10-Q 1 c29843_10q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended ............................. SEPTEMBER 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to ___________ Commission File No.: 000-23809 FIRST SENTINEL BANCORP, INC. (exact name of registrant as specified in its charter) DELAWARE 22-3566151 (State or other jurisdiction of (IRS Employer I.D. No.) incorporation or organization) 1000 WOODBRIDGE CENTER DRIVE, WOODBRIDGE, NJ 07095 (Address of principal executive offices) Registrant's telephone number, including area code: (732) 726-9700 NOT APPLICABLE Former Name, Address, and Fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . ------- --------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No . ------- --------- APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT NOVEMBER 1, 2003 ---------------------------------- --------------------------------------- Common Stock 27,651,463 shares FIRST SENTINEL BANCORP, INC. INDEX TO FORM 10-Q

See accompanying notes to the unaudited consolidated financial statements. 3

See accompanying notes to the unaudited consolidated financial statements. 4 FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands) (Unaudited)

See accompanying notes to the unaudited consolidated financial statements. 5 FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited)

See accompanying notes to the unaudited consolidated financial statements. 6 FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (1) BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X for First Sentinel Bancorp, Inc. ("First Sentinel" or the "Company") and its wholly-owned subsidiaries, First Savings Bank, ("First Savings" or the "Bank") Pulse Investment, Inc., Pulse Insurance Services, Inc. and Pulse Real Estate, Inc., and the Bank's wholly-owned subsidiaries, FSB Financial LLC, and 1000 Woodbridge Center Drive, Inc. Certain disclosures have been omitted or condensed pursuant to such rules. These interim financial statements should be read in conjunction with the December 31, 2002 Annual Report to Stockholders. In the opinion of management, all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial condition, results of operations, and changes in cash flows have been made at and for the three and nine months ended September 30, 2003 and 2002. The results of operations for the three and nine months ended September 30, 2003, are not necessarily indicative of results that may be expected for the entire fiscal year ending December 31, 2003. STOCK-BASED COMPENSATION The Company applies the "intrinsic value based method" as described in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock-based compensation. No employee compensation cost for stock options is reflected in net income, as all options granted under the Company's stock option plans had exercise prices greater than or equal to the market value of the underlying common stock on the date of grant. Stock awarded to employees under the Company's Recognition and Retention Plan is expensed by the Company over the awards' vesting period based upon the fair market value of the stock on the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions for stock-based compensation pursuant to Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation," amended by SFAS No. 148, "Accounting for Stock-based Compensation - Transition and Disclosures" (in thousands, except per share data):

7 EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income by the daily average number of common shares outstanding during the period. Potential dilutive common shares are not included in the calculation. Diluted earnings per share is computed similarly to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potential dilutive common shares were issued utilizing the treasury stock method. Calculation of Basic and Diluted Earnings Per Share -------------------------------------------------------- (dollars in thousands, except per share data)

(2) DIVIDENDS Based upon current operating results, the Company declared a cash dividend of $0.105 per share on July 23, 2003, payable August 29, 2003, to stockholders of record on August 15, 2003. (3) COMMITMENTS AND CONTINGENCIES At September 30, 2003, the Company had the following commitments: (i) to originate loans of $150.1 million; (ii) unused home equity lines of credit of $74.2 million; (iii) unused commercial lines of credit of $14.7 million; (iv) unused construction lines of credit of $87.1 million; and (v) letters of credit outstanding totaling $1.5 million. Further, certificates of deposits which are scheduled to mature and/or rollover in one year or less, totaled $409.1 million at September 30, 2003. (4) ALLOWANCE FOR LOAN LOSSES The following table presents the activity in the allowance for loan losses (in thousands):

8 (5) COMPREHENSIVE INCOME Total comprehensive income, consisting of net income and the net change in unrealized gain/(loss) on securities available for sale, was $2.0 million and $8.3 million for the three months ended September 30, 2003 and 2002, respectively. For the nine months ended September 30, 2003 and 2002, comprehensive income totaled $14.2 million and $26.7 million, respectively. (6) RECENT ACCOUNTING PRONOUNCEMENTS Financial Accounting Standards Board ("FASB") Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities," was issued in January 2003. FIN 46 applies immediately to enterprises that hold a variable interest in variable interest entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after June 15, 2003 to enterprises that hold a variable interest in variable interest entities created before February 1, 2003. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period, and it applies to nonpublic enterprises no later than the end of the applicable annual period. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46 provides guidance on the identification of entities controlled through means other than voting rights. FIN 46 specifies how a business enterprise should evaluate its interest in a variable interest entity to determine whether to consolidate that entity. A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved. On October 9, 2003, the effective date was deferred until the end of the first interim or annual period ending after December 15, 2003, for certain interests held by a public entity in certain variable interest entities or potential variable interest entities created before February 1, 2003. The adoption of FIN 46 is not expected to have a significant effect on the Company's consolidated financial statements. In May 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 established standards for how entities classify and measure certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150 were effective for financial instruments entered into or modified after May 31, 2003, and otherwise were effective at the beginning of the first interim period beginning after June 15, 2003. In the Company's earnings release issued October 22, 2003, the "Preferred capital securities" were reported as a liability in the Company's consolidated statements of financial condition, and the distributions on these trust preferred securities on and after July 1, 2003, were included as interest expense in accordance with the provisions of SFAS No. 150 in effect at that date. Subsequent to the earnings release, but prior to the filing of these financial statements, the FASB voted to defer indefinitely the provisions of SFAS No. 150 with respect to the financial reporting for trust preferred securities. Accordingly $464,000 of distributions on preferred capital securities for the three months ended September 30, 2003, which were classified as interest expense in the October 22, 2003, earnings release have been reported in these financial statements as non-interest expense. Also, these trust preferred securities are reported in the mezzanine (between liabilities and equity) in the accompanying consolidated statements of financial condition. This reporting is consistent with the Company's previous quarterly and annual financial reporting. SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," was issued on April 30, 2003. The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a significant effect on the Company's consolidated financial statements. 9 FIRST SENTINEL BANCORP, INC. AND SUBSIDIARIES Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL. Statements contained in this report that are not historical fact are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements may be characterized as management's intentions, hopes, beliefs, expectations, projections or predictions of the future. It is important to note that such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Factors that could cause future results to vary materially from current expectations include, but are not limited to, changes in interest rates, economic conditions, deposit and loan growth, real estate values, loan loss provisions, competition, customer retention, changes in accounting principles, policies or guidelines and legislative and regulatory changes. CRITICAL ACCOUNTING POLICIES AND ESTIMATES. "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as disclosures found elsewhere in this Form 10-Q, are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company's Audited Consolidated Financial Statements for the year ended December 31, 2002 included in our Annual Report on Form 10-K for the year ended December 31, 2002, as supplemented by the Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003, June 30, 2003, and this report, contains a summary of the Company's significant accounting policies. Management believes the Company's policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application is periodically reviewed with the Audit Committee and the Board of Directors. The provision for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectibility may not be assured, the existence and estimated fair value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company's loans are secured by real estate in the State of New Jersey. Accordingly, the collectibility of a substantial portion of the carrying value of the Company's loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the New Jersey area experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control. ASSETS. Total assets decreased $11.9 million from December 31, 2002, to $2.2 billion at September 30, 2003. The change in assets consisted primarily of decreases in federal funds sold and mortgage-backed securities ("MBS") available for sale, partially offset by increases in investment securities available for sale and loans held for sale. Federal funds sold decreased $10.9 million to $33.4 million at September 30, 2003, from $44.3 million at December 31, 2002, as balances were deployed into higher-yielding assets and used to reduce outstanding borrowings. MBS available for sale decreased $8.9 million to $781.7 million at September 30, 2003, from $790.6 million at December 31, 2002. For the nine months ended September 30, 2003, purchases of MBS available for sale totaled $466.4 million, while principal repayments totaled $335.5 million and sales totaled $126.1 million. During the nine 10 months ended September 30, 2003, the Company experienced high levels of principal repayments on MBS, reflecting the historically low interest rate environment and resultant strong mortgage loan refinance activity. Prepayment levels are expected to decline during the fourth quarter of 2003, as longer-term interest rates have risen and refinance activity has slowed. Investment securities available for sale increased $8.8 million, or 7.7%, to $123.0 million as of September 30, 2003, from $114.2 million at December 31, 2002. For the nine months ended September 30, 2003, purchases of investment securities available for sale totaled $67.7 million, while sales, calls and maturities totaled $59.3 million. Purchases consisted primarily of debt securities issued by U.S. corporations and government-sponsored agencies. At September 30, 2003, U.S. government and agency obligations totaled $78.2 million, or 63.6%, of investment securities available for sale, while state and municipal obligations accounted for another $13.7 million, or 11.1%. Corporate obligations represented $27.6 million, or 22.4%, and equity securities accounted for the remaining $3.5 million, or 2.9%, of investment securities available for sale at September 30, 2003. All corporate obligations held at September 30, 2003, are investment grade with the largest exposure to any single creditor totaling $3.0 million. Net loans, including loans held for sale, increased $1.2 million from December 31, 2002, to $1.2 billion at September 30, 2003. Of the total loan portfolio at September 30, 2003, 1-4 family mortgage loans comprised 65.0%, home equity loans represented 9.2%, commercial real estate, multi-family and construction loans comprised 24.8%, and other consumer loans accounted for 1.0%. Total loan originations for the nine months ended September 30, 2003, were $579.4 million, compared to $462.8 million for the same period in 2002. Fixed-rate, 1-4 family first mortgage loan originations totaled $209.7 million, or 36.2% of production, while adjustable-rate, 1-4 family first mortgage loans accounted for $108.4 million, or 18.7%, of total originations for the first nine months of 2003. Also during the first nine months of 2003, consumer loan originations, consisting primarily of home equity loans and credit lines, totaled $129.9 million, or 22.4% of total originations. During the same period, construction lending totaled $98.7 million, or 17.0% of total originations, while commercial real estate, commercial and multi-family loan originations totaled $32.9 million, or 5.7%. In addition, the Company purchased $21.3 million of primarily adjustable-rate, single-family first mortgage loans through correspondents during the nine months ended September 30, 2003. Purchased loans are re-underwritten by the Company and are extended at rates higher than those currently offered by the Company. Repayment of principal on loans totaled $553.2 million for the nine months ended September 30, 2003, compared to $472.7 million for the same period in 2002. In addition, the Company sold $47.0 million of primarily 30-year, fixed-rate, 1-4 family mortgage loans during the first nine months of 2003 as part of its on-going interest rate risk management process. While management intends to continue to actively seek to originate loans, the future levels of loan originations and repayments will be significantly influenced by external interest rates, competition and other economic factors outside of the control of the Company. At September 30, 2003, the loan pipeline, consisting of loan applications in the process of approval, totaled $150.1 million, including $46.7 million of accepted construction and non-residential loan commitments. LIABILITIES. Total deposits decreased $1.8 million from December 31, 2002, to $1.4 billion at September 30, 2003. Core deposits, consisting of checking, savings and money market accounts, grew by $46.1 million, or 5.9%, to $831.4 million, and accounted for 60.0% of total deposits at September 30, 2003. This compares with a core to total deposits ratio of 56.6% at December 31, 2002 and 55.1% at September 30, 2002. Certificates of deposit decreased by $47.9 million, or 7.9%, compared with year-end 2002, with decreases occurring primarily in one-year and shorter maturity categories. Borrowed funds decreased by $5.1 million, or 0.9%, to $591.5 million at September 30, 2003, from $596.7 million at December 31, 2002. CAPITAL. The Company's stockholders' equity decreased $3.9 million, or 1.8%, to $217.3 million at September 30, 2003, from $221.2 million at December 31, 2002. The decrease in equity was a result of the repurchase of $12.6 million of the Company's common stock, cash dividends declared of $8.3 million and a decrease in net unrealized gains on securities available for sale of $4.7 million, partially offset by net income of $19.0 million for the nine months ended September 30, 2003, the amortization of stock-based compensation and benefit plans and related tax benefits of $2.4 million, and proceeds from the exercise of stock options totaling $366,000. In February 2003, the Company authorized a 5% stock repurchase program. The Company repurchased 871,000 shares during the nine 11 months ended September 30, 2003, at an average cost per share of $14.26. There were no share repurchases in the quarter ended September 30, 2003. Stated and tangible book value per share at September 30, 2003, were $7.86 and $7.71, respectively. The Federal Deposit Insurance Corporation requires that the Bank meet minimum leverage, Tier 1 and Total Risk-based Capital requirements. At September 30, 2003, the Bank exceeded all regulatory capital requirements, as follows (dollars in thousands):

LIQUIDITY AND CAPITAL RESOURCES. The Company's primary sources of funds are deposits; proceeds from principal and interest payments on loans and mortgage-backed securities ("MBS"); sales of loans, MBS and investments available for sale; maturities or calls of investment securities and short-term investments; and advances from the FHLB-NY and other borrowed funds. While maturities and scheduled amortization of loans and MBS are a predictable source of funds, deposit cash flows and mortgage prepayments are greatly influenced by general interest rates, competition, and economic conditions. The most significant sources of funds for the first nine months of 2003 were principal repayments and prepayments of loans and MBS totaling $553.2 million and $335.5 million, respectively. Other significant sources of funds for the nine months ended September 30, 2003, were proceeds from sales of MBS available for sale totaling $127.4 million, sales, calls and maturities of investment securities available for sale of $59.7 million, proceeds from the sales of mortgage loans totaling $47.1 million and new borrowings of $55.0 million. If necessary, the Company has additional borrowing capacity with FHLB-NY, including an available overnight line of credit of up to $50.0 million. At September 30, 2003, the Company had unpledged investment securities and MBS available for sale with a market value of $410.3 million. The Company's primary uses of funds for the first nine months of 2003 were the origination of loans totaling $579.4 million, purchases of MBS available for sale totaling $466.4 million, purchases of investment securities available for sale totaling $67.7 million and repayments of borrowings totaling $60.1 million. Other significant uses of funds during the nine months ended September 30, 2003, were $21.3 million in purchases of mortgage loans, $12.6 million in repurchases of the Company's common stock and $8.3 million in cash dividends paid. COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002. RESULTS OF OPERATIONS. Net income for the three and nine months ended September 30, 2003, totaled $6.2 million and $19.0 million, respectively, versus net income of $7.5 million and $19.6 million, for the comparable 2002 periods. This represented decreases of $1.3 million, or 17.0% and $686,000, or 3.5%, respectively, for the three and nine months ended September 30, 2003, compared with 2002. For the quarter ended September 30, 2003, basic and diluted earnings per share were $0.23, representing decreases of 11.2% and 11.5% over third quarter 2002 basic and diluted earnings per share of $0.26. For the nine months ended September 30, 2003, basic and diluted earnings per share were $0.71 and $0.69, respectively, representing increases of 4.7% and 4.6% over basic and diluted earnings per share of $0.68 and $0.66, respectively, for the first nine months of 2002. Annualized return on average equity was 11.54% and 11.66% for the three and nine months ended September 30, 2003, respectively, compared with 13.01% and 11.34% for the comparable 2002 periods. Annualized return on average assets was 1.11% and 1.12% for the three and nine months ended September 30, 2003, respectively, compared with 1.33% and 1.18% for the three and nine months ended September 30, 2002, respectively. 12 CONSOLIDATED AVERAGE STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands)

(1) Includes FHLB-NY stock. 13 CONSOLIDATED AVERAGE STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands)

(1) Includes FHLB-NY stock. 14 INTEREST INCOME. Interest income decreased $5.7 million, or 17.7%, and $13.2 million, or 13.7%, to $26.4 million and $82.8 million for the three and nine months ended September 30, 2003, respectively, from $32.1 million and $95.9 million for the same periods in 2002. The decline in interest income was primarily attributable to the historically low interest rate environment experienced over the past year. Interest on loans decreased $3.5 million, or 16.4%, and $8.6 million, or 13.3%, to $17.8 million and $55.7 million for the three and nine months ended September 30, 2003, respectively, compared to $21.3 million and $64.2 million for the same periods in 2002. The average balance of the loan portfolio for the three month period ended September 30, 2003, decreased $40.7 million to $1.2 billion from the same period in 2002, while the average yield on the portfolio decreased to 5.79% for the three months ended September 30, 2003, from 6.71% for the same period in 2002. The average balance of the loan portfolio for the nine month period ended September 30, 2003, decreased $40.2 million to $1.2 billion from the same period in 2002, while the average yield on the portfolio decreased to 6.03% for the nine months ended September 30, 2003, from 6.74% for the same period in 2002. Interest on securities decreased $2.2 million, or 20.1% and $4.6 million, or 14.5%, to $8.6 million and $27.1 million for the three and nine months ended September 30, 2003, compared to $10.8 million and $31.7 million for the same periods in 2002. The average balance of the investment, FHLB stock and MBS available for sale portfolios totaled $925.4 million, with an annualized yield of 3.73% for the three months ended September 30, 2003, compared with an average balance of $897.9 million with an annualized yield of 4.80% for the three months ended September 30, 2002. For the first nine months of 2003, the average balance of the investment, FHLB stock and MBS available for sale portfolios totaled $933.8 million, with an annualized yield of 3.87%, compared to an average balance of $875.5 million with an annualized yield of 4.83% for the nine months ended September 30, 2002. Income for the quarter ended September 30, 2003, included the regular quarterly dividend from the FHLB-NY in the amount of $277,000. The FHLB-NY has informed shareholders that it will suspend the fourth quarter 2003 dividend payment. INTEREST EXPENSE. Interest expense decreased $3.6 million, or 23.4%, to $12.0 million for the three months ended September 30, 2003, compared to $15.6 million for the same period in 2002. For the nine months ended September 30, 2003, interest expense decreased $8.8 million, or 18.6%, to $38.7 million versus $47.6 million for the comparable 2002 period. The decrease in interest expense was primarily attributable to reductions in rates paid on time and core deposits, as well as growth in lower-costing core accounts and managed run-off in higher costing certificates of deposit. Interest expense on deposits decreased $2.9 million, or 36.6%, to $5.0 million for the three months ended September 30, 2003, compared to $7.9 million for the same period in 2002. The average balance of interest-bearing core deposits increased $73.7 million, or 10.8%, for the quarter ended September 30, 2003, compared with the same period in 2002, while the average rate paid on these deposits decreased 86 basis points to 0.83%. Average non-interest bearing deposits grew $7.1 million, or 10.2%, to $76.3 million for the third quarter of 2003 compared with 2002. The average balance of certificates of deposit declined $59.8 million, or 9.6%, for the three months ended September 30, 2003, compared with the same period in 2002, while the average rate paid on certificates decreased 79 basis points to 2.46%. For the first nine months of 2003, interest expense on deposits decreased $8.5 million, or 33.5%, to $16.8 million, compared to $25.3 million for the same period in 2002. For the year-to-date, the average balance of interest-bearing core deposits increased $80.9 million, or 12.3%, compared with the same period in 2002, while the average rate paid on these deposits decreased 82 basis points to 0.97%. Average non-interest bearing deposits grew $9.4 million, or 14.3%, to $75.4 million for the first nine months of 2003 compared with the same period in 2002. The average balance of certificates of deposit declined $55.4 million, or 8.7%, for the nine months ended September 30, 2003, compared with the same period in 2002, while the average rate paid on certificates decreased 82 basis points to 2.64%. Interest rates paid on new and renewing certificates of deposit are projected to continue to reprice downward throughout the fourth quarter of 2003 and to stabilize somewhat thereafter. Interest on borrowed funds for the three and nine months ended September 30, 2003, decreased $747,000 and $380,000, respectively, to $6.9 million and $21.9 million, compared to $7.7 million and $22.3 million for the same respective periods in 2002. The average balance of borrowed funds for the three months ended September 30, 2003, decreased to $583.1 million, from $601.8 million for the same period in 2002. The average interest rate paid on 15 borrowed funds was 4.76% for the three months ended September 30, 2003, compared with 5.11% for the same period in 2002. The average balance of borrowed funds for the nine months ended September 30, 2003, increased to $598.8 million, from $584.9 million for the same period in 2002. The average interest rate paid on borrowed funds was 4.88% for the nine months ended September 30, 2003, compared with 5.08% for the same period in 2002. During the first half of 2003, the Company modified $75 million in borrowings with the FHLB-NY, extending terms and reducing the interest rates. The Company had $71.0 million in borrowings with a weighted average interest rate of 4.10% scheduled to mature in the subsequent twelve months at September 30, 2003. The Company expects that these borrowings will favorably reprice based on current market conditions. NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES. Net interest income before provision for loan losses decreased $2.0 million and $4.3 million, or 12.2% and 9.0%, respectively, to $14.4 million and $44.0 million for the three and nine months ended September 30, 2003, compared to $16.5 million and $48.4 million for the same periods in 2002. The decrease was due to the changes in interest income and interest expense described previously. The interest rate spread decreased 26 basis points to 2.38% for the three months ended September 30, 2003, compared with 2.64% for the same period in 2002. For the three months ended September 30, the average earning asset yield declined to 4.90% for 2003, from 5.92% for 2002, while the average cost of interest-bearing liabilities declined to 2.52% for 2003, from 3.28% for 2002. For the nine months ended September 30, 2003, the interest rate spread decreased 17 basis points to 2.41% compared with 2.58% for the same period in 2002. The average earning asset yield was 5.10% for the first nine months of 2003, compared with 5.96% for the first nine months of 2002, while the average cost of interest-bearing liabilities fell to 2.69% from 3.38% for the same respective periods. The net interest margin declined 36 basis points to 2.68% for the third quarter of 2003, from 3.04% for the quarter ended September 30, 2002, and was unchanged from 2.68% for the second quarter of 2003. For the year-to-date, net interest margin declined 29 basis points to 2.71%, compared with 3.00% for the nine months ended September 30, 2002. The Company believes the net interest margin has stabilized. Based on the reduction in mortgage refinance applications received since August, such cash inflows and related deferred expense recognition and premium amortization are expected to slow in the fourth quarter of 2003. PROVISION FOR LOAN LOSSES. The Company did not record a provision for loan losses during the three and nine months ended September 30, 2003, compared to $105,000 and $1.3 million for the same periods in 2002, as a result of a static loan portfolio size and improvements in asset quality. Total non-performing assets decreased to $911,000 at September 30, 2003, from $1.8 million at December 31, 2002 and $3.1 million at September 30, 2002. The allowance for loan losses as a percentage of total loans was 1.05% at September 30, 2003 and 1.06% at December 31, 2002. In management's opinion, the allowance for loan losses, totaling $12.8 million at September 30, 2003, adequately addresses the risks inherent in the portfolio. Management will continue to review the need for additions to its allowance for loan losses based upon its quarterly review of the loan portfolio, the level of delinquencies, and general market and economic conditions. 16 The following table sets forth ratios regarding non-accrual loans and investments, and loans which are 90 days or more delinquent, but on which the Company is accruing interest at the dates indicated. The Company discontinues accruing interest on delinquent loans when collection of interest is considered doubtful, generally when 90 days or more delinquent and when loan-to-value ratios exceed 55%, at which time all accrued but uncollected interest is reversed.

NON-INTEREST INCOME. Non-interest income decreased $969,000, to $1.9 million, for the three months ended September 30, 2003, compared to the same period in 2002. For the nine months ended September 30, 2003, non-interest income increased $2.0 million, to $6.6 million, compared to the same period in 2002. Net gains on sales of loans and securities totaling $276,000 and $1.8 million were realized during the three and nine months ended September 30, 2003, respectively, compared with a net gain of $1.3 million and a net loss of $122,000, respectively, for the comparable 2002 periods. In the third quarter of 2002 and in the first half of 2003, the Company recognized gains on the sales of higher-coupon MBS that demonstrated a significant propensity to prepay, as well as several corporate debt obligations. Prior year results were also impacted by a $1.8 million pre-tax impairment charge recorded on WorldCom, Inc. corporate bonds in the second quarter of 2002. In addition, fee and service charge income increased $149,000 and $80,000 for the three and nine months ended September 30, 2003, respectively, compared with the same periods in 2002. Current year fee and service charge income benefited from core deposit growth and increased fee and service charge levels implemented in July of 2002, as well as prepayment fees received upon the early termination of certain commercial real estate loans. NON-INTEREST EXPENSE. Non-interest expense for the three and nine months ended September 30, 2003, decreased $321,000, or 4.3% and increased $432,000, or 2.0%, to $7.1 million and $22.3 million, respectively, compared to the same periods in 2002. The decrease for the quarter was primarily attributable to reductions in advertising and compensation and benefits expense. For the nine months ended September 30, 2003, the increase was primarily due to an increase in compensation and benefits expense resulting from increased healthcare, pension and ESOP costs. Effective August 1, 2003, the Company adopted changes to its pension plan which reduced the retirement benefit and closed the plan to new participants hired on or after that date. As a result of this amendment, pension expense for the second half of 2003 is expected to decline by $236,000 compared with the first half of the year. INCOME TAXES. The Company's effective tax rate declined to 32.5% and 33.3% for the three and nine months ended September 30, 2003, respectively, compared with 36.3% and 34.3% for the same periods in 2002. Third quarter 2002 taxes reflected the impact of New Jersey's Business Tax Reform Act, which passed on July 2, 2002, retroactive to January 1, 2002. 17 BRANCH SALE. On September 4, 2003, the Bank announced that it had signed an agreement to sell its Lawrenceville, NJ branch to Yardville National Bank ("Yardville"). Under the terms of the agreement, Yardville will assume approximately $40.0 million in deposit liabilities from the Bank. The Company estimates that the transaction will result in the recognition of a pre-tax gain of approximately $2.5 million, or approximately $0.06 per share, net of related taxes, during the fourth quarter of 2003. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. There have been no material changes to information required regarding quantitative and qualitative disclosures about market risk from the end of the preceding fiscal year to the date of the most recent interim financial statements (September 30, 2003). Item 4. CONTROLS AND PROCEDURES. a.) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Christopher Martin, the Company's Chief Executive Officer, and Thomas M. Lyons, the Company's Chief Financial Officer, conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2003. Based upon their evaluation, they each found the Company's disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports that the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. b.) CHANGES IN INTERNAL CONTROLS. There were no changes in the Company's internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS. There are various claims and lawsuits in which the Registrant is periodically involved incidental to the Registrant's business. In the opinion of management, no material loss is expected from any of such pending claims and lawsuits. Item 2. CHANGES IN SECURITIES. None. Item 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. Item 5. OTHER INFORMATION. None. 18 Item 6. EXHIBITS AND REPORTS ON FORM 8-K. a.) EXHIBITS

* Pursuant to SEC rules, this exhibit will not be deemed filed for purposes of Section 18 of the Exchange Act or otherwise be subject to the liability of that section. (a) Previously filed and incorporated herein by reference to the Registration Statement on Form S-1 and exhibits thereto of First Sentinel Bancorp, Inc. (formerly First Source Bancorp, Inc.), and any amendments or supplements thereto filed with the SEC on December 19, 1997 and amended on February 9, 1998, SEC File No. 333-42757. (b) Previously filed and incorporated herein by reference to the December 31, 2002 Annual Report on Form 10-K of First Sentinel Bancorp, Inc. filed with the SEC on March 31, 2003, SEC File No. 000-23809. b.) REPORTS ON FORM 8 - K On July 23, 2003, the Company furnished a Current Report on Form 8-K reporting its earnings for the three and six months ended June 30, 2003. On September 12, 2003, the Company filed a Current Report on Form 8-K announcing that its subsidiary, First Savings Bank, had agreed to sell its Lawrenceville, NJ branch to Yardville National Bank, a subsidiary of Yardville National Bancorp. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST SENTINEL BANCORP, INC. Date: November 14, 2003 By: /S/ CHRISTOPHER MARTIN ---------------------- Christopher Martin President and Chief Executive Officer Date: November 14, 2003 By: /S/ THOMAS M. LYONS ------------------- Thomas M. Lyons Executive Vice President and Chief Financial Officer 20

FIRST SENTINEL BANCORP INC 10-Q