-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IKhK01nTffkQ+42lcLJTdvpcbvyXjqbqdzseo+zAV6nWjxIGNEecUQxizRlZ+WCF 3b6Vf+te8tCvkPtBtu/a5Q== 0000950168-97-003628.txt : 19971216 0000950168-97-003628.hdr.sgml : 19971216 ACCESSION NUMBER: 0000950168-97-003628 CONFORMED SUBMISSION TYPE: POS AM PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19971215 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST UNION CORP CENTRAL INDEX KEY: 0000036995 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 560898180 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: POS AM SEC ACT: SEC FILE NUMBER: 333-37709 FILM NUMBER: 97738527 BUSINESS ADDRESS: STREET 1: ONE FIRST UNION CTR CITY: CHARLOTTE STATE: NC ZIP: 28288-0630 BUSINESS PHONE: 7043746565 MAIL ADDRESS: STREET 1: FIRST UNION CORPORA STREET 2: ONE FIRST UNION CENTER CITY: CHARLOTTE STATE: NC ZIP: 28288-0630 FORMER COMPANY: FORMER CONFORMED NAME: CAMERON FINANCIAL CORP DATE OF NAME CHANGE: 19750522 FORMER COMPANY: FORMER CONFORMED NAME: FIRST UNION NATIONAL BANCORP INC DATE OF NAME CHANGE: 19721115 POS AM 1 FUNB POS AM AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 15, 1997 REGISTRATION NO. 333-37709 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ POST-EFFECTIVE AMENDMENT NO. 1 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ FIRST UNION CORPORATION (Exact name of registrant as specified in its charter) NORTH CAROLINA 6711 56-0898180 (State or other jurisdiction (Primary standard industrial (I.R.S. employer of incorporation or organization) classification code number) identification number)
ONE FIRST UNION CENTER CHARLOTTE, NORTH CAROLINA 28288-0013 (704) 374-6565 (Address, including zip code and telephone number, including area code, of registrant's principal executive offices) MARION A. COWELL, JR., ESQ. EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL FIRST UNION CORPORATION ONE FIRST UNION CENTER CHARLOTTE, NORTH CAROLINA 28288-0013 (704) 374-6828 (Name, address, including zip code, and telephone number, including area code, of agent for service) COPY TO: L. GARRETT DUTTON, JR., ESQ. PEPPER, HAMILTON & SCHEETZ, LLP 3000 TWO LOGAN SQUARE PHILADELPHIA, PA 19103 ------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE PUBLIC: As promptly as practicable after the effective date of this Registration Statement. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [ ] ------------------------ - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- COVENANT BANCORP, INC. 18 KINGS HIGHWAY WEST HADDONFIELD, NEW JERSEY 08033 (609) 428-7300 December 15, 1997 Dear Stockholder: As previously announced, the Special Meeting of Stockholders of Covenant Bancorp, Inc. ("Covenant"), which was adjourned on November 20, 1997, will re-convene at 10:00 a.m., on January 8, 1998, at Tavistock Country Club, Haddonfield, New Jersey (the "Special Meeting"). The purpose of the Special Meeting is to vote on a proposal to approve the Agreement and Plan of Mergers, dated as of August 4, 1997 (the "Merger Agreement"), by and among Covenant, Covenant Bank, First Union Corporation ("FUNC") and First Union National Bank ("FUNB"), pursuant to which, among other things, Covenant will merge with and into FUNC and Covenant Bank will merge with and into FUNB (collectively, the "Mergers"), all on and subject to the terms and conditions contained therein, and as described in the Prospectus/Proxy Statement, dated October 15, 1997 (the "Prospectus/Proxy Statement"), previously delivered to you in connection with the Special Meeting. As you know, the Special Meeting was adjourned in order to provide you with certain information relating to FUNC's agreement to acquire CoreStates Financial Corp ("CoreStates"), which was announced by FUNC on November 18, 1997, and to provide you with additional time to submit new proxies if you wish to do so. Accordingly, attached hereto is a Supplement to the Prospectus/Proxy Statement (the "Supplement") and a new proxy card. The Supplement includes, among other things, information relating to the CoreStates acquisition and certain updated information with respect to FUNC, Covenant and the Mergers, and I urge you to review such information carefully. If you wish to receive another copy of the Prospectus/Proxy Statement, please call Covenant at (609) 428-7300 or FUNC at (704) 374-6782. If you have not previously submitted a proxy or you desire to submit a new proxy, please complete the enclosed proxy, sign and date it and mail it promptly in the enclosed postage-paid return addressed envelope. IF YOU HAVE PREVIOUSLY SUBMITTED A PROXY AND DO NOT WISH TO CHANGE YOUR VOTE, YOU DO NOT NEED TO SUBMIT A NEW PROXY OR TAKE ANY OTHER ACTION. THE BOARD OF DIRECTORS OF COVENANT HAS UNANIMOUSLY APPROVED THE MERGER AGREEMENT, BELIEVES THE MERGER AGREEMENT IS IN THE BEST INTERESTS OF COVENANT AND ITS STOCKHOLDERS AND RECOMMENDS ITS APPROVAL BY COVENANT STOCKHOLDERS. Yours very truly, /s/ CHARLES E. SESSA, JR. ------------------------- CHARLES E. SESSA, JR. PRESIDENT FIRST UNION CORPORATION COVENANT BANCORP, INC. SUPPLEMENT TO PROSPECTUS/PROXY STATEMENT The information set forth herein supplements the Prospectus/Proxy Statement, dated October 15, 1997 (the "Prospectus/Proxy Statement"), previously delivered to you in connection with the solicitation of proxies by the Board of Directors of Covenant Bancorp, Inc. ("Covenant") for use at the Special Meeting of Stockholders of Covenant, which was convened on November 20, 1997 and adjourned to 10 a.m., on January 8, 1998, at Tavistock Country Club (the "Special Meeting"). As set forth in the Prospectus/Proxy Statement, at the Special Meeting stockholders will vote upon a proposal to approve the Agreement and Plan of Mergers, dated as of August 4, 1997 (the "Merger Agreement"), by and among Covenant, Covenant Bank, First Union Corporation ("FUNC") and First Union National Bank ("FUNB"), pursuant to which, among other things, Covenant will merge with and into FUNC (the "Corporate Merger") and Covenant Bank will merge with and into FUNB (the "Bank Merger" and, together with the Corporate Merger, the "Mergers"), all on and subject to the terms and conditions contained therein. As more fully described below, the Special Meeting was adjourned in order to provide Covenant stockholders with certain information relating to FUNC's agreement to acquire CoreStates Financial Corp ("CoreStates"), which was announced by FUNC on November 18, 1997. This Supplement sets forth, among other things, (i) certain information relating to the CoreStates acquisition, including certain pro forma financial information with respect to the Mergers, the CoreStates acquisition, FUNC's recently completed acquisition of Signet Banking Corporation ("Signet") and its pending acquisition of Wheat First Butcher Singer, Inc. ("Wheat"), and (ii) certain updated information with respect to FUNC, Covenant and the Mergers. Certain additional financial information, including certain historical financial information relating to Covenant and CoreStates, is included in EXHIBITS A, B and C attached hereto, respectively. This Supplement should be read in conjunction with the Prospectus/Proxy Statement. Unless otherwise indicated, all capitalized terms used herein shall have the meanings assigned to them in the Prospectus/Proxy Statement. If you wish to receive another copy of the Prospectus/Proxy Statement, please call Covenant at (609) 428-7300 or FUNC at (704) 374-6782. On December 12, 1997, the last reported sale price of FUNC Common Stock on the NYSE Tape, the last reported sale price of Covenant Common Stock on the Nasdaq National Market and the last reported sale prices of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock on the Nasdaq Small-Cap Market were $50.00, $18.50, $66.50 and $55.00, respectively. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION This Supplement and the Prospectus/Proxy Statement (including information included or incorporated by reference herein or therein) contain, among other things, certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of each of FUNC and Covenant, as well as certain information relating to CoreStates, Signet and Wheat, including (i) statements relating to the cost savings estimated to result from the CoreStates and Signet acquisitions (see "CERTAIN RECENT DEVELOPMENTS", "PRO FORMA FINANCIAL INFORMATION" and "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Comparison of Certain Unaudited Per Share Data" and " -- Selected Financial Data" in this Supplement and "RECENT DEVELOPMENTS" in the Prospectus/Proxy Statement), (ii) statements relating to revenues estimated to result from the CoreStates and Signet acquisitions (see "CERTAIN RECENT DEVELOPMENTS", "PRO FORMA FINANCIAL INFORMATION" and "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Comparison of Certain Unaudited Per Share Data" and " -- Selected Financial Data" in this Supplement and "RECENT DEVELOPMENTS" in the Prospectus/Proxy Statement), (iii) statements relating to the restructuring charges estimated to be incurred in connection with the CoreStates and Signet acquisitions (see "CERTAIN RECENT DEVELOPMENTS", "PRO FORMA FINANCIAL INFORMATION" and "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Comparison of Certain Unaudited Per Share Data" and " -- Selected Financial Data" in this Supplement and "RECENT DEVELOPMENTS" in the Prospectus/Proxy Statement), and (iv) statements preceded by, followed by or that include the words "believes", "expects", "anticipates", "estimates" or similar expressions (see, in particular, "CERTAIN RECENT DEVELOPMENTS", "PRO FORMA FINANCIAL INFORMATION" and "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Comparison of Certain Unaudited Per Share Data" and " -- Selected Financial Data" in this Supplement and "RECENT DEVELOPMENTS" and "THE MERGERS -- Background and Reasons" and " -- Opinion of Financial Advisor" in the Prospectus/Proxy Statement). These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (a) expected cost savings from the Mergers and the CoreStates, Signet and Wheat acquisitions may not be fully realized or realized within the expected time frame; (b) revenues following the Mergers and the CoreStates, Signet and Wheat acquisitions may be lower than expected, or deposit attrition, operating costs or customer loss and business disruption following the Mergers and the CoreStates, Signet and Wheat acquisitions may be greater than expected; (c) competitive pressures among depository and other financial institutions may increase significantly; (d) costs or difficulties related to the integration of the business of FUNC, Covenant, CoreStates, Signet and/or Wheat may be greater than expected; (e) changes in the interest rate environment may reduce margins; (f) general economic or business conditions, either nationally or in the states or regions in which FUNC is doing business, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; (g) legislative or regulatory changes may adversely affect the businesses in which FUNC is engaged; and (h) changes may occur in the securities markets. THE DATE OF THIS SUPPLEMENT IS DECEMBER 15, 1997 CERTAIN AVAILABLE INFORMATION THE PROSPECTUS/PROXY STATEMENT INCORPORATES DOCUMENTS BY REFERENCE WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH, INCLUDING, WITHOUT LIMITATION, FUNC'S QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1997, AND FUNC'S CURRENT REPORTS ON FORM 8-K DATED NOVEMBER 18, 1997, NOVEMBER 28, 1997, AND DECEMBER 2, 1997. A COPY OF SUCH DOCUMENTS IS AVAILABLE WITHOUT CHARGE (OTHER THAN CERTAIN EXHIBITS TO SUCH DOCUMENTS) TO ANY PERSON, INCLUDING ANY BENEFICIAL OWNER, TO WHOM THIS SUPPLEMENT AND THE PROSPECTUS/PROXY STATEMENT IS DELIVERED, UPON WRITTEN OR ORAL REQUEST TO: FIRST UNION CORPORATION, CORPORATE RELATIONS, ONE FIRST UNION CENTER, CHARLOTTE, NORTH CAROLINA 28288-0206 (TELEPHONE NUMBER (704) 374-6782). IN ORDER TO ENSURE TIMELY DELIVERY OF SUCH DOCUMENTS, ANY SUCH REQUEST SHOULD BE MADE BY DECEMBER 31, 1997. TABLE OF CONTENTS
PAGE ----- CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION.......................................................... Cover CERTAIN AVAILABLE INFORMATION........................................................................................ 2 CERTAIN RECENT DEVELOPMENTS.......................................................................................... 3 CoreStates Acquisition............................................................................................. 3 Signet and Wheat Acquisitions...................................................................................... 4 CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS.................................................................. 4 Record Date; Vote Required; Revocation of Proxies.................................................................. 4 General; Exchange Ratios........................................................................................... 5 Regulatory Approvals............................................................................................... 5 Comparison of Certain Unaudited Per Share Data..................................................................... 5 Selected Financial Data............................................................................................ 9 Accounting Treatment............................................................................................... 15 Experts............................................................................................................ 15 PRO FORMA FINANCIAL INFORMATION...................................................................................... 16 EXHIBIT A Quarterly Report on Form 10-Q of Covenant Bancorp, Inc. for the Quarter Ended September 30, 1997................... A-1 EXHIBIT B Certain Historical Financial Information Relating to CoreStates.................................................... B-1 EXHIBIT C Independent Auditors' Report with respect to Meridian Bancorp, Inc. (which was acquired by CoreStates in 1996)..... C-1 Independent Auditors' Report with respect to United Counties Bancorporation (which was acquired by CoreStates in 1996)........................................................................................................... C-2
2 CERTAIN RECENT DEVELOPMENTS CORESTATES ACQUISITION On November 18, 1997, FUNC entered into an agreement to acquire CoreStates, a bank holding company based in Philadelphia, Pennsylvania. CoreStates, through its lead bank subsidiary, CoreStates Bank, N.A., provides financial services through banking offices located in Pennsylvania, New Jersey and Delaware. As of September 30, 1997, and for the nine months then ended, CoreStates reported assets of $48 billion, net loans of $35 billion, deposits of $34 billion, stockholders' equity of $3 billion and net income of $597 million. Under the terms of the CoreStates acquisition agreement, FUNC will exchange 1.62 shares of FUNC Common Stock (subject to possible adjustment under certain circumstances) for each outstanding share of CoreStates common stock. The CoreStates acquisition, which will be accounted for as a pooling of interests, is expected to close in the second quarter of 1998, subject to certain conditions of closing, including approval of the CoreStates acquisition agreement by CoreStates and FUNC stockholders, approval by FUNC stockholders of an amendment to the FUNC Articles to increase the number of authorized shares of FUNC Common Stock from 750,000,000 to 2,000,000,000, and approval by various regulatory agencies. Based on the 1.62 exchange ratio, a total of 323,642,000 shares of FUNC Common Stock are expected to be issued upon consummation of the CoreStates acquisition, excluding FUNC Common Stock to be exchanged for an estimated 3.5 million shares of CoreStates common stock that CoreStates expects to issue in order to qualify the CoreStates acquisition as a pooling of interests. See "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Accounting Treatment" in this Supplement and "THE MERGERS -- Accounting Treatment" in the Prospectus/Proxy Statement. In connection with the CoreStates acquisition, CoreStates granted FUNC an option to purchase, under certain circumstances, up to 19.9 percent of the outstanding shares of common stock of CoreStates at a price of $72.00 per share, subject to certain adjustments, and FUNC granted CoreStates an option to purchase, under certain circumstances, up to 9.9 percent of the outstanding shares of FUNC Common Stock at a price of $52.00 per share, subject to certain adjustments. Under certain circumstances, the respective issuers of such options may be required to repurchase the options or the shares acquired pursuant to the exercise thereof. In addition, Terrence A. Larsen, CoreStates' Chairman and Chief Executive Officer, would become a Vice Chairman of FUNC and would become a member of the Office of the Chairman of FUNC, which also would include Edward E. Crutchfield, Chairman and Chief Executive Officer of FUNC, and John R. Georgius, President of FUNC. Also, six directors of CoreStates would become directors of FUNC. On November 18, 1997, FUNC filed a Current Report on Form 8-K with the Commission (the "CoreStates Form 8-K"), which contains, among other things, certain financial and other information (the "CoreStates Form 8-K Materials") about CoreStates and the CoreStates acquisition. The CoreStates Form 8-K Materials contain certain forward-looking statements regarding FUNC, CoreStates and the combined organization following the CoreStates acquisition, including statements relating to estimated cost savings and enhanced revenues that may be realized from the CoreStates acquisition, and certain restructuring charges expected to be incurred in connection with the CoreStates acquisition. Such forward-looking statements involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the CoreStates Form 8-K Materials and herein. Factors that might cause such a difference include, but are not limited to, those discussed in the CoreStates Form 8-K and FUNC's Quarterly Report on Form 10-Q for the period ended September 30, 1997. See "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION" and "CERTAIN AVAILABLE INFORMATION" in this Supplement and "AVAILABLE INFORMATION" and "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE" in the Prospectus/Proxy Statement. As indicated in the CoreStates Form 8-K: (Bullet) FUNC expects to realize before-tax expense savings resulting from the CoreStates acquisition of approximately $406 million and $723 million in 1998 and 1999, respectively, or approximately $258 million and $459 million after-tax, respectively. These estimates assume that approximately 45 percent of CoreStates' 1997 annualized expenses are eliminated by the end of 1999. (Bullet) FUNC expects to realize before-tax revenue enhancements relating to the CoreStates acquisition of approximately $123 million and $194 million in 1998 and 1999, respectively, or approximately $58 million and $89 million after-tax, respectively. These estimates are primarily based on FUNC's broader array of income generating products from its capital markets, capital management and other fee producing businesses. (Bullet) Assuming (i) the restructuring charges discussed below and the expense savings and revenue enhancements discussed above are as estimated, (ii) 985 million shares of FUNC Common Stock are outstanding in 1998 and 999 million shares are outstanding in 1999, (iii) the CoreStates acquisition is consummated by mid-1998, (iv) the conversion of 3 CoreStates' operations and computer systems to FUNC's operations and computer systems is completed by November 1998, (v) 1998 earnings per share of (a) FUNC Common Stock are $3.91, and (b) CoreStates common stock are $4.23, each of which represents the First Call consensus earnings estimates as of November 18, 1997 (before public announcement of the CoreStates acquisition but after public announcement of the Signet acquisition and the filing of the Signet Form 8-K, the "1998 Illustrative First Call Consensus Estimates"), (vi) 1999 earnings per share of FUNC Common Stock and CoreStates common stock are equal to the 1998 Illustrative First Call Consensus Estimates plus 11 percent for FUNC and ten percent for CoreStates (the "1999 Illustrative Estimates") (I.E., $4.34 for FUNC Common Stock and $4.65 for CoreStates common stock), and (vii) certain other assumptions contained in the CoreStates Form 8-K, the CoreStates acquisition is estimated to dilute the 1998 Illustrative First Call Consensus Estimate for FUNC Common Stock by $.09 and add $.12 to the 1999 Illustrative Estimate for FUNC Common Stock. The 1998 Illustrative First Call Consensus Estimates and the 1999 Illustrative Estimates are presented for illustrative purposes only, are subject to the risks and uncertainties set forth in the CoreStates Form 8-K Materials and under "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION" in this Supplement, among others, and do not constitute earnings projections or estimates by FUNC or CoreStates. (Bullet) FUNC expects to record after-tax restructuring and merger-related charges associated with the CoreStates acquisition, currently estimated at $795 million, or $0.81 per share of FUNC Common Stock, in the second quarter of 1998. The estimated $795 million restructuring charge is summarized below.
(IN MILLIONS, AFTER TAX) - ---------------------------------------------------------------------------------- Severance and change in control related obligations............................... $214 Fixed asset write-downs and vacant space accruals................................. 289 Service contract terminations..................................................... 127 Charitable support................................................................ 63 Other............................................................................. 102 ---- Total............................................................................. $795 ---- ----
The estimated restructuring charge includes approximately $149 million in non-cash charges. Cash payments included in the estimated restructuring charge are expected to be completed within 18 months from the date of consummation. The "Other" category includes CoreStates acquisition-related amounts, none of which individually is estimated to exceed $50 million. The amounts included in the $795 million estimated restructuring charge are subject to change prior to the effective date of the CoreStates acquisition. The estimates include assumptions about the timing of the consummation of the CoreStates acquisition and the number of employees whose employment will terminate as a result of the CoreStates acquisition. Changes in such assumptions could result in a change in the estimated restructuring charge. In addition, FUNC estimates that another $75 million in CoreStates pre-tax, acquisition-related costs will be incurred over the 12 months following the date the CoreStates acquisition is consummated. These costs primarily relate to training and systems conversions. See "PRO FORMA FINANCIAL INFORMATION", EXHIBITS B AND C and "CERTAIN AVAILABLE INFORMATION" in this Supplement and "AVAILABLE INFORMATION" and "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE" in the Prospectus/Proxy Statement. SIGNET AND WHEAT ACQUISITIONS The Signet acquisition was consummated on November 28, 1997. The Wheat acquisition is expected to be consummated in the first quarter of 1998. See "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition" and " -- Wheat First Butcher Singer, Inc. Acquisition" in the Prospectus/Proxy Statement. CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS THE FOLLOWING INFORMATION SUPPLEMENTS THE CORRESPONDING INFORMATION SET FORTH IN THE PROSPECTUS/PROXY STATEMENT. RECORD DATE; VOTE REQUIRED; REVOCATION OF PROXIES The Special Meeting, which was adjourned on November 20, 1997 because of the announcement of the CoreStates acquisition, will re-convene at 10:00 a.m., on January 8, 1998, at Tavistock Country Club, Haddonfield, New Jersey. Prior to the adjournment of the Special Meeting on November 20, 1997, it was determined that at least a majority of the votes entitled to be cast at the Special Meeting by the holders of each of Covenant Common Stock, Covenant Series A Preferred Stock and 4 Covenant Series B Preferred Stock was present, in person or by proxy, and that a quorum was present for purposes of conducting business at the Special Meeting on November 20, 1997, and will be present for such purposes on January 8, 1998. At the Special Meeting, holders of record on October 6, 1997 (the "Record Date"), of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, each voting as a separate class, will vote upon a proposal to approve the Merger Agreement. As noted in the Prospectus/Proxy Statement, the Covenant Series A Preferred Stock will automatically convert into 3.976 shares of Covenant Common Stock on December 31, 1997 (the "Automatic Conversion"). Although the Automatic Conversion will occur prior to the date of the continuation of the Special Meeting and the expected date of the consummation of the Corporate Merger, holders of Covenant Series A Preferred Stock on the Record Date may vote at the Special Meeting. Covenant stockholders who have not previously submitted a proxy or who desire to submit a new proxy, should complete the enclosed proxy, sign and date it and mail it promptly in the enclosed postage-paid return addressed envelope. IF YOU HAVE PREVIOUSLY SUBMITTED A PROXY AND DO NOT WISH TO CHANGE YOUR VOTE, YOU DO NOT NEED TO SUBMIT A NEW PROXY OR TAKE ANY OTHER ACTION. As set forth in the Prospectus/Proxy Statement, a previously submitted proxy also may be revoked before it is exercised, by submitting a written notice of revocation of such proxy to the Secretary of Covenant or by appearing in person at the Special Meeting on January 8, 1998, and requesting a return of the proxy. See "GENERAL INFORMATION -- Record Date; Vote Required; Revocation of Proxies" in the Prospectus/Proxy Statement. THE COVENANT BOARD HAS APPROVED THE MERGER AGREEMENT BY UNANIMOUS VOTE, BELIEVES IT IS IN THE BEST INTERESTS OF COVENANT AND ITS STOCKHOLDERS AND RECOMMENDS ITS APPROVAL BY COVENANT STOCKHOLDERS. SEE "THE MERGERS -- BACKGROUND AND REASONS; COVENANT " IN THE PROSPECTUS/PROXY STATEMENT. GENERAL; EXCHANGE RATIOS As described in the Prospectus/Proxy Statement, subject to the terms and conditions of the Merger Agreement and upon consummation of the Corporate Merger, (i) each outstanding share of Covenant Common Stock will be converted into the right to receive .3813 FUNC Common Shares (I.E., the Common Stock Exchange Ratio); (ii) each outstanding share of Covenant Series A Preferred Stock will be converted into the right to receive 1.516 FUNC Common Shares (I.E., the Series A Exchange Ratio); and (iii) each outstanding share of Covenant Series B Preferred Stock will be converted into the right to receive 1.2 FUNC Common Shares (I.E., the Series B Exchange Ratio). As noted above, the Series A Preferred Stock will automatically convert into 3.976 shares of Covenant Common Stock on December 31, 1997, which will be prior to the expected consummation date of the Corporate Merger. As a result, at the time of consummation of the Corporate Merger, each former holder of Covenant Series A Preferred Stock on December 31, 1997, will hold shares of Covenant Common Stock and, upon consummation of the Corporate Merger, will be entitled to receive .3813 FUNC Common Shares for each such outstanding share of Covenant Common Stock held by such holder (I.E., 1.516 FUNC Common Shares for each outstanding share of Covenant Series A Preferred Stock formerly held by such holder). REGULATORY APPROVALS FUNC has received the approval of the OCC with respect to the Bank Merger and has been notified by the Federal Reserve Board that prior approval of the Corporate Merger will not be required. FUNC expects to receive the approval of the NJ Banking Department with respect to the Bank Merger shortly, although there can be no assurance that such approval will be obtained or as to the timing or conditions of such approval. See "THE MERGERS -- Regulatory Approvals" in the Prospectus/Proxy Statement. COMPARISON OF CERTAIN UNAUDITED PER SHARE DATA The following unaudited information, adjusted to reflect the FUNC Stock Split, stock dividends on Covenant Common Stock and Covenant Bank common stock and consummation of the Signet acquisition on November 28, 1997, reflects, where applicable, certain comparative per share data related to book value, cash dividends paid, income and market value: (i) on a historical basis for FUNC and Covenant; (ii) on a pro forma combined basis per share of FUNC Common Stock, reflecting consummation of (a) the Signet acquisition, (b) the Signet acquisition and the Mergers, and (c) the Signet acquisition, the Mergers and the Wheat and CoreStates acquisitions; and (iii) on an equivalent pro forma basis per share of Covenant Common Stock and, with respect to cash dividends paid or declared and market value, Covenant Preferred Stock, reflecting consummation of (a) the Signet acquisition, (b) the Signet acquisition and the Mergers, and (c) the Signet acquisition, the 5 Mergers and the Wheat and CoreStates acquisitions. Such pro forma information has been prepared assuming (a) consummation of the Mergers on a purchase accounting basis only for the nine months ended September 30, 1997, and the year ended December 31, 1996, and (b) consummation of the CoreStates, Signet and Wheat acquisitions on a pooling of interests accounting basis as of the beginning of each of the periods presented. All data relating to Covenant has been restated to reflect the 1996 and 1994 pooling of interests mergers with 1st Southern State Bank and Landis Savings Bank, S.L.A., respectively. See "CERTAIN RECENT DEVELOPMENTS" and " -- Accounting Treatment" in this Supplement and "RECENT DEVELOPMENTS" and "THE MERGERS -- Accounting Treatment" in the Prospectus/Proxy Statement. Since purchase accounting does not require restatement of results for prior periods following consummation of the Mergers, consummation of the Mergers will not affect FUNC's historical results for the periods indicated. Pro forma financial information is intended to show how the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions might have affected historical financial statements if the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions had been consummated at an earlier time. The pro forma financial information does not purport to be indicative of the results that actually would have been realized had the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions taken place at the beginning of the applicable periods indicated, nor is it indicative of the combined financial position or results of operations for any future periods. The information shown below should be read in conjunction with the historical financial statements of FUNC, Covenant, CoreStates, Signet and Wheat, including the respective notes thereto, and the documents included in EXHIBITS A, B and C to this Supplement or incorporated by reference in the Prospectus/Proxy Statement. See "PRO FORMA FINANCIAL INFORMATION", EXHIBITS A, B and C and "CERTAIN AVAILABLE INFORMATION" in this Supplement and "AVAILABLE INFORMATION", "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE", "RECENT DEVELOPMENTS" and ANNEX A in the Prospectus/Proxy Statement.
SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------ ----------------- BOOK VALUE PER SHARE Historical per share of FUNC Common Stock................................................................. $18.86 17.41 Covenant Common Stock............................................................. 8.06 7.17 Pro forma combined per share of FUNC Common Stock (1) FUNC and Signet................................................................... 18.43 17.06 FUNC, Signet and Covenant......................................................... 18.43 17.06 FUNC, Signet, Covenant, Wheat and CoreStates...................................... 15.52 14.85 Equivalent pro forma per share of Covenant Common Stock (2) FUNC and Signet................................................................... 7.03 6.51 FUNC, Signet and Covenant......................................................... 7.03 6.51 FUNC, Signet, Covenant, Wheat and CoreStates...................................... $ 5.92 5.66
- --------------- (1) The pro forma combined book value per share of FUNC Common Stock amounts represent the sum of the pro forma combined common stockholders' equity amounts, divided by the pro forma combined period-end number of shares of FUNC Common Stock outstanding. (2) The equivalent pro forma book value per share of Covenant Common Stock amounts represent the pro forma combined book value per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio. ------------------------ 6
NINE MONTHS ENDED YEARS ENDED SEPTEMBER 30, DECEMBER 31, ----------------- -------------------- 1997 1996 1995 1994 ----------------- ---- ---- ---- CASH DIVIDENDS PAID OR DECLARED PER SHARE Historical per share of FUNC Common Stock.............................................................. $ 0.90 1.10 0.98 0.86 Covenant Common Stock.......................................................... -- -- -- -- Covenant Series A Preferred Stock.............................................. 1.125 1.50 1.50 1.50 Covenant Series B Preferred Stock.............................................. 1.125 1.50 0.75 -- Pro forma combined per share of FUNC Common Stock (3) FUNC and Signet................................................................ 0.87 1.06 0.61 0.57 FUNC, Signet and Covenant...................................................... 0.87 1.06 0.61 0.57 FUNC, Signet, Covenant, Wheat and CoreStates................................... 0.87 1.01 0.87 0.79 Equivalent pro forma per share of Covenant Common Stock (4) FUNC and Signet................................................................ 0.33 0.40 0.23 0.22 FUNC, Signet and Covenant...................................................... 0.33 0.40 0.23 0.22 FUNC, Signet, Covenant, Wheat and CoreStates................................... 0.33 0.39 0.33 0.30 Equivalent pro forma per share of Covenant Series A Preferred Stock (5) FUNC and Signet................................................................ 1.32 1.60 0.93 0.86 FUNC, Signet and Covenant...................................................... 1.32 1.60 0.93 0.86 FUNC, Signet, Covenant, Wheat and CoreStates................................... 1.32 1.53 1.32 1.20 Equivalent pro forma per share of Covenant Series B Preferred Stock (5) FUNC and Signet................................................................ 1.04 1.27 0.74 0.68 FUNC, Signet and Covenant...................................................... 1.04 1.27 0.74 0.68 FUNC, Signet, Covenant, Wheat and CoreStates................................... $ 1.04 1.21 1.04 0.95
- --------------- (3) The pro forma combined cash dividends paid per share of FUNC Common Stock amounts represent pro forma combined cash dividends paid on common stock outstanding, divided by the pro forma combined average number of shares of FUNC Common Stock outstanding, rounded to the nearest cent. (4) The equivalent pro forma cash dividends paid per share of Covenant Common Stock amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio, rounded to the nearest cent. The current annualized dividend rate per share for FUNC Common Stock, based upon the most recently declared quarterly dividend rate of $.32 per share paid on December 15, 1997, is $1.28. On an equivalent pro forma basis, such current annualized FUNC dividend per share of Covenant Common Stock would be $.49, based on the Common Stock Exchange Ratio, rounded to the nearest cent. Neither Covenant nor Covenant Bank paid any cash dividends on Covenant Common Stock or Covenant Bank common stock during the periods indicated above. Any future FUNC and Covenant dividends are dependent upon their respective earnings and financial conditions, government regulations and policies and other factors. See "THE MERGERS -- Exchange of Covenant Certificates" and " -- Dividends" in the Prospectus/Proxy Statement. (5) Holders of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock currently are entitled to receive, when and as declared by the Covenant Board, preferred dividends at the annual rate of $1.50 per share. The equivalent pro forma cash dividends paid per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. On an equivalent pro forma basis, the current annualized FUNC dividend per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock would be $1.94 and $1.54, respectively, which amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. See "THE MERGERS -- Exchange of Covenant Certificates", " -- Business Pending Consummation" and " -- Dividends" in the Prospectus/Proxy Statement. ------------------------ 7
NINE MONTHS ENDED YEARS ENDED SEPTEMBER 30, DECEMBER 31, ----------------- -------------------- 1997 1996 1995 1994 ----------------- ---- ---- ---- NET INCOME APPLICABLE TO COMMON STOCKHOLDERS Historical per share of FUNC Common Stock (6).......................................................... $2.60 2.67 2.52 2.29 Covenant Common Stock.......................................................... 0.63 0.44 0.61 0.35 Pro forma combined per share of FUNC Common Stock (7) FUNC and Signet................................................................ 2.43 2.59 2.43 2.29 FUNC, Signet and Covenant...................................................... 2.43 2.57 2.43 2.29 FUNC, Signet, Covenant, Wheat and CoreStates................................... 2.22 2.31 2.21 1.89 Equivalent pro forma per share of Covenant Common Stock (8) FUNC and Signet................................................................ 0.93 0.99 0.93 0.88 FUNC, Signet and Covenant...................................................... 0.93 0.98 0.93 0.88 FUNC, Signet, Covenant, Wheat and CoreStates................................... $0.85 0.88 0.84 0.72
- --------------- (6) FUNC net income applicable to common stockholders amounts as of and for the year ended December 31, 1996, includes (i) $181 million, or $0.32 per share of FUNC Common Stock, in after-tax First Fidelity Bancorporation ("FFB") merger-related restructuring charges, and (ii) $86 million, or $0.16 per share of FUNC Common Stock, in after-tax charges relating to the recapitalization of the SAIF. The acquisition of FFB by FUNC was consummated on January 1, 1996. See "FUNC -- History and Business" and " -- Certain Regulatory Considerations" in the Prospectus/Proxy Statement. (7) The pro forma combined income per share of FUNC Common Stock amounts represent pro forma combined net income applicable to holders of FUNC Common Stock, divided by the pro forma combined average number of shares of FUNC Common Stock outstanding. (8) The equivalent pro forma income per share of Covenant Common Stock amounts represent pro forma combined income per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio. ------------------------
EQUIVALENT HISTORICAL EQUIVALENT PRO FORMA --------------------------------------------------- PRO FORMA PER SHARE COVENANT COVENANT PER SHARE OF COVENANT SERIES A SERIES B OF COVENANT SERIES A FUNC COVENANT PREFERRED PREFERRED COMMON PREFERRED COMMON STOCK COMMON STOCK STOCK STOCK STOCK (9) STOCK (9) ------------ ------------ --------- --------- ----------- ----------- MARKET VALUE PER SHARE August 4, 1997......................... $ 49.50 21.00 76.00 57.125 18.75 75.00 December 12, 1997...................... $ 50.00 18.50 66.50 55.000 19.00 75.75 EQUIVALENT PRO FORMA PER SHARE OF COVENANT SERIES B PREFERRED STOCK (9) ----------- MARKET VALUE PER SHARE August 4, 1997......................... 59.375 December 12, 1997...................... 60.000
- --------------- (9) The equivalent pro forma market values per share of Covenant Common Stock amounts represent the historical market values per share of FUNC Common Stock multiplied by the Common Stock Exchange Ratio, rounded down to the nearest one-eighth. The equivalent pro forma market values per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent the historical market values per share of FUNC Common Stock multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded down to the nearest one-eighth. The FUNC and Covenant historical market values per share represent the last reported sale prices per share of FUNC Common Stock on the NYSE Tape and the Covenant Common Stock and Covenant Preferred Stock on the Nasdaq National Market and the Nasdaq Small-Cap Market, respectively: (i) on August 4, 1997, the last business day preceding public announcement of the execution of the Merger Agreement; and (ii) on December 12, 1997. See "RECENT DEVELOPMENTS -- Wheat First Butcher Singer, Inc. Acquisition" and "THE MERGERS -- Market Prices" in the Prospectus/Proxy Statement. The high and low last reported sale prices per share of FUNC Common Stock on the NYSE Tape, with respect to the 1997 fourth quarter (through December 12, 1997), were $52.875 and $46.9375, respectively, and the high and low last reported sale prices per share of Covenant Common Stock on the Nasdaq National Market during such period were $19.625 and $17.00, respectively. The corresponding equivalent pro forma market values per share of Covenant Common Stock during such period were $20.125 and $17.875, respectively. The high and low last reported sale prices per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock on the Nasdaq Small-Cap Market during such period were $76.00 and 8 $66.50, and $57.50 and $55.00, respectively. The corresponding equivalent pro forma market values per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock during such period were $80.125 and $71.125, and $63.375 and $56.25, respectively. See "THE MERGERS -- Market Prices" in the Prospectus/Proxy Statement. Because the market price of FUNC Common Stock is subject to fluctuation, the market value of the FUNC Common Shares that holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock will receive upon consummation of the Corporate Merger may increase or decrease prior to and after the receipt of such shares. Covenant stockholders are urged to obtain current market quotations for FUNC Common Stock. SELECTED FINANCIAL DATA The following tables set forth certain unaudited historical consolidated selected financial information for FUNC and Covenant and certain unaudited pro forma combined selected financial information, adjusted to reflect the FUNC Stock Split, stock dividends on Covenant Common Stock and Covenant Bank common stock and consummation of the Signet acquisition on November 28, 1997. Such pro forma information has been prepared assuming (a) consummation of the Mergers on a purchase accounting basis only for the nine months ended September 30, 1997, and the year ended December 31, 1996, and (b) consummation of the Signet, Wheat and CoreStates acquisitions on a pooling of interests accounting basis as of the beginning of each of the periods presented. This information should be read in conjunction with the historical financial statements of FUNC, Covenant, CoreStates, Signet and Wheat, including the respective notes thereto, and the documents included in EXHIBITS A, B and C to this Supplement or incorporated by reference in the Prospectus/Proxy Statement. See "PRO FORMA FINANCIAL INFORMATION", EXHIBITS A, B and C and "CERTAIN AVAILABLE INFORMATION" in this Supplement, and "AVAILABLE INFORMATION", "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE", "RECENT DEVELOPMENTS" and ANNEX A in the Prospectus/Proxy Statement. Interim unaudited historical data of FUNC and Covenant reflect, in the respective opinions of management, all adjustments (consisting only of normal recurring adjustments) necessary to a fair presentation of such data. Since purchase accounting does not require restatement of results for prior periods following consummation of the Mergers, consummation of the Mergers will not affect FUNC's historical results for the periods indicated. Pro forma financial information is intended to show how the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions might have affected historical financial statements if the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions had been consummated at an earlier time. The pro forma financial information does not purport to be indicative of the results that actually would have been realized had the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions taken place at the beginning of the applicable periods indicated, nor is it indicative of the combined financial position or results of operations for any future periods. 9 FUNC (HISTORICAL)
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------- ---------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 - ---------------------------------------------------------- -------- -------- ------- ------- ------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... $ 7,556 7,193 9,628 8,687 7,231 6,602 Interest expense........................................ 3,586 3,452 4,632 4,052 2,793 2,482 -------- -------- ------- ------- ------- ------- Net interest income..................................... 3,970 3,741 4,996 4,635 4,438 4,120 Provision for loan losses............................... 465 255 375 220 179 370 -------- -------- ------- ------- ------- ------- Net interest income after provision for loan losses..... 3,505 3,486 4,621 4,415 4,259 3,750 Securities available for sale transactions.............. 12 20 31 44 6 33 Investment security transactions........................ 3 3 4 5 4 7 Noninterest income...................................... 2,262 1,649 2,322 1,848 1,566 1,542 Merger-related restructuring charges.................... -- 281 281 94 -- -- SAIF special assessment................................. -- 133 133 -- -- -- Noninterest expense..................................... 3,529 3,141 4,254 3,999 3,747 3,536 -------- -------- ------- ------- ------- ------- Income before income taxes.............................. 2,253 1,603 2,310 2,219 2,088 1,796 Income taxes............................................ 792 564 811 789 712 579 -------- -------- ------- ------- ------- ------- Net income.............................................. 1,461 1,039 1,499 1,430 1,376 1,217 Dividends on preferred stock............................ -- 8 9 26 46 46 -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders before redemption premium.................................... 1,461 1,031 1,490 1,404 1,330 1,171 Redemption premium on preferred stock................... -- -- -- -- 41 -- -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders after redemption premium.................................... $ 1,461 1,031 1,490 1,404 1,289 1,171 -------- -------- ------- ------- ------- ------- -------- -------- ------- ------- ------- ------- PER COMMON SHARE DATA (a) Net income before redemption premium.................... $ 2.60 1.85 2.67 2.52 2.36 2.15 Net income after redemption premium..................... 2.60 1.85 2.67 2.52 2.29 2.15 Cash dividends.......................................... 0.90 0.81 1.10 0.98 0.86 0.75 Book value.............................................. 18.86 15.97 17.41 15.94 14.10 13.36 CASH DIVIDENDS PAID ON COMMON STOCK....................... 508 449 611 336 298 244 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets.................................................. 143,904 133,882 140,127 131,880 113,529 104,550 Loans, net of unearned income........................... 94,904 92,520 95,858 90,563 77,831 68,263 Deposits................................................ 91,690 91,444 94,815 92,555 87,865 81,885 Long-term debt.......................................... 7,819 7,332 7,660 7,121 4,242 3,675 Guaranteed preferred beneficial interests............... 990 -- 495 -- -- -- Preferred stockholders' equity.......................... -- 48 -- 183 230 514 Common stockholders' equity............................. 10,720 8,641 10,008 8,860 8,044 7,432 Total stockholders' equity.............................. $ 10,720 8,689 10,008 9,043 8,274 7,946 Preferred shares outstanding (IN THOUSANDS)............. -- 1,911 -- 3,388 5,213 11,560 Common shares outstanding (IN THOUSANDS)................ 568,296 541,015 574,697 555,692 570,721 556,408 CONSOLIDATED AVERAGE BALANCE SHEET ITEMS Assets.................................................. $138,301 133,541 134,127 118,142 106,413 99,610 Loans, net of unearned income........................... 94,636 89,864 90,660 83,265 70,726 62,996 Deposits................................................ 92,325 91,064 91,320 87,274 80,760 76,830 Long-term debt.......................................... 7,489 7,570 7,565 5,707 4,009 3,598 Guaranteed preferred beneficial interests............... 964 -- 47 -- -- -- Common stockholders' equity (b)......................... 9,889 9,000 9,079 8,412 7,870 6,782 Total stockholders' equity (b).......................... $ 9,889 9,138 9,187 8,623 8,372 7,302 Common shares outstanding (IN THOUSANDS)................ 562,534 557,968 557,624 557,354 563,325 544,876 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders before redemption premium to average common stockholders' equity (b)............................................. 19.75%(c) 15.30(c) 16.41 16.69 16.91 17.26 Net income applicable to common stockholders after redemption premium to average common stockholders' equity (b)............................................ 19.75(c) 15.30(c) 16.41 16.69 16.38 17.26 Net income to Average total stockholders' equity (b)................ 19.75(c) 15.19(c) 16.32 16.59 16.44 16.66 Average assets........................................ 1.41(c) 1.04(c) 1.12 1.21 1.29 1.22 Average stockholders' equity to average assets (d)...... 7.14 6.81 6.82 7.23 7.52 7.11 Allowance for loan losses to Net loans............................................. 1.44 1.49 1.42 1.66 2.03 2.38 Nonaccrual and restructured loans..................... 224 188 204 233 248 151 Nonperforming assets.................................. 194 167 179 182 178 115 Net charge-offs to average net loans.................... 0.65(c) 0.58(c) 0.63 0.41 0.40 0.78 Nonperforming assets to loans, net and foreclosed properties............................................ 0.74 0.89 0.80 0.91 1.14 2.06 Capital ratios (d) Tier 1 capital........................................ 8.18 6.38 7.33 6.70 7.76 9.14 Total capital......................................... 13.72 10.94 12.33 11.45 12.94 14.64 Leverage.............................................. 6.53 5.23 6.13 5.49 6.12 6.13 Net interest margin..................................... 4.36%(c) 4.21(c) 4.21 4.46 4.75 4.82 (IN MILLIONS, EXCEPT PER SHARE DATA) 1992 - ---------------------------------------------------------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... 6,609 Interest expense........................................ 2,942 ------- Net interest income..................................... 3,667 Provision for loan losses............................... 643 ------- Net interest income after provision for loan losses..... 3,024 Securities available for sale transactions.............. 39 Investment security transactions........................ (3) Noninterest income...................................... 1,360 Merger-related restructuring charges.................... -- SAIF special assessment................................. -- Noninterest expense..................................... 3,443 ------- Income before income taxes.............................. 977 Income taxes............................................ 278 ------- Net income.............................................. 699 Dividends on preferred stock............................ 53 ------- Net income applicable to common stockholders before redemption premium.................................... 646 Redemption premium on preferred stock................... -- ------- Net income applicable to common stockholders after redemption premium.................................... 646 ------- ------- PER COMMON SHARE DATA (a) Net income before redemption premium.................... 1.26 Net income after redemption premium..................... 1.26 Cash dividends.......................................... 0.64 Book value.............................................. 11.68 CASH DIVIDENDS PAID ON COMMON STOCK....................... 168 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets.................................................. 95,308 Loans, net of unearned income........................... 60,301 Deposits................................................ 76,156 Long-term debt.......................................... 3,733 Guaranteed preferred beneficial interests............... -- Preferred stockholders' equity.......................... 530 Common stockholders' equity............................. 6,187 Total stockholders' equity.............................. 6,717 Preferred shares outstanding (IN THOUSANDS)............. 12,158 Common shares outstanding (IN THOUSANDS)................ 529,790 CONSOLIDATED AVERAGE BALANCE SHEET ITEMS Assets.................................................. 90,621 Loans, net of unearned income........................... 58,700 Deposits................................................ 71,947 Long-term debt.......................................... 3,528 Guaranteed preferred beneficial interests............... -- Common stockholders' equity (b)......................... 5,724 Total stockholders' equity (b).......................... 6,280 Common shares outstanding (IN THOUSANDS)................ 510,768 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders before redemption premium to average common stockholders' equity (b)............................................. 11.28 Net income applicable to common stockholders after redemption premium to average common stockholders' equity (b)............................................ 11.28 Net income to Average total stockholders' equity (b)................ 11.13 Average assets........................................ 0.77 Average stockholders' equity to average assets (d)...... 6.89 Allowance for loan losses to Net loans............................................. 2.57 Nonaccrual and restructured loans..................... 105 Nonperforming assets.................................. 76 Net charge-offs to average net loans.................... 1.03 Nonperforming assets to loans, net and foreclosed properties............................................ 3.36 Capital ratios (d) Tier 1 capital........................................ 9.22 Total capital......................................... 14.31 Leverage.............................................. 6.55 Net interest margin..................................... 4.73
- --------------- (a) Per common share data has been restated to reflect the FUNC Stock Split. (b) Average common stockholders' equity and total stockholders' equity exclude net unrealized gains and (losses) on debt and equity securities in 1994 through 1997. (c) Annualized. (d) The average stockholders' equity to average assets ratios and all capital ratios for 1992-1994 are not restated for pooling of interests acquisitions. Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of four percent and total capital to risk-weighted assets of eight percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from three to five percent. 10 FUNC AND SIGNET PRO FORMA COMBINED SELECTED FINANCIAL DATA (A)
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------- ---------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 - ---------------------------------------------------------- -------- -------- ------- ------- ------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... $ 8,187 7,812 10,459 9,553 8,038 7,406 Interest expense........................................ 3,859 3,719 4,994 4,425 3,090 2,757 -------- -------- ------- ------- ------- ------- Net interest income..................................... 4,328 4,093 5,465 5,128 4,948 4,649 Provision for loan losses............................... 515 299 449 258 193 417 -------- -------- ------- ------- ------- ------- Net interest income after provision for loan losses..... 3,813 3,794 5,016 4,870 4,755 4,232 Securities available for sale transactions.............. 19 20 36 45 9 37 Investment security transactions........................ 3 3 4 6 4 7 Noninterest income...................................... 2,457 1,839 2,597 2,125 2,130 1,903 Merger-related restructuring charges.................... -- 281 281 94 -- -- SAIF special assessment................................. -- 133 133 -- -- -- Noninterest expense..................................... 3,930 3,501 4,740 4,563 4,593 4,134 -------- -------- ------- ------- ------- ------- Income before income taxes.............................. 2,362 1,741 2,499 2,389 2,305 2,045 Income taxes............................................ 828 611 875 848 779 654 -------- -------- ------- ------- ------- ------- Net income.............................................. 1,534 1,130 1,624 1,541 1,526 1,391 Dividends on preferred stock............................ -- 8 9 26 46 46 -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders before redemption premium.................................... 1,534 1,122 1,615 1,515 1,480 1,345 Redemption premium on preferred stock................... -- -- -- -- 41 -- -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders after redemption premium.................................... $ 1,534 1,122 1,615 1,515 1,439 1,345 -------- -------- ------- ------- ------- ------- -------- -------- ------- ------- ------- ------- PER COMMON SHARE DATA Net income before redemption premium..................... $ 2.43 1.80 2.59 2.43 2.36 2.21 Net income after redemption premium..................... 2.43 1.80 2.59 2.43 2.29 2.21 Book value.............................................. 18.43 15.79 17.06 15.66 14.41 13.57 CASH DIVIDENDS PAID ON COMMON STOCK....................... 546 485 659 382 355 289 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets................................................... 155,175 145,375 151,847 142,858 126,460 116,399 Loans, net of unearned income........................... 101,426 98,692 102,213 95,979 85,755 74,573 Deposits................................................ 99,402 99,278 102,702 100,148 95,687 89,706 Long-term debt.......................................... 8,169 7,732 8,060 7,374 4,496 3,941 Guaranteed preferred beneficial interests............... 990 -- 495 -- -- -- Preferred stockholders' equity.......................... -- 48 -- 183 230 514 Common stockholders' equity............................. 11,710 9,530 10,932 9,724 9,155 8,397 Total stockholders' equity.............................. $ 11,710 9,578 10,932 9,907 9,385 8,911 Preferred shares outstanding (IN THOUSANDS)............. -- 1,911 -- 3,388 5,213 11,560 Common shares outstanding (IN THOUSANDS)................ 635,334 606,711 640,782 620,822 635,222 618,678 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans............................................. 1.47% 1.53 1.47 1.71 2.10 2.52 Nonperforming assets.................................. 203 173 187 186 192 123 Net charge-offs to average net loans.................... 0.67(b) 0.61(b) 0.66 0.44 0.42 0.79 Nonperforming assets to loans, net and foreclosed properties............................................ 0.73% 0.88 0.78 0.92 1.09 2.04 (IN MILLIONS, EXCEPT PER SHARE DATA) 1992 - ---------------------------------------------------------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... 7,376 Interest expense........................................ 3,273 ------- Net interest income..................................... 4,103 Provision for loan losses............................... 711 ------- Net interest income after provision for loan losses..... 3,392 Securities available for sale transactions.............. 49 Investment security transactions........................ (21) Noninterest income...................................... 1,641 Merger-related restructuring charges.................... -- SAIF special assessment................................. -- Noninterest expense..................................... 3,942 ------- Income before income taxes.............................. 1,119 Income taxes............................................ 311 ------- Net income.............................................. 808 Dividends on preferred stock............................ 53 ------- Net income applicable to common stockholders before redemption premium.................................... 755 Redemption premium on preferred stock................... -- ------- Net income applicable to common stockholders after redemption premium.................................... 755 ------- ------- PER COMMON SHARE DATA Net income before redemption premium..................... 1.32 Net income after redemption premium..................... 1.32 Book value.............................................. 11.86 CASH DIVIDENDS PAID ON COMMON STOCK....................... 193 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets................................................... 107,401 Loans, net of unearned income........................... 66,110 Deposits................................................ 83,979 Long-term debt.......................................... 4,031 Guaranteed preferred beneficial interests............... -- Preferred stockholders' equity.......................... 530 Common stockholders' equity............................. 7,014 Total stockholders' equity.............................. 7,544 Preferred shares outstanding (IN THOUSANDS)............. 12,158 Common shares outstanding (IN THOUSANDS)................ 591,348 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans............................................. 2.75 Nonperforming assets.................................. 82 Net charge-offs to average net loans.................... 1.14 Nonperforming assets to loans, net and foreclosed properties............................................ 3.34
- --------------- (a) See "PRO FORMA FINANCIAL INFORMATION". (b) Annualized. 11 COVENANT (HISTORICAL) (A)
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, ---------------- ------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 1992 - ----------------------------------------------------------------------- ---------------- ----- ----- ----- ----- ----- CONSOLIDATED SUMMARIES OF INCOME Interest income...................................................... $ 23 29 26 20 17 16 Interest expense..................................................... 12 14 12 8 7 9 ------- ----- ----- ----- ----- ----- Net interest income.................................................. 11 15 14 12 10 7 Provision for loan losses............................................ -- 1 1 1 1 1 ------- ----- ----- ----- ----- ----- Net interest income after provision for loan losses.................. 11 14 13 11 9 6 Noninterest income................................................... 1 1 1 1 1 1 Merger-related restructuring charges................................. -- 1 -- 1 -- -- SAIF special assessment.............................................. -- 1 -- -- -- -- Noninterest expense.................................................. 8 10 11 10 9 6 ------- ----- ----- ----- ----- ----- Income before income taxes........................................... 4 3 3 1 1 1 Income taxes......................................................... 1 1 1 -- -- -- ------- ----- ----- ----- ----- ----- Net income........................................................... 3 2 2 1 1 1 Dividends on preferred stock......................................... -- 1 -- -- -- -- ------- ----- ----- ----- ----- ----- Net income applicable to common stockholders......................... $ 3 1 2 1 1 1 ------- ----- ----- ----- ----- ----- ------- ----- ----- ----- ----- ----- PER COMMON SHARE DATA Net income........................................................... $ 0.63 0.44 0.61 0.35 0.38 0.22 Book value........................................................... 8.06 7.17 7.25 6.19 6.01 5.63 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets............................................................... 420 415 347 317 274 210 Loans, net of unearned income........................................ 258 241 205 194 183 148 Deposits............................................................. 304 277 263 236 244 186 Long-term debt....................................................... 15 20 14 18 7 -- Preferred stockholders' equity....................................... 7 7 7 3 3 3 Common stockholders' equity.......................................... 25 22 23 19 19 17 Total stockholders' equity........................................... $ 32 29 30 22 22 20 Preferred shares outstanding (IN THOUSANDS).......................... 300 300 300 138 138 138 Common shares outstanding (IN THOUSANDS)............................. 3,057 3,023 3,068 3,064 3,054 3,054 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders to average common stockholders' equity.............................................. 13.96%(b) 6.30 9.53 5.72 6.68 4.30 Net income to average assets......................................... 0.86(b) 0.48 0.72 0.45 0.56 0.35 Average stockholders' equity to average assets....................... 7.06 7.56 7.66 7.70 8.49 8.24 Allowance for loan losses to Gross loans....................................................... 1.05 1.25 1.56 1.87 2.00 1.81 Nonaccrual and restructured loans................................. 150 105 87 78 86 137 Nonperforming assets.............................................. 95 85 64 66 70 70 Net charge-offs to average net loans................................. 0.18(b) 0.36 0.37 0.38 0.77 0.46 Nonperforming assets to gross loans and foreclosed properties........ 1.10 1.47 2.43 2.81 2.84 2.56 Capital ratios (c) Tier 1 capital.................................................... 12.46 11.98 13.62 11.68 11.52 13.88 Total capital..................................................... 13.51 13.20 14.87 12.94 12.78 14.83 Leverage.......................................................... 7.50 7.51 8.49 7.42 7.87 9.88 Net interest margin.................................................. 3.83%(b) 4.10 4.37 4.50 4.24 3.86
- --------------- (a) All data has been restated to reflect the 1996 and 1994 pooling of interests mergers with 1st Southern State Bank and Landis Savings Bank, S.L.A., respectively, and to reflect all common stock dividends issued by Covenant and Covenant Bank through July 14, 1997. See "THE MERGERS -- Dividends", "COVENANT -- History and Business" and ANNEX A in the Prospectus/Proxy Statement. (b) Annualized. (c) Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of four percent and total capital to risk-weighted assets of eight percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from three to five percent. 12 FUNC, SIGNET AND COVENANT PRO FORMA COMBINED SELECTED FINANCIAL DATA (A)
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------- ---------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 - ---------------------------------------------------------- -------- -------- ------- ------- ------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... $ 8,206 7,812 10,484 9,553 8,038 7,406 Interest expense........................................ 3,871 3,719 5,008 4,425 3,090 2,757 -------- -------- ------- ------- ------- ------- Net interest income..................................... 4,335 4,093 5,476 5,128 4,948 4,649 Provision for loan losses............................... 515 299 450 258 193 417 -------- -------- ------- ------- ------- ------- Net interest income after provision for loan losses..... 3,820 3,794 5,026 4,870 4,755 4,232 Securities available for sale transactions.............. 19 20 36 45 9 37 Investment security transactions........................ 3 3 4 6 4 7 Noninterest income...................................... 2,458 1,839 2,598 2,125 2,130 1,903 Merger-related restructuring charges.................... -- 281 282 94 -- -- SAIF special assessment................................. -- 133 134 -- -- -- Noninterest expense..................................... 3,940 3,501 4,760 4,563 4,593 4,134 -------- -------- ------- ------- ------- ------- Income before income taxes.............................. 2,360 1,741 2,488 2,389 2,305 2,045 Income taxes............................................ 828 611 871 848 779 654 -------- -------- ------- ------- ------- ------- Net income.............................................. 1,532 1,130 1,617 1,541 1,526 1,391 Dividends on preferred stock............................ -- 8 10 26 46 46 -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders............ 1,532 1,122 1,607 1,515 1,480 1,345 Redemption premium on preferred stock................... -- -- -- -- 41 -- -------- -------- ------- ------- ------- ------- Net income applicable to common stockholders after redemption premium.................................... $ 1,532 1,122 1,607 1,515 1,439 1,345 -------- -------- ------- ------- ------- ------- -------- -------- ------- ------- ------- ------- PER COMMON SHARE DATA Net income before redemption premium..................... $ 2.43 1.80 2.57 2.43 2.36 2.21 Net income after redemption premium..................... 2.43 1.80 2.57 2.43 2.29 2.21 Book value.............................................. 18.43 15.79 17.06 15.66 14.41 13.57 CASH DIVIDENDS PAID ON COMMON STOCK....................... 546 485 659 382 355 289 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets................................................... 155,563 145,375 152,230 142,858 126,460 116,399 Loans, net of unearned income........................... 101,684 98,692 102,454 95,979 85,755 74,573 Deposits................................................ 99,706 99,278 102,979 100,148 95,687 89,706 Long-term debt.......................................... 8,184 7,732 8,080 7,374 4,496 3,941 Guaranteed preferred beneficial interests............... 990 -- 495 -- -- -- Preferred stockholders' equity.......................... -- 48 -- 183 230 514 Common stockholders' equity............................. 11,710 9,530 10,932 9,724 9,155 8,397 Total stockholders' equity.............................. $ 11,710 9,578 10,932 9,907 9,385 8,911 Preferred shares outstanding (IN THOUSANDS)............. -- 1,911 -- 3,388 5,213 11,560 Common shares outstanding (IN THOUSANDS)................ 635,334 606,711 640,782 620,822 635,222 618,678 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans............................................. 1.47% 1.53 1.47 1.71 2.10 2.52 Nonperforming assets.................................. 202 173 187 186 192 123 Net charge-offs to average net loans.................... 0.66(b) 0.61(b) 0.66 0.44 0.42 0.79 Nonperforming assets to loans, net and foreclosed properties............................................ 0.73% 0.88 0.79 0.92 1.09 2.04 (IN MILLIONS, EXCEPT PER SHARE DATA) 1992 - ---------------------------------------------------------- ------- CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... 7,376 Interest expense........................................ 3,273 ------- Net interest income..................................... 4,103 Provision for loan losses............................... 711 ------- Net interest income after provision for loan losses..... 3,392 Securities available for sale transactions.............. 49 Investment security transactions........................ (21) Noninterest income...................................... 1,641 Merger-related restructuring charges.................... -- SAIF special assessment................................. -- Noninterest expense..................................... 3,942 ------- Income before income taxes.............................. 1,119 Income taxes............................................ 311 ------- Net income.............................................. 808 Dividends on preferred stock............................ 53 ------- Net income applicable to common stockholders............ 755 Redemption premium on preferred stock................... -- ------- Net income applicable to common stockholders after redemption premium.................................... 755 ------- ------- PER COMMON SHARE DATA Net income before redemption premium..................... 1.32 Net income after redemption premium..................... 1.32 Book value.............................................. 11.86 CASH DIVIDENDS PAID ON COMMON STOCK....................... 193 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets................................................... 107,401 Loans, net of unearned income........................... 66,110 Deposits................................................ 83,979 Long-term debt.......................................... 4,031 Guaranteed preferred beneficial interests............... -- Preferred stockholders' equity.......................... 530 Common stockholders' equity............................. 7,014 Total stockholders' equity.............................. 7,544 Preferred shares outstanding (IN THOUSANDS)............. 12,158 Common shares outstanding (IN THOUSANDS)................ 591,348 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans............................................. 2.75 Nonperforming assets.................................. 82 Net charge-offs to average net loans.................... 1.14 Nonperforming assets to loans, net and foreclosed properties............................................ 3.34
- --------------- (a) See "PRO FORMA FINANCIAL INFORMATION". (b) Annualized. 13 FUNC, SIGNET, COVENANT, WHEAT AND CORESTATES PRO FORMA COMBINED SELECTED FINANCIAL DATA (A)
NINE MONTHS ENDED SEPTEMBER 30, TWELVE MONTHS ENDED -------------------- ------------------------------------------------ (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1997/1996 1996/1995 1995/1994 1994/1993 - ------------------------------------------------ -------- -------- --------- --------- --------- --------- CONSOLIDATED SUMMARIES OF INCOME Interest income................................ $ 10,787 10,308 13,831 13,068 11,086 10,335 Interest expense.............................. 4,839 4,591 6,187 5,752 4,052 3,660 -------- -------- --------- --------- --------- --------- Net interest income........................... 5,948 5,717 7,644 7,316 7,034 6,675 Provision for loan losses..................... 658 488 679 402 472 606 -------- -------- --------- --------- --------- --------- Net interest income after provision for loan losses...................................... 5,290 5,229 6,965 6,914 6,562 6,069 Securities available for sale transactions.... 101 142 184 156 97 154 Investment security transactions.............. 3 3 4 6 4 7 Noninterest income............................ 3,438 2,715 3,794 3,269 3,115 2,944 Restructuring and merger-related charges...... -- 411 422 233 107 -- SAIF special assessment....................... -- 147 148 -- -- -- Noninterest expense........................... 5,497 5,018 6,802 6,656 6,673 6,332 -------- -------- --------- --------- --------- --------- Income before income taxes.................... 3,335 2,513 3,575 3,456 2,998 2,842 Income taxes.................................. 1,173 905 1,278 1,232 1,018 908 -------- -------- --------- --------- --------- --------- Net income.................................... 2,162 1,608 2,297 2,224 1,980 1,934 Dividends on preferred stock.................. -- 8 10 26 46 46 -------- -------- --------- --------- --------- --------- Net income applicable to common stockholders before redemption premium................... 2,162 1,600 2,287 2,198 1,934 1,888 Redemption premium on preferred stock......... -- -- -- -- 41 -- -------- -------- --------- --------- --------- --------- Net income applicable to common stockholders after redemption premium.................... $ 2,162 1,600 2,287 2,198 1,893 1,888 -------- -------- --------- --------- --------- --------- -------- -------- --------- --------- --------- --------- PER COMMON SHARE DATA Net income before redemption premium........... $ 2.22 1.61 2.31 2.21 1.93 1.91 Net income after redemption premium........... $ 2.22 1.61 2.31 2.21 1.89 1.91 Average common shares outstanding (IN THOUSANDS).................................. 973,263 990,901 989,106 993,504 1,003,740 988,055 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets......................................... $204,327 191,531 198,668 189,592 173,116 161,194 Loans, net of unearned income................. 136,769 131,526 135,231 127,693 116,510 104,411 Deposits...................................... 133,447 131,581 136,706 134,112 130,461 123,570 Long-term debt................................ 12,054 10,291 11,193 9,620 6,695 5,983 Guaranteed preferred beneficial interests..... 990 -- 495 -- -- -- Preferred stockholders' equity................ -- 48 -- 183 230 514 Common stockholders' equity................... 14,988 13,696 14,775 13,722 12,982 12,186 Total stockholders' equity.................... $ 14,988 13,744 14,775 13,905 13,212 12,700 Preferred shares outstanding (IN THOUSANDS)... -- 1,911 -- 3,388 5,213 11,560 Common shares outstanding (IN THOUSANDS)...... 965,709 974,937 995,189 987,596 1,013,603 1,001,056 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans................................... 1.59% 1.68 1.64 1.81 2.13 2.41 Nonperforming assets........................ 217 195 211 201 180 117 Net charge-offs to average net loans.......... 0.67(b) 0.62(b) 0.64 0.45 0.55 0.74 Nonperforming assets to loans, net and foreclosed properties....................... 0.73% 0.86 0.78 0.90 1.18 2.05 (IN MILLIONS, EXCEPT PER SHARE DATA) 1993/1992 - ------------------------------------------------ --------- CONSOLIDATED SUMMARIES OF INCOME Interest income................................ 10,480 Interest expense.............................. 4,477 --------- Net interest income........................... 6,003 Provision for loan losses..................... 972 --------- Net interest income after provision for loan losses...................................... 5,031 Securities available for sale transactions.... 146 Investment security transactions.............. (21) Noninterest income............................ 2,691 Restructuring and merger-related charges...... -- SAIF special assessment....................... -- Noninterest expense........................... 6,246 --------- Income before income taxes.................... 1,601 Income taxes.................................. 455 --------- Net income.................................... 1,146 Dividends on preferred stock.................. 53 --------- Net income applicable to common stockholders before redemption premium................... 1,093 Redemption premium on preferred stock......... -- --------- Net income applicable to common stockholders after redemption premium.................... 1,093 --------- --------- PER COMMON SHARE DATA Net income before redemption premium........... 1.17 Net income after redemption premium........... 1.17 Average common shares outstanding (IN THOUSANDS).................................. 933,400 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets......................................... 152,535 Loans, net of unearned income................. 94,635 Deposits...................................... 118,799 Long-term debt................................ 5,724 Guaranteed preferred beneficial interests..... -- Preferred stockholders' equity................ 530 Common stockholders' equity................... 10,367 Total stockholders' equity.................... 10,897 Preferred shares outstanding (IN THOUSANDS)... 12,158 Common shares outstanding (IN THOUSANDS)...... 969,491 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans................................... 2.57 Nonperforming assets........................ 78 Net charge-offs to average net loans.......... 1.10 Nonperforming assets to loans, net and foreclosed properties....................... 3.28
- --------------- (a) See "PRO FORMA FINANCIAL INFORMATION". (b) Annualized. 14 ACCOUNTING TREATMENT Financial statements of FUNC for periods before consummation of the Mergers will not be restated to reflect the historical financial position or results of operations of Covenant or Wheat. Such financial statements will be restated for the Signet acquisition only for periods beginning on and after January 1, 1995, and will be restated upon consummation of the CoreStates acquisition for all periods presented. See "THE MERGERS -- Accounting Treatment" in the Prospectus/Proxy Statement. EXPERTS The consolidated financial statements of CoreStates at December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996, appearing in Exhibit B herein have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. The consolidated balance sheet of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the two-year period ended December 31, 1995, included in EXHIBIT B herein, have been included herein in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, included in EXHIBIT C, and upon the authority of said firm as experts in accounting and auditing. Such financial statements were combined with those of CoreStates for such periods. The consolidated balance sheet of United Counties Bancorporation and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 1995, included in EXHIBIT B herein, have been included herein in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, included in EXHIBIT C, and upon the authority of said firm as experts in accounting and auditing. Such financial statements were combined with those of CoreStates for such periods. See "EXPERTS" in the Prospectus/Proxy Statement. 15 PRO FORMA FINANCIAL INFORMATION PRO FORMA COMBINED CONDENSED BALANCE SHEET FUNC, SIGNET, COVENANT, WHEAT AND CORESTATES SEPTEMBER 30, 1997 (UNAUDITED) The following unaudited pro forma combined condensed balance sheet combines the consolidated historical balance sheets of FUNC, Signet, Covenant, Wheat and CoreStates, assuming the companies had been combined as of September 30, 1997, on a pooling of interests accounting basis with respect to the Signet, Wheat and CoreStates acquisitions, and on a purchase accounting basis with respect to the Mergers. The Signet acquisition was consummated on November 28, 1997.
FUNC, FUNC SIGNET AND (IN MILLIONS) FUNC SIGNET AND SIGNET COVENANT COVENANT WHEAT CORESTATES - ---------------------------------------------- -------- -------- ---------- -------- ---------- -------- ---------- ASSETS Cash and due from banks....................... $ 6,200 462 6,662 16 6,591 34 3,166 Interest-bearing bank balances................ 200 4 204 -- 204 -- 3,044 Federal funds sold and securities purchased under resale agreements..................... 6,011 887 6,898 -- 6,898 77 139 -------- -------- ---------- -------- ---------- -------- ---------- Total cash and cash equivalents......... 12,411 1,353 13,764 16 13,693 111 6,349 -------- -------- ---------- -------- ---------- -------- ---------- Trading account assets........................ 7,548 277 7,825 -- 7,825 180 327 Securities available for sale................. 16,690 2,233 18,923 120 19,043 -- 2,211 Investment securities......................... 2,268 -- 2,268 11 2,279 6 1,413 Loans, net of unearned income................. 94,904 6,522 101,426 258 101,684 -- 35,085 Allowance for loan losses................... (1,370) (126) (1,496) (3 ) (1,499) -- (679) -------- -------- ---------- -------- ---------- -------- ---------- Loans, net.............................. 93,534 6,396 99,930 255 100,185 -- 34,406 -------- -------- ---------- -------- ---------- -------- ---------- Premises and equipment........................ 4,056 172 4,228 9 4,237 66 627 Due from customers on acceptances............. 837 -- 837 -- 837 -- 791 Other intangible assets....................... 2,701 31 2,732 -- 2,787 -- 287 Other assets.................................. 3,859 809 4,668 9 4,677 810 1,180 -------- -------- ---------- -------- ---------- -------- ---------- Total................................... $143,904 11,271 155,175 420 155,563 1,173 47,591 -------- -------- ---------- -------- ---------- -------- ---------- -------- -------- ---------- -------- ---------- -------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits................ 18,963 1,771 20,734 48 20,782 -- 8,942 Interest-bearing deposits................... 72,727 5,941 78,668 256 78,924 -- 24,799 -------- -------- ---------- -------- ---------- -------- ---------- Total deposits.......................... 91,690 7,712 99,402 304 99,706 -- 33,741 Short-term borrowings......................... 27,623 1,922 29,545 64 29,609 271 4,239 Bank acceptances outstanding.................. 837 -- 837 -- 837 -- 789 Other liabilities............................. 4,225 297 4,522 5 4,527 651 1,925 Long-term debt................................ 7,819 350 8,169 15 8,184 86 3,784 -------- -------- ---------- -------- ---------- -------- ---------- Total liabilities....................... 132,194 10,281 142,475 388 142,863 1,008 44,478 -------- -------- ---------- -------- ---------- -------- ---------- Guaranteed preferred beneficial interests in Corporation's junior subordinated deferrable interest debentures......................... 990 -- 990 -- 990 -- -- -------- -------- ---------- -------- ---------- -------- ---------- STOCKHOLDERS' EQUITY Preferred stock............................... -- -- -- 8 -- 3 -- Common stock.................................. 1,894 305 2,118 15 2,118 17 224 Paid-in capital............................... 999 216 1,296 12 1,296 21 1,253 Retained earnings............................. 7,681 435 8,116 (3 ) 8,116 124 2,955 Unrealized gain on debt and equity securities, net......................................... 146 34 180 -- 180 -- 35 Treasury stock................................ -- -- -- -- -- -- (1,302) Unallocated shares held by ESOP............... -- -- -- -- -- -- (52) -------- -------- ---------- -------- ---------- -------- ---------- Total stockholders' equity.............. 10,720 990 11,710 32 11,710 165 3,113 -------- -------- ---------- -------- ---------- -------- ---------- Total................................... $143,904 11,271 155,175 420 155,563 1,173 47,591 -------- -------- ---------- -------- ---------- -------- ---------- -------- -------- ---------- -------- ---------- -------- ---------- FUNC, SIGNET, WHEAT AND (IN MILLIONS) CORESTATES - ---------------------------------------------- --------- ASSETS Cash and due from banks....................... 9,791 Interest-bearing bank balances................ 3,248 Federal funds sold and securities purchased under resale agreements..................... 7,114 --------- Total cash and cash equivalents......... 20,153 --------- Trading account assets........................ 8,332 Securities available for sale................. 21,254 Investment securities......................... 3,698 Loans, net of unearned income................. 136,769 Allowance for loan losses................... (2,178 ) --------- Loans, net.............................. 134,591 --------- Premises and equipment........................ 4,930 Due from customers on acceptances............. 1,628 Other intangible assets....................... 3,074 Other assets.................................. 6,667 --------- Total................................... 204,327 --------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits................ 29,724 Interest-bearing deposits................... 103,723 --------- Total deposits.......................... 133,447 Short-term borrowings......................... 34,119 Bank acceptances outstanding.................. 1,626 Other liabilities............................. 7,103 Long-term debt................................ 12,054 --------- Total liabilities....................... 188,349 --------- Guaranteed preferred beneficial interests in Corporation's junior subordinated deferrable interest debentures......................... 990 --------- STOCKHOLDERS' EQUITY Preferred stock............................... -- Common stock.................................. 3,226 Paid-in capital............................... 1,497 Retained earnings............................. 10,050 Unrealized gain on debt and equity securities, net......................................... 215 Treasury stock................................ -- Unallocated shares held by ESOP............... -- --------- Total stockholders' equity.............. 14,988 --------- Total................................... 204,327 --------- ---------
See accompanying notes to pro forma financial information. 16 PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME FUNC AND SIGNET (UNAUDITED) The following unaudited pro forma combined condensed statements of income present the combined statements of income of FUNC and Signet assuming the companies had been combined for each period presented on a pooling of interests accounting basis. The Signet acquisition was consummated on November 28, 1997.
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------- -------------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 1992 - ---------------------------------------------- -------- -------- -------- -------- -------- -------- -------- CONSOLIDATED SUMMARIES OF INCOME Interest income............................... $ 8,187 7,812 10,459 9,553 8,038 7,406 7,376 Interest expense.............................. 3,859 3,719 4,994 4,425 3,090 2,757 3,273 -------- -------- -------- -------- -------- -------- -------- Net interest income........................... 4,328 4,093 5,465 5,128 4,948 4,649 4,103 Provision for loan losses..................... 515 299 449 258 193 417 711 -------- -------- -------- -------- -------- -------- -------- Net interest income after provision for loan losses...................................... 3,813 3,794 5,016 4,870 4,755 4,232 3,392 Securities available for sale transactions.... 19 20 36 45 9 37 49 Investment security transactions.............. 3 3 4 6 4 7 (21) Noninterest income............................ 2,457 1,839 2,597 2,125 2,130 1,903 1,641 Merger-related restructuring charges.......... -- 281 281 94 -- -- -- SAIF special assessment....................... -- 133 133 -- -- -- -- Noninterest expense........................... 3,930 3,501 4,740 4,563 4,593 4,134 3,942 -------- -------- -------- -------- -------- -------- -------- Income before income taxes.................... 2,362 1,741 2,499 2,389 2,305 2,045 1,119 Income taxes.................................. 828 611 875 848 779 654 311 -------- -------- -------- -------- -------- -------- -------- Net income.................................... 1,534 1,130 1,624 1,541 1,526 1,391 808 Dividends on preferred stock.................. -- 8 9 26 46 46 53 -------- -------- -------- -------- -------- -------- -------- Net income applicable to common stockholders before redemption premium................... 1,534 1,122 1,615 1,515 1,480 1,345 755 Redemption premium on preferred stock......... -- -- -- -- 41 -- -- -------- -------- -------- -------- -------- -------- -------- Net income applicable to common stockholders after redemption premium.................... $ 1,534 1,122 1,615 1,515 1,439 1,345 755 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- PER COMMON SHARE DATA Net income before redemption premium.......... $ 2.43 1.80 2.59 2.43 2.36 2.21 1.32 Net income after redemption premium........... $ 2.43 1.80 2.59 2.43 2.29 2.21 1.32 Average common shares outstanding (IN THOUSANDS).................................. 630,384 624,554 624,363 623,163 626,974 607,488 572,068 FUNC HISTORICAL PER COMMON SHARE DATA Net income before redemption premium.......... $ 2.60 1.85 2.67 2.52 2.36 2.15 1.26 Net income after redemption premium........... $ 2.60 1.85 2.67 2.52 2.29 2.15 1.26 Average common shares outstanding (IN THOUSANDS).................................. 562,534 557,968 557,624 557,354 563,325 544,876 510,768
See accompanying notes to pro forma financial information. 17 PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME FUNC, SIGNET AND COVENANT (UNAUDITED) The following unaudited pro forma combined condensed statements of income present the combined statements of income of FUNC, Signet and Covenant assuming the companies had been combined for each period presented on a pooling of interests accounting basis with respect to the Signet acquisition, and on a purchase accounting basis with respect to the Mergers (only for the nine months ended September 30, 1997, and the year ended December 31, 1996). The Signet acquisition was consummated on November 28, 1997.
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, ------------------- ---------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 1992 - ---------------------------------------------------- -------- -------- -------- -------- -------- -------- -------- CONSOLIDATED SUMMARIES OF INCOME Interest income..................................... $ 8,206 7,812 10,484 9,553 8,038 7,406 7,376 Interest expense.................................... 3,871 3,719 5,008 4,425 3,090 2,757 3,273 -------- -------- -------- -------- -------- -------- -------- Net interest income................................. 4,335 4,093 5,476 5,128 4,948 4,649 4,103 Provision for loan losses........................... 515 299 450 258 193 417 711 -------- -------- -------- -------- -------- -------- -------- Net interest income after provision for loan losses............................................ 3,820 3,794 5,026 4,870 4,755 4,232 3,392 Securities available for sale transactions.......... 19 20 36 45 9 37 49 Investment security transactions.................... 3 3 4 6 4 7 (21) Noninterest income.................................. 2,458 1,839 2,598 2,125 2,130 1,903 1,641 Merger-related restructuring charges................ -- 281 282 94 -- -- -- SAIF special assessment............................. -- 133 134 -- -- -- -- Noninterest expense................................. 3,940 3,501 4,760 4,563 4,593 4,134 3,942 -------- -------- -------- -------- -------- -------- -------- Income before income taxes.......................... 2,360 1,741 2,488 2,389 2,305 2,045 1,119 Income taxes........................................ 828 611 871 848 779 654 311 -------- -------- -------- -------- -------- -------- -------- Net income.......................................... 1,532 1,130 1,617 1,541 1,526 1,391 808 Dividends on preferred stock........................ -- 8 10 26 46 46 53 -------- -------- -------- -------- -------- -------- -------- Net income applicable to common stockholders........ 1,532 1,122 1,607 1,515 1,480 1,345 755 Redemption premium on preferred stock............... -- -- -- -- 41 -- -- -------- -------- -------- -------- -------- -------- -------- Net income applicable to common stockholders after redemption premium................................ $ 1,532 1,122 1,607 1,515 1,439 1,345 755 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- PER COMMON SHARE DATA Net income before redemption premium................ $ 2.43 1.80 2.57 2.43 2.36 2.21 1.32 Net income after redemption premium................. $ 2.43 1.80 2.57 2.43 2.29 2.21 1.32 Average common shares outstanding (IN THOUSANDS).... 630,384 624,554 624,363 623,163 626,974 607,488 572,068 FUNC HISTORICAL PER COMMON SHARE DATA Net income before redemption premium................ $ 2.60 1.85 2.67 2.52 2.36 2.15 1.26 Net income after redemption premium................. $ 2.60 1.85 2.67 2.52 2.29 2.15 1.26 Average common shares outstanding (IN THOUSANDS).... 562,534 557,968 557,624 557,354 563,325 544,876 510,768
See accompanying notes to pro forma financial information. 18 PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME FUNC, SIGNET, COVENANT, WHEAT AND CORESTATES (UNAUDITED) The following unaudited pro forma combined condensed statements of income present the combined statements of income of FUNC, Signet, Covenant, Wheat and CoreStates assuming the companies had been combined for each period presented on a pooling of interests accounting basis with respect to the Signet acquisition, the Wheat acquisition and the CoreStates acquisition, and on a purchase accounting basis with respect to the Mergers (only for the nine months ended September 30, 1997, and the year ended December 31, 1996). Such information for Wheat for the 12-month periods ended March 31 has been added to comparable information related to FUNC, Signet, CoreStates and Covenant for the preceding 12-month periods ended December 31, to reflect the combined results of operations. The Signet acquisition was consummated on November 28, 1997.
NINE MONTHS ENDED SEPTEMBER 30, TWELVE MONTHS ENDED -------------------- ------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1997/1996 1996/1995 1995/1994 1994/1993 - -------------------------------------------- -------- -------- --------- --------- ---------- --------- CONSOLIDATED SUMMARIES OF INCOME Interest income............................. $ 10,787 10,308 13,831 13,068 11,086 10,335 Interest expense............................ 4,839 4,591 6,187 5,752 4,052 3,660 -------- -------- --------- --------- ---------- --------- Net interest income......................... 5,948 5,717 7,644 7,316 7,034 6,675 Provision for loan losses................... 658 488 679 402 472 606 -------- -------- --------- --------- ---------- --------- Net interest income after provision for loan losses.................................... 5,290 5,229 6,965 6,914 6,562 6,069 Securities available for sale transactions.............................. 101 142 184 156 97 154 Investment security transactions............ 3 3 4 6 4 7 Noninterest income.......................... 3,438 2,715 3,794 3,269 3,115 2,944 Restructuring and merger-related charges.... -- 411 422 233 107 -- SAIF special assessment..................... -- 147 148 -- -- -- Noninterest expense......................... 5,497 5,018 6,802 6,656 6,673 6,332 -------- -------- --------- --------- ---------- --------- Income before income taxes.................. 3,335 2,513 3,575 3,456 2,998 2,842 Income taxes................................ 1,173 905 1,278 1,232 1,018 908 -------- -------- --------- --------- ---------- --------- Net income.................................. 2,162 1,608 2,297 2,224 1,980 1,934 Dividends on preferred stock................ -- 8 10 26 46 46 -------- -------- --------- --------- ---------- --------- Net income applicable to common stockholders before redemption premium................. 2,162 1,600 2,287 2,198 1,934 1,888 Redemption premium on preferred stock....... -- -- -- -- 41 -- -------- -------- --------- --------- ---------- --------- Net income applicable to common stockholders after redemption premium.................. $ 2,162 1,600 2,287 2,198 1,893 1,888 -------- -------- --------- --------- ---------- --------- -------- -------- --------- --------- ---------- --------- PER COMMON SHARE DATA Net income before redemption premium........ $ 2.22 1.61 2.31 2.21 1.93 1.91 Net income after redemption premium......... $ 2.22 1.61 2.31 2.21 1.89 1.91 Average common shares outstanding (IN THOUSANDS)................................ 973,263 990,901 989,106 993,504 1,003,740 988,055 FUNC HISTORICAL PER COMMON SHARE DATA Net income before redemption premium........ $ 2.60 1.85 2.67 2.52 2.36 2.15 Net income after redemption premium......... $ 2.60 1.85 2.67 2.52 2.29 2.15 Average common shares outstanding (IN THOUSANDS)................................ 562,534 557,968 557,624 557,354 563,325 544,876 (IN MILLIONS, EXCEPT PER SHARE DATA) 1993/1992 - -------------------------------------------- --------- CONSOLIDATED SUMMARIES OF INCOME Interest income............................. 10,480 Interest expense............................ 4,477 --------- Net interest income......................... 6,003 Provision for loan losses................... 972 --------- Net interest income after provision for loan losses.................................... 5,031 Securities available for sale transactions.............................. 146 Investment security transactions............ (21 ) Noninterest income.......................... 2,691 Restructuring and merger-related charges.... -- SAIF special assessment..................... -- Noninterest expense......................... 6,246 --------- Income before income taxes.................. 1,601 Income taxes................................ 455 --------- Net income.................................. 1,146 Dividends on preferred stock................ 53 --------- Net income applicable to common stockholders before redemption premium................. 1,093 Redemption premium on preferred stock....... -- --------- Net income applicable to common stockholders after redemption premium.................. 1,093 --------- --------- PER COMMON SHARE DATA Net income before redemption premium........ 1.17 Net income after redemption premium......... 1.17 Average common shares outstanding (IN THOUSANDS)................................ 933,400 FUNC HISTORICAL PER COMMON SHARE DATA Net income before redemption premium........ 1.26 Net income after redemption premium......... 1.26 Average common shares outstanding (IN THOUSANDS)................................ 510,768
See accompanying notes to pro forma financial information. 19 NOTES TO PRO FORMA FINANCIAL INFORMATION (1) The unaudited pro forma information presented herein is not necessarily indicative of the results of operations or the combined financial position that would have resulted had the Mergers, the Signet acquisition or either of the Wheat or CoreStates acquisitions been consummated at the beginning of the applicable periods indicated, nor is it necessarily indicative of the results of operations in future periods or the future financial position of the combined entities. Consummation of the Mergers, the Signet acquisition or either of the Wheat or CoreStates acquisitions is not contingent upon consummation of any other of such acquisitions. Pro forma financial information with respect to the Mergers and the Signet and CoreStates acquisitions assumes such acquisitions were consummated as of the beginning of each period presented. Such information for Wheat for the 12-month periods ended March 31 has been added to comparable information related to FUNC, Signet and CoreStates for the preceding 12-month periods ended December 31, as appropriate. Pro forma financial information for the Mergers is included only for the nine months ended September 30, 1997, and December 31, 1996. See "CERTAIN RECENT DEVELOPMENTS" and "CERTAIN UPDATED INFORMATION RELATING TO THE MERGERS -- Accounting Treatment" in this Supplement and "RECENT DEVELOPMENTS" and "THE MERGER -- Accounting Treatment" in the Prospectus/Proxy Statement. (2) The Mergers will be accounted for on a purchase accounting basis, and accordingly, the related pro forma adjustments herein reflect, where applicable, (i) an exchange ratio of (a) 1.516 shares of FUNC Common Stock for each of the 138,000 shares of Covenant Series A Preferred Stock which were outstanding at September 30, 1997, (b) an exchange ratio of 1.2 shares of FUNC Common Stock for each of the 162,000 shares of Covenant Series B Preferred Stock which were outstanding at September 30, 1997, (c) an exchange ratio of .3813 shares of FUNC Common Stock for each of the 3,057,000 shares of Covenant Common Stock which were outstanding at September 30, 1997, and (d) the resulting issuance of 1,743,000 shares of FUNC Common Stock; (ii) the repurchase of such shares in the open market at a cost of $87 million; and (iii) an increase in goodwill and deposit base premium of $49 million and $6 million, respectively. Additionally, the pro forma adjustments related to the unaudited pro forma combined condensed statements of income with respect to the Mergers reflect a (i) 5.51 percent and 5.27 percent cost of funds for the nine months ended September 30, 1997, and for the year ended December 31, 1996, respectively; (ii) ten-year sum-of-the-years' digits method related to deposit base premium; and (iii) 25-year straight-line life related to goodwill. As a result, for the nine months ended September 30, 1997, and the year ended December 31, 1996, these adjustments amounted to (i) an increase in noninterest expense of $2 million and $10 million, respectively; and (ii) reductions in (a) interest income of $2 million and $4 million, respectively; (b) income taxes of $1 million and $5 million, respectively, and (c) net income applicable to common stockholders of $5 million and $9 million, respectively. (3) The Signet acquisition, which was consummated on November 28, 1997, will be accounted for on a pooling of interests accounting basis, and accordingly, the related pro forma adjustments herein reflect, where applicable, an exchange ratio of 1.10 shares of FUNC Common Stock for each of the 60,944,000 shares of Signet common stock which were outstanding at September 30, 1997. As a result, information was adjusted for the Signet acquisition by the (i) addition of 67,038,000 shares of FUNC Common Stock amounting to $224 million; (ii) elimination of 60,944,000 shares of Signet common stock amounting to $305 million; and (iii) recordation of the remaining amount of $81 million as an increase to paid-in capital at September 30, 1997. As of September 30, 1997, FUNC and Signet had 50,530,000 and 3,501,000 shares of common stock reserved for issuance primarily for stock option plans, respectively, (excluding, as to FUNC, shares reserved for issuance in connection with the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions, or upon exercise of the rights attached to shares of FUNC Common Stock and, as to Signet, shares reserved for issuance upon exercise of the rights attached to shares of Signet common stock), which are not included in the unaudited pro forma financial information presented herein. For the nine months ended September 30, 1997, Signet had net income applicable to common stockholders of $73 million. (4) It is assumed that the Wheat acquisition will be accounted for on a pooling of interests accounting basis, and accordingly, the related pro forma adjustments herein reflect, where applicable, an exchange ratio of 1.1621 shares of FUNC Common Stock for each of the 209,000 shares of Wheat preferred stock and 8,599,000 shares of Wheat common stock which were outstanding at September 30, 1997. The 1.1621 exchange ratio is subject to possible adjustment under certain circumstances. 20 As a result, information was adjusted for the Wheat acquisition by the (i) addition of 10,267,000 shares of FUNC Common Stock amounting to $34 million; (ii) elimination of 209,000 shares of Wheat preferred stock amounting to $3 million; (iii) elimination of 8,599,000 shares of Wheat common stock amounting to $17 million; and (iv) recordation of the remaining amount of $14 million as a reduction of paid-in capital at September 30, 1997. As of September 30, 1997, FUNC had 50,530,000 shares, and Wheat had no shares of common stock reserved for issuance primarily for stock option plans (excluding, as to FUNC, shares reserved for issuance in connection with the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions, or upon exercise of the rights attached to shares of FUNC Common Stock), which are not included in the unaudited pro forma financial information presented herein. For the nine months ended September 30, 1997, Wheat had net income applicable to common stockholders of $33 million, which includes $9 million related to Wheat's results of operations in the fourth quarter ended March 31, 1997. (5) It is assumed that the CoreStates acqusition will be accounted for on a pooling of interests accounting basis, and accordingly, the related pro forma adjustments herein reflect, where applicable, an exchange ratio of 1.62 shares of FUNC Common Stock for each of the 199,779,000 shares of CoreStates common stock which were outstanding at September 30, 1997. The 1.62 exchange ratio is subject to possible adjustment under certain circumstances. As a result, information was adjusted for the CoreStates acquisition by the (i) addition of 323,642,000 shares of FUNC Common Stock amounting to $1.1 billion (excluding an estimated 3.5 million shares of CoreStates common stock that CoreStates expects to issue in order to qualify the CoreStates Acquisition as a pooling of interests and including 2,182,000 shares of CoreStates common stock allocated to the CoreStates ESOP); (ii) elimination of 199,779,000 shares of outstanding CoreStates common stock amounting to $200 million; (iii) elimination of the cost of CoreStates treasury stock of $1.3 billion of which $1.1 billion reduced retained earnings; (iv) reclassification of the cost of unallocated shares held by the CoreStates ESOP of $52 million; and (v) recordation of the remaining amount of $1.0 billion as a reduction of paid-in capital at September 30, 1997. As of September 30, 1997, FUNC and CoreStates had 50,530,000 and 16,915,000 shares of common stock reserved for issuance primarily for stock option plans, respectively, (excluding, as to FUNC, shares reserved for issuance in connection with the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions, or upon exercise of the rights attached to shares of FUNC Common Stock), which are not included in the unaudited pro forma financial information presented herein. For the nine months ended September 30, 1997, CoreStates had net income applicable to common stockholders of $597 million. In 1993, CoreStates changed its method of accounting for postemployment benefits, and in 1993 CoreStates reported additional expense as a cumulative effect of a change in accounting principle, net of tax of $16 million in 1993 and $108 million in 1992. Such amounts have been appropriately reclassified to noninterest expense and income taxes in 1993 and 1992, respectively, in the pro forma financial information presented herein. (6) In the second quarter of 1997, FUNC acquired the Bank of Boca Raton with assets of $29 million, net loans of $15 million and deposits of $27 million for $2 million in cash. This purchase accounting acquisition has been reflected in the pro forma financial information only from the date of consummation. From January 1, 1997, through September 30, 1997, FUNC has purchased 24 million shares of FUNC Common Stock in the open market at a cost of $1.0 billion, of which 1.65 million shares relate to the Mergers as noted above. The historical financial statements of FUNC will be restated for the CoreStates acquisition for all periods presented and for the Signet acquisition only for periods beginning on and after January 1, 1995. Such financial statements will not be restated as a result of the Mergers or the Wheat acquisition. (7) Income per share data has been computed based on the combined historical net income applicable to common stockholders of FUNC, Signet, Covenant, Wheat and CoreStates using the historical weighted average shares outstanding of FUNC Common Stock and the weighted average outstanding shares, adjusted to equivalent shares of FUNC Common Stock, as of the earliest applicable period presented, as appropriate. (8) Certain insignificant reclassifications have been included herein to conform to statement presentations. Transactions conducted in the ordinary course of business between FUNC, Signet, Covenant, Wheat and CoreStates are immaterial, and accordingly, have not been eliminated. 21 (9) The unaudited pro forma financial information does not include any material merger-related expenses or any material expenses related to the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions. FUNC currently estimates after-tax restructuring and merger-related charges of approximately (i) $135 million related to the Signet acquisition, or $0.42 per share of FUNC Common Stock, expected to be taken in the fourth quarter of 1997, and (ii) $795 million related to the CoreStates acquisition, or $0.81 per share of FUNC Common Stock, expected to be taken in the second quarter of 1998. In addition, FUNC expects to incur an estimated $75 million in pre-tax restructuring and merger-related expenses in the 12-month period following the CoreStates acquisition. See "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION" in this Supplement. (10) FUNC expects to realize significant revenue enhancements and cost savings from the Signet acquisition and the CoreStates acquisition. The pro forma financial information, which does not reflect any revenue enhancements, direct costs or potential savings from the consolidation of operations of FUNC, Signet, Covenant, Wheat and CoreStates, is not indicative of the results of future operations. No assurance can be given with respect to the ultimate level of such revenue enhancements or cost savings. As indicated by the foregoing unaudited pro forma financial information and based solely on the foregoing assumptions, consummation of the Mergers, the Signet acquisition and the Wheat and CoreStates acquisitions would have diluted FUNC's historical net income per common share for the nine months ended September 30, 1997, and the year ended December 31, 1996, by 15 percent and 13 percent, respectively. See "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION" in this Supplement. 22 EXHIBIT A QUARTERLY REPORT ON FORM 10-Q OF COVENANT BANCORP, INC. FOR THE QUARTER ENDED SEPTEMBER 30, 1997 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________. Commission file #0-22699 COVENANT BANCORP, INC. (Exact name of registrant as specified in its charter) NEW JERSEY 22-2890624 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number)
18 KINGS HIGHWAY WEST, HADDONFIELD, NEW JERSEY 08033 (Address of Principal Executive Offices) (Zip Code) (609) 428-7300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. (Note: Registrant is successor to Covenant Bank, whose shares were previously registered with the Federal Deposit Insurance Corporation). Yes _X_ No ___ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practical date. COMMON STOCK 3,057,332 - --------------------------------------------- --------------------------------------------- (TITLE OF CLASS) (NO. OF SHARES OUTSTANDING AS OF 11/07/97) SERIES A NON-CUMULATIVE CONVERTIBLE PREFERRED STOCK 138,300 - --------------------------------------------- --------------------------------------------- (TITLE OF CLASS) (NO. OF SHARES OUTSTANDING AS OF 11/07/97) SERIES B NON-CUMULATIVE CONVERTIBLE PREFERRED STOCK 161,700 - --------------------------------------------- --------------------------------------------- (TITLE OF CLASS) (NO. OF SHARES OUTSTANDING AS OF 11/07/97)
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- COVENANT BANCORP, INC. AND SUBSIDIARIES TABLE OF CONTENTS
FINANCIAL INFORMATION PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets (Unaudited) September 30, 1997 and December 31, 1996.................................................................................... A-2 Consolidated Statements of Income (Unaudited) Three months ended September 30, 1997 and September 30, 1996................................................................ A-3 Consolidated Statements of Income (Unaudited) Nine months ended September 30, 1997 and September 30, 1996................................................................ A-4 Consolidated Statements of Cash Flows (Unaudited) Nine months ended September 30, 1997 and September 30, 1996................................................................ A-5 Consolidated Statements of Changes in Stockholders' Equity............................................... A-6 Notes to Consolidated Financial Statements (Unaudited)................................................... A-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................................... A-9 PART II. OTHER INFORMATION........................................................................................ A-19 Item 6. Exhibits and Reports on Form 8-K
A-1 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------ ----------------- (IN THOUSANDS) Assets: Cash and due from banks......................................................... $ 15,653 $ 12,446 Federal funds sold.............................................................. -- 3,100 ------------------ ----------------- Cash and cash equivalents.................................................. 15,653 15,546 ------------------ ----------------- Investments available for sale (cost 1997 -- $120,091; 1996 -- $133,061)............................................................. 119,944 132,578 ------------------ ----------------- Investment securities (fair value 1997 -- $11,236; 1996 -- $11,743).............................................................. 11,144 11,687 Loans held for sale............................................................. 338 -- Loans receivable........................................................... 257,585 241,201 Less allowance for loan losses.................................................. 2,714 3,016 ------------------ ----------------- Loans receivable, net........................................................... 254,871 238,185 ------------------ ----------------- Premises and equipment, net..................................................... 9,376 9,135 Real estate owned............................................................... 1,049 695 Accrued interest receivable..................................................... 3,222 3,913 Other assets.................................................................... 4,255 2,895 ------------------ ----------------- Total Assets............................................................... $419,852 $ 414,634 ------------------ ----------------- ------------------ ----------------- Liabilities: Non-interest bearing deposits................................................... 47,819 41,868 Interest bearing deposits....................................................... 107,237 96,169 Time deposits................................................................... 149,008 139,428 ------------------ ----------------- Total deposits............................................................. 304,064 277,465 ------------------ ----------------- Advances from The Federal Home Loan Bank........................................ 14,700 20,500 Securities sold under agreements to repurchase.................................. 64,362 84,037 Other liabilities............................................................... 4,590 3,381 ------------------ ----------------- Total Liabilities.......................................................... 387,716 385,383 ------------------ ----------------- Commitments and Contingencies Stockholders' Equity: Preferred stock authorized 300,000 shares; Series "A", $25 par value: issued and outstanding 138,300 and 138,300 shares, respectively............................................................... 3,457 3,457 Series "B", $25 par value: issued and outstanding 161,700 and 161,700 shares, respectively............................................................... 4,043 4,043 Common stock, $5 par value: authorized 5,000,000 shares; issued and outstanding 3,057,332 and 2,906,262 shares, respectively.................................. 15,287 14,531 Additional paid-in capital...................................................... 12,137 10,614 Net unrealized holding (loss) on investments available for sale................. (97) (305) Accumulated deficit............................................................. (2,691) (3,089) ------------------ ----------------- Total Stockholders' Equity................................................. 32,136 29,251 ------------------ ----------------- Total Liabilities and Stockholders' Equity................................. $419,852 $ 414,634 ------------------ ----------------- ------------------ -----------------
See accompanying notes to consolidated financial statements. A-2 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, ---------------- 1997 1996 ------ ------ (IN THOUSANDS) Interest Income Interest and fees on loans............................................................................... $5,727 $5,144 Interest on investment securities........................................................................ 2,188 2,130 Other interest income.................................................................................... 24 159 ------ ------ Total interest income................................................................................. 7,939 7,433 Interest Expense Interest on deposits..................................................................................... 2,716 2,469 Interest on borrowings................................................................................... 1,278 1,126 ------ ------ Total interest expense................................................................................ 3,994 3,595 ------ ------ Net interest income........................................................................................ 3,945 3,838 Provision for loan losses.................................................................................. 3 483 ------ ------ Net interest income after provision for loan losses........................................................ 3,942 3,355 ------ ------ Other Income Service charges on deposit accounts...................................................................... 205 179 Loan servicing income.................................................................................... 62 69 Other operating income................................................................................... 67 62 Gain on sale of assets................................................................................... -- -- ------ ------ Total other income.................................................................................... 334 310 ------ ------ Other Expenses Salaries and employee benefits........................................................................... 1,760 1,641 Net occupancy............................................................................................ 470 398 Data processing and other service costs.................................................................. 258 283 Professional services.................................................................................... 80 163 Advertising and promotion................................................................................ 50 53 SAIF recapitalization costs.............................................................................. -- 504 Merger costs............................................................................................. -- 666 Federal insurance premiums............................................................................... 18 59 Other operating expenses................................................................................. 379 397 ------ ------ Total other expenses.................................................................................. 3,015 4,164 ------ ------ Income (loss) before income taxes.......................................................................... 1,261 (499) Income taxes (benefit)..................................................................................... 336 (86) ------ ------ Net income (loss).......................................................................................... 925 (413) Less: preferred stock dividends............................................................................ 112 112 ------ ------ Net income (loss) applicable to common shareholders........................................................ $ 813 $ (525) ------ ------ ------ ------ Income (loss) per common share and common stock equivalents................................................ $ 0.21 $(0.17) ------ ------ ------ ------ Weighted average common stock and common stock equivalents outstanding..................................... 4,358 3,175
See accompanying notes to consolidated financial statements A-3 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------ 1997 1996 ------- ------- (IN THOUSANDS EXCEPT PER SHARE DATA) Interest Income Interest and fees on loans............................................................................ $16,627 $15,010 Interest on investment securities..................................................................... 6,851 6,350 Other interest income................................................................................. 71 356 ------- ------- Total interest income.............................................................................. 23,549 21,716 Interest Expense Interest on deposits.................................................................................. 7,881 7,177 Interest on borrowings................................................................................ 4,201 3,376 ------- ------- Total interest expense............................................................................. 12,082 10,553 ------- ------- Net interest income..................................................................................... 11,467 11,163 Provision for loan losses............................................................................... 33 524 ------- ------- Net interest income after provision for loan losses..................................................... 11,434 10,639 ------- ------- Other Income Service charges on deposit accounts................................................................... 516 519 Loan servicing income................................................................................. 153 193 Other operating income................................................................................ 157 146 Gain on sale of assets................................................................................ 11 -- ------- ------- Total other income................................................................................. 837 858 ------- ------- Other Expenses Salaries and employee benefits........................................................................ 4,835 4,798 Net occupancy......................................................................................... 1,388 1,186 Data processing and other service costs............................................................... 522 707 Professional services................................................................................. 235 434 Advertising and promotion............................................................................. 125 146 SAIF recapitalization costs........................................................................... -- 504 Merger costs.......................................................................................... -- 666 Federal insurance premiums............................................................................ 57 179 Other operating expenses.............................................................................. 1,091 1,118 ------- ------- Total other expenses............................................................................... 8,253 9,738 ------- ------- Income before income taxes.............................................................................. 4,018 1,759 Income taxes............................................................................................ 1,279 736 ------- ------- Net income.............................................................................................. 2,739 1,023 Less: preferred stock dividends......................................................................... 337 337 ------- ------- Net income applicable to common shareholders............................................................ $ 2,402 $ 686 ------- ------- ------- ------- Income per common share and common stock equivalents.................................................... $ 0.63 $ 0.22 ------- ------- ------- ------- Weighted average common stock and common stock equivalents outstanding.................................. 4,347 3,168
See accompanying notes to consolidated financial statements. A-4 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ------------------ 1997 1996 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................................................................ $ 2,739 $ 1,023 Adjustments to reconcile net income to net cash (used) provided by operating activities: Provision for loan losses............................................................................. 33 524 Depreciation and amortization......................................................................... 478 392 Amortization of premiums and discounts, net........................................................... 57 119 Loans originated for sale............................................................................. (641) (951) Proceeds from sales of loans held for sale............................................................ 303 1,887 Decrease in unearned discounts and loan fees, net..................................................... (254) (206) Increase in accrued interest receivable and other assets.............................................. (669) (1,222) Increase in other liabilities......................................................................... 1,209 1,344 ------- ------- Net cash provided by operating activities.......................................................... 3,255 2,910 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments held to maturity............................................................. -- (1,312) Purchases of investments available for sale........................................................... (6,970) (63,095) Proceeds from maturities of investments available for sale............................................ 20,000 -- Proceeds from maturities of investments held to maturity.............................................. -- 41,665 Principal collected on mortgage backed securities..................................................... 518 621 Net increase in loans................................................................................. (17,459) (23,218) Proceeds from sales of real estate owned.............................................................. 420 884 Purchases of premises and equipment................................................................... (719) (977) ------- ------- Net cash used in investing activities.............................................................. (4,210) (45,432) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits.............................................................................. 26,599 23,127 Net increase (decrease) in securities sold under agreements to repurchase............................. (19,675) 22,749 Net decrease in advances from the Federal Home Loan Bank.............................................. (5,800) (5,500) Preferred stock dividends paid........................................................................ (337) (337) Common stock issuance and other....................................................................... 275 (594) ------- ------- Net cash provided by financing activities.......................................................... 1,062 39,445 Net increase (decrease) in cash and cash equivalents.................................................. 107 (3,077) Cash and cash equivalents at the beginning of the year.................................................. 15,546 22,777 ------- ------- Cash and cash equivalents at the end of the period...................................................... $15,653 $19,700 ------- ------- ------- ------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest........................................................... $12,163 $10,575 Cash paid during the period for income taxes....................................................... 1,031 768 Noncash investing and financing activities: Net transfers to real estate owned from loans receivable........................................... 773 559 Net change in gross unrealized (loss) on investments available for sale............................ $ 336 $(1,015)
See accompanying notes to consolidated financial statements. A-5 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS, INCLUDING SHARE DATA)
ADDITIONAL PREFERRED COMMON PAID-IN NET UNREALIZED ACCUMULATED STOCK STOCK CAPITAL GAIN (LOSS) DEFICIT TOTAL --------- ------- ---------- ----------- ----------- ------- Balance at January 1, 1996........................ $ 7,500 $13,559 $ 9,212 $ 1,157 $(1,519) $29,909 Net income twelve months ended December 31, 1996.. -- -- -- -- 1,850 1,850 Preferred stock dividend.......................... -- -- -- -- (450) (450) Adjustment to unrealized gain (net of tax)........ -- -- -- (1,462) -- (1,462) Common stock dividends and other (194 shares)..... -- 972 1,402 -- (2,970) (596) --------- ------- ---------- -------------- ----------- ------- Balance at December 31, 1996...................... 7,500 14,531 10,614 (305) (3,089) 29,251 Net income nine months ended September 30, 1997... -- -- -- -- 2,739 2,739 Preferred stock dividend.......................... -- -- -- -- (337) (337) Adjustment to unrealized loss (net of tax)........ -- -- -- 208 -- 208 Common stock dividends and other (151 shares)..... -- 756 1,523 -- (2,004) 275 --------- ------- ---------- -------------- ----------- ------- Balance at September 30, 1997..................... $ 7,500 $15,287 $ 12,137 $ (97) $(2,691) $32,136 --------- ------- ---------- -------------- ----------- ------- -------- ------- ---------- -------------- ----------- -------
See accompanying notes to consolidated financial statements. A-6 COVENANT BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) A. CONSOLIDATED FINANCIAL STATEMENTS The financial statements included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The accompanying condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. Such adjustments are of a normal recurring nature. On June 13, 1997, Covenant Bancorp, Inc. (the "Company") was formed and registered with the SEC. Also on that date, Covenant Bank (the "Bank") was acquired by the Company. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Bank's Annual Report (Amendment No. 2 to Form F-2 dated April 28, 1997, filed with the Federal Deposit Insurance Corporation) for the period ended December 31, 1996. The annual report is also included in the Registrant's Registration Statement on Form S-4 dated April 28, 1997. The results for the three and nine months ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. The consolidated financial statements include the accounts of Covenant Bancorp, Inc. and all of its subsidiaries, including Covenant Bank. All material intercompany transactions have been eliminated. B. COMMITMENTS In the normal course of business, there are various outstanding commitments to extend credit, such as letters of credit and unadvanced loan commitments, which are not reflected in the accompanying consolidated financial statements. Management does not anticipate any material losses as a result of these transactions. C. SFAS NO. 128 -- EARNINGS PER SHARE In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. This statement establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. This Statement simplifies the standards for computing earnings per share previously found in APB Opinion No. 15, Earnings per Share, and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the statement of operations for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. This Statement is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. This Statement requires restatement of all prior-period EPS data presented. Had the Company adopted this Statement as of September 30, 1997, the pro forma earnings per share would have been:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997 --------------------------------------------- WEIGHTED PRO FORMA INCOME AVERAGE SHARES EARNINGS PER (NUMERATOR) (DENOMINATOR) SHARE ----------- -------------- ------------ Basic EPS Net income available to common shareholders...................................... $ 813 3,057 $ 0.27 Effect of dilutive securities Convertible preferred stock...................................................... 112 1,059 Stock options.................................................................... -- 242 ----------- -------------- Dilutive EPS Income available to common shareholders plus assumed conversions................. $ 925 4,358 $ 0.21
A-7 COVENANT BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED C. SFAS NO. 128 -- EARNINGS PER SHARE -- Continued
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 --------------------------------------------- WEIGHTED PRO FORMA INCOME AVERAGE SHARES EARNINGS PER (NUMERATOR) (DENOMINATOR) SHARE ----------- -------------- ------------ Basic EPS Net income available to common shareholders...................................... $ 2,402 3,051 $ 0.79 Effect of dilutive securities Convertible preferred stock...................................................... 337 1,059 Stock options.................................................................... -- 237 ----------- -------------- Dilutive EPS Income available to common shareholders plus assumed conversions................. $ 2,739 4,347 $ 0.63
D. ISSUANCE OF COMMON STOCK On July 14, 1997, the Company issued a 4% stock dividend on its common stock to shareholders of record on June 24, 1997, resulting in the issuance of 117,110 additional shares of common stock and cash paid in lieu of fractional shares of $5,957. All share and per share data has been adjusted to reflect the retroactive recognition of all stock dividends declared. E. SUBSEQUENT EVENT On August 5, 1997, the Company and First Union Corporation (First Union) executed a definitive merger agreement in which First Union would acquire the Company. The Company's shareholders will receive .3813 shares of First Union common stock for each share of the Company's common stock. Each share of the two issues of the Company's convertible preferred stock will be exchanged for a number of shares of First Union common stock equal to the respective conversion ratios of the preferred stock times the merger exchange ratio of .3813. The acquisition, which will be accounted for under the purchase method of accounting, is subject to various conditions including the approval of the Company's shareholders and regulatory approvals. It is anticipated that the transaction will close during the first quarter of 1998. A-8 COVENANT BANCORP, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Covenant Bancorp, Inc. and its subsidiaries, ("the Company"), recorded net income of $2.7 million, or $0.63 per share for the nine months ended September 30, 1997, as compared to $1.0 million, or $0.22 for the nine months ended September 30, 1996. The nine months ended September 30, 1996 results included merger-related costs associated with the Company's acquisition in September 1996 of 1st Southern State Bank, and a one-time SAIF recapitalization assessment, aggregating $1.2 million, after tax. Net interest income was positively impacted by a 10% increase in average interest-earning assets for the nine month period ended September 30, 1997, compared to the nine months ended September 30, 1996. Return on average assets was 0.86% and return on average common equity was 13.96% for the nine month period ended September 30, 1997, compared to 0.35% and 4.08%, respectively, for the nine month period ended September 30, 1996. All prior period amounts have been restated to reflect the September 1996 acquisition of 1st Southern State Bank ("1st Southern"). For the three months ended September 30, 1997, the Company reported net income of $925,000, or $0.21 per share compared to a net loss of $413,000, or $0.17 per share for the third quarter of 1996 which included the above-mentioned non-recurring costs. Net interest income increased 3% for the third quarter of 1997 when compared to the third quarter of 1996 due to the above-mentioned increase in average interest-earning assets. Return on average assets and return on average common equity for the three months ended September 30, 1997 were 0.86% and 13.67%, respectively, compared to (0.41)% and (9.61)%, respectively, for the same period in 1996. Total assets amounted to $419.9 million at September 30, 1997, compared to $414.6 million at December 31, 1996, representing an increase of $5.3 million since year-end 1996. Net loans totaled $254.9 million, representing a 7% increase, over the year-end 1996 balance. Total deposits increased $26.6 million to reach $304.1 million at September 30, 1997, from the December 31, 1996 balance of $277.5 million. Stockholders' equity was $32.1 million at September 30, 1997. The Company's capital position meets the definition of a well-capitalized institution, which is evident by its leverage ratio, which stood at 7.50% and its Tier 1 and Total Capital ratios, which equaled 12.46% and 13.51%, respectively. On August 5, 1997, the Company and First Union Corporation (First Union) executed a definitive merger agreement in which First Union would acquire the Company. The Company's shareholders will receive .3813 shares of First Union common stock for each share of the Company's common stock. Each share of the two issues of the Company's convertible preferred stock will be exchanged for a number of shares of First Union common stock equal to the respective conversion ratios of the preferred stock times the merger exchange ratio of .3813. The acquisition, which will be accounted for under the purchase method of accounting, is subject to various conditions including the approval of the Company's shareholders and regulatory approvals. It is anticipated that the transaction will close during the first quarter of 1998. RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is the difference between interest earned on loans and investments and interest incurred on deposits and other borrowed funds. Net interest income is affected by changes in both interest rates and the amounts of interest-earning assets and interest-bearing liabilities outstanding. Net interest income for the nine months ended September 30, 1997 increased $304,000 or 3% to $11.5 million, compared to $11.2 million for the same period in 1996 primarily due to an increase in average loans of $34.9 million or 15% and a $2.6 million increase in average investments (see page A-11 for an average balance sheet and average rate comparisons). The increase in average loans is concentrated in the commercial and commercial mortgage portfolios of $22.1 million or 15% and a $8.7 million increase in 1-4 family mortgage loans. The increase in net interest income associated with growth in the loan portfolio has been largely offset by a compression in the net interest margin to 3.83% for the nine months ended September 30, 1997 from 4.12% for the same period in 1996. The decrease in the net interest margin is due to the following factors: 1) a decline in the yield on the total loan portfolio to 8.71% for the nine month period ended September 30, 1997 from 9.11% for the same period in 1996, caused by overall market conditions; and 2) the increase in the Company's loan portfolio funded by higher-priced securities sold under agreements to repurchase and certificates of deposit rather than the Company's core deposit base, causing the Company's cost of funds to increase from 4.50% for the nine months ended September 30, 1996 to A-9 4.65% for the same period of 1997. Delays in the opening of the Company's three new personal financial centers resulted in the need for these types of short-term higher-costing funding sources. Net interest income for the three months ended September 30, 1997 increased $107,000 or 3% to $3.9 million, compared to $3.8 million for the same period in 1996. As discussed in the nine month results, the improvement is directly related to the increase in average interest-earning assets during the third quarter of 1997, as compared to the same period in 1996, partially offset by a narrowing in the net interest margin. OTHER INCOME Other income for the first nine months of 1997 totaled $837,000, compared to $858,000 for the same period of 1996. Service charges on deposit accounts equaled $516,000 for the nine months ended September 30, 1997. Loan servicing income decreased $40,000 to $153,000 for the nine months ended September 30, 1997 when compared to the same period of 1996 and is attributable to volume decreases in investor servicing fees, late fees, and credit card fees. Other operating income increased $11,000 or 7.5% to $157,000 for the nine months ended September 30, 1997, compared to the same period in 1996, due to an increase in MAC surcharge income and volume increases in safe deposit box fees. The one-time gain of $11,000 on sale of assets during the second quarter of 1997 was due to a subdivision and subsequent sale of a small parcel of land and building that had been previously purchased with the Company's North Wildwood personal financial center. Other income for the three month period ended September 30, 1997 totaled $334,000, compared to $310,000 for the same period of 1996, representing a $24,000 or 8% increase. The increase in service charges on deposit accounts of $26,000 was associated with an increase in core deposit accounts over the past twelve months. Loan servicing income decreased $7,000 to $62,000 for the third quarter of 1997 when compared to the same period of 1996 and is also attributable to volume decreases in investor servicing fees, late fees and credit card fees. Other operating income increased $5,000 for the third quarter of 1997, primarily related to an increase in MAC surcharge income and volume increases in safe deposit box fees. OTHER EXPENSES Other expenses for the nine months ended September 30, 1997 equaled $8.3 million, compared to $9.7 million for the same period of 1996. Other expenses for the first nine months of 1996 included the one-time merger costs of $666,000 and the non-recurring SAIF assessment of $504,000. Excluding these one time charges, other expenses equaled $8.6 million for the nine months ended 1996, resulting in a decrease in other expenses of $315,000 or 4% excluding the one-time charges incurred in 1996. The ratio of total other expenses to average assets for the nine months ended September 30, 1997 improved to 2.58% from 2.97% for the same period of 1996. Cost containment and operating efficiency are continuing priorities of management. The Company's operating efficiency ratio (non-interest expenses, less other real estate expenses, divided by net interest income plus non-interest income excluding non-recurring gains) improved to 67% for the first nine months of 1997, compared to 71% for the same period of 1996. Salaries and employee benefits increased $37,000 or 1% and equaled $4.84 million for the first nine months of 1997, compared to $4.80 million for the same period in 1996. The salaries and benefits category is the largest component of other expenses, encompassing 59% of total other expenses as of September 30, 1997. The slight increase in salaries and employee benefits expense is attributable to reductions in staff in connection with the 1st Southern acquisition completed in September 1996, partially offset by staffing increases associated with the new personal financial centers opened since March of 1996. A-10 CONSOLIDATED AVERAGE BALANCE SHEET (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 ----------------------------------- ----------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE -------- -------- ------- -------- -------- ------- (IN THOUSANDS) Assets Loans:(1) Commercial.............................. $ 57,591 $ 3,885 9.01% $ 55,803 $ 3,918 9.39% Commercial mortgage..................... 107,736 7,200 8.93 87,425 6,400 9.79 Mortgage................................ 54,795 3,285 7.98 46,064 2,641 7.64 Consumer................................ 35,080 2,257 8.60 31,053 2,051 8.83 -------- -------- ------- -------- -------- ------- Total loans.......................... 255,202 16,627 8.71 220,345 15,010 9.11 Investments: Federal funds sold...................... 1,421 71 5.23 8,935 356 5.33 Investment securities................... 143,031 6,851 6.39 132,940 6,350 6.30 -------- -------- ------- -------- -------- ------- Total investments.................... 144,452 6,922 6.39 141,875 6,706 6.23 -------- -------- ------- -------- -------- ------- Total interest-earning assets........ 399,654 $ 23,549 7.88% 362,220 $ 21,716 8.02% -------- -------- ------- -------- -------- ------- Allowance for loan losses................. (2,930) (3,105) Cash and due from banks................... 11,912 10,185 Fixed assets (net)........................ 9,399 7,979 REO....................................... 709 1,244 Other assets.............................. 7,516 6,084 -------- -------- Total Assets......................... $426,260 $384,607 -------- -------- -------- -------- Liabilities and Stockholders' Equity Deposits: Interest-bearing demand................. $ 36,029 $ 622 2.31% $ 26,127 $ 473 2.42% Statement savings....................... 39,090 704 2.41 43,955 796 2.42 Money market............................ 21,242 515 3.24 21,858 410 2.51 Certificates of deposit................. 149,594 6,040 5.40 138,362 5,498 5.31 -------- -------- ------- -------- -------- ------- Total interest-bearing deposits...... 245,955 7,881 4.28 230,302 7,177 4.17 FHLB advances and securities sold under agreements to repurchase................ 101,282 4,201 5.55 83,474 3,376 5.41 -------- -------- ------- -------- -------- ------- Total interest bearing liabilities... 347,237 12,082 4.65 313,776 10,553 4.50 -------- -------- ------- -------- -------- ------- Non-interest bearing deposits............. 45,178 38,277 Other liabilities......................... 3,743 2,986 Stockholders' equity...................... 30,102 29,568 -------- -------- Total Liabilities and Stockholders' Equity............................... $426,260 $384,607 -------- -------- -------- -------- Net Interest Income/Spread................ $ 11,467 3.23% $ 11,163 3.52% -------- ------- -------- ------- -------- ------- -------- ------- Net Interest Margin (2)................... 3.83% 4.12% ------- ------- ------- -------
- --------------- (1) Includes non-accruing loans. The effect of including such loans is to reduce the average rate earned on Covenant's loans. (2) Net interest income as a percentage of average interest-earning assets. A-11 Net occupancy increased $202,000 to $1.4 million for the nine months ended September 30, 1997 due to additional personal financial centers opened in Hammonton (3/96), the relocated Linwood center (10/96), Mount Laurel (12/96) and Cherry Hill (3/97), and the establishment of an operations center in Voorhees, NJ during the second quarter of 1996. Data processing and other service costs declined $185,000 to $522,000 for the nine months ended September 30, 1997, compared to $707,000 for the same period of 1996. The Company's acquisition of 1st Southern and the operating efficiencies gained due to the system conversion in September 1996 are primarily attributable for the reduction in costs. Professional services expenses decreased $199,000 to $235,000 for the first nine months of 1997, compared to $434,000 for the same period of 1996. The reduction is related to decreases of $84,000 in legal expenses related to the decrease in problem credits; a $20,000 decrease in consulting expenses due to the discontinuance of certain advertising and promotion programs and a $95,000 decrease in audit and examinations expense due to the acquisition of 1st Southern. Federal insurance premiums declined $122,000 to $57,000 for the first nine months of 1997 due to a reduction in the Bank Insurance Fund premiums. Other operating expenses decreased $27,000 to $1.1 million for the nine months ended September 30, 1997, compared to the same period of 1996. Other expenses for the three months ended September 30, 1997 equaled $3.0 million, compared to $4.2 million for the same period in 1996, excluding the one-time charges incurred mentioned above other expenses equaled $3.0 million, representing an increase of $21,000 or 1% over the third quarter of 1996. Salaries and employee benefits increased $119,000 to $1.8 million for the third quarter of 1997 when compared to the same period in 1996. The increase in salaries and employee benefits expense is directly associated with the new staffing positions created for the new personal financial centers noted above. Net occupancy increased $72,000 to $470,000 for the three months ended September 30, 1997, compared to the same period of 1996 due to the above-mentioned new personal financial centers. Data processing and service costs decreased $25,000 for the three months ended September 30, 1997, compared to the same period in 1996. The Company's system conversion in September 1996 along with the acquisition of 1st Southern created operating efficiencies and are primarily attributable to the reduction in data processing costs offset by increased costs related to new accounts added over the last twelve months. Professional services expenses decreased $83,000 for the third quarter of 1997 to $80,000, compared to the same period in 1996. The reduction is related to a decrease in legal expenses related to a decrease in problem credits, a decrease in consulting expenses due to the discontinuance of certain advertising and promotion programs, and a decrease in audit and examination expense due to the acquisition of 1st Southern. Federal insurance premiums declined $41,000 to $18,000 for the three months ended September 30, 1997 as compared to the same period in 1996 due to a reduction in the Bank Insurance Fund premium. Other operating expenses increased $18,000 to $379,000 for the three months ended September 30, 1997, compared to the same period in 1996 due to increases in postage, insurance and telephone expenses related to the new branch facilities opened. FINANCIAL CONDITION LOAN PORTFOLIO The lending function is the Company's principal business activity and it continues its policy to serve as a reliable source of credit to a diverse customer base. The Company lends primarily to commercial borrowers in the southern New Jersey marketplace. The loan portfolio is diversified, with 64% of the portfolio comprised of commercial and commercial mortgage loans and 36% comprised of residential mortgage loans and consumer loans at September 30, 1997. At September 30, 1997, the Company's net loan portfolio totaled $254.9 million, compared to $238.2 million as of December 31, 1996. The $16.7 million or 7% in growth in net loans has been concentrated within the commercial, commercial mortgage and residential mortgage loan portfolios. The majority of the Company's loan portfolio is primarily categorized as secured by commercial and 1-4 family residential real estate properties (including home equity loans). It is the Company's continuing policy to emphasize well-collaterized and properly-structured loans and to promote long-term quality relationships with financially strong borrowers. NON-PERFORMING ASSETS Non-performing assets include those loans that are not accruing interest (non-accruing loans), loans that have been restructured and real estate owned. A-12 Generally, loans that are contractually past-due are placed on non-accrual status when interest on principal becomes 90 days past-due, unless, in the Company's assessment, the value of collateral securing the loan adequately ensures the likelihood of the ultimate collection of all unpaid principal and interest and the loan is in the process of collection. The following table sets forth information regarding non-performing assets and contractually past-due loans of September 30, 1997 and 1996 and December 31, 1996:
SEPT. 30, SEPT. 30, DEC. 31, 1997 1996 1996 --------- --------- -------- Non-performing assets: Non-accruing loans: Commercial.............................................................................. $ 664 $ 2,199 $1,734 Mortgage................................................................................ 1,024 1,273 931 Consumer................................................................................ 121 220 201 --------- --------- -------- Total non-performing loans................................................................ $ 1,809 $ 3,692 $2,866 Real estate owned......................................................................... 1,049 846 695 --------- --------- -------- Total non-performing assets............................................................... $ 2,858 $ 4,538 $3,561 --------- --------- -------- --------- --------- -------- Accruing loans 90 days past-due........................................................... $ 1,761 $ 1,743 $1,753 --------- --------- -------- --------- --------- -------- Non-performing loans as a percentage of loans............................................. 0.70% 1.62% 1.19% --------- --------- -------- --------- --------- -------- Non-performing asset as a percentage of loans and real estate owned....................... 1.10% 1.98% 1.47% --------- --------- -------- --------- --------- -------- Non-performing assets as a percentage of total assets..................................... 0.68% 1.17% 0.86% --------- --------- -------- --------- --------- --------
Non-performing assets totaled $2.9 million or 1.10% of total loans and real estate owned at September 30, 1997, showing marked improvement when compared to $3.6 million or 1.47% of total loans and real estate owned at December 31, 1996 and $4.5 million or 1.98% of total loans and real estate owned at September 30, 1996. Non-performing loans at September 30, 1997 decreased $1.1 million from the December 31, 1996 balance of $2.9 million due to a $1.1 million reduction in commercial non-performing loans and a reduction in consumer non-performing loans of $80,000 offset by an increase in mortgage non-performing loans of $93,000. The balance of non-performing loans at September 30, 1996 was $3.7 million or 1.62% of total loans. Real estate owned (net of reserves) was $1.1 millon at September 30, 1997, compared to $695,000 at December 31, 1996 and $846,000 at September 30, 1996. During the first nine months of 1997, additions to real estate owned of $773,000 (representing four foreclosed properties) were offset by the sale of six properties for $419,000, which resulted in the $354,000 increase in real estate owned. The balance of accruing loans 90 days past-due was $1.7 million at September 30, 1997, $1.8 million at December 31, 1996 and $1.7 million at September 30, 1996. The $8,000 increase in accruing loans 90 days past-due during the nine months ended September 30, 1997 is related to an increase of $369,000 in well-collateralized commercial loans, a $19,000 increase in various home equity consumer loans, offset by a $380,000 decrease of various residential mortgage loans. At September 30, 1997 and December 31, 1996, the Company had impaired loans totaling approximately $724,000 and $1,734,000, respectively. The allowance for loan losses on impaired loans has a valuation allowance of $124,000, and $199,000 at September 30, 1997 and December 31, 1996, respectively. The average balance of impaired loans totaled $1,315,000 and $1,684,000 for September 30, 1997 and December 31, 1996, respectively. Interest income not accrued for impaired loans for the nine months ended September 30, 1997 and for the twelve months ended December 31, 1996 was approximately $99,000 and $164,000, respectively. PROVISION AND ALLOWANCE FOR LOAN LOSSES The provision and allowance for loan losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be adequate to absorb known and inherent losses in the portfolio. Management considers a variety of factors when establishing the allowance, such as the impact of current economic conditions, diversification of the loan portfolio, delinquency statistics, results of loan review and related classifications, the borrower's perceived financial and managerial strengths, the estimated adequacy of underlying collateral and other relevant factors. Consideration is also given to examinations performed by regulatory authorities. A-13 The following table sets forth information regarding the Company's allowance for loan losses for the six month periods ended September 30, 1997 and 1996, and for the year ended December 31, 1996. CHANGES IN ALLOWANCE FOR LOAN LOSSES
YEAR NINE MONTHS ENDED ENDED ------------------- -------- 9/30/97 9/30/96 12/31/96 ------- ------- -------- Balance at beginning of period.............................................................. $ 3,016 $ 3,195 $3,195 Provision charge to operating expenses...................................................... 33 524 636 Charge-offs: Commercial................................................................................ (259) (456) (449) Mortgage.................................................................................. (55) (198) (417) Consumer.................................................................................. (64) (116) (124) ------- ------- -------- Total Charge-offs........................................................................... (378) (770) (990) Recoveries: Commercial................................................................................ 30 91 124 Mortgage.................................................................................. 4 11 -- Consumer.................................................................................. 9 25 51 ------- ------- -------- Total recoveries............................................................................ 43 127 175 ------- ------- -------- Net charge-offs............................................................................. (335) (643) (815) ------- ------- -------- Balance at end of period.................................................................... $ 2,714 $ 3,076 $3,016 ------- ------- -------- ------- ------- -------- Net charge-offs as a percentage of average loans............................................ 0.18% 0.39% 0.36% Allowance as a percentage of period-end loans............................................... 1.05 1.35 1.25 Allowance as a percentage of non-performing loans........................................... 150.03 83.32 105.20 Allowance as a percentage of non-performing assets.......................................... 94.99 67.78 84.70
Management is consistently informed of changes in economic indicators which may have impact, either positive or adverse, on asset quality, the allowance for loan losses, potential charge-offs and delinquencies. The provision for loan losses charged against earnings was $33,000 in the nine months of 1997, compared to $524,000 for the nine months of 1996 which included a $481,000 provision for loan losses during the third quarter of 1996 to align 1st Southern State Bank's allowance for loan loss methodology with Covenant as to the credit and non-performing processes at the time of the merger. Management believes that the allowance for loan losses at September 30, 1997 is adequate to absorb known and inherent losses in the portfolio. INVESTMENT SECURITIES Investment securities were $131.1 million at September 30, 1997, compared to $144.3 million at December 31, 1996. The $13.2 million decrease in investment securities was the result of purchases of $7.0 million of US Treasury Notes with maturities beyond one year and classified as "Available for Sale," offset by proceeds from maturities of investments available for sale of $20.0 million, $0.5 million principal collected on mortgage backed securities and an decrease of $336,000 in the gross unrealized loss on investments available for sale. At September 30, 1997, the fair value of investments available for sale was $119.9 million, and unrealized holding losses were $147,000. At December 31, 1996, the fair value of investments available for sale was $132.6 million and unrealized holding losses were $483,000. At September 30, 1997, securities held to maturity totaled $11.1 million compared to $11.7 million at December 31, 1996. The fair values of these investments were $11.2 million at September 30, 1997 and $11.7 million at December 31, 1996. The Company's investment portfolio is comprised of US Government securities, federal agency mortgage-backed securities and Federal Home Loan Bank ("FHLB") stock. The portfolio generates substantial interest income, serves as a source of liquidity and is used as a tool in managing interest rate sensitivity. Portions of the portfolio are also used to secure public deposits and serve as collateral for repurchase transactions. The investment portfolio also plays a significant role in the asset/liability management process. Among other things, the investment portfolio is utilized to balance the interest sensitivity of the prime-based portion of the loan portfolio. A-14 DEPOSITS The Company's predominant source of funds is depository accounts comprised of demand deposits, savings and money market accounts, time deposits and individual retirement accounts (IRA's). Deposits are provided by individuals and businesses located within the southern New Jersey marketplace. The Company gathers deposits from local municipalities within the guidelines of the Government Unit Deposit Protection Act (GUDPA). The Bank has no brokered deposits. The Company opened new personal financial centers in Linwood (relocation in October 1996), Mount Laurel (December 1996) and Cherry Hill (March 1997). Total deposits at September 30, 1997 equaled $304.1 million, compared to $277.5 million at December 31, 1996, representing a $26.6 million or 10% increase between December 31, 1996 and September 30, 1997. BORROWINGS Sources of funds for the Company other than deposits include FHLB advances and securities sold under agreements to repurchase. FHLB advances were $14.7 million at September 30, 1997 and $20.5 million at December 31, 1996. Securities sold under agreements to repurchase totaled $64.4 million at September 30, 1997, compared to $84.0 million at December 31, 1996. The decrease in securities sold under agreements to repurchase was related to the maturities and paydowns described above in the "INVESTMENT SECURITIES" section. ASSET AND LIABILITY MANAGEMENT The Company monitors its sensitivity to interest rate changes and its liquidity and capital position through its asset and liability management process. The Company's objectives include (i) controlling interest rate exposures, (ii) ensuring adequate liquidity, (iii) maintaining a strong capital position and (iv) maximizing net interest income opportunities. The Company manages these objectives centrally through the Asset Liability Management Committee (ALCO). INTEREST RATE SENSITIVITY The Company seeks to manage its sensitivity position to maximize earnings and minimize the risk associated with interest rate movements through the use of a "gap analysis" on a monthly basis. The gap analysis assesses the interest rate risk that arises from differences in the volumes of assets and liabilities that mature or reprice within a given period. A "positive" gap position results when the amount of interest-sensitive assets exceeds that of interest-sensitive liabilities, signifying that the net interest margin will be positively affected by rising rates and negatively affected by falling rates; a "negative" gap position results when the amount of interest-sensitive liabilities exceeds that of interest-sensitive assets, indicating that the net interest margin will be negatively affected by rising rates and positively affected by falling rates. However, the Company's gap position does not necessarily predict the impact of changes in general levels of interest rates or net interest income due to assumptions made as to repricing and maturities of certain products. Decisions are also based on "dynamic shock analysis," a process that entails the application of different prime rate increase or decrease scenarios to the current maturity/repricing structure. This analysis measures the impact on net interest income of each of the scenarios applied relative to the Company's interest rate risk management policy guidelines, and seeks to identify appropriate measures to maintain the interest sensitivity of net interest income within such policy guidelines. At September 30, 1997, the Company's "dynamic shock analysis" indicates an acceptable level of interest rate risk and is within policy guidelines. In the event that the Company's interest rate risk models indicate an unacceptable level of risk, the Company could undertake a number of actions that would reduce this risk, including the sale of a portion of its Available for Sale portfolio or the extension of the maturities of its short-term borrowings, or the use of other risk management strategies as determined by the Company's ALCO Committee. A-15 The following table illustrates the gap position of the Company as of September 30, 1997.
NON-INTEREST BEYOND SENSITIVE 1-90 91-180 181-365 ONE-FIVE FIVE ASSETS/ DAYS DAYS DAYS DAYS YEARS LIABILITIES TOTAL --------- --------- --------- --------- --------- ------------ --------- Rate sensitive assets: Interest earning assets Loans.......................... $ 81,916 $ 6,442 $ 13,122 $ 93,468 $ 60,980 -- $ 255,921 Investment securities.......... 8,018 18,108 19,064 47,110 38,788 -- 131,088 Loans held for sale............ 338 -- -- -- -- -- 338 --------- --------- --------- --------- --------- ------------ --------- Total interest earning assets.................... 90,272 24,550 32,186 140,578 99,768 -- 387,354 Non-interest earning assets...... $ 32,498 32,498 ------------ --------- Total assets................ $ 90,272 $ 24,550 $ 32,186 $ 140,578 $ 99,768 $ 32,498 $ 419,852 --------- --------- --------- --------- --------- ------------ --------- --------- --------- --------- --------- --------- ------------ --------- Rate sensitive liabilities: Interest bearing demand........ $ 31,193 -- -- $ 5,199 $ 5,199 -- $ 41,591 Statement Savings.............. 32,408 -- -- 5,401 5,401 -- 43,211 Money Market................... 16,825 -- -- 2,804 2,804 -- 22,433 Certificate of Deposit......... 53,657 33,772 33,397 28,183 -- -- 149,009 FHLB advances and securities sold under agreements to repurchase.................. 71,063 2,000 1,000 5,000 -- -- 79,063 --------- --------- --------- --------- --------- ------------ --------- Total interest bearing liabilities............... $ 205,146 $ 35,772 $ 34,397 $ 46,587 $ 13,404 -- $ 335,307 Non-interest bearing liabilities.................... -- -- -- -- -- $ 52,409 52,409 Stockholders' equity............. -- -- -- -- -- 32,136 32,136 --------- --------- --------- --------- --------- ------------ --------- Total liabilities and stockholders' equity...... $ 205,146 $ 35,768 $ 34,397 $ 46,587 $ 13,404 $ 84,545 $ 419,852 --------- --------- --------- --------- --------- ------------ --------- --------- --------- --------- --------- --------- ------------ --------- Interest rate sensitivity GAP.... $(114,874) $ (11,222) $ (2,211) $ 93,991 $ 86,364 $ (52,047) --------- --------- --------- --------- --------- ------------ --------- --------- --------- --------- --------- ------------ Cumulative GAP................... $(114,874) $(126,096) $(128,307) $ (34,317) $ 52,047 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Cumulative GAP as a percentage of total.......................... 44.00% 47.66% 53.40% 89.34% 115.52%
The Gap Analysis table is intended to illustrate the maturity/repricing characteristics of Company's interest-earning assets and interest-bearing liabilities as of September 30, 1997. The analysis is based upon contractual maturities and, where applicable, management's estimates of the repricing characteristics of various assets and liabilities and on assumptions as to customer behavior. The Gap Analysis indicates a liability-sensitive position through the one-year time period beginning September 30, 1997. The Company's investment in U. S. Treasury Notes with maturities beyond one year funded by a growth in deposits and short-term (three months or less) securities sold under agreements to repurchase and is primarily responsible for the liability-sensitive position through the one-year time period as of September 30, 1997. Covenant's net interest income has not been subject to the degree of sensitivity indicated by this traditional gap analysis. In monitoring interest sensitivity, adjustments are made to the dynamic shock assumptions to reflect management's recent experience regarding the impact of product pricing, interest rate spread relationships and customer behavior. These marginal adjustments are necessarily subjective and will vary over time with loan and deposit changes and market conditions. The investment portfolio is utilized to balance the Company's gap position, to manage the interest rate spread and to mitigate overall maturity risk in the portfolio. LIQUIDITY Adequate liquidity is necessary to meet the borrowing needs and deposit withdrawal requirements of customers as well as to satisfy liabilities, fund operations and support asset growth. Maintaining an appropriate level of liquid funds through the A-16 asset/liability management process ensures that the needs of the Company are met at a reasonable cost. Therefore, the management of liquidity is coordinated with the management of the Company's interest sensitivity and capital position. Major sources of liquidity are core deposits, cash flow generated by the Company's investment and loan portfolios, and short-term borrowings. Earnings and funds provided by operations also serve as a source of liquidity. Cash and cash equivalents equaled $15.7 million at September 30, 1997, compared to $15.6 million at December 31, 1996, resulting in a net increase of $107,000, as shown on the Consolidated Statements of Cash Flows for the nine months ended September 30, 1997. The net increase of $17.5 million in loans and the $7.0 million in purchases of investments available for sale, offset by the $20.0 million in proceeds from maturities of investments available for sale primarily contributed to a net cash used in investing activities equaling $4.2 million. The Company funded the net cash used in investing activities principally through $3.3 million in net cash provided by operating activities and a $26.6 million increase in deposits offset by a $20.0 million decrease in securities sold under agreements to repurchase and a $5.8 million decrease in advances from the Federal Home Loan Bank. The Company places strong emphasis on the composition of the investments available for sale portfolio. Additional sources of liquidity are available to the Company through the purchase of federal funds and borrowings on approved lines of credit. One measure of the Company's liquidity is the FDIC liquidity ratio. This ratio measures net cash, short-term investments and marketable assets divided by net deposits and short-term liabilities. The Company's liquidity ratio at September 30, 1997 was 23%. Overall, based on the its core deposit base, and its available sources of borrowed funds, management believes that the Company's liquidity position is satisfactory. CAPITAL The maintenance of appropriate levels of capital is a management priority and an important objective of the Company's asset and liability management process. The Company's principal capital planning goals are to provide an adequate return to stockholders, to support its growth and expansion activities, to provide stability to current operations, and to promote public confidence. Bank regulatory authorities have issued risk-based capital standards and leverage ratio requirements by which all bank holding companies and banks will be evaluated in terms of capital adequacy. The "Prompt Corrective Action" regulations issued pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 established five categories of depository institutions: (1) well-capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. Each category relates to the level of capital for the depository institution. The highest capital ratios equate to a "well-capitalized" depository institution which is one that significantly exceeds the minimum level required by regulation (i.e., total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater). At September 30, 1997, the Company and the Bank met the definition of a "well-capitalized" institution. The following table sets forth the Company's and the Bank's regulatory capital requirements and compliance therewith as of September 30, 1997: COVENANT BANCORP, INC. AND SUBSIDIARIES
EXCESS WELL- CAPITAL ACTUAL CAPITALIZED (IN THOUSANDS) ------ ----------- -------------- Tier 1 Risk-Based Capital Ratio (1)............................... 12.46 % 6.00% $ 16,710 Total Risk-Based Capital Ratio (2)................................ 13.51 % 10.00% $ 9,075 Tier 1 Leverage Ratio (3)......................................... 7.50 % 5.00% $ 10,752
A-17 COVENANT BANK
EXCESS WELL- CAPITAL ACTUAL CAPITALIZED (IN THOUSANDS) ------ ----------- -------------- Tier 1 Risk-Based Capital Ratio (1)............................... 12.32 % 6.00% $ 16,339 Total Risk-Based Capital Ratio (2)................................ 13.37 % 10.00% $ 8,710 Tier 1 Leverage Ratio (3)......................................... 7.42 % 5.00% $ 10,380
- --------------- (1) Tier 1 Risk-Based Capital Ratio is defined as the ratio of Tier 1 Capital to Total Risk-Weighted Assets. (2) Total Risk-Based Capital Ratio is defined as the ratio of Tier 1 and Tier 2 Capital to Total Risk-Weighted Assets. (3) Tier 1 Leverage Ratio is defined as the ratio of Tier 1 Capital to Total Average Quarterly Assets. INCOME TAXES The Company's effective tax rate for the nine months ended September 30, 1997 was 31.8%, compared to an effective rate of 36.4% for the same period in 1996. The decreased percentage from 1996 to 1997 is attributable to a reduction in state income taxes due to business strategies employed. A-18 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS. 2. Agreement and Plan of Mergers dated August 4, 1997 by and among Covenant Bancorp, Inc., Covenant Bank, First Union Corporation and First Union National Bank, attached as Exhibit 1 to the registrant's Current Report on Form 8-K dated August 12, 1997 and incorporated herein by reference. 11 Statement re: Computation of Per Share Earnings 27 Financial Data Schedule (b) REPORTS ON FORM 8-K. On August 12, 1997, the Company filed an 8-K report with the Commission regarding the Agreement and Plan of Mergers dated August 4, 1997, between and among the Company, its subsidiary Covenant Bank, First Union Corporation and its subsidiary First Union National Bank. A-19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Bank has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COVENANT BANCORP, INC. November 13, 1997 /S/CHARLES E. SESSA, JR. (DATE) CHARLES E. SESSA, JR. PRESIDENT November 13, 1997 /S/J. WILLIAM PARKER, JR. (DATE) J. WILLIAM PARKER, JR. SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER & TREASURER
A-20 EXHIBIT 11 COVENANT BANCORP, INC. AND SUBSIDIARIES COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED ------------------------------ ------------------------------ SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1997 1996 ------------- ------------- ------------- ------------- Net income (loss)................................................ $ 925 $ (413) $ 2,739 $ 1,023 ------------- ------------- ------------- ------------- Less: preferred dividends........................................ (112) (337) ------------- ------------- Net income applicable to common stock............................ (525) 686 ------------- ------------- ------------- ------------- Average number of shares outstanding: Average common shares outstanding.............................. 3,057 3,069 3,051 3,168 Common stock equivalents considered in earnings per share computation: Dilutive stock options...................................... 242 106 237 -- Conversion of preferred stock Series "A".................... 550 -- 550 -- Conversion of preferred stock Series "B".................... 509 -- 509 -- ------------- ------------- ------------- ------------- Average number of shares outstanding............................. 4,358 3,175 4,347 3,168 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Net income (loss) per share of common stock and common stock equivalents............................. $ 0.21 $ (0.17) $ 0.63 $ 0.22 ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
A-21 EXHIBIT B CERTAIN HISTORICAL FINANCIAL INFORMATION RELATING TO CORESTATES CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ (UNAUDITED) (NOTE) ASSETS Cash and due from banks........................................................................ $ 3,166,454 $ 3,462,287 Time deposits, principally Eurodollars......................................................... 3,043,723 2,443,154 Federal funds sold and securities purchased under agreements to resell......................... 138,699 509,694 Trading account assets......................................................................... 326,717 122,317 Investments available-for-sale, at fair value.................................................. 2,211,382 2,394,166 Investments held-to-maturity (fair value: 1997 -- $1,417,351; 1996 -- $1,692,243).............. 1,413,351 1,689,058 Loans, net of unearned discounts of $220,485 in 1997 and $234,607 in 1996...................... 35,085,285 32,777,032 Less: Allowance for loan losses.............................................................. (679,415) (710,327) ------------- ------------ Net loans............................................................................... 34,405,870 32,066,705 ------------- ------------ Due from customers on acceptances.............................................................. 790,548 738,077 Premises and equipment......................................................................... 626,760 625,876 Other assets................................................................................... 1,467,105 1,442,860 ------------- ------------ Total assets............................................................................ $ 47,590,609 $ 45,494,194 ------------- ------------ ------------- ------------ LIABILITIES Deposits: Domestic: Non-interest bearing...................................................................... $ 8,942,224 $ 9,330,445 Interest bearing.......................................................................... 23,401,727 22,986,955 Overseas branches and subsidiaries........................................................... 1,396,731 1,409,756 ------------- ------------ Total deposits.......................................................................... 33,740,682 33,727,156 ------------- ------------ Funds borrowed................................................................................. 4,239,227 2,633,157 Bank acceptances outstanding................................................................... 789,169 727,728 Other liabilities.............................................................................. 1,924,257 1,661,162 Long-term debt................................................................................. 3,784,179 3,049,297 ------------- ------------ Total liabilities....................................................................... 44,477,514 41,798,500 ------------- ------------ COMMITMENTS AND CONTINGENT LIABILITIES SHAREHOLDERS' EQUITY Preferred stock: authorized 10.0 million shares; no shares issued.............................. -- -- Common stock: $1 par value; authorized 350.0 million shares; issued 223.599 million shares in 1997 and 1996 (including treasury shares of 23.820 million in 1997 and 8.900 million in 1996, and unallocated shares held by the Employee Stock Ownership Plan ("ESOP") of 2.182 million in 1997 and 2.267 million in 1996).............................................................. 223,599 223,599 Other common shareholders' equity, net......................................................... 2,889,496 3,472,095 ------------- ------------ Total shareholders' equity.............................................................. 3,113,095 3,695,694 ------------- ------------ Total liabilities and shareholders' equity.............................................. $ 47,590,609 $ 45,494,194 ------------- ------------ ------------- ------------
Note: The balance sheet at December 31, 1996 has been derived from the audited financial statements at that date. See accompanying notes to the consolidated financial statements. B-1 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- ------------------------ 1997 1996 1997 1996 -------- -------- ---------- ---------- INTEREST INCOME Interest and fees on loans: Taxable income......................................................... $760,590 $716,075 $2,221,554 $2,118,771 Tax exempt income...................................................... 5,201 6,009 15,759 19,409 Interest on investment securities: Taxable income......................................................... 51,890 58,363 157,064 198,952 Tax exempt income...................................................... 3,950 5,855 13,006 17,952 Interest on time deposits in banks....................................... 43,234 33,277 112,619 85,969 Interest on Federal funds sold, securities purchased under agreements to resell and other....................................................... 8,169 3,504 20,719 21,503 -------- -------- ---------- ---------- Total interest income............................................... 873,034 823,083 2,540,721 2,462,556 -------- -------- ---------- ---------- INTEREST EXPENSE Interest on deposits..................................................... 229,291 207,391 646,273 629,811 Interest on short-term funds borrowed.................................... 53,586 35,780 132,035 111,379 Interest on long-term debt............................................... 59,663 39,564 171,463 116,969 -------- -------- ---------- ---------- Total interest expense.............................................. 342,540 282,735 949,771 858,159 -------- -------- ---------- ---------- NET INTEREST INCOME................................................. 530,494 540,348 1,590,950 1,604,397 Provision for losses on loans............................................ 50,000 40,000 143,000 188,767 -------- -------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOSSES ON LOANS............. 480,494 500,348 1,447,950 1,415,630 -------- -------- ---------- ---------- NON-INTEREST INCOME Service charges on deposit accounts...................................... 63,039 57,863 180,958 172,779 Trust income............................................................. 47,453 42,102 137,620 124,877 Fees for international services.......................................... 31,445 27,130 84,194 74,805 Debit and credit card fees............................................... 25,261 22,417 70,729 65,041 Third party processing................................................... 19,389 14,075 58,136 42,543 Income from investment in EPS, Inc....................................... 7,499 7,469 22,109 22,192 Income from trading activities........................................... 9,591 2,763 25,377 15,880 Securities gains......................................................... 5,023 31,135 14,857 55,476 Other operating income................................................... 26,777 31,677 82,872 101,105 -------- -------- ---------- ---------- Total non-interest income........................................... 235,477 236,631 676,852 674,698 -------- -------- ---------- ---------- NON-FINANCIAL EXPENSES Salaries, wages and benefits............................................. 206,467 204,945 614,201 619,725 Net occupancy............................................................ 36,286 39,856 110,876 120,201 Equipment expenses....................................................... 30,320 29,427 92,717 90,360 Restructuring and merger-related charges................................. -- 12,298 -- 130,100 Other operating expenses................................................. 136,749 145,327 386,906 399,154 -------- -------- ---------- ---------- Total non-financial expenses........................................ 409,822 431,853 1,204,700 1,359,540 -------- -------- ---------- ---------- INCOME BEFORE INCOME TAXES............................................... 306,149 305,126 920,102 730,788 Provision for income taxes............................................... 107,335 108,269 323,449 277,190 -------- -------- ---------- ---------- NET INCOME............................................................... $198,814 $196,857 $ 596,653 $ 453,598 -------- -------- ---------- ---------- -------- -------- ---------- ---------- Average common shares outstanding........................................ 199,817 220,409 205,316 219,802 -------- -------- ---------- ---------- -------- -------- ---------- ---------- PER COMMON SHARE DATA Net income............................................................... $ 1.00 $ 0.89 $ 2.91 $ 2.06 -------- -------- ---------- ---------- -------- -------- ---------- ---------- Cash dividends declared.................................................. $ 0.47 $ 0.42 $ 1.41 $ 1.26 -------- -------- ---------- ---------- -------- -------- ---------- ----------
See accompanying notes to the consolidated financial statements. B-2 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) (IN THOUSANDS)
COMMON CAPITAL RETAINED NINE MONTHS ENDED SEPTEMBER 30, 1996 STOCK SURPLUS EARNINGS - -------------------------------------------------------------------------------------- -------- ---------- ---------- Balances at beginning of year......................................................... $230,231 $1,225,167 $2,724,298 Net income............................................................................ 453,598 Net change in unrealized gain on investments available-for-sale, net of tax........... (33,264) Treasury shares acquired (741 shares)................................................. Treasury shares issued in merger (7,300 shares)....................................... (7,300) (33,288) (192,042) Repurchase and retirement of common stock (1,340 shares).............................. (1,340) (43,559) (12,804) Common stock issued under employee benefit plans (1,575 new shares; 928 treasury shares)................................................................ 1,575 55,521 (14,668) Common stock issued under dividend reinvestment plan (31 new shares) (347 treasury shares)............................................................... 31 1,727 (68) ESOP shares committed for release (92 shares)......................................... 1,454 Cash paid for fractional shares issued................................................ (341) Foreign currency translation adjustments.............................................. 1,037 Common dividends declared............................................................. (272,658) -------- ---------- ---------- Balances at end of period............................................................. $223,197 $1,207,022 $2,653,088 -------- ---------- ---------- -------- ---------- ---------- NINE MONTHS ENDED SEPTEMBER 30, 1997 - -------------------------------------------------------------------------------------- Balances at beginning of year......................................................... $223,599 $1,234,522 $2,729,310 Net income............................................................................ 596,653 Net change in unrealized gain on investments available-for-sale, net of tax........... 8,406 Treasury shares acquired (17,098 shares).............................................. Common stock issued under employee benefit plans (1,734 treasury shares).............. 15,510 (49,740) Common stock issued under dividend reinvestment plan (444 treasury shares)............ 330 (1,058) ESOP shares committed for release (85 shares)......................................... 2,587 Foreign currency translation adjustments.............................................. (1,194) Common dividends declared............................................................. (291,802) -------- ---------- ---------- Balances at end of period............................................................. $223,599 $1,252,949 $2,990,575 -------- ---------- ---------- -------- ---------- ----------
(continued) B-3 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) -- CONTINUED (IN THOUSANDS)
UNALLOCATED TREASURY ESOP NINE MONTHS ENDED SEPTEMBER 30, 1996 STOCK SHARES TOTAL - ------------------------------------------------------------------------------------ ----------- ---------- ---------- Balances at beginning of year....................................................... $ (250,465) $(53,666) $3,875,565 Net income.......................................................................... 453,598 Net change in unrealized gain on investments available-for-sale, net of tax......... (33,264) Treasury shares acquired (741 shares)............................................... (28,294) (28,294) Treasury shares issued in merger (7,300 shares)..................................... 232,630 -- Repurchase and retirement of common stock (1,340 shares)............................ (57,703) Common stock issued under employee benefit plans (1,575 new shares; 928 treasury shares).............................................................. 33,079 75,507 Common stock issued under dividend reinvestment plan (31 new shares) (347 treasury shares)............................................................. 13,050 14,740 ESOP shares committed for release (92 shares)....................................... 2,250 3,704 Cash paid for fractional shares issued.............................................. (341) Foreign currency translation adjustments............................................ 1,037 Common dividends declared........................................................... (272,658) ----------- ---------- ---------- Balances at end of period........................................................... $ -- $(51,416) $4,031,891 ----------- ---------- ---------- ----------- ---------- ---------- NINE MONTHS ENDED SEPTEMBER 30, 1997 - ------------------------------------------------------------------------------------ Balances at beginning of year....................................................... $ (437,580) $(54,157) $3,695,694 Net income.......................................................................... 596,653 Net change in unrealized gain on investments available-for-sale, net of tax......... 8,406 Treasury shares acquired (17,098 shares)............................................ (986,575) (986,575) Common stock issued under employee benefit plans (1,734 treasury shares)............ 98,986 64,756 Common stock issued under dividend reinvestment plan (444 treasury shares).......... 23,277 22,549 ESOP shares committed for release (85 shares)....................................... 2,021 4,608 Foreign currency translation adjustments............................................ (1,194) Common dividends declared........................................................... (291,802) ----------- ---------- ---------- Balances at end of period........................................................... $(1,301,892) $(52,136) $3,113,095 ----------- ---------- ---------- ----------- ---------- ----------
See accompanying notes to the consolidated financial statements. B-4 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------------- 1997 1996 ------------ ------------ OPERATING ACTIVITIES Net income.................................................................................... $ 596,653 $ 453,598 Adjustments to reconcile net income to net cash provided by operating activities: Restructuring and merger-related charges.................................................... -- 130,100 Provision for losses on loans............................................................... 143,000 188,767 Provision for losses and writedowns on OREO................................................. 2,012 2,753 Depreciation and amortization............................................................... 93,459 88,448 Deferred income tax expense (benefit)....................................................... 32,250 (10,525) Securities gains............................................................................ (14,857) (55,476) (Increase) decrease in trading account assets............................................... (204,400) 90,418 Increase (decrease) in due to factored clients.............................................. 77,028 (16,292) (Increase) decrease in interest receivable.................................................. (13,895) 44,813 Increase (decrease) in interest payable..................................................... 8,776 (5,519) Other, net.................................................................................. 80,356 181,460 ------------ ------------ Net Cash Provided by Operating Activities................................................ 800,382 1,092,545 ------------ ------------ INVESTING ACTIVITIES Net increase in loans......................................................................... (2,462,447) (1,895,346) Proceeds from sales of loans.................................................................. 491,506 843,260 Loans originated or acquired -- non-bank subsidiaries......................................... (27,289,355) (28,572,504) Principal collected on loans -- non-bank subsidiaries......................................... 26,758,059 28,274,066 Net increase in time deposits, principally Eurodollars........................................ (600,569) (685,213) Purchases of investments held-to-maturity..................................................... (445,244) (372,596) Purchases of investments available-for-sale................................................... (549,954) (1,430,753) Proceeds from maturities of investments held-to-maturity...................................... 739,006 1,164,746 Proceeds from maturities of investments available-for-sale.................................... 678,077 767,581 Proceeds from sales of investments available-for-sale......................................... 89,092 856,474 Net decrease in Federal funds sold and securities purchased under agreements to resell........ 370,995 551,235 Purchases of premises and equipment........................................................... (63,050) (77,435) Proceeds from sales and paydowns on OREO...................................................... 12,398 26,536 Other, net.................................................................................... 32,187 27,475 ------------ ------------ Net Cash Used in Investing Activities.................................................... (2,239,299) (522,474) ------------ ------------ FINANCING ACTIVITIES Net increase (decrease) in deposits........................................................... 13,312 (1,251,670) Payment for sale of deposits.................................................................. -- (368,110) Proceeds from issuance of long-term debt...................................................... 1,138,145 533,070 Retirement of long-term debt.................................................................. (402,154) (225,973) Net increase in short-term funds borrowed..................................................... 1,606,070 325,374 Cash dividends paid........................................................................... (297,510) (236,987) Purchases of treasury stock................................................................... (986,575) (28,294) Repurchase and retirement of common stock..................................................... -- (57,703) Common stock issued under employee benefit plans.............................................. 49,247 48,448 Other, net.................................................................................... 22,549 14,399 ------------ ------------ Net Cash Provided by (Used in) Financing Activities...................................... 1,143,084 (1,247,446) ------------ ------------ DECREASE IN CASH AND DUE FROM BANKS...................................................... (295,833) (677,375) Cash and due from banks at January 1,.................................................... 3,462,287 3,662,143 ------------ ------------ Cash and due from banks at September 30,................................................. $ 3,166,454 $ 2,984,768 ------------ ------------ ------------ ------------ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for: Interest................................................................................. $ 940,995 $ 863,678 ------------ ------------ ------------ ------------ Income taxes............................................................................. $ 191,007 $ 248,505 ------------ ------------ ------------ ------------ Net cash received on interest rate swaps...................................................... $ 44,983 $ 46,253 ------------ ------------ ------------ ------------
See accompanying notes to the consolidated financial statements. B-5 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1997 NOTE A -- BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of CoreStates Financial Corp ("CoreStates") have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (comprising only normal recurring accruals) necessary for a fair presentation have been included. Certain amounts in prior periods have been reclassified for comparative purposes. Operating results for the nine-month period ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. NOTE B -- CHANGE IN ACCOUNTING PRINCIPLES Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128") was issued in February 1997. FAS 128, which must be adopted on December 31, 1997, requires entities to change the method currently used to compute earnings per share and to restate earnings per share for all prior periods presented. Under FAS 128, primary earnings per share will exclude the dilutive effect of stock options and fully diluted earnings per share must include the dilutive effect of stock options even if the dilutive effect is immaterial. The impact of FAS 128 on the calculation of primary earnings per share and fully diluted earnings per share is not expected to be material. NOTE C -- LOAN PORTFOLIO Loans, net of unearned discounts, consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------- Domestic: Commercial, industrial and other............................................................. $ 15,800,229 $ 13,906,646 Real estate: Construction and development.............................................................. 625,910 554,924 Residential............................................................................... 4,312,171 4,226,980 Other..................................................................................... 4,284,944 4,541,697 ------------- ------------- Total real estate....................................................................... 9,223,025 9,323,601 ------------- ------------- Consumer: Installment............................................................................... 3,260,034 3,319,970 Credit card............................................................................... 1,686,941 1,674,921 ------------- ------------- Total consumer.......................................................................... 4,946,975 4,994,891 ------------- ------------- Financial institutions....................................................................... 1,362,525 1,153,715 Factoring receivables........................................................................ 564,877 411,280 Lease financing.............................................................................. 1,217,578 1,232,213 ------------- ------------- Total domestic.......................................................................... 33,115,209 31,022,346 ------------- ------------- Foreign........................................................................................ 1,970,076 1,754,686 ------------- ------------- Total loans............................................................................. $ 35,085,285 $ 32,777,032 ------------- ------------- ------------- -------------
B-6 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED NOTE D -- OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS AND COMMITMENTS In the normal course of business, there are outstanding commitments and contingent liabilities which are not reflected in the financial statements. These include various financial instruments with off-balance sheet risk used in connection with CoreStates' asset and liability management and to provide for the needs of customers. These involve varying degrees of credit, interest rate and liquidity risk, but do not represent unusual risks for the Corporation and management does not anticipate any significant losses as a result of these transactions. The following is a summary of contractual or notional amounts of off-balance sheet commitments and derivative financial instruments (in thousands):
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------- Standby letters of credit, net of participations............................................... $ 1,889,145 $ 1,630,621 Commercial letters of credit................................................................... 1,503,337 1,262,593 Commitments to extend credit................................................................... 17,250,051 15,396,553 Unused commitments under credit card lines..................................................... 4,493,830 4,173,013 When-issued securities: Commitments to purchase...................................................................... 15,990 1,770 Commitments to sell.......................................................................... 110,000 75,120 Whole mortgage loans and securities: Commitments to purchase...................................................................... 17,048 17,280 Commitments to sell.......................................................................... 41,195 7,965 Loans sold with recourse and loan servicing acquired with recourse............................. 316,038 361,410 Interest rate futures contracts: Commitments to purchase...................................................................... 1,825,900 4,489,800 Commitments to purchase foreign and U. S. currencies........................................... 2,728,984 1,766,122 Interest rate swaps, notional principal amounts................................................ 11,068,963 9,850,708 Interest rate caps and floors: Written...................................................................................... 1,728,073 908,799 Purchased.................................................................................... 2,802,353 2,039,331 Tender option bonds............................................................................ 471,395 148,711 Treasury float contracts....................................................................... 256,546 270,358 Other derivative financial instruments......................................................... 864,199 597,261
B-7 REPORT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND SHAREHOLDERS CORESTATES FINANCIAL CORP We have audited the accompanying consolidated balance sheets of CoreStates Financial Corp as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1995 or 1994 financial statements of Meridian Bancorp, Inc. and United Counties Bancorporation, which statements reflect combined total assets of 35.6% as of December 31, 1995 and combined net interest income constituting 31.3% and 32.8% of the related consolidated totals for the years ended December 31, 1995 and 1994, respectively. Those statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion, insofar as it relates to data included for Meridian Bancorp, Inc. and United Counties Bancorporation, is based solely on the reports of other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CoreStates Financial Corp at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Philadelphia, Pennsylvania January 22, 1997 B-8 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, -------------------------------------- 1996 1995 1994 ---------- ---------- ---------- INTEREST INCOME Interest and fees on loans: Taxable income.................................................................... $2,845,898 $2,902,265 $2,484,660 Tax exempt income................................................................. 25,335 30,390 34,023 Interest on investment securities: Taxable income.................................................................... 254,576 349,138 365,298 Tax exempt income................................................................. 23,190 31,018 38,180 Interest on time deposits in banks.................................................. 122,752 121,993 70,996 Interest on Federal funds sold, securities purchased under agreements to resell and other............................................................................. 26,453 40,276 21,402 ---------- ---------- ---------- Total interest income.......................................................... 3,298,204 3,475,080 3,014,559 ---------- ---------- ---------- INTEREST EXPENSE Interest on deposits: Domestic savings.................................................................. 295,650 396,176 280,532 Domestic time..................................................................... 497,956 492,610 370,373 Overseas branches and subsidiaries................................................ 48,174 52,261 29,602 ---------- ---------- ---------- Total interest on deposits..................................................... 841,780 941,047 680,507 Interest on short-term funds borrowed............................................... 153,129 214,119 149,618 Interest on long-term debt.......................................................... 161,811 152,989 116,419 ---------- ---------- ---------- Total interest expense......................................................... 1,156,720 1,308,155 946,544 ---------- ---------- ---------- Net interest income............................................................... 2,141,484 2,166,925 2,068,015 Provision for losses on loans....................................................... 228,767 144,002 279,195 ---------- ---------- ---------- Net interest income after provision for losses on loans........................... 1,912,717 2,022,923 1,788,820 ---------- ---------- ---------- NON-INTEREST INCOME Service charges on deposit accounts................................................. 243,696 244,439 239,811 Trust income........................................................................ 167,138 162,776 153,214 Fees for international services..................................................... 101,761 94,396 87,364 Debit and credit card fees.......................................................... 74,707 83,812 80,482 Income from investment in EPS, Inc.................................................. 29,902 30,114 31,800 Income from trading activities...................................................... 25,216 35,403 23,360 Securities gains.................................................................... 59,512 31,475 18,283 Other gains......................................................................... 8,200 26,400 -- Other operating income.............................................................. 188,943 173,407 154,173 ---------- ---------- ---------- Total non-interest income...................................................... 899,075 882,222 788,487 ---------- ---------- ---------- NON-FINANCIAL EXPENSES Salaries, wages and benefits........................................................ 826,442 904,377 947,903 Net occupancy....................................................................... 157,358 159,530 162,003 Equipment expenses.................................................................. 120,602 118,532 117,659 Restructuring and merger-related charges............................................ 139,702 138,600 107,119 Other operating expenses............................................................ 532,724 564,489 583,558 ---------- ---------- ---------- Total non-financial expenses................................................... 1,776,828 1,885,528 1,918,242 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES.......................................................... 1,034,964 1,019,617 659,065 Provision for income taxes.......................................................... 385,820 364,441 225,859 ---------- ---------- ---------- NET INCOME.......................................................................... $ 649,144 $ 655,176 $ 433,206 ---------- ---------- ---------- ---------- ---------- ---------- PER COMMON SHARE DATA (Based on weighted average shares outstanding of 218.812 million in 1996, 222.268 million in 1995 and 226.234 million in 1994) Net income.......................................................................... $ 2.97 $ 2.95 $ 1.91 ---------- ---------- ---------- ---------- ---------- ---------- Cash dividends declared............................................................. $ 1.73 $ 1.44 $ 1.24 ---------- ---------- ---------- ---------- ---------- ----------
(continued) B-9 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS)
DECEMBER 31, -------------------------- 1996 1995 ----------- ----------- ASSETS Cash and due from banks........................................................................ $ 3,462,287 $ 3,662,143 Time deposits, principally Eurodollars......................................................... 2,443,154 1,909,260 Federal funds sold and securities purchased under agreements to resell......................... 509,694 719,937 Trading account assets......................................................................... 122,317 147,218 Investment securities available-for-sale....................................................... 2,394,166 2,572,315 Investment securities held-to-maturity (market value: 1996 -- $1,692,243; 1995 -- $3,075,964).................................................................................. 1,689,058 3,059,917 Total loans, net of unearned discounts of $204,521 in 1996 and $232,077 in 1995................ 32,777,032 31,714,152 Less: Allowance for loan losses.............................................................. (710,327) (670,265) ----------- ----------- Net loans................................................................................. 32,066,705 31,043,887 ----------- ----------- Due from customers on acceptances.............................................................. 738,077 560,707 Premises and equipment......................................................................... 625,876 664,279 Other assets................................................................................... 1,442,860 1,657,579 ----------- ----------- Total assets.............................................................................. $45,494,194 $45,997,242 ----------- ----------- ----------- ----------- LIABILITIES Deposits: Domestic: Non-interest bearing.................................................................... $ 9,330,445 $ 8,937,147 Interest bearing........................................................................ 22,986,955 23,883,726 Overseas branches and subsidiaries........................................................ 1,409,756 1,142,947 ----------- ----------- Total deposits............................................................................ 33,727,156 33,963,820 ----------- ----------- Short-term funds borrowed...................................................................... 2,633,157 3,677,013 Bank acceptances outstanding................................................................... 727,728 549,048 Other liabilities.............................................................................. 1,661,162 1,719,697 Long-term debt................................................................................. 3,049,297 2,212,099 ----------- ----------- Total liabilities......................................................................... 41,798,500 42,121,677 ----------- ----------- COMMITMENTS AND CONTINGENT LIABILITIES SHAREHOLDERS' EQUITY Preferred stock: authorized 10.0 million shares; no shares issued.............................. -- -- Common stock: $1 par value; authorized 350.0 million shares; issued 223.6 million shares in 1996 and 230.2 million shares in 1995 (including treasury shares of 8.9 million in 1996 and 7.8 million in 1995, and unallocated shares held by Employee Stock Ownership Plan ("ESOP") of 2.3 million in 1996 and 2.3 million in 1995)................................................. 223,599 230,231 Other common shareholders' equity, net......................................................... 3,472,095 3,645,334 ----------- ----------- Total shareholders' equity................................................................ 3,695,694 3,875,565 ----------- ----------- Total liabilities and shareholders' equity................................................ $45,494,194 $45,997,242 ----------- ----------- ----------- -----------
(continued) B-10 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARES AMOUNT)
COMMON CAPITAL RETAINED TREASURY UNALLOCATED STOCK SURPLUS EARNINGS STOCK ESOP SHARES TOTAL -------- ---------- ---------- --------- ----------- ---------- Balances at December 31, 1993............... $230,050 $1,194,872 $2,287,406 $ (7,819) $3,704,509 Net income.................................. 433,206 433,206 Net change in unrealized gain on investments available-for-sale, net of tax................................ (66,095) (66,095) Acquisition of Germantown Savings Bank (5,880 treasury shares)................... (8,605) 156,361 147,756 Stock issued in other acquisitions (190 new shares)................................... 190 6,782 6,972 Treasury shares acquired (8,598 shares)..... (228,963) (228,963) Repurchase and retirement of common stock (1,016 shares)............................ (1,016) (6,646) (17,226) (24,888) Common stock issued under employee benefit plans (567 new shares; 688 treasury shares)................................... 567 6,097 (6,410) 18,456 18,710 Common stock issued under dividend reinvestment plan (450 treasury shares)... (447) (483) 12,306 11,376 Purchase of shares for Employee Stock Ownership Plan (1,574 shares)............. $ (35,568) (35,568) Conversion of subordinated debt (36 new shares; 909 treasury shares).............. 36 (2,001) 25,362 23,397 Cash paid for fractional shares............. (83) (83) Foreign currency translation adjustments.... 52 52 Common dividends declared................... (259,449) (259,449) -------- ---------- ---------- --------- ----------- ---------- Balances at December 31, 1994............... 229,827 1,200,658 2,360,312 (24,297) (35,568) 3,730,932 Net income.................................. 655,176 655,176 Net change in unrealized gain on investments available-for-sale, net of tax............ 41,187 41,187 Treasury shares acquired (10,307 shares).... (335,528) (335,528) Repurchase and retirement of common stock (595 shares).............................. (595) (4,093) (12,446) (17,134) Common stock issued under employee benefit plans (1,002 new shares; 3,089 treasury shares)................................... 999 26,825 (25,483) 96,670 99,011 Common stock issued under dividend reinvestment plan (417 treasury shares)... (9) (2) 12,690 12,679 Purchase of shares for Employee Stock Ownership Plan (876 shares)............... (20,922) (20,922) Employee Stock Ownership Plan shares committed for release (123 shares)........ 1,786 2,824 4,610 Cash paid for fractional shares............. (24) (24) Foreign currency translation adjustments.... (29) (29) Common dividends declared................... (294,393) (294,393) -------- ---------- ---------- --------- ----------- ---------- Balances at December 31, 1995............... 230,231 1,225,167 2,724,298 (250,465) (53,666) 3,875,565
(continued) B-11 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY -- CONTINUED (IN THOUSANDS)
COMMON CAPITAL RETAINED TREASURY UNALLOCATED STOCK SURPLUS EARNINGS STOCK ESOP SHARES TOTAL -------- ---------- ---------- --------- ----------- ---------- Net income.................................. $ 649,144 $ 649,144 Net change in unrealized gain on investments available-for-sale, net of tax................................ (25,070) (25,070) Treasury shares acquired (11,055 shares).... $(533,932) (533,932) Treasury shares issued in merger (7,300 shares)............................ $ (7,300) $ (33,288) (192,042) 232,630 -- Repurchase and retirement of common stock (1,340 shares)............................ (1,340) (43,559) (12,804) (57,703) Common stock issued under employee benefit plans (1,824 new shares; 2,330 treasury shares)................................... 1,824 75,618 (48,119) 100,826 130,149 Common stock issued under dividend reinvestment plan (184 new shares; 353 treasury shares).......................... 184 8,225 (68) 13,361 21,702 Purchase of shares for Employee Stock Ownership Plan (65 shares)................ (38) $ (3,509) (3,547) Employee stock ownership plan shares committed for release (126 shares)........ 2,397 3,018 5,415 Cash paid for fractional shares............. (342) (342) Foreign currency translation adjustments.... 5,448 5,448 Common dividends declared................... (371,135) (371,135) -------- ---------- ---------- --------- ----------- ---------- Balances at December 31, 1996............... $223,599 $1,234,522 $2,729,310 $(437,580) $ (54,157) $3,695,694 -------- ---------- ---------- --------- ----------- ---------- -------- ---------- ---------- --------- ----------- ----------
See accompanying notes to the financial statements. B-12 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, -------------------------------------------- 1996 1995 1994 ------------ ------------ ------------ OPERATING ACTIVITIES Net income.................................................................... $ 649,144 $ 655,176 $ 433,206 Adjustments to reconcile net income to net cash provided by operating activities: Restructuring and merger-related charges.................................... 139,702 138,600 107,119 Provision for losses on loans............................................... 228,767 144,002 279,195 Provision for losses and writedowns on other real estate owned.............. 3,387 15,971 14,596 Depreciation and amortization............................................... 110,512 122,996 139,305 Deferred income tax expense................................................. 9,156 28,420 41,847 Securities gains............................................................ (59,512) (31,475) (18,283) Gains on sale of mortgage servicing......................................... -- (2,387) (867) Other gains................................................................. (8,200) (26,400) -- (Increase) decrease in trading account assets............................... 24,901 200,833 (18,392) Increase (decrease) in due to factored clients.............................. 1,805 (86,921) 41,262 (Increase) decrease in interest receivable.................................. 45,046 2,009 (33,548) Increase in interest payable................................................ 10,163 45,044 26,026 Other, net.................................................................. 115,877 (117,411) (102,895) ------------ ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES..................................... 1,270,748 1,088,457 908,571 ------------ ------------ ------------ INVESTING ACTIVITIES Net increase in loans......................................................... (2,896,402) (1,832,179) (1,310,777) Proceeds from sales of loans.................................................. 1,577,270 1,087,732 1,130,918 Loans originated or acquired -- non-bank subsidiaries......................... (39,054,032) (35,767,440) (33,760,035) Principal collected on loans -- non-bank subsidiaries......................... 39,039,627 35,407,667 33,399,764 Net increase in time deposits, principally Eurodollars........................ (533,894) (33,172) (452,747) Purchases of investments held-to-maturity..................................... (490,995) (686,652) (2,386,505) Purchases of investments available-for-sale................................... (2,062,012) (589,327) (711,227) Proceeds from maturities of investments held-to-maturity...................... 1,524,670 2,175,780 2,911,632 Proceeds from maturities of investments available-for-sale.................... 854,898 161,477 386,142 Proceeds from sales of investments available-for-sale......................... 1,500,504 546,728 767,453 Net (increase) decrease in Federal funds sold and securities purchased under agreements to resell........................................................ 210,243 203,693 (646,409) Purchases of premises and equipment........................................... (101,469) (125,216) (147,308) Proceeds from sales and paydowns on other real estate owned................... 31,465 66,834 78,057 Purchase of Germantown Savings Bank, net of cash acquired..................... -- -- (74,053) Net cash provided by other acquisitions....................................... -- -- 379,318 Other, net.................................................................... 141,063 11,303 39,357 ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES........................... (259,064) 627,228 (396,420) ------------ ------------ ------------
(continued) B-13 CORESTATES FINANCIAL CORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS -- CONTINUED (IN THOUSANDS)
YEAR ENDED DECEMBER 31, -------------------------------------------- 1996 1995 1994 ------------ ------------ ------------ FINANCING ACTIVITIES Net increase (decrease) in deposits........................................... $ 172,155 $ (660,745) $ (1,013,622) Payment for sales of deposits................................................. (368,110) (154,360) -- Proceeds from issuance of long-term debt...................................... 1,340,099 582,251 480,433 Retirement of long-term debt.................................................. (501,165) (533,480) (306,452) Net increase (decrease) in short-term funds borrowed.......................... (1,043,856) 215,764 694,499 Cash dividends paid........................................................... (328,114) (286,565) (245,962) Purchases of treasury stock................................................... (533,932) (335,528) (228,963) Purchases of ESOP shares...................................................... -- -- (35,568) Funds transferred to Trust for future ESOP purchases.......................... -- -- (24,432) Repurchase and retirement of common stock..................................... (57,703) (17,134) (24,888) Common stock issued under employee benefit plans.............................. 87,726 99,011 18,710 Other, net.................................................................... 21,360 12,655 11,293 ------------ ------------ ------------ NET CASH USED IN FINANCING ACTIVITIES......................................... (1,211,540) (1,078,131) (674,952) ------------ ------------ ------------ INCREASE (DECREASE) IN CASH AND DUE FROM BANKS................................ (199,856) 637,554 (162,801) Cash and due from banks at January 1,......................................... 3,662,143 3,024,589 3,187,390 ------------ ------------ ------------ CASH AND DUE FROM BANKS AT DECEMBER 31,....................................... $ 3,462,287 $ 3,662,143 $ 3,024,589 ------------ ------------ ------------ ------------ ------------ ------------ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest.................................................................... $ 1,146,557 $ 1,263,681 $ 918,503 ------------ ------------ ------------ ------------ ------------ ------------ Income taxes................................................................ $ 331,940 $ 284,987 $ 189,918 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes to the financial statements. B-14 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of CoreStates Financial Corp ("the Corporation") and all of its subsidiaries, including: CoreStates Bank, N.A. ("CBNA"); CoreStates Bank of Delaware, N.A. ("CBD"); Congress Financial Corporation; and CoreStates Capital Corp ("CSCC"). All material intercompany transactions have been eliminated. The financial statements include the consolidated accounts of Meridian Bancorp, Inc. ("Meridian") which was acquired on April 9, 1996 in a transaction accounted for under the pooling of interests method of accounting. On February 23, 1996, Meridian acquired United Counties Bancorporation ("United Counties") in a transaction accounted for as a pooling of interests. The consolidated accounts of Meridian include United Counties for all periods presented. Certain amounts in prior years have been reclassified for comparative purposes. The Corporation is a bank holding company incorporated under the laws of the Commonwealth of Pennsylvania, primarily operating in the eastern Pennsylvania, northern Delaware and the central and southern New Jersey markets. Through its subsidiaries, the Corporation is engaged in the business of providing global and specialized banking (including international banking services), regional banking, retail credit services, trust and asset management and third party processing services to a diversified customer base. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CHANGES IN ACCOUNTING PRINCIPLES Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") was issued in October 1995 to establish accounting and reporting standards for stock-based employee compensation plans such as stock option and restricted stock plans ("stock-based plans"). FAS 123 defines a fair value method of accounting for measuring compensation expense for stock-based plans and encourages all entities to adopt that method of accounting. However, FAS 123 also permits entities to continue to measure compensation expense for stock-based plans using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Under the fair value method, compensation expense would be measured as the value of an award under a stock-based plan on the date the award is granted, and would be recognized over the vesting period of the award. Under the intrinsic value method, compensation expense is measured as the excess, if any, of the market price of the stock underlying the award on the date the award is granted, over the exercise price. Under the Corporation's stock-based long-term incentive plan, awards have no intrinsic value on the date of grant as the exercise price equals the market price on that date. The Corporation did not adopt the fair value method of accounting for stock-based plans, and will continue to use the intrinsic value method to measure compensation expense. Effective January 1, 1995, the Corporation adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("FAS 114") and Statement No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("FAS 118"). FAS 114 addresses accounting for impairment of certain loans and requires that impaired loans within the scope of FAS 114 be measured based on the present value of expected cash flows discounted at the loan's effective interest rate, or be measured at the loan's observable market price or the fair value of its collateral. FAS 118 amended the income recognition policies and clarified disclosure requirements of FAS 114. The adoption of these standards did not have an impact on CoreStates' provision for loan losses or allowance for loan losses, nor change CoreStates' methodology for recognizing income on impaired loans. INCOME TAXES Under the asset and liability method used by the Corporation to provide for income taxes, deferred tax assets and liabilities are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. B-15 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued The Corporation and its subsidiaries file a consolidated Federal income tax return. INVESTMENTS Held-to-maturity securities, consisting primarily of debt securities, are carried at cost adjusted for amortization of premiums and accretion of discounts, both computed on the interest method. The Corporation has both the ability and positive intent to hold these securities until maturity. Trading account assets are carried at market value. Gains on trading account assets include both realized and unrealized gains and losses on the portfolio. All other securities are classified as available-for-sale and are carried at fair value, with unrealized gains and losses, net of tax, reported as a component of shareholders' equity. The net unrealized gain on available-for-sale securities included in retained earnings was $26,555 at December 31, 1996 and $51,625 at December 31, 1995. Realized securities gains and losses are determined using the adjusted cost of a specific security sold. Interest and dividends on investment securities are recognized as income when earned. LOANS Interest on commercial loans is recognized on the daily principal amounts outstanding. Loan fees are generally considered adjustments of interest rate yields and are amortized into interest income on loans over the terms of the related loans. Interest on installment loans is principally recognized on the interest method. Commercial loans are placed on a non-accrual status, generally recognizing interest as income when received, when, in the opinion of management, the collectability of principal or interest payments becomes doubtful or when such payments are 90 days or more past due, unless the loan is well secured and in the process of collection. The deferral or non-recognition of interest does not constitute forgiveness of the borrower's obligation. Consumer loans, excluding residential mortgage loans and credit card loans, are charged off after reaching 90 days past due. Residential mortgage loans are placed on non-accrual status after reaching 120 days past due and are written down to the fair value of underlying collateral at that time. Credit card loans are charged off after reaching 150 days past due. Prior to the second quarter of 1996, credit card loans were charged off after reaching 180 days past due. OTHER REAL ESTATE OWNED When a property is acquired through foreclosure of a loan secured by real estate, that property is recorded at the lower of the cost basis in the loan or the estimated fair value of the property less estimated disposal costs. Writedowns at the time of foreclosure are charged against the allowance for loan losses. Subsequent writedowns for changes in the fair value of the property are charged to other non-financial expense. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Factors included in management's determination of an adequate level of allowance for loan losses are a statistical analysis of historical loss levels throughout an economic cycle and one year of projected charge-offs, establishing a minimum level below which the allowance for loan losses is considered inadequate and a maximum level above which is considered inappropriate. A quarterly evaluation of loss potential on specific credits, products, industries, portfolios and markets, as well as indicators for loan growth, the economic environment and concentrations assist in validating the position of the allowance for loan losses within those boundaries. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The Corporation adopted FAS 114 effective January 1, 1995. Under FAS 114, the allowance for loan losses related to "impaired loans" is based on discounted cash flows using the impaired loan's initial effective interest rate as the discount rate, or the fair value of the collateral for collateral dependent loans. A loan is impaired when it meets the criteria to be placed on non-accrual status or is a renegotiated loan. Loans which are evaluated for impairment pursuant to FAS 114 are assessed on a loan-by-loan basis, and include only commercial non-accrual and renegotiated loans. Large groups of smaller balance B-16 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued homogeneous loans, such as credit cards, lease financing receivables, loans secured by first and second liens on residential properties, and other consumer loans are evaluated collectively for impairment. Additions to the allowance arise from the provision for loan losses charged to operations or from the recovery of amounts previously charged off. Loan charge-offs reduce the allowance. Loans are charged off when there has been permanent impairment of the related carrying values. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is computed, generally, on the straight-line method at rates based on the following range of lives: buildings -- 10 to 45 years; equipment -- 3 to 12 years; and leasehold improvements -- 3 to 15 years. RETIREMENT PLANS The Corporation maintains non-contributory defined benefit pension plans for substantially all employees. Benefits are primarily based on the employee's years of credited service, average annual salary and primary social security benefit, as defined in the plans. It is the Corporation's policy to fund the plans on a current basis to the extent deductible under existing tax regulations. The Corporation provides postretirement health care and life insurance benefits for substantially all retired employees. In order to participate in the health care plan, an employee must retire with at least 10 years of service. The postretirement health care plan is contributory, with retiree contributions based on years of service. It is the Corporation's policy to fund these plans on a current basis to the extent deductible under existing tax regulations. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP") Compensation expense was recognized based on the average fair value of shares committed to be released to employees. Effective January 1, 1997, the ESOP was combined with the Corporation's 401(k) Savings Plan. The remaining shares in the ESOP will be released to substantially all employees and will be recorded as a portion of the Corporation's match of employee contributions to the 401(k) Savings Plan. FOREIGN EXCHANGE/CURRENCY Forward exchange contracts are valued at current rates of exchange. Gains or losses on forward exchange contracts intended to hedge an identifiable foreign currency commitment, if any, are deferred and included in the measurement of the related foreign currency transaction. All other gains or losses on forward exchange contracts are included in fees for international services. Currency gains and losses in connection with non-dollar denominated loans and deposits, which are included in interest income and expenses, are recognized pro rata over the contract terms. Foreign currency translation adjustments are recorded directly to retained earnings. The cumulative foreign currency translation gain (loss) was $3,848, $(1,600) and $(1,571) at December 31, 1996, 1995 and 1994, respectively. DERIVATIVE INTEREST RATE CONTRACTS The Corporation uses various interest rate contracts such as, interest rate swaps, futures, forward rate agreements, caps and floors, tender option bonds, Treasury float agreements, and forward commitments to purchase and sell loans and securities, primarily to manage the interest rate risk of specific assets, liabilities or anticipated transactions, to manage interest rate risk in securities trading positions and to provide for the needs of its customers. For contracts held for purposes other than trading, gains or losses are deferred and recognized as adjustments to interest income or expense of the underlying assets or liabilities and the interest differentials are recognized as adjustments of the related interest income or expense. Gains or losses resulting from early terminations of these contracts are deferred and amortized over the remaining term of the underlying assets or liabilities. Any fees received or disbursed which represent adjustments to the yield on interest rate contracts are B-17 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued capitalized and amortized over the term of the interest rate contracts. If the underlying assets or liabilities related to a derivative matures, is sold, extinguished, or terminates, the amount of the previously unrecognized gain or loss is recognized at that time in the consolidated income statement. The Corporation's trading and customer-related derivative positions mostly include tender option bonds, Treasury float agreements, and forward commitments to purchase and sell loans and securities, and interest rate caps, floors, and swaps. Tender option bonds represent a contingent liability to purchase securities. Gains and losses and net interest spread earned on these products are included in non-interest income. Treasury float agreements represent purchased option contracts. Forward commitments to purchase and sell loans and securities consist primarily of forward commitments to sell mortgage-backed securities, which are used to hedge mortgage loans held in the trading account. These commitments are marked to fair value with unrealized gains and losses recorded in income from trading activities. Contracts held or issued for customers are valued at market with gains or losses included in income from trading activities. EARNINGS PER COMMON SHARE Earnings per common share for all periods presented are based on weighted average common shares outstanding as dilution from potentially dilutive common stock equivalents (primarily stock options) does not have a materially dilutive effect on earnings per share. For purposes of computing earnings per share, shares committed to be released and shares allocated in the ESOP are considered outstanding. TREASURY STOCK The purchase of the Corporation's common stock is recorded at cost. At the date of subsequent reissuance, the treasury stock account is reduced by the cost of shares reissued on a last-in-first-out basis. CASH DIVIDENDS DECLARED PER SHARE Cash dividends declared per share for the periods prior to the acquisitions of Meridian on April 9, 1996, Independence Bancorp, Inc. on June 27, 1994 and Constellation Bancorp on March 16, 1994 assume that the Corporation would have declared cash dividends equal to the cash dividends per share actually declared by the Corporation. 2. ACQUISITIONS PURCHASE ACQUISITION On December 2, 1994, the Corporation purchased Germantown Savings Bank ("Germantown"), a Pennsylvania chartered stock savings bank with $1.6 billion in assets and $1.4 billion in deposits at the time of the acquisition. Under the terms of the transaction, each of Germantown's 4.15 million shares of common stock was exchanged for a combination of the Corporation's common stock, equal to approximately 55% of the $62 per Germantown share purchase price, and cash, equal to approximately 45% of the purchase price. As a result of this acquisition, 5.9 million shares of the Corporation's common stock were issued out of treasury stock. The transaction had a total value of approximately $260 million and was accounted for under the purchase method of accounting. Accordingly, the results of operations of Germantown have been included since the date of acquisition. Under this method of accounting, the purchase price is allocated to the respective assets acquired and liabilities assumed based on their estimated fair values, net of applicable income tax effects. Intangible assets of $183 million, including $140 million of goodwill, were created in this transaction. Goodwill is being amortized to other operating expense on a straight-line basis over 15 years. A summary of unaudited pro forma combined financial information for the year ended December 31, 1994 for the Corporation and Germantown as if the transaction had occurred on January 1, 1994 is as follows: Net interest income............................................. $2,135,969 Non-interest income............................................. 797,961 Net income...................................................... 451,063 Per common share................................................ $1.94 Average common shares outstanding............................... 232,180
B-18 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 2. ACQUISITIONS -- Continued POOLING ACQUISITION On April 9, 1996, the Corporation acquired Meridian, a Pennsylvania bank holding company with $15.2 billion in assets and $12.1 billion in deposits. The Corporation issued approximately 81.1 million shares of common stock to shareholders of Meridian based on an exchange ratio of 1.225 shares of the Corporation's common stock for each share of Meridian common stock. At a February 6, 1996 shareholders' meeting, the Corporation's shareholders approved an increase in the number of authorized shares from 200 million to 350 million. On February 23, 1996, Meridian acquired United Counties, a New Jersey bank holding company with $1.6 billion in assets in a transaction accounted for as a pooling of interests. Accordingly, the consolidated accounts of Meridian include United Counties for all periods presented. The Meridian acquisition was accounted for under the pooling of interests method of accounting; accordingly, the consolidated financial statements include the consolidated accounts of Meridian for all periods presented. Financial information on a separate company basis for the two years ended December 31, 1995 for the Corporation and Meridian (including United Counties) was as follows:
1995 1994 -------------------------- -------------------------- THE (UNAUDITED) THE (UNAUDITED) CORPORATION MERIDIAN CORPORATION MERIDIAN ----------- ----------- ----------- ----------- Net interest income..................................................$ 1,488,534 $ 678,391 $ 1,389,369 $ 678,646 Provision for losses on loans........................................ 105,000 38,877 246,900 27,261 Non-interest income.................................................. 605,666 276,556 562,264 226,223 Non-financial expenses............................................... 1,274,398 612,695 1,317,561 608,736 Provision for income taxes........................................... 262,565 101,372 141,810 82,992 Income before cumulative effect of a change in accounting principle.. 452,237 202,003 245,362 185,880 Cumulative effect of a change in accounting principle................ -- -- (2,730)(a) Net income........................................................... 452,237 202,003 245,362 183,150 Income per share before cumulative effect of a change in accounting principle..........................................................$ 3.22 $ 3.03 $ 1.73 $ 2.72 Net income per share................................................. 3.22 3.03 1.73 2.68 Cash dividends declared.............................................. 1.44 1.45 1.24 1.34
- --------------- (a) Meridian adopted FAS 112 on January 1, 1994, the date required under that statement, and recognized a charge of $4,200, $2,730 after-tax, as the cumulative effect of a change in accounting principle. CoreStates adopted FAS 112 on January 1, 1993. As permitted under pooling of interests accounting, the restated consolidated financial statements are prepared as if Meridian also adopted FAS 112 effective January 1, 1993. The restated consolidated statements of income for 1995 and 1994 reflect a conforming accounting adjustment for Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"). The Corporation elected to recognize immediately the January 1, 1992 transitional liability of $128,706 pre-tax, $84,946 after-tax, as the cumulative effect of a change in accounting principle in the first quarter of 1992. Meridian adopted FAS 106 on January 1, 1993, the date required under that statement. As permitted by FAS 106, Meridian elected to amortize its liability over 20 years. As permitted under pooling of interests accounting, the restated financial information is prepared as if Meridian adopted FAS 106 effective January 1, 1992 and immediately recognized the $28,827, $18,738 after-tax, transitional liability. Restated salaries, wages and benefits have been adjusted accordingly. 3. FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" ("FAS 107"), requires disclosure of fair value information about financial instruments, whether or not required to be recognized in the balance sheet, for which it is practicable to estimate that value. FAS 107 defines a financial instrument as cash, evidence of ownership interest in an entity, or a contractual obligation or right that will be settled with another financial instrument. B-19 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 3. FAIR VALUES OF FINANCIAL INSTRUMENTS -- Continued In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Fair value estimates derived through those techniques cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. FAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. The following table summarizes the carrying amount and fair value estimates of financial instruments at December 31, 1996 and 1995.
1996 1995 -------------------------- -------------------------- CARRYING CARRYING OR NOTIONAL FAIR OR NOTIONAL FAIR AMOUNT VALUE AMOUNT VALUE ----------- ----------- ----------- ----------- Assets: Cash and short-term assets...................................... $ 6,415,135 $ 6,415,135 $ 6,291,340 $ 6,291,340 Investment securities........................................... 4,083,224 4,086,409 5,632,232 5,648,279 Trading account assets.......................................... 122,317 122,317 147,218 147,218 Net loans, excluding leases..................................... 30,834,492 30,837,703 29,876,531 30,293,254 Liabilities: Demand and savings deposits..................................... 22,629,513 22,629,513 23,063,053 23,063,053 Time deposits, including overseas branches and subsidiaries..... 11,097,643 11,321,471 10,900,767 11,065,260 Short-term borrowings........................................... 2,633,157 2,633,157 3,677,013 3,677,013 Long-term debt.................................................. 3,049,297 3,059,173 2,212,099 2,266,725 Off-balance sheet asset (liability): Letters of credit............................................... 2,893,214 (28,931) 2,873,265 (27,659) Commitments to extend credit.................................... 19,569,566 (21,204) 18,438,277 (16,135) Mortgage loans sold and loan servicing acquired with recourse... 361,410 (9,637) 434,628 (12,260) Derivative financial instruments................................ 20,173,225 96,629 16,091,322 237,649
Fair value estimates, methods, and assumptions for the Corporation's financial instruments are set forth below: CASH AND DUE FROM BANKS AND SHORT-TERM INSTRUMENTS -- The carrying amounts reported in the balance sheet for cash and due from banks and short-term instruments approximate their fair values. Short-term instruments include: time deposits; Federal funds sold; and securities purchased under agreements to resell, all of which generally have original maturities of less than 90 days. INVESTMENT SECURITIES -- Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. TRADING ACCOUNT ASSETS -- Fair values for the Corporation's trading account assets, which also are the amounts recognized in the balance sheet, are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or are derived from pricing models or formulas using discounted cash flows. LOANS -- Fair values are estimated for loans in groups with similar financial and risk characteristics. Loans are segregated by type including: commercial and industrial; commercial real estate; residential real estate; credit card and other consumer; financial institutions; factoring receivables; and foreign. Each loan type is further segmented into fixed and variable rate interest terms and by performing and non-performing categories in order to estimate fair values. The fair value of fixed-rate performing loans is calculated by discounting scheduled principal and interest cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type at December 31, 1996 and 1995. The estimate of maturity is based on the Corporation's historical experience B-20 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 3. FAIR VALUES OF FINANCIAL INSTRUMENTS -- Continued with repayments for each loan type, modified by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by referring to secondary market source pricing. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience and are discounted using secondary market rates adjusted for differences in servicing and credit costs. This estimate does not include the benefit that relates to cash flows which could generate from new loans to existing cardholders over the remaining life of the portfolio. For variable rate loans that reprice frequently and which have experienced no significant change in credit risk, fair values are based on carrying amounts. Fair value for non-performing loans is based on discounting estimated cash flows using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding cash flows and discount rates are determined using available market information and specific borrower information. DEPOSIT LIABILITIES -- The fair values disclosed for demand deposits (non-interest bearing checking accounts, NOW accounts, savings accounts, and money market accounts) are, by FAS 107 definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term certificates of deposit approximate their fair values. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates offered on certificates at December 31, 1996 and 1995, respectively, to an estimate of aggregate expected maturities for those certificates of deposit. The estimated fair values do not include the benefit that results from funding provided by core deposit liabilities as compared to the cost of borrowing funds in the financial markets. SHORT-TERM FUNDS BORROWED -- The carrying amounts of Federal funds purchased, securities sold under agreements to repurchase, commercial paper and other short-term borrowings approximate their fair values. LONG-TERM DEBT -- The fair values for long-term debt are based on quoted market prices where available. If quoted market prices are not available, fair values are estimated using discounted cash flow analyses based on the Corporation's borrowing rates at December 31, 1996 and 1995 for comparable types of borrowing arrangements. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS AND COMMITMENTS -- Fair values for the Corporation's futures, forwards, interest rate swaps, options, interest rate caps and floors, foreign exchange contracts, tender option bonds and Treasury float contracts are based on quoted market prices (futures); current settlement values (forwards); quoted market prices of comparable instruments (foreign currency exchange contracts); or, if there are no directly comparable instruments, on pricing models or formulas using current assumptions (interest rate swaps, interest rate caps and floors, tender option bonds, Treasury float contracts and options). The fair value of commitments to extend credit, other than credit card lines, is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The value of commitments to extend credit under credit card lines is embodied in the benefit that relates to estimated cash flows from new loans expected to be generated from existing cardholders over the remaining life of the portfolio. The fair value of standby and commercial letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate the agreements or otherwise settle the obligations with the counterparties. B-21 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 4. LOAN PORTFOLIO The following are summaries of certain loan categories, net of unearned discounts, for the two years ended December 31, 1996 (in thousands):
1996 1995 ----------- ----------- Domestic loans: Commercial, industrial and other......................... $13,906,646 $12,597,470 Real estate loans: Construction and development.......................... 554,924 607,845 Residential........................................... 4,676,016 5,648,661 Other, primarily commercial mortgages and commercial loans secured by owner-occupied real estate......... 4,541,697 4,712,473 ----------- ----------- Total real estate loans............................. 9,772,637 10,968,979 ----------- ----------- Consumer loans: Installment.............................................. 2,870,934 2,912,670 Credit card.............................................. 1,674,921 1,527,447 ----------- ----------- Total consumer loans................................ 4,545,855 4,440,117 ----------- ----------- Financial institutions..................................... 1,153,715 961,289 Factoring receivables...................................... 411,280 557,272 Lease financing............................................ 1,232,213 1,167,356 ----------- ----------- Total domestic loans................................ 31,022,346 30,692,483 ----------- ----------- ----------- ----------- Foreign loans: Loans to or guaranteed by foreign banks: Government owned and central banks.................... -- -- Other foreign banks................................... 1,369,015 615,166 Commercial and industrial................................ 385,426 406,503 Loans to other financial institutions.................... 245 -- ----------- ----------- Total foreign loans................................. 1,754,686 1,021,669 ----------- ----------- Total loans......................................... $32,777,032 $31,714,152 ----------- ----------- ----------- -----------
The following represents the Corporation's non-accrual loans, renegotiated loans and other real estate owned for the years ended December 31, 1996 and 1995:
1996 1995 -------- -------- Non-accrual loans Domestic........................................................ $220,770 $223,602 Foreign......................................................... -- -- Total non-accrual loans...................................... 220,770 223,602 Renegotiated loans (a)............................................ 18 7,202 -------- -------- Total non-performing loans................................... 220,788 230,804 -------- -------- Other real estate owned (OREO).................................... 24,175 37,502 -------- -------- Total non-performing assets....................................... $244,963 $268,306 -------- -------- -------- --------
- --------------- (a) There were no foreign renegotiated loans in any periods presented. B-22 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 4. LOAN PORTFOLIO -- Continued The following reflects the effect of non-accrual and renegotiated loans on both interest income and net interest income for the three years ended December 31, 1996, 1995 and 1994:
1996 1995 1994 ------- ------- ------- Interest income which would have been recorded in accordance with original terms: Domestic............................................... $20,244 $27,452 $35,554 Foreign................................................ -- 8 9 ------- ------- ------- Total............................................... 20,244 27,460 35,563 ------- ------- ------- Interest income reflected in total operating income: Domestic............................................... 8,977 14,354 12,599 ------- ------- ------- Total............................................... 8,977 14,354 12,599 ------- ------- ------- Net reduction in interest income and net interest income................................................. $11,267 $13,106 $22,964 ------- ------- ------- ------- ------- -------
The Corporation has traditionally maintained limits on industry, market and borrower concentrations as a way to diversify and manage credit risk. The Corporation's current policy is to limit industry concentrations to 50% of total equity and to limit market segment concentrations to 10% of total assets. The Corporation manages industry concentrations by applying these dollar limits to industries that have common risk characteristics. At December 31, 1996 and 1995, the Corporation had loans totaling $110,948 and $152,436, respectively, to its officers, directors and companies in which the directors had a 10% or more voting interest. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The 1996 additions and reductions were $376,984 and $418,472, respectively. Included in loans at December 31, 1996 and 1995 were $446,000 and $514,000, respectively, of loans held for sale and carried at lower of cost or market. The book value of real estate loans transferred to other real estate owned during 1996, 1995 and 1994 was $19,536, $29,337 and $79,539, respectively. The following presents information on derivative financial instruments used to manage interest rate risk associated with loans:
1996 1995 ---------- ---------- At December 31, Notional value.............................................. $9,118,000 $4,251,000 Unrealized gains............................................ 64,000 104,000 Unrealized losses........................................... 19,000 5,000 Effect on loan yield for the years ended December 31, From........................................................ 8.92% 9.37% To.......................................................... 9.03% 9.43%
B-23 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 5. INVESTMENT SECURITIES The carrying and fair values of investment securities at December 31, 1996 and 1995 were as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- 1996 Held-to-Maturity U.S. Treasury and Government agencies.................................... $ 362,736 $ 3,501 $ 815 $ 365,422 State and municipal...................................................... 366,012 8,548 95 374,465 Mortgage-backed.......................................................... 463,796 52 1,023 462,825 Other: Domestic............................................................... 442,082 340 7,529 434,893 Foreign................................................................ 54,432 224 18 54,638 ---------- ---------- ---------- ---------- Total held-to-maturity.............................................. $1,689,058 $ 12,665 $ 9,480 $1,692,243 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Available-for-Sale U.S. Treasury and Government agencies.................................... $1,512,966 $ 9,207 $ 1,061 $1,521,112 State and municipal...................................................... 59,864 468 335 59,997 Mortgage-backed.......................................................... 505,527 4,494 4,854 505,167 Other: Domestic............................................................... 186,029 14,096 939 199,186 Foreign................................................................ 87,741 20,974 11 108,704 ---------- ---------- ---------- ---------- Total available-for-sale............................................ $2,352,127 $ 49,239 $ 7,200 $2,394,166 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- 1995 Held-to-Maturity U.S. Treasury and Government agencies.................................... $ 978,603 $ 12,198 $ 1,310 $ 989,491 State and municipal...................................................... 469,330 13,276 552 482,054 Mortgage-backed.......................................................... 1,136,486 5,587 4,950 1,137,123 Other: Domestic............................................................... 444,090 4,107 12,323 435,874 Foreign................................................................ 31,408 16 2 31,422 ---------- ---------- ---------- ---------- Total held-to-maturity.............................................. $3,059,917 $ 35,184 $ 19,137 $3,075,964 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Available-for-Sale U.S. Treasury and Government agencies.................................... $1,570,689 $ 17,098 $ 1,744 $1,586,043 State and municipal...................................................... 78,625 1,174 94 79,705 Mortgage-backed.......................................................... 620,727 6,508 4,838 622,397 Other: Domestic............................................................... 186,409 45,555 955 231,009 Foreign................................................................ 31,844 21,317 -- 53,161 ---------- ---------- ---------- ---------- Total available-for-sale............................................ $2,488,294 $ 91,652 $ 7,631 $2,572,315 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
On November 15, 1995, the FASB issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities", which permitted an enterprise to reassess the appropriateness of the classification of all investment securities held between November 15, 1995 and December 31, 1995. Based on its reassessment, the Corporation reclassified $1,726,739 in investment securities previously classified as held-to-maturity to the available-for-sale category. Unrealized gains on transferred investments were $12,160, unrealized losses were $8,340, and the fair value was $1,730,559. Marketable equity securities are carried in the available-for-sale portfolio and have been written up by $34,808 at December 31, 1996 and $66,061 at December 31, 1995, the aggregate of their excess fair values over cost, through after-tax B-24 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 5. INVESTMENT SECURITIES -- Continued credits to retained earnings. The Corporation recorded pre-tax gains of $13,210 in 1996, $7,654 in 1995 and $14,167 in 1994 on sales of certain domestic equity securities. During 1996 and 1995, the Corporation recorded pre-tax gains of $28,656 and $13,596, on the exchange of certain domestic equity securities. During 1996, 1995 and 1994, the Corporation recorded pre-tax gains of $18,924, $939 and $2,567 on sales of foreign equity securities. Included in mortgage-backed securities available-for-sale at December 31, 1996 were mortgage residual securities with an amortized cost and fair value of $5,989 and $7,569, respectively. Pre-tax write-downs of $5,276 were recognized in 1994 on these investments and were included in securities gains and losses. At December 31, 1996 and 1995, there were no investments in securities of any single, non-Federal issuer in excess of 10% of shareholders' equity. Securities with a carrying value of $1,734,355 were pledged at December 31, 1996 to secure public deposits, trust deposits, and for certain other purposes as required by law. The amortized cost and estimated fair value of debt securities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.
AMORTIZED FAIR COST VALUE ---------- ---------- Held-to-Maturity Due in one year or less....................................... $ 220,553 $ 221,808 Due after one year through five years......................... 595,215 599,835 Due after five years through ten years........................ 94,845 97,802 Due after ten years........................................... 46,533 49,385 Mortgage-backed securities.................................... 463,796 462,825 ---------- ---------- $1,420,942 $1,431,655 ---------- ---------- ---------- ---------- Available-for-Sale Due in one year or less....................................... $ 562,884 $ 564,608 Due after one year through five years......................... 1,100,626 1,106,603 Due after five years through ten years........................ 11,591 11,627 Due after ten years........................................... 26,130 26,161 Mortgage-backed securities.................................... 505,527 505,167 ---------- ---------- $2,206,758 $2,214,166 ---------- ---------- ---------- ----------
Proceeds from sales of investments in debt securities during 1996, 1995, and 1994 were $1,411,398, $560,022, and $739,457, respectively. Gross gains of $4,100 in 1996, $11,180 in 1995, and $14,646 in 1994, and gross losses of $5,378 in 1996, $1,894 in 1995, and $5,005 in 1994 were realized on those sales. 6. REGULATORY AND CAPITAL MATTERS The Corporation and its subsidiaries are subject to the regulations of certain Federal and state agencies including minimum risk-based and leverage capital guidelines issued by the Federal Reserve Board and Comptroller of the Currency. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. B-25 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 6. REGULATORY AND CAPITAL MATTERS -- Continued At December 31, 1996, management believes that the Corporation and its principal bank subsidiary, CBNA, meet all capital adequacy requirements to which they are subject. The following table illustrates the Corporation's and CBNA's risk-based and leverage capital ratios at December 31, 1996 and 1995:
PER REGULATORY GUIDELINES ---------------------------------------- ACTUAL MINIMUM "WELL-CAPITALIZED" ------------------- ------------------ ------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ---------- ------ ---------- ----- ---------- ----- December 31, 1996 Tier 1 capital (a): Consolidated............................................. $3,725,318 9.45% $1,576,914 4% $2,365,372 6% CBNA..................................................... 3,270,045 8.90 1,471,992 4 2,207,987 6 Total capital (b): Consolidated............................................. 5,215,789 13.23 3,153,829 8 3,942,286 10 CBNA..................................................... 4,206,434 11.43 2,943,983 8 3,679,979 10 Tier 1 leverage ratio: Consolidated............................................. 3,725,318 8.46 1,321,090 3 2,201,817 5 CBNA..................................................... 3,270,045 7.80 1,257,745 3 2,096,241 5 December 31, 1995 Tier 1 capital (a): Consolidated............................................. 3,534,144 9.20 1,537,225 4 2,305,838 6 CBNA..................................................... 1,404,622 7.57 742,217 4 1,113,326 6 Total capital (b): Consolidated............................................. 4,890,929 12.71 3,074,450 8 3,843,063 10 CBNA..................................................... 1,966,829 10.60 1,484,434 8 1,855,543 10 Tier 1 leverage ratio: Consolidated............................................. 3,534,144 7.99 1,327,425 3 2,212,374 5 CBNA..................................................... 1,404,622 6.83 616,934 3 1,028,223 5
- --------------- (a) Consists primarily of common shareholders' equity and Trust Capital Securities, less goodwill and certain intangible assets. (b) Consists of Tier 1 capital plus qualifying subordinated debt and the allowance for loan losses, within permitted limits. The primary source of funds for cash dividend payments by the Corporation to its shareholders is dividends received from its banking subsidiaries. The approval of the Comptroller of the Currency is required for a nationally chartered bank to pay dividends if the total of all dividends declared in any calendar year exceeds the bank's net profits (as defined by national banking regulations) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, CBNA and CBD can declare dividends without approval of the Comptroller of the Currency of approximately $112,000 and $18,000, respectively, plus an additional amount equal to CBNA's and CBD's retained net profits for 1997 up to the date of any such dividend declaration. The Federal Reserve Act requires that extensions of credit by CBNA to certain affiliates, including the Corporation, be secured by specified amounts and types of collateral, that extensions of credit to any such affiliate generally be limited to 10% of capital and surplus (as defined in that Act) and that extensions of credit to all such affiliates be limited to 20% of capital and surplus. The Corporation's banking subsidiaries are required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the years ended December 31, 1996 and 1995 were approximately $257,000 and $429,000, respectively. B-26 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 7. ALLOWANCE FOR LOAN LOSSES The following represents an analysis of changes in the allowance for loan losses for the years ended December 31, 1996, 1995 and 1994:
1996 1995 1994 --------- --------- --------- Balance at beginning of period......................................................... $ 670,265 $ 681,124 $ 636,915 Provision charged to operating expense................................................. 228,767 144,002 279,195 Recoveries of loans previously charged off............................................. 92,985 85,226 83,914 Loan charge-offs....................................................................... (281,690) (240,087) (341,454) Allowance for loans sold at date of sale............................................... -- -- (2,377) Allowance for loans purchased at date of purchase...................................... -- -- 1,192 Allowance for loans of bank acquired under purchase method of accounting............... -- -- 23,739 --------- --------- --------- Balance at end of period............................................................... $ 710,327 $ 670,265 $ 681,124 --------- --------- --------- --------- --------- ---------
The following presents information on loans that are considered impaired under FAS 114:
1996 1995 -------- -------- At December 31, Recorded investment in impaired loans............................. $183,330 $203,399 Impaired loans against which a portion of the allowance for loan losses is specifically allocated................................ 74,609 88,973 Amount of allowance for loan losses specifically allocated to impaired loans.................................................. 15,105 24,445 For the years ended December 31, Average recorded investment in impaired loans..................... 197,854 257,746 Interest income recognized on impaired loans...................... 8,977 14,354
8. PREMISES AND EQUIPMENT Premises and equipment on the consolidated balance sheet is presented net of accumulated depreciation and amortization of $667,412 and $711,830 at December 31, 1996 and 1995, respectively. Depreciation and amortization of premises and equipment for the years ended December 31, 1996, 1995, and 1994, was $95,897, $98,033 and $95,240, respectively. 9. OPERATING LEASES Rental expense, reduced by sublease rental income, charged to operations was $90,982, $85,419 and $85,554 for 1996, 1995 and 1994, respectively. 10. DEPOSITS The following presents a breakdown of deposits at December 31, 1996 and 1995:
1996 1995 ----------- ----------- Domestic: Non-interest bearing checking............................ $ 9,330,445 $ 8,937,147 Savings, NOW and money market accounts................... 13,299,068 14,125,906 Time deposits............................................ 9,687,887 9,757,820 ----------- ----------- Total domestic deposits............................... 32,317,400 32,820,873 Overseas branches and subsidiaries......................... 1,409,756 1,142,947 ----------- ----------- Total deposits........................................ $33,727,156 $33,963,820 ----------- ----------- ----------- -----------
B-27 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 10. DEPOSITS -- Continued Domestic time deposits in denominations of $100 or more at December 31, 1996, 1995, and 1994 were:
1996 1995 1994 ---------- ---------- ---------- Commercial certificates of deposit.............. $ 754,437 $ 695,970 $ 611,206 Other domestic time deposits, principally savings certificates.......................... 613,126 501,058 533,336 ---------- ---------- ---------- Total...................................... $1,367,563 $1,197,028 $1,144,542 ---------- ---------- ---------- ---------- ---------- ----------
Interest expense on domestic time deposits in denominations of $100 or more for the years ended December 31, 1996, 1995, and 1994 was:
1996 1995 1994 ------- ------- ------- Interest expense: Commercial certificates of deposit..................... $30,857 $36,520 $22,499 Other domestic time deposits, principally savings certificates........................................ 25,451 30,057 24,138 ------- ------- ------- Total............................................... $56,308 $66,577 $46,637 ------- ------- ------- ------- ------- -------
Substantially all of the deposits of overseas branches and subsidiaries were time deposits in denominations of $100 or more for each of the three years presented. The following presents information on derivative financial instruments used to manage interest rate risk associated with deposits:
1996 1995 ---------- ---------- At December 31, Notional value.............................................. $5,314,000 $6,962,000 Unrealized gains............................................ 50,000 106,000 Unrealized losses........................................... 16,000 8,000 Effect on deposit cost for the year ended December 31, From........................................................ 3.62% 3.75% To.......................................................... 3.49% 3.76%
B-28 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 11. SHORT-TERM FUNDS BORROWED Short-term funds borrowed at December 31, 1996 and 1995 include the following:
1996 1995 ---------- ---------- Federal funds purchased (a)................................... $ 532,334 $1,129,432 Securities sold under agreements to repurchase (b)............ 656,397 812,281 Commercial paper (c).......................................... 675,181 1,255,656 Other short-term funds borrowed (d)........................... 769,245 479,644 ---------- ---------- Total short-term funds borrowed (e)...................... $2,633,157 $3,677,013 ---------- ---------- ---------- ----------
- --------------- (a) Federal funds purchased generally represent the overnight Federal funds transactions of banking subsidiaries with correspondent banks. The weighted average interest rate paid was 5.54% in 1996, 6.02% in 1995 and 4.58% in 1994. The maximum amount outstanding at any month-end was $1,977,950 during 1996, $2,060,375 during 1995, and $1,646,440 during 1994. (b) Securities sold under agreements to repurchase usually mature within one to thirty days or are due on demand. The weighted average interest rate paid was 4.52% in 1996, 5.03% in 1995 and 3.44% in 1994. The maximum amount outstanding at any month-end was $836,722 during 1996, $863,937 during 1995, and $1,025,217 during 1994. (c) Commercial paper issued by CSCC is used to finance the short-term borrowing requirements of certain banking-related activities. Commercial paper is issued with maturities of not more than nine months and there are no provisions for extension, renewal or automatic rollover. The weighted average interest rate on commercial paper borrowings was 5.44% in 1996, 5.94% in 1995, and 4.24% in 1994. The maximum amount outstanding at any month-end was $1,106,078 during 1996, $1,388,927 during 1995, and $919,292 during 1994. At December 31, 1996, the Corporation had a $700,000 revolving credit facility from unaffiliated banks. The facility was established in support of commercial paper borrowings, Medium Term Note (see Note 12) issuance and general corporate purposes. Unless extended by the Corporation in accordance with the terms of the facility agreement, the facility expires February 2000. There were no borrowings under this facility at December 31, 1996. The interest rate charged for usage of these lines varies with money market conditions. (d) Other short-term funds borrowed include term Federal funds purchased, short-term Bank Notes and demand notes payable to the U.S. Treasury. (e) The aggregate average short-term funds borrowed were $2,958,655 in 1996, $3,751,518 in 1995, and $3,435,972 in 1994. The weighted average interest rate was 5.18% in 1996, 5.71% in 1995 and 4.35% in 1994. The average interest rate is calculated primarily on a daily average of short-term funds borrowed. B-29 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 12. LONG-TERM DEBT Long-term debt at December 31, 1996 and 1995 includes the following:
1996 1995 ---------- ---------- CoreStates Financial Corp: 6 5/8% Notes due 2000 (a)..................................... $ 150,000 $ 150,000 7 7/8% Subordinated Notes due 2002 (b)........................ 100,000 100,000 7 7/8% Subordinated Notes due 1996............................ -- 75,000 8 5/8% Mortgages due 2001..................................... 6,603 8,823 Unamortized Discounts......................................... (271) (325) ---------- ---------- 256,332 333,498 ---------- ---------- CSCC: 6 3/4% Guaranteed Subordinated Notes due 2006 (c)............. 200,000 -- 5 7/8% Guaranteed Subordinated Notes due 2003 (c)............. 200,000 200,000 6 5/8% Guaranteed Subordinated Notes due 2005 (c)............. 175,000 175,000 9 5/8% Guaranteed Subordinated Notes due 2001 (c)............. 150,000 150,000 9 3/8% Guaranteed Subordinated Notes due 2003 (c)............. 100,000 100,000 Medium Term Notes (d)......................................... 1,509,000 1,036,035 Unamortized Discounts......................................... (4,990) (3,631) ---------- ---------- 2,329,010 1,657,404 ---------- ---------- CoreStates Capital I: 8% Trust Capital Securities due 2026(e)....................... 300,000 Unamortized Discounts......................................... (6,491) ---------- 293,509 ---------- Other subsidiaries: 6 5/8% Subordinated Notes due 2003 (f)........................ 150,000 150,000 Federal Home Loan Bank Borrowings (g)......................... 2,888 42,888 Various other................................................. 18,175 29,022 Unamortized Discounts......................................... (617) (713) ---------- ---------- 170,446 221,197 ---------- ---------- Total long-term debt (h)................................. $3,049,297 $2,212,099 ---------- ---------- ---------- ----------
- --------------- (a) The Notes are unsecured and senior in right of payment to all subordinated indebtedness of the Corporation. The Notes are not redeemable by the Corporation or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (b) The Notes are unsecured and subordinate in right of payment to all present and future senior indebtedness of the Corporation. The Notes are not redeemable by the Corporation or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (c) The Notes are not subject to redemption prior to maturity and are unconditionally guaranteed, on a subordinated basis, as to payment of principal and interest by the Corporation. The Notes are subordinated to all existing and future senior CSCC indebtedness and the guarantee is subordinated to all outstanding senior Corporation indebtedness. (d) CSCC can issue Medium Term Notes (Senior and Subordinated) with maturities of nine months or greater from date of issue. The interest rate or interest rate formula on each Note is established by CSCC at the time of issuance. The Senior Notes are unconditionally guaranteed as to payment of principal and interest by the Corporation. The Subordinated Notes are unconditionally guaranteed, on a subordinated basis, as to payment of principal and interest by the Corporation. The B-30 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 12. LONG-TERM DEBT -- Continued Subordinated Notes are subordinated to all existing and future senior CSCC indebtedness and the guarantee is subordinated to all existing and future senior Corporation indebtedness. At December 31, 1996, $1,509,000 of debt is outstanding with maturities up to five years. Interest rates are predominately variable. Under an existing shelf registration statement filed with the Securities and Exchange Commission, the Corporation had debt and capital securities that were registered but unissued of approximately $1,085,000 at December 31, 1996. (e) The Trust Capital Securities evidence a preferred ownership interest in a trust, of which 100% of the common equity is owned by CBNA. The Trust Capital Securities are unconditionally guaranteed by CBNA. The proceeds from issuance of the Trust Capital Securities are invested in 8% Junior Subordinated Deferrable Interest Debentures of CBNA due 2026. These Subordinated Debt Securities have provisions enabling certain actions such as redemption or the deferment of the semiannual payments of interest, which will impact the Trust Capital Securities. CBNA may redeem the Subordinated Debt Securities in whole or in part, on or after December 15, 2006. In addition, Subordinated Debt Securities may be redeemed by CBNA at any time upon the occurrence of certain events. In the event of such a redemption of the Subordinated Debt Securities, the proceeds of such payment or repayment shall concurrently be applied to redeem the Trust Capital Securities. (f) The Notes were issued by CBNA and are unsecured and subordinate to the claims of depositors and other creditors. The Notes are not redeemable by CBNA or the holders prior to the maturity date and are not entitled to the benefit of any sinking fund. (g) The borrowing matures in July 2016 and carries a fixed interest rate of 6.66%. These borrowings require membership in the Federal Home Loan Bank of Pittsburgh and the maintenance of available collateral with a fair value which approximates the total amount of the outstanding debt. (h) The consolidated aggregate maturities for long-term debt for the years ending December 31, 1997 through 2001 are: $376,637; $528,562; $395,740; $216,672; and $298,203, respectively. The following presents information on derivative financial instruments used to manage interest rate risk associated with long-term debt:
1996 1995 ---------- -------- At December 31, Notional value................................................ $1,019,000 $614,000 Unrealized gains.............................................. 16,000 24,000 Unrealized losses............................................. 13,000 8,000 Effect on long-term debt cost for the years ended December 31, From.......................................................... 6.53% 6.78% To............................................................ 6.38% 6.76%
B-31 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 13. RETIREMENT AND BENEFIT PLANS The fair value of the assets in the Corporation's defined benefit pension plans exceeded the projected benefit obligation by $57,158 at December 31, 1996, based on current and estimated future salary levels. The excess of the fair value of plan assets is reconciled to the accrued pension cost included in other liabilities as follows:
DECEMBER 31, -------------------- 1996 1995 -------- -------- Plan assets at fair value(a)...................................... $902,947 $815,621 -------- -------- Present value of benefit obligation: Accumulated benefits based on salaries to date, including vested benefits of $667,536 in 1996 and $611,077 in 1995... 688,102 647,743 Additional benefits based on estimated future salary levels..................................................... 157,687 175,454 -------- -------- Projected benefit obligation...................................... 845,789 823,197 -------- -------- Amount the fair value of plan assets exceeds (is less than) the projected benefit obligation at December 31,.................... 57,158 (7,576) Reconciliation: Unrecognized prior service cost................................. 30,770 11,676 Unrecognized net asset from date of initial application......... (20,016) (25,357) Net deferred actuarial loss (gain).............................. (91,835) 22,151 -------- -------- Prepaid (accrued) pension expense included in other liabilities... $(23,923) $ 894 -------- -------- -------- --------
- --------------- (a) Primarily U.S. Government securities, U.S. agency securities, fixed income securities, common stock, and commingled funds managed by subsidiary banks. Net pension cost for the years ended December 31, 1996, 1995 and 1994 included the following expense (income) components:
1996 1995 1994 --------- --------- -------- Service cost benefits earned during the period...... $ 29,020 $ 24,492 $ 30,411 Interest cost on projected benefit obligation....... 60,793 54,497 51,881 Actual (return) loss on plan assets................. (121,868) (162,143) 22,038 Net amortization and deferral....................... 53,887 96,484 (80,394) --------- --------- -------- Net pension cost............................... $ 21,832 $ 13,330 $ 23,936 --------- --------- -------- --------- --------- --------
The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation for the Corporation was 7.5% and 7.0%-7.5%; respectively, at December 31, 1996 and 1995. The rate of increase on future compensation levels was 5.0% to 6.0% in both 1996 and 1995. The expected long-term rate of return on plan assets was 7.5%-9.5% in both 1996 and 1995. The Corporation sponsors a 401(k) savings plan for substantially all its employees. Contributions to the savings plan for the employer's match were $18,955 in 1996, $18,192 in 1995, and $23,140 in 1994. The ESOP is a leveraged plan funded through a direct loan from the Corporation. The ESOP has acquired a total of 2,450,000 shares of common stock for distribution to eligible employees ratably over a 20 year period. Compensation cost has been recognized based on the fair market value of the shares committed to be released to employees. Total compensation cost recognized was $5,378 in 1996 and $3,600 in 1995. Dividends on allocated shares are paid to participants and are charged to retained earnings. Dividends on unallocated shares are used by the ESOP to reduce its loan. Effective January 1, 1997 the ESOP was combined with the Corporation's 401(k) savings plan. B-32 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 13. RETIREMENT AND BENEFIT PLANS -- Continued The Corporation and its subsidiaries provide postretirement health care and life insurance benefits for substantially all retired employees. Postretirement benefits are provided through an insurance company whose premiums are based on the benefits paid during the year. The postretirement health care plan is contributory, with retiree contributions based on years of service. The liability for postretirement benefits included in other liabilities at December 31, 1996 and 1995 was as follows:
1996 1995 --------- --------- Accumulated postretirement benefit obligation: Retirees...................................................... $ (68,702) $(125,502) Fully eligible active plan participants....................... (1,827) (3,864) Other active plan participants................................ (29,748) (39,709) --------- --------- Accumulated postretirement benefit obligation................... (100,277) (169,075) Plan assets at fair value (a)................................... 52,591 46,974 --------- --------- Unfunded obligation at December 31,............................. (47,686) (122,101) Unrecognized prior service cost................................. (45,239) 115 Unrecognized net gain........................................... (51,157) (22,638) --------- --------- Accrued postretirement benefit obligation included in other liabilities................................................... $(144,082) $(144,624) --------- --------- --------- ---------
- --------------- (a) Primarily municipal bonds and short-term investments. Net periodic postretirement benefit cost for the years ended December 31, 1996, 1995 and 1994 included the following expense (income) components:
1996 1995 1994 ------- ------- ------- Service cost benefits earned during the period............ $ 2,769 $ 3,044 $ 3,602 Interest cost on accumulated postretirement benefit obligation.............................................. 7,947 11,932 11,931 Actual return on plan assets.............................. (1,527) (1,107) (461) Net amortization and deferral............................. (6,069) (1,436) (730) ------- ------- ------- Net periodic postretirement benefit cost.................. $ 3,120 $12,433 $14,342 ------- ------- ------- ------- ------- -------
For measurement purposes, the rate of increase in the per capita cost of covered health care benefits was assumed to be 5.5% per year and remains at that level until a predetermined benefit cap is reached. This fixed dollar cap was established as the per capita projected cost level in 1997 associated with the Corporation's indemnity medical plan. The health care cost trend rate assumption has an effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1 percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by $4,479 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $745. The expected long-term rate of return on plan assets was 6.0%. The weighted-average discount rate used in determining the Corporation's accumulated postretirement benefit obligation was 7.5% and 7.0%, respectively, at December 31, 1996 and 1995. 14. LONG-TERM INCENTIVE PLAN The Corporation has outstanding options granted under the Corporation's long-term incentive plan (the "Plan"). As provided in the Plan, a variety of incentives can be issued to eligible participants including restricted stock awards, incentive stock options, non-qualified stock options, stock appreciation rights, performance units and cash awards. Meridian, Constellation, Independence, United Counties and Germantown had maintained similar plans. Options granted under those plans B-33 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 14. LONG-TERM INCENTIVE PLAN -- Continued were assumed by the Corporation upon consummation of their respective acquisitions. The Plan provides for a maximum number of options available to be granted each year equal to 2% of outstanding common shares as of January 1 of that year. Options under the Plan are granted to purchase the Corporation's common shares at market value on the date of grant and are exercisable one year from the date of grant for a period not exceeding ten years from the date of grant. Stock appreciation rights may be granted in conjunction with the granting of an option. Information on option activity for 1996 follows:
SHARES UNDER WEIGHTED-AVERAGE OPTION EXERCISE PRICE ------------ ---------------- Balance at January 1, 1996............................... 8,581,554 $23.86 Options granted.......................................... 1,968,001(a) 41.49 Options exercised........................................ (4,519,411) 23.27 Options canceled......................................... (241,080) 31.84 ------------ Balance at December 31, 1996............................. 5,789,064 29.98 ------------ ------------
- --------------- (a) The fair value of options granted during 1996 was $12.6 million. The following table summarizes information about options outstanding at December 31, 1996:
OPTIONS OUTSTANDING ----------------------------------------------------- OPTIONS EXERCISABLE WEIGHTED-AVERAGE -------------------------------- RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ---------------- ----------- ---------------- ---------------- ----------- ---------------- $ 3.99 to $15.67 293,947 2.69 years $13.34 293,947 $13.34 $16.12 to $23.27 912,288 6.20 21.51 912,288 21.51 $25.41 to $29.95 2,977,462 7.94 27.74 2,977,462 27.74 $37.96 to $42.63 1,605,367 9.13 41.98 221,843 37.96 ----------- ----------- $ 3.99 to $42.63 5,789,064 7.73 29.98 4,405,540 25.37 ----------- ----------- ----------- -----------
The Corporation uses the intrinsic value method of accounting to measure compensation expense. If the fair value method had been used to measure compensation expense, net income would have been reduced by $7.4 million, or $0.04 per share and $7.2 million, or $0.03 per share, to $641.8 million, or $2.93 per share, and $647.9 million, or $2.92 per share, for the years ended December 31, 1996 and 1995, respectively. The fair value of options granted in 1996 and 1995 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions, respectively: risk-free interest rates of 5.49% to 7.80%, dividend yield of 4.0%, volatility factors of the expected market price of the Corporation's common stock of .148 to .223, and a weighted-average expected life of the options of 6 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Corporation's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, there are outstanding commitments and contingent liabilities which are not reflected in the financial statements. These include various financial instruments with off-balance sheet risk used in connection with the Corporation's asset and liability management, the management of interest rate risk in securities trading positions and to provide for the needs of customers. These involve varying degrees of credit, interest rate and liquidity risk, but do not B-34 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued represent unusual risks for the Corporation and management does not anticipate any significant losses as a result of these transactions. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING The Corporation uses off-balance sheet derivative financial instruments, such as interest rate swaps, futures and caps, to manage interest rate risk. The Corporation's exposure to interest rate risk stems from the mismatch between the sensitivity to movements in interest rates of the Corporation's assets and liabilities and from the spread risk between the rates on those assets and liabilities and financial market rates. The use of derivatives to manage interest rate risk falls into three categories: interest sensitivity adjustments, interest rate spread protection and hedging anticipated asset sales. Interest rate swaps and futures are generally used to lengthen the interest rate sensitivity of short-term assets and to shorten the repricing characteristics of longer term liabilities. Interest rate caps are used to manage spread risk. Interest rate caps are also used to offset the risk of upward interest rate movement on adjustable rate mortgages and other products with imbedded caps as well as to reduce the risk that interest rate spreads narrow on prime based products. Gains or losses are used to adjust the basis of the related asset or liability and interest differentials are adjustments of the related interest income or expense. In connection with anticipated sales of longer term assets acquired through merger or generated in the loan origination process, the Corporation uses interest rate swaps, rate locks and option agreements to reduce interest rate sensitivity as the assets are readied for sale. Hedge gains or losses are used to adjust the basis of the assets held for sale. B-35 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued Derivative financial instruments used in the management of interest rate risk at December 31, 1996 are summarized below (in millions):
INTEREST INTEREST INTEREST RATE RATE RATE CAPS OTHER SWAPS FUTURES AND FLOORS DERIVATIVES -------- -------- ---------- ----------- Interest Sensitivity Adjustment: Assets (primarily loans): Notional amount................................................... $ 4,092 $ 4,451 $ 8 $ 80 Unrealized gains.................................................. 64 2 -- -- Unrealized losses................................................. (19) -- -- -- Deposits and other borrowings: Notional amount................................................... 4,132 925 150 Unrealized gains.................................................. 35 13 2 Unrealized losses................................................. (16) -- -- Long-term debt: Notional amount................................................... 869 150 Unrealized gains.................................................. 13 3 Unrealized losses................................................. (13) -- Spread Protection: Assets (primarily loans): Notional amount................................................... 50 500 Unrealized gains.................................................. 3 2 Unrealized losses................................................. -- -- Deposits and other borrowings: Notional amount................................................... 107 Unrealized gains.................................................. -- Unrealized losses................................................. -- Anticipated Asset Sales: Notional amount................................................... 37 Unrealized gains.................................................. -- Unrealized losses................................................. -- Total Notional amount...................................................... $ 9,143 $ 4,451 $1,540 $ 417 -------- -------- ---------- ----------- Unrealized gains..................................................... $ 115 $ 2 $ 15 $ 5 -------- -------- ---------- ----------- Unrealized losses.................................................... $ (48) $ -- $ -- $ -- -------- -------- ---------- ----------- Net unrealized gains................................................. $ 67 $ 2 $ 15 $ 5 -------- -------- ---------- ----------- TOTAL ------- Interest Sensitivity Adjustment: Assets (primarily loans): Notional amount................................................... $ 8,631 Unrealized gains.................................................. 66 Unrealized losses................................................. (19) Deposits and other borrowings: Notional amount................................................... 5,207 Unrealized gains.................................................. 50 Unrealized losses................................................. (16) Long-term debt: Notional amount................................................... 1,019 Unrealized gains.................................................. 16 Unrealized losses................................................. (13) Spread Protection: Assets (primarily loans): Notional amount................................................... 550 Unrealized gains.................................................. 5 Unrealized losses................................................. -- Deposits and other borrowings: Notional amount................................................... 107 Unrealized gains.................................................. -- Unrealized losses................................................. -- Anticipated Asset Sales: Notional amount................................................... 37 Unrealized gains.................................................. -- Unrealized losses................................................. -- Total Notional amount...................................................... $15,551 ------- Unrealized gains..................................................... $ 137 ------- Unrealized losses.................................................... $ (48) ------- Net unrealized gains................................................. $ 89 -------
B-36 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued A summary of interest rate swap contracts categorized by whether the Corporation receives or pays fixed rates and stratified by repricing or maturity date is below (in millions):
YEARS ------------------------------------------------------------------ 0-1 1-2 2-3 3-4 4-5 OVER 5 TOTAL ------ ------ ------ ------ ------ ------ ------ Receive Fixed/Pay Floating: Receive Notional................................... $1,775 $1,271 $1,346 $1,402 $1,538 $1,050 $8,382 Rate....................................... 6.32% 6.30% 6.79% 6.41% 6.50% 6.74% 6.50% Pay Notional................................... $8,382 $8,382 Rate....................................... 5.68% 5.68% Pay Fixed/Receive Floating: Pay Notional................................... $ 15 $ 9 $ 25 $ 49 Rate....................................... 8.60% 8.09% 9.26% 8.84% Receive Notional................................... $ 49 $ 49 Rate....................................... 5.60% 5.60% Receive Floating/Pay Floating: (Basis Swaps) Notional................................... $ 230 $ 230 Receive Rate....................................... 5.54% 5.54% Pay Rate....................................... 5.58% 5.58% Receive Fixed/Pay Floating(a): (Forward Start) Receive Notional................................... $ 160 $ 275 $ 47 $ 482 Rate....................................... 7.07% 6.48% 7.05% 6.73% Start Date Notional................................... $ 115 $ 132 $ 235 $ 482
- --------------- (a) Pay rate will be determined on forward start date. Foreign currency derivatives used for hedging activities have not had a material impact on income or liquidity of the Corporation for any of the years presented. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES In its business of providing risk management services for its customers, the Corporation purchases and sells certain derivatives including interest rate swaps, caps and floors. In addition, as part of its international business, the Corporation enters into foreign exchange contracts on behalf of customers. These contracts are matched against forward sale or purchase contracts. Customer related derivative financial instrument transactions are generally marked to market and any gains or losses are recorded in the income statement. The Corporation also holds derivatives in connection with its securities trading activities and, at times, as a position taken in the expectation of profiting from favorable movements in interest rates. These products include tender option bonds and Treasury float contracts. Included in the income statement are trading revenues from derivatives of $29,242 of which $22,557 represents net foreign exchange gains included in fees for international services. B-37 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued Outstanding notional amounts and related fair values of trading and customer related derivative financial instruments at December 31, 1996 and 1995 are summarized by type of instrument below (in millions):
1996 1995 -------------------------------------- -------------------- POSITIVE NEGATIVE NOTIONAL NET ASSETS MARKET MARKET NOTIONAL AMOUNT (LIABILITY)(A) VALUE VALUE AMOUNT -------- -------------- -------- -------- -------- Interest Rate Swaps: CoreStates receives fixed................................ $ 355 $ 1.5 $ 2.7 $ (1.2) $ 115 CoreStates pays fixed.................................... 353 (1.0) 1.3 (2.3) 115 Futures.................................................... 39 0.4 0.4 -- 2 Rate Locks: CoreStates receives fixed................................ 30 (0.1) -- (0.1) 15 CoreStates pays fixed.................................... 30 0.1 0.1 -- 15 Interest Rate Caps/Floors: Sold..................................................... 705 (2.7) -- (2.7) 517 Purchased................................................ 704 2.7 2.7 -- 517 Commitments to purchase/sell whole mortgage loans and securities (including when-issued securities): Sold..................................................... 83 (0.2) 0.1 (0.3) 117 Purchased................................................ 19 -- -- -- 106 Other Options: Sold..................................................... 206 6.5 7.1 (0.6) 247 Purchased................................................ 334 0.8 0.8 -- 624 Foreign exchange contracts (b)............................. 1,766 (0.5) 28.0 (28.5) 1,695 -------- -------------- -------- -------- -------- Total Trading and Customer Related Derivatives............. $4,624 $ 7.5 $ 43.2 $(35.7) $4,085 -------- -------------- -------- -------- -------- NET ASSETS (LIABILITY)(A) -------------- Interest Rate Swaps: CoreStates receives fixed................................ $ 2 CoreStates pays fixed.................................... (2) Futures.................................................... -- Rate Locks: CoreStates receives fixed................................ -- CoreStates pays fixed.................................... -- Interest Rate Caps/Floors: Sold..................................................... (1) Purchased................................................ 1 Commitments to purchase/sell whole mortgage loans and securities (including when-issued securities): Sold..................................................... (2) Purchased................................................ 2 Other Options: Sold..................................................... 6 Purchased................................................ 1 Foreign exchange contracts (b)............................. 2(c) --- Total Trading and Customer Related Derivatives............. $ 9 ---
- --------------- (a) Average net assets (liabilities) during 1996 and 1995 were substantially the same as the net assets (liabilities) at December 31, 1996 and 1995, respectively. (b) Foreign exchange contracts purchased and sold at December 31, 1996 were $836 million and $930 million, respectively, and at December 31, 1995 were $853 million and $842 million, respectively. (c) Gross assets and (liabilities) on foreign exchange contracts at December 31, 1995 were $16 million and $14 million, respectively. B-38 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued The following is a summary of off-balance sheet commitments and derivative financial instruments as of December 31, 1996 and 1995, including fair values. See Note 3 for a discussion of fair value.
1996 1995 -------------------------- -------------------------- NOTIONAL FAIR NOTIONAL FAIR OR VALUE OR VALUE CONTRACTUAL OF ASSET CONTRACTUAL OF ASSET AMOUNT (LIABILITY) AMOUNT (LIABILITY) ----------- ----------- ----------- ----------- Standby letters of credit, net of participations (a).................... $ 1,630,621 $ (16,306) $ 1,548,551 $ (14,502) Commercial letters of credit............................................ 1,262,593 (12,625) 1,324,714 (13,157) Commitments to extend credit (b)........................................ 15,396,553 (21,204) 14,565,636 (16,135) Unused commitments under credit card lines.............................. 4,173,013 -- 3,872,641 -- When-issued securities (c): Commitments to purchase............................................... 1,770 -- 500 -- Commitments to sell................................................... 75,120 (140) 145,000 (1,411) Commitments to purchase/sell whole mortgage loans and securities (c): Commitments to purchase............................................... 17,280 30 109,714 2,071 Commitments to sell................................................... 7,965 (70) 47,259 (1,738) Mortgage loans sold and loan servicing acquired with recourse (d)....... 361,410 (9,637) 434,628 (12,260) Interest rate futures contracts (e): Commitments to purchase............................................... 4,489,800 2,781 621,000 658 Commitments to purchase foreign and U.S. currencies (f)................. 1,766,122 (488) 1,695,148 1,567 Interest rate swaps, notional principal amounts (g)..................... 9,850,708 67,673 9,945,840 206,186 Interest rate caps and floors (h): Written............................................................... 908,799 (2,842) 847,323 (1,229) Purchased............................................................. 2,039,331 17,383 1,673,023 25,021 Tender option bonds (i)................................................. 148,711 5,976 208,103 4,995 Treasury float contracts (j)............................................ 270,358 682 623,738 884 Other derivatives....................................................... 597,261 5,644 174,674 645
- --------------- (a) Standby letters of credit ("SBLC") are used in various transactions to enhance the credit standing of the Corporation's customers and are subjected to the same risk, credit review and approval process as loans. SBLC's are irrevocable assurances that the Corporation will make payment in the event that a customer cannot perform its contractual obligations to third parties. (b) Commitments to extend credit represent the Corporation's obligation to fund various types of loans, including home equity lines, lines of credit, revolving lines of credit and other types of commitments. (c) The Corporation has commitments to purchase/sell mortgage-backed securities or loans with delivery at a future date but typically within 120 days. The fair value of these instruments is affected by interest rates. In a declining interest rate environment, commitments to sell mortgage-backed securities or loans will decline in value. In a rising interest rate environment, commitments to buy mortgage-backed securities or loans will increase in value. Forward agreements to sell securities are used in transactions with municipalities that generally have a debt payment due in the future. Under these agreements, the Corporation agrees to deliver primarily United States Treasury securities that will mature on or before the required payment date. The type and associated interest rate of these securities is established when the agreement is entered. The primary risk associated with forward agreements is interest rate risk to the extent the required securities have not been purchased. If interest rates fall, securities yielding the higher agreed upon fixed rate will be more expensive for the Corporation to purchase. Included in when-issued securities and commitments to purchase/sell whole mortgage loans and securities are customer and trading-related products with a notional value of $102,135 and $223,873 at December 31, 1996 and 1995, respectively. B-39 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued (d) The Corporation originates and sells residential mortgage loans as part of various mortgage-backed security programs sponsored by the United States government agencies or government-sponsored agencies, such as the Government National Mortgage Association, Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. Certain sales and other servicing acquired are subject to recourse provisions in the event of default by the borrower. The Corporation provides for potential losses under these recourse provisions by establishing reserves at the time of sale and evaluates the adequacy of these reserves on an ongoing basis. (e) Exchange traded futures contracts represent agreements to exchange dollar amounts at a specified future date for interest rate differentials between an agreed interest rate and a reference rate, computed on a notional amount. Credit and market risk exist with respect to these instruments. Exchange traded futures contracts entail daily cash settlement; therefore, the credit risk amount represents a one-day receivable. (f) Commitments to purchase foreign and U.S. currencies are primarily executed for the needs of customers. These foreign exchange contracts are structured similar to interest rate futures and forward contracts. The risk associated with a foreign exchange contract arises from the counterparty's ability to make payment at settlement and that the value of a foreign currency might change in relation to the U.S. dollar. The Corporation's exposure, if any, to counterparty failure equals the current market value of the contract, which at December 31, 1996 and 1995 was $27,962 and $16,434, respectively. Included in fees for international services are net foreign exchange gains of $22,557, $22,943, and $19,783 for the years ended December 31, 1996, 1995 and 1994, respectively. (g) Interest rate swaps generally represent the contractual exchange of fixed and variable rate interest payments based on a notional principal amount and an interest reference rate. Credit risk exists with respect to these instruments arising from the possible failure of the counterparty to make required payments on those contracts which are favorable to the Corporation. The Corporation's exposure to counterparty failure equals the current replacement cost of the contract. At December 31, 1996 and 1995, the replacement cost of the Corporation's interest rate swap contracts was $118,929 and $225,140, respectively. The risk of counterparty failure is controlled by limiting transactions to an approved list of counterparties and requiring collateral in certain instances. Net cash received on interest rate swaps during 1996 and 1995 totaled $68,103 and $7,493, respectively. (h) Interest rate caps and floors are written by the Corporation to enable customers to transfer, modify or reduce their interest rate risk. Interest rate caps and floors are similar to interest rate swaps except that payments are made only if current interest rates move above or below a predetermined rate. The risk associated with interest rate caps and floors is an unfavorable change in interest rates. As a writer of interest rate caps and floors, the Corporation receives a premium in exchange for bearing the risk of an unfavorable change in interest rates. The Corporation generally reduces risk by entering into offsetting cap and floor positions that essentially counterbalance each other. The Corporation also enters interest rate caps to offset the risk of upward interest rate movement on assets with embedded caps as well as to limit spread risk. As a purchaser of interest rate caps, the Corporation pays a premium in exchange for the right to receive payments if interest rates rise above predetermined levels. The Corporation has also purchased interest rate floors in which the Corporation has paid a fee for the right to receive payments if rates fall below a predetermined level. Similar to interest rate swaps, credit risk exists with respect to the possible failure of the counterparty to make required payments on those contracts which are favorable to the Corporation. Exposure to counterparty failure equals the current replacement cost of the contract which totaled $17,383 and $26,384, respectively, at December 31, 1996 and 1995. (i) Tender option bonds are instruments associated with municipalities. A municipality generally issues a tax-free, fixed rate, long-term security in order to finance the origination of single family residential mortgages. The municipality enters into a tender option bond program with the Corporation, which converts the fixed rate long-term instrument into a variable rate short-term product. (j) A Treasury float contract is created because a municipality, which has defeased a bond issue with government securities, has a mismatch in the timing of the maturity of the securities and the date the funds are needed to pay the debt service. The Corporation will pay an up-front fee for the right to sell government securities to the municipality, generally at par. The Corporation retains any profit between the sales price and the price at which the Corporation acquired the securities. B-40 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 15. OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS, COMMITMENTS AND CONTINGENT LIABILITIES -- Continued CONTINGENT LIABILITIES In the normal course of business, the Corporation and its subsidiaries are subject to numerous pending and threatened legal actions and proceedings, some for which the relief or damages sought are substantial. Management does not believe the outcome of these actions and proceedings will have a materially adverse effect on the consolidated financial position of the Corporation. 16. PROVISION FOR INCOME TAXES The provision for income taxes for the years ended December 31, 1996, 1995, and 1994 consists of the following:
1996 1995 1994 -------- -------- -------- Current: Federal............................................ $344,142 $303,647 $158,771 State.............................................. 20,401 24,134 19,683 -------- -------- -------- Total domestic.................................. 364,543 327,781 178,454 Foreign............................................ 12,121 8,240 5,558 -------- -------- -------- Total current................................... 376,664 336,021 184,012 Deferred Federal and state expense................... 9,156 28,420 41,847 -------- -------- -------- Total provision for income taxes................ $385,820 $364,441 $225,859 -------- -------- -------- -------- -------- --------
The significant components of the Corporation's deferred tax assets and liabilities at December 31, 1996 and 1995 are as follows:
1996 1995 -------- -------- Deferred tax assets: Allowance for loan losses....................................... $261,180 $241,487 Postretirement and postemployment benefits...................... 57,191 54,127 Reserves........................................................ 56,489 54,779 Other........................................................... 77,181 70,928 -------- -------- Total deferred tax assets.................................... 452,041 421,321 -------- -------- Deferred tax liabilities: Auto leasing portfolio.......................................... 142,196 119,894 FAS 115 fair value accounting................................... 14,298 15,596 Partnership investments......................................... 3,781 3,980 Tax over book depreciation...................................... 38,446 30,626 Affiliate income................................................ 32,873 30,404 Other........................................................... 71,802 59,405 -------- -------- Total deferred tax liabilities............................... 303,396 259,905 -------- -------- Net deferred tax assets........................................... $148,645 $161,416 -------- -------- -------- --------
At December 31, 1996, cumulative deductible temporary differences related to the deferred tax asset are approximately $1,292,000. Cumulative taxable temporary differences related to deferred tax liabilities at December 31, 1996 are estimated at $867,000. At December 31, 1996, the Corporation has determined that it is not required to establish a valuation allowance for the deferred tax asset since it is more likely than not that the deferred tax asset of $452,041 will be realized principally through carryback to taxable income in prior years, future reversals of existing taxable temporary differences, future taxable income and to a lesser extent, tax planning strategies. The Corporation's conclusion that it is "more likely than not" that the deferred tax asset will be realized is based on a history of growth in earnings and the prospects for continued growth, including an B-41 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 16. PROVISION FOR INCOME TAXES -- Continued analysis of potential uncertainties that may affect future operating results. The Corporation will continue to review the tax criteria of "more likely than not" for the recognition of deferred tax assets on a quarterly basis. The consolidated effective tax rates are reconciled to the statutory rate as follows:
1996 1995 1994 ----- ----- ----- Statutory rate................................................... 35.0% 35.0% 35.0% Difference resulting from: Tax-exempt income.............................................. (1.6) (2.0) (3.6) State, local and foreign income tax............................ 1.6 1.5 1.9 Other, net..................................................... 2.3 1.2 1.0 ----- ----- ----- Effective tax rate............................................... 37.3% 35.7% 34.3% ----- ----- ----- ----- ----- -----
Foreign earnings of certain subsidiaries would be taxed only upon their transfer to the United States. No transfers or dividends are contemplated at this time. Taxes payable upon remittance of such accumulated earnings of $21,323 at December 31, 1996 would approximate $7,065. Taxes, other than income taxes, included in other operating expenses for the years ended December 31, 1996, 1995 and 1994 are $101,109, $105,913 and $104,805, respectively. B-42 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 17. QUARTERLY FINANCIAL DATA (UNAUDITED) The following represents summarized quarterly financial data of the Corporation, which, in the opinion of management, reflects all adjustments (comprising only normal recurring accruals) necessary for a fair presentation:
THREE MONTHS ENDED ----------------------------------------------- DEC. 31 SEPT. 30 JUNE 30 MARCH 31 -------- -------- -------- -------- 1996 Interest income................................. $835,649 $823,082 $815,755 $823,718 -------- -------- -------- -------- -------- -------- -------- -------- Interest expense................................ $298,561 $282,735 $282,360 $293,064 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income............................. $537,088 $540,347 $533,395 $530,654 -------- -------- -------- -------- -------- -------- -------- -------- Provision for losses on loans................... $ 40,000 $ 40,000 $110,000(a) $ 38,767 -------- -------- -------- -------- -------- -------- -------- -------- Securities gains................................ $ 4,036 $ 31,135 $ 17,393 $ 6,948 -------- -------- -------- -------- -------- -------- -------- -------- Net income...................................... $195,546 $196,857 $ 79,597(a)(b) $177,144 -------- -------- -------- -------- -------- -------- -------- -------- Net income per common share..................... $ 0.91 $ 0.89 $ 0.36(a)(b) $ 0.81 -------- -------- -------- -------- -------- -------- -------- -------- Average common shares outstanding............... 215,866 220,409 219,478 219,512 -------- -------- -------- -------- -------- -------- -------- -------- Common Stock Price Information: High.......................................... $ 55 3/8 $ 44 $ 43 1/8 $ 44 Low........................................... 42 3/4 35 1/2 35 3/4 36 1/8 Quarter-end................................... 51 7/8 43 1/4 38 1/2 42 3/8 1995 Interest income................................. $868,521 $871,164 $884,807 $850,588 -------- -------- -------- -------- -------- -------- -------- -------- Interest expense................................ $322,095 $329,592 $337,203 $319,265 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income............................. $546,426 $541,572 $547,604 $531,323 -------- -------- -------- -------- -------- -------- -------- -------- Provision for losses on loans................... $ 38,225 $ 38,050 $ 34,661 $ 33,066 -------- -------- -------- -------- -------- -------- -------- -------- Securities gains................................ $ 5,729 $ 2,230 $ 5,512 $ 18,004 -------- -------- -------- -------- -------- -------- -------- -------- Net income...................................... $192,145 $194,712 $158,150(c) $110,169(c) -------- -------- -------- -------- -------- -------- -------- -------- Net income per common share..................... $ 0.87 $ 0.88 $ 0.71(c) $ 0.49(c) -------- -------- -------- -------- -------- -------- -------- -------- Average common shares outstanding............... 219,915 220,718 222,440 226,091 -------- -------- -------- -------- -------- -------- -------- -------- Common Stock Price Information: High.......................................... $ 40 1/8 $ 38 7/8 $ 36 $ 33 Low........................................... 34 5/8 34 1/4 30 1/2 25 5/8 Quarter-end................................... 37 7/8 36 5/8 34 5/8 32
- --------------- (a) Includes a provision for loan losses of $70.0 million, $45.5 million after-tax or $0.20 per share, related to the Meridian acquisition. (b) Includes net restructuring and merger-related charges of $139.7 million, $105.3 million after-tax or $0.48 per share, primarily recorded in the second quarter and related to costs associated with the Meridian acquisition. (c) Includes restructuring charges of $110.0 million pre-tax, $70.0 million after-tax or $0.31 per share, recorded by CoreStates, and $32.0 million pre-tax, $20.8 million after-tax or $0.09 per share, recorded by Meridian related to corporate-wide process redesigns in the first and second quarters, respectively. B-43 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 18. JOINT VENTURE In December 1992, the Corporation entered into a joint venture with three other banking companies creating Electronic Payment Services, Inc. ("EPS"). The joint venture combines the partners' separate consumer electronic transaction processing businesses and provides automated teller machine ("ATM") and electronic point-of-sale ("POS") processing services. The Corporation contributed to EPS its wholly-owned subsidiaries of Money Access Service Inc. ("MAC"), a regional ATM network, and BUYPASS Corporation, a third-party processor of electronic POS transactions. At the formation of EPS, the Corporation had equal ownership with two partners in the joint venture, each with 31%. The fourth partner owned 7%. As part of the 1992 transaction, the Corporation received a cash payment of $79,350 and $245,400 of EPS 5% cumulative redeemable preferred stock. The exchange of assets involved in the transaction resulted in a 1992 pre-tax gain to the Corporation of $41,072, $25,670 after-tax. The exchange also generated a deferred gain of approximately $138,000. In December 1993, the Corporation and EPS mutually agreed to enter into a recapitalization of EPS involving the EPS preferred stock held by the Corporation. In exchange for substantially all of the preferred stock, the Corporation received from EPS a ten-year 6.45% note providing for equal principal payments over the life of the note. The recapitalization did not affect the amount of deferred gain, but changed the timing of deferred gain income recognition from a five-year period beginning in 1996 to a ten-year period which began in 1994. On March 27, 1995, EPS added a new partner and increased the ownership interests of an existing partner to that of a full partner, resulting in a decrease in the Corporation's share of ownership from 31% to 20%. As a direct result of this change in ownership interests, the Corporation recognized a pre-tax gain of $19,000, $11,800 after-tax or $0.05 per share, in 1995. Included in the pre-tax gain amount was $4,000 related to the acceleration of deferred gain recognition. The Corporation's investment in EPS at December 31, 1996, net of $104,000 deferred gain, is $65,304 and is included in other assets. "Income from investment in EPS, Inc.", which is included in non-interest income, reflects the Corporation's share in EPS net income, interest income on the 6.45% note and amortization of the deferred gain. 19. RESTRUCTURING AND MERGER-RELATED CHARGES A summary of restructuring and merger-related charges for the years ended December 31, 1996 and 1995 were as follows:
1996 1995 -------- -------- Meridian and United Counties merger-related restructuring charges......................................................... $161,598 $ 10,000 Meridian merger-related implementation costs...................... 29,019 -- Process redesign restructuring charges............................ -- 142,000 Gains on sales of branches........................................ (43,064) (3,988) Pension curtailment gains......................................... (7,851) (9,412) -------- -------- Total........................................................ $139,702 $138,600 -------- -------- -------- --------
B-44 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 19. RESTRUCTURING AND MERGER-RELATED CHARGES -- Continued In 1996, the Corporation recorded merger-related restructuring charges of $161,598, $120,150 after-tax or $0.55 per share, in connection with the acquisitions of Meridian and United Counties. The charges included direct and incremental costs associated with these acquisitions. The components of the merger-related restructuring charges were as follows:
REQUIRING 1996 CASH CASH PROVISION OUTFLOW OUTFLOW --------- --------- ------- Severance costs........................................ $ 70,469 $ 70,469 $33,939 Branch closing costs................................... 33,469 15,102 3,815 Office reconfiguration costs........................... 19,059 2,792 21 Merger transaction costs............................... 14,624 14,624 13,328 System consolidation writedowns........................ 6,391 -- -- Miscellaneous.......................................... 17,586 17,593 9,634 --------- --------- ------- Total............................................. $ 161,598 $ 120,580 $60,737 --------- --------- ------- --------- --------- -------
Restructuring and merger-related charges in 1996 also included $29,019, $18,263 after-tax or $0.07 per share, of implementation costs that were incurred in the process of consolidating Meridian and United Counties businesses and operations. The Corporation recorded restructuring credits of $50,915, $33,096 after-tax or $0.14 per share and $13,400, $8,549 after-tax or $0.03 per share in 1996 and 1995, respectively, related to gains on the curtailment of pension benefits associated with employees displaced during 1996 and 1995 and gains on the sale of branches which were sold as a result of consolidating the Meridian and United Counties branches and the process redesigns. Upon consummation of the merger, the Corporation recorded a $70 million provision for loan losses in connection with a change in strategic direction related to Meridian's problem assets and to conform its consumer lending charge-off policies to those of the Corporation. In 1995, the Corporation recorded restructuring charges of $142,000, $90,800 after-tax or $0.40 per share, in connection with process redesigns commenced during that year. The objectives of the process redesigns were: (i) to enhance customer focus; (ii) to accelerate "cultural changes" which were already in progress; and (iii) to improve productivity. The charges included direct and incremental costs associated with the process redesigns. The components of the process redesign restructuring charges were as follows:
REQUIRING CASH CASH OUTFLOW PROVISION OUTFLOW TO DATE --------- --------- ------- Severance costs........................................ $ 87,900 $ 87,900 $74,944 Office reconfiguration and branch closing costs........ 44,300 16,600 3,881 Outplacement costs..................................... 2,500 2,500 2,002 Miscellaneous.......................................... 7,300 5,300 4,464 --------- --------- ------- Total............................................. $ 142,000 $ 112,300 $85,291 --------- --------- ------- --------- --------- -------
The following table summarizes the activity in the restructuring and merger-related accrual for the year ended December 31, 1996:
1996 -------- Balance at beginning of year.................................................. $ 82,772 Provision charged against income.............................................. 161,598 Cash outflow.................................................................. (100,258) Writedowns of assets.......................................................... (35,907) -------- Balance at December 31,....................................................... $108,205 -------- --------
B-45 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 20. FINANCIAL STATEMENTS OF THE PARENT COMPANY STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 -------- -------- -------- REVENUES Dividends from subsidiaries: Banks.............................................. $657,744 $373,023 $389,733 Other subsidiaries................................. 27,217 91,917 27,575 -------- -------- -------- Total dividends from subsidiaries............... 684,961 464,940 417,308 Management fees and other income from subsidiaries... 178,179 190,027 186,092 Securities gains (losses)............................ (22) 16,343 259 Other income......................................... 3,054 3,241 1,483 -------- -------- -------- Total revenues.................................. 866,172 674,551 605,142 -------- -------- -------- EXPENSES Interest on: Funds borrowed..................................... 5,606 19,685 11,613 Long-term debt..................................... 22,843 21,578 13,137 -------- -------- -------- Total interest expense.......................... 28,449 41,263 24,750 Other operating expenses............................. 245,836 219,463 210,629 -------- -------- -------- Total expenses.................................. 274,285 260,726 235,379 -------- -------- -------- Income before income tax benefit and equity in undistributed income of subsidiaries............... 591,887 413,825 369,763 -------- -------- -------- Income tax benefit................................... (14,911) (11,977) (15,357) -------- -------- -------- Income before equity in undistributed income of subsidiaries....................................... 606,798 425,802 385,120 -------- -------- -------- Equity in undistributed income (excess dividends) of subsidiaries: Banks.............................................. (52,497) 203,909 (9,827) Other subsidiaries................................. 94,843 25,465 57,913 -------- -------- -------- Total equity in undistributed income of subsidiaries.................................. 42,346 229,374 48,086 -------- -------- -------- Net Income........................................... $649,144 $655,176 $433,206 -------- -------- -------- -------- -------- --------
B-46 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 20. FINANCIAL STATEMENTS OF THE PARENT COMPANY -- Continued BALANCE SHEET
DECEMBER 31, ------------------------ 1996 1995 ---------- ---------- ASSETS Cash.......................................................... $ 1,374 $ 1,340 Time deposits................................................. 887 -- Investment-securities available-for-sale...................... 97,786 148,009 Investments and receivables -- subsidiaries: Investments in subsidiaries at equity in underlying net assets: Banks.................................................... 3,389,148 3,769,779 Other subsidiaries....................................... 558,062 427,451 ---------- ---------- Total investments in subsidiaries...................... 3,947,210 4,197,230 Receivables -- subsidiaries................................. 40,814 108,827 ---------- ---------- Total investments and receivables -- subsidiaries...... 3,988,024 4,306,057 Other assets.................................................. 80,039 76,453 ---------- ---------- Total assets........................................... $4,168,110 $4,531,859 ---------- ---------- ---------- ---------- LIABILITIES Funds borrowed -- subsidiaries................................ $ -- $ 177,827 Dividends payable and other liabilities....................... 214,925 143,575 Long-term debt................................................ 257,491 334,892 ---------- ---------- Total liabilities...................................... 472,416 656,294 ---------- ---------- SHAREHOLDERS' EQUITY Total shareholders' equity............................. 3,695,694 3,875,565 ---------- ---------- Total liabilities and shareholders' equity............. $4,168,110 $4,531,859 ---------- ---------- ---------- ----------
The Corporation has guaranteed certain borrowings of its subsidiaries at December 31, 1996 in the amount of $3,259,181, which includes $675,181 for commercial paper. The maturities for parent company long-term debt for the years ending December 31, 1997 through 2001 are: $1,475; $1,607; $1,751; $1,908; and $697, respectively. B-47 CORESTATES FINANCIAL CORP AND SUBSIDIARIES NOTES TO THE FINANCIAL STATEMENTS -- CONTINUED 20. FINANCIAL STATEMENTS OF THE PARENT COMPANY -- Continued STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------- 1996 1995 1994 ----------- --------- --------- OPERATING ACTIVITIES Net income......................................................................... $ 649,144 $ 655,176 $ 433,206 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed income of subsidiaries............................................ (42,346) (229,374) (48,086) Securities (gains) losses....................................................... 22 (16,343) (259) Deferred income tax expense (benefit)........................................... 180 (785) (3,895) Net (increase) decrease in other assets......................................... (6,969) 24,265 6,360 Net increase (decrease) in other liabilities.................................... 8,454 (22,761) 13,921 Other, net...................................................................... 7,288 7,840 (8,865) ----------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES....................................... 615,773 418,018 392,382 ----------- --------- --------- INVESTING ACTIVITIES Net capital returned from (contributed to) subsidiaries............................ 270,226 190,900 (99,903) (Increase) decrease in receivables from subsidiaries............................... 107,069 (3,593) 53,862 Purchases of investment securities................................................. (707,008) (170,988) (202,424) Proceeds from maturities and sales of investment securities........................ 717,536 118,483 188,028 Purchase of Germantown Savings Bank................................................ -- -- (108,061) Other, net......................................................................... -- (1,380) (1,428) ----------- --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES............................. 387,823 133,422 (169,926) ----------- --------- --------- FINANCING ACTIVITIES Issuance (repayment) of funds borrowed............................................. -- (75,000) 75,000 Retirement of long-term debt....................................................... (77,401) (1,471) (45,568) Proceeds from issuance of long-term debt........................................... -- 149,877 -- Net increase (decrease) in financing from and due to subsidiaries.................. (115,498) (94,054) 270,587 Cash dividends paid................................................................ (328,114) (286,565) (245,962) Purchases of treasury stock........................................................ (533,932) (335,528) (228,963) Purchases of ESOP shares........................................................... -- -- (35,568) Repurchase and retirement of common stock.......................................... (57,703) (17,134) (24,888) Common stock issued under employee benefit plans................................... 87,726 99,011 18,710 Funds transferred to Trust for future ESOP purchases............................... -- -- (24,432) Other, net......................................................................... 21,360 6,777 11,294 ----------- --------- --------- NET CASH USED IN FINANCING ACTIVITIES........................................... (1,003,562) (554,087) (229,790) ----------- --------- --------- INCREASE (DECREASE) IN CASH AND DUE FROM BANKS..................................... 34 (2,647) (7,334) Cash and due from banks at January 1,.............................................. 1,340 3,987 11,321 ----------- --------- --------- CASH AND DUE FROM BANKS AT DECEMBER 31,............................................ $ 1,374 $ 1,340 $ 3,987 ----------- --------- --------- ----------- --------- --------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest........................................................................ $ 25,267 $ 40,745 $ 24,500 ----------- --------- --------- ----------- --------- --------- Income taxes.................................................................... $ -- $ 43 $ (626) ----------- --------- --------- ----------- --------- ---------
B-48 EXHIBIT C CERTAIN INDEPENDENT AUDITORS' REPORTS INDEPENDENT AUDITORS' REPORT The Board of Directors Meridian Bancorp, Inc.: We have audited the accompanying consolidated balance sheet of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the two year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the accounts and disclosures in the financial statements. An audit also includes asserting the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995 and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 1995, in conformity with generally accepted accounting principles. As described in Notes 1 and 8, respectively, to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities and Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits, in 1994. Philadelphia, Pa. January 17, 1996, Except as to note 2, which is as of February 23, 1996 /s/ KPMG Peat Marwick LLP C-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders United Counties Bancorporation: We have audited the accompanying consolidated balance sheet of United Counties Bancorporation and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flow for each of the years in the two-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Bancorporation's management. Our responsibility is to express an opinion on these consolidated finanical statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Counties Bancorporation and subsidiaries at December 31, 1995, and the results of their operations and their cash flow for each of the years in the two-year period ended December 31, 1995 in conformity with generally accepted accounting principles. As discussed in notes 1 and 3 to the consolidated financial statements, the Bancorporation adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in 1994. /s/ KPMG Peat Marwick LLP Short Hills, New Jersey January 16, 1996, except for note 20, which is as of February 23, 1996 C-2 COVENANT BANCORP, INC. 18 KINGS HIGHWAY WEST HADDONFIELD, NEW JERSEY 08033 (609) 428-7300 October 15, 1997 Dear Stockholder: On behalf of the Board of Directors, I want to extend to you a cordial invitation to attend a Special Meeting of Stockholders of Covenant Bancorp, Inc. ("Covenant"). The meeting will be held at 2:00 p.m., on November 20, 1997, at Tavistock Country Club, Haddonfield, New Jersey (the "Special Meeting"). The purpose of the Special Meeting is to vote on a proposal to approve the Agreement and Plan of Mergers, dated as of August 4, 1997 (the "Merger Agreement"), by and among Covenant, Covenant Bank, First Union Corporation ("FUNC") and First Union National Bank ("FUNB"), pursuant to which, among other things, Covenant will merge with and into FUNC (the "Corporate Merger") and Covenant Bank will merge with and into FUNB (the "Bank Merger" and, together with the Corporate Merger, the "Mergers"), all on and subject to the terms and conditions contained therein. YOU WILL RECEIVE A SEPARATE PROSPECTUS/PROXY STATEMENT AND PROXY CARD WITH RESPECT TO EACH CLASS OF STOCK THAT YOU HOLD. EVEN IF YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, PLEASE BE SURE TO VOTE ALL OF YOUR SHARES BY RETURNING THE SEPARATE PROXY CARD FOR EACH CLASS OF STOCK THAT YOU HOLD. Upon consummation of the Corporate Merger, each outstanding share of Covenant common stock (excluding certain shares held by Covenant or FUNC ("Excluded Shares")) will be converted into the right to receive .3813 shares of FUNC common stock (the "Exchange Ratio"). In addition, (i) each outstanding share of Covenant Series A preferred stock (other than Excluded Shares) will be converted into the right to receive 1.516 shares of FUNC common stock (I.E., the result obtained by multiplying the Exchange Ratio by 3.976, which is the number of shares of Covenant common stock into which a share of such series of preferred stock would be convertible as of its conversion date); and (ii) each outstanding share of Covenant Series B preferred stock (other than Excluded Shares) will be converted into the right to receive 1.2 shares of FUNC common stock (I.E., the result obtained by multiplying the Exchange Ratio by 3.147, which is the number of shares of Covenant common stock into which a share of such series of preferred stock would be convertible as of its conversion date). The Covenant Series A preferred stock will automatically convert into shares of Covenant common stock on December 31, 1997, if the Corporate Merger has not been consummated by such date. The common stock of FUNC is actively traded and is listed on the New York Stock Exchange. The last reported sale price of FUNC common stock on the New York Stock Exchange Composite Transactions Tape on October 14, 1997, was $51.375 per share. It is expected that the transaction generally will be tax free to Covenant stockholders for federal income tax purposes. Consummation of the Mergers is subject to certain conditions, including approval of the Merger Agreement by Covenant stockholders and approval of the Mergers by various regulatory agencies. Approval of the Merger Agreement requires the affirmative vote of a majority of the votes cast at the Special Meeting by the holders of Covenant common stock, Covenant Series A preferred stock and Covenant Series B preferred stock, each voting as a separate class. The accompanying Notice of Special Meeting and Prospectus/Proxy Statement contain information about the Mergers. I urge you to review carefully such information and the information in FUNC's 1996 Annual Report on Form 10-K, 1997 First and Second Quarter Reports on Form 10-Q, 1997 Annual Meeting Proxy Statement and 1997 Current Reports on Form 8-K, copies of which are available as indicated in the accompanying Prospectus/Proxy Statement under "AVAILABLE INFORMATION". THE BOARD OF DIRECTORS OF COVENANT HAS UNANIMOUSLY APPROVED THE MERGER AGREEMENT, BELIEVES THE MERGER AGREEMENT IS IN THE BEST INTERESTS OF COVENANT AND ITS STOCKHOLDERS AND RECOMMENDS ITS APPROVAL BY COVENANT STOCKHOLDERS. EVEN IF YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, PLEASE COMPLETE THE ENCLOSED PROXY, SIGN AND DATE IT AND MAIL IT PROMPTLY IN THE ENCLOSED POSTAGE-PAID, RETURN ADDRESSED ENVELOPE. Yours very truly, /s/ Charles E. Sessa, Jr. CHARLES E. SESSA, JR. PRESIDENT COVENANT BANCORP, INC. 18 KINGS HIGHWAY WEST HADDONFIELD, NEW JERSEY 08033 (609) 428-7300 NOTICE OF SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON NOVEMBER 20, 1997 October 15, 1997 Dear Stockholder: NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders of Covenant Bancorp, Inc. ("Covenant") will be held at 2:00 p.m., on November 20, 1997, at Tavistock Country Club, Haddonfield, New Jersey (the "Special Meeting"), for the following purpose: To consider and vote upon a proposal to approve the Agreement and Plan of Mergers, dated as of August 4, 1997 (the "Merger Agreement"), by and among Covenant, Covenant Bank, First Union Corporation ("FUNC") and First Union National Bank ("FUNB"), pursuant to which, among other things, (i) Covenant will merge with and into FUNC (the "Corporate Merger") and Covenant Bank will merge with and into FUNB (the "Bank Merger" and, together with the Corporate Merger, the "Mergers"); (ii) each outstanding share of Covenant common stock (excluding certain shares held by Covenant or FUNC ("Excluded Shares")) will be converted into the right to receive .3813 shares of FUNC common stock (the "Exchange Ratio"); (iii) each outstanding share of Covenant Series A preferred stock (other than Excluded Shares) will be converted into the right to receive 1.516 shares of FUNC common stock (I.E., the result obtained by multiplying the Exchange Ratio by 3.976, which is the number of shares of Covenant common stock into which a share of such series of preferred stock would be convertible as of its conversion date); and (iv) each outstanding share of Covenant Series B preferred stock (other than Excluded Shares) will be converted into the right to receive 1.2 shares of FUNC common stock (I.E., the result obtained by multiplying the Exchange Ratio by 3.147, which is the number of shares of Covenant common stock into which a share of such series of preferred stock would be convertible as of its conversion date), all on and subject to the terms and conditions contained in the Merger Agreement. A copy of the Merger Agreement is set forth in ANNEX B to the accompanying Prospectus/Proxy Statement. The Board of Directors of Covenant has fixed October 6, 1997, as the record date for the determination of stockholders entitled to notice of and to vote at the Special Meeting, and accordingly, only holders of record of Covenant common stock, Covenant Series A preferred stock and Covenant Series B preferred stock at the close of business on that date will be entitled to notice of and to vote at the Special Meeting. Approval of the Merger Agreement requires the affirmative vote of a majority of the votes cast at the Special Meeting by the holders of Covenant common stock, Covenant Series A preferred stock and Covenant Series B preferred stock, each voting as a separate class. Pursuant to the New Jersey Business Corporation Act, holders of Covenant common stock, Covenant Series A preferred stock and Covenant Series B preferred stock do not have dissenters' or appraisal rights in connection with the proposal to approve the Merger Agreement. THE BOARD OF DIRECTORS OF COVENANT UNANIMOUSLY RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" APPROVAL OF THE MERGER AGREEMENT. By Order of the Board of Directors of COVENANT BANCORP, INC., /s/ William T. Carson, Jr. WILLIAM T. CARSON, JR. CORPORATE SECRETARY COVENANT STOCKHOLDERS ARE URGED TO COMPLETE, DATE, SIGN AND RETURN PROMPTLY THE ENCLOSED PROXY IN THE ACCOMPANYING ENVELOPE, WHICH REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES. PROSPECTUS PROXY STATEMENT 1,825,000 SHARES FIRST UNION CORPORATION COVENANT BANCORP, INC. COMMON STOCK SPECIAL MEETING OF STOCKHOLDERS $3.33 1/3 PAR VALUE PER SHARE TO BE HELD ON NOVEMBER 20, 1997
This Prospectus/Proxy Statement is being furnished by Covenant Bancorp, Inc., a New Jersey corporation ("Covenant"), to the holders of Covenant common stock, par value $5.00 per share ("Covenant Common Stock"), Covenant Series A preferred stock, par value $25.00 per share ("Covenant Series A Preferred Stock"), and Covenant Series B preferred stock, par value $25.00 per share ("Covenant Series B Preferred Stock" and, together with Covenant Series A Preferred Stock, "Covenant Preferred Stock"), as a Proxy Statement in connection with the solicitation of proxies by the Board of Directors of Covenant (the "Covenant Board") for use at a Special Meeting of Stockholders of Covenant to be held at 2:00 p.m., on November 20, 1997, at Tavistock Country Club, Haddonfield, New Jersey, and at any adjournments or postponements thereof (the "Special Meeting"). This Prospectus/Proxy Statement is also being furnished by First Union Corporation, a North Carolina corporation ("FUNC"), as a Prospectus with respect to the shares (the "FUNC Common Shares") of FUNC common stock, $3.33 1/3 par value per share (together with the FUNC Rights (as hereinafter defined) attached thereto, "FUNC Common Stock"), that are issuable upon consummation of the Corporate Merger (as hereinafter defined). This Prospectus/Proxy Statement, the accompanying Notice of Special Meeting and forms of proxy are first being mailed to the stockholders of Covenant on or about October 20, 1997. The purpose of the Special Meeting is to consider and vote upon a proposal to approve the Agreement and Plan of Mergers, dated as of August 4, 1997 (the "Merger Agreement"), by and among Covenant, Covenant Bank, a New Jersey bank, FUNC and First Union National Bank, a national banking association headquartered in Avondale, Pennsylvania ("FUNB"), pursuant to which, among other things, Covenant will merge with and into FUNC (the "Corporate Merger") and Covenant Bank will merge with and into FUNB (the "Bank Merger" and, together with the Corporate Merger, the "Mergers"), all on and subject to the terms and conditions contained therein. Upon consummation of the Corporate Merger, (i) each outstanding share of Covenant Common Stock (excluding any shares of stock held by Covenant or FUNC, other than in a fiduciary capacity or in satisfaction of a debt previously contracted ("Excluded Shares")) will be converted into the right to receive .3813 FUNC Common Shares (the "Common Stock Exchange Ratio"); (ii) each outstanding share of Covenant Series A Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.516 FUNC Common Shares (I.E., the result obtained by multiplying the Common Stock Exchange Ratio by 3.976, which is the number of shares of Covenant Common Stock into which a share of such series of preferred stock would be convertible as of its conversion date) (the "Series A Exchange Ratio"); and (iii) each outstanding share of Covenant Series B Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.2 FUNC Common Shares (I.E., the result obtained by multiplying the Common Stock Exchange Ratio by 3.147, which is the number of shares of Covenant Common Stock into which a share of such series of preferred stock would be convertible as of its conversion date) (the "Series B Exchange Ratio"). The Covenant Series A Preferred Stock will automatically convert into shares of Covenant Common Stock on December 31, 1997, if the Corporate Merger has not been consummated by such date. See "THE MERGERS -- Exchange of Covenant Certificates". Upon consummation of the Corporate Merger, the Excluded Shares will be canceled. Based on (i) 3,057,332 shares of Covenant Common Stock outstanding on the Record Date (as hereinafter defined); (ii) 138,300 shares of Covenant Series A Preferred Stock outstanding on the Record Date; (iii) 161,700 shares of Covenant Series B Preferred Stock outstanding on the Record Date; (iv) 451,350 shares of Covenant Common Stock issuable upon the exercise of all options outstanding on the Record Date to purchase shares of Covenant Common Stock granted to employees and directors of Covenant; (v) an estimated 5,000 shares of Covenant Common Stock issuable pursuant to Covenant's employee stock purchase plan prior to consummation of the Corporate Merger; and (vi) the Common Stock Exchange Ratio, Series A Exchange Ratio and Series B Exchange Ratio, a total of 1,743,470 FUNC Common Shares will be issuable upon consummation of the Corporate Merger, which represents less than one percent of the total number of FUNC Common Shares outstanding on September 30, 1997. See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks". FUNC Common Stock is listed and traded on the New York Stock Exchange ("NYSE"), Covenant Common Stock is listed and traded on the Nasdaq Stock Market National Market (the "Nasdaq National Market") and Covenant Preferred Stock is listed and traded on the Nasdaq Stock Market Small-Cap Market (the "Nasdaq Small-Cap Market"). On August 4, 1997, the last business day prior to public announcement of the execution of the Merger Agreement, the last reported sale price per share of FUNC Common Stock on the NYSE Composite Transactions Tape (the "NYSE Tape"), the last reported sale price of Covenant Common Stock on the Nasdaq National Market and the last reported sale prices of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock on the Nasdaq Small-Cap Market were $49.50, $21.00, $76.00 and $57.125, respectively. On October 14, 1997, such prices were $51.375, $19.00, $76.00 and $55.00, respectively. See "RECENT DEVELOPMENTS -- Wheat First Butcher Singer, Inc. Acquisition" and "THE MERGERS -- Market Prices". Covenant stockholders do not have dissenters' or appraisal rights in connection with the proposal to approve the Merger Agreement. See "THE MERGERS -- No Dissenters' Rights". THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS PROSPECTUS/PROXY STATEMENT IS OCTOBER 15, 1997. AVAILABLE INFORMATION FUNC and Covenant (since Covenant's reorganization as a holding company for Covenant Bank on June 13, 1997) are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (the "Exchange Act"), and, in accordance therewith, file reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Reports, proxy statements and other information filed by FUNC and Covenant can be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Commission's Regional Offices in New York (7 World Trade Center, 13th Floor, New York, New York 10048) and Chicago (Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60621) and copies of such materials can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Certain of such reports, proxy statements and other information is also available from the Commission over the Internet at http://www.sec.gov. In addition, prior to June 13, 1997, Covenant Bank was subject to the informational requirements of the rules and regulations of the Federal Deposit Insurance Corporation (the "FDIC") promulgated under the Exchange Act, and, in accordance therewith, filed reports, proxy statements and other information with the FDIC. Such reports, proxy statements and other information can be inspected at the office of the FDIC, Registration and Disclosure Section, 550 17th Street, N.W., Washington, D.C. 20429, and copies may be obtained from the FDIC at prescribed rates. Since FUNC Common Stock is listed on the NYSE, reports, proxy statements and other information relating to FUNC can also be inspected at the offices of the NYSE, 20 Broad Street, New York, New York 10005. This Prospectus/Proxy Statement does not contain all of the information set forth in the Registration Statement on Form S-4 (No. 333-37709), of which this Prospectus/Proxy Statement is a part, and the exhibits thereto (together with any amendments or supplements thereto, the "Registration Statement"), which has been filed by FUNC with the Commission under the Securities Act of 1933, as amended, and the rules and regulations thereunder (the "Securities Act"), certain portions of which have been omitted pursuant to the rules and regulations of the Commission and to which portions reference is hereby made for further information. THIS PROSPECTUS/PROXY STATEMENT INCORPORATES DOCUMENTS BY REFERENCE WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. A COPY OF SUCH DOCUMENTS IS AVAILABLE WITHOUT CHARGE (OTHER THAN CERTAIN EXHIBITS TO SUCH DOCUMENTS) TO ANY PERSON, INCLUDING ANY BENEFICIAL OWNER, TO WHOM THIS PROSPECTUS/PROXY STATEMENT IS DELIVERED, UPON WRITTEN OR ORAL REQUEST TO: FIRST UNION CORPORATION, INVESTOR RELATIONS, TWO FIRST UNION CENTER, CHARLOTTE, NORTH CAROLINA 28288-0206 (TELEPHONE NUMBER (704) 374-6782). IN ORDER TO ENSURE TIMELY DELIVERY OF SUCH DOCUMENTS, ANY SUCH REQUEST SHOULD BE MADE BY NOVEMBER 13, 1997. All information contained or incorporated by reference in this Prospectus/Proxy Statement with respect to FUNC was supplied by FUNC, and all information contained in this Prospectus/Proxy Statement with respect to Covenant was supplied by Covenant. NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS/PROXY STATEMENT AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY FUNC OR COVENANT. NEITHER THE DELIVERY OF THIS PROSPECTUS/PROXY STATEMENT NOR ANY DISTRIBUTION OF THE FUNC COMMON SHARES SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF FUNC OR COVENANT SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. THIS PROSPECTUS/PROXY STATEMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE FUNC COMMON SHARES OR AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH AN OFFER OR SOLICITATION IS NOT LAWFUL. The Commissioner of Insurance of the State of North Carolina (the "Commissioner") has not approved or disapproved this offering nor has the Commissioner passed upon the accuracy or adequacy of this Prospectus/Proxy Statement. THE FUNC COMMON SHARES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS, DEPOSITS OR OTHER OBLIGATIONS OF A BANK OR SAVINGS ASSOCIATION AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. 2 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents filed with the Commission by FUNC (File No. 1-10000) under Section 13(a) or 15(d) of the Exchange Act are hereby incorporated by reference in this Prospectus/Proxy Statement: (i) FUNC's Annual Report on Form 10-K for the year ended December 31, 1996; (ii) FUNC's Quarterly Reports on Form 10-Q for the periods ended March 31, 1997 and June 30, 1997; and (iii) FUNC's Current Reports on Form 8-K dated January 13, 1997, July 21, 1997 and August 20, 1997. All documents filed by FUNC pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date hereof and prior to the date of the Special Meeting are hereby incorporated by reference into this Prospectus/Proxy Statement and shall be deemed to be a part hereof from the date of filing of such documents. Certain financial and other information relating to Covenant is contained in this Prospectus/Proxy Statement, including ANNEX A attached hereto. Any statement contained herein, in any supplement hereto or in a document incorporated or deemed to be incorporated by reference herein shall be deemed to be modified or superseded for purposes of the Registration Statement and this Prospectus/Proxy Statement to the extent that a statement contained herein, in any supplement hereto or in any subsequently filed document which also is or is deemed to be incorporated by reference herein modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of the Registration Statement, this Prospectus/Proxy Statement or any supplement hereto. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION This Prospectus/Proxy Statement (including information included or incorporated by reference herein) contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of each of FUNC and Covenant, as well as certain information relating to FUNC's pending acquisitions of Signet Banking Corporation ("Signet") (the "Signet Acquisition") and Wheat First Butcher Singer, Inc. ("WFBS") (the "WFBS Acquisition" and, together with the Signet Acquisition, the "Other Pending Acquisitions"), including (i) statements relating to the cost savings estimated to result from the Signet Acquisition (see "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition"), (ii) statements relating to revenues estimated to result from the Signet Acquisition (see "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition"), (iii) statements relating to the restructuring charges estimated to be incurred in connection with the Signet Acquisition (see "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition"), and (iv) statements preceded by, followed by or that include the words "believes", "expects", "anticipates", "estimates" or similar expressions (see "THE MERGERS -- Background and Reasons" and " -- Opinion of Financial Advisor"). These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (a) expected cost savings from the Mergers and the Other Pending Acquisitions may not be fully realized or realized within the expected time frame; (b) revenues following the Mergers and the Other Pending Acquisitions may be lower than expected, or deposit attrition, operating costs or customer loss and business disruption following the Mergers and the Other Pending Acquisitions may be greater than expected; (c) competitive pressures among depository and other financial institutions may increase significantly; (d) costs or difficulties related to the integration of the business of FUNC, Covenant, Signet and/or WFBS may be greater than expected; (e) changes in the interest rate environment may reduce margins; (f) general economic or business conditions, either nationally or in the states in which FUNC is doing business, may be less favorable than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; (g) legislative or regulatory changes may adversely affect the business in which FUNC is engaged; and (h) changes may occur in the securities markets. 3 TABLE OF CONTENTS
PAGE AVAILABLE INFORMATION................................................................................................. 2 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE....................................................................... 3 CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION........................................................... 3 SUMMARY............................................................................................................... 6 RECENT DEVELOPMENTS................................................................................................... 17 Certain Financial Information for the Period Ended September 30, 1997............................................... 17 Signet Banking Corporation Acquisition.............................................................................. 18 Wheat First Butcher Singer, Inc. Acquisition........................................................................ 19 FUNC Common Stock Buybacks.......................................................................................... 19 FUNC Common Stock Offering.......................................................................................... 19 Future Acquisitions................................................................................................. 20 GENERAL INFORMATION................................................................................................... 20 General............................................................................................................. 20 Record Date; Vote Required; Revocation of Proxies................................................................... 20 THE MERGERS........................................................................................................... 21 General; Exchange Ratios............................................................................................ 21 Effective Date...................................................................................................... 22 Exchange of Covenant Certificates................................................................................... 22 Background and Reasons.............................................................................................. 23 Opinion of Financial Advisor........................................................................................ 26 Interests of Certain Persons........................................................................................ 28 Certain Federal Income Tax Consequences............................................................................. 30 Business Pending Consummation....................................................................................... 31 Regulatory Approvals................................................................................................ 31 Conditions to Consummation; Termination............................................................................. 32 Waiver; Amendment................................................................................................... 33 Accounting Treatment................................................................................................ 33 Expenses; Termination Fee........................................................................................... 33 No Dissenters' Rights............................................................................................... 34 Market Prices....................................................................................................... 35 Dividends........................................................................................................... 37 COVENANT.............................................................................................................. 38 General............................................................................................................. 38 History and Business................................................................................................ 38 FUNC.................................................................................................................. 39 General............................................................................................................. 39 History and Business................................................................................................ 39 Certain Regulatory Considerations................................................................................... 40 DESCRIPTION OF FUNC CAPITAL STOCK..................................................................................... 43 Authorized Capital.................................................................................................. 43 FUNC Common Stock................................................................................................... 43 FUNC Preferred Stock................................................................................................ 44 FUNC Class A Preferred Stock........................................................................................ 44 FUNC Rights Plan.................................................................................................... 44 Other Provisions.................................................................................................... 45 CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS................................................... 46 General............................................................................................................. 46 Authorized Capital.................................................................................................. 46 Amendment to Articles of Incorporation or Bylaws.................................................................... 46 Size and Classification of Board of Directors....................................................................... 47
4
PAGE Removal of Directors................................................................................................ 47 Director Exculpation................................................................................................ 47 Director Conflict of Interest Transactions.......................................................................... 47 Stockholder Meetings................................................................................................ 48 Director Nominations................................................................................................ 48 Stockholder Proposals............................................................................................... 49 Stockholder Protection Rights Plans................................................................................. 49 Stockholder Inspection Rights; Stockholder Lists.................................................................... 49 Required Stockholder Vote for Certain Actions....................................................................... 49 Anti-Takeover Provisions............................................................................................ 50 Dissenters' Rights.................................................................................................. 51 Dividends and Other Distributions................................................................................... 51 Voluntary Dissolution............................................................................................... 52 RESALE OF FUNC COMMON SHARES.......................................................................................... 52 VALIDITY OF FUNC COMMON SHARES........................................................................................ 52 EXPERTS............................................................................................................... 52 ANNEX A -- CERTAIN COVENANT INFORMATION Annual Report on Form F-2, as amended, of Covenant Bank for the Year Ended December 31, 1996................................................................................ A-1 Quarterly Report on Form 10-Q/A of Covenant Bancorp, Inc., for the Quarter Ended June 30, 1997.......................................................................................... A-52 ANNEX B -- AGREEMENT AND PLAN OF MERGERS (including the form of Voting Agreement)..................................... B-1 ANNEX C -- OPINION OF BERWIND FINANCIAL, L.P. ........................................................................ C-1
5 SUMMARY THE FOLLOWING SUMMARY OF CERTAIN INFORMATION RELATING TO THE MERGERS IS NOT INTENDED TO BE A SUMMARY OF ALL MATERIAL INFORMATION RELATING TO THE MERGERS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS/PROXY STATEMENT, INCLUDING THE ANNEXES HERETO, AND IN THE DOCUMENTS INCORPORATED BY REFERENCE IN THIS PROSPECTUS/PROXY STATEMENT. A COPY OF THE MERGER AGREEMENT IS SET FORTH IN ANNEX B TO THIS PROSPECTUS/PROXY STATEMENT AND REFERENCE IS MADE THERETO FOR A COMPLETE DESCRIPTION OF THE TERMS OF THE MERGERS. STOCKHOLDERS ARE URGED TO READ CAREFULLY THIS ENTIRE PROSPECTUS/PROXY STATEMENT, INCLUDING THE ANNEXES HERETO AND THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE. AS USED IN THIS PROSPECTUS/PROXY STATEMENT, THE TERMS "FUNC", "FUNB", "COVENANT" AND "COVENANT BANK" REFER TO SUCH ORGANIZATIONS, RESPECTIVELY, AND UNLESS THE CONTEXT OTHERWISE REQUIRES, TO THEIR RESPECTIVE CONSOLIDATED SUBSIDIARIES AND, WITH RESPECT TO COVENANT FOR PERIODS PRIOR TO ITS FORMATION ON JUNE 13, 1997 AS A HOLDING COMPANY FOR COVENANT BANK, REFERENCES TO COVENANT SHALL MEAN COVENANT BANK. PARTIES TO THE MERGERS FUNC AND FUNB FUNC is a North Carolina-based, multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended, and the rules and regulations promulgated thereunder (the "BHCA"). Through its full-service banking subsidiaries, FUNC provides a wide range of commercial and retail banking services and trust services in North Carolina, Florida, South Carolina, Georgia, Tennessee, Virginia, Maryland, Delaware, Pennsylvania, New Jersey, New York, Connecticut and Washington, D.C. FUNC also provides various other financial services, including mortgage banking, home equity lending, credit cards, leasing, investment banking, insurance and securities brokerage services, through other subsidiaries. As of June 30, 1997, and for the six months then ended, FUNC reported assets of $142.9 billion, net loans of $96.4 billion, deposits of $92.9 billion, stockholders' equity of $10.0 billion and net income applicable to common stockholders of $956 million, and as of such date FUNC operated in 38 states, Washington, D.C. and six foreign countries. FUNC is the sixth largest bank holding company in the United States, based on assets at June 30, 1997. The principal executive offices of FUNC are located at One First Union Center, Charlotte, North Carolina 28288-0013, and its telephone number is (704) 374-6565. FUNB, a national banking association with its headquarters in Avondale, Pennsylvania, provides a wide range of commercial and retail banking services and trust services in New Jersey, New York and Pennsylvania, and is an indirect subsidiary of FUNC. As of June 30, 1997, and for the six months then ended, FUNB reported assets of $27.6 billion, net loans of $19.6 billion, deposits of $21.6 billion, stockholder's equity of $2.3 billion and net income of $228 million. See "FUNC -- Certain Regulatory Considerations; INTERSTATE BANKING AND BRANCHING LEGISLATION". FUNC is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities can be expected. Acquisitions typically involve the payment of a premium over book and market values, and therefore, some dilution of FUNC's book value and net income per common share may occur in connection with any future transactions. See " -- Comparison of Certain Unaudited Per Share Data", " -- Selected Financial Data", "RECENT DEVELOPMENTS" and "FUNC". COVENANT AND COVENANT BANK Covenant is a bank holding company registered under the BHCA. Covenant is the parent corporation of Covenant Bank, a New Jersey commercial bank that provides commercial and retail banking services in southern New Jersey. As of June 30, 1997, and for the six months then ended, Covenant reported assets of $454 million, loans, net of unearned income of $263 million, deposits of $302 million, stockholders' equity of $31 million and net income of $2 million, and as of such date Covenant operated through 17 offices in southern New Jersey. The principal executive offices of Covenant are located at 18 Kings Highway West, Haddonfield, New Jersey 08033 and its telephone number is (609) 428-7300. See " -- Comparison of Certain Unaudited Per Share Data", " -- Selected Financial Data", "RECENT DEVELOPMENTS" and "COVENANT". SPECIAL MEETING; RECORD DATE The Special Meeting is scheduled to be held on November 20, 1997, at 2:00 p.m., at Tavistock Country Club, Haddonfield, New Jersey. At the Special Meeting, holders of Covenant Common Stock, Covenant Series A Preferred Stock and 6 Covenant Series B Preferred Stock, each voting as a separate class, will consider and vote upon a proposal to approve the Merger Agreement. The Covenant Board has fixed October 6, 1997, as the record date for determining stockholders entitled to notice of and to vote at the Special Meeting (the "Record Date"). As of such date, there were 3,057,332 shares of Covenant Common Stock, 138,300 shares of Covenant Series A Preferred Stock and 161,700 shares of Covenant Series B Preferred Stock outstanding and entitled to be voted at the Special Meeting. See "GENERAL INFORMATION". THE MERGERS; EXCHANGE RATIOS Subject to the terms and conditions of the Merger Agreement, Covenant will merge with and into FUNC and Covenant Bank will merge with and into FUNB. Upon consummation of the Corporate Merger, (i) each outstanding share of Covenant Common Stock (other than Excluded Shares) will be converted into the right to receive .3813 FUNC Common Shares (I.E., the Common Stock Exchange Ratio); (ii) each outstanding share of Covenant Series A Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.516 FUNC Common Shares (I.E., the Series A Exchange Ratio); and (iii) each outstanding share of Covenant Series B Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.2 FUNC Common Shares (I.E., the Series B Exchange Ratio). The Covenant Series A Preferred Stock will automatically convert into shares of Covenant Common Stock on December 31, 1997, if the Corporate Merger has not been consummated by such date. See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks", "THE MERGERS -- General; Exchange Ratios" and " -- Exchange of Covenant Certificates", "DESCRIPTION OF FUNC CAPITAL STOCK" and "CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS". VOTE REQUIRED Approval of the Merger Agreement at the Special Meeting requires the affirmative vote of a majority of the votes cast by the holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, each voting as a separate class. The directors and executive officers of Covenant (including certain of their related interests) beneficially owned, as of the Record Date, and are entitled to vote at the Special Meeting, 276,210 shares of Covenant Common Stock, 21,000 shares of Covenant Series A Preferred Stock and 53,326 shares of Covenant Series B Preferred Stock, which represent approximately nine percent, 15 percent and 33 percent of the outstanding shares of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, respectively, entitled to be voted at the Special Meeting. As an inducement to and a condition of FUNC's willingness to enter into the Merger Agreement, each of the directors of Covenant, beneficially owning and entitled to vote in the aggregate approximately nine percent, 14 percent and 32 percent of the shares of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock outstanding on the Record Date, respectively, agreed to vote such shares in favor of approval of the Merger Agreement at the Special Meeting (the "Voting Agreement"). It is currently expected that the directors and executive officers of Covenant will vote the shares of Covenant Common Stock and Covenant Preferred Stock that such directors and executive officers of Covenant are entitled to vote at the Special Meeting in favor of approval of the Merger Agreement. To the best of FUNC's knowledge, no shares of Covenant Common Stock or Covenant Preferred Stock are beneficially owned and entitled to be voted at the Special Meeting by any of the directors, executive officers or affiliates of FUNC. FUNB holds 6,000 shares of Covenant Series B Preferred Stock in a custodial capacity on behalf of a client of an investment advisory firm which is majority owned by Richard A. Hocker, Chairman and Chief Executive Officer of Covenant, but FUNB is not entitled to vote such shares. Such shares are not included in the shares of Covenant Series B Preferred Stock beneficially owned by the directors and executive officers of Covenant indicated above. It is currently expected that such shares will be voted in favor of approval of the Merger Agreement at the Special Meeting. See "GENERAL INFORMATION -- Record Date; Vote Required; Revocation of Proxies". EFFECTIVE DATE Subject to the conditions to the obligations of the parties to effect the Mergers set forth in the Merger Agreement, the Corporate Merger will become effective on such date (the "Effective Date") as FUNC and Covenant mutually agree upon, 7 and if not so agreed upon, such date will be the fifth business day to occur after the last of certain conditions to consummation of the Mergers relating to, among other things, approval of the Merger Agreement by Covenant stockholders, receipt of the requisite regulatory approvals to the Mergers and the listing on the NYSE of the FUNC Common Shares, have been satisfied or waived (or, at the election of FUNC, on the last business day of the month in which such day occurs); provided that such date will be after December 31, 1997, unless FUNC and Covenant mutually agree otherwise. Subject to the foregoing, it is currently anticipated that the Mergers will be consummated in the first quarter of 1998. If the Corporate Merger is consummated in such quarter, or in any other quarter, Covenant stockholders should not assume or expect that the Effective Date will precede the record date for the dividend on FUNC Common Stock for that quarter, so as to enable such stockholders to receive such dividend. Assuming the Corporate Merger is consummated after December 31, 1997, which is currently anticipated, it is currently expected that a dividend on Covenant Series A Preferred Stock and Covenant Series B Preferred Stock in the amount of $.375 per share will be paid on January 14, 1998, to holders of record on December 31, 1997. Such dividend would be paid to holders of shares of Covenant Series A Preferred Stock notwithstanding the conversion of such shares into shares of Covenant Common Stock on December 31, 1997. See "THE MERGERS -- Effective Date", " -- Exchange of Covenant Certificates", " -- Conditions to Consummation; Termination" and " -- Dividends". RECOMMENDATION OF THE COVENANT BOARD THE COVENANT BOARD HAS APPROVED THE MERGER AGREEMENT BY UNANIMOUS VOTE, BELIEVES IT IS IN THE BEST INTERESTS OF COVENANT AND ITS STOCKHOLDERS AND RECOMMENDS ITS APPROVAL BY COVENANT STOCKHOLDERS. SEE "THE MERGERS -- BACKGROUND AND REASONS; COVENANT". OPINION OF FINANCIAL ADVISOR Berwind Financial, L.P. ("Berwind Financial") has advised the Covenant Board that, in its opinion, the consideration to be received by Covenant stockholders in the Corporate Merger is fair, from a financial point of view, to Covenant stockholders. The full text of Berwind Financial's opinion, which describes the procedures followed, assumptions made, limitations on the review undertaken and other matters in connection with rendering such opinion, is set forth in ANNEX C to this Prospectus/Proxy Statement and should be read in its entirety by Covenant stockholders. See "THE MERGERS -- Opinion of Financial Advisor". INTERESTS OF CERTAIN PERSONS IN THE MERGERS Certain members of Covenant's management and the Covenant Board may be deemed to have interests in the Mergers in addition to their interests as stockholders of Covenant generally. These include, among other things, provisions in the Merger Agreement relating to indemnification, directors' and officers' liability insurance, and certain other benefits as summarized below. Pursuant to the Merger Agreement, FUNC has agreed to assume Covenant's obligations under certain agreements (the "Termination Agreements") with Messrs. Richard A. Hocker, Charles E. Sessa, Jr., William Parker, Jr., Eugene D'Orazio and Kenneth R. Mancini (the "Covenant Officers"). Messrs. Hocker and Sessa also are directors of Covenant. Pursuant to the terms of the Termination Agreements with respect to Messrs. Hocker and Sessa, if termination of employment occurs within two years following a "Change in Control" (as such term is defined in the Termination Agreements, and which would include consummation of the Corporate Merger), such officers will be entitled to receive certain payments and benefits, unless such termination of employment is because of such officer's death. In addition, even if a Change in Control has not occurred within two years prior to the date of termination of employment, Messrs. Hocker and Sessa will be entitled to such payments and benefits unless such termination of employment is (i) because of such officer's death, (ii) by the employer for "Cause", or (iii) by such officer for other than "Good Reason" (as each of such terms is defined in the Termination Agreements). Pursuant to the Termination Agreements with respect to the Covenant Officers other than Messrs. Hocker and Sessa, such officers will be entitled to such payments and benefits if termination of employment occurs within two years following a Change in Control, unless such termination is because of any of the reasons set forth in clauses (i), (ii) or (iii) above. In addition, pursuant to the Termination Agreements, the terms of Covenant's option plans and the individual stock option agreements thereunder, options granted to the Covenant Officers will become fully vested and exercisable upon consummation of the Corporate Merger. See "THE MERGERS -- Interests of Certain Persons". 8 CERTAIN FEDERAL INCOME TAX CONSEQUENCES Among other things, consummation of the Mergers is conditioned upon receipt by FUNC and Covenant of an opinion of Sullivan & Cromwell, special counsel for FUNC, dated as of the Effective Date, that (a) the Corporate Merger constitutes a reorganization under Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"), and (b) no gain or loss will be recognized for federal income tax purposes by stockholders of Covenant who receive FUNC Common Shares solely in exchange for their shares of Covenant Common Stock or Covenant Preferred Stock, except that gain or loss may be recognized as to cash received in lieu of fractional share interests. See "THE MERGERS -- Certain Federal Income Tax Consequences". BECAUSE CERTAIN TAX CONSEQUENCES MAY VARY DEPENDING UPON THE PARTICULAR CIRCUMSTANCES OF EACH COVENANT STOCKHOLDER, IT IS RECOMMENDED THAT COVENANT STOCKHOLDERS CONSULT THEIR TAX ADVISORS CONCERNING THE FEDERAL (AND ANY STATE AND LOCAL) TAX CONSEQUENCES OF THE CORPORATE MERGER IN THEIR PARTICULAR CIRCUMSTANCES. RESALE OF FUNC COMMON SHARES The FUNC Common Shares will be freely transferable by the holders of such shares under applicable federal securities laws, except for those shares held by those holders who may be deemed to be "affiliates" (generally including directors, certain executive officers and ten percent or more stockholders) of Covenant or FUNC. See "RESALE OF FUNC COMMON SHARES". BUSINESS PENDING CONSUMMATION Covenant agreed in the Merger Agreement to conduct its business in the ordinary and usual course consistent with past practice and to refrain from taking certain actions relating to its operation pending consummation of the Mergers, without the prior written consent of FUNC, except as otherwise permitted by the Merger Agreement. These actions include, without limitation: (i) paying any dividends, other than dividends payable on Covenant Preferred Stock at a quarterly rate not to exceed the rate provided for in the terms thereof, or redeeming or otherwise acquiring any shares of its capital stock, or issuing any additional shares of its capital stock, or giving any person the right to acquire any such shares; (ii) incurring any indebtedness for borrowed money or becoming liable for the obligations of any other entity (other than in the ordinary course of business consistent with past practice); (iii) entering into any employment, consulting, severance or similar agreements or arrangements with any director, officer or employee of Covenant, or granting any salary or wage increase or increasing any employee benefits (including incentive or bonus payments), except for normal individual increases in regular compensation in the ordinary course of business consistent with past practice; (iv) disposing of any material portion of its assets or acquiring any portion of the business or property of any other entity which is material to it; (v) changing its lending, investment, liability management or other material banking policies in any material respect; (vi) settling any claim, action or proceeding involving money damages in an amount greater than $25,000 or any restrictions upon the operations of Covenant; or (vii) entering into, terminating or materially changing any material agreements, except for those agreements entered into in the ordinary course of business consistent with past practice that are terminable by Covenant without penalty on not more than 60 days' prior written notice. Covenant also has agreed to make such modifications or changes to its accounting, loan, litigation and other reserve and real estate valuation policies and practices prior to the Effective Date, as may be mutually agreed upon between FUNC and Covenant. See "THE MERGERS -- Interests of Certain Persons" and " -- Business Pending Consummation". REGULATORY APPROVALS The Mergers are subject to the prior approval of the Comptroller of the Currency (the "OCC") and the State of New Jersey Department of Banking (the "NJ Banking Department") and to the prior approval, or a waiver of the requirement to receive such approval, from the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). Applications have been filed with such regulatory authorities for such approvals or waiver. There can be no assurance that the necessary regulatory approvals or waiver will be obtained or as to the timing or conditions of such approvals or waiver. See "THE MERGERS -- Regulatory Approvals". 9 CONDITIONS TO CONSUMMATION; TERMINATION Consummation of the Mergers is subject, among other things, to: (i) approval of the Merger Agreement by the requisite vote of the stockholders of Covenant; (ii) receipt of the regulatory approvals referred to above without any restrictions or conditions which, in the reasonable opinion of FUNC, would so materially adversely impact the economic or business benefits to FUNC of the transactions contemplated by the Merger Agreement so as to render inadvisable the consummation of the Mergers; (iii) no court or governmental or regulatory authority having taken any action which prohibits the Mergers; (iv) receipt by FUNC and Covenant of the opinion of Sullivan & Cromwell dated as of the Effective Date, as to certain federal income tax consequences of the Corporate Merger, as discussed above; (v) receipt by FUNC of a letter from Covenant's independent auditors, dated as of or shortly prior to the Effective Date, with respect to Covenant's consolidated financial position and results of operations; and (vi) the FUNC Common Shares having been approved for listing on the NYSE, subject to official notice of issuance. The Merger Agreement may be terminated by mutual consent of FUNC and Covenant. The Merger Agreement may also be terminated by the Board of Directors of either FUNC or Covenant if the Corporate Merger does not occur on or before June 30, 1998, or if certain conditions set forth in the Merger Agreement are not met. See "THE MERGERS -- Conditions to Consummation; Termination". EXPENSES; TERMINATION FEE All expenses incurred by or on behalf of the parties in connection with the Merger Agreement and the transactions contemplated thereby shall be borne by the party incurring the same, except that printing expenses will be shared equally by FUNC and Covenant. FUNC shall be entitled to a fee of $3.5 million (the "Termination Fee") following the occurrence of a Payment Event (as hereinafter defined), provided FUNC shall have sent written notice of such entitlement within 90 days after its awareness of such occurrence. FUNC's right to receive the Termination Fee shall terminate if any of the following occurs prior to a Payment Event; (i) the Effective Date; (ii) termination of the Merger Agreement in accordance with its terms if such termination occurs prior to the occurrence of a Preliminary Payment Event (as hereinafter defined), except for termination by FUNC due to a breach by Covenant; (iii) termination of the Merger Agreement following the occurrence of a Preliminary Payment Event and the passage of 18 months after such termination; or (iv) termination of the Merger Agreement by FUNC due to a breach by Covenant and the passage of 18 months after such termination. See "THE MERGERS -- Expenses; Termination Fee". ACCOUNTING TREATMENT It is intended that the Mergers will be accounted for as a purchase under generally accepted accounting principles. See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks" and "THE MERGERS -- Accounting Treatment". NO DISSENTERS' RIGHTS Holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock do not have dissenters' or appraisal rights in connection with the proposal to approve the Merger Agreement. See "THE MERGERS -- No Dissenters' Rights". CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS The rights of stockholders of Covenant are currently determined by reference to the New Jersey Business Corporation Act (the "NJBCA") and by Covenant's Certificate of Incorporation (the "Covenant Certificate") and Covenant's bylaws (the "Covenant Bylaws"). On the Effective Date, stockholders of Covenant will become stockholders of FUNC, and their rights as stockholders of FUNC will be determined by reference to the North Carolina Business Corporation Act (the "NCBCA") and by FUNC's Articles of Incorporation (the "FUNC Articles") and bylaws (the "FUNC Bylaws"). See "DESCRIPTION OF FUNC CAPITAL STOCK" and "CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS". COMPARISON OF CERTAIN UNAUDITED PER SHARE DATA The following unaudited information, adjusted to reflect the two-for-one FUNC Common Stock split paid on July 31, 1997, to holders of record July 1, 1997 (the "FUNC Stock Split") and stock dividends on Covenant Common Stock and Covenant Bank common stock, reflects, where applicable, certain comparative per share data related to book value, cash 10 dividends paid, income and market value: (i) on a historical basis for FUNC and Covenant; (ii) on a pro forma combined basis per share of FUNC Common Stock; and (iii) on an equivalent pro forma basis per share of Covenant Common Stock and, with respect to cash dividends paid or declared and market value, Covenant Preferred Stock. Such pro forma information has been prepared assuming consummation of the Mergers on a purchase accounting basis as of the beginning of each of the periods presented, and does not reflect the Other Pending Acquisitions or the restatement of FUNC's financial statements in connection with the Signet Acquisition. All data relating to Covenant has been restated to reflect the 1996 and 1994 pooling of interests mergers with 1st Southern State Bank and Landis Savings Bank, S.L.A., respectively. See "RECENT DEVELOPMENTS", "THE MERGERS -- Accounting Treatment" and " -- Dividends" and "COVENANT -- History and Business". Since purchase accounting does not require restatement of results for prior periods following consummation of the Mergers, consummation of the Mergers will not affect FUNC's historical results for the periods indicated. Pro forma financial information is intended to show how the Mergers might have affected historical financial statements if the Mergers had been consummated at an earlier time. The pro forma financial information does not purport to be indicative of the results that actually would have been realized had the Mergers taken place at the beginning of the applicable periods indicated, nor is it indicative of the combined financial position or results of operations for any future periods. The information shown below should be read in conjunction with the historical financial statements of FUNC and Covenant, including the respective notes thereto, and the documents incorporated herein by reference. See "AVAILABLE INFORMATION", "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE" and ANNEX A. See also the footnotes to the table "FUNC and Covenant Pro Forma Combined Selected Financial Data" under " -- Selected Financial Data".
JUNE 30, 1997 DECEMBER 31, 1996 BOOK VALUE PER SHARE: Historical per share of: FUNC Common Stock...................................................................... $ 17.79 17.41 Covenant Common Stock.................................................................. 7.49 7.17 Pro forma combined per share of FUNC Common Stock (1)..................................... 17.79 17.41 Equivalent pro forma per share of Covenant Common Stock (2)............................... $ 6.78 6.64
(1) The pro forma combined book value per share of FUNC Common Stock amounts represent the sum of the pro forma combined common stockholders' equity amounts, divided by pro forma combined period-end number of shares of FUNC Common Stock outstanding. (2) The equivalent pro forma book value per share of Covenant Common Stock amounts represent the pro forma combined book value per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio.
SIX MONTHS YEARS ENDED ENDED JUNE 30, DECEMBER 31, 1997 1996 1995 1994 CASH DIVIDENDS PAID OR DECLARED PER SHARE: Historical per share of: FUNC Common Stock............................................................... $.58 1.10 .98 .86 Covenant Common Stock........................................................... -- -- -- -- Covenant Series A Preferred Stock............................................... .75 1.50 1.50 1.50 Covenant Series B Preferred Stock............................................... .75 1.50 .75 -- Pro forma combined per share of FUNC Common Stock (3).............................. .58 1.10 .98 .86 Equivalent pro forma per share of Covenant Common Stock (4)........................ .22 .42 .37 .33 Equivalent pro forma per share of Covenant Series A Preferred Stock (5)............ .88 1.67 1.49 1.30 Equivalent pro forma per share of Covenant Series B Preferred Stock (5)............ $.70 1.32 .62 --
(3) The pro forma combined cash dividends paid per share of FUNC Common Stock amounts represent pro forma combined cash dividends paid on common stock outstanding, divided by pro forma combined average number of shares of FUNC Common Stock outstanding, rounded to the nearest cent. (4) The equivalent pro forma cash dividends paid per share of Covenant Common Stock amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio, rounded to the nearest cent. The current annualized dividend rate per share for FUNC Common Stock, based upon the most recently 11 declared quarterly dividend rate of $.32 per share paid on September 15, 1997, is $1.28. On an equivalent pro forma basis, such current annualized FUNC dividend per share of Covenant Common Stock would be $.49, based on the Common Stock Exchange Ratio, rounded to the nearest cent. Neither Covenant nor Covenant Bank paid any cash dividends on Covenant Common Stock or Covenant Bank common stock during the periods indicated above. Any future FUNC and Covenant dividends are dependent upon their respective earnings and financial conditions, government regulations and policies and other factors. See "THE MERGERS -- Exchange of Covenant Certificates" and " -- Dividends". (5) Holders of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock currently are entitled to receive, when and as declared by the Covenant Board, preferred dividends at the annual rate of $1.50 per share. The equivalent pro forma cash dividends paid per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. On an equivalent pro forma basis, the current annualized FUNC dividend per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock would be $1.94 and $1.54, respectively, which amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. See "THE MERGERS -- Exchange of Covenant Certificates", " -- Business Pending Consummation" and " -- Dividends".
YEARS ENDED SIX MONTHS ENDED DECEMBER 31, JUNE 30, 1997 1996 1995 1994 NET INCOME APPLICABLE TO COMMON STOCKHOLDERS: Historical per share of: FUNC Common Stock (6)........................................................... $ 1.70 2.67 2.52 2.29 Covenant Common Stock........................................................... .42 .44 .61 .35 Pro forma combined per share of FUNC Common Stock (7).............................. 1.70 2.66 -- -- Equivalent pro forma per share of Covenant Common Stock (8)........................ $ .65 1.01 -- --
(6) FUNC net income applicable to common stockholders amounts as of and for the year ended December 31, 1996, includes (i) $181 million, or $0.32 per share of FUNC Common Stock, in after-tax First Fidelity Bancorporation ("FFB") merger-related restructuring charges, and (ii) $86 million, or $0.16 per share of FUNC Common Stock, in after-tax charges relating to the recapitalization of the Savings Association Insurance Fund ("SAIF"). The acquisition of FFB by FUNC was consummated on January 1, 1996. See "FUNC -- History and Business" and " -- Certain Regulatory Considerations". (7) The pro forma combined income per share of FUNC Common Stock amounts represent pro forma combined net income applicable to holders of FUNC Common Stock, divided by pro forma combined average number of shares of FUNC Common Stock outstanding. (8) The equivalent pro forma income per share of Covenant Common Stock amounts represent pro forma combined income per share of FUNC Common Stock amounts multiplied by the Common Stock Exchange Ratio. 12
EQUIVALENT EQUIVALENT PRO FORMA HISTORICAL PRO FORMA PER SHARE COVENANT COVENANT PER SHARE OF COVENANT SERIES A SERIES B OF COVENANT SERIES A FUNC COVENANT PREFERRED PREFERRED COMMON PREFERRED COMMON STOCK COMMON STOCK STOCK STOCK STOCK (9) STOCK (9) MARKET VALUE PER SHARE: August 4, 1997......................... $ 49.500 21.00 76.00 57.125 18.75 75.000 October 14, 1997....................... $ 51.375 19.00 76.00 55.000 19.50 77.875 EQUIVALENT PRO FORMA PER SHARE OF COVENANT SERIES B PREFERRED STOCK (9) MARKET VALUE PER SHARE: August 4, 1997......................... 59.375 October 14, 1997....................... 61.625
(9) The equivalent pro forma market values per share of Covenant Common Stock amounts represent the historical market values per share of FUNC Common Stock multiplied by the Common Stock Exchange Ratio, rounded down to the nearest one-eighth. The equivalent pro forma market values per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent the historical market values per share of FUNC Common Stock multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded down to the nearest one-eighth. The FUNC and Covenant historical market values per share represent the last reported sale prices per share of FUNC Common Stock on the NYSE Tape and the Covenant Common Stock and Covenant Preferred Stock on the Nasdaq National Market and the Nasdaq Small-Cap Market, respectively: (i) on August 4, 1997, the last business day preceding public announcement of the execution of the Merger Agreement; and (ii) on October 14, 1997. See "RECENT DEVELOPMENTS -- Wheat First Butcher Singer, Inc. Acquisition" and "THE MERGERS -- Market Prices". Because the market price of FUNC Common Stock is subject to fluctuation, the market value of the FUNC Common Shares that holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock will receive upon consummation of the Corporate Merger may increase or decrease prior to and after the receipt of such shares. Covenant stockholders are urged to obtain current market quotations for FUNC Common Stock. SELECTED FINANCIAL DATA The following tables set forth certain unaudited historical consolidated selected financial information for FUNC and Covenant and certain unaudited pro forma combined selected financial information. Such pro forma information has been prepared assuming consummation of the Mergers on a purchase accounting basis as of the beginning of each of the periods presented, and does not reflect the Other Pending Acquisitions or the restatement of FUNC's financial statements in connection with the Signet Acquisition. See "RECENT DEVELOPMENTS" and "THE MERGERS -- Accounting Treatment". This information should be read in conjunction with the historical financial statements of FUNC and Covenant, including the respective notes thereto, and the other documents incorporated herein by reference. See "AVAILABLE INFORMATION", "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE" and ANNEX A. Interim unaudited historical data of FUNC and Covenant reflect, in the respective opinions of management, all adjustments (consisting only of normal recurring adjustments) necessary to a fair presentation of such data. Since purchase accounting does not require restatement of results for prior periods following consummation of the Mergers, consummation of the Mergers will not affect FUNC's historical results for the periods indicated. Pro forma financial information is intended to show how the Mergers might have affected historical financial statements if the Mergers had been consummated at an earlier time. The pro forma combined selected financial information does not purport to be indicative of the results that actually would have been realized had the Mergers taken place at the beginning of the applicable periods indicated, nor is it indicative of the combined financial position or results of operations for any future periods. 13 FUNC (HISTORICAL)
SIX MONTHS ENDED JUNE 30, YEARS ENDED DECEMBER 31, (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1996 1995 1994 1993 CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... $ 4,977 4,770 9,628 8,687 7,231 6,602 Interest expense........................................ 2,350 2,294 4,632 4,052 2,793 2,482 Net interest income..................................... 2,627 2,476 4,996 4,635 4,438 4,120 Provision for loan losses............................... 310 150 375 220 179 370 Net interest income after provision for loan losses..... 2,317 2,326 4,621 4,415 4,259 3,750 Securities available for sale transactions.............. 9 18 31 44 6 33 Investment security transactions........................ 1 3 4 5 4 7 Noninterest income...................................... 1,498 1,051 2,322 1,848 1,566 1,542 Merger-related restructuring charges.................... -- 281 281 -- -- -- SAIF special assessment................................. -- -- 133 -- -- -- Noninterest expense..................................... 2,351 2,063 4,254 4,093 3,747 3,536 Income before income taxes.............................. 1,474 1,054 2,310 2,219 2,088 1,796 Income taxes............................................ 518 372 811 789 712 579 Net income.............................................. 956 682 1,499 1,430 1,376 1,217 Dividends on preferred stock............................ -- 7 9 26 46 46 Net income applicable to common stockholders before redemption premium.................................... 956 675 1,490 1,404 1,330 1,171 Redemption premium on preferred stock................... -- -- -- -- 41 -- Net income applicable to common stockholders after redemption premium.................................... $ 956 675 1,490 1,404 1,289 1,171 PER COMMON SHARE DATA (a) Net income before redemption premium.................... $ 1.70 1.20 2.67 2.52 2.36 2.15 Net income after redemption premium..................... 1.70 1.20 2.67 2.52 2.29 2.15 Cash dividends.......................................... 0.58 0.52 1.10 0.98 0.86 0.75 Book value.............................................. 17.79 16.23 17.41 15.94 14.10 13.36 CASH DIVIDENDS PAID ON COMMON STOCK....................... 329 291 611 336 298 244 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets.................................................. 142,942 139,886 140,127 131,880 113,529 104,550 Loans, net of unearned income........................... 96,411 91,339 95,858 90,563 77,831 68,263 Deposits................................................ 92,934 91,453 94,815 92,555 87,865 81,885 Long-term debt.......................................... 7,258 7,807 7,660 7,121 4,242 3,675 Guaranteed preferred beneficial interests............... 990 -- 495 -- -- -- Preferred stockholders' equity.......................... -- 163 -- 183 230 262 Common stockholders' equity............................. 9,980 9,153 10,008 8,860 8,044 7,432 Total stockholders' equity.............................. $ 9,980 9,316 10,008 9,043 8,274 7,946 Preferred shares outstanding (IN THOUSANDS)............. -- 2,599 -- 3,388 5,213 11,560 Common shares outstanding (IN THOUSANDS)................ 560,977 563,895 574,697 555,692 570,721 556,408 CONSOLIDATED AVERAGE BALANCE SHEET ITEMS Assets.................................................. $137,390 133,597 134,127 118,142 106,413 99,610 Loans, net of unearned income........................... 94,959 89,546 90,660 83,265 70,726 62,996 Deposits................................................ 92,837 91,367 91,320 87,274 80,760 76,830 Long-term debt.......................................... 7,482 7,429 7,565 5,707 4,009 3,598 Guaranteed preferred beneficial interests............... 951 -- 47 -- -- -- Common stockholders' equity (b)......................... 9,767 9,049 9,079 8,412 7,870 6,782 Total stockholders' equity (b).......................... $ 9,767 9,221 9,187 8,623 8,372 7,302 Common shares outstanding (IN THOUSANDS)................ 563,003 562,950 557,624 557,354 563,325 544,876 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders before redemption premium to average common stockholders' equity (b)............................................. 19.74%(c) 14.99(c) 16.41 16.69 16.91 17.26 Net income applicable to common stockholders after redemption premium to average common stockholders' equity (b)............................................ 19.74(c) 14.99(c) 16.41 16.69 16.38 17.26 Net income to Average total stockholders' equity (b)................ 19.74(c) 14.88(c) 16.32 16.59 16.44 16.66 Average assets........................................ 1.40(c) 1.03(c) 1.12 1.21 1.29 1.22 Average stockholders' equity to average assets (d)...... 7.06 6.90 6.82 7.23 7.52 7.11 Allowance for loan losses to Net loans............................................. 1.42 1.55 1.42 1.66 2.03 2.38 Nonaccrual and restructured loans..................... 223 195 204 233 248 151 Nonperforming assets.................................. 194 169 179 182 178 115 Net charge-offs to average net loans.................... 0.64(c) 0.56(c) 0.63 0.41 0.40 0.78 Nonperforming assets to loans, net and foreclosed properties............................................ 0.73 0.91 0.80 0.91 1.14 2.06 Capital ratios (d) Tier 1 capital........................................ 7.55 7.11 7.33 6.70 7.76 9.14 Total capital......................................... 12.64 11.94 12.33 11.45 12.94 14.64 Leverage.............................................. 6.23 5.60 6.13 5.49 6.12 6.13 Net interest margin..................................... 4.36%(c) 4.18(c) 4.21 4.46 4.75 4.82 (IN MILLIONS, EXCEPT PER SHARE DATA) 1992 CONSOLIDATED SUMMARIES OF INCOME Interest income.......................................... 6,609 Interest expense........................................ 2,942 Net interest income..................................... 3,667 Provision for loan losses............................... 643 Net interest income after provision for loan losses..... 3,024 Securities available for sale transactions.............. 39 Investment security transactions........................ (3) Noninterest income...................................... 1,360 Merger-related restructuring charges.................... -- SAIF special assessment................................. -- Noninterest expense..................................... 3,443 Income before income taxes.............................. 977 Income taxes............................................ 278 Net income.............................................. 699 Dividends on preferred stock............................ 53 Net income applicable to common stockholders before redemption premium.................................... 646 Redemption premium on preferred stock................... -- Net income applicable to common stockholders after redemption premium.................................... 646 PER COMMON SHARE DATA (a) Net income before redemption premium.................... 1.26 Net income after redemption premium..................... 1.26 Cash dividends.......................................... 0.64 Book value.............................................. 11.68 CASH DIVIDENDS PAID ON COMMON STOCK....................... 168 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets.................................................. 95,308 Loans, net of unearned income........................... 60,301 Deposits................................................ 76,156 Long-term debt.......................................... 3,733 Guaranteed preferred beneficial interests............... -- Preferred stockholders' equity.......................... 277 Common stockholders' equity............................. 6,187 Total stockholders' equity.............................. 6,717 Preferred shares outstanding (IN THOUSANDS)............. 12,158 Common shares outstanding (IN THOUSANDS)................ 529,790 CONSOLIDATED AVERAGE BALANCE SHEET ITEMS Assets.................................................. 90,621 Loans, net of unearned income........................... 58,700 Deposits................................................ 71,947 Long-term debt.......................................... 3,528 Guaranteed preferred beneficial interests............... -- Common stockholders' equity (b)......................... 5,724 Total stockholders' equity (b).......................... 6,280 Common shares outstanding (IN THOUSANDS)................ 510,768 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders before redemption premium to average common stockholders' equity (b)............................................. 11.28 Net income applicable to common stockholders after redemption premium to average common stockholders' equity (b)............................................ 11.28 Net income to Average total stockholders' equity (b)................ 11.13 Average assets........................................ 0.77 Average stockholders' equity to average assets (d)...... 6.89 Allowance for loan losses to Net loans............................................. 2.57 Nonaccrual and restructured loans..................... 105 Nonperforming assets.................................. 76 Net charge-offs to average net loans.................... 1.03 Nonperforming assets to loans, net and foreclosed properties............................................ 3.36 Capital ratios (d) Tier 1 capital........................................ 9.22 Total capital......................................... 14.31 Leverage.............................................. 6.55 Net interest margin..................................... 4.73
(a) Per common share data has been restated to reflect the FUNC Stock Split. (b) Average common stockholders' equity and total stockholders' equity exclude net unrealized gains and (losses) on debt and equity securities in 1994 through 1997. (c) Annualized. (d) The average stockholders' equity to average assets ratios and all capital ratios for 1992-1994 are not restated for pooling of interests acquisitions. Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of four percent and total capital to risk-weighted assets of eight percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from three to five percent. 14 COVENANT (HISTORICAL) (A)
SIX MONTHS ENDED JUNE 30, YEARS ENDED DECEMBER 31, (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 1992 CONSOLIDATED SUMMARIES OF INCOME Interest income...................................................... $ 16 29 26 20 17 16 Interest expense..................................................... 8 14 12 8 7 9 Net interest income.................................................. 8 15 14 12 10 7 Provision for loan losses............................................ -- 1 1 1 1 1 Net interest income after provision for loan losses.................. 8 14 13 11 9 6 Noninterest income................................................... 1 1 1 1 1 1 Merger-related restructuring charges................................. -- 1 -- 1 -- -- SAIF special assessment.............................................. -- 1 -- -- -- -- Noninterest expense.................................................. 6 10 11 10 9 6 Income before income taxes........................................... 3 3 3 1 1 1 Income taxes......................................................... 1 1 1 -- -- -- Net income........................................................... 2 2 2 1 1 1 Dividends on preferred stock......................................... -- 1 -- -- -- -- Net income applicable to common stockholders......................... $ 2 1 2 1 1 1 PER COMMON SHARE DATA Net income........................................................... $ 0.42 0.44 0.61 0.35 0.38 0.22 Book value........................................................... 7.49 7.17 7.25 6.19 6.01 5.63 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets............................................................... 454 415 347 317 274 210 Loans, net of unearned income........................................ 263 241 205 194 183 148 Deposits............................................................. 302 277 263 236 244 186 Long-term debt....................................................... 21 20 14 18 7 -- Preferred stockholders' equity....................................... 7 7 7 3 3 3 Common stockholders' equity.......................................... 24 22 23 19 19 17 Total stockholders' equity........................................... $ 31 29 30 22 22 20 Preferred shares outstanding (IN THOUSANDS).......................... 300 300 300 138 138 138 Common shares outstanding (IN THOUSANDS)............................. 3,053 3,023 3,068 3,064 3,054 3,054 CONSOLIDATED PERCENTAGES Net income applicable to common stockholders to average common stockholders' equity.............................................. 14.29%(b) 6.30 9.53 5.72 6.68 4.30 Net income to average assets......................................... 0.85(b) 0.48 0.72 0.45 0.56 0.35 Average stockholders' equity to average assets....................... 6.96 7.56 7.66 7.70 8.49 8.24 Allowance for loan losses to Gross loans....................................................... 1.07 1.25 1.56 1.87 2.00 1.81 Nonaccrual and restructured loans................................. 127 105 87 78 86 137 Nonperforming assets.............................................. 95 85 64 66 70 70 Net charge-offs to average net loans................................. 0.18(b) 0.36 0.37 0.38 0.77 0.46 Nonperforming assets to gross loans and foreclosed properties........ 1.12 1.47 2.43 2.81 2.84 2.56 Capital ratios (c) Tier 1 capital.................................................... 11.74 11.98 13.62 11.68 11.52 13.88 Total capital..................................................... 12.79 13.20 14.87 12.94 12.78 14.83 Leverage.......................................................... 7.30 7.51 8.49 7.42 7.87 9.88 Net interest margin.................................................. 3.79%(b) 4.10 4.37 4.50 4.24 3.86
(a) All data has been restated to reflect the 1996 and 1994 pooling of interests mergers with 1st Southern State Bank and Landis Savings Bank, S.L.A., respectively, and to reflect all common stock dividends issued by Covenant and Covenant Bank through July 14, 1997. See "THE MERGERS -- Dividends", "COVENANT -- History and Business" and ANNEX A. (b) Annualized. (c) Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of four percent and total capital to risk-weighted assets of eight percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from three to five percent. 15 FUNC AND COVENANT PRO FORMA COMBINED SELECTED FINANCIAL DATA (A)
AS OF AND FOR THE AS OF AND FOR THE SIX MONTHS YEAR ENDED ENDED JUNE 30, DECEMBER 31, (IN MILLIONS, EXCEPT PER SHARE DATA) 1997 1996 CONSOLIDATED SUMMARIES OF INCOME Interest income......................................................................... $ 4,990 9,653 Interest expense........................................................................ 2,358 4,646 Net interest income..................................................................... 2,632 5,007 Provision for loan losses............................................................... 310 376 Net interest income after provision for loan losses..................................... 2,322 4,631 Securities available for sale transactions.............................................. 9 31 Investment security transactions........................................................ 1 4 Noninterest income...................................................................... 1,499 2,323 Merger-related restructuring charges.................................................... -- 282 SAIF special assessment................................................................. -- 134 Noninterest expense..................................................................... 2,358 4,274 Income before income taxes.............................................................. 1,473 2,299 Income taxes............................................................................ 518 807 Net income.............................................................................. 955 1,492 Dividends on preferred stock............................................................ -- 10 Net income applicable to common stockholders............................................ $ 955 1,482 Net income per common share............................................................. $ 1.70 2.66 CONSOLIDATED PERIOD-END BALANCE SHEET ITEMS Assets.................................................................................. $ 143,446 140,592 Loans, net of unearned income........................................................... 96,674 96,099 Deposits................................................................................ 93,236 95,092 Long-term debt.......................................................................... 7,279 7,680 Guaranteed preferred beneficial interests............................................... 990 495 Common stockholders' equity............................................................. 9,980 10,008 Total stockholders' equity.............................................................. $ 9,980 10,008 Common shares outstanding (IN THOUSANDS)................................................ 560,977 574,697 CONSOLIDATED PERCENTAGES Allowance for loan losses to Net loans............................................................................ 1.42% 1.42 Nonperforming assets................................................................. 193 178 Net charge-offs to average net loans.................................................... 0.64(b) 0.63 Nonperforming assets to loans, net and foreclosed properties............................ 0.73% 0.80
(a) Pro forma assumptions related to the Corporate Merger include (i) the .3813 Common Stock Exchange Ratio, the 1.516 Series A Exchange Ratio and the 1.2 Series B Exchange Ratio; (ii) the issuance of 1.7 million shares of FUNC Common Stock; (iii) the repurchase by FUNC of such shares in the open market at a cost of approximately $81 million; (iv) a cost of funds rate of 5.56 percent for the six months period ended June 30, 1997, and 5.27 percent for the year ended December 31, 1996; and (v) an increase in goodwill and deposit base premium of $44 million and $6 million, respectively, which is being amortized over 25-year straight-line and 10-year accelerated bases, respectively. See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks". (b) Annualized. 16 RECENT DEVELOPMENTS CERTAIN FINANCIAL INFORMATION FOR THE PERIOD ENDED SEPTEMBER 30, 1997 FUNC FUNC's earnings applicable to common stockholders were $505 million in the third quarter of 1997, compared with $485 million in the second quarter of 1997 and $356 million in the third quarter a year ago. On a per common share basis, earnings were $0.90, compared with $0.87 in the second quarter of 1997 and $0.65 in the third quarter a year ago. Earnings applicable to common stockholders for the third quarter of 1996 include a one-time assessment related to DIFA (as hereinafter defined) of $86 million after-tax. Excluding such assessment, FUNC's operating earnings in the third quarter of 1996 were $442 million, or $0.81 per share of FUNC Common Stock. All per share data have been restated to reflect the FUNC Stock Split. In the nine months ended September 30, 1997, net income applicable to common stockholders was $1.5 billion, or $2.60 per share, compared with $1.0 billion, or $1.85 per share, in the first nine months of 1996. Excluding after-tax restructuring charges relating to the FFB acquisition of $181 million incurred in the first quarter of 1996, and the one-time assessment related to DIFA in the third quarter of 1996, operating earnings in the nine months ended September 30, 1996, were $1.3 billion, or $2.33 per share. Tax-equivalent net interest income was $1.4 billion in the third quarter of 1997, compared with $1.4 billion in the second quarter of 1997 and $1.3 billion in the third quarter of 1996. Nonperforming assets were $704 million, or 0.74 percent of net loans and foreclosed properties, at September 30, 1997, compared with $708 million, or 0.73 percent at June 30, 1997, and $825 million, or 0.89 percent, at September 30, 1996. Annualized net charge-offs as a percentage of average net loans were 0.66 percent in the third quarter of 1997, compared with 0.68 percent in the second quarter of 1997 and 0.64 percent in the third quarter of 1996. The loan loss provision was $155 million in the third quarter of 1997, compared with $165 million in the second quarter of 1997 and $105 million in the third quarter of 1996. Net loans at September 30, 1997, were $94.9 billion, compared with $92.5 billion a year ago. Deposits were $91.7 billion at September 30, 1997, compared with $91.4 billion a year ago. Total stockholders' equity was $10.7 billion at September 30, 1997, compared with $8.7 billion a year ago. At September 30, 1997, FUNC had assets of $143.9 billion. See "FUNC". COVENANT Covenant's earnings for the third quarter of 1997 were $925,000, or $0.21 per share, compared to a loss of $413,000, or $0.17 per share, for the third quarter of 1996. Third quarter 1996 results include merger-related costs associated with Covenant's acquisition in September 1996 of 1st Southern State Bank and a one-time assessment related to DIFA amounting to $1.2 million, after-tax. Return on average assets and return on average common equity were 0.86 percent and 13.67 percent, respectively, for the third quarter of 1997. For the nine months ended September 30, 1997, Covenant's earnings were $2.7 million, or $0.63 per share, compared to $1.0 million, or $0.22 per share, for the same period in 1996, which included the above-mentioned non-recurring costs. Return on average assets and return on average common equity for the nine months ended September 30, 1997, were 0.86 percent and 13.96 percent, respectively. Total assets were $419.9 million at September 30, 1997, compared to total assets of $387.2 million at September 30, 1996. Net loans were $254.9 million, compared to net loans of $224.9 million at September 30, 1996. Total deposits were $304.1 million, compared to deposits of $285.9 million at September 30, 1996. Covenant's allowance for loan losses amounted to $2.7 million, or 1.05 percent of gross loans, at September 30, 1997. The loan loss allowance covered 150 percent of nonperforming loans at September 30, 1997, compared to 83 percent coverage at September 30, 1996. Nonperforming assets as a percentage of total loans and other real estate owned were 1.11 percent at September 30, 1997, compared to 1.98 percent at September 30, 1996. See "COVENANT" and ANNEX A. 17 SIGNET BANKING CORPORATION ACQUISITION On July 18, 1997, FUNC entered into an agreement (the "Signet Merger Agreement") to acquire Signet, a Virginia-based, bank holding company. Signet, through its principal bank subsidiary, Signet Bank, provides financial services through banking offices located throughout Virginia, Maryland and Washington, D.C. As of June 30, 1997, and for the six months then ended, Signet reported assets of $11.9 billion, net loans of $6.3 billion, deposits of $8.1 billion, stockholders' equity of $936 million and net income of $31 million. Under the terms of the Signet Merger Agreement, FUNC will exchange 1.10 shares of FUNC Common Stock for each share of Signet common stock. As of June 30, 1997, Signet had 60.4 million shares of common stock outstanding. The Signet Acquisition, which will be accounted for as a pooling of interests, is expected to close in the fourth quarter of 1997, subject to certain conditions of closing. See " -- FUNC Common Stock Offering" and "THE MERGERS -- Accounting Treatment". On July 21, 1997, FUNC filed a Current Report on Form 8-K with the Commission (the "Signet Form 8-K") which contained, among other items, certain financial and other information (the "Signet Form 8-K Materials") about the Signet Acquisition. The Signet Form 8-K Materials contained certain forward-looking statements regarding FUNC, Signet and the combined organization following the Signet Acquisition, including statements relating to estimated cost savings and enhanced revenues that may be realized from the Signet Acquisition, and certain restructuring charges expected to be incurred in connection with the Signet Acquisition. Such forward-looking statements involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the Signet Form 8-K Materials and herein. Factors that might cause such a difference include, but are not limited to, those discussed in the Signet Form 8-K and FUNC's Quarterly Report on Form 10-Q for the period ended June 30, 1997. See "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION" and "AVAILABLE INFORMATION". As indicated in the Signet Form 8-K: (Bullet) FUNC expects to realize before-tax expense savings resulting from the Signet Acquisition of approximately $169 million in 1998 and $242 million in 1999, or approximately $108 million and $155 million after-tax, respectively. These estimates assume that approximately 50 percent of Signet's 1996 annual expenses are eliminated by the end of 1999. (Bullet) FUNC expects to realize before-tax revenue enhancements relating to the Signet Acquisition of approximately $30 million in 1998 and $37 million in 1999, or approximately $15 million and $19 million after-tax, respectively. These estimates are primarily based on an analysis of fee income generating products currently offered by FUNC which either are not offered by Signet or are offered by Signet on a more limited basis. (Bullet) Assuming (i) the restructuring charges discussed below and the expense savings and revenue enhancements discussed above are as indicated, (ii) 641 million shares of FUNC Common Stock are outstanding in 1998 and 646 million shares of FUNC Common Stock are outstanding in 1999, (iii) the Signet Acquisition is consummated in 1997, (iv) the conversion of Signet's operations and computer systems to FUNC's operations and computer systems are completed by April 1998, (v) 1998 earnings per share of (a) FUNC Common Stock are $3.905 and (b) Signet common stock are $2.62, which represent the First Call Consensus estimates (before public announcement of the Signet Merger Agreement and before Signet's June 3, 1997 corporate redesign announcement, the "1998 Illustrative First Call Consensus Estimates"), (vi) 1999 earnings per share of FUNC Common Stock and Signet common stock are equal to the 1998 Illustrative First Call Consensus Estimates plus ten percent (the "1999 Illustrative Estimates") (i.e., $4.295 for FUNC Common Stock and $2.88 for Signet common stock), and (vii) certain other assumptions contained in the Signet Form 8-K, the Signet Acquisition is estimated to add $0.005 per share to the 1998 Illustrative First Call Consensus Estimates for FUNC Common Stock and $0.065 per share to the 1999 Illustrative Estimates for FUNC Common Stock. The 1998 Illustrative First Call Consensus Estimates and the 1999 Illustrative Estimates are presented for illustrative purposes only, are subject to the risks and uncertainties set forth in the Signet Form 8-K Materials and under "CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION", and do not constitute earnings projections or estimates by FUNC or Signet. 18 (Bullet) FUNC expects to take an after-tax restructuring charge relating to the Signet Acquisition currently estimated at $135 million, or $0.42 per share of FUNC Common Stock, in 1997. The estimated $135 million restructuring charge is summarized below.
(IN MILLIONS, AFTER TAX) Severance and change in control related obligations............................... $ 58 Fixed asset write-downs and vacant space accrual.................................. 38 Service contract terminations..................................................... 18 Other............................................................................. 21 Total............................................................................. $135
The estimated restructuring charge includes approximately $18 million in non-cash charges. Cash payments included in the estimated restructuring charge are expected to be completed by the end of the second quarter of 1998. The "Other" category includes Signet Acquisition-related amounts, none of which is estimated to exceed $13 million. The amounts included in the $135 million estimated restructuring charge are subject to change prior to the effective date of the Signet Acquisition. The estimates include assumptions about the timing of the consummation of the Signet Acquisition and number of employees whose employment will terminate as a result of the Signet Acquisition. Changes in such assumptions could result in a change in the estimated restructuring charge. Certain additional financial and other information relating to Signet and the proposed acquisition are set forth in the Signet Form 8-K, which is incorporated by reference herein and a copy of which may be obtained from FUNC as indicated under "AVAILABLE INFORMATION". WHEAT FIRST BUTCHER SINGER, INC. ACQUISITION On August 20, 1997, FUNC entered into an agreement to acquire WFBS, a full service investment banking, brokerage and asset management company based in Richmond, Virginia. WFBS is employee-owned and operates 126 offices in 19 states and Washington, D.C. Under the terms of the agreement, First Union will issue 10,267,029 shares of FUNC Common Stock (as may be adjusted in certain circumstances) in exchange for the outstanding shares of capital stock of WFBS. In addition, FUNC agreed to establish an employee retention pool of $75 million in restricted FUNC Common Stock to be paid over a three-year period to certain key employees of WFBS. The acquisition, which will be accounted for as a pooling of interests, is expected to close in the fourth quarter of 1997, subject to certain conditions of closing. See " -- FUNC Common Stock Offering" and "THE MERGERS -- Accounting Treatment". Certain additional financial and other information relating to WFBS and the proposed acquisition are set forth in FUNC's Current Report on Form 8-K dated August 20, 1997, which is incorporated by reference herein and a copy of which may be obtained from FUNC as indicated under "AVAILABLE INFORMATION". A subsidiary of WFBS is a market maker in Covenant Common Stock and Covenant Preferred Stock. See "THE MERGERS -- Market Prices". FUNC COMMON STOCK BUYBACKS In 1995, as adjusted to reflect the FUNC Stock Split, FUNC repurchased in the open market 51 million shares of FUNC Common Stock at a cost of $1.2 billion; in 1996, 31 million shares at a cost of $968 million; and from January 1, 1997 to the most recent practicable date prior to the mailing of this Prospectus/Proxy Statement, 24 million shares at a cost of $1.0 billion (including 1.65 million shares of FUNC Common Stock expected to be issued in connection with the Corporate Merger at a cost of $79 million). The repurchase of such 1.65 million shares of FUNC Common Stock requires that the Mergers be accounted for as a purchase. See "THE MERGERS -- Accounting Treatment". FUNC COMMON STOCK OFFERING On September 23, 1997, FUNC sold 7.5 million shares of FUNC Common Stock in a public offering (the "Offering"), in order for the Signet Acquisition and the WFBS Acquisition to qualify for pooling of interests accounting treatment. See "THE MERGERS -- Accounting Treatment". The Offering also included the sale by Banco Santander, S.A. ("Santander") of all of the remaining 44.7 million shares of FUNC Common Stock (approximately 7.98 percent of the outstanding shares of FUNC Common Stock as of August 31, 1997) beneficially owned by Santander. Santander had acquired its shares of FUNC Common Stock in connection with FUNC's acquisition of FFB on January 1, 1996. FUNC received $358 million in net proceeds from its sale of the 7.5 million shares in the Offering. FUNC did not receive any proceeds from the sale of Santander's shares in the Offering. 19 FUTURE ACQUISITIONS FUNC is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations, frequently take place and future acquisitions involving cash, debt and equity securities can be expected. Acquisitions typically involve the payment of a premium over book and market values, and therefore, some dilution of FUNC's book value and net income may occur in connection with future acquisitions. See "FUNC -- History and Business". GENERAL INFORMATION GENERAL This Prospectus/Proxy Statement is being furnished by Covenant to its stockholders as a Proxy Statement in connection with the solicitation of proxies by the Covenant Board for use at the Special Meeting to be held on November 20, 1997, and any adjournments or postponements thereof, to consider and vote upon a proposal to approve the Merger Agreement. This Prospectus/Proxy Statement is also being furnished by FUNC to the holders of Covenant Common Stock and Covenant Preferred Stock as a Prospectus in connection with the issuance by FUNC of the FUNC Common Shares upon consummation of the Corporate Merger. Directors, officers and employees of Covenant and FUNC may solicit proxies from Covenant stockholders, either personally or by telephone, telegraph or other forms of communication. Such persons will receive no additional compensation for such services. Covenant has retained Corporate Investor Communications, Inc. to assist in soliciting proxies and to send proxy materials to brokerage houses and other custodians, nominees and fiduciaries for transmittal to their principals, at a cost not expected to exceed $5,000, plus out-of-pocket expenses. All expenses associated with the solicitation of proxies in the form enclosed will be borne by the party incurring the same, except for printing expenses, which will be shared equally between FUNC and Covenant. THE COVENANT BOARD HAS UNANIMOUSLY APPROVED THE MERGER AGREEMENT, BELIEVES THE MERGER AGREEMENT IS IN THE BEST INTERESTS OF COVENANT AND ITS STOCKHOLDERS, AND RECOMMENDS ITS APPROVAL BY COVENANT STOCKHOLDERS. SEE "THE MERGERS -- BACKGROUND AND REASONS; COVENANT". RECORD DATE; VOTE REQUIRED; REVOCATION OF PROXIES The Covenant Board has fixed October 6, 1997, as the Record Date for determining stockholders entitled to notice of and to vote at the Special Meeting, and accordingly, only holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock of record at the close of business on that day are entitled to notice of and to vote at the Special Meeting. The number of shares of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock outstanding on the Record Date was 3,057,332, 138,300 and 161,700, respectively, each of such shares being entitled to one vote. The presence, in person or by proxy, of at least a majority of the votes entitled to be cast at the Special Meeting by the holders of each of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock will constitute a quorum for purposes of conducting business at the Special Meeting. Abstentions and broker non-votes (I.E., proxies from brokers or nominees indicating that such persons have not received instructions from the beneficial owners or other persons as to the proposal to approve the Merger Agreement) will be treated as shares present at the Special Meeting for purposes of determining the presence of a quorum. Approval of the Merger Agreement at the Special Meeting requires the affirmative vote of a majority of the votes cast by the holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, each voting as a separate class. For purposes of determining the votes cast with respect to any matter presented for consideration at the Special Meeting, only those votes cast "FOR" or "AGAINST" are included. The directors and executive officers of Covenant (including certain of their related interests) beneficially owned, as of the Record Date, and are entitled to vote at the Special Meeting 276,210 shares of Covenant Common Stock, 21,000 shares of Covenant Series A Preferred Stock and 53,326 shares of Covenant Series B Preferred Stock, which represent approximately nine percent, 15 percent and 33 percent of the outstanding shares of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, respectively, entitled to be voted at the Special Meeting. As an inducement to and a condition of FUNC's willingness to enter into the Merger Agreement, each of the directors of Covenant, beneficially owning and entitled to vote in the aggregate approximately nine percent, 14 percent and 32 percent of the shares of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock outstanding on the Record Date, respectively, agreed to vote such shares in favor of approval of the Merger Agreement at the Special Meeting pursuant to the terms of the Voting Agreement. It is currently expected that the directors and executive officers of Covenant will vote the 20 shares of Covenant Common Stock and Covenant Preferred Stock that such directors and executive officers of Covenant are entitled to vote at the Special Meeting in favor of approval of the Merger Agreement. To the best of FUNC's knowledge, no shares of Covenant Common Stock or Covenant Preferred Stock are beneficially owned and entitled to be voted at the Special Meeting by any of the directors, executive officers or affiliates of FUNC. FUNB holds 6,000 shares of Covenant Series B Preferred Stock in a custodial capacity on behalf of a client of an investment advisory firm which is majority owned by Richard A. Hocker, Chairman and Chief Executive Officer of Covenant, but FUNB is not entitled to vote such shares. Such shares are not included in the shares of Covenant Series B Preferred Stock beneficially owned by the directors and executive officers of Covenant indicated above. It is currently expected that such shares will be voted in favor of approval of the Merger Agreement at the Special Meeting. COVENANT STOCKHOLDERS ARE URGED TO PROMPTLY SIGN, DATE AND RETURN THE ACCOMPANYING PROXY CARD IN THE ENCLOSED POSTAGE-PAID, ADDRESSED ENVELOPE. STOCKHOLDERS WILL RECEIVE A SEPARATE PROXY CARD WITH RESPECT TO EACH CLASS OF STOCK HELD BY SUCH STOCKHOLDER. STOCKHOLDERS SHOULD BE SURE TO VOTE ALL OF THEIR SHARES BY RETURNING THE SEPARATE PROXY CARD FOR EACH CLASS OF STOCK THAT THEY HOLD. After having been submitted, the enclosed proxy may be revoked by the person giving it, at any time before it is exercised, by: (i) submitting written notice of revocation of such proxy to the Secretary of Covenant; (ii) submitting a proxy having a later date; or (iii) appearing at the Special Meeting and requesting a return of the proxy. All shares represented by valid proxies will be exercised in the manner specified thereon. If no specification is made, such shares will be voted in favor of approval of the Merger Agreement and otherwise in the discretion of the proxyholders named thereon in accordance with their best judgment as to any other matters which may be voted on at the Special Meeting, including among other things, a motion to adjourn or postpone the Special Meeting to another time and/or place for the purpose of soliciting additional proxies or otherwise; provided, however, that no proxy which is voted against the proposal to adopt the Merger Agreement will be voted in favor of any adjournment or postponement proposed for the purpose of soliciting additional votes in favor of the Merger Agreement. THE MERGERS THE FOLLOWING INFORMATION RELATING TO THE MERGERS IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS/PROXY STATEMENT, INCLUDING THE ANNEXES HERETO, AND IN THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE. A COPY OF THE MERGER AGREEMENT IS SET FORTH IN ANNEX B TO THIS PROSPECTUS/PROXY STATEMENT AND IS INCORPORATED HEREIN BY REFERENCE, AND REFERENCE IS MADE THERETO FOR A COMPLETE DESCRIPTION OF THE TERMS OF THE MERGERS. STOCKHOLDERS OF COVENANT ARE URGED TO READ THE MERGER AGREEMENT CAREFULLY. GENERAL; EXCHANGE RATIOS Subject to the terms and conditions of the Merger Agreement, Covenant will merge with and into FUNC and Covenant Bank will merge with and into FUNB. Upon consummation of the Corporate Merger, (i) each outstanding share of Covenant Common Stock (other than Excluded Shares) will be converted into the right to receive .3813 FUNC Common Shares (I.E., the Common Stock Exchange Ratio); (ii) each outstanding share of Covenant Series A Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.516 FUNC Common Shares (I.E., the Series A Exchange Ratio); and (iii) each outstanding share of Covenant Series B Preferred Stock (other than Excluded Shares) will be converted into the right to receive 1.2 FUNC Common Shares (I.E., the Series B Exchange Ratio). Each holder of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock who would otherwise be entitled to a fractional share of FUNC Common Stock will receive cash in lieu thereof in an amount determined by multiplying the last reported sale price per share of FUNC Common Stock on the NYSE Tape on the last trading day prior to the Effective Date by the fraction of a share of FUNC Common Stock to which such holder would otherwise be entitled. The Merger Agreement provides that FUNC may at any time change the method of acquiring Covenant and Covenant Bank; provided, however, no such change may (i) alter the amount or kind of consideration to be issued to the holders of Covenant Common Stock and Covenant Preferred Stock pursuant to the Merger Agreement, (ii) adversely affect the intended tax-free treatment to such holders as a result of receiving such consideration, or (iii) materially impede or delay receipt of any required regulatory approvals of the Mergers or the consummation of the transactions contemplated by the Merger Agreement. 21 EFFECTIVE DATE Subject to the conditions to the obligations of the parties to effect the Mergers, the Effective Date will occur on such date as FUNC and Covenant mutually agree upon, and if not so agreed upon, such date will be the fifth business day to occur after the last of certain conditions to consummation of the Mergers, relating to, among other things, approval of the Merger Agreement by Covenant stockholders, receipt of the requisite regulatory approvals to the Mergers and the listing on the NYSE of the FUNC Common Shares to be issued in the Corporate Merger, have been satisfied or waived (or, at the election of FUNC, on the last business day of the month in which such day occurs); provided that such date will be after December 31, 1997, unless FUNC and Covenant mutually agree otherwise. Subject to the foregoing, it is currently anticipated that the Mergers will be consummated in the first quarter of 1998. If the Corporate Merger is consummated in such quarter, or in any other quarter, Covenant stockholders should not assume or expect that the Effective Date will precede the record date for the dividend on FUNC Common Stock for that quarter, so as to enable such stockholders to receive such dividend. The Board of Directors of either FUNC or Covenant may terminate the Merger Agreement if the Effective Date does not occur on or before June 30, 1998. Assuming the Corporate Merger is consummated after December 31, 1997, which is currently anticipated, it is currently expected that a dividend on Covenant Series A Preferred Stock and Covenant Series B Preferred Stock in the amount of $.375 per share will be paid on January 14, 1998, to holders of record on December 31, 1997. Such dividend would be paid to holders of shares of Covenant Series A Preferred Stock notwithstanding the conversion of such shares into shares of Covenant Common Stock on December 31, 1997. See " -- Exchange of Covenant Certificates", " -- Conditions to Consummation; Termination" and " -- Dividends". EXCHANGE OF COVENANT CERTIFICATES As promptly as practicable after the Effective Date, FUNC will send or cause to be sent to each holder of record of Covenant Common Stock and Covenant Preferred Stock as of the Effective Date, transmittal materials for use in exchanging all of such holder's certificates representing Covenant Common Stock and Covenant Preferred Stock for a certificate or certificates representing the FUNC Common Shares to which such holder is entitled and a check for such holder's fractional share interest and any dividends to which such holder is entitled, as appropriate. The transmittal materials will contain information and instructions with respect to the surrender and exchange of such certificates. COVENANT STOCKHOLDERS SHOULD NOT SEND IN THEIR CERTIFICATES UNTIL THEY RECEIVE THE LETTER OF TRANSMITTAL FORM AND INSTRUCTIONS. Upon surrender of all of the certificates for Covenant Common Stock and Covenant Preferred Stock registered in the name of a holder of such certificates (or indemnity satisfactory to FUNC and the exchange agent selected by FUNC if any of such certificates are lost, stolen or destroyed), together with a properly completed letter of transmittal, such exchange agent will mail to such holder a certificate or certificates representing the number of FUNC Common Shares to which such holder is entitled, together with all undelivered dividends or distributions in respect of such shares and, where applicable, a check for any fractional share interest (in each case, without interest). All FUNC Common Shares issued to the holders of Covenant Common Stock and Covenant Preferred Stock pursuant to the Corporate Merger will be deemed issued as of the Effective Date. After the Effective Date, former holders of record of Covenant Common Stock and Covenant Preferred Stock will be entitled to vote at any meeting of holders of FUNC Common Stock the number of FUNC Common Shares into which their shares of Covenant Common Stock and Covenant Preferred Stock have been converted, regardless of whether they have surrendered their Covenant Common Stock and Covenant Preferred Stock certificates. FUNC dividends having a record date on or after the Effective Date will include dividends on all FUNC Common Shares issued in the Corporate Merger, but no dividend or other distribution payable to the holders of record of FUNC Common Shares at or as of any time after the Effective Date will be distributed to the holder of any Covenant Common Stock and Covenant Preferred Stock certificates until such holder physically surrenders all such certificates as described above. Promptly after such surrender, all undelivered dividends and other distributions and, where applicable, a check for any fractional share interest, will be delivered to such holder, in each case, without interest. FUNC dividends having a record date before the Effective Date (which record date may, in FUNC's sole discretion, be the day immediately preceding the Effective Date or any other day prior to the Effective Date) will not include dividends on the FUNC Common Shares issued in the Corporate Merger. After the Effective Date, the stock transfer books of Covenant will be closed, and there will be no transfers on the transfer books of Covenant of the shares of Covenant Common Stock and Covenant Preferred Stock that were outstanding immediately prior to the Effective Date. 22 In accordance with the terms of the Covenant Series A Preferred Stock and assuming the Corporate Merger has not been consummated, each outstanding share of Covenant Series A Preferred Stock will automatically be converted into 3.976 shares of Covenant Common Stock on December 31, 1997 (the "Automatic Conversion"), after which holders thereof will not be entitled to any further dividends on such Covenant Series A Preferred Stock, except for any such dividends declared but unpaid prior to such date. As indicated above, holders of record on December 31, 1997 of Covenant Series A Preferred Stock are expected to be paid a dividend on January 14, 1998 notwithstanding the Automatic Conversion. See " -- Effective Date" and " -- Dividends". Pursuant to the terms of the Covenant Series A Preferred Stock, Covenant is to deliver to the holders of Covenant Series A Preferred Stock certificates representing the applicable number of full shares of Covenant Common Stock entitled to be received by such holders as a result of the Automatic Conversion within 30 business days after such Automatic Conversion. As a result of the pending Mergers, however, it is not expected that Covenant will deliver such certificates to such holders. Instead, following the Effective Date and upon surrender of all of their certificates for Covenant Series A Preferred Stock, holders of Covenant Series A Preferred Stock will be entitled to receive 1.516 FUNC Common Shares (I.E., the Series A Exchange Ratio), and a check for any fractional share interest as discussed above. The Merger Agreement provides that Covenant will cause each person who may be deemed to be an "affiliate" (as defined in the Securities Act) to execute an agreement restricting the disposition of such affiliate's shares of Covenant Common Stock and Covenant Preferred Stock. The Merger Agreement further provides that although shares of Covenant Common Stock and Covenant Preferred Stock held by an affiliate of Covenant will automatically be converted into FUNC Common Shares upon consummation, such shares will not be physically exchanged for FUNC Common Shares until FUNC receives such an agreement. BACKGROUND AND REASONS COVENANT BACKGROUND OF THE MERGERS. From time to time, Covenant received from representatives of other bank holding companies preliminary expressions of interest in the possibility of engaging in a business combination with Covenant should Covenant be willing to consider such a transaction. Through 1996, Covenant responded to such expressions of interest by affirming its strategy of seeking to create value as an independent institution. Covenant continued to receive expressions of interest from various bank holding companies in 1997. In early April 1997, Mr. Charles E. Sessa, Jr., the President and a director of Covenant, met with representatives of Berwind Financial to discuss an expression of interest that had been presented to Covenant through Berwind Financial and to establish a process with Berwind Financial for evaluating such expression of interest, exploring other possible transactions, and assessing whether it might be in the best interests of Covenant to engage in a combination with another institution. Mr. Sessa reported on these meetings with Berwind Financial to the Covenant Board at its April meeting, and the Covenant Board authorized Mr. Sessa and Mr. Richard A. Hocker, the Chairman and Chief Executive Officer of Covenant, to continue to work with Berwind Financial, which was retained by Covenant as its financial advisor (such engagement was subsequently confirmed in writing on July 14, 1997), to explore and evaluate possible transactions. Working with Berwind Financial, Messrs. Hocker and Sessa identified institutions (including FUNC) that might be interested in a combination with Covenant, and through Berwind Financial such institutions were contacted in April, May and June 1997, regarding their possible interest in such a transaction. The institutions which were interested in considering a possible combination with Covenant and which signed confidentiality agreements were given general information about Covenant. Mr. Sessa advised the Covenant Board of the continuing process to evaluate the possibility of a combination at the May meeting of the Covenant Board, and the Covenant Board approved the continuation of such process. In response to the solicitation of interest by Covenant through Berwind Financial, five institutions (including FUNC) provided preliminary indications of interest in a possible combination with Covenant, including preliminary indications of possible pricing and transaction structure. Messrs. Hocker and Sessa met with Berwind Financial and Covenant's legal counsel on July 11, 1997, to review and evaluate the indications of interest. At a July 14, 1997 special meeting of the Covenant Board, Messrs. Hocker and Sessa and Berwind Financial reported to the Covenant Board on the five interested parties and the expressions of interest that had been received. Legal counsel discussed fiduciary duty matters, and Berwind Financial presented information relating to the five interested parties and the financial terms of the proposed transactions, as well as financial information regarding comparable transactions in the Mid-Atlantic region and nationally. The Covenant Board and Berwind Financial discussed generally the subject of remaining independent versus being acquired by another institution. The Covenant Board authorized Messrs. Hocker and Sessa, working with Berwind Financial and legal counsel, to continue with the process of assessing the possibility of a combination. 23 Arrangements were then made for the institutions that had presented indications of interest in a range potentially acceptable to Covenant, and that remained interested in pursuing a possible combination, to conduct further due diligence, and revised expressions of interest were requested. Three parties, including FUNC, conducted additional due diligence during the week of July 21, 1997, and delivered revised expressions of interest. On July 30, 1997, Messrs. Hocker and Sessa met with Berwind Financial and legal counsel to review the most recent expressions of interest. A special meeting of the Covenant Board was held on July 31, 1997, at which meeting the events since the prior meeting, and the most recent expressions of interest, were reviewed. Counsel to Covenant, as well as Covenant's financial advisor, Berwind Financial, were present. Berwind Financial presented its review of the three possible transactions, and the Covenant Board and Berwind Financial discussed the alternatives of being acquired or continuing as an independent institution. The Covenant Board determined at this meeting that it was in the best interests of Covenant, its stockholders and other constituencies to enter into a combination, and that the proposal presented by FUNC, which had the highest value on such date, was the most favorable of the three proposals that had been received. The Covenant Board directed Messrs. Sessa and Hocker, with the advice and counsel of Covenant's attorneys and financial advisor, to seek to negotiate a definitive agreement with FUNC for review and consideration by the Covenant Board. Following the July 31, 1997 meeting, discussions were held with FUNC's management and legal advisors and a definitive merger agreement was negotiated. At a special meeting of the Covenant Board held on August 4, 1997, with legal counsel and Berwind Financial present, the Merger Agreement and the transactions contemplated thereby were reviewed by the Covenant Board. Berwind Financial reviewed the financial terms of the transaction and presented its opinion that the transaction was fair to Covenant's stockholders from a financial point of view. See " -- Opinion of Financial Advisor". Legal counsel reviewed the terms of the Merger Agreement with the Covenant Board, and after discussion, the Merger Agreement and the transactions contemplated thereby were approved by the Covenant Board. The Merger Agreement was entered into on August 4, 1997, after completion of the Covenant Board meeting. RECOMMENDATION OF THE COVENANT BOARD AND REASONS FOR THE MERGERS. The Covenant Board believes that a combination with FUNC will enable holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock to realize significant value for their shares, and will also enable Covenant's stockholders to acquire shares on a tax-free basis in a larger institution which the Covenant Board believes is better positioned to compete in a consolidating financial services industry. For these reasons, and as further discussed below, the Covenant Board believes that the Mergers are in the best interests of Covenant's stockholders. In reaching its determination to approve the Merger Agreement and the transactions contemplated thereby, the Covenant Board considered the advice and counsel of management and Covenant's outside legal and financial advisors, and based its decision on a number of factors, including, without limitation, the following: (i) The Covenant Board considered the terms of the Merger Agreement and the transactions contemplated thereby, and took into account the historical trading ranges of Covenant Common Stock, Covenant Series A Preferred Stock, Covenant Series B Preferred Stock and FUNC Common Stock, and the consideration to be received by Covenant's stockholders in the Corporate Merger. The Covenant Board also considered the expected increase in dividends to Covenant's stockholders following the Corporate Merger. (ii) The Covenant Board considered that the Mergers are expected to be tax-free to stockholders of Covenant (other than with respect to cash paid in lieu of fractional shares). (iii) The Covenant Board reviewed the detailed financial analysis, pro forma results and other information presented by its financial advisor, Berwind Financial, and considered the opinion of Berwind Financial (including the assumptions and financial information and projections relied upon by it in arriving at such opinion) that the consideration to be received by Covenant's stockholders in the Corporate Merger was fair to such stockholders. For a discussion of the opinion of Berwind Financial, including a summary of the procedures followed, the matters considered, the scope of the review undertaken and the assumptions made with respect thereto, see " -- Opinion of Financial Advisor" and ANNEX C attached hereto. (iv) In considering the terms of the Merger Agreement, the Covenant Board considered that FUNC would be entitled to the Termination Fee if the Merger Agreement were terminated in certain circumstances, and that the existence of such Termination Fee and certain other provisions in the Merger Agreement might discourage third parties from seeking to acquire 24 Covenant. The Covenant Board considered, with respect thereto, that FUNC was unwilling to enter into the Merger Agreement with Covenant absent such provisions and the fact that such Termination Fee was being provided in order to increase the likelihood that the transactions would be completed. (v) The Covenant Board took into account the current and prospective economic environment facing the financial services industry generally, and Covenant in particular, and considered the ability of larger institutions to invest in technology, leverage fixed costs over larger markets, and provide a greater variety of products and services. The Covenant Board perceived that there were limited opportunities for Covenant to grow through acquisition of other institutions. The Covenant Board considered opportunities for its employees that would likely arise from a combination with a larger institution such as FUNC, as well as the possible negative impact the Mergers would have on Covenant employees, including possible job loss. The Covenant Board perceived that the combined institution would be more likely than Covenant alone to possess the financial resources to compete in the areas of business in which Covenant was engaged, and therefore the combination would have long-term benefits for Covenant's stockholders, employees, customers and communities. (vi) The Covenant Board perceived that FUNC had a customer-oriented culture that was consistent with the vision and goals of Covenant and provided a strong basis for integration of Covenant's operations and future performance in a highly-competitive environment. (vii) The Covenant Board considered that Mr. Sessa and, subject to FUNC approval, Mr. Hocker and Mr. John J. Gallagher, Jr., the Vice Chairman of Covenant, would be appointed to an advisory board of FUNB, and perceived that this would facilitate a successful combination. See " -- Interests of Certain Persons". (viii) The Covenant Board considered that consummation of the Mergers would constitute a "Change in Control" under the Termination Agreements that Covenant had previously entered into with the Covenant Officers with the approval of the Covenant Board, such that such officers would be entitled to certain severance payments in the event that their employment were terminated within two years following the Mergers. See " -- Interests of Certain Persons". (ix) In considering all of the foregoing factors, the Covenant Board considered the alternatives of Covenant continuing as an independent institution or combining with other potential merger partners, compared to the effect of Covenant combining with FUNC pursuant to the Merger Agreement, and determined that the combination with FUNC presented the best opportunity for maximizing stockholder value and achieving Covenant's other strategic goals. In reaching their determination to approve the Merger Agreement and the transactions contemplated thereby, individual directors may have given differing weights to different factors and may have viewed certain factors more positively or negatively than others. In addition, there can be no assurances that the benefits of the Mergers perceived by the Covenant Board and described above will be realized. FOR THE REASONS DESCRIBED ABOVE, THE COVENANT BOARD UNANIMOUSLY APPROVED THE MERGER AGREEMENT AND BELIEVES THAT THE MERGERS ARE FAIR TO, AND IN THE BEST INTERESTS OF, THE HOLDERS OF COVENANT COMMON STOCK, COVENANT SERIES A PREFERRED STOCK AND COVENANT SERIES B PREFERRED STOCK. ACCORDINGLY, THE COVENANT BOARD UNANIMOUSLY RECOMMENDS THAT HOLDERS OF COVENANT COMMON STOCK, COVENANT SERIES A PREFERRED STOCK AND COVENANT SERIES B PREFERRED STOCK VOTE "FOR" APPROVAL OF THE MERGER AGREEMENT. FUNC FUNC believes that it is advantageous to build a multi-state banking organization. The economies of banking favor such an organization as a way of gaining efficiency and spreading costs over a large base, as well as providing diversification. To further its objective to build a multi-state banking organization, FUNC has concentrated its efforts on what it perceives to be some of the better banking markets in the eastern region of the United States and on advantageous ways of entering or expanding its presence in those markets. FUNC believes that joining with Covenant is an excellent way to expand FUNC's presence in the southern portion of New Jersey. FUNC is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities can be expected. Acquisitions typically involve the payment of a premium over book and market values, and therefore, some dilution of FUNC's book value and net income per common share may occur in connection with any future transactions. See "FUNC -- History and Business". 25 OPINION OF FINANCIAL ADVISOR Covenant retained Berwind Financial to act as its financial advisor and to render a fairness opinion in connection with the Corporate Merger. Berwind Financial rendered its opinion (the "Covenant Fairness Opinion") to the Covenant Board that, based upon and subject to the various considerations set forth therein, as of August 4, 1997, the consideration to be received in the Corporate Merger is fair, from a financial point of view, to Covenant stockholders. The full text of the Covenant Fairness Opinion, which sets forth the assumptions made, matters considered and limitations of the review undertaken, is attached as ANNEX C to this Prospectus/Proxy Statement, is incorporated herein by reference, and should be read in its entirety in connection with this Prospectus/Proxy Statement. The summary of the Covenant Fairness Opinion set forth herein is qualified in its entirety by reference to the full text of the Covenant Fairness Opinion. Berwind Financial has knowledge of, and experience with, New Jersey and surrounding banking markets as well as banking organizations operating in those markets and was selected by Covenant because of its knowledge of, experience with, and reputation in the financial services industry. Berwind Financial, as part of its investment banking business, is engaged regularly in the valuation of assets, securities and companies in connection with various types of asset and securities transactions, including mergers, acquisitions, private placements, and valuations for various other purposes and in the determination of adequate consideration in such transactions. In rendering the Covenant Fairness Opinion, Berwind Financial (i) reviewed the historical financial performances, current financial positions and general prospects of Covenant and FUNC; (ii) reviewed the Merger Agreement; (iii) reviewed and analyzed the stock market performance of Covenant and FUNC; (iv) studied and analyzed the consolidated financial and operating data of Covenant and FUNC; (v) considered the terms and conditions of the Merger Agreeement as compared with the terms and conditions of comparable bank and bank holding company mergers and acquisitions; (vi) met and/or communicated with certain members of Covenant's and FUNC's senior management to discuss their respective operations, historical financial statements and future prospects; and (vii) conducted such other financial analyses, studies and investigations as Berwind Financial deemed appropriate. No limitations were imposed by the Covenant Board upon Berwind Financial with respect to the investigations made or procedures followed by Berwind Financial in rendering the Covenant Fairness Opinion. In delivering the Covenant Fairness Opinion, Berwind Financial assumed that in the course of obtaining the necessary regulatory and governmental approvals for the Mergers, no restriction will be imposed on FUNC or Covenant that would have a material adverse effect on the contemplated benefits of the Mergers. Berwind Financial also assumed that there will not occur any change in applicable law or regulation that would cause a material adverse change in the future prospects or operations of FUNC. Berwind Financial relied without independent verification upon the accuracy and completeness of all of the financial and other information reviewed by and discussed with it for purposes of the Covenant Fairness Opinion. With respect to Covenant's financial forecasts reviewed by Berwind Financial in rendering the Covenant Fairness Opinion, Berwind Financial assumed that such financial forecasts were reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Covenant as to the future financial performance of Covenant. Berwind Financial did not make an independent evaluation or appraisal of the assets (including loans) or liabilities of Covenant or FUNC nor was it furnished with any such appraisal. Berwind Financial also did not independently verify and has relied on and assumed that all allowances for loan and lease losses set forth in the balance sheets of Covenant and FUNC were adequate and complied fully with applicable law, regulatory policy and sound banking practice as of the dates of such financial statements. The following is a summary of selected analyses prepared and analyzed by Berwind Financial and presented to the Covenant Board in connection with the Covenant Fairness Opinion. COMPARABLE COMPANIES AND COMPARABLE ACQUISITION TRANSACTION ANALYSES. Berwind Financial compared selected financial and operating data for Covenant with those of a peer group of selected banks and bank holding companies, headquartered in New Jersey, with assets between $250 million and $750 million, as of the most recent period publicly available. Such companies included: Broad National Bancorp, Carnegie Bancorp, Center Bancorp, Inc., Greater Community Bancorp, High Point Financial Corp., Interchange Financial Services, Prestige Financial Corp., Ramapo Financial Corp., Sun Bancorp Inc., Vista Bancorp, Inc., and Yardville National Bancorp. Financial data and operating ratios compared in the analysis of the Covenant peer group included but were not limited to: return on average assets, return on average stockholders' equity, stockholders' equity to assets ratios, and certain asset quality ratios. The analysis showed Covenant's return on average assets was .85 percent compared to the peer group median of 1.02 percent, its return on average stockholders' equity was 14.29 26 percent compared to the peer group median of 12.65 percent, its stockholders' equity to assets ratio was 6.80 percent compared to the peer group median of 7.20 percent, and its nonperforming assets to total assets ratio was .49 percent compared to the peer group median of .83 percent. Berwind Financial also compared selected financial, operating and stock market data for FUNC with those of a peer group of selected bank holding companies with assets between $75 billion and $275 billion, as of the most recent period publicly available. Such companies included: BankAmerica Corporation, Wells Fargo & Company, First Chicago NBD Corporation, Fleet Financial Group, Inc. Norwest Corporation, NationsBank Corporation, J.P. Morgan & Co., Bankers Trust New York Corporation, and Banc One Corporation. Financial, operating and stock market data, ratios and multiples compared in the analysis of the FUNC peer group included but were not limited to: return on average assets, return on average stockholders' equity, stockholders' equity to assets ratios, certain asset quality ratios, price to book value, price to tangible book value, price to earnings (latest 12 months) and dividend yield. The analysis showed FUNC's return on average assets was 1.39 percent compared to the peer group median of 1.25 percent, its return on average stockholders' equity was 19.85 percent compared to the peer group median of 15.20 percent, its stockholders' equity to assets ratio was 7.00 percent compared to the peer group median of 7.90 percent, and its nonperforming assets to total assets ratio was .50 percent compared to the peer group median of .42 percent. The analysis also indicated that the per share price of FUNC Common Stock of $49.5625 as of August 1, 1997, as a percentage of book value and tangible book value per share was 278.6 percent and 385.4 percent, respectively, compared to the peer group medians of 275.0 percent and 385.5 percent, respectively, and such per share price of FUNC Common Stock as a multiple of latest 12 months' earnings was 15.6x compared to a peer group median of 17.2x, and its dividend yield was 2.58 percent compared to a peer group median of 2.12 percent. Berwind Financial also compared the multiples of book value, and latest 12 months' earnings inherent in the Corporate Merger with the multiples paid in recent acquisitions of banks and bank holding companies that Berwind Financial deemed comparable. The transactions deemed comparable by Berwind Financial included both interstate and intrastate acquisitions announced from January 1, 1996 to the date of the Covenant Fairness Opinion, in which the selling institution's assets were between $200 million and $600 million as of the most recent period publicly available. Berwind Financial compared transactions located throughout the country and analyzed the transactions in four groups: a national group (60 transactions), a regional group (seven transactions), a performance group (14 transactions) and a 1997 national group (16 transactions). The median values calculated for the purchase price as a percentage of book value for the national, regional, performance and 1997 national groups were 207.6 percent, 222.5 percent, 220.1 percent and 215.9 percent, respectively. The median values calculated for the purchase price as a multiple of the latest 12 months' earnings per share for the national, regional, performance and 1997 national groups were 16.9x, 17.7x, 15.9x and 16.6x, respectively. These medians compare to the FUNC/Covenant purchase price as a percentage of book value of 251.9 percent and purchase price as a multiple of latest 12 months' earnings per share of 41.0x (23.6x excluding SAIF assessment charges and certain one-time merger-related expenses). No company or transaction, however, used in this analysis is identical to Covenant, FUNC or the Corporate Merger. Accordingly, an analysis of the results of the foregoing is not mathematical; rather, it involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that would affect the public trading values of the companies or company to which they are being compared. DISCOUNTED DIVIDEND ANALYSES. Using discounted dividend analyses, Berwind Financial estimated the present value of Covenant Common Stock after a five-year period by applying a range of earnings multiples to Covenant's terminal year earnings under various growth assumptions. The range of multiples used reflected a variety of scenarios regarding the growth and profitability prospects of Covenant. The terminal values were then discounted to present value using discount rates, reflecting different assumptions regarding the rates of return required by holders or prospective buyers of Covenant Common Stock. The discounted dividend analysis indicated a range of values of $8.12 to $18.81 per share. PRO FORMA CONTRIBUTION ANALYSIS. Berwind Financial analyzed the changes in the amount of earnings, book value and dividends represented by one share of Covenant Common Stock and Covenant Preferred Stock as of June 30, 1997, and the number of FUNC Common Shares to be received in the Corporate Merger resulting from the Common Stock Exchange Ratio and, with respect to the Covenant Preferred Stock, the Series A Exchange Ratio and the Series B Exchange Ratio. The analysis considered, among other things, the changes that the Corporate Merger would cause to Covenant's 1997 estimated earnings per share (based on management estimates, with respect to Covenant earnings, and consensus estimates, with respect to FUNC earnings), book value per share and indicated dividends. On a Covenant Common Stock per share basis, Covenant's 1997 estimated earnings per share would increase from $.85 to $1.33, pro forma book value per share would decrease from $7.49 to $6.78, and indicated dividends per share would increase from zero to $.49. 27 In connection with rendering the Covenant Fairness Opinion, Berwind Financial performed a variety of financial analyses. Although the evaluation of the fairness, from a financial point of view, of the consideration to be paid in the Corporate Merger was to some extent a subjective one based on the experience and judgment of Berwind Financial and not merely the result of mathematical analysis of financial data, Berwind Financial principally relied on the previously discussed financial valuation methodologies in its determinations. Berwind Financial believes its analyses must be considered as a whole and that selecting portions of such analyses and factors considered by Berwind Financial without considering all such analyses and factors could create an incomplete view of the process underlying the Covenant Fairness Opinion. In its analysis, Berwind Financial made numerous assumptions with respect to business, market, monetary and economic conditions, industry performance and other matters, many of which are beyond Covenant's and FUNC's control. Any estimates contained in Berwind Financial's analyses are not necessarily indicative of future results or values, which may be significantly more or less favorable than such estimates. In reaching its opinion as to fairness, none of the analyses performed by Berwind Financial was assigned a greater or lesser weighting by Berwind Financial than any other analysis. As a result of its consideration of the aggregate of all factors present and analyses performed, Berwind Financial reached the conclusion, and opined, that the consideration to be received in the Corporate Merger as set forth in the Merger Agreement, is fair, from a financial point of view, to Covenant stockholders. The Covenant Fairness Opinion was based solely upon the information available to Berwind Financial and the economic, market and other circumstances as they existed as of the date the Covenant Fairness Opinion was delivered; events occurring after the date of the Covenant Fairness Opinion could materially affect the assumptions used in preparing the Covenant Fairness Opinion. Berwind Financial has not undertaken to reaffirm and revise the Covenant Fairness Opinion or otherwise comment upon any events occurring after the date thereof. Pursuant to the terms of the engagement letter dated July 14, 1997, Covenant has paid Berwind Financial $75,000 for acting as financial advisor in connection with the Mergers, including delivering the Covenant Fairness Opinion. In addition, Covenant has also agreed to pay Berwind Financial a fee based on a formula relating to the transaction value of the Corporate Merger as of August 5, 1997, which fee is approximately $782,500 and is payable upon consummation of the Corporate Merger. Whether or not the Corporate Merger is consummated, Covenant has also agreed to reimburse Berwind Financial for its reasonable out-of-pocket expenses incurred in connection with its advisory work, and to indemnify Berwind Financial and certain related persons against certain liabilities relating to or arising out of its engagement. The full text of the Covenant Fairness Opinion, which sets forth assumptions made and matters considered, is attached hereto as ANNEX C. Covenant stockholders are urged to read the Covenant Fairness Opinion in its entirety. The Covenant Fairness Opinion is directed only to the consideration to be received by Covenant's stockholders in the Corporate Merger and does not constitute a recommendation to any Covenant stockholder as to how such holder should vote at the Special Meeting. THE FOREGOING PROVIDES ONLY A SUMMARY OF THE COVENANT FAIRNESS OPINION OF BERWIND FINANCIAL AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF SUCH OPINION, WHICH IS SET FORTH IN ANNEX C TO THIS PROSPECTUS/PROXY STATEMENT. INTERESTS OF CERTAIN PERSONS GENERAL Certain members of Covenant's management and the Covenant Board have interests in the Mergers that are in addition to any interests they have as stockholders of Covenant generally. The material interests include provisions in the Merger Agreement relating to the indemnification of Covenant's directors and officers, directors' and officers' liability insurance, and certain other benefits, as described below. TERMINATION AGREEMENTS AND OPTION PLANS On November 22, 1995, Covenant Bank entered into the Termination Agreements with its senior executive officers -- Messrs. Hocker, Sessa, Parker, D'Orazio and Mancini (I.E., the "Covenant Officers"), and amended such Termination Agreements on June 10, 1997. Such Termination Agreements were assumed by Covenant, as amended, in connection with its formation as a holding company for Covenant Bank on June 13, 1997. Pursuant to the Merger Agreement, FUNC has agreed to assume Covenant's obligations under the Termination Agreements. Pursuant to the Termination Agreements with respect to Messrs. Hocker and Sessa, (i) if termination of employment occurs within two years following a "Change in Control" (which term includes consummation of the Corporate Merger), such officers will be entitled to the payments and benefits set 28 forth below (the "Termination Payments"), unless such termination of employment is because of such officer's death, and (ii) even if a Change in Control has not occurred within two years prior to the date of termination of employment, such officers will be entitled to the Termination Payments unless such termination of employment is (a) because of such officer's death, (b) by the employer for "Cause", or (c) by such officer for other than "Good Reason". Messrs. Hocker and Sessa also are directors of Covenant. Pursuant to the Termination Agreements with respect to the Covenant Officers other than Messrs. Hocker and Sessa, such officers will be entitled to the Termination Payments if termination of employment occurs within two years following a Change in Control, unless such termination is because of any of the reasons set forth in clauses (a), (b) or (c) above. The Termination Payments that the Covenant Officers would be entitled to receive pursuant to the Termination Agreements would generally be as follows: (i) such officer's full base salary, as in effect at the time notice of termination is provided, through the date of termination, plus all other amounts to which such officer is entitled under any of Covenant's compensation plans at the time such payments are due; (ii) a lump sum severance payment equal to three times (in the case of Messrs. Hocker and Sessa) or one times (in the case of Messrs. Parker, D'Orazio and Mancini) the annual rate of base salary; and (iii) continued uninterrupted health care coverage to the Covenant Officers substantially comparable to, and no less beneficial than, that in effect at the time notice of termination is provided, for a period of two years (in the case of Messrs. Hocker and Sessa) or one year (in the case of Messrs. Parker, D'Orazio and Mancini) following the date of termination. In addition, the Termination Agreements with respect to Messrs. Hocker and Sessa provide for gross-up payments to be made to such officers, if necessary, to eliminate the effects of the imposition of the excise tax under Section 4999 of the Code on payments made to such officers and the imposition of income and excise taxes on such gross-up payments. Assuming the Corporate Merger were to occur on January 1, 1998, and the Covenant Officers were terminated immediately thereafter, based on the Covenant Officers' current base salaries and the estimated cost of health care coverage required under the Termination Agreements, the Termination Payments payable to the Covenant Officers are currently estimated to be approximately equal to the following: Mr. Hocker $696,445; Mr. Sessa $854,798; Mr. Parker $98,637; Mr. D'Orazio $96,637; and Mr. Mancini $129,137. Pursuant to the Merger Agreement, it is expected that regular annual salary increases (not exceeding an aggregate of $100,000 for the Covenant Officers) will be given effect prior to consummation of the Corporate Merger, which would result in an increase in the foregoing payments. In addition, pursuant to the Termination Agreements, the terms of Covenant's Incentive Stock Option Plan and 1996 Stock Option Plan for Employees and Non-Employee Directors (the "Covenant Option Plans"), and the individual stock option agreements thereunder, upon consummation of the Corporate Merger, all outstanding options to purchase shares of Covenant Common Stock (the "Covenant Options") will become immediately exercisable. Pursuant to the Merger Agreement, upon consummation of the Corporate Merger, FUNC has agreed to assume all outstanding Covenant Options granted pursuant to the Covenant Option Plans. The number of shares covered by each Covenant Option would be equal to the number of shares of Covenant Common Stock covered thereby multiplied by the Common Stock Exchange Ratio and rounded down to the nearest whole share, and the Covenant Option exercise price would be adjusted by dividing such price by the Common Stock Exchange Ratio and rounding to the nearest cent. The following table sets forth the following information with respect to each of the Covenant Officers, the Covenant Officers as a group and the non-employee directors of Covenant as a group (the "Non-Employee Directors"): (i) the number of shares of Covenant Common Stock covered by Covenant Options held by such persons as of the Record Date; (ii) the number of shares of Covenant Common Stock covered by such Covenant Options that are exercisable as of the Record Date; (iii) the number of shares of Covenant Common Stock covered by such Covenant Options that will be exercisable upon consummation of the Corporate Merger; (iv) the weighted average exercise price for such exercisable Covenant Options; and (v) the aggregate value of such exercisable Covenant Options based upon the Common Stock Exchange Ratio and $52.875 (the closing sale price of FUNC Common Stock on the Record Date), less the applicable Covenant Option exercise price.
COVENANT OPTIONS WEIGHTED AVERAGE COVENANT OPTIONS EXERCISABLE UPON EXERCISE PRICE PER AGGREGATE VALUE COVENANT OPTIONS CURRENTLY CONSUMMATION OF THE EXERCISABLE COVENANT OF EXERCISABLE HELD EXERCISABLE CORPORATE MERGER OPTION COVENANT OPTIONS Mr. Hocker...................... 158,612 147,588 158,612 $ 8.20 $1,897,172 Mr. Sessa....................... 73,775 64,387 73,775 9.13 813,818 Mr. Parker...................... 19,768 17,012 19,768 9.39 212,911 Mr D'Orazio..................... 12,833 10,627 12,833 9.83 132,575 Mr. Mancini..................... 36,222 32,732 36,222 8.78 412,238 Covenant Officers............... 301,210 272,546 301,210 8.65 3,468,714 Non-Employee Directors.......... 41,340 24,798 41,340 $12.63 $ 311,343
29 CERTAIN CASH-BASED INCENTIVE As permitted by the Merger Agreement, Covenant has established a $530,000 retention bonus pool for employees of Covenant (other than Messrs. Hocker and Sessa) to be administered as mutually agreed upon by Covenant and FUNC. In addition, the Merger Agreement provides that regular performance-based bonuses for 1997 may be paid prior to consummation of the Corporate Merger. INDEMNIFICATION; DIRECTORS' AND OFFICERS' INSURANCE The Merger Agreement provides that for the six-year period following the Effective Date, FUNC will indemnify the directors, officers and employees of Covenant holding such positions on or prior to the date of the Merger Agreement, against certain liabilities to the extent such persons were indemnified under the NJBCA, the Covenant Certificate and the Covenant Bylaws, as in effect on the date of the Merger Agreement. In addition, FUNC agreed in the Merger Agreement to use its reasonable best efforts to maintain Covenant's existing directors' and officers' liability insurance policy for persons who were covered by such insurance maintained by Covenant on the date of the Merger Agreement for a period of three years after the Effective Date at an annual cost not to exceed 150 percent of Covenant's annual premium payment on Covenant's current policy. CERTAIN OTHER MATTERS RELATING TO THE MERGERS In connection with the execution of the Merger Agreement, FUNC has agreed to cause Mr. Sessa and, subject to FUNC approval, Messrs. Hocker and Gallagher, to be appointed to an advisory board following consummation of the Mergers, which advises FUNB on its activities in the south New Jersey area. The directors of Covenant who serve on the advisory board will receive $500 for each meeting they attend. Currently, Messrs. Hocker, Sessa and Gallagher receive no additional compensation for their services as directors of Covenant. All other employee-directors receive an annual retainer of $5,400, and all non-employee directors receive an annual retainer of $8,400 for their services as directors of Covenant. Barry M. Abelson, a director of Covenant, is a partner in the law firm of Pepper, Hamilton & Scheetz LLP, which has acted as counsel to Covenant in connection with the Mergers. CERTAIN FEDERAL INCOME TAX CONSEQUENCES THE FOLLOWING IS A DISCUSSION OF ALL MATERIAL FEDERAL INCOME TAX CONSEQUENCES OF THE CORPORATE MERGER. THE DISCUSSION IS INCLUDED FOR GENERAL INFORMATION PURPOSES ONLY AND MAY NOT APPLY TO SPECIAL SITUATIONS, SUCH AS COVENANT STOCKHOLDERS, IF ANY, WHO RECEIVED THEIR COVENANT COMMON STOCK UPON THE EXERCISE OF EMPLOYEE STOCK OPTIONS OR OTHERWISE AS COMPENSATION, THAT HOLD THEIR COVENANT COMMON STOCK AND/OR COVENANT PREFERRED STOCK AS PART OF A "STRADDLE" OR "CONVERSION TRANSACTION", OR THAT ARE INSURANCE COMPANIES, SECURITIES DEALERS, FINANCIAL INSTITUTIONS OR FOREIGN PERSONS. Sullivan & Cromwell, special counsel for FUNC, has advised FUNC and Covenant, that, in its opinion the Corporate Merger will constitute a reorganization under Section 368 of the Code and: (i) No gain or loss will be recognized for federal income tax purposes by Covenant stockholders upon the exchange in the Corporate Merger of shares of Covenant Common Stock and/or Covenant Preferred Stock solely for FUNC Common Shares (except with respect to cash received in lieu of a fractional share interest in FUNC Common Stock). (ii) The basis of FUNC Common Shares received in the Corporate Merger by Covenant stockholders (including the basis of any fractional share interest in FUNC Common Stock) will be the same as the basis of the shares of Covenant Common Stock and/or Covenant Preferred Stock surrendered in exchange therefor. (iii) The holding period of the FUNC Common Shares received in the Corporate Merger by a Covenant stockholder (including the holding period of any fractional share interest in FUNC Common Stock) will include the holding period during which the shares of Covenant Common Stock and/or Covenant Preferred Stock surrendered in exchange therefor were held by the Covenant stockholder, provided such shares of Covenant Common Stock and/or Covenant Preferred Stock were held as capital assets. (iv) Cash received by a holder of Covenant Common Stock and/or Covenant Preferred Stock in lieu of a fractional share interest in FUNC Common Stock will be treated as received for such fractional share interest and, provided the fractional share would have constituted a capital asset in the hands of such holder, the holder should in general recognize capital gain or loss in an amount equal to the difference between the amount of cash received and the portion of the 30 adjusted tax basis in the Covenant Common Stock and/or Covenant Preferred Stock allocable to the fractional share interest. In addition, consummation of the Mergers is conditioned, among other things, upon receipt by FUNC and Covenant of an opinion of Sullivan & Cromwell dated as of the Effective Date, that (i) the Corporate Merger constitutes a reorganization under Section 368 of the Code, and (ii) no gain or loss will be recognized by Covenant stockholders who receive FUNC Common Shares solely in exchange for their shares of Covenant Common Stock and/or Covenant Preferred Stock, except that gain or loss may be recognized as to cash received in lieu of fractional share interests. FUNC and Covenant do not currently intend to waive the receipt of such tax opinion; however, if such tax opinion were waived and the material federal income tax consequences of the Corporate Merger were materially different from those summarized above, Covenant would resolicit its stockholders prior to consummating the Corporate Merger. The tax opinion of Sullivan & Cromwell summarized above is or will be based, among other things, on representations relating to certain facts and circumstances of, and the intentions of the parties to, the Corporate Merger. BECAUSE CERTAIN TAX CONSEQUENCES OF THE CORPORATE MERGER MAY VARY DEPENDING UPON THE PARTICULAR CIRCUMSTANCES OF EACH COVENANT STOCKHOLDER AND OTHER FACTORS, EACH COVENANT STOCKHOLDER IS URGED TO CONSULT SUCH HOLDER'S OWN TAX ADVISOR TO DETERMINE THE PARTICULAR TAX CONSEQUENCES TO SUCH HOLDER OF THE CORPORATE MERGER (INCLUDING THE APPLICATION AND EFFECT OF STATE AND LOCAL INCOME AND OTHER TAX LAWS). BUSINESS PENDING CONSUMMATION Covenant agreed in the Merger Agreement to conduct its business in the ordinary and usual course consistent with past practice and to refrain from taking certain actions relating to its operation pending consummation of the Mergers, without the prior written consent of FUNC, except as otherwise permitted in the Merger Agreement. These actions include, without limitation: (i) paying any dividends, other than dividends on Covenant Preferred Stock at a quarterly rate not to exceed the rate provided for in the terms thereof, or redeeming or otherwise acquiring any shares of its capital stock, or issuing any additional shares of its capital stock, or giving any person the right to acquire any such shares; (ii) incurring any indebtedness for borrowed money or becoming liable for the obligations of any other entity other than in the ordinary course of business consistent with past practice; (iii) entering into any employment, consulting, severance or similar agreements or arrangements with any director, officer or employee of Covenant, or granting any salary or wage increase or increasing any employee benefits (including incentive or bonus payments) except for normal individual increases in regular compensation in the ordinary course of business consistent with past practice; (iv) disposing of any material portion of its assets or acquiring any portion of the business or property of any other entity which is material to it; (v) changing its lending, investment, liability management or other material banking policies in any material respect; (vi) settling any claims involving any liability for money damages in an amount greater than $25,000 or restrictions on the operations of Covenant; (vii) entering into, terminating or changing any material agreements, except for those agreements entered into in the ordinary course of business consistent with past practices that are terminable by Covenant without penalty on not more than 60 days' prior written notice. Covenant also agreed in the Merger Agreement to make such modifications or changes to its accounting, loan, litigation and other reserve and real estate valuation policies and practices prior to the Effective Date, as may be mutually agreed upon between FUNC and Covenant. From time to time Covenant and its affiliates engage in transactions with FUNC and its affiliates in the ordinary course of business. It is anticipated that such transactions may increase as a result of the execution of the Merger Agreement. REGULATORY APPROVALS Consummation of the Bank Merger is subject to receipt of the prior approval of the OCC under the Bank Merger Act, 12 U.S.C. (section mark)1828(c) (the "BMA") and the prior approval of the NJ Banking Department under New Jersey law. The BMA requires that the relevant regulatory agency take into consideration, among other factors, the financial and managerial resources and future prospects of the institutions and the convenience and needs of the communities to be served. The BMA prohibits the OCC from approving the Bank Merger (i) if such transaction would result in a monopoly or be in furtherance of any combination or conspiracy to monopolize or to attempt to monopolize the business of banking in any part of the United States, or (ii) if the effect of such transaction in any section of the country may be substantially to lessen competition or to tend to create a monopoly, or if it would in any other manner be a restraint of trade, unless the relevant regulatory agency finds that the anti-competitive effects of such merger are clearly outweighed by the public interest and by the probable effect of the transaction in meeting the convenience and needs of the communities to be served. 31 In addition to receipt of the approvals necessary for consummation of the Bank Merger, consummation of the Corporate Merger also is subject to receipt of the prior approval of the Federal Reserve Board under the BHCA, or a waiver of such requirement in accordance with regulations adopted by the Federal Reserve Board under the BHCA, 12 C.F.R. (section mark)225.12(d). If an application is required under the BHCA, the Federal Reserve Board would consider whether the proposed transaction can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices. In addition, the Federal Reserve Board would be prohibited from approving an application if it finds that the proposed transaction (i) would result in a monopoly or which would be in furtherance of any combination or conspiracy to monopolize or to attempt to monopolize the business of banking in any part of the United States; or (ii) may have the effect in any section of the United States of substantially lessening competition, or tending to create a monopoly, or resulting in a restraint of trade, unless the Federal Reserve Board finds that the anti-competitive effects of the transaction are clearly outweighed by the public interest and by the probable effect of the transaction in meeting the convenience and needs of the communities to be served. Under both statutes, the relevant federal regulatory agency has the authority to deny an application if it concludes that the combined organization would have an inadequate capital position or if the acquiring organization does not meet the requirements of the Community Reinvestment Act of 1977. The Mergers may not be consummated until the 15th day following the dates of each of the requisite approvals, during which period the United States Department of Justice may comment adversely on the transaction (which has the effect of extending the waiting period to the 30th day following approval) or challenge such merger on antitrust grounds. The commencement of an antitrust action would stay the effectiveness of such an approval unless a court specifically orders otherwise. Applications have been filed pursuant to the BMA with the OCC and pursuant to state law with the NJ Banking Department. A request for a waiver pursuant to the BHCA has been filed with the Federal Reserve Board. THE MERGERS WILL NOT PROCEED IN THE ABSENCE OF THE REQUISITE REGULATORY APPROVALS FOR BOTH THE CORPORATE MERGER AND THE BANK MERGER. THERE CAN BE NO ASSURANCE THAT SUCH REGULATORY APPROVALS WILL BE OBTAINED, AND IF THE MERGERS ARE APPROVED, THERE CAN BE NO ASSURANCE AS TO THE DATE OF ANY SUCH APPROVAL. THERE CAN ALSO BE NO ASSURANCE THAT SUCH APPROVALS WILL NOT CONTAIN A CONDITION OR REQUIREMENT WHICH CAUSES SUCH APPROVALS TO FAIL TO SATISFY THE CONDITIONS SET FORTH IN THE MERGER AGREEMENT AND DESCRIBED BELOW UNDER " -- CONDITIONS TO CONSUMMATION; TERMINATION". THERE CAN LIKEWISE BE NO ASSURANCE THAT THE UNITED STATES DEPARTMENT OF JUSTICE OR A STATE ATTORNEY GENERAL WILL NOT CHALLENGE THE CORPORATE MERGER OR THE BANK MERGER, OR IF SUCH A CHALLENGE IS MADE, AS TO THE OUTCOME THEREOF. CONDITIONS TO CONSUMMATION; TERMINATION Consummation of the Mergers is subject, among other things, to: (i) approval of the Merger Agreement by the requisite vote of the stockholders of Covenant; (ii) receipt of the regulatory approvals referred to above without any restrictions or conditions which, in the reasonable opinion of FUNC, would so materially adversely impact the economic or business benefits to FUNC of the transactions contemplated by the Merger Agreement so as to render inadvisable the consummation of the Mergers; (iii) no court or governmental or regulatory authority having taken any action which enjoins or prohibits the Mergers; (iv) receipt by FUNC and Covenant of the opinion of Sullivan & Cromwell dated as of the Effective Date, as to certain federal income tax consequences of the Corporate Merger; and (v) the FUNC Common Shares having been approved for listing on the NYSE, subject to official notice of issuance. Consummation of the Mergers is also subject to the satisfaction or waiver of various other conditions specified in the Merger Agreement, including, among others: (i) the delivery by Covenant and FUNC, each to the other, of (a) opinions of their respective counsel, and (b) certificates executed by certain of their respective executive officers as to compliance with the Merger Agreement; (ii) the receipt by FUNC of a letter from Covenant's independent certified public accountants, dated as of or shortly prior to the Effective Date, with respect to Covenant's financial position and results of operations; and (iii) the receipt by FUNC of an agreement from each "affiliate" of Covenant restricting the sale of FUNC Common Shares received by such affiliate in the Corporate Merger. See "RESALE OF FUNC COMMON SHARES". The Merger Agreement provides that, whether before or after the Special Meeting and notwithstanding the approval of the Merger Agreement by the stockholders of Covenant, the Merger Agreement may be terminated and the Mergers abandoned at any time prior to the Effective Date: (i) by mutual consent of FUNC and Covenant; or (ii) by either the Board of Directors of FUNC (the "FUNC Board") or the Covenant Board (a) if the stockholders of Covenant fail to approve the 32 Merger Agreement or any required regulatory approval is denied, (b) in the event of a breach by the other party of any representation, warranty or covenant contained in the Merger Agreement, which breach is not cured after 30 days' written notice thereof is given to the party committing such breach, or (c) if the Corporate Merger is not consummated on or before June 30, 1998. WAIVER; AMENDMENT Prior to the Effective Date, any provision of the Merger Agreement may be: (i) waived by the party benefitted by the provision; or (ii) amended or modified at any time (including the structure of the transaction) by an agreement in writing among the parties thereto approved by their respective Boards of Directors and executed in the same manner as the Merger Agreement, provided that after approval by the stockholders of Covenant, the consideration to be received by the stockholders of Covenant may not thereby be decreased. ACCOUNTING TREATMENT It is expected that the purchase method of accounting will be used to reflect the Mergers upon consummation. As required by generally accepted accounting principles, under purchase accounting the assets and liabilities of Covenant as of the Effective Date will be recorded at their respective fair market values and added to those of FUNC. Financial statements of FUNC issued after consummation of the Mergers would reflect such values. Financial statements of FUNC for periods before consummation of the Mergers would not be restated to reflect Covenant's historical financial position or results of operations. It is expected that the pooling of interests method of accounting will be used to reflect the Signet Acquisition and the WFBS Acquisition. Under pooling of interests accounting, as of the effective date of an acquisition, the assets and liabilities of the acquired company are added to those of the acquiring company at their recorded book values, and the stockholders' equity accounts of the acquired company and the acquiring company are combined on the acquiring company's consolidated balance sheet. Depending on the relative significance of the acquisition, together with any other pending acquisitions, to the acquiring company, income and other financial statements of the acquiring company for periods ended prior to the effective date of the acquisition may be restated to reflect the consolidated combined financial position and results of operations as if such acquisition had taken place prior to the periods covered by such financial statements. Due to the relative significance of the Signet Acquisition to FUNC, it is currently expected that FUNC's financial statements will be restated as a result of the Signet Acquisition, but will not be restated as a result of the WFBS Acquisition. The unaudited pro forma financial information contained in this Prospectus/Proxy Statement has been prepared using purchase accounting to account for the Mergers and does not reflect the Other Pending Acquisitions or the restatement of FUNC's financial statements in connection with the Signet Acquisition. See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks". See "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition", " -- Wheat First Butcher Singer, Inc. Acquisition" and " -- FUNC Common Stock Offering". EXPENSES; TERMINATION FEE All expenses incurred by or on behalf of the parties in connection with the Merger Agreement and the transactions contemplated thereby shall be borne by the party incurring the same, except that printing expenses will be shared equally by FUNC and Covenant. FUNC shall be entitled to the Termination Fee of $3.5 million from Covenant following the occurrence of a Payment Event, provided FUNC shall have sent written notice of such entitlement within 90 days after its awareness of such occurrence. FUNC's right to receive the Termination Fee shall terminate if any of the following occurs prior to a Payment Event: (i) the Effective Date; (ii) termination of the Merger Agreement in accordance with its terms if such termination occurs prior to the occurrence of a Preliminary Payment Event, except termination by FUNC due to a breach by Covenant; (iii) termination of the Merger Agreement following the occurrence of a Preliminary Payment Event and the passage of 18 months after such termination; or (iv) termination of the Merger Agreement by FUNC due to a breach by Covenant and the passage of 18 months after such termination. A Preliminary Payment Event refers to any of the following events or transactions occurring after the date of the Merger Agreement: (i) Covenant or Covenant Bank, without having received FUNC's prior written consent, shall have entered into an agreement to engage in any Acquisition Transaction (as hereinafter defined) with any person other than FUNC, or the 33 Covenant Board shall have recommended that the stockholders of Covenant approve or accept any Acquisition Transaction with any person other than FUNC. "Acquisition Transaction" means (a) a merger or consolidation, or any similar transaction, involving Covenant or Covenant Bank, (b) a purchase, lease or other acquisition of all or substantially all of the assets or deposits of Covenant or Covenant Bank, (c) a purchase or other acquisition (including by way of merger, consolidation, share exchange or otherwise) of securities representing 20 percent or more of the voting power of Covenant or Covenant Bank; provided that the term "Acquisition Transaction" does not include any internal merger or consolidation involving only Covenant or Covenant Bank; (ii)(a) any person (other than FUNC) shall have acquired beneficial ownership or the right to acquire beneficial ownership of 20 percent or more of the outstanding shares of Covenant Common Stock, or (b) any group, other than a group of which FUNC is a member, shall have been formed that beneficially owns 20 percent or more of the shares of Covenant Common Stock then outstanding; (iii) any person other than FUNC shall have made a bona fide proposal to Covenant or its stockholders, by public announcement or written communication that is or becomes the subject of public disclosure, to engage in an Acquisition Transaction (including, without limitation, any situation in which any person other than FUNC shall have commenced (as such term is defined in Rule 14d-2 under the Exchange Act) or shall have filed a registration statement under the Securities Act, with respect to a tender offer or exchange offer to purchase any shares of Covenant Common Stock such that, upon consummation of such offer, such person would own or control 20 percent or more of the then outstanding shares of Covenant Common Stock (such an offering referred to herein as a "Tender Offer" or an "Exchange Offer", respectively)); (iv) after a proposal is made by a third party to Covenant or its stockholders to engage in an Acquisition Transaction, or such third party states its intentions to Covenant to make such a proposal if the Merger Agreement terminates, Covenant shall have knowingly breached any representation, covenant or obligation contained in the Merger Agreement and such breach would entitle FUNC to terminate the Merger Agreement (without regard to the cure period provided for in the Merger Agreement unless such cure is promptly effected without jeopardizing consummation of the Corporate Merger); or (v) the holders of shares of Covenant Common Stock and Covenant Preferred Stock shall not have approved the Merger Agreement at the Special Meeting or the Special Meeting shall not have been held or shall have been canceled prior to termination of the Merger Agreement, in each case after any person (other than FUNC) shall have (a) made, or disclosed an intention to make, a bona fide proposal to engage in an Acquisition Transaction, or (b) commenced a Tender Offer or filed a registration statement under the Securities Act, with respect to an Exchange Offer. The term "Payment Event" shall mean either of the following events or transactions occurring after the date of the Merger Agreement: (a) the acquisition by any person, other than FUNC, alone or together with such person's affiliates and associates, or any group, of beneficial ownership of 25 percent or more of the outstanding shares of Covenant Common Stock; or (b) the occurrence of a Preliminary Payment Event described in (x) clause (i) above, except that the percentage referred therein shall be 25 percent, or (y) clause (v) above. The foregoing discussion is qualified in its entirety by reference to the applicable provisions in the Merger Agreement relating to the Termination Fee. NO DISSENTERS' RIGHTS Pursuant to the NJBCA, holders of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock do not have dissenters' or appraisal rights in connection with the proposal to approve the Merger Agreement because the FUNC Common Shares to be issued to Covenant stockholders upon consummation of the Corporate Merger will be listed on the NYSE and FUNC has at least 1,000 record stockholders. See " -- Conditions to Consummation; Termination" and "CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS -- Dissenters' Rights". 34 MARKET PRICES The following table sets forth (i) the high and low last reported sale prices per share of FUNC Common Stock on the NYSE Tape (trading symbol, FTU), with respect to each quarterly period since January 1, 1995; (ii) the high and low last reported sale prices per share of Covenant Common Stock on the Nasdaq National Market (trading symbol, CNSK) with respect to the period from June 13, 1997; (iii) the high and low last reported sale prices per share of Covenant Bank common stock on the Nasdaq National Market (trading symbol, CNSK) prior to June 13, 1997; (iv) the high and low last reported sale prices per share of Covenant Series A Preferred Stock (Covenant Bank Series A 6% convertible non-cumulative preferred stock ("Covenant Bank Series A Preferred Stock") prior to June 13, 1997) on the Nasdaq Small-Cap Market (trading symbol, CNSKP) since January 1, 1995; (v) the high and low last reported sales prices per share of Covenant Series B Preferred Stock (Covenant Bank Series B 6% convertible non-cumulative preferred stock ("Covenant Bank Series B Preferred Stock") prior to June 13, 1997) on the Nasdaq Small-Cap Market (trading symbol, CNSKO) since June 30, 1995; (vi) the equivalent pro forma market values per share of Covenant Common Stock, based on the Common Stock Exchange Ratio; (vii) the equivalent pro forma market values per share of Covenant Series A Preferred Stock, based on the Series A Exchange Ratio; and (viii) the equivalent pro forma market values per share of Covenant Series B Preferred Stock, based on the Series B Exchange Ratio. The following Covenant Common Stock and Covenant Bank common stock prices have been adjusted to reflect all stock dividends issued by Covenant and Covenant Bank on such stock. See " -- Dividends". A subsidiary of WFBS is a market maker in Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, and acted as a market maker in Covenant Bank common stock, Covenant Bank Series A Preferred Stock and Covenant Bank Series B Preferred Stock. See "RECENT DEVELOPMENTS -- Wheat First Butcher Singer, Inc. Acquisition".
FUNC COVENANT COMMON STOCK COMMON STOCK HIGH LOW HIGH LOW 1995 First quarter................................... $ 22 1/2 20 5/8 9 7 1/2 Second quarter.................................. 24 7/8 21 3/8 8 3/4 7 1/2 Third quarter................................... 25 5/8 22 5/8 9 3/8 8 1/4 Fourth quarter.................................. 29 3/8 24 3/4 12 3/8 8 3/4 1996 First quarter................................... 31 3/8 25 3/4 11 1/2 10 7/8 Second quarter.................................. 32 1/4 28 3/4 11 3/4 11 1/4 Third quarter................................... 33 7/8 30 1/2 12 7/8 11 1/4 Fourth quarter.................................. 38 1/2 33 1/2 14 3/4 12 1997 First quarter................................... 47 3/4 36 5/8 13 7/8 12 3/8 Second quarter.................................. 47 7/8 39 1/8 18 1/4 13 3/8 Third quarter................................... 50 11/16 45 7/8 21 17 Fourth quarter (through October 14, 1997)....... $ 52 7/8 50 3/8 19 1/2 18 1/2 EQUIVALENT PRO FORMA PER SHARE OF COVENANT COMMON STOCK (1) HIGH LOW 1995 First quarter................................... 8 1/2 7 3/4 Second quarter.................................. 9 3/8 8 1/8 Third quarter................................... 9 3/4 8 5/8 Fourth quarter.................................. 11 1/8 9 3/8 1996 First quarter................................... 11 7/8 9 3/4 Second quarter.................................. 12 1/4 10 7/8 Third quarter................................... 12 7/8 11 5/8 Fourth quarter.................................. 14 5/8 12 3/4 1997 First quarter................................... 18 1/8 13 7/8 Second quarter.................................. 18 1/4 14 7/8 Third quarter................................... 19 1/4 17 3/8 Fourth quarter (through October 14, 1997)....... 20 1/8 19 1/8
35
EQUIVALENT PRO FORMA PER SHARE OF COVENANT COVENANT COVENANT SERIES A SERIES A PREFERRED SERIES B PREFERRED STOCK STOCK (1) PREFERRED STOCK HIGH LOW HIGH LOW HIGH LOW 1995 First quarter......... $39 1/8 35 3/8 34 31 1/4 -- -- Second quarter........ 37 5/8 34 37 5/8 32 3/8 -- -- Third quarter......... 38 1/4 35 1/8 38 3/4 34 1/4 37 5/8 31 1/2 Fourth quarter........ 40 1/8 42 3/8 44 1/2 37 1/2 38 7/8 34 3/8 1996 First quarter......... 48 1/8 48 1/8 47 1/2 39 43 1/2 38 7/8 Second quarter........ 46 1/4 46 1/4 48 7/8 43 1/2 41 7/8 37 3/8 Third quarter......... 49 47 3/8 51 1/4 46 1/8 40 3/4 38 1/2 Fourth quarter........ 49 7/8 49 7/8 58 1/4 50 3/4 43 5/8 39 1/2 1997 First quarter......... 49 7/8 49 7/8 72 3/8 55 1/2 43 5/8 39 1/2 Second quarter........ 48 48 72 1/2 59 1/4 42 38 Third quarter......... 76 70 76 3/4 69 1/2 57 1/2 55 Fourth quarter (through October 14, 1997)... $76 70 80 1/8 76 1/4 57 1/2 55 EQUIVALENT PRO FORMA PER SHARE OF COVENANT SERIES B PREFERRED STOCK (1) HIGH LOW 1995 First quarter......... -- -- Second quarter........ -- -- Third quarter......... 30 5/8 27 1/8 Fourth quarter........ 35 1/8 29 5/8 1996 First quarter......... 37 5/8 30 7/8 Second quarter........ 38 5/8 34 3/8 Third quarter......... 40 5/8 36 1/2 Fourth quarter........ 46 1/8 40 1/8 1997 First quarter......... 57 1/4 43 7/8 Second quarter........ 57 3/8 46 7/8 Third quarter......... 60 3/4 55 Fourth quarter (through October 14, 1997)... 63 3/8 60 3/8
(1) Equivalent pro forma market values per share of Covenant Common Stock amounts represent the high and low last reported sales prices per share of FUNC Common Stock multiplied by the Common Stock Exchange Ratio, rounded down to the nearest one-eighth. Equivalent pro forma market values per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent the high and low last reported sales prices per share of FUNC Common Stock multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded down to the nearest one-eighth. On August 4, 1997, the last business day prior to public announcement of the execution of the Merger Agreement, the last reported sale prices per share of FUNC Common Stock on the NYSE Tape, Covenant Common Stock on the Nasdaq National Market, and Covenant Series A Preferred Stock and Covenant Series B Preferred Stock on the Nasdaq Small-Cap Market were $49.50, $21.00, $76.00 and $57.125, respectively. On October 14, 1997, such prices were $51.375, $19.00, $76.00 and $55.00, respectively. Covenant stockholders are urged to obtain current quotations of the market price of FUNC Common Stock. The Merger Agreement provides for the filing of a listing application with the NYSE covering the FUNC Common Shares. It is a condition to consummation of the Corporate Merger that the FUNC Common Shares be authorized for listing on the NYSE effective upon official notice of issuance. See " -- Conditions to Consummation; Termination". See "RECENT DEVELOPMENTS -- FUNC Common Stock Buybacks". 36 DIVIDENDS The following table sets forth the cash dividends paid or declared on FUNC Common Stock with respect to each quarterly period since January 1, 1995, Covenant Series A Preferred Stock (Covenant Bank Series A Preferred Stock prior to June 13, 1997) with respect to each quarterly period since January 1, 1995, and Covenant Series B Preferred Stock (Covenant Bank Series B Preferred Stock prior to June 13, 1997) with respect to the period from June 30, 1995, and the equivalent pro forma cash dividends paid per share of Covenant Common Stock, Covenant Series A Preferred Stock and Covenant Series B Preferred Stock, based on the Common Stock Exchange Ratio, the Series A Exchange Ratio and the Series B Exchange Ratio, respectively. Neither Covenant nor Covenant Bank paid any cash dividends on Covenant Common Stock or Covenant Bank common stock during such periods. Covenant issued a four percent stock dividend on Covenant Common Stock on July 14, 1997, and Covenant Bank issued (i) a four percent stock dividend on Covenant Bank common stock on each of June 15, 1996 and June 15, 1995, and (ii) a six percent stock dividend on Covenant Bank common stock on each of December 16, 1996 and December 15, 1995.
EQUIVALENT PRO FORMA EQUIVALENT PER PRO FORMA SHARE PER SHARE OF OF COVENANT COVENANT COVENANT COVENANT FUNC COVENANT COMMON SERIES A SERIES A SERIES B COMMON COMMON STOCK PREFERRED PREFERRED PREFERRED STOCK STOCK (1) STOCK (2) STOCK (1) STOCK (2) 1995 First quarter... $0.23 -- 0.085 0.375 0.350 -- Second quarter......... 0.23 -- 0.085 0.375 0.350 -- Third quarter... 0.26 -- 0.100 0.375 0.395 0.375 Fourth quarter......... 0.26 -- 0.100 0.375 0.395 0.375 1996 First quarter... 0.26 -- 0.100 0.375 0.395 0.375 Second quarter......... 0.26 -- 0.100 0.375 0.395 0.375 Third quarter... 0.29 -- 0.110 0.375 0.440 0.375 Fourth quarter......... 0.29 -- 0.110 0.375 0.440 0.375 1997 First quarter... 0.29 -- 0.110 0.375 0.440 0.375 Second quarter......... 0.29 -- 0.110 0.375 0.440 0.375 Third quarter... $0.32 -- 0.120 0.375 0.485 0.375 EQUIVALENT PRO FORMA PER SHARE OF COVENANT SERIES B PREFERRED STOCK (1) 1995 First quarter... -- Second quarter......... -- Third quarter... 0.310 Fourth quarter......... 0.310 1996 First quarter... 0.310 Second quarter......... 0.310 Third quarter... 0.350 Fourth quarter......... 0.350 1997 First quarter... 0.350 Second quarter......... 0.350 Third quarter... 0.385
(1) Equivalent pro forma cash dividends paid per share of Covenant Common Stock amounts represent FUNC historical dividend rates per share multiplied by the Common Stock Exchange Ratio, rounded to the nearest one-half cent. The current annualized dividend rate per share for FUNC Common Stock, based upon the most recently declared quarterly dividend of $.32 per share paid on September 15, 1997, is $1.28. On an equivalent pro forma basis, such current annualized FUNC dividend per share of Covenant Common Stock would be $.49, based on the Common Stock Exchange Ratio, rounded to the nearest cent. Any future FUNC and Covenant dividends are dependent upon their respective earnings and financial condition, government regulations and policies and other factors. Holders of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock currently are entitled to receive, when and as declared by the Covenant Board, preferred dividends at the annual rate of $1.50 per share. The equivalent pro forma cash dividends paid per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. On an equivalent pro forma basis, the current annualized FUNC dividend per share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock would be $1.94 and $1.54, respectively, which amounts represent pro forma combined per share of FUNC Common Stock amounts multiplied by the Series A Exchange Ratio, with respect to the Covenant Series A Preferred Stock, and the Series B Exchange Ratio, with respect to the Covenant Series B Preferred Stock, in each case rounded to the nearest cent. (2) Assuming the Corporate Merger is consummated after December 31, 1997, which is currently anticipated, it is currently expected that a dividend on Covenant Series A Preferred Stock and Covenant Series B Preferred Stock in the amount of $.375 per share will be paid on January 14, 1998, to holders of record on December 31, 1997. Such dividend would be paid to holders of shares of Covenant Series A Preferred Stock notwithstanding the conversion of such shares into shares of Covenant Common Stock on December 31, 1997. See " -- Effective Date" and " -- Business Pending Consummation", "FUNC -- Certain Regulatory Considerations; PAYMENTS OF DIVIDENDS" and "DESCRIPTION OF FUNC CAPITAL STOCK". 37 COVENANT GENERAL Financial and other information relating to Covenant, including certain information about Covenant's directors and executive officers, is set forth in Covenant Bank's 1996 Annual Report on Form F-2, as amended, and Covenant's Second Quarter Report on Form 10-Q/A, copies of which are included in ANNEX A to this Prospectus/Proxy Statement. See also "RECENT DEVELOPMENTS". HISTORY AND BUSINESS Covenant is a bank holding company registered under the BHCA. It was organized under the laws of the State of New Jersey on February 13, 1997, and became a bank holding company on June 13, 1997, through the consummation of a plan of acquisition between Covenant and Covenant Bank, pursuant to which Covenant Bank became a wholly-owned subsidiary of Covenant. In connection with such acquisition, each outstanding share of common stock and preferred stock of Covenant Bank was exchanged for a share of Covenant Common Stock and Covenant Preferred Stock. Covenant Bank commenced operations in September 1988 as a savings bank chartered under the laws of the State of New Jersey. Effective January 1, 1997, Covenant Bank converted its charter to a commercial bank under the laws of the State of New Jersey. Covenant's market focus is southern New Jersey, where it offers, through its 17 personal financial centers, a broad range of lending, depository and related financial services to individual consumers, businesses and governmental units. The lending function is Covenant's principal business activity, and it is its continuing policy to serve as a reliable source of credit for a diverse customer base. Commercial credit services offered by Covenant include short- and medium-term loans, lines of credit, certain types of asset-based lending, real estate construction loans and commercial mortgage loans. Consumer credit services include secured and unsecured loans, installment loans, mortgage loans and home equity loans. Covenant offers the customary range of retail and commercial deposit services. Personal accounts include checking accounts, NOW accounts, money market accounts, savings accounts, IRAs, and both retail and wholesale certificates of deposit. For commercial clients, Covenant also offers cash management accounts with an automatic investment feature, and escrow management and lockbox payment processing services. In June 1993, Covenant acquired New Jersey Savings & Loan Association, with three offices in Waterford Township, Sicklerville and Voorhees, New Jersey, and in September 1994, Covenant acquired Landis Savings Bank, S.L.A., with an office in Vineland, New Jersey. In addition, in September 1996, Covenant acquired 1st Southern State Bank, adding three personal financial centers in Avalon, Cape May and Sea Isle City, New Jersey. 38 FUNC GENERAL Financial and other information relating to FUNC, including information relating to FUNC's directors and executive officers, is set forth in FUNC's 1996 Annual Report on Form 10-K, 1997 First and Second Quarter Reports on Form 10-Q, 1997 Annual Meeting Proxy Statement and 1997 Current Reports on Form 8-K, copies of which may be obtained from FUNC as indicated under "AVAILABLE INFORMATION". HISTORY AND BUSINESS FUNC was incorporated under the laws of North Carolina in 1967 and is registered as a bank holding company under the BHCA. Pursuant to a corporate reorganization in 1968, First Union National Bank, headquartered in Charlotte, North Carolina and formerly named First Union National Bank of North Carolina ("FUNB-NC"), and First Union Mortgage Corporation, a mortgage banking firm acquired by FUNB-NC in 1964, became subsidiaries of FUNC. In addition to FUNB's operations in New Jersey, New York, and Pennsylvania, FUNC also owns banks conducting operations in Connecticut, Delaware, Florida, Georgia, Maryland, North Carolina, South Carolina, Tennessee, Virginia and Washington, D.C. In addition to providing a wide range of commercial and retail banking and trust services through its banking subsidiaries, FUNC also provides various other financial services, including mortgage banking, home equity lending, credit cards, leasing, investment banking, insurance and securities' brokerage services, through other subsidiaries. See " -- Certain Regulatory Considerations; INTERSTATE BANKING AND BRANCHING LEGISLATION". Since the 1985 Supreme Court decision upholding regional interstate banking legislation, FUNC has concentrated its efforts on building a large, regional banking organization in what it perceives to be some of the better banking markets in the eastern region of the United States. Since November 1985, FUNC has completed 72 banking-related acquisitions, and currently has pending three banking-related acquisitions (including Covenant), including the more significant acquisitions (I.E., involving the acquisition of $3.0 billion or more of assets or deposits) set forth in the following table. See "RECENT DEVELOPMENTS -- Signet Banking Corporation Acquisition" and " -- Wheat First Butcher Singer, Inc. Acquisition".
ASSETS/ CONSIDERATION/ NAME HEADQUARTERS DEPOSITS(1)(2) ACCOUNTING TREATMENT COMPLETION DATE Atlantic Bancorporation...................... Florida $ 3.8 billion common stock/pooling November 1985 Northwestern Financial Corporation........... North Carolina 3.0 billion common stock/pooling December 1985 First Railroad & Banking Company of Georgia.................................... Georgia 3.7 billion common stock/pooling November 1986 Florida National Banks of Florida, Inc....... Florida 7.9 billion cash and preferred January 1990 stock/purchase Southeast banks.............................. Florida 9.9 billion cash, notes and preferred September 1991 stock/ purchase Resolution Trust Company ("RTC") 5.3 billion cash/purchase 1991-1994 acquisitions............................... Florida, Georgia, Virginia Dominion Bankshares Corporation.............. Virginia 8.9 billion common stock and March 1993 preferred stock/pooling Georgia Federal Bank, FSB.................... Georgia 4.0 billion cash/purchase June 1993 First American Metro Corp.................... Virginia 4.6 billion cash/purchase June 1993 American Savings of Florida, F.S.B........... Florida 3.6 billion common stock/purchase July 1995 FFB.......................................... New Jersey, Pennsylvania 35.3 billion common stock and January 1996 preferred stock/pooling Center Financial Corporation................. Connecticut $ 4.0 billion common stock/purchase November 1996 Signet....................................... Virginia $ 11.9 billion common stock/pooling pending
(1) The dollar amounts indicated represent the assets of the related organization as of the last reporting period prior to acquisition, except for (i) the dollar amount relating to RTC acquisitions, which represents savings and loan deposits 39 acquired from the RTC, and (ii) the dollar amount relating to Southeast banks, which represent assets of the two banking subsidiaries of Southeast Banking Corporation acquired from the FDIC. (2) In addition, FUNC acquired (i) Lieber & Company ("Lieber"), a mutual fund advisory company with approximately $3.4 billion in assets under management, in June 1994, and (ii) Keystone Investments, Inc., a mutual fund advisory company with approximately $11.6 billion in assets under management, in December 1996. Since such assets are not owned by these mutual advisory companies, they are not reflected on FUNC's balance sheet. FUNC is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities can be expected. Acquisitions typically involve the payment of a premium over book and market values, and therefore, some dilution of FUNC's book value and net income per common share may occur in connection with any future transactions. See "RECENT DEVELOPMENTS". CERTAIN REGULATORY CONSIDERATIONS AS A BANK HOLDING COMPANY, FUNC IS SUBJECT TO REGULATION UNDER THE BHCA AND TO ITS EXAMINATION AND REPORTING REQUIREMENTS. THE FOLLOWING DISCUSSION SETS FORTH CERTAIN OF THE MATERIAL ELEMENTS OF THE REGULATORY FRAMEWORK APPLICABLE TO BANK HOLDING COMPANIES AND THEIR SUBSIDIARIES AND PROVIDES CERTAIN SPECIFIC INFORMATION RELEVANT TO FUNC. TO THE EXTENT THAT THE FOLLOWING INFORMATION DESCRIBES STATUTORY AND REGULATORY PROVISIONS, IT IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE APPLICABLE STATUTORY AND REGULATORY PROVISIONS. A CHANGE IN APPLICABLE STATUTES, REGULATIONS OR REGULATORY POLICY MAY HAVE A MATERIAL EFFECT ON THE BUSINESS OF FUNC. GENERAL As a bank holding company, FUNC is subject to regulation under the BHCA and to its examination and reporting requirements. Under the BHCA, bank holding companies may not directly or indirectly acquire the ownership or control of more than five percent of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of, or a waiver of the requirement for such approval by, the Federal Reserve Board. In addition, bank holding companies are generally prohibited under the BHCA from engaging in nonbanking activities, subject to certain exceptions. The earnings of FUNC are affected by the legislative and governmental actions of various regulatory authorities, including the Federal Reserve Board, the OCC and the FDIC. In addition, there are numerous governmental requirements and regulations which affect the activities of FUNC. PAYMENT OF DIVIDENDS FUNC is a legal entity separate and distinct from its banking and other subsidiaries. A major portion of FUNC's revenues result from amounts paid as dividends to FUNC by its national bank subsidiaries. The prior approval of the OCC is required for the payment of any dividend by a national bank if the total of all dividends declared by the board of directors of such bank in any calendar year will exceed the sum of such bank's net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits any national bank from paying dividends which would be greater than such bank's undivided profits after deducting statutory bad debt in excess of such bank's allowance for loan losses. In addition to its national bank subsidiaries, FUNC has one state-chartered bank subsidiary which is subject to dividend limitations under applicable state laws. Under the foregoing dividend restrictions and certain restrictions applicable to certain of FUNC's nonbanking subsidiaries, as of June 30, 1997, FUNC's subsidiaries, without obtaining affirmative governmental approvals, could pay aggregate dividends of $717 million to FUNC. In the first six months of 1997, FUNC's subsidiaries paid $603 million in cash dividends to FUNC. In addition, the corporate reorganization of FUNC's subsidiary banks in Georgia and Florida into FUNB-NC on June 5, 1997, resulted in a reduction of capital in the amount of $400 million, which was paid to FUNC. In addition, FUNC and its bank subsidiaries are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine, under certain circumstances relating to the financial condition of a national bank or bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The OCC (the appropriate agency with respect to FUNC's national bank subsidiaries) and the 40 FDIC (the appropriate agency with respect to FUNC's state-chartered bank subsidiary) have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsound and unsafe banking practice. The OCC, the FDIC and the Federal Reserve Board have each indicated that banking organizations should generally pay dividends only out of current operating earnings. BORROWINGS; ETC. There are also various legal restrictions on the extent to which each of FUNC and certain of its nonbank subsidiaries can borrow or otherwise obtain credit from its bank subsidiaries. In general, these restrictions require that any such extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of FUNC or such nonbank subsidiaries, to ten percent of the lending bank's capital stock and surplus, and as to FUNC and all such nonbank subsidiaries in the aggregate, to 20 percent of such lending bank's capital stock and surplus. The Federal Deposit Insurance Act, as amended (the "FDIA") imposes liability on an institution the deposits of which are insured by the FDIC, such as FUNC's subsidiary banks, for certain potential losses of the FDIC incurred in connection with other FDIC-insured institutions under common control with such institution. Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the OCC is authorized to require payment of the deficiency by assessment upon the bank's stockholders, pro rata and, to the extent necessary, if any such assessment is not paid by any stockholder after three months notice, to sell the stock of such stockholder to make good the deficiency. Under Federal Reserve Board policy, FUNC is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each of such subsidiaries. This support may be required at times when, absent such Federal Reserve Board policy, FUNC may not find itself willing or able to provide it. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. CAPITAL ADEQUACY The Federal Reserve Board, the FDIC and the OCC have adopted substantially similar risk-based and leverage capital guidelines for United States banking organizations. Under these risked-based capital standards, the minimum consolidated ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is eight percent. At least half of the total capital is to be composed of common stockholder's equity, retained earnings, a limited amount of qualifying perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles ("tier 1 capital" and, together with tier 2 capital, "total capital"). The remainder of total capital may consist of mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock and loan loss allowance ("tier 2 capital"). At June 30, 1997, FUNC's tier 1 and total capital ratios were 7.55 percent and 12.64 percent, respectively. On an FUNC and Covenant combined basis, such ratios at June 30, 1997, would have been 7.48 percent and 12.56 percent, respectively. In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of tier 1 capital to adjusted average quarterly assets less certain amounts ("leverage ratio") equal to three percent for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of from at least four to five percent. FUNC's leverage ratio at June 30, 1997, was 6.23 percent. On an FUNC and Covenant combined basis, such ratio at June 30, 1997, would have been 6.17 percent. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "tangible tier 1 leverage ratio" (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve Board has not advised FUNC of any specific minimum leverage ratio or tangible tier 1 leverage ratio applicable to it. Each of FUNC's subsidiary banks is subject to similar capital requirements adopted by the OCC or the FDIC. Each of FUNC's subsidiary banks had a leverage ratio in excess of 5.47 percent as of June 30, 1997. The federal banking agencies have not advised any of the subsidiary banks of any specific minimum leverage ratio applicable to it. 41 PROMPT CORRECTIVE ACTION The FDIA, among other things, requires the federal banking agencies to take "prompt corrective action" in respect of depository institutions that do not meet minimum capital requirements. The FDIA establishes five capital tiers: "well capitalized"; "adequately capitalized"; "undercapitalized"; "significantly undercapitalized"; and "critically undercapitalized". A depository institution's capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. The federal bank regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels applicable to FDIC-insured banks. The relevant capital measures are the total capital ratio, tier 1 capital ratio and the leverage ratio. Under the regulations, a FDIC-insured bank will be (i) "well capitalized" if it has a total capital ratio of ten percent or greater, a tier 1 capital ratio of six percent or greater and a leverage ratio of five percent or greater and is not subject to any order or written directive by the OCC to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total capital ratio of eight percent or greater, a tier 1 capital ratio of four percent or greater and a leverage ratio of four percent or greater (three percent in certain circumstances) and is not "well capitalized"; (iii) "undercapitalized" if it has a total capital ratio of less than eight percent, a tier 1 capital ratio of less than four percent or a leverage ratio of less than four percent (three percent in certain circumstances); (iv) "significantly undercapitalized" if it has a total capital ratio of less than six percent, a tier 1 capital ratio of less than three percent or a leverage ratio of less than three percent; and (v) "critically undercapitalized" if its tangible equity is equal to or less than two percent of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than is indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. As of June 30, 1997, all of FUNC's deposit-taking subsidiary banks had capital levels that qualify them as being "well capitalized" under such regulations. The FDIA generally prohibits a FDIC-insured depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be "undercapitalized". "Undercapitalized" depository institutions are subject to growth limitations and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of: (i) an amount equal to five percent of the depository institution's total assets at the time it became "undercapitalized"; and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized". "Significantly undercapitalized" insured depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized", requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator. A bank that is not "well capitalized" is subject to certain limitations relating to so-called "brokered" deposits. DEPOSITOR PREFERENCE STATUTE Under federal law, deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. INTERSTATE BANKING AND BRANCHING LEGISLATION The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") authorized interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, it authorized, beginning June 1, 1997, a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of the IBBEA and May 31, 1997. In addition, a bank may establish and operate a DE NOVO branch in a state in which the bank does not maintain a branch if that state expressly permits DE NOVO interstate branching. It was pursuant to authority from IBBEA that FUNB-NC completed corporate reorganizations in June and July 1997 (I.E., FUNC's commercial banking subsidiaries operating in Florida, Georgia, South Carolina, Tennessee, Virginia, Maryland, Connecticut and Washington, D.C. were merged into FUNB-NC). In addition, FUNB, which conducts 42 banking operations in New Jersey, New York and Pennsylvania, is to be merged with FUNB-NC in February 1998, pending regulatory approval. FDIC INSURANCE ASSESSMENTS; DIFA Effective January 1, 1996, the FDIC reduced the insurance premiums it currently charges on bank deposits insured by the Bank Insurance Fund ("BIF") to the statutory minimum of $2,000 for "well capitalized" banks. The Deposit Insurance Funds Act of 1996, which was enacted on September 30, 1996 ("DIFA"), reduced the amount of semi-annual FDIC insurance premiums for savings association deposits acquired by banks and insured by SAIF to the same levels assessed for deposits insured by BIF. DIFA also provided for a special one-time assessment imposed on deposits insured by SAIF, including such deposits held by banks, to bring the SAIF up to statutorily required levels. FUNC accrued for the one-time assessment in the third quarter of 1996 in the amount of $86 million after tax in connection with the SAIF recapitalization. DIFA further provides for assessments to be imposed on insured depository institutions with respect to deposits insured by the BIF, and continues the assessments currently imposed on depository institutions with respect to SAIF-insured deposits, to pay for the cost of Financing Corporation funding. DESCRIPTION OF FUNC CAPITAL STOCK THE DESCRIPTIVE INFORMATION SUPPLIED HEREIN OUTLINES CERTAIN PROVISIONS OF THE FUNC ARTICLES, THE FUNC BYLAWS AND THE NCBCA. THE INFORMATION DOES NOT PURPORT TO BE COMPLETE AND IS QUALIFIED IN ALL RESPECTS BY REFERENCE TO THE PROVISIONS OF THE FUNC ARTICLES, THE FUNC BYLAWS AND THE NCBCA. AUTHORIZED CAPITAL The authorized capital stock of FUNC consists of 750,000,000 shares of FUNC Common Stock, 10,000,000 shares of Preferred Stock, no-par value per share ("FUNC Preferred Stock"), and 40,000,000 shares of FUNC Class A Preferred Stock, no-par value per share ("FUNC Class A Preferred Stock"). As of September 30, 1997, there were 568,296,416 shares of FUNC Common Stock, no shares of FUNC Preferred Stock and no shares of FUNC Class A Preferred Stock issued and outstanding. The FUNC Preferred Stock and FUNC Class A Preferred Stock are each issuable in one or more series, and with respect to any series, the FUNC Board, subject to certain limitations, is authorized to fix the numbers of shares, dividend rates, liquidation prices, liquidation rights of holders, redemption, conversion and voting rights and other terms of the series. Shares of FUNC Class A Preferred Stock and FUNC Preferred Stock that are redeemed, repurchased or otherwise acquired by FUNC have the status of authorized, unissued and undesignated shares of FUNC Class A Preferred Stock and FUNC Preferred Stock, respectively, and may be reissued. FUNC COMMON STOCK Subject to the prior rights of the holders of any FUNC Preferred Stock and any FUNC Class A Preferred Stock then outstanding, holders of FUNC Common Stock are entitled to receive such dividends as may be declared by the FUNC Board out of funds legally available therefor, and in the event of liquidation or dissolution, to receive the net assets of FUNC remaining after payment of all liabilities and after payment to holders of all shares of FUNC Preferred Stock and FUNC Class A Preferred Stock of the full preferential amounts to which such holders are respectively entitled, in proportion to their respective holdings. See "FUNC -- Certain Regulatory Considerations; PAYMENT OF DIVIDENDS". Pursuant to an indenture dated as of November 27, 1996, between FUNC and Wilmington Trust Company, as trustee, under which certain of FUNC's outstanding junior subordinated debt securities have been issued, FUNC has covenanted that it generally will not declare or pay any dividends or distributions on, or redeem, repurchase, acquire or make a liquidation payment with respect to, any of FUNC's capital stock, including FUNC Common Stock, FUNC Preferred Stock and FUNC Class A Preferred Stock if, at such time, certain defaults have occurred under such indenture or a related guarantee of FUNC or FUNC shall have exercised its rights under such indenture to defer interest payments on the securities issued thereunder. Subject to the rights of the holders of any FUNC Preferred Stock and any FUNC Class A Preferred Stock then outstanding, all voting rights are vested in the holders of the shares of FUNC Common Stock, each share being entitled to one vote on all matters requiring stockholder action and in the election of directors. Holders of FUNC Common Stock have no preemptive, subscription or conversion rights. All of the outstanding shares of FUNC Common Stock are fully paid and nonassessable, and the FUNC Common Shares issuable to the stockholders of Covenant upon consummation of the Corporate Merger will, upon issuance, be fully paid and nonassessable. 43 FUNC PREFERRED STOCK All shares of each series of FUNC Preferred Stock must be of equal rank and have the same powers, preferences and rights and are subject to the same qualifications, limitations and restrictions, except with respect to dividend rates, redemption prices, liquidation amounts, terms of conversion or exchange and voting rights. FUNC CLASS A PREFERRED STOCK Shares of FUNC Class A Preferred Stock rank prior or superior to FUNC Common Stock and on a parity with or junior to (but not prior or superior to) FUNC Preferred Stock or any series thereof, in respect of the right to receive dividends and/or the right to receive payments out of the net assets of FUNC upon any involuntary or voluntary liquidation, dissolution or winding up of FUNC. Subject to the foregoing and to the terms of any particular series of FUNC Class A Preferred Stock, each series of FUNC Class A Preferred Stock may vary as to priority. FUNC RIGHTS PLAN Each outstanding share of FUNC Common Stock currently has attached to it one right (an "FUNC Right") issued pursuant to an Amended and Restated Shareholder Protection Rights Agreement (as amended, the "FUNC Rights Agreement"). Accordingly, in the Corporate Merger, holders of Covenant Common Stock and Covenant Preferred Stock would receive one FUNC Right with respect to each share of FUNC Common Stock they receive, which FUNC Right will be attached to the related shares of FUNC Common Stock, unless the Separation Time (as defined below) has occurred, in which case holders of Covenant Common Stock and Covenant Preferred Stock would receive separate certificates with respect to such FUNC Rights. Each FUNC Right entitles its registered holder to purchase one-hundredth of a share of a junior participating series of FUNC Class A Preferred Stock designed to have economic and voting terms similar to those of one share of FUNC Common Stock, for $105.00 (as adjusted to reflect the FUNC Stock Split), subject to adjustment (the "Rights Exercise Price"), but only after the earlier to occur (the "Separation Time") of: (i) the tenth business day (subject to extension) after any person (an "Acquiring Person") (x) commences a tender or exchange offer, which, if consummated, would result in such person becoming the beneficial owner of 15 percent or more of the outstanding shares of FUNC Common Stock, or (y) is determined by the Federal Reserve Board to "control" FUNC within the meaning of the BHCA (see " -- Other Provisions" below), subject to certain exceptions; and (ii) the tenth business day after the first date (the "Flip-in Date") of a public announcement by FUNC that a person has become an Acquiring Person. The FUNC Rights will not trade separately from the shares of FUNC Common Stock unless and until the Separation Time occurs. The FUNC Rights Agreement provides that a person will not become an Acquiring Person under the BHCA control-based test described above if either (i) the Federal Reserve Board's control determination would not have been made but for such person's failure to make certain customary passivity commitments, or such person's violation of such commitments made, to the Federal Reserve Board, so long as the Federal Reserve Board determines that such person no longer controls FUNC within 30 days (or 60 days in certain circumstances), or (ii) the Federal Reserve Board's control determination was not based on such a failure or violation and such person (x) obtains a noncontrol determination within three years, and (y) is using its best efforts to allow FUNC to make any acquisition or engage in any legally permissible activity notwithstanding such person's being deemed to control FUNC for purposes of the BHCA. The FUNC Rights will not be exercisable until the business day following the Separation Time. The FUNC Rights will expire on the earliest of: (i) the Exchange Time (as defined below); (ii) the close of business on December 28, 2000; and (iii) the date on which the FUNC Rights are redeemed or terminated as described below (in any such case, the "Expiration Time"). The Rights Exercise Price and the number of FUNC Rights outstanding, or in certain circumstances the securities purchasable upon exercise of the FUNC Rights, are subject to adjustment upon the occurrence of certain events. In the event that prior to the Expiration Time a Flip-in Date occurs, FUNC has agreed to take such action as shall be necessary to ensure and provide that each FUNC Right (other than FUNC Rights beneficially owned by an Acquiring Person or any affiliate, associate or transferee thereof, which FUNC Rights shall become void) shall constitute the right to purchase, from FUNC, shares of FUNC Common Stock having an aggregate market price equal to twice the Rights Exercise Price for an amount in cash equal to the then current Rights Exercise Price. In addition, the FUNC Board may, at its option, at any time after a Flip-in Date, elect to exchange all of the then outstanding FUNC Rights for shares of FUNC Common Stock, at an exchange ratio of two shares of FUNC Common Stock per FUNC Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the Separation Time (the "Rights Exchange Rate"). Immediately upon such action by the FUNC Board (the "Exchange Time"), the right to exercise the FUNC Rights will terminate and each FUNC Right will thereafter represent only the right to receive a number of shares of FUNC Common Stock equal to the 44 Rights Exchange Rate. If FUNC becomes obligated to issue shares of FUNC Common Stock upon exercise of or in exchange for FUNC Rights, FUNC, at its option, may substitute for each such share of FUNC Common Stock one one-hundredth of a share of junior participating FUNC Class A Preferred Stock. The FUNC Rights may be canceled and terminated without any payment to holders thereof at any time prior to the date that they become exercisable and are redeemable by FUNC at $.01 per FUNC Right, subject to adjustment upon the occurrence of certain events, at any date between the date on which they become exercisable and the Flip-In Date. The FUNC Rights have no voting rights and are not entitled to dividends. The FUNC Rights will not prevent a takeover of FUNC. The FUNC Rights, however, may cause substantial dilution to a person or group that acquires 15 percent or more of FUNC Common Stock (or that acquires "control" of FUNC within the meaning of the BHCA) unless the FUNC Rights are first redeemed or terminated by the FUNC Board. Nevertheless, the FUNC Rights should not interfere with a transaction that is in the best interests of FUNC and its stockholders because the FUNC Rights can be redeemed or terminated, as hereinabove described, before the consummation of such transaction. The complete terms of the FUNC Rights are set forth in the FUNC Rights Agreement. The foregoing description of the FUNC Rights and the FUNC Rights Agreement is qualified in its entirety by reference to such document. The FUNC Rights Agreement is incorporated by reference as an exhibit to the Registration Statement. A copy of the FUNC Rights Agreement can be obtained upon written request to the Rights Agent, First Union National Bank, Two First Union Center, Charlotte, North Carolina 28288-1154. OTHER PROVISIONS The FUNC Articles and the FUNC Bylaws contain a number of provisions which may be deemed to have the effect of discouraging or delaying attempts to gain control of FUNC. These include provisions in the FUNC Articles: (i) classifying the FUNC Board into three classes with each class to serve for three years with one class being elected annually; (ii) authorizing the FUNC Board to fix the size of the FUNC Board between nine and 30 directors; (iii) authorizing directors to fill vacancies on the FUNC Board that occur between annual meetings, except that vacancies resulting from a removal of a director by a stockholder vote may only be filled by a stockholder vote; (iv) providing that directors may be removed only for cause and only by affirmative vote of the majority of shares entitled to be voted in the election of directors, voting as a single class; (v) authorizing only the FUNC Board, the Chairman of the FUNC Board or the President to call a special meeting of stockholders (except for special meetings called under specified circumstances for holders of classes or series of stock ranking superior to the FUNC Common Stock); and (vi) requiring an 80 percent vote of stockholders entitled to vote in the election of directors, voting as a single class, to alter any of the foregoing provisions. The FUNC Bylaws include provisions setting forth specific conditions under which: (i) business may be transacted at an annual meeting of stockholders; and (ii) persons may be nominated for election as directors of FUNC at an annual meeting of stockholders. The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company unless the Federal Reserve Board has been given 60 days' prior written notice of such proposed acquisition and within that time period the Federal Reserve Board has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued, or unless the acquisition is subject to Federal Reserve Board approval under the BHCA. An acquisition may be made prior to the expiration of the disapproval period if the Federal Reserve Board issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of more than ten percent of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as FUNC, would, under the circumstances set forth in the presumption, constitute the acquisition of control. In addition, any "company" would be required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25 percent (five percent in the case of an acquiror that is a bank holding company) or more of the outstanding shares of FUNC Common Stock, or otherwise obtaining "control" over FUNC. Under the BHCA, "control" generally means (i) the ownership or control of 25 percent or more of any class of voting securities of the bank holding company, (ii) the ability to elect a majority of the bank holding company's directors, or (iii) the ability otherwise to exercise a controlling influence over the management and policies of the bank holding company. Two North Carolina "anti-takeover" statutes adopted in 1987, The North Carolina Shareholder Protection Act and The North Carolina Control Share Acquisition Act, allowed North Carolina corporations to elect to either be covered or not be covered by such statutes. FUNC elected not to be covered by such statutes. 45 In addition to the foregoing, in certain instances the ability of the FUNC Board to issue authorized but theretofore unissued shares of FUNC Common Stock, FUNC Class A Preferred Stock or FUNC Preferred Stock may have an anti-takeover effect. The existence of the foregoing provisions could (i) result in FUNC being less attractive to a potential acquiror, or (ii) result in FUNC stockholders receiving less for their shares of FUNC Common Stock than otherwise might be available in the event of a takeover attempt. CERTAIN DIFFERENCES IN THE RIGHTS OF COVENANT AND FUNC STOCKHOLDERS GENERAL FUNC is a North Carolina corporation subject to the provisions of the NCBCA, and Covenant is a New Jersey corporation subject to the provisions of the NJBCA. Stockholders of Covenant will, upon consummation of the Corporate Merger, become stockholders of FUNC. The rights of such stockholders as stockholders of FUNC will then be governed by the FUNC Articles and the FUNC Bylaws, in addition to the NCBCA. Set forth below are the material differences between the rights of a Covenant stockholder under the NJBCA, the Covenant Certificate and the Covenant Bylaws, on the one hand, and the rights of an FUNC stockholder under the NCBCA, the FUNC Articles and the FUNC Bylaws, on the other hand. This summary does not purport to be a complete discussion of, and is qualified in its entirety by reference to, the governing law and the charter and bylaws of each corporation. AUTHORIZED CAPITAL COVENANT. Covenant has authority to issue 25,000,000 shares of Covenant Common Stock and 1,000,000 shares of Covenant Preferred Stock. Such shares of Covenant Preferred Stock are issuable from time to time in one or more series and, with respect to any such series, the Covenant Board is authorized to establish such voting rights, designations, preferences, qualifications, privileges, limitations, options, conversion rights, dividend rate and other special rights as the Covenant Board may determine. Pursuant to such authority, 138,300 shares have been designated as Covenant Series A Preferred Stock and 161,700 shares have been designated as Covenant Series B Preferred Stock. Each share of Covenant Series A Preferred Stock and Covenant Series B Preferred Stock is entitled to receive, when and as declared by the Covenant Board, non-cumulative dividends at the annual rate of $1.50 per share. Covenant Series A Preferred Stock and Covenant Series B Preferred Stock rank prior to Covenant Common Stock and on a parity basis with each other with respect to the right to receive dividends and/or the right to receive payments out of the net assets of Covenant upon any involuntary or voluntary liquidation, dissolution or winding up of Covenant, and have no voting rights, except as may be otherwise required by law. Each outstanding share of Covenant Series A Preferred Stock will automatically be converted into 3.976 shares of Covenant Common Stock on December 31, 1997, if the Corporate Merger is not consummated by such date, and each outstanding share of Covenant Series B Preferred Stock would, absent the Corporate Merger, automatically be converted into 3.147 shares of Covenant Common Stock on June 30, 2000. See "THE MERGERS -- General; Exchange Ratios" and " -- Exchange of Covenant Certificates". As of the Record Date, Covenant had outstanding 3,057,332 shares of Covenant Common Stock, 138,300 shares of Covenant Series A Preferred Stock and 161,700 shares of Covenant Series B Preferred Stock. FUNC. FUNC's authorized capital is set forth under "DESCRIPTION OF FUNC CAPITAL STOCK -- Authorized Capital". AMENDMENT TO ARTICLES OF INCORPORATION OR BYLAWS COVENANT. Pursuant to the NJBCA, an amendment of the provisions of the Covenant Certificate requires the approval of the Covenant Board and the affirmative vote of a majority of the votes cast by the stockholders entitled to vote thereon, if a quorum exists. Pursuant to the NJBCA, under certain circumstances, the approval of the holders of a majority of the outstanding shares of a series of Covenant Preferred Stock may also be required to amend the Covenant Certificate. In accordance with the NJBCA and the Covenant Bylaws, the provisions of the Covenant Bylaws generally may be amended, added to or repealed in whole or in part (i) by the vote of the stockholders at a meeting, or (ii) by vote of a majority of the entire Covenant Board. FUNC. Under North Carolina law, an amendment to the FUNC Articles generally requires the recommendation of the FUNC Board and the approval of either a majority of all shares entitled to vote thereon or a majority of the votes cast thereon, depending on the nature of the amendment. In accordance with North Carolina law, the FUNC Board may condition 46 its submission of the proposed amendment on any basis. An amendment to the bylaws of FUNC generally requires the approval of either the stockholders or the FUNC Board. The FUNC Board generally may not amend any bylaw approved by the stockholders. Under certain circumstances, the approval of the holders of at least two-thirds, or in some cases a majority, of the outstanding shares of any series of FUNC Preferred Stock or FUNC Class A Preferred Stock may be required to amend the FUNC Articles. In addition, certain amendments to the FUNC Articles or the FUNC Bylaws require the approval of not less than 80 percent of the outstanding shares of FUNC entitled to vote in the election of directors, voting together as a single class. See "DESCRIPTION OF FUNC CAPITAL STOCK". SIZE AND CLASSIFICATION OF BOARD OF DIRECTORS COVENANT. Under the NJBCA, subject to any provisions contained in a New Jersey corporation's certificate of incorporation, the corporation's bylaws must specify the number of directors or provide that the number of directors not be less than a stated minimum or more than a stated maximum. The Covenant Bylaws provides that the total number of directors will be established by the Covenant Board and shall be not less than one or more than 25. Covenant currently has ten directors. As permitted by the NJBCA, the Covenant Board is divided into three classes, each as nearly as possible equal in number, with one class being elected annually for staggered three-year terms. FUNC. The size of the FUNC Board is determined by the affirmative vote of a majority of the FUNC Board, provided that the FUNC Board may not set the number of directors at less than nine nor more than 30, and provided further that no decrease in the number of directors may shorten the term of any director then in office. The number of directors of FUNC is currently set at 29. The FUNC Board is divided into three classes, each as nearly as possible equal in number as the others, with one class being elected annually. See "DESCRIPTION OF FUNC CAPITAL STOCK". REMOVAL OF DIRECTORS COVENANT. In accordance with the NJBCA, the Covenant Certificate and the Covenant Bylaws, directors of Covenant may be removed by the stockholders of Covenant for cause by the affirmative vote of the majority of the votes cast by the holders of shares entitled to vote for the election of directors. The Covenant Board also may remove any director for cause. FUNC. Except for directors elected under specified circumstances by holders of any class or series of stock having a preference over FUNC Common Stock as to dividends or upon liquidation, directors of FUNC may be removed only for cause and only by a vote of the holders of a majority of the shares then entitled to vote in the election of directors, voting together as a single class. DIRECTOR EXCULPATION COVENANT. The Covenant Certificate provides for the elimination of personal liability of each director and officer of Covenant for a breach of fiduciary duty as a director or officer, as the case may be. The NJBCA does not presently permit the elimination of such liability with respect to an act or omission (i) in breach of such person's duty of loyalty to the corporation or its stockholders, (ii) not in good faith or involving a knowing violation of law, or (iii) resulting in receipt of an improper personal benefit. FUNC. The FUNC Articles provide for the elimination of personal liability of each director of FUNC to the fullest extent permitted by the provisions of the NCBCA, as the same may be in effect from time to time. The NCBCA does not permit the elimination of such liability with respect to (i) acts or omissions the director knew or believed were clearly in conflict with the best interests of FUNC, (ii) any liability under the NCBCA for unlawful distributions by FUNC, or (iii) any transaction from which the director derived an improper personal benefit. DIRECTOR CONFLICT OF INTEREST TRANSACTIONS COVENANT. The NJBCA generally permits transactions between a New Jersey corporation and one of its directors or a corporation in which one of its directors is interested if: (i) the contract or other transaction is fair and reasonable as to the corporation at the time it is authorized, approved or ratified; (ii) the common directorship or interest is disclosed or known to the board or committee and the board or committee approves, authorizes or ratifies the contract or transaction by unanimous written consent, provided at least one director consenting is disinterested, or by the affirmative vote of a majority of the disinterested directors even though less than a quorum; or (iii) the common directorship or interest is disclosed or known to the stockholders, and they authorize, approve or ratify the contract or transaction. Under the NJBCA, a New Jersey corporation may loan money to, or guarantee the obligation of, a director if, in the judgment of the board, such action may reasonably be expected to benefit the corporation. 47 FUNC. North Carolina law generally permits transactions involving a North Carolina corporation and an interested director of that corporation if: (i) the material facts of the transaction and the director's interest are disclosed and a majority of disinterested shares entitled to vote thereon authorizes, approves or ratifies the transaction; (ii) the material facts are disclosed and a majority of disinterested directors or a committee of the board of directors authorizes, approves or ratifies the transaction; or (iii) the transaction is fair to the corporation. North Carolina law prohibits loans to directors or the guaranteeing of their obligations by a North Carolina corporation unless approved by a majority vote of disinterested stockholders or unless the corporation's board of directors determines that the loan or guarantee benefits the corporation and either approves the specific loan or guarantee or a general plan of loans and guarantees by the corporation. STOCKHOLDER MEETINGS COVENANT. Special meetings of stockholders may be called by the chief executive officer, the president or the Covenant Board, and must be called by Covenant upon the written application by the holder or holders of a majority of all stock entitled to vote on the matter or matters to be considered at the meeting. In addition, a court may order a special meeting upon the application of the holders of not less than ten percent of all shares entitled to vote at a meeting. Holders of shares of Covenant Common Stock vote on all matters submitted to a vote of stockholders, with each share of Covenant Common Stock being entitled to one vote. In addition, in certain circumstances, holders of Covenant Common Stock and each of the series of Covenant Preferred Stock are entitled to vote as a class with respect to certain matters. Except as provided in the NJBCA, a majority of the votes cast is generally required for action by the stockholders of Covenant, provided that a quorum is present. In general, the holders of shares entitled to cast a majority of the votes at a Covenant stockholder meeting will constitute a quorum. Pursuant to the NJBCA and the Covenant Certificate, Covenant stockholders may take any action by written consent or without a meeting only upon the unanimous written consent of all stockholders. FUNC. A special meeting of stockholders may be called for any purpose only by the FUNC Board, by the Chairman of the FUNC Board or the President (except for special meetings called under specified circumstances for holders of any class or series of stock having a preference over FUNC Common Stock as to dividends or upon liquidation). A quorum for a meeting of the stockholders of FUNC is a majority of the outstanding shares of FUNC entitled to vote. Except as provided in the FUNC Articles or the NCBCA, a majority of the votes cast is generally required for any action by the stockholders of FUNC. North Carolina law provides that such quorum and voting requirements may be increased only with the approval of the stockholders of FUNC. DIRECTOR NOMINATIONS COVENANT. Covenant does not have a provision in the Covenant Certificate or Covenant Bylaws relating to director nominations. FUNC. The FUNC Bylaws establish procedures that must be followed for stockholders to nominate persons for election to the FUNC Board. Such nominations must be made by delivering written notice to the Secretary of FUNC not less than 60 or more than 90 days prior to the annual meeting at which directors will be elected; provided, however, that if less than 70 days' notice of the date of the meeting is given, such written notice by the stockholder must be so delivered not later than the tenth day after the day on which such notice of the date of the meeting was given. Notice will be deemed to have been given more than 70 days prior to the meeting if the meeting is called on the third Tuesday of April regardless as to when public disclosure is made. The nomination notice must set forth certain information about the person to be nominated similar to that required to be disclosed in the solicitation of proxies for election of directors pursuant to Items 7(a) and 7(b) of Regulation 14A under the Exchange Act, and such person's written consent to being nominated and to serving as a director if elected. The nomination notice must also set forth certain information about the person submitting the notice, including the name and address of the stockholder and the class and number of shares of FUNC Common Stock owned of record or beneficially by such stockholder. The Chairman of the meeting will, if the facts warrant, determine that a nomination was not made in accordance with the provisions prescribed by the FUNC Bylaws, and the defective nomination will be disregarded. The foregoing procedures do not apply to any director who is nominated under specified circumstances by holders of any class or series of stock having a preference over FUNC Common Stock as to dividends or upon liquidation. 48 STOCKHOLDER PROPOSALS COVENANT. Covenant does not have a provision in the Covenant Certificate or Covenant Bylaws relating to stockholder proposals at annual meetings of stockholders. However, pursuant to the NJBCA, only those matters specified in the notice of meeting to stockholders may be submitted to a vote of the stockholders at an annual or special meeting of stockholders. FUNC. The FUNC Bylaws establish procedures that must be followed for a stockholder to submit a proposal to a vote of the stockholders of FUNC at an annual meeting of stockholders. Such proposal must be made by the stockholder delivering written notice to the Secretary of FUNC not less than 60 days nor more than 90 days prior to the meeting; provided, however, that if less than 70 days' notice of the date of the meeting is given, such written notice by the stockholder must be so delivered not later than the tenth day after the day on which such notice of the date of the meeting was given. Notice will be deemed to have been given more than 70 days prior to the meeting if the meeting is called on the third Tuesday of April. The stockholder proposal notice must set forth: (i) a brief description of the proposal and the reasons for its submission; (ii) the name and address of the stockholder, as they appear on FUNC's books; (iii) the classes and number of shares of FUNC stock owned by the stockholder; and (iv) any material interest of the stockholder in such proposal other than such holder's interest as a stockholder of FUNC. The chairman of the meeting will, if the facts warrant, determine that any proposal was not properly submitted in accordance with the provisions prescribed by the FUNC Bylaws, and the defective proposal will not be submitted to the meeting for a vote of the stockholders. STOCKHOLDER PROTECTION RIGHTS PLANS COVENANT. Covenant does not have a stockholder rights plan. FUNC. FUNC has adopted the FUNC Rights Agreement. See "DESCRIPTION OF FUNC CAPITAL STOCK -- FUNC Rights Plan". STOCKHOLDER INSPECTION RIGHTS; STOCKHOLDER LISTS COVENANT. Under the NJBCA, any stockholder who has been a stockholder for at least six months or who holds, or is authorized by persons who hold, at least five percent of the outstanding shares of any class or series of stock of Covenant has the right, for any proper purpose, to inspect the minutes of the proceedings of Covenant stockholders and record of stockholders. Upon establishing a proper purpose and receiving a court order, a stockholder may examine the books and records of account, minutes and record of stockholders of Covenant. FUNC. Under the NCBCA, qualified stockholders have the right to inspect and copy certain records of FUNC if their demand is made in good faith and for a proper purpose. Such right of inspection requires that the stockholder give FUNC at least five business days' written notice of the demand, describing with reasonable particularity his purpose and the requested records. The records must be directly connected with the stockholder's purpose. The rights of inspection and copying extend not only to stockholders of record but also to beneficial owners whose beneficial ownership is certified to FUNC by the stockholder of record. However, FUNC is under no duty to provide any accounting records or any records with respect to any matter that FUNC determines in good faith may, if disclosed, adversely affect FUNC in the conduct of its business or may constitute material non-public information, and the rights of inspection and copying are limited to stockholders who either have been stockholders for at least six months or who hold at least five percent of the outstanding shares of any class of stock of FUNC. A stockholder's agent or attorney has the same inspection and copying rights as the stockholder he represents. In addition, after fixing a record date for a stockholders' meeting, FUNC is required to prepare a stockholder list with respect to such stockholders' meeting and to make such list available at FUNC's principal office or at a place identified in the meeting notice to any stockholder beginning two business days after notice of such meeting is given and continuing through such meeting and any adjournment thereof. Subject to the applicable provisions of the NCBCA, a stockholder or his agent or attorney upon written demand at his own expense during regular business hours is entitled to copy such list. Such list must be available at the stockholders' meeting, and any stockholder, his agent or attorney, may inspect such list at any time during the meeting or any adjournment thereof. REQUIRED STOCKHOLDER VOTE FOR CERTAIN ACTIONS COVENANT. Under the Covenant Certificate and the NJBCA, absent circumstances described below under " -- Anti-Takeover Provisions", consummation of a merger or consolidation involving Covenant requires the approval of the Covenant Board and the affirmative vote of at least 80 percent of the outstanding shares of Covenant Common Stock, unless such transaction has been approved by a majority of the independent members of the Covenant Board. If so approved by such 49 independent members, such a transaction would require the affirmative vote of a majority of the votes cast by the holders of Covenant Common Stock entitled to vote thereon. Under certain circumstances under the NJBCA, certain actions will require a class vote of the holders of each series of Covenant Preferred Stock. FUNC. Under North Carolina law, except as otherwise provided below or in the NCBCA, any plan of merger or share exchange to which FUNC is a party, would require adoption by the FUNC Board, who would generally be required to recommend its approval to the stockholders, who in turn would be required to approve the plan by a vote of a majority of the outstanding shares. Except as otherwise provided below or in the NCBCA, any sale, lease, exchange or other disposition of all or substantially all of FUNC's assets not made in the usual and regular course of business would generally require that the FUNC Board recommend the proposed transaction to the stockholders who would be required to approve the transaction by a vote of a majority of the outstanding shares. In accordance with North Carolina law, the submission by the FUNC Board of any such action may be conditioned on any basis, including, without limitation, conditions regarding a supermajority voting requirement or that no more than a certain number of shares indicate that they will seek dissenters' rights. With respect to a plan of merger to which FUNC is a party, no vote of the stockholders of FUNC is required if FUNC is the surviving corporation and: (i) the FUNC Articles would remain unchanged after the merger, subject to certain exceptions; (ii) each stockholder of FUNC immediately before the merger would hold an identical number of shares, with identical designations, limitations, preferences and relative rights, after the merger; (iii) the number of shares of FUNC stock entitled to vote unconditionally in the election of directors to be issued in the merger (either by the conversion of securities issued in the merger or by the exercise of rights and warrants issued in the merger) would not exceed 20 percent of the shares of FUNC stock entitled to vote unconditionally in the election of directors outstanding immediately before the merger; and (iv) the number of shares of FUNC stock entitling holders to participate without limitation in distributions to be issued in the merger (either by the conversion of securities issued in the merger or by the exercise of rights and warrants issued in the merger) would not exceed 20 percent of the shares of FUNC stock entitling holders to participate without limitation in distributions outstanding immediately before the merger. In addition, no vote of the stockholders of FUNC would be required to merge a subsidiary of which FUNC owns at least 90 percent of the outstanding shares of each class of subsidiary shares, into FUNC, as long as no amendment is made to the FUNC Articles that could not be made without approval of FUNC's stockholders. With respect to a sale, lease, exchange or other disposition of all or substantially all the assets of FUNC made upon the authority of the FUNC Board, no vote of the stockholders of FUNC would be required if such disposition is made in the usual and regular course of business or if such disposition is made to a wholly-owned subsidiary of FUNC. ANTI-TAKEOVER PROVISIONS COVENANT. The NJBCA provides that no publicly held corporation organized under the laws of New Jersey with its principal executive offices or significant operations located in New Jersey (a "resident domestic corporation") may engage in any "business combination" (as defined in the NJBCA) with any "interested stockholder" (generally, a ten percent or greater stockholder) of such corporation for a period of five years following such interested stockholder's stock acquisition unless such business combination is approved by the board of directors of such corporation prior to the stock acquisition. A resident domestic corporation, such as Covenant, cannot opt out of the foregoing provisions of the NJBCA. In addition to the foregoing, no resident domestic corporation may engage, at any time, in any business combination with any interested stockholder of such corporation other than: (i) a business combination approved by the board of directors of such corporation prior to the stock acquisition; (ii) a business combination approved by the affirmative vote of the holders of two-thirds of the voting stock not beneficially owned by that interested stockholder at a meeting called for such purpose; or (iii) a business combination in which the interested stockholder pays a formula price designed to ensure that all other stockholders receive at least the highest price per share paid by that interested stockholder. Under the NJBCA, the director of a New Jersey corporation may consider, in discharging his or her duties to the corporation and in determining what he or she reasonably believes to be in the best interest of the corporation, any of the following (in addition to the effects of any action on stockholders): (i) the effects of the action on the corporation's employees, suppliers, creditors and customers; (ii) the effects of the action on the community in which the corporation operates; and (iii) the long-term as well as the short-term interests of the corporation and its stockholders, including the possibility that these interests may best be served by the continued independence of the corporation. If, on the basis of the foregoing factors, the board of directors determines that any proposal or offer to acquire the corporation is not in the best interest of the corporation, 50 it may reject such proposal or offer, in which event the board of directors will have no duty to facilitate, remove any obstacles to, or refrain from impeding, such proposal or offer. The existence of the foregoing provisions could (i) result in Covenant being less attractive to a potential acquiror, and (ii) result in Covenant stockholders receiving less for their shares of Covenant Common Stock and Covenant Preferred Stock than otherwise might be available in the event of a takeover attempt. FUNC. North Carolina has two anti-takeover statutes in force, The North Carolina Shareholder Protection Act and The North Carolina Control Share Acquisition Act. These statutes restrict business combinations with, and the accumulation of shares of voting stock of, certain North Carolina corporations. In accordance with the provisions of these statutes, FUNC elected not to be covered by the restrictions imposed by these statutes. As a result, such statutes do not apply to FUNC. In addition, North Carolina has a Tender Offer Disclosure Act, which contains certain prohibitions against deceptive practices in connection with making a tender offer and also contains a filing requirement with the North Carolina Secretary of State that has been held unenforceable as to its 30-day waiting period. DISSENTERS' RIGHTS COVENANT. The NJBCA generally provides for dissenters' rights in connection with any merger or consolidation or any sale, lease, exchange or other disposition of all or substantially all of the assets of the corporation not in the usual or ordinary course of business. A stockholder of a corporation may also dissent from any acquisition of shares owned by such stockholder in connection with the acquisition by another New Jersey corporation, in exchange for its shares, of all the shares of a class or series of securities of such corporation. However, no such rights exist with respect to (i) any class or series of shares that is listed on a national securities exchange or is held of record by not less than 1,000 holders on the record date fixed to determine the stockholders entitled to vote on the transaction, or generally, (ii) any transaction in connection with which the stockholders of the corporation will receive only (a) cash, (b) securities that, upon consummation of the transaction, will be listed on a national securities exchange or held of record by not less than 1,000 holders, or (c) cash and such securities. Any stockholder that perfects dissenters' rights under the NJBCA is entitled to receive the "fair value" of such shares as determined either by agreement between such stockholder and the corporation or by a court of competent jurisdiction. As described under "THE MERGER -- No Dissenters' Rights", holders of Covenant Common Stock and Covenant Preferred Stock do not have dissenters' or appraisal rights in connection with the proposal to approve the Merger Agreement because the FUNC Common Shares to be issued to Covenant stockholders upon consummation of the Corporate Merger will be listed on the NYSE and FUNC has at least 1,000 record stockholders. FUNC. North Carolina law generally provides dissenters' rights for mergers and certain share exchanges that would require stockholder approval, sales of all or substantially all of the assets (other than sales that are in the usual and regular course of business and certain liquidations and court-ordered sales), certain amendments to the articles of incorporation and any corporate action taken pursuant to a stockholder vote to the extent the articles of incorporation, bylaws or a resolution of the board of directors entitles stockholders to dissent. DIVIDENDS AND OTHER DISTRIBUTIONS COVENANT. Under the NJBCA, a corporation may pay dividends or purchase, redeem or otherwise acquire its own shares unless, after giving effect thereto, (i) the corporation would be unable to pay its debts as they become due in the usual course of its business, or (ii) the corporation's total assets would be less than its total liabilities. FUNC. Under North Carolina law, FUNC generally may make dividends or other distributions to its stockholders unless after the distribution either: (i) FUNC would not be able to pay its debts as they become due in the usual course of business; or (ii) FUNC's assets would be less than the sum of its liabilities plus the amount that would be needed to satisfy the preferential dissolution rights of stockholders whose preferential rights are superior to those receiving the distribution. See "FUNC -- Certain Regulatory Considerations; PAYMENT OF DIVIDENDS" and "DESCRIPTION OF FUNC CAPITAL STOCK". 51 VOLUNTARY DISSOLUTION COVENANT. Under the NJBCA, Covenant may be dissolved upon the consent of all of its stockholders entitled to vote thereon or, alternatively, if the Covenant Board recommends that Covenant be dissolved and directs that the question be submitted to a vote at a meeting of stockholders, Covenant may be dissolved upon the affirmative vote of a majority of the votes cast by the stockholders entitled to vote thereon and, if any class or series of securities of Covenant is entitled to vote as a class, upon the affirmative vote of a majority of the votes cast by each such class. FUNC. North Carolina law provides that FUNC may be dissolved if the FUNC Board proposes dissolution and a majority of the shares of FUNC entitled to vote thereon approves. In accordance with North Carolina law, the FUNC Board may condition its submission of a proposal for dissolution on any basis. RESALE OF FUNC COMMON SHARES The FUNC Common Shares have been registered under the Securities Act, thereby allowing such shares to be traded freely and without restriction by those holders of Covenant Common Stock and Covenant Preferred Stock who receive such shares following consummation of the Corporate Merger and who are not deemed to be "affiliates" (as defined under the Securities Act, but generally including directors, certain executive officers and ten percent or more stockholders) of Covenant or FUNC. It is a condition to consummation of the Mergers that each holder of Covenant Common Stock and Covenant Preferred Stock who is deemed by Covenant to be an affiliate has entered into an agreement with FUNC providing, among other things, that such affiliate will not transfer any FUNC Common Shares received by such affiliate in the Corporate Merger except in compliance with the Securities Act. This Prospectus/Proxy Statement does not cover any resales of FUNC Common Shares received by affiliates of Covenant. VALIDITY OF FUNC COMMON SHARES The validity of the FUNC Common Shares being offered hereby is being passed upon for FUNC by Marion A. Cowell, Jr., Esq., Executive Vice President, Secretary and General Counsel of FUNC. Mr. Cowell is also a stockholder of FUNC and holds options to purchase additional shares of FUNC Common Stock. EXPERTS The statement of financial condition of Covenant Bank as of December 31, 1996, and the related statements of operations, changes in stockholders' equity and cash flows for the year then ended have been audited by KPMG Peat Marwick LLP. KPMG Peat Marwick LLP has also audited Covenant Bank's statement of financial condition as of December 31, 1995, and the related statements of operations, changes in stockholders' equity and cash flows for the year then ended, prior to their restatement for the 1996 pooling of interests merger with 1st Southern State Bank. Coopers & Lybrand L.L.P. audited Covenant Bank's statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 1994, prior to their restatement for the 1996 pooling of interests merger with 1st Southern State Bank. Moore, Costello & Co. (formerly Moore & Fitzpatrick, LLC) audited 1st Southern State Bank's statements of income, changes in stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 1995, such statements of which have been included in the 1995 and 1994 restated financial statements of Covenant Bank. The combination of the statement of financial condition as of December 31, 1995, and the related statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 1995 and 1994, after restatement for the 1996 pooling of interests, have been audited by KPMG Peat Marwick LLP. The aforementioned financial statements of Covenant Bank have been included herein in reliance upon the separate reports of KPMG Peat Marwick LLP, Coopers & Lybrand L.L.P and Moore & Fitzpatrick, LLC, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firms as experts in accounting and auditing. The consolidated balance sheets of FUNC as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, included in FUNC's 1996 Annual Report to Stockholders, which is incorporated by reference in FUNC's 1996 Annual Report on Form 10-K and incorporated by reference herein, have been incorporated by reference herein in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, incorporated by reference herein, and upon the authority of said firm as experts in accounting and auditing. 52 ANNEX A AMENDMENT NO. 2 TO FORM F-2 ANNUAL REPORT UNDER SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 FDIC CERTIFICATE NO. 27339 COVENANT BANK (Exact name of bank as specified in charter) NEW JERSEY (State or other jurisdiction of incorporation or organization) 22-2890624 (IRS Employer Identification No.) 18 KINGS HIGHWAY WEST HADDONFIELD, NJ 08033 (Address of principal office) (609) 428-7300 (Bank's telephone number, including area code) SECURITIES REGISTERED UNDER SECTION 12(B) OF THE ACT: SECURITIES REGISTERED UNDER SECTION 12(G) OF THE ACT: Title of Class: Common Stock, par value $5.00 per share; Series A 6% Convertible Non-Cumulative Preferred Stock, par value $25.00 per share; and Series B 6% Convertible Non-Cumulative Preferred Stock, par value $25.00 per share Indicate by check mark if disclosure of delinquent filers pursuant to item 10 is not contained herein, and will not be contained, to the best of bank's knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form F-2 or any amendment of this Form F-2. H Indicate by check mark whether the bank (1) has filed all reports required to be filed by Section 13 of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the bank was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The aggregate market value of the voting stock held by non-affiliates of the registrant based on the closing sales price on March 10, 1997 was approximately $36,074,673. The number of shares of Common Stock outstanding on March 10, 1997 was 2,936,480. DOCUMENTS INCORPORATED BY REFERENCE 1. Definitive Proxy Statement for the 1997 Annual Shareholders' Meeting, portions of which are incorporated by reference in this Report. A-1 PART I ITEM 1 -- BUSINESS GENERAL. Covenant Bank ("Covenant" or "the Bank") is a bank organized under the laws of the State of New Jersey. Covenant's market focus is southern New Jersey. Covenant offers a broad range of lending, depository and related financial services to individual consumers, businesses and governmental units. Covenant is a member of the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). As a state-chartered bank, Covenant is subject to extensive regulation and supervision by the New Jersey Department of Banking (the "Department of Banking") under New Jersey law and by the FDIC under federal law. See "Supervision and Regulation." Since commencing operations in September, 1988 with a single office in Haddonfield, New Jersey, Covenant has grown through acquisitions and internal growth to approximately $415 million in assets and 15 personal financial centers throughout the southern New Jersey market place as of December 31, 1996. In March 1997, Covenant opened an additional personal financial center in Cherry Hill, New Jersey. Covenant acquired New Jersey Savings & Loan Association, with three offices in Waterford Township, Sicklerville and Voorhees, New Jersey, in June, 1993, and in September, 1994, Covenant acquired Landis Savings Bank, S.L.A., with an office in Vineland, New Jersey. In addition to expanding Covenant's network of personal financial centers, these acquisitions expanded and diversified Covenant's loan portfolio and loan product offerings into residential mortgage lending and consumer lending. In September, 1996 Covenant acquired 1st Southern State Bank, adding three personal financial centers in Avalon, Cape May and Sea Isle City, New Jersey. As of December 31, 1996, Covenant had 166.5 full-time equivalent employees. The lending function is Covenant's principal business activity and it is Covenant's continuing policy to serve as a reliable source of credit for a diverse customer base. Commercial credit services offered by Covenant include short- and medium-term loans, lines of credit, certain types of asset-based lending, real estate construction loans and commercial mortgage loans. Consumer credit services include secured and unsecured loans, installment loans, mortgage loans and home equity loans. Covenant offers the customary range of retail and commercial deposit services. Personal accounts include checking accounts, NOW accounts, money market accounts, savings accounts, IRAs, and both retail and wholesale certificates of deposit. Covenant is a member of the MAC(R) automated teller machine network. Deposits into and withdrawals from transaction accounts can be made by MAC cards which are provided with an annual fee and no transaction charges. In addition, Covenant offers a Covenant Visa(R) credit card, travelers checks and direct deposit facilities. For commercial clients, Covenant offers checking and savings accounts, money market accounts, certificates of deposit and cash management accounts with an automatic investment feature. Businesses can make deposits at branches of other financial institutions which can be transferred to Covenant by a Depository Transfer Check initiated by a toll-free telephone call or by use of a corporate MAC card with respect to deposits made at a MAC terminal. In addition, Covenant offers escrow management and lockbox payment processing services. While Covenant's deposit base is somewhat seasonal as a result of its personal financial centers in the New Jersey shore communities, its earnings and total assets are not seasonal in any material respect. MARKET AREA AND COMPETITION. Covenant's market focus is southern New Jersey. Covenant has established "hub" personal financial centers in Atlantic, Burlington, Camden, Cape May and Cumberland counties, and has a total of fifteen personal financial centers in the southern New Jersey market represented by those counties. Covenant intends to continue to explore opportunities for additional locations in its southern New Jersey marketplace. Covenant faces significant competition, both in making loans and in attracting deposits. Covenant's competition for loans comes principally from other banks and thrift institutions. Covenant encounters competition in attracting deposits not only from area financial institutions, but also from alternative investment opportunities such as mutual funds and other corporate and government securities funds. Most of Covenant's competitors have greater financial and marketing resources than those of Covenant. Covenant has placed a major emphasis on providing its customers with superior service, and believes that this emphasis has contributed to its growth both in deposits and loans outstanding. A-2 SUPERVISION AND REGULATION. GENERAL. As a bank organized under the banking laws of the State of New Jersey and insured by the FDIC, Covenant is subject to regulation by the Department of Banking and the FDIC. Various regulations, requirements and restrictions under the laws of New Jersey and the United States affect the operations of Covenant, including the requirement to maintain reserves against deposits and to maintain certain capital ratios, restrictions on the nature and amount of loans which may be made and the interest which may be charged thereon, regulations relating to investments, and restrictions on other activities of Covenant. Covenant is a member of and owns stock in the Federal Home Loan Bank ("FHLB") of New York, one of 12 regional banks in the Federal Home Loan Bank System, and is subject to certain requirements in connection therewith. The FDIC, in connection with its provision of deposit insurance, has primary responsibility for regulation of Covenant at the federal level and in that capacity undertakes periodic reviews of the operations of Covenant to assess whether Covenant is engaging in unsafe or unsound banking practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulations, rule or order of, or condition imposed by, the FDIC. The Department of Banking likewise oversees the operations of Covenant to monitor compliance with all applicable state law requirements. The regulation and supervision of Covenant by the FDIC and the Department of Banking are designed primarily for the protection of depositors and the FDIC, and not Covenant or its stockholders. Legislative and regulatory proposals regarding changes in banking, and the regulation of banks, thrifts and other financial institutions could significantly change the regulation of banks and the financial services industry. It cannot be predicted whether any of these proposals will be adopted or, if adopted, how these proposals will affect Covenant. CAPITAL REQUIREMENTS. Under regulations of the FDIC and the Department of Banking, Covenant must maintain a minimum ratio of qualified total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) of 8.00%. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of permanent preferred stock, less goodwill ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier 1 capital and Tier 2 capital is "total risk-based capital." FDIC and Department of Banking regulations also require a minimum ratio of Tier 1 capital to risk-weighted assets of 4.00%. Covenant's Tier 1 risk-based capital and total risk-based capital ratios as of December 31, 1996 were 11.98% and 13.20%, respectively. In addition, the FDIC has established a minimum leverage ratio (Tier 1 capital to quarterly average assets less goodwill) of 3.00% for banking institutions that meet certain specified criteria, including that they must have the highest regulatory rating. All other banking institutions are required to maintain a leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Department of Banking has established a minimum leverage ratio of not less than 4.00%, and may set a minimum leverage ratio of more than 4.00% for an institution based on certain factors. Pursuant to the foregoing, Covenant is required to maintain a leverage ratio of not less than 4.00%. As of December 31, 1996, Covenant's leverage ratio was 7.51%. Covenant's ability to maintain the required levels of capital is substantially dependent upon the success of Covenant's capital and business plans, the impact of future economic events on Covenant's loan customers, and Covenant's ability to manage its interest rate risk and control its growth and other operating expenses. A bank that is not in compliance with applicable federal or state capital requirements may be subject to certain growth restrictions, issuance of a capital directive by the appropriate regulator, and various other possible enforcement actions by the appropriate regulators, including a cease and desist order, civil money penalties, and the establishment of restrictions on operations. In addition, the institution could be subject to appointment of a receiver or conservator or a forced merger into another institution. PROMPT CORRECTIVE ACTION. In addition to the foregoing capital requirements, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established a system of "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "under capitalized," "significantly under capitalized" and "critically under capitalized." At December 31, 1996, Covenant was "well capitalized." The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered well capitalized or adequately capitalized under FDIC regulations and Covenant's ratios at December 31, 1996: A-3
ADEQUATELY WELL COVENANT AT CAPITALIZED CAPITALIZED DECEMBER 31, 1996 Total Risk-Based Capital Ratio........................... 8% 10% 13.20% Tier 1 Risk-Based Capital Ratio.......................... 4% 6% 11.98% Leverage Ratio........................................... 4% 5% 7.51%
If a bank does not meet all of the minimum capital ratios necessary to be considered adequately capitalized, it will be considered undercapitalized, significantly undercapitalized or critically undercapitalized, depending on the amount of the shortfall in its capital. If its principal federal regulator determines that an adequately capitalized institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan, restrict its asset growth and prohibit branching, new acquisitions and new lines of business. An institution's principal federal regulator may deem it to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings or liquidity in its most recent examination. Among other possible sanctions, an undercapitalized depository institution may not pay dividends and is required to submit a capital restoration plan to its principal federal regulator. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Generally, FDICIA requires the appropriate federal regulator to appoint or receive a conservator for an institution that is critically undercapitalized. DEPOSIT INSURANCE. The FDIC has adopted deposit insurance regulations under which insured institutions are assigned to one of the following three capital groups based on their capital levels: "well-capitalized," "adequately capitalized" and "undercapitalized." Banks in each of these three groups are further classified into three subgroups based upon the level of supervisory concern with respect to each bank. The resulting matrix creates nine assessment risk classifications to which are assigned deposit insurance premiums ranging from 0.00% for the best capitalized, healthiest institutions to 0.27% for undercapitalized institutions with substantial supervisory concerns. In addition, Covenant is subject to semi-annual assessments by the FDIC relating to interest payments on Financing Corporation (FICO) Bonds issued in connection with the resolution of the thrift industry crisis. LIMITS ON DIVIDENDS AND OTHER PAYMENTS. As a bank chartered under the laws of the State of New Jersey, Covenant may not declare a cash dividend or a stock dividend unless, following payment of the dividend, the capital stock of Covenant will be unimpaired and Covenant will have surplus of at least 50% of its capital stock or, if not, the payment of the dividend will not reduce surplus. In addition, the FDIC and the Department of Banking are authorized to determine under certain circumstances relating to the financial condition of Covenant that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or unsound practice. FEDERAL HOME LOAN BANK SYSTEM. Covenant is a member of the FHLB of New York, which is one of 12 regional FHLBs. As a member of the FHLB, Covenant is required to purchase and maintain stock in the FHLB of New York in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year, 5% (or such greater fraction as established by FHLB) of outstanding FHLB advances, or 0.3% of total assets. At December 31, 1996, Covenant had $4.5 million in FHLB of New York stock which was in compliance with this requirement. Covenant has received dividends on its FHLB stock. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board (the "FHFB"). ACTIVITIES AND INVESTMENTS. Pursuant to FDICIA, the activities and equity investments of FDIC-insured state-chartered banks are generally limited to those that are permissible for national banks, notwithstanding powers which may be granted under state law. INTERSTATE BANKING AND BRANCHING LEGISLATION. Legislation enacted in 1994 is eliminating many restrictions on interstate banking. Effective September 29, 1995, this legislation authorized interstate acquisitions of banks by bank holding companies A-4 without geographic limitations. Beginning June 1, 1997, the legislation will eliminate certain restrictions on interstate branching under federal law in states that have not passed legislation prohibiting interstate branching, except that de novo branching or acquisition of a branch in another state without acquisition of the entire bank will only be permitted if expressly permitted by the law of the state in which such branch would be located. Interstate branching prior to June 1, 1997 will be possible in states that pass laws affirmatively authorizing such interstate branching. Prior to this legislation, interstate acquisitions of banks have required affirmative authorization in state law, and interstate branching has been possible only to a very limited degree. The effect of this legislation on Covenant cannot be predicted at this time. ITEM 2 -- PROPERTIES Covenant has sixteen personal banking centers in southern New Jersey, in the communities of Haddonfield, Moorestown, Waterford Township, Sicklerville, Voorhees, Linwood, Cape May Court House, the Greater Wildwoods, Vineland, Hammonton, Avalon, Sea Isle City, Cape May, Mt. Laurel and Cherry Hill. Covenant also has administrative offices adjacent to its main office in Haddonfield, New Jersey, and an operating center in Voorhees, New Jersey. Covenant leases its main office pursuant to a lease with an initial term of ten years ending October 31, 1997. The lease also contains two separate five-year renewal options and a right of first refusal in the event of sale by the landlord during the term of the lease. Covenant also leases its Linwood, Cape May Court House, Sea Isle City, Cape May, Hammonton, Mt. Laurel and Cherry Hill (land lease only) personal financial centers, and its administrative offices adjacent to its main office. Covenant owns all of its other personal financial centers and its Voorhees operations center free and clear of any mortgages or other material liens. ITEM 3 -- LEGAL PROCEEDINGS There are no material legal proceedings to which Covenant is a party or to which any of its property is subject. From time to time, Covenant is a party to various legal proceedings incident to its business. ITEM 4 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT To the knowledge of the Bank, based solely upon a review of Forms F-7, Forms F-8 and Forms F-8A, and amendments thereto, furnished to the Bank, and representations of such persons to the Bank, no director, officer or beneficial owner of more than 10% of any class of the Bank's capital stock has failed to file on a timely basis any report required by Section 16(a) of the Securities Exchange Act of 1934, as amended. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS. The following table describes, to the Bank's knowledge, the security ownership of those persons who own beneficially more than five percent (5%) of the Bank's Common Stock as of April 11, 1997:
NAME AND ADDRESS OF BENEFICIAL AMOUNT AND NATURE OF PERCENT OWNER BENEFICIAL OWNERSHIP (1) OF CLASS Richard A. Hocker 199,209 shares (2) 6.50% 107 E. Cottage Avenue Haddonfield, NJ 08033
(1) The information in this table is based on information furnished by the respective stockholders. Shares are deemed to be beneficially owned by a person if he or she directly or indirectly has or shares the power to vote or dispose of the shares, whether or not he or she has any economic interest in such shares. Unless otherwise indicated, the named beneficial owner has sole voting and dispositive power with respect to the shares. (2) Includes (i) 3,995 shares owned by Mr. Hocker's wife and 1,363 shares owned in custodial and trust accounts for the benefit of Mr. Hocker's daughter, and (ii) 129,365 shares issuable under stock options exercisable currently or within 60 days by Mr. Hocker. A-5 SECURITY OWNERSHIP OF DIRECTORS AND DIRECTORS AND OFFICERS AS A GROUP. The following table describes the security ownership of each director, each named executive officer and all directors and executive officers as a group as of April 11, 1997:
SERIES A SERIES B COMMON STOCK PREFERRED STOCK PREFERRED STOCK AMOUNT(1) PERCENT AMOUNT(1) PERCENT AMOUNT(1) PERCENT Directors: Barry M. Abelson................................ 4,213 (2) * % -- -- % 800 * % Thomas V.G. Brown............................... 2,729 * 7,000 5.06 -- -- William T. Carson, Jr........................... 49,824 (3) 1.68 3,000 2.17 2,000 1.24 John J. Gallagher, Jr........................... 66,600 (4) 2.25 4,000 (5) 2.89 6,046 (6) 3.74 Gary E. Greenblatt.............................. 29,482 (7) 1.00 -- -- 272 (8) * Richard A. Hocker............................... 199,209 (9) 6.50 5,000 (10) 3.62 37,000 (11) 22.88 James R. Iannone................................ 58,862 (12) 2.00 -- -- -- -- Joseph Maressa, Sr.............................. 41,131 (13) 1.40 -- -- 4,000 2.47 Charles E. Sessa, Jr............................ 55,727 (14) 1.87 -- -- 440 * Kyle W. Will.................................... 4,897 (15) * 2,000 1.45% 2,000 1.24 Named Executive Officers: Kenneth R. Mancini, Jr.......................... 27,873 (16) * -- -- 300 0.19 J. William Parker, Jr........................... 13,569 (17) * -- -- 320 (18) * Eugene D. D'Orazio, Jr.......................... 7,760 (19) * -- -- 148 * All directors and executive officers as a group (13 Persons).................................. 561,876 (20) 17.37% 21,000 15.18% 53,326 32.98%
* indicates less than 1% (1) The information in this table is based on information furnished by the respective stockholders. Shares are deemed to be beneficially owned by a person if he or she directly or indirectly has or shares the power to vote or dispose of the shares, whether or not he or she has any economic interest in such shares. Unless otherwise indicated, the named beneficial owner has sole voting and dispositive power with respect to the shares. (2) Includes 3,534 shares issuable under stock options exercisable currently or within 60 days by Mr. Abelson. (3) Includes 28,276 shares issuable under stock options exercisable currently or within 60 days by Mr. Carson. (4) Includes (i) 3,320 shares owned by Mr. Gallagher's wife, with respect to which beneficial ownership is disclaimed, 25,928 shares owned jointly with Mr. Gallagher's wife, 678 shares owned by his son and 320 shares owned in a custodial account for the benefit of Mr. Gallagher's daughter; (ii) 6,825 shares owned by Gallagher Associates Pension Trust Fund, in which Mr. Gallagher is a participant and as to which beneficial ownership is disclaimed; and (iii) 29,529 shares issuable under stock options exercisable currently or within 60 days by Mr. Gallagher. (5) Includes 2,000 shares owned by Gallagher Associates Pension Trust Fund, in which Mr. Gallagher is a participant and as to which beneficial ownership is disclaimed and 2,000 shares owned jointly with Mr. Gallagher's wife. (6) Includes (i) 2,660 shares owned by Gallagher Associates Pension Trust Fund, in which Mr. Gallagher is a participant and as to which beneficial ownership is disclaimed, (ii) 25 shares owned by Mr. Gallagher's wife, as to which beneficial ownership is disclaimed and (iii) 3,361 shares owned jointly with Mr. Gallagher's wife. (7) Includes (i) 3,149 shares owned by Mr. Greenblatt's wife, as to which beneficial ownership is disclaimed, and 531 shares in a custodial account for the benefit of Mr. Greenblatt's daughter; and (ii) 1,097 shares issuable under stock options exercisable currently or within 60 days by Mr. Greenblatt. (8) Shares owned by Mr. Greenblatt in a custodial account for the benefit of Mr. Greenblatt's daughter. (9) Includes (i) 3,995 shares owned by Mr. Hocker's wife, as to which beneficial ownership is disclaimed, and 1,363 shares owned in a custodial account for the benefit of Mr. Hocker's daughter; and (ii) 129,365 shares issuable under stock options exercisable currently or within 60 days by Mr. Hocker. (10) Includes 1,725 shares owned by Mr. Hocker's wife, as to which beneficial ownership is disclaimed. (11) Includes 800 shares owned by Mr. Hocker's wife, as to which beneficial ownership is disclaimed. A-6 (12) Includes (i) 25,138 shares as to which Mr. Iannone holds the power to vote pursuant to a power of attorney; and (ii) 1,724 shares owned in a custodial account for the benefit of Mr. Iannone's daughters. (13) Includes 3,534 shares issuable under stock options exercisable currently or within 60 days by Mr. Maressa. (14) Includes (i) 22 shares held by Mr. Sessa's wife in a custodial account for the benefit of Mr. Sessa's son; and (ii) 51,328 shares issuable under stock options exercisable currently or within 60 days by Mr. Sessa. (15) Includes 3,534 shares issuable under stock options exercisable currently or within 60 days by Mr. Will. (16) Includes 27,143 shares issuable under stock options exercisable currently or within 60 days by Mr. Mancini. (17) Includes 12,931 shares issuable under stock options exercisable currently or within 60 days by Mr. Parker. (18) Shares owned by Mr. Parker in a custodial account for the benefit of Mr. Parker's daughters. (19) Includes 7,323 shares issuable under stock options exercisable currently or within 60 days by Mr. D'Orazio. (20) Includes 297,594 shares issuable under stock options which are currently exercisable or become exercisable within 60 days. A-7 PART II ITEM 5 -- MARKET FOR THE BANK'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Bank's Common Stock is traded on the NNM under the symbol "CNSK." There are currently five market makers in Covenant Stock including: Janney Montgomery Scott Inc., Wheat First Butcher Singer, and Ryan, Beck & Co., Inc. Set forth below for each quarter of 1995 and 1996 are the low and high prices of the Bank's Common Stock during the fiscal quarter as reported by the NASDAQ National Market, Inc.
1995 LOW HIGH 1st Quarter............................................................ $7.60 $9.05 2nd Quarter............................................................ 7.60 8.76 3rd Quarter............................................................ 8.34 9.42 4th Quarter............................................................ 8.76 12.47 1996 1st Quarter............................................................ $10.89 $11.57 2nd Quarter............................................................ 11.32 11.79 3rd Quarter............................................................ 11.32 12.97 4th Quarter............................................................ 12.00 14.75
Note: The above prices have been adjusted to reflect all stock dividends issued on the Common Stock. The Bank has never paid a cash dividend on its Common Stock. The Bank has paid quarterly dividends of $.375 per share with respect to the Bank Preferred Stock, in accordance with the terms of the Bank Preferred Stock. Holders of the Preferred Stock are entitled to receive non-cumulative dividends at the rate of 6% of par value per annum before dividends are declared with respect to Bank Common Stock for such year. The declaration of such dividends, however, is discretionary with the Board of Directors. In the event the Board of Directors chooses not to declare a dividend in any year, such arrearage will not accumulate or be payable in future years, even though the Bank has earnings in such year. See "DESCRIPTION OF HOLDING COMPANY SECURITIES AND COMPARISON OF STOCKHOLDERS' RIGHTS." The Bank is subject to regulatory limitations on the payment of dividends. As a New Jersey bank, the Bank may not declare a cash dividend or a stock dividend unless, following payment of the dividend, the capital stock of the Bank will be unimpaired and the Bank will have a surplus of at least 50% of its capital stock or, if not, the payment of the dividend will not reduce the surplus of the Bank. In addition, the Department of Banking or the FDIC may restrict the ability of the Bank to pay dividends in certain circumstances, including if such payment would constitute an unsafe or unsound banking practice, if the Bank is not meeting certain capital requirements, or if the Bank is in default of any assessment to the FDIC. A-8 ITEM 6 -- SELECTED FINANCIAL DATA COVENANT BANK FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992 IN THOUSANDS, EXCEPT PER SHARE AMOUNTS Balance Sheet Data Total assets $414,634 $347,161 $316,722 $274,351 $210,129 Loans receivable, net...................................... 238,185 201,666 190,037 179,825 145,371 Investments available for sale............................. 132,578 57,178 16,823 20,604 17,034 Investments held to maturity............................... 11,687 50,343 79,518 24,923 12,422 Deposits................................................... 277,465 262,752 235,821 244,015 186,187 Stockholders' equity....................................... 29,251 29,909 22,376 21,645 20,288 Book value per share (5)................................... $7.45 $7.54 $6.44 $6.24 $5.85 Income Statement Data Net interest income........................................ 14,934 13,668 12,140 9,697 7,344 Provision for loan losses.................................. 636 314 682 1,043 947 Non-interest income........................................ 1,090 844 779 799 811 Non-interest expense....................................... 12,337 (1) 11,121 11,296 8,769 6,310 Income before income tax................................... 3,051 (1) 3,077 941 684 898 Net income................................................. $1,850 (4) $2,379 $1,281 $1,373 $ 712 Operating earnings -- pre-tax.............................. $4,701 (2) $3,077 $2,077 (3) $ 684 $ 898 Average common shares outstanding.......................... 4,069 3,761 3,535 3,454 3,018 Earnings per share......................................... $0.45 (4) $0.63 $0.36 $0.40 $0.24 Net interest margin........................................ 4.10% 4.37% 4.50% 4.24% 3.86% Profitability Statistics Pre-tax operating return on average assets................. 1.21% 0.93% 0.73% 0.28% 0.45% Return on average assets................................... 0.48 (4) 0.72 0.45 0.56 0.35 Return on average common equity............................ 6.30 (4) 9.53 5.72 6.68 4.30 Book value per share excluding FAS 115 valuation adjustment............................................... $7.53 $7.24 $6.51 $6.20 $5.85 Non-performing assets/total period end assets.............. 0.86 1.44 1.73 1.91 1.83 Allowance/non-performing loans............................. 105.23 86.84 77.95 86.33 137.42 Allowance/total loans...................................... 1.25 1.56 1.87 2.00 1.81 Net charge-offs/average loans outstanding.................. 0.36 0.37 0.38 0.77 0.46 Capital Measures Average stockholders' equity/average assets................ 7.56% 7.66% 7.70% 8.49% 8.24% Leverage ratio............................................. 7.51 8.49 7.42 7.87 9.88 Tier 1 capital ratio....................................... 11.98 13.62 11.68 11.52 13.88 Total capital ratio........................................ 13.20 14.87 12.94 12.78 14.83 Number of full-service offices............................. 15 14 13 11 6
Note: All data has been restated to reflect the 1996 merger with 1st Southern State Bank. All share data has been restated for all stock dividends issued on common stock to date. Covenant has not paid cash dividends on common stock to date; therefore, dividend payout ratio is not applicable. (1) Includes pre-tax merger-related costs of $1,147,000 and pre-tax one-time SAIF recapitalization assessment of $503,000. (2) Excludes pre-tax merger-related costs of $1,147,000 and pre-tax one-time SAIF recapitalization assessment of $503,000. (3) Excludes pre-tax merger-related costs of $1,136,000 recorded for the Landis Savings Bank, S.L.A. acquisition. (4) Excluding after-tax merger-related costs of $860,000 and after-tax one-time SAIF assessment of $323,000, operating earnings data is as follows:
1996 Operating earnings............................................................... $3,033 Operating earnings per share..................................................... $0.75 Operating return on average assets............................................... 0.78 % Operating return on average common equity........................................ 11.63 %
(5) Book value per share calculation includes SFAS 115 valuation adjustment. A-9 ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion is presented in conjunction with and should be read with the audited financial statements and the accompanying notes contained herein of Covenant Bank ("Covenant" or "the Bank") for the years 1996, 1995 and 1994. Tabular information is presented throughout this report in thousands of dollars, except for share and per share data. SUMMARY On September 27, 1996, Covenant consummated its acquisition of 1st Southern State Bank ("1st Southern"), thus adding three personal financial centers and $47.2 million to Covenant's assets. The pooling of interests method of accounting was used for this transaction and accordingly the financial statements contained herein have been restated to include 1st Southern for all periods presented. The acquisition resulted in the conversion of 1st Southern common stock outstanding as of September 27, 1996 to Covenant common stock at a rate of 1.55 shares of Covenant common stock for each share of 1st Southern common stock. Covenant recorded net income of $1.9 million, or $0.45 per share, for the year ended December 31, 1996. Net income includes one-time merger-related costs of $1,147,000 $(860,000, after-tax) (A) recorded in 1996 associated with the 1st Southern transaction. Net income for the year ended December 31, 1996 also includes a non-recurring Savings Association Insurance Fund ("SAIF") assessment of $503,000 $(322,700, after-tax). Excluding the merger-related costs and the SAIF assessment, Covenant reported for the year ended December 31, 1996 operating earnings of $3.0 million, or $0.75 per share, compared to $2.4 million, or $0.63 per share, for the year ended December 31, 1995. Covenant recorded net income of $1.3 million, or $0.36 per share, for the year ended December 31, 1994. Net income in 1994 included merger-related costs $(917,000, after-tax) as a result of Covenant's acquisition of Landis Savings Bank, S.L.A. Pre-tax operating earnings increased to $4.7 million or 52% (excluding the one-time merger related costs and non-recurring SAIF assessment) for the year ended December 31, 1996, compared to $3.1 million for 1995 and $2.1 million for 1994 (adjusted for pre-tax merger-related costs of $1.1 million). Covenant's enhanced pre-tax operating earnings performance in 1996 reflects higher net interest income primarily due to increased loan and investment balances, a reduction in the provision for loan losses (exclusive of $481,000, as described in Note A below), and increases in non-interest income coupled with a stabilization of non-interest expenses. Return on average assets was 0.48% and return on average common equity was 6.30% for the year ended December 31, 1996. Excluding the one-time merger-related costs and SAIF assessment, return on average assets was 0.78% and return on average common equity was 11.63% for the year ended December 31, 1996, compared to 0.72% and 9.53%, respectively, for the year ended December 31, 1995, and 0.45% and 5.72%, respectively, for the year ended December 31, 1994. In 1996, Covenant reached record levels of total assets, loans, investments and deposits. Total assets at December 31, 1996 equaled $414.6 million; representing an increase of $67.5 million or 19% over December 31, 1995 balances. Net loans increased 18% during 1996 to reach $238.2 million, compared to $201.7 million at December 31, 1995. Total investments grew to $144.3 million or 34% at December 31, 1996 from December 31, 1995's balance of $107.5 million. Total deposits reached $277.5 million at December 31, 1996, compared to $262.8 million at December 31, 1995. Total stockholders' equity stood at $29.3 million at December 31, 1996 compared to $29.9 million as of December 31, 1995. Non-performing assets at December 31, 1996 decreased $1.4 million or 28% to $3.6 million from $5.0 million at year-end 1995. Non-performing loans at December 31, 1996 amounted to $2.9 million, representing a 25% decrease from 1995's balance of $3.8 million. Non-performing loans as a percentage of total loans decreased to 1.19% at December 31, 1996, from 1.87% at December 31, 1995 as Covenant continued to identify and aggressively pursue problem credits. The allowance for loan loss as a percentage of non-performing loans increased to 105.23% at December 31, 1996, from 86.84% at December 31, 1995. (A) One-time merger-related charges consist of $666,000 of merger costs and a $481,000 provision for loan losses recorded during 1996 to align the two Banks' allowance for loan loss methodologies as to the credit and non-performing process. The total one-time merger-related charges of $1,147,000 are equal to $860,000 on an after-tax basis. A-10 RESULTS OF OPERATIONS NET INTEREST INCOME AND NET INTEREST MARGIN Net interest income is the difference between interest earned on loans and investments and interest incurred on deposits and other borrowed funds. Net interest income is affected by changes in both interest rates and the amounts of interest-earning assets and interest-bearing liabilities outstanding. Net interest income represents the principal source of income for Covenant Bank. Net interest income for the year 1996 was $14.9 million, compared to $13.7 million for 1995. The improvement in net interest income is directly related to the increase in average interest-earning assets for the year 1996 by $51.6 million or 16%, as compared to the average interest-earning asset balance in 1995. The increase in average interest-earning assets during 1996 as compared to 1995 was attributable to a $25.8 million or 13% growth in average loans and a $25.8 million or 22% growth in average investments. The yield on average interest-earning assets decreased by 32 basis points to 7.99% for 1996, compared to 8.31% for 1995, and was directly responsible for the 27 basis point decrease in the Bank's net interest margin between 1995 and 1996. The net interest margin for 1996 was 4.10%, compared to 4.37% for 1995. Competition in the southern New Jersey marketplace with respect to loan pricing has compelled Covenant to price loans and deposits to remain competitive and to draw and maintain market share. Net interest income for 1995 totaled $13.7 million compared to $12.1 million for 1994, representing an increase of $1.6 million. In 1995, average interest-earning assets increased by $42.8 million or 16% over 1994's balances. The increase in average interest-earning assets during 1995 as compared to 1994 was primarily attributable to a $34.8 million increase in the average investment portfolio balance, as well as a $8.1 million increase in the average loan portfolio. The yield on average interest-earning assets increased by 83 basis points to 8.31% for 1995, compared to 7.48% for 1994, but offsetting this increase was an increase in the cost of funds for interest-bearing liabilities of 111 basis points between 1994 and 1995, which contributed to the 13 basis point decrease in the net interest margin. Table 1 provides for each of the years 1996, 1995 and 1994 an analysis of the following: (i) average assets, liabilities and stockholders' equity, (ii) net interest income and the interest income earned and interest expense incurred for each major component of interest-earning assets and interest-bearing liabilities, as well as average rates earned and incurred, (iii) the net interest spread (the difference between the average yield earned on assets and the average rate incurred on liabilities) and (iv) the net yield on average interest-earning assets (the net interest margin). A-11
1996 1995 1994 AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE P INTEREST RATE BALANCE INTEREST RATE ASSETS Loans:(1) Commercial..................... $65,244 $6,127 9.39% $58,821 $5,885 10.00% $59,333 $5,013 8.45% Mortgage....................... 126,888 11,338 8.94 111,079 10,234 9.21 105,317 9,083 8.62 Consumer....................... 31,584 2,774 8.78 28,012 2,635 9.41 25,201 2,207 8.76 Total loans................. 223,716 20,239 9.05 197,912 18,754 9.48 189,851 16,303 8.59 Investments: Federal funds sold............. 6,867 366 5.33 9,715 572 5.89 15,573 569 3.65 Other short-term investments... -- -- -- -- -- -- 1,395 49 3.51 Investment securities.......... 133,755 8,493 6.35 105,140 6,673 6.35 63,105 3,267 5.18 Total investments........... 140,622 8,859 6.30 114,855 7,245 6.31 80,073 3,885 4.85 Total interest-earning assets................. 364,338 29,098 7.99% 312,767 25,999 8.31% 269,924 20,188 7.48% Allowance for loan losses........ (3,087 ) (3,486 ) (4,026 ) Cash and due from banks.......... 10,021 9,292 9,801 Other assets..................... 15,644 12,428 10,652 Total Assets................ $386,916 $331,001 $286,351 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Interest-bearing demand........ $27,644 $592 2.14% $24,730 $518 2.09% $23,641 $416 1.76% Statement savings.............. 43,221 1,038 2.40 42,849 1,132 2.64 51,927 1,269 2.44 Money market................... 21,906 639 2.92 22,494 630 2.80 28,041 681 2.43 Time deposits.................. 138,833 7,374 5.31 129,107 6,852 5.31 112,166 4,585 4.09 Total interest-bearing deposits.................. 231,604 9,643 4.16 219,180 9,132 4.17 215,775 6,951 3.22 FHLB advances and reverse repurchase agreements.......... 83,443 4,521 5.42 54,667 3,199 5.85 21,570 1,097 5.09 Total interest-bearing liabilities............... 315,047 14,164 4.50 273,847 12,331 4.50 237,345 8,048 3.39 Non-interest bearing deposits.... 39,331 29,562 24,414 Other liabilities................ 3,278 2,224 2,532 Stockholders' equity............. 29,260 25,368 22,060 Total Liabilities and Stockholders' Equity...... $386,916 $331,001 $286,351 Net Interest Income/Spread....... $14,934 3.49% $13,668 3.81% $12,140 4.09% Net Interest Margin.............. 4.10% 4.37% 4.50%
(1) Includes non-accruing loans. The effect of including such loans is to reduce the average rate earned on Covenant's loans. A-12 Table 2 presents the major factors that contributed to the changes in net interest income for the years ended December 31, 1996 and 1995 as compared to the respective previous periods. Amounts in brackets represent a decrease in interest income or expense.
YEAR ENDED DECEMBER 31, 1996 VS. 1995 1995 VS. 1994 TOTAL TOTAL RATE/ INCREASE RATE/ INCREASE VOLUME RATE VOLUME (DECREASE) VOLUME RATE VOLUME (DECREASE) Interest income: Commercial............................... $642 $(361) $(39 ) $242 $(43 ) $923 $(8 ) $872 Mortgage................................. 1,456 (309 ) (43 ) 1,104 496 620 35 1,151 Consumer................................. 336 (174 ) (23 ) 139 246 164 18 428 Federal funds sold....................... (168 ) (54 ) 16 (206 ) (214 ) 348 (131 ) 3 Other short-term investments............. -- -- -- -- (49 ) (49 ) 49 (49 ) Investment securities.................... 1,816 3 1 1,820 2,177 738 491 3,406 Total interest-earning assets......... 4,082 (895 ) (88 ) 3,099 2,613 2,744 454 5,811 Interest expense Interest-bearing demand.................. 61 12 1 74 20 79 3 102 Statement savings........................ 10 (103 ) (1 ) (94 ) (222 ) 103 (18 ) (137 ) Money market............................. (16 ) 27 (2 ) 9 (135 ) 104 (20 ) (51 ) Time deposits............................ 516 5 1 522 692 1,368 207 2,267 Borrowed funds........................... 1,684 (237 ) (125 ) 1,322 1,684 165 253 2,102 Total interest-bearing liabilities.... 2,255 (296 ) (126 ) 1,833 2,039 1,819 425 4,283 Net change in net interest income.......... $1,827 $(599 ) $ 38 $1,266 $574 $925 $29 $1,528
NON-INTEREST INCOME Non-interest income for the year ended December 31, 1996 totaled $1,090,000, compared to $844,000 for the same period of 1995, representing an increase of $246,000 or 29%. As Covenant continues to grow, management continues to focus on its core business to generate a greater base of non-interest income. Service charges on deposit accounts equaled $631,000 for 1996, an increase of $257,000 or 69% over 1995's level. The level of these fees have been enhanced by additional transaction volume and a significant increase in core deposit accounts. Loan servicing-related income amounted to $274,000 for 1996, compared to $248,000 in 1995. The increases in service charges on deposit accounts and loan servicing income was slightly offset by a $36,000 decrease in other income to $185,000 for 1996 from $221,000 for 1995 due to the discontinuance of a fee-based residential loan origination program during the latter part of 1995, offset by the implementation of ATM surcharging beginning in the second quarter of 1996. Non-interest income for the year ended December 31, 1995 totaled $844,000, compared to 1994's level of $779,000, representing an increase of $65,000 or 8%. Service charges on deposit accounts amounted to $374,000, representing a $74,000 or 25% increase over 1994's service charges. Loan servicing-related income for 1995 was $248,000, compared to $227,000 for the year ended December 31, 1994. Other income increased $17,000 between 1994 and 1995. The Bank reported gains on the sale of loans totaling $46,000 for the year ended December 31, 1994, which represented gains on the sale of mortgage loans which were recognized by Landis Savings Bank, S.L.A. ("Landis") prior to its acquisition by Covenant in September 1994. NON-INTEREST EXPENSE For 1996, non-interest expenses were $12.3 million, compared to $11.1 million for 1995. Expenses for 1996 included $666,000 of pre-tax merger costs associated with the 1st Southern acquisition and the pre-tax SAIF assessment of $503,000. Excluding these one-time charges, total non-interest expenses equaled $11.2 million for the twelve months ended December 31, 1996, compared to $11.1 million for the twelve month period ended December 31, 1995, representing a less than 1% increase. Total salaries and employee benefits were $6.4 million for 1996, compared to $6.0 million for 1995. The increase of $331,000 between 1995 and 1996 is primarily attributable to additional personnel to staff Covenant's new personal financial centers in Cape May Court House, Hammonton, Linwood and Mount Laurel, New Jersey coupled with staff additions to the A-13 commercial lending group during the latter part of 1995 to better position Covenant to take advantage of current and future opportunities in the commercial lending market. Occupancy costs equaled $1.6 million for 1996, compared to $1.4 million for 1995. The $207,000 increase in occupancy costs in 1996 over 1995 is attributable to expenses associated with the above-mentioned new personal financial centers and the establishment of an operations center in Voorhees, NJ during the second quarter of 1996. In 1996, a decrease of $145,000 occurred in data processing and other service costs due to Covenant's conversion to a more cost-efficient, state-of-the-art data processing system in September of 1996. Federal insurance premiums include the above-mentioned pre-tax SAIF recapitalization assessment of $503,000. Excluding the non-recurring assessment, federal insurance premiums decreased $206,000 in 1996 compared to 1995 due to a reduction in the Bank Insurance Fund premium rates. Advertising and promotion expenses decreased $35,000 to equal $173,000 for the year 1996, compared to $208,000 for 1995. Other expenses for 1996 were $1.6 million, compared to $1.7 million for 1995, representing a decrease of 6%. This decrease was attributable to the implementation of cost-containment strategies, which contributed to an improvement in Covenant's efficiency ratio to 69.25% for 1996, (excluding the one-time merger costs and non-recurring SAIF assessment), compared to 76.19% for 1995. For 1995, non-interest expenses were $11.1 million, compared to $11.3 million for 1994, which included pre-tax merger-costs of $809,000 related to the Bank's acquisition of Landis in September 1994. Salaries and employee benefits expenses were $6.0 million in 1995, compared to $5.3 million for 1994. The increase of $721,000 between 1994 and 1995 was primarily attributable to additions to the commercial lending group to ensure adequate staffing to enable Covenant to take advantage of current and future market opportunities. Occupancy costs totaled $1.4 million in 1995, compared to $1.3 million in 1994. Professional services decreased $151,000 between 1994 and 1995. Due to a reduction in Bank Insurance Fund premium rates in 1995, federal insurance premium rates were $387,000, which is $234,000 lower than 1994's expense of $621,000. Other expenses were $1.7 million in 1995, compared to $1.5 million in 1994. This increase was due to increased credit report volume, and increased fees related to the growth in the investment portfolio. The ratio of non-interest expenses to average assets for the year ended December 31, 1996 improved to 2.89% (excluding pre-tax merger costs associated with the 1st Southern acquisition and the pre-tax one-time SAIF assessment) from 3.36% for 1995 and 3.66% for 1994 (excluding merger costs associated with the Landis acquisition). A-14 FINANCIAL CONDITION LOAN PORTFOLIO The lending function is Covenant's principal business activity, and Covenant continues its mission to serve as a reliable source of credit to a diverse customer base. Covenant lends primarily to commercial borrowers in the southern New Jersey marketplace. Covenant's loan portfolio is diversified among commercial, residential and consumer loans, with 35% of the total loan portfolio comprised of residential mortgage loans and consumer loans at December 31, 1996. Table 3 sets forth information regarding Covenant's loan portfolio as of December 31, for each of the years 1992 through 1996.
1996 1995 1994 1993 1992 AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT Loans By Type COMMERCIAL Collateralized by: 1-4 family dwelling....... $5,435 2% $9,070 4% $7,635 4% $8,617 5% $7,032 5% multi-family, office building, retail center................. 15,500 6 13,739 7 11,840 6 11,127 6 10,969 7 accounts receivable, inventory, fixed assets................. 9,744 4 9,240 4 9,449 5 6,639 4 7,233 5 hotel, motel.............. 1,900 1 3,118 2 4,170 2 4,496 2 3,348 2 fishing/agricultural...... 4,563 2 3,938 2 4,127 2 3,442 2 3,706 2 land...................... 3,955 2 3,392 2 3,789 2 3,492 2 2,976 2 CD's, stock, bonds........ 9,076 4 8,123 4 6,781 3 10,216 6 2,732 2 other..................... 8,747 4 7,474 4 7,182 4 6,035 3 2,346 2 Unsecured................... 6,431 3 4,423 2 5,551 3 5,161 3 5,651 4 Total Commercial....... $65,351 27% $62,517 31% $60,524 31% $59,225 32% $45,993 31% MORTGAGE Construction................ 7,075 3% 3,346 2% 6,002 3% 4,872 3% 1,817 1% Collateralized by: 1-4 family................ 52,563 22 43,193 21 43,912 23 45,615 25 35,985 24 multi-family.............. 5,058 2 3,919 2 6,116 3 5,920 3 6,605 4 office building........... 21,989 9 20,315 10 15,417 8 14,027 8 10,209 7 retail center............. 19,843 8 24,141 12 19,586 10 17,388 9 16,873 11 hotel, motel.............. 13,183 5 9,823 5 7,587 4 5,643 3 2,644 2 other..................... 22,628 9 9,007 4 8,369 4 7,348 4 7,194 5 Total Mortgage......... $142,339 59% $113,744 54% $106,989 55% $100,813 55% $81,327 55% CONSUMER Installment................. 3,364 1% 3,730 2% 3,899 2% 2,527 1% 2,151 1% Home equity................. 30,262 13 25,372 13 22,902 12 21,307 12 19,345 13 Other....................... 134 0 55 0 28 0 12 0 5 0 Total Consumer......... $33,760 14% $29,157 15% $26,829 14% $23,846 13% $21,501 14% Total Loans................. $241,450 100% $205,418 100% $194,342 100% $183,884 100% $148,821 100% Unearned discounts and deferred loan fees........ (249) (557) (682) (389) (751) Loans receivable............ $241,201 $204,861 $193,660 $183,495 $148,070
The majority of Covenant's loans are located within the southern New Jersey marketplace, which is its only significant geographic concentration. During 1996, total loans increased $36.0 million or 18% from $205.4 million to $241.4 million. The increase in total loans has been concentrated within the commercial, commercial mortgage and residential loan portfolios. The increase in commercial and commercial mortgage loans outstanding during 1996 is directly related to a localized lending approach, coupled with personalized service and products that compete with larger institutions that enable Covenant to take advantage of current opportunities in the commercial lending market. The Bank's loan-to-deposit ratio was 87% at A-15 December 31, 1996 and 78% at December 31, 1995. The majority of Covenant's loan portfolio is categorized as secured by commercial and real estate properties (including home equity loans). Unsecured loans at December 31, 1996 amounted to $6.4 million or 2.66% of total loans, compared to $4.4 million or 2.15% and $5.6 million or 2.86% of total loans at December 31, 1995 and 1994, respectively. Covenant's policy continues to emphasize well-collateralized and properly structured loans and the promotion of long-term quality relationships with financially strong borrowers. At December 31, 1996, commercial and commercial mortgage loans totaled $155.1 million, representing 64% of Covenant's total loan portfolio. Covenant directs its lending efforts toward small- and medium-sized businesses that operate within its marketplace. Residential mortgage and consumer lending are segments of the lending market in which Covenant has developed a presence. Residential mortgages are the second largest component of Covenant's loan portfolio, encompassing 22%. At December 31, 1996, residential mortgages totaled $52.6 million; the majority of these loans are collateralized by 1-4 family dwellings. In 1996, Covenant discontinued a program of origination and sale of residential mortgage loans (without recourse) to the secondary market. There were no loans held for sale at December 31, 1996, as compared to $936,000 and $494,000 as of December 31, 1995 and 1994, respectively. Consumer loans amounted to $33.8 million at December 31, 1996. The largest segment of the consumer loan portfolio is home equity loans, which are fixed borrowings or variable rate lines of credit, and totaled $30.3 million at December 31, 1996. Covenant services loans for the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA). This service includes processing payments, maintaining escrow accounts, disbursing funds to FHLMC and FNMA, and engaging in collection activities, if necessary. The total amount of loans serviced for these parties was $14.4 million in 1996 and $16.0 million in 1995. Covenant received servicing fees of $75,000, $94,000, and $115,000 for 1996, 1995 and 1994, respectively. The maturity ranges of the loan portfolio and the amount of loans with predetermined interest rates and floating rates in each maturity range at December 31, 1996 are summarized in Table 4.
ONE TO OVER WITHIN FIVE FIVE ONE YEAR YEARS YEARS TOTAL Commercial.................................................. $28,102 $31,870 $5,379 $65,351 Mortgage.................................................... 7,856 39,812 94,671 142,339 Total....................................................... $35,958 $71,682 $100,050 $207,690 Fixed Rate.................................................. $9,085 $41,754 $63,611 $114,450 Variable Rate............................................... 26,873 29,928 36,439 93,240 Total....................................................... $35,958 $71,682 $100,050 $207,690
ASSET QUALITY Covenant manages asset quality and controls credit risk through diversification of its loan portfolio and the application of policies designed to foster sound underwriting and loan monitoring practices. Covenant's senior credit officer is charged with monitoring asset quality, establishing credit policies and procedures as approved by the Board of Directors, seeking the consistent application of these policies and procedures across the Bank, and adjusting policies as appropriate for changes in market conditions. The loan review process entails three levels of review, each made in accordance with the Bank's loan classification system. In general, the loan classification system makes use of the guidelines employed by federal and state regulators. At the first level, the Bank's loan officer reviews and assigns a rating to all new commercial and commercial real estate mortgage loans at the time of origination. At the second level, each loan officer's portfolio is independently reviewed by the loan review officer on a twelve-month schedule utilizing a threshold of $100,000 or more. The loan review officer reports directly to the Board of Directors and all findings are reported on a quarterly basis to the Loan Committee of the Board of Directors. The Bank, as part of its asset-monitoring procedures, requires officers to perform self-grading loan reviews, whereby each loan officer is responsible for self-grading his/her individual credits on a periodic basis, but not less than once a year. In addition, a monthly and quarterly reporting and review process is in place for monitoring those credits that have been identified as problematic or vulnerable in order to assess the Bank's progress in working toward a solution and to assist in determining an appropriate allowance for loan losses. These reports are reviewed with the Loan Committee of the Board and are reported to the full Board of Directors. A-16 NON-PERFORMING ASSETS Non-performing assets include loans that are not accruing interest (non-accruing loans), loans that have been restructured (a loan is categorized as restructured if the original interest rate on the loan, repayment terms, or both were restructured on a below-market basis, due to deterioration in the financial condition of the borrower), and real estate owned. Generally, loans are placed on non-accrual status when interest or principal becomes contractually 90 days past-due, unless, in Covenant's assessment, the value of collateral securing the loan adequately ensures the likelihood of the ultimate collection of all unpaid principal and interest and the loan is in the process of collection.
DECEMBER 31, 1996 1995 1994 1993 1992 Non-performing assets: Non-accruing loans: Commercial....................................................... $1,734 $2,045 $2,376 $1,981 $1,197 Mortgage......................................................... 931 1,536 1,526 1,943 556 Consumer......................................................... 201 263 262 328 211 Total.......................................................... 2,866 3,844 4,164 4,252 1,964 Restructured loans.................................................. -- -- 595 -- -- Total non-performing loans............................................ 2,866 3,844 4,759 4,252 1,964 Real estate owned................................................... 695 1,171 715 998 1,889 Total non-performing assets........................................... $3,561 $5,015 $5,474 $5,250 $3,853 Accruing loans 90 days past due....................................... $1,753 $993 $2,124 $2,058 $351 Non-performing loans as a percentage of loans......................... 1.19% 1.87% 2.45% 2.31% 1.32% Non-performing assets as a percentage of loans and real estate owned............................................................... 1.47% 2.43% 2.81% 2.84% 2.56% Non-performing assets as a percentage of total assets................. 0.86% 1.44% 1.73% 1.91% 1.83% Allowance as a percentage of non-performing loans..................... 105.23% 86.84% 77.95% 86.33% 137.42%
Non-accruing loans at December 31, 1996 and 1995 totaled $2.9 million and $3.8 million, respectively. Interest income recognized on non-accruing loans totaled $89,000 in 1996, $28,000 in 1995, and $195,000 in 1994. Had interest income on year-end non-accrual loans been paid at the contracted rates and due dates, Covenant would have recorded additional interest income in 1996, 1995 and 1994 of $273,000, $508,000, and $464,000, respectively. Restructured loans at December 31, 1994 totaled $595,000. Had interest income on restructured loans been paid in accordance with contracted rates, Covenant would have recorded additional interest income of $4,000 in 1994. There were no restructured loans at December 31, 1996, consequently, no interest income on restructured loans was recognized. Non-performing assets totaled $3.6 million or 1.47% of total loans and real estate owned at December 31, 1996, compared to $5.0 million or 2.43% of total loans and real estate owned at December 31, 1995. Non-performing loans at December 31, 1996 of $2.9 million represent a decrease of $978,000 when compared to December 31, 1995's balance of $3.8 million. At December 31, 1996, non-performing loans as a percentage of total loans were 1.19%, compared to 1.87% for 1995. These favorable variances show the significant progress Covenant has made in reducing problem loans primarily in the mortgage and commercial categories. The balance of real estate owned was $695,000 (six properties totaling $493,000 are residential) at December 31, 1996, compared to $1,171,000 at December 31, 1995. The decrease from 1995 to 1996 was due to the sale of fourteen properties for $1,319,000 offset by the addition of eight properties for $843,000, during 1996. The balance of real estate owned was $715,000 at December 31, 1994. All properties are reported at the lower of cost or fair value less estimated selling costs. The $760,000 increase in accruing loans 90 days past-due between December 31, 1995 and December 31, 1996 is related to the following: (1) two matured, well-collateralized commercial loans totaling $116,000 that are in the process of collection; (2) a $61,000 increase in commercial share loans that are 100% secured by certificates of deposit and are in the process of collection; (3) two commercial loans totaling $39,000 that are in the process of collection; (4) an increase of $544,000 in various residential and consumer loans that are well-collateralized and are in the process of collection. A-17 PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be adequate to absorb known and inherent losses in the portfolio. Management considers a variety of factors when establishing the allowance, such as the impact of current economic conditions, diversification of the loan portfolio, delinquency statistics, results of loan review and related classifications, the borrower's perceived financial and managerial strengths, the estimated adequacy of underlying collateral and other relevant factors. Consideration is also given to examinations performed by regulatory agencies. At December 31, 1996, the recorded investment in loans for which impairment has been recognized in accordance with FAS 114 and FAS 118 totaled $1.7 million, which have a valuation allowance of $199,000. Such valuation allowance is included in the allowance for loan losses. Table 6 sets forth information regarding Covenant's allowance for loan losses as of December 31, for each of the years 1992 through 1996.
DECEMBER 31, 1996 1995 1994 1993 1992 Balance at beginning of period......................................... $3,195 $3,623 $3,670 $2,699 $2,404 Acquired allowance for loan losses from NJS&L.......................... -- -- -- 1,039 -- Provision charged to operating expense................................. 636 314 682 1,043 947 Charge-offs: Commercial........................................................... (449) (865) (877) (1,208) (366) Mortgage............................................................. (417) (68) (125) (20) (283) Consumer............................................................. (124) (70) (59) (57) (24) Total Charge-offs...................................................... (990) (1,003) (1,061) (1,284) (673) Recoveries............................................................. 175 261 332 173 21 Net charge-offs........................................................ (815) (742) (729) (1,111) (652) Balance at end of period............................................... $3,016 $3,195 $3,623 $3,670 $2,699 Net charge-offs as a percentage of average loans....................... 0.36% 0.37% 0.38% 0.77% 0.46% Allowance as a percentage of period-end loans.......................... 1.25% 1.56% 1.87% 2.00% 1.81% Allowance as a percentage of non-performing loans...................... 105.23% 86.84% 77.95% 86.33% 137.42% Allowance as a percentage of non-performing assets..................... 84.70% 63.71% 66.19% 69.92% 70.05%
Management is consistently informed of changes in economic indicators which may have impact, either positive or adverse, on asset quality, the allowance for loan losses, potential charge-offs and delinquencies. The provision for loan losses charged against earnings was $636,000 in 1996, compared to $314,000 in 1995, an increase of 103%. A substantial portion ($481,000) of the provision in 1996 was taken in connection with the acquisition of 1st Southern, and reflects the conformance of 1st Southern reserves for loan losses to the Bank's policies with respect thereto. Asset quality in the Bank's loan portfolio continues to be at reasonable levels. Net charge-offs as a percentage of average loans was 0.36% for 1996, compared to 0.37% for 1995. The Bank's allowance for loan losses as a percentage of non-performing loans and as a percentage of non-performing assets increased to 105.23% and 84.70%, respectively, at December 31, 1996, compared to 86.84% and 63.71%, respectively, at December 31, 1995. A-18 Table 7 sets forth Covenant's allocation of the allowance for loan losses as of December 31, for each of the years 1992 through 1996. The allocation of the allowance for loan losses in Table 7 is based upon historical experience and the Bank's review of each specific loan category in which future losses may ultimately occur. However, the entire allowance for loan losses is available to absorb further loan losses in any category. Covenant is unable to determine in which category future charge-offs and recoveries may occur.
DECEMBER 31, 1996 1995 1994 1993 1992 % OF % OF % OF % OF GROSS GROSS GROSS GROSS LOANS LOANS LOANS LOANS AMOUNT (1) AMOUNT (1) AMOUNT (1) AMOUNT (1) AMOUNT Commercial......................... $1,088 27% $1,484 31% $1,817 31% $1,609 32% $1,375 Mortgage........................... 1,619 59 1,390 54 1,427 55 1,302 55 827 Consumer........................... 309 14 321 15 379 14 759 13 497 Total............................ $3,016 100% $3,195 100% $3,623 100% $3,670 100% $2,699 % OF GROSS LOANS (1) Commercial......................... 31% Mortgage........................... 55 Consumer........................... 14 Total............................ 100%
(1) Represents the amount of loans in each category as a percentage of gross loans. Note: Unallocated reserves have been allocated proportionately to each category. INVESTMENT SECURITIES Table 8 summarizes the fair value of investments available for sale and the amortized cost of investments held to maturity at December 31, 1996, 1995 and 1994, respectively. See Note 4 of "COVENANT BANK NOTES TO FINANCIAL STATEMENTS" for information relating to fair values.
DECEMBER 31, 1996 1995 1994 Investments Available For Sale U.S. Treasury.............................. $132,578 $57,178 $16,823 Investments Held to Maturity U.S. Treasury........................................................... -- 38,091 72,795 Obligations of U.S. Government Agencies................................. 7,209 10,596 6,745 Federal Home Loan Bank Stock............................................ 4,478 1,656 900 Total Investments Held to Maturity........................................ $11,687 $50,343 $80,440
Investment securities were $144.3 million at December 31, 1996, compared to $107.5 million at December 31, 1995. The increase in investment securities during 1996 was the result of additional purchases of US Treasury Notes classified as "Available for Sale" which were funded with securities sold under agreements to repurchase, FHLB advances and deposits. In December, 1995, the Bank responded to a Special Report issued by the Financial Accounting Standards Board by reclassifying a portion of its investment securities from the "Held to Maturity" category to the "Available for Sale" category. Covenant reclassified US Treasury Notes with a book value of $45.4 million and a fair value of $46.8 million, resulting in a $0.9 million unrealized holding gain, after related income taxes, that was credited to stockholders' equity on the Statement of Financial Condition contained herein. Management reclassified only those securities with scheduled maturities beyond March 31, 1997 due to interest rate sensitivity issues. At December 31, 1996, the fair value of investments available for sale was $132.6 million, resulting in unrealized holding losses of $0.5 million. At December 31, 1995, the fair value of investments available for sale was $57.2 million, resulting in unrealized holding gains of $1.8 million. At December 31, 1996, investments held to maturity totaled $11.7 million, compared to $50.3 million at December 31, 1995. The decline is primarily due to maturities of $41.7 million during 1996. The fair values of these investments were $11.8 million at December 31, 1996 and $50.6 million at December 31, 1995, respectively. Investments held to maturity are classified as such and are carried at amortized cost. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as investments available for sale and carried at fair value. A-19 Covenant's investment portfolio is comprised of US Government securities, Federal Agency mortgage-backed securities and Federal Home Loan Bank ("FHLB") stock. The portfolio generates substantial interest income, serves as a source of liquidity and is utilized as a tool in managing interest rate sensitivity. Portions of the portfolio are also used to secure public deposits and serve as collateral for repurchase transactions. The investment portfolio also plays a significant role in the asset/liability management process. Among other things, the investment portfolio is utilized to balance the interest sensitivity of the prime-based portion of the loan portfolio. Table 9 sets forth Covenant's securities portfolio by contractual maturity distribution and weighted average yield as of December 31, 1996.
ONE TO FIVE FIVE TO TEN NO STATED ONE YEAR OR LESS YEARS YEARS OVER TEN YEARS MATURITY AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED COST YIELD COST YIELD COST YIELD COST YIELD COST YIELD Investments Held to Maturity: U.S. Treasury.................... $ -- -- % $ -- -- % $ -- -- % $ -- -- % $ -- -- % Obligations of U.S. Government Agencies....................... -- -- -- -- -- -- 7,209 6.70 % -- -- % Federal Home Loan Bank stock..... -- -- -- -- -- -- -- -- 4,478 6.48 % Total.............................. $ -- -- % $ -- -- % $ -- -- % $7,209 6.70 % $4,478 6.48 % TOTAL AMORTIZED COST YIELD Investments Held to Maturity: U.S. Treasury.................... $ -- -- % Obligations of U.S. Government Agencies....................... 7,209 6.70 % Federal Home Loan Bank stock..... 4,478 6.48 % Total.............................. $11,687 6.64 %
ONE TO FIVE FIVE TO TEN NO STATED ONE YEAR OR LESS YEARS YEARS OVER TEN YEARS MATURITY FAIR FAIR FAIR FAIR FAIR VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD Securities Available for Sale: U.S. Treasury......... $28,171 6.94 % $77,198 6.30 % $27,208 6.10 % $ -- -- % $ -- -- % TOTAL FAIR VALUE YIELD Securities Available for Sale: U.S. Treasury......... $132,578 6.30 %
DEPOSITS Covenant's predominant source of funds is depository accounts. Covenant's deposit base is comprised of demand deposits, savings and money market accounts, time deposits and individual retirement accounts (IRA's). Deposits are held by individuals and businesses located within the southern New Jersey marketplace. Covenant gathers deposits from a diverse customer base and accepts deposits from local municipalities within the guidelines of the New Jersey Government Unit Deposit Protection Act (GUDPA). Covenant has no brokered deposits. Deposits totaled $277.5 million at December 31, 1996, compared to $262.8 million at December 31, 1995, representing a $14.7 million or 6% increase. Of the increase in deposits, $7.5 million is attributable to increases in non-interest demand accounts. The remainder is due to increases in interest-bearing demand, savings and money market balances $(4.7 million) and time deposits $(2.5 million). Table 10 sets forth the major classifications of deposits at December 31, 1996, 1995 and 1994.
1996 1995 1994 WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RATE AMOUNT PERCENT RATE AMOUNT PERCENT RATE AMOUNT PERCENT Noninterest-bearing deposits.................... 0.00 % $41,868 15% 0.00 % $34,347 13% 0.00 % $25,625 11% Interest-bearing deposits: Demand...................... 2.15 % 34,757 13% 2.09 % 26,517 10% 1.76 % 25,009 11% Statement savings........... 2.40 % 40,257 15% 2.64 % 44,756 17% 2.44 % 45,563 19% Money market................ 2.92 % 21,155 8% 2.80 % 20,215 8% 2.43 % 24,350 10% Time deposits............... 5.31 % 139,428 50% 5.31 % 136,917 52% 4.09 % 115,274 49% Total deposits................ 3.56 % $277,465 100% 3.67 % $262,752 100% 2.89 % $235,821 100%
The aggregate amounts of certificates of deposit of $100,000 or more at December 31, 1996, 1995 and 1994 were $37,035,000, $42,976,000 and $30,046,000, respectively. A-20 A summary of certificates of deposit of $100,000 or more by maturity is shown in Table 11.
1996 AMOUNT PERCENT Within one year....................................................... $35,798 97% One to two years...................................................... 837 2% Two to three years.................................................... 400 1% Three to four years................................................... -- -- Four to five years.................................................... -- -- Over five years....................................................... -- -- $37,035 100%
BORROWINGS Sources of funds for Covenant other than deposits include FHLB advances and securities sold under agreements to repurchase. FHLB advances were $20.5 million at December 31, 1996 and $14.5 million at December 31, 1995. Securities sold under agreements to repurchase totaled $84.0 million at December 31, 1996 and $37.6 million at December 31, 1995. The increase in securities sold under agreements to repurchase was directly related to purchases of investments available for sale as noted in the investment section and the net increase in loans. Table 12 summarizes information regarding securities sold under agreements to repurchase.
DECEMBER 31, 1996 1995 1994 Balance................................................................. $84,037 $37,582 $38,795 Weighted average interest rate at December 31........................... 5.72% 5.74% 6.29% Maximum amount outstanding during the period............................ 96,088 62,715 49,737 Average amount outstanding during the period............................ 72,358 46,774 13,657 Weighted average interest rate during the period........................ 5.30% 5.93% 5.04%
ASSET AND LIABILITY MANAGEMENT Covenant monitors its sensitivity to interest rate changes and its liquidity and capital position through its asset and liability management process. Covenant's objectives include (i) controlling interest rate exposure, (ii) ensuring adequate liquidity, (iii) maintaining a strong capital position and (iv) maximizing net interest income opportunities. Covenant manages these objectives centrally through its Asset Liability Management Committee (ALCO). INTEREST RATE SENSITIVITY Covenant seeks to manage its interest sensitivity position to maximize earnings and minimize the risk associated with interest rate movements through the use of a "gap analysis" on a monthly basis. The gap analysis assesses the interest rate risk that arises from differences in the volumes of assets and liabilities that mature or reprice within a given period. A "positive" gap position results when the amount of interest-sensitive assets exceeds that of interest-sensitive liabilities, signifying that the net interest margin will be positively affected by rising rates and negatively affected by falling rates (i.e., liability-sensitive position); conversely, a "negative" gap position results when the amount of interest-sensitive liabilities exceeds that of interest-sensitive assets, indicating that the net interest margin will be negatively affected by rising rates and positively affected by falling rates. However, the Bank's gap position does not necessarily predict the impact of changes in general levels of interest rates or net interest income due to assumptions made as to repricing and maturities of certain products. A-21 Decisions are also based on "dynamic shock analysis," a process that entails the application of different prime rate increase or decrease scenarios to the current maturity/repricing structure. This analysis measures the impact on net interest income of each of the scenarios applied relative to Covenant's interest rate risk management policy guidelines, and seeks to identify appropriate measures to maintain the interest sensitivity of net interest income within such policy guidelines. Table 13 illustrates the gap position of Covenant Bank as of December 31, 1996.
NON-INTEREST ONE TO OVER SENSITIVE 1-90 91-180 181-365 THREE THREE ASSETS/ DAYS DAYS DAYS YEARS YEARS LIABILITIES Rate sensitive assets: Interest earning assets Loans............................... $92,473 $6,162 $12,338 $36,582 $90,879 $ -- Investment securities............... -- 7,023 21,149 64,257 51,836 -- Federal funds sold.................. 3,100 -- -- -- -- -- Total interest earning assets..... 95,573 13,185 33,487 100,839 142,715 -- Non-interest earning assets........... -- -- -- -- -- 28,835 Total assets...................... $95,573 $13,185 $33,487 $100,839 $142,715 $28,835 Rate sensitive liabilities: Interest bearing demand............. $26,068 $ -- $ -- $4,345 $4,344 $ -- Statement savings................... 30,150 -- -- 5,058 5,049 -- Money market........................ 15,866 -- -- 2,645 2,644 -- Time deposits....................... 59,660 26,830 26,824 13,305 12,809 -- Borrowings.......................... 95,537 1,000 -- 3,000 5,000 -- Total interest bearing liabilities..................... 227,281 27,830 26,824 28,353 29,846 -- Non-interest bearing liabilities...... -- -- -- -- -- 45,249 Stockholders' equity.................. -- -- -- -- -- 29,251 Total liabilities and stockholders' equity............ $227,281 $27,830 $26,824 $28,353 $29,846 $74,500 Interest rate sensitivity GAP......... $(131,708) $(14,645 ) $6,663 $72,486 $112,869 $(45,665) Cumulative GAP........................ $(131,708) $(146,353) $(139,690) $(67,204) $45,665 Cumulative GAP as a percentage of total interest earning assets....... -34.14% -37.94% -36.21% -17.42% 11.84% TOTAL Rate sensitive assets: Interest earning assets Loans............................... $238,434 Investment securities............... 144,265 Federal funds sold.................. 3,100 Total interest earning assets..... 385,799 Non-interest earning assets........... 28,835 Total assets...................... $414,634 Rate sensitive liabilities: Interest bearing demand............. $34,757 Statement savings................... 40,257 Money market........................ 21,155 Time deposits....................... 139,428 Borrowings.......................... 104,537 Total interest bearing liabilities..................... 340,134 Non-interest bearing liabilities...... 45,249 Stockholders' equity.................. 29,251 Total liabilities and stockholders' equity............ $414,634 Interest rate sensitivity GAP......... Cumulative GAP........................ Cumulative GAP as a percentage of total interest earning assets.......
The gap analysis table is intended to illustrate the maturity/repricing characteristics of Covenant's interest-earning assets and interest-bearing liabilities as of December 31, 1996. The analysis is based on contractual maturities and, where applicable, management's estimates of the repricing characteristics of various assets and liabilities and on assumptions as to customer behavior. The gap analysis presented in Table 13 indicates a liability-sensitive position through the one-year time period beginning December 31, 1996. During 1995 and 1996, Covenant increased its investment in US Treasury Notes with maturities beyond one year that have been funded by growth in deposits and short-term (three months or less) securities sold under agreements to repurchase and FHLB advances. This transaction is primarily responsible for the liability-sensitive position as of December 31, 1996. Covenant's net interest income has not been subject to the degree of sensitivity indicated by this traditional gap analysis. Interest-bearing core deposits (interest-bearing demand, statement savings and money market deposits) have no contractual maturity; therefore, management has assigned a repricing interval of 1-90 days for 75% of the balance outstanding of each category, with the remaining 25% of the total core deposit balance included in the one- to three-year category. This allocation is based on management's recent experience regarding deposit changes and market conditions. In monitoring interest sensitivity, adjustments are made to the dynamic shock assumptions to reflect management's recent experience regarding the impact of product pricing, interest rate spread relationships and customer behavior. These marginal adjustments are necessarily subjective and will vary over time with loan and deposit changes and market conditions. The investment portfolio is utilized to manage the Bank's gap position, interest rate spread and to mitigate overall maturity risk in the portfolio. A-22 LIQUIDITY Adequate liquidity is necessary to meet the borrowing needs and deposit withdrawal requirements of customers as well as to satisfy liabilities, fund operations and support asset growth. Maintaining an appropriate level of liquid funds through the asset/liability management process ensures that the needs of the Bank are met at a reasonable cost. Therefore, the management of liquidity is coordinated with the management of Covenant's interest sensitivity and capital position. Major sources of liquidity are core deposits, cash flow generated by the Bank's investment and loan portfolios, and short-term borrowings. Earnings and funds provided by operations also serve as a source of liquidity. Cash and cash equivalents equaled $15.5 million at December 31, 1996, representing a decrease of $7.3 million from the $22.8 million balance at December 31, 1995. During 1996, the Bank purchased $77.9 million of US Treasury Notes with various maturities beyond one year and classified as "Available for Sale," and the Bank purchased $3.8 million of FHLB stock and U.S. Government agency securities classified as "Held to Maturity," offset by proceeds from maturities of investments held to maturity of $41.6 million. In addition, a net increase of $36.8 million in loans contributed to a net cash used in investing activities totaling $76.6 million as shown on the Statement of Cash Flows for 1996. Covenant funded the net cash used in investing activities by a $46.5 million increase in securities sold under agreements to repurchase, a $6.0 million increase in FHLB advances and a $14.7 million increase in deposits. Covenant places a strong emphasis on the composition of the investment portfolio as a source of liquidity. Additional sources of liquidity are available to Covenant through the purchase of federal funds and borrowings on approved lines of credit. On measure of Covenant's liquidity is the FDIC liquidity ratio. This ratio measures net cash, short-term investments and marketable assets divided by net deposits and short-term liabilities. Covenant's liquidity ratio at December 31, 1996 was 23%. Overall, based on the Bank's core deposit base, and its available sources of borrowed funds, management believes that Covenant's liquidity position remains at an adequate level. CAPITAL The maintenance of appropriate levels of capital is a management priority and an important objective of Covenant's asset and liability management process. Covenant's principle capital planning goals are to provide an adequate return to stockholders, to support Covenant's growth and expansion activities, to provide stability to current operations and to promote public confidence. At December 31, 1996, Covenant met the definition of a "well-capitalized" institution. See Note 13 of "COVENANT BANK NOTES TO FINANCIAL STATEMENTS" (Regulatory Matters) for additional information regarding various regulatory capital requirements. Table 14 sets forth Covenant's minimum regulatory capital requirements and compliance therewith as of December 31, 1996 and 1995.
1996 1995 Stockholders' equity to total assets.................................... 7.05 % 8.62 % Leverage ratio.......................................................... 7.51 % 8.49 % Risk-based capital ratios: Tier 1................................................................ 11.98% 13.62% Total capital......................................................... 13.20% 14.87%
INCOME TAXES The provision for income taxes for 1996 was $1.2 million compared to $0.7 million for 1995. The effective tax rate, which is the ratio of income tax expense to income before income taxes, was 39% in 1996, up from 23% in 1995, due to the non-deductible merger expenses incurred during 1996 and a smaller reduction in the valuation allowance for deferred tax assets recorded during 1996 vs. 1995. References should be made to Note 15 of the "COVENANT BANK NOTES TO FINANCIAL STATEMENTS" for an additional analysis of the provision for income taxes. At December 31, 1996, deferred tax assets amounted to $1.4 million and deferred tax liabilities amounted to $0.3 million. Under SFAS NO. 109, a valuation allowance is required to be provided for the deferred tax assets to the extent it is more likely than not that they will not be realized. At December 31, 1996 the net change in the valuation allowance for the year ended December 31, 1996 was a decrease of $74,000. This change resulted from a reassessment of the realizability of the existing net deductible temporary differences which give rise to the net deferred income tax asset. Based upon the Bank's tax history and anticipated level of future taxable income, management believes the existing net deductible temporary differences will, more-likely-than-not, reverse in future periods in which the Bank generates net taxable income. A-23 NEW ACCOUNTING PRONOUNCEMENTS In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 (SFAS 125), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Principally, SFAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on the consistent application of a financial components approach (for example, focus on assets and liabilities that remain after the transfer takes place) that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. In addition, SFAS 125 extends the "available for sale" or "trading" approach of SFAS 115 to all financial assets that contractually can be prepaid or otherwise settled in such a way that the holder of the asset would not recover substantially all of its recorded investment. Such financial assets can no longer be classified as held to maturity. SFAS 125 is effective for transfers of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. Earlier or retroactive application is not permitted. The extension of SFAS 125 to all financial assets subject to prepayment risk is effective for financial assets held on or after January 1, 1997. Management does not believe that this statement will have a material effect on the Bank's financial position or results of operations. A-24 (KPMG Peat Marwick LLP logo) The Board of Directors Covenant Bank We have audited the accompanying statement of financial condition of Covenant Bank as of December 31, 1996, and the related statements of operations, changes in stockholders' equity, and cash flows for the year then ended. We have also audited the accompanying statement of financial condition of Covenant Bank as of December 31, 1995, and the related statements of operations, changes in stockholders' equity, and cash flows for the year then ended, prior to their restatement for the 1996 pooling-of-interests transaction described in Note 2 to the financial statements. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Covenant Bank for the year ended December 31, 1994, prior to their restatement for the 1996 pooling-of-interests transaction described in Note 2 to the financial statements, were audited by other auditors whose report dated January 19, 1995, expressed an unqualified opinion on those statements. Separate financial statements of 1st Southern State Bank also included in the 1995 and 1994 restated financial statements were audited by other auditors whose report dated January 16, 1996, expressed an unqualified opinion on those statements. The report of the other auditors has been furnished to us, and our opinion, insofar as it relates to the amounts included for 1st Southern State Bank, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Covenant Bank as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. We also audited the combination of the accompanying statement of financial condition as of December 31, 1995 and the statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 1995 and 1994, after restatement for the 1996 pooling-of-interests; in our opinion, such statements have been properly combined on the basis described in Note 2 of the notes to the financial statements. KPMG PEAT MARWICK, LLP January 27, 1997 Philadelphia, Pennsylvania A-25 (Moore & Fitzpatrick LLC logo) Kenneth W. Moore, CPA, RMA, PFS Members of American Institute Thomas J. Fitzpatrick, CPA, PFS of Certified Public Accountants Leon P. Costello, CPA, RMA New Jersey Society of Certified Public Accountants REPORT OF INDEPENDENT AUDITORS The Board of Directors 1st Southern State Bank: We have audited the statement of financial condition of 1st Southern State Bank as of December 31, 1995, and the related statements of income, changes in stockholders' equity, and cash flows for each of the years in the two-year period then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of 1st Southern State Bank as of December 31, 1995, and the results of their operations and their cash flows for each of the years in the two-year period then ended in conformity with generally accepted accounting principles. MOORE & FITZPATRICK, LLC CERTIFIED PUBLIC ACCOUNTANTS January 16, 1996 200 S. Shore Road P.O. Box 523 Marmora, New Jersey 08223 Phone (609) 390-3600 Fax (609) 390-0056 Bank Street Commons Suite 150 510 Bank Street, Cape May, New Jersey 08204 Phone (609) 898-9600 Fax (609) 898-9568 207 Locust Street Turnersville, New Jersey 08012 Phone (609) 232-1520 Fax (609) 232-1521 A-26 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of Covenant Bank: We have audited the statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 1994. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statements of operations, changes in stockholders' equity and cash flows are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statements of operations, changes in stockholders' equity and cash flows. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the statements of operations, changes in stockholders' equity and cash flows. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of its operations and its cash flows for the year ended December 31, 1994, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania January 19, 1995 A-27 COVENANT BANK STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 1995 (IN THOUSANDS, EXCEPT SHARE DATA) Assets: Cash and due from banks............................................................................ $ 12,446 $ 10,788 Federal funds sold................................................................................. 3,100 11,989 Cash and cash equivalents..................................................................... 15,546 22,777 Investments available for sale..................................................................... 132,578 57,178 Investments held to maturity (fair value 1996-$11,743; 1995-$50,635)............................... 11,687 50,343 Loans held for sale................................................................................ -- 936 Loans receivable................................................................................... 241,201 204,861 Less allowance for loan losses................................................................... 3,016 3,195 Loans receivable, net......................................................................... 238,185 201,666 Premises and equipment, net........................................................................ 9,135 7,749 Real estate owned.................................................................................. 695 1,171 Accrued interest receivable........................................................................ 3,913 3,523 Deferred income taxes, net......................................................................... 1,076 427 Other assets....................................................................................... 1,819 1,391 Total Assets.................................................................................. $414,634 $347,161 Liabilities: Non-interest bearing deposits...................................................................... $ 41,868 $ 34,347 Interest bearing deposits.......................................................................... 96,169 91,488 Time deposits...................................................................................... 139,428 136,917 Total deposits................................................................................ 277,465 262,752 Advances from The Federal Home Loan Bank........................................................... 20,500 14,500 Securities sold under agreements to repurchase..................................................... 84,037 37,582 Other liabilities.................................................................................. 3,381 2,418 Total Liabilities............................................................................. 385,383 317,252 Commitments and Contingencies Stockholders' Equity: Convertible preferred stock, authorized 300,000 shares; Series "A", $25 par value: 138,300 shares issued and outstanding................................. 3,457 3,457 Series "B", $25 par value: 161,700 shares issued and outstanding................................. 4,043 4,043 Common stock, $5 par value: authorized 5,000,000 shares; issued and outstanding 2,906,262 and 2,711,800 shares, respectively................................................................... 14,531 13,559 Additional paid-in capital......................................................................... 10,614 9,212 Net unrealized gain (loss) on investments available for sale, net of deferred income taxes......... (305) 1,157 Accumulated deficit................................................................................ (3,089) (1,519) Total Stockholders' Equity.................................................................... 29,251 29,909 Total Liabilities and Stockholders' Equity.................................................... $414,634 $347,161
See accompanying notes to financial statements. A-28 COVENANT BANK STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 1995 1994 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Interest Income Interest and fees on loans.................................................. $ 20,239 $ 18,754 $ 16,303 Interest on investment securities........................................... 8,493 6,673 3,267 Other interest income....................................................... 366 572 618 Total interest income.................................................... 29,098 25,999 20,188 Interest Expense Interest on deposits........................................................ 9,643 9,132 6,951 Interest on borrowings...................................................... 4,521 3,199 1,097 Total interest expense................................................... 14,164 12,331 8,048 Net interest income........................................................... 14,934 13,668 12,140 Provision for loan losses..................................................... 636 314 682 Net interest income after provision for loan losses........................... 14,298 13,354 11,458 Non-interest Income Service charges on deposit accounts......................................... 631 374 300 Gain on sale of investment securities....................................... -- 1 2 Gain on sale of loans....................................................... -- -- 46 Loan servicing-related income............................................... 274 248 227 Other income................................................................ 185 221 204 Total other income....................................................... 1,090 844 779 Non-interest Expense Salaries and employee benefits.............................................. 6,367 6,036 5,315 Occupancy................................................................... 1,610 1,403 1,323 Data processing and other service costs..................................... 681 826 847 Professional services....................................................... 524 491 642 Advertising and promotion................................................... 173 208 227 Federal insurance premiums.................................................. 684 387 621 Amortization of organizational costs........................................ -- 40 49 Merger costs................................................................ 666 -- 809 Other expenses.............................................................. 1,632 1,730 1,463 Total other expenses..................................................... 12,337 11,121 11,296 Income before income taxes.................................................... 3,051 3,077 941 Income taxes (benefit)........................................................ 1,201 698 (340) Net income.................................................................... 1,850 2,379 1,281 Less dividends on preferred stock............................................. 450 268 208 Net income applicable to common stock......................................... $ 1,400 $ 2,111 $ 1,073 Earnings per share: (1)....................................................... $ 0.45 $ 0.63 $ 0.36 Weighted average common shares outstanding, including common stock equivalents................................................................. 4,068,680 3,760,524 3,534,979
(1) Earnings per share data has been restated to reflect the common stock dividends declared in 1996 and 1995. See accompanying notes to financial statements. A-29 COVENANT BANK STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NET UNREALIZED GAIN(LOSS), ADDITIONAL NET OF PREFERRED COMMON PAID-IN DEFERRED ACCUMULATED STOCK STOCK CAPITAL INCOME TAXES DEFICIT (IN THOUSANDS, INCLUDING SHARE DATA) Balance at January 1, 1994................................. $ 3,457 $12,138 $ 7,553 $ 140 $(1,643) Net income................................................. -- -- -- -- 1,281 Preferred stock dividend................................... -- -- -- -- (208) Adjustment to unrealized gain (net of tax)................. -- -- -- (394) -- Common stock dividends and other (106 shares).............. -- 531 654 -- (1,133) Balance at December 31, 1994............................... $ 3,457 $12,669 $ 8,207 $ (254) $(1,703) Net income................................................. -- -- -- -- 2,379 Issuance of preferred stock series "B"..................... 4,043 -- (60) -- Preferred stock dividend................................... -- -- -- -- (268) Adjustment to unrealized gain (net of tax)................. -- -- -- 1,411 -- Common stock dividends and other (178 shares).............. -- 890 1,065 -- (1,927) Balance at December 31, 1995............................... $ 7,500 $13,559 $ 9,212 $1,157 $(1,519) Net income................................................. -- -- -- -- 1,850 Preferred stock dividend................................... -- -- -- -- (450) Adjustment to unrealized gain (net of tax)................. -- -- -- (1,462) -- Common stock dividends and other (194 shares).............. -- 972 1,402 -- (2,970) Balance at December 31, 1996............................... $ 7,500 $14,531 $ 10,614 $ (305) $(3,089) TOTAL Balance at January 1, 1994................................. $21,645 Net income................................................. 1,281 Preferred stock dividend................................... (208) Adjustment to unrealized gain (net of tax)................. (394) Common stock dividends and other (106 shares).............. 52 Balance at December 31, 1994............................... $22,376 Net income................................................. 2,379 Issuance of preferred stock series "B"..................... 3,983 Preferred stock dividend................................... (268) Adjustment to unrealized gain (net of tax)................. 1,411 Common stock dividends and other (178 shares).............. 28 Balance at December 31, 1995............................... $29,909 Net income................................................. 1,850 Preferred stock dividend................................... (450) Adjustment to unrealized gain (net of tax)................. (1,462) Common stock dividends and other (194 shares).............. (596) Balance at December 31, 1996............................... $29,251
See accompanying notes to financial statements. A-30 COVENANT BANK STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 1995 1994 (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................................................ $ 1,850 $ 2,379 $ 1,281 Adjustments to reconcile net income to net cash (used) provided by operating activities: Provision for loan losses............................................................. 636 314 682 Depreciation and amortization......................................................... 535 575 565 Amortization of premiums and discounts, net........................................... 84 77 302 Gain on sale of investments........................................................... -- (1) (2) Loans originated for sale............................................................. (951) (12,292) (2,854) Proceeds from sales of loans held for sale............................................ 1,887 11,850 2,360 Increase (decrease) in unearned discounts and loan fees, net.......................... (308) (123) 129 Increase in accrued interest receivable and other assets.............................. (1,467) (835) (1,921) Increase in other liabilities......................................................... 963 688 35 Net cash provided by operating activities.......................................... 3,229 2,632 577 CASH FLOWS FROM INVESTING ACTIVITIES: (Increase) decrease in other short-term investments................................... -- -- 6,990 Purchases of investments held to maturity............................................. (3,822) (8,297) (65,654) Purchases of investments available for sale........................................... (77,304) (27,926) -- Proceeds from maturities of investments held to maturity.............................. 39,894 9,399 10,245 Proceeds from maturities of investments available for sale............................ 1,250 14,100 1,000 Proceeds from sales of investments available for sale................................. -- 2,843 2,010 Principal collected on mortgage backed securities..................................... 834 714 1,017 Net increase in loans................................................................. (36,832) (13,261) (11,123) Proceeds from sales of real estate owned.............................................. 1,319 333 303 Purchases of premises and equipment................................................... (1,921) (1,636) (1,213) Net cash used in investing activities.............................................. (76,582) (23,731) (56,425) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in deposits................................................... 14,713 26,931 (8,195) Net increase (decrease) in securities sold under agreements to repurchase............. 46,455 (1,213) 38,795 Net increase (decrease) in advances from the Federal Home Loan Bank................... 6,000 (3,500) 11,000 Preferred stock dividends paid........................................................ (450) (268) (208) Net proceeds from issuance of preferred stock......................................... -- 3,983 Common stock dividends and other...................................................... (596) 52 Net cash provided by financing activities.......................................... 66,122 25,933 41,444 Net increase (decrease) in cash and cash equivalents............................. (7,231) 4,834 (14,404) Cash and cash equivalents at the beginning of the year.................................. 22,777 17,943 32,347 Cash and cash equivalents at the end of the year........................................ $ 15,546 $ 22,777 $ 17,943 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest........................................... $ 14,062 $ 12,220 $ 7,733 Cash paid during the period for income taxes....................................... 768 917 250 Noncash investing and financing activities: Fair value of investments transferred from Held To Maturity to Available For Sale.............................................................................. 1,750(1) 46,881 -- Net transfers to real estate owned from loans receivable........................... 843 789 141 Preferred stock dividends declared not paid........................................ -- 113 52 Net change in unrealized gain (loss) on investments available for sale................ $ (2,320) $ 2,091 $ (467)
(1) Transfer of securities at September 27, 1996 in conjunction with the merger of 1st Southern State Bank into Covenant Bank. See accompanying notes to financial statements. A-31 COVENANT BANK NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Covenant Bank ("Covenant" or "the Bank") is a bank organized under the laws of the state of New Jersey. Covenant's market focus is southern New Jersey. Covenant offers a broad range of lending, depository and related financial services to individual customers, businesses and governmental units. Covenant is a member of the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). Since commencing operations in 1988, Covenant has grown to $415 million in assets and operates fifteen personal financial centers throughout the southern New Jersey marketplace as of December 31, 1996. Through December 31, 1996, Covenant Bank ("Covenant" or "the Bank") was a state-chartered savings bank incorporated under the laws of the State of New Jersey. Effective January 1, 1997, Covenant Bank converted its charter to a state-chartered commercial bank. The following is a description of the significant accounting policies of Covenant. Such accounting policies are in accordance with generally accepted accounting principles and have been applied on a consistent basis. Tabular information is presented in thousands of dollars, except for share and per share data. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and certain assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from banks, interest-bearing deposits with an original maturity of 90 days or less, and federal funds sold. Generally, federal funds sold are repurchased the following day. INVESTMENT SECURITIES Investments held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts, since management intends to hold these securities until maturity. Investment securities to be held for indefinite periods of time and not intended to be held to maturity are classified as investments available for sale and carried at fair value, with a corresponding adjustment for the related unrealized appreciation/(depreciation), net of taxes, to stockholders' equity. Gains or losses on the sale of investments available for sale are recognized using the specific identification method. LOANS HELD FOR SALE In 1996, Covenant discontinued a program of origination and sale of residential mortgage loans (without recourse) to the secondary market. Prior to the discontinuance of the program, loans held for sale were reported at the lower of their aggregate cost or fair value. LOANS Loan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the loans' yields on a level yield basis. Net loan fees are amortized over the contractual lives of the related loans. Interest income is recorded on the accrual basis. Loans are reported as non-accrual if they are past due as to principal or interest payments for a period of ninety days or more. Exceptions may be made if a loan is deemed by management to be adequately collateralized and in the process of collection. Loans that are on a current payment status may also be classified as non-accrual if there is serious doubt as to the borrower's ability to continue interest or principal payments. When a loan is placed in the non-accrual category, interest accruals cease and uncollected accrued interest receivable is reversed and charged against current interest income. Non-accrual loans are generally not returned to accruing status until principal and interest payments have been brought current and full collectibility is reasonably assured. A-32 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued Servicing loans for others generally consists of collecting mortgage payments of principal and interest, the maintenance of escrow accounts for payment of taxes and insurance, disbursing payments to investors and the collection of delinquent payments. Mortgage loans serviced for others are not included in the accompanying Statements of Financial Condition. Fees earned by servicing loans for others are reported as income when the related loan payments are collected. Loan servicing costs are charged to expense as incurred. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is based on periodic evaluations of the loan portfolio and reflects an amount that in management's opinion is adequate to absorb known and inherent losses in the portfolio. Management considers a variety of factors when establishing the allowance, including the impact of current economic conditions, diversification of the loan portfolio, historical loss experience, delinquency statistics, results of loan reviews, borrowers' perceived financial and managerial strengths, the estimated adequacy of underlying collateral and other relevant factors. Actual loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. The provision for loan losses is charged to operating expense. While management uses available information to recognize losses on loans, future modifications to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance for loan losses based on their judgments of information which is available to them at the time of their examinations. Recovery of the carrying value of such loans and real estate is dependent, to a great extent, on general economic and other conditions that may be beyond the Bank's control. 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 fair value of the collateral. Covenant considers a loan 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. Generally all non-accrual loans are considered to be impaired. Large groups of smaller-balance, homogeneous loans such as residential mortgage and consumer loans that are collectively evaluated for impairment are not included in the impaired loans category. All cash received on both impaired loans and non-accrual loans are applied against principal. PREMISES AND EQUIPMENT Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight line method over the estimated useful lives of the assets, which range from 3 to 40 years. Leasehold improvements are amortized over the shorter of the lease term or the life of the improvement. Expenditures for maintenance and repairs are expensed as incurred. REAL ESTATE OWNED Real estate owned (REO) consists of real estate acquired in partial or full satisfaction of loans. Prior to transferring a real estate loan to REO, it is written down to the lower of cost or fair value through a charge to the allowance for loan losses. Subsequently, REO is carried at the lower of fair value less estimated costs to sell or carrying value. INCOME TAXES Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets are recognized for future deductible temporary differences and tax loss and credit carryforwards if their realization is "more likely than not." Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A-33 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued INCOME PER COMMON SHARE AND COMMON STOCK EQUIVALENTS Both series of preferred stock and all stock options are considered to be common stock equivalents. The number of common stock equivalents is based upon the if-converted method for both series of preferred stock and the treasury stock method for stock options. Primary earnings per share is the lower of (i) net income less preferred stock dividends, divided by the weighted average number of common shares outstanding plus dilutive stock options or (ii) net income divided by the weighted average number of common shares outstanding plus the effect of convertible non-cumulative preferred stock and dilutive stock options. Fully diluted net income per common share and common stock equivalents is not materially different from primary net income per share for any of the periods presented. Earnings per share has been restated to reflect all stock dividends. RECLASSIFICATION Prior period amounts are reclassified when necessary to conform with the current year's presentation. 2. MERGER On September 27, 1996, 1st Southern State Bank ("1st Southern") headquartered in Avalon, NJ, was merged with and into Covenant Bank. Covenant issued 778,061 shares of common stock and $1,363 cash in lieu of fractional shares for all the outstanding shares of 1st Southern common stock. In conjunction with the merger, Covenant recorded one-time merger costs of $666,000. The merger qualified as a tax-free reorganization and was accounted for as a pooling of interests. Accordingly, Covenant's financial statements have been restated to include the results of 1st Southern for all periods presented. The following is a reconciliation of amounts previously reported with amounts reflected herein. FOR THE YEAR ENDED DECEMBER 31, 1995
COVENANT BANK 1ST COVENANT AS SOUTHERN BANK PREVIOUSLY STATE AS STATED BANK RESTATED Net Interest Income.................................................. $ 11,848 $1,820 $13,668 Provision for Possible Loan Losses................................... 225 89 314 Other Income......................................................... 764 80 844 Other Expenses....................................................... 9,645 1,476 11,121 Income Before Income Taxes........................................... 2,742 335 3,077 Provision for Income Taxes........................................... 654 44 698 Net Income........................................................... $ 2,088 $ 291 $ 2,379
FOR THE YEAR ENDED DECEMBER 31, 1994
COVENANT BANK 1ST COVENANT AS SOUTHERN BANK PREVIOUSLY STATE AS STATED BANK RESTATED Net Interest Income.................................................. $ 10,617 $1,523 $12,140 Provision for Possible Loan Losses................................... 670 12 682 Other Income......................................................... 720 59 779 Other Expenses....................................................... 9,943 1,353 11,296 Income Before Income Taxes........................................... 724 217 941 Provision for Income Tax Expense (Benefit)........................... (390) 50 (340 ) Net Income........................................................... $ 1,114 $ 167 $ 1,281
A-34 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 2. MERGER -- Continued In September 1994, Covenant acquired all of the outstanding common shares of Landis Savings Bank, S.L.A. of Vineland, New Jersey. The acquisition was accounted for by a pooling of interests and resulted in the issuance of 429,747 shares of common stock and $2,071 cash in lieu of fractional shares. Accordingly, Covenant's financial statements have been restated to include the results of the Landis merger for all prior periods. 3. CASH AND DUE FROM BANKS Covenant is required to maintain certain average reserve balances as established by the Federal Reserve Board. The amounts of those balances for the reserve computation periods which included December 31, 1996 and 1995 were $1.9 million and $1.4 million, respectively. These requirements were satisfied through the restriction of vault cash and a balance at the Federal Reserve Bank of Philadelphia. 4. INVESTMENT SECURITIES The amortized cost and estimated fair value of investments held to maturity and investments available for sale as of December 31, 1996 and 1995 were as follows:
1996 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE Investments Held to Maturity: U.S. Treasury...................................... $ -- $ -- $ -- $ -- Obligations of U.S. Government Agencies............ 7,209 56 -- 7,265 Federal Home Loan Bank Stock....................... 4,478 -- -- 4,478 Total........................................... $ 11,687 $ 56 $ -- $ 11,743 Investments Available for Sale: U.S. Treasury...................................... $ 133,061 $ -- $483 $ 132,578
1995 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE Investments Held to Maturity: U.S. Treasury...................................... $ 38,091 $ 204 $ -- $ 38,295 Obligations of U.S. Government Agencies............ 10,596 98 10 10,684 Federal Home Loan Bank Stock....................... 1,656 -- -- 1,656 Total........................................... $ 50,343 $ 302 $ 10 $ 50,635 Investments Available for Sale: U.S. Treasury...................................... $ 55,341 $1,837 $ -- $ 57,178
The amortized cost and estimated fair value of investments held to maturity and investments available for sale at December 31, 1996, by contractual maturity are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Obligations of US Government Agencies are shown separately due to the amortization and prepayment of principal occurring throughout the life of these instruments. A-35 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 4. INVESTMENT SECURITIES -- Continued
INVESTMENTS INVESTMENTS HELD TO MATURITY AVAILABLE FOR SALE AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE Due in one year or less.............................. $ -- $ -- $ 27,969 $ 28,172 Due after one year through five years................ -- -- 76,889 77,198 Due after five years through ten years............... -- -- 28,203 27,208 No stated maturity................................... 4,478 4,478 -- -- Obligations of U.S. Government Agencies.............. 7,209 7,265 -- -- $11,687 $ 11,743 $ 133,061 $ 132,578
There were no sales of investments available for sale during 1996. Proceeds from sales of investments available for sale during 1995 were $2.8 million, and gross realized gains of $1,000 were realized on these sales. Proceeds from sales of investments available for sale during 1994 were $2.0 million, and gross realized gains of $2,000 were realized on these sales. There were no sales of investments held to maturity during 1996, 1995 and 1994. Investments held to maturity and investments available for sale with amortized costs aggregating $69.8 million and $50.8 million at December 31, 1996 and 1995, respectively, are pledged as collateral for securities sold under agreements to repurchase and public deposits. The FASB issued a Special Report stating that effective November 15, 1995 until December 31, 1995, banks could redesignate some or all of current "Held to Maturity" portfolios to an "Available for Sale" classification without the intent to hold other securities to maturity being questioned. On December 22, 1995, Covenant reclassified US Treasury Notes categorized as "Held to Maturity" to "Available for Sale" with an amortized cost of $45.4 million. This reclassification resulted in the recording of an unrealized gain of $1.4 million on those US Treasury Notes. Management reclassified only those securities in the "Held to Maturity" portfolio with scheduled maturities beyond March 31, 1997. 5. LOANS Loans at December 31, 1996 and 1995 consist of the following:
1996 1995 Commercial and financial...................................................... $ 65,351 $ 62,517 Real estate -- construction................................................... 7,075 3,346 Mortgage -- residential....................................................... 50,744 42,415 Mortgage -- commercial........................................................ 84,520 67,983 Consumer (including home equity lines of credit).............................. 33,760 29,157 Subtotal.................................................................... 241,450 205,418 Unearned discounts and deferred loan fees..................................... (249) (557) Allowance for loan losses..................................................... (3,016) (3,195) Loans receivable, net......................................................... $238,185 $201,666
Non-accruing loans at December 31, 1996 and 1995 totaled $2,866,000 and $3,844,000, respectively. Interest income recognized on non-accruing loans totaled $89,000 in 1996, $28,000 in 1995, and $195,000 in 1994. Had interest income on year-end non-accrual loans been paid at the contracted rates and due dates, Covenant would have recorded additional interest income in 1996, 1995 and 1994 of $273,000, $508,000, and $464,000, respectively. Restructured loans at December 31, 1994 totaled $595,000. Had interest income on restructured loans been paid in accordance with contracted rates, Covenant would have recorded additional interest income of $4,000 in 1994. There were no restructured loans at December 31, 1996, consequently, no interest income on restructured loans was recognized. A-36 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 5. LOANS -- Continued Under New Jersey Banking statutes, Covenant is subject to a loans-to-one-borrower limitation of 15% of capital funds. At December 31, 1996, Covenant's loans-to-one-borrower limitation was $4,885,800; this excludes an additional 10% of adjusted capital funds or $3,257,200, which may be loaned if collateralized by readily marketable securities, as defined in the regulations. At December 31, 1996, there are no loans to any borrower which individually or in the aggregate exceed that limit. The majority of Covenant's loans are located within the southern New Jersey marketplace, which is its only significant geographic concentration. Credit exposure to customers with credit extensions (on and off-balance sheet) collateralized at least in part by commercial real estate was $81.2 million or 29.1% and $80.3 million or 34.0% of total credit extensions at December 31, 1996 and 1995, respectively. No other concentration of credit risk exceeds 10% of total credit extensions at year-end. The total amount of loans serviced for the benefit of others was $14.4 million and $16.0 million at December 31, 1995 and 1994, respectively. The total amount of loan servicing fees received from investors was approximately $75,000, $94,000, and $115,000 during 1996, 1995, and 1994 respectively. Loans to directors and executive officers including loans to related parties and entities were $7,194,000 and $5,868,000 December 31, 1996 and 1995, respectively. These loans were made in the ordinary course of business at substantially the same terms and conditions as those with other borrowers. During 1996, there were increases of approximately $1,493,000 and loan repayments of approximately $167,000 on such loans. Covenant engaged in certain legal, rental and consulting services with other entities which are affiliated with Directors of the Bank. Such aggregate services amounted to $369,000, $469,000, and $628,000, in 1996, 1995, and 1994, respectively. In management's opinion, the terms of such services were substantially equivalent to those which would have been obtained from unaffiliated parties. As of December 31, 1996 and December 31, 1995, the Bank had impaired loans totaling approximately $1,734,000 and $2,947,000, respectively. The allowance for loan losses on impaired loans had a valuation allowance of $199,000 and $440,000 at December 31, 1996 and 1995, respectively. The average balance of impaired loans totaled $1,684,000 for 1996 and $2,655,000 for 1995. Interest income not accrued for impaired loans for the years ended December 31, 1996 and 1995 was approximately $164,000 and $275,000, respectively. An analysis of the changes in the allowance for loan losses for the years ended December 31, 1996, 1995 and 1994 is as follows:
DECEMBER 31, 1996 1995 1994 Balance at January 1......................................... $3,195 $3,623 $3,670 Provision for loan losses.................................... 636 314 682 Charge-offs:................................................. (990) (1,003) (1,061) Recoveries................................................... 175 261 332 Net charge-offs.............................................. (815) (742) (729) Balance at end of period..................................... $3,016 $3,195 $3,623
A-37 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 6. PREMISES AND EQUIPMENT Premises and equipment at December 31, 1996 and 1995 consisted of the following:
1996 1995 Land................................................................ $ 1,886 $ 1,574 Buildings........................................................... 6,860 5,896 Leasehold improvements.............................................. 713 646 Equipment and furniture............................................. 3,683 3,153 13,142 11,269 Accumulated depreciation and amortization........................... (4,007) (3,520) $ 9,135 $ 7,749
Depreciation and amortization expenses for 1996, 1995 and 1994 were $535,000, $536,000 and $517,000, respectively. 7. ACCRUED INTEREST RECEIVABLE Accrued interest receivable at December 31, 1996 and 1995 consisted of the following:
1996 1995 Investment securities.................................................. $2,356 $1,969 Loans receivable....................................................... 1,486 1,523 Obligations of U.S. Government Agencies................................ 71 31 $3,913 $3,523
8. DEPOSITS Interest expense on deposits for the years ended December 31, 1996, 1995 and 1994 is summarized as follows:
1996 1995 1994 Interest-bearing demand...................................... $ 592 $ 518 $ 416 Statement savings............................................ 1,038 1,132 1,269 Money market................................................. 639 630 681 Time deposits................................................ 7,374 6,852 4,585 $9,643 $9,132 $6,951
The major classifications of deposits at December 31, 1996, 1995 and 1994 consisted of the following:
1996 1995 1994 WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RATE AMOUNT PERCENT RATE AMOUNT PERCENT RATE AMOUNT PERCENT Noninterest-bearing deposits................ 0.00% $ 41,868 15% 0.00% $ 34,347 13% 0.00% $ 25,625 11% Interest-bearing deposits: Demand.................. 2.15% 34,757 13% 2.09% 26,517 10% 1.76% 25,009 11% Statement savings....... 2.40% 40,257 15% 2.64% 44,756 17% 2.44% 45,563 19% Money market............ 2.92% 21,155 8% 2.80% 20,215 8% 2.43% 24,350 10% Time deposits........... 5.31% 139,428 50% 5.31% 136,917 52% 4.09% 115,274 49% Total deposits............ 3.56% $277,465 100% 3.67% $262,752 100% 2.89% $235,821 100%
The aggregate amounts of certificates of deposit of $100,000 or more at December 31, 1996, 1995 and 1994 were $37,035,000, $42,976,000 and $30,046,000, respectively. A-38 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 8. DEPOSITS -- Continued A summary of certificates of deposit of $100,000 or more by maturity is as follows:
1996 AMOUNT PERCENT Within one year...................................................... $35,798 97% One to two years..................................................... 837 2% Two to three years................................................... 400 1% Three to four years.................................................. -- -- Four to five years................................................... -- -- Over five years...................................................... -- -- $37,035 100%
9. ADVANCES FROM THE FEDERAL HOME LOAN BANK At December 31, 1996, Covenant had advances from the Federal Home Loan Bank of New York (FHLB) in the amount of $20.5 million with a weighted average interest rate of 6.50%. The advances are scheduled to mature as follows:
AMOUNT MATURITY $12,500..................................... 1997 3,000..................................... 1998 5,000..................................... 2000 $20,500
At December 31, 1996, Covenant had an unused credit line with the FHLB of $6.2 million. At December 31, 1995, Covenant had $14.5 million in advances from the FHLB with a weighted average interest rate of 5.38%. Advances are collateralized by FHLB stock and residential mortgage loans. Interest expense incurred on Federal Home Loan Bank advances for 1996, 1995 and 1994 was $623,000, $421,000, and $404,000, respectively. 10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Securities sold under agreements to repurchase range in maturity from one day to three months. Securities underlying these repurchase agreements consisted of US Treasury securities which had a carrying value of $84.6 million and $36.9 million at December 31, 1996 and 1995, respectively, and a market value of $84.0 million, $37.6 million and $38.8 million at December 31, 1996, 1995, and 1994, respectively. The securities collateralizing the securities sold under agreements to repurchase have one- to three-year maturities and are held by three broker/dealers. In certain instances, the broker may sell, loan, or dispose of the securities to other parties in the normal course of their operations, and have agreed to sell to Covenant substantially similar securities at the maturity of the existing agreements. The following table summarizes information regarding securities sold under repurchase agreements.
DECEMBER 31, 1996 1995 1994 Balance...................................................................................... $84,037 $37,582 $38,795 Weighted average interest rate at December 31................................................ 5.72% 5.74% 6.29% Maximum amount outstanding during the period................................................. 96,088 62,715 49,737 Average amount outstanding during the period................................................. 72,358 46,774 13,657 Weighted average interest rate during the period............................................. 5.30% 5.93% 5.04%
A-39 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 11. COMMITMENTS AND CONTINGENCIES Covenant is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. The contract amounts of these instruments reflect the extent of involvement Covenant has in particular classes of financial instruments and are not included in the financial statements as of December 31, 1996. Covenant's involvement in such financial instruments at December 31, 1996 and 1995 is summarized as follows:
CONTRACT AMOUNT 1996 1995 Amounts representing credit risk: Commitments to extend credit.......................... $36,732 $29,094 Standby letters of credit............................. 1,313 2,163
Covenant uses the same credit policies in extending commitments and standby letters of credit as it does for financial instruments recorded in the statement of financial condition. Covenant controls its exposure to loss from these agreements through credit approval processes and monitoring procedures. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The total commitment amounts do not necessarily represent future cash disbursements, as many of the commitments expire without being drawn upon. Covenant may require collateral in extending commitments, which may include cash, accounts receivable, investment securities, real or personal property, or other assets. Covenant is subject to certain legal actions and proceedings arising in the normal course of business. Management, after consultation with legal counsel, does not anticipate any liability will have a material adverse effect on Covenant's financial statements. 12. OPERATING LEASES At December 31, 1996, Covenant was obligated under non-cancelable operating leases, which generally include options to renew, for certain premises and equipment. Future minimum rental payments under these leases for the years 1997 through 2001 are as follows: 1997................................................................. $ 400 1998................................................................. 305 1999................................................................. 305 2000................................................................. 105 2001................................................................. 59 Total........................................................... $1,174
Total rent expense for all leases for the years ended December 31, 1996, 1995, and 1994 were $372,000, $310,000, and $225,000, respectively. 13. REGULATORY MATTERS Covenant Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios set forth in the following table. As of December 31, 1996, the Bank meets all capital adequacy requirements to which it is subject. A-40 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 13. REGULATORY MATTERS -- Continued As of December 31, 1996, the most recent notification from the FDIC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized under the regulatory framework for prompt corrective action, the Bank must maintain minimum ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Bank's actual capital amounts and ratios are presented in the table.
TO BE WELL CAPITALIZED UNDER PROMPT FOR CAPITAL CORRECTIVE ADEQUACY ACTION ACTUAL PURPOSE PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO As of December 31, 1996: Total Capital (to Risk Weighted Assets)............................... $32,572 13.20% $19,739 8.00 % $24,674 10.00% Tier I Captial (to Risk Weighted Assets).............................. $29,556 11.98% $ 9,870 4.00 % $14,804 6.00% Tier I Capital (to Average Assets).................................... $29,556 7.51% $15,752 4.00 % $19,690 5.00% As of December 31, 1995: Total Capital (to Risk Weighted Assets)............................... $31,398 14.87% $16,892 8.00 % $21,115 10.00% Tier I Capital (to Risk Weighted Assets).............................. $28,752 13.62% $ 8,446 4.00 % $12,669 6.00% Tier I Capital (to Average Assets).................................... $28,752 8.49% $13,549 4.00 % $16,936 5.00%
Under New Jersey Banking Statutes, Covenant may not declare a cash dividend or a stock dividend unless, following the payment of the dividend, the capital stock of the Bank will be unimpaired and the Bank will have a surplus amounting to at least 50% of its capital stock or, if not, the payment of the dividend will not reduce the surplus of the Bank. To date, Covenant has not paid a cash dividend on its common stock. 14. CAPITAL STOCK On June 30, 1995, Covenant issued 161,700 shares of Series B 6% convertible non-cumulative preferred stock ("Series B"). At that time, the 138,300 shares of 6% convertible non-cumulative preferred stock issued on December 31, 1992, were renamed to Series A 6% convertible non-cumulative preferred stock ("Series A"). Holders of both series of Covenant's 6% convertible non-cumulative preferred stock (par value $25 per share) are senior to Covenant's common stock and are entitled to receive, when and as declared by the Board of Directors, preferred dividends at the annual rate of 6% of par value, or $1.50 per share annually. Such dividends are not cumulative. In 1996, the Board of Directors declared preferred stock dividends amounting to $450,000, $268,000 in 1995, and $207,450 in 1994. The Series A preferred stock will be automatically converted into common stock on December 31, 1997 at the rate of 3.823 shares of common stock for each share of Series A preferred stock. The Series B preferred stock will be automatically converted into common stock on June 30, 2000 at the rate of 3.026 shares of common stock for each share of Series B preferred stock. The preferred stock has no voting rights, except as may be otherwise required by law. On June 15, 1996, Covenant issued a 4% stock dividend on its common stock to shareholders of record on May 31, 1996, resulting in the issuance of 75,171 additional common shares and cash paid in lieu of fractional shares of $3,881. On December 16, 1996, Covenant issued a 6% stock dividend on its common stock to shareholders of record on December 2, 1996, resulting in the issuance of 164,113 additional common shares and cash paid in lieu of fractional shares of $5,174. On June 15, 1995, Covenant issued a 4% stock dividend on its common stock to shareholders of record on May 31, 1995, resulting in the issuance of 67,813 additional common shares and cash paid in lieu of fractional shares of $2,959. On December 15, 1995, Covenant issued a 6% stock dividend on its common stock to shareholders of record on November 30, 1995, resulting in the issuance of 106,111 additional common shares and cash paid in lieu of fractional shares of $3,639. A-41 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 15. INCOME TAXES Income tax expense (benefit) for the years ended December 31, 1996, 1995 and 1994 is comprised as shown below:
DECEMBER 31, 1996 1995 1994 Current: Federal....................................................... $ 914 $556 $ 227 State......................................................... 77 103 55 $ 991 $659 $ 282 Deferred: Federal....................................................... 188 6 (514) State......................................................... 22 33 (108) 210 39 (622) Total tax expense (benefit)..................................... $1,201 $698 $(340)
The Bank's provision (benefit) for income taxes differs from that computed by applying the federal income tax rate to income before income taxes as shown below:
1996 1995 1994 Computed "expected" tax expense................................................................... $1,037 $1,047 $ 320 State tax expense, net of federal benefit......................................................... 72 90 11 Decrease in valuation allowance for deferred tax assets........................................... (74) (333) (918) Non-deductible merger expenses.................................................................... 155 -- 208 Alternative minimum tax credits................................................................... -- (75) -- Other, net........................................................................................ 11 (31) 39 Income tax expense (benefit)...................................................................... $1,201 $ 698 $(340)
Under SFAS No. 109, a valuation allowance is required to be provided for the deferred tax assets to the extent it is more likely than not that they will not be realized. The net change in the valuation allowance for the year ended December 31, 1996 was a decrease of $74,000. This change resulted from a reassessment of the realizability of the existing net deductible temporary differences which give rise to the net deferred income tax asset. Based upon the Bank's tax history and anticipated level of future taxable income, management believes the existing net deductible temporary differences will, more-likely-than-not, reverse in future periods in which the Bank generates net taxable income. The Small Business Job Protection Act of 1996, enacted on August 20, 1996, provides for the repeal of the tax bad debt deduction computed under the percentage of taxable income method. The repeal of the use of this method is effective for tax years beginning after December 31, 1995. Prior to the change in law, Covenant had qualified under the provisions of the Internal Revenue Code which permitted it to deduct from taxable income an allowance for bad debts based on 8% of taxable income. Upon repeal, Covenant is required to recapture into income, over a six-year period, the portion of its tax bad debt reserves that exceed its base year reserves (i.e., tax reserves for tax years beginning before 1988). The base year tax reserves, which may be subject to recapture if Covenant ceases to qualify as a bank for federal income tax purposes, are restricted with respect to certain distributions. Covenant's total tax bad debt reserves at December 31, 1996, are approximately $2.5 million, of which $2.0 million represents the base year amount and $500,000 is subject to recapture. Covenant has previously recorded a deferred tax liability for the amount to be recaptured; therefore, this recapture will not impact the statement of operations. A-42 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 15. INCOME TAXES -- Continued
DECEMBER 31, 1996 1995 Deferred Income Tax Assets: Allowance for loan losses................................................................................ $ 944 $1,054 Deferred loan fees, net.................................................................................. 67 213 Real estate owned allowance.............................................................................. 181 249 Amortization of organization costs....................................................................... -- 70 Net operating loss carryovers............................................................................ -- 23 Unrealized loss on investments available for sale........................................................ 179 -- Other.................................................................................................... 11 5 Gross deferred tax assets................................................................................ 1,382 1,614 Valuation allowance...................................................................................... -- (74) Deferred tax assets........................................................................................ $1,382 $1,540 Deferred Income Tax Liabilities: Premium on acquired assets............................................................................... $ 60 $ 217 Unrealized gain on investments available for sale........................................................ -- 680 Depreciation............................................................................................. 221 165 Prepaid expenses......................................................................................... 14 41 Other.................................................................................................... 11 10 Gross deferred tax liabilities........................................................................... 306 1,113 Net deferred tax assets.................................................................................... $1,076 $ 427
16. EMPLOYEE BENEFIT PLANS At December 31, 1996, Covenant had three stock-based compensation plans and a 401(k) retirement plan, which are described below. Covenant applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for the stock option plans or the employee stock purchase plan. Had compensation cost for Covenant's stock-based compensation plans been determined in accordance with the fair value method of Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," Covenant's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1996 1995 Net income: As reported................................................................. $1,850 $2,379 Pro forma................................................................... $1,019 $2,155 Primary earnings per share: As reported................................................................. $ 0.45 $ 0.63 Pro forma................................................................... $ 0.19 $ 0.57
INCENTIVE STOCK OPTION PLAN. Covenant maintains an incentive stock option plan pursuant to which an aggregate of 313,281 shares of common stock has been authorized for issuance to certain officers and key employees of Covenant upon exercise of stock options. During 1996, there were 1,590 options granted under the plan which are exercisable at a price equal to the fair market value of the common stock on the date of grant and expire not more than ten years after the date of grant. Rights to exercise options become vested according to schedules set forth in individual agreements with participants. Under Covenant's stock option plan, the exercisable option prices range from $7.32 to $12.12 per share at December 31, 1996, which have been adjusted for all stock dividends issued on common stock to date. A-43 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 16. EMPLOYEE BENEFIT PLANS -- Continued The fair value of each option granted under the Incentive Stock Option Plan was estimated using the Black-Scholes option-pricing model with the following assumptions for 1996 and 1995: assuming no cash dividends; an expected life of ten years; expected volatility of 15.3%; and risk free interest rates of 6.3% for 1996 grants, 7.59% and 6.63% for the two 1995 grants. The fair value of those options granted in 1996 and 1995 were $5.85 and $4.21 per share, respectively. An analysis of the activity under the plan during the years 1996, 1995 and 1994 is as follows:
WEIGHTED AVERAGE SHARES EXERCISE PRICE Balance, December 31, 1993......................................................................... 298,703 $ 7.46 Granted.......................................................................................... 82,973 $ 9.32 Exercised........................................................................................ (6,367) $ 9.12 Terminated....................................................................................... (55,422) $ 9.65 Balance, December 31, 1994......................................................................... 319,887 $ 7.53 Granted.......................................................................................... 180,551 $ 7.80 Exercised........................................................................................ (138) $ 9.47 Terminated....................................................................................... (88,222) $ 9.27 Balance, December 31, 1995......................................................................... 412,078 $ 7.74 Granted.......................................................................................... 1,590 $12.12 Exercised........................................................................................ (797) $ 8.72 Terminated....................................................................................... (665) $ 8.77 Balance, December 31, 1996......................................................................... 412,206 $ 7.76
Two exercises of stock options totalling 797 shares of Covenant common stock were executed as follows: 570 shares for an average price of $8.79 per share on May 30, 1996, and, 227 shares for an average price of $8.53 per share on July 31, 1996. STOCK OPTION PLAN FOR EMPLOYEES AND NON-EMPLOYEE DIRECTORS. An aggregate of 148,400 shares have been authorized for issuance to employees and non-employee directors of Covenant Bank. As provided in the Stock Option Plan for Employees and Non-Employee Directors (the "Plan"), a non-discretionary option to purchase 10,600 shares of Covenant common stock was granted to each non-employee director during 1996. In addition, the Plan outlines that each non-employee director is also eligible to receive a non-discretionary option to purchase 2,650 shares each year following Covenant's annual meeting for as long as such individual is a non-employee director of the Bank, provided such shares are available. During 1996, there were 140,450 options granted under the Plan which are exercisable at a price equal to the fair market value of the common stock on the date of grant and expire not more than ten years after the date of grant. Rights to exercise options become vested on a one-third per year basis, with one-third being immediately vested. Under the Plan, the exercisable option prices range from $12.12 to $12.15 per share at December 31, 1996, which have been adjusted for all stock dividends issued on Covenant common stock to date. The fair value of each option granted under the Plan was estimated using the Black-Scholes option-pricing model with the following assumptions for 1996: assuming no cash dividends; an expected life of ten years; expected volatility of 15.3%; and a risk free interest rate of 6.3%. The fair value of those options granted in 1996 was $5.85 per share. A-44 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 16. EMPLOYEE BENEFIT PLANS -- Continued An analysis of the activity under the Plan during the year 1996 is as follows:
WEIGHTED AVERAGE SHARES EXERCISE PRICE Balance, December 31, 1995..................................... -- $ -- Granted...................................................... 140,450 12.13 Exercised.................................................... -- -- Terminated................................................... -- -- Balance, December 31, 1996..................................... 140,450 $12.13
401(K) RETIREMENT PLAN. Covenant maintains a qualified 401(k) plan which allows employees to participate after satisfaction of service requirements. This contributory savings plan provides for an employee salary reduction feature pursuant to Section 401(k) of the Internal Revenue Code. Employee contributions are voluntary, and the employee can elect to defer up to 10% of his/her compensation. Covenant provides a 25% matching contribution on up to 6% of the employee's compensation, for a total matching contribution of 1.5%. The total of Covenant's contribution to the 401(k) plan, which is subject to a vesting schedule pursuant to the Plan, amounted to approximately $40,700 for the year ended December 31, 1996. EMPLOYEE STOCK PURCHASE PLAN. Covenant maintains an Employee Stock Purchase Plan, whereby eligible employees may purchase Covenant common stock directly from the Bank. Purchases of common stock are limited to 10% of a participant's compensation. Since 1994, participants have purchased Covenant common stock at a price equal to 85% of the fair value of Covenant's common stock at the lower of either the market price on the first day of the six-month participation period or the last day of that participation period. 17. FAIR VALUE OF FINANCIAL INSTRUMENTS FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments" (FAS 107), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates may not be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. FAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank. A-45 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 17. FAIR VALUE OF FINANCIAL INSTRUMENTS -- Continued The following represents the carrying value and fair value of Covenant's financial instruments at December 31, 1996 and 1995:
1996 1995 CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE Financial assets: Cash and cash equivalents.................................................. $ 15,546 $ 15,546 $ 22,777 $ 22,777 Mortgages held for sale.................................................... -- -- 936 936 Investment securities...................................................... 144,265 144,321 107,521 107,813 Loans: Commercial.............................................................. 156,946 158,380 133,846 135,057 Residential mortgage.................................................... 50,744 51,582 42,415 45,941 Consumer................................................................ 33,760 33,817 29,157 29,309 Unearned discounts and deferred loan fees............................... (249) -- (557) -- Allowance for loan losses............................................... (3,016) -- (3,195) -- Loans receivable, net................................................... 238,185 243,779 201,666 210,307 Accrued interest receivable............................................. 3,931 -- 3,523 -- Financial liabilities: Deposits................................................................... $277,465 $277,472 $262,752 $262,815 Federal Home Loan Bank advances............................................ 20,500 20,329 14,500 14,457 Securities sold under agreements to repurchase............................. 84,037 84,037 37,582 37,582 Accrued interest payable................................................... 861 -- 759 -- Off-balance sheet instruments: Letters of credit.......................................................... $ 13 $ 22 Unfunded lines of credit................................................... -- 5
The following methods and assumptions were used by the Bank in estimating its fair value disclosures for financial instruments: Cash and cash equivalents, mortgages held for sale, and accrued interest receivable and accrued interest payable: The carrying amounts reported approximate those assets' or liabilities fair value. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans receivable were estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loans with significant collectibility concerns were fair valued on a loan-by-loan basis using a discounted cash flow method. The carrying amount of accrued interest approximates its fair value. Off-balance sheet instruments: Off-balance sheet instruments of the Bank consist of letters of credit, loan commitments and unfunded lines of credit. Fair values for the Bank's off- balance sheet instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest-bearing and non-interest-bearing checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected monthly maturities on time deposits. A-46 COVENANT BANK NOTES TO FINANCIAL STATEMENTS -- CONTINUED 17. FAIR VALUE OF FINANCIAL INSTRUMENTS -- Continued Federal Home Loan Bank Advances: Current quoted market prices were used to estimate fair value. Securities Sold Under Agreements to Repurchase: The carrying amounts reported approximate fair value. 18. QUARTERLY FINANCIAL DATA (UNAUDITED)
THREE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, 1996 Interest income........................................................... $7,398 $ 7,433 $7,367 $ 6,900 Interest expense.......................................................... 3,611 3,595 3,656 3,302 Net interest income....................................................... 3,787 3,838 3,711 3,598 Provision for loan losses................................................. 112 483 23 18 Merger costs.............................................................. -- 666 -- -- Income (loss) before taxes................................................ 1,292 (499) 1,186 1,072 Provision for federal and state income taxes (benefit).................... 465 (86) 432 390 Net income (loss)......................................................... 827 (413) 754 682 Earnings per share (1).................................................... $ 0.20 $ (0.17) $ 0.18 $ 0.17 1995 Interest income........................................................... $6,623 $ 6,640 $6,598 $ 6,138 Interest expense.......................................................... 3,077 3,098 3,272 2,884 Net interest income....................................................... 3,546 3,542 3,326 3,254 Provision for loan losses................................................. 77 81 63 93 Net investment securities gains........................................... -- -- 1 -- Income before taxes....................................................... 847 836 737 657 Provision for federal and state income taxes.............................. 150 207 175 166 Net income................................................................ 697 629 562 491 Earnings per share (1).................................................... $ 0.17 $ 0.16 $ 0.16 $ 0.14
(1) Earnings per share has been restated to reflect all stock dividends issued on common stock to date. A-47 MARKET INFORMATION Covenant's common stock is traded on the NASDAQ National Market ("NASDAQ") under the symbol "CNSK". There are currently five market makers in Covenant stock including: Janney Montgomery Scott Inc., Wheat First Butcher Singer, and Ryan, Beck & Co. The following table sets forth the low and high prices of the common stock on the-over-counter market, as reported by the NASDAQ National Market, Inc. for the each of the quarters outlined below.
LOW HIGH 1995 1st Quarter........................................................................ $ 7.60 $ 9.05 2nd Quarter........................................................................ 7.60 8.76 3rd Quarter........................................................................ 8.34 9.42 4th Quarter........................................................................ 8.76 12.47 1996 1st Quarter........................................................................ $10.89 $11.57 2nd Quarter........................................................................ 11.32 11.79 3rd Quarter........................................................................ 11.32 12.97 4th Quarter........................................................................ 12.00 14.75
The above prices have been adjusted to reflect all stock dividends issued on the common stock. A-48 PART III ITEM 9 -- DIRECTORS AND PRINCIPAL OFFICERS OF THE BANK Information required by this Item is incorporated by reference from "Directors" and "Management of the Bank" in Covenant's Proxy Statement for its 1997 Annual Meeting. ITEM 10 -- MANAGEMENT COMPENSATION AND TRANSACTIONS Information required by this Item is incorporated by reference from "Executive Compensation", "Certain Transactions" and "Principal Holders of Covenant Common Stock and Holdings of Management" in Covenant's Proxy Statement for its 1997 Annual Meeting. A-49 PART IV ITEM 11 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM F-3 (a)(1) Financial Statements. The consolidated financial statements listed on the index to Item 8 of this Annual Report on Form F-2 are filed as part of this report. (a)(2) Financial Statement Schedules. All schedules applicable to Covenant are shown in the respective financial statements or in the notes thereto included in this Annual Report. (b) Reports on Form F-3: The following reports on Form F-3 were filed during the fourth quarter of 1996: -- Current report dated October 8, 1996 and filed on or about October 10, 1996. -- Current report dated December 9, 1996 and filed on or about December 10, 1996. (c) Exhibits 1.1 Charter, filed as Exhibit 1.1 to the Bank's Annual Report on Form F-2 dated March 29, 1995 and incorporated herein by reference. 1.2 By-laws (as amended), filed as Exhibit 1.2 to the Bank's Annual Report on Form F-2 dated March 27, 1996 and incorporated herein by reference. 2.1 Form of Stock Certificate (Common Stock), filed as Exhibit 2.1 to the Bank's Annual Report on Form F-2 dated March 29, 1995 and incorporated herein by reference. 2.2 Form of Stock Certificate (Series A Preferred Stock), filed as Exhibit 2.2 to the Bank's Annual Report on Form F-2 dated March 29, 1995 and incorporated herein by reference. 2.3 Form of Stock Certificate (Series B Preferred Stock) filed as Exhibit 3 to the Bank's Registration Statement for Additional Classes of Securities on Form F-10 dated May 31, 1995, and incorporated herein by reference. 3.1 Incentive Stock Option Plan, filed as Exhibit 5.1 to the Bank's Registration Statement on Form F-1 dated November 7, 1994 and incorporated herein by reference. 3.2 Employee Stock Purchase Plan, filed as Exhibit 5.2 to the Bank's Registration Statement on Form F-1 dated November 7, 1994 and incorporated herein by reference. *3.3 1996 Stock Option Plan for Officers and Non-Employee Directors. 4.1 Statement re: computation of per share earnings.
* Previously filed A-50 SIGNATURES Pursuant to the requirements of section 13 of the Securities Exchange Act of 1934, the Bank has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COVENANT BANK Date: April 28, 1997 By: /s/ CHARLES E. SESSA, JR. Name: Charles E. Sessa, Jr. Title: President Date: April 28, 1997 By: /s/ J. WILLIAM PARKER, JR. Name: J. William Parker, Jr. Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: By: Barry M. Abelson, Director Date: April 28, 1997 By: /s/ WILLIAM T. CARSON William T. Carson, Director Date: By: John J. Gallagher, Director Date: April 28, 1997 By: /s/ GARY E. GREENBLATT Gary E. Greenblatt, Director Date: April 28, 1997 By: /s/ RICHARD A. HOCKER Richard A. Hocker, Director Date: April 28, 1997 By: /s/ JAMES R. IANNONE James R. Iannone, Director Date: By: Joseph A. Maressa, Sr., Director Date: April 28, 1997 By: /s/ CHARLES E. SESSA, JR. Charles E. Sessa, Jr., Director Date: April 28, 1997 By: /s/ KYLE W. WILL Kyle W. Will, Director
A-51 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE #0-22699 COVENANT BANCORP, INC. (Exact name of registrant as specified in its charter) NEW JERSEY 22-2890624 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number)
18 KINGS HIGHWAY WEST, HADDONFIELD, NEW JERSEY 08033 (Address of Principal Executive Offices) (Zip Code) (609) 428-7300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. (Note: Registrant is successor to Covenant Bank, whose shares were previously registered with the Federal Deposit Insurance Corporation). Yes X No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practical date. COMMON STOCK 3,057,193 (Title of Class) (No. of Shares Outstanding as of 8/11/97) SERIES A NON-CUMULATIVE CONVERTIBLE PREFERRED STOCK 138,300 (Title of Class) (No. of Shares Outstanding as of 8/11/97) SERIES B NON-CUMULATIVE CONVERTIBLE PREFERRED STOCK 161,700 (Title of Class) (No. of Shares Outstanding as of 8/11/97)
A-52 COVENANT BANCORP, INC. AND SUBSIDIARIES TABLE OF CONTENTS FINANCIAL INFORMATION
PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Financial Condition (Unaudited) June 30, 1997 and December 31, 1996.................................................................................... A-54 Consolidated Statements of Operations (Unaudited) Three months ended June 30, 1997 and June 30, 1996 and six months ended June 30, 1997 and June 30, 1996................................... A-55-A-56 Consolidated Statements of Cash Flows (Unaudited) Six months ended June 30, 1997 and June 30, 1996... A-57 Consolidated Statements of Changes in Stockholders' Equity........................................... A-58 Notes to Consolidated Financial Statements (Unaudited)............................................... A-59 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................ A-61 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders.................................................. A-70 Item 6. Exhibits and Reports on Form 8-K..................................................................... A-70
A-53 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
JUNE 30, 1997 DECEMBER 31, 1996 (IN THOUSANDS) Assets: Cash and due from banks..................................................................... $ 23,989 $ 12,446 Federal funds sold.......................................................................... 8,500 3,100 Cash and cash equivalents................................................................. 32,489 15,546 Investments available for sale (cost 1997-$132,572; 1996-$133,061).......................... 131,706 132,578 Investment securities (fair value 1997-$11,425; 1996-$11,743)............................... 11,353 11,687 Loans held for sale......................................................................... -- -- Loans receivable............................................................................ 262,848 241,201 Less allowance for loan losses............................................................ 2,817 3,016 Loans receivable, net.................................................................. 260,031 238,185 Premises and equipment, net................................................................. 9,495 9,135 Real estate owned........................................................................... 747 695 Accrued interest receivable................................................................. 4,036 3,913 Other assets................................................................................ 4,114 2,895 Total Assets.............................................................................. $ 453,971 $ 414,634 Liabilities: Non-interest bearing deposits............................................................... 57,137 41,868 Interest bearing deposits................................................................... 96,480 96,169 Time deposits............................................................................... 148,166 139,428 Total deposits............................................................................ 301,783 277,465 Advances from The Federal Home Loan Bank.................................................... 21,000 20,500 Securities sold under agreements to repurchase.............................................. 96,242 84,037 Other liabilities........................................................................... 4,134 3,381 Total Liabilities......................................................................... 423,159 385,383 Commitments and Contingencies Stockholders' Equity: Preferred stock authorized 300,000 shares; Series "A", $25 par value: issued and outstanding 138,300 and 138,300 shares, respectively........................... 3,457 3,457 Series "B", $25 par value: issued and outstanding 161,700 and 161,700 shares, respectively........................... 4,043 4,043 Common stock, $5 par value: authorized 5,000,000 shares; issued and outstanding 2,936,480 and 2,906,262 shares, respectively....................... 14,682 14,531 Additional paid-in capital.................................................................. 10,702 10,614 Net unrealized holding (loss) on investments available for sale............................. (572) (305) Accumulated deficit......................................................................... (1,500) (3,089) Total Stockholders' Equity................................................................ 30,812 29,251 Total Liabilities and Stockholders' Equity................................................ $ 453,971 $ 414,634
See accompanying notes to financial statements. A-54 COVENANT BANCORP, INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 1997 1996 (IN THOUSANDS EXCEPT PER SHARE DATA) Interest Income Interest and fees on loans............................................................................ $5,602 $5,005 Interest on investment securities..................................................................... 2,336 2,256 Other interest income................................................................................. 16 106 Total interest income.............................................................................. 7,954 7,367 Interest Expense Interest on deposits.................................................................................. 2,612 2,360 Interest on borrowings................................................................................ 1,507 1,296 Total interest expense............................................................................. 4,119 3,656 Net interest income..................................................................................... 3,835 3,711 Provision for loan losses............................................................................... 5 23 Net interest income after provision for loan losses..................................................... 3,830 3,688 Other Income Service charges on deposit accounts................................................................... 172 165 Loan servicing income................................................................................. 48 64 Other operating income................................................................................ 51 38 Gain on sale of assets................................................................................ 11 -- Total other income................................................................................. 282 267 Other Expenses Salaries and employee benefits........................................................................ 1,600 1,584 Net occupancy......................................................................................... 457 395 Data processing and other service costs............................................................... 162 187 Professional services................................................................................. 76 137 Advertising and promotion............................................................................. 45 58 Federal insurance premiums............................................................................ 19 61 Other operating expenses.............................................................................. 370 347 Total other expenses............................................................................... 2,729 2,769 Income before income taxes.............................................................................. 1,383 1,186 Income taxes............................................................................................ 473 432 Net income.............................................................................................. 910 754 Less: preferred stock dividends......................................................................... 113 113 Net income applicable to common shareholders............................................................ $ 797 $ 641 Income per common share and common stock equivalents.................................................... $ 0.21 $ 0.18 Weighted average common stock and common stock equivalents outstanding.................................. 4,314 4,238
See accompanying notes to financial statements. A-55 COVENANT BANCORP, INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1997 1996 (IN THOUSANDS EXCEPT PER SHARE DATA) Interest Income Interest and fees on loans............................................................................ $10,899 $ 9,850 Interest on investment securities..................................................................... 4,663 4,220 Other interest income................................................................................. 47 197 Total interest income.............................................................................. 15,609 14,267 Interest Expense Interest on deposits.................................................................................. 5,166 4,708 Interest on borrowings................................................................................ 2,922 2,250 Total interest expense............................................................................. 8,088 6,958 Net interest income..................................................................................... 7,521 7,309 Provision for loan losses............................................................................... 30 41 Net interest income after provision for loan losses..................................................... 7,491 7,268 Other Income Service charges on deposit accounts................................................................... 311 290 Loan servicing income................................................................................. 91 124 Other operating income................................................................................ 90 84 Gain on sale of assets................................................................................ 11 -- Total other income................................................................................. 503 498 Other Expenses Salaries and employee benefits........................................................................ 3,075 3,157 Net occupancy......................................................................................... 918 788 Data processing and other service costs............................................................... 264 374 Professional services................................................................................. 155 271 Advertising and promotion............................................................................. 75 93 Federal insurance premiums............................................................................ 39 120 Other operating expenses.............................................................................. 711 706 Total other expenses............................................................................... 5,237 5,509 Income before income taxes.............................................................................. 2,757 2,257 Income taxes............................................................................................ 943 822 Net income.............................................................................................. 1,814 1,435 Less: preferred stock dividends......................................................................... 225 225 Net income applicable to common shareholders............................................................ $ 1,589 $ 1,210 Income per common share and common stock equivalents.................................................... $ 0.42 $ 0.34 Weighted average common stock and common stock equivalents outstanding.................................. 4,283 4,239
See accompanying notes to financial statements. A-56 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1997 1996 (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................................................................ $ 1,814 $ 1,435 Adjustments to reconcile net income to net cash (used) provided by operating activities: Provision for loan losses............................................................................. 30 41 Depreciation and amortization......................................................................... 317 346 Amortization of premiums and discounts, net........................................................... 36 156 Loans originated for sale............................................................................. -- (951) Proceeds from sales of loans held for sale............................................................ -- 1,887 Decrease in unearned discounts and loan fees, net..................................................... (247) (106) Increase in accrued interest receivable and other assets.............................................. (1,342) (2,359) Increase in other liabilities......................................................................... 753 991 Net cash provided by operating activities.......................................................... 1,361 1,440 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments held to maturity............................................................. -- (1,312) Purchases of investments available for sale........................................................... (6,970) (52,674) Proceeds from maturities of investments available for sale............................................ 7,500 -- Proceeds from maturities of investments held to maturity.............................................. -- 25,860 Principal collected on mortgage backed securities..................................................... 309 498 Net increase in loans................................................................................. (21,958) (23,688) Proceeds from sales of real estate owned.............................................................. 341 357 Purchases of premises and equipment................................................................... (677) (629) Net cash used in investing activities.............................................................. (21,455) (51,588) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits.............................................................................. 24,318 13,018 Net increase in securities sold under agreements to repurchase........................................ 12,205 44,473 Net increase (decrease) in advances from the Federal Home Loan Bank................................... 500 (3,000) Preferred stock dividends paid........................................................................ (225) (225) Common stock issuance and other....................................................................... 239 41 Net cash provided by financing activities.......................................................... 37,037 54,307 Net increase in cash and cash equivalents............................................................. 16,943 4,159 Cash and cash equivalents at the beginning of the year.................................................. 15,546 22,777 Cash and cash equivalents at the end of the period...................................................... $32,489 $26,936 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest........................................................... $ 8,107 $ 6,525 Cash paid during the period for income taxes....................................................... 881 568 Noncash investing and financing activities: Net transfers to real estate owned from loans receivable........................................... 393 559 Net change in gross unrealized (loss) on investments available for sale............................ $ (383) $(1,082)
See accompanying notes to financial statements. A-57 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ADDITIONAL PREFERRED COMMON PAID-IN NET UNREALIZED ACCUMULATED STOCK STOCK CAPITAL GAIN (LOSS) DEFICIT TOTAL (IN THOUSANDS, INCLUDING SHARE DATA) Balance at January 1, 1996.................................. $ 7,500 $13,559 $ 9,212 $ 1,157 $(1,519) $29,909 Net income twelve months ended December 31, 1996... -- -- -- -- 1,850 1,850 Preferred stock dividend........................... -- -- -- -- (450) (450) Adjustment to unrealized gain (net of of tax)...... -- -- -- (1,462) -- (1,462) Common stock dividends and other (194 shares)...... -- 972 1,402 -- (2,970) (596) Balance at December 31, 1996................................ 7,500 14,531 10,614 (305) (3,089) 29,251 Net income six months ended June 30, 1997.......... -- -- -- -- 1,814 1,814 Preferred stock dividend........................... -- -- -- -- (225) (225) Adjustment to unrealized gain (net of tax)......... -- -- -- (267) -- (267) Common stock dividends and other (30 shares)....... -- 151 88 -- -- 239 Balance at June 30, 1997.................................... $ 7,500 $14,682 $ 10,702 $ (572) $(1,500) $30,812
See accompanying notes to financial statements. A-58 COVENANT BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) A. CONSOLIDATED FINANCIAL STATEMENTS The financial statements included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The accompanying condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. Such adjustments are of a normal recurring nature. On June 13, 1997, Covenant Bancorp, Inc. (the "Company") was formed and registered with the SEC. Also on that date, Covenant Bank (the "Bank") was acquired by the Company. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Bank's Annual Report (Amendment No. 2 to Form F-2 dated April 28, 1997, filed with the Federal Deposit Insurance Corporation) for the period ended December 31, 1996. The annual report is also included in the Registrant's Registration Statement on Form S-4 dated April 28, 1997. The results for the three and six months ended June 30, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. The consolidated financial statements include the accounts of Covenant Bancorp, Inc. and all of its subsidiaries, including Covenant Bank. All material intercompany transactions have been eliminated. B. COMMITMENTS In the normal course of business, there are various outstanding commitments to extend credit, such as letters of credit and unadvanced loan commitments, which are not reflected in the accompanying consolidated financial statements. Management does not anticipate any material losses as a result of these transactions. C. SFAS NO. 128 -- EARNINGS PER SHARE In February 1997, the FASB issued SFAS No. 128, EARNINGS PER SHARE. This statement establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. This Statement simplifies the standards for computing earnings per share previously found in APB Opinion No. 15, Earnings per Share, and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the statement of operations for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. This Statement is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. This Statement requires restatement of all prior-period EPS data presented. Had the Company adopted this Statement as of June 30, 1997, the pro forma earnings per share would have been:
FOR THE THREE MONTHS ENDED JUNE 30, 1997 WEIGHTED PRO FORMA INCOME AVERAGE SHARES EARNINGS (NUMERATOR) (DENOMINATOR) PER SHARE Basic EPS Net income available to common shareholders........................................ $ 797 3,054 $0.26 Effect of dilutive securities Convertible preferred stock........................................................ $ 113 1,059 Stock options...................................................................... -- 201 Dilutive EPS Income available to common shareholders plus assumed conversions................... $ 910 4,314 $0.21
A-59 COVENANT BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (UNAUDITED) C. SFAS NO. 128 -- EARNINGS PER SHARE -- Continued
FOR THE SIX MONTHS ENDED JUNE 30, 1997 WEIGHTED PRO FORMA INCOME AVERAGE SHARES EARNINGS (NUMERATOR) (DENOMINATOR) PER SHARE Basic EPS Net income available to common shareholders........................................ $ 1,589 3,044 $0.52 Effect of dilutive securities Convertible preferred stock........................................................ $ 225 1,059 Stock options...................................................................... -- 180 Dilutive EPS Income available to common shareholders plus assumed conversions................... $ 1,814 4,283 $0.42
D. ISSUANCE OF COMMON STOCK On July 14, 1997, the Company issued a 4% stock dividend on its common stock to shareholders of record on June 24, 1997, resulting in the issuance of 117,110 additional shares of common stock and cash paid in lieu of fractional shares of $5,957. All share and per share data has been adjusted to reflect the retroactive recognition of all stock dividends declared. E. SUBSEQUENT EVENT On August 5, 1997, the Company and First Union Corporation (First Union) executed a definitive merger agreement in which First Union would acquire the Company. The Company's shareholders will receive .3813 shares of First Union common stock for each share of the Company's common stock. Each share of the two issues of the Company's convertible preferred stock will be exchanged for a number of shares of First Union common stock equal to the respective conversion ratios of the preferred stock times the merger exchange ratio of .3813. The acquisition, which will be accounted for under the purchase method of accounting, is subject to various conditions including the approval of the Company's shareholders and regulatory approvals. It is anticipated that the transaction will close during the first quarter of 1998. A-60 COVENANT BANCORP, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Covenant Bancorp, Inc. and its subsidiaries, ("the Company"), recorded net income of $1.8 million for the six months ended June 30, 1997, as compared to $1.4 million for the six months ended June 30, 1996. The 26% increase in net income between the two periods is the result of an increase in net interest income coupled with meaningful expense reduction and control. Net interest income was positively impacted by a 12% increase in average interest-earning assets for the six month period ended June 30, 1997, compared to the six months ended June 30, 1996. Return on average assets was 0.85% and return on average common equity was 14.29% for the six month period ended June 30, 1997, compared to 0.76% and 10.79%, respectively, for the six month period ended June 30, 1996. All prior period amounts have been restated to reflect the September 1996 acquisition of 1st Southern State Bank ("1st Southern"). For the three months ended June 30, 1997, the Company reported net income of $910,000, representing an increase of 21% in earnings compared to net income of $754,000 for the second quarter of 1996. Net interest income increased 3% for the second quarter of 1997 when compared to the second quarter of 1996 due to the above-mentioned increase in average interest-earning assets. Return on average assets and return on average common equity for the three months ended June 30, 1997 were 0.84% and 14.40%, respectively, compared to 0.76% and 11.66%, respectively, for the same period in 1996. Total assets amounted to $454.0 million at June 30, 1997, compared to $414.6 million at December 31, 1996, representing an increase of $39.4 million or 10% since year-end 1996. Net loans totaled $260.0 million, representing a 9% increase, over the year-end 1996 balance. Total deposits increased $24.3 million to reach $301.8 million at June 30, 1997, from the December 31, 1996 balance of $277.5 million. Stockholders' equity was $30.8 million at June 30, 1997. The Company's capital position meets the definition of a well-capitalized institution, which is evident by its leverage ratio, which stood at 7.30% and its Tier 1 and Total Capital ratios, which equaled 11.74% and 12.79%, respectively. On August 5, 1997, the Company and First Union Corporation (First Union) executed a definitive merger agreement in which First Union would acquire the Company. The Company's shareholders will receive .3813 shares of First Union common stock for each share of the Company's common stock. Each share of the two issues of the Company's convertible preferred stock will be exchanged for a number of shares of First Union common stock equal to the respective conversion ratios of the preferred stock times the merger exchange ratio of .3813. The acquisition, which will be accounted for under the purchase method of accounting, is subject to various conditions including the approval of the Company's shareholders and regulatory approvals. It is anticipated that the transaction will close during the first quarter of 1998. RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is the difference between interest earned on loans and investments and interest incurred on deposits and other borrowed funds. Net interest income is affected by changes in both interest rates and the amounts of interest-earning assets and interest-bearing liabilities outstanding. Net interest income for the six months ended June 30, 1997 increased $212,000 or 3% to $7.5 million, compared to $7.3 million for the same period in 1996 primarily due to an increase in average loans of $35.2 million and a $7.8 million or 6% increase in average investments (see page A-63 for an average balance sheet and average rate comparisons). The increase in average loans is concentrated in the commercial and commercial mortgage portfolios of $21.9 million or 16% and a $8.6 million increase in 1-4 family mortgage loans. The increase in net interest income associated with growth in the loan portfolio has been largely offset by a compression in the net interest margin to 3.79% for the six months ended June 30, 1997 from 4.14% for the same period in 1996. The decrease in the net interest margin is due to the following factors: 1) a decline in the yield on the total loan portfolio to 8.71% for the six month period ended June 30, 1997 from 9.18% for the same period in 1997, caused by overall market conditions and 2) the increase in the Company's loan portfolio funded by higher-priced securities sold under agreements to repurchase and certificates of deposit rather than the Company's core deposit base, causing the Company's cost of funds to increase from 4.51% for the six months ended June 30, 1996 to 4.67% for the same period of 1997. Delays in the opening of the Company's three new personal financial centers resulted in the need for these types of short-term higher-costing funding sources. A-61 Net interest income for the three months ended June 30, 1997 increased $124,000 or 3% to $3.8 million, compared to $3.7 million for the same period in 1996. As discussed in the six month results, the improvement is directly related to the increase in average interest-earning assets during the second quarter of 1997, as compared to the same period in 1996, partially offset by a narrowing in the net interest margin. OTHER INCOME Other income for the first six months of 1997 totaled $503,000, compared to $498,000 for the same period of 1996. Service charges on deposit accounts increased $21,000 or 7% to $311,000 for the six months ended June 30, 1997 when compared to the same period in 1996, due to an increase in core deposit accounts over the past twelve months. Loan servicing income decreased $33,000 to $91,000 for the six months ended June 30, 1997 when compared to the same period of 1996 and is attributable to volume decreases in investor servicing fees, late fees, and credit card fees. Other operating income increased $6,000 for the first half of 1997, compared to the same period in 1996, due to an increase in MAC surcharge income and volume increases in safe deposit box fees offset by the discontinuance of a fee-based residential loan origination program. The one-time gain of $11,000 on the sale of assets during the second quarter of 1997 was due to a subdivision and subsequent sale of a small parcel of land and building that had been previously purchased with the Company's North Wildwood personal financial center. Other income for the three month period ended June 30, 1997 totaled $282,000, compared to $267,000 for the same period of 1996, representing a $15,000 or 6% increase. The increase in service charges on deposit accounts of $7,000 was associated with the above-mentioned increase in core deposit accounts. Loan servicing income decreased $16,000 to $48,000 for the second quarter of 1997 when compared to the same period of 1996 and is also attributable to volume decreases in investor servicing fees, late fees and credit card fees. Other operating income increased $13,000 for the second quarter of 1997, primarily related to an increase in MAC surcharge income and volume increases in safe deposit box fees. OTHER EXPENSES Other expenses for the six months ended June 30, 1997 equaled $5.2 million, compared to $5.5 million for the same period of 1996. This represents a decrease of $272,000 or 5% between the two periods. The ratio of total other expenses to average assets for the six months ended June 30, 1997 improved to 2.47% from 2.91% for the same period of 1996. Cost containment and operating efficiency are continuing priorities of management. The Company's operating efficiency ratio (non-interest expenses, less other real estate expenses, divided by net interest income plus non-interest income excluding non-recurring gains) improved to 65% for the first half of 1997, compared to 70% for the same period of 1996. Salaries and employee benefits equaled $3.1 million for the first six months of 1997, compared to $3.2 million for the same period in 1996. The salaries and benefits category is the largest component of other expenses, encompassing 59% of total other expenses as of June 30, 1997. The decrease in salaries and employee benefits expense is attributable to reductions in staff in connection with the 1st Southern acquisition completed in September 1996, partially offset by staffing increases associated with the new personal financial centers opened since March of 1996. Net occupancy increased $130,000 to $918,000 for the six months ended June 30, 1997 due to additional personal financial centers opened in Hammonton (3/96), the relocated Linwood center (10/96), Mount Laurel (12/96) and Cherry Hill (3/97), and the establishment of an operations center in Voorhees, NJ during the second quarter of 1996. Data processing and other service costs declined $110,000 to $264,000 for the six months ended June 30, 1997, compared to $374,000 for the same period of 1996. The Company's acquisition of 1st Southern and the operating efficiencies gained due to the system conversion in September 1996 are primarily attributable for the reduction in costs. Professional services expenses decreased $116,000 to $155,000 for the first six months of 1997, compared to $271,000 for the same period of 1996. The reduction is related to decreases of $48,000 in legal expenses related to the decrease in problem credits; a $25,000 decrease in consulting expenses due to the discontinuance of certain advertising and promotion programs and a $43,000 decrease in examinations expense due to the acquisition of 1st Southern. Federal insurance premiums declined $81,000 to $39,000 for the first half of 1997 due to a reduction in the Bank Insurance Fund premiums. Other operating expenses increased $5,000 to $711,000 for the six months ended June 30, 1997, compared to the same period of 1996. A-62 COVENANT BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED AVERAGE BALANCE SHEET (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1997 SIX MONTHS ENDED JUNE 30, 1996 AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE (IN THOUSANDS) Assets Loans:(1) Commercial................................................ $ 57,634 $ 2,575 8.98% $ 55,754 $ 2,626 9.50% Commercial mortgage....................................... 105,211 4,685 8.96 85,224 4,042 9.56 Mortgage.................................................. 53,630 2,155 8.00 45,070 1,842 8.18 Consumer.................................................. 35,193 1,484 8.50 30,395 1,340 8.89 Total loans............................................ 251,668 10,899 8.71 216,443 9,850 9.18 Investments: Federal funds sold........................................ 1,508 47 5.28 7,386 197 5.38 Investment securities..................................... 146,300 4,663 6.37 132,609 4,220 6.33 Total investments...................................... 147,808 4,710 6.37 139,995 4,417 6.27 Total interest-earning assets........................ 399,476 $ 15,609 7.84% 356,438 $ 14,267 8.07% Allowance for loan losses................................... (2,994) (3,101) Cash and due from banks..................................... 10,764 9,534 Fixed assets (net).......................................... 9,368 7,861 REO......................................................... 679 1,372 Other assets................................................ 7,268 5,654 Total Assets.............................................. $424,561 $377,758 Liabilities and Stockholders' Equity Deposits: Interest-bearing demand................................... $ 34,154 $ 394 2.33% $ 25,527 $ 254 2.01% Statement savings......................................... 38,940 467 2.42 44,494 539 2.44 Money market.............................................. 20,895 330 3.18 20,808 295 2.86 Certificates of deposit................................... 148,620 3,975 5.39 136,322 3,620 5.35 Total interest-bearing deposits........................ 242,609 5,166 4.29 227,151 4,708 4.18 FHLB advances and securities sold under agreements to repurchase................................................ 106,691 2,922 5.52 83,939 2,250 5.41 Total interest bearing liabilities..................... 349,300 8,088 4.67 311,090 6,958 4.51 Non-interest bearing deposits............................... 42,204 34,181 Other liabilities........................................... 3,488 2,792 Stockholders' equity........................................ 29,569 29,695 Total Liabilities and Stockholders' Equity............. $424,561 $377,758 Net Interest Income/Spread.................................. $ 7,521 3.17% $ 7,309 3.56% Net Interest Margin (2)..................................... 3.79% 4.14%
(1) Includes non-accruing loans. The effect of including such loans is to reduce the average rate earned on Covenant's loans. (2) Net interest income as a percentage of average interest-earning assets. A-63 Other expenses for the three months ended June 30, 1997 equaled $2.7 million, compared to $2.8 million, representing a decrease of $40,000 or 1% over the second quarter of 1996. Salaries and employee benefits increased $16,000 to $1.6 million for the second quarter of 1997 when compared to the same period in 1996. The increase in salaries and employee benefits expense is directly associated with the new staffing positions created for the new personal financial centers noted above. Net occupancy increased $62,000 to $457,000 for the three months ended June 30, 1997, compared to the same period of 1996 due to the above-mentioned new personal financial centers. Data processing and service costs decreased $25,000 for the three months ended June 30, 1997, compared to the same period in 1996. The Company's acquisition of 1st Southern and operating efficiencies gained due to the system conversion in September 1996 are primarily attributable to the reduction in costs offset by new accounts added over the last twelve months. Professional services expenses decreased $61,000 for the second quarter of 1997 to $76,000, compared to the same period in 1996. The reduction is related to a decrease of $27,000 in legal expenses; a $6,000 decrease in consulting expenses due to the discontinuance of certain advertising and promotion programs and a $20,000 decrease in examination expense due to the acquisition of 1st Southern. Federal insurance premiums declined $42,000 to $19,000 for the three months ended June 30, 1997 as compared to the same period in 1996 due to a reduction in the Bank Insurance Fund premium. Other operating expenses increased $23,000 to $370,000 for the three months ended June 30, 1997, compared to the same period in 1996 due to increases in postage, insurance and telephone expenses related to the new branch facilities opened. FINANCIAL CONDITION LOAN PORTFOLIO The lending function is the Company's principal business activity and it continues its policy to serve as a reliable source of credit to a diverse customer base. The Company lends primarily to commercial borrowers in the southern New Jersey marketplace. The loan portfolio is diversified, with 65% of the portfolio comprised of commercial and commercial mortgage loans and 35% comprised of residential mortgage loans and consumer loans at June 30, 1997. At June 30, 1997, the Company's net loan portfolio totaled $260.0 million, compared to $238.2 million as of December 31, 1996. The $21.8 million or 9% (18% annualized) in growth in net loans has been concentrated within the commercial, commercial mortgage and residential mortgage loan portfolios. The majority of the Company's loan portfolio is primarily categorized as secured by commercial and 1-4 family residential real estate properties (including home equity loans). It is the Company's continuing policy to emphasize well-collaterized and properly-structured loans and to promote long-term quality relationships with financially strong borrowers. NON-PERFORMING ASSETS Non-performing assets include those loans that are not accruing interest (non-accruing loans), loans that have been restructured and real estate owned. Generally, loans that are contractually past-due are placed on non-accrual status when interest on principal becomes 90 days past-due, unless, in the Company's assessment, the value of collateral securing the loan adequately ensures the likelihood of the ultimate collection of all unpaid principal and interest and the loan is in the process of collection. A-64 The following table sets forth information regarding non-performing assets and contractually past-due loans of June 30, 1997 and 1996 and December 31, 1996:
JUNE 30, JUNE 30, DEC. 31, 1997 1996 1996 Non-performing assets: Non-accruing loans: Commercial................................................................................. $ 993 $2,500 $1,734 Mortgage................................................................................... 1,111 1,180 931 Consumer................................................................................... 112 232 201 Total non-performing loans................................................................... $2,216 $3,912 $2,866 Real estate owned............................................................................ 747 1,222 695 Total non-performing assets.................................................................. $2,963 $5,134 $3,561 Accruing loans 90 days past-due.............................................................. $1,324 $2,236 $1,753 Non-performing loans as a percentage of loans................................................ 0.84% 1.71% 1.19% Non-performing assets as a percentage of loans and real estate owned......................... 1.12% 2.23% 1.47% Non-performing assets as a percentage of total assets........................................ 0.65% 1.28% 0.86%
Non-performing assets totaled $3.0 million or 1.12% of total loans and real estate owned at June 30, 1997, showing marked improvement when compared to $3.6 million or 1.47% of total loans and real estate owned at December 31, 1996 and $5.1 million or 2.23% of total loans and real estate owned at June 30, 1996. Non-performing loans at June 30, 1997 decreased $650,000 from the December 31, 1996 balance of $2.9 million due to a $741,000 reduction in commercial non- performing loans and a reduction in consumer non-performing loans of $89,000 offset by an increase in mortgage non-performing loans of $180,000. The balance of non-performing loans at June 30, 1996 was $3.9 million or 1.71% of total loans. Real estate owned (net of reserves) was $747,000 at June 30, 1997, compared to $695,000 at December 31, 1996 and $1.2 million at June 30, 1996. During the first six months of 1997, additions to real estate owned of $393,000 (representing three foreclosed properties) were offset by the sale of five properties for $341,000, which resulted in the $52,000 increase in real estate owned. The balance of accruing loans 90 days past-due was $1.3 million at June 30, 1997, $1.8 million at December 31, 1996 and $2.2 million at June 30, 1996. The $429,000 decrease in accruing loans 90 days past-due during the six months ended June 30, 1997 is related to a decrease of $366,000 in various residential mortgage loans and a decrease in various home equity consumer loans of $107,000 offset by an increase in well-collateralized commercial loans of $44,000. At June 30, 1997 and December 31, 1996, the Company had impaired loans totaling approximately $993,000 and $1,734,000, respectively. The allowance for loan losses on impaired loans has a valuation allowance of $101,000, and $199,000 at June 30, 1997 and December 31, 1996, respectively. The average balance of impaired loans totaled $1,532,000 and $1,684,000 for June 30, 1997 and December 31, 1996, respectively. Interest income not accrued for impaired loans for the six months ended June 30, 1997 and for the twelve months ended December 31, 1996 was approximately $75,000 and $164,000, respectively. PROVISION AND ALLOWANCE FOR LOAN LOSSES The provision and allowance for loan losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be adequate to absorb known and inherent losses in the portfolio. Management considers a variety of factors when establishing the allowance, such as the impact of current economic conditions, diversification of the loan portfolio, delinquency statistics, results of loan review and related classifications, the borrower's perceived financial and managerial strengths, the estimated adequacy of underlying collateral and other relevant factors. Consideration is also given to examinations performed by regulatory authorities. A-65 The following table sets forth information regarding the Company's allowance for loan losses for the six month periods ended June 30, 1997 and 1996, and for the year ended December 31, 1996. CHANGES IN ALLOWANCE FOR LOAN LOSSES
YEAR SIX MONTHS ENDED ENDED 6/30/97 6/30/96 12/31/96 Balance at beginning of period............................................................... $ 3,016 $ 3,195 $ 3,195 Provision charged to operating expenses...................................................... 30 41 636 Charge-offs: Commercial................................................................................. (171) (49) (449) Mortgage................................................................................... (29) (119) (417) Consumer................................................................................... (57) (101) (124) Total Charge-offs............................................................................ (257) (269) (990) Recoveries: Commercial 24 85 124 Mortgage................................................................................... 3 4 -- Consumer................................................................................... 1 25 51 Total recoveries............................................................................. 28 114 175 Net charge-offs.............................................................................. (229) (155) (815) Balance at end of period..................................................................... $ 2,817 $ 3,081 $ 3,016 Net charge-offs as a percentage of average loans............................................. 0.18% 0.14% 0.36% Allowance as a percentage of period-end loans........................................................................... 1.07% 1.34% 1.25% Allowance as a percentage of non-performing loans....................................................................... 127.12% 78.76% 105.20% Allowance as a percentage of non-performing assets...................................................................... 95.07% 60.01% 84.70%
Management is consistently informed of changes in economic indicators which may have impact, either positive or adverse, on asset quality, the allowance for loan losses, potential charge-offs and delinquencies. The provision for loan losses charged against earnings was $30,000 in the first six months of 1997, compared to $41,000 for the first six months of 1996. Management believes that the allowance for loan losses at June 30, 1997 is adequate to absorb known and inherent losses in the portfolio. INVESTMENT SECURITIES Investment securities were $143.1 million at June 30, 1997, compared to $144.3 million at December 31, 1996. The decrease in investment securities was the result of purchases of $7.0 million of US Treasury Notes with maturities beyond one year and classified as "Available for Sale," offset by maturities and paydowns of $7.8 million and a decline of $400,000 in the gross unrealized holding loss on investments available for sale. At June 30, 1997, the fair value of investments available for sale was $131.7 million, and unrealized holding losses were $866,000. At December 31, 1996, the fair value of investments available for sale was $132.6 million and unrealized holding losses were $483,000. At June 30, 1997, securities held to maturity totaled $11.4 million compared to $11.7 million at December 31, 1996. The fair values of these investments were $11.4 million at June 30, 1997 and $11.7 million at December 31, 1996. The Company's investment portfolio is comprised of US Government securities, federal agency mortgage-backed securities and Federal Home Loan Bank ("FHLB") stock. The portfolio generates substantial interest income, serves as a source of liquidity and is used as a tool in managing interest rate sensitivity. Portions of the portfolio are also used to secure public deposits and serve as collateral for repurchase transactions. The investment portfolio also plays a significant role in the asset/liability management process. Among other things, the investment portfolio is utilized to balance the interest sensitivity of the prime-based portion of the loan portfolio. A-66 DEPOSITS The Company's predominant source of funds is depository accounts comprised of demand deposits, savings and money market accounts, time deposits and individual retirement accounts (IRA's). Deposits are provided by individuals and businesses located within the southern New Jersey marketplace. The Company gathers deposits from local municipalities within the guidelines of the Government Unit Deposit Protection Act (GUDPA). The Bank has no brokered deposits. The Company opened new personal financial centers in Linwood (relocation in October 1996), Mount Laurel (December 1996) and Cherry Hill (March 1997). Total deposits at June 30, 1997 equaled $301.8 million, compared to $277.5 million at December 31, 1996, representing a $24.3 million or 9% increase between December 31, 1996 and June 30, 1997. BORROWINGS Sources of funds for the Company other than deposits include FHLB advances and securities sold under agreements to repurchase. FHLB advances were $21.0 million at June 30, 1997 and $20.5 million at December 31, 1996. Securities sold under agreements to repurchase totaled $96.2 million at June 30, 1997, compared to $84.0 million at December 31, 1996. The increase in securities sold under agreements to repurchase was related to the increase in loans during the first six months of 1997. ASSET AND LIABILITY MANAGEMENT The Company monitors its sensitivity to interest rate changes and its liquidity and capital position through its asset and liability management process. The Company's objectives include (i) controlling interest rate exposures, (ii) ensuring adequate liquidity, (iii) maintaining a strong capital position and (iv) maximizing net interest income opportunities. The Company manages these objectives centrally through the Asset Liability Management Committee (ALCO). INTEREST RATE SENSITIVITY The Company seeks to manage its sensitivity position to maximize earnings and minimize the risk associated with interest rate movements through the use of a "gap analysis" on a monthly basis. The gap analysis assesses the interest rate risk that arises from differences in the volumes of assets and liabilities that mature or reprice within a given period. A "positive" gap position results when the amount of interest-sensitive assets exceeds that of interest-sensitive liabilities, signifying that the net interest margin will be positively affected by rising rates and negatively affected by falling rates; a "negative" gap position results when the amount of interest-sensitive liabilities exceeds that of interest-sensitive assets, indicating that the net interest margin will be negatively affected by rising rates and positively affected by falling rates. However, the Company's gap position does not necessarily predict the impact of changes in general levels of interest rates or net interest income due to assumptions made as to repricing and maturities of certain products. Decisions are also based on "dynamic shock analysis," a process that entails the application of different prime rate increase or decrease scenarios to the current maturity/repricing structure. This analysis measures the impact on net interest income of each of the scenarios applied relative to the Company's interest rate risk management policy guidelines, and seeks to identify appropriate measures to maintain the interest sensitivity of net interest income within such policy guidelines. At June 30, 1997, the Company's "dynamic shock analysis" indicates an acceptable level of interest rate risk and is within policy guidelines. In the event that the Company's interest rate risk models indicate an unacceptable level of risk, the Company could undertake a number of actions that would reduce this risk, including the sale of a portion of its Available for Sale portfolio or the extension of the maturities of its short-term borrowings, or the use of other risk management strategies as determined by the Company's ALCO Committee. A-67 The following table illustrates the gap position of the Company as of June 30, 1997.
NON-INTEREST BEYOND SENSITIVE 1-90 91-180 181-365 ONE-FIVE FIVE ASSETS/ DAYS DAYS DAYS YEARS YEARS LIABILITIES TOTAL Rate sensitive assets: Interest earning assets Loans............................ $ 96,515 $ 6,859 $ 12,616 $ 82,980 $ 61,061 -- $ 260,031 Investment securities............ 21,015 8,050 26,174 57,890 38,430 -- 151,559 Other short-term investments..... -- -- -- -- -- -- -- Total interest earning assets...................... 117,530 14,909 38,790 140,870 99,491 -- 412,368 Non-interest earning assets........ 42,381 42,381 Total assets..................... $ 117,530 $ 14,909 $ 38,790 $140,870 $ 99,491 $ 42,381 $ 453,971 Rate sensitive liabilities: Interest bearing demand.......... $ 26,649 -- -- $ 4,442 $ 4,441 -- $ 35,532 Statement Savings................ 29,367 -- -- 4,895 4,894 -- 39,156 Money Market..................... 16,344 -- -- 2,724 2,724 -- 21,792 Certificates of Deposit.......... 56,797 27,672 32,751 30,946 -- -- 148,166 FHLB advances and securities sold under agreements to repurchase.................... 109,242 -- 3,000 5,000 -- -- 117,242 Total interest bearing liabilities................... $ 238,399 $ 27,672 $ 35,751 $ 48,007 $ 12,059 -- $ 361,888 Non-interest bearing liabilities... -- -- -- -- -- 61,271 61,271 Stockholders' equity............... -- -- -- -- -- 30,812 30,812 Total liabilities and stockholders' equity.......... $ 238,399 $ 27,672 $ 35,751 $ 48,007 $ 12,059 $ 92,083 $ 453,971 Interest rate sensitivity GAP...... $(120,869) $ (12,763) $ 3,039 $ 92,863 $ 87,432 $(49,702) Cumulative GAP..................... $(120,869) $(133,632) $(130,593) $(37,730) $ 49,702 Cumulative GAP as a percentage of total............................ 49.30% 49.78% 56.73% 89.47% 113.73%
The Gap Analysis table is intended to illustrate the maturity/repricing characteristics of the Company's interest-earning assets and interest-bearing liabilities as of June 30, 1997. The analysis is based upon contractual maturities and, where applicable, management's estimates of the repricing characteristics of various assets and liabilities and on assumptions as to customer behavior. The Gap Analysis indicates a liability-sensitive position through the one-year time period beginning June 30, 1997. The Company's investment in U. S. Treasury Notes with maturities beyond one year is funded by a growth in deposits and short-term (three months or less) securities sold under agreements to repurchase and is primarily responsible for the liability-sensitive position through the one-year time period as of June 30, 1997. Covenant's net interest income has not been subject to the degree of sensitivity indicated by this traditional gap analysis. In monitoring interest sensitivity, adjustments are made to the dynamic shock assumptions to reflect management's recent experience regarding the impact of product pricing, interest rate spread relationships and customer behavior. These marginal adjustments are necessarily subjective and will vary over time with loan and deposit changes and market conditions. The investment portfolio is utilized to balance the Company's gap position, to manage the interest rate spread and to mitigate overall maturity risk in the portfolio. LIQUIDITY Adequate liquidity is necessary to meet the borrowing needs and deposit withdrawal requirements of customers as well as to satisfy liabilities, fund operations and support asset growth. Maintaining an appropriate level of liquid funds through the asset/liability management process ensures that the needs of the Company are met at a reasonable cost. Therefore, the management of liquidity is coordinated with the management of the Company's interest sensitivity and capital position. Major A-68 sources of liquidity are core deposits, cash flow generated by the Company's investment and loan portfolios, and short-term borrowings. Earnings and funds provided by operations also serve as a source of liquidity. Cash and cash equivalents equaled $32.5 million at June 30, 1997, compared to $15.6 million at December 31, 1996, resulting in a net increase of $16.9 million, as shown on the Consolidated Statements of Cash Flows for the six months ended June 30, 1997. The net increase of $22.0 million in loans contributed to a net cash used in investing activities equaling $21.5 million. The Company funded the net cash used in investing activities and the net increase in cash and cash equivalents principally through a $24.3 million increase in deposits, and a $12.2 million increase in securities sold under agreements to repurchase. The Company places strong emphasis on the composition of the investments available for sale portfolio. Additional sources of liquidity are available to the Company through the purchase of federal funds and borrowings on approved lines of credit. One measure of the Company's liquidity is the FDIC liquidity ratio. This ratio measures net cash, short-term investments and marketable assets divided by net deposits and short-term liabilities. The Company's liquidity ratio at June 30, 1997 was 23%. Overall, based on the its core deposit base, and its available sources of borrowed funds, management believes that the Company's liquidity position is satisfactory. CAPITAL The maintenance of appropriate levels of capital is a management priority and an important objective of the Company's asset and liability management process. The Company's principal capital planning goals are to provide an adequate return to stockholders, to support its growth and expansion activities, to provide stability to current operations, and to promote public confidence. Bank regulatory authorities have issued risk-based capital standards and leverage ratio requirements by which all bank holding companies and banks will be evaluated in terms of capital adequacy. The "Prompt Corrective Action" regulations issued pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 established five categories of depository institutions: (1) well-capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. Each category relates to the level of capital for the depository institution. The highest capital ratios equate to a "well-capitalized" depository institution which is one that significantly exceeds the minimum level required by regulation (i.e., total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater). At June 30, 1997, the Company and the Bank met the definition of a "well-capitalized" institution. The following table sets forth the Company's and the Bank's regulatory capital requirements and compliance therewith as of June 30, 1997: COVENANT BANCORP, INC. AND SUBSIDIARIES
WELL- CAPITAL EXCESS ACTUAL CAPITALIZED (IN THOUSANDS) Tier 1 Risk-Based Capital Ratio (1)..................................................... 11.74% 6.00% $ 15,342 Total Risk-Based Capital Ratio (2)...................................................... 12.79% 10.00% $ 7,464 Tier 1 Leverage Ratio (3)............................................................... 7.30% 5.00% $ 9,896
COVENANT BANK
WELL- CAPITAL EXCESS ACTUAL CAPITALIZED (IN THOUSANDS) Tier 1 Risk-Based Capital Ratio (1)..................................................... 11.74% 6.00% $ 15,342 Total Risk-Based Capital Ratio (2)...................................................... 12.79% 10.00% $ 7,464 Tier 1 Leverage Ratio (3)............................................................... 7.30% 5.00% $ 9,896
(1) Tier 1 Risk-Based Capital Ratio is defined as the ratio of Tier 1 Capital to Total Risk-Weighted Assets. (2) Total Risk-Based Capital Ratio is defined as the ratio of Tier 1 and Tier 2 Capital to Total Risk-Weighted Assets. (3) Tier 1 Leverage Ratio is defined as the ratio of Tier 1 Capital to Total Average Quarterly Assets. A-69 INCOME TAXES The Company's effective tax rate for the six months ended June 30, 1997 was 34.2%, compared to an effective rate of 36.4% for the same period in 1996. The decreased percentage from 1996 to 1997 is attributable to a reduction in state income taxes due to business strategies employed. PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS The Annual Meeting of the Registrant's Shareholders was held on June 10, 1997. The items of business acted upon at the Annual Meeting were the formation of Covenant Bancorp, Inc. (the Registrant) and the election of ten directors for one year terms. The number of votes cast for, against and abstained as to each proposal are as follows: Proposal 1 -- Formation of Covenant Bancorp, Inc.
FOR AGAINST ABSTAIN 2,026,595 118,123 791,762
Proposal 2 -- Election of Directors
NAME OF NOMINEE FOR AGAINST ABSTAIN Richard A. Hocker 2,418,836 119,873 1,045 John J. Gallagher, Jr. 2,419,881 118,828 0 Charles E. Sessa, Jr. 2,419,881 118,828 0 Barry M. Abelson 2,418,518 120,191 1,363 Thomas V.G. Brown 2,419,881 118,828 0 William T. Carson, Jr. 2,419,881 118,828 0 Gary E. Greenblatt 2,419,509 119,200 372 James R. Iannone 2,419,364 119,345 517 Joseph A. Maressa, Jr. 2,415,220 123,489 4,661 Kyle W. Will 2,415,220 123,489 4,661
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 2. Agreement and Plan of Mergers dated August 4, 1997 by and among Covenant Bancorp, Inc., Covenant Bank, First Union Corporation and First Union National Bank, attached as Exhibit 1 to the registrant's Current Report on Form 8-K dated August 8, 1997 and incorporated herein by reference. 10.1 Amendment No. 1 to Agreement, dated June 10, 1997, amending the Agreement dated November 22, 1995 between Covenant Bank and Richard A. Hocker. 10.2 Amendment No. 1 to Agreement, dated June 10, 1997, amending the Agreement dated November 22, 1995 between Covenant Bank and Charles E. Sessa, Jr. 10.3 Amendment No. 1 to Agreement, dated June 10, 1997, amending the Agreement dated November 22, 1995 between Covenant Bank and Kenneth R. Mancini, Jr. 10.4 Amendment No. 1 to Agreement, dated June 10, 1997, amending the Agreement dated November 22, 1995 between Covenant Bank and J. William Parker, Jr. 10.5 Amendment No. 1 to Agreement, dated June 10, 1997, amending the Agreement dated November 22, 1995 between Covenant Bank and Eugene D. D'Orazio. 11 Statement re Computation of Per Share Earnings 27 Financial Data Schedule
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the second quarter ended June 30, 1997. A-70 COVENANT BANCORP, INC. AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Bank has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COVENANT BANCORP, INC. /S/ CHARLES E. SESSA, JR. CHARLES E. SESSA, JR. PRESIDENT August 12, 1997 /S/ J. WILLIAM PARKER, JR. J. WILLIAM PARKER, JR. SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER & TREASURER August 12, 1997 A-71 EXHIBIT 11 COVENANT BANCORP, INC. AND SUBSIDIARIES COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1997 1996 1997 1996 Net income.................................................................. $ 910 $ 754 $1,814 $1,435 Average number of shares outstanding: Average common shares outstanding......................................... 3,054 3,073 3,044 3,073 Common stock equivalents considered in earnings per share computation: Dilutive stock options................................................. 201 106 180 107 Conversion of preferred stock Series "A"............................... 550 550 550 550 Conversion of preferred stock Series "B"............................... 509 509 509 509 Average number of shares outstanding........................................ 4,314 4,238 4,283 4,239 Net income per share of common stock and common stock equivalents........... $ 0.21 $ 0.18 $ 0.42 $ 0.34
A-72 ANNEX B AGREEMENT AND PLAN OF MERGERS AGREEMENT AND PLAN OF MERGERS, dated as of the 4th day of August, 1997 (this "Plan"), by and among COVENANT BANCORP, INC. (the "Company"), COVENANT BANK (the "Bank"), FIRST UNION CORPORATION ("First Union"), and FIRST UNION NATIONAL BANK ("FUNB"). RECITALS: (A) THE COMPANY. The Company is a corporation duly organized and existing in good standing under the laws of the State of New Jersey, with its principal executive offices located in Haddonfield, New Jersey. The Company is a registered bank holding company under the Bank Holding Company Act of 1956, as amended ("BHCA"). As of the date hereof, the Company has 25,000,000 authorized shares of common stock, each of $5.00 par value ("Company Common Stock"), and 1,000,000 authorized shares of preferred stock, each of $25.00 par value ("Company Preferred Stock" and, together with the Company Common Stock, "Company Stock"), of which 138,300 shares have been authorized and designated as Series A Preferred Stock ("Series A Preferred Stock") and 161,700 shares have been authorized and designated as Series B Preferred Stock ("Series B Preferred Stock") (no other class of capital stock being authorized), of which 3,057,193 shares of Company Common Stock, 138,300 shares of Series A Preferred Stock and 161,700 shares of Series B Preferred Stock are issued and outstanding. (B) THE BANK. The Bank is a commercial bank duly organized and existing in good standing under the laws of the State of New Jersey, with its principal executive offices located in Haddonfield, New Jersey. As of June 30, 1997, the Bank had capital of $30,812,000, divided into common stock of $14,682,000, preferred stock of $7,500,000, surplus of $10,702,000, undivided profits (loss), including retained earnings, of $(1,500,000), and net unrealized gain (loss) on investment securities of $(572,000). All of the issued and outstanding shares of capital stock of the Bank ("Bank Capital Stock") are owned by the Company. (C) FIRST UNION. First Union is a corporation duly organized and existing in good standing under the laws of the State of North Carolina, with its principal executive offices located in Charlotte, North Carolina. First Union is a registered bank holding company under the BHCA. As of the date hereof, First Union has 750,000,000 authorized shares of common stock, each of $3.33 1/3 par value ("First Union Common Stock"), 40,000,000 authorized shares of Class A Preferred Stock, no-par value ("First Union Class A Preferred Stock"), and 10,000,000 authorized shares of Preferred Stock, no-par value ("First Union Preferred Stock") (no other class of capital stock being authorized), of which 280,488,704 shares of First Union Common Stock (without giving effect to the two-for-one First Union Common Stock split paid on July 31, 1997 to holders of record of First Union Common Stock on July 1, 1997), no shares of First Union Class A Preferred Stock, and no shares of First Union Preferred Stock, were issued and outstanding as of June 30, 1997. (D) FUNB. FUNB is a national banking association duly organized and existing under the laws of the United States, with its principal executive offices located in Avondale, Pennsylvania. As of June 30, 1997, FUNB had capital of $2,267,270,516, divided into common stock of $452,155,620, preferred stock of $160,540,000, surplus of $1,300,079,773, undivided profits, including capital reserves, of $353,444,727, and net unrealized holding gains on available for sale securities of $1,050,396. All of FUNB's issued and outstanding shares of capital stock are owned by First Fidelity Incorporated ("FFI"), a wholly-owned subsidiary of First Union Corporation of New Jersey ("FUNC-NJ"), a wholly-owned subsidiary of First Union. (E) RIGHTS, ETC. Except as Previously Disclosed (as hereinafter defined) in SCHEDULE 4.01(C), there are no shares of capital stock of the Company or the Bank authorized and reserved for issuance, neither the Company nor the Bank has any Rights (as defined below) issued or outstanding and neither the Company nor the Bank has any commitment to authorize, issue or sell any such shares or any Rights, except pursuant to this Plan. The term "Rights" means securities or obligations convertible into or exchangeable for, or giving any person any right to subscribe for or acquire, or any options, calls or commitments relating to, shares of capital stock (and shall include stock appreciation rights). There are no preemptive rights in respect of the Company Stock. (F) APPROVALS. The Board of Directors of each of the Company, the Bank, First Union and FUNB has approved, at meetings of each of such Boards of Directors, this Plan and has authorized the execution hereof in counterparts. B-1 In consideration of their mutual promises and obligations, the parties hereto adopt and make this Plan and prescribe the terms and conditions thereof and the manner and basis of carrying it into effect, which shall be as follows: I. THE MERGERS. 1.01. THE CORPORATE MERGER. On the Effective Date (as hereinafter defined): (A) THE CONTINUING CORPORATION. The Company shall merge with and into First Union (the "Corporate Merger"), the separate existence of the Company shall cease and First Union (the "Continuing Corporation") shall survive and the name of the Continuing Corporation shall be "First Union Corporation". (B) EFFECT OF THE CORPORATE MERGER. Subject to the satisfaction or waiver of the conditions set forth in ARTICLE VI in accordance with the terms of this Plan, the Corporate Merger shall become effective upon the filing in the offices of the Secretary of State of the States of North Carolina and New Jersey of Articles of Merger and a Certificate of Merger, as applicable, or such later date and time as may be set forth in such Articles of Merger and Certificate of Merger, in accordance with applicable law. (C) RIGHTS, ETC. The Continuing Corporation shall thereupon and thereafter possess all of the rights, privileges, immunities and franchises, of a public as well as of a private nature, of each of the merging corporations; and all property, real, personal and mixed, and all debts due on whatever account, and all other choses in action, and all and every other interest, of or belonging to or due to each of the corporations so merged, shall be deemed to be vested in the Continuing Corporation without further act or deed; and the title to any real estate or any interest therein, vested in each of such corporations, shall not revert or be in any way impaired by reason of the Corporate Merger. (D) LIABILITIES. The Continuing Corporation shall thenceforth be responsible and liable for all the liabilities, obligations and penalties of each of the corporations so merged, in accordance with applicable law. (E) ARTICLES OF INCORPORATION; BYLAWS; DIRECTORS; OFFICERS. The Articles of Incorporation and Bylaws of the Continuing Corporation shall be those of First Union, as in effect immediately prior to the Corporate Merger becoming effective. The directors and officers of First Union in office immediately prior to the Corporate Merger becoming effective shall be the directors and officers of the Continuing Corporation, together with such additional directors and officers as may thereafter be elected, who shall hold office until such time as their successors are elected and qualified. 1.02. THE BANK MERGER. Following the Corporate Merger on the Effective Date or as soon thereafter as First Union may deem appropriate: (A) CONTRIBUTION OF BANK CAPITAL STOCK. First Union shall contribute the Bank Capital Stock to FUNC-NJ and shall cause FUNC-NJ to contribute the Bank Capital Stock to FFI. (B) THE CONTINUING BANK. Following the contribution of the Bank Capital Stock to FUNC-NJ and from FUNC-NJ to FFI and at least one day following the Effective Date, the Bank shall be merged with and into FUNB (the "Bank Merger" and together with the Corporate Merger, the "Mergers"), the separate existence of the Bank shall cease and FUNB (the "Continuing Bank") shall survive; the name of the Continuing Bank shall be "First Union National Bank"; and the Continuing Bank shall continue to conduct the business of a national banking association at FUNB's main office in Avondale, Pennsylvania and at the legally established branches of the Bank and FUNB. (C) RIGHTS, ETC. The Continuing Bank shall thereupon and thereafter possess all the rights, privileges, immunities and franchises, of a public as well as of a private nature, of each of the banks so merged; and all property, real, personal and mixed, and all debts due on whatever account, and all other choses in action, and all and every other interest, of or belonging to or due to each of the banks so merged, shall be taken and deemed to be transferred to and vested in the Continuing Bank without further act or deed, including appointments, designations and nominations and all other rights and interests in any fiduciary capacity; and the title to any real estate or any interest therein, vested in each of such banks, shall not revert or be in any way impaired by reason of the Bank Merger. (D) LIABILITIES, ETC. The Continuing Bank shall thenceforth be responsible and liable for all the liabilities, obligations and penalties of the banks so merged (including liabilities arising out of the operation of any trust departments). All rights of creditors and obligors and all liens on the property of each of the Bank and FUNB shall be preserved unimpaired. (E) CHARTER; BYLAWS; DIRECTORS; OFFICERS. The Charter and Bylaws of the Continuing Bank shall be those of FUNB, as in effect immediately prior to the Bank Merger becoming effective. The directors and officers of FUNB in B-2 office immediately prior to the Bank Merger becoming effective shall be the directors and officers of the Continuing Bank, together with such additional directors and officers as may thereafter be elected, who shall hold office until such time as their successors are elected and qualified. (F) OUTSTANDING STOCK OF THE CONTINUING BANK. The amount of the capital stock of the Continuing Bank shall be not less than $612,695,620 and shall consist of not less than 22,727,147 issued and outstanding shares of common stock, each of $20.00 par value, and 160,540 issued and outstanding shares of preferred stock, each of $1.00 par value, and such issued and outstanding shares shall remain issued and outstanding as shares of FUNB, each of $20.00 par value and $1.00 par value, as applicable, and the holders thereof shall retain their rights therein. (G) OUTSTANDING STOCK OF THE BANK. Promptly after the Bank Merger becomes effective, FFI shall deliver all of the issued and outstanding shares of the capital stock of the Bank to the Continuing Bank for cancellation. 1.03. EFFECTIVE DATE AND EFFECTIVE TIME. Subject to the conditions to the obligations of the parties to effect the Corporate Merger as set forth in ARTICLE VI, the parties shall cause the effective date of the Corporate Merger (the "Effective Date") to occur on such date as the Company and First Union mutually agree upon, or if such parties cannot agree on such date, such date shall be the fifth business day to occur after the last of the conditions set forth in SECTIONS 6.01, 6.02, 6.03, 6.10, 6.11 and 6.13 shall have been satisfied or waived in accordance with the terms of this Plan (or, at the election of First Union, on the last business day of the month in which such day occurs); PROVIDED, HOWEVER, that such date shall be after December 31, 1997, unless the parties mutually agree otherwise. The time on the Effective Date when the Corporate Merger shall become effective is referred to as the "Effective Time". II. CONSIDERATION. 2.01. CORPORATE MERGER CONSIDERATION. Subject to the provisions of this Plan, on the Effective Date: (A) OUTSTANDING FIRST UNION COMMON STOCK. The shares of First Union Common Stock (together with the rights ("First Union Rights") issued pursuant to an Amended and Restated Shareholder Protection Rights Agreement, dated December 18, 1990, and as amended and restated as of October 15, 1996, attached thereto), issued and outstanding immediately prior to the Effective Time shall, on and after the Effective Time, remain as issued and outstanding shares of First Union Common Stock. (B) OUTSTANDING COMPANY COMMON STOCK. Each share (excluding shares held by the Company or any of the Company Subsidiaries (as hereinafter defined) or by First Union or any of its subsidiaries, in each case other than in a fiduciary capacity or as a result of debts previously contracted ("Excluded Shares")) of Company Common Stock issued and outstanding immediately prior to the Effective Time shall, by virtue of the Corporate Merger, automatically and without any action on the part of the holder thereof, become and be converted into the right to receive .3813 shares of First Union Common Stock (the "Exchange Ratio") (together with the attached First Union Rights), subject to possible adjustment as set forth in SECTION 2.08 (upon any such adjustment any reference in this Plan to "Exchange Ratio" shall thereafter be deemed to refer to the Exchange Ratio as adjusted). (C) OUTSTANDING SERIES A PREFERRED STOCK. If, immediately prior to the Effective Time, there shall be issued and outstanding any shares of Series A Preferred Stock, then each such share (excluding Excluded Shares) of Series A Preferred Stock shall become and be converted into the right to receive the number of shares of First Union Common Stock equal to the result of the product of the Exchange Ratio and 3.976, the conversion number for the Series A Preferred Stock provided for in the Company's Certificate of Incorporation, as amended (the "Company Certificate"). (D) OUTSTANDING SERIES B PREFERRED STOCK. If, immediately prior to the Effective Time, there shall be issued and outstanding any shares of Series B Preferred Stock, then each such share (excluding Excluded Shares) of Series B Preferred Stock shall become and be converted into the right to receive the number of shares of First Union Common Stock equal to the result of the product of the Exchange Ratio and 3.147, the conversion number for the Series B Preferred Stock provided for in the Company Certificate. 2.02. STOCKHOLDER RIGHTS; STOCK TRANSFERS. At the Effective Time, holders of Company Common Stock and Company Preferred Stock shall cease to be, and shall have no rights as, stockholders of the Company, other than to receive the consideration provided under this ARTICLE II, without interest. After the Effective Time, there shall be no transfers on the stock transfer books of the Company or the Continuing Corporation of the shares of Company Stock which were issued and outstanding immediately prior to the Effective Time. B-3 2.03. FRACTIONAL SHARES. Notwithstanding any other provision hereof, no fractional shares of First Union Common Stock and no certificates or scrip therefor, or other evidence of ownership thereof, will be issued in the Corporate Merger; instead, First Union shall pay to each holder of Company Stock who would otherwise be entitled to a fractional share an amount in cash (without interest) determined by multiplying such fraction by the last sale price of First Union Common Stock on the last trading day prior to the Effective Date, as reported by the New York Stock Exchange, Inc. (the "NYSE") Composite Transactions tape (as reported in THE WALL STREET JOURNAL). 2.04. EXCHANGE PROCEDURES. As promptly as practicable after the Effective Date, First Union will send or cause to be sent to each former stockholder of the Company of record immediately prior to the Effective Time, transmittal materials for use in exchanging such stockholder's certificates for Company Stock for the consideration set forth in this ARTICLE II. The certificates representing the shares of First Union Common Stock into which shares of such stockholder's Company Stock are converted on the Effective Date, any fractional share check which such stockholder shall be entitled to receive, and any dividends paid on such shares of First Union Common Stock for which the record date for determination of stockholders entitled to such dividends is on or after the Effective Date, will be delivered to such stockholder only upon delivery to First Union National Bank (the "Exchange Agent") of the certificates representing all of such shares of Company Stock (or indemnity satisfactory to First Union and the Exchange Agent, in their judgment, if any of such certificates are lost, stolen or destroyed). No interest will be paid on any such fractional share check or dividends which the holder of such shares shall be entitled to receive upon such delivery. Certificates surrendered for exchange by any person constituting an Affiliate (as hereinafter defined) of the Company shall not be exchanged for certificates representing First Union Common Stock until First Union has received a written agreement from such person as specified in SECTION 5.10. 2.05. EXCLUDED SHARES. Each of the Excluded Shares of Company Stock shall be canceled and retired at the Effective Time, and no consideration shall be issued in exchange therefor. 2.06. RESERVATION OF RIGHT TO REVISE TRANSACTION. First Union may at any time change the method of effecting the acquisition of the Company and the Bank (including without limitation the provisions of this ARTICLE II) if and to the extent it deems such change to be desirable; PROVIDED, HOWEVER, that no such change shall (A) alter or change the amount or kind of consideration to be issued to holders of Company Stock as provided for in this Plan, (B) adversely affect the intended tax-free treatment to the Company's stockholders as a result of receiving such consideration, or (C) materially impede or delay receipt of any approval referred to in SECTION 6.02 or the consummation of the transactions contemplated by this Plan. 2.07. STOCK OPTIONS. From and after the Effective Time, all employee and director stock options to purchase shares of Company Common Stock ("Stock Options"), which are then outstanding and unexercised (whether vested or unvested), shall be converted into and become options with respect to First Union Common Stock, and First Union shall assume each such Stock Option in accordance with the terms of the plan and agreement by which it is evidenced; PROVIDED, HOWEVER, that from and after the Effective Time, (A) each such Stock Option assumed by First Union may be exercised solely for shares of First Union Common Stock, (B) the number of shares of First Union Common Stock subject to such Stock Option shall be equal to the number of shares of Company Common Stock subject to such Stock Option immediately prior to the Effective Time, multiplied by the Exchange Ratio and rounded down to the nearest whole share, and (C) the per share exercise price under each such Stock Option shall be adjusted by dividing such price by the Exchange Ratio and rounding to the nearest cent. The Company represents and warrants that the number of shares of Company Common Stock which are issuable upon exercise of Stock Options as of the date hereof are Previously Disclosed in SCHEDULE 4.01(C). 2.08. ANTI-DILUTION PROVISIONS. In the event First Union changes the number of shares of First Union Common Stock issued and outstanding prior to the Effective Date as a result of a stock split, stock dividend, recapitalization or similar transaction with respect to the outstanding First Union Common Stock and the record date therefor shall be prior to the Effective Time, the Exchange Ratio shall be proportionately adjusted. III. ACTIONS PENDING CONSUMMATION. From the date hereof until the Effective Time, except as expressly contemplated by this Plan, without the prior written consent of First Union, each of the Company and the Bank will not, and will cause each of the Company Subsidiaries not to, agree to: 3.01. ORDINARY COURSE. Conduct its and each of the Company Subsidiaries' business other than in the ordinary and usual course consistent with past practice or fail to use its best efforts to maintain and preserve intact its and each of the Company Subsidiaries' business organization and assets and maintain its rights, franchises and existing relations with customers, suppliers, employees and business associates. B-4 3.02. CAPITAL STOCK. Except as Previously Disclosed in SCHEDULE 4.01(C), (A) issue, sell or otherwise permit to become outstanding any additional shares of capital stock of the Company or the Company Subsidiaries, or any Rights with respect thereto, (B) enter into any agreement with respect to the foregoing, or (C) permit any additional shares of Company Common Stock to become subject to new grants of employee stock options, stock appreciation rights or similar stock based employee compensation rights or take any action that permits the acceleration of Stock Options. 3.03. DIVIDENDS, ETC. Make, declare, pay or set aside for payment any dividend, cash or stock (other than dividends payable on Company Preferred Stock at a rate not exceeding the rate provided for in the terms thereof, and dividends from Company Subsidiaries to the Company or the Bank, as applicable), on or in respect of or declare or make any distribution on, or directly or indirectly combine, split, redeem, reclassify (except as Previously Disclosed in SCHEDULE 3.03), purchase or otherwise acquire, any shares of the capital stock of the Company or the Company Subsidiaries or, other than as permitted in or contemplated by this Plan, authorize the creation or issuance of, or issue, any additional shares of such capital stock or any Rights with respect thereto. 3.04. INDEBTEDNESS; LIABILITIES; ETC. Other than in the ordinary course of business consistent with past practice, incur any indebtedness for borrowed money or assume, guarantee, endorse or otherwise as an accommodation become liable for the obligations of any other individual or corporation, bank, partnership, limited liability company, joint venture, business trust, association or other organization (each, a "Business Entity"). 3.05. OPERATING PROCEDURES; CAPITAL EXPENDITURES; ETC. Except as may be directed by applicable law or regulation, (A) change its or any of the Company Subisidiaries' lending, investment, liability management or other material banking or other policies in any material respect, except such changes as are in accordance and in an effort to comply with SECTION 5.11, (B) incur or commit to incur any capital expenditures beyond those Previously Disclosed in SCHEDULE 3.05, other than in the ordinary course of business and not exceeding the Company's current budget for such expenditures as set forth in SCHEDULE 3.05, or (C) implement or adopt any change in accounting principles, practices or methods, other than as may be required by generally accepted accounting principles. 3.06. LIENS. Impose, or permit or suffer the imposition, on any shares of capital stock of any of the Company Subsidiaries, or on any of its or the Company Subsidiaries' other assets, any Liens (as hereinafter defined), other than Liens on such other assets that, individually or in the aggregate, are not reasonably likely to have a Material Adverse Effect (as hereinafter defined) on the Company. 3.07. COMPENSATION; EMPLOYMENT AGREEMENTS; ETC. Except as Previously Disclosed in SCHEDULE 3.07, enter into or amend any employment, consulting, severance or similar agreement or arrangement with any of its directors, officers, employees or consultants, or grant any salary or wage increase, amend the terms of any Stock Option or increase any employee benefit (including incentive or bonus payments), except normal individual increases in regular compensation to employees in the ordinary course of business consistent with past practice. 3.08. BENEFIT PLANS. Except as Previously Disclosed in SCHEDULE 3.08, enter into, establish, adopt or modify (except as may be required by applicable law) any pension, retirement, stock option, stock purchase, savings, profit sharing, deferred compensation, consulting, bonus, group insurance or other employee benefit, incentive or welfare contract, plan or arrangement, or any trust agreement related thereto, in respect of any of its directors, officers or other employees, including without limitation taking any action that accelerates the vesting or exercise of any benefits payable thereunder (other than any such acceleration or vesting that results from this Plan or the transactions contemplated herein). 3.09. ACQUISITIONS AND DISPOSITIONS. (A) sell, transfer or otherwise dispose of any portion of its assets, deposits, business or properties, except for any such dispositions which taken together are not material to the Company and the Company Subsidiaries taken as a whole, or discontinue or terminate any existing line of business, (B) merge or consolidate with, or acquire all or any portion of the business or property of, any other entity except for any such transaction that is in the ordinary course of business and which is not material to the Company and the Company Subsidiaries taken as a whole (except foreclosures or acquisitions by the Bank in a fiduciary capacity, in each case in the ordinary course of business consistent with past practice) or (C) make any material investment either by purchase of stock or securities, contributions to capital, property transfers, or purchase of any property or assets of any person or Business Entity other than from wholly-owned Company Subsidiaries and other than the purchase or sale of loans or marketable securities in the ordinary course of business consistent with past practices. 3.10. GOVERNING DOCUMENTS. Amend its Certificate of Incorporation, Charter or Bylaws. B-5 3.11. CLAIMS. Settle any claim, action or proceeding involving liability for any material money damages in an amount greater than $25,000 or any restrictions upon the operations of the Company or any of the Company Subsidiaries, or forgive or compromise any material amount of debt of any person or Business Entity, other than from wholly-owned Company Subsidiaries. 3.12. CONTRACTS. Enter into, terminate or make any change in any material contract, agreement or lease, except in the ordinary course of business consistent with past practice with respect to such contracts, agreements and leases that are terminable by it without penalty on not more than 60 days prior written notice. 3.13. OTHER ACTIONS. Take any actions that would (A) impede or delay the receipt of any approval referred to in SECTION 6.02 without the imposition of a condition or restriction of the type referred to in the proviso to such Section or (B) adversely affect the ability of any party to perform its obligations under this Plan. 3.14. AGREEMENTS. Authorize, commit or enter into any agreement to take any of the actions referred to in SECTIONS 3.01 through 3.13. IV. REPRESENTATIONS AND WARRANTIES. 4.01. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE BANK. Each of the Company and the Bank hereby represents and warrants to First Union and FUNB as follows: (A) RECITALS. The facts set forth in the Recitals of this Plan with respect to it are true and correct. (B) ORGANIZATION, STANDING AND AUTHORITY. It is duly qualified to do business and is in good standing in the States of the United States and foreign jurisdictions where its ownership or leasing of property or the conduct of its business requires it to be so qualified and in which the failure to be duly qualified, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company. Each of the Company and the Company Subsidiaries has in effect all federal, state, local, and foreign governmental authorizations necessary for it to own or lease its properties and assets and to carry on its business as it is now conducted, the absence of which, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company. (C) SHARES. The outstanding shares of it are duly authorized, validly issued and outstanding, fully paid and nonassessable, and are subject to no, and have not been issued in violation of any, preemptive rights. Except as Previously Disclosed in SCHEDULE 4.01(C), there are no shares of capital stock or other equity securities of the Company or the Bank outstanding and no outstanding Rights with respect thereto. (D) COMPANY SUBSIDIARIES. The Company has Previously Disclosed in SCHEDULE 4.01(D) a list of all the Company Subsidiaries, including the state of organization and principal business activities of each such Company Subsidiary. Each of the Company Subsidiaries that is a bank is an "insured depository institution" as defined in the Federal Deposit Insurance Act and applicable regulations thereunder. No equity securities of any of the Company Subsidiaries are or may become required to be issued (other than to the Company or a wholly-owned Company Subsidiary) by reason of any Rights with respect thereto. There are no contracts, commitments, understandings or arrangements by which any of the Company Subsidiaries is or may be bound to sell or otherwise issue any shares of its capital stock, and there are no contracts, commitments, understandings or arrangements relating to the rights of the Company or the Bank, as applicable, to vote or to dispose of such shares. All of the shares of capital stock of each Company Subsidiary held by the Company or a Company Subsidiary are fully paid and nonassessable and subject to no preemptive rights and are owned by the Company or a Company Subsidiary free and clear of any Liens. Each Company Subsidiary is in good standing under the laws of the jurisdiction in which it is incorporated or organized, and is duly qualified to do business and in good standing in each jurisdiction where its ownership or leasing of property or the conduct of its business requires it to be so qualified and in which the failure to be duly qualified is reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company. Except as Previously Disclosed in SCHEDULE 4.01(D), the Company does not own beneficially, directly or indirectly, any equity securities or similar interests of any Business Entity. The Bank is a member of the Bank Insurance Fund (the "BIF") of the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is a member in good standing of the Federal Home Loan Bank of New York (the "FHL Bank"). The term "Company Subsidiary" means any Business Entity (including the Bank), five percent or more of the equity interests of which are owned directly or indirectly by the Company. (E) CORPORATE POWER. It and each of the Company Subsidiaries has the corporate power and authority to carry on its business as it is now being conducted and to own or lease all its material properties and assets and it has the corporate power B-6 and authority to execute, deliver and perform its obligations under this Plan, and to consummate the transactions contemplated hereby. (F) CORPORATE AUTHORITY. Each of this Plan and the transactions contemplated hereby and, subject to any necessary receipt of approval by its stockholders referred to in SECTION 4.01(Y), consummation of the Corporate Merger, has been authorized by all necessary corporate action of it and is a valid and binding agreement of it enforceable against it in accordance with its terms, subject as to enforcement to bankruptcy, insolvency and other similar laws of general applicability relating to or affecting creditors' rights and to general equity principles. (G) NO DEFAULTS. Subject to the approval by its stockholders referred to in SECTION 6.01, the required regulatory approvals referred to in SECTION 6.02, and the required filings under federal and state securities laws, and except as Previously Disclosed in SCHEDULE 4.01(G), the execution, delivery and performance of this Plan and the consummation of the transactions contemplated hereby, do not and will not (1) constitute a breach or violation of, or a default under, or cause or allow the acceleration or creation of a Lien (with or without the giving of notice, passage of time or both) pursuant to, any law, rule or regulation or any judgment, decree, order, governmental or non-governmental permit or license, or agreement, indenture or instrument of it or of any of the Company Subsidiaries or to which it or any of the Company Subsidiaries or its or their properties is subject or bound, which breach, violation, default or Lien is reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company, (2) constitute a breach or violation of, or a default under, its Certificate of Incorporation, Charter or Bylaws, or (3) require any consent or approval under any such law, rule, regulation, judgment, decree, order, governmental or non-governmental permit or license or the consent or approval of any other party to any such agreement, indenture or instrument, other than any such consent or approval, which if not obtained, would not be reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company. (H) FINANCIAL REPORTS. As to (1) the Company, its Registration Statement on Form S-4, dated March 13, 1997, as amended, filed under the Securities Act of 1933, as amended (together with the rules and regulations thereunder, the "Securities Act"), and all other documents filed or to be filed subsequent to the date hereof, under Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended (together with the rules and regulations thereunder, the "Exchange Act"), in the form filed with the Securities and Exchange Commission (the "SEC") (in each such case, the "Company Financial Reports"), and (2) the Bank, (i) its Call Reports for the fiscal year ended December 31, 1996, and all other Call Reports filed or to be filed subsequent to December 31, 1996, in the form filed with the FDIC and (ii) its Annual Report on Form F-2 for the fiscal year ended December 31, 1996, as amended, and all other documents filed subsequent to December 31, 1996 under Section 13, 14 or 15(d) of the Exchange Act, in the form filed with the FDIC (in each case, the "Bank Financial Reports" and together with the Company Financial Reports, the "Company/Bank Financial Reports"), did not and will not as of their respective dates contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading; and each of the balance sheets in or incorporated by reference into the Company/Bank Financial Reports (including the related notes and schedules thereto) fairly presents and will fairly present the financial position of the entity or entities to which it relates as of its date and each of the statements of income and changes in stockholders' equity and cash flows or equivalent statements in the Company/Bank Financial Reports (including any related notes and schedules thereto) fairly presents and will fairly present the results of operations, changes in stockholders' equity and cash flows, as the case may be, of the entity or entities to which it relates for the periods set forth therein, in each case in accordance with generally accepted accounting principles consistently applied during the periods involved, except in each case as may be noted therein, subject to normal and recurring year-end audit adjustments in the case of unaudited statements. (I) ABSENCE OF UNDISCLOSED LIABILITIES. Except as disclosed in the Company/Bank Financial Reports prior to the date hereof, none of the Company or the Company Subsidiaries has any obligation or liability (contingent or otherwise) that, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company. (J) NO EVENTS. No events have occurred, or circumstances have arisen, since March 31, 1997, which, individually or in the aggregate, have had or are reasonably likely to have a Material Adverse Effect on the Company. (K) PROPERTIES. Except as specifically reserved against or otherwise disclosed in the Company/Bank Financial Reports (including the related notes and schedules thereto) and except for those properties and assets that have been sold or otherwise disposed of in the ordinary course of business, and except as Previously Disclosed in SCHEDULE 4.01(K), the Company and the Company Subsidiaries have good and marketable title, free and clear of all liens, encumbrances, charges, security interests, restrictions (including restrictions on voting rights or rights of disposition), defaults or equities of any character or claims or third party rights of whatever nature (collectively "Liens"), to all of the properties and assets, tangible and intangible, reflected in the Company/Bank Financial Reports as being owned by the Company or the Company Subsidiaries as of the B-7 dates thereof, other than those Liens that, individually or in the aggregate, are not reasonably likely to have a Material Adverse Effect on the Company. All buildings and all fixtures, equipment, and other property and assets which are held under leases or subleases by any of the Company or the Company Subsidiaries are held under valid leases or subleases enforceable in accordance with their respective terms. (L) LITIGATION; REGULATORY ACTION. Except as Previously Disclosed in SCHEDULE 4.01(L), no litigation, proceeding or controversy before any court or governmental agency is pending which, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company or which alleges claims under any fair lending law or other law relating to discrimination, including, without limitation, the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Community Reinvestment Act and the Home Mortgage Disclosure Act, and, to the best of its knowledge, no such litigation, proceeding or controversy has been threatened; and except as Previously Disclosed in SCHEDULE 4.01(L), neither it nor any of the Company Subsidiaries or any of its or their material properties or their officers, directors or controlling persons is a party to or is subject to any order, decree, agreement, memorandum of understanding or similar arrangement with, or a commitment or supervisory letter or similar submission to or from, any federal or state governmental agency or authority charged with the supervision or regulation of depository institutions or engaged in the insurance of deposits (together with any and all agencies or departments of federal, state or local government (including, without limitation, the FHL Bank, the Federal Reserve Board, the FDIC and any other federal or state bank, thrift or other financial institution, insurance or securities regulatory authorities (including the SEC, the "Regulatory Authorities")) and neither it nor any of the Company Subsidiaries has been advised by any of the Regulatory Authorities that any such authority is contemplating issuing or requesting (or is considering the appropriateness of issuing or requesting) any such order, decree, agreement, memorandum of understanding, commitment or supervisory letter or similar submission. (M) COMPLIANCE WITH LAWS. Except as Previously Disclosed in SCHEDULE 4.01(M), each of the Company and the Company Subsidiaries: (1) has all permits, licenses, authorizations, orders and approvals of, and has made all filings, applications and registrations with, all Regulatory Authorities that are required in order to permit it to conduct its business as presently conducted and that are material to the business of the Company and the Company Subsidiaries taken as a whole; all such permits, licenses, certificates of authority, orders and approvals are in full force and effect and, to the best of its knowledge, no suspension or cancellation of any of them is threatened; and all such filings, applications and registrations are current; (2) has received no notification or communication from any Regulatory Authority or the staff thereof (a) asserting that any of the Company or the Company Subsidiaries is not in compliance with any of the statutes, regulations or ordinances which such Regulatory Authority enforces, which, as a result of such noncompliance in any such instance, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company, (b) threatening to revoke any license, franchise, permit or governmental authorization, which revocation, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company, or (c) requiring any of the Company or the Company Subsidiaries (or any of their officers, directors or controlling persons) to enter into a cease and desist order, agreement or memorandum of understanding (or requiring the board of directors thereof to adopt any material resolution or policy); (3) is in compliance in all material respects with all fair lending laws or other laws relating to discrimination, including, without limitation, the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Community Reinvestment Act and the Home Mortgage Disclosure Act and similar federal and state laws and regulations. (N) MATERIAL CONTRACTS. Except as Previously Disclosed in SCHEDULE 4.01(N), none of the Company or the Company Subsidiaries, nor any of its respective assets, businesses or operations, is a party to, or is bound or affected by, or receives benefits under, any contract or agreement or amendment thereto that in each case (1) is required to be filed as an exhibit to an Exchange Act or Securities Act report filed by the Company or as an exhibit to an Annual Report on Form F-2 filed by the Bank that has not been filed as an exhibit to the Company's Exchange Act or Securities Act reports or the Bank's Annual Report on Form F-2 filed for the fiscal year ended December 31, 1996, or (2) which provides for annual payments by the Company or a Company Subsidiary of $100,000 or more. True and correct copies of such contracts, and any agreements or amendments thereto, have been supplied to First Union. Except as Previously Disclosed in SCHEDULE 4.01(N), none of the Company or the Company Subsidiaries is in default under any contract, agreement, commitment, arrangement, lease, insurance policy or other instrument to which it is a party, by which its respective assets, businesses or operations may be bound B-8 or affected, or under which it or any of its respective assets, business or operations receives benefits, which default, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on the Company, and there has not occurred any event that, with lapse of time or giving of notice or both, would constitute such a default. Except as Previously Disclosed in SCHEDULE 4.01(N), neither the Company nor any Company Subsidiary is subject to, or bound by, any contract containing covenants which (i) limit the ability of the Company or any Company Subsidiary to compete in any line of business or with any person, or (ii) involve any restriction of geographical area in which, or method by which, the Company or any Company Subsidiary may carry on its business (other than as may be required by law or any applicable Regulatory Authority). (O) REPORTS. Since January 1, 1994, each of the Company and the Company Subsidiaries has filed all reports and statements, together with any amendments required to be made with respect thereto, that it was required to file with (1) the SEC, (2) the FDIC, the New Jersey Department of Banking, the FHL Bank and (3) any other applicable Regulatory Authorities. As of their respective dates (and without giving effect to any amendments or modifications filed after the date of this Plan with respect to reports and documents filed before the date of this Plan), each of such reports and documents, including the financial statements, exhibits and schedules thereto, complied in all material respects with all of the statutes, rules and regulations enforced or promulgated by the Regulatory Authority with which they were filed and did not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. (P) NO BROKERS. All negotiations relative to this Plan and the transactions contemplated hereby have been carried on by it directly with the other parties hereto and no action has been taken by it that would give rise to any valid claim against any party hereto for a brokerage commission, finder's fee or other like payment, excluding a fee previously disclosed to First Union to be paid to Berwind Financial, L.P. (Q) EMPLOYEE BENEFIT PLANS. (1) SCHEDULE 4.01(Q) contains a complete list of all bonus, deferred compensation, pension, retirement, profit-sharing, thrift, savings, employee stock ownership, stock bonus, stock purchase, restricted stock and stock option plans, all employment or severance contracts, all medical, dental, health and life insurance plans, all other employee benefit plans, contracts or arrangements and any applicable "change of control" or similar provisions in any plan, contract or arrangement maintained or contributed to by it or any of the Company Subsidiaries for the benefit of employees, former employees, directors, former directors or their beneficiaries (the "Compensation and Benefit Plans"). True and complete copies of all Compensation and Benefit Plans, including, but not limited to, any trust instruments and/or insurance contracts, if any, forming a part thereof, and all amendments thereto have been supplied to First Union. Neither it nor any of the Company Subsidiaries has any commitment to create any additional Compensation and Benefit Plan or to modify or change any existing Compensation and Benefit Plan. (2) All "employee benefit plans" within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), other than "multiemployer plans" within the meaning of Section 3(37) of ERISA ("Multiemployer Plans"), covering employees or former employees of it and the Company Subsidiaries (the "ERISA Plans"), to the extent subject to ERISA, are in substantial compliance with ERISA. Except as Previously Disclosed in SCHEDULE 4.01(Q) each ERISA Plan which is an "employee pension benefit plan" within the meaning of Section 3(2) of ERISA ("Pension Plan") and which is intended to be qualified, under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), has received a favorable determination letter from the Internal Revenue Service, and it is not aware of any circumstances reasonably likely to result in the revocation or denial of any such favorable determination letter or the inability to receive such a favorable determination letter. There is no material pending or, to its knowledge, threatened litigation relating to the ERISA Plans. Neither it nor any of the Company Subsidiaries has engaged in a transaction with respect to any ERISA Plan that would subject it or any of the Company Subsidiaries to a tax or penalty imposed by either Section 4975 of the Code or Section 502 (i) of ERISA in an amount which would be material. (3) No liability under Subtitle C or D of Title IV of ERISA has been or is expected to be incurred by it or any of the Company Subsidiaries with respect to any ongoing, frozen or terminated "single-employer plan", within the meaning of Section 4001(a)(15) of ERISA, currently or formerly maintained by any of them, or the single-employer plan of any entity which is considered one employer with it under Section 4001(a)(15) of ERISA or Section 414 of the Code (an "ERISA Affiliate"). Neither it nor any of the Company Subsidiaries presently contributes to a Multiemployer Plan, nor have they contributed to such a plan within the past five calendar years. No notice of a "reportable event", within the meaning of Section 4043 of ERISA for which the 30-day reporting requirement has not been waived, has been required to be filed for any Pension Plan or by any ERISA Affiliate within the past 12-month period. B-9 (4) All contributions required to be made under the terms of any ERISA Plan have been timely made. Neither any Pension Plan nor any single-employer plan of an ERISA Affiliate has an "accumulated funding deficiency" (whether or not waived) within the meaning of Section 412 of the Code or Section 302 of ERISA. Neither it nor any of the Company Subsidiaries has provided, or is required to provide, security to any Pension Plan or to any single-employer plan of an ERISA Affiliate pursuant to Section 401(a)(29) of the Code. (5) Under each Pension Plan which is a single-employer plan, as of the last day of the most recent plan year, the actuarially determined present value of all "benefit liabilities", within the meaning of Section 4001(a)(16) of ERISA (as determined on the basis of the actuarial assumptions contained in the plan's most recent actuarial valuation) did not exceed the then current value of the assets of such plan, and there has been no material change in the financial condition of such plan since the last day of the most recent plan year. (6) Neither it nor any of the Company Subsidiaries has any obligations for retiree health and life benefits under any plan, except as set forth in SCHEDULE 4.01(Q). There are no restrictions on the rights of it or any of the Company Subsidiaries to amend or terminate any such plan without incurring any liability thereunder. (7) Except as Previously Disclosed in SCHEDULE 4.01(Q), neither the execution and delivery of this Plan nor the consummation of the transactions contemplated hereby will (a) result in any payment (including, without limitation, severance, unemployment compensation, golden parachute or otherwise) becoming due to any director or any employee of it or any of the Company Subsidiaries under any Compensation and Benefit Plan or otherwise from it or any of the Company Subsidiaries, (b) increase any benefits otherwise payable under any Compensation and Benefit Plan, (c) result in any acceleration of the time of payment or vesting of any such benefit, or (d) result in the imposition to the recipient of any excise tax pursuant to Section 4999 of the Code. (8) Neither the Company nor any of the Company Subsidiaries maintains any compensation plans, programs or arrangements the payments under which would not reasonably be expected to be deductible as a result of the limitations under Section 162(m) of the Code and the regulations issued thereunder. Except as Previously Disclosed in SCHEDULE 4.01(Q), as a result, directly or indirectly, of the transactions contemplated by this Plan (including, without limitation, as a result of any termination of employment prior to or following the Effective Time), none of First Union, the Company or the Continuing Corporation, or any of their respective subsidiaries will be obligated to make a payment that would be characterized as an "excess parachute payment" to an individual who is a "disqualified individual" (as such terms are defined in Section 280G of the Code), without regard to whether such payment is reasonable compensation for personal services performed or to be performed in the future. (R) NO KNOWLEDGE. It knows of no reason why the regulatory approvals referred to in SECTION 6.02 should not be obtained without the imposition of any condition of the type referred to in the proviso following such SECTION 6.02. (S) LABOR AGREEMENTS. Neither it nor any of the Company Subsidiaries is a party to, or is bound by, any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization, nor is it or any of the Company Subsidiaries the subject of a proceeding asserting that it or any such Company Subsidiary has committed an unfair labor practice (within the meaning of the National Labor Relations Act) or seeking to compel it or such subsidiary to bargain with any labor organization as to wages and conditions of employment, nor is there any strike or other labor dispute involving it or any of the Company Subsidiaries, pending or, to the best of its knowledge, threatened, nor is it aware of any activity involving its or any of the Company Subsidiaries' employees seeking to certify a collective bargaining unit or engaging in any other organization activity. (T) ASSET CLASSIFICATION. It has Previously Disclosed in SCHEDULE 4.01(T) a list, accurate and complete in all material respects, of the aggregate amounts of loans, extensions of credit or other assets of the Company and the Company Subsidiaries that have been classified by it as of June 30, 1997 (the "Asset Classification"); and no amounts of loans, extensions of credit or other assets that have been classified as of June 30, 1997 by any Regulatory Authority as "Other Loans Specially Mentioned", "Substandard", "Doubtful", "Loss", or words of similar import are excluded from the amounts disclosed in the Asset Classification, other than amounts of loans, extensions of credit or other assets that were charged off by the Company or a Company Subsidiary prior to June 30, 1997. (U) ALLOWANCE FOR POSSIBLE LOAN LOSSES. The allowance for possible loan losses shown on the consolidated balance sheets of the Bank included in the March 31, 1997 Bank Financial Reports was, and the allowance for possible loan losses to be shown on subsequent Company/Bank Financial Reports, will be, adequate, in the opinion of the Board of Directors and B-10 management of the Company, determined in accordance with generally accepted accounting principles, to provide for possible losses, net of recoveries relating to loans previously charged off, on loans outstanding (including accrued interest receivable) as of the date thereof. (V) INSURANCE. Each of Company and the Company Subsidiaries has taken all requisite action (including without limitation the making of claims and the giving of notices) pursuant to its directors' and officers' liability insurance policy or policies in order to preserve all rights thereunder with respect to all matters that are known to it, except for such matters which, individually or in the aggregate, are not reasonably likely to have a Material Adverse Effect on the Company. Set forth in SCHEDULE 4.01(V) is a list of all insurance policies maintained by or for the benefit of the Company or the Company Subsidiaries or their directors, officers, employees or agents. (W) AFFILIATES. Except as Previously Disclosed in SCHEDULE 4.01(W), there is no person who, as of the date of this Plan, may be deemed to be an "affiliate" of the Company (each, an "Affiliate") as that term is used in Rule 145 under the Securities Act. (X) STATE TAKEOVER LAWS; ARTICLES OF INCORPORATION. It has taken all necessary action to exempt this Plan and the transactions contemplated hereby from, and this Plan, and the transactions contemplated hereby are exempt from, (a) any applicable state takeover laws, including, without limitation, the provisions of Article 14A:10A of the New Jersey Business Corporation Act ("NJBCA"), (b) any applicable takeover provisions in the Company Certificate, and (c) any takeover provisions set forth in any agreement to which the Company is a party or may be bound and which provides for the issuance of any Rights in connection with a takeover. (Y) NO FURTHER ACTION. It has taken all action so that the entering into of this Plan and the consummation of the transactions contemplated hereby (including without limitation the Mergers) or any other action or combination of actions, or any other transactions, contemplated hereby do not and will not (1) require a vote of stockholders (other than the affirmative vote of the holders of a majority of the votes cast by the holders of shares of Company Common Stock, Series A Preferred Stock and Series B Preferred Stock, each voting as a separate class, on this Plan, and the approval of the Company in its capacity as sole stockholder of the Bank, which approval has been given), or (2) result in the grant of any rights to any person under the Company Certificate, Charter or Bylaws of the Company or any Company Subsidiary or under any agreement to which the Company or any of the Company Subsidiaries is a party, or (3) restrict or impair in any way the ability of First Union or FUNB to exercise the rights granted hereunder. (Z) ENVIRONMENTAL MATTERS. (1) To its knowledge, it and each of the Company Subsidiaries, the Participation Facilities and the Loan/Fiduciary Properties (each as defined below) are, and have been, in compliance with all Environmental Laws (as defined below), except for instances of noncompliance which are not reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company or have been Previously Disclosed in SCHEDULE 4.01(Z). (2) There is no proceeding pending or, to its knowledge, threatened before any court, governmental agency or board or other forum in which it or any of the Company Subsidiaries or any Participation Facility has been, or with respect to threatened proceedings, reasonably would be expected to be, named as a defendant or potentially responsible party (a) for alleged noncompliance (including by any predecessor) with any Environmental Law, or (b) relating to the release or threatened release into the environment of any Hazardous Material (as defined below), whether or not occurring at or on a site owned, leased or operated by it or any of the Company Subsidiaries or any Participation Facility, except for such proceedings pending or threatened that are not reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company or have been Previously Disclosed in SCHEDULE 4.01(Z). (3) There is no proceeding pending or, to its knowledge, threatened before any court, governmental agency or board or other forum in which any Loan/Fiduciary Property (or it or any of the Company Subsidiaries in respect of any Loan/Fiduciary Property) has been, or with respect to threatened proceedings, reasonably would be expected to be, named as a defendant or potentially responsible party (a) for alleged noncompliance (including by any predecessor) with any Environmental Law, or (b) relating to the release or threatened release into the environment of any Hazardous Material, whether or not occurring at or on a Loan/Fiduciary Property, except for such proceedings pending or threatened that are not reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company or have been Previously Disclosed in SCHEDULE 4.01(Z). (4) To its knowledge, there is no reasonable basis for any proceeding of a type described in SUBSECTIONS (2) OR (3) above, except as has been Previously Disclosed in SCHEDULE 4.01(Z). B-11 (5) To its knowledge, during the period of (a) its or any of the Company Subsidiaries' ownership or operation of any of their respective current properties, (b) its or any of the Company Subsidiaries' participation in the management of any Participation Facility, or (c) its or any of the Company Subsidiaries' holding of a security or other interest in a Loan/Fiduciary Property, there have been no releases of Hazardous Material in, on, under or affecting any such property, Participation Facility or Loan/Fiduciary Property, except for such releases that are not reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company or have been Previously Disclosed in SCHEDULE 4.01(Z). (6) To its knowledge, prior to the period of (a) its or any of the Company Subsidiaries' ownership or operation of any of their respective current properties, (b) its or any of the Company Subsidiaries' participation in the management of any Participation Facility, or (c) its or any of the Company Subsidiaries' holding of a security or other interest in a Loan/Fiduciary Property, there were no releases of Hazardous Material in, on, under or affecting any such property, Participation Facility or Loan/Fiduciary Property, except for such releases that are not reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on the Company or have been Previously Disclosed in SCHEDULE 4.01(Z). (7) The following definitions apply for purposes of this SECTION 4.01(Z): "Loan/Fiduciary Property" means any property owned or controlled by it or any of the Company Subsidiaries or in which it or any of the Company Subsidiaries holds a security or other interest, and, where required by the context, includes any such property where the Company or any of the Company Subsidiaries constitutes the owner or operator of such property, but only with respect to such property; "Participation Facility" means any facility in which it or any of the Company Subsidiaries participates in the management and, where required by the context, includes the owner or operator of such property, but only with respect to such property; "Environmental Law" means (a) any federal, state and local law, statute, ordinance, rule, regulation, code, license, permit, approval, order, judgment, decree, injunction, or agreement with any governmental entity, relating to (i) the protection, preservation or restoration of the environment, (including, without limitation, air, water vapor, surface water, groundwater, drinking water supply, surface land, subsurface land, plant and animal life or any other natural resource), or to human health or safety, or (ii) the exposure to, or the use, storage, recycling, treatment, generation, transportation, processing, handling, labeling, production, release or disposal of Hazardous Material, in each case as amended and as now in effect and includes, without limitation, the federal Comprehensive Environmental Response, Compensation, and Liability Act of 1980, the Superfund Amendments and Reauthorization Act, the Federal Water Pollution Control Act of 1972, the federal Clean Air Act, the federal Clean Water Act, the federal Resource Conservation and Recovery Act of 1976 (including the Hazardous and Solid Waste Amendments thereto), the federal Solid Waste Disposal and the federal Toxic Substances Control Act, and the Federal Insecticide, Fungicide and Rodenticide Act, the Federal Occupational Safety and Health Act of 1970, each as amended and as now in effect, and (b) any common law or equitable doctrine (including, without limitation, injunctive relief and tort doctrines such as negligence, nuisance, trespass and strict liability) that may impose liability or obligations for injuries or damages due to, or threatened as a result of, the presence of or exposure to any Hazardous Material; "Hazardous Material" means any substance presently listed, defined, designated or classified as hazardous, toxic, radioactive or dangerous, or otherwise regulated, under any Environmental Law, whether by type or quantity, and includes, without limitation, any oil or other petroleum product, toxic waste, pollutant, contaminant, hazardous substance, toxic substance, hazardous waste, special waste or petroleum or any derivative or by-product thereof, radon, radioactive material, asbestos, asbestos containing material, urea formaldehyde foam insulation, lead and polychlorinated biphenyl. (8) For purposes of this SECTION 4.01(Z), the term "knowledge" means the actual knowledge of the directors and officers of the Company and the Company Subsidiaries. (AA) TAXES. Except as Previously Disclosed in SCHEDULE 4.01(AA), (1) all reports and returns with respect to Taxes (as defined below) and tax related information reporting requirements that are required to be filed by or with respect to it or the Company Subsidiaries, including without limitation consolidated federal income tax returns of it and the Company Subsidiaries (collectively, the "Company Tax Returns"), have been duly filed, or requests for extensions have been timely filed and have not expired, and such Company Tax Returns were true, complete and accurate in all material respects, (2) all taxes (which shall mean federal, state, local or foreign income, gross receipts, windfall profits, severance, property, production, sales, use, license, excise, franchise, employment, premium, recording, documentary, documentary stamps, real estate transfer, transfer, back-up withholding or similar taxes, together with any interest, additions, or penalties with respect thereto, imposed on the income, properties or operations of it or the Company Subsidiaries, together with any interest in respect of such additions or penalties, collectively the "Taxes") shown to be due on the Company Tax Returns or otherwise imposed on the income, properties or operations of the Company or Company Subsidiaries have been paid in full, (3) the Company Tax B-12 Returns have been examined by the Internal Revenue Service or the appropriate state, local or foreign taxing authority or the period for assessment of the Taxes in respect of which such Company Tax Returns were required to be filed has expired, (4) all Taxes due with respect to completed and settled examinations have been paid in full, (5) no issues have been raised by the relevant taxing authority in connection with the examination of any of the Company Tax Returns which are reasonably likely, individually or in the aggregate, to result in a determination that would have a Material Adverse Effect on the Company, except as reserved against in the Company/Bank Financial Reports filed prior to the date of this Plan, (6) no waivers of statutes of limitations (excluding such statutes that relate to years under examination by the Internal Revenue Service) have been given by or requested with respect to any Taxes of it or the Company Subsidiaries, and (7) the bank holding company formation completed on June 13, 1997 (the "Transaction") constituted a tax-free transaction under the Code; neither the Company, the Bank, the Company's stockholders nor any other holders of beneficial ownership interest in any party to the Transaction were required to recognize any gain or loss for purposes of the Code by virtue of the Transaction. (BB) ACCURACY OF INFORMATION. The statements with respect to the Company and the Company Subsidiaries contained in this Plan, the Schedules and any other written documents executed and delivered by or on behalf of it pursuant to the terms of this Plan are true and correct in all material respects, and such statements and documents do not omit any material fact necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. (CC) DERIVATIVES CONTRACTS; STRUCTURED NOTES; ETC. None of the Company or the Company Subsidiaries is a party to or has agreed to enter into an exchange-traded or over-the-counter swap, forward, future, option, cap, floor or collar financial contract or any other contract not included on the balance sheet which is a derivative contract (including various combinations thereof) (each a "Derivatives Contract") or owns securities that (1) are referred to as "structured notes", "high risk mortgage derivatives", "capped floating rate notes", or "capped floating rate mortgage derivatives," or (2) are likely to have changes in value as a result of interest rate changes that significantly exceed normal changes in value attributable to interest rate changes, except for those Derivatives Contracts and other instruments legally purchased or entered into in the ordinary course of business and Previously Disclosed in SCHEDULE 4.01(CC), including a list, as applicable, of any Company or Company Subsidiary assets pledged as security for each such instrument. (DD) ACCOUNTING CONTROLS. Each of the Company and the Company Subsidiaries has devised and maintained systems of internal accounting controls sufficient to provide reasonable assurances, in the judgment of the Board of Directors of the Company, that (1) all material transactions are executed in accordance with management's general or specific authorization; (2) all material transactions are recorded as necessary to permit the preparation of financial statements in conformity with generally accepted accounting principles consistently applied with respect to banks or any other criteria applicable to such statements, (3) access to the material property and assets of the Company and the Company Subsidiaries is permitted only in accordance with management's general or specific authorization; (4) the recorded accountability for items is compared with the actual levels at reasonable intervals and appropriate action is taken with respect to any differences; and (5) there are no violations of the Bank Secrecy Act. (EE) NO DISSENTERS' RIGHTS. The holders of Company Stock have no dissenters' or appraisal rights in connection with the execution of this Plan or the consummation of any of the transactions contemplated hereby. 4.02. FIRST UNION AND FUNB REPRESENTATIONS AND WARRANTIES. Each of First Union and FUNB hereby represents and warrants to the Company and the Bank, as follows: (A) RECITALS. The facts set forth in the Recitals of this Plan with respect to it are true and correct. (B) CORPORATE AUTHORITY. Subject to the required regulatory approvals referred to in SECTION 6.02, this Plan has been authorized by all necessary corporate action of it and is a valid and binding agreement of it enforceable against it in accordance with its terms, subject as to enforcement to bankruptcy, insolvency and other similar laws of general applicability relating to or affecting creditors' rights and to general equity principles. (C) NO DEFAULTS. Subject to the required regulatory approvals referred to in SECTION 6.02, and the required filings under federal and state securities' laws, the execution, delivery and performance of this Plan, and the consummation of the transactions contemplated hereby by it, does not and will not (1) constitute a breach or violation of, or a default under, any law, rule or regulation or any judgment, decree, order, governmental permit or license, or agreement, indenture or instrument of it or of any of its subsidiaries or to which it or any of its subsidiaries or properties is subject or bound, which breach, violation or default is reasonably likely to have a Material Adverse Effect on First Union, (2) constitute a breach or violation of, or a default under, its Articles of Incorporation, Charter or Bylaws, or (3) require any consent or approval under any such law, rule, regulation, judgment, decree, order, governmental permit or license, or the consent or approval of any other party to any B-13 such agreement, indenture or instrument other than such consent or approval, which if not obtained, would not be reasonably likely, individually or in the aggregate, to have a Material Adverse Effect. (D) FINANCIAL REPORTS. In the case of First Union, its Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and all other documents filed or to be filed subsequent to December 31, 1996 under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act, in the form filed with the SEC (in each such case, the "First Union Financial Reports"), did not and will not as of their respective dates contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading; and each of the balance sheets in or incorporated by reference into the First Union Financial Reports (including the related notes and schedules thereto) fairly presents and will fairly present the financial position of the entity or entities to which it relates as of its date and each of the statements of income and changes in stockholders' equity and cash flows or equivalent statements in the First Union Financial Reports (including any related notes and schedules thereto) fairly presents and will fairly present the results of operations, changes in stockholders' equity and changes in cash flows, as the case may be, of the entity or entities to which it relates for the periods set forth therein, in each case in accordance with generally accepted accounting principles consistently applied to banks and bank holding companies during the periods involved, except as may be noted therein, subject to normal and recurring year-end audit adjustments in the case of unaudited statements. (E) NO EVENTS. No events have occurred, or circumstances have arisen, since March 31, 1997, which, individually or in the aggregate, have had or are reasonably likely to have a Material Adverse Effect on First Union. (F) NO BROKERS. All negotiations relative to this Plan and the transactions contemplated hereby have been carried on by it directly with the other parties hereto and no action has been taken by it that would give rise to any valid claim against any party hereto for a brokerage commission, finder's fee or other like payment. (G) NO KNOWLEDGE. It knows of no reason why the regulatory approvals referred to in SECTION 6.02 should not be obtained without the imposition of any condition of the type referred to in the proviso following such SECTION 6.02. (H) SHARES AUTHORIZED. In the case of First Union, the shares of First Union Common Stock to be issued (1) in exchange for shares of Company Stock upon consummation of the Corporate Merger in accordance with ARTICLE II of this Plan, and (2) upon exercise of outstanding Stock Options pursuant to SECTION 2.07, have been duly authorized and, when issued in accordance with the terms of this Plan, will be validly issued, fully paid and nonassessable and subject to no preemptive rights. (I) ORGANIZATION, STANDING AND AUTHORITY. It is duly qualified to do business and is in good standing in the States of the United States and foreign jurisdictions where the failure to be duly qualified, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on First Union. Each of First Union and its subsidiaries has in effect all federal, state, local and foreign governmental authorizations necessary for it to own or lease its properties and assets and to carry on its business as it is now conducted, the absence of which, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on First Union. (J) CORPORATE POWER. First Union and FUNB each has the corporate power and authority to carry on its business as it is now being conducted and to own or lease all its material properties and assets. (K) ACCURACY OF INFORMATION. The statements with respect to First Union and FUNB contained in this Plan, the Schedules and any other written documents executed and delivered by or on behalf of First Union or FUNB pursuant to the terms of this Plan, are true and correct in all material respects, and such statements and documents do not omit any material fact necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. (L) LITIGATION; REGULATORY ACTION. Neither First Union nor any of its subsidiaries is a party to any litigation, proceeding or controversy before any court or governmental agency which, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on First Union and, to the best of its knowledge, no such litigation, proceeding or controversy has been threatened; and neither it nor any of its subsidiaries or any of its or their material properties or their officers, directors or controlling persons is a party to or is the subject of any order, decree, agreement, memorandum of understanding or similar arrangement with, or a commitment letter or similar submission to, any Regulatory Authorities, which is reasonably likely, individually or in the aggregate, to have a Material Adverse Effect on First Union and neither it nor any of its subsidiaries has been advised by any Regulatory Authorities that any such authority is contemplating issuing or requesting (or is considering the appropriateness of issuing or requesting) any such order, decree, agreement, memorandum or understanding, commitment letter or similar submission. B-14 (M) ABSENCE OF UNDISCLOSED LIABILITIES. None of First Union or its subsidiaries has any obligation or liability (contingent or otherwise) that, individually or in the aggregate, is reasonably likely to have a Material Adverse Effect on it, except as reflected in the First Union Financial Reports prior to the date of this Plan. V. COVENANTS. Each of the Company and the Bank hereby covenants to First Union and FUNB, and each of First Union and FUNB hereby covenants to the Company and the Bank, that: 5.01. EFFORTS. Subject to the terms and conditions of this Plan, it shall use its reasonable best efforts in good faith to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper or desirable, or advisable under applicable laws, so as to permit consummation of the Corporate Merger on the Effective Date and to otherwise enable consummation of the transactions contemplated hereby and shall cooperate fully with the other parties hereto to that end (it being understood that any amendments to the Registration Statement (as hereinafter defined) or a resolicitation of proxies as a consequence of an acquisition agreement by First Union or any of its subsidiaries shall not violate this covenant), including, without limitation, cooperating in developing and implementing a plan relating to data processing and any other systems conversions, and the sending of notices and other communications to employees, customers or others. 5.02. COMPANY PROXY/REGISTRATION STATEMENT. The Company and First Union shall prepare a proxy statement/prospectus (the "Proxy Statement") to be mailed to the holders of Company Stock in connection with the transactions contemplated hereby and to be filed by First Union (after providing drafts in advance to the Company and its counsel for review and comment) in a registration statement (the "Registration Statement") with the SEC as provided in SECTION 5.08, which shall conform to all applicable legal requirements. The Company shall call a special meeting (the "Meeting") of the holders of Company Stock to be held as soon as practicable for purposes of voting upon the approval of this Plan and the Company shall use its best efforts to solicit and obtain votes of the holders of Company Stock in favor of the approval of this Plan, and, subject to the exercise of its fiduciary duties under applicable law (based upon the advice of outside counsel), the Board of Directors of the Company shall recommend approval of this Plan by such holders. 5.03. REGISTRATION STATEMENT COMPLIANCE WITH SECURITIES LAWS. When the Registration Statement or any post-effective amendment or supplement thereto shall become effective, and at all times subsequent to such effectiveness, up to and including the date of the Meeting, such Registration Statement and all amendments or supplements thereto, with respect to all information set forth therein furnished or to be furnished by or on behalf of the Company relating to the Company or the Company Subsidiaries and by or on behalf of First Union relating to First Union or its subsidiaries, (A) will comply in all material respects with the provisions of the Securities Act and the Exchange Act and any other applicable statutory or regulatory requirements, and (B) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements contained therein not misleading; PROVIDED, HOWEVER, in no event shall any party hereto be liable for any untrue statement of a material fact or omission to state a material fact in the Registration Statement made in reliance upon, and in conformity with, written information concerning another party furnished by or on behalf of such other party specifically for use in the Registration Statement. 5.04. REGISTRATION STATEMENT EFFECTIVENESS. First Union will advise the Company, promptly after First Union receives notice thereof, of the time when the Registration Statement has become effective or any supplement or amendment has been filed (after providing drafts in advance to the Company and its counsel for review and comment), of the issuance of any stop order or the suspension of the qualification of the First Union Common Stock for offering or sale in any jurisdiction, of the initiation or threat of any proceeding for any such purpose, or of any request by the SEC for the amendment or supplement of the Registration Statement or for additional information. 5.05. PRESS RELEASES. Neither the Company nor the Bank will, without the prior approval of First Union (which approval shall not be unreasonably withheld or delayed), and neither First Union nor FUNB will, without the prior approval of the Company (which approval shall not be unreasonably withheld or delayed), issue any press release or written statement for general circulation relating to the transactions contemplated hereby, except as otherwise required by law. 5.06. ACCESS; INFORMATION. (A) Upon reasonable notice, the Company and the Bank shall afford First Union and its officers, employees, counsel, accountants and other authorized representatives, access, during normal business hours throughout the period prior to the Effective Date, to all of its and the Company Subsidiaries' properties, books, contracts, data processing system files, commitments and records and, during such period, the Company and the Bank shall furnish promptly to First Union (1) a copy of each material report, schedule and other document filed by the Company and the Company Subsidiaries with any Regulatory Authority, and (2) all other information concerning the business, properties and personnel B-15 of the Company and the Company Subsidiaries as First Union may reasonably request, PROVIDED that no investigation pursuant to this SECTION 5.06 shall affect or be deemed to modify or waive any representation or warranty made by the Company or the Bank or the conditions to the obligations of the Company and the Bank to consummate the transactions contemplated by this Plan; and (B) First Union will not use any information obtained pursuant to this SECTION 5.06 for any purpose unrelated to the consummation of the transactions contemplated by this Plan and, if this Plan is terminated, will hold all information and documents obtained pursuant to this paragraph in confidence (as provided in SECTION 8.06) unless and until such time as such information or documents become publicly available other than by reason of any action or failure to act by First Union or as it is advised by counsel in writing that any such information or document is required by law or applicable published stock exchange rule to be disclosed, and in the event of the termination of this Plan, First Union will, upon request by the Company, deliver to the Company all documents so obtained by First Union or destroy such documents and, in the case of destruction, will certify such fact to the Company. 5.07. ACQUISITION PROPOSALS. In the case of the Company, without the prior written consent of First Union, it shall not, and it shall cause the Company Subsidiaries not to, initiate, solicit or encourage inquiries or proposals with respect to, or, except as required by the fiduciary duties of the Board of Directors of the Company under applicable law (as advised by its outside counsel), furnish any nonpublic information relating to or participate in any negotiations or discussions concerning, any acquisition or purchase of all or a substantial portion of the assets or deposits of, or a substantial equity interest in, the Company or any of the Company Subsidiaries or any merger or other business combination with the Company or any of the Company Subsidiaries other than as contemplated by this Plan; it shall instruct its and the Company Subsidiaries' officers, directors, agents, advisors and affiliates to refrain from taking any action that would violate or conflict with any of the foregoing; and it shall notify First Union immediately if any such inquiries or proposals are received by, or any such negotiations or discussions are sought to be initiated with, the Company or any of the Company Subsidiaries. 5.08. REGISTRATION STATEMENT PREPARATION. In the case of First Union, it shall, as promptly as practicable following the date of this Plan, and subject to the cooperation of the Company, prepare and file the Registration Statement with the SEC, and shall use its best efforts to cause the Registration Statement to be declared effective as soon as practicable after the filing thereof. 5.09. BLUE-SKY FILINGS. In the case of First Union, it shall use its reasonable best efforts to obtain all necessary state securities laws or "blue sky" permits and approvals, PROVIDED that First Union shall not be required by virtue thereof to submit to general jurisdiction in any state. 5.10. AFFILIATE AGREEMENTS. In the case of the Company, it will cause each person who may be deemed to be an Affiliate of the Company to execute and deliver to First Union on or before the mailing of the Proxy Statement for the Meeting an agreement in the form attached hereto as EXHIBIT A restricting the disposition of the shares of First Union Common Stock to be received by such Affiliate in exchange for such Affiliate's shares of Company Stock. 5.11. CERTAIN MODIFICATIONS. The Company and First Union shall consult with respect to their accounting, loan, litigation and real estate valuation policies and practices (including loan classifications and levels of reserves) and the Company shall make such modifications or changes to its policies and practices, if any, and at such date prior to the Effective Time, as may be mutually agreed upon. No party's representations, warranties and covenants contained in this Plan shall be deemed to be untrue or breached in any respect for any purpose as a consequence of any modifications or changes to such policies and practices which may be undertaken on account of this SECTION 5.11. 5.12. STATE TAKEOVER LAWS; CERTIFICATE OF INCORPORATION. In the case of the Company, it shall not take any action that would cause the transactions contemplated by this Plan to be subject to any applicable state takeover statute and the Company shall take all necessary steps to exempt (or ensure the continued exemption of) the transactions contemplated by this Plan from (A) any applicable state takeover law, as now or hereafter in effect, including, without limitation, Article 14A:10A of the NJBCA, (B) any applicable takeover provisions in the Company Certificate, and (C) any takeover provisions set forth in any agreement to which the Company is a party or may be bound and which provides for the issuance of any Rights in connection with a takeover. 5.13. NO RIGHTS TRIGGERED. In the case of the Company, it shall take all necessary steps to ensure that the entering into of this Plan and the consummation of the transactions contemplated hereby (including without limitation the Mergers) and any other action or combination of actions, or any other transactions contemplated hereby or thereby do not and will not, (A) result in the grant of any Rights to any person (including directors, officers and employees of the Company or any Company Subsidiary) (1) under the Company Certificate or Bylaws of the Company or (2) under any agreement to which the B-16 Company or any of the Company Subsidiaries is a party or (B) restrict or impair in any way the ability of First Union or FUNB to exercise the rights granted hereunder. 5.14. SHARES LISTED. In the case of First Union, it shall use its reasonable best efforts to list, prior to the Effective Date, on the NYSE, upon official notice of issuance, the shares of First Union Common Stock to be issued to the holders of Company Stock and the outstanding Stock Options referred to in SECTION 2.07, pursuant to this Plan. 5.15. REGULATORY APPLICATIONS. In the case of First Union and FUNB, subject to the cooperation of the Company and the Bank, (A) it shall promptly prepare and submit applications to the appropriate Regulatory Authorities for approval of the Mergers, and (B) promptly make all other appropriate filings to secure all other approvals, consents and rulings which are necessary for the consummation of the Mergers by First Union and FUNB. First Union will provide copies of such applications and responses to the Company and its counsel prior to submitting such applications and responses to the applicable Regulatory Authorities. In the case of the Company, it agrees, upon request, to furnish First Union with information concerning itself, the Company Subsidiaries, its and their directors, officers and stockholders and such other matters as may be necessary or advisable in connection with any filing, notice or application made by or on behalf of First Union or any of its subsidiaries in connection with the Mergers and the other transactions contemplated in this Plan. 5.16. REGULATORY DIVESTITURES. In the case of the Company, effective on or before the Effective Date (to the extent required by any Regulatory Authority), the Company and the Company Subsidiaries shall cease engaging in such activities as First Union shall advise the Company in writing are not permitted to be engaged in by First Union under applicable law following the Effective Date, and to the extent required by any Regulatory Authority as a conditional approval of the transactions contemplated by this Plan, the Company shall divest any Company Subsidiary engaged in activities or holding assets that are impermissible for a bank holding company, on terms and conditions agreed to by First Union. 5.17. INDEMNIFICATION/LIABILITY COVERAGE. (A) For six years after the Effective Date, First Union shall, and shall cause the Continuing Corporation to, indemnify, defend and hold harmless the present and former directors, officers and employees of the Company and the Company Subsidiaries (each, an "Indemnified Party") against all liabilities arising out of actions or omissions occurring at or prior to the Effective Date (including, without limitation, the transactions contemplated by this Plan) to the extent such persons are indemnified under the NJBCA and the Company Certificate and Bylaws of the Company as in effect on the date hereof, including provisions relating to advances of expenses incurred in the defense of any litigation. (B) First Union shall use its reasonable best efforts to maintain the Company's existing directors' and officers' liability insurance policy (or a policy, including First Union's existing policy, providing comparable coverage amount on terms no less favorable) covering persons who are currently covered by such insurance for a period of three years after the Effective Date; PROVIDED, that First Union shall not be obligated to make an annual premium payment in respect of such policy (or replacement policy) which exceeds, for the portion related to the Company's directors and officers, 150% of the annual premium payment on the Company's current policy in effect as of the date of this Plan; PROVIDED, FURTHER, that if such coverage can only be obtained upon the payment of an annual premium in excess of 150% of the annual premium payment of the Company's current policy, First Union shall obtain such coverage as can reasonably be obtained by paying a premium of 150% of the annual premium payment of the Company's current policy in effect as of the date of this Plan. (C) Any Indemnified Party wishing to claim indemnification under SECTION 5.17(A), upon learning of such claim, action, suit, proceeding or investigation, shall promptly notify First Union thereof; PROVIDED, that the failure so to notify shall not affect the obligations of First Union and the Continuing Corporation under SECTION 5.17(A) (unless such failure materially increases First Union's liability under such Section). In the event of any such claim, action, suit, proceeding or investigation (whether arising before or after the Effective Date), (1) First Union or the Continuing Corporation shall have the right to assume the defense thereof, if it so elects, and First Union or the Continuing Corporation shall pay all reasonable fees and expenses of counsel for the Indemnified Parties promptly as statements therefor are received; PROVIDED, HOWEVER, that First Union shall be obligated pursuant to this subsection (C) to pay for only one firm of counsel for all Indemnified Parties in any jurisdiction for any single action, suit or proceeding or any group of actions, suits or proceedings arising out of or related to a common body of facts, (2) the Indemnified Parties will cooperate in the defense of any such matter, and (3) First Union shall not be liable for any settlement effected without its prior written consent. (D) If First Union or the Continuing Corporation or any of its successors or assigns shall consolidate with or merge into any other entity and shall not be the continuing or surviving entity of such consolidation or merger or shall transfer all or substantially all of its assets to any entity, then and in each case, proper provision shall be made so that the successors and assigns of First Union or the Continuing Corporation shall assume the obligations set forth in this SECTION 5.17. B-17 (E) First Union shall pay, or cause the Continuing Corporation to pay, all reasonable expenses, including attorneys' fees, promptly as statements therefor are received, that may be incurred by any Indemnified Party in enforcing the indemnity and other obligations provided for in this SECTION 5.17. The rights of each Indemnified Party hereunder shall be in addition to any other rights such Indemnified Party may have under the Company Certificate or Bylaws of the Company, under the NJBCA or otherwise. 5.18. CURRENT INFORMATION. (A) During the period from the date of this Plan to the Effective Date, each of the Company and First Union shall, and shall cause its representatives to, confer on a regular and frequent basis with representatives of the other. (B) The Company and the Bank shall promptly notify First Union of (1) any material change in the business or operations of the Company or any Company Subsidiary, (2) any material complaints, investigations or hearings (or communications indicating that the same may be contemplated) of any Regulatory Authority relating to the Company or any Company Subsidiary, (3) the institution or the threat of material litigation involving or relating to the Company or any Company Subsidiary, or (4) any event or condition that might be reasonably expected to cause any of the Company's and the Bank's representations or warranties set forth herein not to be true and correct as of the Effective Time (except to the extent contemplated by SECTION 6.09) or prevent the Company or the Bank from fulfilling its or their obligations hereunder; and in each case shall keep First Union informed with respect thereto. (C) First Union shall (1) promptly notify the Company of any event or condition that might reasonably be expected to cause any of First Union's and FUNB's representations or warranties set forth herein not to be true and correct as of the Effective Date (except to the extent contemplated by SECTION 6.08), and (2) notify the Company immediately of any denial of any application filed by First Union or FUNB with any Regulatory Authority with respect to this Plan, and in each case shall keep the Company and the Bank informed with respect thereto. 5.19. COORDINATION OF DIVIDENDS. Until the Effective Time, the Company and First Union shall coordinate with the other the declaration of any dividends or other distributions with respect to the Company Preferred Stock and First Union Common Stock and the record dates and payment dates relating thereto, it being the intention of the parties that holders of shares of Company Preferred Stock or First Union Common Stock shall not receive more than one dividend, or fail to receive one dividend, for any single calendar quarter on their shares of Company Preferred Stock (including any shares of First Union Common Stock received in exchange therefor in the Corporate Merger) or First Union Common Stock, as the case may be. VI. CONDITIONS TO CONSUMMATION OF THE MERGERS. Consummation of the Mergers is conditioned upon: 6.01. SHAREHOLDER VOTE. Approval of this Plan by the requisite vote of the stockholders of the Company. 6.02. REGULATORY APPROVALS. Procurement by First Union and FUNB, as applicable, of all required regulatory consents and approvals by the appropriate Regulatory Authorities and the expiration of the statutory waiting period relating thereto; PROVIDED, HOWEVER, that no such approval or consent shall have imposed any condition or requirement which, in the reasonable opinion of First Union, would so materially and adversely impact the economic or business benefits to First Union of the transactions contemplated by this Plan so as to render inadvisable the consummation of the Mergers. 6.03. THIRD PARTY CONSENTS. All consents or approvals of all persons (other than Regulatory Authorities) required for the consummation of the Mergers shall have been obtained and shall be in full force and effect, unless the failure to obtain any such consent or approval is not reasonably likely to have, individually or in the aggregate, a Material Adverse Effect on the Company or First Union. 6.04. NO INJUNCTION. There shall not be in effect any order, decree or injunction of any court or agency of competent jurisdiction that enjoins or prohibits consummation of any of the transactions contemplated hereby. 6.05. ACCOUNTANTS' LETTERS. The Company shall cause KPMG Peat Marwick LLP to deliver to First Union letters, dated the date of or shortly prior to (A) the mailing of the Proxy Statement, and (B) the Effective Date, in form and substance reasonably satisfactory to First Union, with respect to the Company's consolidated financial position and results of operations, which letters shall be based upon "agreed upon procedures" undertaken by such firm in accordance with the Statement on Auditing Standards No. 72. 6.06. LEGAL OPINION. The Company and the Bank shall have received an opinion, dated the Effective Date, of Marion A. Cowell, Jr., counsel for First Union and FUNB in form reasonably satisfactory to the Company and the Bank, which shall B-18 cover the matters contained in the first sentence in RECITAL (C), the first sentence in RECITAL (D), SECTION 4.02(B), (C), (H) and (I), the first clause of the first sentence in SECTION 4.02(L), and SECTION 5.03. 6.07. LEGAL OPINION. First Union and FUNB shall have received an opinion, dated the Effective Date, of Pepper, Hamilton & Scheetz LLP, counsel for the Company and the Bank, in form reasonably satisfactory to First Union and FUNB which together shall cover the matters contained in the first sentence in RECITAL (A), the first sentence in RECITAL (B), SECTION 4.01 (B) and (C), the fifth and sixth sentences in SECTION 4.01(D), SECTION 4.01(F) and (G), the first clause of the first sentence in SECTION 4.01(L), SECTION 4.01(X), (Y) and (EE) and SECTION 5.03. 6.08. OFFICERS' CERTIFICATE. (A) Each of the representations and warranties contained herein of First Union and FUNB shall be true and correct (in the case of each representation and warranty that contains a materiality qualification) or true and correct in all material respects (in the case of each representation and warranty that contains no materiality qualification) as of the date of this Plan and upon the Effective Date with the same effect as though all such representations and warranties had been made on the Effective Date, except for any such representations and warranties made as of a specified date, which shall be true and correct as of such date, and (B) each and all of the agreements and covenants of First Union and FUNB to be performed and complied with pursuant to this Plan on or prior to the Effective Date shall have been duly performed and complied with in all material respects, and the Company and the Bank shall have received a certificate signed by an executive officer of each of First Union and FUNB, dated the Effective Date, to such effect. 6.09. OFFICERS' CERTIFICATE. (A) Each of the representations and warranties contained herein of the Company and the Bank shall be true and correct (in the case of each representation and warranty that contains a materiality qualification) or true and correct in all material respects (in the case of each representation and warranty that contains no materiality qualification) as of the date of this Plan and upon the Effective Date with the same effect as though all such representations and warranties had been made on the Effective Date, except for any such representations and warranties made as of a specified date, which shall be true and correct as of such date, and (B) each and all of the agreements and covenants of the Company and the Bank to be performed and complied with pursuant to this Plan on or prior to the Effective Date shall have been duly performed and complied with in all material respects, and First Union and FUNB shall have received a certificate signed by the Chief Executive Officers and the Chief Financial Officers of the Company and the Bank, dated the Effective Date, to such effect. 6.10. EFFECTIVE REGISTRATION STATEMENT. The Registration Statement shall have become effective and no stop or other order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been initiated or threatened by the SEC or any other Regulatory Authority. 6.11. BLUE-SKY PERMITS. First Union shall have received all state securities laws and "blue sky" permits necessary to consummate the Corporate Merger. 6.12. TAX OPINION. First Union and the Company shall have received an opinion from Sullivan & Cromwell to the effect that (A) the Corporate Merger constitutes a reorganization under Section 368 of the Code, and (B) no gain or loss will be recognized by stockholders of the Company who receive shares of First Union Common Stock solely in exchange for their shares of Company Stock, except that gain or loss may be recognized as to cash received in lieu of fractional share interests. In rendering its opinion, Sullivan & Cromwell may require and rely upon representations and agreements contained in documents executed by officers of First Union, the Company and others. 6.13. NYSE LISTING. The shares of First Union Common Stock issuable pursuant to this Plan shall have been approved for listing on the NYSE, subject to official notice of issuance. 6.14. RECEIPT OF AFFILIATE AGREEMENTS. First Union shall have received from each Affiliate of the Company the agreement referred to in SECTION 5.10. PROVIDED, HOWEVER, that a failure to satisfy any of the conditions set forth in the proviso following SECTION 6.02 or in SECTIONS 6.05, 6.07, 6.09, or 6.14 shall only constitute conditions if asserted by First Union, and a failure to satisfy any of the conditions set forth in SECTION 6.06 or 6.08 shall only constitute conditions if asserted by the Company. VII. TERMINATION. This Plan may be terminated prior to the Effective Date, either before or after receipt of required stockholder approvals: 7.01. MUTUAL CONSENT. By the mutual consent of First Union and the Company. B-19 7.02. BREACH. By First Union or the Company, if its Board of Directors so determines by vote of a majority of the members of its entire Board, in the event of (A) a breach by the other party of any representation or warranty contained herein, which breach cannot be or has not been cured within thirty (30) days after the giving of written notice to the breaching party of such breach, or (B) a breach by the other party of any of the covenants or agreements contained herein, which breach cannot be or has not been cured within thirty (30) days after the giving of written notice to the breaching party of such breach. 7.03. DELAY. By First Union or the Company, if its Board of Directors so determines by vote of a majority of the members of its entire Board, in the event that the Corporate Merger is not consummated by June 30, 1998. 7.04. NO STOCKHOLDER OR REGULATORY APPROVAL. By the Company or First Union, if its Board of Directors so determines by a vote of a majority of the members of its entire Board, in the event that any stockholder approval contemplated by SECTION 6.01 is not obtained at the Meeting, including any adjournment or adjournments thereof, or in the event that written notice is received which states that any required regulatory approval contemplated by SECTION 6.02 will not be approved or has been denied. 7.05. VOTING AGREEMENT. By First Union, if a Voting Agreement between First Union and certain of the stockholders of the Company, holding an aggregate beneficial ownership interest of not less than 30% and 12% of the outstanding shares of Series B Preferred Stock and Series A Preferred Stock, respectively, in substantially the form of EXHIBIT B hereto, shall not have been executed and delivered by such stockholders by the close of business on the day following the date of execution of this Plan. 7.06. FAILURE TO RECOMMEND, ETC. At any time prior to the Meeting, by First Union if the Board of Directors of the Company shall have failed to make its recommendation referred to in SECTION 5.02, withdrawn such recommendation or modified or changed such recommendation in a manner adverse to the interests of First Union. 7.07. TERMINATION FEE. (A) The Company hereby agrees to pay First Union and First Union shall be entitled to payment of, a nonperformance fee (the "Termination Fee") of $3.5 million following the occurrence of a Payment Event (as defined below, PROVIDED that First Union shall have sent written notice of such entitlement within 90 days after First Union actually becomes aware of such occurrence. Such payment shall be made in immediately available funds within five business days after delivery of a notice from First Union requesting such payment. The right to receive the Termination Fee shall terminate if any of the following (a "Fee Termination Event") occurs prior to a Payment Event: (i) the Effective Date, (ii) termination of this Plan in accordance with the provisions hereof if such termination occurs prior to the occurrence of a Preliminary Payment Event (as defined below), except a termination by First Union pursuant to SECTION 7.02, (iii) termination of this Plan following the occurrence of a Preliminary Payment Event and the passage of eighteen (18) months after such termination, or (iv) termination of this Plan by First Union pursuant to SECTION 7.02, and the passage of eighteen (18) months after such termination. (B) The term "Preliminary Payment Event" shall mean any of the following events or transactions occurring after the date hereof: (1) The Company or the Bank without having received First Union's prior written consent, shall have entered into an agreement to engage in any Acquisition Transaction (as defined below) with any person (the term "person" for purposes of this SECTION 7.07 having the meaning assigned thereto in Section 3(a)(9) and 13(d)(3) of the Exchange Act) other than First Union or any of its subsidiaries or affiliates, or the Board of Directors of the Company shall have recommended that the stockholders of the Company approve or accept any Acquisition Transaction with any person other than First Union or any of its subsidiaries or affiliates. For purposes of this Plan, "Acquisition Transaction" shall mean (a) a merger or consolidation, or any similar transaction, involving the Company or the Bank, (b) a purchase, lease or other acquisition of all or substantially all of the assets or deposits of the Company or the Bank, (c) a purchase or other acquisition (including by way of merger, consolidation, share exchange or otherwise) of securities representing 20% or more of the voting power of the Company or of the Bank; PROVIDED that the term "Acquisition Transaction" does not include any internal merger or consolidation involving only the Company and/or any of the Company Subsidiaries; (2) (a) any person other than First Union or any of its subsidiaries or affiliates shall have acquired beneficial ownership or the right to acquire beneficial ownership of 20% or more of the outstanding shares of Company Common Stock (the term "beneficial ownership" for purposes of this SECTION 7.07 having the meaning assigned thereto in Section 13(d) of the Exchange Act, or (b) any group (as such term is defined in Section 13(d)(3) of the Exchange Act), other than a group of which any of First Union or any of its subsidiaries or affiliates is a member, shall have been formed that beneficially owns 20% or more of the Company Common Stock then outstanding; B-20 (3) any person other than First Union or any of its subsidiaries or affiliates shall have made a proposal to the Company or its stockholders, by public announcement or written communication that is or becomes the subject of public disclosure, to engage in an Acquisition Transaction (including, without limitation, any situation in which any person other than First Union or any of its subsidiaries or affiliates shall have commenced (as such term is defined in Rule 14d-2 under the Exchange Act) or shall have filed a registration statement under the Securities Act, with respect to, a tender offer or exchange offer to purchase any shares of Company Common Stock such that, upon consummation of such offer, such person would own or control 20% or more of the then outstanding shares of Company Common Stock (such offering referred to herein as a "Tender Offer" or an "Exchange Offer", respectively)); (4) after a proposal is made by a third party to the Company or its stockholders to engage in an Acquisition Transaction, or such third party states its intention to the Company to make such a proposal, the Company shall have breached any representation, covenant or obligation contained in this Plan and such breach would entitle First Union to terminate this Plan under SECTION 7.02 (without regard to the cure period provided for therein unless such cure is promptly effected without jeopardizing consummation of the Corporate Merger); or (5) the holders of shares of Company Stock shall not have approved this Plan at the Meeting or the Meeting shall not have been held or shall have been canceled prior to termination of this Plan, in each case after any person other than First Union or any of its subsidiaries or affiliates shall have (a) made, or disclosed an intention to make, a proposal to engage in an Acquisition Transaction or (b) commenced a Tender Offer or filed a registration statement under the Securities Act, with respect to an Exchange Offer. (C) The term "Payment Event" shall mean either of the following events or transactions occurring after the date hereof: (1) the acquisition by any person other than First Union or any of its subsidiaries or affiliates, alone or together with such person's affiliates and associates, or any group (as defined in Section 13(d)(3) of the Exchange Act), of beneficial ownership of 25% or more of the outstanding shares of Company Common Stock; or (2) the occurrence of a Preliminary Payment Event described in (x) clause (B)(1) above, except that the percentage referred to in clause (c) thereof shall be 25%, or (y) clause (B)(5) above. (D) The Company shall notify First Union promptly in writing of its knowledge of the occurrence of any Preliminary Payment Event or Payment Event; PROVIDED, HOWEVER, that the giving of such notice by the Company shall not be a condition to the right of First Union to the Termination Fee. VIII. OTHER MATTERS. 8.01. SURVIVAL. If the Effective Date occurs, all representations, warranties, agreements and covenants contained in this Plan, except for SECTIONS 5.17, 8.04 and 8.09, shall not survive the Effective Date. If this Plan is terminated prior to the Effective Date, the agreements and representations of the parties in SECTIONS 4.01(P) and 4.02(F), SECTIONS 5.03, 5.06(B), 5.12 and 5.13, and SECTIONS 8.01, 8.03, 8.04, 8.05, 8.06, 8.07, 8.09 and 8.11 shall survive such termination. 8.02. WAIVER; AMENDMENT. Prior to the Effective Date, any provision of this Plan may be (A) waived in writing by the party benefitting by the provision, or (B) amended or modified at any time (including the structure of the transactions contemplated hereby) by an agreement in writing among the parties hereto approved by their respective Boards of Directors and executed in the same manner as this Plan, except that, after the vote by the stockholders of the Company, the consideration to be received by the stockholders of the Company for each share of Company Stock shall not thereby be decreased. 8.03. COUNTERPARTS. This Plan may be executed in one or more counterparts, each of which shall be deemed to constitute an original. This Plan shall become effective when one counterpart has been signed by each party hereto. 8.04. GOVERNING LAW. This Plan shall be governed by, and interpreted in accordance with, the laws of the State of North Carolina. 8.05. EXPENSES. Each party hereto will bear all expenses incurred by it in connection with this Plan and the transactions contemplated hereby, except printing expenses which shall be shared equally between the Company and First Union. 8.06. CONFIDENTIALITY. Except as otherwise provided in SECTION 5.06(B), each of the parties hereto and their respective agents, attorneys and accountants will maintain the confidentiality of all information provided in connection herewith which has not been publicly disclosed. B-21 8.07. NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally, telecopied (with confirmation) or mailed by registered or certified mail (return receipt requested) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): If to First Union or FUNB, to: First Union Corporation One First Union Center Charlotte, North Carolina 28288-0013 Telecopy Number: (704) 374-3425 Attention: Marion A. Cowell, Jr. General Counsel If to the Company or the Bank, to: Covenant Bancorp, Inc. 18 Kings Highway West Haddonfield, New Jersey 08033 Telecopy Number: (609) 428-8820 Attention: Charles E. Sessa, Jr. President Copy to: Pepper, Hamilton & Scheetz, LLP 3000 Two Logan Square Eighteenth and Arch Streets Philadelphia, PA 19103 Telecopy Number: (215) 981-4750 Attention: L. Garrett Dutton, Jr. 8.08. DEFINITIONS. Any term defined anywhere in this Plan shall have the meaning ascribed to it for all purposes of this Plan (unless expressly noted to the contrary). In addition: (A) the term "Material Adverse Effect", when applied to a party, shall mean an event, occurrence or circumstance (including without limitation, any breach of a representation or warranty contained herein by such party) which (1) has a material adverse effect on the financial condition, results of operations, business or prospects of such party and its subsidiaries, taken as a whole, or (2) would materially impair such party's, or any affiliated party's (which includes, as to the Company, the Bank and as to First Union, FUNB), ability to timely perform its obligations under this Plan or the consummation of any of the transactions contemplated hereby; PROVIDED, that a Material Adverse Effect with respect to a party shall not include effects resulting from general economic conditions (including changes in interest rates), changes in accounting practices or changes to statutes, regulations or regulatory policies, that do not have a materially more adverse effect on such party than that experienced by similarly situated financial institutions; (B) the term "individually or in the aggregate" as used in ARTICLE IV of this Plan includes all events, occurrences and circumstances described in any paragraph of ARTICLE IV, and is not linked to, or limited by, any specific paragraph; and (C) the term "Previously Disclosed" by a party shall mean information set forth in a Schedule that is delivered by such party to the other party contemporaneously with the execution of this Plan and specifically designated as information "Previously Disclosed" pursuant to this Plan. 8.09. ENTIRE UNDERSTANDING; NO THIRD PARTY BENEFICIARIES. This Plan and all schedules hereto represent the entire understanding of the parties hereto with reference to the transactions contemplated hereby and supersede any and all other oral or written agreements heretofore made. Except for SECTION 5.17, nothing in this Plan, expressed or implied, is intended to confer upon any person, other than the parties hereto or their respective successors, any rights, remedies, obligations or liabilities under or by reason of this Plan. 8.10. BENEFIT PLANS. As soon as administratively practicable after the Effective Time, employees of the Company and the Company Subsidiaries shall be generally entitled to participate in the pension, benefit, severance and similar plans of First Union on substantially the same terms and conditions as employees of First Union and its subsidiaries; without duplication with respect to pension, benefit, severance and similar plans provided by the Company that survive the Effective Time. For the purpose of determining eligibility to participate in such plans and the vesting of benefits under such plans (but not for the accrual of benefits under such plans), First Union shall give effect to years of service with the Company or the Company B-22 Subsidiaries, as the case may be, as if such service had been with First Union or its subsidiaries. Following the Effective Time, First Union shall assume and honor in accordance with their terms the change of control agreements between the Company and any director, officer or employee that are set forth in SCHEDULE 8.10. 8.11. HEADINGS. The headings contained in this Plan are for reference purposes only and are not part of this Plan. IN WITNESS WHEREOF, the parties hereto have caused this instrument to be executed in counterparts by their duly authorized officers, all as of the day and year first above written. FIRST UNION CORPORATION By: /s/ KENNETH R. STANCLIFF ----------------------- Name: Kenneth R. Stancliff Title: Senior Vice President FIRST UNION NATIONAL BANK By: /s/ KENNETH R. STANCLIFF ---------------------------- Name: Kenneth R. Stancliff Title: Senior Vice President COVENANT BANCORP, INC. By: /s/ CHARLES E. SESSA, JR. ------------------------- Name: Charles E. Sessa, Jr. Title: President COVENANT BANK By: /s/ CHARLES E. SESSA, JR. -------------------------- Name: Charles E. Sessa, Jr. Title: President B-23 EXHIBIT B FORM OF VOTING AGREEMENT AGREEMENT, dated as of August 4, 1997, by and between the individual stockholder of Covenant Bancorp, Inc. (the "Stockholder") and First Union Corporation ("First Union"). WHEREAS, the Stockholder is the beneficial owner of and has the right to vote shares of Common Stock, shares of Series A Preferred Stock and/or shares of Series B Preferred Stock of Covenant Bancorp, Inc. ("Covenant") (collectively, the "Shares"); WHEREAS, First Union and Covenant have entered into an Agreement and Plan of Mergers (the "Plan"), pursuant to which First Union will acquire Covenant, subject to the terms and conditions of the Plan; WHEREAS, as a condition and inducement to First Union's willingness to enter into the Plan, the Stockholder has agreed to enter into this Agreement; NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, the parties hereto agree as follows: 1. The Stockholder shall vote all the Shares, and any other shares of stock of Covenant owned or controlled by him or her entitled to be voted, in favor of the Plan and the transactions contemplated thereby at the meeting of stockholders of Covenant called for that purpose. 2. The Stockholder agrees that he/she will not sell or transfer any Shares to any other party unless such party enters into an agreement, satisfactory to First Union, to abide by all the terms of this Agreement. 3. The parties hereto agree that this Agreement shall terminate and be of no further force and effect if the Plan is terminated in accordance with its terms or if the Board of Directors of Covenant withdraws its recommendation of the transactions contemplated by the Plan. 4. The Stockholder represents and warrants to First Union as follows: (i) the Stockholder has good title to the Shares and owns the Shares free and clear of any rights, claims, encumbrances, liens, interests or restrictions of any nature whatsoever, including, without limitation, any restrictions on the voting of the Shares or any rights of others to vote, or to participate (including by consultation) in the voting of, the Shares; (ii) this Agreement is a valid and legally binding agreement enforceable against the Stockholder in accordance with its terms, subject to bankruptcy, insolvency and other laws of general applicability relating to or affecting creditors' rights and to general equity principles; and (iii) the execution, delivery and performance of this Agreement, and the consummation of the transactions contemplated hereby by the Stockholder, do not and will not constitute a breach or violation of, or a default under, any law, rule or regulation or any judgment, decree, order, governmental permit or license, or agreement, indenture or instrument of the Stockholder or to which the Stockholder is subject or bound, or require any consent or approval under such law, rule, regulation, judgment, decree, order, governmental permit or license or the consent or approval of any other party to any such agreement, indenture or instrument. 5. The Stockholder hereby agrees that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed by the Stockholder in accordance with its specific terms or were otherwise breached. Accordingly, the Stockholder agrees that First Union shall be entitled to an injunction or injunctions to prevent breaches of this Agreement by the Stockholder and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which First Union may be entitled at law or in equity. 6. This Agreement shall be governed and construed in accordance with the laws of the State of North Carolina without regard to any applicable conflicts of law rules. 7. This Agreement may be executed in one or more counterparts, each of which shall be deemed to constitute an original. This Agreement shall become effective when one counterpart has been signed by each party hereto. B-24 IN WITNESS WHEREOF, the parties have caused this instrument to be executed as of the day and year first above written. FIRST UNION CORPORATION By: Name: Title: (the Stockholder) B-25 ANNEX C BERWIND FINANCIAL, L.P. August 4, 1997 BOARD OF DIRECTORS COVENANT BANCORP, INC. 18 Kings Highway West Haddonfield, New Jersey 08033 Members of the Board: You have requested our opinion as to the fairness, from a financial point of view, to the shareholders of Covenant Bancorp, Inc. ("Covenant") of the financial terms of the proposed merger by and between Covenant and First Union Corporation ("First Union"). The terms of the proposed merger (the "Proposed Merger") by and between Covenant and First Union are set forth in the Agreement and Plan of Mergers dated August 4, 1997 (the "Merger Agreement") and provide that each outstanding share of Covenant common stock (including the common stock into which the preferred stock of Covenant is convertible) will be converted into the right to receive .3813 shares of First Union Common Stock as defined in the Merger Agreement. Berwind Financial, L.P., as part of its investment banking business, regularly is engaged in the valuation of assets, securities and companies in connection with various types of asset and security transactions, including mergers, acquisitions, private placements and valuations for various other purposes, and in the determination of adequate consideration in such transactions. In arriving at our opinion, we have, among other things: (i) reviewed the historical financial performances, current financial positions and general prospects of Covenant and First Union, (ii) reviewed the Merger Agreement, (iii) reviewed and analyzed the stock market performance of Covenant and First Union, (iv) studied and analyzed the consolidated financial and operating data of Covenant and First Union, (v) considered the terms and conditions of the Proposed Merger between Covenant and First Union as compared with the terms and conditions of comparable bank and bank holding company mergers and acquisitions, (vi) met and/or communicated with certain members of Covenant's and First Union's senior management to discuss their respective operations, historical financial statements and future prospects, and (vii) conducted such other financial analyses, studies and investigations as we deemed appropriate. Our opinion is given in reliance on information and representations made or given by Covenant and First Union, and their respective officers, directors, auditors, counsel and other agents, and on filings, releases and other information issued by Covenant and First Union including financial statements, financial projections, and stock price data as well as certain information from recognized independent sources. We have not independently verified the information concerning Covenant and First Union nor other data which we have considered in our review and, for purposes of the opinion set forth below, we have assumed and relied upon the accuracy and completeness of all such information and data. Additionally, we assume that the Proposed Merger is, in all respects, lawful under applicable law. With regard to financial and other information relating to the general prospects of Covenant, we have assumed that such information has been reasonably prepared and reflects the best currently available estimates and judgment of the management of Covenant as to its most likely future performance. In rendering our opinion, we have assumed that in the course of obtaining the necessary regulatory approvals for the Proposed Merger no conditions will be imposed that will have a material adverse effect on the contemplated benefits of the Proposed Merger to Covenant. Our opinion is based upon information provided to us by the management of Covenant, as well as market, economic, financial and other conditions as they exist and can be evaluated only as of the date hereof and speaks to no other period. Our opinion pertains only to the financial consideration of the Proposed Merger and does not constitute a recommendation to the Board of Covenant and does not constitute a recommendation to Covenant shareholders as to how such shareholders should vote on the Proposed Merger. Based on the foregoing, it is our opinion that, as of the date hereof, the financial terms of the Proposed Merger by and between Covenant and First Union are fair, from a financial point of view, to the shareholders of Covenant. Sincerely, /s/ BERWIND FINANCIAL --------------------- BERWIND FINANCIAL, L.P. 3000 CENTRE SQUARE WEST, 1500 MARKET STREET, PHILADELPHIA, PENNSYLVANIA 19102, PHONE (215) 575-2400, FAX: (215) 564-5402 MEMBER NATIONAL ASSOCIATION OF SECURITIES DEALERS C-1 PART II. INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Sections 55-8-50 through 55-8-58 of the NCBCA contain specific provisions relating to indemnification of directors and officers of North Carolina corporations. In general, the statute provides that (i) a corporation must indemnify a director or officer who is wholly successful in his defense of a proceeding to which he is a party because of his status as such, unless limited by the articles of incorporation, and (ii) a corporation may indemnify a director or officer if he is not wholly successful in such defense, if it is determined as provided in the statute that the director or officer meets a certain standard of conduct, provided when a director or officer is liable to the corporation, the corporation may not indemnify him. The statute also permits a director or officer of a corporation who is a party to a proceeding to apply to the courts for indemnification, unless the articles of incorporation provide otherwise, and the court may order indemnification under certain circumstances set forth in the statute. The statute further provides that a corporation may in its articles of incorporation or bylaws or by contract or resolution provide indemnification in addition to that provided by the statute, subject to certain conditions set forth in the statute. FUNC's bylaws provide for the indemnification of FUNC's directors and executive officers by FUNC against liabilities arising out of his status as such, excluding any liability relating to activities which were at the time taken known or believed by such person to be clearly in conflict with the best interests of FUNC. The FUNC Articles provide for the elimination of the personal liability of each director of FUNC to the fullest extent permitted by the provisions of the NCBCA, as the same may from time to time be in effect. FUNC maintains directors and officers liability insurance, which provides coverage of up to $80,000,000, subject to certain deductible amounts. In general, the policy insures (i) FUNC's directors and officers against loss by reason of any of their wrongful acts, and/or (ii) FUNC against loss arising from claims against the directors and officers by reason of their wrongful acts, all subject to the terms and conditions contained in the policy. ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
EXHIBIT NO. DESCRIPTION ----------- ---------------------------------------------------------------------------------------------------------------- (2)(a) The Merger Agreement, including the form of Voting Agreement as Exhibit B thereto. (Incorporated by reference to ANNEX B to the Prospectus/Proxy Statement included in this Registration Statement.)* (2)(b) The CoreStates acquisition agreement. (Incorporated by reference to Exhibit (2) to FUNC's Current Report on Form 8-K dated November 28, 1997.)* (3)(a) Articles of Incorporation of FUNC, as amended. (Incorporated by reference to Exhibit (4) to FUNC's 1990 First Quarter Report on Form 10-Q, to Exhibit (99)(a) to FUNC's 1993 First Quarter Report on Form 10-Q and to Exhibit (4)(a) to FUNC's Current Report on Form 8-K dated January 10, 1996.) (3)(b) Bylaws of FUNC, as amended. (Incorporated by reference to Exhibit (3)(b) to FUNC's 1995 Annual Report on Form 10-K.) (4)(a) Shareholder Protection Rights Agreement, as amended. (Incorporated by reference to Exhibits (4)(b) to FUNC's Forms 8-K dated December 18, 1990 and October 20, 1992, and to Exhibit (99) to FUNC's Current Reports on Form 8-K dated June 20, 1995 and June 21, 1995 and to Exhibit (4) to FUNC's Current Report on Form 8-K dated October 16, 1996.) (4)(b) All instruments defining the rights of holders of long-term debt of FUNC and its subsidiaries. (Not filed pursuant to (4)(iii) of Item 601(b) of Regulation S-K; to be furnished upon request of the Commission.) (5) Opinion of Marion A. Cowell, Jr., Esq.** (8) Tax opinion of Sullivan & Cromwell.** (12) Computations of Consolidated Ratios of Earnings to Fixed Charges. (Incorporated by reference to Exhibit (12) to FUNC's 1997 Third Quarter Report on Form 10-Q.) (23)(a) Consent of KPMG Peat Marwick LLP. (23)(b) Consent of Coopers & Lybrand L.L.P. (23)(c) Consent of Moore & Costello LLC. (23)(d) Consent of KPMG Peat Marwick LLP. (23)(e) Consent of Ernst & Young LLP. (23)(f) Consent of KPMG Peat Marwick LLP. (23)(g) Consent of KPMG Peat Marwick LLP. (23)(h) Consent of Marion A. Cowell, Jr., Esq. (Included in Exhibit (5).) (23)(i) Consent of Sullivan & Cromwell. (Included in Exhibit (8).) (23)(j) Consent of Berwind Financial, L.P. (24) Power of Attorney.** (27) FUNC's Financial Data Schedule. (Incorporated by reference to Exhibit (27) to FUNC's 1997 Third Quarter Report on Form 10-Q.) (99) Form of proxies for the Special Meeting of Stockholders of Covenant.**
- --------------- * Omitted exhibits to be furnished upon request of the Commission. ** Previously filed. II-1 ITEM 22. UNDERTAKINGS. (a)(1) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933 (as amended and the rules and regulations thereunder, the "Securities Act"), each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (as amended and the rules and regulations thereunder, the "Exchange Act") (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Exchange Act) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (2) The undersigned registrant hereby undertakes as follows: that prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this registration statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c) promulgated pursuant to the Securities Act, the issuer undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other Items of the applicable form. (3) The registrant undertakes that every prospectus (i) that is filed pursuant to paragraph (2) immediately preceding, or (ii) that purports to meet the requirements of Section 10(a)(3) of the Securities Act and is used in connection with an offering of securities subject to Rule 415 promulgated pursuant to the Securities Act, will be filed as a part of an amendment to the registration statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (4) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions of this Item 22, or otherwise (other than insurance), the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (b) The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request. (c) The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective. (d) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement; (i) To include any prospectus required by Section 10(a) (3) of the Securities Act; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high and of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and II-2 (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial BONA FIDE offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this Post-Effective Amendment No. 1 to Registration Statement No. 333-37709 on Form S-4 to be signed on its behalf by the undersigned, thereunto, duly authorized, in the City of Charlotte, State of North Carolina, on December 15, 1997. FIRST UNION CORPORATION By: /s/ MARION A. COWELL, JR. ------------------------- MARION A. COWELL, JR. EXECUTIVE VICE PRESIDENT, SECRETARY AND GENERAL COUNSEL Pursuant to the requirements of the Securities Act of 1933, as amended, this Post-Effective Amendment No. 1 to Registration Statement No. 333-37709 on Form S-4 has been signed by the following persons in the capacities and on the date indicated.
SIGNATURE CAPACITY - ------------------------------------------------------ ------------------------------------------------------------------ *EDWARD E. CRUTCHFIELD Chairman and Chief Executive Officer and Director - ------------------------------------------------------ EDWARD E. CRUTCHFIELD *ROBERT T. ATWOOD Executive Vice President and Chief Financial Officer - ------------------------------------------------------ ROBERT T. ATWOOD *JAMES H. HATCH Senior Vice President and Corporate Controller (Principal - ------------------------------------------------------ Accounting Officer) JAMES H. HATCH *EDWARD E. BARR Director - ------------------------------------------------------ EDWARD E. BARR *G. ALEX BERNHARDT Director - ------------------------------------------------------ G. ALEX BERNHARDT *W. WALDO BRADLEY Director - ------------------------------------------------------ W. WALDO BRADLEY *ROBERT J. BROWN Director - ------------------------------------------------------ ROBERT J. BROWN *A. DANO DAVIS Director - ------------------------------------------------------ A. DANO DAVIS *R. STUART DICKSON Director - ------------------------------------------------------ R. STUART DICKSON *B.F. DOLAN Director - ------------------------------------------------------ B.F. DOLAN
II-4
SIGNATURE CAPACITY - ------------------------------------------------------ ------------------------------------------------------------------ *RODDEY DOWD, SR. Director - ------------------------------------------------------ RODDEY DOWD, SR. *JOHN R. GEORGIUS Director - ------------------------------------------------------ JOHN R. GEORGIUS Director - ------------------------------------------------------ ARTHUR M. GOLDBERG *WILLIAM N. GOODWIN, JR. Director - ------------------------------------------------------ WILLIAM N. GOODWIN, JR. *HOWARD H. HAWORTH Director - ------------------------------------------------------ HOWARD H. HAWORTH *FRANK M. HENRY Director - ------------------------------------------------------ FRANK M. HENRY *LEONARD G. HERRING Director - ------------------------------------------------------ LEONARD G. HERRING Director - ------------------------------------------------------ JACK A. LAUGHERY *MAX LENNON Director - ------------------------------------------------------ MAX LENNON *RADFORD D. LOVETT Director - ------------------------------------------------------ RADFORD D. LOVETT *MACKEY J. MCDONALD Director - ------------------------------------------------------ MACKEY J. MCDONALD *JOSEPH NEUBAUER Director - ------------------------------------------------------ JOSEPH NEUBAUER *RANDOLPH N. REYNOLDS Director - ------------------------------------------------------ RANDOLPH N. REYNOLDS *RUTH G. SHAW Director - ------------------------------------------------------ RUTH G. SHAW *CHARLES M. SHELTON, SR. Director - ------------------------------------------------------ CHARLES M. SHELTON, SR.
II-5
SIGNATURE CAPACITY - ------------------------------------------------------ ------------------------------------------------------------------ *LANTY L. SMITH Director - ------------------------------------------------------ LANTY L. SMITH *ANTHONY P. TERRACCIANO Director - ------------------------------------------------------ ANTHONY P. TERRACCIANO *DEWEY L. TROGDON Director - ------------------------------------------------------ DEWEY L. TROGDON Director - ------------------------------------------------------ JOHN D. UIBLE *B. J. WALKER Director - ------------------------------------------------------ B. J. WALKER *By Marion A. Cowell, Jr., Attorney-in-Fact MARION A. COWELL, JR. - ------------------------------------------------------ MARION A. COWELL, JR.
Date: December 15, 1997 II-6 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION LOCATION - ----------- ------------------------------------------------------ ------------------------------------------------------ (2)(a) The Merger Agreement, including the form of Voting Incorporated by reference to ANNEX B to the Agreement as Exhibit B thereto. Prospectus/Proxy Statement included in this Registration Statement.* (2)(b) The CoreStates acquisition agreement. Incorporated by reference to Exhibit (2) to FUNC's Current Report on Form 8-K dated November 28, 1997.* (3)(a) Articles of Incorporation of FUNC, as amended. Incorporated by reference to Exhibit (4) to FUNC's 1990 First Quarter Report on Form 10-Q, to Exhibit (99)(a) to FUNC's 1993 First Quarter Report on Form 10-Q and to Exhibit (4)(a) to FUNC's Current Report on Form 8-K dated January 10, 1996. (3)(b) Bylaws of FUNC, as amended. Incorporated by reference to Exhibit (3)(b) to FUNC's 1995 Annual Report on Form 10-K. (4)(a) Shareholder Protection Rights Agreement, as amended. Incorporated by reference to Exhibits (4)(b) to FUNC's Forms 8-K dated December 18, 1990 and October 20, 1992, and to Exhibit (99) to FUNC's Current Reports on Form 8-K dated June 20, 1995 and June 21, 1995 and to Exhibit (4) to FUNC's Current Report on Form 8-K dated October 16, 1996. (4)(b) All instruments defining the rights of holders of Not filed pursuant to (4)(iii) of Item 601(b) of long-term debt of FUNC and its subsidiaries. Regulation S-K; to be furnished upon request of the Commission. (5) Opinion of Marion A. Cowell, Jr., Esq. ** (8) Tax opinion of Sullivan & Cromwell. ** (12) Computations of Consolidated Ratios of Earnings to Incorporated by reference to Exhibit (12) to FUNC's Fixed Charges. 1997 Third Quarter on Form 10-Q. (23)(a) Consent of KPMG Peat Marwick LLP. Filed herewith. (23)(b) Consent of Coopers & Lybrand L.L.P. Filed herewith. (23)(c) Consent of Moore & Costello LLC. Filed herewith. (23)(d) Consent of KPMG Peat Marwick LLP. Filed herewith. (23)(e) Consent of Ernst & Young LLP. Filed herewith. (23)(f) Consent of KPMG Peat Marwick LLP. Filed herewith. (23)(g) Consent of KPMG Peat Marwick LLP. Filed herewith. (23)(h) Consent of Marion A. Cowell, Jr., Esq. Included in Exhibit (5). (23)(i) Consent of Sullivan & Cromwell. Included in Exhibit (8). (23)(j) Consent of Berwind Financial, L.P. Filed herewith. (24) Power of Attorney. ** (27) FUNC's Financial Data Schedule. Incorporated by reference to Exhibit (27) to FUNC's 1997 Third Quarter Report on Form 10-Q. (99) Form of proxies for the Special Meeting of ** Stockholders of Covenant.
- --------------- * Omitted exhibits to be furnished upon request of the Commission. ** Previously filed. EX-23 2 EXHIBIT 23(A) EXHIBIT (23)(A) CONSENT OF KPMG PEAT MARWICK LLP BOARD OF DIRECTORS COVENANT BANK We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 of First Union Corporation of our report dated January 27, 1997, relating to (i) the statement of financial condition of Covenant Bank as of December 31, 1996, and the related statements of operations, changes in stockholders' equity, and cash flows for the year then ended, (ii) the statement of financial condition of Covenant bank as of December 31, 1995, and the related statements of operations, changes in stockholder's equity, and cash flows for the year then ended, prior to their restatement for the 1966 pooling-of-interests transaction with 1st Southern State Bank and (iii) the combination of the statement of financial condition as of December 31, 1995 and the statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 1995 and 1994, after restatement for the 1996 pooling-of-interests. We also consent to the reference to our firm under the caption "Experts." KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania December 12, 1997 EX-23 3 EXHIBIT 23(B) EXHIBIT (23)(B) CONSENT OF COOPERS & LYBRAND L.L.P. We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 of First Union Corporation of our report dated January 19, 1995, on our audit of the 1994 statement of operations, and changes in stockholders' equity and cash flows of Covenant Bank as included in ANNEX A of the Registration Statement. We also consent to the reference to our firm under the caption "Experts." COOPERS & LYBRAND L.L.P. Philadelphia, Pennsylvania December 10, 1997 EX-23 4 EXHIBIT 23(C) EXHIBIT (23)(C) CONSENT OF MOORE & COSTELLO LLC We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 of First Union Corporation of our report dated January 16, 1996, relating to the statements of financial condition of 1st Southern State Bank as of December 31, 1995 and 1994, and the related statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995, which report appears in ANNEX A of the Registration Statement. MOORE & COSTELLO LLC (formerly Moore & Fitzpatrick LLC) Marmora, New Jersey December 12, 1997 EX-23 5 EXHIBIT 23(D) EXHIBIT (23)(D) CONSENT OF KPMG PEAT MARWICK LLP BOARD OF DIRECTORS FIRST UNION CORPORATION We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 of First Union Corporation of our report dated January 16, 1997, relating to the consolidated balance sheets of First Union Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, which report appears in the 1996 Annual Report to Stockholders which is incorporated by reference in the 1996 Form 10-K of First Union Corporation. We also consent to the reference to our firm under the caption "Experts." KPMG PEAT MARWICK LLP Charlotte, North Carolina December 12, 1997 EX-23 6 EXHIBIT 23(E) EXHIBIT (23)(E) CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated January 22, 1997, with respect to the consolidated financial statements of CoreStates Financial Corp included in the Prospectus/Proxy Statement of Covenant Bancorp, Inc. that is made a part of the Post-Effective Amendment No. 1 to the Registration Statement (Form S-4 No. 333-37709) and related prospectus of First Union Corporation for the registration of 1,825,000 shares of its common stock. /S/ ERNST & YOUNG LLP Philadelphia, Pennsylvania December 12, 1997 EX-23 7 EXHIBIT 23(F) EXHIBIT (23)(F) CONSENT OF KPMG PEAT MARWICK LLP BOARD OF DIRECTORS CORESTATES FINANCIAL CORP We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 (333-37709) of First Union Corporation of our report dated January 17, 1996, except as to Note 2, which is as of February 23, 1996, relating to the consolidated balance sheet of Meridian Bancorp, Inc. and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the two-year period ended December 31, 1995, which report appears on page C-1 of Exhibit C herein. The report includes an explanatory paragraph indicating that Meridian Bancorp, Inc. adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, and No. 112, Employers' Accounting for Postemployment Benefits, in 1994. We also consent to the reference to our firm under the caption "Experts." KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania December 12, 1997 EX-23 8 EXHIBIT 23(G) EXHIBIT (23)(G) CONSENT OF KPMG PEAT MARWICK LLP BOARD OF DIRECTORS CORESTATES FINANCIAL CORP We consent to the incorporation by reference in this Post-Effective Amendment No. 1 to the Registration Statement on Form S-4 (333-37709) of First Union Corporation of our report dated January 16, 1996, except as to Note 20, which is as of February 23, 1996, relating to the consolidated balance sheet of United Counties Bancorporation and subsidiaries as of December 31, 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 1995, which report on page C-2 of Exhibit C herein. The report includes an explanatory paragraph indicating that United Counties Bancorporation adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, in 1994. We also consent to the reference to our firm under the caption "Experts." KPMG PEAT MARWICK LLP Philadelphia, Pennsylvania December 12, 1997 EX-23 9 EXHIBIT 23(J) EXHIBIT (23)(J) CONSENT OF BERWIND FINANCIAL, L.P. We hereby consent to (i) the use of our opinion letter dated August 4, 1997 to the Board of Directors of Covenant Bancorp, Inc. (the "Company") included as Annex C to the Prospectus/Proxy Statement which forms a part of the Registration Statement on Form S-4, as amended by Post-Effective Amendment No. 1, relating to the proposed merger of the Company and First Union Corporation, and (ii) the references to such opinion in such Prospectus/Proxy Statement. In giving such consent, we do not admit that we come within the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission thereunder, nor do we hereby admit that we are experts with respect to any part of such Registration Statement within the meaning of the term "experts" as used in the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission thereunder. BERWIND FINANCIAL, L.P. December 12, 1997 -----END PRIVACY-ENHANCED MESSAGE-----