ITEM 1. BUSINESS
General
Federal Trust Corporation ("Federal Trust" or the "Company" or the "Holding Company") was organized in February 1989 for the purpose of becoming the unitary savings and loan holding company of Federal Trust Bank (the "Bank"), a federally chartered stock savings bank then headquartered in Amelia Island, Florida. Federal Trust's and the Bank's headquarters are currently located in Winter Park, Florida. Federal Trust is currently conducting business as a unitary savings and loan holding company, and its principal asset is all of the capital stock of the Bank. As a unitary holding company, Federal Trust has greater flexibility than the Bank to diversify and expand its business activities, either through newly formed subsidiaries or through acquisitions.
Federal Trust's primary investment is the ownership of the Bank. The Bank is chartered as a federal stock savings bank and is primarily engaged in the business of obtaining funds in the form of deposits and Federal Home Loan Bank ("FHLB") advances and investing such funds in permanent loans on residential and to a lesser extent commercial real estate primarily in Florida, in various types of construction and other loans and in investment securities. The Holding Company had been operating two non-bank subsidiaries, Federal Trust Properties Corp. ("FTPC") , a real estate holding and development company, organized December 12, 1994, which owned two office buildings in Amelia Island, Florida until December, 1995 and a residential site in Augusta, Georgia; and 1270 Leasing Co. ("1270 LC"), a real estate leasing entity organized May 27, 1994, which leased the Holding Company's office located in Winter Park, Florida. On July 1, 1996, the Company sold FTPC to an unaffiliated third party and is renting the office space previously occupied by the Company to FTPC. On September 26, 1996, the company dissolved 1270 Leasing Co.
The Federal Deposit Insurance Corporation ("FDIC"), an agency of the United States Government, insures through the Savings Association Insurance Fund ("SAIF") all depositors of the Bank up to $100,000 in accordance with the rules and regulations of the FDIC. The Bank is subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision ("OTS") and the FDIC, which is intended primarily for the benefit of depositors. See "Regulation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Federal Trust is a legal entity separate from the Bank. The principal sources of Federal Trust's revenues on an unconsolidated basis are earnings on its investments and dividends from the Bank. Various regulatory restrictions and tax considerations limit directly or indirectly the amount of dividends the Bank can pay to Federal Trust. Currently no dividends can be paid to Federal Trust by the Bank without the specific approval of the OTS. In addition, federal law restricts the Bank in the making of investments in or loans to Federal Trust or its affiliates. See "Regulation."
Federal Trust's executive offices are located at 1211 Orange Avenue, Winter Park, Florida 32789 and its telephone number is (407) 645-1201. As used herein, references to "Federal Trust and the Bank" may include Federal Trust and its consolidated subsidiaries (the Bank) unless the context otherwise indicates.
The Bank is primarily engaged in the bulk purchase of loans and other assets, the origination of one-to-four family residential mortgage loans, residential construction loans, multi-family loans, commercial real estate loans, land acquisition and development loans, as well as consumer loans. The Bank originates loans within its market area, defined generally as the state of Florida and well known out of state regions. The Bank also invests in U.S. Government securities, federal funds and other debt securities as well as mortgage-backed securities as appropriate. Funding for these activities is primarily from customer deposits, FHLB advances and other borrowings as well as normal amortization and prepayments from its loan portfolio.
Traditional thrift institutions are changing rapidly. Consumer-oriented services historically provided by banks are now offered by thrift institutions. The Bank's current operating strategy focuses on banking strategies which include loan origination, bulk loan/asset purchases and core deposit generation in its local community. Variable rate, short-term loans and adjustable rate loans are offered to help the Bank manage its interest rate spreads. Also, the Bank enhances its profitability by attracting deposits without a network of branch
offices thus gaining increased operating efficiency. The mortgage lending emphasis is on bulk loan purchases, as well as, the origination of residential loans in its market area. Management intends, to the extent possible, to control interest rates paid on deposits; however, outside factors such as economic, environmental, competitive and liquidity needs will have an effect on the cost of deposits. The Bank's principal sources of earnings are currently interest on real estate mortgage loans, investments, and overnight deposits, fees on checking accounts and sales of loans. Its principal expenses are interest paid on deposits, FHLB advances and operating expenses.
Market Area and Competition
The bank is located in Winter Park, a city of 24,000 residents, located approximately 7 miles northeast of downtown Orlando. Winter Park is in the heart of the greater metropolitan Orlando area which encompasses Orange, Seminole, Lake, and Osceola counties in central Florida. The total population of the four county area is estimated at 1.417 million in 1996, with the majority in Orange and Seminole counties. The bank's primary market area is northeast Orange county and southwest Seminole county, although its customers come from the entire four county area. Although best known as a tourist destination, with over 20 million visitors a year, the area has become a center for industries such as aerospace and defense, electro-optics and lasers, computer simulated training, computer networking and data management. In addition, motion picture production, professional and amateur sports, and distribution make the local economy more diverse each year. Many companies, including some in the Fortune 500, have chosen the Orlando area as a base for corporate, regional, and divisional headquarters. The area is also home to the University of Central Florida with an enrollment of 26,000, one of the fastest growing schools in the state university system, as well as Valencia Community College and Seminole Community College whose combined enrollment exceeds 90,000. Winter Park is home to Rollins College, the oldest college in Florida founded in 1885. The greater metropolitan Orlando area is projected to be one of the fastest growing areas in the United States through the year 2000, at which time the area is projected to be the 27th largest market in the country.
The Bank experiences substantial competition in attracting and retaining deposits and in lending funds. The primary factor in competing for deposits is interest rates. Direct competition for deposits comes from other thrift institutions and commercial banks. Additional significant competition for deposits comes from corporate and government securities and money market funds. The primary factors in competing for loans are interest rates and loan origination points. The Bank is currently competing aggressively, due to the current level of interest rates, for the origination of construction and permanent residential mortgage loans. Competition for origination of real estate loans normally comes from other thrift institutions, commercial banks, mortgage bankers, insurance companies and real estate investment trusts.
In addition to competition from other thrifts, the Bank faces significant competition from other financial services organizations. Commercial banks continue to compete for loans and deposits, while finance companies and credit unions compete in the important areas of consumer lending and deposit gathering. Additionally, nontraditional financial service providers such as brokerages, mutual funds and insurance companies have intensified competition for savings and investment dollars in recent years.
Consolidation within the banking industry, and in particular within Florida, has been dramatic. As of September 30, 1996, the four largest banking institutions in the state controlled approximately 57% of the bank deposits. In 1980, the four largest controlled less than 33% of the deposits. This consolidation should result in more rational pricing, with rates and fees more closely matching the actual costs of providing products and services.
Geographic deregulation also has had a material impact on the banking industry. While the most common forms of interstate statutes have either regional limitations or reciprocity requirements, a growing number of states allow unrestricted entry. Florida is a member of a regional compact which permits entry by financial institutions headquartered in certain other southeastern states and the District of Columbia.
Risk Factors
Readers shoud note, in particular, that this document contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that involve substantial risks and uncertainties. When used in this document, or in the documents incorporated by reference herein, the words "anticipate", "believe", "estimate", "may", "intend" and "expect" and similar expressions identify certain of such forward-looking statements. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward- looking statements contained herein. The considerations listed herein represent certain important
factors the Company believes could cause such results to differ. These considerations are not intended to represent a complete list of the general or specific risks that may affect the Company. It should be recognized that other risks, including general economic factors and expansion strategies, may be significant, presently or in the future, and the risks set forth herein may affect the Company to a greater extent than indicated.
Lending Activities
General. The primary lending activity of the Bank is the acquisition and origination of conventional loans for the purchase or construction of residential real property, which loans are secured by first liens on such property. Conventional loans are loans which are not insured by the Federal Housing Administration ("FHA") or partially guaranteed by the Veterans Administration ("VA"). Within this category, the largest portion of the Bank's loans are made to homeowners on the security of single-family dwellings. The Bank has also, to a lesser extent, made commercial real estate and consumer loans.
Loan Portfolio Composition. The Bank's net loan portfolio, which is total loans plus premiums paid for loans purchased less loans in process, unearned discounts and loan origination fees and allowance for loan losses, totaled $112.5 million at December 31, 1996, representing 80.6% of total assets at such date. At December 31, 1995, the Bank's total loan portfolio (excluding mortgage-backed securities) amounted to $112.9 million ("total loan portfolio").
Single-family residential loans comprise the largest group of loans in the Bank's loan portfolio, amounting to $101.5 million or 88.3% of the total loan portfolio at December 31, 1996, of which approximately 98.3% are first mortgage loans and includes $3.8 million in loans for the construction of single-family homes and $.92 million which are either insured by the Federal Housing Administration ("FHA") or partially guaranteed by the Department of Veterans Administration ("VA"). The percentage of the Bank's loan portfolio consisting of single-family residential real estate loans has remained stable during the past few years.
In addition, commercial real estate loans, including land loans, amounted to $11.3 million or 9.8% of the total loan portfolio at December 31, 1996. Commercial real estate loans consist of $10.8 million of loans secured by other non-residential property and $.5 million of loans secured by undeveloped land as of December 31, 1996. The percentage of the Bank's loan portfolio consisting of such loans has, in the past five years, ranged from 19.54% of the total loan portfolio, in 1990, to 9.8% of the total loan portfolio in 1996. At December 31, 1996, consumer and other loans, consisting of installment loans and savings account loans, amounted to $0.84 million or 0.73% of the total loan portfolio.
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The following table sets forth information concerning the Bank's loan portfolio by type at the dates indicated.
Contractual Repayments. Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their average contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgages are substantially higher than current mortgage loan rates. As of December 31, 1996, the Bank had $3.8 million in construction loans, all of which mature in one year or less. Thirteen percent (13%) of such loans have fixed rates and 87% have adjustable rates.
Origination, Purchase and Sale of Loans. The Bank generally originates loans on real estate located in its primary lending area of central Florida. The Bank has authority within regulatory limitations to originate loans secured by real estate throughout the United States and has exercised this authority on a limited basis.
Historically, Florida has experienced a rate of population growth in excess of national averages. However, the real estate development and construction industries in Florida have been sensitive to cyclical changes in economic conditions and the demand for and supply of residential units. The Bank's real estate mortgage loan origination activities will be affected by changes in the real estate development and construction industries.
The Bank's residential real estate loan volume has been primarily purchased since 1992. Residential mortgage loan originations by the Bank are attributable to depositors, other existing customers, advertising and referrals from real estate brokers, mortgage brokers and developers. Consumer loan originations by the Bank are attributable largely to depositors and walk-in customers and referrals. Commercial real estate loan originations are also attributable largely to brokers, walk-in customers, and referrals. All of the Bank's loan applications are evaluated by the Bank's staff at the main office to ensure compliance with the Bank's underwriting standards.See "Lending Activities - Loan Portfolio Composition - Loan Underwriting Policies."
The Bank's residential mortgage loans generally are originated to ensure compliance with documentation and underwriting standards which permit their sale to Fannie Mae and other investors in the secondary market. The Bank has engaged in the sale of whole loans and participations.
The following table sets forth for the Bank total loans originated, purchased, sold and repaid during the periods indicated.
Loan Underwriting The bank's lending activities are subject to the bank's underwriting standards and loan origination procedures prescribed by the bank's board of directors and its management. Loan applications are obtained to determine the borrower's ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations. Bank lending policy for real estate loans generally requires that collateral be appraised by an independent, outside appraiser approved by the bank's board of directors.
Loans are approved at various management levels up to and including the board of directors of the bank, depending on the amount of the loan. Loan approvals are made in accordance with a Chart of Delegated Authority approved by the board of directors. Generally, loans less than $250,000 are approved by authorized officers or underwriters. Loans in excess of $250,000 to $350,000 require the concurrence of two or more authorized officers. Loans over $350,000 usually require approval by the bank's loan committee or board of directors.
General lending policies. For real estate loans, it is the bank's policy to have a valid mortgage lien on real estate securing a loan and to obtain a title insurance policy which insures the validity and priority of the lien. Borrowers must also obtain hazard insurance policies prior to closing, and when the property is in a flood prone area, flood insurance is required. Most real estate loans also require the borrower to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which the bank makes disbursements for items such as real estate taxes and property insurance.
The bank is permitted to lend up to 100% of the appraised value of real property securing a mortgage loan. However, if the amount of a conventional, residential loan (including a construction loan or a combination construction and permanent loan) originated or refinanced exceeds 90% of the appraised value, the bank is required by federal regulations to obtain private mortgage insurance on that portion of the principal amount of the loan that exceeds 80% of the appraised value of the property. The bank will originate single family residential mortgage loans up to a 95% loan-to-value ratio if the required private mortgage insurance is obtained. Loans over 95% loan-to-value ratio, if originated, would be under special community support programs or one of the Federal Housing Administration, Veterans Administration or Farmers Home Guarantee or insurance programs. The loan-to-value ratio on a home loan secured by a junior lien generally does not exceed 90%, including the amount of the first mortgage on the collateral. With respect to home loans granted for construction or combination construction/permanent financing, the bank will lend up to 95% of the appraised value of the property on an "as completed" basis. The bank generally limits the loan-to-value ratio on multi-family residential and commercial real estate loans to 80% of value. Consumer loans are considered to be loans to natural persons for personal, family or household purposes, and these loans may be unsecured, secured by personal property or secured by liens on real estate which, when aggregated with prior liens, equals or exceeds the appraised value of the collateral property.
The maximum amount which the Bank could have loaned to one borrower and the borrower's related entities at December 31, 1996 was approximately $.99 million. The Bank currently has three loan relationships in excess of this amount. See "Regulation."
Federal regulations also permit the Bank to invest, in the aggregate, up to four times its regulatory capital in loans secured by non-residential or commercial real estate. At December 31, 1996, this limit allowed the Bank to invest in non-residential or commercial real estate loans in an aggregate amount up to $26.5 million. Loans in the Bank's loan portfolio secured by non-residential or commercial real estate totaled $11.5 million at such date.
Interest rates charged by the Bank on loans are affected principally by competitive factors, the demand for such loans and the supply of funds available for lending purposes. These factors are, in turn, affected by general economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and government budgetary matters.
Home Lending. The bank historically has been and continues to be primarily an originator and/or buyer of 1-4 family residential real estate loans secured by properties located in the southeastern United States. The bank currently originates fixed rate residential mortgage loans and adjustable rate residential mortgage loans (ARMS) for terms of up to 30 years. At December 31, 1996, $97.7 Million or 85.0% of the bank's total loan portfolio consisted of 1-4 family residential real estate loans. As of such date, approximately $79.4 Million or 81.3% of such loans were ARMS and $18.3 Million or 18.7 % of such loans were fixed rate.
The home loans with adjustable rate terms currently offered by the bank have interest rates that are fixed for a period of 1, 3 or 5 years and then after the initial period, the interest rate is adjusted annually based upon an index such as the yield on Treasury Securities adjusted to a one year maturity, plus a margin. Most of the bank's ARM lending programs limit the amount of any increase or decrease in the interest rate at each adjustment and over the life of the loan. Typical limitations are 2% at each adjustment with a limit of 6% over the life of the loan. The bank may offer ARMS with different annual and life of loan interest change limits, shorter or longer adjustment periods and different base indices as may be appropriate to meet market demand, the needs of the bank's portfolio, and the bank's interest rate risk management goals. Although the bank usually offers an initial rate on ARM loans below a fully indexed rate, the bank always underwrites a borrower's ability to pay at the interest rate which would be in effect after adjustment of the loan. Some ARM loans include features that allow the borrower, under special conditions, to convert the loan to a fixed rate at the then prevailing market rates.
Adjustable rate mortgage loans reduce the risks to the bank concerning changes in interest rates, but involve other risks because as interest rates increase, the borrower's required payments increase, thus increasing the potential for default. Marketability of real estate is also affected by the level of interest rates.
Most fixed rate home loans are originated for 30 year amortization terms. Borrowers requesting a term of 15 years or less are usually granted an interest rate slightly lower than is offered for a 30 year amortizing loan. These loans are originated to ensure compliance with documentation and underwriting standards which permit their sale in the secondary market to institutional investors such as the Federal National Mortgage Association (Fannie Mae). Fixed rate home loans include a "Due on Sale" clause which provides the bank with the contractual right to declare the loan immediately due and payable in the event the borrower transfers ownership of the property without the bank's consent. It is the bank's policy to enforce "Due on Sale" provisions.
Construction Lending. The bank offers adjustable and fixed rate residential construction loans to owners wishing to construct their primary residence and to selected builders/developers acceptable to the bank to build 1-4 family dwellings in the bank's primary market area. Loans to builders/developers are for homes that are pre-sold or are constructed on a speculative basis. Loans to builders for the construction of a home for which there is no end buyer at the time of construction are considered speculative loans. Construction loans to individuals usually are originated in connection with a permanent loan on the property (a construction/permanent loan). Construction/permanent loans typically provide for a construction term of six months to one year followed by the permanent loan term of up to 30 years. Speculative builder loans are typically for one year and provide for interest only payments during the loan term. The bank reviews the financial capacity of the builder, the experience and credit history of the builder, and present market conditions before approving speculative loans. Speculative loans to one builder are generally limited to a specific dollar amount in the aggregate. Loan advances to borrowers during construction are made on a percentage of completion basis, and funds are typically disbursed in four to six draws after an inspection is made by bank personnel and/or authorized independent inspectors and a written report of construction progress is received by the bank. At December 31, 1996 construction loans amounted to $3.8 million or 3.3% of the total loan portfolio.
Construction financing is generally considered to involve a higher degree of risk of loss 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 construction cost and of the initial estimate of the property's value upon completion. During construction, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the bank may be required to advance funds beyond the amount originally committed to complete construction. If the estimate of value is high, the bank may be confronted with a project having a value which is insufficient to assure full repayment. Repayment of construction loans to builders of single family homes usually depends upon the builder successfully negotiating a sale for the property. Sales of homes are affected by market conditions and the supply and demand for such products.
Consumer and Other Loans. Federal regulations permit the bank to make secured and unsecured consumer loans up to 35% of the bank's assets. Management considers consumer lending to be an important component of its future strategic plan. Federal Trust originates consumer loans in order to provide a wide range of financial services to its customers and to create stronger ties to its customers and because the shorter term and normally higher interest rates on such loans help the bank increase the sensitivity of its interest earning assets to changes in interest rates and maintain a profitable spread between its average loan yield and its cost of funds. The terms of consumer loans generally range from one to ten years. Federal Trust's underwriting standards for consumer loans include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. Consumer loans generally involve more credit risks than mortgage loans because of the type and nature of the collateral or absence of collateral. Consumer lending collections are dependent on the borrower's continuing financial stability, and are likely to be adversely affected by job loss, divorce and illness. Furthermore, 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 most cases, any repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance. The bank believes that the yields earned on consumer loans are commensurate with the credit risk associated with such loans. At December 31, 1996 consumer loans amounted to $.84 million or .73% of the total loan portfolio.
Multi-family and Commercial Real Estate Loans. Multi-family real estate loans are collateralized primarily by garden style apartments located in Florida. Commercial real estate loans are secured primarily by office, warehouse and retail business properties located in Florida. These types of loans amounted to $12.6 million or 11.00% of the total loan portfolio at December 31, 1996. These loans may be for an amortization term of up to 30 years but frequently include a maturity in 7 to 15 years. Commercial and multi-family loans are usually originated with an interest rate that adjusts based upon an index such as the prime rate or the yield on Treasury Securities adjusted to a maturity of 1, 3 or 5 years. The bank generally does not offer fixed rate commercial real estate or multi-family loans.
Loans secured by multi-family and commercial real estate are originated with loan-to-value not exceeding 80% of the appraised value of the properties. Loans on this type of collateral continue to be a part of the bank's future lending programs.
Loans secured by multi-family and commercial real estate are generally larger and involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by multi-family and commercial property depend to a large degree on results of operations and management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. As of December 31, 1996 the bank had $0.5 million in loans secured by land which is undeveloped or in the process of development. The bank will originate multi-family residential real estate, commercial real estate and business loans, and management estimates such lending will be between 5% and 10% of the bank's total loan portfolio in the future.
Business Loans with Government Guarantee. Through 1996, the bank has originated three loans where the principal balance is partially guaranteed by the U.S. Small Business Administration (SBA). The bank expects to continue to originate loans to small businesses with guarantee by the SBA or the Farmers Home Administration (FmHA). These loans are underwritten consistent with the bank's policies but may include a higher loan relative to the value of collateral than commercial loans originated without a government guarantee. These lending programs help small businesses to develop and/or expand and are an important tool in helping meet the credit needs of the bank's lending area.
Applications for SBA or FmHA guaranteed or insured loans are carefully underwritten and include an analysis of the borrower's business plan, the value of collateral, financial capacity, the experience of the borrower and market conditions. After the bank's underwriting review, a complete application is submitted to the appropriate agency which in turn performs its own underwriting analysis and makes a credit decision authorizing guarantee or insurance of the loan. SBA usually guarantees up to 75% of a loan, and some programs of FmHA provide guarantees up to 90% of the loan. Loans with government guarantees may be originated with fixed or adjustable rates; however, the bank usually originates loans with adjustable rate terms. Amortization terms for such loans are commensurate with the business purpose and expected life of the collateral. Real estate secured loans are usually offered for terms up to 25 years. SBA/FmHA guaranteed loans are originated on fully amortizing terms without a shorter maturity date and balloon payment requirement. At December 31, 1996 SBA guaranteed loans amounted to $.96 thousand or .08% of the total loan portfolio.
Income from Lending Activities. Federal Trust receives fees in connection with loan commitments and originations, loan modifications, late payments, changes of property ownership and for miscellaneous services related to its loans. Federal Trust also receives fees for servicing loans sold to others. Income from these activities varies from period to period with the volume and type of loans originated, sold and purchased, which in turn is dependent upon prevailing mortgage interest rates and their effect on the demand for loans in the market served by Federal Trust.
Loan fees typically are charged at the time of loan origination and may be a flat fee or a percentage of the amount of the loan. Such fees cannot typically be recognized as income and are deferred and taken into income over the contractual life of the loan, using a level yield method. If a loan is prepaid or refinanced, all remaining deferred fees with respect to such loan are taken into income at that time.
The accounting for non-refundable fees and costs associated with originating and acquiring loans is governed by Statement of Financial Accounting Standards ("SFAS") 91, promulgated by the Financial Accounting Standards Board ("FASB"). SFAS 91 required that loan origination fees be offset against certain related direct loan origination costs and that the resulting net amount be deferred and amortized over the life of the related loans as an adjustment to the yield of such related loans. In addition, commitment fees are required to be offset against related direct costs, and the resulting net amount is recognized either over the life of the related loans as an adjustment to the yield if the commitment is exercised, or upon expiration of the commitment, if the commitment expires unexercised.
Non-performing Loans and Real Estate Owned. When a borrower from the bank fails to make a required payment on a loan, the bank attempts to collect the payment by contacting the borrower. If a payment on a loan has not been received by the end of a grace period (usually 15 days from the payment due date), notices are sent at that time, with follow-up contacts made thereafter. In most cases, the delinquencies are cured promptly. If the delinquency exceeds 90 days and is not cured through the bank's normal collection procedures, the bank will institute more formal measures to remedy the default, including the commencement of foreclosure proceedings. The bank will attempt to negotiate with the delinquent borrower to establish a satisfactory payment schedule.
If foreclosure is effected, the property is sold at a public auction in which the bank may participate as a bidder. If the bank is the successful bidder, the acquired real estate property is then included in the bank's "real estate owned" account until it is sold. The bank is permitted under federal regulations to finance sales of real estate owned by "loans to facilitate," which may involve more favorable interest rates and terms than generally would be granted under the bank's underwriting guidelines. At December 31, 1996 the bank had no loans to facilitate.
Loans are placed on non-accrual status when, in the judgment of management, the
probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. As a matter of policy, the bank does not accrue interest on loans past due 90 days or more.
Real estate acquired by the bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired, it is recorded at the lower of cost or fair value at the date of acquisition and any write-down resulting therefrom is charged to the allowance for losses on loans.
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The following table sets forth for the Company certain information regarding non-accrual loans and real estate owned, including in-substance foreclosures, the ratio as such loans and real estate owned to total assets as of the date indicated, and certain other related information. The Bank did not have any troubled debt restructuring or accruing loans more than 90 days delinquent at any of the dates presented.
If the non-accrual loans at December 31, 1996 had been current in accordance with their original terms for the entire year (or from the date of origination if originated during such period), the total interest income on such loans for the period ended December 31, 1996 would have been increased approximately $181,000.
The $.32 million of non-accruing single-family residential permanent loans at December 31, 1996 consists of 10 loans. Such loans have an average loan balance of approximately $32,000 and no loan exceeds $110,000.
The Bank had one non-accruing land acquisition and development loan at December 31, 1996 in the amount of $547,930.
At December 31, 1996, the Bank had real estate owned of $1,508,166 acquired by foreclosure consisting of eight single family properties with an average balance of $62,776, two vacant land properties zoned commercial with an average balance of $393,229, one acquisition and development project with a balance of $184,500 and one developed building lot with a balance of $35,000.
Allowance for Losses on Loans
The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. The allowance is an estimated amount that management believes will be adequate to absorb losses inherent in the loan portfolio and commitments to extend credit, based on evaluations of its collectibility. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, specific problem loans and commitments, and current and anticipated economic conditions that may affect the borrower's ability to pay. While management uses the best information available to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.
In accordance with SFAS No. 114, as amended by SFAS No. 118, the Bank records impairment in the value of its loan as an addition to the allowance for loan losses. Any changes in the value of impaired loans due to the passage of time or revisions in estimates are reported as adjustments to provision expense in the same manner in which impairment initially was recognized. Adoption of SFAS No. 114, as amended by SFAS No. 118, had no impact on the level of the overall allowance for loan losses or on operating results, and does not affect the Bank's policies regarding write-offs, recoveries or income recognition.
Regulatory examiners may require the Bank to recognize additions to the allowance based upon their judgment about the information available to them at the time of their examination.
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The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
Mortgage-Backed Securities and Mortgage Derivatives
During 1994, the Bank invested in a GNMA "Dollar Roll" consisting of a portfolio of mortgage-backed securities which were guaranteed as to principal and interest by the full faith and credit of the United States or insured or guaranteed by agencies of or corporations or entities chartered by the Federal government or have investment grade ratings issued by either of the top two rating agencies. The mortgage-backed securities owned by the Bank were insured or guaranteed by the Government National Mortgage Association ("GNMA"). The securities were purchased for a period of 20 days and were sold on July 9, 1994, and at December 31, 1994, December 31, 1995, and December 31, 1996 the Bank had no investment in mortgage-backed securities or mortgage derivatives.
The following table sets forth mortgage-backed securities purchased, sold and repaid during the periods indicated:
Year Ended December 31, ----------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ----
(In Thousands of Dollars)
Purchases - - 4,647 4,521 -- Sales - - 4,124 (2,416) -- Principal reductions, net - - 13 (2,105) -- ---- ---- ----- ----- ---- Increase (decrease) in mortgage-backed securities - - -- -- - ==== ==== ===== ===== ====
Investment Activities
The Bank's investment portfolio currently consists of $15,047,984 in bonds issued by the Federal Home Loan Bank. The Bank purchases securities to meet regulatory liquidity requirements, to invest excess funds resulting from excess liquidity and to leverage capital through the use of borrowed funds. Of the securities held at December 31, 1996, $8,763,641 have maturities of five (5) years or less which meet the liquidity requirements of the Office of Thrift Supervision.
The Bank's investment in obligations of U.S. government agencies consist of dual indexed bonds issued by the Federal Home Loan Bank. At December 31, 1996, the bonds had a market value of $15,030,829 and gross unrealized losses of $1,069,171. The bonds have a par value of $16,100,000 and pay interest based on the difference between two indices. All of the bonds pay interest at the10 year constant maturity treasury rate less the 3 month or 6 month LIBOR rate plus a contractual amount ranging from 2.3% to 4.0%. The Bank purchased the bonds to offset some of its risk related to its portfolio of adjustable rate mortgages and, as such, subjects the Bank to a certain degree of market risk as the indices change with prevailing market interest rates. Generally, when short term interest rates are low and the yield curve is in a normal slope, i.e., long term interest rates higher than short term interest rates, the bonds will have a yield that is above the yields on other agency securities of three or six month maturities, however, the bank's portfolio of adjustable rate mortgage ("ARM") loans will have yields that are declining due to the adjustment on these loans being based on a short term index, primarily the one year CMT. When short term rates are high and the yield curve is flat or inverted, the bonds will have yields that are generally lower than the yields on other agency securities of three or six month maturities, however, the bank's ARM loans will have yields that are increasing since their adjustment is based on a short term index, primarily the one year CMT. As a result, the yields on the dual indexed bonds generally move in an inverse relationship to the movement in yields on the bank's ARM loans and as a result, offset some of the risk related to the movement of interest rates in the loan portfolio. The risk associated with changes in the indices is that when the yield curve is flat, the bonds will generally have yields that are below the yields on bonds that mature or reprice in three or six months unless the general level of rates is very low in which case the margin on the bonds would reduce or mitigate the effects of a flat yield curve. If the yield curve is inverted, the bonds will generally have below market yields. The Bank does not currently have any investments in hedges to offset the market risk for these securities. The effective rates earned for the portfolio of dual indexed bonds for 1994, 1995, and 1996 were, 6.79%, 5.43%, and 3.98% respectively. Market values for all securities were calculated using published prices or the equivalent at December 31, 1996.
Based on Office of Thrift Supervision (OTS) Thrift Bulletin 65 - Structured Notes, and other releases from the OTS, it is the opinion of management that the OTS would prefer that the institutions that they regulate not hold structured notes because many institutions do not clearly understand them, and the OTS has directed that the Bank refrain from purchasing any dual indexed bonds (see "Supervision"), although they continue to be a permissible investment for Thrifts.
At December 31, 1996, 1995, and 1994, the Bank had $7,000,000, $7,000,000, and $22,850,000 (par value), respectively, in investments securities pledged to the Federal Home Loan Bank as collateral under its short-term credit agreement with
the Bank. On November 30, 1995 the bank reclassified its entire portfolio of Federal Home Loan Bank bonds from the held to maturity category to the available for sale category, in accordance with the guidance issued by the Financial Accounting Standards Board (FASB), which permitted the one-time opportunity to reassess the designations of all securities between November 15, 1995 and December 31, 1995. The transfer resulted in an increase in the unrealized loss on investment securities available for sale, net (of the effect of income taxes) account, a component of stockholders' equity, to $1,291,699 at November 30,1995. During December 1995, the bank sold $7,250,000, par value, of the Federal Home Loan Bank bonds maturing in 2003, at a gross loss of $942,500, which decreased the unrealized loss on investment securities available for sale, net (of the effect of income taxes) account in stockholder's equity to $779,872 at December 31, 1995. On April 1, 1996, the Bank transferred $7,000,000 par value of the Federal Home Loan Bank bonds maturing in 2003 from the available for sale to the held to maturity category, and during November, 1996, the Bank sold $1,000,000 par value of the Federal Home Loan Bank bonds that mature in 1998 at a gross loss of $12,344.
As a member of the FHLB System, the Bank must maintain minimum liquidity levels specified by the OTS which vary from time to time. The Bank complies with such requirement primarily by maintaining a significant amount of funds in interest-bearing deposits at the FHLB of Atlanta and with the qualifying unpledged bonds in the investment portfolio that have maturities of 5 years of less. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Liquidity may increase or decrease depending upon the yields available on investment opportunities and upon management's judgment as to the attractiveness of such yields and its expectation of the level of yields that will be available in the future. The Bank also has an investment in the common stock of the FHLB of Atlanta in order to satisfy the requirement for membership in such FHLB.
The following table sets forth the carrying value of the Bank's total investments and liquidity as of the dates indicated.
Sources of Funds
General. Deposits are the primary source of the Bank's funds for use in lending and for other general business purposes. In addition to deposits, the Bank obtains funds from normal loan amortization and prepayments and from operations. Contractual loan payments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general market interest rates and economic conditions. Borrowings are also used on a short-term basis to compensate for seasonal or other reductions in normal sources of funds. Borrowings may also be used on a longer term basis to support expanded lending or investment activities. At December 31, 1996, the Bank had $19.8 million in FHLB Advances outstanding which are due in one year or less.
Deposits. Due to changes in regulatory and economic conditions in recent years, the Bank has increasingly emphasized deregulated fixed-rate certificate accounts and other types of deposits. The Bank has a number of different programs designed to attract both short-term and long-term deposits of the general public by providing an assortment of accounts and rates. These programs include statement savings accounts, NOW accounts, MMDAs and certificates of deposit currently ranging in terms from 91 days to 120 months.
The Bank's deposits are obtained from residents in its primary market area and, to a much lesser extent, nationwide via a computer network and the principal methods used by the Bank to attract "in market" deposit accounts include offering a wide variety of services and accounts, competitive interest rates and a convenient office location, including access to automated teller machines ("ATMs"). The Bank currently operates no ATM's but issues cards which have access to the Honor(R) and other shared ATM networks. The Bank utilizes very few brokered deposits and at times seeks some negotiated rate certificates of deposit less than $100,000 through the CD Network(R) which electronically allows the Bank to display its rates on certificates to individual investors nationwide. Bank personnel then deal directly with investors who telephone or write for information concerning certificates of deposit.
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The following table shows the average amount of and the average rate paid on each of the following categories during the periods indicated.
The variety of deposit accounts offered by the Bank has increased the Bank's ability to retain deposits and has allowed it to be competitive in obtaining new funds, although the threat of disintermediation (the flow of funds away from savings institutions into direct investment vehicles such as government and corporate securities) still exists. Newer types of accounts, however, have been more costly than traditional accounts during periods of high interest rates. The Bank's ability to attract and retain deposits and the Bank's cost of funds have been, and will continue to be, significantly affected by market conditions.
Management of the Bank periodically reviews rates offered by other savings institutions in its market area and will adjust the rates it offers to be competitive with such institutions. Due to the increase in customers and the Bank's adequate capital levels, the Bank has generally not had to price its deposit products higher than its competitors to attract deposits. The increases in deposits after interest credited of $37.7 million, $25.9 million and $17.8 million for the years ended 1992, 1991 and 1990, respectively, were due to an increase in the number of customers during each of the years and, during 1992, to the acquisition of a local savings institution, a portion of the deposits of which remained in the Bank. The $18.7 million decrease in 1993 resulted from the sale of the Bank's Amelia Island branch. During the year ended December 31, 1996 the Bank's deposits decreased $2.9 million.
The following table sets forth the net deposit flows of the Bank during the periods indicated.
Borrowings. The Bank is permitted to obtain advances from the FHLB of Atlanta, upon the security of the capital stock of the FHLB of Atlanta it owns and certain of its home mortgage loans and other assets (principally, securities which are obligations of, or guaranteed by, the U.S. government or agencies thereof), provided certain standards related to creditworthiness have been met. Such advances may be made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities, and the FHLB of Atlanta prescribes the acceptable uses to which the advances pursuant to each program may be made as well as limitations on the size of such advances. Depending on the program, such limitations are based either on a fixed percentage of the Bank's regulatory capital or its liability for shares and deposits or on the FHLB's assessment of Federal Trust Bank's creditworthiness. The FHLB is required to review its credit limitations and standards at least once every six months. Prepayment of FHLB of Atlanta advances would incur prepayment penalties. At December 31, 1996, the Bank had $24.8 million in borrowings outstanding and at December 31, 1995, the bank had $21.0 million in borrowings outstanding.
The following is an analysis of the advances from the Federal Home Loan Bank:
Amounts outstanding at December 31, 1996:
Maturity Date Rate Amount Type 12/31/97 6.95% $ 4,800,000 Variable Rate 06/28/97 6.01% 5,000,000 Fixed Rate 09/16/97 6.01% 5,000,000 Fixed Rate 10/16/97 5.86% 5,000,000 Fixed Rate 09/15/98 6.12% 5,000,000 Fixed Rate ---- ---------- Total 6.18% $24,800,000 ==== ===========
Amounts outstanding at December 31, 1995:
Maturity Date Rate Amount Type
01/02/96 6.10% $ 700,000 Variable Rate 01/27/96 5.76% 7,000,000 Fixed Rate 01/31/96 6.10% 3,300,000 Variable Rate 09/15/96 5.83% 5,000,000 Fixed Rate 09/15/98 6.12% 5,000,000 Fixed Rate ---- ---------- Total 5.93% $21,000,000 ==== ===========
Variable rate advances reprice daily and may be repaid at any time without penalty. Fixed rate advances incur a prepayment penalty if repaid prior to maturity, and the interest rate is fixed for the term of the advance.
Amounts outstanding at: - -------------------------------------------------------------------------------- 1996 1995 ---- ---- Monthend Rate Amount Monthend Rate Amount - -------- ---- ------ -------- ---- ------ 01/31/96 6.12% 20,500,000 01/31/95 6.21% 33,400,000 02/29/96 5.81% 19,300,000 02/28/95 6.27% 34,400,000 03/31/96 5.77% 22,300,000 03/31/95 6.29% 33,400,000 04/30/96 5.77% 23,300,000 04/30/95 6.34% 30,100,000 05/31/96 5.74% 24,700,000 05/31/95 6.36% 28,100,000 06/30/96 5.80% 25,500,000 06/30/95 6.43% 28,600,000 07/31/96 5.93% 22,800,000 07/31/95 6.33% 30,600,000 08/31/96 5.78% 24,100,000 08/31/95 6.36% 27,700,000 09/30/96 6.05% 25,000,000 09/30/95 6.37% 31,100,000 10/31/96 5.98% 24,200,000 10/31/95 6.19% 29,700,000 11/30/96 6.01% 23,800,000 11/30/95 6.23% 28,600,000 12/31/96 6.18% 24,800,000 12/31/95 5.93% 21,000,000
During the twelve-month periods ended December 31, 1996 and December 31, 1995, average advances outstanding totaled $23.4 million and $29.7 million at an average rate of 5.91% and 6.28%, respectively.
Advances from the FHLB are collateralized by loans, securities, and FHLB stock that totaled approximately $34.6 million, $6.3, and $1.3 million, respectively at December 31, 1996.
Expansion Plans
Management plans to raise additional capital in the first half of 1997. If successful in raising the additional capital, management plans to expand the operations of the bank via a branch in the near future. It is anticipated that the branch would be located in the greater Orlando market area. The ability to branch is subject to approval by the OTS. The OTS considers factors such as earnings, capital, management and Community Reinvestment Activities prior to approving branch applications.
Employees
At December 31, 1996, the Holding Company had no full-time employees and the Bank had 26 full-time employees. Management considers its relations with its employees to be excellent.
Federal Trust currently maintains a comprehensive employee benefit program providing, among other benefits, hospitalization and major medical insurance, long-term disability insurance, life insurance, and education assistance. In
addition, on April 1, 1997, the bank will begin offering its employees a 401k Plan. Such employee benefits are considered by management to be generally competitive with employee benefits provided by other major employers in Federal Trust's market areas. Federal Trust's employees are not represented by any collective bargaining group.
Other Subsidiaries
At December 31, 1996, the Company had no subsidiaries other than Federal Trust Bank.
Total Equity Investments at December 31, 1996
Federal Trust Bank $ 6,401,425
Thrift Subsidiaries
Current OTS regulations permit a thrift to invest up to 3% of its assets in service corporations, provided any investment in excess of 2% must serve primarily community, inner city or community development purposes. In addition, a thrift can invest up to 20% of its net worth in conforming loans to service corporations if net worth is equal to the minimum net worth requirement of the thrift and scheduled items do not exceed 2.5% of specified assets. At December 31, 1996, the Bank had one subsidiary, FTB Financial Services, Inc.("FTBFS"), that commenced operations in 1996. FTBFS is engaged in the business of selling non-FDIC insured annuities, and its operations in 1996 were minimal.
Legal Proceedings
There are no material pending legal proceedings to which Federal Trust or the Bank or any other subsidiary of Federal Trust is a party or to which any of their property is subject.
Asset Sales
Sale of First Coast Financial Corporation. Pursuant to a Purchase Agreement dated June 30, 1993, the Company sold all of the stock of First Coast Financial Corporation for $200,000 comprised of $1,000 in cash and a $199,000 note secured by FCFC stock payable over ten (10) years. No loss was reported on the sale. Subsequent to the sale, the operations of the company and its profitability declined and the purchaser was unable to make the required payments on the note held by Federal Trust Corporation (FTC). In December 1994, the purchaser defaulted on the note and FTC's subsidiary FTPC acquired the personal property consisting of furniture and equipment valued at $12,410. FTPC chose not to acquire the stock of FCFC, as it had determined that the operations of the company had essentially ceased and could not be restarted without an investment of significant resources, if at all. The Company recognized a loss on the note in the amount of $187,028.
Sale of Subsidiary Assets. A Purchase Agreement with Amelia Building Corporation ("ABC"), a South Carolina Corporation, was entered into by FCCSC in July, 1993 for the sale of (i) a multi-family building site located in Augusta, Georgia with a book value of $17,350 for a purchase price of $25,000, resulting in a gain on the sale of $7,650, and (ii) an Installment Note receivable and accrued interest, from a large multi-family apartment developer, in the amount of $68,250 for a purchase price of $43,250, resulting in a loss on the sale of $25,000. Both sales closed on July 31, 1993 and FCCSC agreed to finance $67,250 of the purchase price through a Secured Promissory Note payable in 5 years at an interest rate of 4.5% per annum with payments of interest payable annually. The Note was secured by the property located in Georgia and the Installment Note receivable. The $7,650 gain was deferred until such time as the Note would be substantially paid. FCCSC assigned the Secured Promissory Note to FTC, ceased operations, and the company was dissolved. During 1994, ABC defaulted on its note and, in December, 1994, FTPC, to whom FTC had subsequently assigned the Secured Promissory Note, acquired the Georgia property through a deed in lieu of foreclosure and the Note through a voluntary assignment.
A Purchase Agreement with ABC was also entered into by FTBC in July, 1993 for the sale of Buildings 100 and 300 and all of the common area located in First Coast Plaza, Amelia Island, Florida with a book value of $811,682 for a purchase price of $1,069,323, resulting in a gain on the sale of $257,641. The Bank then held a first mortgage on the property in the amount of $370,404. The sale closed on July 31, 1993 and ABC assumed the mortgage with the Bank and FTBC agreed to finance $697,919 of the remaining purchase price through a Secured Promissory Note payable in 5 years at an interest rate of 4.5% per annum with payments of interest payable annually. The Note was secured by the property located in First Coast Plaza. The $257,641 gain was deferred until such time as the Note would be substantially paid. FTBC assigned the Secured Promissory Note to FTC, ceased operations, and the company was dissolved. During 1994, ABC defaulted on its notes and, in December, 1994, FTPC, to whom FTC had subsequently assigned the Secured Promissory Note, acquired the property through a deed in lieu of
foreclosure and the deferred gain was offset against the Secured Promissory Note. In 1994, Federal Trust recognized a loss on the disposition of subsidiaries in the amount of $15,361 in connection with the ABC transactions.
In December, 1995, FTPC sold Buildings 100 and 300 and all of the common area located in First Coast Plaza, Amelia Island, Florida with a book value of $677,605 for a purchase price of $583,334, resulting in a loss on the sale of $94,271. The properties were sold to an unaffiliated party for cash.
Sale of Federal Trust Properties Corporation. Pursuant to a Purchase Agreement dated June 30, 1996 the Company sold all of the stock of Federal Trust Properties Corporation to an unaffiliated party for $425,354 consisting of $60,000 in cash, a note for $60,000 which was due and paid on August 8, 1996, a note for $230,354 due upon the earlier of certain events, but in any event due no later than July 31, 1997, and three notes for $25,000 each, due December 31, 1998, 1999 and 2000, respectively. In addition, the Company is renting the quarters it previously occupied to FTPC on a month to month basis, and plans to sub-lease the space to a long term tenant. No gain or loss was recognized on the sale.
Dissolution of 1270 Leasing Company. The Company dissolved 1270 LC on September 26, 1996, as it was no longer necessary to maintain the entity for purposes of the lease on the office space previously occupied by the Company.
Regulatory and Supervisory Actions. On October 3, 1994, the OTS issued a Supervisory Order to Cease and Desist (the "Order") for the Bank. Management and the Board of Directors have committed to adhering to the terms of the Order. The Order provides for the Board of Directors to: develop, adopt and adhere to policies and procedures to strengthen the Bank's underwriting, administration, collection and foreclosure efforts; review and revise underwriting policies and procedures to comply with regulatory requirements; record minutes to the loan committee and grant loans only on terms approved by the committee and document the recipient of proceeds of the loan; develop and implement a written plan to collect, strengthen and reduce the risk of loss for all real estate owned and for certain loans at risk and secured by real estate; comply with policies and procedures requiring written inspection of development and construction loans; pay no more than market rate, determined by a rent study approved by the OTS for lease of the Bank's offices; make no payment of taxes owed by a person affiliated with the Bank; seek services agreement for work performed for the Holding Company by the Bank; develop and submit for approval a three year business plan; comply with loans to one borrower policy; pay no dividend without consent of the OTS; appoint a compliance committee; refrain from purchasing dual indexed bonds. In addition, the OTS issued a separate Order for the Company requiring: the Holding Company shall not request dividends from the Bank without written permission from the OTS; the Holding Company reimburse the Bank for the Holding Company's expenses, develop a management services agreement with the Bank which provides for the reimbursement for employees who work for both the Bank and the Holding Company; appoint a compliance committee to report to the Board of Directors as to the Holding Company's compliance with the Order. See "Regulation".
TAXATION Federal
Federal Trust files a consolidated calendar tax year federal income tax return on behalf of itself and its subsidiaries. In previous years, the Bank reported its income and expenses using the cash method of accounting and the other companies used the accrual method. During 1993, the Bank was required to switch to the accrual method of accounting inasmuch as its average annual gross receipts for the prior three tax years exceeded $5 million.
Thrift institutions are generally taxed in the same manner as other corporations. Unlike other corporations, however, qualifying savings institutions such as the Bank that meet certain definitional tests relating to the nature of their supervision, income, assets and business operations are allowed to establish a reserve for bad debts and are permitted to deduct additions to that reserve on "qualifying real property loans"..
Until 1996, savings institutions that met certain definitional tests and other conditions prescribed by the Internal Revenue Code of 1986 (the "Code") relating primarily to the composition of their assets and the nature of their business activities, were, within certain limitations, permitted to establish and deduct additions to reserves for bad debts in amounts in excess of those which would otherwise be allowable on the basis of actual loss experience. A qualifying savings institution could elect annually to compute the addition to its bad debt reserve for qualifying real property loans (generally, loans secured by interests in improved real property) using the more favorable of the following methods: (i) a method based on the institution's actual loss experience (the "experience method") or (ii) a method based on specified percentage of the institution's taxable income (the "percentage of taxable income method"), and not be bound by the election in any subsequent year. The addition to the reserve for nonqualifying loans was required to be computed under the experience method and reduced by the current year's addition to the reserve for losses on nonqualifying loans, unless that addition also was determined under the experience method. The aggregate of the additions to each reserve for each year
was Federal Trust Bank's annual bad debt deduction for years preceding 1996, Federal Trust Bank utilized either the percentage of taxable income method and the experience method in computing the tax-deductible addition to its bad debt reserves.
If the percentage of Federal Trust Bank's specified qualifying assets (generally, loans secured by residential real estate or deposits, banker's acceptances, educational loans, cash, government obligations and certain certificates of deposit) were to fall below 60% of total assets, Federal Trust Bank would not be eligible to claim further bad debt reserve deductions and would recapture into income all previously accumulated bad debt reserves. At December 31, 1996, Federal Trust Bank's qualifying assets were in excess of 60% of total assets.
The Small Business Job Protection Act of 1996 repealed the percentage of taxable income method of accounting for bad debts for tax years beginning after 1995. Federal Trust Bank switched solely to the experience method to compute its bad debt deduction in 1996 and future years. Federal Trust Bank is required to recapture into taxable income the portion of its bad debt reserves that exceed its bad debt reserves calculated under the experience method from the bank's inception. Accordingly, Federal Trust Bank will have to recapture approximately $70,000 of bad debt reserves as a result of this change in law.
The recapture amount resulting from the change in method of account for bad debt reserves generally will be taken into Federal Trust Bank's taxable income ratably (on a straight-line basis) over a six-year period. If a thrift meets a residential loan requirement for a tax year beginning in 1996 or 1997, the recapture of the reserves will be suspended for that tax year. Thus, recapture can potentially be deferred for up to two years.
To the extent that (i) the Bank's reserve for losses on qualifying real property loans exceeds the amount that would have been allowed under the experience method and (ii) the Bank makes distributions to its stockholders that are considered to result in withdrawals from that excess bad debt reserve, then the amounts withdrawn will be included in the Bank's taxable income. The amount considered to be withdrawn by a distribution will be the amount of the distribution plus the amount necessary to pay the tax with respect to the withdrawal. Dividends paid out of the Bank's current or accumulated earnings and profits as calculated for federal income tax purposes, however, will not be considered to result in withdrawals from the Bank's bad debt reserves. 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 of the Bank will be considered to result in withdrawals from the Bank's bad debt reserves. Because the Bank made no distributions to Federal Trust during the year, it has no excess loss reserves that could be subject to these provisions.
Depending on the composition of its items of income and expense, a thrift institution may be subject to the alternative minimum tax. A thrift institution must pay an alternative minimum tax equal to the amount (if any) by which 20% of alternative minimum taxable income ("AMTI"), as reduced by an exemption varying with AMTI, exceeds the regular tax due. AMTI equals regular taxable income increased by certain tax preferences, including depreciation deductions in excess of that allowable for alternative minimum tax purposes, tax-exempt interest on most private activity bonds issued after August 7, 1986 (reduced by any related interest expense disallowed for regular tax purposes), the amount of the bad debt reserve deduction claimed in excess of the deduction based on the experience method and, 75% of the excess of adjusted current earnings over AMTI. The alternative minimum tax applicable to tax years after 1986 is significantly broader in scope than the old minimum tax and substantially increases the likelihood that savings institutions will have to pay alternative minimum tax. The Bank's federal income tax returns have never been examined by the Internal Revenue Service.
State
The State of Florida imposes a corporate income/franchise tax on banks and thrift institutions which subjects the Florida taxable income of such institutions to a 5.5% tax (or, if greater, an alternative minimum tax equal to 3.3% of alternative minimum taxable income). Florida taxable income is substantially similar to federal taxable income less $5,000, except that it includes interest income on obligations of any state or political subdivision thereof which is not otherwise exempt under Florida laws, and net operating losses cannot be carried back to prior taxable years. The Florida income/franchise tax may be reduced by a credit equal to the lesser of (i) intangible tax paid or (ii) 65% of the sum of the franchise tax due before the credit and the emergency excise tax due. The Florida franchise tax is deductible in determining federal tax income.
REGULATION AND SUPERVISION
General
The banking industry is highly regulated with numerous federal and state laws and regulations governing its activities. As a saving and loan holding company, Federal Trust is subject to examination and the regulations of the OTS as provided under the Home Owners
Loan Act, as amended ("HOLA"). Federal Trust is a reporting Holding Company with the Securities and Exchange Commission for purposes of the Securities Exchange Act of 1934. Being a Florida Corporation, Federal Trust is also subject to the Florida Business Corporations Act ("Act") and the regulation of the Florida Department of State under its authority to administer and implement the Act.
The Bank is a federally-chartered savings bank and its deposits accounts are insured by the Savings Association Insurance Fund ("SAIF") which is administered by the FDIC. The Bank is subject to examination and regulation by the OTS and the FDIC, and to a lesser extent the Federal Reserve Board ("Federal Reserve").
Federal Trust and the Bank are required to file reports with the OTS and the FDIC concerning their activities and financial conditions, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other financial institutions.
Recent Regulatory Action
On October 3, 1994, Federal Trust and the Bank each entered into a voluntary Cease and Desist Order (collectively the "Orders") with the OTS. The decision by management and the Board of Directors of both companies to enter into the Orders was reached after several months of discussions with the OTS following the 1994 examinations. Although management and the Board of Directors of the Holding Company and the Bank believed that significant action had been taken to correct operational deficiencies cited in the Bank's 1992 examination, which resulted in a Supervisory Agreement between the Bank and the OTS, and the deficiencies cited in the 1994 examinations, it was determined that it was in the best interest of the Federal Trust and the Bank to agree to the Orders, due to the increase in the Bank's classified assets and the resulting increase to the Bank's loan loss reserves. Another factor that was considered in this decision was the fact that most of the items included in the Bank's Order were repetitive of the directives contained in the Supervisory Agreement which the Bank was either were in compliance with or had been corrected. The holding company's Order, on the other hand, was administrative in nature and likewise could be easily monitored.
In August, 1995 the OTS informed Federal Trust that it was conducting an expanded examination of the holding company with regard to certain transactions that were entered into 1990 and 1991 by prior Bank management. As of the date of this filing, Federal Trust has had no further contact with the OTS concerning this examination. See, "Item 7. Supervision".
In the 1996 examinations of Federal Trust and the Bank, the OTS found the companies to be in compliance with their Orders and upgraded the supervisory rating of Federal Trust to "Satisfactory". In light of the improvement of the Bank's operations, the OTS reduced the number of provisions in the Bank's Order from 27 to 23. Management has been advised that the OTS will consider lifting the Bank's Order when the ratio of classified assets to capital is reduced below 100%. With regard to the Bank, further improvement was noted in a number of areas, including underwriting procedures, documentation, disposition of problem assets, significant reduction in the dependency on wholesale funds, and a continued reduction in operating expenses.
Regulation of the Holding Company
Restrictions on the Acquisition of Federal Trust. Section 1467a of the HOLA provides that no holding company, "directly or indirectly" or acting in concert with one or more persons, or through one or more subsidiaries, or through one or more transactions, may acquire "control" of an insured savings institution at any time without the prior approval of the OTS. In addition, any holding company that acquires such control becomes a "savings and loan Holding Company" subject to registration, examination and regulation under HOLA and the regulations promulgated thereunder. "Control" in this context means ownership, control of, or holding proxies representing more than 25% of the voting shares of, an insured institution, the power to control in any manner the election of a majority of the directors of such institution or the power to exercise a controlling influence over the management or policies of the institution.
Transactions with Affiliates. The authority of Federal Trust to engage in transactions with related parties or "affiliates" or to make loans to certain insiders, is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings institution and also limits the aggregate amount of transactions with all affiliates 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 the FRA and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and circumstances, including credit standards, that are substantially the same or at least as favorable to the savings institution as those prevailing at the time for comparable transactions with a non-related party or nonaffiliated holding company. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to non-related parties or nonaffiliated
companies. Notwithstanding Sections 23A and 23B, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956. Further, no savings institution may purchase the securities of any affiliate other than a subsidiary.
In addition, Sections 22(g) and 22(h) of the FRA and Regulation O (which set limits on extensions of credit to executive officers, directors and 10% shareholders, as well as companies which such persons control) apply to savings institutions. Among other things, such loans must be made on terms, including interest rates, substantially the same as loans to unaffiliated individuals and which involve no more than the normal risk of collectability. In addition, these regulations place limits on the amount of loans the Bank may make to such persons. These restrictions apply in addition to certain restrictions on transactions with affiliates contained in the OTS regulations.
Support of Subsidiary Depository Institutions. Under OTS policy, Federal Trust is expected to act as a source of financial strength to and to commit resources to support the Bank. This support may be required at times when, in the absence of such OTS policy, Federal Trust might not be inclined to provide such support. In addition, any capital loans by Federal Trust to the Bank must be subordinate in right of payment to deposits and to certain other indebtedness of the Bank. In the event of bankruptcy, any commitment by a Holding Company to a federal bank regulatory agency to maintain the capital of a subsidiary depository institution will be assumed by the bankruptcy trustee and will be entitled to a priority of payment.
Under the FDIA, a depository institution of a holding company, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989, in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default". "Default" is defined generally as the appointment of a conservator or a receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance.
Payment of Dividends. Federal Trust is a legal business entity separate and distinct from the Bank. To date, the principal source of cash flow of Federal Trust, including cash flow to pay cash dividends, has been dividends from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank. In general, the ability of the Bank to pay a dividend to Federal Trust is governed by the OTS's capital distribution regulation. The OTS regulation establishes three tiers of savings institutions based primarily on an institution's capital level. A savings institution that exceeds all fully phased-in capital requirements before and after the proposed capital distribution ("Tier 1 association") and has not been advised by the OTS that it is in need of more than normal supervision could, after prior notice but without the approval of the OTS, make capital distribution during a calendar year equal to the greater of: (i) 100% of its net income to date during the calendar year, plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year, or (ii) 75% of the savings institution's net income for the previous four quarters. Any additional capital distributions require prior regulatory approval. Because the Bank is currently operating under an OTS Order, the Bank is considered a Tier 2 association and is required to obtain OTS approval before it can make a capital distribution to the Holding Company. A Tier 2 association may make capital distributions of between 25% and 75% of its net income over the most recent four-quarter period, depending on its risk-based capital level. The OTS can prohibit a proposed capital distribution by a savings institution, which would otherwise be permitted by the regulation if the OTS determines that such distribution would constitute an unsafe or unsound practice. The Bank did not make a capital distribution to Federal Trust in 1996.
According to the holding company's Order, Federal Trust cannot request dividends from the Bank without written permission from the OTS. It is unlikely that the Bank will be permitted to pay a dividend to Federal Trust while the Orders are in effect.
Regulation of the Bank
Bills are introduced from time to time in the United States Congress with respect to the regulation of financial institutions. Recent banking legislation, particularly the Financial Institution Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), has broadened the regulatory powers of the federal bank regulatory agencies and restructured the nation's banking system.
FIRREA. The activities of savings institutions are governed by the HOLA and, in certain respects, the Federal Deposit Insurance Act ("FDIA"). The HOLA and the FDIA were amended by the FIRREA and the FDICIA. The FIRREA was enacted for the purpose of resolving problem savings institutions, establishing a new thrift insurance fund, reorganizing the regulatory structure applicable to savings institutions, and imposing bank-like standards on savings institutions.
FDICIA. The FDICIA revised sections of the Federal Deposit Insurance Act affecting bank regulation, deposit insurance and provisions for funding of the Bank Insurance Fund ("BIF"). The FDICIA also revised bank regulatory structures embodied in several other federal banking statutes, strengthened the bank regulators' authority to intervene in cases of deterioration of a bank's capital level, placed limits on real estate lending and imposes detailed audit requirements.
Prompt and Corrective Action. The FDICIA required the federal banking regulatory agencies to set certain capital and other criteria which would define the category under which a particular financial institution would be classified. The FDICIA imposes progressively more restrictive constraints on operations, management, and capital distributions depending on the category in which a financial institution is classified. The OTS' prompt and corrective action regulation became effective December 19, 1992. Among other things, the regulations define the relevant capital measures for the five capital categories. (well capitalized, adequately capitalized, undercapitalized, significantly under capitalized and critically under capitalized). For example, a savings institution is deemed to be "well capitalized" if it has a total risk-based capital ratio (total capital to risk-weighted assets) of 10% or greater, a Tier 1 risk-based capital ratio (Tier 1 capital to risk-weighted assets) of 6% or greater, and a Tier 1 leverage capital ratio (Tier 1 capital to adjusted total assets) of 5% or greater, and is not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. The OTS has also established minimum tangible and minimum leverage capital requirements for savings institutions. These requirements provide for a minimum ratio of tangible capital of not less than 1.5% of the savings institutions adjusted total assets. Tangible capital is defined as core capital minus any "intangible assets (as defined by the regulation). The minimum leverage capital (as defined by the regulation) ratio established by the regulation is 3% of adjusted total assets.
A savings institution is deemed to be "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, and (generally) a Tier 1 leverage capital ratio of 4% or greater, and the institution does not meet the definition of a "well capitalized" institution. A savings institution is deemed to be "critically undercapitalized" if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. In addition, the OTS is authorized to downgrade a savings institution to a lower capital category than the savings institution's capital ratios would otherwise indicate, based upon safety and soundness considerations (such as when the institution has received a less than satisfactory examination rating for any of the equivalent CAMEL rating categories). Both the risk-based capital guidelines and the leverage ratio are minimum requirements, applicable only to top-rated savings institutions. Institutions operating at or near these levels are expected to have well-diversified risk, excellent asset quality, high liquidity, good earnings and in general, have to be considered strong banking organizations and rated composite 1 under the CAMEL rating system adopted by the OTS. Institutions with lower ratings and institutions with high levels of risk or experiencing or anticipating significant growth would be expected to maintain ratios 100 to 200 basis points above the state minimums. A savings institution cannot make a capital distribution such as cash dividends, redemptions and other purchases of stock, or pay management fees to any person having control of that institution, if after doing so, the savings institution would be undercapitalized.
Capital Requirements. Both OTS and FDIC have promulgated regulations setting forth capital requirements applicable to depository institutions. The OTS capital regulations require savings institutions to meet three capital standards: a 1.5% tangible capital ratio (defined as the ratio of tangible capital to adjusted total assets), a 3% leverage (core capital) ratio (defined as the ratio of core capital to adjusted total assets ) and an 8% risk-based capital standard as defined below. Core capital is defined as common stockholder's equity (including retained earning), certain noncumulative perpetual preferred stock and related surplus, minority interests in equity accounts of consolidated subsidiaries, certain goodwill and certain mortgage servicing rights less certain intangible assets, mortgage servicing rights less certain intangible assets, mortgage servicing rights and investments in nonincludable subsidiaries. Tangible capital is defined in the same manner as core capital, except that all intangible assets (excluding certain mortgage servicing rights) must be deducted. Adjusted total assets is defined as GAAP total assets, minus intangible assets (except those included in core capital). The OTS regulations also require that in calculating the leverage ratio, tangible and risk-based capital standards, savings institutions must deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank. The Bank currently has one subsidiaries.
The OTS risk-based capital standard for savings institutions requires that total capital (comprised of core capital and supplementary capital) be at least 8% of risk-weighted assets. In determining risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. Generally, zero weight is assigned to risk-free assets, such as cash and unconditionally guaranteed United States government securities. A weight of 20% is assigned to, among other things, certain obligations of United States government- sponsored agencies (such as the FNMA and the FHLMC) and certain high quality mortgage-related securities. A weight of 50% is assigned to qualifying mortgage loans and certain other mortgaged-related Securities, repossessed assets and assets that are 90 days or more past due. The components of core capital are equivalent to those discussed above. The components of supplementary capital include permanent capital instruments (such as cumulative perpetual preferred stock, mandatory convertible subordinated debt and perpetual subordinated debt), maturing capital instruments (such as mandatory convertible subordinated debt and intermediate-term preferred stock) and the allowance for loan and lease losses. Allowance for loan and lease losses
includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital.
On August 31, 1995, the OTS issued an interim rule providing that the amount of risk-based capital that may be required to be maintained by an institution for recourse assets cannot be greater than the total of the recourse liability. The interim rule provides that whenever the calculation of risk-based assets (including assets sold with recourse) would result in a capital charge greater than the institution's maximum recourse liability on the assets sold, instead of including the assets sold in the savings institution's risk-weighted assets, the institution may increase its risk-based capital by its maximum recourse liability. In addition, qualified savings institutions may include in their risk-weighted assets for the purpose of capital standards and other capital measure, only the amount of retained recourse of small business obligation transfers multiplied by the appropriate risk weight percentage. The interim rule sets reserve requirements and aggregate limits for recourse held under the modified treatment. Only well-capitalized institutions and adequately capitalized institutions with OTS permission may use this reduced capital treatment.
On August 16, 1996, the OTS and the other federal banking agencies jointly proposed to revise their respective risk-based capital rules relating to treatment of certain collateralized transactions. These types of transactions generally include claims held by banks (such as loans and repurchase agreements) that are collateralized by cash or securities issued by the U.S. Treasury or U.S. Government agencies. If adopted, the proposal would permit certain partially collateralized claims to qualify for the 0% risk category. To qualify for the 0% risk category, the portion of the claim that will be continuously collateralized must be specified either in terms of dollar amount or percentage of the claim. For off-balance-sheet derivative contracts, the collateralized portion of the transaction could be specified by dollar amount or percentage of the current or potential future exposure.
On January 1, 1994 the OTS incorporated an interest-rate component as part of the calculation of a savings institution's regulatory capital. 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. A savings institution's interest-rate risk is measured by the decline in the net portfolio value of its assets (i.e. the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates (except when the three-month Treasury bond equivalent yield falls below 4%, then the decrease will be equal to one-half of that Treasury rate) divided by the estimated economic value of the savings institution's assets, as calculated in accordance with guidelines set forth by the OTS. A savings institution whose measured interest-rate risk exposure exceeds 2% must deduct an interest-rate component in calculating its total capital under the risk-based capital rule. The interest-rate risk component is an amount equal to one-half of the difference between the savings institution's measured interest-rate risk and 2%, multiplied by the estimated economic value of the savings institution's assets. That dollar amount is deducted from the savings institution's total capital in calculating compliance with its risk-based capital requirement. Effective September 1, 1995, the interest rate-risk rule was amended to include, in evaluating capital adequacy, an assessment of exposure to declines in the economic value of a savings institution's capital due to changes in interest rates. Under the rule, there is a three-quarter lag between the reporting date of an institution's financial data and the effective date for the new capital requirement based on that data. Each quarter, the OTS calculates a savings institution's interest-rate risk exposure and advised the savings institution of any interest-rate risk capital component resulting from greater than "normal" exposure. The rule also provides that the Director of the OTS may waive or defer a savings institution's interest-rate risk component on a case by case basis.
The Bank's interest-rate risk exposure, according to OTS calculations, has been determined to be not greater than "normal" exposure as of December 31, 1996.
The OTS issued a Thrift Bulletin in August 1995 that described how and under what circumstances a savings institution may appeal its interest-rate risk component by requesting an adjustment to the interest-rate risk component generated by the OTS model or seek approval to use its own internal interest-rate risk model to calculate the interest rate risk component. The Thrift Bulletin provides that to be eligible to seek an adjustment to the interest rate risk component, an institution must show that its interest-rate risk component, as calculated by the OTS, could cause the savings institution to move to a lower prompt corrective action category and that the accuracy of the OTS' estimate of interest-rate risk exposure can be materially improved through the use of more refined data or more appropriate assumptions tailored to the specific institution. The Thrift Bulletin also outlines the circumstances under which well-capitalized institutions may request to use their own internal interest-rate risk model in place of the OTS model in calculating interest-rate risk capital requirements. The internal model must meet certain OTS standards, including reasonable assumptions about future interest rates, prepayment rates for assets and attrition rates for liabilities.
The FDICIA also required that the OTS (and other federal banking agencies) revise the risk-based capital standards with appropriate transition rules to take into account concentration of credit risks and risks of nontraditional activities. Effective January 17, 1995, the OTS (along with the other federal banking agencies) issued final regulations which explicitly identify concentration of credit risk and other risks from nontraditional activities, as well as an institution's ability to manage these risks, as important factors in
assessing an institution's overall capital adequacy. These final regulations do not contain any specific mathematical formulas or capital requirements.
At December 31, 1996, the Bank met each of its capital requirements, in each case on a fully phased-in basis. The following table sets forth the regulatory capital calculations of the Bank at December 31, 1996:
Tangible Core Risk-Based - -------------------------------------------------------------------------------- Percent of Percent Percent Risk- of of Weighted Amount Assets Amount Assets Amount Assets ------ ------ ------ ------ ------ ------ Regulatory Capital $6,614,345 4.74% $6,614,345 4.74% $7,485,055 9.92% Requirement $2,093,147 1.50% $4,186,294 3.00% $6,036,335 8.00% Excess $4,521,198 3.24% $2,428,051 1.74% $1,448,720 1.92%
New Standards for Safety and Soundness. The FDICIA, as amended by the Reigle Community Development and Regulatory Improvement Act of 1994, requires each federal banking agency to prescribe for all insured depository institutions and their holding companies standards relating to internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, and compensation, fees and benefits and such other operational and managerial standards as the agency deems appropriate. On July 10, 1995 the OTS and the other federal banking agencies adopted a final rule establishing deadlines for the agencies to submit and review safety and soundness compliance plans and Interagency Guidelines Establishing Standards for Safety and Soundness. The final rule and guidelines went in to effect on August 9, 1995. The guidelines require savings institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution's business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate-risk exposure, and asset growth. The guidelines further provide that savings institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and that they should take into account factors such as compensation practices at comparable institutions. In October 1996, the federal banking agencies jointly adopted asset quality and earning standards to be added to the Interagency Guidelines.
If the OTS determines that a savings institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A savings institution is required to submit an acceptable compliance plan to the OTS within 30 days after receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions. Management believes that the Bank already meets substantially all the standards adopted in the interagency guidelines and, therefore, does not believe that implementation of these regulatory standards will materially affect the Bank's operations.
Insurance of Deposit Accounts. The FDIC is the administrator for the SAIF and the Bank Insurance Fund ("BIF"), independently setting insurance premiums for each Fund. The FDIC is authorized to adjust the assessment rates. The Bank's deposit accounts are insured by the SAIF which is administered by the FDIC. The Federal Deposit Insurance Act required the FDIC to increase the reserves of the SAIF and the BIF to 1.25% of total insured deposits. The Deposit Insurance Funds Act of 1996 ("Deposit Act") required a depository institutions to pay a one-time special assessment of 65.7 basis points on SAIF-insured deposits held at March 31, 1995 in order to recapitalize the SAIF to the same level as the BIF. The Bank's pre-tax special assessment was $716,498. The FDICIA required the FDIC to establish a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The first semi-annual assessment was made on January 1, 1994. In accordance with its rule, the FDIC assigns a financial institution to one of three capital categories based on the institution's financial information, as of the reporting period ending seven months before the assessment period. These categories consist of well capitalized, adequately capitalized or undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the financial institution's primary regulator, in the Bank's case the OTS, and information which the FDIC determines to be relevant to the institution's primary federal regulator and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. A financial institution's assessment rate depends on the capital category and supervisory category to which it is assigned. There are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates range from 23 basis points on deposits for a financial institution in the highest category (i.e.. well-capitalized and
financially sound with only a few minor weaknesses) to 31 basis points on deposits for an institution in the lowest category (i.e., undercapitalized and posing a substantial probability of loss to the SAIF or the BIF, unless effective corrective action is taken). The Bank's assessment for 1995 and 1996 was 29 basis points on deposits.
The FDIC in early December, 1996 adopted a rule that would reduce regular semi-annual SAIF assessments from the current range of 0.23% - 0.31% of deposits to a range of 0% - 0.27% of deposits. The new rates will be effective for SAIF-assessable institutions on January 1, 1997. From October 1, 1996 through December 31, 1996, SAIF-assessable institutions will be assessed at rates ranging from 0.18% to 0.27% of deposits, which represents the amount the FDIC calculates as necessary to cover the interest due for that period on outstanding Financing Corporation ("FICO") Bonds discussed below. Because SAIF-assessable institutions have already been assessed at current rates (i.e., 0.23% - 0.31% of deposits) for the semi-annual period ending December 31, 1996, the FDIC will refund or credit with interest the amount collected for the period from October 1, 1996 through December 31, 1996 which exceeds the amount due for that period under the reduced assessment schedule. Assuming the Bank retains its current risk classification under the FDIC's risk-based assessment system, the deposit insurance assessments payable by the Bank will be reduced significantly. Effective October 1, 1996, the Bank's SAIF insurance premiums were reduced from $0.29 per $100 to $0.17 per $100 of insured deposits in January, 1997.
The federal banking agencies are required by the Deposit Act to take appropriate measures to prevent insured depository institutions and insured depository holding companies from facilitating or encouraging shifting from SAIF-assessable deposits to BIF-assessable deposits to avoid assessments imposed on SAIF members. These measures include enforcement actions, denial of applications, and treating the transaction as a conversion by imposing exit fees and entrance fees.
The Deposit Act also reduced the burden on SAIF-insured institutions in paying bonds (the "FICO Bonds") issued by the FICO, the entity created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF's predecessor insurance fund. Prior to the Deposit Act, a substantial amount of the SAIF assessment revenue was used to pay the interest due on the FICO Bonds. Beginning with the semi-annual period after December 31, 1996, interest due on FICO Bonds will be covered by assessments against both SAIF and BIF insured institutions. Between January 1, 1997 and December 31, 1999, BIF-assessable deposits will be assessed at a rate of 20% of the assessment rate applicable to SAIF-assessable deposits. After December 31, 1999, FICO assessments are to be shared on a pro rata basis.
The Deposit Act also provides for the merger of the SAIF and the BIF into one "Deposit Insurance Fund" on January 1, 1999, provided there are no state or federally chartered FDIC-insured savings associations existing on that date. To facilitate the merger of the BIF and SAIF, the Treasury Department is required to conduct a study on the development of a common charter and to submit a report, along with appropriate legislative recommendations, to Congress by March 31, 1997. Immediately prior to the merger of the SAIF and the BIF, a Special Reserve of the Deposit Insurance Fund (the "DIF Special Reserve") will be created that will consist of the excess amount in the SAIF reserve ratio over the designated reserve ratio as of that date, if any. The DIF Special Reserve would be available for emergency purposes if the reserve ratio of the Deposit Insurance Fund is less than 50% of the designated reserve ratio and the FDIC expects the reserve ratio to remain at less than 50% of the designated reserve ratio for each of the next four calendar quarters.
If the SAIF and the BIF are not merged, the Deposit Act provides for creation of a SAIF Special Reserve if the reserve ratio of the SAIF exceeds the designated reserve ratio. The amount by which the SAIF reserve ratio exceeds the designated reserve ratio will be deposited into the SAIF Special Reserve. Like the DIF Special Reserve, the SAIF Special Reserve would be available for emergency purposes if the reserve ratio of the SAIF is less than 50% of the designated reserve ratio and the FDIC expects the reserve ratio to remain at less than 50% of the designated reserve ratio for each of the next four calendar quarters. Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the savings institution has engaged in unsafe or unsound practices, is in such an unsafe or unsound condition so as to warrant discontinuation of operations or has violated any applicable law regulation, rule, order or condition imposed by the FDIC or the OTS. Management does not know of any practice, condition or violation that might lead to termination of deposit insurance. At December 31, 1996, the Bank exceeded all of the fully phased-in capital requirements.
Brokered Deposits. The FDIC has adopted regulations under FDICIA governing the acceptance or retention of brokered deposits. Under these regulations, a depository institution cannot accept, rollover or renew brokered deposits unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDIC. A depository institution that cannot receive brokered deposits also cannot offer "pass-through" insurance on certain employee benefit accounts. Whether or not it has obtained such a waiver, an adequately capitalized depository institution may not pay an interest rate on any deposits in excess of 75 basis points over certain prevailing market rates specified by regulation. There are no such restrictions on a depository institution that is well capitalized. As of December 31, 1996, the Bank had one brokered deposit, a $99,000 five-year certificate of deposit which was acquired in March 1992.
Loans to One Borrower. Under the HOLA, savings institutions are subject to the same limits on loans to one borrower as national banks. Generally, savings institutions may lend to a single or related group of borrowers on an unsecured basis an amount equal to 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate.
On February 21, 1995, the Office of the Comptroller of the Currency revised the rules governing national bank lending limits which was effective March 17, 1995. The revisions automatically apply to savings institutions regulated by the OTS. Under the revision, the calculation of capital has been changed to include the bank's total Tier 1 and Tier 2 capital, plus the balance of the bank's allowance for loan and lease losses not included in the total Tier 1 and Tier 2 capital. The revisions have simplified the calculation of loan limits as savings banks may now rely mainly on information from quarterly reports of condition of income or call reports, instead of requiring calculation of the lending limits on a daily basis. At December 31, 1996, the Bank had four loans which exceeded the loans to one borrower limit, totaling $7,044,577.
Qualified Thrift Lender Test ("QTL"). The HOLA requires savings institutions to meet a QTL test. The QTL test, as amended by the FDICIA, requires savings institutions to 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 qualified thrift investments, primarily residential mortgages and related investments (including certain mortgage-backed and mortgage-related securities) on a monthly basis in nine out of every 12 months.
A savings institution that fails to become or remain a qualified thrift lender must convert to a bank charter or be subject to certain operating restrictions. A savings institution that fails to meet the QTL test and does not convert to a bank charter will be prohibited from: (i) making any new investment or engaging in activities that would not be permissible for national banks; (ii) establishing any new branch offices where a national bank located in the savings institution's home state would not be able to establish a branch office; (iii) obtaining new advances from any FHLB; and (iv) the payment of dividends except as limited to the statutory and regulatory dividend restrictions applicable to national banks. Also, beginning three years after the savings institution ceases to be a qualified thrift lender, the savings institution would be prohibited from retaining any investment or engaging in any activity not permissible for a national bank and would be required to repay any outstanding advances to any FHLB. A savings institution may requalify as a qualified thrift lender if it thereafter complies with the QTL test.
As of December 31, 1996, the Bank met the QTL test, maintaining 84.1% of its portfolio assets in qualified thrift investments.
Branching. In April 1992, the OTS amended its rules on branching by federally chartered savings institutions to allow nationwide branching to the extent allowed by federal statute. This action permits savings institutions with interstate networks to diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions. Prior approval of the OTS is required for a savings institution to branch interstate or intrastate. To obtain supervisory clearance for branching, an applicant's regulatory capital must meet or exceed the minimum requirements established by law and by the OTS regulations. In addition, the savings institution must have a satisfactory record under the Community Reinvestment Act ("CRA"). The Bank does not conduct interstate branching operations and does not plan to do so in the foreseeable future.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act") which became effective September 29, 1995, eliminates many existing restrictions on interstate banking by authorizing interstate acquisitions of banks by bank holding companies without geographic limitations and without regard to whether such acquisitions are permissible under the state law.
Florida enacted the Florida Interstate Banking Act ("Florida Act") which became effective May 16, 1996. The Florida Act permits acquisitions of Florida banks in existence three years or more (or all Florida bank subsidiaries in the case of Florida bank holding companies) by bank holding companies based in other states.
Florida law has permitted interstate reciprocal acquisitions of and by Florida savings institutions since 1986. The effect of the Interstate Act and the Florida Act, which will expand the number of out-of-state bank holding companies permitted to acquire Florida banks, on the Bank cannot be predicted at this time. It is anticipated that these acts may facilitate further consolidation in the banking industry and, by permitting out-of-state banks nationwide to acquire Florida banks, may increase competition in the Bank's market.
Liquidity. The Bank is required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified United States Government, state or federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement may be
changed from time to time by the OTS to any amount within the range of 4% to 10% of the institution's average daily liquidity base balance during the preceding calendar month, depending upon economic conditions and the savings flows of member institutions. The current liquidity requirement is 5%. The OTS regulations also require each member savings institution to maintain an average daily balance of short-term liquid assets at a specified percentage (currently 1%) of the total of its net withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's average daily liquidity ratios at December 31, 1996, was 9.55%, and it's short-term liquidity ratio for the same period was 2.33%. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements.
OTS Assessments. Savings institutions are required by OTS regulation to pay assessments to the OTS to fund the operations of the OTS. The general assessment, to be paid on a semiannually basis, is computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the institution's latest quarterly thrift financial report. The Bank paid $66,255 in OTS assessments for the year-ended December 31, 1996.
Community Reinvestment. The Community Reinvestment Act of 1977 ("CRA") and the implementing regulations of the Federal Reserve and the FDIC are intended to encourage regulated financial institutions to help meet the credit needs of their local community or communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of such financial institutions. The CRA and such regulations provide that the appropriate regulatory authority will access the records of regulated financial institutions in satisfying their continuing and affirmative obligations to help meet the credit needs of their local communities as part of their regulatory examination of the financial institution. The results of such examinations are made public and are taken into account upon the filing of any application to establish a domestic branch or to merge or to acquire the assets or assume the liabilities of a financial institution. In the case of a bank or savings and loan holding company, the CRA performance recorded of the financial institutions involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a financial institution or to merge with any other bank or savings and loan holding company. An unsatisfactory record can substantially delay or block the transaction. The Bank received a "Satisfactory" CRA Rating in its last CRA Examination.
On May 4, 1995, the OTS and the other federal banking agencies adopted new, uniform CRA regulations that provide guidance to financial institutions on their CRA obligations and the methods by which those obligations would be assessed and enforced. The regulations establish three tests applicable to the Bank: (i) a lending test to evaluate direct lending in low-income areas and indirect lending to groups that specialize in community lending; (ii) a service test to evaluate an institution's delivery of services to such areas; and (iii) an investment test to evaluate an institution's investment in programs beneficial to such areas. The new CRA regulations became effective on July 1, 1995, but reporting requirements are not effective until January 1, 1997. Evaluation under the regulations is not mandatory until July 1, 1997. The Bank believes its current operations and policies substantially comply with the new regulations and, therefore, no material changes to operations or policies are expected.
Annual Independent Audits and Reporting Requirements. On May 11, 1993, the FDIC adopted a rule implementing a provision in FDICIA that imposes more stringent reporting requirements and requires the establishment and maintenance of internal control structures and procedures effective July 2, 1993. The FDIC rule is applicable to any insured depository institution having assets of $500 million or more as of the beginning of each fiscal year after December 31, 1992, and requires management to prepare annual and agency reports on the financial condition of the institution that are to be filed with the FDIC and the OTS in the case a federally-chartered savings association. The annual report would contain financial statements prepared in accordance with generally accepted accounting principles that are audited by the institution's independent public accountant. The annual report must also contain management's assertions concerning the effectiveness of the institution's internal control structure and procedures and its compliance with designated laws and regulations. The rule requires that the independent public accountant examine the institution's internal control structure and apply procedures agreed upon by the FDIC to determine the extent of the institution's compliance with certain laws and regulations designated by the FDIC concerning the safety and soundness, such as regulations governing affiliate transactions, legal lending limitations, loans to insiders, dividend restrictions and financial reporting in thrift financial reports. The Bank is not subject to this requirement; nevertheless, the Bank has opted to comply with this rule. The financial statements of the Company are audited by independent auditors.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank ("FHLB") System which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. As a member of the FHLB-Atlanta, the Bank is required to acquire and hold shares of capital stock in that FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20th of its advances (borrowings) from the FHLB-Atlanta, whichever is greater. The Bank is in compliance with this requirement. FHLB advances must be secured by specified types of collateral and may be obtained only for the purpose of providing funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent savings institutions and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to members. For the year ended December 31, 1996, dividends paid by the FHLB-Atlanta to the Bank amounted $127,746, of the Bank's pre-tax income. Should dividends be reduced, or interest on FHLB advances increased, the consolidated net interest income might also be reduced for the Bank. Furthermore, there can be no assurance at the value of the FHLB-Atlanta stock held by the Bank will not decrease as a result of any new legislation.
Federal Reserve System
The Federal Reserve regulations require savings institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve regulations generally require that reserves of 3% must be maintained against aggregate transaction accounts of $52.0 million less (subject to adjustment by the Federal Reserve), and an initial reserve of $1,560,000 plus 10% (subject to adjustment by the Federal Reserve between 11 3/4% and 16 1/4%) against that portion of total transaction accounts in excess of $52 million. The first $4.3 million of otherwise reversible balances (subject to adjustments by the Federal Reserve) are exempted from the reserve requirements. The Bank is in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the OTS. Because required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve or a pass-through account as defined by the Federal Reserve, the effect of this reserve requirement is to reduce the Bank's interest-earning assets. FHLB System members are also authorized to borrow from the Federal Reserve "discount window", however, Federal Reserve regulations require institutions to exhaust all FHLB sources before borrowing from a Federal Reserve.
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ITEM 2.

ITEM 2. PROPERTIES
During 1990, Federal Trust entered into a long-term lease obligation with John Martin Bell, a stockholder and former director of Federal Trust, and the wife of a director of Federal Trust, James T. Bell, for the use of the Federal Trust Building located at 1211 Orange Avenue, Winter Park, Florida. The Federal Trust Building serves as the headquarters for the Bank. The base annual rental paid in 1996 was $268,987 or $20.22 per square foot and increases annually according to the CPI. The lease was restated in 1991 and amended in 1992, 1993 and 1995 and expires in 2000, unless allowed to automatically renew for two successive ten year periods. The lease is considered an "affiliated party" transaction under Federal Reserve Board regulations.
The offices leased by, and formerly occupied by, Federal Trust Corporation are rented on a month to month basis by Federal Trust Properties Corporation, a former subsidiary of the Corporation, for the same amount as the Corporation pays.
The following table sets forth certain information on the Federal Trust's principal offices, net carrying value and the expiration of leases when applicable at December 31, 1996.
Net carrying value of real property
Lease Owned Leased expiration ----- ------ ----------
Federal Trust Building -0- $777,714 12/31/00 1211 Orange Avenue Winter Park, Florida 32789
Federal Trust Corporation - former offices -0- $ -0- 10/1/01 1270 Orange Avenue, Suite C Winter Park, Florida 32789
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party or to which any of its property is subject.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December 31, 1996, no matters were submitted to a vote of the security holders through a solicitation or otherwise.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
There has been no active or established public market in the common stock of the Company. As of March 1, 1997, there are 437 holders of common stock of the Company. The Company paid quarterly cash dividends to stockholders during 1994, 1993, and 1992 in the annual amount of $0.12, $.092 and $.064 per share of common stock, respectively, as adjusted to reflect the five-for-four stock split effective November 30, 1992. The Company did not pay dividends during 1995 or 1996.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for Federal Trust as of the dates and for the periods indicated. Such information is qualified in its entirety by the more detailed information set forth in the Financial Statements and the notes thereto included elsewhere herein.
Summary of Operations
(1) Difference between weighted average yield on all interest-earning assets and weighted average rate on all interest-bearing liabilities.
(2) Includes interest-earning balances in other banks, federal funds sold, U.S. government and agency obligations, FHLB Stock and marketable equity securities.
(3) Adjusted for five for four stock splits effective November 30, 1992; and in 1991, 1990, and 1989.
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ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FEDERAL TRUST CORPORATION
RESULTS OF OPERATIONS
Overview
The Bank's net earnings have been adversely affected by the rise in interest rates that has occurred during 1994 and 1995, due to its negative GAP position, as its liabilities have repriced sooner than, and in greater amounts than, its assets. As a result, the Bank's cost of funds has increased faster than the yields earned on its assets, resulting in a decrease in its interest rate spread and lower earnings. The Bank has continued to concentrate on increasing its portfolio of adjustable rate loans and, as interest rates have begun to decline in 1995, is increasing its efforts to lengthen the maturities of its liabilities in order to reduce its negative GAP position and the impact of higher interest rates in the future. Should interest rates begin to rise before the Bank is able to further reduce its negative GAP, the Bank's earnings would be adversely affected.
In addition, the Bank has had to increase its loss reserves as a result of a higher level of non-performing loans. The level of non-performing loans decreased in 1996 and, although management believes that the level of non-performing assets will continue to decrease in future periods, unforeseen economic conditions and other circumstances beyond the Bank's control could result in material additions to the loss reserves in future periods if the level of non-performing assets increases. The Bank does anticipate additions to the loss reserves in future periods as part of the normal course of business, as the Bank's assets, consisting primarily of loans, are continually evaluated and the loss allowances are adjusted to reflect the potential losses in the portfolio on an ongoing basis.
The Company incurred a loss for 1996, primarily as a result of the continued legal expenses and other costs associated with repossessed assets, the continuing impact of higher interest rates on the Bank's net interest margin, the reduced yields on the Bank's portfolio of structured notes resulting from the current yield curve in which the spread between short term and longer term interest rates is narrow, and the one time special assessment that was charged to all SAIF insured institutions to fully capitalize the SAIF at 1.25 percent of insured deposits, which amounted to $716,498 for the Bank. In addition, the Holding Company incurred one time charges of $64,921 to sell the remote drive-in facility previously used by the Bank, and a one time charge to write-off the leasehold improvements at the offices it previously occupied.
General
Federal Trust Corporation ("Federal Trust" or the "Company" or the "Holding Company"), formerly FedTrust Corporation, was incorporated as a unitary savings and loan holding company in August, 1988. Federal Trust was capitalized on February 28, 1989 and acquired all outstanding common stock of Federal Trust Bank, a federally chartered savings bank (the "Bank"), formerly First Coast Savings Bank, F.S.B., in exchange for all the outstanding shares of Federal Trust. Five shares of Federal Trust's common stock were exchanged for each four shares of the Bank's common stock on that date. The acquisition of the Bank was accounted for as a pooling of interests. The Bank is currently the only operating subsidiary of Federal Trust and began operations on May 3, 1988.
The Holding Company had been operating two non-bank subsidiaries, Federal Trust Properties Corp. ("FTPC"), a real estate holding and development company, organized December 12, 1994, which owned two office buildings in Amelia Island, Florida, which were sold in December, 1995, and a residential site in Augusta, Georgia, which was sold in February, 1996; and 1270 Leasing Co. ("1270 LC"), a real estate entity organized May 27, 1994, which leased the Holding Company's office located in Winter Park, Florida. FTPC was sold on July 1, 1996, and 1270 LC was dissolved on September 26, 1996. Three former subsidiaries, First Coast Financial Corporation ("FCFC"), a mortgage broker, FC Construction Services Corp. ("FCCSC"), a commercial construction company and FedTrust Building Corporation ("FTBC"), which operated office buildings in Amelia Island, Florida were all disposed of during fiscal year 1993. See "Business - Asset Sales - Sale of Subsidiary Assets". The assets of FCCSC and FTBC were sold on July 31, 1993 and the companies were dissolved in December, 1993. The stock of FCFC was sold on June 30, 1993. Operations of these subsidiaries were not significant to the consolidated entity.
Federal Trust acquired FCFC on February 17, 1989. The acquisition of FCFC was accounted for as a purchase and goodwill of $193,585 resulted. Federal Trust sold the stock of FCFC on June 30, 1993 for $200,000 comprised of $1,000 in cash and a $199,000 note secured by FCFC stock payable over ten (10) years. No loss was reported on the sale. During 1994, the purchaser of FCFC defaulted on the $199,000 note and, in December, 1994, FTPC acquired FCFC's personal property valued at $12,410. FTPC chose not to acquire the stock of FCFC, as it had determined that the operations of the company had essentially ceased and could
not be restarted without an investment of significant resources, if at all. The Company recognized a loss on the note in the amount of $187,028.
Federal Trust also formed FCCSC, a commercial construction company, during 1989. FCCSC actively marketed its services during 1989 by building and selling an office building, and during 1990 by buying and selling an office building site, developing and licensing plans for residential townhouse units, and providing technical and consulting services to a real estate contractor/developer, and in 1991 by continuing to provide significant technical and consulting services to real estate contractors and developers. During 1992, FCCSC continued to license plans for residential townhouse units, but no significant marketing of services of FCCSC occurred in 1992 or during 1993. In July, 1993, Federal Trust sold substantially all of the assets held by FCCSC to two unrelated third parties and ceased operations of FCCSC. During 1994, the purchaser of a portion of FCCSC's assets defaulted on its note and, in December, 1994, FTPC acquired Georgia property through a deed in lieu of foreclosure and a Note through a voluntary assignment. See "Business - Asset Sales - Sale of Subsidiary Assets".
On March 27, 1990, Federal Trust acquired FTBC, formerly The John Martin Bell Corporation, from the sole shareholder who is a former director and major shareholder of Federal Trust, in exchange for 174,212 shares of Federal Trust's common stock. The transaction was approved by Federal Trust's stockholders and was accounted for as a purchase. The effect of the transaction was to increase net assets of Federal Trust by approximately $1.7 million. The primary business of FTBC was the ownership of commercial rental property comprising the office complex where the Amelia Island offices of Federal Trust were located. In 1992, FTBC conveyed the portion of the office complex which housed FCFC and the Bank to FCFC, subject to the outstanding mortgage. In December, 1992, FTBC and FCFC conveyed their interests in the property to the Bank, and the outstanding mortgage was paid in full. In July, 1993, the Bank sold its interest in the property to another bank as part of the sale of its Amelia Island deposits and branch office and the remaining property was sold by FTBC to an unrelated third party and Federal Trust ceased operations of FTBC. During 1994, the purchaser of the remaining property defaulted on its notes and, in December, 1994, FTPC acquired the property through a deed in lieu of foreclosure. See "Business - Asset Sales - Sale of Subsidiary Assets".
In December, 1995, FTPC sold Buildings 100 and 300 and all of the common area located in First Coast Plaza, Amelia Island, Florida with a book value of $677,605 for a purchase price of $583,334, resulting in a loss on the sale of $94,271. The properties were sold to an unaffiliated party for cash. In February, 1996, FTPC sold the residential site in Augusta, Georgia for cash for a loss of $1,647.
During 1995 and the first half of 1996 FTPC had been in the initial stages of a HUD insured apartment development project, which during the quarter ended June 30, 1996, had advanced to the stage of applying for a mortgage insurance commitment. Based on the anticipated cash needs and continuing overhead for such a project, the Company concluded that it would be in the best interest of the Company, and its banking subsidiary, to sell FTPC, in order to focus the Company's efforts and resources on the Bank. On July 1, 1996, the Company sold the stock of FTPC for $425,354 consisting of $60,000 in cash, a note for $60,000 which was due and paid on August 8, 1996, a note for $230,354 due upon the earlier of certain events, but in any event due no later than July 31, 1997, and three notes for $25,000 each, due December 31, 1998, 1999 and 2000, respectively. In addition, the Company is renting the quarters it previously occupied to FTPC on a month to month basis, and plans to sub-lease the space to a long term tenant. The Company dissolved 1270 LC on September 26, 1996, as it was no longer necessary to maintain the entity for purposes of the lease on the office space previously occupied by the Company.
As a result of the sale of FTPC and the dissolution of 1270 LC, the only remaining subsidiary of the Company is the Bank, and the Company's expenses have been reduced to minimal levels, as there are no longer any salaried employees in the Company and its offices have been sub-let. As a part of this reorganization, Mr. James T. Bell resigned as Chairman, President and Chief Executive Officer of the Company, although he remains on the Board of Directors. The Board has named James V. Suskiewich, the Chairman, President and Chief Executive Officer of the Bank, to the positions previously held by Mr. Bell. Employees of the Bank perform all necessary functions needed by the Company, and the Company reimburses the Bank for the time they spend on Company business.
On June 1, 1995, the Company assumed the lease from the Bank on the remote drive-in facility that had been previously used by the Bank. The current annual lease payment on this facility was $40,063. During the second quarter of 1996, the Company entered into a contract to sell this facility under the purchase option in the lease. This was done in order to terminate the remaining lease obligation which had 16 years remaining. The sale closed in September and the Company incurred a loss of $34,262, which was the lease termination fee and closing costs on the sale. In addition, the Company wrote off the remaining balance of the leasehold improvements at the facility, totaling $34,921, during the second quarter of 1996.
Asset/Liability Management
In order to minimize the potential for adverse effects of material and prolonged increases in interest rates on Federal Trust's results of operations, Federal Trust's management has implemented and continues to monitor asset and liability management policies to better match the maturities and repricing terms of Federal Trust's interest-earning assets and interest-bearing liabilities. Such policies have consisted primarily of: (i) emphasizing the origination and purchase of single-family residential adjustable-rate mortgage loans ("ARMs"); (ii) maintaining a stable core deposit base with a relatively high percentage of low-cost deposits; and (iii) maintaining an adequate portion of liquid assets (cash and interest-bearing deposits).
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative gap would adversely affect net interest income, while a positive gap would result in an increase in net interest income. During a period of falling interest rates, a negative gap would result in an increase in net interest income, while a positive gap would adversely affect net interest income.
Between 1988 and 1989, Federal Trust successfully emphasized the origination of single-family residential ARMs. However, due to the generally lower interest rates which have prevailed during the past few years, Federal Trust's originations of ARMs have decreased, especially during 1992, 1993, 1994 and 1995, due to the preference of Federal Trust's customers for fixed-rate residential mortgage loans. As of December 31, 1996, $79.0 million or 81.2% of the Bank's portfolio of single-family residential mortgage loans consisted of ARMs and 77.8% of the Bank's total mortgage loan portfolio had adjustable interest rates.
The Bank also seeks to maintain a large stable core deposit base by providing quality service to its customers without significantly increasing its cost of funds or operating expenses. The success of Federal Trust's core deposit strategy is demonstrated by the stability of its money market demand ("MMDA"), passbook, regular savings, checking and negotiable order of withdrawal ("NOW") accounts, which totaled $9.5 million or 9.0% of total deposits at December 31, 1996. These accounts bore a weighted average nominal rate of 3.59% at December 31, 1996. Since 1988, these accounts have consistently accounted for more than 9% of total deposits and Federal Trust anticipates that these accounts will continue to comprise a significant portion of its deposit base.
The Bank has also maintained a portfolio of short-term liquid assets (cash and assets maturing in one year or less) in order to reduce its vulnerability to shifts in market rates of interest. At December 31, 1996, 3.92 % of Federal Trust's total assets consisted of cash and interest-earning deposits. Furthermore, as of such date, Federal Trust's overall average liquidity ratio was 9.55%.
Based upon the assumptions set forth below, the Bank's one-year negative interest rate sensitivity gap amounted to $18.2 million or 13.1% of total assets as of December 31, 1996. At December 31, 1995, the one-year negative interest rate sensitivity gap was $ 30.4 million or 21.8% of total assets based on the assumptions in effect on such date. During 1996, the Bank's one-year negative interest rate sensitivity gap improved and contributed to the increase in the Bank's interest rate spread from 1.58% in 1995 to 1.99% in 1996. During this period, general interest rates decreased slightly and the average volume of interest-earning assets decreased $11.4 million and the average yield on these assets increased by .13%, due to the lagging nature of the adjustable rate mortgage loan portfolio. For the same period, interest-bearing liabilities decreased $10.1 million and the average rate on these liabilities decreased .31% due to the lower level of interest rates on certificates of deposit and FHLB advances. Although management believes that the Bank's current asset and liability management strategies reduce the potential adverse effects of changes in interest rates on the Bank's results of operations, any substantial and prolonged increases in market rates of interest would have an adverse impact on the Bank's results of operations. Management of Federal Trust Bank monitors the Bank's interest rate sensitivity and believes that its present gap position is appropriate for the current interest rate environment.
In preparing the tables below, the following assumptions have been made, which are based upon assumptions used by the FHLB of Atlanta during 1996. The FHLB's prepayment estimates are based upon a major Wall Street firm's prepayment model and the specific prepayment speeds applied to the bank's mortgages are a function of their underlying coupons, maturities and lifetime rate caps. Adjustable-rate mortgages are separated into 160 individual buckets by current versus lagging market index, coupon reset frequency, teaser versus non-teaser, distance to lifetime cap and periodic rate caps. The one-year decay rates for NOW, money market, passbook and non-interest demand deposits are 37%, 79%, 17% and 37%, respectively, based on a study done by the Office of Thrift Supervision. The above assumptions should not be regarded as indicative of the actual prepayments or withdrawals which may be experienced by Federal Trust in the future. The interest rate sensitivity gaps as of December 31, 1996, 1995 and 1994 were based on the assumptions for 1996, 1995 and 1994 and were based on economic and interest rate conditions during such years including the then prevailing prepayment experience and decay rate levels.
December 31, ------------ 1996 1995 1994 ---- ---- ---- (In Thousands of Dollars) Interest-earning assets maturing or repricing within one year 86,677 72,382 94,392 Interest-bearing liabilities maturing or repricing within one year 104,845 102,781 127,762 ------- ------- ------- Excess (deficiency) of interest-earning assets over interest-bearing liabilities (18,168) (30,399) (33,370) ======= ======= ======= Excess (deficiency) of interest-earning assets over interest-bearing liabilities maturing or repricing within one year as a percentage of total assets (13.08%) (21.85%) (21,88%) ======= ======= ======= Percentage of assets to liabilities maturing or repricing within one year (82.67%) 70.42% 73.88% ======= ======= =======
The following table sets forth certain information relating to Federal Trust's interest-earning assets and interest-bearing liabilities at December 31, 1996 that are estimated to mature or are scheduled to reprice within the periods shown.
(Mortgage loans and mortgage-backed securities are net of the undisbursed portion of loans due borrowers. (Consists of interest-bearing deposits, FHLB stock and investment securities. (3) Decay rates for deposits, based on a study by the Office of Thrift Supervision:
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The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest and dividend income of Federal Trust from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average cost; (iii) net interest income; (iv) interest rate spread; (v) net interest margin; and (vi) weighted average yields and rates. Average balances are based on average daily balances.
(1) Includes non-accrual loans.
(2) Includes interest-earning deposits and FHLB of Atlanta stock.
(3) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4) Net interest margin is net interest income dividend divided by average interest-earning assets.
Rate/Volume Analysis: The following table sets forth certain information regarding changes in interest income and interest income expense of Federal Trust for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (change in rate multiplied by prior volume, (2) changes in volume multiplied by prior rate and (3) changes in rate-volume (change in rate multiplied by change in volume).
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Impact of Increased Interest Rates on Investment Portfolio
During 1994 the Federal Reserve began raising interest rates to combat the growing threat of inflation that was becoming evident from the Leading Indicators of the U.S. economy. Starting in February, 1994 interest rates increased 250 basis points (2.50%) by the end of 1994, however during the fourth quarter of 1995 the Federal Reserve began decreasing interest rates as the economy slowed. As a result of the increased interest rates in 1994, the Bank's portfolio of investments consisting primarily of Federal Home Loan Bank Bonds ("Bonds"), was adversely affected as to their market value, but the market value has improved as a result of decreasing interest rates in 1995 and 1996. At December 31, 1994, the portfolio had unrealized losses totaling $5,342,700, at December 31, 1995, the unrealized losses had decreased to $1,181,624, and at December 31, 1996 the unrealized losses had decreased to $1,069,171.
Pursuant to Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and equity Securities", which requires that investments be classified into three categories, the Bank had classified the Bonds as Held-to-maturity securities, and, as a result, the Bonds were reported at amortized cost. However, on November 30, 1995 the bank reclassified its entire portfolio of Federal Home Loan Bank bonds from the held to maturity category to the available for sale category, in accordance with the guidance issued by the Financial Accounting Standards Board (FASB), which permitted the one-time opportunity to reassess the designations of all securities between November 15, 1995 and December 31, 1995. The transfer resulted in an increase in the unrealized loss on investment securities available for sale, net of the effect of income taxes as a component of stockholders' equity, to $1,291,699 at November 30,1995. During December 1995, the bank sold $7,250,000, par value, of the Federal Home Loan Bank bonds maturing in 2003, at a gross loss of $942,500, which decreased the unrealized loss on investment securities available for sale, net of the effect of income taxes as a separate component of stockholder's equity to $779,872 at December 31, 1995. During November 1996, the Bank sold $1,000,000 par value, of the Federal Home Loan Bank bonds maturing in 1997 and 1998 at a gross loss of $12,344. The unrealized loss on investment securities available for sale, net of the effect of income taxes as a component of stockholder's equity at December 31, 1996 was $210,224. (See "Impact of Accounting Requirements").
The Bonds are issued by, and are joint and several obligations of, the Federal Home Loan Banks, which are instrumentalities of the U.S. Government and are rated AAA by Moody's. As a result, management is of the opinion that the Bonds carry little, if any, risk of default. The market value of the Bonds has been and will continue to be affected by the overall level of interest rates until they mature. As, and when, interest rates decline the unrealized losses on the Bonds should decrease and the market value of the Bonds should be affected to a lesser extent as they near maturity. The bonds begin maturing in 1998, and the longest issue matures in 2003.
Acquisitions
On April 3, 1992, the Bank acquired certain assets and liabilities of First Federal Savings and Loan Association of Seminole County, F.A. from the RTC. The Bank acquired approximately $77,988,000 of loans and assumed $120,227,000 in deposits and other liabilities. In addition, the Bank paid a net premium of approximately $2,056,269 to the RTC and First Guaranty Mortgage Corporation in connection with the acquisition. The Bank has amortized $1,618,308 of the premium as of December 31, 1996 as an adjustment to interest income. The acquisition was accounted for as a purchase.
Branch Office and Asset Sale
Pursuant to an Agreement to Purchase Assets and Assume Liabilities dated as of February 26, 1993, between the Bank and SouthTrust Bank of Jacksonville, N.A. ("SouthTrust"), a national banking association having its principal office in Jacksonville, Florida, the Bank conveyed to SouthTrust $26,947,063 in assets and $19,153,517 in deposit liabilities of the Bank's branch office located at 1890 S. 14th Street, Amelia Island, Florida on July 22, 1993 for a net purchase price of $7,451,499.
The transaction included, the Bank's (i) conveyance to SouthTrust of deposit liabilities, with a book value of $19,153,517, at a premium to the Bank of $360,410, resulting in a cash payment by the Bank of $18,793,107, (ii) sale to SouthTrust of real estate, consisting of the branch office building with a book value of $1,282,908, for $1,300,000 in cash, resulting in a gain on the sale of real estate of $17,092, (iii) sale to SouthTrust of other fixed assets, consisting of furniture, fixtures, equipment and leasehold improvements to the branch office building, with an aggregate book value of $434,299, for $221,902 in cash, resulting in a loss on the sale of other fixed assets of $212,397, and (iv) sale to SouthTrust of certain loans, with a book value of $25,229,856, for $25,391,383, resulting in a gain on the sale of loans of $161,527. The resulting net gain to the Bank on the transaction was $326,632.
The sale of a portion of the loans was conditioned on the prepayment experience of such loans over the subsequent twenty-four (24) month period, and $20,333 of the resulting gain on the sale of said loans was deferred from income and held in escrow by SouthTrust. As a result of the subsequent prepayments experienced on the loans, the bank earned all of the deferred gain of $20,333 in 1995.
Liquidity
As a member of the Federal Home Loan Bank system, the Bank is required to maintain a daily average balance of liquid assets equal to a specified percentage (currently 5%) of net withdrawable deposit accounts and borrowings payable in one year or less. Federal regulations also require that each member institution maintain short-term liquid assets of at least 1% of its net withdrawable deposit accounts and borrowings payable in one year or less. Generally, the Bank's management seeks to maintain its liquid assets at comfortable levels above the minimum requirements imposed by its regulators. In December 1996, the Bank's average liquidity was 9.55%.
Federal Trust expects the Bank to generate sufficient deposits to provide liquidity for expected loan growth and other investments. The Asset/Liability Management Committee of the Bank meets regularly and, in part, reviews liquidity levels to ensure that funds are available as needed.
Provisions for Loan Losses
A provision for loan losses is generally charged to operations based upon management's evaluation of the potential losses in its loan portfolio and as a result, the Bank charged $279,596 to its provision for loan losses during 1996.
The Bank's net loans were essentially unchanged during 1996. Although management believes that its present allowance for loan losses is adequate as of December 31, 1996, the Bank's provisions are based on the current and currently anticipated future operating conditions, thereby causing these estimates to be susceptible to changes that could result in a material adjustment to results of operations in the near term. The amount needed in the allowance for loan losses is based on the particular circumstances of the individual non-performing loans, including the type, amount, and value of the collateral, if any, and the overall composition and amount of the performing loans in the portfolio at the time of evaluation, and, as a result, will vary over time. Recovery of the carrying value of such loans is dependent to a great extent on economic, operating and other conditions that may be beyond the Bank's control. Therefore, actual losses in future periods could differ materially from amounts provided in the current period and could result in a material adjustment to operations.
It is the Bank's practice to maintain the allowance for loan losses at a level considered by management to be adequate to provide for reasonably foreseeable loan losses. There is no precise method of predicting specific losses or amounts that ultimately may be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, in whole or in part, is a matter of judgement. Similarly, the adequacy of the allowance for loan losses can be determined only on a judgmental basis, after full review, including consideration of:
The borrower's financial data, together with evaluations of industry data, competition, the borrower's management capabilities and the underlying collateral for secured loans, including, when appropriate, independent appraisals of real estate properties, and other factors;
Consumer loan growth trends and delinquency and default rates, together with an analysis of past and present repayment performance;
A continuing evaluation of the loan portfolio by lending officers and senior management; and
Monthly review and evaluation of loans identified as having loss potential. If, as a result of such monthly reviews, a loan is judged to be uncollectible, the carrying value of the loan is reduced to that portion that is considered to be collectible.
The allowance for loan losses at December 31, 1996 was $1,533,003 or 154.7% of non-performing loans and 1.36% of net loans receivable compared to $2,060,568 or 61.9% of non-performing loans and 1.83% of net loans at December 31, 1995.
In addition to the continuing internal assessment of the loan portfolio, the Bank's loan portfolio is also subject to examination by the OTS. The most recent OTS regular examination was as of June 30, 1996 and concluded September 6, 1996. See "Supervision".
During 1996, the Bank's total non-accrual loans decreased by approximately $2,336,000.
Credit Risk
The Bank's primary business is the origination and acquisition of loans to families and businesses. That activity entails potential credit losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond the control of the Bank. While the Bank has instituted guidelines and credit review procedures to protect it from avoidable credit losses, some losses may inevitably occur.
Short-term balloon mortgage loans are sometimes used to allow borrowers the option of waiting until interest rates are more favorable for a long term fixed rate loan. If interest rates rise, these loans may require renewals if borrowers fail to qualify for a long term fixed rate loan at maturity and there is no assurance that a borrower's income will be sufficient to service the renewal. Management recognizes the risks associated with this type of lending and believes that the policies and procedures it applies to such loans lowers the general risk.
Supervision
The Holding Company and the Bank are subject to extensive regulation, supervision and examination by the OTS, the primary federal regulator, by the FDIC with regard to the insurance of deposit accounts and, to a lesser extent, the Federal Reserve. Such regulation and supervision establishes a comprehensive framework of activities in which a savings and loan holding company and its financial institution subsidiaries may engage and is intended primarily for the protection of the SAIF administered by the FDIC and depositors.
The first significant supervisory concerns regarding the Bank's operation and underwriting policy were cited by the OTS in the Bank's December 1992 examination. In response to the supervisory concerns, in January 1993, the Bank hired a new Chief Executive Officer/President who was given the responsibility of evaluating existing personnel, policies and procedures, and the development of new operating strategies for the Bank.
In May 1993, the OTS and the Bank entered into a Supervisory Agreement which was mainly directed at correcting loan underwriting deficiencies; limiting certain affiliated party transactions, including taking measures to avoid the appearance of conflicts of interest in transactions with affiliated persons; amending the Bank's main office lease with an affiliate to more accurately reflect market rates; developing plans for the disposition of classified assets; and better monitoring and documenting of loans to borrowers to ensure compliance with the Bank's loan to one borrower limits. To ensure compliance with the terms of the Supervisory Agreement, the Bank hired its outside independent auditors, KPMG Peat Marwick LLP, to report to management on a quarterly basis their assessment of the Bank's performance. The independent auditors reviewed the operations of the Bank in connection with the Supervisory Agreement and certified to management that the Bank was in compliance with the Supervisory Agreement.
In the following examinations of the Holding Company and the Bank, which were completed in April, 1994, the OTS cited the Holding Company and the Bank with certain deficiencies, many of which were the subject of the individual cease and desist orders that were entered into on October 3, 1994 (collectively, the "Orders"). The Bank's Order superseded the 1993 Supervisory Agreement with the OTS. Management of the Holding Company and the Bank consented to the issuance of the respective Orders, without admitting or denying that grounds for such Orders existed.
The OTS examination directives which were not included in the Holding Company's Order, require management of the Holding Company to amend the Holding Company's office lease with an affiliated party to better reflect market terms and conditions; discount certain notes receivable to better reflect market rates; require officers to submit detailed expense reports to the Board of Directors; discontinue use of the Bank's credit cards for Holding Company expenditures; and obtain written approval from the Board of Directors for all Holding Company expenses. The Board and management of the Holding Company believe that the Holding Company has complied and is in compliance with each of these directives.
The OTS examination directives that were not included in the Bank's Order, required management of the Bank to ensure adequate documentation of accounting information, modify loan relationships to comply with loans to one borrower; obtain appraisals for certain collateral property; obtain Board of Directors approval for changes to policies and procedures of the Bank; increase the amount of the general valuation allowance to $1.85 million and effectuate changes in the management of the lending department, establishing guidelines and individual responsibility for monitoring loan maturities, collection and foreclosures. The Board and management believe the Bank has complied and is in compliance with each of these directives.
Under the Holding Company's Order, the Company: (i) cannot request dividends from the Bank without written permission from the OTS; (ii) must reimburse the Bank for the Holding Company's expenses; (iii) develop a Management Services Agreement with the Bank which provides for the reimbursement for employees who work for both the Bank and the Holding Company; (iv) must appoint a Compliance Committee to report to the Board of Directors as to the Company's compliance with the Order; and (v) the Board must report to the OTS on a quarterly basis the Company's compliance with the Order.
The Bank's Order provides for the Board of Directors to: (i) develop, adopt and adhere to policies and procedures to strengthen the Bank's underwriting, administration, collection and foreclosure efforts; (ii) review and revise underwriting policies and procedures to comply with regulatory requirements; (iii) record minutes of the loan committee and grant loans only on procedures to comply with regulatory requirements; (iv) record minutes of the loan committee and grant loans only on terms approved by the loan committee; (v) develop and implement a written plan to collect, strengthen and reduce the risk of loss for all real estate owned and for certain loans at risk and secured by real estate; (vi) comply with policies and procedures requiring written inspection of development and construction loans; (vii) pay no more than market rate, determined by a rent study approved by the OTS for lease of the Bank's offices; (viii) make no payment of taxes owned by a person affiliated with the Bank; (ix) seek a Management Services Agreement for work performed for the Holding Company by Bank employees; (x) develop and submit for approval a three year business plan; (xi) comply with loans to one borrower policy; (xii) make no capital distribution to the Holding Company without the consent of the OTS; (xiii) appoint a compliance committee; and (xiv) refrain from purchasing additional dual indexed bonds.
The Orders require the Holding Company and the Bank to establish separate Compliance Committees. The Compliance Committees meet monthly to review, in detail, the terms of the Orders to ensure that the respective companies are in compliance with their Orders. The Bank also contracted with a company specializing in the review of the system of internal controls and operating procedures of financial institutions, including compliance with internal policies and procedures.
In the examinations of the Holding Company and the Bank, which were concluded in June, 1995, the OTS found the companies to be in compliance with their Orders. With regard to the Bank, improvement was noted in a number of areas, including underwriting procedures, documentation, disposition of problem assets, reduction in the dependency on wholesale funds and a reduction in operating expenses. In August, 1995 the OTS informed the Holding Company that it was conducting an expanded examination of the Holding Company with regard to certain transactions that were entered into by prior Bank management in 1990 and 1991. As of the date of this filing, the examination had not been concluded. See, "Item 7. Supervision".
In the 1996 examinations of Federal Trust and the Bank, the OTS found the companies to be in compliance with their Orders and upgraded the supervisory rating of Federal Trust to "Satisfactory". In light of the improvement of the Bank's operations, the OTS reduced the number of provisions in the Bank's Order from 27 to 23. Management has been advised that the OTS will consider lifting the Bank's Order when the ratio of classified assets to capital is reduced below 100%. With regard to the Bank, further improvement was noted in a number of areas, including underwriting procedures, documentation, disposition of problem assets, significant reduction in the dependency on wholesale funds, and a continued reduction in operating expenses.
Since the issuance of the 1993 Supervisory Agreement, the Board of Directors of the Bank has strengthened the overall management of the Bank with the hiring of a Chief Executive Officer/President in January 1993, the addition of a new Chief Financial Officer in June 1993, the reorganization of the Loan Department and the establishment of a new credit culture, coupled with the addition of a new Chief Lending Officer/Senior Problem Asset Officer in March, 1995. The Board and management of the Holding Company and the Bank believe that the Bank's management is taking the necessary corrective measures to ensure that the Bank is being operated properly and that the level of classified assets are being carefully monitored and managed in order to provide for the steady reduction of classified assets. The respective management's are committed to taking the appropriate steps to have the Orders lifted as soon as possible.
Management expects that the interest income of the Bank will continue to be limited, so long as the Bank's Order and current growth limitations remain in place. Under the growth limitations, the Bank cannot increase its total assets during any quarter in excess of an amount equal to net interest credited on deposit liabilities during the quarter. Management of the Holding Company and the Bank, however, do not believe that the respective Orders, or the current growth limitations on the Bank, will have a material impact on the financial condition of the Holding Company or the Bank. Changes in banking regulation by the U.S. Congress, or changes in the banking regulations by the OTS or the FDIC could, however, have a significant impact on the Holding Company and the Bank and their operations.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP"), which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of Federal Trust are monetary in nature. As a result, interest rates have a more significant impact on Federal Trust's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
Impact of Accounting Requirements
In June 1996, the FASB issued Statement of Financial Accounting Standards No. 125, "Accounting for transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial- components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The Company does not anticipate a material impact on its operations or financial position from the implementation of SFAS 125.
In February 1997, the FASB issued Statement of Accounting Standards No. 128, "Earnings Per Share". SFAS 128 establishes new standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock. In effect, this statement simplifies the standards for computing EPS previously addressed in APB Opinion No. 15, "Earnings Per Share", by making them comparable to international EPS standards. SFAS 128 replaces the presentation of primary EPS with a presentation of basic EPS and it also requires dual presentation of basic and diluted EPS on the face of the income statement for all public entities with complex capital structures. In addition, the statement requires a reconciliation of the numerator and denominator used to compute basic EPS. SFAS 128 supersedes APB Opinion No. 15 and the AICPA Interpretations thereon and is effective for financial statements issued for periods ending after December 15, 1997. The standard also requires the restatement of all prior-period EPS data presented in the financial statements. The Company has not adopted the disclosure requirements of this standard in its December 31, 1996 financial statements and does not anticipate a material impact on its operations or financial position from its implementation during the fiscal year ending December 31, 1997.
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Results of Operations
Comparison of the Years Ended December 31, 1996 and 1995 and 1994
General. The Company had a net loss for 1996 of $976,503 or $.43 per share, compared to a net loss of $2,249,701 or $1.00 per share in 1995 and a net loss of $179,173 or $.08 per share for 1994, respectively. The decrease in the net loss for 1996 was due to an increase in net interest income, a decreased provision for loan losses, and a decrease in other expenses, offset partially by a decrease in other income.
Interest Income and Expense. Interest income was $9,936,960 in 1996 compared to $10,609,387 in 1995 and $9,846,673 in 1994. Interest income on loans increased to $9,039,426 in 1996 from $9,001,646 in 1994 compared to $7,731,077 in 1994. The increase in interest income on loans in 1996 as compared to 1995 was primarily attributable to increased interest rates on the loans and a lower amount of non-accruing loans. The increase in interest income on loans between 1995 and 1994 was the result of an increase in interest rates in 1995. Interest income on investment securities decreased to $675,279 in 1996 from $1,289,085 in 1995 as a result of a decrease in the interest rates earned on the securities and a decrease in the average balance of investment securities held by the Bank. Other interest and dividends decreased $96,401 during 1996 and $43,315 during 1995 as a result of a decrease in the average balance of other interest-bearing assets. Management does not believe that interest income will increase, except for increases in interest rates, until the cease and desist order and growth restrictions are removed and the Bank is able to increase its loan and investment portfolios. Management expects the rates earned on the portfolios to fluctuate with general market conditions.
Interest expense decreased during 1996 to $7,037,882 compared to $8,026,334 in 1995 and $5,789,569 in 1994 primarily due to a decrease in interest rates and the average amount of deposit accounts and FHLB advances outstanding. Management believes that deposit accounts and FHLB advances will remain relatively stable in the future and will not increase until the cease and desist order and growth restrictions are removed and the Bank is able increase its asset size. Interest expense on these accounts will increase or decrease according to the general level of interest rates. Interest on FHLB advances and other borrowings decreased to $1,277,492 in 1996 from $1,812,655 in 1995 and $1,978,219 in 1994 due to a decrease in the average amount of FHLB advances outstanding during the year and a decrease in interest rates. Management expects to continue to use such advances when the proceeds can be invested wisely.
Provisions for Loan Losses. A provision for loan losses is generally charged to operations based upon management's evaluation of the potential losses in its loan portfolio. However, in May 1995, the OTS directed the Bank to increase its reserves for loan and REO losses by $730,000. The increase was primarily the result of the classification of the first mortgages on two loans on which the Bank has a second mortgage position. Also, additional reserves were required on two commercial loans whose classification was downgraded. The Bank's provision for loan losses for 1996 was $279,596 compared to $779,415 in 1995 and $531,483 in 1994. Net charge-offs totaled $1,223,240 in1996 compared to $707,222 for 1995 and $409,329 for 1994. Total non-performing loans at December 31, 1996 were $991,000 compared to $3,327,000 at December 31, 1995 and $6,373,000 at December 31, 1994. The allowance for loan losses at December 31, 1996 was $1,533,003 or 150.00% of non-performing loans and 1.36% of net loans receivable compared to $2,060,568 or 61.95% of non-performing loans and 1.83% of net loans receivable at December 31, 1995 compared to $1,974,950 or 31.0% of non-performing loans and 1.78% of net loans receivable at December, 31, 1994. The amount needed in the allowance for loan losses is based on the particular circumstances of the individual non-performing loans, including the type, amount, and value of the collateral, if any, and the overall composition and amount of the performing loans in the portfolio at the time of evaluation, and, as a result, will vary over time.
Total Other Income. Other income decreased from $505,424 in 1995 to $426,707 for the year ended December 31, 1996. The decrease in other income during 1996 resulted from a $88,171 decrease in rent income attributable to a repossessed office building that was sold in December, 1995, a decrease in fees and service charges of $24,772, a decrease of $2,673 in other income consisting mainly of decreased other loan income, offset partially by an increase in the gain on the sale of loans of $31,381 and an increase in the gain on the sale of other real estate of $5,518.
Total Other Expense. Other expense decreased to $4,236,492 in 1996 from $5,790,591 in 1995 and to $4,238,071 in 1994. The decrease of $1,554,099 in 1996 was primarily the result of a decrease of $263,891 in salary and employee benefits, a decrease of $118,383 in occupancy and equipment expense, decreased legal and professional expense of $490,556, a decrease of $402,620 in real estate owned expenses, decreased general and administrative expenses of $124,442, a decrease of $930,156 in losses on sale of investment securities, a decrease of $122,222 in losses on the sale of real estate, partially offset by an increase in deposit insurance premiums of $710,415, a loss on the sale of fixed assets of $152,621, and increased other expense of $35,135. The decrease in salary and employee benefits were the result of reduced staff levels, particularly at the Holding Company which eliminated all of its staff, which consisted of three positions. Occupancy and equipment expense were reduced as a result of the sale of the drive-in facility and the sub-letting of the Holding Company's offices, both of which were no longer necessary. Legal and professional expense decreased as a result of the reduction in the amount and number of non-performing loans. Real estate owned expenses and losses on the sale of real estate owned were reduced as the result of a reduction in the amount of repossessed properties at the bank during 1996.
General and administrative expenses were reduced primarily as a result of the elimination of the staff and offices of the Holding Company. The increase in deposit insurance premiums was the result of the one-time special assessment that was charged by the FDIC on all SAIF insured deposits as a result of legislation approved by Congress which the President signed on September 30, 1996. The special assessment was paid in November 1996 at the rate of $0.657 per $100 and the Bank charged $716,498 against third quarter earnings, which resulted in a $448,198 or $.20 per share after tax reduction in earnings for the Company in 1996. The loss on the sale of fixed assets was the result of the leasehold improvements written-off by the Holding Company in conjunction with the sale of the drive-in facility, and the write-off of the leasehold improvements at the Holding Company's office which it no longer uses. The decrease in loss on the sale of investment securities was a result of the large loss incurred in 1995 on the sale of a $7,250,000 block of bonds.
Liquidity and Capital Resources at December 31, 1995
General. Like other financial institutions, the Bank must ensure that sufficient funds are available to meet deposit withdrawals, loan commitments, investment needs and expenses. Control of the Bank's cash flow requires the anticipation of deposit flows and loan payments. The Bank's primary sources of funds are deposit accounts, FHLB advances and principal and interest payments on loans.
The Bank requires funds in the short term to finance ongoing operating expenses, pay liquidating deposits, purchase temporary investments in securities and invest in loans. The Bank funds short-term requirements through advances from the FHLB, the sale of temporary investments, deposit growth and loan principal payments. In addition, management has no plans to significantly change long-term funding requirements. The Bank requires funds in the long-term to invest in loans for its portfolio, purchase fixed assets and provide for the liquidation of deposits maturing in the future. The Bank funds its long-term requirements with proceeds from maturing loans, the sale of loans, the sale of investments in securities and deposits and the sale of real estate.
During the year ended December 31, 1996, the Company used funds primarily from sale of loans of $7,942,943, funds from Federal Home Loan Bank advances of $3,800,000, proceeds from the sales of real estate owned of $1,014,345, proceeds from the sale of investment securities of $987,656, and funds from the sale of Federal Home Loan Bank stock of $600,000 to fund $7,394,909 in loan originations and purchases, net, decreases in total deposits of $3,076,286, repayment of debentures of $420,000 and an increase in cash and cash equivalents of $3,796,001. Management believes that in the future, funds will be obtained from the above sources. The weighted average cost of interest-bearing liabilities at December 31, 1996 was 5.63% compared to 5.94% at December 31, 1995.
At December 31, 1996, loans-in-process, or closed loans scheduled to be funded over a future period of time, totaled $1,902,256. Loans committed, but not closed, totaled $2,959,941, available lines of credit totaled $179,000, and standby letters of credit totaled $500,000. Funding for these amounts is expected to be provided by the sources described above. As of December 31, 1996, the Bank had outstanding FHLB advances of $24,800,000 compared to $21,000,000 in 1995.
During 1993 and 1994, the Company sold common stock through a private placement memorandum. The offering provided for the sale of a maximum of 500,000 shares (minimum of 125,000 shares). The offering terminated on March 31, 1994. The number of shares sold during 1993 and 1994 were 177,704 and 157,935, respectively and generated $1,281,611 and $1,011,953, respectively, for the Company after payment of offering expenses. No securities were sold during 1995 or 1996.
As a member of the Federal Home Loan Bank system, the Bank is required to maintain a daily average balance of liquid assets equal to a specified percentage (currently 5%) of net withdrawable deposit accounts and borrowings payable in one year or less. Federal regulations also require that each member institution maintain short-term liquid assets of at least 1% of its net withdrawable deposit accounts and borrowings payable in one year or less. Generally, the Bank's management seeks to maintain its liquid assets at comfortable levels above the minimum requirements imposed by its regulators. For the month ending December 31, 1996, liquidity averaged 9.55%.
The Company expects the Bank's central Florida office to generate sufficient deposits to provide liquidity for expected loan originations and other investments. The Asset/Liability Management Committee of the Bank meets regularly and, in part, reviews liquidity levels to ensure that funds are available as needed.
The Company last declared a dividend to its stockholders on September 30, 1994, which was paid on November 14, 1994. As a result of the net losses that have been incurred by the Company since the fourth quarter of 1994, no additional dividends have been declared and the Board of Directors decided to suspend the payment of dividends for calendar year 1995 and 1996, and does not anticipate the payment of dividends in 1997. In addition, although the Company does not require OTS approval for the granting of dividends, the Bank is prohibited from granting dividends without OTS approval and Bank does not anticipate the payment of dividends to the Company for calendar year 1997. The payment of dividends in subsequent years will depend on general economic conditions, the overall
performance of the Company, and the capital needs of the Company Credit Risk. The Bank's primary business is the origination or acquisition of loans to families and businesses. That activity entails potential credit losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond the control of the Bank. While the Bank has instituted guidelines and credit review procedures to protect it from avoidable credit losses, some losses may occur.
Short-term balloon mortgage loans are sometimes used to allow borrowers the option of waiting until interest rates are more favorable for a long term fixed rate loan. If interest rates rise, these loans may require renewals if borrowers fail to qualify for a long term fixed rate loan at maturity and there is no assurance that a borrower's income will be sufficient to service the renewal. Management recognizes the risks associated with this type of lending and believes that the policies and procedures it applies to such loans lowers the general risk.
The following table is a reconciliation of the Bank's stockholder's equity calculated in accordance with generally accepted accounting principles to regulatory capital:
At December 31, 1995 -------------------- Tangible Core Risk-Based -------- ---- ---------- (In Thousands of Dollars) Stockholders' equity as shown in the accompanying financial statements 6,401 6,401 6,401 Other: Unrealized loss on investments 699 699 699 General valuation allowances -- -- 945 Less: Excess mortgage servicing rights and Excess net deferred tax assets (486) (486) (486) Less: Assets required to be deducted -- -- (74) ----- ----- ----- Regulatory capital 6,614 6,614 7,485 ===== ===== =====
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ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 1996, 1995 and 1994
With Independent Auditors' Report Thereon
Independent Auditors' Report
Board of Directors Federal Trust Corporation and Subsidiaries:
We have audited the consolidated balance sheets of Federal Trust Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Federal Trust Corporation and subsidiaries at December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1996, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwich LLP
February 7, 1997, except as to note 18, which is as of March 7, 1997
See accompanying notes to consolidated financial statements
See accompanying notes to consolidated financial statements
(Continued)
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1996 and 1995
(1) Organization and Summary of Significant Accounting Policies
(a) Organization
Federal Trust Corporation (the "Holding Company"), is the sole shareholder of Federal Trust Bank (the "Bank"). The Holding Company operates as a unitary savings and loan holding company. The Holding Company's business activities primarily include the operation of the Bank.
During the current year the Holding Company sold a subsidiary, Federal Trust Properties Corp. ("FTPC"), a real estate holding and development company for book value. In addition, the Holding Company dissolved its other subsidiary, 1270 Leasing Company ("1270 LC"), a real estate leasing entity. The assets of 1270 LC were transferred to the Bank or written-off. Operations of these subsidiaries were not significant to the consolidated entity.
The Bank was chartered as a federal stock savings bank. The Bank provides a full range of banking services to individual and corporate customers.
(b) Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of the Holding Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
The accounting and reporting policies of Federal Trust Corporation and subsidiaries (collectively called the "Company") conform to generally accepted accounting principles and to general practices within the thrift industry. The following summarizes the more significant of these policies and practices.
(c) Earnings Per Share
Earnings per share is computed using the weighted average number of common shares outstanding during the period. Stock warrants issued are not included in the calculation of earnings per share as their effect is not dilutive.
(d) Cash and Cash Equivalents
For the purposes of reporting cash flows, cash and cash equivalents includes cash and interest-bearing deposits with maturities of three months or less.
(e) Federal Home Loan Bank ("FHLB") Stock
This asset is owned due to regulatory requirements and is carried at cost. This stock is pledged as collateral to secure FHLB advances.
(f) Investment Securities Held to Maturity and Investment Securities Available for Sale
Certain securities are reported at fair value except for those securities which the Company has the positive intent and ability to hold to maturity. Investments to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and are carried at fair value. Unrealized holding gains and losses are included in stockholders' equity net of the effect of income taxes. (Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Securities that management has the intent and the Company has the ability at the time of purchase or origination to hold until maturity are classified as investment securities held to maturity. Securities in this category are carried at amortized cost adjusted for accretion of discounts and amortization of premiums using the level yield method over the estimated life of the securities. If a security has a decline in fair value below its amortized cost that is other than temporary, then the security will be written down to its new cost basis by recording a loss in the consolidated statements of operations. Realized gains and losses on investment securities are computed using the specific identification method.
(g) Loans
Loans receivable that the Bank has the intent and ability to hold until maturity or payoff are reported at their outstanding unpaid principal balance reduced by any charge-offs or specific valuation accounts, net of any deferred fees on originated loans.
Loan origination fees and certain direct loan origination costs are capitalized and recognized in income over the contractual life of the loans, adjusted for estimated prepayments based on the Bank's historical prepayment experience. If the loan is prepaid, the remaining unamortized fees and costs are charged to operations. Amortization is ceased on nonaccrual loans.
Commitment fees and costs relating to the commitments are recognized over the commitment period on a straight-line basis. If the commitment is exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield.
Loans are placed on nonaccrual status when the loan becomes 90 days past due as to interest or principal, unless the loan is both well secured and in the process of collection, or when the full timely collection of interest or principal becomes uncertain. When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is written off and the loan is accounted for on the cash or cost recovery method thereafter until qualifying for return to accrual status.
(h) Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. The allowance is an estimated amount that management believes will be adequate to absorb losses inherent in the loan portfolio and commitments to extend credit, based on evaluations of its collectibility. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, specific problem loans and commitments, and current and anticipated economic conditions that may affect the borrower's ability pay. While management uses the best information available to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.
Regulatory examiners may require the Bank to recognize additions to the allowance based upon their judgment about the information available to them at the time of their examination.
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(i) Mortgage Servicing Rights
The Bank originates mortgage servicing rights by selling loans and retaining servicing rights. In May 1995, the Financial Accounting Standards Board ("FASB") issued Statement of financial Accounting Standards ("Statement") No. 122, Accounting for Mortgage Servicing Rights. This Statement provides guidance for the recognition of mortgage servicing rights as an asset when a mortgage loan is sold and servicing rights are retained. The Bank adopted this standards effective January 1, 1996. The results of this adoption was to capitalize approximately $70,303 in mortgage servicing rights related to loans originated by the Bank in 1996. The carrying value of mortgage servicing rights is amortized over the life of the related loan portfolio. (j) Real Estate Owned
Real estate acquired in the settlement of loans is initially recorded at the lower of cost (principal balance of the former loan plus costs of obtaining title and possession) or estimated fair value at the date of acquisition. Subsequently, such real estate acquired is carried at the lower of cost or fair value less estimated costs to sell. Costs relating to development and improvement of the property are capitalized, whereas those relating to holding the property are charged to operations.
(k) Office Facilities and Equipment
Office facilities and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are stated at cost less accumulated amortization. Amortization of leasehold improvements is computed using the straight-line method over the lesser of the estimated useful life or the respective lease terms.
(l) Income Taxes
The Holding Company and its subsidiaries file a consolidated income tax return. Income taxes are allocated proportionately to the Holding Company and its subsidiaries as though separate income tax returns were filed.
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that included the enactment date.
(m) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
reported amount of revenues and expenses during the reporting period. The most significant estimates made by management are the determination of the adequacy of the allowance for loan losses, that real estate owned is stated at the lower of cost or fair value, and the recoverability of the deferred tax asset. Actual results could differ from these estimates.
(n) Effect of New Accounting Pronouncements
In October 1995, the FASB issued Statement No. 123, Accounting for Stock-Based Compensation. The Statement provides that companies must either charge the value of stock options granted to their income statement or provide pro forma equivalent information in a footnote disclosure and continue to account for the value of the stock options in accordance with APB Opinion No. 25. The Company adopted this standard effective January 1, 1996 by accounting for employee stock-based compensation under APB Opinion No. 25.
(2) Investment Securities Held to Maturity and Investments Securities Available for Sale
The amortized cost and estimated market values of investment securities held to maturity and available for sale at December 31, 1996 and 1995 are as follows:
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The amortized cost and estimated market value of investment securities held to maturity and investment securities available for sale at December 31, 1996, by contractual maturity, are below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Estimated cost market value ---- ------------ Investment securities held to maturity: Due in one year or less $ 6,267 $ 6,267 Due after five years through ten years 6,284,343 6,267,188 --------- ---------
$6,290,610 $6,273,455 ========== ==========
Investment securities available for sale:
Due after one year through five years $9,100,000 $8,796,641 ========== ==========
Market values for all securities were calculated using published prices or the equivalent at December 31, 1996.
The Company's investment in obligations of U.S. government agencies consist of dual indexed bonds issued by the Federal Home Loan Bank. The bonds have a par value of $16,100,000 and pay interest based on the difference between two indices. The bonds at December 31, 1996, pay interest at the 10 year constant maturity treasury rate less the 3 month or 6 month LIBOR rate plus a contractual amount ranging from 2.3% to 4.0%. The Company purchased the bonds to partially offset its risk related to its portfolio of adjustable rate mortgages and as such subjects the Company to a certain degree of market risk as the indices change with prevailing market interest rates.
Proceeds from sales of investment securities available for sale were $987,656, $6,307,501 and $12,117,605 in 1996, 1995 and 1994, respectively. Gross realized losses on sales of investment securities available for sale during 1996, 1995 and 1994 were $12,344, $942,500 and $9,927, respectively.
In November 1995, the Company transferred investment securities classified as held to maturity to investment securities available for sale in accordance with guidelines issued by the Financial Accounting Standards Board which permitted such a one-time election. The amortized cost of the investment securities transferred was $24,350,000 and the estimated market value was $22,283,281 and the unrealized loss was $2,066,719.
In March 1996, the Company transferred securities in the amount of $7,000,000 from the available for sale category to the held to maturity category resulting in an unrealized loss of $780,937 which remains in equity, net of amortization and income tax. Amortization is an adjustment to yield over the remaining term of the investments.
(Continued)
At December 31, 1996 and 1995, nonaccrual loans were approximately $991,000 and $3,326,600, respectively. Nonaccrual loans consist primarily of residential and nonresidential mortgage loans. If interest due on all nonaccrual loans had been accrued at the original contract rates, estimated interest income would have been increased by approximately $181,000, $381,000 and $616,000 in 1996, 1995 and 1994, respectively.
The recorded investment in loans for which an impairment has been recognized and the related allowance for loan losses at December 31, 1996 were $4,078,174 and $626,435, respectively. The average recorded investment in impaired loans during 1996 and 1995 was $5,071,872 and $6,032,515, respectively. Interest income recognized on impaired loans during 1996 and 1995 was $259,263 and $338,997, respectively.
The activity in the allowance for loan losses for the years ended December 31, 1996, 1995 and 1994 is as follows: (Continued)
Loan customers of the Bank include certain executive officers and directors and their related interests and associates. All loans to this group were made in the ordinary course of business at prevailing terms and conditions.
There were no outstanding loans to executive officers, directors and affiliates at December 31, 1995 or 1996.
(4) Loan Servicing
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $7,915,631 and $1,301,078 at December 31, 1996 and 1995, respectively. Servicing fees earned were $22,086, $22,026 and $52,144 for the years ended December 31, 1996, 1995 and 1994, respectively.
(5) Mortgage Servicing Rights
An analysis of the activity for originated mortgage servicing rights for the year ended December 31, 1996 is as follows:
Balance, January 1, 1996 $ - Originations 70,303 Amortization (2,672) -------
Balance, December 31, 1996 $ 67,631 ======
(6) Office Facilities and Equipment
Office facilities and equipment and their related accumulated depreciation and amortization at December 31, 1996 and 1995 are summarized as follows:
(Continued)
(7) Deposits
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company's large denomination ($100,000 and over) deposits included in certificate accounts mature as follows:
Interest expense on deposits for the years ended December 31, 1996, 1995 and 1994 is as follows:
(8) Federal Home Loan Bank Advances
A summary of advances from the Federal Home Loan Bank of Atlanta at December 31, 1996 and 1995 follows:
Maturing in year Interest rate ending December 31, (variable rates) December 31, 1996 ------------------- ---------------- -----------------
1997 6.01 $ 10,000,000 1997 5.86 5,000,000 1997 (6.95) 4,800,000 1998 6.12 5,000,000 --------- $ 24,800,000 =================
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Maturing in year Interest rate ending December 31, (variable rates) December 31, 1995 ------------------- ---------------- -----------------
1996 5.83 $ 5,000,000 1996 5.76 7,000,000 1996 (6.10) 4,000,000 1998 6.12 5,000,000 ---------
$ 21,000,000 =================
Pursuant to collateral agreements with the Federal Home Loan Bank ("FHLB"), advances are secured by all stock in the FHLB in the amount of $1,253,200 and qualifying mortgage loans in the amount of $34,588,904. In addition, investment securities with book values of $6,284,343 and $7,000,000 at December 31, 1996 and 1995, respectively, and with market values of approximately $6,267,188 and $6,348,125 at December 31, 1996 and 1995, respectively, were pledged as collateral to the Federal Home Loan Bank for FHLB advances.
(9) Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:
Cash and Cash Equivalents - The carrying amount of cash and cash equivalents (demand deposits maintained by the Company at various financial institutions) and interest bearing deposits represents fair value.
Investment Securities Available for Sale and Held to Maturity - The Company's investment securities available for sale represent investments in Federal Home Loan Bank ("FHLB") bonds. The fair value of the FHLB bonds was based on quoted market prices. The Company's investments held to maturity represent investments in Orange County, Florida Tax Certificates and FHLB bonds. The carrying value of tax certificates approximates the fair value. The fair value of FHLB bonds was based on quoted market prices.
Federal Home Loan Bank Stock - Fair value approximates carrying value.
Loans - For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for commercial real estate, commercial and consumer loans other than variable rate loans are estimated using discount cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable.
Deposits - The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at December 31, 1996 (that is their carrying amounts). The carrying amounts of variable rate, fixed term money market accounts and certificates of deposit (CDs) approximate their fair value at the reporting date. Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Federal Home Loan Bank Advances - Fair value of Federal Home Loan Bank advances are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Commitments - Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.
The estimated fair values of the Company's financial instruments at December 31, 1996 are as follows:
Carrying amount Fair value --------------- ----------
Financial assets: Cash and cash equivalents $ 5,465,762 5,465,762 Investment securities available for sale 8,763,641 8,763,641 Investment securities held to maturity 6,290,610 6,273,455 Loans (carrying amount less allowance for loan loss of $1,533,003) 112,547,266 112,879,373 Federal Home Loan Bank stock 1,253,200 1,253,200
Financial liabilities: Deposits: Without stated maturities $ 9,505,847 9,505,847 With stated maturities 96,609,264 96,869,394 Federal Home Loan Bank advances 24,800,000 24,784,484
Commitments: Letters of credit $ -- 500,000 Loan commitments -- 2,959,941
The carrying amounts shown in the table are included in the consolidated balance sheet under the indicated captions.
(10) Debentures and Common Stock Purchase Warrants
During 1991, the Company issued $420,000 of 10% callable debentures maturing in 1996. The debentures were issued in $1,000 denominations and were unsecured. Interest on the debentures is payable annually. The debentures were redeemed during 1996.
One stock purchase warrant was issued in connection with each $10 of debentures purchased. Each warrant entitled the registered owner to purchase one and a quarter shares of common stock at the greater of $10 or the book value per share of common stock as determined in accordance with generally accepted accounting principles at the end of the Company's most recent fiscal year end or, at any time prior to November 15, 1996. All warrants expired on November 15, 1996.
(Continued)
The tax effects of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts which give rise to significant portions of deferred tax assets and liabilities are as follows:
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1996, the Company has net operating loss carryovers (NOL's) of approximately $2,055,954 for federal and $5,121,042 state tax purposes, which expire between 2009 and 2011. In addition, the Company has approximately $44,000 in alternative minimum tax (AMT) credit carryforwards. A valuation allowance has been established for those NOL and AMT carryovers that management believes are more likely than not to be utilized prior to their expiration through future profitable operations.
The Company's effective tax rate on pretax (loss) income for 1996, 1995 and 1994 differs from the statutory Federal income tax rate as follows:
(12) Commitments
Future minimum lease payments under noncancelable leases, at December 31, 1996 are as follows:
Year ending December 31, Operating leases
1997 $ 288,217 1998 288,217 1999 288,217 2000 288,217 2001 26,288 ------
Total minimum lease payments $ 1,179,156 =========
Rent expense amounted to $351,150, $334,834 and $282,868 for the years ended 1996, 1995 and 1994, respectively.
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(13) Parent Company Financial Information
The parent company financial information is as follows at December 31, 1996 and 1995:
Condensed Balance Sheets
1996 1995 ---- ----
Assets: Cash, deposited with subsidiary $ 115,099 242 Prepaid expenses and other assets 79,303 315,186 Property, plant and equipment, net 377,678 655,237 Note receivable 305,354 -- Investment in subsidiaries 6,401,425 7,764,936 ---------- ----------
$7,278,859 8,735,601 ========== ==========
Liabilities and stockholders' equity: Due to subsidiaries $ -- 103,000 Accounts payable and accrued expenses 114,231 152,475 Capital debentures -- 420,000 Stockholders' equity 7,164,628 8,060,126 ---------- ----------
$7,278,859 8,735,601 ========== ==========
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
- -16-
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed Statements of Cash Flows, Continued
The major sources of funds available to the Company for payment of dividends are dividends from the Bank. The ability of the Bank to pay dividends to the Holding Company is subject to the approval of the Office of Thrift Supervision.
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(14) Selected Quarterly Financial Data (Unaudited)
Summarized quarterly financial data follows (in thousands, except for per share amounts):
Fourth quarter -------------- 1996 1995 1994 ---- ---- ---- Interest income $ 2,460 2,548 2,632 Net interest income 685 516 859 Provision for loan losses (311) 5 278 Income (loss) before income taxes 361 (1,806) (834) Net income (loss) 16 (1,177) (582) == ====== ====
Earnings (loss) per share $ .01 (.52) (.26) ======= ==== ====
Third quarter ------------- 1996 1995 1994 ---- ---- ---- Interest income $ 2,487 2,648 2,504 Net interest income 752 548 995 Provision for loan losses 441 42 -- Income (loss) before income taxes (1,151) (626) 61 Net income (loss) (737) (400) 40 ==== ==== ==
Earnings (loss) per share $ (.33) (.18) .02 ======= ==== ===
Second quarter -------------- 1996 1995 1994 ---- ---- ---- Interest income $ 2,432 2,765 2,447 Net interest income 731 735 1,078 Provision for loan losses 132 730 38 Income (loss) before income taxes (405) (1,006) 254 Net income (loss) (259) (644) 173 ==== ==== ===
Earnings (loss) per share $ (.11) (.29) .08 ======= ==== ===
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
First quarter ------------- 1996 1995 1994 ---- ---- ---- Interest income 2,558 2,648 2,264 Net interest income 741 784 1,134 Provision for loan losses 18 2 -- Income (loss) before income 5 (46) 299 Net income (loss) 3 (26) 190 ----- ----- -----
Earnings (loss) per share $ - (.01) .08 ===== ===== =====
(15) Related Party Transactions
During 1990, the Company entered into a long-term lease obligation with John Martin Bell, wife of the former president of the Company, James T. Bell, and a stockholder and director of the Company for the use of the building in Winter Park, Florida. Rent payments in the amount of $291,767, $247,923 and $223,552 were made during the years ended December 31, 1996, 1995 and 1994, respectively.
During the years ended December 31, 1996, 1995 and 1994, the Company reimbursed John M. and James T. Bell for their cost of furniture and fixtures and leasehold improvements for the Winter Park, Florida location in the amounts of $-0-, $1,417 and $23,937, respectively.
(16) Employee Stock Ownership Plan
The Company maintains a qualified employee stock ownership plan (the "Plan"). The Plan is qualified under Section 4975(e)(7) of the Internal Revenue Code, under which all of its subsidiaries may act as participating employees. In addition, the Plan meets all applicable requirements of the Tax Reform Act of 1986 and is qualified under Section 401(c) of the Internal Revenue Code.
At the discretion of the Board of Directors, the Company may make a contribution to the Plan of up to 15% of total compensation paid to employees during the year. Employees are 100% vested after five years of service. For the years ended December 31, 1996, 1995 and 1994, the Company contributed cash to the Plan of $38,000, $10,000 and $25,000, respectively.
(17) Regulation and Supervisory Agreement
The Bank is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision ("OTS"), its primary federal regulator, and by the FDIC, which insures deposits up to applicable limits. Such regulation and supervision establishes a comprehensive framework of activities in which a bank may engage and is intended primarily for the protection of the SAIF administered by the FDIC and depositors. During the current year, the FDIC imposed a one-time assessment on all SAIF-insured deposits in the amount of 65.7 cents per $100 of insured deposits, held as of March 31, 1995. The effect of this assessment resulted in a pre-tax charge to income of $716,498. As a thrift holding company, the Holding Company also is subject to extensive regulation, supervision and examination by the OTS and, to a lesser extent, the FDIC.
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The OTS completed a regular examination of both the Holding Company and the Bank in December 1992 and cited certain deficiencies which management believes it has addressed in the form of various corrective actions. In May 1993, the OTS and the Bank entered into a supervisory agreement which provides that the Bank shall; (i) adopt policies and procedures regarding affiliated party transactions; (ii) not permit overdrafts by affiliated persons; (iii) take action necessary to prohibit and to avoid the appearance of conflicts of interest in transactions with affiliated persons; (iv) either amend its lease for the Winter Park office to lower the rent or obtain a market rent study to support the rent; (v) comply with loan to one borrower limits; (vi) maintain adequate documentation to support compliance with loan to one borrower limits; (vii) develop plans for the disposition of real estate owned and other classified assets; (viii) review and revise loan underwriting policies and loan documentation procedures; (ix) fully document all loans approved by the loan committee and grant such loans only in accordance with approved terms; (x) establish procedures requiring written inspection reports for each development and construction loan; (xi) not use transactions with affiliates to increase capital of the Bank; and (xii) report to OTS quarterly its compliance with the agreement.
The OTS completed a regular examination of both the Holding Company and the Bank in April 1994 and cited certain deficiencies which management believes it has addressed in the form of corrective actions. Supervisory directives were issued by the OTS and provide for the Bank to take specific actions: (i) reimbursement of Holding company expenses paid by the Bank and prohibit further payment of Holding Company expenses by the Bank; (ii) the Bank is prohibited from granting dividends without OTS approval; (iii) management is directed to complete a Management Services Agreement with the Holding Company detailing employees' specific duties, and rate of remuneration; (iv) rectify deficiencies in employment arrangements consistent with OTS regulations; (v) ensure adequate documentation of accounting information; (vi) prepare a plan and timetable to modify loan relationships so as to comply with OTS regulations for loans to one borrower; (vii) obtain appraisals for certain collateral property; (viii) ensure that requested changes to policies and procedures are approved by the Board within 45 days; (ix) increase the amount of the general valuation allowance; (x) properly classify assets consistent with OTS recommendations; (xi) effectuate changes in the management of the lending department, establishing guidelines and individual responsibility for monitoring loan maturities, collections, and foreclosures, and (xii) establish a three year business plan detailing effects to improve the local core deposit base, establishing future lending patterns, plan for less reliance on telemarketing and out-of-state brokers, borrowers and collateral, and provide support for material changes in the financial structure of the Bank.
The OTS also issued supervisory directives requiring specific action by Holding Company as follows: (i) amend the existing lease of the office premises to reflect market terms and conditions; (ii) the Holding Company is prohibited from recognizing profit on the sale of First Coast Plaza buildings without prior approval of the OTS; (iii) discount certain notes receivable to reflect market rates; (iv) require officers to submit detail expense reports for review by the Board; (v) discontinue use of the Bank's credit cards for Holding Company expenditures; (vi) completion of a Management Services Agreement between the Holding Company and the Bank; (vii) ensure that all consulting agreements are written and approved by the Board and (viii) reimburse the Bank for all Holding Company expenses paid by the Bank. Based on conclusions set forth in the examination report, the Holding Company has been assigned a rating of "unsatisfactory" by the OTS.
On October 3, 1994, the OTS issued a Supervision Order to Cease and Desist (the "Order") for the Bank. Management and the Board of Directors have committed to adhering to the terms of the Order. The Order provides for the Board of Directors to: develop, adopt and adhere to policies and procedures to strengthen the Bank's underwriting, administration, collection and foreclosure efforts; review and revise underwriting policies and procedures to comply with regulatory requirements; record minutes to the loan committee and grant loans only on terms approved by the committee and document the recipient of proceeds of the loan; develop and implement a written plan to collect, strengthen and reduce the risk of loss for all real estate owned and for certain loans at risk and secured by real estate; comply with policies and procedures requiring written inspection of development and construction loans; pay no more than market rate, determined by a rent study approved by the OTS for lease of the Bank's offices; make no payment of taxes owed by a person affiliated with the Bank; seek reimbursement of expenses of the Holding Company paid by the Bank; provide a management services agreement for work performed for the Holding Company by the Bank; develop and submit for approval a three year business plan; comply with loans to one borrower policy; pay no dividend without consent of the OTS; appoint a compliance committee; refrain from purchasing dual indexed bonds. In addition, the OTS issued a separate Order for the Company requiring: the Holding Company
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
shall not request dividends from the Bank without written permission from the OTS; the Holding Company reimburse the Bank for the Holding Company's expenses, develop a management services agreement with the Bank which provides for the reimbursement for employees who work for both the Bank and the Holding Company; appoint a compliance committee to report to the board of directors as to the Holding Company's compliance with the Order.
In the 1996 examinations of the Holding Company and Bank, which were concluded in September 1996, the OTS found the Companies to be in compliance with their Orders. With regard to the Bank, improvement was noted in a number of areas, including disposition of problem assets, reduction of interest rate risk, and a reduction in operating expenses. Subsequent to year end, the OTS upgraded the Holding Company's rating to satisfactory.
Management does not believe that the supervisory agreement or the Order and the required actions relating to cited deficiencies will have a material impact on the financial condition of the Holding Company or the Bank. In addition, management believes it is in substantial compliance with the above provisions.
The regulatory structure governing savings associations and savings and loan holding companies gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities. Any change in such regulation, whether by the OTS, the FDIC or the U.S. Congress, could have a significant impact on the Bank and the Holding Company and their operations.
(18) Stock Options
On May 5, 1993, the Board of Directors of the Company approved a Stock Option Plan for Directors. The Plan provides that a maximum of 176,968 shares of common stock (the "Option Shares") will be made available to directors and former directors of the Company. Options for all the Option Shares were issued on May 6, 1993 to 13 present and former directors. The options are for a term of ten (10) years from the date of grant. The Options were issued at an exercise price of $6.40 per share determined at the time of issuance to be the fair market value of the underlying Common Stock subject to the Option on the date the Option was granted. No options have been exercised under the Plan at December 31, 1996. On March 7, 1997, the board of directors of the Company rescinded all options previously granted and terminated the plan.
In addition, the Company has issued stock options to certain sales representatives for their commitment in selling Federal Trust Corporation stock. These options have a strike price of $10.00 per share and will expire on October 26, 1999. At December 31, 1996 and 1995, options for 58,453 shares were outstanding to various sales representatives.
(19) Credit Commitments
The Bank has outstanding at any time a significant number of commitments to extend credit. These arrangements are subject to strict credit control assessments and each customer's credit worthiness is evaluated on a case-by-case basis. A summary of commitments to extend credit and standby letters of credit written at December 31, 1996 and 1995 are as follows:
(Continued)
FEDERAL TRUST CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Because many commitments expire without being funded in whole or part, the contract amounts are not estimates of future cash flows.
Loan commitments written have off-balance-sheet credit risk because only original fees are recognized in the balance sheet until the commitments are fulfilled or expire. Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. The credit risk amounts are equal to the contractual amounts, assuming that the amounts are fully advanced, and that collateral or other security is of no value.
The Bank's policy is to require customers to provide collateral prior to the disbursement of approved loans. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, real estate and income producing commercial properties.
Standby letters of credit are contractual commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
(20) Concentration of Credit Risk
The Bank originates real estate, consumer and commercial loans primarily in its Central Florida market area. Although the Bank has a diversified loan portfolio, a substantial portion of its borrowers' ability to honor their contracts is dependent upon the economy of Central Florida. The Bank does not have a significant exposure to any individual customer or counterparty.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT
Management of Federal Trust
The Board of Directors of Federal Trust Corporation consists of 6 members of whom 2 also presently serve as directors of the Bank. See "Management of the Bank." The table below sets forth the name and positions of each director and executive officer of Federal Trust.
Directors are elected for a term of one year effective with the 1996 Annual meeting, however two directors had terms remaining of greater than one year when the Corporation's By-laws were amended in1996.
Set forth below is certain information with respect to the persons who are directors or executive officers of Federal Trust, including an employment history covering the past five years. Except as otherwise indicated, all persons named have been engaged in their principal occupations for more than the past five years.
James T. Bell served as a director and Chairman of the Board of the Bank from 1986 to December 1992 and as Chairman of the Board and President of Federal Trust from 1988 to June 1996. Mr. Bell was President of the Bank during 1990. Mr. Bell is the President of Federal Trust Properties Corporation.
Anne T. Coonrod served as Vice President of the Corporation from December 1989 to July 1996. She is the former Vice President of FedTrust Building Corporation and the Bank. She is also the owner of the Front and Center Gift shop located in Fernandina Beach, Florida. She has been the owner of Atlantic Seafood, a seafood retailer/wholesaler since 1973.
Edwin J. Feiler, Jr. is the Vice Chairman of the Board of Directors of Federal Trust. He is also President of Metro Developers, Inc., a residential construction and property management company located in Savannah, Georgia and a general partner of American Housing Associates, a multi-family construction supervision and management partnership located in Savannah, Georgia and Arlington, Virginia.
Francis T. West, now retired, was the President and Chairman of the Board of West Window Corporation, Martinsville, Virginia, a company that has manufactured windows since 1949. He is also the retired Mayor of Martinsville and is a former director of the Crestar Bank of Martinsville. Mr. West presently serves as President of Franklin Finance Company and Chairman of Multitrade Group, Inc. He is a former Member of the White House Commission on Presidential Scholars, the former Chairman of Radio Free Europe and the former President of the Virginia Municipal League.
Mr. Suskiewich has served as President of the Bank since January 1993 and as Chairman of the Board of Directors of the Bank since May 1996. He has been President and Chairman of the Board of Directors of Federal Trust Corporation since June 1996. Prior to joining the Bank, he was the President and a director of First Federal Savings Bank of the Glades, Clewiston, Florida from March, 1988 to December 31, 1992.
Aubrey H. Wright, Jr., has been the Chief Financial Officer of the Company since April, 1994 and of the Bank since June, 1993. He was elected to the Board of Directors of the Bank in August, 1994. Prior to joining the Bank, Mr. Wright was President, Chief Operating Officer and a director of Essex Savings Bank, F.S.B. in West Palm Beach, Florida from August, 1991 to May, 1993. From 1989 to August, 1991, Mr. Wright served as President and Chief Financial Officer of Coral Savings and Loan Association, Coral Springs, Florida and Senior Vice President for Finance and Operations of Ambassador Federal Savings, Tamarac, Florida.
The executive officers of Federal Trust are elected annually at the discretion of the Board of Directors and hold office until their respective successors have been elected and qualified or until death, resignation or removal by the Board of Directors.
Management of the Bank
The direction and control of the Bank is vested in its Board of Directors, who are elected by Federal Trust as the sole stockholder of the Bank. Directors are elected for a term of three years, with one-third of the directors standing for election each year.
Age at Position with Expiration Name January 1, 1995 the Bank Director Since of Term - -------------------------------------------------------------------------------- James V. Suskiewich 49 President/ Chairman Director 1993 1997
George W. Foster 67 Director 1991 1997
Aubrey H. Wright, Jr. 50 SVP and CFO/ Director 1994 1998
Samuel C. Certo 49 Director 1996 1999
Kenneth W. Hill 63 Director 1996 1999
Louis Laubscher 53 VP and CLO N/A N/A
Mr. Suskiewich joined the Bank as President in January 1993. He has served as Chairman of the Board of Directors since May 1996. Prior to joining the Bank, he was the President and a director of First Federal Savings Bank of the Glades, Clewiston, Florida from March, 1988 to December 31, 1992.
Mr. Foster served as President of the Bank from December, 1990 to January, 1993, has served as President of Barnett Bank of Seminole County, President of Seminole County Chamber of Commerce, National President of the American Safe Deposit Association, as well as Director and President of numerous other civic and professional organizations. Prior to joining the Bank, Mr. Foster served as Assistant Vice President, Security Branch manager of First Federal Savings and Loan Association of Seminole County from 1980 to 1990.
Mr. Wright joined the Bank as Chief Financial Officer in June, 1993. Prior to joining the Bank, Mr. Wright was President, Chief Operating Officer and director of Essex Saving Bank, F.S.B. in West Palm Beach, Florida from August, 1991 to May, 1993. From 1989 to August, 1991, Mr. Wright served as and President and Chief Financial Officer of Coral Savings and Loan Association, Coral Springs, Florida and Senior Vice President for Finance and Operations of Ambassador Federal Savings, Tamarac, Florida. Coral Savings and Loan Association was placed under conservatorship by the Resolution Trust Corporation in January, 1991.
Dr. Certo is the former dean and has been a professor of management in the Crummer Graduate School of Business at Rollins College in Winter Park since 1986. In addition, Dr. Certo serves as a business consultant and has published textbooks in the areas of management and strategic management, and has been involved in executive education for the past 20 years.
Mr. Hill is retired from SunBank, N.A., where he served as Vice President and Trust Officer from 1983 until 1995. Mr. Hill's banking career began in 1966 and he has been a resident of central Florida since 1957.
Mr. Laubscher joined the Bank in February, 1995 and has been Chief Lending Officer since January, 1996. Prior to joining the Bank, Mr. Laubscher was Executive Vice President, Director and Chief Loan Officer for First Family Bank, FSB from March, 1992 to January, 1995. Mr. Laubscher was employed by The First, F.A. as Senior Vice President and Manager of the Loan and Investment divisions. The First, F.A. was acquired by Great Western Bank in a Resolution Trust Corporation assisted transaction in October, 1991. Mr. Laubscher has over 20 years of experience in senior management of financial institutions. He holds an MBA from the University of California at Berkeley.
Principal Holders of Voting Securities
The following table sets forth information as of March 1, 1997 with respect to the ownership of shares of the Common Stock by (i) such persons are believed by management to be the beneficial owners of more than 5% of the Common Stock, (ii) directors and officers of Federal Trust, and (iii) all directors and officers as a group.
(1) Except as indicated below, includes all shares of Common Stock owned by each director's spouse, or as custodian or trustee for minor children, over which shares such individuals effectively exercise sole voting and investment power.
(2) The Stock Option Plan was rescinded by the Board of Directors of the Company on March 7, 1997. See "Item 11.

ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
Compensation. The following table sets forth, for the fiscal years ended December 31, 1995, 1994 and 1993, the total compensation paid or accrued for the Chief Executive Officer and each of the four most highly compensated executive officers of the Company and its subsidiaries, whose aggregate salary and bonus exceeded $100,000 per year.
(1) Includes all compensation in the year earned whether received or deferred at the election of the executive.
(2) Includes CEO. There were no other executives whose salary and bonus exceed $100,000 per year.
(3) Includes the estimated value of:
James V. Suskiewich 1996 1995 1994 - ------------------- ---- ---- ---- Health & Life insurance premiums 4,454 $3,933 $3,926 Use of Company automobile 6,928 6,564 7,263 Social/Country Club Dues 2,779 2,671 2,633 ----- ----- ----- Total: $14,161 $13,169 $13,822
(4) Includes value of fully vested participation in the Company's Employee Stock Ownership Plan ("ESOP"). In 1990, the Company adopted an ESOP which provides that the Company can make a contribution to a trust fund for the purpose of purchasing shares of the Company's common stock on behalf of the participants. The Company pays the entire cost of the ESOP and all salaried employees of the Company who have completed six months of service are eligible to participate. The ESOP is qualified under Section 497(e)(7) of the Internal Revenue Code, under which subsidiaries may act as participating employees. In addition, the ESOP meets all applicable requirements of the Tax Replacement Act of 1986 and is qualified under Section 401(c) of the Internal Revenue Code.
All full-time salaried employees of the Company, and its subsidiaries are participants in the ESOP. Executive officers of the Company are eligible to participate in the ESOP, but directors are not eligible unless they are also full-time salaried employees. A participant's interest in the ESOP is vested after five years of service and there is no vesting prior to that period of time. Two employees had vested interest in the ESOP as of December 31, 1996. Mr. Suskiewich is not vested in the ESOP.
The ESOP contributions by the Company are determined annually by the Board of Directors of the Company, taking into consideration the prevailing financial conditions, the Company's fiscal requirements and other factors deemed relevant by the Board. The Company, generally, may make contributions to the ESOP of up to 15% of total compensation paid to employees during the year. Each participant's contribution equals the proportion that each such participant's compensation for the year bears to the total compensation of all participants for such year. In 1996, 1995 and 1994, the Company contributed cash of $38,000, $10,000 and $25,000, respectively to the ESOP.
Options and Long-term Compensation
Stock Option Plan for Directors: On May 5, 1993, the Board of Directors of the Company approved a Stock Option Plan for Directors. The Plan provides that a maximum of 176,968 shares of common stock (the "Option Shares") will be made available to directors and former directors of the Company. Options for all the Option Shares were issued on May 6, 1993 to 13 present and former directors. The options are for a term of ten (10) years from the date of grant. The Options were issued at an exercise price of $6.40 per share determined at the time of
issuance to be the fair market value of the underlying Common Stock subject to the Option on the date the Option was granted. The options held by an active director are canceled immediately if such director is removed for "cause" as defined in the Plan.
The Company issued no stock options or stock appreciation rights as compensation during the fiscal year ended December 31, 1995. On March 7, 1997, the Board of Directors of the Company rescinded the Stock Option Plan for Directors. The Company issued no stock options or stock appreciation rights as compensation during the period January 1, 1996 through March 7, 1997.
Director Compensation
Each director of the Company receives a fee of $500 for each meeting of the Board which he or she attends plus $750 per quarter, $250 for each Compliance Committee meeting and no fee for any other standing committee of which he or she is a member which he or she attends. Directors are reimbursed for expenses incurred in connection with attendance at meetings of the Board of Directors and all standing committees. The Company temporarily suspended the payment on all Board and Committee fees in July 1996.
Report of Board of Directors
The compensation of the Company's executive officers is determined by the Company's entire Board of Directors excluding any Director who is also an executive officer. The Chief Executive Officer (the"CEO") determines the salary range recommendations for all employees, including executives other than himself. The CEO presents these to the Board and the Board, in turn, reviews and analyzes all information submitted to it. Thereafter, the Board determines compensation of all executive officers of the Company including the compensation of the CEO.
Executive Compensation Policies and Program. The Company's executive compensation program is designed to:
o Attract and retain qualified management of the Company; o Enhance hort-term financial goals of the Company; and o Enhance long-term shareholder value of the Company.
The Company strives to pay each executive officer the base salary that would be paid on the open market for a fully qualified officer of that position. The Board of Directors determines the level of base salary and any incentive bonus plan for the CEO and certain senior executive officers of the Company and a range for other executive officers based upon competitive norms, derived from annual surveys published by several independent banking institutes or private companies specializing in financial analysis of financial institutions. Such surveys provide information regarding compensation of financial institution officers and employees based on size and geographic location of the financial institution and serve as a bench mark for determining executive salaries. Actual salary changes are based upon an evaluation of each individual's performance based upon Holding Company objectives and specific job description objectives, as well as the overall performance of the Holding Company. Executive officers's salaries were reduced in fiscal year 1995 as compared to 1994, consistent with the Holding Company's efforts to reduce budgeted expenses and overhead. Bonus awards are made based upon the attainment of the Holding Company's net income targets, the officer's responsibilities and individual performance standards with each officer given the opportunity to earn an annual performance bonus, generally in the range of approximately 10-40% of his or her base salary. In fiscal year 1995, however, no bonuses were awarded primarily because the Holding Company failed to attain its performance goals.
Compensation of the Chief Executive Officer. The CEO of the Company does not receive compensation from the Company, but is compensated in his position as CEO of the Bank. The Company reimburses the Bank for the time that the CEO spends on Company matters.
The employment contract of the former CEO of the Company was assigned to Federal Trust Properties Corporation ("FTPC") in June 1996, and FTPC was sold to an unaffiliated third party on July 1, 1996.
Board of Directors
James T. Bell Anne T. Coonrod James V. Suskiewich Edwin J. Feiler, Jr. Francis T. West
Compensation Committee Interlocks and Insider Participation in Compensation Decisions
James V. Suskiewich, President and Chief Executive Officer of the Company and President and Chief Executive Officer of Federal Trust Bank, (the "Bank") is a member of the Company's Board of Directors and participated in deliberations of the Board of Directors regarding executive compensation. Mr. Suskiewich, however, did not participate in any deliberation regarding his own compensation or transactions.
Employment Contracts
The Company and Bank entered into an employment agreement with James V. Suskiewich (Agreement). Mr. Suskiewich is the President and Chief Executive Officer, and a director of the Company and serves as the Chief Executive Officer and President of the Bank. The Agreement which became effective September 1, 1995 has a three-year term. The Agreement provides for a minimum base salary of $120,000 per year. Mr. Suskiewich is entitled to a discretionary performance bonus payable annually for the duration of the Agreement. For the year ended December 31, 1996, Mr. Suskiewich received a performance bonus of $20,000. The base salary and any bonus is paid by the Bank. In addition to the base salary and bonus, the Agreement provides for participation in all employee benefits, stock option plans, pension plans, insurance plans and other fringe benefits including club memberships and business related expenditures commensurate with his position. On each successive anniversary of the employment contract, the Board of directors is required to vote on whether the Agreement should be extended an additional year so that the remaining term shall be three years. The decision to extend the Agreement is within the sole discretion of the Board of Directors.
The Agreement provides for termination by the Bank for "cause", as defined in the Agreement. In the event the Bank chooses to terminate Mr. Suskiewich's employment for reasons other than for cause, Mr. Suskiewich (or in the event of death, Mr. Suskiewich's beneficiary) would be entitled to a severance payment equal to his total annual compensation for the remainder of the term of the Agreement. In the event of a change of control of the Company or the Bank, Mr. Suskiewich will be entitled to a special incentive bonus equal to two times his annual salary, times the price/book value ratio at which the Company or Bank is acquired. If Mr. Suskiewich accepts employment with the acquirer, he will be entitled to fifty percent (50%) of the special incentive bonus. The special incentive bonus is payable by either the Company or the Bank.
The Agreement permits Mr. Suskiewich to terminate his employment voluntarily. In the event of voluntary termination, except as previously described herein, all rights and benefits under the contract shall immediately terminate upon the effective date of termination.
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ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company is not aware of any person who, on March 1, 1995, was the beneficial owners of 5% or more of the Company's outstanding Common Stock, except for James T. Bell and John M. Bell. Information concerning such ownership is set forth in the following table together with information concerning beneficial ownership by directors and officers as a group.
Amount and Nature of Beneficial Ownership ---------
Beneficial Owner Percent of Class - ---------------- ----------------
James T. and John M. Bell 675 Osceola Avenue Winter Park, Florida 32789 522,369(1) 23.3
Directors and Executive Officers as a Group (7 persons) 671,392(1) 29.9 - ---------------------
(1) Includes 115,558 shares held by Mr. Bell in his name, 12,500 shares held as trustee, with respect to which Mr. Bell exercises sole voting and investment power, 212,405 shares held by Mrs. Bell in her name, with respect to which Mrs. Bell exercises sole voting and investment power, 181,906 shares held by Mr. and Mrs. Bell as joint tenants, with respect to which Mr. and Mrs. Bell share voting and investment power.
Security Ownership of Management
The table set forth in "Item 10. Directors and Executive Officers of the Registrant" contains certain information concerning shares of the Company's Common Stock beneficially owned by directors and all directors and officers as a group. There are no shares of the Company's Preferred Stock issued and outstanding.
Changes in Control
The Registrant does not know of any arrangement, including any pledge by any person of the securities of the Registrant or any of its subsidiaries, the operation of which may at a subsequent date result in a change in control of the Registrant.
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ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS TRANSACTIONS WITH MANAGEMENT
Indebtedness of Management
In 1994 the Board of Directors of the Company and the Bank amended their loan policies with regard to loans to directors, officers and employees. The current policy is generally not to make loans to directors, officers and employees. Any loans that are made, however, will require approval of a majority of the disinterested directors of the company making the loan. The Bank is also subject to the provisions of Section 22(h) of the Federal Reserve Act. Any credit extended by the Bank to directors, executive officers and, to the extent otherwise permitted, principal shareholders, or any affiliates thereof must be: (I) on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions by the Bank with non-affiliated parties and (ii) not involve more than the normal risk of repayment or present other unfavorable features.
As of December 31, 1996, neither the Company nor the Bank had any loans outstanding to directors or executive officers. The Bank, however, did have $737,472 in commercial loans to Morrone, Smoker and Grill, Inc., whose President Jack L. Morrone is the brother-in-law of the Company's former Chairman and Chief Executive Officer, who remains as a director of the Company. Mr. Morrone is considered to be an "affiliate", as that term is defined by SEC regulations. This largest outstanding balance during 1996 was $737,128. As of February 28, 1996 the balance was $478,128.
Transactions With Certain Related Persons
Effective January 1, 1990, John Martin Bell, a director and major shareholder of the Company and the wife of the Chairman of the Board of the Company, as lessor, and the Company, as lessee, entered into a triple net lease (the "Lease"), pursuant to which the Company leased from Mrs. Bell 3,953 square feet of office space located at 1211 Orange Avenue, Winter Park, Florida (the "Premises"). The term of the Lease was two (2) years. Effective January 1, 1991, the Lease was amended to increase the term from December 31, 1991 to December 31, 2000. The square footage leased by the Company increased to 11,393 square feet. On November 11, 1991, the Company and Ms. Bell terminated the Lease and executed a new triple net lease (the "New Lease"), pursuant to which the Company has leased 13,305 square feet in the Premises. The term of the New Lease runs until December 31, 2000. The New Lease will automatically be extended for two (2) consecutive periods of ten (10) years each unless the Company elects to terminate the New Lease pursuant to the notice provisions in the New Lease prior to the expiration of the ten year lease period. Effective July 15, 1992, the New Lease was modified to reduce the amount of space leased to 12,392 square feet and to decrease the annual rental by $49,510 to $240,686. Effective June 6, 1994, the New Lease was modified to decrease the annual rent for the years 1993 and 1994 to $216,984 and $223,552, respectively. Effective June 1, 1995, the New Lease was modified to increase the amount of space leased to 13,305 square feet. The rent for 1996 through the end of the New Lease term will be the preceding year's rent increased by the Consumer Price Index Escalation, provided however, that in no event shall the rent increase be less than 3% or more than 6%. The Company believes that the terms of this transaction are no less favorable to the Company than transactions obtainable from unaffiliated parties.
During the year 1995, the Company reimbursed John Martin Bell for her cost of furniture, fixtures and leasehold improvements for the Company's office space located at 1270 Orange Avenue, Winter Park, Florida in the amount of $1,417. No fees or profit was paid to the Bells in connection with this reimbursement. The Company believes that the terms of this reimbursement are no less favorable to the Company than what could be obtained from unaffiliated parties.
All future transactions with officers, directors, principal shareholders or affiliates of the Company and its subsidiaries will be on terms no less favorable than could be obtained from unaffiliated parties, and shall be approved by the Board of Directors, including a majority of the independent disinterested directors of the Company.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) List of Documents filed by Registrant as part of this report:
Financial Statements. Financial statements of Registrant included herein for the year ended December 31, 1996.
o Independent Auditors' Report
o Consolidated Balance Sheets at December 31, 1996 and 1995
o Consolidated Statements of Operations for each of the years in the three year period ended December 31, 1996
o Consolidated Statements of Cash Flows for each of the three years in the three year period ended December 31, 1996
o Consolidated Statement of Stockholders' Equity for each of the three years in the three year period ended December 31,
o Notes to Consolidated Financial Statements
(b) The following exhibits are filed as part of this report:
(c) Financial Statement Schedules
All supplemental schedules are omitted as inapplicable or because the required information is included in the financial statements or notes thereto.
* Incorporated by reference to such documents filed as Exhibits 3, 10(a), 10(b), and 22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989
** Incorporated by reference to the document filed as Exhibits 10(c) and 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990
*** Incorporated by reference to the document files as Exhibit 10(d) and Exhibit 99 to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1991.
**** Incorporated by reference to the document files as Exhibits 3(a), 3(g), 10(f), 10(g), 10(h) and 10(i) to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1994.
***** Incorporated by reference to the document files as Exhibits 10(j) to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1995.
SIGNATURES
Pursuant to the requirement of Section 13 of 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 25, 1996 FEDERAL TRUST CORPORATION
By:/s/ Aubrey H. Wright ---------------- Aubrey H. Wright Chief Financial Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ James V. Suskiewich Chairman of the Board and March 25, 1996 - ------------------------- James V. Suskiewich President
/s/ James T. Bell Director March 25, 1996 - ------------------------- James T. Bell
/s/ Anne T. Coonrod Director March 25, 1996 - ------------------------- Anne T. Coonrod
/s/ Francis T. West Director March 25, 1996 - ------------------------- Francis T. West
/s/ Edwin J. Feiler, Jr. Director March 25, 1996 - ------------------------- Edwin J. Feiler, Jr.
/s/ Aubrey H. Wright, Jr. Director March 25, 1996 - ------------------------- Aubrey H. Wright, Jr.
Supplemental information to be furnished with Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act.
No Annual Report or proxy material has been sent to security holders.
(c) Financial Statement Schedules
All supplemental schedules are omitted as inapplicable or because the required information is included in the financial statements or notes thereto.
Incorporated by reference to such documents filed as Exhibits 3, 10(a), 10(b), and 22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989
* Incorporated by reference to the document filed as Exhibits 10(c) and 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990
** Incorporated by reference to the document files as Exhibit 10(d) and Exhibit 99 to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1991.
** Incorporated by reference to the document files as Exhibits 3(a), 3(g), 10(f), 10(g), 10(h) and 10(i) to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1994.
***** Incorporated by reference to the document files as Exhibits 10(j) to the Company's Annual Report on Form 10-K from the fiscal year ended December 31, 1995.