TABLE OF CONTENTS ITEM 1. BUSINESS..........................................................1 ITEM 1A. RISK FACTORS.....................................................36 ITEM 1.B UNRESOLVED STAFF COMMENTS........................................38 ITEM 2. PROPERTIES.......................................................39 ITEM 3. LEGAL PROCEEDINGS................................................41 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............41 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES....42 ITEM 6. SELECTED FINANCIAL DATA..........................................43 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..............................43 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......44 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................45 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.........................................45 ITEM 9A. CONTROLS AND PROCEDURES..........................................45 ITEM 9B. OTHER INFORMATION................................................46 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE...........46 ITEM 11. EXECUTIVE COMPENSATION...........................................47 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS...................47 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE............................................47 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...........................47 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.......................48 PART I ITEM 1. BUSINESS ---------------- Oneida Financial Corp. Oneida Financial Corp. (the "Company") was organized in September 1998, for the purpose of acquiring all of the capital stock of The Oneida Savings Bank (the "Bank") upon completion of the Bank's reorganization into the two-tier form of mutual holding company ownership. The Company is majority-owned by Oneida Financial, MHC, a Federally-chartered mutual holding company (the "Mutual Holding Company"). The Company and the mutual holding company are each subject to regulation by the Office of Thrift Supervision ("OTS"). The Company's assets consist primarily of its ownership in the shares of the Bank's common stock. At December 31, 2007 the Company had consolidated assets and consolidated stockholders' equity of $522.3 million and $59.3 million, respectively. Through the Bank and its municipal bank subsidiary, the Company has deposits totaling $400.1 million. All financial information is presented on a consolidated basis. The Company's executive office is located at the main office of the Bank, at 182 Main Street, Oneida, New York 13421-1676. The Company's telephone number is (315) 363-2000. The Oneida Savings Bank The Bank was organized in 1866 as a New York-chartered mutual savings bank. The Bank's deposits are insured by the FDIC up to the maximum amount permitted by law. The Bank is a community bank engaged primarily in the business of accepting deposits from customers through its main office and 11 full service branch offices and using those deposits, together with funds generated from operations and borrowings to make one-to-four family residential and commercial real estate loans, commercial business loans, consumer loans and to invest in mortgage-backed and other securities. The Bank also sells insurance and other commercial services and products through Bailey & Haskell Associates, Inc., its insurance agency subsidiary and provides employee benefit consulting services through its wholly-owned subsidiary Benefit Consulting Group, Inc. At December 31, 2007, $203.2 million, or 70.8%, of the Bank's loans were secured by real estate, $99.6 million, or 34.7%, of the Bank's loans were secured by one-to-four family residential real estate, $71.3 million, or 24.8%, of the Bank's loans were secured by commercial real estate and multi-family loans, and $32.4 million, or 11.3%, of the Bank's loans were home equity loans. Consumer loans totaled $43.8 million, or 15.3% of the Bank's loans at December 31, 2007. The Bank also originates commercial business loans which totaled $39.9 million, or 13.9%, of loans at December 31, 2007. The Bank's investment securities and mortgage-backed securities portfolios totaled $96.1 million and $46.6 million, respectively, at December 31, 2007. In April 1999 the Bank established Oneida Preferred Funding Corp. as the Bank's wholly owned real estate investment trust subsidiary. At December 31, 2007 Oneida Preferred Funding Corp. held $39.7 million in mortgage and mortgage related assets. All disclosures in this Form 10-K relating to the Bank's loans and investments include loans and investments that are held by Oneida Preferred Funding Corp. 1 In October 2000, the Bank acquired Bailey & Haskell Associates, Inc., which is a wholly owned insurance and financial services subsidiary. Since the acquisition of Bailey & Haskell Associates, Inc. the Bank has acquired four insurance agencies, all of which have been merged into Bailey & Haskell Associates, Inc. On May 31, 2002, the Bank completed its acquisition of SBC Financial Corporation ("SBC"), the holding company of State Bank of Chittenango ("Chittenango"); a New York State chartered commercial bank. The two banking offices of Chittenango became banking offices of the Bank. The Bank has retained Chittenango as a special purpose commercial bank subsidiary of the Bank. Chittenango is permitted to accept municipal deposit accounts from the various municipalities, school districts and other public sources, a source of funds not available to the Bank under New York law. The acquisition resulted in additional goodwill of $5.6 million and a core deposit intangible of approximately $1.2 million. At December 31, 2007, no impairment adjustment has been made to goodwill or other intangibles that were created in the transaction. At December 31, 2007 Chittenango had $29.7 million in municipal deposits. All disclosures in this Form 10-K relating to the Bank's investments and deposits include investments and deposits that are held by Chittenango. In February 2006, the Bank completed its acquisition of the assets of Parsons, Cote & Company, Inc., an insurance agency, for $206,655 cash and a note payable for $419,750 to be paid over 36 months with interest at 5.00% per annum. In June 2006, the Bank completed its acquisition of Benefit Consulting Group LLC., an employee benefits consulting and retirement plan administration firm, for $1.5 million cash and established a note payable for $2.2 million to be paid over 24 months with interest at 5.00% per annum. Goodwill in the amount of $2.5 million and intangible assets in the amount of $1.1 million were recorded in conjunction with the transaction. The resulting company, Benefit Consulting Group Inc., is a wholly-owned subsidiary of Oneida Savings Bank. On April 2, 2007, the Bank completed its acquisition of Vernon Bank Corporation and its wholly-owned subsidiary, The National Bank of Vernon, for $11.4 million. The three banking offices of The National Bank of Vernon ("NBV") became banking offices of the Bank. The acquisition resulted in additional goodwill of $4.5 million and a core deposit intangible of approximately $1.5 million. At December 31, 2007, no impairment adjustment has been made to goodwill or other intangibles that were created in the transaction. This acquisition resulted in $7.4 million of additional municipal deposits being placed in Chittenango. The Bank's main office is located at 182 Main Street, Oneida, New York 13421-1676. The Bank's telephone number is (315) 363-2000. Market Area The Bank is a community-based savings institution that offers a variety of financial products and services. The Bank's primary lending area is Madison and Oneida Counties in New York and surrounding counties, and most of the Bank's deposit customers reside in Madison and Oneida Counties and surrounding counties. The City of Oneida is located approximately 30 miles from Syracuse and 20 miles from Utica. The Bank's market area is characterized as rural, although the local economy is also affected by economic conditions in Syracuse and Utica, New York. The average household income of persons residing in Oneida and Madison counties was below that of New York State and the United States. 2 The Bank competes with commercial banks, savings banks and credit unions for deposits and loans. In addition to the financial institutions operating in Madison and Oneida Counties, the Bank competes with a number of mortgage bankers for the origination of loans. The largest employers in the Bank's market area are Oneida Healthcare Center and The Oneida Indian Nation of New York. Lending Activities General. The principal lending activity of the Bank has been the origination for retention in its portfolio of adjustable-rate mortgage ("ARM") loans collateralized by one-to-four family residential real estate located within its primary market area. As a result of the continuation of relatively low market interest rates throughout the year, borrowers have shown a preference for fixed-rate loans. Consequently, in recent periods the Bank has originated more fixed-rate one-to-four family loans for resale in the secondary market, without recourse and on a servicing retained basis. In order to complement the Bank's traditional emphasis of one-to-four family residential real estate lending, management has sought to increase the number of higher yielding commercial real estate loans, consumer loans and commercial business loans. To a limited extent, the Bank will originate loans secured by multi-family properties. The Bank does not view multi-family lending as a significant aspect of its business. 3 Loan Portfolio Composition. Set forth below is selected information concerning the composition of the Bank's loan portfolio (included loans held for sale) in dollar amounts and in percentages (before deductions for allowance for loan losses) as of the dates indicated. <TABLE> <CAPTION> At December 31, ------------------------------------------------------------------------------------------------- 2007 2006 2005 2004 2003 ----------------- ----------------- ----------------- ------------------ ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- Real Estate Loans: (Dollars in thousands) ----------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> One-to-four family .......... $ 99,596 34.7% $ 85,864 34.4% $ 83,001 34.9% $ 81,621 38.2% $ 79,910 39.4% Multi-family ................ 2,036 0.7 2,092 0.8 2,338 1.0 2,154 1.0 2,378 1.2 Home equity ................. 32,363 11.3 25,088 10.1 22,189 9.3 20,309 9.5 17,001 8.4 Commercial real estate ...... 69,224 24.1 57,144 22.9 51,980 21.8 42,566 19.9 35,806 17.6 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans .. 203,219 70.8 170,188 68.2 159,508 67.0 146,650 68.6 135,095 66.6 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Consumer Loans: --------------- Automobile loans ........... 38,871 13.6 39,885 16.0 41,123 17.3 32,059 15.0 30,042 14.8 Mobile home ................ 55 0.0 91 0.0 117 0.0 177 0.1 205 0.1 Personal loans ............. 2,680 0.9 2,236 0.9 2,058 0.9 2,910 1.4 4,326 2.1 Other consumer loans ....... 2,171 0.8 1,830 0.7 1,597 0.7 1,361 0.5 1,549 0.8 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans ..... 43,777 15.3 44,042 17.7 44,895 18.9 36,507 17.0 36,122 17.8 Commercial business loans ...... 39,933 13.9 35,292 14.1 33,633 14.1 30,704 14.4 31,494 15.6 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer and commercial business loans ........... 83,710 29.2 79,334 31.8 78,528 33.0 67,211 31.4 67,616 33.4 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans .............. $286,929 100.00% $249,522 100.00% $238,036 100.00% $213,861 100.00% $202,711 100.00% ======== ====== ======== ====== ======== ====== ======== ====== ======== ====== Less: ----- Allowance for losses ........ 2,511 2,081 1,959 1,982 2,115 -------- -------- -------- -------- -------- Total loans receivable, net . $284,418 $247,441 $236,077 $211,879 $200,596 ======== ======== ======== ======== ======== </TABLE> 4 The following table sets forth the composition of the Bank's loan portfolio by fixed and adjustable rates at the dates indicated. <TABLE> <CAPTION> At December 31, 2007 2006 2005 2004 2003 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> FIXED-RATE LOANS: Real Estate Loans: ------------------ One-to-four family ............. $ 37,030 12.9% $ 25,880 10.4% $ 27,638 11.6% $ 31,201 14.6% $ 29,197 14.4% Multi-family ................... 67 0.0 -- -- -- -- -- -- -- -- Home equity .................... 17,317 6.1 13,002 5.2 10,716 4.5 9,274 4.3 10,543 5.2 Commercial real estate ......... 5,822 2.0 9,261 3.7 6,220 2.6 6,299 2.9 4,174 2.0 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ Total real estate loans ..... 60,236 21.0 48,143 19.3 44,574 18.7 46,774 21.8 43,914 21.6 Consumer Loans: --------------- Total consumer loans ........... 42,657 14.9 43,380 17.4 44,189 18.6 35,695 16.6 35,211 17.4 Commercial business loans: -------------------------- Total commercial loans ......... 17,770 6.2 17,157 6.9 14,112 5.9 14,118 6.6 13,981 7.0 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ Total fixed-rate loans ......... 120,663 42.1 108,680 43.6 102,875 43.2 96,587 45.0 93,106 46.0 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ ADJUSTABLE-RATE LOANS: Real Estate Loans: ------------------ One-to-four family ............. $ 62,566 21.8% $ 59,984 24.0% $ 55,363 23.3% $ 50,420 23.6% $ 50,713 25.0% Multi-family ................... 1,969 0.7 2,092 0.8 2,338 1.0 2,154 1.0 2,378 1.2 Home equity .................... 15,046 5.2 12,086 4.8 11,473 4.8 11,035 5.2 6,458 3.2 Commercial real estate ......... 63,402 22.1 47,883 19.2 45,760 19.2 36,267 17.0 31,632 15.6 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ Total real estate loans ..... 142,983 49.8 122,045 48.8 114,934 48.3 99,876 46.8 91,181 45.0 Consumer Loans: --------------- Total consumer loans ........... 1,120 0.4 662 0.3 706 0.3 812 0.4 911 0.4 Commercial business loans: -------------------------- Total commercial business loans. 22,163 7.7 18,135 7.3 19,521 8.2 16,586 7.8 17,513 8.6 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ Total adjustable-rate loans .... 166,266 57.9 140,842 56.4 135,161 56.8 117,274 55.0 109,605 54.0 -------- ------ -------- ------ -------- ------- -------- ------- -------- ------ Total loans .................... 286,929 100.00% 249,252 100.00% 238,036 100.00% 213,861 100.00% 202,711 100.00% ======== ====== ======== ====== ======== ======= ======== ======= ======== ====== Less: ----- Allowance for loan losses ...... 2,511 2,081 1,959 1,982 2,115 -------- -------- -------- -------- -------- Total loans receivable, net ....... $284,418 $247,441 $236,077 $211,879 $200,596 ======== ======== ======== ======== ======== </TABLE> 5 One-to-four Family Residential Loans. The Bank's primary lending activity is the origination of one-to-four family residential mortgage loans secured by property located in the Bank's primary lending area. Generally, one-to-four family residential mortgage loans are made in amounts up to 80% of the lesser of the appraised value or purchase price of the property. However, the Bank will originate one-to- four family loans with loan-to-value ratios of up to 97%, provided the borrower obtains private mortgage insurance. Generally, fixed-rate loans are originated for terms of up to 30 years. One-to-four family fixed-rate loans are offered with a monthly payment feature. The Bank originates both adjustable-rate and fixed-rate one-to-four family loans. The interest rate on ARM loans is indexed to the one year Treasury bill rate. The Bank's ARM loans currently provide for maximum rate adjustments of 200 basis points per year and 600 basis points over the term of the loan. The Bank offers ARM loans with initial interest rates that are below market, referred to as "teaser rates." Residential ARM loans amortize over a maximum term of up to 30 years. ARM loans are offered with both monthly and bi-weekly payment features. ARM loans are originated for retention in the Bank's portfolio. As a result of the continued low interest rate environment during the past year, a greater percentage of the Bank's one-to-four family loan originations consisted of fixed-rate one-to-four family mortgage loans. The Bank originates and generally sells its fixed-rate one-to-four family loans on a servicing retained basis without recourse to the Bank. At December 31, 2007, loans serviced by the Bank for others totaled $101.9 million. During the year ended December 31, 2007 and December 31, 2006, the Bank sold $17.9 million and $17.0 million, respectively in fixed-rate one-to-four family loans. As of December 31, 2007 the Bank had $3.6 million of mortgage loan forward sale commitments. The fair value of these commitments is not material. ARM loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks. As interest rates increase, the underlying required periodic payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustment permitted by the terms of the ARM loans, and therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. At December 31, 2007, 21.8% of the Bank's loan portfolio consisted of one-to-four family residential loans with adjustable interest rates. All one-to-four family residential mortgage loans originated by the Bank include "due-on-sale" clauses, which give the Bank the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. At December 31, 2007, approximately $99.6 million, or 34.7% of the Bank's loan portfolio, consisted of one-to-four family residential loans. Approximately $223,000 of such loans (representing three loans) were included in nonperforming loans as of that date. Home Equity Loans. The Bank offers home equity loans that are secured by the borrower's primary residence. The Bank offers a home equity line of credit under which the borrower is permitted to draw on the home equity line of credit during the first ten years after it is originated and repay the outstanding balance over a term not to exceed 25 years from the date the line of credit is originated. The interest rates on home equity lines of credit are fixed for the first year and adjust monthly thereafter at a margin over the prime interest rate. The Bank also offers a home equity product providing for a fixed-rate of interest. Both adjustable-rate and fixed-rate home equity loans are underwritten under the same criteria that the Bank uses to underwrite one-to-four family fixed-rate loans. Fixed-rate home equity 6 loans are originated with terms up to ten years. Home equity loans may be underwritten with a loan to value ratio of 85% when combined with the principal balance of the existing mortgage loan. The maximum amount of a home equity loan may not exceed $250,000 unless approved by the Board of Directors. The Bank appraises the property securing the loan at the time of the loan application (but not thereafter) in order to determine the value of the property securing the home equity loans. At December 31, 2007 the outstanding balance of home equity loans totaled $32.4 million, or 11.3% of the Bank's loan portfolio. At December 31, 2007, there was $18,000 (representing one loan) of home equity loans included in nonperforming loans. Commercial Real Estate Loans. At December 31, 2007, $71.3 million, or 24.8% of the total loan portfolio consisted of commercial real estate loans. Commercial real estate loans are secured by office buildings, mixed-use properties, religious facilities and other commercial properties. The Bank originates adjustable rate commercial mortgage loans with terms of up to 20 years. The maximum loan-to-value ratio of commercial real estate loans is 80%. At December 31, 2007, the largest commercial real estate loan had a principal balance of $3.0 million and was secured by a car dealership building and assets. This loan is performing in accordance with its terms. As of December 31, 2007, there was no commercial real estate loans included in nonperforming loans. In underwriting commercial real estate loans, the Bank reviews the expected net operating income generated by the real estate to ensure that it is at least 110% of the amount of the monthly debt service; the age and condition of the collateral; the financial resources and income level of the borrower; and the borrower's business experience. Personal guarantees are routinely obtained from all commercial real estate borrowers. Loans secured by commercial real estate generally are larger than one-to-four family residential loans and involve a greater degree of risk. Commercial mortgage loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on the results of operations and management of the properties or underlying businesses, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of commercial real estate loans makes them more difficult for Bank management to monitor and evaluate. Consumer Lending. At December 31, 2007, consumer loans totaled $43.8 million, or 15.3% of the total loan portfolio. The Bank's consumer loans consist of automobile loans, mobile home loans, secured personal loans (secured by bonds, equity securities or other readily marketable collateral), and other consumer loans (consisting of passbook loans, unsecured home improvement loans and recreational vehicle loans). Consumer loans are originated with terms to maturity of three to seven years. The Bank has sought to increase its level of consumer loans primarily through increased automobile lending. The Bank participates in a number of indirect automobile lending programs with local automobile dealerships. All indirect automobile loans must satisfy the Bank's underwriting criteria for automobile loans originated directly by the Bank to the borrower and must be approved by one of the Bank's lending officers. At December 31, 2007, loans secured by automobiles totaled $38.9 million, of which $31.9 million were originated through the Bank's indirect automobile lending program. The Bank has also sought to increase its level of automobile loans directly to borrowers by increasing its marketing efforts with existing customers. Automobile loans generally do not have terms exceeding five years. The Bank does not provide financing for leased automobiles. Consumer loans generally have shorter terms and higher interest rates than one-to-four family mortgage loans. In addition, consumer loans expand the products and services offered by the Bank to better meet the financial services needs of its customers. Consumer loans generally involve greater credit risk than residential mortgage loans because of the difference in the underlying collateral. Repossessed 7 collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage to, loss of, or depreciation in the underlying collateral. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections depend on the borrower's personal financial stability. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. The Bank's underwriting procedures for consumer loans include an assessment of the applicant's credit history and the ability to meet existing and proposed debt obligations. Although the applicant's creditworthiness is the primary consideration, the underwriting process also includes a comparison of the value of the security to the proposed loan amount. The Bank underwrites its consumer loans internally, which the Bank believes limits its exposure to credit risks associated with loans underwritten or purchased from brokers and other external sources. As of December 31, 2007, there were no consumer loans included in nonperforming loans. Commercial Business Loans. The Bank also originates commercial business loans. Commercial business loans are originated with terms of up to seven years, at fixed rates of interest except for lines of credit which have variable rates of interest. Commercial business loans are originated to persons with a prior relationship with the Bank or referrals from persons with a prior relationship with the Bank. The decision to grant a commercial business loan depends primarily on the creditworthiness and cash flow of the borrower (and any guarantors) and secondarily on the value of and ability to liquidate the collateral which generally consists of receivables, inventory and equipment. The Bank generally requires annual financial statements and tax returns from its commercial business borrowers and personal guarantees from the commercial business borrowers. The Bank also generally requires an appraisal of any real estate that secures the commercial business loan. At December 31, 2007, the Bank had $39.9 million of commercial business loans which represented 13.9% of the total loan portfolio. On such date, the largest commercial business lending relationship totaled $3.7 million, which was secured by business assets of a not-for-profit corporation. At December 31, 2007, unsecured commercial business loans totaled $3.0 million. Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based, with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because equipment and other business assets may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. At December 31, 2007, there was $134,000 (representing three loans) of commercial business loans included in nonperforming loans as of that date. 8 Loan Maturity Schedule. The following table sets forth certain information as of December 31, 2007, regarding the amount of loans maturing in the Bank's portfolio. Demand loans having no stated schedule of repayment and no stated maturity and overdrafts are reported as due in one year or less. All loans are included in the period in which the final contractual repayment is due. <TABLE> <CAPTION> One Three Five Ten Through Beyond Within Through Through Through Twenty-Five Twenty-Five One Year Three Years Five Years Ten Years Years Years Total --------- --------- --------- --------- --------- --------- --------- (In thousands) <S> <C> <C> <C> <C> <C> <C> <C> Real estate loans: One-to-four family .................... $ 932 $ 661 $ 1,545 $ 8,934 $ 65,515 $ 22,009 $ 99,596 Multi-family ......................... -- 60 141 212 1,623 -- 2,036 Home equity .......................... 237 1,128 3,584 17,067 10,347 -- 32,363 Commercial real estate ............... 3,404 558 806 10,690 53,766 -- 69,224 --------- --------- --------- --------- --------- --------- --------- Total real estate loans ............ 4,573 2,407 6,076 36,903 131,251 22,009 203,219 Consumer and other loans ................ 2,303 13,799 21,501 5,399 656 119 43,777 Commercial business loans ............... 17,669 6,002 9,585 5,862 815 -- 39,933 --------- --------- --------- --------- --------- --------- --------- Total loans ........................ $ 24,545 $ 22,208 $ 37,162 $ 48,164 $ 132,722 $ 22,128 $ 286,929 ========= ========= ========= ========= ========= ========= ========= </TABLE> Fixed- and Adjustable-Rate Loan Schedule. The following table sets forth at December 31, 2007, the dollar amount of all fixed-rate and adjustable-rate loans due after December 31, 2008. Adjustable- and floating-rate loans are included based on contractual maturities. <TABLE> <CAPTION> Due After December 31, 2008 --------------------------------------------- Fixed Adjustable Total ----------- ----------- ----------- (In thousands) <S> <C> <C> <C> Real estate loans One-to-four family .............................. $ 36,132 $ 62,532 $ 98,664 Multi-family .................................... 67 1,969 2,036 Home equity ..................................... 17,256 14,870 32,126 Commercial real estate .. ....................... 4,188 61,632 65,820 ----------- ----------- ----------- Total real estate loans ....................... 57,643 141,003 198,646 Consumer and other loans ........................... 40,921 553 41,474 Commercial business loans .. ....................... 14,973 7,291 22,264 ----------- ----------- ----------- Total loans ................................... $ 113,537 $ 148,847 $ 262,384 =========== =========== =========== </TABLE> 9 Loan Origination, Sales and Repayments. The following table sets forth the loan origination, sales and repayment activities of the Bank for the periods indicated. The Bank did not purchase any loans during the periods presented except for those purchased as part of the acquisition of NBV. <TABLE> <CAPTION> Year Ended December 31, --------------------------------------------- 2007 2006 2005 --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> Originations by Type: --------------------- Adjustable-Rate: Real estate: One-to-four family ................................ $ 10,868 $ 8,591 $ 10,821 Multi-family ...................................... 405 96 544 Home equity ....................................... 5,838 5,140 6,274 Commercial and real estate ........................ 7,611 11,876 21,385 --------- --------- --------- Total real estate loans ........................... 24,722 25,703 39,024 Consumer loans .................................... 1,632 2,863 1,029 Commercial business loans ......................... 11,523 8,136 8,581 --------- --------- --------- Total adjustable rate loans .................. $ 37,877 $ 36,702 $ 48,634 --------- --------- --------- Fixed-Rate: Real estate: One-to-four family ................................ $ 24,343 $ 21,945 $ 19,897 Multi-family ...................................... -- -- -- Home equity ....................................... 7,166 5,727 3,315 Commercial and real estate ........................ 2,264 317 110 --------- --------- --------- Total real estate loans ........................... 33,773 27,989 23,322 Consumer loans .................................... 20,987 19,888 28,887 Commercial business loans ......................... 12,779 14,203 13,591 --------- --------- --------- Total fixed rate loans ....................... $ 67,539 $ 62,080 $ 65,800 --------- --------- --------- Total loans originated .................................... $ 105,416 $ 98,782 $ 114,434 --------- --------- --------- Purchased: ---------- Adjustable-Rate: Real estate: One-to-four family ................................ $ -- -- -- Multi-family ...................................... -- -- -- Home equity ....................................... 2,353 -- -- Commercial and real estate ........................ -- -- -- --------- --------- --------- Total real estate loans ........................... 2,353 -- -- Consumer loans .................................... -- -- -- Commercial business loans ......................... 517 -- -- --------- --------- --------- Total adjustable loans ....................... $ 2,870 $ -- $ -- --------- --------- --------- Fixed-Rate: Real estate: One-to-four family ................................ $ 10,676 $ -- $ -- Multi-family ...................................... -- -- -- Home equity ....................................... 768 -- -- Commercial and real estate ........................ 8,320 -- -- --------- --------- --------- Total real estate loans ........................... 19,764 -- -- Consumer loans .................................... 1,443 -- -- Commercial business loans ......................... 1,906 -- -- --------- --------- --------- Total fixed rate loans ....................... $ 23,113 $ -- $ -- --------- --------- --------- Total loans purchased ..................................... $ 25,983 $ -- $ -- --------- --------- --------- Sales: ------ Real estate: One-to-four family ................................ $ 17,938 $ 17,015 $ 14,845 --------- --------- --------- Total loans sold .......................................... $ 17,938 $ 17,015 $ 14,845 Repayments: ----------- Real estate: One-to-four family ................................ $ 14,217 $ 10,658 $ 14,493 Multi-family ...................................... 461 342 360 Home equity ....................................... 8,850 7,968 7,709 Commercial and real estate ........................ 6,115 7,029 12,081 --------- --------- --------- Total real estate loans ...................... 29,643 25,997 34,643 Consumer loans ....................................... 24,327 23,604 21,528 Commercial business loans ............................ 22,084 20,680 19,243 --------- --------- --------- Total repayments ............................. $ 76,054 $ 70,281 $ 75,414 --------- --------- --------- Total reductions ............................. $ 93,992 $ 87,296 $ 90,259 --------- --------- --------- Net increases ..................................... $ 37,407 $ 11,486 $ 24,175 ========= ========= ========= </TABLE> 10 Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and loan approval limits of the Bank. Loan officers generally have the authority to originate mortgage loans, consumer loans and commercial business loans up to amounts established for each lending officer. All residential loans over $500,000 must be approved by the Bank Loan Committee (consisting of two person; the President and/or Executive Vice President in charge of credit administration and either one of two senior lending officers appointed to this committee). All loan relationships in excess of $500,000 and up to $750,000 (exclusive of residential mortgages and home equity loans secured by a lien on the borrower's primary residence) must be approved by the Bank Loan Committee. All lending relationships in excess of $750,000 up to $1.5 million (exclusive of residential mortgages and home equity loans secured by a lien on the borrower's primary residence) must be approved by the Executive Committee of the Board of Directors. All lending relationships in excess of $1.5 million must be approved by the Board of Directors. The Board annually approves independent appraisers used by the Bank. The Bank requires an environmental site assessment to be performed by an independent professional for all non-residential mortgage loans. It is the Bank's policy to require hazard insurance on all mortgage loans and title insurance on fixed-rate one-to-four family loans. Loan Origination Fees and Other Income. In addition to interest earned on loans, the Bank receives loan origination fees. Such fees and costs vary with the volume and type of loans and commitments made and purchased, principal repayments and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money. In addition to loan origination fees, the Bank also receives other fees, service charges and other income that consist primarily of deposit transaction account service charges and late charges. Loans-to-One Borrower. Savings banks are subject to the same loans-to-one borrower limits as those applicable to national banks, which under current regulations restrict loans to one borrower to an amount equal to 15% of unimpaired net worth on an unsecured basis, and an additional amount equal to 10% of unimpaired net worth if the loan is secured by readily marketable collateral (generally, financial instruments and bullion, but not real estate). The Bank's policy provides that loans to one borrower (or related borrowers) should not exceed 15% of the Bank's capital. At December 31, 2007, the largest amount loaned by the Bank to one borrower consisted of commercial real estate loans secured by medical office space to a corporation with an outstanding balance totaling $4.5 million. This amount consisted of four commercial real estate loans secured by the property and other business assets. At December 31, 2007 this lending relationship was performing in accordance with its terms. Delinquencies and Classified Assets Collection Procedures. A computer generated late notice is sent when a loan's grace period ends. After the late notice has been mailed, accounts are assigned to collectors for follow-up to determine reasons for delinquency and explore payment options. Generally, loans that are 30 days delinquent will receive a default notice from the Bank. With respect to consumer loans, the Bank will commence efforts to repossess the collateral after the loan becomes 45 days delinquent. Loans secured by real estate that are delinquent over 60 days are turned over to the Bank's Managed Asset Manager. Generally, after 90 days the Bank will commence legal action. 11 Loans Past Due and Nonperforming Assets. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due. Interest accrued and unpaid at the time a loan is placed on a non-accrual status is reversed from interest income. At December 31, 2007, the Bank had nonperforming loans of $375,000 and a ratio of nonperforming loans to total assets of 0.07%. At December 31, 2007, the Bank's ratio of nonperforming assets to total assets was 0.07%. Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as Other Real Estate ("REO") until such time as it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value, less estimated costs of disposal. If the value of the property is less than the loan, less any related specific loan loss provisions, the difference is charged against the allowance for loan losses. Any subsequent write-down of REO is charged against earnings. The following table sets forth delinquencies in the Bank's loan portfolio as of December 31, 2007. When a loan is delinquent 90 days or more, the Bank fully reverses all interest accrued and ceases to accrue interest thereafter. <TABLE> <CAPTION> Loans Delinquent for: ------------------------------------------------------------------------- 60-89 Days 90 Days or More Total Delinquent Loans --------------------- ------------ ------- ---------------------- Number Amount Number Amount Number Amount ------- ------- ------- ------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> One-to-four family ............................ -- $ -- 3 $ 223 3 $ 223 Multi-family .................................. -- -- -- -- -- -- Home equity ................................... 1 5 1 18 2 23 Commercial real estate ........................ -- -- -- -- -- -- Construction and land ......................... -- -- -- -- -- -- Consumer ...................................... -- -- -- -- -- -- Commercial business ........................... 1 15 1 14 2 29 ------- ------- ------- ------- ------- ------- Total ....................................... 2 $ 20 5 $ 255 7 $ 275 ======= ======= ======= ======= ======= ======= </TABLE> 12 Nonaccrual Loans and Nonperforming Assets. The following table sets forth information regarding nonaccrual loans and other nonperforming assets. <TABLE> <CAPTION> At December 31, ------------------------------------------------------- 2007 2006 2005 2004 2003 -------- -------- -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Non-accruing loans: One-to-four family ............................................... $ 223 $ 51 $ 223 $ 128 $ 114 Multi-family ..................................................... -- -- -- -- -- Home equity ...................................................... 18 -- -- -- -- Commercial real estate ........................................... -- -- -- 436 -- Construction and land ............................................ -- -- -- -- -- Consumer ......................................................... -- -- 2 31 11 Commercial business .............................................. 134 -- -- -- 22 -------- -------- -------- -------- -------- Total ......................................................... 375 51 225 595 147 -------- -------- -------- -------- -------- Accruing loans delinquent more than 90 days: One-to-four family ............................................... -- -- -- -- -- Multi-family ..................................................... -- -- -- -- -- Home equity ...................................................... -- -- -- -- -- Commercial real estate ........................................... -- -- -- -- -- Construction and land ............................................ -- -- -- -- -- Consumer ......................................................... -- -- -- -- 34 Commercial business .............................................. -- -- -- -- -- -------- -------- -------- -------- -------- Total ......................................................... -- -- -- -- 34 -------- -------- -------- -------- -------- Total nonperforming loans ........................................... $ 375 $ 51 $ 225 $ 595 $ 181 ======== ======== ======== ======== ======== Foreclosed assets: One-to-four family ............................................... $ -- $ -- $ -- $ -- $ -- Multi-family ..................................................... -- -- -- -- -- Home equity ...................................................... -- -- -- -- -- Commercial real estate ........................................... -- -- -- -- 115 Construction and land ............................................ -- -- -- -- -- Consumer ......................................................... -- -- -- -- -- Commercial business .............................................. -- -- -- -- -- -------- -------- -------- -------- -------- Total ......................................................... -- -- -- -- 115 ======== ======== ======== ======== ======== Total nonperforming loans as a percentage of total assets ........... 0.07% 0.01% 0.05% 0.14% 0.04% ======== ======== ======== ======== ======== Total nonperforming assets .......................................... $ 375 $ 51 $ 225 $ 595 $ 296 ======== ======== ======== ======== ======== Total nonperforming assets as a percentage of total assets .......... 0.07% 0.01% 0.05% 0.14% 0.07% ======== ======== ======== ======== ======== </TABLE> During the years ended December 31, 2007 and 2006, respectively, gross interest income of $13,000 and $1,800 would have been recorded on nonaccruing loans under their original terms, if the loans had been current throughout the period. No interest income was recorded on nonaccruing loans during the years ended December 31, 2007 and 2006. 13 Classification of Assets. On the basis of management's review of its assets, at December 31, 2007 the Bank had classified a total of $7.3 million of loans as follows: <TABLE> <CAPTION> 2007 2006 2005 ------------------------------------- (In thousands) <S> <C> <C> <C> Special mention .................. $ 2,509 $ 961 $ -- Substandard ...................... 4,722 3,450 1,565 Doubtful assets .................. 75 22 29 Loss assets ...................... -- -- -- Impaired assets .................. -- -- 39 --------- --------- --------- Total ....................... $ 7,306 $ 4,433 $ 1,633 ========= ========= ========= General loss allowance ........... $ 1,640 $ 1,505 $ 1,690 ========= ========= ========= Specific loss allowance .......... 871 576 269 ========= ========= ========= Net charge-offs .................. 96 158 383 ========= ========= ========= </TABLE> Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses and valuation of real estate owned. Such agencies may require the Bank to recognize additions to the allowance based on their judgment about information available to them at the time of their examination. At December 31, 2007, the total allowance was $2.5 million, which amounted to 0.88% of loans, net and 669.6% of nonperforming loans. Management monitors and modifies the level of the allowance for loan losses in order to maintain it at a level which it considers adequate to provide for probable incurred loan losses. For the years ended December 31, 2007 and 2006, the Bank had charge-offs of $231,000 and $427,000, respectively, against this allowance. Quarterly, the Bank evaluates the adequacy of the allowance for loan losses and determines the appropriate level of provision for loan losses by applying a range of estimated loss percentages to each category of performing loans and classified loans. The allowance adjustment is based upon the net change in each portfolio category, as well as adjustments related to impaired loans, since the prior quarter. A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the estimated fair value of the collateral securing the loan. Management believes the current method of determining the adequacy of the allowance is prudent in light of the Bank's intention to continue to diversify its lending operations through the increased origination of consumer loans, commercial business loans and commercial real estate loans. 14 Analysis of the Allowance For Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated. <TABLE> <CAPTION> December 31, ---------------------------------------------------------------- 2007 2006 2005 2004 2003 -------- -------- -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Balance at beginning of period ............................... $ 2,081 $ 1,959 $ 1,982 $ 2,115 $ 2,109 Charge-offs: One-to-four family ........................................ -- 17 9 -- 13 Multi-family .............................................. -- -- -- -- -- Home equity ............................................... -- 10 10 -- -- Commercial real estate .................................... -- -- 44 -- -- Construction and land ..................................... -- -- -- -- -- Consumer .................................................. 215 301 448 415 509 Commercial business ....................................... 16 99 10 283 203 -------- -------- -------- -------- -------- Total ..................................................... 231 427 521 698 725 -------- -------- -------- -------- -------- Recoveries: One-to-four family ........................................ 6 5 10 2 -- Multi-family .............................................. -- -- -- -- -- Home equity ............................................... -- 19 -- -- -- Commercial real estate .................................... -- -- -- -- -- Construction and land ..................................... -- -- -- -- -- Consumer .................................................. 88 139 127 102 95 Commercial business ....................................... 41 106 1 11 106 -------- -------- -------- -------- -------- Total ..................................................... 135 269 138 115 201 -------- -------- -------- -------- -------- Net charge-offs .............................................. (96) (158) (383) (583) (524) Addition of NBV allowance from acquisition ................... 526 -- -- -- -- Provision charged to operations .............................. -- 280 360 450 530 -------- -------- -------- -------- -------- Balance at end of period ..................................... $ 2,511 $ 2,081 $ 1,959 $ 1,982 $ 2,115 ======== ======== ======== ======== ======== Allowance for loan losses as a percentage of total loans receivable, net ........................................ 0.88% 0.84% 0.83% 0.94% 1.05% ======== ======== ======== ======== ======== Ratio of net charge-offs to average loans .................... 0.04% 0.06% 0.17% 0.28% 0.26% ======== ======== ======== ======== ======== Ratio of net charge-offs to non-performing loans ............. 25.6% 309.80% 170.22% 97.98% 289.50% ======== ======== ======== ======== ======== </TABLE> 15 Allocation of Allowance for Loan Losses. The following table sets forth the allocation of the allowance for loan losses by loan category for the periods indicated. <TABLE> <CAPTION> At December 31, ------------------------------------------------------------------------------------------------------------- 2007 2006 2005 ---------------------------------- ----------------------------------- ---------------------------------- Percentage Percentage Percentage of of of Loans in Loans in Loans in Amount of Loan Each Amount of Loan Each Amount of Loan Each Loan Loss Amounts by Category to Loan Loss Amounts by Category to Loan Loss Amounts by Category to Allowance Category Total Loans Allowance Category Total Loans Allowance Category Total Loans --------- ---------- ----------- --------- ---------- ----------- --------- ---------- ----------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> One-to-four family . $ 329 $ 99,596 34.71% $ 273 $ 85,864 34.42% $ 376 $ 83,001 34.87% Multi-family ....... 7 2,036 0.70 7 2,092 0.84 9 2,338 0.98 Home equity ........ 275 32,363 11.28 220 25,088 10.05 222 22,189 9.32 Commercial real estate ........... 831 69,224 24.13 539 57,144 22.90 287 51,980 21.84 Consumer ........... 413 43,777 15.26 424 44,042 17.65 451 44,895 18.86 Commercial business.......... 656 39,933 13.92 618 35,292 14.14 614 33,633 14.13 --------- ---------- ---------- --------- ---------- ---------- --------- ---------- ---------- Total ........... $ 2,511 $ 286,929 100.00% $ 2,081 $ 249,522 100.00% $ 1,959 $ 238,036 100.00% ========= ========== ========== ========= ========== ========== ========= ========== ========== <CAPTION> At December 31, ------------------------------------------------------------------------ 2004 2003 ---------------------------------- ----------------------------------- Percentage Percentage of of Loans in Loans in Amount of Loan Each Amount of Loan Each Loan Loss Amounts by Category to Loan Loss Amounts by Category to Allowance Category Total Loans Allowance Category Total Loans --------- ---------- ----------- --------- ---------- ----------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> One-to-four family . $ 357 $ 81,621 38.17% $ 344 $ 79,910 39.42% Multi-family ....... 8 2,154 1.00 9 2,378 1.17 Home equity ........ 203 20,309 9.50 170 17,001 8.39 Commercial real estate ............ 296 42,566 19.90 344 35,806 17.66 Consumer ........... 474 36,507 17.07 505 36,122 17.82 Commercial business .......... 644 30,704 14.36 743 31,494 15.54 --------- ---------- --------- --------- --------- --------- Total ........... $ 1,982 $ 2 13,861 100.00% $ 2,115 $ 202,711 100.00% ========= ========== ========= ========= ========= ========= </TABLE> 16 Securities Investment Activities The securities investment policy is established by the Board of Directors of the Bank. This policy dictates that investment decisions will be made based on the safety of the investment, the Bank's liquidity needs, potential returns, cash flow targets and desired risk parameters. In pursuing these objectives, management considers the ability of an investment to provide earnings consistent with factors of quality, maturity, marketability and risk diversification. The Bank's current policies generally limit security investments to U.S. Government and agency securities, tax-exempt bonds, public utilities debt obligations, corporate debt obligations and corporate equity securities. In addition, the Bank's policy permits investments in mortgage related securities, including securities issued by government sponsored enterprises such as Fannie Mae, Freddie Mac and Ginnie Mae. In the past, the Bank invested in privately issued collateralized mortgage obligations ("CMOs"), but has only invested in agency issued CMOs in recent years. The Bank's investment strategy is to increase overall investment securities yields while managing interest rate risk. The Bank will only purchase securities rated as investment grade by a nationally recognized investment rating agency. The Bank does not engage in any hedging transactions, such as interest rate swaps or caps. Investment Securities. At December 31, 2007, the Bank had $96.1 million, or 18.4% of total assets, invested in investment securities, which consisted primarily of U.S. Government obligations, tax-exempt securities, corporate obligations, a mutual fund and equity investments in corporate stock. There were no trust preferred investments included in corporate debt obligations at December 31, 2007. SFAS No. 115 requires the Bank to designate its securities as held to maturity, available for sale or trading, depending on the Bank's ability and intent regarding its investments. The Bank does not have a trading portfolio. Investment securities are classified as available for sale. At December 31, 2007, the Bank's investment securities portfolio had a weighted average life of 6.89 years. 17 Investment Securities. The following table sets forth certain information regarding the investment securities and other interest earning assets as of the dates indicated. <TABLE> <CAPTION> At December 31, ------------------------------------------------------------------------------------ 2007 2006 2005 ------------------------ ------------------------ ------------------------ Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- --------- --------- --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Investment securities available for sale: Federal agency securities ............ $ 38,005 $ 37,949 $ 36,892 $ 36,245 $ 36,523 $ 35,436 Corporate debt securities ............ 23,791 22,455 18,361 18,067 22,696 21,903 Tax exempt bonds ..................... 19,120 19,252 15,747 15,706 32,491 32,498 Equity securities .................... 18,988 16,455 15,392 15,699 17,012 16,595 --------- --------- --------- --------- --------- --------- Total ........................... $ 99,904 $ 96,111 $ 86,392 $ 85,717 $ 108,722 $ 106,432 ========= ========= ========= ========= ========= ========= Average remaining life of investment securities 6.89 years 5.99 years 7.18 years Other interest earning assets: Interest-earning deposits with banks . 1,234 1,234 854 854 1,437 1,437 Federal funds sold ................... 1,717 1,717 6,196 6,196 730 730 FHLB Stock ........................... 3,404 3,404 3,228 3,228 3,858 3,858 --------- --------- --------- --------- --------- --------- Total ........................... $ 6,355 $ 6,355 $ 10,278 $ 10,278 $ 6,025 $ 6,025 ========= ========= ========= ========= ========= ========= <CAPTION> At December 31, ------------------------------------------------------ 2004 2003 ------------------------ ------------------------ Amortized Fair Amortized Fair Cost Value Cost Value --------- --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> Investment securities available for sale: Federal agency securities ............ $ 38,835 $ 38,213 $ 45,840 $ 45,500 Corporate debt securities ............ 21,767 22,194 31,175 31,736 Tax exempt bonds ..................... 30,743 31,168 25,496 26,109 Equity securities .................... 14,720 14,898 15,020 15,334 --------- --------- --------- --------- Total ........................... $ 106,065 $ 106,473 $ 117,531 $ 118,679 ========= ========= ========= ========= Average remaining life of investment securities 8.92 years 7.51 years Other interest earning assets: Interest-earning deposits with banks . 986 986 1,340 1,340 Federal funds sold ................... 3,180 3,180 -- -- FHLB Stock ........................... 3,257 3,257 3,370 3,370 --------- --------- --------- --------- Total ........................... $ 7,423 $ 7,423 $ 4,710 $ 4,710 ========= ========= ========= ========= </TABLE> 18 Investment Portfolio Maturities. The following table sets forth the scheduled maturities, market value and weighted average yields for the Bank's investment portfolio at December 31, 2007. <TABLE> <CAPTION> December 31, 2007 ------------------------------------------------------------------------------ After 1 Year After 5 Years Within but Within but Within After 1 Year 5 Years 10 Years 10 Years Total ---------- ------------ -------------- ---------- ---------- Carrying Carrying Carrying Carrying Carrying Value Value Value Value Value ---------- ---------- ---------- ---------- ---------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> Federal agency securities ...... $ 6,215 $ 16,695 $ 7,340 $ 7,699 $ 37,949 Corporate debt securities ...... -- 6,706 2,041 13,708 22,455 Tax exempt bonds ............... 2,741 1,437 10,905 4,169 19,252 ---------- ---------- ---------- ---------- ---------- Total securities ............. $ 8,956 $ 24,838 $ 20,286 $ 25,576 $ 79,656 ========== ========== ========== ========== ========== Weighted average yield (1) ........ 4.05% 4.55% 5.66% 5.79% 4.78% </TABLE> -------------- (1) Weighted average yield has not been adjusted to reflect tax equivalent adjustments. Mortgage-Backed Securities. The Bank purchases mortgage-backed securities in order to: (i) generate positive interest rate spreads with minimal administrative expense; (ii) lower the Bank's credit risk; and (iii) increase liquidity. At December 31, 2007, the amortized cost of mortgage-backed securities totaled $46.6 million or 8.9% of total assets, all of which were classified as available for sale. The mortgage-backed securities portfolio had coupon rates ranging from 3.66% to 7.79%, a weighted average yield of 5.03% and a weighted average life (including payment assumption) of 7.95 years at December 31, 2007. The estimated fair value of the Bank's mortgage-backed securities at December 31, 2007 was $46.6 million, which was $30,000 lower than the amortized cost of $46.6 million. Mortgage-backed securities are created by the pooling of mortgages and the issuance of a security with an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although the Bank focuses its investments on mortgage-related securities backed by single-family mortgages. The issuers of such securities (generally U.S. Government agencies and government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors, such as the Bank, and guarantee the payment of principal and interest to these investors. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. In addition, mortgage-related securities are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of the Bank. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby reducing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates. Management reviews prepayment estimates periodically to ensure that prepayment assumptions are reasonable considering the underlying collateral for the securities at issue and current interest rates and to determine the yield and estimated maturity of the Bank's mortgage-backed securities portfolio. Of the Bank's $46.6 million mortgage-backed securities portfolio at December 31, 2007, $75,000 with a weighted average yield of 10.02% had contractual maturities within five years, $393,000 with a weighted average yield of 4.96% had contractual maturities of five to ten years and $46.1 million with a weighted average yield of 5.02% had contractual maturities of over ten years. However, the actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and may result in a loss of any premiums paid and thereby reduce the net yield on such securities. 19 Although prepayments of underlying mortgages depend on many factors, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Bank may be subject to reinvestment risk because, to the extent that the Bank's mortgage related securities prepay faster than anticipated, the Bank may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate of return. Conversely, in a rising interest rate environment prepayments may decline, thereby extending the estimated life of the security and depriving the Bank of the ability to reinvest cash flows at the increased rates of interest. 20 Mortgage-Backed Securities. Set forth below is information relating to the Bank's mortgage-backed securities for the periods indicated. <TABLE> <CAPTION> December 31, ----------------------------------------------------------------------------- 2007 2006 2005 ----------------------- ------------------------ ------------------------ Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ---------- ---------- ---------- ---------- ---------- ---------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Mortgage-backed securities available for sale: GinnieMae ................................. $ 2,441 $ 2,467 $ 994 $ 989 $ -- $ -- FannieMae ................................. 15,481 15,481 10,224 10,008 9,226 8,937 FreddieMac ................................ 21,890 21,826 16,571 16,196 18,494 18,034 CMOs ...................................... 6,787 6,795 1,903 1,871 2,161 2,103 Small business administration ............. 14 14 17 17 23 23 ---------- ---------- ---------- ---------- ---------- ---------- Total ............................... $ 46,613 $ 46,583 $ 29,709 $ 29,081 $ 29,904 $ 29,097 ========== ========== ========== ========== ========== ========== <CAPTION> December 31, ---------------------------------------------------------- 2004 2003 -------------------------- -------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ---------- ---------- ---------- ---------- (In thousands) <S> <C> <C> <C> <C> Mortgage-backed securities available for sale: GinnieMae ................................. $ 416 $ 444 $ 1,504 $ 1,588 FannieMae ................................. 14,819 14,675 21,863 21,979 FreddieMac ................................ 19,706 19,672 22,795 22,934 CMOs ...................................... 9,151 9,182 4,961 4,723 Small business administration ............. 405 405 565 564 ---------- ---------- ---------- ---------- Total ............................... $ 44,497 $ 44,378 $ 51,688 $ 51,788 ========== ========== ========== ========== </TABLE> 21 Sources of Funds General. The primary sources of the Bank's funds for use in lending, investing and for other general purposes are deposits, repayments and prepayments of loans and securities, proceeds from sales of loans and securities, proceeds from maturing securities and cash flows from operations. Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Bank's deposit accounts consist of savings, interest-bearing demand accounts, non interest-bearing checking accounts, money market accounts and certificates of deposit. The Bank also offers IRAs and other qualified plan accounts. Through our special purpose subsidiary at December 31, 2007 the Bank held $29.7 million in municipal deposits. At December 31, 2007, deposits totaled $400.1 million. At December 31, 2007, the Bank had a total of $152.9 million in certificates of deposit, of which $119.1 million had maturities of one year or less. Although the Bank has a significant portion of its deposits in shorter term certificates of deposit, management monitors activity on these accounts. Based on historical experience and the Bank's current pricing strategy, management believes it will retain a large portion of such accounts upon maturity. At December 31, 2007 certificates of deposit with balances of $100,000 or more totaled $47.0 million. The flow of deposits is influenced significantly by general economic conditions, changes in prevailing interest rates, internal pricing decisions and competition. Deposits are obtained predominantly from the areas in which the Bank's branch offices are located. The Bank relies primarily on competitive pricing of its deposit products and customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits. The Bank uses traditional means of advertising its deposit products, including radio and print media and it generally does not solicit deposits from outside its market area. While certificates of deposit in excess of $100,000 are accepted by the Bank, and may be subject to preferential rates, the Bank does not actively solicit such deposits as they are more difficult to retain than core deposits. Historically, the Bank has not used brokers to obtain deposits. The following table sets forth the deposit activities of the Bank for the periods indicated. <TABLE> <CAPTION> Year Ended December 31, ---------------------------------------------- 2007 2006 2005 ----------- ----------- ----------- (Dollars in thousands) <S> <C> <C> <C> Opening balance ................................ $ 313,270 $ 301,186 $ 301,647 Deposits acquired from NBV ..................... 54,631 -- -- Deposits ....................................... 3,373,810 2,766,018 2,589,258 Withdrawals .................................... (3,350,619) (2,759,898) (2,594,264) Interest credited .............................. 9,037 5,964 4,545 ----------- ----------- ----------- Ending balance ................................. $ 400,129 $ 313,270 $ 301,186 ----------- ----------- ----------- Net increase (decrease) ........................ $ 86,859 $ 12,084 $ (461) =========== =========== =========== Percent increase (decrease) .................... 27.73% 4.01% (0.15)% =========== =========== =========== </TABLE> 22 The following table indicates the amount of the Bank's certificates of deposit by time remaining until maturity as of December 31, 2007. <TABLE> <CAPTION> Maturity ----------------------------------------- 3 Months Over 3 to 6 Over 6 to 12 Over 12 or Less Months Months Months Total --------- --------- ------------ --------- --------- (In thousands) <S> <C> <C> <C> <C> <C> Certificates of deposit less than $100,000 .............. $ 26,667 $ 19,264 $ 35,303 $ 24,635 $ 105,869 Certificates of deposit of $100,000 or more ............. 13,231 7,174 17,439 9,185 47,029 --------- --------- --------- --------- --------- Total of certificates of deposit ........................ $ 39,898 $ 26,438 $ 52,742 $ 33,820 $ 152,898 ========= ========= ========= ========= ========= </TABLE> The following tables set forth information, by various rate categories, regarding the dollar balance of deposits by types of deposit for the periods indicated. <TABLE> <CAPTION> December 31, ------------------------------------------------------------------------------------ 2007 2006 2005 ------------------------ ------------------------ ---------------------- Amount Percent Amount Percent Amount Percent --------- --------- --------- --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Transactions and savings deposits: Noninterest-bearing .................... $ 65,685 16.42% $ 53,097 16.95% $ 51,044 16.95% Savings accounts ....................... 71,345 17.83 64,377 20.55 68,036 22.59 Interest-bearing checking .............. 38,170 9.54 31,559 10.07 31,734 10.54 Money market accounts .................. 72,031 18.00 46,213 14.75 41,723 13.85 --------- --------- --------- --------- --------- --------- Total ............................. 247,231 61.79 195,246 62.32 192,537 63.93 --------- --------- --------- --------- --------- --------- Certificates of deposit: Less than 2.00% ........................ 4,482 1.12 3,098 0.99 6,914 2.30 2.00-3.99% ............................. 17,491 4.37 29,731 9.49 80,739 26.81 4.00-5.99% ............................. 129,217 32.29 84,849 27.09 19,513 6.48 6.00-7.99% ............................. 1,708 0.43 346 0.11 1,483 0.48 --------- --------- --------- --------- --------- --------- Total certificates of deposit ..... 152,898 38.21 118,024 37.68 108,649 36.07 --------- --------- --------- --------- --------- --------- Total deposits ................. $ 400,129 100.00% $ 313,270 100.00% $ 301,186 100.00% ========= ========= ========= ========= ========= ========= </TABLE> The following table sets forth the amount and remaining maturities of the Bank's certificates of deposit accounts at December 31, 2007. <TABLE> <CAPTION> Percent <2.00% 2.00-3.99% 4.00-5.99% 6.00-7.99% Total of Total --------- ---------- ---------- ---------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Certificate accounts maturing ----------------------------- in quarter ending: ----------------- March 31, 2008 ............ 3,286 5,450 30,316 846 39,898 26.09% June 30, 2008 ............. 516 4,479 21,443 -- 26,438 17.29 September 30, 2008 ........ 11 1,375 23,746 308 25,440 16.64 December 31, 2008 ......... 647 1,125 24,975 554 27,301 17.86 March 31, 2009 ............ -- 860 5,552 -- 6,412 4.19 June 30, 2009 ............. -- 365 7,482 -- 7,847 5.13 September 30, 2009 ........ -- 1,002 1,104 -- 2,106 1.38 December 31, 2009 ......... -- 786 3,022 -- 3,808 2.49 Thereafter ................ 22 2,049 11,577 -- 13,648 8.93 --------- --------- --------- --------- --------- --------- Total .................. $ 4,482 $ 17,491 $ 129,217 $ 1,708 $ 152,898 100.00% ========= ========= ========= ========= ========= ========= Percent of total ....... 2.93% 11.44% 84.51% 1.12% 100.00% </TABLE> 23 Borrowed Funds. Set forth below is a schedule detailing the Bank's borrowings. <TABLE> <CAPTION> At December 31, ----------------------------------------- 2007 2006 2005 --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> Short-term borrowings: Overnight line of credit ............................................ $ -- $ -- $ 10,870 Repurchase agreements - FHLB ........................................ -- 1,000 8,000 Term advances - FHLB ................................................ 15,900 6,500 15,000 Long-term borrowings: Repurchase agreements - FHLB ........................................ 13,000 18,000 24,000 Term advances - FHLB ................................................ 27,500 35,900 19,400 --------- --------- --------- Total borrowings .................................................. $ 56,400 $ 61,400 $ 77,270 --------- --------- --------- Weighted Average interest cost of short-term borrowings during the year 5.34% 4.23% 4.18% --------- --------- --------- Weighted Average interest cost of long-term borrowings during the year. 5.02% 4.99% 4.70% --------- --------- --------- Average Balance of borrowings outstanding during the year ............. $ 59,710 $ 68,436 $ 68,372 --------- --------- --------- </TABLE> Trust Activities. The Bank provides trust and investment services, acts as executor or administrator of estates and as trustee or custodian for various types of trusts. Trust services are offered through the Bank's Trust Department. Services include fiduciary services for trusts and estates, money management and custodial services. At December 31, 2007, the Bank maintained 541 trust/fiduciary accounts, with total assets of $137.5 million under management as compared to 538 trust/fiduciary accounts, with total assets of $110.4 million total assets at December 31, 2006. Management anticipates that in the future the Trust Department will become a more significant component of the Bank's business. Limited Purpose Commercial Bank In connection with the acquisition of SBC on May 31, 2002, the Bank holds The State Bank of Chittenango as a limited purpose commercial bank. At December 31, 2007, The State Bank of Chittenango held $37.1 million in assets, consisting primarily of U.S. Government obligations and mortgage-backed securities and $29.7 million in deposits. Insurance Activities On October 2, 2000, the Bank completed the acquisition of Bailey & Haskell Associates, Inc., ("B&H"), an insurance agency located in Central New York State. B&H has offices in Oneida, Cazenovia, Chittenango, New Hartford and Syracuse. B&H is a full-service insurance and financial services firm with over 90 employees providing services to over 19,000 customers. Adding B&H insurance and financial services business has enabled the Bank to evolve from a traditional depository institution into a full-service financial services organization. B&H offers personal and commercial property insurance, life insurance, pension plan services, mutual funds and annuity sales, and other products and services. B&H represents many insurance companies including, Travelers, CNA, Hartford, Progressive, Utica National, Chubb and many more. The Bank acquired a number of brokerage agencies, notably Noyes and LaLonde, Inc., The Dunn Agency, Kennedy & Clarke, Inc., MacDonald/Yando Agency, Inc., and Parsons, Cote & Company which was added during 2006. These companies were merged into B&H. Employee Benefit Consulting Activities On June 28, 2006, the Bank completed its acquisition of Benefit Consulting Group L.L.C., an employee benefits consulting and retirement plan administration firm located in Syracuse, New York. The new company, Benefit Consulting Group Inc. will operate as a wholly owned subsidiary of Oneida Savings Bank. Benefit Consulting Group currently serves more than 700 corporate and personal clients 24 and offers employee benefit related services that are complementary to those provided by Oneida Savings Bank and B&H. Benefit Consulting Group provides defined contribution and benefit plans, actuarial services, investment management, estate planning and human resource management services. Competition Competition in the banking and financial services industry is intense. The Bank competes with commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than the Bank and may offer certain services that the Bank does not or cannot provide. Moreover, credit unions which offer substantially the same services as the Bank are not subject to federal or state income taxation. Trends toward the consolidation of the financial services industry and the removal of restrictions on interstate branching and banking powers may make it more difficult for smaller institutions such as the Bank to compete effectively with large national and regional banking institutions. The Bank's profitability depends upon its ability to successfully compete in its market area. Personnel As of December 31, 2007, the Bank had 301 full-time employees and 16 part-time employees. The employees are not represented by a collective bargaining unit. The Bank considers its relationship with its employees to be good. Regulation General. The Bank is a New York-chartered stock savings bank and its deposit accounts are insured up to applicable limits by the FDIC through its Deposit Insurance Fund. The Bank is subject to extensive regulation by the New York State Banking Department (the "Department"), and by the FDIC. The Bank is required to file reports with, and is periodically examined by, the FDIC and the Department concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other banking institutions. The Bank is a member of the FHLB of New York and is subject to certain regulations by the Federal Home Loan Bank System. On July 18, 2001 the Company and the Mutual Holding Company completed their conversion to federal charters. Consequently, they are subject to regulations of the Office of Thrift Supervision ("OTS") as savings and loan holding companies. Any change in such regulations, whether by the Department, the FDIC, or the OTS could have a material adverse impact on the Bank, the Company, or the Mutual Holding Company. Regulatory requirements applicable to the Bank, the Company and the Mutual Holding Company are referred to below or elsewhere herein. New York Bank Regulation. The Bank derives its lending, investment and other authority primarily from the applicable provisions of New York State Banking Law and the regulations of the Department, as limited by federal laws and regulations. Under these laws and regulations, savings banks, including the Bank, may invest in real estate mortgages, consumer and commercial loans, certain types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies, certain types of corporate equity securities and certain other assets. Under the statutory authority for investing in equity securities, a savings bank may invest up to 7.5% of its assets in corporate stock, with an overall limit of 5% of its assets invested in common stock. Investment in the stock of a single corporation is limited to the lesser of 2% of the outstanding stock of such corporation or 25 1% of the savings bank's assets, except as set forth below. Such equity securities must meet certain earnings ratios and other tests of financial performance. A savings bank's lending powers are not subject to percentage of assets limitations, although there are limits applicable to single borrowers. A savings bank may also, pursuant to the "leeway" power, make investments not otherwise permitted under the New York State Banking Law. This power permits investments in otherwise impermissible investments of up to 1% of assets in any single investment, subject to certain restrictions and to an aggregate limit for all such investments of up to 5% of assets. Additionally, in lieu of investing in such securities in accordance with and reliance upon the specific investment authority set forth in the New York State Banking Law, savings banks are authorized to elect to invest under a "prudent person" standard in a wider range of investment securities as compared to the types of investments permissible under such specific investment authority. However, in the event a savings bank elects to utilize the "prudent person" standard, it will be unable to avail itself of the other provisions of the New York State Banking Law and regulations which set forth specific investment authority. The Bank has not elected to conduct its investment activities under the "prudent person" standard. A savings bank may also exercise trust powers upon approval of the Department. New York State chartered savings banks may also invest in subsidiaries under their service corporation investment authority. A savings bank may use this power to invest in corporations that engage in various activities authorized for savings banks, plus any additional activities which may be authorized by the Banking Board. Investment by a savings bank in the stock, capital notes and debentures of its service corporations is limited to 3% of the bank's assets, and such investments, together with the bank's loans to its service corporations, may not exceed 10% of the savings bank's assets. Furthermore, New York banking regulations impose requirements on loans which a bank may make to its executive officers and directors and to certain corporations or partnerships in which such persons have equity interests. These requirements include, but are not limited to, requirements that (i) certain loans must be approved in advance by a majority of the entire board of directors and the interested party must abstain from participating directly or indirectly in the voting on such loan, (ii) the loan must be on terms that are not more favorable than those offered to unaffiliated third parties, and (iii) the loan must not involve more than a normal risk of repayment or present other unfavorable features. Under the New York State Banking Law, the Superintendent may issue an order to a New York State chartered banking institution to appear and explain an apparent violation of law, to discontinue unauthorized or unsafe practices and to keep prescribed books and accounts. Upon a finding by the Department that any director, trustee or officer of any banking organization has violated any law, or has continued unauthorized or unsafe practices in conducting the business of the banking organization after having been notified by the Superintendent to discontinue such practices, such director, trustee or officer may be removed from office after notice and an opportunity to be heard. The Bank does not know of any past or current practice, condition or violation that might lead to any proceeding by the Superintendent or the Department against the Bank or any of its directors, trustees or officers. Insurance of Accounts and Regulation by the FDIC. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The Bank's deposits, therefore, are subject to FDIC insurance assessments. The FDIC regulations assess insurance premiums based on an institution's risk. Under this assessment system, the FDIC evaluates the risk of each financial institution based on its supervisory rating, financial ratios, and long-term debt issuer rating. The rates for nearly all of the financial institutions industry vary between five and seven cents for every $100 of domestic deposits. The assessment to be paid subsequent to the year ending December 31, 2007 will be offset by a credit from the FDIC to the Bank of $208,012. Federal law requires the FDIC to establish a deposit reserve ratio for the 26 deposit insurance fund of between 1.15% and 1.50% of estimated deposits. The FDIC has designated the reserve ratio for the deposit insurance fund through the first quarter of 2008 at 1.25% of estimated insured deposits. Effective March 31, 2006, the FDIC merged the Bank Insurance Fund and the Savings Association Insurance Fund into a single fund called the Deposit Insurance Fund. In addition to the FDIC assessments, the Financing Corporation ("FICO") is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2007, the annualized FICO assessment was equal to 1.14 basis points for each $100 in domestic deposits maintained at an institution. Regulatory Capital Requirements. The FDIC has adopted risk-based capital guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. The Bank is required to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of such regulatory capital to regulatory risk-weighted assets is referred to as the Bank's "risk-based capital ratio." Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk. These guidelines divide a savings bank's capital into two tiers. The first tier ("Tier I") includes common equity, retained earnings, certain non-cumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangible assets (except mortgage servicing rights and purchased credit card relationships subject to certain limitations). Supplementary ("Tier II") capital includes, among other items, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Savings banks are required to maintain a total risk-based capital ratio of at least 8%, of which at least 4% must be Tier I capital. In addition, the FDIC has established regulations prescribing a minimum Tier I leverage ratio (Tier I capital to adjusted total assets as specified in the regulations). These regulations provide for a minimum Tier I leverage ratio of 3% for banks that meet certain specified criteria, including that they have the highest examination rating and are not experiencing or anticipating significant growth. All other banks are required to maintain a Tier I leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The FDIC may, however, set higher leverage and risk-based capital requirements on individual institutions when particular circumstances warrant. Savings banks experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels. Limitations on Dividends and Other Capital Distributions. The FDIC has the authority to use its enforcement powers to prohibit a savings bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. New York law also restricts the Bank from declaring a dividend which would reduce its capital below (i) the amount required to be maintained under state law and regulation or (ii) the amount of the Bank's liquidation account established in connection with the Reorganization. 27 Prompt Corrective Action. The federal banking agencies have promulgated regulations to implement the system of prompt corrective action required by federal law. Under the regulations, a bank shall be deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized"; (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Federal law and regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). Based on the foregoing, the Bank is currently classified as a "well capitalized" savings institution. Activities and Investments of Insured State-Chartered Banks Acting as Principal. Federal law generally limits the activities and equity investments of FDIC-insured state-chartered banks to those that are permissible for national banks, notwithstanding state laws. Under federal regulations dealing with equity investments, an insured state bank generally may not, directly or indirectly, acquire or retain any equity investment of a type