UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ________ Commission file number 0-27428 OCEAN FINANCIAL CORP. -------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 22-3412577 -------------------------------- ------------------------------------ (State of other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 975 Hooper Avenue, Toms River, NJ 08753 ---------------------------------- ------------------------------------ (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (732) 240-4500 ------------------------------------ (Former name, former address and formal fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO _____. ----- As of November 6, 1998, there were 14,757,428 shares of the Registrant's Common Stock, par value $.01 per share, outstanding.
OCEAN FINANCIAL CORP. INDEX TO FORM 10-Q <TABLE> <CAPTION> PART I. FINANCIAL INFORMATION - ------- --------------------- PAGE ---- <S> <C> <C> Item 1. Consolidated Financial Statements Consolidated Statements of Financial Condition as of September 30, 1998 (unaudited) and December 31, 1997................................... 1 Consolidated Statements of Income for the three and nine months ended September 30, 1998 and 1997 (unaudited)......................................... 2 Consolidated Statements of Cash Flows for the nine months ended September 30, 1998 and 1997 (unaudited)......................................... 3 Notes to Unaudited Consolidated Financial Statements......................................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................... 7 Item 3. Quantitative and Qualitative Disclosure about Market Risk.................................... 11 Part II. OTHER INFORMATION - -------- ----------------- Item 1. Legal Proceedings............................................................................ 13 Item 2. Changes in Securities........................................................................ 13 Item 3. Default Upon Senior Securities............................................................... 13 Item 4. Submission of Matters to a Vote of Security Holders.......................................... 13 Item 5. Other Information............................................................................ 13 Item 6. Exhibits and Reports on Form 8-K............................................................. 13 Signatures ............................................................................................. 14 </TABLE>
OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except per share amounts) <TABLE> <CAPTION> September 30, December 31, 1998 1997 ------------ ----------- (Unaudited) ASSETS - ------ <S> <C> <C> Cash and due from banks $ 8,738 $ 2,225 Federal funds sold - - ----------- ----------- Cash and cash equivalents 8,738 2,225 Investment securities available for sale 145,468 207,357 Federal Home Loan Bank of New York stock, at cost 15,042 14,980 Mortgage-backed securities available for sale 428,955 457,148 Loans receivable, net 893,417 783,695 Interest and dividends receivable 10,242 11,064 Real estate owned, net 576 1,198 Premises and equipment, net 14,251 14,279 Other assets 27,645 19,001 ----------- ----------- Total assets $ 1,544,334 $ 1,510,947 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Deposits $ 1,028,522 $ 976,764 Federal Home Loan Bank borrowings 27,000 20,400 Securities sold under agreements to repurchase 275,405 288,200 Advances by borrowers for taxes and insurance 5,453 4,773 Other liabilities 11,368 5,266 ----------- ----------- Total liabilities 1,347,748 1,295,403 ----------- ----------- Stockholders' Equity: Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued - - Common stock, $.01 par value, 55,000,000 shares authorized, 18,118,248 shares issued and 14,757,428 and 15,705,720 shares outstanding at September 30, 1998 and December 31, 1997, respectively 181 181 Additional paid-in capital 178,306 177,223 Retained earnings-substantially restricted 102,606 97,487 Accumulated other comprehensive income (1,728) 989 Less: Unallocated common stock held by Employee Stock Ownership Plan (18,079) (10,903) Unearned Incentive Awards (6,447) (7,897) Treasury Stock at cost (3,360,820 and 2,412,528 shares at September 30, 1998 and December 31, 1997, respectively) (58,253) (41,536) ----------- ----------- Total stockholders' equity 196,586 215,544 ----------- ----------- Total liabilities and stockholders' equity $ 1,544,334 $ 1,510,947 =========== =========== </TABLE> See accompanying notes to unaudited consolidated financial statements Note: Shares and related amounts for prior periods have been adjusted for the two-for-one stock split effected in the form of a 100% stock dividend paid on May 15, 1998. 1
OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (dollars and shares in thousands, except per share amounts) <TABLE> <CAPTION> For the three months For the nine months ended September 30, ended September 30, ------------------------ ---------------------- 1998 1997 1998 1997 ------ ------- ------- ------- (Unaudited) (Unaudited) <S> <C> <C> <C> <C> Interest income: Loans $17,048 $14,637 $49,465 $42,328 Mortgage-backed securities 5,853 7,192 19,185 19,602 Investment securities and other 3,593 3,739 10,290 10,493 ------- ------- ------- -------- Total interest income 26,494 25,568 78,940 72,423 ------- ------- ------- -------- Interest expense: Deposits 11,248 11,001 32,923 31,901 Borrowed funds 4,412 3,657 13,194 8,300 ------- ------- ------- ------- Total interest expense 15,660 14,658 46,117 40,201 ------- ------- ------- ------- Net interest income 10,834 10,910 32,823 32,222 Provision for loan losses 225 225 675 675 ------- ------- -------- ------- Net interest income after provision for loan losses 10,609 10,685 32,148 31,547 ------- ------- -------- ------- Other income: Fees and service charges 622 477 1,663 1,427 Net gain on sales of loans available for sale 53 1 221 1 Net income from other real estate operations 20 5 160 12 Other 181 89 506 294 ------- ------- ------- ------- Total other income 876 572 2,550 1,734 ------- ------- ------- ------- Operating expenses: Compensation and employee benefits 3,710 3,492 10,994 10,290 Occupancy 490 480 1,408 1,445 Equipment 343 307 1,011 978 Marketing 301 138 1,053 541 Federal deposit insurance 217 210 651 506 Data processing 319 288 945 959 General and administrative 924 809 2,897 2,311 ------- ------- ------- ------- Total operating expenses 6,304 5,724 18,959 17,030 ------- ------- ------- ------- Income before provision for income taxes 5,181 5,533 15,739 16,251 Provision for income taxes 1,845 1,993 5,692 5,906 ------- ------- ------- ------- Net income $ 3,336 $ 3,540 $10,047 $10,345 ======= ======= ======= ======== Basic earnings per share $ .25 $ .24 $ .74 $ .66 ======= ======= ======= ======== Diluted earnings per share $ .25 $ .23 $ .72 $ .65 ======= ======= ======= ======== Average basic shares outstanding 13,202 14,834 13,517 15,706 ======= ======= ======= ======== Average diluted shares outstanding 13,505 15,169 13,893 15,887 ======= ======= ======= ======== </TABLE> See accompanying notes to unaudited consolidated financial statements. Note: Earnings per share and shares outstanding for prior periods have been adjusted for the two-for-one stock split effected in the form of a 100% stock dividend paid on May 15, 1998. 2
OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) <TABLE> <CAPTION> For the nine months ended September 30, ----------------------- 1998 1997 --------- --------- (Unaudited) <S> <C> <C> Cash flows from operating activities: Net income $ 10,047 $ 10,345 --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of premises and equipment 1,093 1,008 Amortization of Incentive Awards 1,450 1,289 Amortization of ESOP 1,024 1,071 ESOP adjustment 826 613 Tax benefit of stock plans 257 - Amortization of servicing asset 238 138 Net premium amortization in excess of discount accretion on securities 2,524 2,719 Net accretion of deferred fees and discounts in excess of premium amortization on loans (380) (272) Provision for loan losses 675 675 Net gain on sales of real estate owned (107) (184) Net gain on sales of loans available for sale (221) (1) Proceeds from sales of mortgage loans held for sale 15,962 703 Mortgage loans originated for sale (16,132) - Decrease (increase) in interest and dividends receivable 822 (2,456) Increase in other assets (5,866) (612) Increase in other liabilities 6,102 1,007 --------- --------- Total adjustments 8,267 5,698 --------- --------- Net cash provided by operating activities 18,314 16,043 --------- --------- Cash flows from investing activities: Net increase in loans receivable (110,864) (77,843) Purchase of investment securities available for sale (126,986) (50,984) Purchase of mortgage-backed securities available for sale (131,172) (202,319) Proceeds from maturities of investment securities available for sale 185,160 20,270 Principal payments on mortgage-backed securities available for sale 156,243 123,253 Purchases of Federal Home Loan Bank of New York stock (62) (4,709) Proceeds from sales of real estate owned 1,576 2,205 Purchases of premises and equipment (1,065) (1,407) --------- --------- Net cash used in investing activities (27,170) (191,534) --------- --------- </TABLE> Continued 3
OCEAN FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (dollars in thousands) <TABLE> <CAPTION> For the nine months ended September 30, ------------------------ 1998 1997 ------------------------ (Unaudited) <S> <C> <C> Cash flows from financing activities: Acquisition of deposits $ 10,732 -- Deposit premium (1,030) -- Increase in deposits 41,026 31,006 Increase in Federal Home Loan Bank borrowings 6,600 9,600 (Decrease) increase in securities sold under agreements to repurchase (12,795) 169,793 Increase in advances by borrowers for taxes and insurance 680 854 Dividends paid (4,927) (3,287) Purchase of Incentive Award stock -- (10,176) Purchase of ESOP shares (8,200) -- Purchase of treasury stock (16,717) (29,546) --------- --------- Net cash provided by financing activities 15,369 168,244 --------- --------- Net increase (decrease) in cash and cash equivalents 6,513 (7,247) Cash and cash equivalents at beginning of period 2,225 5,372 --------- --------- Cash and cash equivalents at end of period $ 8,738 $ 1,875 ========= ========= Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ 45,691 $ 39,656 Income taxes 20 5,346 Noncash investing activities: Transfer of loans receivable to real estate owned 847 1,455 Mortgage loans securitized into mortgage-backed securities 16,082 -- ========= ========= </TABLE> See accompanying notes to unaudited consolidated financial statements. 4
OCEAN FINANCIAL CORP. AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS ---------------------------------------------------- NOTE 1. BASIS OF PRESENTATION - ----------------------------- The accompanying unaudited consolidated financial statements include the accounts of Ocean Financial Corp. (the "Company") and its wholly-owned subsidiary, Ocean Federal Savings Bank (the "Bank") and its wholly-owned subsidiaries, Ocean Federal Realty Inc. and Ocean Investment Services, Inc. The interim consolidated financial statements reflect all normal and recurring adjustments which are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the periods presented. The results of operations for the three and nine months ended September 30, 1998 are not necessarily indicative of the results of operations that may be expected for all of 1998. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report to Stockholders on Form 10-K for the year ended December 31, 1997. NOTE 2. EARNINGS PER SHARE - --------------------------- Amounts per common share for prior periods have been adjusted for the two-for-one stock split effected in the form of a 100% stock dividend declared by the Company's Board of Directors on April 22, 1998 and paid on May 15, 1998. The following reconciles shares outstanding for basic and diluted earnings per share for the three and nine months ended September 30, 1998 and 1997 <TABLE> <CAPTION> Three months ended Nine months ended September 30, September 30, ------------------ ------------------- 1998 1997 1998 1997 ------- ------- ------- ------- <S> <C> <C> <C> <C> Weighted average shares issued net of Treasury shares 15,172 16,647 15,322 17,470 Less: Unallocated ESOP Shares (1,424) (1,142) (1,243) (1,177) Unallocated incentive award shares (546) (671) (562) (587) ------- ------- ------- ------- Average basic shares outstanding 13,202 14,834 13,517 15,706 Add: Effect of dilutive securities: Stock options 166 190 222 97 Incentive awards 137 145 154 84 ------- ------- ------- ------- Average diluted shares outstanding 13,505 15,169 13,893 15,887 ======= ======= ======= ======= </TABLE> NOTE 3. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS - -------------------------------------------------- Effective January 1, 1998, the Company adopted the provisions of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Under SFAS 130, comprehensive income is divided into net income and other comprehensive income. Other comprehensive income includes items previously recorded directly inequity, such as unrealized gains or losses on 5
securities available for sale. Comparative financial statements provided for earlier periods have been reclassified to conform with the provisions of this Statement. SFAS 130 requires total comprehensive income and its components to be displayed on the face of a financial statement for annual financial statements. For interim financial statements, SFAS 130 requires only total comprehensive income to be reported and allows such disclosure to be presented in the notes to the interim financial statements. For the three month periods ended September 30, 1998 and 1997 total comprehensive income (loss) amounted to $(161,000) and $6,266,000, respectively. For the nine month periods ended September 30, 1998 and 1997, total comprehensive income amounted to $7,330,000 and $13,131,000, respectively. In February 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132). SFAS 132 revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information about changes in the benefit obligations and fair value of plan assets that will facilitate financial analysis, and eliminates certain required disclosures of previous accounting pronouncements. SFAS 132 is effective for fiscal years beginning after December 15, 1997. Earlier application is encouraged. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available. As SFAS 132 affects disclosure requirements, it is not expected to have an impact on the financial statements of the Company. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Actitivies." This statement establishes accounting and reporting standards for derivative instruments, and for hedging activities. SFAS No. 133 supersedes the disclosure requirements in SFAS No. 80, 105 and 119. This statement is effective for periods after June 15, 1999. The adoption of SFAS No. 133 is not expected to have a material impact on the financial position or results of operations of the Company. In October 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 134 "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement amends FASB Statement 65 "Accounting for Certain Mortgage Banking Activities" to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. This Statement is effective for the first fiscal quarter beginning after December 15, 1998. The adoption of this Statement is not expected to have a material impact on the financial position or results of operations of the Company. 6
NOTE 4. LOANS RECEIVABLE, NET - ----------------------------- Loans receivable, net at September 30, 1998 and December 31, 1997 consisted of the following (in thousands): <TABLE> <CAPTION> September 30, 1998 December 31, 1997 ------------------ ----------------- (Unaudited) <S> <C> <C> Real estate: One- to four-family $802,662 $711,548 Commercial real estate, multi- family and land 36,139 25,699 Construction 7,284 8,748 Consumer 51,635 45,417 Commercial 6,340 2,904 --------- --------- Total loans 904,060 794,316 Less: Loans in process 2,712 2,867 Deferred fees 676 1,133 Unearned discounts 9 9 Allowance for loan losses 7,246 6,612 --------- --------- Total loans, net 893,417 783,695 Less: mortgage loans held for sale - - --------- --------- Loans receivable, net $893,417 $783,695 ========= ========= </TABLE> NOTE 5. DEPOSITS - ---------------- The major types of deposits at September 30, 1998 and December 31, 1997 were as follows (in thousands): <TABLE> <CAPTION> September 30, 1998 December 31, 1997 ------------------ ----------------- Type of Account (Unaudited) - --------------- <S> <C> <C> Non-interest bearing $ 21,686 $ 13,149 NOW 85,950 77,994 Money market deposit 74,147 67,979 Savings 168,140 163,202 Time deposits 678,599 654,440 ---------- ---------- $1,028,522 $ 976,764 ========== ========== </TABLE> ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION Total assets at September 30, 1998 were $1.544 billion, an increase of $33.4 million, compared to $1.511 billion at December 31, 1997. Investment securities available for sale decreased by $61.9 million, to a balance of $145.5 million at September 30, 1998, compared to a balance of $207.4 million at December 31, 1997, and mortgage-backed securities available for sale decreased by $28.2 million, to $429.0 million at September 30, 1998, from $457.1 million at December 31, 1997. The investment and mortgage-backed securities available for sale portfolios decreased in order to fund growth in the Bank's loans receivable. Loans receivable, net, increased by $109.7 million, or 14.0%, to a balance of $893.4 million at September 30, 1998, compared to a balance of $783.7 million at December 31, 1997. The increase was largely attributable to robust residential loan growth (including mortgage refinance activity) in the Bank's market area, as well as commercial lending (including 7
commercial real estate) initiatives which accounted for $13.9 million of this growth. Included in the residential loan growth is $64.0 million of 30-year fixed-rate non-conforming mortgage loans which the Bank retained in portfolio, while $16.1 million of 30-year fixed-rate mortgage loans were sold. In the past, the Bank has often sold most of this product into the secondary market. Of the loans retained, the Bank funded $58.5 million with repurchase agreements with approximate terms of three to seven years, mitigating part of the interest rate risk associated with retaining these mortgages. Total deposits at September 30, 1998 were $1.029 billion, an increase of $51.8 million, compared to $976.8 million at December 31, 1997. On June 29, 1998, the Company completed the purchase of $10.7 million in deposit balances from Summit Bank's Whiting, New Jersey branch, for a deposit premium of $1.0 million. Stockholders' equity at September 30, 1998 was $196.6 million, compared to $215.5 million at December 31, 1997. The Company repurchased 948,292 shares of common stock during the nine months ended September 30, 1998 for $16.7 million, fully completing the remainder of a 5% repurchase program announced in October 1997 and another 5% repurchase program announced in July 1998. Additionally, during the second quarter of 1998, the Company loaned $8.2 million to the Bank's Employee Stock Ownership Plan ("ESOP" or the "Plan") which enabled the ESOP trustee to purchase 422,500 shares of common stock. After the initial 12 year ESOP term expires in year 2008, these shares will begin to be allocated to employees covered by the Plan at which time they will be expensed by the Company. RESULTS OF OPERATIONS GENERAL Net income decreased to $3.3 million for the three months ended September 30, 1998 as compared to net income of $3.5 million for the three months ended September 30, 1997. For the nine months ended September 30, 1998 net income decreased to $10.0 million from $10.3 million for the nine months ended September 30, 1997. INTEREST INCOME Interest income for the three months ended September 30, 1998 was $26.5 million, compared to $25.6 million for the three months ended September 30, 1997, an increase of $926,000, or 3.6%. For the nine months ended September 30, 1998, interest income was $78.9 million compared to $72.4 million for the same period in 1997, an increase of $6.5 million or 9.0%. The increases in interest income were the result of increases in the average balance of loans receivable which increased by $143.5 million and $133.5 million for the three and nine months ended September 30, 1998, respectively, as compared to the same prior year periods. For the three months ended September 30, 1998, a $77.0 million increase in earning assets was largely offset by a decline in the yield on earning assets which decreased to 7.11% as compared to 7.24% for the same period in 1997 due to declines in yields for loans and investment and mortgage-backed securities. For the nine months ended September 30, 1998 the yield on earning assets increased 1 basis point to 7.14% as compared to the same period in 1997 as declines in yields for loans and investment securities were offset by a shift in the asset mix from lower yielding securities to higher yielding loans receivable. INTEREST EXPENSE Interest expense for the three months ended September 30, 1998 was $15.7 million, compared to $14.7 million for the three months ended September 30, 1997, an increase of $1.0 million, or 6.8%. For the nine months ended September 30, 1998 interest expense was $46.1 million compared to $40.2 million for the same period in 1997, an increase of $5.9 million or 14.7%. The increases in interest expense were primarily the result of an increase in the average outstanding balance of total borrowings (Federal Home Loan Bank and securities sold under agreements to repurchase) which increased by $46.3 million and $106.8 million for the three and nine months ended September 30, 1998, respectively, as compared to the same prior year periods and an additional increase in average interest-bearing deposits of $50.1 million and $38.4 million for the three and nine months ended September 30, 1998, respectively, as compared to the same prior year periods. The increase in wholesale borrowings was part of a leverage strategy adopted in late 1996 to improve returns on invested capital. Proceeds from the borrowings were invested in mortgage loans and investment and mortgage-backed securities. The average cost of interest-bearing liabilities decreased to 4.79% for the three months ended September 30, 1998, as compared to 4.84% for the same prior year period, due to the recent market decline in interest rates. For the nine months ended September 30, 1998, 8
the average cost of interest-bearing liabilities increased to 4.79%, as compared to 4.70% for the same prior year period due to a greater percentage increase in higher cost wholesale funding over retail deposit funding. PROVISION FOR LOAN LOSSES For the three and nine months ended September 30, 1998, the Company's provision for loan losses was $225,000 and $675,000, respectively, unchanged from the same prior year periods. The Company's non-performing assets declined by $1.4 million at September 30, 1998 as compared to September 30, 1997 allowing for stable provisions despite loan growth. OTHER INCOME Other income increased to $876,000 and $2.6 million for the three and nine months ended September 30, 1998, respectively, compared to $572,000 and $1.7 million for the same prior year periods. The increases were primarily due to gains recognized on the sale of 30-year fixed-rate mortgage loans, which the Company periodically sells as part of the management of interest rate risk. These gains amounted to $53,000 and $221,000 for the three and nine months ended September 30, 1998, respectively. Additionally, deposit related fees (part of fees and service charges) increased by $129,000 and $315,000 for the three and nine months ended September 30, 1998, respectively, as compared to the same prior year periods, due to growth in commercial account services and retail core account balances. The Company also realized $40,000 in fee income during the third quarter of 1998 from the sale of alternative investment products, a service the Company introduced late in this year's second quarter. The growth in these fees was partly offset by reductions in loan servicing fees due to prepayments of the loans underlying the servicing portfolio. OPERATING EXPENSES Operating expenses were $6.3 million and $19.0 million for the three and nine months ended September 30, 1998, representing increases of $580,000 and $1.9 million compared to the same prior year periods. For the nine months ended September 30, 1998, the increase was partly due to higher non-cash charges relating to the Employee Stock Ownership Plan and expenses associated with the stock awards granted to directors and officers under the 1997 Incentive Plan. For the three and nine months ended September 30, 1998, marketing expense increased by $163,000 and $512,000 as the Bank aggressively promoted its new retail checking products. The Bank also opened its eleventh branch office in early April of 1998. PROVISION FOR INCOME TAXES Income tax expense was $1.8 million and $5.7 million for the three and nine months ended September 30, 1998, respectively, compared to $2.0 million and $5.9 million for the three and nine months ended September 30, 1997, respectively. The effective tax rate was relatively stable at 36.2% for the nine months ended September 30, 1998 as compared to 36.3% for the same prior year period. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds are deposits, principal and interest payments on loans, FHLB and other borrowings and, to a lesser extent, investment maturities and proceeds from the sale of loans. While scheduled amortization of loans is a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including an overnight line of credit and advances from the FHLB. At September 30, 1998, the Company had $27.0 outstanding in overnight borrowings from the FHLB, representing an increase from $20.4 million at December 31, 1997. The Company utilizes the overnight line from time to time to fund short-term liquidity needs. The Company also borrowed $275.4 million at September 30, 1998 through securities sold under agreements to repurchase, a decrease from $288.2 million at December 31, 1997. These borrowings were used to fund a wholesale leverage strategy designed to improve returns on invested capital. 9
The Company's cash needs for the nine months ended September 30, 1998, were principally provided by maturities of investment securities available for sale, principal payments on loans and mortgage-backed securities and increased deposits, including a deposit acquisition. The cash provided was principally used for investing activities, which included the purchase of investment and mortgage-backed securities and the origination of loans. For the nine months ended September 30, 1997, the cash needs of the Company were primarily satisfied by principal payments on loans and mortgage-backed securities, securities sold under agreements to repurchase and increased deposits. The cash was principally utilized for loan originations, purchases of investment and mortgage-backed securities and the purchase of treasury stock. Federal regulations require the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time to time based upon economic conditions and savings flows and is currently 4% of net withdrawable savings deposits and borrowings payable on demand or in one year or less during the preceding calendar month. Liquid assets for purposes of this ratio include cash, accrued interest receivable, certain time deposits, U.S. Treasury and Government agencies and other securities and obligations generally having remaining maturities of less than five years. The levels of these assets are dependent on the Bank's operating, financing, lending and investing activities during any given period. As of September 30, 1998 and December 31, 1997, the Bank's liquidity ratios were 38.7% and 9.8%, respectively, both in excess of the minimum regulatory requirement. At September 30, 1998, the Bank exceeded all of its regulatory capital requirements with tangible capital of $164.1 million, or 10.68%, of total adjusted assets, which is above the required level of $23.0 million or 1.5%; core capital of $164.1 million or 10.68% of total adjusted assets, which is above the required level of $61.5 million, or 4.0%; and risk-based capital of $171.2 million, or 23.2% of risk-weighted assets, which is above the required level of $59.0 million or 8.0%. The Bank is considered a "well capitalized" institution under the Office of Thrift Supervision's prompt corrective action regulations. NON-PERFORMING ASSETS The following table sets forth information regarding the Company's nonperforming assets consisting of non-accrual loans and Real Estate Owned (REO). The Company had no troubled-debt restructured loans within the meaning of SFAS 15 at September 30, 1998 or December 31, 1997. It is the policy of the Company to cease accruing interest on loans 90 days or more past due or in the process of foreclosure. <TABLE> <CAPTION> September 30, December 31, 1998 1997 ------------- ------------ (Dollars in thousands) (Unaudited) <S> <C> <C> Non-accrual loans: Real estate: One-to four-family $5,059 $5,062 Commercial real estate, multi-family and land 574 382 Consumer 161 110 ------- ------- Total 5,794 5,554 REO, net 576 1,198 ------- ------- Total non-performing assets $6,370 $6,752 ======= ======= Non-performing loans as a percent of total loans receivable .64% .70% Non-performing assets as a percent of total assets .41% .45% Allowance for loan losses as a percent of total loans receivable .80% .83% Allowance for loan losses as percent of total non-performing loans 125.06% 119.03% </TABLE> 10
IMPACT OF YEAR 2000 The Company has developed a formal project plan to prepare its systems, hardware, and facilities for the Year 2000. The project plan has been in place since 1997 and is designed to follow the guidelines and recommendations of the Federal Financial Institutions Examination Council (FFIEC). The Year 2000 effort is being implemented by qualified personnel from areas throughout the Company. As stated in the FFIEC guidelines, the Company has created a plan consisting of five phases. The phases include awareness, assessment, renovation, validation and implementation. The awareness phase was completed with the development of a Year 2000 committee and a formal reporting and tracking process. A thorough analysis of all hardware, software, and facilities that may be effected by the turn of the century was done to complete the assessment phase. Based on this analysis, items were prioritized and the renovation effort was started. The Company primarily utilizes third-party vendors to provide processing of its mission critical systems. Vendors are being closely monitored to ensure that renovation and validation dates are met. The planned completion date for all renovations is December 31, 1998 with all validation and implementation scheduled to be complete by June 30, 1999. Detailed updates are provided to the Board of Directors covering all aspects of the project on a periodic basis. In the case where third party systems fail or are not completed on time, there is the potential to experience operational problems throughout the Company. To reduce the risk of any problem due to this type of failure, contingency plans are being drafted for all mission critical functions and systems. The contingency plans will address other methods and vendors that may be required to continue to do business. In the event that any mission critical system renovation or validation falls behind schedule, the Company may decide to execute contingency plans to ensure uninterrupted service to customers. The cost of the Year 2000 project is estimated to be between $300,000 and $400,000. The cost includes all renovation, testing, and contingency planning expense for in-house and third-party processing. The expense for the nine months ended September 30, 1998 is $52,000. The expenses associated with the Year 2000 project are not considered to be incremental to the Company in total. Although the expense was necessitated by the Year 2000 project, the Company has realized substantial improvements in its internal system technology. Estimated expenses and completion dates associated with this project are based on all known facts and available resources. It is the expectation that the represented estimates will not change materially, but there can be no guarantee that the estimates will be achieved. Factors that may influence changes in the estimates include, but are not limited to, expenses associated for obtaining qualified personnel, ability to correctly identify and renovate all functions related to the Year 2000 and other similar items. PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT In addition to historical information, this quarterly report may include certain forward looking statements based on current management expectations. The Company's actual results could differ materially from those management expectations. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal and state tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Bank's loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices. Further description of the risks and uncertainties to the business are included in Item 1, Business, of the Company's 1997 Form 10-K. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company's interest rate sensitivity is monitored by management through the use of an interest rate risk (IRR) model. Based on internal IRR modeling, management does not believe that there has been a material change in the Company's interest rate sensitivity from December 31, 1997 to September 30, 1998. All methods used to measure interest rate sensitivity involve the use of assumptions, which may tend to oversimplify the manner in which actual yields and costs 11
respond to changes in market interest rates. The Company's interest rate sensitivity should be reviewed in conjunction with the financial statements and notes thereto contained in the Company's Annual Report for the fiscal year ended December 31, 1997. 12
PART II. OTHER INFORMATION Item 1. Legal Proceedings ----------------- The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to routine legal proceedings within the normal course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations. Item 2. Changes in Securities --------------------- Not Applicable Item 3. Defaults Upon Senior Securities ------------------------------- Not Applicable Item 4. Submission of Matters to Vote of Security Holders ------------------------------------------------- Not Applicable Item 5. Other Information ----------------- Not Applicable Item 6. Exhibits and Reports on Form 8-K -------------------------------- a) Exhibits: 3.1 Certificate of Incorporation of Ocean Financial Corp.* 3.2 Bylaws of Ocean Financial Corp.* 4.0 Stock Certificate of Ocean Financial Corp.* 10.8 Amended and Restated Ocean Financial Corp. 1997 Incentive Plan (filed herewith) 27 Financial Data Schedule (filed herewith) b) There were no reports on Form 8-K filed during the three months ended September 30, 1998. * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, filed on December 7, 1995, as amended, Registration No. 33-80123. 13
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Ocean Financial Corp. --------------------- Registrant DATE: November 12, 1998 /s/ John R. Garbarino ---------------------- John R. Garbarino Chairman of the Board, President and Chief Executive Officer DATE: November 12, 1998 /s/ Michael Fitzpatrick ----------------------- Michael Fitzpatrick Executive Vice President and Chief Financial Officer 14