U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
| S | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012
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 Number 000-50055
SOMERSET HILLS BANCORP
(Exact name of registrant as specified in its charter)
| New Jersey | | 22-3768777 |
| (State of other jurisdiction of | | (I. R. S. Employer |
| incorporation or organization) | | Identification No.) |
| | | |
| 155 Morristown Road, Bernardsville, NJ | | 07924 |
| (Address of principal executive offices) | | (Zip Code) |
(908) 221-0100
(Registrants’ telephone number including area code)
Securities registered under Section 12(b) of the Exchange Act:
| Title of each class | | Name of each exchange on which registered |
| Common Stock, no par value | | NASDAQ |
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes£ NoS
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes£ NoS
Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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. YesS No£
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesx Noo
Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by referenced in Part III of this Form 10-K or any amendment to this Form 10-K.£
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (check one) : Large accelerated filer£ Accelerated filer£ Non-accelerated filer£ Smaller reporting companyS
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes£ NoS
As of June 30, 2012, the aggregate market value of voting and non-voting equity held by non-affiliates was $39.5 million.
As of March 1, 2013, there were 5,369,800 shares of common stock, no par value per share outstanding.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Somerset Hills Bancorp (the “Company”) is a one-bank holding company incorporated under the laws of New Jersey in January 2000 to serve as the holding company for Somerset Hills Bank (the “Bank”). We were organized at the direction of the Board of Directors of the Bank. Effective January 1, 2001, Somerset Hills Bancorp acquired all of the capital stock of the Bank and became a bank holding company under the Bank Holding Company Act of 1956, as amended. Our only significant operation is our investment in the Bank. Our main office is located at 155 Morristown Road, Bernardsville, New Jersey and our telephone number is (908) 630-5029.
The Bank is a commercial bank formed under the laws of the State of New Jersey in 1997. The Bank operates from its main office at 155 Morristown Road, Bernardsville, New Jersey, and its five branch offices located in Long Valley, Madison, Mendham, Morristown and Summit, New Jersey. The Bank operates a licensed mortgage company subsidiary, Sullivan Financial Services, Inc. (“Sullivan”). Sullivan’s operations are located in Madison, New Jersey. The Company considers Sullivan to be a separate business segment.
The Bank’s deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation up to applicable limits. The operations of the Bank are subject to the supervision and regulation of the Federal Deposit Insurance Corporation and the New Jersey Department of Banking and Insurance. Our mortgage company’s operations are subject to regulation by the New Jersey Department of Banking and Insurance, the Departments of Banking in Florida, New York and Pennsylvania as well as the Department of Housing and Urban Development and the Veterans Administration.
We separate our business into two reporting segments: community banking and mortgage banking. For financial information on our business segments, see Note 12 to the accompanying Financial Statements.
Pending Merger
On January 29, 2013, the Company and Lakeland Bancorp, Inc. (NASDAQ: LBAI) (“Lakeland”), the parent company of Lakeland Bank, announced that the companies have entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which the Company will be merged with and into Lakeland, with Lakeland as the surviving bank holding company. The Merger Agreement provides that the shareholders of Somerset Hills Bancorp will receive, at their election, for each outstanding share of Somerset Hills Bancorp common stock that they own at the effective time of the merger, either 1.1962 shares of Lakeland common stock or $12.00 in cash, subject to proration as described in the Merger Agreement, so that 90% of the aggregate merger consideration will be shares of Lakeland common stock and 10% will be cash. The Merger Agreement also provides that immediately after the merger of the Company into Lakeland, the Bank will merge with and into Lakeland Bank, with Lakeland Bank as the surviving bank. Consummation of the merger is subject to the satisfaction of a number of conditions, including but not limited to (i) approval of the merger by the holders of a majority of the outstanding shares of Company’s common stock; (ii) approval of the issuance of the shares of Lakeland common stock issuable in the Merger by a majority of the votes cast at the Lakeland annual meeting: (iii) the receipt of all required regulatory approvals, without significant adverse or burdensome conditions; and (iv) the absence of a material adverse change with respect to the Company, as well as other conditions to closing as are customary in transactions such as the Merger.
Business of the Bank
The Bank conducts a traditional commercial banking business and offers services including personal and business checking accounts, time deposits, money market accounts and regular savings accounts. The Bank’s lending activities are oriented to the small-to-medium sized business, high net worth individuals, professional practices and consumer and retail customers living and working primarily in the Bank’s market area of Somerset, Morris and Union Counties, New Jersey. The Bank offers the commercial, consumer, and mortgage-lending products typically offered by community banks and, through its mortgage company subsidiary, a variety of residential mortgage products.
The deposit services offered by the Bank include small business and personal checking and savings accounts and certificates of deposit. The Bank’s signature retail deposit account is the Paramount Checking Account, an interest paying checking account offering features such as free checks, telephone banking, text banking, internet banking and bill payment, free safe deposit box and a refund of foreign ATM fees. Another deposit service the bank offers is the Escrow Ease product. Escrow Ease is specifically designed to meet the trust account needs of attorneys, realtors and title companies. The Escrow Ease Account offers the convenience of segregation of client funds, by subaccount, within a single master trust account with detailed subaccount reporting including the preparation of year-end tax documents. Subaccounts may be either interest or non-interest bearing and, for attorneys, can also be designated as IOLTA accounts. The Bank concentrates on customer relationships in building our customer deposit base and competes aggressively in the area of transaction accounts.
In addition, the Bank has established a wealth management subsidiary pursuant to which it offers insurance services, securities brokerage and investment advisory services on a non-proprietary basis under the terms of an agreement with Mass Mutual,
its affiliated securities brokerage and its locally affiliated agents. The Bank has also established a title insurance agency joint venture which offers traditional title agency services in connection with commercial real estate transactions. The Bank is a 50 percent owner of the joint venture.
Service Area
The service area of the Bank primarily consists of Somerset, Morris and Union Counties, New Jersey, although we make loans throughout New Jersey. The Bank operates through its main office in Bernardsville, New Jersey, and its branch offices located in Long Valley, Madison, Mendham, Morristown and Summit, New Jersey.
Our mortgage company subsidiary originates loans primarily in New Jersey, and to a lesser degree, New York, Pennsylvania and Florida. The mortgage company’s operations are located in Madison, New Jersey.
Competition
The Bank operates in a highly competitive environment competing for deposits and loans with commercial banks, thrifts and other financial institutions, many of which have greater financial resources than the Bank. Many large financial institutions compete for business in the service area of the Bank. In addition, in November 1999, the Gramm-Leach-Bliley Financial Modernization Act of 1999 was passed into law. The act permits insurance companies and securities firms, among others, to acquire financial institutions and has increased competition within the financial services industry. Certain of our competitors have significantly higher lending limits than we do and provide services to their customers that we do not offer.
Management believes that the Bank is able to compete favorably with our competitors because we provide responsive personalized service through management’s knowledge and awareness of our market area, customers and businesses.
Employees
At December 31, 2012 and 2011, we employed 53 and 56 full-time employees and 8 and 5 part-time employees, respectively. None of these employees are covered by a collective bargaining agreement and we believe that our employee relations are good.
Supervision and Regulation
Bank holding companies and banks are extensively regulated under both federal and state law. These laws and regulations are intended to protect depositors, not shareholders. In addition, the operations of Sullivan are subject to various state and federal regulations designed to protect consumers, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in the applicable law or regulation may have a material effect on the business and prospects of the Company and the Bank.
BANK HOLDING COMPANY REGULATION
General
As a bank holding company registered under the Bank Holding Company Act, the Company is subject to the regulation and supervision applicable to bank holding companies by the Board of Governors of the Federal Reserve System. The Company is required to file with the Federal Reserve annual reports and other information regarding its business operations and those of its subsidiaries.
The Bank Holding Company Act requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire all or substantially all of the assets of any other bank, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank (unless it owns a majority of such company’s voting shares) or (iii) merge or consolidate with any other bank holding company. The Federal Reserve will not approve any acquisition, merger, or consolidation that would have a substantially anticompetitive effect, unless the anti-competitive impact of the proposed transaction is clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial resources and future prospects of the companies and the banks concerned, together with the convenience and needs of the community to be served, when reviewing acquisitions or mergers.
The Bank Holding Company Act generally prohibits a bank holding company, with certain limited exceptions, from (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company, or (ii) engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries, unless such non-banking business is determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be properly incident thereto.
The Bank Holding Company Act was substantially amended through the Gramm-Leach Bliley Financial Modernization Act of 1999 (“Financial Modernization Act”). The Financial Modernization Act permits bank holding companies and banks, which meet certain capital, management and Community Reinvestment Act standards to engage in a broader range of non-banking activities. In addition, bank holding companies that elect to become financial holding companies may engage in certain banking and non-banking activities without prior Federal Reserve approval. Finally, the Financial Modernization Act imposes certain privacy requirements on all financial institutions and their treatment of consumer information. At this time, the Company has elected not to become a financial holding company, as it does not engage in any activities that are not permissible for banks.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulation that are designed to minimize potential loss to the depositors of such depository institutions and the Deposit Insurance Fund in the event the depository institution becomes in danger of default. Under provisions of the Bank Holding Company Act, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve also has the authority under the Bank Holding Company Act to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
Capital Adequacy Guidelines for Bank Holding Companies
The Federal Reserve has adopted risk-based capital guidelines for bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. These requirements apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and to certain bank holding companies with less than $500 million in consolidated assets if they are engaged in substantial non-banking activities or meet certain other criteria. We do not meet these criteria, and so are not subject to a minimum consolidated capital requirement.
In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum. This minimum leverage requirement only applies to bank holding companies on a consolidated basis if the risk based capital requirements discussed above apply. We do not have a minimum consolidated capital requirement at the holding company level at this time.
BANK REGULATION
As a New Jersey-chartered commercial bank, the Bank is subject to the regulation, supervision, and control of the New Jersey Department of Banking and Insurance. As an FDIC-insured institution, the Bank is subject to regulation, supervision and control of the FDIC, an agency of the federal government. The regulations of the FDIC and the New Jersey Department of Banking and Insurance impact virtually all of the Bank’s activities, including the minimum level of capital we must maintain, our ability to pay dividends, our ability to expand through new branches or acquisitions and various other matters.
Insurance of Deposits
The Dodd-Frank Wall Street Reform and Consumer Protection act of 2010 (the “Dodd-Frank Act”) has caused significant changes in the FDIC’s insurance of deposit accounts. Among other things, the Dodd-Frank Act permanently increased the FDIC deposit insurance limit to $250,000 per depositor. In addition, the Dodd-Frank Act includes provisions replacing, by statute, the FDIC’s program to provide unlimited deposit insurance coverage for noninterest bearing transactional accounts. The program expired at year-end 2012.
On February 7, 2011, the FDIC announced the approval of a revised assessment system mandated by the Dodd-Frank Act. The Dodd-Frank Act requires that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on average total consolidated assets minus average tangible equity. The new rate schedule became effective during the second quarter of 2011 and reduced the Company’s costs for Federal deposit insurance.
Capital Adequacy Guidelines
The FDIC has promulgated risk-based capital guidelines, which are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least 4% of the total capital is required to be “Tier I Capital,” consisting of common stockholders’ equity, qualifying preferred stock and certain permissible hybrid instruments, less certain goodwill items and other intangible assets. The remainder (“Tier II Capital”) may consist of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) non-qualifying preferred stock, (c) hybrid capital instruments, (d) perpetual debt, (e) mandatory convertible securities, and (f) qualifying subordinated debt and intermediate-term preferred stock up to 50% of Tier I capital. Total capital is the sum of Tier I and Tier II capital less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the Federal Reserve (determined on a case by case basis or as a matter of policy after formal rule-making).
Bank assets are given risk-weights of 0%, 20%, 50% and 100%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets. Most loans are assigned to the 100% risk category, except for performing first mortgage loans fully secured by residential property, which carry a 50% risk-weighting, and loans secured by deposits in the Bank which carry a 20% risk weighting. Most investment securities (including, primarily general obligation claims of states or other political subdivisions of the United States) are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S. Government, which have a 0% risk-weight. In converting off-balance sheet items, direct credit substitutes including general guarantees and standby letters of credit backing financial obligations are given a 100% risk weighting. Transaction related contingencies such as bid bonds, standby letters of credit backing non-financial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50% risk weighting. Short-term commercial letters of credit have a 20% risk weighting and certain short-term unconditionally cancelable commitments have a 0% risk weighting.
In addition to the risk-based capital guidelines, the FDIC has adopted a minimum Tier 1 capital (leverage) ratio. Under these guidelines, a bank must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other banks are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum.
The capital requirements applicable to the Company and the Bank may be enhanced in the future. The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a strengthened set of capital requirements for banking organizations in the United States and around the world. Basel III is currently the subject of notices of proposed rulemakings released in June of 2012 by the respective U.S. federal banking agencies. Basel III would require a minimum amount of capital to be held in the form of tangible common equity, generally increase the required capital ratios, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of assets used to determine required capital ratios. In addition, institutions that seek the freedom to make capital distributions and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in common equity attributable to a capital conservation buffer to be phased in from January 1, 2016 until January 1, 2019. However, on November 9, 2012, the U.S. federal banking agencies announced that they do not expect that any of the proposed rules would become effective on January 1, 2013. They did not indicate the likely new effective date.
Dividends
As long as the operations of the Bank remain our primary source of income, our ability to pay dividends will be affected by any legal or regulatory limitations on the Bank’s ability to pay dividends. The Bank may pay dividends as declared from time to time by the Board of Directors out of funds legally available, subject to certain restrictions. Under the New Jersey Banking Act of 1948, the Bank may not pay a cash dividend unless, following the payment, the Bank’s capital stock will be unimpaired and the Bank will have a surplus of no less than 50% of the Bank’s capital stock or, if not, the payment of the dividend will not reduce the surplus. In addition, the Bank would be prohibited from paying dividends in such amounts as would reduce the Bank’s capital below regulatory imposed minimums.
REGULATION OF SULLIVAN
As a subsidiary of the Bank, Sullivan is subject to regulation and examination by the New Jersey Department of Banking and Insurance and the FDIC. In addition, as a licensed lender, Sullivan is subject to the jurisdiction of the New Jersey Department of Banking and Insurance and, as an approved Department of Housing and Urban Development and Veterans Administration lender, Sullivan is subject to examination by the Department of Housing and Urban Development and the Veterans Administration. Sullivan is also subject to regulation by the Pennsylvania Department of Banking.
The Dodd-Frank Act, discussed below, also imposes new obligations on originators of residential mortgage loans, such as Sullivan. Among other things, the Dodd Frank Act requires originators to make a reasonable and good faith determination based on documented information that a borrower has a reasonable ability to repay a particular mortgage loan over the long term. If the originator cannot meet this standard, the loan may be unenforceable in foreclosure proceedings. The Dodd Frank Act contains an exception from this ability to repay rule for “qualified mortgages”, which are deemed to satisfy the rule, but does not define the term, and left authority to the Consumer Financial Protection Bureau (“CFPB”) to adopt a definition. A rule issued by the CFPB in January 2013, and effective January 10, 2014, sets forth specific underwriting criteria for a loan to qualify as a Qualified Mortgage Loan. The criteria generally exclude loans that are interest-only, have excessive upfront points or fees, have negative amortization features or balloon payments, or have terms in excess of 30 years. The underwriting criteria also impose a maximum debt to income ratio of 43%. If a loan meets these criteria and is not a “higher priced loan” as defined in Federal Reserve regulations, the CFPB rule establishes a safe harbor preventing a consumer from asserting as a defense to foreclosure the failure of the originator to establish the consumer’s ability to repay. However, this defense will be available to a consumer for all other residential mortgage loans.
Although the majority of residential mortgages historically originated by Sullivan would qualify as Qualified Mortgage Loans, Sullivan has also made, and may continue to make in the future, residential mortgage loans that will not qualify as Qualified Mortgage Loans. These loans may expose Sullivan to greater losses, loan repurchase obligations, or litigation related expenses and delays in taking title to collateral real estate, if these loans do not perform and borrowers challenge whether Sullivan satisfied the ability to repay rule on originating the loan.
LEGISLATIVE AND REGULATORY CHANGES
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law on July 21, 2010. Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Some uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry by increasing compliance costs and reducing some sources of revenue. The Dodd-Frank Act, among other things:
| • | Directs the Federal Reserve to issue rules which limit debit-card interchange fees; |
| • | Provides for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets; |
| • | Permanently increases the deposit insurance coverage to $250,000 and allows depository institutions to pay interest on checking accounts; |
| • | Creates a new consumer financial protection bureau that has rulemaking authority for a wide range of consumer protection laws that would apply to all banks and has broad powers to supervise and enforce consumer protection laws directly for large institutions; |
| • | Provides for new disclosure and other requirements relating to executive compensation and corporate governance; |
| • | Changes standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries; |
| • | Provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and |
| • | Creates a financial stability oversight council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity. |
On July 30, 2002, the Sarbanes-Oxley Act, or “SOX” was enacted. SOX is not a banking law, but applies to all public companies, including Somerset Hills Bancorp. The stated goals of SOX are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the
accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX is the most far reaching U.S. securities legislation enacted in some time. SOX generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended.
SOX includes very specific additional disclosure requirements and new corporate governance rules and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specific issues by the SEC. SOX represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. SOX addresses, among other matters:
| • | certification of financial statements by the chief executive officer and the chief financial officer; |
| • | management’s assessment of a company’s internal controls over financial reporting, and a company’s auditor’s certification of such assessment; |
| • | the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; |
| • | a prohibition on insider trading during pension plan blackout periods; |
| • | disclosure of off-balance sheet transactions; |
| • | a prohibition on personal loans to officers and directors, unless subject to Federal Reserve Regulation O; |
| • | expedited filing requirements for Form 4 statements of changes of beneficial ownership of securities required to be filed by officers, directors and 10% shareholders; |
| • | disclosure of whether or not a company has adopted a code of ethics; |
| • | “real time” filing of periodic reports; |
| • | auditor independence; and |
| • | various increased criminal penalties for violations of securities laws. |
Complying with the requirements of SOX as implemented by the SEC has and will continue to increase our compliance costs and could make it more difficult to attract and retain board members.
On October 26, 2001, a new anti-terrorism bill, the International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001, was signed into law. This law restricts money laundering by terrorists in the United States and abroad. This act specifies new “know your customer” requirements that will obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with the act’s money laundering provisions in making decisions regarding approval of acquisitions and mergers. In addition, sanctions for violations of the act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1 million.
ITEM 1A. RISK FACTORS
Risks affecting our business:
Our pending merger with Lakeland may not occur. Compliance with the terms of the Merger Agreement in the interim could adversely affect our business, and if the merger does not occur, it could have a material and adverse effect on our business, results of operations and our stock price.
Consummation of our merger with Lakeland is subject to a number of conditions, including shareholder and regulatory approval, many of which are not within our control. We can therefore offer you no assurance that the proposed merger will in fact be consummated.
As a result of the pending merger: (i) the attention of management and employees may be diverted from day to day operations as they focus on matters relating to preparation for integrating the Company’s operations with those of Lakeland; (ii) the restrictions and limitations on the conduct of the Company’s business imposed by the merger agreement pending the merger may disrupt or otherwise adversely affect our business and our relationships with customers,; (iii) the Company’s ability to retain its existing employees may be adversely affected due to the uncertainties created by the merger; and (iv) the Company’s ability to establish new customer relationships may be adversely affected. Any delay in consummating the merger may exacerbate these issues.
If the Merger is not consummated, our stock price will likely decline as our stock has recently traded at prices based on the proposed per share price for the merger. In addition, our results of operations and financial condition may be adversely effected if (i) key employees have left the Company during the pendency of the merger, (ii) our relationships with our existing customers have been weakened due to the merger, (iii) we have failed to develop new customer relationships because of the pendency of the merger; and (iv) the termination of the Merger Agreement negatively effects market perception of our reputation. In addition, we will have incurred substantial expenses in negotiating and attempting to consummate the merger. These effects could also adversely affect our stock price.
The recent nationwide recession has reduced real estate values in our trade area and may adversely affect our business by stressing the ability of our customers to repay their loans.
Our trade area, like the rest of the United States, is currently experiencing weak economic conditions. As a result, many companies have experienced reduced revenues and have laid off employees. These factors have stressed the ability of both commercial and consumer customers to repay their loans and may result in higher levels of nonaccrual loans. In addition, real estate values have declined in our trade area. Since the majority of our loans are secured by real estate, declines in the market value of real estate impact the value of the collateral securing our loans, and could lead to greater losses in the event of defaults on loans secured by real estate.
Changes in interest rates can have an adverse effect on profitability.
Our earnings and cash flows are largely dependent upon net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition, and policies of various governmental and regulatory agencies and, in particular, the policies of the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, including our securities portfolio, and (iii) the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk). Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.
Our earnings may not grow if we are unable to successfully attract core deposits and lending opportunities and exploit opportunities to generate fee-based income.
Historically, the growth of our loans and deposits has been the principal factor in our increase in net interest income. In the event that we are unable to execute our business strategy of continued growth in loans and deposits, our earnings could be adversely impacted. Our ability to continue to grow depends, in part, upon our ability to expand our market share, to successfully attract core deposits and identify loan and investment opportunities, as well as opportunities to generate fee-based income. Our ability to manage
growth successfully will also depend on whether we can continue to efficiently fund asset growth and maintain asset quality and cost controls, as well as on factors beyond our control, such as economic conditions and interest rate trends.
Our business strategy could be adversely affected if we are not able to attract and retain skilled employees and manage our expenses.
Our ability to successfully implement business strategies, especially given the persistently poor economy and an increasingly onerous regulatory environment, will depend upon our ability to continue to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our staff employees.
Our mortgage banking operations expose us to risks that are different from community banking.
The bank’s mortgage banking operations expose us to risks that are different from our retail banking operations. Our mortgage banking operations are dependent upon the level of demand for residential mortgages. During higher and rising interest rate environments, the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues than currently recognized and that may not exceed our fixed costs to run the business. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third-party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, the bank may be required to charge such shortfall to earnings.
In addition, Sullivan has made in the past, and may make in the future, residential mortgage loans that do not qualify as Qualified Mortgage Loans under the Dodd-Frank Act and the recently enacted CFPB regulations effective January 10, 2014. See “REGULATION OF SULLIVAN”. These loans may expose Sullivan and the Company to greater losses, or litigation related expenses and delays in taking title to collateral real estate, if these loans do not perform and borrowers challenge whether Sullivan satisfied the ability to repay rule on originating the loan.
Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Hurricanes and other weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. In addition, these weather events may result in a decline in value or destruction of properties securing our loans and an increase in delinquencies, foreclosures and loan losses.
Risks Related to the Banking Industry:
Changes in local economic conditions could adversely affect our loan portfolio.
Our success depends to a great extent upon the general economic conditions of the local markets that we serve. Unlike larger banks that are more geographically diversified, we provide banking and financial services primarily to customers in our central and northern New Jersey trade area, so any decline in the economy of this specific region could have an adverse impact on us.
Our loans, the ability of borrowers to repay these loans and the value of collateral securing these loans, are impacted by economic conditions. Our financial results, the credit quality of our existing loan portfolio, and the ability to generate new loans with acceptable yield and credit characteristics may be adversely affected by changes in prevailing economic conditions, including declines in real estate values, changes in interest rates, adverse employment conditions and the monetary and fiscal policies of the federal government. We cannot assure you that negative trends or developments will not have a significant adverse effect on us.
There is a risk that we may not be repaid in a timely manner, or at all, for loans we make.
The risk of non-payment (or deferred or delayed payment) of loans is inherent in banking. Such non-payment, or delayed or deferred payment of loans to the Company, if they occur, may have a material adverse effect on our earnings and overall financial condition. Additionally, in compliance with generally accepted accounting principles (“GAAP”) and applicable banking laws and regulations, the Company maintains an allowance for loan losses created through charges against earnings. As of December 31, 2012, the Company’s allowance for loan losses was $3.2 million. The Company’s marketing focus on small to medium-sized businesses may result in the assumption by the Company of certain lending risks that are different from or greater than those which would apply to loans made to larger companies. We seek to minimize our credit risk exposure through credit controls, which include evaluation of potential borrowers’ available collateral, liquidity and cash flow. However, there can be no assurance that such procedures will actually reduce loan losses.
Our allowance for loan losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. Our allowance for loan losses may not be adequate to cover actual losses, and future provisions for loan losses could materially and adversely affect the results of our operations. Risks within the loan portfolio are analyzed on a continuous basis by management; and,
periodically, by an independent loan review function and by the Audit Committee. A risk system, consisting of multiple-grading categories for each loan class, is utilized as an analytical tool to assess risk and the appropriate level of loss reserves. Along with the risk system, management further evaluates risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrowers, past and expected loan loss experience and other factors management feels deserve recognition in establishing an adequate reserve. This risk assessment process is performed at least quarterly and as adjustments become necessary, they are realized in the periods in which they become known. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. State and federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses and may require an increase in our allowance for loan losses. Although we believe that our allowance for loan losses is adequate to cover probable and reasonably estimated losses, we cannot assure you that we will not further increase the allowance for loan losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings.
We are in competition with many other banks, including larger commercial banks which have greater resources than us.
The banking industry within our trade area is highly competitive. The Company’s principal market area is also served by branch offices of large commercial banks and thrift institutions. In addition, in 1999 the Gramm-Leach-Bliley Financial Modernization Act of 1999 was passed into law. The Financial Modernization Act permits other financial entities, such as insurance companies and securities firms, to acquire or form financial institutions, thereby further increasing competition. A number of our competitors have substantially greater resources than we do to expend upon advertising and marketing, and their substantially greater capitalization enables them to make much larger loans. Our success depends a great deal upon our judgment that large and mid-size financial institutions do not adequately serve small businesses in our principal market area and upon our ability to compete favorably for such customers.
The banking business is subject to significant government regulations, which are designed for the protection of depositors and the public, but not our stockholders.
We are subject to extensive governmental supervision, regulation and control. These laws and regulations are subject to change, and may require substantial modifications to our operations or may cause us to incur substantial additional compliance costs. In addition, future legislation and government policy could adversely affect the commercial banking industry and our operations. Such governing laws can be anticipated to continue to be the subject of future modification. These laws and regulations are generally designed to protect depositors and the deposit insurance funds and to foster economic growth and not for the purpose of protecting stockholders. Our management cannot predict what effect any such future modifications will have on our operations.
For example, the Dodd-Frank Act has and may result in substantial new compliance costs, and may restrict certain sources of revenue. The Dodd-Frank Act was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on our business, results of operations and financial condition. The Dodd-Frank Act, among other things:
| • | Directs the Federal Reserve to issue rules which limit debit-card interchange fees; |
| • | Provides for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets less capital; |
| • | Permanently increases the deposit insurance coverage to $250,000 and allows depository institutions to pay interest on checking accounts; |
| • | Creates a new consumer financial protection bureau that has rulemaking authority for a wide range of consumer protection laws that would apply to all banks and has broad powers to supervise and enforce consumer protection laws directly for large institutions; |
| • | Provides for new disclosure and other requirements relating to executive compensation and corporate governance; |
| • | Changes standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries; |
| • | Provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and |
| • | Creates a financial stability oversight council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity. |
In addition, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a strengthened set of capital requirements for banking organizations in the United States and around the world. Basel III is currently the subject of notices of proposed rulemakings released in June of 2012 by the respective U.S. federal banking agencies. The comment period for these notices of proposed rulemakings ended on October 22, 2012. Basel III is intended to be implemented beginning January 1, 2013 and to be fully-phased in on a global basis on January 1, 2019. Basel III would require capital to be held in the form of tangible common equity, generally increase the required capital ratios, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of assets used to determine required capital ratios. However, on November 9, 2012, the U.S. federal banking agencies announced that they do not expect that any of the proposed rules would become effective on January 1, 2013. They did not indicate the likely new effective date.
These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of operations.
Our management is actively reviewing the provisions of the Dodd-Frank Act and Basel III, many of which are to be phased-in over the next several months and years, and assessing the probable impact on our operations. However, the ultimate effect of these changes on the financial services industry in general, and us in particular, is uncertain at this time.
We cannot predict how changes in technology will impact our business.
The financial services market, including banking services, is increasingly affected by advances in technology, including developments in:
| • | internet-based banking, including fraud and computer virus protection; |
| • | telephone and mobile banking; and |
| • | debit cards and so-called “smart cards.” |
Our ability to compete successfully in the future will depend on whether we can anticipate and respond to technological changes. To develop these and other new technologies, we will likely have to make additional capital investments. Although we continually invest in new technology, we cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain competitive in the future.
The Company’s information systems may experience an interruption or breach in security.
The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer-relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company’s information systems could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny or expose the Company to civil litigation and possible financial liability; any of which could have a material adverse effect on the Company’s financial condition and results of operations. In addition, with the advent of new delivery channels in banking including, but not limited to, internet banking and mobile banking, the risk of financial fraud is increased.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved staff comments.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank owns its main office in Bernardsville, New Jersey and branch office in Long Valley, New Jersey, and leases its Madison, Mendham, Morristown and Summit, New Jersey branch offices.
The following table sets forth certain information regarding the properties of the Bank:
| Owned Properties |
| Location | | Square Feet |
| Bernardsville | | 14,000 |
| Long Valley | | 1,200 |
| Leased Properties |
| Location | | Square Feet | | Monthly Rental | | | Expiration of Term |
| Madison | | 4,000 | * | $ | 11,241 | | | 2016 |
| Mendham | | 2,500 | | | 7,500 | | | 2015 |
| Morristown | | 2,379 | | | 4,758 | | | 2018 |
| Summit | | 4,016 | | | 9,625 | | | 2014 |
* Represents a lease on land upon which the Bank owns the building.
ITEM 3. LEGAL PROCEEDINGS
On February 8, 2013, a complaint was filed against the Company and the members of its Board of Directors in the Superior Court of New Jersey, Somerset County, seeking class action status and asserting that the Company and the members of its Board had violated their duties to the Company’s shareholders in connection with the proposed merger with Lakeland Bancorp, Inc. The litigation is in its very early stages, and the Company’s time to answer has not yet run. The Company believes this complaint is without merit, and intends to vigorously defend this complaint.
We are periodically parties to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to the business of the Company and the Bank. Management does not believe that there is any pending or threatened proceeding against the Company or the Bank, which if determined adversely, would have a material effect on the business or financial position of the Company.
ITEM 4. MINE SAFETY DISCLOSURE
Not applicable
PART II
ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company’s common stock is currently traded on NASDAQ Global Market under the symbol “SOMH.”
The following table sets forth for the periods indicated the high and low reported sale prices as reported on the NASDAQ and dividends declared per share.
| | | Sales Price | | | Dividends | |
| | | High | | | Low | | | Declared | |
| 2012 | | | | | | | | | | | | |
| First Quarter | | $ | 8.68 | | | $ | 7.46 | | | $ | 0.07 | |
| Second Quarter | | | 9.05 | | | | 8.15 | | | | 0.08 | |
| Third Quarter | | | 9.29 | | | | 8.19 | | | | 0.08 | |
| Fourth Quarter | | | 8.99 | | | | 8.25 | | | | 0.08 | |
| 2011 | | | | | | | | | | | | |
| First Quarter | | $ | 10.18 | | | $ | 8.50 | | | $ | 0.06 | |
| Second Quarter | | | 9.24 | | | | 8.05 | | | | 0.06 | |
| Third Quarter | | | 8.60 | | | | 7.10 | | | | 0.06 | |
| Fourth Quarter | | | 7.98 | | | | 7.10 | | | | 0.07 | |
As of December 31, 2012, there were 175 record holders of our common stock.
In February 2007, our Board of Directors adopted a stock repurchase program under which we may repurchase up to 250,000 shares of our common stock in open market or privately negotiated transactions. In October 2007, the Board increased this program by 250,000 shares and, in October 2011, the Board increased this program by another 250,000 shares. The following table shows the Company’s repurchases during the fourth quarter of 2012:
| Period | | Total Number of
Shares Purchased | | | Average Price
Paid per Share | | | Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs | | | Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs | |
| | | | | | | | | | | | | |
| October 1 – October 31 | | | 141 | | | $ | 8.57 | | | | 141 | | | | 285,936 | |
| November 1 – November 30 | | | 2,477 | | | | 8.43 | | | | 2,477 | | | | 283,459 | |
| December 1 – December 31 | | | — | | | | — | | | | — | | | | 283,459 | |
| Total | | | 2,618 | | | | 8.44 | | | | 2,618 | | | | 283,459 | |
Under the Merger Agreement with Lakeland, we are prohibited from repurchasing shares of our common stock without Lakeland’s prior consent.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA AND OTHER DATA
SELECTED CONSOLIDATED FINANCIAL DATA AND OTHER DATA
(in thousands, except per share data)
Set forth below is selected historical financial data of the Company. This information is derived in part from and should be read in conjunction with the consolidated financial statements and notes thereto presented elsewhere in this Annual Report on Form 10-K.
| | | Years Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| Selected Operating Data: | | | | | | | | | | | | | | | | | | | | |
| Total interest income | | $ | 13,204 | | | $ | 13,640 | | | $ | 13,473 | | | $ | 13,854 | | | $ | 14,988 | |
| Total interest expense | | | 1,289 | | | | 1,793 | | | | 2,193 | | | | 3,391 | | | | 4,275 | |
| Net interest income | | | 11,915 | | | | 11,847 | | | | 11,280 | | | | 10,463 | | | | 10,713 | |
| Provision for loan losses | | | 290 | | | | 220 | | | | 125 | | | | 950 | | | | 515 | |
| Net interest income after provision for loan losses | | | 11,625 | | | | 11,627 | | | | 11,155 | | | | 9,513 | | | | 10,198 | |
| Other income | | | 2,848 | | | | 2,002 | | | | 2,214 | | | | 2,931 | | | | 1,747 | |
| Other expenses | | | 9,265 | | | | 9,627 | | | | 9,640 | | | | 10,109 | | | | 9,780 | |
| Income before income taxes | | | 5,208 | | | | 4,002 | | | | 3,729 | | | | 2,335 | | | | 2,165 | |
| Income tax expense | | | 1,830 | | | | 1,189 | | | | 1,219 | | | | 441 | | | | 599 | |
| Net income | | | 3,378 | | | | 2,813 | | | | 2,510 | | | | 1,894 | | | | 1,566 | |
| Dividends on preferred stock and accretion | | | — | | | | — | | | | — | | | | 350 | | | | — | |
| Net income available to common stockholders | | $ | 3,378 | | | $ | 2,813 | | | $ | 2,510 | | | $ | 1,544 | | | $ | 1,566 | |
| | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | 0.63 | | | $ | 0.52 | | | $ | 0.46 | | | $ | 0.28 | | | $ | 0.29 | |
| Diluted earnings per share | | | 0.63 | | | | 0.52 | | | | 0.46 | | | $ | 0.28 | | | | 0.28 | |
Note: All per share data has been restated to reflect the 5% stock dividends declared in 2008 and 2010.
| | | At December 31, | |
| | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| Selected Financial Data: | | | | | | | | | | | | | | | |
| Total Assets | | $ | 368,930 | | | $ | 364,025 | | | $ | 328,896 | | | $ | 330,110 | | | $ | 299,663 | |
| Net Loans | | | 238,753 | | | | 229,503 | | | | 204,271 | | | | 203,657 | | | | 208,427 | |
| Total Deposits | | | 320,187 | | | | 314,714 | | | | 276,541 | | | | 279,125 | | | | 249,760 | |
| Stockholders’ Equity | | | 41,848 | | | | 40,369 | | | | 39,391 | | | | 38,200 | | | | 37,529 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected Financial Ratios: | | | | | | | | | | | | | | | | | | | | |
| Return on Average Assets (ROA) | | | 0.95 | % | | | 0.83 | % | | | 0.80 | % | | | 0.61 | % | | | 0.56 | % |
| Return on Average Equity (ROE) | | | 8.15 | | | | 6.98 | | | | 6.37 | | | | 4.65 | | | | 4.24 | |
| Tangible Common Equity to Total Assets at Year-End* | | | 11.34 | | | | 11.09 | | | | 11.98 | | | | 11.57 | | | | 12.52 | |
___________________
* Represents stockholders’ equity as a percentage of total assets at the end of each period, since the Company did not have any goodwill or other intangibles at these dates.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in this document discuss future expectations, contain projections or results of operations or financial conditions or state other “forward-looking” information. Those statements are subject to known and unknown risk; uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. We based the forward-looking statements on various factors and using numerous assumptions. Important factors that may cause actual results to differ from those contemplated by forward-looking statements include those disclosed under Item 1A – Risk Factors as well as the following factors:
| • | the success or failure of our efforts to implement our business strategy; |
| • | the effect of changing economic conditions and, in particular, changes in interest rates; |
| • | changes in government regulations, tax rates and similar matters; |
| • | our ability to attract and retain quality employees; and |
| • | other risks which may be described in our future filings with the SEC. |
We do not promise to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. 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, 2012 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 are periodically reviewed with the Audit Committee and the Board of Directors of the Company.
The allowance 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 collectability may not be assured, the existence and estimated net realizable 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 collectability 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 by declines in real estate values, or if the Central or Northern areas of New Jersey 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.
OVERVIEW AND STRATEGY
The Company serves as a holding company for the Bank, which is its primary asset and only operating subsidiary. The Bank conducts a traditional banking business, making commercial loans, consumer loans, and residential and commercial real estate loans. In addition, the Bank offers various non-deposit products through non-proprietary relationships with third party vendors. The Bank relies primarily upon deposits as the funding source for its assets. The Bank offers traditional deposit products. In addition, as an alternative to traditional certificate of deposit accounts, the Bank offers its Paramount Checking Account, a retail interest paying checking account which also provides a suite of additional services, such as free checks, free telephone banking and free bill payment, free safe deposit box and refunds for foreign ATM fees. Although the rate the Bank pays on the Paramount Checking Account may be higher than the rate offered on interest paying checking accounts by many of the Bank’s competitors, management believes the account has helped to reduce the Bank’s overall cost of funds and has been an integral part of the Bank’s core account acquisition strategy. Core accounts consist of noninterest-bearing deposits-demand, NOW, money market and savings accounts. Paramount Checking Account balances are generally higher than other account balances, and the account helps the Bank develop an overall relationship with its customers, which frequently leads to cross-selling opportunities, which the Bank actively pursues through direct
mailings and other special promotions. Another component to the Bank’s core account acquisition strategy is the generation of deposit accounts which result from new commercial loan customers who move their deposit relationship to the Bank and the continued expansion of the Bank’s Escrow Ease product. Escrow Ease is specially designed to meet the trust account needs of attorneys, realtors and title companies. At December 31, 2012, the core account balances represented 89.3% of total deposit balances.
Through its Sullivan Financial Services subsidiary (“Sullivan”), the Bank also engages in mortgage banking operations, originating loans primarily for resale into the secondary market and, to a lesser extent, for the Bank’s loan portfolio. We treat the operations of Sullivan as a separate reporting segment apart from our community banking business. See Note 12 to the accompanying Consolidated Financial Statements for financial information on our business segments.
The Company’s results of operations depend primarily on its net interest income, which is the difference between the interest earned on its interest-earning assets and the interest paid on funds borrowed to support those assets, primarily deposits. Net interest margin is the difference between the weighted average rate received on interest-earning assets and the weighted average rate paid on interest-bearing liabilities, and is also affected by the average level of interest-earning assets as compared with that of interest-bearing liabilities. Net income is also affected by the amount of non-interest income and non-interest expenses.
RESULTS OF OPERATIONS - 2012 versus 2011
Net Income
Net income for 2012 was $3.4 million, up $565,000, or 20.1%, from $2.8 million in 2011. On a fully diluted basis, net income per share was $0.63 for 2012, a 21.2% increase from $0.52 in 2011. The significant improvement in both net income and earnings per share for 2012 versus 2011 was due primarily to higher gains on sale of residential mortgages combined with effective cost containment efforts that resulted in lower staff-related costs and lower occupancy and data processing expenses. During 2012, the Company realized $500,000 in net securities gains and incurred a $334,000 pretax charge on the early extinguishment of certain of the Bank’s Federal Home Loan Bank (“FHLB”) borrowings, as part of its overall asset/liability management strategy. Operating results for 2011 included a $267,000 tax-free mortality gain on a bank-owned insurance policy (“BOLI”) and a $426,000 pretax charge on the early extinguishment of certain of the Bank’s FHLB borrowings.
Net Interest Income
Fully taxable equivalent (“FTE”) net interest income for 2012 was $12.1 million, up modestly, from the $12.0 million earned in 2011. The slight increase in net interest income during 2012 was primarily attributable to a 4.7% increase in average interest-earning assets to $334.0 million in 2012 from $318.9 million in 2011, which was partially offset by a 16 basis-point decline in the net interest margin to 3.62% in 2012 from 3.78% in 2011. The increase in average interest earning assets was largely due to growth in average loans, primarily funded by a growth in core deposits. Average loans increased to $235.5 million, or 5.1%, in 2012 over $223.9 million in 2011, while average core deposits (defined as all deposits other than time deposits) grew by 8.0% to $266.3 million in 2012 from $246.5 million in 2011. The excess in average core deposit growth over that of average loans contributed to the increase in the Bank’s average interest earning deposits in 2012 from 2011. The decrease in net interest margin in 2012 versus 2011 was due to the aforementioned increase in average interest earning deposits, which was predominantly invested at low overnight rates, as well as the repricing characteristics of our loans and investment securities, which repriced downward at a faster pace than our deposits.
Average Balance Sheets
The following table sets forth certain information relating to the Company’s average assets and liabilities for the years ended December 31, 2012, 2011, and 2010, as well as the average yield on assets and average cost of liabilities for the periods indicated. Such yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Securities available for sale are reflected in the following table at amortized cost. Nonaccrual loans are included in the average loan balance.
| | | For the years ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| (dollars in thousands) | | Average
Balance | | | Interest | | | Average
Yield/Cost | | | Average
Balance | | | Interest | | | Average
Yield/Cost | | | Average
Balance | | | Interest | | | Average
Yield/Cost | |
| ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | $ | 51,874 | | | $ | 135 | | | | 0.26 | % | | $ | 45,602 | | | $ | 135 | | | | 0.30 | % | | $ | 38,789 | | | $ | 119 | | | | 0.31 | % |
| Loans receivable | | | 235,457 | | | | 11,648 | | | | 4.95 | | | | 223,937 | | | | 11,776 | | | | 5.26 | | | | 206,639 | | | | 11,357 | | | | 5.50 | |
| Investment securities | | | 42,954 | | | | 1,434 | | | | 3.34 | | | | 46,421 | | | | 1,780 | | | | 3.83 | | | | 44,550 | | | | 1,980 | | | | 4.44 | |
| Loans held for sale | | | 2,894 | | | | 127 | | | | 4.40 | | | | 1,989 | | | | 103 | | | | 5.22 | | | | 3,429 | | | | 187 | | | | 5.46 | |
| Restricted stock | | | 815 | | | | 36 | | | | 4.44 | | | | 902 | | | | 43 | | | | 4.79 | | | | 938 | | | | 47 | | | | 5.05 | |
| Total interest earning assets | | | 333,994 | | | | 13,380 | | | | 4.01 | | | | 318,851 | | | | 13,837 | | | | 4.34 | | | | 294,345 | | | | 13,690 | | | | 4.65 | |
| Non-interest earning assets | | | 23,530 | | | | | | | | | | | | 23,699 | | | | | | | | | | | | 23,126 | | | | | | | | | |
| Allowance for loan losses | | | (3,089 | ) | | | | | | | | | | | (2,968 | ) | | | | | | | | | | | (3,160 | ) | | | | | | | | |
| TOTAL ASSETS | | $ | 354,435 | | | | | | | | | | | $ | 339,582 | | | | | | | | | | | $ | 314,311 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing demand deposits | | $ | 153,447 | | | $ | 250 | | | | 0.16 | % | | $ | 145,012 | | | $ | 535 | | | | 0.37 | % | | $ | 131,368 | | | $ | 786 | | | | 0.60 | % |
| Savings accounts | | | 7,772 | | | | 8 | | | | 0.10 | | | | 7,851 | | | | 14 | | | | 0.19 | | | | 6,940 | | | | 19 | | | | 0.27 | |
| Money market accounts | | | 24,200 | | | | 43 | | | | 0.18 | | | | 20,486 | | | | 60 | | | | 0.29 | | | | 20,900 | | | | 91 | | | | 0.44 | |
| Certificates of deposit | | | 37,981 | | | | 728 | | | | 1.92 | | | | 41,494 | | | | 841 | | | | 2.03 | | | | 43,069 | | | | 926 | | | | 2.15 | |
| FHLB advances | | | 7,380 | | | | 260 | | | | 3.52 | | | | 10,082 | | | | 343 | | | | 3.40 | | | | 11,003 | | | | 371 | | | | 3.37 | |
| Other borrowings | | | 3 | | | | — | | | | 0.77 | | | | 3 | | | | — | | | | 0.73 | | | | 3 | | | | — | | | | 0.73 | |
| Federal funds purchased | | | — | | | | — | | | | — | | | | 8 | | | | — | | | | 0.92 | | | | — | | | | — | | | | — | |
| Total interest bearing liabilities | | | 230,783 | | | | 1,289 | | | | 0.56 | | | | 224,936 | | | | 1,793 | | | | 0.80 | | | | 213,283 | | | | 2,193 | | | | 1.03 | |
| Non-interest bearing deposits | | | 80,883 | | | | | | | | | | | | 73,184 | | | | | | | | | | | | 60,330 | | | | | | | | | |
| Other liabilities | | | 1,327 | | | | | | | | | | | | 1,154 | | | | | | | | | | | | 1,325 | | | | | | | | | |
| Total liabilities | | | 312,993 | | | | | | | | | | | | 299,274 | | | | | | | | | | | | 274,938 | | | | | | | | | |
| Stockholders’ Equity | | | 41,442 | | | | | | | | | | | | 40,308 | | | | | | | | | | | | 39,373 | | | | | | | | | |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 354,435 | | | | | | | | | | | $ | 339,582 | | | | | | | | | | | $ | 314,311 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Income | | | | | | $ | 12,091 | | | | | | | | | | | $ | 12,044 | | | | | | | | | | | $ | 11,497 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Rate Spread(1) | | | | | | | | | | | 3.45 | % | | | | | | | | | | | 3.54 | % | | | | | | | | | | | 3.62 | % |
| Net Interest Margin(2) | | | | | | | | | | | 3.62 | % | | | | | | | | | | | 3.78 | % | | | | | | | | | | | 3.91 | % |
| Ratio of Average Interest-Earning Assets to Average Interest-Bearing Liabilities | | | 144.7 | % | | | | | | | | | | | 141.75 | % | | | | | | | | | | | 138.01 | % | | | | | | | | |
| (1) | Net Interest Rate Spread equals Total interest earning assets yield less Total interest bearing liabilities cost. |
| (2) | Net Interest Margin equals Net Interest Income divided by Total average interest earning assets. |
The data contained in the table has been adjusted to a tax equivalent basis, based on the Company’s federal statutory rate of 34 percent. Management believes that this presentation provides comparability of net interest income and net interest margin arising from both taxable and tax-exempt sources and is consistent with industry practice and SEC rules.
Rate/Volume Analysis
The following table presents, by category, the major factors that contributed to the changes in net interest income. Changes due to both volume and rate have been allocated fully to the rate variance.
| | | Year Ended December 31,
2012 versus 2011 | | | Year Ended December 31,
2011 versus 2010 | |
| | | (in thousands) | |
| | | Increase (Decrease)
due to change in Average | | | Increase (Decrease)
due to change in Average | |
| | | Volume | | | Rate | | | Net | | | Volume | | | Rate | | | Net | |
| Interest Income: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | $ | 19 | | | $ | (19 | ) | | $ | — | | | $ | 21 | | | $ | (5 | ) | | $ | 16 | |
| Loans receivable | | | 606 | | | | (734 | ) | | | (128 | ) | | | 951 | | | | (532 | ) | | | 419 | |
| Investment securities | | | (133 | ) | | | (213 | ) | | | (346 | ) | | | 83 | | | | (283 | ) | | | (200 | ) |
| Loans held for sale | | | 47 | | | | (23 | ) | | | 24 | | | | (79 | ) | | | (5 | ) | | | (84 | ) |
| Restricted stock | | | (4 | ) | | | (3 | ) | | | (7 | ) | | | (2 | ) | | | (2 | ) | | | (4 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest income | | | 535 | | | | (992 | ) | | | (457 | ) | | | 974 | | | | (827 | ) | | | 147 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | | 31 | | | | (316 | ) | | | (285 | ) | | | 82 | | | | (333 | ) | | | (251 | ) |
| Savings accounts | | | — | | | | (6 | ) | | | (6 | ) | | | 2 | | | | (7 | ) | | | (5 | ) |
| Money market accounts | | | 11 | | | | (28 | ) | | | (17 | ) | | | (2 | ) | | | (29 | ) | | | (31 | ) |
| Certificates of deposit | | | (72 | ) | | | (41 | ) | | | (113 | ) | | | (34 | ) | | | (51 | ) | | | (85 | ) |
| FHLB advances | | | (92 | ) | | | 9 | | | | (83 | ) | | | (31 | ) | | | 3 | | | | (28 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest expense | | | (122 | ) | | | (382 | ) | | | (504 | ) | | | 17 | | | | (417 | ) | | | (400 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 657 | | | $ | (610 | ) | | $ | 47 | | | $ | 957 | | | $ | (410 | ) | | $ | 547 | |
Provision for Loan Losses
For the year ended December 31, 2012, the Company’s provision for loan losses was $290,000, an increase of $70,000 from $220,000 for the year ended December 31, 2011. The increase in provision for loan losses in 2012 versus 2011 was largely due to growth in the loan portfolio in 2012. The Company’s asset quality metrics, such as nonaccrual loan, charge-off, and delinquency ratios remain sound relative to its competitive peer groups, and the relatively low level of loan loss provisioning during both 2012 and 2011 reflects very few new problem credits. Nevertheless, management continues to believe that there remains a heightened risk in certain segments of the loan portfolio. Management regularly reviews the adequacy of its allowance and may provide for additional provisions in future periods due to increased general weakness in the economy or in our geographic trade area, deterioration or impairment of specific credits, or as management may deem necessary.
Non-Interest Income
The largest component of our non-interest income is gains on sales of mortgage loans originated by Sullivan, our mortgage company subsidiary (see Note 12 to the accompanying Consolidated Financial Statements). The Company also earns non-interest revenue from additional sources such as BOLI, wealth management, fees on deposit accounts, ATM usage, wire transfer, lock box services, and safe deposit boxes.
Non-interest income increased to $2.8 million for the year 2012 from $2.0 million for 2011. After excluding net securities gains realized in both years and a nonrecurring, tax-free mortality gain recorded in 2011 of $267,000 on a BOLI policy, adjusted non-interest income grew 36.0% during 2012 to $2.3 million over the $1.7 million earned in 2011. An increase in gains on sales of residential loans at Sullivan in 2012 to $1.4 million from $786,000 in 2011 was the primary factor contributing to the year-to-year growth in adjusted non-interest income. The gains realized on the sales of investment securities in 2012 amounted to $500,000 and were undertaken by the Company as part of its ongoing asset liability management strategy.
Non-Interest Expense
Management continued its focus on operating efficiency throughout 2012. Non-interest expense declined to $9.3 million for the year 2012 from $9.6 million for all of 2011. Included in non-interest expense were nonrecurring charges on the early extinguishment of FHLB borrowings of $334,000 in 2012 and $426,000 in 2011. Excluding these items, adjusted non-interest expense decreased by $270,000 or 2.9% to $8.9 million for the year 2012 from $9.2 million in the year 2011. The decline in non-interest expense resulted primarily from decreases in personnel, occupancy and data processing expenses.
Income Taxes
The Company recorded provisions for income taxes of $1.8 million and $1.2 million for the full-year 2012 and 2011, respectively. The effective tax rates were 35.1% for 2012 and 29.7% for 2011. The increase in the effective tax rate was due to the previously mentioned tax-free BOLI death benefit received in 2011.
FINANCIAL CONDITION
Total assets as of December 31, 2012 were $368.9 million, largely unchanged from $364.0 million at December 31, 2011. Loans receivable increased by $9.4 million to $241.9 million at year-end 2012, and total cash and cash equivalents increased by $23.4 million to $82.7 million at December 31, 2012, while investment securities available for sale declined $30.2 million to $13.4 million at the end of 2012. Half of the decline in investment securities available for sale during 2012 resulted from planned sales of mortgage-backed and certain government-sponsored agency securities as part of its overall asset liability management strategy. A $12.1 million growth in core deposits (defined as all deposits other than time deposits) to $285.9 million as of year-end 2012 served offset a $6.6 million runoff in time deposits and a $2.0 million decline in FHLB advances.
Loan Portfolio
The Bank’s lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail customers living and working in the Bank’s market area of Somerset, Morris and Union Counties, New Jersey. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of customer service, competitive rate structures and selective marketing have enabled it to gain market entry. Bank mergers and lending restrictions at larger banks competing with the Bank have also contributed to the Bank’s success in attracting borrowers.
Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, inventory and equipment and liens on commercial and residential real estate. Construction, land and land development loans include loans secured by first liens on commercial or residential properties to finance the construction or renovation of such properties. Commercial mortgages include loans secured by first liens on completed commercial properties to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Consumer loans consist primarily of home equity loans secured by 1st or 2nd liens.
During 2012, the loan portfolio was positively impacted by an increase in commercial real estate loan demand, as well as refinancing strategies employed by many of the Bank’s borrowers. With regard to new loan originations, the Bank has made a strategic decision to hold in its loan portfolio a portion of residential mortgages that meet our credit quality standards that were closed by Sullivan Financial, the Bank’s mortgage banking subsidiary.
The following table sets forth the classification of our loans by major category as of December 31, 2012, 2011, 2010, 2009 and 2008, respectively:
| | | December 31, | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| (dollars in thousands) | | Amount | | | Percent of
Total Loans | | | Amount | | | Percent of
Total Loans | | | Amount | | | Percent of
Total Loans | | | Amount | | | Percent of
Total Loans | | | Amount | | | Percent of
Total Loans | |
| Commercial | | $ | 32,192 | | | | 13.3 | % | | $ | 32,206 | | | | 13.9 | % | | $ | 31,556 | | | | 15.2 | % | | $ | 40,102 | | | | 19.4 | % | | $ | 57,600 | | | | 27.3 | % |
| Construction, land and land development | | | 1,902 | | | | 0.8 | | | | 7,505 | | | | 3.2 | | | | 7,489 | | | | 3.6 | | | | 7,540 | | | | 3.7 | | | | 6,945 | | | | 3.3 | |
| Commercial mortgages | | | 130,733 | | | | 54.1 | | | | 113,148 | | | | 48.7 | | | | 98,183 | | | | 47.4 | | | | 100,118 | | | | 48.4 | | | | 84,578 | | | | 40.1 | |
| Residential mortgages | | | 39,766 | | | | 16.5 | | | | 37,360 | | | | 16.1 | | | | 26,907 | | | | 13.0 | | | | 11,656 | | | | 5.6 | | | | 12,718 | | | | 6.0 | |
| Consumer | | | 37,088 | | | | 15.3 | | | | 42,074 | | | | 18.1 | | | | 42,864 | | | | 20.8 | | | | 47,237 | | | | 22.9 | | | | 49,274 | | | | 23.3 | |
| Gross Loans | | | 241,681 | | | | 100.0 | % | | | 232,293 | | | | 100.0 | % | | | 206,999 | | | | 100.0 | % | | | 206,653 | | | | 100.0 | % | | | 211,115 | | | | 100.0 | % |
| Net deferred costs | | | 230 | | | | | | | | 192 | | | | | | | | 147 | | | | | | | | 115 | | | | | | | | 131 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total loans | | | 241,911 | | | | | | | | 232,485 | | | | | | | | 207,146 | | | | | | | | 206,768 | | | | | | | | 211,246 | | | | | |
| Less: Allowance for loan losses | | | 3,158 | | | | | | | | 2,982 | | | | | | | | 2,875 | | | | | | | | 3,111 | | | | | | | | 2,819 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loans | | $ | 238,753 | | | | | | | $ | 229,503 | | | | | | | $ | 204,271 | | | | | | | $ | 203,657 | | | | | | | $ | 208,427 | | | | | |
The following table sets forth fixed and adjustable rate loans in the loan portfolio as of December 31, 2012 in terms of contractual maturity:
| (dollars in thousands) | | Within One
Year | | | One to
Five
Years | | | After Five
Years | | | Total | |
| Loans with Fixed Rate | | $ | 15,175 | | | $ | 6,916 | | | $ | 94,405 | | | $ | 116,496 | |
| Loans with Adjustable Rate | | | 27,581 | | | | 75,665 | | | | 21,939 | | | | 125,185 | |
Asset Quality
The Company’s principal assets are its loans. Inherent in the lending function is the risk of the borrower’s inability to repay a loan under its existing terms. The Company attempts to minimize overall credit risk through loan diversification and its loan approval procedures. Due diligence begins at the time a borrower and the Company begin to discuss the origination of a loan. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source and timing of the repayment of the loan, and other factors are analyzed before a loan is submitted for approval. Loans made are also subject to periodic audit and review.
Non-performing assets include nonaccrual loans and other real estate owned (“OREO”). Generally, a loan is placed on nonaccrual status when principal or interest is past due for a period of 90 days or more, unless the asset is both well secured and in the process of collection. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest, including interest applicable to prior periods, is reversed and charged against current income. OREO refers to real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure. The OREO property is recorded at the lower of cost or estimated fair value at the time of acquisition. Estimated fair value generally represents the estimated sale price based on current market conditions, less estimated costs to sell the property. Holding costs and declines in estimated fair value result in charges to expense after acquisition.
In limited situations the Company will modify or restructure a borrower’s existing loan terms and conditions. A restructured loan is considered a troubled debt restructuring (“TDRs”) when the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower in modifying or renewing a loan that the institution would not otherwise consider. As of December 31, 2012, the Company had one TDR totaling $340,000, which is currently performing under its restructured terms.
The following table sets forth information concerning the Company’s non-performing assets, loans delinquent 90 days or more and still accruing and TDRs as of the dates indicated:
| | | December 31, | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (in thousands) | |
| Nonaccrual loans | | $ | 746 | | | $ | 146 | | | $ | 254 | | | $ | 256 | | | $ | 1,365 | |
| OREO | | | — | | | | — | | | | — | | | | — | | | | — | |
| Total non-performing assets | | $ | 746 | | | $ | 146 | | | $ | 254 | | | $ | 256 | | | $ | 1,365 | |
| Troubled debt restructured loans | | $ | 340 | | | $ | 344 | | | $ | 738 | | | $ | 394 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Loans past due 90 days or more and still accruing | | $ | 420 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Nonaccrual loans to total loans | | | 0.31 | % | | | 0.06 | % | | | 0.12 | % | | | 0.12 | % | | | 0.65 | % |
| Non-performing assets to total assets | | | 0.20 | | | | 0.04 | | | | 0.08 | | | | 0.08 | | | | 0.46 | |
| Allowance for loan losses as a percentage of nonaccrual loans | | | 423 | | | | 2,042 | | | | 1,132 | | | | 1,215 | | | | 207 | |
Other than as disclosed in the table above and impaired loans (as disclosed in Note 3 to the Company’s Consolidated Financial Statements), there were no loans where information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans in the table above.
As of December 31, 2012 and 2011, there were no concentrations of loans to any one borrower or group of borrowers exceeding 10% of the Company’s total loans. The Company’s loans are primarily to businesses and individuals located in northern and central New Jersey which are secured by real estate.
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level considered adequate to provide for probable incurred loan losses. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. The Company’s officers analyze risks within the loan portfolio on a continuous basis, through an external independent loan review function, and by the Company’s Audit Committee. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the Company’s allowance for loan losses.
The following is a summary of the reconciliation of the allowance for loan losses for the periods indicated:
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | (in thousands) | |
| Balance, beginning of year | | $ | 2,982 | | | $ | 2,875 | | | $ | 3,111 | | | $ | 2,819 | | | $ | 3,201 | |
| Charge-offs | | | | | | | | | | | | | | | | | | | | |
| Commercial and commercial mortgage | | | (67 | ) | | | (125 | ) | | | (389 | ) | | | (656 | ) | | | (898 | ) |
| Residential mortgage | | | — | | | | — | | | | — | | | | — | | | | — | |
| Consumer | | | (77 | ) | | | (2 | ) | | | (6 | ) | | | (7 | ) | | | (3 | ) |
| Total Charge-offs | | | (144 | ) | | | (127 | ) | | | (395 | ) | | | (663 | ) | | | (901 | ) |
| Recoveries | | | | | | | | | | | | | | | | | | | | |
| Commercial and commercial mortgage | | | 27 | | | | 14 | | | | 34 | | | | — | | | | — | |
| Real Estate | | | — | | | | — | | | | — | | | | — | | | | — | |
| Consumer | | | 3 | | | | — | | | | — | | | | 5 | | | | 4 | |
| Total Recoveries | | | 30 | | | | 14 | | | | 34 | | | | 5 | | | | 4 | |
| Provision charged to expense | | | 290 | | | | 220 | | | | 125 | | | | 950 | | | | 515 | |
| Balance, end of year | | $ | 3,158 | | | $ | 2,982 | | | $ | 2,875 | | | $ | 3,111 | | | $ | 2,819 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs to average loans outstanding | | | 0.05 | % | | | 0.05 | % | | | 0.17 | % | | | 0.32 | % | | | 0.43 | % |
| Balance of allowance as a percentage of total loans at end of year | | | 1.31 | | | | 1.28 | | | | 1.39 | | | | 1.50 | | | | 1.33 | |
The following table sets forth, for each of the Company’s major lending areas, the amount and percentage of the Company’s allowance for loan losses attributable to such category, and the percentage of total loans represented by such category, as of the periods indicated:
| | | Allocation of the Allowance for Loan Losses (ALL) by Category
For the years ended December 31,
(dollars in thousands) | |
| | | | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| | | Amount | | | % of
ALL | | | % of
Total
Loans | | | Amount | | | % of
ALL | | | % of
Total
Loans | | | Amount | | | % of
ALL | | | % of
Total
Loans | | | Amount | | | % of
ALL | | | % of
Total
Loans | | | Amount | | | % of
ALL | | | % of
Total
Loans | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance applicable to: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial and commercial real estate | | $ | 2,336 | | | | 74.0 | % | | | 65.8 | % | | $ | 2,186 | | | | 73.3 | % | | | 65.8 | % | | $ | 2,109 | | | | 73.4 | % | | | 66.2 | % | | $ | 2,503 | | | | 80.4 | % | | | 71.5 | % | | $ | 2,240 | | | | 79.5 | % | | | 70.7 | % |
| Residential real estate | | | 227 | | | | 7.2 | | | | 16.1 | | | | 215 | | | | 7.2 | | | | 16.1 | | | | 205 | | | | 7.1 | | | | 13.0 | | | | 65 | | | | 2.1 | | | | 5.6 | | | | 64 | | | | 2.3 | | | | 6.0 | |
| Consumer, installment and home equity loans | | | 551 | | | | 17.4 | | | | 18.1 | | | | 531 | | | | 17.8 | | | | 18.1 | | | | 506 | | | | 17.6 | | | | 20.8 | | | | 537 | | | | 17.3 | | | | 22.9 | | | | 489 | | | | 17.3 | | | | 23.3 | |
| Sub-total | | $ | 3,114 | | | | 98.6 | | | | 100.0 | | | $ | 2,932 | | | | 98.3 | | | | 100.0 | | | $ | 2,820 | | | | 98.1 | | | | 100.0 | | | $ | 3,105 | | | | 99.8 | | | | 100.0 | | | $ | 2,793 | | | | 99.1 | | | | 100.0 | |
| Unallocated reserves | | | 44 | | | | 1.4 | | | | — | | | | 50 | | | | 1.7 | | | | — | | | | 55 | | | | 1.9 | | | | — | | | | 6 | | | | 0.2 | | | | — | | | | 26 | | | | 0.9 | | | | — | |
| TOTAL | | $ | 3,158 | | | | 100.0 | % | | | 100.0 | % | | $ | 2,982 | | | | 100.0 | % | | | 100.0 | % | | $ | 2,875 | | | | 100.0 | % | | | 100.0 | % | | $ | 3,111 | | | | 100.0 | % | | | 100.0 | % | | $ | 2,819 | | | | 100.0 | % | | | 100.0 | % |
Investment Securities
The Company maintains an investment portfolio to fund increased loan demand or deposit withdrawals and other liquidity needs and to provide an additional source of interest income. The portfolio is composed of obligations of U.S. Government Agencies, obligations of U.S. States and Political Subdivisions and corporate debt securities, stock in the Federal Home Loan Bank, and equity securities of another financial institution. Corporate debt securities consist of trust preferred securities and corporate debt securities issued by various large-capitalization financial institutions.
Securities are classified as “held-to-maturity” (HTM), “available for sale” (AFS), or “trading” at time of purchase. Securities are classified as HTM based upon management’s intent and the Company’s ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts. Securities which are bought and held principally for resale in the near term are classified as trading securities, which are carried at market value. Realized gains and losses as well as gains and losses from marking the portfolio to market value are included in trading revenue. The Company has no trading securities. Securities not classified as HTM or trading securities are classified as AFS and are stated at fair value. Unrealized gains and losses on AFS securities are excluded from results of operations, and are reported as a component of accumulated other comprehensive (loss) income, net of taxes, which is included in stockholders’ equity. Securities classified as AFS include securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital, or other similar requirements.
Management determines the appropriate classification of securities, whether AFS or HTM, at the time of purchase. The carrying value of our available for sale investment securities portfolio decreased $30.2 million from year-end 2011 to $13.4 million at year-end 2012. This decline was primarily due to sales, calls and maturities of general obligation bonds and mortgage-backed securities issued by U.S. Government sponsored agencies. The carrying value of our held to maturity investment securities portfolio declined to $8.9 million at December 31, 2012 from $10.7 million at year-end 2011. The following table sets forth both the amortized cost and the estimated fair value of the Company’s investment securities portfolio as of the dates indicated.
| | | At December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| (in thousands) | | Amortized
Cost | | | Estimated
Fair Value | | | Amortized
Cost | | | Estimated
Fair Value | | | Amortized
Cost | | | Estimated
Fair Value | |
| Available for sale | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Government sponsored agency securities | | $ | 2,894 | | | $ | 2,921 | | | $ | 14,560 | | | $ | 14,753 | | | $ | 9,051 | | | $ | 9,023 | |
| Mortgage backed securities | | | 7,160 | | | | 7,667 | | | | 22,775 | | | | 23,814 | | | | 18,909 | | | | 19,847 | |
| Collateralized mortgage obligations | | | 1,290 | | | | 1,324 | | | | 2,677 | | | | 2,734 | | | | 5,583 | | | | 5,677 | |
| Corporate debt securities | | | 1,463 | | | | 1,458 | | | | 2,372 | | | | 2,278 | | | | 1,470 | | | | 1,446 | |
| Total available for sale | | | 12,807 | | | | 13,370 | | | | 42,384 | | | | 43,579 | | | | 35,013 | | | | 35,993 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Held to maturity | | | | | | | | | | | | | | | | | | | | | | | | |
| Obligations of US States and Political Subdivisions | | | 7,902 | | | | 8,294 | | | | 9,228 | | | | 9,640 | | | | 9,227 | | | | 9,209 | |
| Corporate debt securities | | | 998 | | | | 892 | | | | 1,510 | | | | 1,209 | | | | 1,513 | | | | 1,339 | |
| Total held to maturity | | | 8,900 | | | | 9,186 | | | | 10,738 | | | | 10,849 | | | | 10,740 | | | | 10,548 | |
| Total securities | | $ | 21,707 | | | $ | 22,556 | | | $ | 53,122 | | | $ | 54,428 | | | $ | 45,753 | | | $ | 46,541 | |
The following table sets forth as of December 31, 2012 and December 31, 2011, the maturity distribution of the Company’s debt investment portfolio:
| | | Maturity of Debt Investment Securities
Securities Available for Sale | |
| | | December 31, 2012 | | | December 31, 2011 | |
| (dollars in thousands) | | Amortized
Cost | | | Estimated
Fair Value | | | Weighted
Average
Yield | | | Amortized
Cost | | | Estimated
Fair Value | | | Weighted
Average
Yield | |
| Within One Year | | $ | 42 | | | $ | 45 | | | | 3.23 | % | | $ | 1,032 | | | $ | 1,034 | | | | 0.52 | % |
| One to Five Years | | | 1,696 | | | | 1,742 | | | | 2.50 | % | | | 8,628 | | | | 8,661 | | | | 1.43 | % |
| Over Five Years | | | 11,069 | | | | 11,583 | | | | 3.49 | % | | | 32,724 | | | | 33,884 | | | | 3.12 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 12,807 | | | $ | 13,370 | | | | | | | $ | 42,384 | | | $ | 43,579 | | | | | |
| | | Maturity of Debt Investment Securities
Securities Held to Maturity | |
| | | December 31, 2012 | | | December 31, 2011 | |
| (dollars in thousands) | | Amortized
Cost | | | Estimated
Fair Value | | | Weighted
Average
Yield* | | | Amortized
Cost | | | Estimated
Fair Value | | | Weighted
Average
Yield (1) | |
| Within One Year | | $ | — | | | $ | — | | | | — | % | | $ | 375 | | | $ | 378 | | | | 4.71 | % |
| One to Five Years | | | 704 | | | | 687 | | | | 1.94 | % | | | 706 | | | | 611 | | | | 2.11 | % |
| Over Five Years | | | 8,196 | | | | 8,499 | | | | 5.86 | % | | | 9,657 | | | | 9,860 | | | | 5.95 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 8,900 | | | $ | 9,186 | | | | | | | $ | 10,738 | | | $ | 10,849 | | | | | |
* Weighted average yield, where applicable, is reflected on a tax equivalent basis.
Deposits
Deposits are the Company’s primary source of funds. Average total deposits increased $16.3 million, or 5.6%, to $304.3 million in 2012 from $288.0 million in 2011. The increase in deposits in 2012 was largely due to growth in demand deposits (both interest- and noninterest-bearing), which increased by $16.1 million, or 7.4%, to $234.3 million in 2012 from $218.2 million in 2011. This growth in demand deposits served to reduce the Bank’s overall cost of deposits.
The following table sets forth the average amount of various types of deposits for each of the periods indicated:
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| (dollars in thousands) | | Average
Amount | | | Average
Yield/Rate | | | Average
Amount | | | Average
Yield/Rate | | | Average
Amount | | | Average
Yield/Rate | |
| Non-interest bearing demand | | $ | 80,883 | | | | — | % | | $ | 73,184 | | | | — | % | | $ | 60,330 | | | | — | % |
| Interest bearing demand | | | 153,447 | | | | 0.16 | | | | 145,012 | | | | 0.37 | | | | 131,368 | | | | 0.60 | |
| Savings and money market | | | 31,972 | | | | 0.16 | | | | 28,337 | | | | 0.26 | | | | 27,840 | | | | 0.39 | |
| Time deposits | | | 37,981 | | | | 1.92 | | | | 41,494 | | | | 2.03 | | | | 43,069 | | | | 2.15 | |
| | | $ | 304,283 | | | | 0.34 | % | | $ | 288,027 | | | | 0.50 | % | | $ | 262,607 | | | | 0.69 | % |
The Company does not typically rely on short-term deposits of $100,000 or more because of the liquidity risks posed by such deposits. The following table summarizes the maturity distribution of time deposits in denominations of $100,000 or more as of December 31, 2012.
| | | Amount | |
| | | (in thousands) | |
| Three months or less | | $ | 3,546 | |
| Over three months through six months | | | 3,757 | |
| Over six months through twelve months | | | 2,303 | |
| Over twelve months | | | 6,908 | |
| Total | | $ | 16,514 | |
Liquidity
The Company’s liquidity is a measure of its ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. The Company’s principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition.
At December 31, 2012, the amount of liquid assets remained at a level management deemed adequate to ensure that, on a short- and long-term basis, contractual liabilities, depositors’ withdrawal requirements, and other operational and customer credit needs could be satisfied. As of December 31, 2012, liquid assets (cash and due from banks, interest bearing deposits at other banks and unencumbered investment securities) were $91.7 million, which represented 24.8% of total assets and 28.1% of total deposits and borrowings.
The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2012, had the ability to borrow $83.5 million. The Bank also has a credit facility with the Federal Reserve Bank of New York for direct discount window borrowings that had, as of December 31, 2012, an approximate borrowing capacity based on pledged collateral of $9.0 million. In addition, the Bank has in place additional borrowing capacity of $18.5 million through correspondent banks. At December 31, 2012, the Bank had aggregate available and unused credit of $105.5 million, which represents the aforementioned facilities totaling $111.0 million net of $5.5 million in outstanding borrowings. At December 31, 2012, the Bank’s outstanding commitments to extend credit and standby letters of credit totaled $86.9 million.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The following table shows the amounts and expected maturities of significant commitments, as of December 31, 2012. Further discussion of these commitments is included in Note 11 to the Consolidated Financial Statements.
| | | One Year
or Less | | | One to Three
Years | | | Three to
Five Years | | | Over Five
Years | | | Total | |
| | | (in thousands) |
| Standby letters of credit | | $ | 1,324 | | | $ | 97 | | | $ | — | | | $ | — | | | $ | 1,421 | |
Commitments under standby letters of credit, both financial and performance letters, do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.
CONTRACTUAL OBLIGATIONS
The following table shows the contractual obligations of the Company by expected payment period, as of December 31, 2012. Further discussion of these commitments is included in Notes 10 and 11 to the Consolidated Financial Statements.
| | | Total | | | Within
One Year | | | One to Three
Years | | | Three to
Five Years | | | Over Five
Years | |
| Contractual Obligation | | (in thousands) |
| Operating Lease Obligations | | $ | 1,010 | | | $ | 364 | | | $ | 545 | | | $ | 101 | | | $ | — | |
| Federal Home Loan Bank Borrowings | | | 5,500 | | | | — | | | | — | | | | 1,500 | | | | 4,000 | |
Operating leases represent obligations entered into by the Company for the use of land, premises and equipment. The leases generally have escalation terms based upon certain defined indexes.
Interest Rate Sensitivity Analysis
The principal objective of the Company’s asset and liability management function is to evaluate the interest-rate risk included in certain balance sheet accounts; determine the level of risk appropriate given the Company’s business focus, operating environment, and capital and liquidity requirements; establish prudent asset concentration guidelines; and manage the risk consistent with Board approved guidelines. The Company seeks to reduce the vulnerability of its operations to changes in interest rates, and actions in this
regard are taken under the guidance of the Asset/Liability Committee (the “ALCO”). The ALCO generally reviews the Company’s liquidity, cash flow needs, maturities of investments, deposits and borrowings, and current market conditions and interest rates.
The Company currently utilizes net interest income simulation and economic value of portfolio equity (“EVPE”) models to measure the potential impact to the Company of future changes in interest rates. As of December 31, 2012 and 2011, the results of the models were within guidelines prescribed by the Company’s Board of Directors. If model results were to fall outside prescribed ranges, action would be required by the ALCO.
The net interest income simulation model attempts to measure the change in net interest income over the next one-year period assuming certain changes in the general level of interest rates. In our model, which was run as of December 31, 2012, we estimated that a gradual (often referred to as “ramped”) 200 basis-point increase in the general level of interest rates will increase our net interest income by 9.3%, while a ramped 200 basis-point decrease in interest rates will decrease net interest income by 2.9%. As of December 31, 2011, our model predicted that a 200 basis-point ramped increase in general interest rates would increase net interest income by 0.1%, while a 200 basis point decrease would decrease net interest income by 1.7%.
An EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of up and down 200 basis points. The economic value of equity is likely to be different as interest rates change. The Company’s variance in EVPE as a percentage of assets as of December 31, 2011, was -0.26% with a rate shock of up 200 basis points, and -1.00% with a rate shock of down 200 basis points. At December 31, 2011, the variances were -1.25% assuming an up 200 basis-point rate shock and -0.34% assuming a down 200 basis-point rate shock.
Capital
A significant measure of the strength of a financial institution is its capital base. The Bank’s Federal regulators have classified and defined capital into the following components: (1) Tier I Capital, which includes tangible stockholders’ equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) Tier II Capital, which includes a portion of the allowance for probable loan losses, certain qualifying long-term debt, and preferred stock which does not qualify for Tier I Capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines which require certain capital as a percent of the Bank’s assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets).
A bank is required to maintain, at a minimum, Tier I Capital as a percentage of risk-adjusted assets of 4.0% and combined Tier I and Tier II Capital as a percentage of risk-adjusted assets of 8.0%.
In addition to the risk-based guidelines, the Bank’s regulators require that an institution which meets the regulator’s highest performance and operation standards maintain a minimum leverage ratio (Tier I Capital as a percentage of average tangible assets) of 4.0%. For those institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be evaluated through the ongoing regulatory examination process.
The following table summarizes the risk-based and leverage capital ratios for the Bank as well as the required minimum regulatory capital ratios:
| | | At December 31, 2012 | |
| | | Actual
Ratio | | | Minimum
Requirement | | | Well
Capitalized
Requirement | |
| Somerset Hills Bank: | | | | | | | | | | | | |
| Total risk-based capital ratio | | | 16.30 | % | | | 8.00 | % | | | 10.00 | % |
| Tier 1 risk-based capital ratio | | | 15.12 | | | | 4.00 | | | | 6.00 | |
| Leverage ratio | | | 11.04 | | | | 4.00 | | | | 5.00 | |
| | | At December 31, 2011 | |
| | | Actual
Ratio | | | Minimum
Requirement | | | Well
Capitalized
Requirement | |
| Somerset Hills Bank: | | | | | | | | | | | | |
| Total risk-based capital ratio | | | 15.03 | % | | | 8.00 | % | | | 10.00 | % |
| Tier 1 risk-based capital ratio | | | 13.91 | | | | 4.00 | | | | 6.00 | |
| Leverage ratio | | | 10.16 | | | | 4.00 | | | | 5.00 | |
The Company’s tangible common equity ratio was 11.34% as of December 31, 2012 and 11.09% as of December 31, 2011.
Borrowings
As an additional source of liquidity, we use advances from the Federal Home Loan Bank of New York. The Company had outstanding advances at December 31, 2012 as follows:
| Maturity | | Rate | | | Amount | |
| November 29, 2017 | | | 3.41 | % | | $ | 1,500,000 | |
| January 8, 2018 | | | 3.12 | % | | $ | 2,000,000 | |
| January 8, 2018 | | | 3.61 | % | | $ | 2,000,000 | |
| | | | | | | $ | 5,500,000 | |
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, nearly all of the assets and liabilities of the Company are monetary. Therefore, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of the impact of recently issued accounting standards, please see Note 1 to the Company’s Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS
The information required by this item is included elsewhere in this Annual Report on Form 10-K. See page 40.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.
(b) Management’s report on internal control over financial reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting was designed by or under the supervision of the Company’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of the preparation of the Company’s financial statements for external and regulatory reporting purposes, in accordance with U.S. generally accepted accounting principles. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control—Integrated Framework issued by the COSO. Based on the assessment, management determined that, as of December 31, 2012, the Company’s internal control over financial reporting is effective.
The forgoing shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section. In addition, this information shall not be deemed to be incorporated by reference into any of the Registrant’s filings with the Securities and Exchange Commission, except as shall be expressly set forth by specific reference in any such filing.
| | /s/ Stewart E. McClure, Jr. | | /s/ Alfred J. Soles | |
| | Stewart E. McClure, Jr. | | Alfred J. Soles | |
| | President & CEO | | Executive Vice President | |
| | | | & Chief Financial Officer | |
(c) Changes in internal controls:
There were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
ITEM 9B. OTHER INFORMATION
Not applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE WITH SECTION 16(A)
The By-Laws of the Company provide that the number of Directors shall not be less than one or more than 25 and permit the exact number to be determined from time to time by the Board of Directors. Our Certificate of Incorporation provides for a Board of Directors divided into three classes. For 2013, there are two nominees for Director.
The Board of Directors of the Company has nominated for election to the Board of Directors the persons named below, each of whom is currently serving as a member of the Board. If elected, each nominee will serve until the 2016 annual meeting of stockholders and until his replacement has been duly elected and qualified. The Board of Directors has no reason to believe that any of the nominees will be unavailable to serve if elected.
The following table sets forth the names, ages, principal occupations, and business experience for all nominees, as well as their prior service on the Board. Each nominee is currently a member of the Board of Directors of the Company. Unless otherwise indicated, principal occupations shown for each Director have extended for five or more years.
NOMINEES FOR ELECTION
Name and Position with
Company | | Age | | Principal Occupation for Past Five Years | | Term of Office
Since(1) - Expires |
| | | | | | | |
Gerald B. O’Connor
Director | | 70 | | Senior Partner, O’Connor, Parsons & Lane, LLC (law firm) | | 1998-2016 |
| | | | | | | |
| M. Gerald Sedam, II | | 70 | | Retired Partner and Senior Advisor, Beck, | | 1998-2016 |
| Director | | | | Mack & Oliver (investment management firm) | | |
(1) Includes prior service on the Board of Directors of the Somerset Hills Bank.
DIRECTORS WHOSE TERMS CONTINUE BEYOND THE 2013 ANNUAL MEETING
(in the event the Merger is not consummated and the Merger Agreement is terminated)
Name and Position with
Company | | Age | | Principal Occupation for Past Five Years | | Term of Office
Since(1) - Expires |
| | | | | | | |
Edward B. Deutsch, Esq.
Chairman of the Board | | 66 | | Managing Partner, McElroy, Deutsch, Mulvaney & Carpenter, LLP (law firm) | | 1998-2014 |
| | | | | | | |
Thomas J. Marino
Director | | 65 | | Co- CEO, CohnReznickLLP (accounting and consulting firm) | | 2003-2014 |
| | | | | | | |
Jefferson W. Kirby
Director | | 51 | | Managing Member of Broadfield Capital Management, LLC (investment management firm) | | 2008-2014 |
| | | | | | | |
William F. Keefe
Director | | 54 | | Senior Portfolio Manager, TSP Capital Management Group; formerly Executive Vice President and Chief Financial Officer, First Morris Bank and Trust | | 2009 - 2015 |
| | | | | | | |
| Stewart E. McClure, Jr. Director, Vice Chairman, President, Chief Executive Officer and Chief Operating Officer | | 62 | | President, Chief Executive Officer and Chief Operating Officer of the Company, President, Chief Executive Officer and Chief Operating Officer of the Bank | | 2001 - 2015 |
(1) Includes prior service on the Board of Directors of the Somerset Hills Bank.
No Director of the Company, other than Mr. Jefferson W. Kirby, is also a director of a company having a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, or subject to the requirements of Section 15(d) of such Act or any company registered as an investment company under the Investment Company Act of 1940. Mr. Kirby is the Chairman of the Board of Alleghany Corporation, a company whose common stock is registered under Section 12 of the Securities Exchange Act of 1934.
The Company encourages all directors to attend the Company’s annual meeting. Other than Mr. Sedam, each of the Company’s directors attended the 2012 annual meeting.
INFORMATION ABOUT THE BOARD OF DIRECTORS
Edward B. Deutsch is the founding and Managing Partner of McElroy, Deutsch, Mulvaney & Carpenter, LLP, New Jersey’s largest law firm with more than 300 attorneys. Mr. Deutsch is a civil trial attorney, certified by the Supreme Court of New Jersey and has been a fellow of the American College of Trial Lawyers since 1992. He is founder and Chairman of the Board of Directors of Somerset Hills Bank. He was recently ranked number 10 on the NJBIZ Power 50 Banking List of the 50 most powerful people in N.J. banking. He is consistently ranked by PolitickerNJ and NJBIZ as one of the top 100 most influential people doing business in N.J. He is also consistently listed as a top lawyer by Best Lawyers, the oldest and most highly respected peer review guide to the legal profession worldwide. Mr. Deutsch has served on a number of other boards of directors and trustees. He and his wife Nancy live in Bernardsville and are active in numerous charitable endeavors.
William Keefe is a Senior Portfolio Manager with TSP Capital Management Group, Summit, NJ.A former banking executive with over 25 years’ experience as a CFO, Treasurer and Controller, Mr. Keefe has extensive experience in Asset/Liability and Treasury management, Mergers and Acquisitions, Human Resources, and corporate governance. Mr. Keefe has value added input in all financial matters that impact the Board.
Jefferson W. Kirby is the Managing Member, Broadfield Capital Management, LLC. Mr. Kirby’s extensive business background in acquisitions and investment analysis, strategic planning and investment management brings unique insight to the Board. His undergraduate degree from Lafayette College,his MBA from Duke University and his former directorships on several bank boards and boards of publicly traded companies provide him with unique experience and insight that benefits our Board. Mr. Kirby is also Chairman of the Board of Alleghany Corporation.
Thomas Marino is a Partner and Co-CEO of CohnReznick LLP, which is headquartered in New York and among the 11th largest accounting and consulting firms in the United States. Mr. Marino brings his more than 40 years of experience as a CPA to the Board. The Chairman of the Audit Committee, Mr. Marino has expertise in the areas of real estate, construction, private companies and publicly traded companies. His membership in professional associations and his advisory roles in local community service organizations and foundations further enable him to make valuable contributions to the Board
Stewart E. McClure, Jr. is the President and Chief Executive Officer of the Company and Bank, Mr. McClure’s insight and expertise is critical to the Board’s oversight of the Company’s operations. His 40+ years in banking, with broad experience in many areas, particularly lending, has helped manage the assets and investments of the Company for the benefit of its shareholders.
Gerald B. O’Connor is a Senior Partner of O’Connor, Parsons & Lane, LLC, Mr. O’Connor specializes in all areas of personal injury litigation. He is a founding Director of Somerset Hills Bank; he has served on the Audit Committee from 1999-2003 and is currently Chairman of the Compensation, Nominating and Human Resources committee. He is a seasoned attorney who adds considerable insight to all areas of importance to the Board.
M. Gerald Sedam, II– is a former partner and now senior advisor to Beck, Mack & Oliver, an investment management firm; Mr. Sedam provides a unique perspective on a range of issues to the Board. He earned his MBA at the Wharton Graduate School of Business; he is a past member of the Board of Directors of the New York Society of Security Analysts and is a Trustee Emeritus of Colgate University, where he earned his undergraduate degree. His understanding of the securities markets and finance is a significant benefit to the Board.
Code of Business Conduct and Ethics
The Board of Directors has adopted a Code of Business Conduct and Ethics governing the Company’s CEO and senior financial officers, as required by the Sarbanes-Oxley Act and SEC regulations, as well as the Board of Directors and other senior members of management. Our Code of Business Conduct governs such matters as conflicts of interest, use of corporate opportunity, confidentiality, compliance with law and the like. Our Code of Ethics is available on our website at www.somersethillsbank.com.
Audit Committee
The Company maintains an Audit Committee. The Audit Committee is responsible for the selection of the independent registered accounting firm for the annual audit and to establish, and oversee the adherence to, a system of internal controls. The Audit Committee reviews and accepts the reports of the Company’s independent auditors and regulatory examiners. The Audit Committee arranges for the Bank’s directors’ examinations through its independent certified public accountants, evaluates and implements the recommendations of the directors’ examinations and interim audits performed by the Bank’s internal auditors, receives all reports of examination of the Company and the Bank by bank regulatory agencies, analyzes such regulatory reports, and reports to the Board the results of its analysis of the regulatory reports. The Audit Committee met four times during 2012. The Board of Directors has adopted a written charter for the Audit Committee which is available on our website at www.somersethillsbank.com. The Audit Committee currently consists of Messrs. Marino (Chairman), Kirby, Keefe, and Sedam, all of whom are “independent” under the NASDAQ listing standards and meet the independence standards of the Sarbanes-Oxley Act. In addition, Mr. Marino has been determined by the Board to be the Audit Committee financial expert; as such term is defined by SEC Rules.
COMPLIANCE WITH SECTION 16(A)
The Company believes that all persons associated with the Company and subject to Section 16(a) have timely made all required filings for the fiscal year ended December 31, 2012, except as disclosed herein. Late filings were made for all board members for the stock option award granted on October 23, 2012. The delay was in part caused by the effects of Super Storm Sandy, which impacted the east coast. Mr. Soles’ initial Form 3 was filed late.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth for the prior three years the compensation paid to the CEO, and up to two other most highly compensated executive officers of the Company earning in excess of $100,000 (the “named executive officers”) as of the fiscal year ended December 31, 2012.
Name and
Principal
Position | | | Year | | | Salary
($) | | | Bonus
($)1 | | | Option
Awards
($)2 | | | All Other
Compensation
($) | | | Total
($) | |
| | | | | | | | | | | | | | | | | | | |
| Stewart E. McClure, Jr., | | | 2012 | | | | 265,000 | | | | 130,000 | | | | — | | | | 7,059 | | | | 402,059 | |
| President, Chief Executive | | | 2011 | | | | 262,500 | | | | 50,000 | | | | 29,280 | | | | 9,251 | | | | 351,031 | |
| Officer and Chief Operating | | | 2010 | | | | 257,500 | | | | 25,000 | | | | 16,500 | | | | 6,798 | | | | 305,798 | |
| Officer | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| James Nigro | | | 2012 | | | | 155,309 | | | | 75,000 | | | | 7,875 | | | | 5,495 | | | | 243,679 | |
| EVP and Chief Lending | | | 2011 | | | | 154,000 | | | | 30,000 | | | | 14,640 | | | | 313 | | | | 198,953 | |
| Officer | | | 2010 | | | | 147,500 | | | | 15,000 | | | | 8,250 | | | | 305 | | | | 171,055 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Alfred J. Soles3 | | | 2012 | | | | 38,850 | | | | 15,000 | | | | 7,875 | | | | 432 | | | | 62,157 | |
| EVP and Chief Financial Officer | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | Bonuses paid to all employees in 2012 were for bank performance in 2011 and 2012. The 2012 bonus was paid prior to the end of 2012 for tax reasons. |
| (2) | Represents the grant date fair value computed in accordance with FASB ASC Topic 718. |
| (3) | Mr. Soles joined Somerset Hills Bank on October 9, 2012 at an annual salary of $125,000. |
Stewart E. McClure, Jr. serves as the President, Chief Executive Officer, Chief Operating Officer and Vice Chairman of the Company and the Bank pursuant to the terms of an employment agreement originally signed in March 2001 and subsequently amended. The agreement has one-year terms which automatically renew unless either party gives six months’ notice of its intent not to renew. Pursuant to the employment agreement, Mr. McClure is entitled to be paid an annual base salary as determined by the Board, although it cannot be less than his prior year’s salary adjusted by the Consumer Price Index.
The Bank is also party to a Supplemental Executive Retirement Plan with Mr. McClure. Under the plan, Mr. McClure will receive an annual retirement benefit of $48,000 per year for 15 years, commencing upon the date he turns 65. In the event of Mr. McClure’s death prior to his retirement, or in the event of his death after his retirement date, Mr. McClure’s beneficiary will receive the payments due under the plan. Mr. McClure’s benefits under the plan are currently vested, unless he voluntarily leaves his employment prior to age 65. In 2012, the Bank accrued $74,619 in connection with Mr. McClure’s plan.
Potential Payments upon Termination or Change-in-Control
Mr. McClure’s employment agreement contains several provisions which provide for payments upon the termination of his employment or a change in control of the Company. The employment agreement provides that if Mr. McClure terminates his employment upon certain circumstances that are defined as good reason, or if his employment is terminated without “just cause” as defined in his contract, he will be entitled to receive a lump sum payment equal to twice his then current base salary and twice the bonus he received in the preceding contract year. He is also entitled to receive continued medical and insurance coverage for a period equal to the lesser of (i) two years or (ii) until he receives medical and insurance coverage from a new employer. He is also entitled to continue to receive from the Company or its successor use of an automobile and payment of his club membership. “Good reason” is defined under Mr. McClure’s agreement as including:
| · | Any breach of the agreement by the Company which has not been cured within ten days; |
| · | After a change in control, the assignment of Mr. McClure to duties inconsistent with his position before the change in control or failure to elect Mr. McClure to any position he held prior to the change in control; |
| · | After a change in control, any reduction in Mr. McClure’s compensation or the relocation of his place of employment by more than 25 miles from its location prior to the change in control; or |
| · | After a change in control, the company’s decision not to renew Mr. McClure’s employment agreement. |
If the Company provides notice to Mr. McClure that it will not extend his contract, it will be deemed a termination without just cause under the agreement.
If Mr. McClure were terminated at December 31, 2012, without just cause, or if he were entitled to resign for good reason, he would
be entitled to the following benefits:
| Salary and bonus | | $ | 670,000 | |
| Medical and insurance coverage(1) | | | 31,374 | |
| Automobile usage(1) | | | 34,594 | |
| Club membership(1) | | | 23,576 | |
(1) Assumes two years of coverage
If Mr. McClure is terminated with “just cause”, he will not be entitled to any further compensation.
If Mr. McClure’s employment is terminated other than for cause after a change in control, he will be entitled to receive a severance payment of three times his then current base salary and bonus, unless he is offered employment, and continues such employment after the change in control for at least two years, in which case he will be entitled to two and one-half times his then current base salary and bonus. If his employment is terminated prior to the end of the two-year period, he will be entitled to the difference between the amount he was paid and the amount he would have received had his employment been terminated upon the change in control. Mr. McClure’s employment agreement also provides that in no event may any severance payment payable under the agreement for any reason, whether in the event of a change in control, termination without just cause or resignation for good reason, equal more than 3 times his “base amount”, calculated in accordance with Section 280G of the Internal Revenue Code and regulations thereunder. If any such payment would exceed the permissible amount, it will be reduced to $1.00 less than the amount which equals three times Mr. McClure’s “base amount”. Mr. McClure will also be entitled to the insurance, automobile and club payments described above. In the event a change in control occurred on December 31, 2012 and Mr. McClure was not retained or did not accept continued employment, he would be entitled to the following benefits:
| Salary and Bonus | | $ | 1,005,000 | |
| Medical and insurance coverage(1) | | | 31,374 | |
| Automobile usage(1) | | | 34,594 | |
| Club membership(1) | | | 23,576 | |
(1) Assumes two years of coverage
Mr. McClure’s employment agreement defines a change in control as including:
| · | Any event requiring the filing of a Current Report on Form 8-K to announce a change in control; |
| · | Any person acquiring 25% or more of the company’s voting power; |
| · | If, over any two-year period, persons who serve on the Board at the beginning of the period fail to make up a majority of the Board at the end of the period; |
| · | If the company fails to satisfy the listing criteria for any exchange or which its shares are traded due to the number of shareholders or the number of round lot holders; or |
| · | If the Board of the company approves any transaction after which the shareholders of the company fail to control 51% of the voting power of the resulting entity. |
Mr. McClure’s employment agreement contains several restrictive covenants. For a period of one year after the termination of Mr. McClure’s employment, he is not permitted to solicit any customer of the Company or the Bank to become a customer of any other party or entity. In addition, he is not permitted to solicit any employee of the Company or the Bank to become employed by any other party.
The Company also entered into a change in control agreement with Mr. Soles in 2012. Under this agreement, in the first year of employment, upon a change in control, provided certain provisions in the agreement are met, Mr. Soles is entitled to receive a payment equal to 50% of his then current base salary, but in no event less than $75,000 In the event of a change in control as of December 31, 2012, Mr. Soles would have been entitled to a payment of $75,000. The Company has a change in control agreement with Mr. Nigro. Under this agreement, upon a change in control, provided certain provisions in the agreement are met, Mr. Nigro is entitled to receive a payment equal to one and one-half times the sum of (i) the highest annual salary paid during the twenty four months prior to the consummation of the change in control and (ii) the highest annual bonus paid to or accrued over the twenty four months prior the consummation of the change in control. In the event of a change in control as of December 31, 2012, Mr. Nigro would have been entitled to a payment of $322,500.
OUTSTANDING EQUITY AWARDS AT 2012 FISCAL YEAR-END
| | | | | Option Awards1 | | | | |
| Name | | Number of Securities
Underlying
Unexercised Options
(#) Exercisable | | Number of Securities
Underlying Unexercised
Options
(#) Un-exercisable | | Option Exercise
Price ($) | | Option Expiration
Date |
| | | | | | | | | |
| Stewart E. McClure, Jr. | | 98,169 | | | | 6.05 | | 03/19/2014 |
| | | 6,701 | | | | 9.65 | | 04/01/2014 |
| | | 6,382 | | | | 9.28 | | 04/01/2015 |
| | | 3,859 | | | | 11.56 | | 05/23/2017 |
| | | 5,250 | | 5,250 | | 7.52 | | 02/01/2020 |
| | | 2,500 | | 7,500 | | 9.83 | | 02/02/2021 |
| | | 2,000 | | 6,000 | | 7.85 | | 10/25/2021 |
| | | | | | | | | |
| Alfred J. Soles | | | | 7,500 | | 8.57 | | 10/23/2022 |
| | | | | | | | | |
| James Nigro | | 2,681 | | | | 9.65 | | 04/01/2014 |
| | | 2,553 | | | | 9.28 | | 04/01/2015 |
| | | 551 | | | | 11.56 | | 05/23/2017 |
| | | 827 | | | | 11.36 | | 07/19/2017 |
| | | 2,625 | | 2,625 | | 7.52 | | 02/01/2020 |
| | | 1,250 | | 3,750 | | 9.83 | | 02/02/2021 |
| | | 1,000 | | 3,000 | | 7.85 | | 10/25/2021 |
| | | | | 7,500 | | 8.57 | | 10/23/2022 |
| 1 | Option awards vest in four equal amounts on the anniversaries of the date of grant, based on the vesting terms established at the time of issuance. Vesting will accelerate in the event of a change-in-control, as defined in the applicable plans. |
DIRECTOR COMPENSATION
| Name | | Fees Earned or Paid in Cash
($) | | Option
Awards
($) | | All Other
Compensation
($) | | Total
($) |
| Edward B. Deutsch1 | | — | | 3,150 | | 60,000 | | 63,150 |
| William F. Keefe2 | | 30,000 | | 3,150 | | — | | 33,150 |
| Jefferson W. Kirby3 | | 27,500 | | 3,150 | | — | | 30,650 |
| Thomas J. Marino4 | | 32,500 | | 3,150 | | — | | 35,650 |
| Gerald O’Connor5 | | 32,500 | | 3,150 | | — | | 35,650 |
| M. Gerald Sedam,II6 | | 30,000 | | 3,150 | | — | | 33,150 |
| 1 | Mr. Deutsch serves as an executive officer of the Company, and is compensated as an employee of the Company. He does not receive any additional compensation for serving on the Board of Directors. At December 31, 2012, Mr. Deutsch held options to purchase 26,869 shares of common stock. |
| 2 | At December 31, 2012, Mr. Keefe held options to purchase 6,313 shares of common stock. |
| 3 | At December 31, 2012, Mr. Kirby held options to purchase 9,900 shares of common stock. |
| 4 | At December 31, 2012, Mr. Marino held options to purchase 10,770 shares of common stock. |
| 5 | At December 31, 2012, Mr. O’Connor held options to purchase 6,750 shares of common stock. |
| 6 | At December 31, 2012, Mr. Sedam held options to purchase 6,750 shares of common stock. |
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Security Ownership of Management
The following table sets forth information as of March 1, 2013 regarding the number of shares of Common Stock beneficially owned by all Directors, executive officers described in the compensation table, and by all Directors and executive officers as a group (9 Persons).
| Name | | Common Stock
Beneficially Owned (A) | | | Percentage
of Class | |
| Edward B. Deutsch | | | 136,853 | 1 | | | 2.47 | % |
| William F. Keefe | | | 5,745 | 2 | | | 0.10 | |
| Jefferson W. Kirby | | | 118,459 | 3 | | | 2.13 | |
| Thomas J. Marino | | | 11,089 | 4 | | | 0.20 | |
| Stewart E. McClure, Jr. | | | 206,750 | 5 | | | 3.73 | |
| James M. Nigro | | | 31,019 | 6 | | | 0.56 | |
| Gerald B. O’Connor | | | 21,386 | 7 | | | 0.38 | |
| M. Gerald Sedam, II | | | 134,054 | 8 | | | 2.42 | |
| Alfred J. Soles | | | 1,000 | | | | 0.02 | |
| All Directors and Executive Officers as a Group (9 Persons) | | | 666,355 | | | | 12.01 | % |
| (A) | Beneficial ownership includes shares, if any, held in the name of the spouse, minor children or other relatives of the nominee living in such person’s home, as well as shares, if any, held in the name of another person under an arrangement whereby the Director or executive officer can vest title in himself at once or within sixty days. Beneficially owned shares also include shares over which the named person has sole or shared voting or investment power, shares owned by corporations controlled by the named person, and shares owned by a partnership in which the named person is a general partner. |
None of the shares disclosed in the table above are pledged as security for extensions of credit.
| 1 | Includes 21,556 shares purchasable pursuant to immediately exercisable stock options, 18,815 shares held by Mr. Deutsch’s spouse and 74,238 shares held in a Trust. |
| 2 | Includes 1,000 shares purchasable pursuant to exercisable stock options. |
| 3 | Includes 78,872 shares held by Mr. Kirby’s spouse and children and an LLC of which Mr. Kirby is the sole member and 4,587 shares purchasable pursuant to exercisable stock options. |
| 4 | Includes 5,547 shares purchasable pursuant to exercisable stock optionsand 2,000 shares held by Mr. Marino’s spouse. |
| 5 | Includes 129,986 shares purchasable pursuant to exercisable stock options, 1,126 shares held by Mr. McClure’s spouse, and 12,395 shares held in a self-directed retirement plan. |
| 6 | Includes 14,050 shares purchasable pursuant to exercisable stock options. |
| 7 | Includes 1,437 shares purchasable pursuant to exercisable stock options. |
| 8 | Includes 1,437 shares purchasable pursuant to exercisable stock options. |
The following table sets forth information with respect to the Company’s equity compensation plans as of the end of the most recently completed fiscal year.
Equity Compensation Plan Information
| Plan category | | Number of securities
to be issued
upon exercise of
outstanding options,
warrants and rights
(a) | | | Weighted-average
exercise price of
outstanding options,
warrants and rights
(b) | | | Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a)
(c) | |
| | | | | | | | | | |
| Equity compensation plans approved by security holders | | | 334,536 | | | $ | 7.95 | | | | 105,479 | |
| | | | | | | | | | | | | |
| Equity compensation plans not approved by security holders | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | |
| Total | | | 334,536 | | | $ | 7.95 | | | | 105,479 | |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company, including its subsidiary and affiliates, has had, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal stockholders and their associates, on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with others. Those transactions do not involve more than the normal risk of collectability or present other unfavorable features.
Other than the ordinary course lending transactions or the extension of credit to insiders set forth above made pursuant to Regulation O, which must be approved by the Bank’s Board under bank regulatory requirements, all related party transactions are reviewed and approved by our Audit Committee. This authority is provided to our Audit Committee under its written charter. In reviewing these transactions, our Audit Committee seeks to ensure that the transaction is no less favorable to the Company than a transaction with an unaffiliated third party. During 2012, there were no transactions with related parties which would not have been required to be approved by our Audit Committee, and there were no related party transactions not approved by our Audit Committee.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Company’s independent registered auditors for the fiscal year ended December 31, 2012 were Crowe Horwath LLP. Crowe Horwath LLP has advised the Company that one or more of its representatives will be present at the annual meeting to make a statement if they so desire and to respond to appropriate questions.
Principal Accounting Firm Fees
Aggregate fees billed to the Company by the Company’s principal accounting firm for the year are shown in the following table:
| | | 2012 | | | 2011 | |
| Audit and related fees | | $ | 145,000 | | | $ | 144,500 | |
| All other fees | | | — | | | | — | |
| | | | | | | | | |
| Total fees | | $ | 145,000 | | | $ | 144,500 | |
ITEM 15. EXHIBITS
(a) Exhibits
| Exhibit number | | Description of Exhibits |
| | | |
| 2.1 | | Agreement and Plan of Merger by and between Lakeland Bancorp and Somerset Hills Bancorp(1) |
| | | |
| 3.1 | | Certificate of Incorporation of Somerset Hills Bancorp(2) |
| | | |
| 3.2 | | Bylaws of Somerset Hills Bancorp(3) |
| | | |
| 3.3 | | Certificate of Incorporation for Somerset Hills Bank(2) |
| | | |
| 3.4 | | Bylaws of Somerset Hills Bank(2) |
| | | |
| 4.1 | | Specimen Common Stock Certificate(2) |
| | | |
| 10.1 | | 2001 Combined Stock Option Plan(2) |
| | | |
| 10.2 | | 2007 Equity Incentive Plan(4) |
| | | |
| 10.3 | | Supplemental Retirement Plan dated July 19, 2007 with Stewart E. McClure, Jr.(5) and as amended on January 28, 2013(8) |
| | | |
| 10.4 | | Form of Change in Control Agreement with James Nigro(6) |
| | | |
| 10.5 | | Employment Agreement of Stewart E. McClure, Jr. as amended(1) on May 15, 2003(6), September 26, 2007, January 16, 2009(7)and January 28, 2013(8) |
| | | |
| 10.6 | | Form of Change in Control Agreement dated October 1, 2012 with Alfred J. Soles(9) |
| | | |
| 10.7 | | Form of Change in Control Agreement dated January 10, 2013 with David Lidster |
| | | |
| 14 | | Code of Ethics(10) |
| | | |
| 21 | | Subsidiaries of Somerset Hills Bancorp |
| | | |
| 23 | | Consent of Crowe Horwath LLP |
| | | |
| 31 | | Rule 13a-14(a)/15d-14(a) Certifications |
| | | |
| 32 | | Section 1350 Certification |
| (1) | | Incorporated by reference from Exhibit 2.1 of Current Report on Form 8-K filed January 28, 2013. |
| | | |
| (2) | | Incorporated by reference from the Registrant’s Registration Statement on Form SB-2, as amended, File No. 333-99647, declared effective on November 12, 2002. |
| | | |
| (3) | | Incorporated by reference from Current Report on Form 8-K filed December 20, 2007. |
| | | |
| (4) | | Incorporated by reference from Exhibit 4 from the Registrant’s registration Statement on Form S-8 File No.333 – 143194 filed on May 23, 2007. |
| | | |
| (5) | | Incorporated by reference from Exhibits 10.1 and 10.2 of Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 and as amended as set forth in the Current Report on Form 8-K filed July 28, 2008. |
| | | |
| (6) | | Incorporated by reference from Exhibit 10.1 of Current Report on Form 8-K filed May 19, 2011. |
| | | |
| (7) | | Incorporated by reference from Exhibit 10.3 of Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 and Exhibit 10.4(1) and (2) to Annual Report on Form 10-K for the year ended December 31, 2010. |
| | | |
| (8) | | Incorporated by reference from Exhibit 10.2 of Current Report on Form 8-K filed January 28, 2013. |
| | | |
| (9) | | Incorporated by reference from Exhibit 10.1 of Quarterly Report on form 10-Q for the quarter ended September 30, 2012. |
| | | |
| (10) | | Incorporated by reference from Exhibit 14 from the Registrant’s Annual Report on Form 10-KSB for the year ended December 31, 2003. |
SOMERSET HILLS BANCORP AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Somerset Hills Bancorp
Bernardsville, New Jersey
We have audited the accompanying consolidated statements of financial condition of Somerset Hills Bancorp and subsidiary as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Somerset Hills Bancorp and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
Livingston, New Jersey
March 11, 2013
SOMERSET HILLS BANCORP AND SUBSIDIARY
Consolidated Statements of Financial Condition
December 31, 2012 and 2011
(Dollars in Thousands)
| | | 2012 | | | 2011 | |
| ASSETS | | | | | | | | |
| Cash and due from banks | | $ | 7,544 | | | $ | 4,588 | |
| Federal funds sold | | | 75,127 | | | | 54,636 | |
| Total cash and cash equivalents | | | 82,671 | | | | 59,224 | |
| | | | | | | | | |
| Interest bearing deposits in other financial institutions | | | 775 | | | | 775 | |
| Loans held for sale | | | 6,977 | | | | 2,969 | |
| | | | | | | | | |
| Investment securities available for sale | | | 13,370 | | | | 43,579 | |
| Investment securities held to maturity (Estimated fair value of $9,186 in 2012 and $10,849 in 2011) | | | 8,900 | | | | 10,738 | |
| Restricted stock, at cost | | | 743 | | | | 784 | |
| | | | | | | | | |
| Loans receivable | | | 241,911 | | | | 232,485 | |
| Less: allowance for loan losses | | | (3,158 | ) | | | (2,982 | ) |
| Net loans receivable | | | 238,753 | | | | 229,503 | |
| | | | | | | | | |
| Premises and equipment, net | | | 4,868 | | | | 4,996 | |
| Bank owned life insurance | | | 8,245 | | | | 8,000 | |
| Accrued interest receivable | | | 1,036 | | | | 1,168 | |
| Prepaid expenses | | | 790 | | | | 985 | |
| Other assets | | | 1,802 | | | | 1,304 | |
| Total assets | | $ | 368,930 | | | $ | 364,025 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| | | | | | | | | |
| LIABILITIES | | | | | | | | |
| Deposits | | | | | | | | |
| Noninterest-bearing deposits-demand | | $ | 87,279 | | | $ | 80,532 | |
| Interest bearing deposits | | | | | | | | |
| NOW, money market and savings | | | 198,595 | | | | 193,276 | |
| Certificates of deposit, under $100,000 | | | 17,799 | | | | 20,875 | |
| Certificates of deposit, $100,000 and over | | | 16,514 | | | | 20,031 | |
| Total deposits | | | 320,187 | | | | 314,714 | |
| | | | | | | | | |
| Federal Home Loan Bank advances | | | 5,500 | | | | 7,500 | |
| Other liabilities | | | 1,395 | | | | 1,442 | |
| Total liabilities | | | 327,082 | | | | 323,656 | |
| Commitments and contingencies (notes 10 and 11) | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS’ EQUITY | | | | | | | | |
| Preferred stock-1,000,000 shares authorized; none issued | | | — | | | | — | |
| Common stock-authorized, 9,000,000 shares of no par value; issued and outstanding, 5,369,673 in 2012 and 5,344,648 in 2011 | | | 37,143 | | | | 36,972 | |
| Retained earnings | | | 4,333 | | | | 2,608 | |
| Accumulated other comprehensive income | | | 372 | | | | 789 | |
| Total stockholders’ equity | | | 41,848 | | | | 40,369 | |
| Total liabilities and stockholders’ equity | | $ | 368,930 | | | $ | 364,025 | |
See accompanying notes to consolidated financial statements.
SOMERSET HILLS BANCORP AND SUBSIDIARY
Consolidated Statements of Income
Years ended December 31, 2012 and 2011
(Dollars in thousands, except per share data)
| | | 2012 | | | 2011 | |
| INTEREST INCOME | | | | | | | | |
| Loans, including fees | | $ | 11,775 | | | $ | 11,879 | |
| Investment securities | | | 1,294 | | | | 1,626 | |
| Interest bearing deposits with other banks | | | 135 | | | | 135 | |
| Total interest income | | | 13,204 | | | | 13,640 | |
| | | | | | | | | |
| INTEREST EXPENSE | | | | | | | | |
| Deposits | | | 1,029 | | | | 1,450 | |
| Federal Home Loan Bank advances | | | 260 | | | | 343 | |
| Total interest expense | | | 1,289 | | | | 1,793 | |
| | | | | | | | | |
| Net interest income | | | 11,915 | | | | 11,847 | |
| | | | | | | | | |
| PROVISION FOR LOAN LOSSES | | | 290 | | | | 220 | |
| | | | | | | | | |
| Net interest income after provision for loan losses | | | 11,625 | | | | 11,627 | |
| | | | | | | | | |
| NON-INTEREST INCOME | | | | | | | | |
| Service fees on deposit accounts | | | 322 | | | | 286 | |
| Gains on sales of mortgage loans and fees, net | | | 1,362 | | | | 786 | |
| Bank owned life insurance | | | 270 | | | | 555 | |
| Gain on sales of investment securities, net | | | 500 | | | | 9 | |
| Other income | | | 394 | | | | 366 | |
| Total non-interest income | | | 2,848 | | | | 2,002 | |
| NON-INTEREST EXPENSE | | | | | | | | |
| Salaries and employee benefits | | | 5,238 | | | | 5,324 | |
| Occupancy expense | | | 1,328 | | | | 1,499 | |
| Advertising and business promotion | | | 119 | | | | 129 | |
| Stationery and supplies | | | 134 | | | | 128 | |
| Data processing | | | 505 | | | | 539 | |
| Loss on debt extinguishment | | | 334 | | | | 426 | |
| Other operating expenses | | | 1,607 | | | | 1,582 | |
| Total non-interest expense | | | 9,265 | | | | 9,627 | |
| Income before income taxes | | | 5,208 | | | | 4,002 | |
| | | | | | | | | |
| PROVISION FOR INCOME TAXES | | | 1,830 | | | | 1,189 | |
| NET INCOME | | $ | 3,378 | | | $ | 2,813 | |
| Earnings per share: | | | | | | | | |
| Basic | | $ | 0.63 | | | $ | 0.52 | |
| Diluted | | $ | 0.63 | | | $ | 0.52 | |
| | | | | | | | | |
| Weighted average shares outstanding-basic | | | 5,333,723 | | | | 5,409,947 | |
| Weighted average shares outstanding-diluted | | | 5,371,483 | | | | 5,459,476 | |
See accompanying notes to consolidated financial statements.
SOMERSET HILLS BANCORP AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
Years ended December 31, 2012 and 2011
(Dollars in thousands)
| | | 2012 | | | 2011 | |
| | | | | | | | | |
| Net income | | $ | 3,378 | | | $ | 2,813 | |
| | | | | | | | | |
| Unrealized gains and losses on securities available for sale: | | | | | | | | |
| Net (losses) gains arising during the year | | | (131 | ) | | | 226 | |
| Reclassification adjustment for gains in realized income | | | (500 | ) | | | (9 | ) |
| | | | | | | | | |
| Net change in unrealized (losses) gains | | | (631 | ) | | | 217 | |
| Tax effect | | | 214 | | | | (74 | ) |
| | | | | | | | | |
| Other comprehensive (loss) income | | | (417 | ) | | | 143 | |
| | | | | | | | | |
| Comprehensive income | | $ | 2,961 | | | $ | 2,956 | |
See accompanying notes to consolidated financial statements.
SOMERSET HILLS BANCORP AND SUBSIDIARY
Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2012 and 2011
(Dollars in Thousands)
| | | Common
Stock
Number of
Shares | | | Common
Stock | | | Retained
Earnings | | | Accumulated
Other
Comprehensive
Income (loss),
Net of tax | | | Total | |
| Balance January 1, 2011 | | | 5,421,924 | | | $ | 37,600 | | | $ | 1,145 | | | $ | 646 | | | $ | 39,391 | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercise of common stock options, net of tax benefit | | | 34,371 | | | | 210 | | | | — | | | | — | | | | 210 | |
| Stock based compensation | | | | | | | 44 | | | | — | | | | — | | | | 44 | |
| Net income for the period | | | | | | | — | | | | 2,813 | | | | — | | | | 2,813 | |
| Forfeiture of restricted shares | | | (979 | ) | | | — | | | | — | | | | — | | | | — | |
| Cash dividend paid ($0.25 per share) | | | | | | | — | | | | (1,350 | ) | | | — | | | | (1,350 | ) |
| Common stock repurchased | | | (110,668 | ) | | | (882 | ) | | | — | | | | — | | | | (882 | ) |
| Other comprehensive income, net of taxes | | | | | | | — | | | | — | | | | 143 | | | | 143 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance December 31, 2011 | | | 5,344,648 | | | | 36,972 | | | | 2,608 | | | | 789 | | | | 40,369 | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercise of common stock options, net of tax benefit | | | 50,850 | | | | 344 | | | | — | | | | — | | | | 344 | |
| Stock based compensation | | | | | | | 41 | | | | — | | | | — | | | | 41 | |
| Net income for the period | | | | | | | — | | | | 3,378 | | | | — | | | | 3,378 | |
| Cash dividend paid ($0.31 per share) | | | | | | | — | | | | (1,653 | ) | | | — | | | | (1,653 | ) |
| Common stock repurchased | | | (25,825 | ) | | | (214 | ) | | | — | | | | — | | | | (214 | ) |
| Other comprehensive income, net of taxes | | | | | | | — | | | | — | | | | (417 | ) | | | (417 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Balance December 31, 2012 | | | 5,369,673 | | | $ | 37,143 | | | $ | 4,333 | | | $ | 372 | | | $ | 41,848 | |
See accompanying notes to consolidated financial statements.
SOMERSET HILLS BANCORP AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2012 and 2011
(Dollars in Thousands)
| | | 2012 | | | 2011 | |
| OPERATING ACTIVITIES | | | | | | | | |
| Net income | | $ | 3,378 | | | $ | 2,813 | |
| Adjustments to reconcile net income to net cash provided by operating activities | | | | | | | | |
| Depreciation and amortization | | | 506 | | | | 604 | |
| Provision for loan losses | | | 290 | | | | 220 | |
| Gain on sale of investment securities, net | | | (500 | ) | | | (9 | ) |
| Stock-based compensation | | | 41 | | | | 44 | |
| Mortgage loans originated for sale | | | (93,570 | ) | | | (70,426 | ) |
| Proceeds from mortgage loan sales | | | 90,924 | | | | 70,473 | |
| Gain on sale of mortgage loans and fees, net | | | (1,362 | ) | | | (786 | ) |
| Decrease (increase) in accrued interest receivable | | | 132 | | | | (57 | ) |
| Proceeds from life insurance death benefit | | | — | | | | 267 | |
| Increase in bank owned life insurance | | | (245 | ) | | | (214 | ) |
| (Increase) decrease in other assets | | | (303 | ) | | | 411 | |
| Increase (decrease) in other liabilities | | | 168 | | | | (595 | ) |
| Net cash (used in) provided by operating activities | | | (541 | ) | | | 2,745 | |
| | | | | | | | | |
| INVESTING ACTIVITIES | | | | | | | | |
| Net decrease in interest bearing deposits at other financial institutions | | | — | | | | 730 | |
| Maturity and payments of investment securities held to maturity | | | 1,833 | | | | — | |
| Purchases of investment securities available for sale | | | (1,966 | ) | | | (23,401 | ) |
| Maturity and payments of investment securities available for sale | | | 18,569 | | | | 13,905 | |
| Proceeds from sale of investment securities available for sale | | | 13,257 | | | | 1,934 | |
| Redemption of restricted stock | | | 41 | | | | 163 | |
| Net increase in loans receivable | | | (9,540 | ) | | | (25,452 | ) |
| Purchases of premises and equipment | | | (156 | ) | | | (112 | ) |
| Net cash provided by (used in) investing activities | | | 22,038 | | | | (32,233 | ) |
| | | | | | | | | |
| FINANCING ACTIVITIES | | | | | | | | |
| Net proceeds from exercise of common stock and options, including tax benefit | | | 344 | | | | 210 | |
| Cash dividends paid common stock | | | (1,653 | ) | | | (1,350 | ) |
| Net increase in demand deposits and savings accounts | | | 12,066 | | | | 38,983 | |
| Net decrease in certificates of deposit | | | (6,593 | ) | | | (810 | ) |
| Repurchase of common stock | | | (214 | ) | | | (882 | ) |
| Prepayment of Federal Home Loan Bank advances | | | (2,000 | ) | | | (3,500 | ) |
| Net cash provided by financing activities | | | 1,950 | | | | 32,651 | |
| Net increase in cash and cash equivalents | | | 23,447 | | | | 3,163 | |
| Cash and cash equivalents at beginning of period | | | 59,224 | | | | 56,061 | |
| Cash and cash equivalents at end of period | | $ | 82,671 | | | $ | 59,224 | |
| | | | | | | | | |
| Supplemental information: | | | | | | | | |
| Cash paid during the year for: | | | | | | | | |
| Interest | | $ | 1,902 | | | $ | 1,823 | |
| Income taxes | | | 1,310 | | | | 1,427 | |
See accompanying notes to consolidated financial statements.
SOMERSET HILLS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2012 and 2011
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a)Basis of Financial Statement Presentation
The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (US GAAP). The financial statements include the accounts of the Company and its wholly-owned subsidiary, Somerset Hills Bank (the “Bank”) and its wholly-owned subsidiaries, Sullivan Financial Services, Inc. (“Sullivan”), Somerset Hills Wealth Management Services, LLC, Somerset Hills Investment Holdings, Inc. and SOMH Holdings, LLC. All material intercompany balances and transactions have been eliminated in the financial statements.
In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses during the reporting periods. Therefore, actual results could differ from those estimates.
To prepare financial statements in conformity with accounting principles generally accepted in the United States of America management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in determining the allocation of resources and in assessing operating performance. The Company has two reportable segments: community banking and mortgage banking.
b) Pending Merger
On January 29, 2013, the Company and Lakeland Bancorp, Inc. (NASDAQ: LBAI) (“Lakeland”), the parent company of Lakeland Bank, announced that the companies have entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which the Company will be merged with and into Lakeland, with Lakeland as the surviving bank holding company. The Merger Agreement provides that the shareholders of Somerset Hills Bancorp will receive, at their election, for each outstanding share of Somerset Hills Bancorp common stock that they own at the effective time of the merger, either 1.1962 shares of Lakeland common stock or $12.00 in cash, subject to proration as described in the Merger Agreement, so that 90% of the aggregate merger consideration will be shares of Lakeland common stock and 10% will be cash. The Merger Agreement also provides that immediately after the merger of the Company into Lakeland, the Bank will merge with and into Lakeland Bank, with Lakeland Bank as the surviving bank.
c) Earnings per Share
Basic earnings per share of common stock is calculated by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is calculated by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period plus the dilutive effect of potential common shares.
The following tables set forth the computations of basic and diluted earnings per share:
| | | Year Ended December 31, 2012 | | | Year Ended December 31, 2011 | |
| | | Income
(Numerator) | | | Shares
(Denominator) | | | Per Share
Amount | | | Income
(Numerator) | | | Shares
(Denominator) | | | Per Share
Amount | |
| | | (dollars and share data in thousands) | |
| Basic earnings per share: | | | | | | | | | | | | | | | | | | |
| Net income applicable to common stockholders | | $ | 3,378 | | | | 5,334 | | | $ | 0.63 | | | $ | 2,813 | | | | 5,410 | | | $ | 0.52 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Effect of dilutive securities:
Options | | | | | | | 37 | | | | | | | | | | | | 50 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per share: | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income applicable to common stock holders and assumed conversions | | $ | 3,378 | | | | 5,371 | | | $ | 0.63 | | | $ | 2,813 | | | | 5,460 | | | $ | 0.52 | |
The tables above exclude options with exercise prices that exceed the average market price of the Company’s common stock during the periods presented because such options would have an anti-dilutive effect on the diluted earnings per common share calculation. The number of anti-dilutive common stock options totaled 97,585 and 111,400 at December 31, 2012 and 2011, respectively.
d) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, overnight amounts due from banks and federal funds sold. Included in cash and due from banks at December 31, 2012 and 2011 is $946,000 and $1,110,000, respectively, representing reserves required by banking regulations.
e) Investment Securities
Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of taxes.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
f) Stock-Based Compensation
At December 31, 2012, the Company had three stock-based plans, which are described more fully in Note 9. The Company recognizes compensation expense based on the fair value of awards under the plan at the date of the grant over the period the awards are earned.
The Company recognizes compensation expense related to stock options granted based on the fair value of such awards at the date of the grant over the period the awards are earned.
g) Restricted Stock
The Bank is a member of the Federal Home Loan Bank (“FHLB”) system and Atlantic Central Bankers Bank (“ACBB”). Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. Stock in the FHLB and ACBB is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
h) Loans and Allowance for Loan Losses
Loans — Loans Receivable, for all loan portfolio classes, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal, adjusted for any charge-offs, the allowance for
loan losses, and any deferred fees or costs on originated loans. Interest on loans, for all loan portfolio classes, is accrued and credited to operations based upon the principal amounts outstanding.
Allowance for Loan Losses — The Company maintains an allowance for loan losses to absorb probable incurred losses in the loan portfolio based, for all loan portfolio classes, on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio.
The specific component incorporates the results of measuring impaired loans as required by the “Receivables” topic of the FASB Accounting Standards Codification. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered troubled debt restructurings and are also recognized as impaired. A loan is not deemed to be impaired if there is a short delay in receipt of payment. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the impairment measurement of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a partial charge-off is recorded against the allowance for loan losses.
The formula component is calculated using many factors including: (i) the Company’s historical charge-off and delinquency experience, (ii) the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and (iii) other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by loan type and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.
Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectability of the loan portfolio as of the evaluation date have changed. Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2012. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, 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 recognize additions to the allowance based on their judgments at the time of their examinations.
Our primary market area is Morris, Somerset and Union Counties, New Jersey. Negative economic conditions in our market area could affect both depositors and borrowers, and thereby adversely affect our performance.
Nonaccrual Policy — The Company’s nonaccrual loan policy covers all loan portfolio classes. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. Loans are considered delinquent when they become 30 or more days past due. Loans are placed on non-accrual when principal or interest is delinquent for 90 days or more unless the loan is both well-secured and in the process of collection, or when management no longer expects payment in full of principal or interest. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. Loans can be returned to accruing status when they become current as to principal and interest, and when, in management’s opinion, they are estimated to be fully collectible.
Charge-off Policy — The Company’s charge-off policy covers all loan portfolio classes. Loans are generally charged-off at the earlier of when it is determined that collection efforts are no longer productive or when they have been identified as losses by management, internal loan review and/or bank examiners. Factors considered in determining whether collection efforts are no longer productive include any amounts currently being collected, the status of discussions or negotiations with the borrower, the principal and/or guarantors, the cost of continuing efforts to collect, the status of any foreclosure or other legal actions, the value of the collateral, and any other pertinent factors.
i) Loans Held for Sale
Residential mortgage loans funded by the Bank and held for sale in the secondary market are carried at fair value. Fair value is generally determined by the value of purchase commitments. Aggregate net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Aggregate net unrealized gains, if any, are recorded in other assets and credited to income. Estimated net revenue related to commitments to fund residential mortgage loans that are expected to be sold are recorded as a receivable and credited to income. Residential mortgage loans held for sale are typically sold with servicing rights released.
j) Premises and Equipment
Land is stated at cost. Buildings and improvements and furniture, fixtures and equipment are stated at cost, less accumulated depreciation computed on the straight-line method over the estimated lives of each type of asset. Estimated useful lives are five to thirty- nine and one half years for buildings and improvements and three to five years for furniture, fixtures and equipment. Leasehold improvements are stated at cost less accumulated amortization computed on the straight-line method over the shorter of the term of the lease or useful life. Significant renewals and improvements are capitalized. Maintenance and repairs are charged to operations as incurred.
k) Bank Owned Life Insurance
The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
l) Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to temporary differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.
m) Comprehensive Income
Comprehensive income includes net income and unrealized gains and losses on investment securities available for sale.
n) Foreclosed Assets
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. There were no foreclosed assets in 2012 and 2011.
o) Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
p) Recent Accounting Pronouncements
Adoption of New Accounting Guidance
In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.”The provisions of ASU No. 2011-02 amend and clarify GAAP related to the accounting for debt restructurings. Specifically, ASU No. 2011-02 requires that, when evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. In evaluating whether a concession has been granted, a creditor must evaluate whether (i) a debtor has access to funds at a market rate for debt with similar risk characteristics as the restructured debt in order to determine if the restructuring would be considered to be at a below-market rate, indicating that the creditor has granted a concession, (ii) a temporary or permanent increase in the contractual interest rate as a result of a restructuring may be considered a concession because the new contractual interest rate on the restructured debt is still below the market interest rate for new debt with similar risk characteristics, and (iii) a restructuring that results in a delay in payment is either significant and is a concession or is insignificant and is not a concession. In evaluating whether a debtor is experiencing financial difficulties, a creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default. A creditor should evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without a modification of the debt. The provisions of ASU No. 2011-02 are
effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retroactively to the beginning of the annual period of adoption. The impact of adoption was not material.
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, which represents the convergence of the FASB’s and the IASB’s guidance on fair value measurement. ASU 2011-04 reflects the common requirements under U.S. GAAP and IFRS for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning for the term “fair value.” The new guidance does not extend the use of fair value but, rather, provides guidance about how fair value should be applied where it is already required or permitted under IFRS or U.S. GAAP. For U.S. GAAP, most of the changes are clarifications of existing guidance or wording changes to align with IFRS 13. A public company is required to apply the ASU prospectively for interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Company’s financial condition or results of operations.
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income” the provisions of which allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively and is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Company’s financial condition or results of operations.
NOTE 2 – INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities held to maturity and available for sale are as follows:
| Held to Maturity | | Amortized
Cost | | | Gross
Unrecognized
Gains | | | Gross
Unrecognized
Losses | | | Estimated
Fair
Value | |
| | | | | | (in thousands) | | | | |
| December 31, 2012 | | | | | | | | | | | | | | | | |
| Obligations of U.S. states and political subdivisions | | $ | 7,902 | | | $ | 392 | | | $ | — | | | $ | 8,294 | |
| Corporate debt securities | | | 998 | | | | — | | | | (106 | ) | | | 892 | |
| Total held to maturity | | $ | 8,900 | | | $ | 392 | | | $ | (106 | ) | | $ | 9,186 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | |
| Obligations of U.S. states and political subdivisions | | $ | 9,228 | | | $ | 412 | | | $ | — | | | $ | 9,640 | |
| Corporate debt securities | | | 1,510 | | | | — | | | | (301 | ) | | | 1,209 | |
| Total held to maturity | | $ | 10,738 | | | $ | 412 | | | $ | (301 | ) | | $ | 10,849 | |
| Available for Sale | | Amortized
Cost | | | Gross
Unrealized
Gains | | | Gross
Unrealized
Losses | | | Estimated
Fair
Value | |
| | | | | | (in thousands) | | | | |
| December 31, 2012 | | | | | | | | | | | | | | | | |
| U.S. Government sponsored agency securities | | $ | 2,894 | | | $ | 27 | | | $ | — | | | $ | 2,921 | |
| Mortgage backed securities, residential | | | 7,160 | | | | 507 | | | | — | | | | 7,667 | |
| Collateralized mortgage obligations | | | 1,290 | | | | 34 | | | | — | | | | 1,324 | |
| Corporate debt securities | | | 1,463 | | | | 22 | | | | (27 | ) | | | 1,458 | |
| Total available for sale | | $ | 12,807 | | | $ | 590 | | | $ | (27 | ) | | $ | 13,370 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | |
| U.S. Government sponsored agency securities | | $ | 14,560 | | | $ | 198 | | | | (5 | ) | | $ | 14,753 | |
| Mortgage backed securities, residential | | | 22,775 | | | | 1,039 | | | | — | | | | 23,814 | |
| Collateralized mortgage obligations | | | 2,677 | | | | 57 | | | | — | | | | 2,734 | |
| Corporate debt securities | | | 2,372 | | | | — | | | | (94 | ) | | | 2,278 | |
| Total available for sale | | $ | 42,384 | | | $ | 1,294 | | | $ | (99 | ) | | $ | 43,579 | |
The amortized cost and fair value of the Company’s investment securities held to maturity and available for sale at December 31, 2012, 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.
| | | Amortized
Cost | | | Estimated
Fair
Value | |
| | | (in thousands) | |
| Held to Maturity | | | |
| Due in one year or less | | $ | — | | | $ | — | |
| Due in one to five years | | | 704 | | | | 687 | |
| Due in five years to ten years | | | 2,694 | | | | 2,822 | |
| Due after ten years | | | 5,502 | | | | 5,677 | |
| | | $ | 8,900 | | | $ | 9,186 | |
| | | | | | | | | |
| Available for Sale | | | | | | | | |
| Due in one year or less | | $ | — | | | $ | — | |
| Due in one year to five years | | | 1,463 | | | | 1,495 | |
| Due in five years to ten years | | | 1,000 | | | | 972 | |
| Due after ten years | | | 1,894 | | | | 1,912 | |
| Mortgage backed securities and collateralized mortgage obligations | | | 8,450 | | | | 8,991 | |
| | | $ | 12,807 | | | $ | 13,370 | |
Gross unrealized losses on securities and the estimated fair value of the related securities aggregated by securities category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2012 and 2011 are as follows:
| | | December 31, 2012 | |
| | | Less than 12 months | | | 12 Months or longer | | | Total | |
| | | Estimated | | | | | | Estimated | | | | | | Estimated | | | | |
| | | Fair
Value | | | Unrecognized
Losses | | | Fair
Value | | | Unrecognized
Losses | | | Fair
Value | | | Unrecognized
Losses | |
| Held to Maturity | | (in thousands) | |
| Corporate debt securities | | $ | — | | | $ | — | | | $ | 892 | | | $ | 106 | | | $ | 892 | | | $ | 106 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | — | | | $ | — | | | $ | 892 | | | $ | 106 | | | $ | 892 | | | $ | 106 | |
| | | December 31, 2011 | |
| | | Less than 12 months | | | 12 Months or longer | | | Total | |
| | | Estimated | | | | | | Estimated | | | | | | Estimated | | | | |
| | | Fair
Value | | | Unrecognized
Losses | | | Fair
Value | | | Unrecognized
Losses | | | Fair
Value | | | Unrecognized
Losses | |
| Held to Maturity | | (in thousands) | |
| Corporate debt securities | | $ | 450 | | | $ | 62 | | | $ | 759 | | | $ | 239 | | | $ | 1,209 | | | $ | 301 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 450 | | | $ | 62 | | | $ | 759 | | | $ | 239 | | | $ | 1,209 | | | $ | 301 | |
| | | December 31, 2012 | |
| | | Less than 12 months | | | 12 Months or longer | | | Total | |
| | | Estimated | | | | | | Estimated | | | | | | Estimated | | | | |
| | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | |
| Available for Sale | | (in thousands) | |
| Corporate debt securities | | $ | — | | | $ | — | | | $ | 973 | | | $ | 27 | | | $ | 973 | | | $ | 27 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | — | | | $ | — | | | $ | 973 | | | $ | 27 | | | $ | 973 | | | $ | 27 | |
| | | December 31, 2011 | |
| | | Less than 12 months | | | 12 Months or longer | | | Total | |
| | | Estimated | | | | | | Estimated | | | | | | Estimated | | | | |
| | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | |
| Available for Sale | | (in thousands) | |
| U.S. Government sponsored agency securities | | $ | 3,010 | | | $ | 5 | | | $ | — | | | $ | — | | | $ | 3,010 | | | $ | 5 | |
| Corporate debt securities | | | 1,352 | | | | 20 | | | | 926 | | | | 74 | | | | 2,278 | | | | 94 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 4,362 | | | $ | 25 | | | $ | 926 | | | $ | 74 | | | $ | 5,288 | | | $ | 99 | |
At December 31, 2012, there were $1.9 million in securities with gross unrecognized losses that have been in a continuous unrealized loss position for twelve or more months. Unrealized losses on these securities have not been recognized into income because the issuer(s) bonds are investment grade, management does not intend to sell and it is not likely that management will be required to sell the securities prior to their anticipated recovery. The decline in fair value is largely a result of the securities of these issuers falling out of favor in the broader bond market. The fair value is expected to recover as the bonds approach maturity.
For the year ended December 31, 2012, the gross proceeds on sales of securities were approximately $13.3 million. For the year ended December 31, 2012, the gross gain on sales of securities was approximately $500,000. The tax provision related to the net realized gain was $200,000 in 2012. For the year ended December 31, 2011, the gross gain on sales of securities was approximately $20,000. There was $11,000 in gross losses on sales of securities for the year ended December 31, 2011. The tax provision related to the net realized gain was $3,000.
Securities with an amortized cost of $1.9 million and $974,000 were pledged to secure public funds on deposit at December 31, 2012 and 2011, respectively.
The Company is a member of the Federal Home Loan Bank of New York (FHLBNY) and Atlantic Central Bankers Bank. As a result, the Company is required to hold shares of capital stock of FHLBNY, as well as Atlantic Central Bankers Bank, which are carried at cost, based upon a specified formula.
NOTE 3 – LOANS
Loans are summarized as follows:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Commercial | | $ | 32,192 | | | $ | 32,206 | |
| Commercial mortgage | | | 130,733 | | | | 113,148 | |
| Construction, land and land development | | | 1,902 | | | | 7,505 | |
| Consumer | | | 37,088 | | | | 42,074 | |
| Residential | | | 39,766 | | | | 37,360 | |
| Gross loans | | | 241,681 | | | | 232,293 | |
| Net deferred costs | | | 230 | | | | 192 | |
| Less: Allowance for loan losses | | | (3,158 | ) | | | (2,982 | ) |
| Total | | $ | 238,753 | | | $ | 229,503 | |
The portfolio classes in the above table have unique risk characteristics with respect to credit quality:
| • | The repayment of commercial loans is generally dependent on the creditworthiness and cash flow of borrowers and, if applicable, guarantors, which may be negatively impacted by adverse economic conditions. While the majority of these loans are secured, collateral type, marketability, coverage, valuation and monitoring is not as uniform as in other portfolio classes and recovery from liquidation of such collateral may be subject to greater variability. |
| | | |
| • | Payment on commercial mortgages is driven principally by operating results of the managed properties or underlying businesses and secondarily by the sale or refinance of such properties. Both primary and secondary sources of repayment, and value of the properties in liquidation, may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. |
| | | |
| • | Properties underlying construction, land and land development loans often do not generate sufficient cash flow to service debt and thus repayment is subject to the ability of the borrower and, if applicable, guarantors, to complete development or construction of the property and carry the project, often for extended periods of time. As a result, the performance of these loans is contingent upon future events whose probability at the time of origination is uncertain. |
| | | |
| • | The ability of borrowers to service debt in the residential and consumer loan portfolios is generally subject to personal income which may be impacted by general economic conditions, such as increased unemployment levels. These loans are predominantly collateralized by first and second liens on single family properties. If a borrower cannot maintain the loan, the Company’s ability to recover against the collateral in sufficient amount and in a timely manner may be significantly influenced by market, legal and regulatory conditions. |
The following table presents information about impaired loans by loan portfolio class as of December 31, 2012 and 2011:
| | | Impaired Loans at December 31, 2012 | |
| | | Unpaid
Principal
Balance | | | Recorded
Investment | | | Related
Allowance | |
| | | (in thousands) | |
| With no related allowance recorded: | | | | | | | | | | | | |
| Commercial | | $ | — | | | $ | — | | | $ | — | |
| Commercial mortgage | | | — | | | | — | | | | — | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | 234 | | | | 234 | | | | — | |
| Residential | | | — | | | | — | | | | — | |
| With an allowance recorded: | | | | | | | | | | | | |
| Commercial | | | — | | | | — | | | | — | |
| Commercial mortgage | | | 2,314 | | | | 2,327 | | | | 96 | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | 512 | | | | 512 | | | | 69 | |
| Residential | | | — | | | | — | | | | — | |
| Total: | | | | | | | | | | | | |
| Commercial | | | — | | | | — | | | | — | |
| Commercial mortgage | | | 2,314 | | | | 2,327 | | | | 96 | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | 746 | | | | 746 | | | | 69 | |
| Residential | | | — | | | | — | | | | — | |
| | | Impaired Loans at December 31, 2011 | |
| | | Unpaid
Principal
Balance | | | Recorded
Investment | | | Related
Allowance | |
| | | (in thousands) | |
| With no related allowance recorded: | | | | | | | | | | | | |
| Commercial | | $ | — | | | $ | — | | | $ | — | |
| Commercial mortgage | | | 765 | | | | 768 | | | | — | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | 146 | | | | 146 | | | | — | |
| Residential | | | — | | | | — | | | | — | |
| With an allowance recorded: | | | | | | | | | | | | |
| Commercial | | | — | | | | — | | | | — | |
| Commercial mortgage | | | 344 | | | | 344 | | | | 11 | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | — | | | | — | | | | — | |
| Residential | | | — | | | | — | | | | — | |
| Total: | | | | | | | | | | | | |
| Commercial | | | — | | | | — | | | | — | |
| Commercial mortgage | | | 1,109 | | | | 1,112 | | | | 11 | |
| Construction, land and land development | | | — | | | | — | | | | — | |
| Consumer | | | 146 | | | | 146 | | | | — | |
| Residential | | | — | | | | — | | | | — | |
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Average of individually impaired loans during period: | | | | | | |
| Commercial | | $ | — | | | $ | 71 | |
| Commercial mortgage | | | 1,028 | | | | 1,643 | |
| Construction, land and land development | | | — | | | | — | |
| Consumer | | | 288 | | | | 49 | |
| Residential | | | — | | | | — | |
| Total | | $ | 1,316 | | | $ | 1,763 | |
| Interest income recognized during impairment: | | | | | | | | |
| Commercial | | $ | — | | | $ | 4 | |
| Commercial mortgage | | | 55 | | | | 89 | |
| Construction, land and land development | | | — | | | | — | |
| Consumer | | | 1 | | | | 1 | |
| Residential | | | — | | | | — | |
| Total | | $ | 56 | | | $ | 94 | |
There was no cash-basis interest income recognized on any loans for the twelve months ended December 31, 2012 and 2011, respectively.
The outstanding balances of nonaccrual loans, loans past due 90 days and still accruing, other real estate owned, and troubled debt restructured loans as of year-end were as follows:
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Nonaccrual loans | | $ | 746 | | | $ | 146 | |
| OREO | | | — | | | | — | |
| Total non-performing assets | | $ | 746 | | | $ | 146 | |
| Loans past due 90 days and still accruing | | $ | 420 | | | $ | — | |
| Troubled debt restructured loans | | $ | 340 | | | $ | 344 | |
The following table presents loans receivable on nonaccrual status by loan portfolio class as of December 31, 2012 and 2011, respectively:
| | | Nonaccrual Loans | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Commercial | | $ | — | | | $ | — | |
| Commercial mortgage | | | — | | | | — | |
| Construction, land and land development | | | — | | | | — | |
| Consumer | | | 746 | | | | 146 | |
| Residential | | | — | | | | — | |
| Total | | $ | 746 | | | $ | 146 | |
The balance of troubled debt restructured loans at year-end 2012 and 2011 is represented by one credit that is currently performing under its restructured terms and for which the Company has no commitment to lend additional funds. There were no TDR’s during 2012 that did not perform in accordance with their modified terms. During the twelve months ended December 31, 2012 there were no new loans modified as troubled debt restructurings.
The following table presents past due and current loans by the loan portfolio class as of December 31, 2012 and 2011, respectively:
| | | December 31, 2012 | |
| | | 30-59
Days
Past Due | | | 60-89
Days
Past Due | | | Greater than
90 Days
Past Due | | | Total
Past Due | | | Current | | | Total
Loans
Receivable | | | Loans Past
Due 90
Days and
Still Accruing | |
| | | (in thousands) | |
| Commercial | | $ | — | | | $ | 216 | | | $ | — | | | $ | 216 | | | $ | 31,976 | | | $ | 32,192 | | | $ | — | |
| Commercial mortgage | | | — | | | | — | | | | 420 | | | | 420 | | | | 130,313 | | | | 130,733 | | | | 420 | |
| Construction, land and land development | | | — | | | | — | | | | — | | | | — | | | | 1,902 | | | | 1,902 | | | | — | |
| Consumer | | | 234 | | | | — | | | | — | | | | 234 | | | | 36,854 | | | | 37,088 | | | | — | |
| Residential | | | — | | | | — | | | | — | | | | — | | | | 39,766 | | | | 39,766 | | | | — | |
| Total | | $ | 234 | | | $ | 216 | | | $ | 420 | | | $ | 870 | | | $ | 240,811 | | | $ | 241,681 | | | $ | 420 | |
| | | December 31, 2011 | |
| | | 30-59
Days
Past Due | | | 60-89
Days
Past Due | | | Greater than
90 Days
Past Due | | | Total
Past Due | | | Current | | | Total
Loans
Receivable | | | Loans Past
Due 90
Days and
Still Accruing | |
| | | (in thousands) | |
| Commercial | | $ | — | | | $ | 259 | | | $ | — | | | $ | 259 | | | $ | 31,947 | | | $ | 32,206 | | | $ | — | |
| Commercial mortgage | | | — | | | | 468 | | | | — | | | | 468 | | | | 112,680 | | | | 113,148 | | | | — | |
| Construction, land and land development | | | — | | | | — | | | | — | | | | — | | | | 7,505 | | | | 7,505 | | | | — | |
| Consumer | | | — | | | | 148 | | | | 146 | | | | 294 | | | | 41,780 | | | | 42,074 | | | | — | |
| Residential | | | — | | | | — | | | | — | | | | — | | | | 37,360 | | | | 37,360 | | | | — | |
| Total | | $ | — | | | $ | 875 | | | $ | 146 | | | $ | 1,021 | | | $ | 231,272 | | | $ | 232,293 | | | $ | — | |
The Company categorizes loans into risk categories based on relevant information about the quality and realizable value of collateral, if any, and the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed whenever a credit is extended, renewed or modified, or when an observable event occurs indicating a potential decline in credit quality, and no less than annually for large balance loans. The Company uses the following definitions for risk ratings:
Special Mention– Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.
Substandard– Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Normal payment from the borrower is in jeopardy, although loss of principal, while still possible, is not imminent.
Doubtful– Loans classified as doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable.
The following table presents the risk category of loans by class of loans based on the most recent analysis performed as of December 31, 2012 and 2011, respectively:
| | | December 31, 2012 | |
| | | Pass | | | Special Mention | | | Substandard | | | Doubtful | | | Total | |
| Credit Risk Profile by Internally Assigned Grades | | (in thousands) | |
| Commercial | | $ | 30,158 | | | $ | 2,034 | | | $ | — | | | $ | — | | | $ | 32,192 | |
| Commercial mortgage | | | 127,999 | | | | 420 | | | | 2,314 | | | | — | | | | 130,733 | |
| Construction, land and land development | | | 1,902 | | | | — | | | | — | | | | — | | | | 1,902 | |
| Consumer | | | 36,067 | | | | 275 | | | | 746 | | | | — | | | | 37,088 | |
| Residential | | | 38,961 | | | | 805 | | | | — | | | | — | | | | 39,766 | |
| Total | | $ | 235,087 | | | $ | 3,534 | | | $ | 3,060 | | | $ | — | | | $ | 241,681 | |
| | | December 31, 2011 | |
| | | Pass | | | Special Mention | | | Substandard | | | Doubtful | | | Total | |
| Credit Risk Profile by Internally Assigned Grades | | (in thousands) | |
| Commercial | | $ | 29,215 | | | $ | 2,991 | | | $ | — | | | $ | — | | | $ | 32,206 | |
| Commercial mortgage | | | 110,500 | | | | 1,539 | | | | 1,109 | | | | — | | | | 113,148 | |
| Construction, land and land development | | | 7,505 | | | | — | | | | — | | | | — | | | | 7,505 | |
| Consumer | | | 41,780 | | | | 148 | | | | 146 | | | | — | | | | 42,074 | |
| Residential | | | 36,555 | | | | 805 | | | | — | | | | — | | | | 37,360 | |
| Total | | $ | 225,555 | | | $ | 5,483 | | | $ | 1,255 | | | $ | — | | | $ | 232,293 | |
Changes in the allowance for loan losses were as follows:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Balance at beginning of year | | $ | 2,982 | | | $ | 2,875 | |
| Charge-offs | | | (144 | ) | | | (127 | ) |
| Recoveries | | | 30 | | | | 14 | |
| Provision charged to operations | | | 290 | | | | 220 | |
| Balance at end of year | | $ | 3,158 | | | $ | 2,982 | |
The following table represents the allocation of allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the impairment methodology at December 31, 2012 and 2011, respectively:
| | | December 31, 2012 | |
| | | Commercial | | | Commercial
Mortgage | | | Construction,
Land and Land
Development | | | Consumer | | | Residential | | | Unallocated | | | Total | |
| | | (in thousands) | |
| Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Individually evaluated for impairment | | $ | — | | | $ | 96 | | | $ | — | | | $ | 69 | | | $ | — | | | $ | — | | | $ | 165 | |
| Collectively evaluated for impairment | | | 551 | | | | 1,659 | | | | 30 | | | | 482 | | | | 227 | | | | 44 | | | | 2,993 | |
| Total | | $ | 551 | | | $ | 1,755 | | | $ | 30 | | | $ | 551 | | | $ | 227 | | | $ | 44 | | | $ | 3,158 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans Receivable | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Individually evaluated for impairment | | $ | — | | | $ | 2,314 | | | $ | — | | | $ | 746 | | | $ | — | | | | | | | $ | 3,060 | |
| Collectively evaluated for impairment | | | 32,192 | | | | 128,419 | | | | 1,902 | | | | 36,342 | | | | 39,766 | | | | | | | | 238,621 | |
| Total | | $ | 32,192 | | | $ | 130,733 | | | $ | 1,902 | | | $ | 37,088 | | | $ | 39,766 | | | | | | | $ | 241,681 | |
| | | December 31, 2011 | |
| | | Commercial | | | Commercial
Mortgage | | | Construction,
Land and Land
Development | | | Consumer | | | Residential | | | Unallocated | | | Total | |
| | | (in thousands) | |
| Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Individually evaluated for impairment | | $ | — | | | $ | 11 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 11 | |
| Collectively evaluated for impairment | | | 522 | | | | 1,531 | | | | 122 | | | | 531 | | | | 215 | | | | 50 | | | | 2,971 | |
| Total | | $ | 522 | | | $ | 1,542 | | | $ | 122 | | | $ | 531 | | | $ | 215 | | | $ | 50 | | | $ | 2,982 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans Receivable | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Individually evaluated for impairment | | $ | — | | | $ | 1,109 | | | $ | — | | | $ | 146 | | | $ | — | | | | | | | $ | 1,255 | |
| Collectively evaluated for impairment | | | 32,206 | | | | 112,039 | | | | 7,505 | | | | 41,928 | | | | 37,360 | | | | | | | | 231,038 | |
| Total | | $ | 32,206 | | | $ | 113,148 | | | $ | 7,505 | | | $ | 42,074 | | | $ | 37,360 | | | | | | | $ | 232,293 | |
The following table presents the activity in the Company’s allowance for loan losses by class of loans based on the most recent analysis performed for the twelve months ended December 31, 2012:
| | | Allowance for Loan Losses | |
| | | Commercial | | | Commercial
Mortgage | | | Construction,
Land and Land
Development | | | Consumer | | | Residential | | | Unallocated | | | Total | |
| | | (in thousands) | |
| Balance December 31, 2011 | | $ | 522 | | | $ | 1,542 | | | $ | 122 | | | $ | 531 | | | $ | 215 | | | $ | 50 | | | $ | 2,982 | |
| Charge-offs | | | — | | | | (67 | ) | | | — | | | | (77 | ) | | | — | | | | — | | | | (144 | ) |
| Recoveries | | | 18 | | | | 8 | | | | — | | | | 4 | | | | — | | | | — | | | | 30 | |
| Provision for loan losses | | | 11 | | | | 272 | | | | (92 | ) | | | 93 | | | | 12 | | | | (6 | ) | | | 290 | |
| Balance, December 31, 2012 | | $ | 551 | | | $ | 1,755 | | | $ | 30 | | | $ | 551 | | | $ | 227 | | | $ | 44 | | | $ | 3,158 | |
| | | Commercial | | | Commercial
Mortgage | | | Construction,
Land and Land
Development | | | Consumer | | | Residential | | | Unallocated | | | Total | |
| | | (in thousands) | |
| Balance December 31, 2010 | | $ | 186 | | | $ | 1,821 | | | $ | 102 | | | $ | 506 | | | $ | 205 | | | $ | 55 | | | $ | 2,875 | |
| Charge-offs | | | — | | | | (125 | ) | | | — | | | | (2 | ) | | | — | | | | — | | | | (127 | ) |
| Recoveries | | | 14 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 14 | |
| Provision for loan losses | | | 322 | | | | (154 | ) | | | 20 | | | | 27 | | | | 10 | | | | (5 | ) | | | 220 | |
| Balance, December 31, 2011 | | $ | 522 | | | $ | 1,542 | | | $ | 122 | | | $ | 531 | | | $ | 215 | | | $ | 50 | | | $ | 2,982 | |
NOTE 4 – PREMISES AND EQUIPMENT
Premises and equipment are as follows:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Land | | $ | 693 | | | $ | 693 | |
| Buildings and improvements | | | 5,293 | | | | 5,294 | |
| Furniture, fixtures and equipment | | | 2,283 | | | | 2,244 | |
| Leasehold improvements | | | 955 | | | | 955 | |
| Computer equipment and software | | | 939 | | | | 939 | |
| | | | 10,163 | | | | 10,125 | |
| Less accumulated depreciation and amortization | | | (5,295 | ) | | | (5,129 | ) |
| Total premises and equipment, net | | $ | 4,868 | | | $ | 4,996 | |
Depreciation charged to operations amounted to approximately $284,000 and $401,000 for the years ended December 31, 2012 and 2011, respectively.
NOTE 5 – CERTIFICATES OF DEPOSIT
At December 31, 2012, a summary of the maturity of certificates of deposit is as follows:
| | | Amount | |
| | | (in thousands) | |
| 2013 | | $ | 18,845 | |
| 2014 | | | 5,083 | |
| 2015 | | | 7,528 | |
| 2016 | | | 2,366 | |
| 2017 | | | 491 | |
| | | $ | 34,313 | |
Deposits held at the Company by related parties, which include executive officers, directors, and companies in which Board members have a significant ownership interest, approximated $17.8 million and $23.4 million at December 31, 2012 and 2011, respectively.
NOTE 6 – BORROWINGS
a) Federal Home Loan Bank Borrowing
As of December 31, 2012 and 2011, the Company had an approved borrowing capacity of approximately $83.5 million and $76.7 million, respectively, with the Federal Home Loan Bank of New York (FHLB), based on total assets and eligible collateral. Eligible collateral may include certain investment securities and qualifying mortgage loans. Borrowings under this arrangement have fixed interest rates that range from 3.12% to 3.61% at December 31, 2012 with maturity dates of November 29, 2017 through January 8, 2018 and are callable at the option of the FHLB. At December 31, 2012 and 2011, $5.5 million and $7.5 million, respectively, in borrowings were outstanding with the FHLB. FHLB borrowings of $2.0 million and $3.5 million were prepaid during 2012 and 2011, respectively. The Company incurred losses on debt extinguishment of $334,000 in 2012 and $426,000 in 2011, which were recorded as losses on debt extinguishment. The Company had outstanding advances at December 31, 2012 and 2011 as follows:
| Maturity | | First Date Callable | | Rate | | | December 31,
2012 | |
| November 29, 2017 | | November 29, 2010 | | | 3.41 | % | | $ | 1,500,000 | |
| January 8, 2018 | | January 8, 2011 | | | 3.12 | % | | | 2,000,000 | |
| January 8, 2018 | | January 8, 2013 | | | 3.61 | % | | | 2,000,000 | |
| Total | | | | | | | | $ | 5,500,000 | |
| Maturity | | First Date Callable | | Rate | | | December 31,
2011 | |
| November 29, 2017 | | November 29, 2010 | | | 3.41 | % | | $ | 1,500,000 | |
| January 8, 2018 | | January 8, 2011 | | | 3.12 | % | | | 2,000,000 | |
| January 8, 2018 | | January 8, 2013 | | | 3.61 | % | | | 2,000,000 | |
| February 22, 2018 | | February 22, 2013 | | | 3.71 | % | | | 2,000,000 | |
| Total | | | | | | | | $ | 7,500,000 | |
b) Credit Lines and Borrowings
The Company has three lines of credit with financial institutions aggregating $18.5 million at December 31, 2012. Borrowings under these agreements have interest rates that fluctuate based on market conditions. The Company may also purchase Federal Funds on an overnight basis. The Company had no borrowings outstanding under these lines as of December 31, 2012 and 2011, respectively.
NOTE 7 – INCOME TAXES
Deferred income taxes are provided for the temporary difference between the financial reporting basis and the tax basis of the Company’s assets and liabilities.
The components of income taxes (benefit) are summarized as follows:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Current Tax Expense: | | | | | | | | |
| Federal | | $ | 1,532 | | | $ | 1,118 | |
| State | | | 275 | | | | 247 | |
| | | | 1,807 | | | | 1,365 | |
| Deferred Tax (Benefit): | | | | | | | | |
| Federal | | | 93 | | | | (153 | ) |
| State | | | (70 | ) | | | (23 | ) |
| | | | 23 | | | | (176 | ) |
| | | $ | 1,830 | | | $ | 1,189 | |
The following table presents reconciliation between the reported income taxes and the income taxes, which would be computed by applying the Federal statutory tax rate of 34% to income before taxes:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Federal income tax | | $ | 1,771 | | | $ | 1,361 | |
| Add (deduct) effect of: | | | | | | | | |
| State income taxes net of federal income tax effect | | | 252 | | | | 136 | |
| Stock options | | | — | | | | 1 | |
| Meals and entertainment | | | 14 | | | | 15 | |
| Increase in cash surrender value life insurance | | | (92 | ) | | | (189 | ) |
| Tax-exempt income | | | (115 | ) | | | (128 | ) |
| Other | | | — | | | | (7 | ) |
| | | $ | 1,830 | | | $ | 1,189 | |
The tax effects of existing temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
| | | 2012 | | | 2011 | |
| | (in thousands) | |
| Deferred tax assets and (liabilities): | | | |
| Allowance for loan losses | | $ | 1,129 | | | $ | 1,064 | |
| Deferred costs – loans | | | 21 | | | | 37 | |
| Nonaccrual loan income | | | 9 | | | | 3 | |
| Depreciation | | | (203 | ) | | | (107 | ) |
| Deferred compensation | | | 242 | | | | 180 | |
| Unrealized loss (gain) – AFS | | | (192 | ) | | | (406 | ) |
| NOL carryover and other | | | 43 | | | | 38 | |
| Net deferred tax assets | | $ | 1,049 | | | $ | 809 | |
There was no valuation allowance for deferred taxes as of December 31, 2012 and 2011. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
The Company is subject to U.S. Federal income tax as well as income tax of the State of New Jersey. The Company is no longer subject to examination by taxing authorities for years before 2009. The Company does not have a material amount of unrecognized tax benefits and does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and /or penalties related to income tax matters in income tax expense.
NOTE 8 – RELATED PARTY TRANSACTIONS
Loans to executive officers, directors, and their affiliates during 2012 were as follows:
| | | Amount | |
| | | (in thousands) | |
| Beginning balance | | $ | 1, 262 | |
| New loans | | | 36 | |
| Repayments | | | (167 | ) |
| Ending balance | | $ | 1,131 | |
A director of the Company is a member of a law firm which represents the Company in various matters from time-to-time. The Company paid fees to this law firm, relating to general corporate matters, of approximately $5,000 and $11,000 during the years ended December 31, 2012 and 2011, respectively. This law firm had no loan balance outstanding at December 31, 2012 and an outstanding loan balance of $96,000 at December 31, 2011, in connection with single term loan made by the Bank in 2009. This law firm had approximately $15,959,000 and $20,978,000 of deposits held with the Company as of December 31, 2012 and 2011, respectively.
A director of the Company is an owner of a restaurant which the Company uses for entertainment purposes. The Company paid this restaurant approximately $2,000 in each of the years ended December 31, 2012 and 2011. The restaurant had outstanding loan balances of $210,000 and $231,000 at December 31, 2012 and 2011, respectively, in connection with one line of credit loan made by the Bank in 2003 and converted to a term loan in 2011. This restaurant had approximately $21,000 and $13,000 of deposits held with the Company as of December 31, 2012 and 2011, respectively.
NOTE 9 – BENEFIT PLANS
Stock Options
The Company has three equity compensation plans outstanding for the members of the board of directors, executive officers, and certain employees of the Bank.
The Company’s 2001 Combined Stock Option Plan (“2001 Combined Plan”) provides for the granting of 295,490 shares of the Company’s common stock. The Company’s 2007 Equity Incentive Plan (“2007 Plan”) provides for the granting of 137,813 shares of the Company’s common stock. The Company’s 2012 Equity Incentive Plan (“2012 Plan”) provides for the granting of 150,000 shares of the Company’s common stock. Both incentive stock options (ISOs) and non-qualified options (NQOs) may be granted under the plans. The 2007 Plan and the 2012 Plan also permit grants of shares of restricted stock. Only employees of the Company may receive ISOs.
Options granted pursuant to the 2001 Combined Stock Option Plan must be exercisable at a price greater than or equal to the par value of the Common Stock, but in no event may the option price be lower than (i) in the case of an ISO, the fair market value of the shares subject to the ISO on the date of grant, (ii) in the case of an NQO issued to a Director as compensation for serving as a Director or as a member of the advisory boards of the Bank, the fair market value of the shares subject to the NQO on the date of grant, and (iii) in the case of an NQO issued to a grantee as employment compensation, eighty-five percent (85%) of the fair market value of the shares subject to the NQO on the date of grant. In addition, no ISO may be granted to an employee who owns common stock possessing more than ten percent (10%) of the total combined voting power of the Company’s common stock unless the price is at least 110% of the fair market value (on the date of grant) of the common stock. Options granted under the 2007 Plan and the 2012 Plan must have an exercise price equal to at least 100% of the fair market value of the shares on the grant date.
A summary of the status of the Company’s stock option plans as of December 31, 2012, and the change during the year ended is represented below:
| | | Number of
shares | | | Weighted
average
exercise price | | | Weighted
average life | | | Aggregate
intrinsic value | |
| | | | | | | | | | | | (in thousands) | |
| Outstanding at December 31, 2011 | | | 346,018 | | | $ | 7.64 | | | | 4.9 years | | | $ | 235 | |
| | | | | | | | | | | | | | | | | |
| Granted | | | 63,000 | | | | 8.57 | | | | | | | | | |
| Exercised | | | (50,850 | ) | | | 6.12 | | | | | | | | | |
| Forfeited | | | (23,632 | ) | | | 9.05 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Outstanding at December 31, 2012 | | | 334,536 | | | $ | 7.95 | | | | 5.1 years | | | $ | 436 | |
| Vested and expected to vest | | | 334,536 | | | $ | 7.95 | | | | 5.1 years | | | $ | 436 | |
| Exercisable at end of the year | | | 206,835 | | | $ | 7.53 | | | | 2.6 years | | | $ | 364 | |
The fair value of stock options granted during 2012 was $1.05 on the date of grant using the Black Scholes option-pricing model with the following assumptions for 2012: expected dividend yield of 3.73%, stock price volatility of 21.26%, risk-free interest rates of 1.21% and expected life of 7 years. In 2011, stock options were granted on two separate dates. The fair values of stock options granted during 2011 were $1.96 and $1.21 on the dates of grant using the Black Scholes option-pricing model with the following assumptions for 2011: expected dividend yields of 2.44% and 3.06%, stock price volatility of 21.69% for both grants, risk-free interest rates of 2.84% and 1.70% and expected life of 7 years for both grants.
At December 31, 2012 and 2011, the number of options exercisable was 206,835 and 233,605, respectively, and the weighted-average exercise price of those options was $7.53 and $7.22, respectively.
At December 31, 2012 and 2011, there were 105,479 and 1,056 additional shares available for grant under the Plans.
Information related to the stock option plan during each year follows:
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Intrinsic value of options exercised | | $ | 128 | | | $ | 99 | |
| Cash received from options exercised | | | 311 | | | | 210 | |
| Tax benefit realized from option exercises | | | 33 | | | | 2 | |
| | | | | | | | | |
| Weighted average fair value of options granted in dollars | | $ | 1.05 | | | $ | 1.60 | |
As of December 31, 2012, there was $142,000 of total unrecognized compensation cost related to nonvested stock options granted under the Company’s Plans. The cost is expected to be recognized over a weighted-average period of 3.8 years.
Stock Awards
For accounting purposes, the Company recognizes compensation expense for grants of restricted stock awarded under the Company’s Plans over the vesting period at the fair market value of the shares on the date they are awarded. For share awards granted to date, the vesting period is four years with 25% of the award for each year vesting annually on May 23th of each year. As of December 31, 2012, 3,067 shares were vested. For the year ended December 31, 2012, the Company did not recognize any compensation expense related to the shares awarded. As of December 31, 2012, all share awards were vested and no additional costs related to previously granted shares are expected to be recognized.
Other Benefit Plans
During 2007, the Company entered into a non-qualified Supplemental Executive Retirement Plan (“SERP”) with its Chief Executive Officer and its then current Chief Financial Officer. The benefit provided to them by the SERP is calculated at $48,000 and $24,000, respectively, per year for 15 years after retirement. The Company’s expense for the SERP was $101,000 and $70,000 for the period ending December 31, 2012 and 2011, respectively, resulting in a deferred compensation liability of $528,000 and $451,000 as of year-end 2012 and 2011. Due to the passing of the Chief Financial Officer in January 2009, the Company incurred an expense of $183,000 in the first quarter of 2009. Payment of the benefit accrued for the former Chief Financial Officer is being paid to his beneficiary evenly over 12 years.
The Company has a 401(k) profit sharing plan for eligible employees. The Company matches employee contributions equal to 50% of the amount of the salary reduction the employee elects to defer, up to a maximum of 5% of eligible compensation. The Company may also contribute a discretionary amount each year as determined by the Company. The Company’s contribution to the Plan was approximately $86,000 and $95,000 for the years ended December 31, 2012 and 2011, respectively.
NOTE 10 – COMMITMENTS
a) Lease Commitments
The Company leases certain office space and equipment under non-cancelable lease agreements, which have expiration dates through 2016. Lease and rental expense was approximately $443,000 and $447,000 for the years ended December 31, 2012 and 2012, respectively.
The following is a schedule of minimum commitments under operating leases at December 31, 2012:
| | | Amount | |
| | | (in thousands) | |
| 2013 | | $ | 364 | |
| 2014 | | | 315 | |
| 2015 | | | 230 | |
| 2016 | | | 101 | |
| Thereafter | | | — | |
| | | $ | 1,010 | |
b) Employment Agreements
The Company is a party to an employment agreement with its President and CEO. The agreement provides for one-year terms which automatically renew unless either party provides notice at least six (6) months prior to the termination date of their intention not to renew. Pursuant to this agreement, our President and CEO will receive a base salary and certain increases as defined in the agreement.
c) Preferred Stock
The Company’s certificate of incorporation authorizes it to issue up to 1,000,000 shares of preferred stock, in one or more series, with such designations and such relative voting, dividend and liquidation, conversion and other rights, preferences and limitations as shall be resolved by the Board of Directors. There are currently no shares issued or outstanding.
d) Litigation
The Company is involved in legal proceedings incurred in the normal course of business. On February 8, 2013, the Company received a class action complaint in connection with its pending merger with Lakeland Bancorp, Inc. In the opinion of management, none of these proceedings are expected to have a material effect on the financial position or results of operations of the Company.
NOTE 11 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The Company had the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk. These instruments are almost entirely made up of variable rate loans:
| | | December 31, | |
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Commitments to extend credit and unused lines of credit | | $ | 85,461 | | | $ | 92,807 | |
| Letters of credit—standby and performance | | | 1,421 | | | | 1,724 | |
| | | | | | | | | |
| Total | | $ | 86,882 | | | $ | 94,531 | |
Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include guarantees, marketable securities, residential or commercial real estate, accounts receivable, inventory or equipment. The Company had commitments to extend credit to related parties for approximately $456,000 and $1.4 million at December 31, 2012 and 2011, respectively.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
NOTE 12 – REPORTABLE SEGMENTS
We separate our business into two reporting segments: community banking and mortgage banking.
The primary activities of the Company include acceptance of deposits from the general public, origination of mortgage loans secured by residential and commercial real estate, commercial and consumer loans, and investment in debt securities, mortgage-backed securities and other financial instruments (community banking). Sullivan provides mortgage-banking services to customers on behalf of investor companies (mortgage banking).
The Company follows U.S. generally accepted accounting principles as described in the summary of significant accounting policies. Consolidation adjustments reflect elimination of intersegment revenue and expenses and statement of financial condition.
The following table sets forth certain information about the reconciliation of reported net income for each of the reportable segments as of and for the year ended December 31, 2012.
| | | The Bank
and Bancorp | | | Sullivan | | | Eliminating
Entries | | | Consolidated | |
| | | (in thousands) | |
| Interest income | | $ | 13,133 | | | $ | 128 | | | $ | (57 | ) | | $ | 13,204 | |
| Interest expense | | | 1,289 | | | | 57 | | | | (57 | ) | | | 1,289 | |
| Provision for loan losses | | | 290 | | | | — | | | | — | | | | 290 | |
| Non-interest income | | | 1,606 | | | | 1,362 | | | | (120 | ) | | | 2,848 | |
| Non-interest expense(1) | | | 10,102 | | | | 1,113 | | | | (120 | ) | | | 11,095 | |
| Net income | | $ | 3,058 | | | $ | 320 | | | $ | — | | | $ | 3,378 | |
| Total assets | | $ | 368,302 | | | $ | 9,299 | | | $ | (8,671 | ) | | $ | 368,930 | |
The following table sets forth certain information about the reconciliation of reported net income for each of the reportable segments as of and for the year ended December 31, 2011.
| | | The Bank
and Bancorp | | | Sullivan | | | Eliminating
Entries | | | Consolidated | |
| | | (in thousands) | |
| Interest income | | $ | 13,571 | | | $ | 111 | | | $ | (42 | ) | | $ | 13,640 | |
| Interest expense | | | 1,793 | | | | 42 | | | | (42 | ) | | | 1,793 | |
| Provision for loan losses | | | 220 | | | | — | | | | — | | | | 220 | |
| Non-interest income | | | 1,336 | | | | 786 | | | | (102 | ) | | | 2,002 | |
| Non-interest expense(1) | | | 10,069 | | | | 867 | | | | (102 | ) | | | 10,816 | |
| Net income | | $ | 2,825 | | | $ | (12 | ) | | $ | — | | | $ | 2,813 | |
| Total assets | | $ | 363,482 | | | $ | 4,928 | | | $ | (4,385 | ) | | $ | 364,025 | |
(1)Includes income taxes.
NOTE 13 – REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. At year-end 2012 and 2011, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2012, management believes the Bank met all capital adequacy requirements to which it is subject.
The Bank’s actual capital amounts and ratios are presented in the following tables:
| | | Actual | | | For Capital
Adequacy Purpose | | | For Classification
As Well Capitalized | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| December 31, 2012: | | (dollars in thousands) | |
| Total capital (to risk-weighted assets) | | $ | 43,595 | | | | 16.30 | % | | $ | 21,392 | | | | ³8.00 | % | | $ | 26,581 | | | | ³10.00 | % |
| Tier I capital (to risk-weighted assets) | | | 40,437 | | | | 15.12 | % | | | 10,696 | | | | ³4.00 | % | | | 15,949 | | | | ³6.00 | % |
| Tier I capital (to average assets) | | | 40,437 | | | | 11.04 | % | | | 14,656 | | | | ³4.00 | % | | | 18,206 | | | | ³5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2011: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total capital (to risk-weighted assets) | | $ | 39,962 | | | | 15.03 | % | | $ | 21,266 | | | | ³8.00 | % | | $ | 26,581 | | | | ³10.00 | % |
| Tier I capital (to risk-weighted assets) | | | 36,980 | | | | 13.91 | % | | | 10,633 | | | | ³4.00 | % | | | 15,949 | | | | ³6.00 | % |
| Tier I capital (to average assets) | | | 36,980 | | | | 10.16 | % | | | 14,565 | | | | ³4.00 | % | | | 18,206 | | | | ³5.00 | % |
As of December 31, 2012 and 2011, the Bank’s ratio of equity capital to total assets was 10.97% and 10.17%, respectively.
NOTE 14 – FAIR VALUE
FASB ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability
The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
The fair value of loans held for sale is based upon binding quotes from third party investors (Level 2 inputs).
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
| | | Fair Value Measurements at December 31, 2012 | |
| | | Quoted Prices in
Active Markets
for Identical
Unobservable
Assets
(Level 1) | | | Significant
Other
Observable
Inputs
(Level 2) | | | Significant
Unobservable
Inputs
(Level 3) | |
| Assets: | | (in thousands) | |
| Available for Sale Securities: | | | | | | | | | | | | |
| U.S. Government Sponsored Agency Securities | | $ | — | | | $ | 2,921 | | | $ | — | |
| Mortgage Backed Securities – Residential | | | — | | | | 7,667 | | | | — | |
| Collaterized Mortgage Obligations | | | — | | | | 1,324 | | | | — | |
| Corporate Debt Securities | | | — | | | | 1,458 | | | | — | |
| Loans Held for Sale | | | — | | | | 6,977 | | | | — | |
| | | Fair Value Measurements at December 31, 2011 | |
| | | Quoted Prices in
Active Markets
for Identical
Unobservable
Assets
(Level 1) | | | Significant
Other
Observable
Inputs
(Level 2) | | | Significant
Unobservable
Inputs
(Level 3) | |
| Assets: | | (in thousands) | |
| Available for Sale Securities: | | | | | | | | | | | | |
| U.S. Government Sponsored Agency Securities | | $ | — | | | $ | 14,753 | | | $ | — | |
| Mortgage Backed Securities – Residential | | | — | | | | 23,814 | | | | — | |
| Collaterized Mortgage Obligations | | | — | | | | 2,734 | | | | — | |
| Corporate Debt Securities | | | — | | | | 2,278 | | | | — | |
| Loans Held for Sale | | | — | | | | 2,969 | | | | — | |
Assets and Liabilities Measured on a Non-Recurring Basis
Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
| | | Fair Value Measurements at December 31, 2012 | |
| | | Quoted Prices in
Active Markets
for Identical
Unobservable
Assets
(Level 1) | | | Significant
Other
Observable
Inputs
(Level 2) | | | Significant
Unobservable
Inputs
(Level 3) | |
| Assets: | | (in thousands) | |
| Impaired loans: | | | | | | | | | | | | |
| Commercial Mortgage | | $ | — | | | $ | — | | | $ | 1,887 | |
| Consumer | | | — | | | | — | | | | 677 | |
A loan is impaired when full payment under the loan terms is not expected. The fair value measurement for collateral dependent loans is based on the lesser of appraised value, broker opinion or projected list price of the property less estimated expenses for the disposal of the property, which include taxes, commissions, first liens and legal fees. At December 31, 2012, impaired loans that are measured for impairment using the fair value of collateral had an unpaid principal balance of $2.7 million with a valuation allowance of $157,000. If a loan is impaired, a portion of the allowance for loan losses is allocated so that the loan is reported net of the allocated allowance.
The Level 3 fair value measurements on collateral dependent impaired loans were based on a current forecast of anticipated sale proceeds, net of expected closing costs and related fees, to arrive at fair value.
There were no impaired loans measured at fair value on a non-recurring basis at December 31, 2011.
The Company has elected the fair value option for loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policy on loans held for investment. None of these loans are 90 days or more past due or on nonaccrual at either December 31, 2012 or December 31, 2011. No impairment charges were recognized on loans held for sale for the year ended December 31, 2012 or December 31, 2011.
The carrying amounts and estimated fair values of financial instruments not previously presented are summarized below at December 31, 2012 and December 31, 2011:
| | | Fair Value Measurements at December 31, 2012 Using | | |
| | | Carrying Value | Quoted Prices in Active
Markets for Identical
Assets
(Level 1) | | Significant
Other
Observable
Inputs (Level 2) | | Significant
Unobservable
Inputs
(Level 3) | | |
| | | (in thousands) | | |
| Cash and due from banks | $ | 7,544 | | $ | 7,544 | | | | $ | — | | | | $ | — | | |
| Federal funds sold | | 75,127 | | | 75,127 | | | | | — | | | | | — | | |
| Interest bearing deposits in other financial institutions | | 775 | | | 775 | | | | | | | | | | | | |
| Investment securities held to maturity | | 8,900 | | | — | | | | | 9,186 | | | | | — | | |
| Restricted stock | | 743 | | | N/A | * | | | | — | | | | | — | | |
| Loans receivable, including deferred fees and costs | | 241,911 | | | — | | | | | — | | | | | 243,747 | | |
| Demand, NOW, money market and savings | | 285,874 | | | 285,874 | | | | | — | | | | | — | | |
| Certificates of deposit | | 34,313 | | | — | | | | | 34,962 | | | | | — | | |
| Federal Home Loan Bank advances | | 5,500 | | | — | | | | | 6,211 | | | | | — | | |
| | | | Fair Value Measurements at December 31, 2011 Using | |
| | | Carrying Value | Quoted Prices in Active
Markets for Identical
Assets
(Level 1) | | Significant
Other
Observable
Inputs (Level 2) | | Significant
Unobservable
Inputs
(Level 3) | |
| | | (in thousands) | |
| Cash and due from banks | $ | 4,588 | | $ | 4,588 | | | | $ | - | | | | $ | - | | |
| Federal funds sold | | 54,636 | | | 54,636 | | | | | - | | | | | - | | |
| Interest bearing deposits in other financial institutions | | 775 | | | 775 | | | | | - | | | | | - | | |
| Investment securities held to maturity | | 10,738 | | | - | | | | | 10,849 | | | | | - | | |
| Restricted stock | | 784 | | | N/A | * | | | | - | | | | | - | | |
| Loans receivable, including deferred fees and costs | | 232,485 | | | - | | | | | - | | | | | 235,344 | | |
| Demand, NOW, money market and savings | | 273,808 | | | 273,808 | | | | | - | | | | | - | | |
| Certificates of deposit | | 40,906 | | | - | | | | | 41,883 | | | | | - | | |
| Federal Home Loan Bank advances | | 7,500 | | | - | | | | | 8,682 | | | | | - | | |
| | | | | | | | | | | | | | | | | | |
| * It is not practical to determine the fair value of restricted stock due to restrictions placed on its transferability. |
For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Therefore, the Company uses significant estimations and present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.
Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instrument. The estimation methodologies used, the estimated fair values, and recorded book balances at December 31, 2012 and 2011 are outlined below.
The fair values of loans are estimated based on a discounted cash flow analysis using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.
The estimated fair values of demand deposits (i.e., interest and non-interest bearing checking accounts, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly time deposit maturities.
The fair values of fixed-rate Federal Home Loan Bank borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly Federal Home Loan borrowings maturities.
The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated costs to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial.
NOTE 15 – PARENT COMPANY ONLY
The following information on the parent only financial statements as of December 31, 2012 and 2011 and for the years ended December 31, 2012 and 2011 should be read in conjunction with the notes to the consolidated financial statements.
Statements of Financial Condition
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Assets: | | | | | | | | |
| Cash and due from subsidiaries | | $ | 591 | | | $ | 2,226 | |
| Investment in subsidiaries | | | 40,809 | | | | 37,769 | |
| Other assets | | | 448 | | | | 374 | |
| Total assets | | $ | 41,848 | | | $ | 40,369 | |
| | | | | | | | | |
| Liabilities: | | | | | | | | |
| Other liabilities | | $ | — | | | $ | — | |
| | | | | | | | | |
| Stockholders’ equity: | | | | | | | | |
| Common stock | | | 37,143 | | | | 36,972 | |
| Retained earnings | | | 4,333 | | | | 2,608 | |
| Accumulated other comprehensive income | | | 372 | | | | 789 | |
| Total stockholders’ equity | | | 41,848 | | | | 40,369 | |
| Total liabilities and stockholders’ equity | | $ | 41,848 | | | $ | 40,369 | |
The following information on the parent only operating statements and cash flows as of December 31, 2012 and 2011 and for the years then ended should be read in conjunction with the notes to the consolidated financial statements.
Statements of Operations
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Equity in undistributed income of subsidiaries | | $ | 3,457 | | | $ | 2,851 | |
| Other expenses | | | 79 | | | | 38 | |
| Net income | | $ | 3,378 | | | $ | 2,813 | |
Statements of Cash Flows
| | | 2012 | | | 2011 | |
| | | (in thousands) | |
| Cash flows from operating activities: | | | | | | | | |
| Net income | | $ | 3,378 | | | $ | 2,813 | |
| Equity in undistributed income of the subsidiaries | | | (3,457 | ) | | | (2,851 | ) |
| Increase in other assets | | | (74 | ) | | | (72 | ) |
| Stock-based compensation | | | 41 | | | | 44 | |
| Net cash used in operating activities | | | (112 | ) | | | (66 | ) |
| | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | |
| Proceeds from exercise of options | | | 344 | | | | 210 | |
| Common stock repurchase | | | (214 | ) | | | (882 | ) |
| Cash dividend paid common stock | | | (1,653 | ) | | | (1,350 | ) |
| Net cash used in financing activities | | | (1,523 | ) | | | (2,022 | ) |
| | | | | | | | | |
| Net change in cash for the period | | | (1,635 | ) | | | (2,088 | ) |
| Net cash at beginning of year | | | 2,226 | | | | 4,314 | |
| Net cash at end of year | | $ | 591 | | | $ | 2,226 | |
NOTE 16 – QUARTERLY FINANCIAL DATA (unaudited)
Selected Consolidated Quarterly Financial Data
| | | 2012 Quarter Ended | |
| | | March 31, | | | June 30, | | | September 30, | | | December 31, | |
| | | (in thousands, except per share data) | |
| Total interest income | | $ | 3,455 | | | $ | 3,308 | | | $ | 3,299 | | | $ | 3,142 | |
| Total interest expense | | | 356 | | | | 339 | | | | 327 | | | | 267 | |
| | | | | | | | | | | | | | | | | |
| Net interest income | | | 3,099 | | | | 2,969 | | | | 2,972 | | | | 2,875 | |
| Provision for loan losses | | | 75 | | | | 90 | | | | 75 | | | | 50 | |
| | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 3,024 | | | | 2,879 | | | | 2,897 | | | | 2,825 | |
| Other income | | | 551 | | | | 712 | | | | 580 | | | | 1,005 | |
| Other expenses | | | 2,317 | | | | 2,190 | | | | 2,221 | | | | 2,537 | |
| | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 1,258 | | | | 1,401 | | | | 1,256 | | | | 1,293 | |
| Income tax expense | | | 438 | | | | 500 | | | | 443 | | | | 449 | |
| | | | | | | | | | | | | | | | | |
| Net income | | $ | 820 | | | $ | 901 | | | $ | 813 | | | $ | 844 | |
| | | | | | | | | | | | | | | | | |
| Earnings per share: | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.15 | | | $ | 0.17 | | | $ | 0.15 | | | $ | 0.16 | |
| Diluted | | $ | 0.15 | | | $ | 0.17 | | | $ | 0.15 | | | $ | 0.16 | |
| | | 2011 Quarter Ended | |
| | | March 31, | | | June 30, | | | September 30, | | | December 31, | |
| | | (in thousands, except per share data) | |
| Total interest income | | $ | 3,325 | | | $ | 3,376 | | | $ | 3,484 | | | $ | 3,454 | |
| Total interest expense | | | 450 | | | | 463 | | | | 445 | | | | 434 | |
| | | | | | | | | | | | | | | | | |
| Net interest income | | | 2,875 | | | | 2,913 | | | | 3,039 | | | | 3,020 | |
| Provision for loan losses | | | 75 | | | | 30 | | | | 95 | | | | 20 | |
| | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 2,800 | | | | 2,883 | | | | 2,944 | | | | 3,000 | |
| Other income | | | 396 | | | | 368 | | | | 734 | | | | 503 | |
| Other expenses | | | 2,353 | | | | 2,278 | | | | 2,744 | | | | 2,251 | |
| | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 843 | | | | 973 | | | | 934 | | | | 1,252 | |
| Income tax expense | | | 240 | | | | 322 | | | | 197 | | | | 430 | |
| | | | | | | | | | | | | | | | | |
| Net income | | $ | 603 | | | $ | 651 | | | $ | 737 | | | $ | 822 | |
| | | | | | | | | | | | | | | | | |
| Earnings per share: | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.11 | | | $ | 0.12 | | | $ | 0.14 | | | $ | 0.16 | |
| Diluted | | $ | 0.11 | | | $ | 0.12 | | | $ | 0.13 | | | $ | 0.16 | |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 in the Borough of Bernardsville, State of New Jersey, on March 11, 2013.
| | | SOMERSET HILLS BANCORP |
| | | By:/s/ Stewart E. McClure, Jr. |
| | | Stewart E. McClure, Jr. |
| | | President, Chief Executive Officer |
| | | and Chief Operating Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated below on March 11, 2013.
| /s/ Stewart E. McClure, Jr. | | President, Chief Executive Officer and |
| Stewart E. McClure, Jr. | | Chief Operating Officer |
| | | |
| /s/ Alfred J. Soles | | Executive Vice President and |
| Alfred J. Soles | | Chief Financial Officer |
| | | |
| /s/ Edward B. Deutsch | | Chairman |
| Edward B. Deutsch | | |
| | | |
| /s/ William F. Keefe | | Director |
| William F. Keefe | | |
| | | |
| /s/ Jefferson W. Kirby | | Director |
| Jefferson W. Kirby | | |
| | | |
| /s/ Thomas J. Marino | | Director |
| Thomas J. Marino | | |
| | | |
| /s/ Gerald B. O’Connor | | Director |
| Gerald B. O’Connor | | |
| | | |
| /s/ M. Gerald Sedam, II | | Director |
| M. Gerald Sedam, II | | |
