F l u s h i n g F i n a n c i a l C o r p o r a t i o n thriving Annual Report 2002 (cid:2) Flushing Financial Corporation, a Delaware corporation, was formed in May 1994 to serve as the holding company for Flushing Savings Bank, FSB, a federally chartered, FDIC-insured savings institution originally organized in 1929. (cid:2) The Bank is a customer-oriented, full-service community bank primarily engaged in attracting deposits from residents and businesses in the local communities of Queens, Nassau, Brooklyn, the Bronx and Manhattan and investing such deposits and other available funds primarily in originations of multi-family mortgage loans, commercial real estate loans and one-to-four family residential loans. (cid:2) Flushing Financial Corporation’s common stock is publicly traded on the Nasdaq National Market® under the symbol “FFIC.” (cid:2) Additional information on Flushing Financial Corporation may be obtained by visiting the Company’s web site at http://www.flushingsavings.com. Flushing Financial Corporation and Subsidiaries 1(cid:2) (cid:2) F I N A N C I A L H I G H L I G H T S At or for the year ended December 31, (cid:2) Selected Financial Data Total assets .............................................................................................. Loans receivable, net ............................................................................... Securities available for sale ...................................................................... Certificate of deposit accounts ................................................................ Other deposit accounts............................................................................ Stockholders’ equity ................................................................................ Dividends paid per common share........................................................... Book value per share ............................................................................... (cid:2) Selected Operating Data Net interest income ................................................................................. Net income (1) .......................................................................................... Basic earnings per share (1) ....................................................................... Diluted earnings per share (1) ................................................................... (cid:2) Financial Ratios Return on average assets (1) ..................................................................... Return on average equity (1) ..................................................................... Net interest spread .................................................................................. Interest rate margin ................................................................................. Efficiency ratio ......................................................................................... Equity to total assets ............................................................................... Non-performing assets to total assets ...................................................... Allowance for possible loan losses to gross loans .................................... Allowance for possible loan losses to non-performing loans .................... 2002 2001 (Dollars in thousands, except per share data) $1,652,958 1,169,560 358,984 543,330 468,495 131,386 0.36 10.43 $ $ $ $ $ 52,342 16,263 1.40 1.34 $1,487,529 1,067,197 305,539 467,172 361,410 133,387 0.31 9.89 $ $ $ $ $ 42,197 14,929 1.22 1.17 1.03% 1.06% 12.57 3.32 3.55 47.41 7.95 0.26 0.56 183.23 11.52 2.89 3.20 50.06 8.97 0.16 0.61 283.85 (1) Excluding the $2.6 million after-tax impairment charge for a WorldCom, Inc. senior note recorded during the second quarter of 2002, these amounts would have been as follows: net income $18,843, basic earnings per share $1.62, diluted earnings per share $1.56, return on average assets 1.20%, return on average equity 14.56%. Return on Equity (percent) 2002 2001 2000 1999 1998 7.51%(cid:2) 12.57% 11.52% 10.48% 10.31% Net Interest Income (millions) 2002 2001 2000 1999 1998 $52 $42 $40 $39 $36(cid:2) Diluted Earnings Per Share (dollars) $1.34 $1.17 2002 2001 2000 1999 1998 $0.97 $0.92 $0.65(cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Flushing Financial Corporation and Subsidiaries Flushing Financial Corporation and Subsidiaries 2(cid:2) 2(cid:2) (cid:2) T O O U R S H A R E H O L D E R S thriving I N O U R M A R K E T S We are pleased to report that 2002 was Financial Corporation. The strategic another outstanding year for Flushing initiatives that we began carefully implementing in 2001 have culminated in the strongest financial performance in our history as a public company. We believe we are attaining the goals we set out to accomplish and consider ourselves well positioned for the future. In addition to generating record earnings of $1.34 per diluted share, up 14.5% from $1.17 a year earlier, our assets surpassed $1.65 billion and stockholders’ equity ended the year at a level to support continued growth in the future. Return on average equity increased to 12.57%. In the environment of economic uncertainty and sus- tained low interest rates that prevailed during 2002, we produced significant increases in net interest margin and grew our balance sheet, while continuing to maintain strong asset quality. But those numbers do not tell the full story of our operating success for 2002. Our results were negatively influenced by a $2.6 million after-tax writedown of a WorldCom senior note. Excluding that one-time event, earnings per diluted share would have been $1.56, up 33% from the prior year and return on average equity would have reached 14.6%. Underpinning our strong results was a focus on the continued implementation of key objectives of our strategic plan, and concen- tration on our core businesses of retail banking and real estate lending. Michael J. Hegarty President and Chief Executive Officer Flushing Financial Corporation and Subsidiaries Flushing Financial Corporation and Subsidiaries 3(cid:2) 3(cid:2) Our retail banking business hit a milestone in Flushing for the past 25 years, who has chosen not 2002, as deposits exceeded the $1 billion mark, to stand for re-election to the Board at this year's including more than 30% growth in core deposits. annual meeting. On a personal note, we and all Our customer base continued to grow as more who have worked with Bob will miss his great local families and businesses across our multi- generosity, dependability and vision. We have ethnic market chose Flushing for their banking been fortunate to benefit from his expertise and needs. Customers who have been with us contin- friendship. We wish him well. ued to show their loyalty as average household In closing, we would like to thank our Board of balances grew throughout the year. Directors for their commitment and guidance, our Lower interest rates and high refinance activity customers for their continued allegiance, and our made 2002 a very active and challenging lending employees for their exceptional contributions to year. In our view, our strategy of diversifying our remarkable story. We would also like to thank our lending to emphasize higher yields worked our shareholders for their confidence and invest- extremely well. As single-family mortgages were ment in our future. refinancing at lower rates, we remained true to our strategic plan and focused on higher yielding lending niches. Average loan yields remained strong throughout the declining rate environment. In addition to increased income from loan volume and yields, the brisk business done in loans throughout the year brought in a substantial increase in loan related fees. Our sales and service culture continued to mature as we completed our first full year of incentive based pay, tied to strategic goals and profitability. Our people responded well to these incentives that reinforced customer-friendly behav- iors and enhanced financial results. Customers, we believe, responded to our more motivated and knowledgeable staff. Ever mindful of you, the shareholder, we com- pleted our 9th and 10th share repurchase pro- grams, buying back more than one million shares during the year to increase the value of your out- standing shares. Late in the year we announced our 11th program to repurchase 630,000 shares. We increased our quarterly dividend to $0.09 per common share—for an annual rate of $0.36, making 26 straight quarters of uninterrupted divi- dend payments. In our opinion, we successfully met the chal- lenges of 2002 and emerged a stronger, more prof- itable institution. As we face a year of continued economic uncertainty, we are confident that we have the strategy, the management and the people to meet the new challenges ahead. We wish to acknowledge the commitment and dedication of Robert A. Marani, a Director of Gerard P. Tully, Sr. Chairman of the Board Flushing Financial Corporation and Subsidiaries 4(cid:2) (cid:2) P R E S E R V I N G L O A N Y I E L D thrivingI N L E N D I N G Flushing Financial Corporation and Subsidiaries 5(cid:2) We focused on higher margin niche products — multi-family, mixed use and commercial real estate mortgages. (cid:2) The bank’s lending businesses emerged stronger than ever in 2002. Originations for the first time topped the $300 million mark, although this increase was partially offset by amortization and satisfactions, resulting in net loan growth of over $100 million. Our core multi-family real estate mortgage business led the way with robust support from mixed-use one-to-four family real estate mortgages and commercial real estate mortgages. Preserving loan yield was the real story. Despite a significantly lower rate environment, our average loan yields dropped only 10 basis points. We accomplished this by focusing on higher margin niche products where our lenders had significant experience and knowledge. Results for our key niche product—mixed-use one-to-four family property loans—were particularly strong as we built upon last year’s changes in sales processes and marketing to increase loan originations in this category. Not only did we increase loan volume, we also gained market share vs. our competition. During the year, we added to our talent pool of experi- enced loan officers and processing staff as our business expanded. We restructured our loan processing area and introduced new systems to better serve our growing cus- tomer base. While our lending operations grew, we remained true to our longstanding focus on quality of underwriting. Loan delinquencies remained minimal and charge-offs were negligible despite a lackluster economy. 2002 2001 2000 1999 1998 Net Loan Portfolio (millions) $1,170 $1,067 $986 $876 $751(cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Flushing Financial Corporation and Subsidiaries 6(cid:2) (cid:2) P E R S O N A L I Z E D B A N K I N G S E R V I C E S thriving I N R E T A I L B A N K I N G (cid:2) It was a banner year for our retail banking business. We grew deposits over $180 million and exceeded last year’s record deposit growth by 34%. We not only hit a milestone $1 billion in deposits, but we did it while making substantial improvements in our approach to the business. Our retail banking staff in 2002 was, in our view, better trained, better motivated and better supported than in 2001. A competitive profitability-based compensation structure was introduced and provided our branch network with the added incentive to grow and deepen customer relationships. In addition, our lending operation led an effort to cross-sell loan customers on full banking relationships. We grew deposit share in every one of our branch markets and reinforced to our staff and our competitors the strength of our approach to personalized banking services delivered through a more thorough understand- ing of customer needs. Furthermore, we introduced several new services in 2002 $1,012 including Internet banking and a debit card, both of which have been very well received. We enhanced our ability to offer invest- ment products by training and licensing the majority of our sales staff. We refined our direct mail capabilities using a more targeted approach resulting in a more positive customer response to our marketing messages. Deposits (millions) 2002 2001 2000 1999 1998 $829 $690 $667 $664(cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Flushing Financial Corporation and Subsidiaries 7(cid:2) We hit a milestone $1 billion in deposits—our retail banking staff was better trained, better motivated and better supported. Flushing Financial Corporation and Subsidiaries 8(cid:2) (cid:2) A W E L L - C A P I T A L I Z E D I N S T I T U T I O N thriving I N T H E F U T U R E (cid:2) Throughout our history, we have been, and intend to remain, a strongly capitalized bank. During 2002, the low interest rate environment enabled us to enhance our capital position through the issuance of $20 million of floating rate capital securities in anticipation of continued investment in our future. In 2003, we plan to open a new modern banking facility, in a bustling market of almost a billion dollars in deposits in Northern Queens. In the coming years we will continue to evaluate new opportunities for expansion of our retail banking business. In 2002, we embarked upon a review of our technology infrastructure. As a result, work has already begun on modernizing the branch, back office and administrative communications network to more rapidly exchange information and respond to customers and changing market conditions. We expect to substan- tially complete that effort in 2003. In the coming months, we plan to upgrade our branch teller and customer service systems to put better customer information on the desktops of our most important asset— our customer contact staff. We are still in the early stages of our development of a strong core deposit business and the reshaping of our loan business. Continued focus on staff and managerial training and development will, we believe, help support the necessary growth in both of these areas. Most importantly, we are committed to growing our business in a manner that serves our customers in an exemplary fashion while providing strong returns for our shareholders. We expect to $1,653 accomplish this, as we have done since 1929, by offering valuable banking services, controlling our costs, managing our capital $1,488 effectively and growing our asset base in a prudent manner. $1,338 $1,250 $1,142 We are committed to growing our business in a manner that serves our customers in an exemplary fashion while providing strong returns for our shareholders. Total Assets (millions) 2002 2001 2000 1999 1998 (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Flushing Financial Corporation and Subsidiaries 9(cid:2) (cid:2) S E L E C T E D F I N A N C I A L D A T A At or for the year ended December 31, 2002 2001 2000 1999 1998 (cid:2) Selected Financial Condition Data Total assets............................................................ Loans, net ............................................................. Securities available for sale .................................... Real estate owned, net ......................................... Deposits ................................................................ Borrowed funds .................................................... Stockholders’ equity .............................................. Book value per share (1) (2) ..................................... $1,652,958 1,169,560 358,984 — 1,011,825 493,164 131,386 10.43 $ (Dollars in thousands, except per share data) $1,487,529 1,067,197 305,539 93 828,582 513,435 133,387 9.89 $ $1,338,092 986,359 255,220 44 689,811 508,839 126,737 9.11 $ $1,249,529 875,886 285,016 368 666,941 451,831 118,176 8.10 $ $1,142,055 750,555 326,690 77 664,059 335,458 132,087 8.08 $ (cid:2) Selected Operating Data Interest and dividend income ................................ Interest expense .................................................... $ 106,906 54,564 $ 101,899 59,702 $ Net interest income ........................................... Provision for loan losses ........................................ 52,342 — 42,197 — 96,941 57,048 39,893 — $ 87,143 47,795 39,348 36 $ 82,846 46,702 36,144 214 Net interest income after provision for loan losses..................................................... 52,342 42,197 39,893 39,312 35,930 Non-interest income: Net gains (losses) on sales of securities and loans ...................................................... Other income .................................................... Total non-interest income .......................... Non-interest expense............................................. Income before income tax provision ...................... Income tax provision ............................................. Net income ............................................... Basic earnings per share (2) (3) ................................. Diluted earnings per share (2) (3) .............................. Dividends declared per share (2).............................. Dividend payout ratio............................................ $ $ $ $ (4,158) 5,667 1,509 27,621 26,230 9,967 16,263 1.40 1.34 0.36 25.7% 321 5,737 6,058 24,457 23,798 8,869 14,929 1.22 1.17 0.31 25.4% $ $ $ $ (651) 4,509 3,858 23,797 19,954 7,532 12,422 0.99 0.97 0.27 27.3% 252 3,622 3,874 22,646 20,540 7,805 12,735 0.94 0.92 0.21 22.3% $ $ $ $ $ $ $ $ $ $ $ $ 368 2,927 3,295 23,023 16,202 6,012 10,190 0.67 0.65 0.15 22.3% Continued (Footnotes on the following page) T A B L E O F C O N T E N T S Selected Financial Data ........................................................................................... (cid:2) 9 Management’s Discussion and Analysis of Financial Condition and Results of Operations ......................................................... (cid:2) 11 Consolidated Financial Statements .......................................................................... (cid:2) 25 Notes to Consolidated Financial Statements ............................................................. (cid:2) 30 Report of Independent Accountants.......................................................................... (cid:2) 48 Corporate and Shareholder Information ................................................................... (cid:2) IBC Flushing Financial Corporation and Subsidiaries 10(cid:2) (cid:2) S E L E C T E D F I N A N C I A L D A T A (continued) At or for the year ended December 31, 2002 2001 2000 1999 1998 (cid:2) Selected Financial Ratios and Other Data Performance ratios: Return on average assets ..................................................................... Return on average equity ..................................................................... Average equity to average assets ......................................................... Equity to total assets ............................................................................ Interest rate spread .............................................................................. Net interest margin .............................................................................. Non-interest expense to average assets ................................................ Efficiency ratio...................................................................................... Average interest-earning assets to average interest-bearing liabilities ... 1.03% 1.06% 0.96% 1.08% 12.57 8.22 7.95 3.32 3.55 1.76 47.41 1.06x 11.52 9.19 8.97 2.89 3.20 1.74 50.06 1.07x 10.48 9.18 9.47 2.87 3.24 1.84 53.07 1.08x 10.31 10.49 9.46 3.05 3.49 1.92 51.54 1.11x Regulatory capital ratios (4): Tangible capital .................................................................................... Core capital ......................................................................................... Total risk-based capital ......................................................................... 7.74% 7.74 14.27 7.32% 7.32 13.58 8.02% 8.02 15.77 8.28% 8.28 16.33 0.92% 7.51 12.24 11.57 2.88 3.43 2.08 53.44 1.12x 9.46% 9.46 19.43 Asset quality ratios: Non-performing loans to gross loans (5) ................................................ Non-performing assets to total assets (6) ............................................... Net charge-offs (recoveries) to average loans ....................................... Allowance for loan losses to gross loans .............................................. Allowance for loan losses to total non-performing assets (6).................. Allowance for loan losses to total non-performing loans (5)................... Full-service customer facilities................................................................... 0.31% 0.26 — 0.56 153.34 183.23 10 0.22% 0.16 0.01 0.61 272.94 283.85 10 0.16% 0.12 0.01 0.68 404.28 415.32 10 0.36% 0.29 — 0.77 191.29 213.29 9 0.34% 0.23 (0.01) 0.89 252.83 260.36 8 (1) Calculated by dividing stockholders’ equity of $131.4 million and $133.4 million at December 31, 2002 and 2001, respectively, by 12,598,343 and 13,487,784 shares outstanding at December 31, 2002 and 2001, respectively. (2) All per share data has been adjusted for the three-for-two stock split distributed on August 30, 2001 in the form of a stock dividend. (3) The shares held in the Company’s Employee Benefit Trust are not included in shares outstanding for purposes of calculating earnings per share. Unvested restricted stock awards are not included in basic earnings per share calculations, but are included in diluted earnings per share calculations. (4) The Bank exceeded all minimum regulatory capital requirements during the periods presented. (5) Non-performing loans consist of non-accrual loans and loans delinquent 90 days or more that are still accruing. (6) Non-performing assets consist of non-performing loans, real estate owned and non-performing investment securities. (cid:2) M A R K E T P R I C E O F C O M M O N S T O C K Flushing Financial Corporation Common Stock is traded on the Nasdaq National Market(cid:3) under the symbol “FFIC.” As of December 31, 2002 the Company had approximately 750 shareholders of record, not including the number of persons or entities holding stock in nominee or street name through various brokers and banks. The Company’s stock closed at $16.38 on December 31, 2002. The following table shows the high and low sales price of the Common Stock during the periods indi- cated. Such prices do not necessarily reflect retail markups, markdowns or commissions. All price and dividend information has been adjusted for the three-for-two stock split distributed on August 30, 2001 in the form of a stock dividend. See Note 12 of Notes to Consolidated Financial Statements for dividend restrictions. First Quarter............................................................................................... Second Quarter.......................................................................................... Third Quarter ............................................................................................. Fourth Quarter ........................................................................................... $18.08 20.83 20.84 18.52 $15.95 16.45 16.00 14.85 $0.090 0.090 0.090 0.090 $12.54 16.20 17.00 18.96 $11.00 12.17 13.71 15.44 $0.073 0.073 0.080 0.080 2002 2001 High Low Dividend High Low Dividend Flushing Financial Corporation and Subsidiaries 11(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (cid:2) GENERAL for losses on real estate owned. Such results also are sig- Flushing Financial Corporation (“Holding Company”) is nificantly affected by general economic and competitive the parent holding company for Flushing Savings Bank, conditions, including changes in market interest rates, the FSB (“Bank”), a federally chartered stock savings bank. strength of the local economy, government policies and The Holding Company also owns a special purpose busi- actions of regulatory authorities. ness trust, Flushing Financial Capital Trust I (“Trust”). In September 2000, the Bank sold certain lower-yielding The following discussion of financial condition and results mortgage-backed securities and invested the proceeds in of operations includes the collective results of the Hold- $20.0 million of BOLI. The purchase of BOLI, with its ing Company, the Trust and the Bank (collectively the tax-advantaged earnings and other benefits, allows the “Company”), but reflects principally the Bank’s activities. Company to fund a substantial portion of the Company’s The Company’s principal business is attracting retail employee benefit costs. deposits from the general public and investing those During the fourth quarter of 2001, the Bank began deposits together with funds generated from operations to: (1) expand its business loan and deposit products, and borrowings, primarily in (1) originations and purchases (2) increase its focus on the investment products it offers, of one-to-four family residential mortgage loans (focusing and (3) plan for the anticipated introduction in 2002 of a on mixed-use properties—properties that contain both debit card and Internet banking. This effort continued into residential dwelling units and commercial units), multi- 2002, as the Bank continued to explore new products that family income-producing property loans and commercial will help it continue to be the provider of choice for existing real estate loans; (2) mortgage loan surrogates such as customers and help attract new customers. The debit card mortgage-backed securities; and (3) U.S. government and and Internet banking were introduced in 2002. federal agency securities, corporate fixed-income securities During the third quarter of 2002, the Holding Company and other marketable securities. To a lesser extent, the issued $20.0 million of floating rate capital securities Company originates certain other loans, including con- through the Trust, a newly created special purpose busi- struction loans, Small Business Administration loans and ness trust formed by the Holding Company. The capital other small business loans. securities have a maturity date of October 7, 2032, are The Company’s results of operations depend primarily callable at par in five years and every quarter thereafter, on net interest income, which is the difference between and pay cumulative cash distributions at a floating per the interest income earned on its loan and investment port- annum rate of interest, reset quarterly, equal to 3.65% over folios, and its cost of funds, consisting primarily of interest 3-month LIBOR, with an initial rate of 5.51387%. A rate cap paid on deposit accounts and borrowed funds. Net interest of 12.50% is effective through October 7, 2007. The rate at income is the result of the Company’s interest rate margin, December 31, 2002 was 5.425%. which is the difference between the average yield earned As part of the Company’s strategy to find ways to best on interest-earning assets and the average cost utilize its available capital, during 2002 Flushing Financial of interest-bearing liabilities, and the average balance of Corporation continued its stock repurchase programs by interest-earning assets compared to the average balance of repurchasing 1,202,450 shares of its common stock. The interest-bearing liabilities. The Company also generates total number of treasury shares, at December 31, 2002 is non-interest income from loan fees, service charges on 1,253,720 and the total number of outstanding common deposit accounts, mortgage servicing fees, late charges and shares is 12,598,343. At December 31, 2002, 630,000 other fees, income earned on Bank Owned Life Insurance shares remain to be repurchased under the current stock (“BOLI”), dividends on Federal Home Bank of NY (“FHLB- repurchase program. NY”) stock and net gains and losses on sales of securities Statements contained in this Annual Report relating to and loans. The Company’s operating expenses consist prin- plans, strategies, objectives, economic performance and cipally of employee compensation and benefits, occupancy trends, projections of results of specific activities or invest- and equipment costs, other general and administrative ments and other statements that are not descriptions of expenses and income tax expense. The Company’s results historical facts may be forward-looking statements within of operations also can be significantly affected by its the meaning of the Private Securities Litigation Reform Act periodic provision for loan losses and specific provision Flushing Financial Corporation and Subsidiaries 12(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) of 1995, Section 27A of the Securities Act of 1933 and properties), multi-family residential mortgage and commer- Section 21E of the Securities Exchange Act of 1934. cial real estate mortgage loans, (2) maintain asset quality, Forward-looking information is inherently subject to risks (3) manage deposit growth and maintain a low cost of and uncertainties, and actual results could differ materially funds, (4) manage interest rate risk, and (5) explore new from those currently anticipated due to a number of business opportunities. The Company has in the past factors, which include, but are not limited to, the factors set increased growth through acquisitions of financial insti- forth in the third paragraph of this section, and under cap- tutions and branches of other financial institutions, and tions “Management Strategy” and “Other Trends and will continue to pursue growth through acquisitions that Contingencies” below, and elsewhere in this Annual Report are, or are expected to be within a reasonable time frame, and in other documents filed by the Company with the accretive to earnings. The Company has also opened new Securities and Exchange Commission from time to time. branches. There can be no assurance that the Company Forward-looking statements may be identified by terms will be able to effectively implement this strategy. The such as “may,” “will,” “should,” “could,” “expects,” “plans,” Company’s strategy is subject to change by the Board of “intends,” “anticipates,” “believes,” “estimates,” “predicts,” Directors. “forecasts,” “potential” or “continue” or similar terms or the negative of these terms. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. The Company has no obligation to update these forward-looking statements. (cid:2) FLUSHING SAVINGS BANK, FSB The Bank was organized in 1929 as a New York State chartered mutual savings bank. On May 10, 1994, the Bank converted to a federally chartered mutual savings bank and changed its name from Flushing Savings Bank to Flushing Savings Bank, FSB. The Bank converted to a federally char- tered stock savings bank in 1995. As a federal savings bank, the Bank’s primary regulator is the Office of Thrift Supervision (“OTS”). The Bank’s deposits are insured to the maximum allowable amount by the Federal Deposit Insurance Corporation (“FDIC”). The Bank owns three subsidiaries: (1) Flushing Preferred Funding Corporation (“FPFC”)—a real estate investment trust; (2) Flushing Service Corporation (“FSC”)—a service corporation which markets insurance products and mutual funds; and (3) FSB Properties, Inc.—a service corporation formed to manage certain real estate properties, which is currently inactive. (cid:2) MANAGEMENT STRATEGY Management’s strategy is to continue the Bank’s focus as a consumer-oriented institution serving its local mar- kets. In furtherance of this objective, the Company intends to (1) continue its emphasis on the origination of one-to- four family residential mortgage (focusing on mixed-use One-to-Four Family, Multi-Family Real Estate and Commercial Real Estate Lending. The Company has tra- ditionally emphasized the origination and acquisition of one-to-four family residential mortgage loans, which include mixed-use property mortgage loans, adjustable rate mortgage (“ARM”) loans, fixed rate mortgage loans and home equity loans. Market interest rates on conventional one-to-four family residential mortgage loans declined to their lowest levels in almost 40 years during 2002. As a result, many borrowers sought to refinance their mort- gages. The Company decided not to actively pursue this refinance market due to the low rates. The Company focused its origination efforts on higher yielding mixed-use property one-to-four family residential mortgage loans, multi-family residential mortgage loans and commercial real estate mortgage loans. The Company expects to con- tinue this emphasis on the higher yielding mortgage loan products. During 2002, loan originations and purchases were $19.4 million for conventional one-to-four family residential mortgage loans, $71.9 million for mixed-use property one-to-four family residential mortgage loans, $136.9 million for multi-family residential mortgage loans, $73.1 million for commercial real estate loans and $13.8 million for construction loans. At December 31, 2002, the Company’s conventional one-to-four family residential mortgage loans, mixed-use property one-to-four family residential mortgage loans, multi-family residential mort- gage loans and commercial real estate loans amounted to $268.1 million (22.8%), $170.5 million (14.5%), $452.7 million (38.5%) and $257.1 million (21.9%), respectively, of gross loans. Flushing Financial Corporation and Subsidiaries 13(cid:2) The Company seeks to increase its originations of mixed- non-performing assets in an effort to return them to use property one-to-four family residential mortgage, performing status. To this end, management reviews the multi-family residential mortgage and commercial real quality of loans and reports to the Loan Committee of the estate mortgage loans through aggressive marketing and Board of Directors of the Bank on a monthly basis. From by maintaining competitive interest rates and origination time to time, the Company has sold and may continue to fees. The Company’s marketing efforts include frequent make sales of non-performing assets. Non-performing contacts with mortgage brokers and other professionals assets amounted to $4.3 million and $2.4 million at who serve as referral sources. From time-to-time, the December 31, 2002 and 2001, respectively. This increase Company may purchase loans from mortgage bankers in non-performing assets is primarily attributed to one and other financial institutions. Loans purchased by the borrower. None of the loan-to-value ratios for each of this Company comply with the Bank’s underwriting standards. borrower’s three loans is greater than 65 percent. There- Fully underwritten one-to-four family residential mort- fore, management believes the Bank will recover its invest- gage loans generally are considered by the banking indus- ment in these loans. Non-performing assets as a percentage try to have less risk than other types of loans. Multi-family of total assets were 0.26% and 0.16% at December 31, 2002 residential mortgage loans and commercial real estate and 2001, respectively. loans generally have higher yields than one-to-four family residential mortgage loans and shorter terms to maturity, but typically involve higher principal amounts and gen- erally expose the lender to a greater risk of credit loss than one-to-four family residential mortgage loans. The Company’s increased emphasis on multi-family residential and commercial real estate loans has increased the overall level of credit risk inherent in the Company’s loan portfolio. The greater risk associated with multi-family and commer- cial real estate loans could require the Company to increase its provisions for loan losses and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance currently maintained by the Company. To date, the Company has not experienced significant losses in its multi-family and commercial real estate loan portfolios, and has determined that, at this time, additional provisions are not required. Managing Deposit Growth and Maintaining Low Cost of Funds. The Company has a relatively stable retail deposit base drawn from its market area through its ten full-service offices. Although the Company seeks to retain existing deposits and maintain depositor relationships by offering quality service and competitive interest rates to its customers, the Company seeks to keep deposit growth within reasonable limits and its strategic plan. Manage- ment intends to balance its goal to maintain competitive interest rates on deposits while seeking to manage its over- all cost of funds to finance its strategies. Historically, the Company has relied on its deposit base as its principal source of funding. The Bank is also a member of the FHLB- NY, which provides it with an additional source of borrow- ing, which the Company has utilized to provide funding for asset growth which has increased net interest income. During 2002, the Company realized an increase in due to Maintain Asset Quality. By adherence to its strict under- depositors of $183.5 million and a reduction in borrowed writing standards the Bank has been able to minimize funds of $20.3 million. net losses from impaired loans with net charge-offs of $4,000 and $136,000 for the years ended December 31, 2002 and 2001, respectively. The Company has maintained the strength of its loan portfolio, as evidenced by the Company’s ratio of its allowance for loan losses to non- performing loans of 183.23% and 283.85% at December 31, 2002 and 2001, respectively. The Company seeks to main- tain its loans in performing status through, among other things, strict collection efforts, and consistently monitors Managing Interest Rate Risk. The Company seeks to manage its interest rate risk by actively reviewing the repricing and maturities of its interest rate sensitive assets and liabilities. The mix of loans originated by the Company (fixed or ARM) is determined in large part by borrowers’ preferences and prevailing market conditions. The Company seeks to manage the interest rate risk of the loan portfolio by actively managing its security portfolio and borrowings. Flushing Financial Corporation and Subsidiaries 14(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) By adjusting the mix of fixed and adjustable rate securities, During the second quarter of 1998, the Company as well as the maturities of the securities, the Company has launched Flushing Service Corporation, which began offer- the ability to manage the combined interest rate sensitivity ing mutual funds, tax-deferred annuities and other invest- of its assets. In order to maintain flexibility in managing the ment products, expanding the services offered by the Bank. Company’s interest rate sensitive assets, the majority of The Bank placed additional emphasis on the sale of these fixed rate residential mortgage loans originated by the products in 2002 through the licensing of Bank employees, Company in recent years were made in accordance with allowing them to sell certain of these products. Federal National Mortgage Association requirements to The Bank also established, in June 1998, a Business and facilitate sale in the secondary market. Additionally, the Community Development Department. In the Company’s Company seeks to balance the interest rate sensitivity of its demanding and constantly evolving marketplace, this office assets by managing the maturities of its liabilities. plays an active role in enhancing the Company’s reputation Prevailing interest rates also affect the extent to which as an essential player in the local economy, and expanding borrowers repay and refinance loans. An increasing inter- its participation in new business opportunities. In the est rate environment would tend to extend the average lives fourth quarter of 2001, staffing was increased in this of lower yielding fixed rate mortgages and mortgage- department, which has allowed the Bank to further expand backed securities, which could adversely affect net interest these efforts. income. In addition, depositors tend to open longer term, During 2002, the Bank introduced a debit card and higher costing certificate of deposit accounts which could Internet banking, and continued to expand its business adversely affect the Bank’s net interest income if rates loan and deposit products. Management plans to con- were to subsequently decline. In a declining interest rate tinue reviewing the profitability potential of various new environment, the number of loan prepayments and loan products to further expand the Company’s product lines refinancings may increase, as well as prepayments of and market. These initiatives are designed to allow us to mortgage-backed securities. Call provisions associated with continue to be the provider of choice for our current cus- the Company’s investment in U.S. government agency and tomers and help attract new customers. corporate securities may also adversely affect yield in a declining interest rate environment. Such prepayments (cid:2) INTEREST RATE SENSITIVITY ANALYSIS and calls may adversely affect the yield of the Company’s A financial institution’s exposure to the risks of changing loan portfolio and mortgage-backed and other securities as interest rates may be analyzed, in part, by examining the the Company reinvests the prepaid funds in a lower interest extent to which its assets and liabilities are “interest rate rate environment. However, the Company typically receives sensitive” and by monitoring the institution’s interest rate additional loan fees when existing loans are refinanced, sensitivity “gap.” An asset or liability is said to be interest which partially offset the reduced yield on the Company’s rate sensitive within a specific time period if it will mature loan portfolio resulting from prepayments. In periods of low or reprice within that time period. The interest rate sensi- interest rates, the Company’s level of core deposits also tivity gap is defined as the difference between the amount may decline if depositors seek higher yielding instruments of interest-earning assets maturing or repricing within a or other investments not offered by the Company, which specific time period and the amount of interest-bearing in turn may increase the Company’s cost of funds and liabilities maturing or repricing within that time period. decrease its net interest margin to the extent alternative A gap is considered positive when the amount of interest- funding sources are utilized. Additionally, adjustable rate earning assets maturing or repricing exceeds the amount mortgage loans and mortgage-backed securities generally of interest-bearing liabilities maturing or repricing within contain interim and lifetime caps that limit the amount the the same period. A gap is considered negative when the interest rate can increase or decrease at repricing dates. amount of interest-bearing liabilities maturing or repricing Exploring New Business Opportunities. As part of the Company’s strategy to expand its operations, the Bank opened a traditional branch in July 2000 on Kissena Boulevard in Flushing, Queens, and plans to open a tradi- tional branch in Northern Queens in the second half of 2003. exceeds the amount of interest-earning assets maturing or repricing within the same period. Accordingly, a positive gap may enhance net interest income in a rising rate envi- ronment and reduce net interest income in a falling rate environment. Conversely, a negative gap may enhance net interest income in a falling rate environment and reduce net interest income in a rising rate environment. Flushing Financial Corporation and Subsidiaries 15(cid:2) The table below sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2002 which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period was determined in accordance with the earlier of the term to repricing or the contractual terms of the asset or liability. Prepayment assumptions for mortgage loans, other loans and mortgage-backed securities are based on industry averages, which generally range from 6% to 40%. Passbook and Money Market accounts were assumed to have a withdrawal or “run-off” rate of 5%, based on historical experience. While management believes that these assumptions are indicative of actual prepayments and withdrawals experienced by the Company, there is no guarantee that these trends will continue in the future. Interest Rate Sensitivity Gap Analysis at December 31, 2002 Three Months and Less More Than Three Months to One Year More Than One Year to Three Years More Than Three Years to Five Years More Than Five Years to Ten Years More Than Ten Years Total (Dollars in thousands) $ 23,947 946 34,785 $ 108,442 1,314 — $390,626 1,755 — $442,711 1,590 — $150,357 2,881 — $ 50,109 — — $1,166,192 8,486 34,785 Interest-Ear ning Assets Mortgage loans ................................................. Other loans........................................................ Short-term securities (1)....................................... Securities available for sale: Mortgage-backed securities ........................... Other............................................................. 33,686 21,033 87,178 — Total interest-earning assets ....................... 114,397 196,934 Interest-Bearing Liabilities Passbook accounts............................................. NOW accounts .................................................. Money market accounts .................................... Certificate of deposit accounts .......................... Mortgagors’ escrow deposits ............................. Borrowed funds................................................. 2,670 — 2,125 97,460 — 75,000 8,010 — 6,375 161,083 — 95,000 112,687 2,252 507,320 19,782 — 15,749 197,647 — 114,900 58,093 276 25,202 10,462 2,409 5,706 319,255 39,729 502,670 188,902 58,224 1,568,447 17,854 — 14,214 78,958 — 113,000 37,384 — 29,762 8,182 — 95,264 127,872 39,795 101,804 — 9,812 — 213,572 39,795 170,029 543,330 9,812 493,164 Total interest-bearing liabilities (2)................ $177,255 $ 270,468 $348,078 $224,026 $170,592 $ 279,283 $1,469,702 Interest rate sensitivity gap ................................ Cumulative interest-rate sensitivity gap.............. Cumulative interest-rate sensitivity gap $ (62,858) $ (62,858) $ (73,534) $(136,392) $159,242 $ 22,850 $278,644 $301,494 $ 18,310 $319,804 $(221,059) $ 98,745 $ 98,745 as a percentage of total assets....................... (3.80)% (8.25)% 1.38% 18.24% 19.35% 5.97% Cumulative interest-earning assets as a percentage of cumulative interest- bearing liabilities............................................ 64.54% 69.54% 102.87% 129.56% 126.86% 106.72% (1) Consists of interest-earning deposits and federal funds sold. (2) Does not include non-interest-bearing demand accounts totaling $35.3 million at December 31, 2002. Certain shortcomings are inherent in the method of may lag behind changes in market rates. Additionally, analysis presented in the foregoing table. For example, certain assets, such as ARM loans, have features that although certain assets and liabilities may have similar restrict changes in interest rates on a short-term basis and estimated maturities or periods to repricing, they may react over the life of the asset. Further, in the event of a signifi- in differing degrees to changes in market interest rates cant change in the level of interest rates, prepayments on and may bear rates that differ in varying degrees from the loans and mortgage-backed securities, and deposit with- rates that would apply upon maturity and reinvestment or drawal or “run-off” levels, would likely deviate materially upon repricing. Also, the interest rates on certain types of from those assumed in calculating the above table. In the assets and liabilities may fluctuate in advance of changes event of an interest rate increase, some borrowers may be in market interest rates, while interest rates on other types Flushing Financial Corporation and Subsidiaries 16(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) unable to meet the increased payments on their adjustable- Rate” report for review by the Board of Directors, as sum- rate debt. The interest rate sensitivity analysis assumes marized below. This report quantifies the potential changes that the nature of the Company’s assets and liabilities in net interest income and net portfolio value should inter- remains static. Interest rates may have an effect on cus- est rates go up or down (shocked) 300 basis points, assum- tomer preferences for deposits and loan products. Finally, ing the yield curves of the rate shocks will be parallel to the maturity and repricing characteristics of many assets each other. The OTS currently places its focus on the net and liabilities as set forth in the above table are not portfolio value ratio, focusing on a rate shock up or down of governed by contract but rather by management’s best 200 basis points. The OTS uses the change in Net Portfolio judgment based on current market conditions and antici- Value Ratio to measure the interest rate sensitivity of the pated business strategies. (cid:2) INTEREST RATE RISK Company. Net portfolio value is defined as the market value of assets net of the market value of liabilities. The market value of assets and liabilities is determined using a dis- The Consolidated Financial Statements have been pre- counted cash flow calculation. The net portfolio value ratio pared in accordance with generally accepted accounting is the ratio of the net portfolio value to the market value of principles, which requires the measurement of financial assets. All changes in income and value are measured as position and operating results in terms of historical dollars percentage changes from the projected net interest income without considering the changes in fair value of certain and net portfolio value at the base interest rate scenario. investments due to changes in interest rates. Generally, the The base interest rate scenario assumes interest rates at fair value of financial investments such as loans and securi- December 31, 2002. Various estimates regarding prepay- ties fluctuates inversely with changes in interest rates. As a ment assumptions are made at each level of rate shock. result, increases in interest rates could result in decreases Actual results could differ significantly from these esti- in the fair value of the Company’s interest-earning assets mates. At December 31, 2002, the Company is within the which could adversely affect the Company’s results of oper- guidelines established by the Board of Directors for each ations if such assets were sold, or, in the case of securities interest rate level for Net Interest Income and Net Portfolio classified as available for sale, decreases in the Company’s Value. The Company, however, does not meet the guideline stockholders’ equity, if such securities were retained. established by the Board of Directors for the Net Portfolio The Company manages the mix of interest-earning Value Ratio for plus 300 basis points, which is 6.00%. This assets and interest-bearing liabilities on a continuous basis exception has been reviewed with the Board of Directors, to maximize return and adjust its exposure to interest who is monitoring the exception and considering the steps rate risk. On a quarterly basis, management prepares the to be taken, if any, required to bring this exposure into “Earnings and Economic Exposure to Changes in Interest compliance in the near term. Change in Interest Rate Net Interest Income Net Portfolio Value Projected Percentage Change In Net Portfolio Value Ratio 2002 2001 2002 2001 2002 2001 –300 basis points........................................................................... –200 basis points........................................................................... –100 basis points........................................................................... Base interest rate ........................................................................... +100 basis points .......................................................................... +200 basis points .......................................................................... +300 basis points .......................................................................... –0.09% –4.72% 1.70 1.15 — –2.10 –5.39 –10.06 –1.11 0.17 — –2.63 –5.89 –9.29 12.04% 4.84 2.29 — –8.58 –25.42 –43.83 –3.02% –1.28 1.97 — –14.47 –28.81 –43.21 9.48% 9.10 9.09 9.09 8.55 7.22 5.64 9.76% 10.13 10.65 10.67 9.42 8.10 6.68 (cid:2) ANALYSIS OF NET INTEREST INCOME Net interest income represents the difference between income on interest-earning assets and expense on interest- bearing liabilities. Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. Flushing Financial Corporation and Subsidiaries 17(cid:2) The following table sets forth certain information relating to the Company’s Consolidated Statements of Financial Condition and the Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees that are considered adjustments to yields. For the years ended December 31, 2002 2001 2000 Average Balance Interest Average Yield/ Cost Average Balance Interest (Dollars in thousands) Average Yield/ Cost Average Balance Interest Average Yield/ Cost Assets Interest-earning assets: Mortgage loans, net (1) (2) ........................................... $1,118,016 $ 89,978 523 Other loans, net (1) (2).................................................. 7,293 8.05% $1,030,126 $ 83,811 558 7.17 6,405 8.14% $ 936,222 $76,094 8.71 6,681 686 10.27 8.13% Total loans, net.................................................. 1,125,309 90,501 8.04 1,036,531 84,369 8.14 942,903 76,780 8.14 Mortgage-backed securities....................................... Other securities ......................................................... 247,733 62,110 13,342 2,436 5.39 3.92 228,681 21,640 14,938 1,260 6.53 5.82 261,903 16,504 18,304 1,182 6.99 7.16 Total securities ................................................... 309,843 15,778 5.09 250,321 16,198 6.47 278,407 19,486 7.00 Interest-earning deposits and federal funds sold........ 39,798 627 1.58 33,810 1,332 3.94 9,542 675 7.07 Total interest-earning assets........................................... 1,474,950 106,906 7.25 1,320,662 101,899 7.72 1,230,852 96,941 7.88 Other assets .................................................................. 98,201 Total assets ........................................................ $1,573,151 88,237 $1,408,899 60,344 $1,291,196 Liabilities and Equity Interest-bearing liabilities: Deposits: Passbook accounts ................................................ $ 208,250 NOW accounts ...................................................... Money market accounts ........................................ Certificate of deposit accounts .............................. 36,054 126,431 507,104 Total due to depositors ...................................... Mortgagors’ escrow accounts................................ Total deposits .................................................... Other borrowed funds............................................... 877,839 15,064 892,903 496,964 3,147 321 3,039 21,640 28,147 57 28,204 26,360 1.51 0.89 2.40 4.27 3.21 0.38 3.16 5.30 $ 188,701 30,736 71,820 423,812 715,069 13,013 728,082 508,434 3,767 504 2,309 23,062 29,642 69 29,711 29,991 2.00 1.64 3.21 5.44 4.15 0.53 4.08 5.90 $ 189,852 27,838 42,791 385,237 645,718 13,177 658,895 478,675 3,931 530 1,438 21,488 27,387 86 27,473 29,575 2.07 1.90 3.36 5.58 4.24 0.65 4.17 6.18 Total interest-bearing liabilities....................................... 1,389,867 54,564 3.93 1,236,516 59,702 4.83 1,137,570 57,048 5.01 Other liabilities (3) ........................................................... 53,905 Total liabilities .................................................... Equity............................................................................ 1,443,772 129,379 Total liabilities and equity................................... $1,573,151 42,845 1,279,361 129,538 $1,408,899 35,073 1,172,643 118,553 $1,291,196 Net interest income/net interest rate spread (4) ............... $52,342 3.32% $ 42,197 2.89% $39,893 2.87% Net interest-earning assets/net interest margin (5) ........... $ 85,083 3.55% $ 84,146 3.20% $ 93,282 3.24% Ratio of interest-earning assets to interest-bearing liabilities ........................................... 1.06x 1.07x 1.08x (1) Average balances include non-accrual loans. (2) Loan interest income includes loan fee income of approximately $186,000, $321,000 and $555,000 for the years ended December 31, 2002, 2001 and 2000, respectively. (3) Includes non-interest-bearing demand deposit accounts of $29,827, $23,200 and $24,624 for the years ended December 31, 2002, 2001 and 2000, respectively. (4) Interest rate spread represents the difference between the average rate on interest-earning assets and the average cost of interest-bearing liabilities. (5) Net interest margin represents net interest income before the provision for loan losses divided by average interest-earning assets. Flushing Financial Corporation and Subsidiaries 18(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) (cid:2) RATE/VOLUME ANALYSIS The following table presents the impact of changes in interest rates and in the volume of interest-earning assets and interest-bearing liabilities on the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (1) changes attributable to changes in volume (changes in volume multiplied by the prior rate), (2) changes attributable to changes in rate (changes in rate multiplied by the prior volume) and (3) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate. Increase (Decrease) in Net Interest Income Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Due to Due to Volume Rate Net Volume Rate Net (Dollars in thousands) Interest-Ear ning Assets Mortgage loans, net ............................................................................. Other loans, net.................................................................................... Mortgage-backed securities .................................................................. Other securities..................................................................................... Interest-earning deposits and federal funds sold ................................... $ 7,101 71 1,169 1,701 203 $ (934) (106) (2,765) (525) (908) $ 6,167 (35) (1,596) 1,176 (705) $ 7,623 (27) (2,216) 195 796 $ 94 (101) (1,150) (117) (139) $ 7,717 (128) (3,366) 78 657 Total interest-earning assets .............................................................. 10,245 (5,238) 5,007 6,371 (1,413) 4,958 Interest-Bearing Liabilities Deposits: Passbook accounts............................................................................ NOW accounts.................................................................................. Money market accounts ................................................................... Certificate of deposit accounts.......................................................... Mortgagors’ escrow deposits ............................................................ Other borrowed funds .......................................................................... 365 76 1,422 4,056 10 (659) (985) (259) (692) (5,478) (22) (2,972) (620) (183) 730 (1,422) (12) (3,631) (25) 84 932 2,100 (1) 1,533 (139) (110) (61) (526) (16) (1,117) (164) (26) 871 1,574 (17) 416 Total interest-bearing liabilities .......................................................... 5,270 (10,408) (5,138) 4,623 (1,969) 2,654 Net change in net interest income ........................................................ $ 4,975 $ 5,170 $10,145 $ 1,748 $ 556 $ 2,304 (cid:2) COMPARISON OF OPERATING RESULTS FOR THE which on an after-tax basis was $2.6 million, diluted earn- YEARS ENDED DECEMBER 31, 2002 AND 2001 ings per share would have increased 33.3% to $1.56 for the General. Diluted earnings per share increased 14.5% to year ended December 31, 2002 from $1.17 per share for $1.34 for the year ended December 31, 2002 from $1.17 for the year ended December 31, 2001, and net income for the the year ended December 31, 2001. Net income increased year ended December 31, 2002 would have increased $1.4 million, or 8.9%, to $16.3 million for the year ended 26.2% to $18.8 million from $14.9 million for the year December 31, 2002 from $14.9 million for the year ended ended December 31, 2001. December 31, 2001. This was due to an increase in net Return on average assets declined to 1.03% for the year interest income of $10.1 million, partially offset by a ended December 31, 2002 from 1.06% for the year ended decrease in non-interest income of $4.6 million and an December 31, 2001, due to the increase in average assets. increase in non-interest expense of $3.1 million. As a result Return on average equity increased to 12.57% for the of the increased net income before income taxes, there was year ended December 31, 2002 from 11.52% for the year a $1.1 million increase in income tax expense. The ended December 31, 2001. Excluding the above mentioned decrease in non-interest income was primarily attributed to impairment writedown, return on average assets and return a $4.4 million pre-tax impairment writedown of the Bank’s on average equity would have been 1.20% and 14.56%, investment in a WorldCom, Inc. senior note during the sec- respectively, for the year ended December 31, 2002. ond quarter of 2002. Excluding this impairment writedown, Flushing Financial Corporation and Subsidiaries 19(cid:2) Interest Income. Interest income increased $5.0 million, as decreases in cost were seen in all categories of deposits or 4.9%, to $106.9 million for the year ended December 31, due to the declining interest rate environment experienced 2002 from $101.9 million for the year ended December 31, during 2002 and 2001. The average balance for borrowed 2001. This increase is due to an increase of $154.3 million funds decreased $11.4 million to $497.0 million for 2002 in the average balance of interest-earning assets, partially from $508.4 million for 2001. The cost of borrowed funds offset by a 47 basis point decline in the yield on interest- decreased 60 basis points to 5.30% during 2002. earning assets to 7.25% for 2002. The increase in interest Net Interest Income. Net interest income for the year and fees on loans of $6.1 million was partially offset by ended December 31, 2002 totaled $52.3 million, an decreases in interest and dividends on investment securi- increase of $10.1 million from $42.2 million for 2001. The ties and interest on interest-earning deposits and federal net interest spread improved 43 basis points to 3.32% for funds sold of $0.4 million and $0.7 million, respectively. 2002 from 2.89% in 2001, as the yield on interest-earning The increase in interest and fee income from loans is due to assets declined 47 basis points while the cost of interest- an $88.8 million increase in the average balance of loans bearing liabilities declined 90 basis points. The net interest to $1.13 billion during the year ended December 31, 2002, margin improved 35 basis points to 3.55% for the year which was partially offset by a decrease in the yield of 10 ended December 31, 2002 from 3.20% for the year ended basis points to 8.04% for the year ended December 31, December 31, 2001. 2002 from 8.14% for the year ended December 31, 2001. Provision for Loan Losses. There was no provision Our focus on the origination of higher yielding multi-family for loan losses for the years ended December 31, 2002 residential and commercial real estate mortgage loans, and 2001. In assessing the adequacy of the Company’s along with the origination of mixed-use property one- allowance for loan losses, management considers the to-four family residential mortgage loans, allowed us to Company’s historical loss experience, recent trends in maintain a higher yield on our loan portfolio than we losses, collection policies and collection experience, trends would have otherwise experienced, despite the declining in the volume of non-performing loans, changes in the interest rate environment experienced during 2002 and composition and volume of the gross loan portfolio, and 2001. The decrease in interest and dividend income from local and national economic conditions. Based on these investment securities is due to a 138 basis point decline in reviews, no provision for loan losses was deemed necessary the yield to 5.09% for 2002 from 6.47% in 2001, partially for the years ended December 31, 2002 and 2001. The offset by a $59.5 million increase in the average balances of ratio of non-performing loans to gross loans was 0.31% at investment securities during 2002 to $309.8 million. The December 31, 2002 compared to 0.22% at December 31, decrease in interest on interest-earning deposits and fed- 2001. The allowance for loan losses as percentage of non- eral funds sold is due to a 236 basis point decline in the performing loans was 183.23% and 283.85% at December yield to 1.58% for 2002 from 3.94% in 2002, partially offset 31, 2002 and 2001, respectively. The ratio of allowance for by a $6.0 million increase in the average balance of these loan losses to gross loans was 0.56% and 0.61% at items in 2002. December 31, 2002 and 2001, respectively. The Company Interest Expense. Interest expense decreased $5.1 mil- experienced net charge-offs of $4,000 and $136,000 for the lion, or 8.6%, to $54.6 million for the year ended December years ended December 31, 2002 and 2001, respectively. 31, 2002 from $59.7 million for the year ended December Non-Interest Income. Non-interest income for the year 31, 2001. The decrease in interest expense is due to a 90 ended December 31, 2002 decreased $4.6 million, or basis point decline in the cost of interest-bearing liabilities, 75.1%, to $1.5 million from $6.1 million for the year ended partially offset by a $153.4 million increase in the average December 31, 2001. The decrease is primarily due to a $4.4 balance of total interest-bearing liabilities to $1.39 billion million pretax impairment writedown of the Bank’s invest- during 2002. ment in a WorldCom, Inc. senior note. In addition, higher The average balance for due to depositors increased income from loan fees and banking services were offset by $162.8 million to $877.8 million for 2002. The cost of these reduced dividends on Federal Home Loan Bank of New deposits decreased 94 basis points to 3.21% during 2002, York stock. Flushing Financial Corporation and Subsidiaries 20(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) Non-Interest Expense. Non-interest expense for the Return on average assets increased to 1.06% for the year ended December 31, 2002 totaled $27.6 million, rep- year ended December 31, 2001 from 0.96% for the year resenting an increase of $3.1 million, or 12.9%, from the ended December 31, 2000. Return on average equity year ended December 31, 2001. The increase is primarily increased to 11.52% for the year ended December 31, 2001 attributed to the Bank’s continued focus on expanding its from 10.48% for the year ended December 31, 2000. current product offerings to enhance its ability to serve Interest Income. Interest income increased $5.0 million, its customers. During the fourth quarter of 2001, the or 5.1%, to $101.9 million for the year ended December 31, Bank began increasing its staffing to provide additional 2001 from $96.9 million for the year ended December 31, services to its customers, and to process the increasing 2000. This increase was due to an increase of $89.8 million volume of loan applications. Additional staffing increases in the average balance of interest-earning assets, partially for these same purposes were made in 2002. The Bank also offset by a 16 basis point decline in the yield on interest- expanded its training program to provide its staff with the earning assets to 7.72% for 2001. Interest and fees on loans knowledge needed to expand into new services. Advertising increased $7.6 million while interest on interest-earning and business promotions were also expanded in 2002 to deposits and federal funds sold increased $0.7 million. better promote new and existing services. Management These increases were partially offset by a $3.3 million continues to closely monitor expenditures, resulting in an decrease in interest and dividends on investment securities. efficiency ratio of 47.4% for the year ended December 31, The increase in interest and fee income from loans was due 2002 compared to 50.1% for 2001. to a $93.6 million increase in the average balance of loans Income Tax Provisions. Income tax expense for the year to $1.04 billion during the year ended December 31, 2001, ended December 31, 2002 totaled $10.0 million, compared as the yield of 8.14% remained unchanged for 2001 from to $8.9 million for the year ended December 31, 2000. This 2000. Our focus on the origination of higher yielding multi- increase is primarily attributed to the increase of $2.4 mil- family residential and commercial real estate mortgage lion in income before income taxes. The effective tax rate loans, along with the origination of mixed-use property was 38.0% for the year ended December 31, 2002 com- one-to-four family residential mortgage loans, allowed pared to 37.3% for the year ended December 31, 2001. us to maintain the yield on our loan portfolio despite the declining interest rate environment experienced during the (cid:2) COMPARISON OF OPERATING RESULTS FOR THE year ended December 31, 2001. The increase in interest on YEARS ENDED DECEMBER 31, 2001 AND 2000 interest-earning deposits and federal funds sold was due to General. Diluted earnings per share increased 20.6% a $24.3 million increase in the average balance of these to $1.17 for the year ended December 31, 2001 from $0.97 items, partially offset by a decline in the yield to 3.94% for for the year ended December 31, 2000. Net income 2001 from 7.07% for 2000. The decrease in interest and increased $2.5 million, or 20.2%, to $14.9 million for the dividend income from investment securities reflected a year ended December 31, 2001 from $12.4 million for the $28.1 million decrease in the average balances of invest- year ended December 31, 2000. This was due to increases ment securities during 2001 to $250.3 million, combined in net interest income and non-interest income of $2.3 mil- with a 53 basis point decline in the yield on investment lion and $2.2 million, respectively, partially offset by an securities. The decrease in the average balance of invest- increase in non-interest expense of $0.7 million. As a result ment securities was primarily due to the sale of mortgage- of the increased net income before income taxes, there was backed securities in the third quarter of 2000 and the a $1.3 million increase in income tax expense. The year reinvestment of the proceeds in BOLI. The investment ended December 31, 2000 included the sale of approxi- in BOLI is included in Other Assets in the Consolidated mately $20.7 million of mortgage-backed securities in Statements of Financial Condition, and the income earned September, which resulted in an after tax loss of $445,000. on BOLI is included in Non-Interest Income in the Excluding this loss on sale of securities, net income for the Consolidated Statements of Income. The income on BOLI year ended December 31, 2000 would have been $12.9 amounted to $1.3 million for the year ended December million, or $1.01 per diluted share. 31, 2001 compared to $0.4 million for the year ended December 31, 2000. Flushing Financial Corporation and Subsidiaries 21(cid:2) Interest Expense. Interest expense increased $2.7 mil- Non-Interest Income. Non-interest income for the year lion, or 4.7%, to $59.7 million for the year ended December ended December 31, 2001 increased $2.2 million, or 57.0%, 31, 2001 from $57.0 million for the year ended December to $6.1 million from $3.9 million for the year ended 31, 2000. The increase in interest expense was due to a December 31, 2000. The increase was due to net gains on $98.9 million increase in the average balance of total the sale of securities and loans of $0.3 million for the year interest-bearing liabilities during 2001, partially offset by ended December 31, 2001 compared to net losses on sales an 18 basis point decline in the cost of interest-bearing of securities and loans of $0.7 million in the year ended liabilities. December 31, 2000, increased income earned on BOLI, and The average balance for deposits increased $69.2 higher fee income from loan fees and banking services. million to $728.1 million for 2001. The cost of deposits Non-Interest Expense. Non-interest expense for the decreased nine basis points to 4.08% during 2001, as year ended December 31, 2001 totaled $24.5 million, rep- decreases in cost were seen in all categories of deposits resenting an increase of $0.7 million, or 2.8%, from the in the declining interest rate environment experienced dur- year ended December 31, 2000. The increase was primarily ing the year. The average balance for borrowed funds attributed to the full year impact of the expenses associated increased $29.7 million to $508.4 million for 2001 from with the operations of the Kissena branch (opened in July $478.7 million for 2000. The cost of borrowed funds 2000) and an increase in salaries and benefits and profes- decreased 28 basis points to 5.90% during 2001. sional services (which includes advertising) in the fourth Net Interest Income. Net interest income for the year quarter of 2001 as the Bank focused on expanding its prod- ended December 31, 2001 totaled $42.2 million, an increase uct offerings to enhance its ability to serve its customers. of $2.3 million from $39.9 million for 2000. The net interest Management continued to closely monitor expenditures, spread improved two basis points to 2.89% for 2001 from resulting in an efficiency ratio of 50.1% for the year ended 2.87% in 2000, as the yield on interest-earning assets December 31, 2001 compared to 53.1% for 2000. declined 16 basis points while the cost of interest-bearing Income Tax Provisions. Income tax expense for the year liabilities declined 18 basis points. However, the net interest ended December 31, 2001 totaled $8.9 million, compared margin declined four basis points to 3.20% for the year to $7.5 million for the year ended December 31, 2000. This ended December 31, 2001 from 3.24% for the year ended increase was primarily attributed to the increase of $3.8 December 31, 2000. The decline in the net interest margin million in income before income taxes. The effective tax was primarily due to a decline in the amount by which rate was 37.3% for the year ended December 31, 2001 interest-earning assets exceed interest-bearing liabilities. compared to 37.7% for the year ended December 31, 2000. During 2001, average interest-earning assets exceeded average interest-bearing liabilities by $84.2 million, a (cid:2) LIQUIDITY, REGULATORY CAPITAL AND decline of $9.1 million from the $93.3 million during 2000. CAPITAL RESOURCES This decline was primarily due to the sale of mortgage- The Company’s primary sources of funds are deposits, backed securities in September 2000 and the reinvestment borrowings, principal and interest payments on loans, of the proceeds in BOLI. mortgage-backed and other securities, proceeds from sales Provision for Loan Losses. There was no provision for of securities and, to a lesser extent, proceeds from sales of loan losses for the years ended December 31, 2001 and loans. Deposit flows and mortgage prepayments, however, 2000. The ratio of non-performing loans to gross loans are greatly influenced by general interest rates, economic was 0.22% at December 31, 2001 compared to 0.16% at conditions and competition. At December 31, 2002, the December 31, 2000. The allowance for loan losses as Bank had an approved overnight line of credit of $46.0 mil- percentage of non-performing loans was 283.85% and lion with the FHLB-NY. In total, as of December 31, 2002, 415.32% at December 31, 2001 and 2000, respectively. the Bank may borrow up to $557.7 million from the The ratio of allowance for loan losses to gross loans was FHLB-NY in Federal Home Loan advances and overnight 0.61% and 0.68% at December 31, 2001 and 2000, respec- lines of credit. As of December 31, 2002, the Bank had tively. The Company experienced net charge-offs of borrowed $359.3 million in FHLB-NY advances. There $136,000 and $97,000 for the years ended December 31, 2001 and 2000, respectively. Flushing Financial Corporation and Subsidiaries 22(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) were no funds outstanding at December 31, 2002 under the During 2002, funds provided by the Company’s operat- overnight line of credit with the FHLB-NY. In addition, the ing activities amounted to $25.1 million. These funds, Trust has $20.0 million in capital securities (which are together with $139.2 million provided by financing activi- included in Borrowed Funds) and the Bank had $113.9 mil- ties and $38.5 million available at the beginning of the lion in repurchase agreements to fund lending and invest- year, were utilized to fund net investing activities of $155.2 ment opportunities. (See Note 8 of Notes to Consolidated million. Financing activities were primarily provided by a Financial Statements.) growth in due to depositors of $183.5 million. Principal The Company’s most liquid assets are cash and cash payments and calls on loans and securities provided addi- equivalents, which include cash and due from banks, tional funds. The primary investment activity of the overnight interest-earning deposits and federal funds sold Company is the origination of loans, and the purchase of with original maturities of 90 days or less. The level of mortgage-backed securities. During 2002, the Bank had these assets is dependent on the Company’s operating, loan originations and purchases of $325.0 million. Further, financing, lending and investing activities during any given during 2002, the Company purchased $262.5 million of period. At December 31, 2002, cash and cash equivalents mortgage-backed and other securities. totaled $47.6 million, an increase of $9.1 million from At the time of the Bank’s conversion from a federally December 31, 2001. The Company also held marketable chartered mutual savings bank to a federally chartered securities available for sale with a carrying value of $359.0 stock savings bank, the Bank was required by the OTS to million at December 31, 2002. establish a liquidation account which is reduced as and to At December 31, 2002, the Company had commitments the extent that eligible account holders reduce their quali- to extend credit (principally real estate mortgage loans) of fying deposits. The balance of the liquidation account at $53.0 million and open lines of credit for borrowers (princi- December 31, 2002 was $6.2 million. In the unlikely event pally construction loan and home equity loan lines of credit) of a complete liquidation of the Bank, each eligible account of $17.7 million. Since generally all of the loan commit- holder will be entitled to receive a distribution from the ments are expected to be drawn upon, the total loan com- liquidation account. The Bank is not permitted to declare or mitments approximate future cash requirements, whereas pay a dividend or to repurchase any of its capital stock if the amounts of lines of credit may not be indicative of the the effect would be to cause the Bank’s regulatory capital to Company’s future cash requirements. The loan commit- be reduced below the amount required for the liquidation ments generally expire in ninety days, while construction account. Unlike the Bank, the Holding Company is not sub- loan lines of credit mature within eighteen months and ject to OTS regulatory restrictions on the declaration or home equity loan lines of credit mature within ten years. payment of dividends to its stockholders, although the The Company uses the same credit policies in making source of such dividends could depend upon dividend pay- commitments and conditional obligations as it does for on- ments from the Bank. The Holding Company is subject, balance-sheet instruments. however, to the requirements of Delaware law, which gen- The Company’s total interest and operating expenses in erally limit dividends to an amount equal to the excess of its 2002 were $54.6 million and $27.6 million, respectively. net assets (the amount by which total assets exceed total Certificates of deposit accounts which are scheduled to liabilities) over its stated capital or, if there is no such mature in one year or less as of December 31, 2002 totaled excess, to its net profits for the current and/or immediately $258.5 million. preceding fiscal year. The market value of the assets of the Company’s defined Regulatory Capital Position. Under OTS capital regula- benefit pension plan is $10.1 million at December 31, 2002, tions, the Bank is required to comply with each of three which is $1.2 million less than the benefit obligation. separate capital adequacy standards: tangible capital, core During 2002, the Bank contributed $2.5 million to the pen- capital and total risk-based capital. Such classifications are sion plan. The underfunding is due to a decline in the mar- used by the OTS and other bank regulatory agencies to ket value of pension plan’s investments in 2002 and 2001. determine matters ranging from each institution’s semi- The Company does not anticipate a change in the market annual FDIC deposit insurance premium assessments, to value of these assets which would have a significant effect approvals of applications authorizing institutions to grow on liquidity, capital resources, or results of operations. their asset size or otherwise expand business activities. At Flushing Financial Corporation and Subsidiaries 23(cid:2) December 31, 2002 and 2001, the Bank exceeded each of An allowance for loan losses is provided to absorb esti- the three OTS capital requirements. (See Note 13 of Notes mated losses on existing loans that may be uncollectable. to Consolidated Financial Statements.) Management reviews the adequacy of the allowance for loan losses by reviewing all impaired loans on an individual (cid:2) IMPACT OF NEW ACCOUNTING STANDARDS basis. The remaining portfolio is evaluated based on the In June 2001, The Financial Accounting Standards Company’s historical loss experience, recent trends in Board issued Statement of Financial Accounting Standards losses, collection policies and collection experience, trends No. 142, “Goodwill and Other Intangible Assets,” which is in the volume of non-performing loans, changes in the com- effective for fiscal years beginning after December 15, position and volume of the gross loan portfolio, and local 2001. The Statement changes the approach to how goodwill and national economic conditions. Judgment is required to and other intangible assets are accounted for subsequent determine how many years of historical loss experience are to their recognition. Goodwill and intangible assets that to be included when reviewing historical loss experience. have indefinite useful lives will not be amortized but rather A full credit cycle must be used, or loss estimates may be will be tested at least annually for impairment. Intangible inaccurate. This evaluation is inherently subjective, as it assets that have finite useful lives will be amortized over requires estimates that are susceptible to significant revi- their useful lives. The Statement provides specific guidance sions as more information becomes available. on testing intangible assets that will not be amortized for Notwithstanding the judgment required in assessing the impairment. As of December 31, 2001, the Company had components of the allowance for loan losses, the Company goodwill with a remaining balance of $3.9 million recorded believes that the allowance for loan losses is adequate to in connection with its purchase of New York Federal cover losses inherent in the loan portfolio. The policy has Savings Bank in 1997. Amortization expense for each of the been applied on a consistent basis for all periods presented years in the two-year period ended December 31, 2001 was in the Consolidated Financial Statements. $0.4 million. Effective January 1, 2002, the Company no longer recorded this amortization expense, but rather is (cid:2) OTHER TRENDS AND CONTINGENCIES required, at least annually, to test the remaining goodwill Interest rates remained low during 2002, with long-term for impairment. The impairment test performed in connec- rates declining over the course of the year, while short-term tion with the adoption of this Statement in January 2002, rates remained stable at low levels until November, when and the subsequent annual impairment test performed in they declined approximately 50 basis points. At December January 2003, did not require an adjustment to the carry- 31, 2002, interest rates were at their lowest level in almost ing value of the goodwill. 40 years. This presented significant challenges and oppor- tunities in managing our mortgage loan and investment (cid:2) CRITICAL ACCOUNTING POLICIES portfolios. We remained strategically focused in 2002 on The Company’s accounting policies are integral to the origination of multi-family residential and commercial understanding the results of operations and statement real estate mortgage loans, and on mixed-use property of financial condition. These policies are described in one-to-four family residential mortgage loans. Mixed-use the Notes to Consolidated Financial Statements. Several properties are those that contain both residential dwelling of these policies require management’s judgment to deter- units and commercial units. These types of loans have mine the value of the Company’s assets and liabilities. The higher interest rates than traditional one-to-four family Company has established detailed written policies and residential mortgage loans. As a result of this strategy, we control procedures to ensure consistent application of these were able to achieve a higher yield on our mortgage port- policies. The accounting policy that requires significant folio then we would have otherwise experienced, despite management valuation judgment is determining the allow- the declining interest-rate environment experienced during ance for loan losses. 2002 and 2001. Flushing Financial Corporation and Subsidiaries 24(cid:2) (cid:2) M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (continued) Due to the availability of lower interest rates, many of We are unable to predict the direction of future interest our mortgagors chose to refinance their loans. We saw a rate changes. Should interest rates increase during 2003, significant increase in our mortgagors refinancing with we could see an increase in the cost of our existing deposit other institutions. In addition, due to depositors increased accounts and in obtaining new funds. However, approxi- $183.5 million during 2002. Combining the increase in mately 59% of the Company’s certificates of deposit accounts deposits with higher than anticipated loan prepayments, we and borrowed funds do not reprice or mature during the experienced an increase in our cash position. Rather than next year. As a result, the average cost of our interest- investing these funds in low-yielding long-term investment bearing liabilities may not immediately reflect the full effect securities, we invested these funds in readily marketable of an increasing interest-rate environment. Also, in an mortgage-backed securities and shorter-term investment increasing interest rate environment, mortgage loans and securities to provide readily available funding for loan mortgage-backed securities with lower rates do not usually originations. Other securities primarily consists of securi- prepay as quickly. In a rising interest rate environment, this ties issued by government agencies and mutual or bond could result in our cost of funds increasing more than the funds that invest in government and government agency yield on our interest-earning assets. securities. At December 31, 2002, we had loans in process The Company’s operating results can also be affected by of $189.2 million. national and local economic conditions. During 2002, the For the year ended December 31, 2002, the higher cost- nation’s economy was generally considered to be expanding ing certificate of deposits increased $76.2 million while slowly. World events, particularly the “War on Terror” and lower costing deposits increased $107.3 million. We seek to the unsettled situation in the Middle East (primarily the sit- maintain our deposits at competitive rates. In recent years, uation with Iraq), slowed the economic recovery. The local we had increased our utilization of FHLB-NY advances and area economy has been further hurt by the September 11, repurchase agreements as alternative sources of funding. 2001 attacks on New York City’s financial district, in partic- During 2002, as a result of the increase in deposits, we ular, the destruction of the World Trade Center buildings. decreased our borrowed funds by $20.3 million. As a result The Bank does not have a significant amount of mortgages of the declining interest rate environment experienced or other loans to borrowers located in the area that was during 2002 and 2001, and the increase in lower costing destroyed or damaged in the attacks of September 11, deposits, we experienced a decrease in our cost of funds 2001. In addition, job growth was limited during 2002. in each quarter during 2002. The cost of funds declined These economic conditions can result in borrowers default- to 3.76% in the fourth quarter of 2002 from 4.47% in the ing on their loans, or withdrawing their funds on deposit at fourth quarter of 2001. the Bank to meet their financial obligations. While we have As a result of the low interest-rate environment during not seen a significant increase in delinquent loans, and 2002 and 2001, the yield on our total interest-earning have seen an increase in deposits, we cannot predict the assets declined 47 basis points. This was more than offset effect of these economic conditions on the Company’s finan- by a 90 basis point decline in the cost of our total interest- cial condition or operating results. bearing liabilities. This resulted in an increase of 43 basis points in the net interest spread to 3.32% for the year ended December 31, 2002 from 2.89% for the year ended December 31, 2001. The net interest rate margin improved 35 basis points to 3.55% for the year ended December 31, 2002 from 3.20% for the year ended December 31, 2001. The net interest margin improved to 3.55% in the fourth quarter of 2002 from 3.34% in the fourth quarter of 2001. Flushing Financial Corporation and Subsidiaries 25(cid:2) (cid:2) C O N S O L I D A T E D S T A T E M E N T S O F F I N A N C I A L C O N D I T I O N December 31, (cid:2) Assets Cash and due from banks ......................................................................................................................... Federal funds sold ..................................................................................................................................... Securities available for sale: 2002 2001 (Dollars in thousands, except share data) $ 29,119 18,500 $ 20,008 18,500 Mortgage-backed securities................................................................................................................... Other securities ..................................................................................................................................... 319,255 39,729 243,058 62,481 Loans ........................................................................................................................................................ Less: Allowance for loan losses .............................................................................................................. 1,176,141 (6,581) 1,073,782 (6,585) Net loans........................................................................................................................................... 1,169,560 1,067,197 Interest and dividends receivable ............................................................................................................... Real estate owned, net.............................................................................................................................. Bank premises and equipment, net............................................................................................................ Federal Home Loan Bank of New York stock ............................................................................................. Goodwill ................................................................................................................................................... Other assets .............................................................................................................................................. 8,409 — 5,389 22,213 3,905 36,879 7,945 93 5,565 25,422 3,905 33,355 Total assets ........................................................................................................................................ $1,652,958 $1,487,529 (cid:2) Liabilities Due to depositors: Non-interest bearing.............................................................................................................................. Interest-bearing ..................................................................................................................................... Mortgagors’ escrow deposits..................................................................................................................... Borrowed funds, including securities sold under agreements to repurchase $ 35,287 966,726 9,812 $ 28,594 789,923 10,065 of $113,900 and $113,150 at December 31, 2002 and 2001, respectively ........................................... Other liabilities .......................................................................................................................................... 493,164 16,583 513,435 12,125 Total liabilities .................................................................................................................................... 1,521,572 1,354,142 Commitments and contingencies (Note 14) (cid:2) Stockholders’ Equity Preferred stock, ($0.01 par value, authorized 5,000,000 shares; none issued) ........................................... Common stock, ($0.01 par value, authorized 40,000,000 shares; 13,852,063 shares issued; 12,598,343 and 13,487,784 shares outstanding at December 31, 2002 and 2001, respectively) .......... Additional paid-in capital........................................................................................................................... Treasury stock, at average cost (1,253,720 and 364,279 shares at December 31, 2002 and 2001, respectively)................................................................................................................................. Unearned compensation............................................................................................................................ Retained earnings...................................................................................................................................... Accumulated other comprehensive income, net of taxes ........................................................................... — — 139 47,208 (21,733) (7,825) 109,208 4,389 139 45,280 (5,750) (7,766) 99,641 1,843 Total stockholders’ equity .................................................................................................................. 131,386 133,387 Total liabilities and stockholders’ equity ............................................................................................. $1,652,958 $1,487,529 The accompanying notes are an integral part of these consolidated financial statements. Flushing Financial Corporation and Subsidiaries 26(cid:2) (cid:2) C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E For the years ended December 31, (cid:2) Interest and dividend income Interest and fees on loans ............................................................................................................... Interest and dividends on securities: 2002 2001 2000 (In thousands, except per share data) $ 90,501 $ 84,369 $76,780 Interest........................................................................................................................................ Dividends .................................................................................................................................... Other interest income...................................................................................................................... 15,613 165 627 15,943 255 1,332 19,214 272 675 Total interest and dividend income .......................................................................................... 106,906 101,899 96,941 (cid:2) Interest expense Deposits .......................................................................................................................................... Other interest expense .................................................................................................................... Total interest expense .............................................................................................................. Net interest income ........................................................................................................ Provision for loan losses .................................................................................................................. Net interest income after provision for loan losses ........................................... (cid:2) Non-interest income Other fee income ............................................................................................................................ Net gain (loss) on sales of securities and loans................................................................................. Other income .................................................................................................................................. Total non-interest income ........................................................................................................ (cid:2) Non-interest expense Salaries and employee benefits........................................................................................................ Occupancy and equipment.............................................................................................................. Professional services ........................................................................................................................ Data processing............................................................................................................................... Depreciation and amortization of premises and equipment ............................................................. Other operating .............................................................................................................................. Total non-interest expense....................................................................................................... Income before income taxes ............................................................................................... (cid:2) Provision for income taxes Federal ............................................................................................................................................ State and local ................................................................................................................................ Total provision for income taxes .............................................................................................. 28,204 26,360 54,564 52,342 — 52,342 2,896 (4,158) 2,771 1,509 13,921 2,749 2,759 1,566 1,035 5,591 27,621 26,230 8,247 1,720 9,967 29,711 29,991 27,473 29,575 59,702 57,048 42,197 — 39,893 — 42,197 39,893 2,261 321 3,476 6,058 12,679 2,368 2,291 1,313 1,065 4,741 2,053 (651) 2,456 3,858 12,254 2,222 2,245 1,309 1,085 4,682 24,457 23,797 23,798 19,954 7,245 1,624 8,869 6,195 1,337 7,532 Net income ................................................................................................................................. $ 16,263 $ 14,929 $12,422 Basic earnings per share .................................................................................................................. Diluted earnings per share............................................................................................................... $ $ 1.40 1.34 $ $ 1.22 1.17 $ 0.99 $ 0.97 The accompanying notes are an integral part of these consolidated financial statements. Flushing Financial Corporation and Subsidiaries 27(cid:2) (cid:2) C O N S O L I D A T E D S T A T E M E N T S O F C H A N G E S I N S T O C K H O L D E R S ’ E Q U I T Y For the years ended December 31, (cid:2) Common Stock Balance, beginning of year............................................................................................................... Stock dividend (4,617,270 shares, 2,120,885 shares funded from Treasury) ..................................... Balance, end of year ........................................................................................................................ (cid:2) Additional Paid-In Capital Balance, beginning of year............................................................................................................... Stock dividend ................................................................................................................................. Award of shares released from Employee Benefit Trust (35,341, 32,930 and 49,480 2002 2001 2000 (In thousands, except share data) $ $ 139 — 139 $ $ 114 25 139 $ $ 114 — 114 $ 45,280 $ 76,396 — (33,169) $ 75,952 — shares for the years ended December 31, 2002, 2001 and 2000, respectively)............................. 416 376 Restricted stock awards (69,075, 78,675 and 6,900 shares for the years ended December 31, 2002, 2001 and 2000, respectively) ...................................................................... Stock options exercised (8,250 shares for the year ended December 31, 2001)................................ Tax benefit of unearned compensation ............................................................................................ 146 — 1,366 391 5 1,281 257 3 — 184 Balance, end of year ........................................................................................................................ $ 47,208 $ 45,280 $ 76,396 (cid:2) Treasury Stock Balance, beginning of year............................................................................................................... Purchases of common shares outstanding (1,202,450, 639,950 and 475,516 shares for the years ended December 31, 2002, 2001 and 2000, respectively) ....................................... Stock dividend ................................................................................................................................. Restricted stock award forfeitures (2,180, 1,400 and 1,500 shares for the years $ (5,750) $(31,755) $(25,308) (21,196) — (10,694) 33,142 (6,797) — ended December 31, 2002, 2001 and 2000, respectively)............................................................ (28) Restricted stock awards (69,075, 52,950 and 9,600 shares for the years ended December 31, 2002, 2001 and 2000, respectively) ...................................................................... 1,140 Repurchase of restricted stock awards (13,553, 23,757 and 23,234 shares for the years (26) 821 (22) 148 ended December 31, 2002, 2001 and 2000, respectively) to satisfy tax obligations ..................... (260) (519) (333) Stock options exercised (259,667, 210,750, and 36,600 shares for the years ended December 31, 2002, 2001, and 2000, respectively) ..................................................................... 4,361 3,281 557 Balance, end of year ........................................................................................................................ $(21,733) $ (5,750) $(31,755) (cid:2) Unear ned Compensation Balance, beginning of year............................................................................................................... Release of shares from Employee Benefit Trust (87,679, 76,641 and 69,176 shares $ (7,766) $ (7,781) $ (9,142) for the years ended December 31, 2002, 2001 and 2000, respectively) ....................................... 448 391 354 Restricted stock awards (69,075, 78,675 and 14,400 shares for the years ended December 31, 2002, 2001 and 2000, respectively) ...................................................................... (1,286) (1,212) (145) Restricted stock award forfeitures (2,180, 2,100 and 2,250 shares for the years ended December 31, 2002, 2001 and 2000, respectively) ...................................................................... Restricted stock award expense........................................................................................................ 28 751 26 810 22 1,130 Balance, end of year ........................................................................................................................ $ (7,825) $ (7,766) $ (7,781) Continued Flushing Financial Corporation and Subsidiaries 28(cid:2) (cid:2) C O N S O L I D A T E D S T A T E M E N T S O F C H A N G E S I N S T O C K H O L D E R S ’ E Q U I T Y (continued) For the years ended December 31, (cid:2) Retained Ear nings Balance, beginning of year ............................................................................................................ Net income ................................................................................................................................... Stock options exercised (259,667, 246,475 and 54,900 shares for the years ended 2002 2001 2000 (In thousands, except share data) $ 99,641 16,263 $ 89,896 14,929 $ 81,056 12,422 December 31, 2002, 2001 and 2000, respectively) ................................................................... Restricted stock awards (7,500 shares for the year ended December 31, 2000) ............................ Cash dividends declared and paid ................................................................................................. (2,458) — (4,238) (1,362) — (3,822) (159) (6) (3,417) Balance, end of year ..................................................................................................................... $109,208 $ 99,641 $ 89,896 (cid:2) Accumulated Other Comprehensive Income, Net of Taxes Balance, beginning of year ............................................................................................................ Adjustment required to recognize minimum pension liability, net of taxes of $ 1,843 $ (133) $ (4,496) approximately $221 .................................................................................................................. (254) — — Change in net unrealized gain (loss), net of taxes of approximately $(347), $(1,719) and $(3,434) for the years ended December 31, 2002, 2001 and 2000, respectively, on securities available for sale ................................................................................................... Less: Reclassification adjustment for losses (gains) included in net income, net of taxes of approximately $(2,038), $35 and $(283) for the years ended December 31, 2002, 2001 and 2000, respectively ..................................................................................................... 408 2,035 3,902 2,392 (59) 461 Balance, end of year ..................................................................................................................... $ 4,389 $1,843 $(133) Total stockholders’ equity .................................................................................................. $131,386 $133,387 $126,737 (cid:2) Comprehensive Income Net income ................................................................................................................................... Other comprehensive income, net of tax: $ 16,263 $ 14,929 $ 12,422 Minimum pension liability ......................................................................................................... Unrealized gains (losses) on securities........................................................................................ (254) 2,800 — 1,976 — 4,363 Comprehensive income ................................................................................................................. $ 18,809 $ 16,905 $ 16,785 The accompanying notes are an integral part of these consolidated financial statements. Flushing Financial Corporation and Subsidiaries 29(cid:2) (cid:2) C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W For the years ended December 31, (cid:2) Operating Activities Net income ................................................................................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses .......................................................................................................... Provision for losses on real estate owned ................................................................................ Depreciation and amortization of bank premises and equipment ............................................ Amortization of goodwill ........................................................................................................ Impairment writedown of investment security ........................................................................ Net (gain) loss on sales of securities ........................................................................................ Net gain on sales of loans....................................................................................................... Net gain on sales of real estate owned ................................................................................... Amortization of unearned premium, net of accretion of unearned discount ........................... Amortization of deferred income ............................................................................................ Deferred income tax (benefit) provision................................................................................... Deferred compensation........................................................................................................... Net decrease in other assets and liabilities................................................................................... Unearned compensation ............................................................................................................. 2002 2001 2000 (In thousands) $ 16,263 $ 14,929 $ 12,422 — — 1,035 — 4,429 1 (272) (4) 2,988 (174) (859) 523 (428) 1,615 — 4 1,065 367 — (94) (227) (15) 1,215 (309) 132 469 (3,912) 1,577 — — 1,085 366 — 744 (93) (199) 1,142 (544) 7 232 (2,709) 1,741 Net cash provided by operating activities ............................................................................ 25,117 15,201 14,194 (cid:2) Investing Activities Purchases of bank premises and equipment................................................................................ Net redemptions (purchases) of Federal Home Loan Bank shares ................................................ Purchase of Bank Owned Life Insurance...................................................................................... Purchases of securities available for sale...................................................................................... Proceeds from sales and calls of securities available for sale ........................................................ Proceeds from maturities and prepayments of securities available for sale................................... Net originations and repayments of loans ................................................................................... Purchases of loans ...................................................................................................................... Proceeds from sales of real estate owned ................................................................................... (859) 3,209 — (262,506) 39,022 168,133 (92,100) (10,183) 97 (319) (490) — (189,858) 39,395 102,953 (79,840) (887) 106 (1,194) (2,340) (20,000) (28,667) 28,735 36,130 (94,312) (15,783) 567 Net cash used in investing activities .................................................................................... (155,187) (128,940) (96,864) (cid:2) Financing Activities Net increase in non-interest bearing deposits .............................................................................. Net increase in interest-bearing deposits ..................................................................................... Net increase (decrease) in mortgagors’ escrow deposits .............................................................. Net decrease in short-term borrowed funds ................................................................................ Proceeds from long-term borrowings .......................................................................................... Repayment of long-term borrowings .......................................................................................... Purchases of treasury stock, net .................................................................................................. Cash dividends paid.................................................................................................................... 6,693 176,803 (253) — 90,000 (110,271) (19,553) (4,238) 7,681 128,778 2,312 (14,232) 123,000 (104,172) (9,291) (3,822) 423 25,717 (3,270) (5,768) 159,150 (96,374) (6,732) (3,417) Net cash provided by financing activities............................................................................. 139,181 130,254 69,729 Net increase (decrease) in cash and cash equivalents .................................................................. Cash and cash equivalents, beginning of year............................................................................. 9,111 38,508 16,515 21,993 (12,941) 34,934 Cash and cash equivalents, end of year .............................................................................. $ 47,619 $ 38,508 $ 21,993 (cid:2) Supplemental Cash Flow Disclosure Interest paid................................................................................................................................ Income taxes paid....................................................................................................................... Non-cash activities: $ 54,479 9,273 $ 59,937 7,615 $ 56,227 7,849 Loans originated as the result of real estate sales.................................................................... Loans transferred through the foreclosure of a related mortgage loan to real estate owned ... — — — 119 191 235 The accompanying notes are an integral part of these consolidated financial statements. Flushing Financial Corporation and Subsidiaries 30(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S For the years ended December 31, 2002, 2001 and 2000 (cid:2) 1. NATURE OF OPERATIONS Corporation (“FSC”) and FSB Properties, Incorporated Flushing Financial Corporation (the “Holding Company”), (“Properties”). FFCTI is a special purpose business trust a Delaware business corporation, is a savings and loan formed to issue capital securities. FPFC is a real estate holding company organized at the direction of its sub- investment trust formed to hold a portion of the Bank’s sidiary, Flushing Savings Bank, FSB (the “Bank”), in con- mortgage loans to facilitate access to capital markets. FSC nection with the Bank’s conversion from a mutual to capital was formed to market insurance products and mutual stock form of organization. The Holding Company and its funds. Properties is an inactive subsidiary whose purpose direct and indirect wholly-owned subsidiaries, the Bank, was to manage real estate properties and joint ventures. All Flushing Financial Capital Trust I, Flushing Preferred significant intercompany accounts and transactions have Funding Corporation, Flushing Service Corporation and FSB been eliminated in consolidation. Properties, Incorporated are collectively herein referred to as the “Company.” The Company’s principal business is attracting retail deposits from the general public and investing those deposits together with funds generated from operations and borrowings, primarily in (1) originations and purchases of one-to-four family residential mortgage loans (focusing on mixed-use properties—properties that contain both Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. residential dwelling units and commercial units), multi- Cash and cash equivalents: family income-producing property loans, and commercial For the purpose of reporting cash flows, the Company real estate loans; (2) mortgage loan surrogates such as defines cash and due from banks, overnight interest-earning mortgage-backed securities and; (3) U.S. government and deposits and federal funds sold with original maturities of federal agency securities, corporate fixed-income securities 90 days or less as cash and cash equivalents. and other marketable securities. To a lesser extent, the Company originates certain other loans, including con- struction loans, Small Business Administration loans and other small business loans. The Bank conducts its business through ten full-service banking offices, five of which are located in Queens County, two in Nassau County, one in Kings County (Brooklyn), one in Bronx County and one in New York County (Manhattan), New York. (cid:2) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of the Company follow generally accepted accounting principles (“GAAP”) and general practices applicable to the banking industry. The policies which materially affect the determination of the Company’s financial position, results of operations and cash flows are summarized below. Principles of consolidation: The accompanying consolidated financial statements include the accounts of Flushing Financial Corporation and its direct and indirect wholly-owned subsidiaries, the Bank, Flushing Financial Capital Trust I (“FFCTI”), Flushing Preferred Funding Corporation (“FPFC”), Flushing Service Securities available for sale: Securities are classified as available for sale when management intends to hold the securities for an indefinite period of time or when the securities may be utilized for tactical asset/liability purposes and may be sold from time to time to effectively manage interest rate exposure and resultant prepayment risk and liquidity needs. Premiums and discounts are amortized or accreted, respectively, using the level-yield method. Realized gains and losses on the sales of securities are determined using the specific identification method. Unrealized gains and losses (other than unrealized losses considered other than temporary which are recognized in the Consolidated Statements of Income) on securities available for sale are excluded from earnings and reported as accumulated other comprehen- sive income, net of taxes. Loans: Loans are carried at amortized cost. Interest on loans is recognized on the accrual basis. The accrual of income on loans is discontinued when certain factors, such as contractual delinquency of ninety days or more, indicate reasonable doubt as to the timely collectibility of such income. Interest previously recognized on non-accrual Flushing Financial Corporation and Subsidiaries 31(cid:2) loans is reversed against interest income at the time the Real estate owned: loan is placed on non-accrual status. A non-accrual loan Real estate owned consists of property acquired by fore- can be returned to accrual status after the loan meets closure. These properties are carried at the lower of carry- certain criteria. Subsequent cash payments received on ing amount or fair value (which is based on appraised value non-accrual loans that do not meet the criteria are applied with certain adjustments) less estimated costs to sell (here- first as a reduction of principal until all principal is recov- inafter defined as fair value). This determination is made ered and then subsequently to interest. on an individual asset basis. If the fair value is less than The portion of loan origination fees that exceeds the the carrying amount, the deficiency is recognized as a valu- direct costs of underwriting and closing loans is deferred. ation allowance. Further decreases to fair value will be The deferred fees received in connection with a loan are recorded in this valuation allowance through a provision recognized as an adjustment of the loan’s yield over the for losses on real estate owned. The Company utilizes esti- shorter of the repricing period or the contractual life of mates of fair value to determine the amount of its valuation the related loan by the interest method, which results in a allowance. Actual values may differ from those estimates. constant rate of return. The direct costs of underwriting and closing loans that exceed loan origination fees, and premiums on loans purchased, are deferred and amortized to income over the life of the loans using the level-yield method. Allowance for loan losses: Bank premises and equipment: Bank premises and equipment are stated at cost, less depreciation accumulated on a straight-line basis over the estimated useful lives of the related assets (3 to 40 years). Leasehold improvements are amortized on a straight-line basis over the terms of the related leases or the lives of the The Company maintains an allowance for loan losses at assets, whichever is shorter. an amount, which, in management’s judgment, is adequate to absorb estimated losses on existing loans. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revisions as more infor- mation becomes available. In assessing the adequacy of the Company’s allowance for loan losses, management con- Federal Home Loan Bank Stock: In connection with the Bank’s borrowings from the Federal Home Loan Bank of New York (“FHLB-NY”), the Bank is required to purchase shares of FHLB-NY non- marketable capital stock at par. Such shares are redeemed by FHLB-NY at par with reductions in the Bank’s borrowing levels. The Bank carries this investment at historical cost. siders the Company’s historical loss experience, recent Securities sold under agreements to repurchase: trends in losses, collection policies and collection expe- Securities sold under agreements to repurchase are rience, trends in the volume of non-performing loans, accounted for as collateralized financing and are carried changes in the composition and volume of the gross loan at amounts at which the securities will be subsequently portfolio, and local and national economic conditions. The reacquired as specified in the respective agreements. Board of Directors reviews and approves management’s evaluation of the adequacy of the allowance for loan losses on a quarterly basis. A loan is considered impaired when, based upon current information, the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan. Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recorded on the cash basis. The Company reviews all non-accrual loans for impairment. Goodwill: Goodwill, prior to January 1, 2002, was amortized using the straight-line method over fifteen years. The Company had periodically reviewed its goodwill for possible impair- ment. Upon the adoption of SFAS No. 142 on January 1, 2002, the company no longer amortizes goodwill, but rather performs annual tests for impairment as of the end of each year. Flushing Financial Corporation and Subsidiaries 32(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 Stock Compensation Plans: Common stock equivalents that are antidilutive are not Statement of Financial Accounting Standards (SFAS) included in the computation of diluted earnings per share. No. 123, “Accounting for Stock-Based Compensation,” Options to purchase 274,400 shares at $18.70, 255,600 establishes a fair value based method of accounting for shares at $16.18, and 290,550 shares at $10.38 were not employee stock compensation plans. Under this method, included in the computation of diluted earnings per share compensation cost is measured at the grant date based on for 2002, 2001 and 2000, respectively. Unvested restricted the value of the award and is recognized over the service stock awards of 68,875 shares at $18.62, 62,925 shares at period, which is usually the vesting period. However, it $16.27, and 110,400 shares at $10.37 were not included in also allows an entity to continue to measure compensa- the computation of diluted earnings per share for 2002, tion cost for those plans using the intrinsic value based 2001 and 2000, respectively method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to (cid:2) 3. LOANS Employees.” The Company has elected to continue with the The composition of loans is as follows at December 31: accounting methodology in Opinion No. 25. As a result, pro forma disclosures of net income and earnings per share 2002 2001 (In thousands) and other disclosures, as if the fair value based method of One-to-four family residential— accounting had been applied, are provided in the notes to conventional ..................................... $ 262,944 $ 351,992 the consolidated financial statements. Earnings per share: Basic earnings per share for the years ended December 31, 2002, 2001 and 2000 was computed by dividing net income by the total weighted average number of common shares outstanding, including only the vested portion of restricted stock awards. Diluted earnings per share includes the additional dilutive effect of stock options outstanding and the unvested portions of restricted stock awards during the period. The shares held in the Company’s Employee One-to-four family residential— mixed-use properties......................... Multi-family residential.......................... Commercial real estate ......................... Co-operative apartments ...................... Construction ......................................... Small Business Administration ............... Consumer and other............................. 170,499 452,663 257,054 5,205 17,827 4,301 4,185 109,809 369,651 214,410 6,601 13,807 3,911 2,814 Gross loans ................................... 1,174,678 1,072,995 Unearned loan fees and deferred costs, net .......................................... 1,463 787 Total loans .................................... $1,176,141 $1,073,782 Benefit Trust are not included in shares outstanding for The total amount of loans on non-accrual status, and purposes of calculating earnings per share. loans classified as impaired, at December 31, 2002, 2001 Earnings per share has been computed based on the and 2000 was $3,592,000, $2,320,000 and $1,618,000, following for the years ended December 31: Net income .................................. Divided by: Weighted average common 2002 2001 2000 (Amounts in thousands, except per share data) $12,422 $14,929 $16,263 shares outstanding ............... 11,600 12,267 12,565 Weighted average common respectively. The portion of the allowance for loan losses allocated to impaired loans was $340,000 (5.2%), $541,000 (8.2%) and $257,000 (3.8%) at December 31, 2002, 2001 and 2000, respectively. The portion of the impaired loan amount above 100% of the loan-to-value ratio is charged off. The average balance of impaired loans was $2,681,000, $2,105,000 and $1,692,000 for 2002, 2001 and 2000, stock equivalents.................. 514 504 227 respectively. Total weighted average com- mon shares outstanding & common stock equivalents ... Basic earnings per share ............... Diluted earnings per share............ 12,114 $ 1.40 $ 1.34 12,771 $ 1.22 $ 1.17 12,792 $ 0.99 $ 0.97 Flushing Financial Corporation and Subsidiaries 33(cid:2) The following is a summary of interest foregone on non- (cid:2) 4. REAL ESTATE OWNED accrual loans for the years ended December 31: The following are changes in the allowance for losses on Interest income that would have been recognized had the loans performed in accordance with their original terms ....... Less: Interest income included in the 2002 2001 2000 (In thousands) $298 $193 $141 results of operations................................ 76 76 62 Foregone interest ........................................ $222 $117 $ 79 The following are changes in the allowance for loan losses for the years ended December 31: real estate owned for the years ended December 31: 2002 2001 2000 Balance, beginning of year ................ Provision............................................ Reduction due to sales of (In thousands) $ — $ — $ — — — 4 real estate owned.......................... — (4) — Balance, end of year.......................... $ — $ — $ — (cid:2) 5. BANK PREMISES AND EQUIPMENT, NET Bank premises and equipment are as follows at Decem- 2002 2001 2000 ber 31: Balance, beginning of year ................ Provision for loan losses .................... Charge-offs ....................................... Recoveries ......................................... $6,585 — (12) 8 (In thousands) $6,721 — (149) 13 $6,818 — (99) 2 Balance, end of year...................... $6,581 $6,585 $6,721 2002 2001 (In thousands) Land .............................................................. Building and leasehold improvements............ Equipment and furniture ............................... $ 801 4,214 9,595 $ 801 4,231 9,162 Total .......................................................... 14,610 14,194 Less: Accumulated depreciation and amortization ....................................... 9,221 8,629 Bank premises and equipment, net............ $ 5,389 $ 5,565 (cid:2) 6. DEBT AND EQUITY SECURITIES Investments in equity securities that have readily determinable fair values and all investments in debt securities are classified in one of the following three categories and accounted for accordingly: (1) trading securities, (2) securities available for sale and (3) securities held-to-maturity. The Company did not hold any trading securities or securities held-to-maturity during the years ended December 31, 2002, 2001 and 2000. Securities available for sale are recorded at estimated fair value based on dealer quotations where available. Actual values may differ from estimates provided by outside dealers. Securities classified as held-to-maturity would be stated at cost, adjusted for amortization of premium and accretion of discount using the level-yield method. The amortized cost and estimated fair value of the Company’s securities, classified as available for sale at December 31, 2002 are as follows: Amortized Cost Estimated Fair Value Gross Unrealized Gains Gross Unrealized Losses (In thousands) U.S. Treasury securities and government agencies............................................................... Corporate debt securities.................................................................................................... Mutual funds...................................................................................................................... Other.................................................................................................................................. $ 15,376 1,700 19,535 1,853 $ 15,609 2,252 19,412 2,456 Total other securities....................................................................................................... 38,464 39,729 GNMA................................................................................................................................ FNMA................................................................................................................................. FHLMC ............................................................................................................................... REMIC and CMO ................................................................................................................ 94,302 114,103 46,468 57,049 97,529 116,983 47,153 57,590 Total mortgage-backed securities.................................................................................... 311,922 319,255 $ 233 552 99 645 1,529 3,227 2,882 691 619 7,419 $ — — 222 42 264 — 2 6 78 86 Total securities available for sale ..................................................................................... $350,386 $358,984 $8,948 $350 Flushing Financial Corporation and Subsidiaries 34(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 The amortized cost and estimated fair value of the Company’s securities, classified as available for sale at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Due in one year or less............................................................................................................................................ Due after one year through five years ..................................................................................................................... Due after five years through ten years..................................................................................................................... Due after ten years ................................................................................................................................................. Total other securities ........................................................................................................................................... Mortgage-backed securities .................................................................................................................................... Amortized Cost Estimated Fair Value (In thousands) $ 20,513 1,975 10,282 5,694 38,464 311,922 $ 21,033 2,528 10,462 5,706 39,729 319,255 Total securities available for sale .......................................................................................................................... $350,386 $358,984 The amortized cost and estimated fair value of the Company’s securities classified as available for sale at December 31, 2001 were as follows: Amortized Cost Estimated Fair Value Gross Unrealized Gains Gross Unrealized Losses (In thousands) Corporate debt securities.................................................................................................... Public utility debt securities................................................................................................. Mutual funds...................................................................................................................... Other.................................................................................................................................. $ 32,884 8,042 18,899 1,884 $ 32,985 8,132 18,867 2,497 Total other securities....................................................................................................... 61,709 62,481 GNMA................................................................................................................................ FNMA................................................................................................................................. FHLMC ............................................................................................................................... REMIC and CMO ................................................................................................................ 132,678 50,895 20,552 36,292 134,125 51,359 20,810 36,764 Total mortgage-backed securities.................................................................................... 240,417 243,058 $ 123 90 32 614 859 1,560 591 273 500 2,924 $ 22 — 64 1 87 113 127 15 28 283 Total securities available for sale ..................................................................................... $302,126 $305,539 $3,783 $370 For the year ended December 31, 2002, gross gains of $423,000 and losses of $424,000 were realized on sales of securities available for sale. In addition, an impairment writedown of $4,429,000 was recorded during the year ended December 31, 2002. For the year ended December 31, 2001, gross gains of $179,000 and losses of $85,000 were realized on sales of securities available for sale. For the year ended December 31, 2000, gross gains of $205,000 and losses of $949,000 were realized on sales of securities available for sale. (cid:2) 7. DEPOSITS Total deposits at December 31, 2002 and 2001, and the weighted average rate on deposits at December 31, 2002, are as follows: 2002 2001 Weighted Average Rate 2002 (Dollars in thousands) Interest-bearing deposits: Certificate of deposit accounts...................................................................................................... Passbook savings accounts............................................................................................................ Money market accounts................................................................................................................ NOW accounts.............................................................................................................................. $ 543,330 213,572 170,029 39,795 $467,172 195,855 93,789 33,107 3.96% 1.00 2.31 0.75 Total interest-bearing deposits................................................................................................... 966,726 789,923 Non-interest bearing deposits: Demand accounts ......................................................................................................................... 35,287 28,594 Total due to depositors ............................................................................................................. Mortgagors’ escrow deposits ............................................................................................................ 1,002,013 9,812 818,517 10,065 0.38 Total deposits ............................................................................................................................. $1,011,825 $828,582 Flushing Financial Corporation and Subsidiaries 35(cid:2) The aggregate amount of time deposits with denominations of $100,000 or more was $100,926,000 and $75,175,000 at December 31, 2002 and 2001, respectively. Interest expense on deposits is summarized as follows for the years ended December 31: Certificate of deposit accounts ......................................................................................................................... Passbook savings accounts ............................................................................................................................... Money market accounts ................................................................................................................................... NOW accounts ................................................................................................................................................. Total due to depositors ................................................................................................................................. Mortgagors’ escrow deposits............................................................................................................................ 2002 2001 2000 $21,640 3,147 3,039 321 28,147 57 (In thousands) $23,062 3,767 2,309 504 29,642 69 $21,488 3,931 1,438 530 27,387 86 Total interest expense on deposits ................................................................................................................ $28,204 $29,711 $27,473 (cid:2) 8. BORROWED FUNDS Borrowed funds are summarized as follows at December 31: 2002 2001 Weighted Average Rate Weighted Average Rate Amount Amount (Dollars in thousands) Repurchase agreements—fixed rate: Due in 2002 ..................................................................................................................... Due in 2005 ..................................................................................................................... Due in 2006 ..................................................................................................................... Due in 2007 ..................................................................................................................... Due in 2009 ..................................................................................................................... $ — 10,900 18,000 60,000 25,000 Total repurchase agreements ........................................................................................ 113,900 FHLB-NY advances—adjustable rate: Due in 2002 ..................................................................................................................... Due in 2003 ..................................................................................................................... Due in 2004 ..................................................................................................................... Due in 2007 ..................................................................................................................... Total FHLB-NY advances—adjustable rate ..................................................................... FHLB-NY advances—fixed rate: Due in 2002 ..................................................................................................................... Due in 2003 ..................................................................................................................... Due in 2004 ..................................................................................................................... Due in 2006 ..................................................................................................................... Due in 2007 ..................................................................................................................... Due in 2008 ..................................................................................................................... Due in 2010 ..................................................................................................................... Due in 2011 ..................................................................................................................... — 25,000 50,000 20,000 95,000 — 85,000 49,000 35,000 25,000 30,000 40,000 264 Total FHLB-NY advances—fixed rate ............................................................................. 264,264 Total FHLB-NY advances ............................................................................................... 359,264 Other borrowings—adjustable rate: —% 6.36 4.96 5.25 5.52 5.37 — 5.50 2.54 3.15 3.45 — 6.12 5.33 4.93 6.15 3.85 7.30 7.34 5.74 5.13 $ 9,250 10,900 18,000 50,000 25,000 6.01% 6.36 4.96 5.64 5.52 113,150 5.60 25,000 25,000 50,000 — 100,000 76,000 85,000 49,000 25,000 25,000 — 40,000 285 300,285 400,285 1.95 5.50 3.15 — 3.44 5.93 6.12 5.33 4.99 6.15 — 7.30 7.34 6.01 5.37 Due in 2032 ..................................................................................................................... 20,000 5.43 — — Total borrowings .......................................................................................................... $493,164 5.20% $513,435 5.42% Flushing Financial Corporation and Subsidiaries 36(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 As part of the Company’s strategy to finance investment with an initial rate of 5.51387%. The rate was 5.425% opportunities and manage its cost of funds, the Company at December 31, 2002. A rate cap of 12.50% is effective enters into repurchase agreements with broker-dealers and through October 7, 2007. The Holding Company has guar- the FHLB-NY. These agreements are recorded as financing anteed the payment of FFCTI’s obligations under these cap- transactions and the obligations to repurchase are reflected ital securities. as a liability in the consolidated financial statements. The securities underlying the agreements were delivered to the (cid:2) 9. INCOME TAXES broker-dealers or the FHLB-NY who arranged the trans- Flushing Financial Corporation files consolidated action. The securities remain registered in the name of the Federal and combined New York State and New York City Company and are returned upon the maturity of the agree- income tax returns with its subsidiaries, with the exception ment. The Company retains the right of substitution of col- of FFCTI and FPFC, which file separate Federal, New York lateral throughout the terms of the agreements. All the State and New York City income tax returns as a trust and repurchase agreements are collateralized by mortgage- real estate investment trust, respectively. A deferred tax backed securities. Information relating to these agreements liability is recognized on all taxable temporary differences at or for the years ended December 31 is as follows: and a deferred tax asset is recognized on all deductible 113,900 182,226 Statements of Financial Condition. Book value of collateral ....................... Estimated fair value of collateral .......... Average balance of outstanding 2002 2001 (Dollars in thousands) $111,634 111,634 $119,011 119,011 agreements during the year............. 108,514 156,640 Maximum balance of outstanding agreements at a month end during the year................................ Average interest rate of outstanding agreements during the year............. 5.58% 5.71% Pursuant to a blanket collateral agreement with the FHLB-NY, advances are secured by all of the Bank’s stock in the FHLB-NY, certain qualifying mortgage loans, mortgage- backed and mortgage-related securities, and other securi- ties not otherwise pledged in an amount at least equal to 110% of the advances outstanding. The Holding Company also has a trust formed under the laws of the State of Delaware for the purpose of issuing capital and common securities and investing the proceeds thereof in junior subordinated debentures of the Holding Company. On July 11, 2002, FFCTI issued $20.0 million of temporary differences and operating losses and tax credit carryforwards. A valuation allowance is recognized to reduce the potential deferred tax asset if it is “more likely than not” that all or some portion of that potential deferred tax asset will not be realized. The Company must also take into account changes in tax laws or rates when valuing the deferred income tax amounts it carries on its Consolidated The Company’s annual tax liability for New York State and New York City was the greater of a tax based on “entire net income,” “alternative entire net income,” “taxable assets” or a minimum tax. For each of the years ended December 31, 2002, 2001 and 2000, the Company’s state and city tax was based on “alternative entire net income.” Income tax provisions (benefits) are summarized as fol- lows for the years ended December 31: 2002 2001 2000 (In thousands) Federal: Current ......................................... Deferred........................................ $9,174 (927) $7,350 (105) $6,387 (192) floating rate capital securities. The capital securities have Total federal tax provision.......... 8,247 7,245 6,195 a maturity date of October 7, 2032, are callable at par in State and Local: 5 years and every quarter thereafter, and pay cumulative cash distributions at a floating per annum rate of inter- est, reset quarterly, equal to 3.65% over 3-month LIBOR, Current ......................................... Deferred........................................ 1,652 68 1,387 237 1,138 199 Total state and local tax provision.......................... 1,720 1,624 1,337 Total income tax provision ................. $9,967 $8,869 $7,532 Flushing Financial Corporation and Subsidiaries 37(cid:2) The income tax provision in the Consolidated Statements of Income has been provided at effective rates of 38.0%, 37.3% and 37.7% for the years ended December 31, 2002, 2001 and 2000, respectively. The effective rates differ from the statutory federal income tax rate as follows for the years ended December 31: Taxes at federal statutory rate ........................................................................... Increase (reduction) in taxes resulting from: 2002 2001 2000 $9,181 35.0% $8,329 (Dollars in thousands) 35.0% $6,984 35.0% State & local income tax, net of Federal income tax benefit .......................... Other ............................................................................................................ 1,118 (332) 4.3 (1.3) 1,056 (516) 4.5 (2.2) 869 (321) 4.3 (1.6) Taxes at effective rate................................................................................ $9,967 38.0% $8,869 37.3% $7,532 37.7% The components of the income taxes attributable to The Company has recorded a net deferred tax asset of income from operations and changes in equity are as fol- $403,000. This represents the anticipated net federal, state lows for the years ended December 31: and local tax benefits expected to be realized in future Income from operations ............... Equity: Change in fair value of 2002 2001 2000 $ 9,967 (In thousands) $ 8,869 $ 7,532 securities available for sale ... 2,385 1,684 3,717 (221) — — Adjustment required to recognize minimum pension liability .................... Compensation expense for tax purposes in excess of that recognized for financial reporting purposes ............... years upon the utilization of the underlying tax attributes comprising this balance. The Company has reported tax- able income for federal, state, and local tax purposes in each of the past three years. In management’s opinion, in view of the Company’s previous, current and projected future earnings trend, it is more likely than not that the net deferred tax asset will be fully realized. Accordingly, no valuation allowance was deemed necessary for the net deferred tax asset at December 31, 2002. (1,366) (1,281) (184) (cid:2) 10. BENEFIT PLANS Total ................................. $10,765 $ 9,272 $11,065 The components of the net deferred tax asset are as follows at December 31: 2002 2001 (In thousands) Deferred tax asset: Postretirement benefits ............................... Impairment writedown ............................... Allowance for loan losses ........................... Minimum pension liability ........................... Other.......................................................... $ 1,923 1,849 206 221 237 $ 3,117 — — — 907 Deferred tax asset................................... 4,436 4,024 Deferred tax liabilities: Unrealized gains on securities available for sale ..................................... Allowance for loan losses ........................... Depreciation ............................................... Other.......................................................... Deferred tax liability ................................ 3,955 — 64 14 4,033 1,570 545 192 9 2,316 Net deferred tax asset included in other assets ................................................ $ 403 $ 1,708 Defined Contribution Plans: The Company maintains a profit-sharing plan and the Bank maintains a 401(k) plan. Both plans are tax-qualified defined contribution plans which cover substantially all employees. Annual contributions are at the discretion of the Company’s Board of Directors, but not to exceed the maximum amount allowable under the Internal Revenue Code. Currently, annual matching contributions under the Bank’s 401(k) plan equal 50% of the employee’s contribu- tions, up to a maximum of 3% of the employee’s compensa- tion. Contributions to the profit-sharing plan are determined at the end of each year. Contributions by the Bank into the 401(k) plan vest 20% per year over a five-year period beginning after the employee has completed one year of service. Contributions into the profit-sharing plan vest 20% per year over the employee’s first five years of service. Compensation expense recorded by the Company for these plans amounted to $679,000, $619,000 and $581,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Flushing Financial Corporation and Subsidiaries 38(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 Employee Benefit Trust: Restricted Stock Plan: An Employee Benefit Trust (“EBT”) has been established The 1996 Restricted Stock Incentive Plan (“Restricted to assist the Company in funding its benefit plan Stock Plan”) became effective on May 21, 1996 after adop- obligations. In connection with the Bank’s conversion, the tion by the Board of Directors and approval by stockhold- EBT borrowed $7,928,000 from the Company and used ers. The aggregate number of shares of common stock $7,000 of cash received from the Bank to purchase which may be issued under the Restricted Stock Plan, as 1,552,500 shares of the common stock of the Company. The amended, may not exceed 817,125 shares to employees, loan will be repaid principally from the Company’s discre- and may not exceed 262,875 shares to outside directors, tionary contributions to the EBT and dividend payments for a total of 1,080,000 shares. Lapsed, forfeited or can- received on common stock held by the EBT, or may be celed awards and shares withheld from an award to satisfy forgiven by the Company, over a period of 30 years. At tax obligations will not count against these limits, and will December 31, 2002 the loan had an outstanding balance be available for subsequent grants. The shares distributed of $5,465,000, bearing a fixed interest rate of 6.22% under the Restricted Stock Plan may be shares held in per annum. The loan obligation of the EBT is considered treasury or authorized but unissued shares. The following unearned compensation and, as such, is recorded as a table summarizes certain activity for the Restricted Stock reduction of the Company’s stockholders’ equity. Both the Plan, after giving effect to the three-for-two common stock loan obligation and the unearned compensation are split distributed in the form of a stock dividend on August reduced by the amount of loan repayments made by the 30, 2001, for the years ended December 31: EBT or forgiven by the Company. Shares purchased with the loan proceeds are held in a suspense account for contri- bution to specified benefit plans as the loan is repaid or for- given. Shares released from the suspense account are used solely for funding matching contributions under the Bank’s 401(k) plan and contributions to the Company’s profit- sharing plan. Since annual contributions are discretionary with the Company or dependent upon employee contri- butions, compensation payable under the EBT cannot be estimated. For the years ended December 31, 2002, 2001 and 2000, the Company funded $597,000, $545,000 and $511,000, respectively, of employer contributions to the 401(k) and profit sharing plans from the EBT. The shares held in the suspense account are pledged as collateral and are reported as unallocated EBT shares in stockholders’ equity. As shares are released from the sus- pense account, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share compu- tations. The EBT shares are as follows at December 31: Shares owned by Employee Benefit Trust, beginning balance ............... Shares released and allocated ........... Shares owned by Employee Benefit 2002 2001 1,246,237 35,341 1,279,167 32,930 Trust, ending balance.................... 1,210,896 1,246,237 Market value of unallocated shares... $19,832,055 $22,183,019 Shares available for future Restricted Stock Awards at beginning of year............ Shares authorized for Restricted Stock Awards .......................... Restricted Stock Awards .............. Restricted shares repurchased to satisfy tax obligations.......... Forfeitures ................................... Shares available for future Restricted Stock Awards at end of year ......................... 2002 2001 2000 331,849 238,203 215,502 — 135,000 (78,675) (69,075) — (14,400) 13,553 2,180 35,221 2,100 34,851 2,250 278,507 331,849 238,203 The Board of Directors has discretion to determine the vesting period of all grants to employees. All grants that have been awarded to employees vest 20% per year over a five-year period. Initial grants to outside directors vest 20% per year over a five-year period, while subsequent annual grants to outside directors vest one-third per year over a three-year period. All grants have full vesting in the event of death, disability, retirement or a change in control. Total restricted stock award expense in 2002, 2001 and 2000 was $751,000, $810,000 and $1,130,000, respectively. Flushing Financial Corporation and Subsidiaries 39(cid:2) Stock Option Plan: directors vest one-third per year over a three-year period. The 1996 Stock Option Incentive Plan (“Stock Option All grants have full vesting in the event of death, disability, Plan”) became effective on May 21, 1996 after adoption by retirement or a change in control. The following table the Board of Directors and approval by stockholders. The summarizes certain information regarding the Stock Option Stock Option Plan provides for the grant of incentive stock Plan after giving effect to the three-for-two common stock options intended to comply with the requirements of split distributed in the form of a stock dividend on August Section 422 of the Internal Revenue Code, nonstatutory 30, 2001. stock options, and limited stock appreciation rights granted in tandem with such options. The aggregate number of shares of common stock which may be issued under the Stock Option Plan, as amended, with respect to options Shares Underlying Options Weighted Average Exercise Price granted to employees may not exceed 2,115,937 shares, Balance outstanding and with respect to options granted to outside directors may not exceed 814,687 shares, for a total of 2,930,624 shares. Lapsed, forfeited or canceled options will not count December 31, 1999 .............................. Granted ............................................ Exercised ........................................... Forfeited ........................................... 1,902,821 28,800 (54,900) (36,900) against these limits and will be available for subsequent Balance outstanding grants. However, the cancellation of an option upon exer- cise of a related stock appreciation right will count against these limits. Options with respect to more than 168,750 December 31, 2000 .............................. Granted ............................................ Exercised ........................................... Forfeited ........................................... 1,839,821 348,600 (254,725) (5,700) shares of common stock may not be granted to any Balance outstanding employee in any calendar year. The shares distributed under the Stock Option Plan may be shares held in treasury or authorized but unissued shares. The Board of Directors has discretion to determine the vesting period of all grants December 31, 2001 .............................. Granted ............................................ Exercised ........................................... Forfeited ........................................... 1,927,996 275,000 (259,667) (4,860) Balance Outstanding $ 7.79 $10.05 $ 7.22 $ 9.71 $ 7.80 $15.01 $ 7.56 $13.40 $ 9.12 $18.70 $ 7.33 $13.23 to employees. All grants that have been awarded to December 31, 2002 .............................. 1,938,469 $10.71 employees vest 20% per year over a five-year period. Initial Shares available for future stock option grants to outside directors vest 20% per year over a five- awards at December 31, 2002 .............. 287,076 year period, while subsequent annual grants to outside The following table summarizes information about the Stock Option Plan at December 31, 2002: Exercise Prices Options Outstanding Options Exercisable Number Outstanding at 12/31/02 Weighted Average Remaining Contractual Life Number Exercisable at Weighted Average 12/31/02 Exercise Price $ 7.22 .................................................................................... $ 8.00–$11.00........................................................................ $11.01–$14.00........................................................................ $14.01–$17.00........................................................................ $17.01–$20.00........................................................................ 966,209 339,810 103,950 254,100 274,400 $ 7.22–$20.00........................................................................ 1,938,469 3.4 Years 6.1 Years 7.7 Years 8.5 Years 9.5 Years 5.6 Years 966,209 224,700 28,350 62,700 — 1,281,959 $ 7.22 $ 9.62 $11.83 $16.13 — $ 8.18 Flushing Financial Corporation and Subsidiaries 40(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 As permitted by SFAS No. 123, “Accounting for Stock- The components of the net pension expense are as fol- Based Compensation,” the Company has chosen to apply lows for the years ended December 31: APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations in accounting for its Stock Option Plan. Accordingly, no compensation cost has been recognized for options granted under the Stock Option Plan. Had compensation cost for the Company’s Stock Option Plan been determined based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, the Company’s net income and earnings Service cost ............................................. Interest cost ............................................ Amortization of past service liability ........ Amortization of unrecognized gain ......... Expected return on plan assets................ 2002 2001 2000 $ 452 695 (24) — (947) (In thousands) $ 396 683 (24) (116) (986) $ 350 621 (25) (48) (823) Net pension expense (benefit) ............. $ 176 $ (47) $ 75 per share would have been as indicated in the table below. The following table sets forth, for the Retirement Plan, However, the present impact of SFAS No. 123 may not be the change in benefit obligation and assets, and for the representative of the effect on income in future years Company, the amounts recognized in the Consolidated because the options vest over several years and additional Statements of Financial Condition at December 31: option grants may be made each year. 2002 2001 2000 (Dollars in thousands, except per share data) Net income: As reported .............................. Pro forma ................................. $16,263 $15,751 $14,929 $14,219 $12,422 $11,655 Diluted earnings per share: As reported .............................. Pro forma ................................. $ 1.34 $ 1.30 $ 1.17 $ 1.11 $ 0.97 $ 0.91 2002 2001 2000 (In thousands) Change in benefit obligation: Benefit obligation at beginning of year................ Service cost ............................. Interest cost ............................ Actuarial loss........................... Benefits paid ........................... Plan amendments.................... $ 9,927 452 695 738 (495) 12 $ 8,671 396 683 594 (417) — $ 7,998 350 621 94 (392) — The fair value of each option grant is estimated on the Benefit obligation at date of grant using the Black-Scholes option-pricing model. end of year ..................... 11,329 9,927 8,671 The weighted average assumptions used for grants made in Change in plan assets: 2002, 2001 and 2000 are as follows: 2002 Grants 2001 Grants 2000 Grants Dividend yield................................ Expected volatility.......................... Risk-free interest rate..................... Expected option life....................... Pension Plans: 1.93% 2.65% 2.13% 29.33% 27.49% 24.37% 6.08% 5.27% 7 Years 7 Years 4.76% 7 Years The Bank has a defined benefit pension plan covering substantially all of its employees (the “Retirement Plan”). The benefits are based on years of service and the employee’s compensation during the three consecutive years out of the final ten years of service that produces the highest average. The Bank’s funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to Market value of assets at beginning of year................ Actual return on plan assets.... Employer contributions............ Benefits paid ........................... Market value of plan assets at end of year ................. Funded status.............................. Unrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions ........................ Prior service cost not yet recognized in periodic pension cost............................ Prepaid (accrued) pension cost included in other assets/ liabilities .................................. 9,215 (1,136) 2,528 (495) 11,155 (1,523) — (417) 9,871 1,676 — (392) 10,112 9,215 11,155 (1,217) (712) 2,484 3,638 805 (2,414) (37) (62) (86) $ 2,384 $ 31 $ (16) provide not only for the benefits attributed to service to Assumptions used to develop periodic pension amounts date but also for those expected to be earned in the future. were: The Bank’s Retirement Plan invests in diversified equity and fixed-income funds, which are independently managed by a third party. Weighted average discount rate.......... Rate of increase in future 2002 2001 2000 6.50% 7.25% 8.00% compensation levels ........................ 4.00% 4.50% 5.50% Expected long-term rate of return on assets .............................. 8.50% 9.00% 9.00% Flushing Financial Corporation and Subsidiaries 41(cid:2) The Bank has an Outside Director Retirement Plan (the The following table sets forth, for the Directors’ Plan, “Directors’ Plan”), which provides benefits to each outside the change in benefit obligation and assets, and for the director who has at least five years of service as an outside Company, the amounts recognized in the Consolidated director (including service as a director or trustee of the Statements of Financial Condition at December 31: Bank or any predecessor) and whose years of service as an outside director plus age equal or exceed 55. Benefits are also payable to an outside director whose status as an out- side director terminates because of death or disability or who is an outside director upon a change of control (as defined in the Directors’ Plan). An eligible director will be paid an annual retirement benefit equal to the last annual retainer paid, plus fees paid to such director for attendance at Board meetings during the twelve-month period prior to retirement. Such benefit will be paid in equal monthly installments for the lesser of the number of months such director served as an outside director or 120 months. In the event of a termination of Board service due to a change of control, an outside director who has completed at least two years of service as an outside director will receive a cash lump sum payment equal to 120 months of benefit, and an outside director with less than two years service will receive a cash lump sum payment equal to a number of months of benefit equal to the number of months of his service as an outside director. In the event of the director’s death, the surviving spouse will receive the equivalent benefit. No benefits will be payable to a director who is removed for cause. The Holding Company has guaranteed the payment of benefits under the Directors’ Plan. Upon adopting the Directors’ Plan, the Bank elected to imme- 2002 2001 2000 (In thousands) Change in benefit obligation: Benefit obligation at beginning of year ................... Service cost ................................ Interest cost................................ Actuarial (gain) loss .................... Benefits paid .............................. Plan amendments....................... $ 2,508 38 32 — (60) — $ 2,043 27 11 465 (38) — $ 1,913 20 8 (24) (22) 148 Benefit obligation at end of year......................... 2,518 2,508 2,043 Change in plan assets: Market value of assets at beginning of year ................... Employer contributions............... Benefits paid .............................. — 60 (60) — 38 (38) — 22 (22) Market value of assets at end of year......................... — — — Funded status................................. Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions ........................... Prior service cost not yet recognized in periodic pension cost ............................... Adjustment required to (2,518) (2,508) (2,043) 475 489 15 663 782 901 recognize minimum liability ........ (1,123) — — diately recognize the effect of adopting the Directors’ Accrued pension cost included Plan. Subsequent plan amendments are amortized as a past in other liabilities ........................ $(2,503) $(1,237) $(1,127) service liability. The components of the net pension expense for the Directors’ Plan are as follows for the years ended December 31: Service cost ................................................. Interest cost ................................................ Amortization of unrecognized loss .............. Amortization of past service liability ............ 2002 2001 2000 (In thousands) $ 27 11 — 119 $ 38 32 14 119 $ 20 8 — 109 Net pension expense ................................... $203 $157 $137 For the years ended December 31, 2002, 2001 and 2000, the weighted average discount rate used in deter- mining the actuarial present value of the projected benefit obligation was 6.50%, 7.25% and 8.00%, respectively. The level of future retainers and meeting fees was projected to remain constant. Flushing Financial Corporation and Subsidiaries 42(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 (cid:2) 11. POSTRETIREMENT BENEFITS Assumptions used in determining the actuarial present OTHER THAN PENSION value of the accumulated postretirement benefit obligations The Company sponsors two postretirement benefit plans at December 31 are as follows: that cover all retirees who were full-time permanent employees with at least five years of service and their spouses. One plan provides medical benefits through a 50% cost sharing arrangement. Effective January 1, 2000, the spouses of future retirees will be required to pay 100% of the premiums for their coverage. The other plan pro- vides life insurance benefits and is noncontributory. Under these programs, eligible retirees receive lifetime medical and life insurance coverage for themselves and lifetime medical coverage for their spouses. The Company reserves the right to amend or terminate these plans at its discretion. Comprehensive medical plan benefits equal the lesser of the normal plan benefit or the total amount not paid by Medicare. Life insurance benefits for retirees are based on annual compensation and age at retirement. As of December 31, 2002, the Bank has not funded these plans. The following table sets forth, for the postretirement Rate of return on plan assets .............. Discount rate ...................................... Rate of increase in health care costs: Initial............................................... Ultimate (year 2008) ....................... Annual rate of salary increases ............ 2002 2001 2000 NA NA 6.50% 7.25% 8.00% NA 9.00% 9.00% 6.50% 4.50% 4.50% 5.00% 4.50% 5.50% 5.00% The health care cost trend rate assumptions have a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumu- lated postretirement benefit obligation as of December 31, 2002 by $327,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for the year then ended by $26,000. The resulting net periodic postretirement benefit expense consisted of the following components for the years ended plans, the change in benefit obligation and assets, and for the Company, the amounts recognized in the Consolidated December 31: Statements of Financial Condition at December 31: Change in benefit obligation: Benefit obligation at 2002 2001 2000 (In thousands) Service cost ............................................. Interest cost ............................................ Amortization of unrecognized loss .......... Amortization of past service liability ........ 2002 2001 2000 $ 98 153 — (130) (In thousands) $ 79 174 — (131) $ 82 171 4 (124) beginning of year ................... Service cost ................................ Actuarial (gain) loss .................... Plan amendments....................... Interest cost................................ Benefits paid .............................. $2,164 98 1,131 — 153 (123) $ 2,227 79 (222) — 174 (94) $ 2,407 82 (69) (265) 171 (99) Benefit obligation at end of year......................... 3,423 2,164 2,227 Change in plan assets: Market value of assets at beginning of year ................... Employer contributions............... Benefits paid .............................. — 123 (123) — 94 (94) — 99 (99) Market value of assets at end of year......................... — — — Net postretirement benefit expense..... $ 121 $ 122 $ 133 (cid:2) 12. STOCKHOLDERS’ EQUITY Dividend Restrictions: In connection with the Bank’s conversion from mutual to stock form in November 1995, a special liquidation account was established at the time of conversion, in accordance with the requirements of the Office of Thrift Supervision (“OTS”), which was equal to its capital as of June 30, 1995. The liquidation account is reduced as and to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases in deposits do not Funded status................................. Unrecognized net (gain) loss from past experience different from that assumed and effects of changes in assumptions.............. Prior service cost not yet (3,423) (2,164) (2,227) restore an eligible account holder’s interest in the liqui- 1,118 (13) 208 receive a distribution from the liquidation account in an dation account. In the event of a complete liquidation of the Bank, each eligible account holder will be entitled to recognized in periodic expense... (397) (527) (658) Accrued postretirement cost included in other liabilities .......... $(2,702) $(2,704) $(2,677) amount proportionate to the current adjusted qualifying balances for accounts then held. As of December 31, 2002, the Bank’s liquidation account was $6.2 million and was presented within retained earnings. Flushing Financial Corporation and Subsidiaries 43(cid:2) In addition to the restriction described above, Federal dividend. This dividend was not paid on shares held in banking regulations place certain restrictions on dividends treasury. Shares issued and outstanding for prior years paid by the Bank to the Holding Company. The total amount have been restated to reflect this three-for-two stock split. of dividends which may be paid at any date is generally Treasury share amounts have not been restated for prior limited to the net income of the Bank for the current year years as the stock dividend was not paid on these shares. and prior two years, less any dividends previously paid from those earnings. As of December 31, 2002, the Bank had $19.6 million in retained earnings available to distrib- ute to the Holding Company in the form of cash dividends. In addition, dividends paid by the Bank to the Holding Company would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. Stock Split: Treasury Stock Transactions: During 2002, the Holding Company repurchased 1,202,450 shares of its outstanding common stock on the open market under its stock repurchase programs. During 2001, 2,120,885 shares of Treasury Stock were used to pay the stock dividend discussed above. At December 31, 2002, the Company had 1,253,720 shares of Treasury Stock which, among other things, could be used to award grants under the Company’s Restricted Stock Plan and to satisfy The Company declared a three-for-two stock split which obligations under the Stock Option Plan. Treasury stock is was distributed on August 30, 2001 in the form of a stock being accounted for using the average cost method. (cid:2) 13. REGULATORY CAPITAL The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) imposes a number of mandatory super- visory measures on banks and thrift institutions. Among other matters, FDICIA established five capital zones or classifications (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Such classifications are used by the OTS and other bank regulatory agencies to determine matters rang- ing from each institution’s semi-annual FDIC deposit insurance premium assessments, to approvals of applications author- izing institutions to grow their asset size or otherwise expand business activities. Under OTS capital regulations, the Bank is required to comply with each of three separate capital adequacy standards. As of December 31, 2002, the Bank continues to be categorized as “well-capitalized” by the OTS under the prompt corrective action regulations and continues to exceed all regulatory capital requirements. Set forth below is a summary of the Bank’s compliance with OTS capital standards. December 31, 2002 December 31, 2001 Amount Percent of Assets Amount Percent of Assets (Dollars in thousands) Tangible capital: Capital level.....................................................................................................................$125,656 Requirement .................................................................................................................... 24,344 Excess..............................................................................................................................$101,312 Core (Tier I) capital: Capital level.....................................................................................................................$125,656 Requirement .................................................................................................................... 48,687 Excess..............................................................................................................................$ 76,969 Total risk-based capital: 7.74% 1.50% 6.24% 7.74% 3.00% 4.74% Capital level.....................................................................................................................$132,237 74,151 Requirement .................................................................................................................... Excess..............................................................................................................................$ 58,086 14.27% 8.00% 6.27% $107,811 22,081 $ 85,730 $107,811 44,162 $ 63,649 $114,396 67,395 $ 47,001 7.32% 1.50% 5.82% 7.32% 3.00% 4.32% 13.58% 8.00% 5.58% (cid:2) 14. COMMITMENTS AND CONTINGENCIES meet the financing needs of its customers. These financial Commitments: The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to instruments include commitments to extend credit and lines of credit. The instruments involve, to varying degrees, elements of credit and market risks in excess of the amount recognized in the consolidated financial statements. Flushing Financial Corporation and Subsidiaries 44(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 The Company’s exposure to credit loss in the event of The leases have escalation clauses for operating expenses nonperformance by the counterparty to the financial instru- and real estate taxes. Certain lease agreements provide for ment for loan commitments and lines of credit is repre- increases in rental payments based upon increases in the sented by the contractual amounts of these instruments. consumer price index. Rent expense under these leases Commitments to extend credit (principally real estate for the years ended December 31, 2002, 2001 and 2000 mortgages) and lines of credit (principally construction loan was approximately $936,000, $715,000 and $643,000, and home equity loan lines of credit) amounted to approx- respectively. imately $53,043,000 and $17,667,000, respectively, at December 31, 2002. Since generally all of the loan commit- ments are expected to be drawn upon, the total loan com- mitments approximate future cash requirements, whereas the amounts of lines of credit may not be indicative of the Company’s future cash requirements. The loan commit- ments generally expire in ninety days, while construction loan lines of credit mature within eighteen months and home equity lines of credit mature within ten years. The Company uses the same credit policies in making commit- ments and conditional obligations as it does for on-balance- sheet instruments. As of December 31, 2002, commitments to extend credit for fixed-rate real estate mortgages amounted to $16.1 mil- lion, with an average interest rate of 7.17%. Commitments to extend credit are legally binding agree- ments to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and require payment of a fee. The Company evaluates each customer’s credit- worthiness on a case-by-case basis. Collateral held consists primarily of real estate. FFCTI issued $20.0 million of floating rate capital secu- rities in July 2002. The Holding Company has guaranteed the payment of FFCTI’s obligations under these capital securities. The Company’s minimum annual rental payments for Bank premises due under non-cancelable leases are as follows: Contingencies: The Company is a defendant in various lawsuits. Man- agement of the Company, after consultation with outside legal counsels, believes that the resolution of these various matters will not result in any material adverse effect on the Company’s consolidated financial condition, results of oper- ations or cash flows. (cid:2) 15. CONCENTRATION OF CREDIT RISK The Company’s lending is concentrated in one-to-four family residential real estate, multi-family residential real estate and commercial real estate loans to borrowers in the metropolitan New York area. The Company evaluates each customer’s creditworthiness on a case-by-case basis under the Company’s established underwriting policies. The col- lateral obtained by the Company generally consists of first liens on one-to-four family and multi-family residential real estate and commercial income producing real estate. (cid:2) 16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, “Disclosures About Fair Value of Finan- cial Instruments,” requires that the Company disclose the estimated fair values for certain of its financial instru- ments. Financial instruments include items such as loans, deposits, securities, commitments to lend and other items as defined in SFAS No. 107. Fair value estimates are supposed to represent esti- mates of the amounts at which a financial instrument could Minimum Rental be exchanged between willing parties in a current trans- (In thousands) action other than in a forced liquidation. However, in many Years ending December 31: 2003 .................................................................... 2004 .................................................................... 2005 .................................................................... 2006 .................................................................... 2007 .................................................................... Thereafter............................................................. Total minimum payments required .................... $ 971 998 968 887 273 745 $4,842 instances current exchange prices are not available for many of the Company’s financial instruments, since no active market generally exists for a significant portion of the Bank’s financial instruments. Accordingly, the Company uses other valuation techniques to estimate fair values of its financial instruments such as discounted cash flow method- ologies and other methods allowable under SFAS No. 107. Flushing Financial Corporation and Subsidiaries 45(cid:2) Fair value estimates are subjective in nature and are Securities available for sale: dependent on a number of significant assumptions based The estimated fair values of securities available for sale on management’s judgment regarding future expected loss are contained in Note 6 of Notes to Consolidated Financial experience, current economic condition, risk characteris- Statements. Fair value is based upon quoted market prices, tics of various financial instruments, and other factors. In where available. If a quoted market price is not available, addition, SFAS No. 107 allows a wide range of valuation fair value is estimated using quoted market prices for simi- techniques; therefore, it may be difficult to compare the lar securities and adjusted for differences between the Company’s fair value information to independent markets quoted instrument and the instrument being valued. or to other financial institutions’ fair value information. The Company generally holds its earning assets, other than securities available for sale, to maturity and settles its liabilities at maturity. However, fair value estimates are made at a specific point in time and are based on relevant market information. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Accordingly, as assumptions change, such as interest rates and prepayments, fair value estimates change and these amounts may not necessarily be realized in an immediate sale. SFAS No. 107 does not require disclosure about fair value information for items that do not meet the definition of a financial instrument or certain other financial instru- Loans: The estimated fair value of loans, with carrying amounts of $1,169,560,000 and $1,067,197,000 at Decem- ber 31, 2002 and 2001, respectively, was $1,207,408,000 and $1,092,221,000 at December 31, 2002 and 2001, respectively. Fair value is estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit rat- ings and remaining maturities. For non-accruing loans, fair value is generally estimated by discounting management’s estimate of future cash flows with a discount rate commensurate with the risk associated with such assets. ments specifically excluded from its requirements. These Due to depositors: items include core deposit intangibles and other customer The estimated fair value of due to depositors, with relationships, premises and equipment, leases, income carrying amounts of $1,002,013,000 and $818,517,000 taxes, foreclosed properties and equity. at December 31, 2002 and 2001, respectively, was Further, SFAS No. 107 does not attempt to value future $1,018,495,000 and $831,808,000 at December 31, 2002 income or business. These items may be material and and 2001, respectively. accordingly, the fair value information presented does not The fair values of demand, passbook savings, NOW and purport to represent, nor should it be construed to repre- money market deposits are, by definition, equal to the sent, the underlying “market” or franchise value of the amount payable on demand at the reporting dates Company. (i.e., their carrying value). The fair value of fixed-maturity The estimated fair value of each material class of finan- certificates of deposits are estimated by discounting the cial instruments at December 31, 2002 and 2001 and the expected future cash flows using the rates currently offered related methods and assumptions used to estimate fair for deposits of similar remaining maturities. value are as follows: Borrowed funds: Cash and due from banks, overnight interest-earning The estimated fair value of borrowed funds, with carry- deposits and federal funds sold, FHLB-NY stock, interest ing amounts of $493,164,000 and $513,435,000 at Decem- and dividends receivable, mortgagors’ escrow deposits ber 31, 2002 and 2001, respectively, was $524,480,000 and other liabilities: and $527,398,000 at December 31, 2002 and 2001, The carrying amounts are a reasonable estimate of fair respectively. value. The fair value of borrowed funds is estimated by dis- counting the contractual cash flows using interest rates in effect for borrowings with similar maturities and collateral requirements. Flushing Financial Corporation and Subsidiaries 46(cid:2) (cid:2) N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (continued) For the years ended December 31, 2002, 2001 and 2000 Other financial instruments: 2001. The Statement changes the approach to how goodwill The fair values of commitments to sell, lend or borrow and other intangible assets are accounted for subsequent to are estimated using the fees currently charged or paid to their recognition. Goodwill and intangible assets that have enter into similar agreements, taking into account the indefinite useful lives will not be amortized but rather will remaining terms of the agreements and the present credit- be tested at least annually for impairment. Intangible worthiness of the counterparties or on the estimated cost to assets that have finite useful lives will be amortized over terminate them or otherwise settle with the counterparties their useful lives. The Statement provides specific guidance at the reporting date. For fixed-rate loan commitments to on testing intangible assets that will not be amortized for sell, lend or borrow, fair values also consider the difference impairment. As of December 31, 2001, the Company had between current levels of interest rates and committed goodwill with a remaining balance of $3.9 million recorded rates (where applicable). in connection with its purchase of New York Federal At December 31, 2002 and 2001, the fair values of the Savings Bank in 1997. Amortization expense for each of the above financial instruments approximate the recorded years in the three-year period ended December 31, 2001 amounts of the related fees and were not considered to was $0.4 million. Effective January 1, 2002, the Company is be material. no longer recording this amortization expense, but rather is required, at least annually, to test the remaining goodwill (cid:2) 17. RECENT ACCOUNTING PRONOUNCEMENTS for impairment. The impairment test performed in connec- In June 2001, The Financial Accounting Standards tion with the adoption of this Statement in January 2002, Board issued Statement of Financial Accounting Standards and the subsequent annual impairment test performed in No. 142, “Goodwill and Other Intangible Assets,” which is January 2003, did not require an adjustment to the carry- effective for fiscal years beginning after December 15, ing value of the goodwill. (cid:2) 18. QUARTERLY FINANCIAL DATA (UNAUDITED) Selected unaudited quarterly financial data for the fiscal years ended December 31, 2002 and 2001 is presented below: 2002 2001 4th 3rd 2nd 1st 4th 3rd 2nd 1st (In thousands, except per share data) Quarterly operating data: Interest income ................................................ Interest expense ............................................... $27,260 13,636 $26,855 13,732 $26,678 13,494 $26,113 13,702 $26,038 14,501 $25,583 15,042 $25,227 15,079 $25,051 15,080 Net interest income...................................... Provision for loan losses ................................... Other operating income ................................... Other expense.................................................. Income before income tax expense .............. Income tax expense.......................................... 13,624 — 1,543 7,234 7,933 3,014 13,123 — 1,476 6,913 7,686 2,921 13,184 — (2,896) 6,973 3,315 1,274 12,411 — 1,386 6,501 7,296 2,758 11,537 — 1,417 6,567 6,387 2,427 10,541 — 1,300 5,939 5,902 2,184 10,148 — 1,618 5,984 5,782 2,140 9,971 — 1,723 5,967 5,727 2,118 Net income .................................................. $ 4,919 $ 4,765 $ 2,041 $ 4,538 $ 3,960 $ 3,718 $ 3,642 $ 3,609 Basic earnings per share ................................... Diluted earnings per share ............................... Dividends per share.......................................... Average common shares outstanding for: $ 0.44 $ 0.42 $ 0.090 $ 0.41 $ 0.39 $ 0.090 $ 0.17 $ 0.17 $ 0.090 $ 0.38 $ 0.36 $ 0.090 $ 0.33 $ 0.31 $ 0.080 $ 0.30 $ 0.29 $ 0.080 $ 0.30 $ 0.28 $ 0.073 $ 0.29 $ 0.28 $ 0.073 Basic earnings per share ............................... Diluted earnings per share ........................... 11,258 11,741 11,491 12,070 11,689 12,308 11,970 12,541 12,107 12,700 12,316 12,882 12,284 12,832 12,364 12,800 Flushing Financial Corporation and Subsidiaries 47(cid:2) (cid:2) 19. PARENT COMPANY ONLY FINANCIAL INFORMATION Earnings of the Bank are recognized by the Holding Company using the equity method of accounting. Accord- ingly, earnings of the Bank are recorded as increases in the Holding Company’s investment, any dividends would reduce the Holding Company’s investment in the Bank, and any changes in the Bank’s unrealized gain or loss on securities available for sale, net of taxes, would increase or decrease, respectively, the Holding Company’s investment in the Bank. The condensed financial statements for the Holding Condensed Statements of Income Dividends from the Bank ........................... Interest income.......................................... Interest expense......................................... Non-interest income .................................. Other operating expenses.......................... Income before taxes and equity in undistributed earnings of subsidiary ... Income tax benefit..................................... Income before equity in undistributed 2002 2001 (In thousands) $ — $ 15,000 438 — — (609) 333 (540) — (722) (929) 457 14,829 127 earnings of subsidiary ........................ (472) 14,956 Company at and for the years ended December 31, 2002 Excess of dividends over current and 2001 are presented below: 2002 2001 (In thousands) year earnings......................................... — Equity in undistributed earnings of the Bank ........................................... 16,735 (27) — Net income.................................... $ 16,263 $ 14,929 Condensed Statements of Financial Condition Assets: Cash and due from banks ..................... Federal funds sold and overnight $ 9,976 $ 12,679 interest-earning deposit ..................... — 924 Securities available for sale: Mortgage-backed securities ............... Other securities.................................. Interest receivable.................................. Investment in subsidiaries ...................... Other assets........................................... — 6,153 30 134,598 1,821 — 6,263 17 113,232 600 Total assets .................................... $152,578 $133,715 Liabilities: Other liabilities....................................... Borrowings ............................................ $ 573 20,619 $ Total liabilities ............................................ 21,192 Stockholders’ equity: Common stock ...................................... Additional paid-in capital....................... Treasury stock ........................................ Unearned compensation........................ Retained earnings.................................. Accumulated other comprehensive 139 47,208 (21,733) (7,825) 109,208 328 — 328 139 45,280 (5,750) (7,766) 99,641 income, net of taxes .......................... 4,389 1,843 Total equity.................................... 131,386 133,387 Total liabilities and equity............... $152,578 $133,715 2002 2001 (In thousands) Condensed Statements of Cash Flow Operating activities: Net income............................................ Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings $ 16,263 $ 14,929 of the Bank ............................... (16,735) Net decrease in operating assets and liabilities.............................. (898) 27 (91) Amortization of unearned premium, net of accretion of unearned discount ................ Unearned compensation, net......... Net cash provided by 1 1,615 8 1,577 operating activities............. 246 16,450 Investing activities: Purchases of securities available for sale .............................................. (112) (709) Proceeds from sales and calls of securities available for sale................. Investment in subsidiary......................... Net cash (used) provided 30 (619) 1,460 — by investing activities ......... (701) 751 Financing activities: Purchase of treasury stock ..................... Cash dividends paid............................... Proceeds from long-term borrowings..... (19,553) (4,238) 20,619 (9,289) (3,824) — Net cash used in financing activities ............. (3,172) (13,113) Net increase (decrease) in cash and cash equivalents .................................... (3,627) 4,088 Cash and cash equivalents, beginning of year................................................... 13,603 9,515 Cash and cash equivalents, end of year ..... $ 9,976 $ 13,603 Flushing Financial Corporation and Subsidiaries 48(cid:2) (cid:2) R E P O R T O F I N D E P E N D E N T A C C O U N T A N T S To the Board of Directors and Stockholders of Flushing Financial Corporation: In our opinion, the accompanying consolidated state- require that we plan and perform the audit to obtain rea- ments of financial condition and the related consolidated sonable assurance about whether the financial statements statements of income, changes in stockholders’ equity, and are free of material misstatement. An audit includes exam- cash flows present fairly, in all material respects, the finan- ining, on a test basis, evidence supporting the amounts and cial position of Flushing Financial Corporation and its sub- disclosures in the financial statements, assessing the sidiaries at December 31, 2002 and 2001, and the results accounting principles used and significant estimates made of their operations and their cash flows for each of the by management, and evaluating the overall financial state- three years in the period ended December 31, 2002, in con- ment presentation. We believe that our audits provide a formity with accounting principles generally accepted in reasonable basis for our opinion. the United States of America. 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 of these statements in accordance with auditing standards New York, New York generally accepted in the United States of America, which January 29, 2003 Flushing Financial Corporation and Subsidiaries (cid:3) C O R P O R A T E I N F O R M A T I O N EXECUTIVE MANAGEMENT Gerard P. Tully, Sr. Chairman of the Board Michael J. Hegarty President & Chief Executive Officer John R. Buran Executive Vice President & Chief Operating Officer Monica C. Passick Senior Vice President, Treasurer & Chief Financial Officer Henry A. Braun Senior Vice President Robert L. Callicutt Senior Vice President Francis W. Korzekwinski Senior Vice President Anna M. Piacentini Senior Vice President & Corporate Secretary BOARD OF DIRECTORS Gerard P. Tully, Sr. Chairman Real estate development and management Michael J. Hegarty President & Chief Executive Officer James D. Bennett Attorney in Nassau County, New York Louis C. Grassi Managing Partner of Grassi & Co., CPAs, P.C. Robert A. Marani Commercial real estate development and management John O. Mead Retired fabric manufacturer and marketer Vincent F. Nicolosi Attorney in Bayside, New York Franklin F. Regan, Jr. Attorney in Flushing, New York John E. Roe, Sr. Chairman of City Underwriting Agency, Inc. Insurance Brokers Michael J. Russo Consulting Engineer, President and Director of Operations for Northeastern Aviation Corp. CORPORATE HEADQUARTERS Flushing Savings Bank, FSB 144-51 Northern Boulevard Flushing, New York 11354 718-961-5400 facsimile 718-539-1025 www.flushingsavings.com RETAIL BRANCH LOCATIONS Flushing 144-51 Northern Boulevard 159-18 Northern Boulevard 188-08 Hollis Court Boulevard 44-43 Kissena Boulevard Bayside 61-54 Springfield Boulevard New Hyde Park 661 Hillside Avenue In-Store Branch (Stop & Shop Supermarket) 653 Hillside Avenue Bay Ridge 7102 Third Avenue Manhattan 33 Irving Place Bronx In-Store Branch (Stop & Shop Supermarket) 753 Co-Op City Boulevard MORTGAGE ORIGINATIONS Flushing Savings Bank, FSB and New York Federal Division 144-51 Northern Boulevard 718-961-5400 SMALL BUSINESS LENDING 33 Irving Place 212-477-9424 Flushing Financial Corporation and Subsidiaries (cid:3) S H A R E H O L D E R I N F O R M A T I O N ANNUAL MEETING TRANSFER AGENT AND REGISTRAR LEGAL COUNSEL The Annual Meeting of Shareholders of Flushing Financial Corporation will be held at 2:00 PM, May 20, 2003, at the La Guardia Marriott located at 102-05 Ditmars Boulevard, East Elmhurst, New York 11369 STOCK LISTING Nasdaq National Market(cid:2) Symbol “FFIC” EquiServe Trust Company NA P. O. Box 43011 Providence, Rhode Island 02940-3011 1-800-426-5523 Hughes Hubbard & Reed LLP One Battery Park Plaza New York, New York 10004 212-837-6000 INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York 10036 646-471-4000 SHAREHOLDER RELATIONS Van Negris and Company, Inc. 766 Madison Avenue New York, New York 10021 212-396-0606 Designed by Curran & Connors, Inc. / www.curran-connors.com F l u s h i n g F i n a n c i a l C o r p o r a t i o n 1 4 4 - 5 1 N O R T H E R N B LV D . F L U S H I N G , N E W Y O R K 1 1 3 5 4