.3 million for the year ended December 31, 2010. The cost of interest-bearing liabilities decreased to 0.95% for the year ended December 31, 2011 as compared to 1.30% for the prior year. Average interest-bearing liabilities increased by $40.0 million for the year ended December 31, 2011, as compared to the prior year. The increase in average interest-bearing liabilities was primarily due to an increase in average interest-bearing deposits of $127.6 million, offset by a decrease in average FHLB advances of $87.6 million.

Net Interest Income

Net interest income for the year ended December 31, 2011 was $77.3 million, as compared to $77.1 million in the prior year, reflecting a lower net interest margin partly offset by greater interest-earning assets. The net interest margin decreased to 3.59% for the year ended December 31, 2011 from 3.69% in the prior year.

Provision for Loan Losses

For the year ended December 31, 2011, the provision for loan losses was $7.8 million, as compared to $8.0 million for the prior year. Non-performing loans increased $6.5 million, to $44.0 million at December 31, 2011 from $37.5 million at December 31, 2010. The increase is primarily due to the second quarter addition of a $6.4 million loan relationship secured by commercial and residential real estate, all business assets and a personal guarantee. An appraisal performed in May 2011 values the real estate collateral at $8.7 million. Most of the remaining increase in non-performing loans is related to a net increase in non-performing one-to-four family loans of $2.6 million. Loans receivable, net decreased by $97.8 million at December 31, 2011 as compared to December 31, 2010. Net loan charge-offs increased to $9.2 million for the year ended December 31, 2011, as compared to $3.0 million for the prior year. During the fourth quarter of 2011, the Company modified its charge-off policy on problem loans secured by real estate. Historically, the Company established specific valuation reserves for estimated losses for problem real estate related loans when the loans were deemed uncollectible. The specific valuation reserves were based upon the estimated fair value of the underlying collateral, less costs to sell. The actual loan charge-off was not recorded until the foreclosure process was complete. Under the modified policy, losses on loans secured by real estate are charged-off in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 120 days delinquent. The modification to the charge-off policy resulted in additional charge-offs in the fourth quarter of 2011 of $5.7 million. All of these charge-offs were timely identified in previous periods in the Company’s allowance for loan losses process as a specific valuation reserve and were included in the Company’s loss history as part of the evaluation of the allowance for loan losses. Accordingly, the additional charge-offs did not affect the Company’s provision for loan losses or net income for 2011. Without the additional charge-offs of $5.7 million recorded in the fourth quarter of 2011, the Company would have reported the following as of and for the year ended December 31, 2011: total charge-offs of $3.6 million; allowance for loan losses of

 

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$23.9 million; total non-performing loans of $49.7 million; allowance for loan losses as percent of total loans receivable of 1.50%; allowance for loan losses as percent of total non-performing loans of 48.12%; non-performing loans as a percent of total loans receivable of 3.12%; and non-performing assets as a percent of total assets of 2.24%.

Other Income

Other income for the year ended December 31, 2011, was unchanged at $15.3 million. For the year the ended December 31, 2011, the net gain on the sale of loans decreased $655,000 due to a decline in the volume of loans sold. Additionally, during 2011, the Company recognized an other-than-temporary impairment loss on equity securities of $148,000. For the year ended December 31, 2011, the lower gain on sale of loans and the impairment loss were largely offset by an increase in income from Bank owned life insurance of $327,000 and an increase in fees and service charges of $217,000.

Operating Expenses

Operating expenses decreased by 1.8%, to $52.7 million for the year ended December 31, 2011, as compared to $53.6 million for the prior year. The decrease for the year ended December 31, 2011 as compared to the prior year was partly due to lower compensation and employee benefit costs, which decreased by $71,000, or 0.3%, to $28.1 million due to a reduction in headcount. Federal deposit insurance decreased by $152,000 due to a lower assessment rate and a change in the assessment methodology from deposit-based to a total liability-based assessment. For the year ended December 31, 2011, occupancy expense benefited by $184,000 from the negotiated settlement of the remaining office lease obligation at Columbia. Additionally, legal expense decreased $305,000 for the year ended December 31, 2011 as compared to the prior year and general and administrative expense decreased $290,000 primarily due to a decrease in correspondent bank charges.

Provision for Income Taxes

The provision for income taxes was $11.5 million for the year ended December 31, 2011, as compared to $10.4 million for the prior year. The effective tax rate increased to 35.6% for the year ended December 31, 2011, as compared to 33.8%, in the same prior year period. The increase in the effective tax rate was due to the fourth quarter 2010 reduction in the state tax valuation allowance of $922,000.

Comparison of Operating Results for the Years Ended December 31, 2010 and December 31, 2009

General

Net income available to common stockholders increased to $20.4 million for the year ended December 31, 2010, as compared to $12.5 million for the year ended December 31, 2009, an increase of 63.2%. Diluted earnings per share increased to $1.12 for the year ended December 31, 2010, as compared to $.98 for the same prior year period. Diluted earnings per share reflects the higher number of average diluted shares outstanding from the public issuance of an additional 6,389,400 common shares in November 2009. Additionally, diluted earnings per share includes $922,000, or $0.05 per share, relating to a reduction in the state deferred tax valuation allowance.

Interest Income

Interest income for the year ended December 31, 2010 was $101.4 million, as compared to $95.9 million for the year ended December 31, 2009 reflecting greater interest-earning assets. Average interest-earning assets increased $283.4 million for the year ended December 31, 2010, as compared to the same prior year period. The increase was primarily in average mortgage-backed securities which increased $244.6 million.

Interest Expense

Interest expense for the year ended December 31, 2010 was $24.3 million, as compared to $30.4 million for the year ended December 31, 2009. The cost of interest-bearing liabilities decreased to 1.30% for the year ended December 31, 2010, as compared to 1.89% for the prior year due to the lower interest rate environment. Average interest-bearing liabilities increased by $258.3 million for the year ended December 31, 2010, as compared to the prior year. The increase was primarily in average core deposits, which increased $204.6 million and average FHLB advances, which increased $94.5 million, partly offset by a decrease in average time deposits of $43.5 million. The increases in average core deposits and average borrowings were primarily used to fund the increase in average mortgage-backed securities.

 

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Net Interest Income

Net interest income for the year ended December 31, 2010 increased to $77.1 million, as compared to $65.5 million in the prior year, reflecting a higher net interest margin and higher levels of interest-earning assets. The net interest margin increased to 3.69% for the year ended December 31, 2010 from 3.63% in the prior year.

Provision for Loan Losses

For the year ended December 31, 2010, the Company’s provision for loan losses was $8.0 million, as compared to $5.7 million for the prior year, primarily due to the increase in non-performing loans, continued economic stress and higher loan balances. Non-performing loans increased $9.2 million, or 32.5%, to $37.5 million at December 31, 2010, from $28.3 million at December 31, 2009, primarily due to increased delinquencies in residential mortgages caused by continued high unemployment and the difficult economic environment. Net charge-offs increased to $3.0 million for the year ended December 31, 2010, as compared to $2.6 million for the same prior year period.

Other Income

Other income was $15.3 million for the year ended December 31, 2010, as compared to $15.6 million for the prior year. Loan servicing income (loss) increased to income of $292,000 for the year ended December 31, 2010 from a loss of $18,000 for the prior year due to an impairment to the loan servicing asset of $263,000 recognized in the first quarter of 2009. Fees and service charges increased to $11.2 million for the year ended December 31, 2010, as compared to $10.5 million for the prior year. The increase was due to higher fees from merchant services, commercial checking accounts and trust services partly offset by a reduction in private mortgage insurance fee income of $146,000 related to several rescission claims. The net gain on sales of loans decreased to $3.7 million as compared to $3.9 million for the prior year due to a decline in the volume of loans sold partly offset by a higher gain on sale margin. The net loss from other real estate operations was $701,000 for the year ended December 31, 2010 as compared to a loss of $2,000 in the prior year due to current period write-downs in the value of properties previously acquired. Other income decreased $372,000 for the year ended December 31, 2010, as compared to the prior year due to the prior year recovery of $367,000 on borrower escrow funds at Columbia.

Operating Expenses

Operating expenses increased 6.1%, to $53.6 million for the year ended December 31, 2010, as compared to $50.5 million for the prior year primarily a result of increased compensation and general and administrative expense partially offset by decreases in occupancy, federal deposit insurance and merger related expenses. Compensation and employee benefits costs increased due to higher incentive compensation, salary and stock plan expense. The increase was also due to the reduction in mortgage loan closings from prior year levels. Fewer loan closings in the current year decreased deferred loan expense which results in an increase to compensation expense. Occupancy expense decreased by $490,000 for the year ended December 31, 2010, as compared to the prior year due to a $556,000 charge in the second quarter of 2009 relating to the termination of all remaining lease obligations of Columbia. Federal deposit insurance expense for the year ended December 31, 2010 decreased by $394,000 from the prior year primarily due to a special assessment of $869,000 in 2009, partly offset by additional insurance resulting from higher deposit balances. Merger related expenses for the year ended December 31, 2009 totaled $1.3 million, which related to the Company’s announced, but subsequently terminated, merger with Central Jersey Bancorp. General and administrative expense increased for the year ended December 31, 2010, over the prior year partly due to higher loan related expenses. Although loan closings have decreased from prior year levels, the marginal cost to originate each loan in the current regulatory and economic environment has increased and the Company has also incurred increased costs relating to loan applications which may not result in a closed loan.

 

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Provision for Income Taxes

The provision for income taxes was $10.4 million for the year ended December 31, 2010, as compared to $9.2 million for the prior year. The effective tax rate decreased to 33.8% for the year ended December 31, 2010, as compared to 36.9% in the prior year. The decrease in the effective tax rate was due to a reduction in the state deferred tax valuation allowance of $922,000.

Dividends on Preferred Stock and Discount Accretion

Dividends on preferred stock and discount accretion totaled $3.2 million for the year ended December 31, 2009 as compared to no amount in the current year period. The preferred stock was redeemed on December 30, 2009 and the related warrant was repurchased on February 3, 2010. The warrant repurchase had no effect on net income available to common stockholders for the year ended December 31, 2010.

Liquidity and Capital Resources

The Company’s primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, proceeds from the sales of loans, FHLB advances and other borrowings and, to a lesser extent, investment maturities. While scheduled amortization of loans is a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including advances from the FHLB.

At December 31, 2011 and 2010, the Bank had no outstanding overnight borrowings from the FHLB. The Bank utilizes overnight borrowings from time-to-time to fund short-term liquidity needs. FHLB advances totaled $266.0 million at December 31, 2011, an increase from $265.0 million at December 31, 2010. Securities sold under agreements to repurchase with retail customers decreased to $66.1 million at December 31, 2011 from $67.9 million at December 31, 2010. Like deposit flows, this funding source is dependent upon demand from the Bank’s customer base.

The Company’s cash needs for the year ended December 31, 2011 were primarily satisfied by principal payments on loans and mortgage-backed securities, proceeds from the sale of mortgage loans held for sale and increased deposits. The low interest rate environment during the year accelerated prepayments of loans and mortgage-backed securities which increased the Company’s cash flows. The cash was principally utilized for loan originations and the purchase of investment and mortgage-backed securities. For the year ended December 31, 2010, the cash needs of the Company were primarily satisfied by principal payments on loans and mortgage-backed securities, proceeds from the sale of mortgage loans held for sale and increased deposits. The cash was principally utilized for loan originations, the purchase of investment and mortgage-backed securities and the repayment of borrowings.

In the normal course of business, the Bank routinely enters into various commitments, primarily relating to the origination and sale of loans. At December 31, 2011, outstanding commitments to originate loans totaled $76.9 million; outstanding unused lines of credit totaled $228.8 million; and outstanding commitments to sell loans totaled $34.8 million. The Bank expects to have sufficient funds available to meet current commitments in the normal course of business.

Time deposits scheduled to mature in one year or less totaled $180.8 million at December 31, 2011. Based upon historical experience, management estimates that a significant portion of such deposits will remain with the Bank.

The Company has a detailed contingency funding plan and comprehensive reporting of trends on a monthly and quarterly basis. Management also monitors cash on a daily basis to determine the liquidity needs of the Bank. Additionally, management performs a liquidity stress test in several scenarios on a quarterly basis. The Bank continues to maintain significant liquidity under all stress scenarios.

Under the Company’s stock repurchase program, shares of OceanFirst Financial Corp. common stock may be purchased in the open market and through other privately negotiated transactions, from time-to-time, depending on market conditions. The repurchased shares are held as treasury stock for general corporate purposes. For the year ended December 31, 2011, the Company repurchased 165,154 shares of common stock at a total cost of $2.1 million compared with no repurchases for the year ended December 31, 2010. At December 31, 2011 there were 777,152 shares remaining to be repurchased under the existing stock repurchase program. Cash dividends on common stock declared and paid during the year ended December 31, 2011 were $8.8 million, unchanged from the prior year. On January 18, 2012, the Board of Directors declared a quarterly cash dividend of twelve cents ($0.12) per common share. The dividend was payable on February 10, 2012 to common stockholders of record at the close of business on January 30, 2012.

 

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The primary source of liquidity specifically available to the Company are capital distributions from the Bank and the issuance of preferred and common stock and long-term debt. For the year ended December 31, 2011, the Company received dividend payments of $13.8 million from the Bank. At December 31, 2011, the Company had received notice from the Federal Reserve Bank of Philadelphia that it does not object to the payment of $16.5 million in dividends from the Bank to the Holding Company over the first three quarters of 2012, although the Federal Reserve Bank reserved the right to revoke the approval at any time if a safety and soundness concern arises throughout the period. The Company’s ability to continue to pay dividends will be largely dependent upon capital distributions from the Bank, which may be adversely affected by capital restraints imposed by the applicable regulations. The Company cannot predict whether the Bank will be permitted under applicable regulations to pay a dividend to the Company. If applicable regulations or regulatory bodies prevent the Bank from paying a dividend to the Company, the Company may not have the liquidity necessary to pay a dividend in the future or pay a dividend at the same rate as historically paid, or be able to meet current debt obligations. At December 31, 2011, OceanFirst Financial Corp. held $18.1 million in cash and $4.5 million in investment securities available for sale.

As of December 31, 2011, the Bank exceeded all regulatory capital requirements as follows (in thousands):

 

     Actual     Required  
     Amount      Ratio     Amount      Ratio  

Tangible capital

   $ 217,022         9.41   $ 34,593         1.50

Core capital

     217,022         9.41        92,247         4.00   

Tier 1 risk-based capital

     217,022         15.42        56,298         4.00   

Total risk-based capital

     230,825         16.40        112,595         8.00   

The Bank is considered a “well-capitalized” institution under the Prompt Corrective Action Regulations.

At December 31, 2011, the Company maintained tangible common equity of $216.8 million for a tangible common equity to assets ratio of 9.42%.

Off-Balance-Sheet Arrangements and Contractual Obligations

In the normal course of operations, the Bank engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ requests for funding. These financial instruments and commitments include unused consumer lines of credit and commitments to extend credit and are discussed in Note 14 to the Consolidated Financial Statements. The Bank also has outstanding commitments to sell loans amounting to $34.8 million.

The Bank and Columbia have each entered into loan sale agreements with investors in the normal course of business. The loan sale agreements generally require the Bank or Columbia to repurchase loans previously sold in the event of an early payment default or a violation of various representations and warranties customary to the mortgage banking industry. In the opinion of management, the potential exposure related to the loan sale agreements is adequately provided for in the reserve for repurchased loans included in other liabilities. At December 31, 2011 and 2010 the reserve for repurchased loans amounted to $705,000 and $809,000, respectively.

 

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The following table shows the contractual obligations of the Bank by expected payment period as of December 31, 2011 (in thousands). Further discussion of these commitments is included in Notes 10 and 14 to the Consolidated Financial Statements.

 

Contractual Obligation

   Total      Less than
one year
     1-3 years      More than
3-5 years
     5 years  

Debt Obligations

   $ 359,601       $ 107,101       $ 121,000       $ 109,000       $ 22,500   

Operating Lease Obligations

     20,796         1,852         3,648         2,638         12,658   

Purchase Obligations

     19,445         3,557         7,113         5,938         2,837   

Long-term debt obligations include borrowings from the Federal Home Loan Bank and other borrowings and have defined terms.

Operating leases represent obligations entered into by the Bank for the use of land and premises. The leases generally have escalation terms based upon certain defined indexes.

Purchase obligations represent legally binding and enforceable agreements to purchase goods and services from third parties and consist primarily of contractual obligations under data processing servicing agreements. Actual amounts expended vary based on transaction volumes, number of users and other factors.

Impact of New Accounting Pronouncements

Accounting Standards Update No. 2011-05, “Comprehensive Income” requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is not expected to have a material effect on the Company’s consolidated financial statements.

Accounting Standards Update No. 2011-04, “Fair Value Measurement, Amendments to achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” develops common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRSs”). The amendments are effective for interim and annual periods beginning after December 15, 2011. The adoption of this Accounting Standard Update is not expected to have a material effect on the Company’s consolidated financial statements.

Accounting Standards Update No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements”, amends Topic 860 (Transfers and Servicing) where an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements, based on whether or not the transferor has maintained effective control. In the assessment of effective control, Accounting Standard Update 2011-03 has removed the criteria that requires transferors to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee. Other criteria applicable to the assessment of effective control have not been changed. This guidance is effective for prospective periods beginning on or after December 15, 2011. Early adoption is prohibited. The adoption of this Accounting Standard Update is not expected to have a material effect on the Company’s consolidated financial statements.

Accounting Standards Update No. 2011-02 amends Topic 310 and clarifies the guidance on a creditor’s evaluation of whether it has granted a concession, and whether a restructuring constitutes a troubled debt restructuring. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the information which was deferred by Accounting Standards Update No. 2011-01, “Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructuring” in Update NO. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The adoption of this Accounting Standard Update did not result in a material change to the Company’s consolidated financial statements.

Accounting Standards Update No. 2010-20, amends ASC 310 (Receivables) to require significant new disclosures about the credit quality of financial receivables/loans and the allowance for credit losses. The objective of the new disclosures is to improve financial statement users’ understanding of (1) the nature of an entity’s credit risk associated with its financing receivables, and (2) the entity’s assessment of that risk in estimating its allowance for credit losses, as well as changes in the

 

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allowance and the reasons for those changes. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance (either by portfolio segment or by class of financing receivables). The required disclosures include, among other things, a rollforward of the allowance for credit losses by portfolio segment, as well as information about credit quality indicators and modified, impaired, non-accrual and past due loans. The disclosures related to period-end information (e.g., credit-quality information and the ending financing receivables balance segregated by impairment method) will be required in all interim and annual reporting periods ending on or after December 15, 2010 (December 31, 2010 for the Company). Disclosures of activity that occurs during a reporting period (e.g., loan modifications and the rollforward of the allowance for credit losses by portfolio segment) were required in interim or annual periods beginning on or after December 15, 2010 (January 1, 2011 for the Company). The adoption of this Accounting Standards Update did not result in a material change to the Company’s consolidated financial statements.

Impact of Inflation and Changing Prices

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts 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 of 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.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Management of Interest Rate Risk (“IRR”)

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from IRR inherent in its lending, investment and deposit-taking activities. The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. To that end, management actively monitors and manages IRR.

The principal objectives of the Company’s IRR management function are to evaluate the IRR inherent in certain balance sheet accounts; determine the level of risk appropriate given the Company’s business focus, operating environment, capital and liquidity requirements and performance objectives; and manage the risk consistent with Board approved guidelines. Through such management, the Company seeks to reduce the exposure of its operations to changes in interest rates. The Company monitors its IRR as such risk relates to its operating strategies. The Bank’s Board has established an Asset Liability Committee (“ALCO”) consisting of members of the Bank’s management, responsible for reviewing the asset liability policies and IRR position. ALCO meets monthly and reports trends and the Company’s IRR position to the Board on a quarterly basis. The extent of the movement of interest rates, higher or lower, is an uncertainty that could have an impact on the earnings of the Company.

The Bank utilizes the following strategies to manage IRR: (1) emphasizing the origination for portfolio of fixed-rate mortgage loans generally having terms to maturity of not more than fifteen years, adjustable-rate loans, floating-rate and balloon maturity commercial loans, and consumer loans consisting primarily of home equity loans and lines of credit; (2) attempting to reduce the overall interest rate sensitivity of liabilities by emphasizing core and longer-term deposits; and (3) managing the maturities of wholesale borrowings. The Bank may also sell fixed-rate mortgage loans into the secondary market. In determining whether to retain fixed-rate mortgages or to purchase fixed-rate mortgage-backed securities, management considers the Bank’s overall IRR position, the volume of such loans originated or the amount of MBS to be purchased, the loan or MBS yield and the types and amount of funding sources. The Bank periodically retains fixed-rate mortgage loan production or purchases fixed-rate MBS in order to improve yields and increase balance sheet leverage. During periods when fixed-rate mortgage loan production is retained, the Bank generally attempts to extend the maturity on part of its wholesale borrowings. For the past few years, the Bank has sold most 30 year fixed-rate mortgage loan originations in the secondary market. The Company currently does not participate in financial futures contracts, interest rate swaps or other activities involving the use of off-balance-sheet derivative financial instruments, but may do so in the future to manage IRR.

 

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The matching 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 within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Accordingly, during a period of rising interest rates, an institution with a negative gap position theoretically would not be in as favorable a position, compared to an institution with a positive gap, to invest in higher-yielding assets. This may result in the yield on the institution’s assets increasing at a slower rate than the increase in its cost of interest-bearing liabilities. Conversely, during a period of falling interest rates, an institution with a negative gap might experience a repricing of its assets at a slower rate than its interest-bearing liabilities, which, consequently, may result in its net interest income growing at a faster rate than an institution with a positive gap position.

The Company’s interest rate sensitivity is monitored through the use of an IRR model. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2011, which were anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown. At December 31, 2011, the Company’s one-year gap was negative 0.03% as compared to positive .25% at December 31, 2010. Except as stated below, the amount of assets and liabilities which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table is intended to provide an approximation of the projected repricing of assets and liabilities at December 31, 2011, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three month period and subsequent selected time intervals. Loans receivable reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. Loans were projected to prepay at rates between 3% and 33% annually. Mortgage-backed securities were projected to prepay at rates between 10% and 24% annually. Money market deposit accounts, savings accounts and interest-bearing checking accounts are assumed to have average lives of 4.6 years, 5.3 years and 4.4 years, respectively. Prepayment and average life assumptions can have a significant impact on the Company’s estimated gap.

 

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There can be no assurance that projected prepayment rates for loans and mortgage-backed securities will be achieved or that projected average lives for deposits will be realized.

 

At December 31, 2011

   3 Months or
Less
    More than
3 Months to
1 Year
    More than
1 Year to

3 Years
    More than
3 Years to
5 Years
    More than
5 Years
    Total  
(dollars in thousands)                                     

Interest-earning assets (1):

            

Interest-earning deposits and short-term investments

   $ 49,389      $ —        $ —        $ —        $ —        $ 49,389   

Investment securities

     57,669        25,258        80,899        11,759        4,294        179,879   

FHLB stock

     —          —          —          —          18,160        18,160   

Mortgage-backed securities

     57,490        64,533        101,508        58,880        72,093        354,504   

Loans receivable (2)

     313,220        446,428        472,297        177,214        177,021        1,586,180   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     477,768        536,219        654,704        247,853        271,568        2,188,112   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Money market deposit accounts

     31,853        8,991        19,745        14,862        47,654        123,105   

Savings accounts

     23,762        21,155        44,809        33,916        105,599        229,241   

Interest-bearing checking accounts

     553,519        64,965        116,050        96,254        111,614        942,402   

Time deposits

     81,755        99,035        34,359        37,286        16,464        268,899   

FHLB advances

     21,000        20,000        121,000        104,000        —          266,000   

Securities sold under agreements to repurchase and other borrowings

     88,601        —          —          5,000        —          93,601   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     800,490        214,146        335,963        291,318        281,331        1,923,248   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest sensitivity gap (3)

   $ (322,722   $ 322,073      $ 318,741      $ (43,465   $ (9,763   $ 264,864