U.S. SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-KSB Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2001 Commission File No.: 0-29770 WEST ESSEX BANCORP, INC. (Name of small business issuer in its charter) UNITED STATES 22-3597632 ------------------------------- -------------------------- (State or other jurisdiction of (I.R.S. Employer I.D. No.) incorporation or organization) 417 Bloomfield Avenue, Caldwell, New Jersey 07006 (Address of principal executive offices) (Zip Code) ---------------------------------------- ---------- Issuer's telephone number, including area code: (973) 226-7911 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share (Title of class) Check whether the issuer (1) 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 [ _ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. Yes [ X ] No [ _ ] The issuer's revenues for its most recent fiscal year ended December 31, 2001 were $24,152,950. The aggregate market value of the voting stock held by non-affiliates of the registrant, i.e., persons other than the directors and executive officers of the registrant, was $23,655,161 based upon the last sales price of $19.41 as listed on The Nasdaq National Market for March 15, 2002. Solely for purposes of this calculation, the shares held by West Essex Bancorp, M.H.C. and the directors and officers of the registrant are deemed to be shares held by affiliates. The number of shares of Common Stock outstanding as of March 15, 2002 was: 4,900,643. DOCUMENTS INCORPORATED BY REFERENCE Portions of the 2001 Annual Report to Shareholders and the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2002 are incorporated herein by reference to Parts II and III, respectively, of this Form 10-KSB. Transitional Small Business Disclosure Format: Yes [ _ ] No [ X ] INDEX PAGE PART I Item 1. Description of Business...............................................2 Item 2. Description of Properties............................................34 Item 3. Legal Proceedings....................................................34 Item 4. Submission of Matters to a Vote of Security Holders..................34 PART II Item 5. Market for Common Equity and Related Stockholder Matters..................................................35 Item 6. Management's Discussion and Analysis or Plan of Operation............35 Item 7. Financial Statements.................................................35 Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...............................35 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act....................35 Item 10.Executive Compensation...............................................35 Item 11.Security Ownership of Certain Beneficial Owners and Management.......35 Item 12.Certain Relationships and Related Transactions.......................35 Item 13.Exhibits, List and Reports on Form 8-K...............................36 SIGNATURES 1 This report contains certain "forward-looking statements" within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on West Essex Bancorp, Inc.'s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as "expects," believes," "anticipates," "intends" and similar expressions. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the market area in which West Essex Bancorp, Inc. operates, as well as nationwide, West Essex Bancorp, Inc.'s ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. West Essex Bancorp, Inc. assumes no obligation to update any forward-looking statements. Item 1. Description of Business. General West Essex Bancorp, Inc. (the "Company") became the federally chartered stock holding company for West Essex Bank (the "Bank"), a federally chartered stock savings bank on October 2, 1998 in connection with the conversion of the Bank from the mutual to stock form and reorganization of the Bank into a mutual holding company structure ("Reorganization"). In connection with the Reorganization, West Essex Bancorp, M.H.C. (the "MHC") was organized and became a majority holder of the Company's outstanding common stock. The Company, the Bank and the MHC are regulated by the Office of Thrift Supervision (the "OTS"). The Bank is a federally chartered savings bank and is wholly-owned by the Company. The Company is a savings and loan holding company and is subject to regulation by the OTS, the Federal Deposit Insurance Corporation ("the FDIC") and the Securities and Exchange Commission (the "SEC"). Currently, other than investing in various securities, the Company does not directly transact any material business other than through the Bank. Accordingly, the discussion herein addresses the operations of the Company as they are conducted through the Bank. At December 31, 2001, the Company had total assets of $370.8 million, total deposits of $240.9 million and total stockholders' equity of $50.9 million. The Bank was originally organized in 1915 as a New Jersey chartered building and loan association and, in 1995, became a federally chartered savings bank. The Bank is a community-oriented savings institution whose business primarily consists of accepting deposits from customers and investing those funds primarily in mortgage-backed securities and mortgage loans secured by one- to four-family residences located in the Bank's primary market area. To a significantly lesser extent, the Bank invests in commercial real estate loans, multi-family loans, construction and land development loans and home equity loans as well as consumer loans and obligations of the federal government and federal agencies as well as states and municipalities. The Bank generally retains for its portfolio all one- to four-family mortgage loans which it originates. The Company's and Bank's executive offices are located at 417 Bloomfield Avenue, Caldwell, New Jersey 07006. The telephone number is (973) 226-7911. Market Area and Competition The Bank conducts its business through its administrative and branch office located in Caldwell, New Jersey, and seven other full service branch offices located in West Orange, Franklin Lakes, River Vale, Pine Brook, Old Tappan and Northvale, all of which are located in the Northern New Jersey counties of 2 Essex, Morris and Bergen. The Bank's deposit gathering base is concentrated in the communities surrounding its offices. While its lending area extends throughout New Jersey, most of the Bank's mortgage loans are secured by properties located in Essex, Morris and Bergen Counties in Northern New Jersey. 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 the greater New York City metropolitan area. Certain communities in Bergen, Essex and Morris Counties are among the highest per capita income in the country. Essex County contains many older residential commuter towns which function partially as business and service centers. Morris County was once predominantly a rural farming area; however, it has experienced rapid growth in the residential, commercial and industrial sectors. Bergen County has benefitted from its geographical proximity to New York City. Originally an agricultural region, the county shifted toward manufacturing and service industries and many foreign firms have set up their American headquarters in this County. 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 which are branches of significantly larger institutions which have greater financial resources than the Bank, all of which are competitors of the Bank to varying degrees. 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. These companies compete aggressively through advertising and by cutting interest rates on loans. The Bank has sought to compete for loans by advertising in local papers, developing contacts with local real estate brokers, and providing cash incentives to its retail and mortgage origination staff to attract loans to the Bank. In addition, the Bank is affiliated with several mortgage brokers who, for a fee, provide the Bank with loans. The Bank does not attempt to compete by offering interest rates below those offered by its competitors, but does endeavor to keep its interest rates competitive in that the Bank's rates are neither higher nor lower than rates generally available from the Bank's competitors in its market area. Its most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. The Bank faces additional competition for deposits from short-term money market funds, common stock, other corporate and government securities funds and from other financial service institutions such as brokerage firms and insurance companies. 3 Loan Portfolio Analysis. 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, -------------------------------------------------------------- 2001 2000 1999 -------------------- ------------------- ------------------- Percent Percent Percent Amount of Total Amount of Total Amount of Total --------- --------- --------- -------- --------- -------- Mortgage Loans: Residential: One- to four-family..................... $125,313 73.72 $125,933 74.40 $122,680 78.54 Multi-family............................ 3,515 2.07 1,804 1.07 1,693 1.08 Home equity loans and lines............. 16,919 9.95 16,663 9.84 14,382 9.21 Commercial real estate.................... 14,167 8.33 13,522 7.99 12,965 8.30 Construction and development.............. 9,524 5.60 10,587 6.25 3,819 2.45 -------- ----- -------- ----- -------- ----- Total mortgage loans.................. 169,438 99.67 168,509 99.55 155,539 99.58 -------- ----- -------- ----- -------- ----- Commercial loans............................ 30 0.02 35 0.02 40 0.02 -------- ----- -------- ----- -------- ----- Consumer Loans: Passbook or certificate................. 298 0.18 454 0.27 341 0.22 Other................................... 224 0.13 267 0.16 276 0.18 -------- ----- -------- ----- -------- ----- Total consumer loans.................. 522 0.31 721 0.43 617 0.40 -------- ----- -------- ----- -------- ----- Total loans receivable.................... 169,990 100.00 169,265 100.00 156,196 100.00 ====== ====== ====== Less: Construction loans in process........... (3,078) (4,219) (1,886) Allowance for loan losses............... (1,363) (1,363) (1,400) Deferred loan fees, net................. 387 355 366 -------- -------- -------- Loans receivable, net..................... $165,936 $164,038 $153,276 ======== ======== ======== At December 31, ---------------------------------------- 1998 1997 -------------------- ------------------ Percent Percent Amount of Total Amount of Total ---------- -------- -------- -------- Mortgage Loans: Residential: One- to four-family..................... $114,690 80.20 $ 87,489 75.34 Multi-family............................ 1,943 1.36 2,004 1.73 Home equity loans and lines............. 9,631 6.73 8,554 7.37 Commercial real estate.................... 11,589 8.11 10,695 9.21 Construction and development.............. 4,394 3.07 6,485 5.58 -------- ---- -------- ----- Total mortgage loans.................. 142,247 99.47 115,227 99.23 -------- ---- -------- ----- Commercial loans............................ 49 0.04 59 0.05 -------- ---- -------- ----- Consumer Loans: Passbook or certificate................. 401 0.28 550 0.47 Other................................... 305 0.21 291 0.25 -------- ---- -------- ----- Total consumer loans.................. 706 0.49 841 0.72 -------- ---- -------- ----- Total loans receivable.................... 143,002 100.00 116,127 100.00 ====== ====== Less: Construction loans in process........... (1,311) (1,437) Allowance for loan losses............... (1,717) (1,885) Deferred loan fees, net................. 298 (70) -------- -------- Loans receivable, net..................... $140,272 $ 112,735 ======== =========== 4 Loan Maturity. The following table shows the remaining contractual maturity of the Bank's loans at December 31, 2001. The table does not include the effect of future principal repayments or prepayments. At December 31, 2001 ------------------------------------------------------------------------------------------ One- to Equity Construction Four- Multi- Loans and Commercial and Total Family Family Lines Real Estate Development Commercial Consumer Loans --------- --------- --------- ---------- ----------- ----------- ---------- --------- (In thousands) Amounts due: One year or less $ 221 $ -- $ 291 $ 270 $ 8,502 $ -- $ 281 $ 9,565 --------- ------- --------- --------- --------- ------- ------- --------- After one year: More than one year to three years 1,020 288 624 758 1,022 -- 78 3,790 More than three years to five years 770 -- 1,410 181 -- -- 28 2,389 More than five years to ten years 5,278 -- 3,801 3,905 -- -- 53 13,037 More than 10 years to 20 years 21,312 1,961 10,693 8,623 -- 30 82 42,701 More than 20 years 96,712 1,266 100 430 -- -- -- 98,508 --------- ------- --------- --------- --------- ------- ------- --------- Total due after one year 125,092 3,515 16,628 13,897 1,022 30 241 160,425 --------- ------- --------- --------- --------- ------- ------- --------- Total due 125,313 3,515 16,919 14,167 9,524 30 522 169,990 Less: Loans in process -- -- -- -- (3,078) -- -- (3,078) Deferred loan (fees) costs 355 -- -- 40 (8) -- -- 387 Allowance for loan losses (709) (64) (210) (181) (195) -- (4) (1,363) --------- ------- --------- --------- --------- ------- ------- --------- Loans receivable, net $ 124,959 $ 3,451 $ 16,709 $ 14,026 $ 6,243 $ 30 $ 518 $ 165,936 ========= ======= ========= ========= ========= ====== ======= ========= 5 The following table sets forth, at December 31, 2001, the dollar amount of loans contractually due after December 31, 2002, and whether such loans have fixed interest rates or adjustable interest rates. Due After December 31, 2002 Fixed Adjustable Total -------- -------- -------- (In thousands) Mortgage loans: One- to four-family...................... $85,592 $39,500 $125,092 Multi-family............................. 3,515 - 3,515 Equity loans and lines................... 10,804 5,824 16,628 Commercial real estate................... 13,897 - 13,897 Construction and development............. 22 1,000 1,022 -------- ------- -------- Total mortgage loans................... 113,830 46,324 160,154 Commercial loans............................ 30 - 30 Consumer loans.............................. 188 53 241 -------- ------- -------- Total loans ......................... $114,048 $46,377 $160,425 ======== ======= ======== Origination, Purchase and Servicing of Loans. The Bank's mortgage lending activities are conducted primarily by its loan personnel operating in all of the Bank's branch offices. All loans originated by the Bank, either through internal sources or through loan brokers, are underwritten by the Bank pursuant to the Bank's policies and procedures. The Bank's underwriting policies, guidelines and procedures are modeled after those of FNMA and FHLMC. The Bank originates both adjustable-rate and fixed-rate loans. The Bank's ability to originate fixed- or adjustable-rate loans is dependent upon the relative customer demand for such loans, which is affected by the current and expected future level of interest rates. It is the general policy of the Bank to retain all loans originated in its portfolio. The Bank currently retains the servicing for all loans originated in its portfolio. The Bank has faced significant competition for loans in its market area. To that end, the Bank pays its retail and mortgage loan origination staff cash incentives based upon loan originations and also works with mortgage brokers, paying them fees for loans closed and purchased by the Bank. Based upon the Bank's investment needs and market opportunities, the Bank has, on occasion, participated in loans, primarily multi-family loans through the Thrift Institutions Community Investment Corporation of New Jersey ("TICIC"). At December 31, 2001, the Bank had 13 loan participations through TICIC totaling $3.7 million. The Bank has in its loan portfolio loans generated by third-party mortgage companies which were underwritten pursuant to the Bank's policies, and closed in the name of the Bank. 6 The following table sets forth the Bank's loan originations, purchases, and principal repayments for the periods indicated. The Bank sold no loans during the periods indicated. For the Years Ended December 31, ------------------------------------ 2001 2000 1999 ----------- ----------- ----------- Beginning balance ...................... $ 169,265 $ 156,196 $ 143,002 --------- --------- --------- Loans purchased: One- to four-family mortgage ....... 1,944 3,297 2,040 Multi-family mortgage .............. 80 235 970 Construction and land development .. 892 1,525 -- --------- --------- --------- Total ........................... 2,916 5,057 3,010 --------- --------- --------- Loans originated: Mortgage loans: One- to four-family ............. 26,766 13,875 23,400 Multi-family .................... -- -- 455 Home equity lines ............... 4,467 7,070 9,022 Commercial real estate .......... 2,272 2,055 2,485 Construction and land development 5,296 6,526 4,803 --------- --------- --------- Total mortgage loans ........ 38,801 29,526 40,165 --------- --------- --------- Consumer loans: Passbook loans .................. 541 621 725 Automobile ...................... 21 107 116 Credit lines .................... 84 161 141 --------- --------- --------- Total consumer loans ........ 646 889 982 --------- --------- --------- Total originations .......... 39,447 30,415 41,147 --------- --------- --------- Loans transferred to real estate owned -- (165) (309) --------- --------- --------- Principal repayments and other, net (41,638) (21,349) (30,654) --------- --------- --------- Ending balance ........................ $ 169,990 $ 169,265 $ 156,196 ========= ========= ========= One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate and adjustable-rate mortgage loans ("ARM") secured by one- to four-family residences with maturities of up to 30 years. Loan originations are generally obtained from the Bank's retail and loan origination staff, from local real estate agents, from wholesale brokers and their contacts in the Bank's local real estate industry, from existing or past customers and through referrals from members of the local communities and advertising. One- to four- family mortgage loans are generally underwritten in accordance with FHLMC/FNMA standards. The Bank currently offers fixed-rate mortgage loans with terms from 10 to 30 years. The Bank generally retains for its portfolio all loans it originates. The Bank also offers ARM loan programs made for terms of 30 years with interest rates which adjust periodically. The Bank's ARM loans generally provide for periodic (not more than 2.0% over the existing interest rate) and overall (not more than 6.0%) caps on the increase or decrease in the interest rate at any adjustment date and over the life of the loan. The interest rate adjustment on these loans is indexed to the one-year U.S. Treasury CMT Index with a repricing margin of 2.75% above the index. 7 The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps reduce the Bank's interest rate exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the credit risk associated with the Bank's adjustable-rate loans but also limit the interest rate sensitivity of its adjustable-rate mortgage loans. The Bank's policy generally is to originate one- to four-family residential mortgage loans in amounts up to 90% of the lower of the appraised value or the selling price of the property securing the loan, but generally requires private mortgage insurance if the loan is in an amount in excess of 80% of the lower of the appraised value or selling price. Mortgage loans originated by the Bank include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower 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 requires fire, casualty, title and, in certain cases, flood insurance on all properties securing real estate loans made by the Bank. In an effort to provide financing for first-time home buyers, the Bank offers a first-time home buyers program. This program offers one- to four-family residential mortgage loans to qualified individuals. These loans are originated using the Bank's standard underwriting guidelines with preferred interest rates. With respect to loans granted under this program, the Bank originates these loans in amounts up to 95% of the lower of the appraised value or selling price of the property securing the loan. In addition, the Bank also participates in the First Home Club Program through the FHLB-NY, which benefits low income first time homebuyers. Home Equity Loans. The Bank offers fixed-rate home equity loans and floating rate home equity lines of credit in amounts of up to $150,000. Loans in excess of $150,000 may be made at the discretion of the Chief Lending Officer. Home equity loans have fixed rates of interest with terms of up to 20 years. Interest rates on such loans will vary depending on the amortization period chosen by the borrowers. Home equity lines of credit have adjustable-rates of interest, which may adjust on a monthly basis. The adjustable- rate of interest charged on such loans is indexed to the prime rate as published in The Wall Street Journal. Currently, home equity lines of credit originated at this time bear a maximum lifetime interest rate cap of 14%. The maximum combined loan-to-value ("LTV") ratio on home equity loans and equity lines of credit is 70%; however, this policy provides that management has the discretion to make such real estate loans in excess of 70%. The underwriting standards employed by the Bank for home equity loans and lines of credit include a determination of the applicant's credit history and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment and, additionally, from any verifiable secondary income. Creditworthiness of the applicant is of primary consideration. The Bank's home equity loans and lines of credit are secured by first or second liens on one- to four-family residences and condominiums located in the Bank's primary market area. Commercial Real Estate and Multi-Family Lending. The Bank also originates multi-family and commercial real estate loans that are generally secured by five or more apartment units and properties used for business purposes such as small shopping centers located in northern New Jersey. The Bank's multi- family and commercial real estate underwriting policy provides that such real estate loans may be made in amounts up to 65% of the appraised value of the property; however, this policy provides that management has the discretion to make such real estate loans in excess of 65% of the appraised value of the property. The Bank's multi-family and commercial real estate lending is limited by the regulatory loans-to-one borrower 8 limit which at December 31, 2001 was $6.8 million. The Bank currently originates multi-family and commercial real estate loans, generally with terms of up to 20 years and has developed a variety of programs, including balloon-type and adjustable mortgages, indexed to the FHLB advance rate, the Prime Rate and the U.S. Treasury Bill rate. The Bank's multi-family and commercial real estate loans have fixed or adjustable rates of interest that adjust periodically and are indexed to either the prime rate as published in The Wall Street Journal or the U.S. Treasury Bill. In reaching its decision on whether to make a multi-family or commercial real estate loan, the Bank considers the net operating income of the property, the borrower's expertise, credit history and profitability and the value of the underlying property. The Bank has generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.15. In addition, environmental impact surveys may be required for multi-family and commercial real estate loans. Generally, multi-family and commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals. The Bank may not require a personal guarantee on such loans depending on the creditworthiness of the borrower and the amount of the downpayment and other mitigating circumstances. Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to the then prevailing conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards. Construction and Development Lending. The Bank originates construction and development loans for the development of one- to four-family residences. Such loans are made principally to licensed and experienced developers known to the Bank in its primary market area for the construction of single-family developments. The Bank also originates construction and development loans for the development of commercial properties. The Bank generally does not originate loans secured by unimproved land. Construction loans are originated in amounts up to 70% of the lesser of the appraised value of the property, as improved, or the sales price. Such loans are offered for up to two year terms and adjustable interest rates which may adjust monthly and float at margins which are generally indexed to the Prime Rate of interest as reported in The Wall Street Journal. Proceeds of construction loans are disbursed as phases of the construction are completed. Generally, if the borrower is a corporation, partnership or other business entity, personal guarantees by the principals are required. Construction and development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development compared to the estimated cost (including interest) of construction and other assumptions, including the estimated time to sell residential properties. If the estimate of value proves to be inaccurate, the Bank may be confronted with a project, when completed, having a value which is insufficient to assure full repayment. Consumer Lending. Consumer loans at December 31, 2001 consisted primarily of $298,000 in loans secured by deposit accounts and $118,000 in automobile loans. Such loans are generally originated in the Bank's primary market area. These loans are generally shorter term and have higher interest rates than one- to four-family mortgage loans. Loans secured by rapidly depreciable assets such as automobiles or that are unsecured, entail greater risks than one- to four-family mortgage loans. In such cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance, since there is a greater likelihood of damage, loss or depreciation of the underlying collateral. Further, consumer loan collections 9 on these loans are dependent on the borrower's continuing financial stability and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Finally, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the event of a default. Commercial Lending. At December 31, 2001, the Bank had $30,000 in commercial loans. Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and loan approval limits of the Bank. All loans originated by the Bank with principal amounts in excess of $1.0 million require the approval of the Board of Directors. All loans originated by the Bank with principal amounts less than or equal to $1.0 million may be approved by the Bank's Chief Lending Officer. All approved loans are reported to the Board of Directors or the Lending Committee. Pursuant to OTS regulations, loans to one borrower cannot exceed 15% of the Bank's unimpaired capital and surplus. The Bank will not make loans to one borrower that are in excess of the regulatory limits. Underwriting. With respect to all loans originated by the Bank, it is the general policy of the Bank to retain all such loans in its portfolio. The Bank usually underwrites loans in accordance with FNMA or FHLMC guidelines. Upon receipt of a completed loan application from a prospective borrower, a credit report is ordered and certain other information is verified by an independent credit agency. If necessary, additional financial information may be required. An appraisal of real estate intended to secure a proposed loan generally is required to be performed by outside appraisers approved by the Bank. The Board annually approves independent appraisers used by the Bank and approves the Bank's appraisal policy. The Bank's policy is to obtain title and hazard insurance on all mortgage loans and flood insurance when necessary and the Bank generally requires borrowers to make payments to a mortgage escrow account for the payment of property taxes. No title or flood insurance is required, however, for home equity loans. Delinquent Loans, Classified Assets and Real Estate Owned Delinquencies and Classified Assets. Reports listing all delinquent accounts are generated and reviewed by management at least once a month and the Board of Directors performs a monthly review of all loans or lending relationships delinquent 60 days or more and all real estate owned ("REO"). The procedures taken by the Bank with respect to delinquencies vary depending on the nature of the loan, period and cause of delinquency and whether the borrower is habitually delinquent. 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. The Bank's guidelines provide that telephone, written correspondence and/or face-to- face contact will be attempted to ascertain the reasons for delinquency and the prospects of repayment. When contact is made with the borrower at any time prior to foreclosure, the Bank will attempt to obtain full payment, offer to work out a repayment schedule with the borrower to avoid foreclosure or, in some instances, accept a deed in lieu of foreclosure. In the event payment is not then received or the loan not otherwise satisfied, additional letters and telephone calls generally are made. If the loan is still not brought current or satisfied and it becomes necessary for the Bank to take legal action, which typically occurs after a loan is 90 days or more delinquent, the Bank will commence 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 refinanced before the foreclosure sale, the property securing the loan generally is sold at foreclosure and, if purchased by the Bank, becomes REO. Federal regulations and the Bank's Asset Classification Policy require that the Bank utilize an internal asset classification system as a means of reporting problem and potential problem assets. The Bank has incorporated the OTS internal asset classifications as a part of its credit monitoring system. The Bank 10 currently classifies problem and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is considered "Substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "Doubtful" have all of the weaknesses inherent in those classified "Substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "Loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Management of the Bank, in determining the allowance for loan losses, considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with the general economic and real estate market conditions. The Bank utilizes a two tier approach: (i) identification of impaired loans and the establishment of specific loss allowances on such loans; and (ii) establishment of general valuation allowances on the remainder of its loan portfolio. The Bank maintains a loan review system which allows for a periodic review of its loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and estimated fair value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified loans based on a review of such information. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions and management's judgment. Although management believes that adequate loan loss allowances are established, actual losses are dependent upon future events and, as such, further additions to the level of the allowance for loan losses may be necessary. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances. The OTS, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Although management believes that, based on information currently available to it at this time, its allowance for loan losses is adequate, actual losses are dependent upon future events and, as such, further additions to the level of allowances for loan losses may become necessary. The Board reviews classified assets reports prepared by management and classifies its assets on a quarterly basis. The Bank classifies assets in accordance with the management guidelines described above. At December 31, 2001, the Bank had $452,000, or 0.12% of total assets, of assets designated as "Substandard," consisting of two one- to four-family mortgage loans, totaling $222,000, and a multi-family mortgage loan totaling $230,000. At December 31, 2001, the largest loan designated as "Substandard" had a carrying balance of $230,000, and was a multi-family mortgage loan. At December 31, 2001, no assets were designated as "Doubtful" or "Loss." 11 The following table sets forth delinquencies in the Bank's loan portfolio as of the dates indicated. At December 31, 2001 ----------------------------------------------------------- 60-89 Days 90 Days or More --------------------------- --------------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans ------------ ---------- ----------- ---------- Loans: (Dollars in thousands) Residential Mortgage......... 15 $1,127 6 $575 Commercial Mortgage.......... 1 35 - - Construction and land development............... - - - - Consumer loans............... - - 5 3 ---- ---- ---- ---- Total loans................ 16 $1,162 11 $578 ==== ====== ==== ==== Delinquent loans to total loans....................... 1.11% 0.68% 0.76% 0.34% ==== ====== ==== ==== At December 31, 2000 --------------------------------------------------------- 60-89 Days 90 Days or More -------------------------- -------------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans ----------- ---------- ----------- ---------- Loans: (Dollars in thousands) Residential Mortgage......... 5 $443 3 $109 Commercial Mortgage.......... - - - - Construction and land development............... - - - - Consumer loans............... 1 14 3 2 ---- ---- ---- ---- Total loans................ 6 $457 6 $111 ==== ==== ==== ==== Delinquent loans to total loans....................... 0.40% 0.27% 0.40% 0.07% ==== ==== ==== ==== At December 31, 1999 ---------------------------------------------------------- 60-89 Days 90 Days or More --------------------------- ------------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans ------------ ---------- ----------- ---------- Loans: (Dollars in thousands) Residential Mortgage......... 7 $369 11 $792 Commercial Mortgage.......... - - - - Construction and land development............... - - - - Consumer loans............... - - - - ---- ---- ---- ---- Total loans................ 7 $369 11 $792 ==== ==== ==== ==== Delinquent loans to total loans......................... 0.51% 0.24% 0.79% 0.51% ==== ==== ==== ==== 12 Non-Performing Assets and Impaired Loans. The following table sets forth information regarding nonaccrual loans and REO. At December 31, 2001, REO totaled $209,000 and consisted of two properties owned by the Company which are being held for possible future use in operations. It is the policy of the Bank to cease accruing interest on loans 90 days or more past due and to fully reserve for all previously accrued interest. For the years ended December 31, 2001 and 2000, the amount of additional 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 $25,000 and $8,000, respectively. At December 31, 2001 and 2000 and during the year ended December 31, 2001, there were no loans classified as impaired. At December 31, ------------------------------------------------------- 2001 2000 1999 1998 1997 --------- --------- --------- --------- --------- (Dollars in thousands) Nonaccrual loans: Residential Mortgages ............... $ 575 $ 109 $ 792 $1,201 $1,576 Commercial Mortgages ................ -- -- -- 158 119 Construction and land development ... -- -- -- 725 718 Consumer ............................ 3 -- -- -- -- ------ ------ ------ ------ ------ Total nonaccrual loans ............ 578 109 792 2,084 2,413 Delinquent 90 or more days and accruing: Consumer ............................ -- 2 -- -- -- Restructured loans: Residential Mortgages ............... -- 90 92 94 94 ------ ------ ------ ------ ------ Total non-performing loans ........ 578 201 884 2,188 2,507 Real estate owned, net(1) .............. 209 602 900 582 1,215 ------ ------ ------ ------ ------ Total non-performing assets ....... $ 787 $ 803 $1,784 $2,770 $3,722 ====== ====== ====== ====== ====== Non-performing loans as a percent of total loans(2) ........... 0.34% 0.12% 0.57% 1.46% 2.16% ==== ==== ==== ==== ==== Non-performing assets as a percent of total assets(3)......... 0.21% 0.22% 0.51% 0.84% 1.24% ==== ==== ==== ==== ==== ------------------- (1) REO balances are shown net of related valuation allowances. At all period ends, REO includes $209,000 of property that is not considered substandard. (2) Non-performing loans consist of all loans 90 days or more past due and other loans which have been identified by the Bank as presenting uncertainty with respect to the collectibility of interest or principal. (3) Non-performing assets consist of non-performing loans and REO. Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. As of December 31, 2001 and 2000, the Bank's allowance for loan losses was 0.80% and 0.81%, respectively, of total loans receivable and 235.8% and 1251.7%, respectively, of nonaccrual loans. The Bank had non-accrual loans of $578,000 and $109,000 at December 31, 2001 and 2000, respectively. The Bank will continue to monitor and modify its allowances for loan losses as conditions dictate. While management believes the Bank's allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank's level of allowance 13 for loan losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses. The Bank has established a standardized process to assess the adequacy of the allowance for loan losses and to identify the risks inherent in the loan portfolio. The process incorporates credit reviews and gives consideration to areas of exposure such as concentrations of credit, local economic conditions, trends in delinquencies, collateral coverage, the composition of the performing and non-performing loan portfolios, and other risks inherent in the loan portfolio. Specific allocations of the allowance for loan losses are identified by individual loan based upon a detailed credit review of each such loan. General loan loss allowances are allocated to pools of loans categorized by type and assigned allowance percentages which take into effect past charge-off history, industry averages and current trends and risks. Finally, an unallocated portion of the allowance is maintained to account for the general inherent risk in the loan portfolio, known circumstances which are not addressed in the allocated portion of the allowance (such as the increased dependence on outside mortgage brokers for originations), and the necessary imprecision in the determination of the allocation portion of the allowance. The following table sets forth activity in the Bank's allowance for loan losses for the periods set forth in the following table. At or For the Years Ended December 31, ----------------------------------------------------------------- 2001 2000 1999 1998 1997 -------- --------- --------- --------- ---------- (Dollars in thousands) Balance at beginning of period ......... $ 1,363 $ 1,400 $ 1,717 $ 1,885 $ 1,564 --------- --------- --------- ------- ------- Provision for (recapture of) loan losses -- -- -- (131) 487 --------- --------- --------- ------- ------- Charge-offs: Mortgage loans: One- to four-family .............. -- 37 -- 37 60 Multi-family ..................... -- -- -- -- -- Commercial real estate .............. -- -- -- -- 106 Construction and land development ... -- -- 317 -- -- --------- --------- --------- ------- ------- Total mortgage loans ............. -- 37 317 37 166 --------- --------- --------- ------- ------- Recoveries: Construction and land development ... -- -- -- -- -- --------- --------- --------- ------- ------- Balance at end of period ............... $ 1,363 $ 1,363 $ 1,400 $ 1,717 $ 1,885 ========= ========= ========= ======= ======= Ratio of net charge-offs during the period to average gross loans during the period .................... 0.00% 0.02% 0.21% 0.03% 0.17% ========= ========= ========= ======= ======= Allowance for loan losses as a percent of total loans .............. 0.80% 0.81% 0.90% 1.20% 1.62% ========= ========= ========= ======= ======= Allowance for loan losses as a percent of non-performing loans.......... 235.82% 677.75% 158.37% 78.47% 75.19% ========= ========= ========= ======= ======= 14 The following tables set forth the Bank's percent of allowance for loan losses to total allowance for loan losses and the percent of loans to total loans in each of the categories listed at the dates indicated. At December 31, 2001 Percent of Loans in Percent of Each Allowance Category to Total to Total Amount Allowance Loans -------- ----------- ----------- (Dollars in thousands) Mortgage loans: Residential........................... $ 786 57.67% 85.74 Commercial real estate................ 145 10.64 8.33 Construction and land development..... 156 11.44 5.60 ------ ------ ------ Total mortgage loans................ 1,087 79.75 99.67 Commercial loans........................ -- -- 0.02 Consumer loans.......................... 3 0.22 0.31 ------ ------ ------ 1,090 79.97 100.00% Unallocated............................. 273 20.03 ====== ------ ------ Total allowance for loan losses..... $1,363 100.00% ====== ====== At December 31, ------------------------------------------------------------------ 2000 1999 --------------------------------- -------------------------------- Percent of Percent Loans in of Loans Percent of Each Percent of in Each Allowance Category Allowance Category to Total to Total to Total to Total Amount Allowance Loans Amount Allowance Loans ------- ------------ ----------- ------- ------------ ----------- (Dollars in thousands) Mortgage loans: Residential............. $694 50.92% 85.31% $ 735 52.50% 88.83% Commercial real estate................ 149 10.93 7.99 141 10.07 8.30 Construction and land development..... 129 9.46 6.25 46 3.29 2.45 ---- ----- ----- ------- ----- ----- Total mortgage loans.............. 972 71.31 99.55 922 65.86 99.58 Commercial loans........... -- -- 0.02 -- -- 0.02 Consumer loans............. 5 0.37 0.43 6 0.43 0.40 ---- ----- ----- ------- ----- ----- 977 71.68 100.00% 928 66.29 100.00% ====== ====== Unallocated................ 386 28.32 472 33.71 ---- ----- ------- ------ Total................... $1,363 100.00% $1,400 100.00% ====== ====== ====== ====== At December 31, ---------------------------------------------------------------- 1998 1997 ------------------------------- -------------------------------- Percent Percent of Loans of Loans Percent of in Each Percent of in Each Allowance Category Allowance Category to Total to Total to Total to Total Amount Allowance Loans Amount Allowance Loans ------- ------------ ---------- -------- ------------ ---------- (Dollars in thousands) Mortgage loans: Residential............. $ 763 44.44% 88.29% $ 621 32.94% 84.44% Commercial real estate................ 122 7.11 8.11 112 5.94 9.21 Construction and land development..... 418 24.34 3.07 628 33.32 5.58 ------- ----- ----- ------ ----- ----- Total mortgage loans.............. 1,303 75.89 99.47 1,361 72.20 99.23 Commercial loans........... -- -- 0.04 -- -- 0.05 Consumer loans............. 6 0.35 0.49 6 0.32 0.72 ------- ----- ----- ------ ----- ----- 1,309 76.24 100.00% 1,367 72.52 100.00% ====== ====== Unallocated................ 408 23.76 518 27.48 ------- ----- ------ ----- Total................... $1,717 100.00% $1,885 100.00% ====== ====== ====== ====== 15 Real Estate Owned. At December 31, 2001, the Company and the Bank had $209,000 of real estate owned consisting of two properties, neither of which were acquired through foreclosure. When a property is acquired through foreclosure or deed in lieu of foreclosure, it is initially recorded at the lower of the recorded investment in the corresponding loan or the fair value of the related assets at the date of foreclosure, less costs to sell. Thereafter, if there is a further deterioration in value, a specific valuation allowance is provided via a charge to operations for the diminution in value. It is the policy of the Company and the Bank to have obtained an appraisal on all real estate subject to foreclosure proceedings prior to the time of foreclosure, to require appraisals on a periodic basis on foreclosed properties and to conduct inspections on foreclosed properties. Investment Activities The Company can invest in common and preferred stocks, limited partnerships and all investments in which the Bank is permitted to invest. Anything else requires the Board of Director's approval. 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 their assets in commercial paper, investment-grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. Additionally, the Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. Historically, the Bank has maintained liquid assets above the minimum OTS requirements and at a level considered to be adequate to meet its normal daily activities. The Company's current policies generally limit securities investments to U.S. Government and agency securities, municipal bonds and corporate debt obligations and corporate equities. In addition, the Company's policies permit investments in mortgage-backed securities, including securities issued and guaranteed by FNMA, FHLMC and GNMA. The Company's current securities investment strategy is to continue to emphasize the purchase of mortgage-backed securities and U.S. Government and agency obligations as well as state and municipal obligations for purposes of interest rate risk management. At December 31, 2001, the Company had $170.5 million in securities, consisting primarily of mortgage-backed securities, U.S. Government and agency obligations, trust preferred securities and municipal obligations. SFAS No. 115 requires the Company to designate its securities as held-to-maturity, available-for-sale or trading depending on the Company's intent regarding its investments. The Company does not currently maintain a trading portfolio of securities. Mortgage-Backed Securities. The Company purchases mortgage-backed securities in order to: (i) generate positive interest rate spreads with minimal administrative expense; (ii) reduce its credit risk as a result of the guarantee provided by FHLMC, FNMA and GNMA; (iii) utilize these securities as collateral for borrowings; and (iv) increase the liquidity of the Company. The Company has primarily invested in mortgage-backed securities issued or sponsored by FNMA, FHLMC and GNMA and private issuers. The mortgage-backed securities portfolio had coupon rates ranging from 3.63% to 15.00% and had a weighted average yield of 6.20% at December 31, 2001. Mortgage-backed securities are created by the pooling of mortgages and issuance of a security with an interest rate which is less than the interest rate on the underlying mortgage. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although the Company focuses its investments on mortgage-backed securities backed by single-family mortgages. The issuers of such securities (generally U.S. Government agencies and government sponsored enterprises, 16 including FNMA, FHLMC and GNMA) pool and resell the participation interests in the form of securities to investors such as the Company and guarantee the payment of principal and interest to investors. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of loan servicing and payment guarantees. In addition, mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of the Company. Investments in mortgage-backed securities involve a risk that actual prepayments will differ from estimated prepayments used in pricing the security at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates. The Company estimates prepayments for its mortgage-backed securities at purchase to ensure that prepayment assumptions are reasonable considering the underlying collateral for the mortgage-backed securities at issue and current mortgage interest rates and to determine the yield and estimated maturity of its mortgage-backed security portfolio. Of the Company's $137.3 million mortgage-backed securities portfolio at December 31, 2001, $384,000 with a weighted average yield of 8.07% had contractual maturities within five years and $136.9 million with a weighted average yield of 6.19% had contractual maturities over five years. However, the actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and may result in a loss of any premiums paid and thereby reduce the net yield on such securities. Although prepayments of underlying mortgages depend on many factors, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Company may be subject to reinvestment risk because, to the extent that the Company's mortgage-backed securities prepay faster than anticipated, the Company may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. U.S. Government and Agency Obligations and Obligations of States and Municipalities. At December 31, 2001, the U.S. Government and Agency securities portfolio totaled $22.6 million, or 6.1% of total assets, all of which were classified as held-to-maturity. In addition, the Company held $584,000 in obligations of New Jersey municipal subdivisions. Trust Preferred Securities. At December 31, 2001, the investment portfolio included $10.0 million, or 2.7% of total assets, in trust preferred securities, all of which were purchased in 1998. Trust preferred securities are non-perpetual cumulative preferred stock issued by a wholly owned subsidiary of a bank and are classified as debt securities under generally accepted accounting principles. Securities of this nature are permissible investments for banks and thrifts provided they are of investment grade quality and are rated as such by any of the top rating services. Before purchasing these investments, the Bank researched extensively the permissibility and suitability of these investments and whether they had a place on the balance sheet of the Bank. The Bank's policy as approved by the Board of Directors allows for the purchase of investments which are considered investment grade and are permissible investments under OTS regulations. Securities considered investment grade must be rated in one of the four highest categories by a nationally recognized statistical rating agency. Additionally, the Board's policy limits these type of investments to a maximum aggregate dollar amount of $10,000,000. The Bank's conclusion was that these investments had a place on the balance sheet and, during 1998, $10.0 million of trust preferred security investments in five of the most well known large commercial banks in the eastern United States was made. In addition to $8.9 million of such securities owned by the Bank, the Company owns one trust preferred security which is carried at $1.1 million. 17 During 1999, the OTS reviewed these securities and concluded that, in its opinion, three of the five investments were not of a type suitable for the Bank. Accordingly, the OTS mandated that the Bank liquidate these issues as soon as possible without incurring a loss. The Company determined that these three securities should be retained and thus the Bank may transfer them to the Company over a period of time. One of the three issues was transferred during the fourth quarter of 1999. The $10.0 million in trust preferred securities is a combination of $6.8 million in floating rate (spread to Libor) investments and $3.2 million in fixed rate investments. The adjustable investments offer quarterly interest adjustments, uncapped coupons and call protection unavailable in most other types of adjustable investments. The fixed rate investments offer yield for the balance sheet and presented a cost of funds spread which was unavailable in other types of alternative investments. These investments present the normal type of risk to the Company and the Bank that is associated with other forms of marketable debt securities. These include credit risk, which is associated with the underlying creditworthiness of the issuer, liquidity risk, which is associated with the ability to dispose of a security in a reasonable time period at a reasonable price, and call risk, which is associated with these securities having call provisions after 10 years. The following table sets forth certain information regarding the amortized cost and fair value of securities at the dates indicated. At December 31, ----------------------------------------------------------- 2001 2000 1999 -------------------- ------------------- ------------------ Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- -------- --------- --------- --------- -------- (In thousands) Investment securities available-for-sale(1): U.S. Government and Agency obligations................ $ -- $ -- $ 2,999 $ 2,994 $ 2,998 $ 2,924 ------- ------- ------- ------- ------- ------- Investment securities held-to-maturity (1): U.S. Government and Agency obligations............ 22,600 22,342 31,155 30,577 30,856 28,904 Trust preferred securities...... 9,985 8,457 9,989 8,768 9,993 9,286 Obligations of states and municipal subdivisions........ 584 576 584 580 733 679 ------- ------- ------- ------- ------- ------- 33,169 31,375 41,728 39,925 41,582 38,869 ------- ------- ------- ------- ------- ------- Federal Home Loan Bank of New York stock (2).............. 3,843 3,843 3,558 3,558 3,273 3,273 ------- ------- ------- ------- ------- ------- Total......................... $37,012 $35,218 $48,285 $46,477 $47,853 $45,066 ======= ======= ======= ======= ======= ======= (1) Available-for-sale securities are carried at fair value while held-to-maturity securities are carried at amortized cost. (2) Investment is required by regulation. As the security is not readily marketable, its cost approximates fair value. 18 The following table sets forth investment securities activities for the periods indicated. At December 31, ------------------------------ 2001 2000 1999 --------- -------- --------- (In thousands) Investment securities: Investment securities, beginning of period(1)... $44,722 $44,506 $45,156 ------- ------- ------- Purchases: Investment securities-held-to-maturity....... 14,000 -- 21,045 Investment securities-available-for-sale..... -- -- - Calls: Investment securities-held-to-maturity....... (22,848) -- (14,550) Investment securities-available-for-sale..... (1,000) -- -- Maturities: Investment securities-held-to-maturity....... -- (150) (1,150) Investment securities-available-for-sale..... -- -- -- Sales: Investment securities-held-to-maturity....... -- -- (908) Investment securities-available-for-sale..... (2,000) -- (4,987) Amortization of premiums and discounts.......... 290 297 274 Unrealized gain (loss).......................... 5 69 (374) ------- ------- ------- Net increase in investment securities........ (11,553) 216 (650) ------- ------- ------- Investment securities, end of period............ $33,169 $44,722 $44,506 ======= ======= ======= (1) Includes investment securities available-for-sale. 19 The following table sets forth certain information regarding the amortized cost and fair values of the Company's mortgage-backed securities, all of which are held-to-maturity, at the dates indicated. At December 31, ----------------------------------------------------------------------------------------- 2001 2000 1999 ----------------------------- ---------------------------- ---------------------------- Percent Percent Percent Amortized of Fair Amortized of Fair Amortized of Fair Cost Total(1) Value Cost Total(1) Value Cost Total(1) Value ---- -------- ----- ---- -------- ----- ---- -------- ----- (Dollars in thousands) By Issuer: GNMA.................... $ 56,909 41.44% $ 57,689 $ 56,873 43.54% $57,226 $ 51,616 42.58% $ 51,762 FHLMC................... 29,269 21.31 30,025 31,052 23.77 31,176 18,781 15.49 18,576 FNMA.................... 27,132 19.76 27,108 17,243 13.20 17,259 16,894 13.94 16,787 Other................... 24,018 17.49 24,513 25,460 19.49 24,524 33,932 27.99 31,682 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total mortgage-backed securities (1)(2). $137,328 100.00% $139,335 $130,628 100.00% $130,185 $121,223 100.00% $118,807 ======== ====== ======== ======== ====== ======== ======== ====== ======== By Coupon Type: Adjustable-rate......... $ 71,991 52.42% $ 72,973 $ 78,092 59.78%$ 78,446 $ 59,667 49.22% $ 59,764 Fixed-rate.............. 65,337 47.58 66,362 52,536 40.22 51,739 61,556 50.78 59,043 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total mortgage-backed securities (1)(2). $137,328 100.00% $139,335 $130,628 100.00% $130,185 $121,223 100.00% $118,807 ======== ====== ======== ======== ====== ======== ======== ====== ======== (1) Based on amortized cost. (2) Includes net unamortized (discounts) premiums of $106, $(35) and $(37) at December 31, 2001, 2000 and 1999, respectively. The following table sets forth the Company's mortgage-backed securities activities for the periods indicated. For the Years Ended December 31, ---------------------------------------- 2001 2000 1999 ---------- ----------- ------------ (In thousands) Beginning balance ..................... $130,628 $121,223 $110,376 Purchases........................... 47,112 32,016 46,531 Principal repayments................ (40,383) (22,699) (35,580) Net amortization and accretion of discounts and premiums........... (29) (88) (104) -------- -------- -------- Ending balance......................... $137,328 $130,628 $121,223 ======== ======== ======== 20 The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of investment securities available-for-sale and held-to-maturity and mortgage-backed securities held-to-maturity as of December 31, 2001. At December 31, 2001 ------------------------------------------------------------------ More than One More than Five One Year or Less Year to Five Years Years to Ten Years ----------------------- -------------------- --------------------- Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield ---------- ----------- -------- -------- ---------- -------- (Dollars in thousands) Investment securities held-to-maturity: U.S. Treasury and Government agency obligations....................... $ -- -- $ -- -- $ 4,000 5.68% Municipal obligations (1)................... -- -- -- -- 100 6.14% Trust preferred securities.................. -- -- -- -- -- -- ------ ---- ------- Total investment securities held to maturity .......................... $ -- -- $ -- -- $ 4,100 5.69% ====== ==== ======= Mortgage-backed securities held-to-maturity: Adjustable-rate: GNMA ................................... $ -- -- $ -- -- $ -- -- FHLMC .................................. -- -- -- -- -- -- FNMA ................................... -- -- -- -- -- -- Other .................................. -- -- -- -- -- -- ------ ------- Total....................... -- -- -- -- -- -- ------ ------- Fixed-rate: GNMA ................................... -- -- 361 8.01% 3,346 7.34% FHLMC .................................. 1 9.00% 22 9.00% 6,897 6.77% FNMA ................................... -- -- -- -- 5,856 6.30% Other .................................. -- -- -- -- 4 11.00% ------ ---- ------- Total .......................... 1 9.00% 383 8.07% 16,103 6.72% ------ ---- ------- Total mortgage-backed securities held-to-maturity............................ $ 1 9.00% $383 8.07% $16,103 6.72% ====== ==== ======= At December 31, 2001 -------------------------------------------- More than Ten Years Total Weighted Weighted Carrying Average Carrying Average Value Yield Value Yield ----------- -------- ----------- -------- Investment securities held-to-maturity: U.S. Treasury and Government agency obligations....................... $ 18,600 6.59% $ 22,600 6.43% Municipal obligations (1)................... 484 6.42% 584 6.37% Trust preferred securities.................. 9,985 4.32% 9,985 4.32% -------- -------- Total investment securities held to maturity .......................... $ 29,069 5.81% $ 33,169 5.79% ======== ======== Mortgage-backed securities held-to-maturity: Adjustable-rate: GNMA ................................... $ 52,411 5.58% $ 52,411 5.58% FHLMC .................................. 16,917 6.84% 16,917 6.84% FNMA ................................... 1,287 6.44% 1,287 6.44% Other .................................. 1,600 3.63% 1,600 3.63% -------- -------- Total....................... 72,215 5.84% 72,215 5.84% -------- -------- Fixed-rate: GNMA ................................... 792 8.52% 4,499 7.60% FHLMC .................................. 5,432 6.69% 12,352 6.74% FNMA ................................... 19,989 6.15% 25,845 6.18% Other .................................. 22,413 6.78% 22,417 6.78% -------- -------- Total .......................... 48,626 6.54% 65,113 6.59% -------- -------- Total mortgage-backed securities held-to-maturity............................ $120,841 6.12% $137,328 6.20% ======== ======== ----------------------- (1) Weighted average yield for municipal securities is based on a tax equivalent basis on an assumed tax rate of 34%. 21 Sources of Funds General. Deposits, loan repayments and prepayments, security maturities, cash flows generated from operations and FHLB 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. The Bank's deposits consist of savings, checking accounts, NOW accounts, money market and club accounts, certificate of deposit accounts and Individual Retirement Accounts. For the year ended December 31, 2001, average core deposits, which include all non-certificate deposits, represented 38.2% 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 has historically relied primarily on 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 uses traditional means of advertising its deposit products through print media and generally does not solicit deposits from outside its market area. The Bank does not actively solicit certificate accounts in excess of $100,000 or use brokers to obtain deposits. At December 31, 2001, 85.6% of the Bank's certificate of deposit accounts had remaining terms of less than twelve months. The following table presents the deposit activity of the Bank for the periods indicated. For the Years Ended December 31, -------------------------------------- 2001 2000 1999 -------- -------- -------- (In thousands) Beginning balance.......................... $237,956 $234,978 $238,313 -------- -------- -------- Net deposits (withdrawals).............. (6,140) (6,378) (11,919) Interest credited....................... 9,048 9,356 8,584 -------- -------- -------- Increase (decrease) in deposit accounts.... 2,908 2,978 (3,335) -------- -------- -------- Ending balance............................. $240,864 $237,956 $234,978 ======== ======== ======== At December 31, 2001, the Bank had $25.9 million in certificate accounts in amounts of $100,000 or more maturing as follows. Weighted Average Maturity Period Amount Rate --------------- ---------- ------------ (Dollars in thousands) Three months or less........................ $ 8,619 4.59% Over 3 through 6 months..................... 5,421 4.22 Over 6 through 12 months.................... 8,119 4.27 Over 12 months.............................. 3,726 5.37 -------- Total....................................... $ 25,885 4.53 ======== 22 The following table sets forth the distribution of the Bank's average deposit accounts for the periods indicated and the weighted average interest rates on each category of deposits presented. Averages for the periods presented utilize month-end balances. For the Years Ended December 31, --------------------------------------------------------------- 2001 2000 ------------------------------ ------------------------------ Percent Percent of Total Weighted of Total Weighted Average Average Average Average Average Average Balance Deposits Rate Balance Deposits Rate ---------- --------- -------- --------- --------- -------- (Dollars in thousands) Demand accounts.......................... $ 36,245 15.22% 0.68% $ 36,536 15.48% 0.75% Savings and Club accounts................ 54,585 22.93 2.02 54,218 22.97 2.05 Certificates of deposit.................. 147,240 61.85 5.23 145,253 61.55 5.49 ------- ------ --------- ------ Total........................... $238,070 100.00% 3.80 $236,007 100.00% 3.96 ======== ====== ======== ====== Certificate accounts(1): Less than six months.................. $ 80,272 55.25% 4.41% $ 79,969 53.65% 5.59% Over six through 12 months............ 44,158 30.39 4.00 41,539 27.87 5.95 Over 12 months through 36 months...... 18,523 12.75 4.98 24,274 16.29 5.95 Over 36 months........................ 2,333 1.61 5.15 3,269 2.19 5.92 ------- ------ --------- ------ Total certificate accounts...... $145,286 100.00% 4.37 $149,051 100.00% 5.76 ======== ====== ======== ====== For the Years Ended December 31, ------------------------------ 1999 ------------------------------ Percent of Total Weighted Average Average Average Balance Deposits Rate ---------- --------- -------- (Dollars in thousands) Demand accounts.......................... $ 36,308 15.35% 0.78% Savings and Club accounts................ 58,727 24.84 2.06 Certificates of deposit.................. 141,432 59.81 5.01 ------- ----- Total........................... $236,467 100.00% 3.63 ======== ====== Certificate accounts(1): Less than six months.................. $ 71,619 51.11% 4.84% Over six through 12 months............ 40,181 28.67 5.11 Over 12 months through 36 months...... 24,400 17.41 5.49 Over 36 months........................ 3,940 2.81 5.81 -- ----- ---- Total certificate accounts...... $140,140 100.00% 5.05 ======== ====== (1) Based on remaining maturity of certificates calculated as of the end of the period. 23 The following table presents, by various rate categories, the amount of certificate accounts outstanding at the dates indicated and the periods to maturity of the certificate accounts outstanding at December 31, 2001. Period to Maturity from December 31, 2001 ------------------------------------------------------------------------- Less than One to Two to Three to Four to After One Year Two years Three years Four years Five years Five Years ----------- ---------- ----------- ----------- ---------- ----------- (In thousands) Certificate accounts: 2.00% and below........ $ 4,410 $ 17 $ -- $ -- $ -- $ 55 2.01% to 3.00%......... 18,358 2,041 233 5 1 -- 3.01 to 4.00%.......... 30,072 2,309 500 44 202 259 4.01 to 5.00%.......... 46,089 3,868 1,062 202 621 1 5.01 to 6.00%.......... 10,914 2,107 1,279 420 21 3 6.01 to 7.00%.......... 13,642 3,924 946 428 -- -- 7.01 to 8.00%.......... 285 237 -- 70 -- -- Over 9.00%............. -- -- -- -- -- -- -------- ------- ------ ------ ---- ---- $123,770 $14,503 $4,020 $1,169 $845 $318 ======== ======= ====== ====== ==== ==== Accrued interest payable At December 31, ------------------------------------- 2001 2000 1999 ---------- ----------- ----------- Certificate accounts: 2.00% and below........ $ 4,482 $ -- $ -- 2.01% to 3.00%......... 20,638 -- -- 3.01 to 4.00%.......... 33,386 3,603 2,808 4.01 to 5.00%.......... 51,843 34,193 66,049 5.01 to 6.00%.......... 14,744 32,323 60,282 6.01 to 7.00%.......... 18,940 76,074 10,303 7.01 to 8.00%.......... 592 2,289 424 Over 9.00%............. -- -- 21 -------- -------- -------- 144,625 148,482 139,887 Accrued interest payable.. 661 569 253 -------- -------- -------- Total.................. $145,286 $149,051 $140,140 ======== ======== ======== 24 Borrowings. The Bank utilizes borrowings from the FHLB as an alternative to retail deposits to fund its operations as part of its operating strategy. These FHLB borrowings are collateralized primarily by certain of the Bank's mortgage-related securities and secondarily by the Bank's investment in capital stock of the FHLB. FHLB borrowings are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the FHLB. See "Regulation and Supervision-Federal Home Loan Bank System." At December 31, 2001, the Bank had $76.9 million in outstanding FHLB borrowings, compared to $62.3 million at December 31, 2000. The following table sets forth certain information regarding the Bank's borrowed funds at or for the periods ended on the dates indicated. At or For the Years Ended December 31, -------------------------------------- 2001 2000 1999 ------------ ------------ ---------- (Dollars in thousands) Average balance outstanding............... $66,532 $65,592 $57,756 Maximum amount outstanding at any month-end during the period........... 76,856 69,167 65,453 Balance outstanding at end of period...... 76,856 62,290 64,340 Weighted average interest rate during the period...................... 5.61% 5.85% 5.67% Weighted average interest rate at end of period.......................... 5.08% 5.78% 5.66% Subsidiary Activities The Company is the parent corporation of two wholly owned subsidiaries, the Bank and West Essex Property Company ("West Essex Property"). West Essex Property was formed in April 1999 to purchase a parcel of land located in Sussex County, New Jersey from the Company. Upon the purchase of this parcel of land, West Essex Property was to have entered into an arrangement to lease the property to a restaurant chain. As of December 31, 2001, West Essex Property has neither purchased the parcel of land nor entered into a lease arrangement. As of December 31, 2001 and for the year then ended, West Essex Property had no operations, assets, liabilities or equity. In addition, the Bank is the parent corporation of one wholly owned subsidiary corporation, West Essex Insurance Agency ("WEIA"). WEIA was formed in December 1982 to offer insurance products and tax-deferred annuities through an agent. Originally, these products were sold at one of the Bank's branches. Commencing in 1993, customers have been referred to Anthony R. Davis Agency at an off-site location. WEIA receives a fee for each customer referral resulting in the purchase of an insurance and/or annuity product. Sales of annuity products totaled $777,000 for the year ended December 31, 2001. WEIA's earnings are at a nominal level since management decided in early 1994 to de-emphasize this activity due to the lack of demand and controversial publicity associated with uninsured annuity products. Personnel As of December 31, 2001, the Company had 49 authorized full-time employee positions and 6 authorized part-time employee positions. The employees are not represented by a collective bargaining unit and the Bank considers its relationship with its employees to be good. 25 REGULATION AND SUPERVISION General The Bank is subject to extensive regulation, examination and supervision by the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The Bank is a member of the FHLB System. The Bank's deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to test the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the MHC and the Bank and their operations. The MHC, as a federal mutual holding company and the Company, as a federal corporation, will also be required to file certain reports with, and otherwise comply with the rules and regulations of the OTS. The following summary of the regulation and supervision of savings associations and their holding companies does not purport to be a complete description of the applicable statutes and regulations and is qualified in its entirety by reference to such statutes and regulations. Federal Savings Institution Regulation Business Activities. The activities of federal savings banks 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, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution's capital or assets. 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. 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, 2001, the Bank's limit on loans to one borrower was $6.8 million, and the Bank's largest aggregate outstanding balance of loans to one borrower was $2.8 million. QTL Test. The HOLA 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: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. 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, 2001, the Bank maintained 88.8% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. 26 Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by a savings institution, 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 prior approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under OTS regulations (i.e., generally, 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 agreement with OTS. If an application is not required, the institution must still provide prior notice to OTS 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 OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended December 31, 2001 totaled $79,000. 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. The Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed. Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may 27 range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that a savings institution fails to meet any standard prescribed by the guidelines, the OTS may require the institution to submit an acceptable plan to achieve compliance with the standard. Capital Requirements. The OTS 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 CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The OTS 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 Tier 1 (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 assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OTS capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) 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 cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, 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 capital regulations also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. For the present time, the OTS has deferred implementation of the interest rate risk capital charge. At December 31, 2001, the Bank met each of its capital requirements. 28 The following table presents the Bank's capital position at December 31, 2001. Excess Capital --------------------------------- Actual Required (Deficiency) Actual Required Capital Capital Amount Percent Percent ----------------- ------------- ----------------- -------------- --------------- (Dollars in thousands) Tangible............ $44,281 $5,487 $38,794 12.11% 1.50% Core (Leverage)..... 44,281 14,632 29,649 12.11 4.00 Risk-based.......... 45,644 11,286 34,358 32.35 8.00 Prompt Corrective Regulatory Action. The OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Insurance of Deposit Accounts. The Bank is a member of the SAIF. The FDIC maintains a risk- based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends upon the categories to which it is assigned. Assessment rates for SAIF member institutions are determined semi-annually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. The FDIC has authority to increase insurance assessments. A significant increase in SAIF insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future. In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 2001, FICO payments for SAIF members approximated 1.9 basis points. 29 Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Community Reinvestment Act. Under the Community Reinvestment Act, as amended ("CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The Bank's latest CRA rating received from the OTS was "Satisfactory." Federal Home Loan Bank System The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank's net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership. Federal Reserve System The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The 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 $41.3 million; a 10% reserve ratio is applied above $41.3 million. The first $5.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. The Bank complies with the foregoing requirements. Holding Company Regulation General. The Company is a federal savings and loan holding company within the meaning of the HOLA. As such, the Company is registered with the OTS and is subject to OTS regulations, examinations, supervision and reporting requirements. In addition, the OTS has enforcement authority over the Company 30 and its non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. The Bank must notify the OTS 30 days before declaring any dividend to the Company. Restrictions Applicable to Mutual Holding Companies. Pursuant to Section 10(o) of the HOLA and the Regulations, a mutual holding company, such as the MHC, may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association and (iv) any activity approved by the Federal Reserve Board for a bank holding company or financial holding company. Recent legislation, which authorized MHCs to engage in activities permitted financial holding companies, expanded the authorized activities. Financial holding companies may engage in a broad array of financial service activities including insurance and securities. The HOLA prohibits a savings and loan holding company, including a federal mutual holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of the voting stock of another savings institution, or holding company thereof, without prior written approval of the OTS. The HOLA also prohibits a savings and loan holding company from acquiring more than 5% of a company engaged in activities other than those authorized for savings and loan holding companies by the HOLA; or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors. The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, except: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions. If the savings institution subsidiary of a savings and loan holding company fails to meet the QTL test set forth in Section 10(m) of the HOLA and the regulations of the OTS, the holding company must register with the Federal Reserve Board as a Bank Holding Company within one year of the savings institution's failure to so qualify. Stock Holding Company Subsidiary Regulation. The OTS has adopted regulations governing the two-tier mutual holding company form of organization and mid-tier stock holding companies that are controlled by mutual holding companies. Under these rules, the stock holding company subsidiary holds all the shares of the mutual holding company's savings association subsidiary and issues the majority of its own shares to the mutual holding company parent. In addition, the stock holding company subsidiary is permitted to engage in activities that are permitted for its mutual holding company parent and to have the same indemnification and employment contract restrictions imposed that are on the mutual holding company parent. Finally, OTS regulations maintain that the stock holding company subsidiary must be federally chartered for supervisory reasons. 31 FEDERAL AND STATE TAXATION Federal Taxation General. The Bank, the Company and the MHC will report their income on a calendar year basis using the accrual method of accounting and will be subject to federal income taxation in the same manner as other corporations with some exceptions, 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, the Company and the MHC. Bad Debt Reserve. Historically, savings institutions such as the Bank which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrifts") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Bank's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted addition to the non-qualifying loan loss reserve. Due to the Bank's loss experience, the Bank generally recognized a bad debt deduction equal to 8% of taxable income. In August 1996, the provisions repealing the above thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also require that all thrift institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has previously recorded a deferred tax liability equal to the bad debt recapture and as such, the new rules will have no effect on net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Bank's bad debt deduction will be equal to net charge-offs. The new rules allow an institution to suspend the bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996. For this purpose, only home purchase and home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to a provision of present law referred to below that require recapture in the case of certain excess distributions to shareholders. Distributions. To the extent that the Bank makes "non-dividend distributions" to the Company that are considered as made (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method, or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the Bank's taxable income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank's bad debt 32 reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. 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. 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). Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Bank. The MHC may exclude from its income 80% of dividends received from the Company as long as it maintains ownership in the Company of at least 20%. In addition, the MHC waived dividends from the Company during the year ended December 31, 2001 and 2000. Audits. The Bank was last audited by the IRS in 1994. The Bank was not audited by the New Jersey Department of Revenue ("DOR") in the past five years. State and Local Taxation State of New Jersey. The Bank, the Company and the MHC file New Jersey income tax returns. For New Jersey income tax purposes, savings institutions are presently taxed at a rate equal to 3% 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). For New Jersey tax purposes, regular corporations are presently taxed at a rate equal to 9% of taxable income (7.5% is the rate if taxable income is less than $100,000). 33 Item 2. Description of Properties. ----------------------------------- The Bank currently conducts its business through an administrative and full service branch office located in Caldwell, New Jersey and seven other full service branch offices located in West Orange, Franklin Lakes, River Vale, Pine Brook, Old Tappan and Northvale, New Jersey. Management believes that the Bank's facilities are adequate to meet the present and immediately foreseeable needs of the Bank and the Company. Original Net Book Value Year of Property or Leased Leased Leasehold or or Improvements at Location Owned Acquired December 31, 2001 --------- ---------- ---------- ---------------- (In thousands) Administrative/Corporate/ Branch Office: 417 Bloomfield Avenue Owned 1962 $346 Caldwell, NJ 07006 Branch Offices: 216 Main Street Owned 1987 140 West Orange, NJ 07052 487 Pleasant Valley Way Owned 1987 174 West Orange, NJ 07052 574 Franklin Avenue Leased 1978 0 Franklin Lakes, NJ 07417 653 Westwood Avenue Owned 1997 454 River Vale, NJ 07675 267 Changebridge Road Owned 1974 223 Pine Brook, NJ 07058 207 Old Tappan Road Owned 1997 463 Old Tappan, NJ 07675 119 Paris Avenue Owned 1997 301 Northvale, NJ 07647 Item 3. Legal Proceedings. ---------------------------- Neither the Company nor the Bank is involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, including a recent lawsuit filed by a former employee related to a claim filed by that employee under the Workers' Compensation Law of the State of New Jersey. Such routine legal proceedings in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders. -------------------------------------------------------------- None. 34 PART II Item 5. Market for Common Equity and Related Stockholder Matters. ------------------------------------------------------------------ Information regarding the market for the Company's common equity and related stockholder matters appears on the inside front cover of the 2001 Annual Report under the caption "Investor and Corporate Information" and is incorporated herein by reference. Item 6. Management's Discussion and Analysis or Plan of Operation. ------------------------------------------------------------------- Information regarding management's discussion and analysis of financial condition and results of operations appears in the 2001 Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and is incorporated herein by this reference. Item 7. Financial Statements. ------------------------------ Information regarding the financial statements and the Independent Auditors' Report appears in the 2001 Annual Report and is incorporated herein by this reference. Item 8. Changes in and Disagreements with Accountants on Accounting and ----------------------------------------------------------------------- Financial Disclosure. --------------------- None. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance -------------------------------------------------------------------------------- With Section 16(a) of the Exchange Act. --------------------------------------- The information relating to Directors and Executive Officers of the Registrant and compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the Registrant's Proxy Statement for the 2002 Annual Meeting of Stockholders, sections entitled "Proposal 1- Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance." Item 10. Executive Compensation. --------------------------------- The information relating to directors' compensation and executives' compensation is incorporated herein by reference to the Registrant's Proxy Statement for the 2002 Annual Meeting of Stockholders, sections entitled "Proposal 1 - Election of Directors - Directors' Compensation" and "Executive Compensation." Item 11. Security Ownership of Certain Beneficial Owners and Management. ------------------------------------------------------------------------- The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the 2002 Annual Meeting of Stockholders, section entitled "Stock Ownership." Item 12. Certain Relationships and Related Transactions. --------------------------------------------------------- The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the 2002 Annual Meeting of Stockholders, section entitled "Transactions with Management." 35 Item 13. Exhibits, List and Reports on Form 8-K. ------------------------------------------------- (a) (1) The following are filed as a part of this report by means of incorporation to the Company's 2001 Annual Report to Stockholders: o Independent Auditors Report o Consolidated Statements of Financial Condition as of December 31, 2001 and December 31, 2000 o Consolidated Statements of Income for the Years Ended December 31, 2001 and December 31, 2000 o Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2001 and 2000 o Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2001 and December 31, 2000 o Consolidated Statements of Cash Flows for the Years Ended December 31, 2001 and December 31, 2000 o Notes to Consolidated Financial Statements (2) All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto. (3) The following exhibits are filed as part of this report. 3.1 Federal MHC Subsidiary Holding Company Charter of West Essex Bancorp, Inc.* 3.2 Bylaws of West Essex Bancorp, Inc.* 4.0 Draft Stock Certificate of West Essex Bancorp, Inc.* 10.1 West Essex Bank Employee Stock Ownership Plan** 10.2 West Essex Bank Employee Stock Ownership Plan Trust** 10.3 ESOP Loan Commitment Letter** 10.4 West Essex Bank Employee Stock Ownership Trust Loan and Security Agreement** 10.5 Employment Agreement between West Essex Bank and Leopold W. Montanaro** 10.6 Employment Agreement between West Essex Bancorp, Inc. and Leopold W. Montanaro** 10.7 Three Year Change in Control Agreement between West Essex Bank and Dennis A. Petrello** 10.8 Three Year Change in Control Agreement between West Essex Bank and Charles E. Filippo** 10.9 Three Year Change in Control Agreement between West Essex Bank and Craig L. Montanaro** 10.10 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Dennis A. Petrello** 10.11 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Charles E. Filippo** 10.12 Three Year Change in Control Agreement between West Essex Bancorp, Inc. and Craig L. Montanaro** 10.13 West Essex Bank Employee Severance Compensation Plan** 10.14 West Essex Bank Supplemental Executive Retirement Plan** 10.15 West Essex Bank Management Supplemental Executive Retirement Plan** 10.16 Restated Executive Supplemental Retirement Income Agreement for Leopold W. Montanaro* 10.17 Restated Executive Supplemental Retirement Income Agreement for Charles E. Filippo* 36 10.18 West Essex Bancorp, Inc. 1999 Stock Based Incentive Plan, as amended and restated*** 11.0 Computation of Earnings Per Share 13.0 Portions of the 2001 Annual Report to Shareholders 21.0 Subsidiary information is incorporated herein by reference to "Part I-Business-Subsidiary Activities" 23.0 Consent of Radics & Co., LLC (b) Reports on Form 8-K None. __________________________________ * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, filed on June 12, 1998, as amended, Registration No. 333-56729. ** Incorporated herein by reference into this document from the Exhibits to the Form 10-K, filed on March 31, 1999. ***Incorporated herein by reference into this document from the definitive Proxy Statement dated March 27, 2000. 37 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. WEST ESSEX BANCORP, INC. By:/s/ Leopold W. Montanaro ----------------------------- Leopold W. Montanaro Chairman of the Board, President and Chief Executive Officer Date: March 27, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Name Title Date ---- ----- ---- /s/ Leopold W. Montanar Chairman of the Board March 27, 2002 --------------------------- Leopold W. Montanaro President and Chief Executive Officer (principal executive officer) /s/ Dennis A. Petrello Senior Executive Vice President March 27, 2002 --------------------------- Dennis A. Petrello and Chief Financial Officer (principal accounting and financial officer) /s/ William J. Foody Director March 28, 2002 --------------------------- William J. Foody /s/ David F. Brandley Director March 27, 2002 --------------------------- David F. Brandley /s/ Everett N. Leonard Director March 27, 2002 --------------------------- Everett N. Leonard /s/ John J. Burke Director March 27, 2002 --------------------------- John J. Burke 38