The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods presented:
For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2011 and December 31, 2010 are as follows:
The following valuation techniques were used to measure fair value of assets in the tables above:
NOTE 11 – FAIR VALUE MEASUREMENTS (Continued)
| | · | Property held for sale – This real estate property is carried in other assets as property held for sale at fair value based upon the appraised value of the property. An impairment charge of $75,000 was recorded during the three month period ending June 30, 2011. |
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at June 30, 2011 and December 31, 2010:
Cash and Cash Equivalents (carried at cost):
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Securities:
The fair value of securities available-for-sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). At June 30, 2011 and December 31, 2010, the Company determined that no active market existed for our pooled trust preferred security. This security is classified as a Level 3 investment. Management’s best estimate of fair value consists of both internal and external support on the Level 3 investment. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support the fair value of the Level 3 investment.
Restricted Investment in Federal Home Loan Bank Stock and ACBB Stock (carried at cost):
The carrying amount of restricted investment in Federal Home Loan Bank stock and Atlantic Central Bankers Bank stock approximates fair value, and considers the limited marketability of such securities.
Loans Receivable (carried at cost):
The fair values of loans, excluding collateral dependent impaired loans, are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.
Accrued Interest Receivable and Payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest payable approximates their respective fair values.
Deposit Liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Securities Sold Under Agreements to Repurchase (carried at cost):
The carrying amounts of these short-term borrowings approximate their fair values.
NOTE 11 – FAIR VALUE MEASUREMENTS (Continued)
Long-term Debt (carried at cost):
Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Off-balance Sheet Financial Instruments (disclosed at cost):
Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing. The fair values of such fees are not material at June 30, 2011 and December 31, 2010.
The estimated fair values of the Company’s financial instruments at June 30, 2011 and December 31, 2010 were as follows:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | Carrying Amount | | | Estimated Fair Value | | | Carrying Amount | | | Estimated Fair Value | |
| | | (in thousands) | |
| | | | | | | | | | | | | |
| Financial assets: | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 64,312 | | | $ | 64,312 | | | $ | 34,443 | | | $ | 34,443 | |
| Securities available for sale | | | 39,619 | | | | 39,619 | | | | 35,079 | | | | 35,079 | |
| Securities held to maturity | | | 10,053 | | | | 10,193 | | | | 10,829 | | | | 10,643 | |
| Restricted stock | | | 1,480 | | | | 1,480 | | | | 1,420 | | | | 1,420 | |
| Loans receivable | | | 513,616 | | | | 519,039 | | | | 506,748 | | | | 507,968 | |
| Accrued interest receivable | | | 1,834 | | | | 1,834 | | | | 1,911 | | | | 1,911 | |
| | | | | | | | | | | | | | | | | |
| Financial liabilities: | | | | | | | | | | | | | | | | |
| Deposits | | | 560,952 | | | | 563,207 | | | | 524,471 | | | | 526,142 | |
| Securities sold under agreements to repurchase | | | 16,373 | | | | 16,373 | | | | 14,857 | | | | 14,857 | |
| Long-term debt | | | 13,500 | | | | 14,869 | | | | 13,500 | | | | 14,649 | |
| Accrued interest payable | | | 105 | | | | 105 | | | | 93 | | | | 93 | |
| | | | | | | | | | | | | | | | | |
| Off-balance sheet financial instruments: | | | | | | | | | | | | | | | | |
Commitments to extend credit and outstanding letters of credit | | | - | | | | - | | | | - | | | | - | |
NOTE 12 – SHAREHOLDERS’ EQUITY
In connection with the Emergency Economic Stabilization Act of 2008 (“EESA”), the Department of the Treasury (the “Treasury”) was authorized to establish a Troubled Asset Relief Program (“TARP”) to purchase up to $700 billion in troubled assets from qualified financial institutions (“QFI”). EESA has also been interpreted by the Treasury to allow it to make direct equity investments in QFIs. Subsequent to the enactment of EESA, the Treasury announced the TARP Capital Purchase Program under which QFIs that elected to participate in the TARP Capital Purchase Program were allowed to issue senior perpetual preferred stock to the Treasury, and the Treasury was authorized to purchase such preferred stock of QFIs, subject to certain limitations and terms. EESA was developed to stabilize the financial system and increase lending to benefit the national economy and citizens of the United States.
On January 30, 2009, the Company entered into a Securities Purchase Agreement with the Treasury as part of the TARP Capital Purchase Program, pursuant to which the Company sold to the Treasury 9,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Senior Preferred Stock”), no par value per share and with a liquidation preference of $1,000 per share, and a warrant (the “Warrant”) to purchase 311,972 shares of the Company’s common stock, as adjusted for the stock dividend declared in August 2010, for an aggregate purchase price of $9,000,000.
The shares of Senior Preferred Stock have no stated maturity, do not have voting rights except in certain limited circumstances and are not subject to mandatory redemption or a sinking fund. The Senior Preferred Stock may be redeemed at any time following consultation by the Company’s primary bank regulator and the Treasury, at liquidation preference plus accrued and unpaid dividends. The Company must provide at least 30 days and no more than 60 days notice to the holder of its intention to redeem the shares. Participants in the TARP Capital Purchase Program desiring to repay part of an investment by the Treasury must repay a minimum of 25% of the issue price of the Senior Preferred Stock.
In February 2009, the American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”), which amended and supplemented EESA, was signed into law. EESA, as amended and supplemented by the Stimulus Act, imposes extensive new restrictions applicable to participants in the TARP, including the Company, and removes the requirement of being limited to using proceeds from only qualifying equity offerings.
The Senior Preferred Stock has priority over the Company’s common stock with regard to the payment of dividends and liquidation distribution. The Senior Preferred Stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. Dividends are payable quarterly on February 15, May 15, August 15 and November 15 of each year.
Prior to the earlier of the third anniversary date (January 30, 2012) of the issuance of the Senior Preferred Stock or the date on which the Senior Preferred Stock has been redeemed in whole or the Treasury has transferred all of the Senior Preferred Stock to third parties which are not affiliates of the Treasury, the Company cannot declare or pay any cash dividend on its common stock or with certain limited exceptions, redeem, purchase or acquire any shares of the Company’s stock without the consent of the Treasury.
The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.33 per share of common stock, as adjusted for the stock dividend declared in August 2010. In the event that the Company redeems the Senior Preferred Stock, the Company can repurchase the Warrant at “Fair Market Value,” as defined in the Securities Purchase Agreement with the Treasury.
The proceeds received were allocated between the Senior Preferred Stock and the Warrant based upon their relative fair values as of the date of issuance, which resulted in the recording of a discount of the Senior Preferred Stock upon issuance that reflects the value allocated to the Warrant. The discount is accreted by a charge to accumulated deficit on a straight-line basis over the expected life of the preferred stock of five years.
The agreement with the Treasury contains limitations on certain actions by the Company, including the Treasury consent prior to the payment of cash dividends on the Company’s common stock and the repurchase of its common stock during the first three years of the agreement. In addition, the Company agreed that, while the Treasury owns the Senior Preferred Stock, the Company’s employee benefit plans and other executive compensation arrangements for its senior executive officers must comply with Section 111 of EESA, as amended.
NOTE 13 – SUBSEQUENT EVENT
The Small Business Lending Fund (“SBLF”) was created in fall of 2010 as part of the Small Business Jobs Act. The SBLF provides Tier 1 capital to community banks with assets of $10 billion or less, and provides incentives for making small business loans, defined as certain loans of up to $10 million to businesses with up to $50 million in annual revenues.
NOTE 13 – SUBSEQUENT EVENT (Continued)
Unlike (“TARP”), under the SBLF program Treasury will not receive any warrants in exchange for SBLF funding. Rates will be determined by the bank’s lending practices with small business loans.
The noncumulative dividend rate on the SBLF funds, which will be in the form of Non-Cumulative Perpetual Preferred Stock (the “SBLF Preferred Shares”) will be adjusted to reflect the amount of a change in the Company’s qualified small business lending from its baseline, determined based upon the Company’s qualified small business lending for each of the four full quarters ending June 30, 2010. Accordingly, the dividend rate will change as follows:
| | | Dividend Rate Following Investment Date | |
Increase in Qualified Small Business Lending from the Baseline | | First 9 Quarters* | | | Quarter 10 to Year 4.5 | | | After Year 4.5 | |
| 0% or less | | 5% | | | 7% | | | 9% | |
| More than 0%, but less than 2.5% | | 5% | | | 5% | | | 9% | |
| 2.5% or more, but less than 5% | | 4% | | | 4% | | | 9% | |
| 5% or more, but less than 7.5% | | 3% | | | 3% | | | 9% | |
| 7.5% or more, but less than 10% | | 2% | | | 2% | | | 9% | |
| 10% or more | | 1% | | | 1% | | | 9% | |
| * For the first nine quarters, the dividend rate will be adjusted quarterly. | |
After 10 years, if the SBLF Preferred Shares are not redeemed, the dividend rate will increase to the highest possible dividend rate as permitted by the Company’s regulators.
During the first quarter of 2011, the Company had applied to the U.S. Department of the Treasury for $12 million under the SBLF program. On July 20, 2011, the Company announced that it had received preliminary approval to receive an investment of $12 million in SBLF Preferred Shares from the U.S. Treasury. In connection with the investment, the Company will use $9.0 million of the SBLF funds to redeem all of the outstanding shares of preferred stock issued to the U.S. Treasury under TARP. It is also the intention of the Company to redeem at a to-be-determined price the 311,972 warrants to purchase additional shares of preferred stock issued to the U.S. Treasury as part of the original TARP funding. On August 11, 2011, the Company received the $12 million under the SBLF program and simultaneously, redeemed the full $9.0 million of its outstanding shares of preferred stock issued to the U.S. Treasury under TARP.
On July 20, 2011, the Company’s board of directors declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's common stock, to shareholders of record at the close of business on August 1, 2011 (the “Record Date”). Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series B Junior Participating Preferred Stock, at a purchase price of $25.00, subject to adjustment, (as so adjusted, the “Exercise Price”). The description and terms of the Rights are set forth in the Rights Agreement (the "Rights Agreement") between the Company and Registrar and Transfer Company, as Rights Agent, which is attached as Exhibit 4.1 to the Company’s 8-K filed with the SEC on July 21, 2011. The Rights Agreement is designed to protect shareholders from abusive takeover tactics and attempts to acquire control of the Company at an inadequate price. The Rights are not exercisable or transferable unless certain specified events occur.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward looking statements. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, relationships, opportunities, taxation, technology and market conditions. When used in this and in our future filings with the SEC in our press releases and in oral statements made with the approval of an authorized executive officer, the words or phrases “will,” “will likely result,” “could,” “anticipates,” “believes,” “continues,” “expects,” “plans,” “will continue,” “is anticipated,” “estimated,” “project” or “outlook” or similar expressions (including confirmations by one of our authorized executive officers of any such expressions made by a third party with respect to us) are intended to identify forward-looking statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made, even if subsequently made available on our website or otherwise. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.
Factors that may cause actual results to differ from those results, expressed or implied, include, but are not limited to, those discussed under “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2010 Form 10-K, under this Item 2, and in our other filings with the SEC.
Although management has taken certain steps to mitigate any negative effect of these factors, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on profitability. The Company undertakes no obligation to publicly revise any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.
The following information should be read in conjunction with the consolidated financial statements and the related notes thereto included in the 2010 Form 10-K and in this Form 10-Q.
Critical Accounting Policies and Estimates
The following discussion is based upon the financial statements of the Company, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses.
Note 1 to the Company’s consolidated financial statements included in the 2010 Form 10-K contains a summary of our significant accounting policies. Management believes the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Allowance for Loan Losses. We maintain an allowance for loan losses at a level that we believe is adequate to provide for probable losses inherent in the loan portfolio. Loan losses are charged directly to the allowance when they occur and any recovery is credited to the allowance when realized. Risks from the loan portfolio are analyzed on a continuous basis by the Bank’s senior management, outside independent loan review auditors, the directors’ loan committee, and the Board of Directors.
The level of the allowance is determined by assigning specific allowances to impaired loans and general allowances on all other loans. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of the underlying collateral. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and set appropriate general allowances. Along with the risk system, senior management 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 management feels deserve recognition in establishing an appropriate allowance. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are realized in the periods in which they become known. Additions to the allowance are made by provisions charged to expense and the allowance is reduced by net charge-offs (i.e., loans judged to be uncollectible and charged against the reserve, less any recoveries on such loans).
Although management attempts to maintain the allowance at a level deemed adequate to cover any losses, future additions to the allowance may be necessary based upon any changes in market conditions, either generally or specific to our area, or changes in the circumstances of particular borrowers. In addition, various regulatory agencies periodically review our allowance for loan losses, and may require us to take additional provisions based on their judgments about information available to them at the time of their examination.
Stock Based Compensation. Stock based compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.
Goodwill Impairment. Although goodwill is not subject to amortization, the Company must test the carrying value for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. Our reporting unit is identified as our community bank operations. If the fair value of the reporting unit exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less than book value, an expense may be required on the Company’s books to write-down the related goodwill to the proper carrying value.
Investment Securities Impairment Valuation. Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. The analysis of other-than-temporary impairment requires the use of various assumptions including, but not limited to, the length of time the investment’s book value has been greater than fair value, the severity of the investment’s decline and the credit deterioration of the issuer. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment.
In instances when a determination is made that an other-than-temporary impairment exists but the Company does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
Deferred Tax Assets and Liabilities. We recognize deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management determines that we may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.
Overview
The Company reported net income to common shareholders of $935,000 for the three months ended June 30, 2011, compared to $695,000, for the same period in 2010, an increase of 34.5%. Basic and diluted earnings per common share after preferred stock dividends and accretion were $0.12 for the quarter ended June 30, 2011 compared to $0.09 for the same period in 2010. Dividends and accretion related to the preferred stock issued to the Treasury reduced earnings for the second quarter of 2011 and 2010 by $143,000, or $0.02 per fully diluted common share. The annualized return on average assets increased to 0.65% for the three months ended June 30, 2011 as compared to 0.51% for the same period in 2010. The annualized return on average shareholders’ equity increased to 5.26% for the three month period ended June 30, 2011 as compared to 4.30% for the three months ended June 30, 2010.
The Company reported net income to common shareholders of $1.7 million for the six months ended June 30, 2011, compared to $1.2 million, for the same period in 2010, an increase of 44.7%. Basic and diluted earnings per common share after preferred stock dividends and accretion were $0.22 for the six months ended June 30, 2011 compared to $0.16 for the same period in 2010. Dividends and accretion related to the preferred stock issued to the Treasury reduced earnings for the six months ended June 30, 2011 and 2010 by $286,000, or $0.04 per fully diluted common share, respectively. The annualized return on average assets increased to 0.61% for the six months ended June 30, 2011 as compared to 0.45% for the same period in 2010. The annualized return on average shareholders’ equity increased to 4.92% for the six month period ended June 30, 2011 as compared to 3.79% for the six months ended June 30, 2010.
Net interest income increased by $285,000, or 4.6%, for the quarter ended June 30, 2011 over the same period in 2010, primarily as a result of lower deposit rates, a higher level of core checking deposits and a continued improvement in the mix of average interest earning assets. On a linked quarter basis, net interest income increased by $162,000, or 2.6%, from the $6.3 million earned in the first quarter of 2011. The Company reported a net interest margin of 4.23% for the quarter ended June 30, 2011, a decrease of 10 basis points when compared to the 4.33% for the quarter ended March 31, 2011, primarily due to a higher cash liquidity position due to deposit growth. Net interest margin increased 19 basis points when compared to the 4.04% reported for the quarter ended June 30, 2010, primarily due to lower deposit rates, a higher level of core checking deposits and an improvement in our earning asset mix.
Net interest income increased by $779,000, or 6.5%, for the six months ended June 30, 2011 over the same period in 2010, primarily as a result of lower deposit rates and a higher level of core checking deposits. The Company reported a net interest margin of 4.28% for the six months ended June 30, 2011, an increase of 28 basis points when compared to the 4.00% reported for the six months ended June 30, 2010.
The provision for loan losses for the three months ended June 30, 2011 decreased to $600,000, as compared to a provision for loan losses of $700,000 for the corresponding 2010 period. The provision for loan losses for the six months ended June 30, 2011 decreased to $1.1 million, as compared to a provision for loan losses of $1.4 million for the corresponding 2010 period. The decrease in both the three and six month periods was primarily due to lesser allowance requirements for certain identified impaired loans and slower loan growth in the overall portfolio.
Non-interest income for the quarter ended June 30, 2011 totaled $868,000, an increase of $388,000, or 80.8%, compared to the same period in 2010. The increase was primarily due to the $305,000 of net gains on the sale of three OREO properties and the $81,000 gain on the sale of SBA loans recorded during the quarter ended June 30, 2011. Non-interest income for the six months ended June 30, 2011 totaled $1.3 million, an increase of $298,000, or 29.6%, compared to the same period in 2010. This increase for the six month period was due primarily to the above mentioned gains offset in part by lower fees generated by our residential mortgage department.
Non-interest expense for the quarter ended June 30, 2011 totaled $5.1 million, an increase of $371,000, or 7.9%, from the same period in 2010. The increase was due primarily to higher salary and benefit costs resulting in part to the expansion of our lending division, annual increases and rising medical health care costs. Additionally, OREO and impaired loan expenses were higher due to a $100,000 write-down on an existing OREO property coupled with an increase in other expenses resulting primarily from a $75,000 write-down taken on a property held for sale. Non-interest expense for the six months ended June 30, 2011 totaled $9.8 million, an increase of $473,000, or 5.1%, from the same period in 2010. This increase for the six month period was due primarily to the same items discussed above.
Total assets at June 30, 2011 were $676.8 million, up 6.3% from total assets of $636.8 million at December 31, 2010. Total loans at June 30, 2011 were $520.4 million, an increase of 1.5% compared to $513.0 million at December 31, 2010. Total deposits were $561.0 million at June 30, 2011, an increase of 7.0% from total deposits of $524.5 million at December 31, 2010.
At June 30, 2011, the Company’s allowance for loan losses was $6.8 million, compared with $6.2 million at December 31, 2010. The allowance for loan losses as a percentage of total loans at June 30, 2011 was 1.31%, compared with 1.22% at December 31, 2010. Non-accrual loans were $6.0 million at June 30, 2011, compared with $5.6 million at December 31, 2010. OREO properties were $7.6 million at June 30, 2011, compared to $8.1 million at December 31, 2010.
RESULTS OF OPERATIONS
The Company’s principal source of revenue is net interest income, which is the difference between interest income on earning assets and interest expense on deposits and borrowings. Interest earning assets consist primarily of loans, investment securities and Federal funds sold. Sources to fund interest-earning assets consist primarily of deposits and borrowed funds. The Company’s net income is also affected by its provision for loan losses, other income and other expenses. Other income consists primarily of service charges, commissions and fees, earnings from investment in life insurance and gains on security sales, while other expenses are primarily comprised of salaries and employee benefits, occupancy costs and other operating expenses.
The following table provides information on our performance ratios for the dates indicated.
| | | | (Annualized) Six months ended June 30, |
| | | | 2011 | | 2010 |
| Return on average assets | | | 0.61% | | 0.45% |
| Return on average tangible assets (1) | | | 0.63% | | 0.46% |
| Return on average shareholders' equity | | | 4.92% | | 3.79% |
| Return on average tangible shareholders' equity (1) | | | 6.39% | | 5.00% |
| Net interest margin | | | 4.28% | | 4.00% |
| Average equity to average assets | | | 12.39% | | 11.84% |
| Average tangible equity to average tangible assets (1) | | | 9.83% | | 9.22% |
| | | | | | |
| | (1) | The following table provided the reconciliation of Non-GAAP Financial Measures for the dates indicated: |
| | | | For the Six months ended June 30, |
| | | | 2011 | | 2010 |
| | | | | | |
| Return on average assets | | | 0.61% | | 0.45% |
| Effect of intangible assets | | | 0.02% | | 0.01% |
| Return on average tangible assets | | | 0.63% | | 0.46% |
| | | | | | |
| Return on average equity | | | 4.92% | | 3.79% |
| Effect of average intangible assets | | | 1.47% | | 1.21% |
| Return on average tangible equity | | | 6.39% | | 5.00% |
| | | | | | |
| Average equity to average assets | | | 12.39% | | 11.84% |
| Effect of intangible assets | | | (2.56%) | | (2.62%) |
| Average tangible equity to average tangible assets | | | 9.83% | | 9.22% |
This Report contains certain financial information determined by methods other than in accordance with generally accepted accounting policies in the United States (GAAP). These non-GAAP financial measures are “return on average tangible assets,” “return on average tangible equity,” and “average tangible equity to average tangible assets.” This non-GAAP disclosure has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Our management uses these non-GAAP measures in its analysis of our performance because it believes these measures are material and will be used as a measure of our performance by investors.
We anticipate that our earnings will remain challenged in 2011 principally due to the sluggish economic conditions in the New Jersey commercial and real estate markets. In addition, should a further general decline in economic conditions in New Jersey continue throughout 2011 and beyond, the Company may suffer higher default rates on its loans, decreased value of assets it holds as collateral, and potentially lower loan originations due to heightened competition for lending relationships coupled with our higher credit standards and requirements.
Three months ended June 30, 2011 compared to June 30, 2010
Net Interest Income
Net interest income increased by $285,000, or 4.6%, to $6.5 million for the three months ended June 30, 2011 compared to $6.2 million for the corresponding period in 2010, primarily due to a continued improvement in the mix of average interest-earning assets coupled with lower deposit rates and a higher level of core checking deposits. The net interest margin and net interest spread increased to 4.23% and 4.01%, respectively, for the three months ended June 30, 2011 from 4.04% and 3.81%, respectively, for the three months ended June 30, 2010.
Total interest income for the three months ended June 30, 2011 increased by $55,000, or 0.7%. The increase in interest income was primarily due to a volume related increase in interest income of $161,000 partially offset by an interest rate related decrease in interest income of $106,000 for the second quarter of 2011 as compared to the same prior year period.
Interest and fees on loans increased $86,000, or 1.2%, to $7.4 million for the three months ended June 30, 2011 compared to $7.3 million for the corresponding period in 2010. Volume related increases equaled $141,000 and these were partially offset by an interest rate-related decrease of $55,000. The average balance of the loan portfolio for the three months ended June 30, 2011 increased by $9.9 million, or 1.9%, to $521.9 million from $512.0 million for the corresponding period in 2010. The average annualized yield on the loan portfolio was 5.71% for the quarter ended June 30, 2011 compared to 5.75% for the quarter ended June 30, 2010. Additionally, the average balance of non-accrual loans, which amounted to $5.6 million and $12.8 million at June 30, 2011 and 2010, respectively, impacted the Company’s loan yield for both periods presented.
Interest income on Federal funds sold and interest bearing deposits was $27,000 for the three months ended June 30, 2011, representing a decrease of $10,000, or 27.0%, from $37,000 for the three months ended June 30, 2010. For the three months ended June 30, 2011, Federal funds sold had an average balance of $5.7 million with an average annualized yield of 0.21%, as compared to $7.0 million with an average annualized yield of 0.34% for the three months ended June 30, 2010. During the second quarter 2011, in order to maximize earnings on excess liquidity and increase the safety of our funds, the Bank transferred its entire Fed funds sold balance to the Federal Reserve Bank of New York, which paid a higher return than our correspondent banks. For the three months ended June 30, 2011, interest bearing deposits had an average balance of $38.8 million and an average annualized yield of 0.25% as compared to an average balance of $50.4 million and an average annualized yield of 0.25% for the same period in 2010. This average balance decrease was primarily due to an increase in loan fundings and investment securities purchased.
Interest income on investment securities totaled $392,000 for the three months ended June 30, 2011 compared to $413,000 for the three months ended June 30, 2010, a decrease of $21,000, or 5.1%. The decrease in interest income on investment securities was primarily attributable to the partial replacement of maturities, calls and principal paydowns of existing securities with new purchases that had generally lower rates resulting from the lower rate environment. For the three months ended June 30, 2011, investment securities had an average balance of $50.0 million with an average annualized yield of 3.14% compared to an average balance of $46.8 million with an average annualized yield of 3.53% for the three months ended June 30, 2010.
Interest expense on interest-bearing liabilities amounted to $1.3 million for the three months ended June 30, 2011 compared to $1.6 million for the corresponding period in 2010, a decrease of $230,000, or 14.6%. This decrease in interest expense was comprised of a $254,000 rate-related decrease primarily resulting from lower deposit costs, partially offset by $24,000 in volume-related increases.
During 2010 and into 2011, management continued to focus on developing core deposit relationships at the Bank. Additionally, management continued to restructure the mix of interest-bearing liabilities portfolio by decreasing our funding dependence from high-cost time deposits to lower-cost core checking, money market and savings account deposit products. The average balance of interest-bearing liabilities decreased to $495.6 million for the three months ended June 30, 2011 from $503.4 million for the same period last year, a decrease of $7.8 million, or 1.5%. Our average balance in certificates of deposit decreased by $1.0 million, or 0.8%, to $119.5 million with an average annualized yield of 1.88% for the second quarter of 2011 from $120.5 million with an average annualized yield of 1.95% for the same period in 2010. Average money market deposits decreased by $15.2 million over this same period while the average annualized yield declined by 25 basis points. Additionally, average savings deposits decreased by $3.6 million over this same period and the average annualized yield declined by 23 basis points. These average balance decreases were partially offset by increases of $5.9 million in average NOW deposits, which increased from $50.9 million with an average annualized yield of 0.64% during the second quarter of 2010, to $56.8 million with an average annualized yield of 0.47% during the second quarter of 2011. During the second quarter of 2011, our average demand deposits reached $86.4 million, an increase of $7.3 million, or 9.2%, over the same period last year. For the three months ended June 30, 2011, the average annualized cost for all interest-bearing liabilities was 1.09%, compared to 1.26% for the three months ended June 30, 2010, a decrease of 17 basis points.
Our strategies for increasing and retaining core relationship deposits, managing loan originations within our acceptable credit criteria and loan category concentrations, and our planned branch network growth have combined to meet our liquidity needs. The Company also offers agreements to repurchase securities, commonly known as repurchase agreements, to its customers as an alternative to other insured deposits. Average balances of repurchase agreements for the second quarter of 2011 were $16.0 million, with an average interest rate of 0.80%, compared to $15.7 million, with an average interest rate of 1.07%, for the second quarter of 2010.
The Company also utilizes FHLB term borrowings as an additional funding source. The average balance of such borrowings for the second quarter of 2011 were $13.5 million, with an average interest rate of 3.21%, compared to $7.5 million, with an average interest rate of 4.06%, for the second quarter of 2010.
The following tables reflect, for the periods presented, the components of our net interest income, setting forth (1) average assets, liabilities, and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expenses paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) our net interest spread (i.e., the average yield on interest-earning assets less the average rate on interest-bearing liabilities), and (5) our margin on interest-earning assets. Yields on tax-exempt assets have not been calculated on a fully tax-exempt basis.
| | | Three Months Ended June 30, 2011 | | Three Months Ended June 30, 2010 |
| (dollars in thousands) | | Average Balance | | | Interest Income/ Expense | | | Average Rate | | Average Balance | | | Interest Income/ Expense | | | Average Rate |
| ASSETS | | | | | | | | | | | | | | | | | | |
| Interest Earning Assets: | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits in banks | | $ | 38,813 | | | $ | 24 | | | | 0.25% | | | $ | 50,405 | | | $ | 31 | | | | 0.25% | |
| Federal funds sold | | | 5,692 | | | | 3 | | | | 0.21% | | | | 7,000 | | | | 6 | | | | 0.34% | |
| Investment securities | | | 49,988 | | | | 392 | | | | 3.14% | | | | 46,787 | | | | 413 | | | | 3.53% | |
| Loans, net of unearned fees (1) (2) | | | 521,910 | | | | 7,424 | | | | 5.71% | | | | 512,046 | | | | 7,338 | | | | 5.75% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Earning Assets | | | 616,403 | | | | 7,843 | | | | 5.10% | | | | 616,238 | | | | 7,788 | | | | 5.07% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses | | | (6,502 | ) | | | | | | | | | | | (7,098 | ) | | | | | | | | |
| All other assets | | | 58,020 | | | | | | | | | | | | 55,210 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Assets | | $ | 667,921 | | | | | | | | | | | $ | 664,350 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES & SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | $ | 56,774 | | | | 67 | | | | 0.47% | | | $ | 50,936 | | | | 81 | | | | 0.64% | |
| Savings deposits | | | 202,061 | | | | 453 | | | | 0.90% | | | | 205,676 | | | | 577 | | | | 1.13% | |
| Money market deposits | | | 87,805 | | | | 129 | | | | 0.59% | | | | 103,030 | | | | 217 | | | | 0.84% | |
| Time deposits | | | 119,497 | | | | 559 | | | | 1.88% | | | | 120,510 | | | | 585 | | | | 1.95% | |
| Repurchase agreements | | | 15,996 | | | | 32 | | | | 0.80% | | | | 15,738 | | | | 42 | | | | 1.07% | |
| FHLB-term borrowings | | | 13,500 | | | | 108 | | | | 3.21% | | | | 7,500 | | | | 76 | | | | 4.06% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Bearing Liabilities | | | 495,633 | | | | 1,348 | | | | 1.09% | | | | 503,390 | | | | 1,578 | | | | 1.26% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 86,372 | | | | | | | | | | | | 79,126 | | | | | | | | | |
| Other liabilities | | | 3,984 | | | | | | | | | | | | 3,702 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Non-Interest Bearing Liabilities | | | 90,356 | | | | | | | | | | | | 82,828 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' Equity | | | 81,932 | | | | | | | | | | | | 78,132 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Liabilities and Shareholders' Equity | | $ | 667,921 | | | | | | | | | | | $ | 664,350 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST INCOME | | | | | | $ | 6,495 | | | | | | | | | | | $ | 6,210 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST SPREAD (3) | | | | | | | | | | | 4.01% | | | | | | | | | | | | 3.81% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST MARGIN(4) | | | | | | | | | | | 4.23% | | | | | | | | | | | | 4.04% | |
| (1) | Included in interest income on loans are loan fees. |
| (2) | Includes non-performing loans. |
| (3) | The interest rate spread is the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities. |
| (4) | The interest rate margin is calculated by dividing annualized net interest income by average interest earning assets. |
| | | Six Months Ended June 30, 2011 | | Six Months Ended June 30, 2010 |
| (dollars in thousands) | | Average Balance | | | Interest Income/ Expense | | | Average Rate | | Average Balance | | | Interest Income/ Expense | | | Average Rate |
| ASSETS | | | | | | | | | | | | | | | | | | |
| Interest Earning Assets: | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits in banks | | $ | 31,449 | | | $ | 39 | | | | 0.25% | | | $ | 30,541 | | | $ | 38 | | | | 0.25% | |
| Federal funds sold | | | 6,342 | | | | 7 | | | | 0.22% | | | | 18,509 | | | | 16 | | | | 0.17% | |
| Investment securities | | | 48,417 | | | | 767 | | | | 3.17% | | | | 47,675 | | | | 861 | | | | 3.61% | |
| Loans, net of unearned fees (1) (2) | | | 518,514 | | | | 14,675 | | | | 5.71% | | | | 511,128 | | | | 14,531 | | | | 5.73% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Earning Assets | | | 604,722 | | | | 15,488 | | | | 5.16% | | | | 607,853 | | | | 15,446 | | | | 5.12% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses | | | (6,383 | ) | | | | | | | | | | | (6,690 | ) | | | | | | | | |
| All other assets | | | 58,019 | | | | | | | | | | | | 55,037 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Assets | | $ | 656,358 | | | | | | | | | | | $ | 656,200 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES & SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | $ | 54,544 | | | | 125 | | | | 0.46% | | | $ | 48,609 | | | | 166 | | | | 0.69% | |
| Savings deposits | | | 197,956 | | | | 895 | | | | 0.91% | | | | 201,379 | | | | 1,259 | | | | 1.26% | |
| Money market deposits | | | 89,928 | | | | 282 | | | | 0.63% | | | | 102,720 | | | | 525 | | | | 1.03% | |
| Time deposits | | | 115,123 | | | | 1,080 | | | | 1.89% | | | | 123,200 | | | | 1,202 | | | | 1.97% | |
| Repurchase agreements | | | 15,625 | | | | 63 | | | | 0.81% | | | | 15,300 | | | | 95 | | | | 1.25% | |
| FHLB-term borrowings | | | 13,500 | | | | 215 | | | | 3.21% | | | | 7,500 | | | | 150 | | | | 4.03% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Bearing Liabilities | | | 486,676 | | | | 2,660 | | | | 1.10% | | | | 498,708 | | | | 3,397 | | | | 1.37% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 83,964 | | | | | | | | | | | | 76,124 | | | | | | | | | |
| Other liabilities | | | 4,366 | | | | | | | | | | | | 3,666 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Non-Interest Bearing Liabilities | | | 88,330 | | | | | | | | | | | | 79,790 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' Equity | | | 81,352 | | | | | | | | | | | | 77,702 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Liabilities and Shareholders' Equity | | $ | 656,358 | | | | | | | | | | | $ | 656,200 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST INCOME | | | | | | $ | 12,828 | | | | | | | | | | | $ | 12,049 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST SPREAD (3) | | | | | | | | | | | 4.06% | | | | | | | | | | | | 3.75% | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST MARGIN(4) | | | | | | | | | | | 4.28% | | | | | | | | | | | | 4.00% | |
| (1) | Included in interest income on loans are loan fees. |
| (2) | Includes non-performing loans. |
| (3) | The interest rate spread is the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities. |
| (4) | The interest rate margin is calculated by dividing annualized net interest income by average interest earning assets. |
Analysis of Changes in Net Interest Income
The following table sets forth for the periods indicated a summary of changes in interest earned and interest paid resulting from changes in volume and changes in rates:
| | | Three Months Ended June 30, 2011 | | | Six Months Ended June 30, 2011 | |
| | | Compared to Three Months Ended | | | Compared to Six Months Ended | |
| | | June 30, 2010 | | | June 30, 2010 | |
| | | Increase (decrease) due to change in | |
| | | Volume | | | Rate | | | Net | | | Volume | | | Rate | | | Net | |
| | | (in thousands) | | | (in thousands) | |
| Interest Earned On: | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits in banks | | $ | (7 | ) | | $ | - | | | $ | (7 | ) | | $ | 1 | | | $ | - | | | $ | 1 | |
| Federal funds sold | | | (1 | ) | | | (2 | ) | | | (3 | ) | | | (11 | ) | | | 2 | | | | (9 | ) |
| Investment securities | | | 28 | | | | (49 | ) | | | (21 | ) | | | 13 | | | | (107 | ) | | | (94 | ) |
| Loans | | | 141 | | | | (55 | ) | | | 86 | | | | 210 | | | | (66 | ) | | | 144 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Income | | | 161 | | | | (106 | ) | | | 55 | | | | 213 | | | | (171 | ) | | | 42 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Paid On: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | | 9 | | | | (23 | ) | | | (14 | ) | | | 20 | | | | (61 | ) | | | (41 | ) |
| Savings deposits | | | (10 | ) | | | (114 | ) | | | (124 | ) | | | (21 | ) | | | (343 | ) | | | (364 | ) |
| Money market deposits | | | (32 | ) | | | (56 | ) | | | (88 | ) | | | (65 | ) | | | (178 | ) | | | (243 | ) |
| Time deposits | | | (5 | ) | | | (21 | ) | | | (26 | ) | | | (79 | ) | | | (43 | ) | | | (122 | ) |
| Repurchase agreements | | | 1 | | | | (11 | ) | | | (10 | ) | | | 2 | | | | (34 | ) | | | (32 | ) |
| Long-term debt | | | 61 | | | | (29 | ) | | | 32 | | | | 120 | | | | (55 | ) | | | 65 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Expense | | | 24 | | | | (254 | ) | | | (230 | ) | | | (23 | ) | | | (714 | ) | | | (737 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Income | | $ | 137 | | | $ | 148 | | | $ | 285 | | | $ | 236 | | | $ | 543 | | | $ | 779 | |
The change in interest due to both volume and rate has been allocated proportionally to both, based on their relative absolute values.
Provision for Loan Losses
The provision for loan losses for the three months ended June 30, 2011 decreased to $600,000, as compared to a provision for loan losses of $700,000 for the corresponding 2010 period. The $600,000 provision for three months ended June 30, 2011 was primarily due to our assessment of the current state of the economy, prolonged high levels of unemployment in our market, and allowances related to impaired loans and loan growth. The allowance for loan loss totaled $6.8 million, or 1.31% of total loans at June 30, 2011, as compared to $6.2 million, or 1.22% at December 31, 2010.
In management’s opinion, the allowance for loan losses, totaling $6.8 million at June 30, 2011, is adequate to cover losses inherent in the portfolio. In the current interest rate and credit quality environment, our prudent risk management philosophy has been to stay within our established credit culture. We anticipate continued loan volume during 2011 as we continue to target credit worthy customers that have become dissatisfied with their relationships with larger institutions. Management will continue to review the need for additions to its allowance for loan losses based upon its ongoing review of the loan portfolio, the level of delinquencies and general market and economic conditions.
Non-Interest Income
For the three months ended June 30, 2011, non-interest income amounted to $868,000 compared to $480,000 for the corresponding period in 2010. The increase of $388,000 was primarily due to the $305,000 of net gains resulting from the sale of three OREO properties totaling $895,000 and the $81,000 gain on the sale of SBA loans recorded during the quarter ended June 30, 2011. Other increases included $21,000 in service fees on deposit accounts and higher bank-owned life insurance income of $6,000, resulting from increased purchases of such investments during 2010, as well as an increase of $11,000 in other income primarily due to higher debit card activity. These increases were partially offset by a decrease of $34,000 in other loan fees primarily due to lower fees generated by our residential mortgage department.
Non-Interest Expenses
Non-interest expenses for the three months ended June 30, 2011 increased $371,000, or 7.9%, to $5.1 million compared to $4.7 million for the three months ended June 30, 2010. This increase was primarily due to salaries and employee benefits increasing $254,000, or 10.4%, resulting in part to the expansion of our lending division, annual salary merit increases and rising medical insurance costs. Loan workout and OREO expenses increased $185,000, or 253.4% primarily due to a $100,000 write-down to an existing OREO property as well as an increase in carrying costs and workout expenses relating to our impaired loans. Other operating expense increased $104,000 primarily due to a $75,000 write-down recorded on a property held for sale. Both write-downs were reflective of declining valuations in the current real estate markets. These increases were partially offset by decreases in occupancy and equipment expense of $27,000, or 3.3%, primarily due to lower depreciation on capitalized expenditures. FDIC insurance and assessments decreased by $89,000, or 35.3%, primarily due to the change in assessment calculation from a deposit based calculation to an asset based less Tier 1 capital calculation. Amortization of intangible assets, which was the result of The Town Bank acquisition in 2006, amounted to $48,000 for the second quarter of 2011 compared to $57,000 for the corresponding period in 2010.
Income Taxes
The Company recorded income tax expense of $633,000 for the three months ended June 30, 2011 compared to $471,000 for the three months ended June 30, 2010. The effective tax rate for the three months ended June 30, 2011 was 37.0%, compared to 36.0% for the corresponding period in 2010.
Six months ended June 30, 2011 compared to June 30, 2010
Net Interest Income
Net interest income increased by $779,000, or 6.5%, to $12.8 million for the six months ended June 30, 2011 compared to $12.0 million for the corresponding period in 2010, primarily as a result of lower deposit rates, higher level of core checking deposits and an improvement in the mix of average interest-earning assets. The net interest margin and net interest spread increased to 4.28% and 4.06%, respectively, for the six months ended June 30, 2011 from 4.00% and 3.75%, respectively, for the three months ended June 30, 2010.
Total interest income for the six months ended June 30, 2011 increased by $42,000, or 0.3%. The increase in interest income was primarily due to a volume related increase in interest income of $213,000 partially offset by a interest rate related decrease in interest income of $171,000 for the second quarter of 2011 as compared to the same prior year period.
Interest and fees on loans increased $144,000, or 1.0%, to $14.7 million for the six months ended June 30, 2011 compared to $14.5 million for the corresponding period in 2010. Of the $144,000 increase in interest and fees on loans, $210,000 was attributable to volume-related increases. This increase was partially offset by an interest rate-related decrease of $66,000. The average balance of the loan portfolio for the six months ended June 30, 2011 increased by $7.4 million, or 1.4%, to $518.5 million from $511.1 million for the corresponding period in 2010. The average annualized yield on the loan portfolio was 5.71% for the six months ended June 30, 2011 compared to 5.73% for the six months ended June 30, 2010. Additionally, the average balance of non-accrual loans, which amounted to $5.8 million and $13.0 million at June 30, 2011 and 2010, respectively, impacted the Company’s loan yield for both periods presented.
Interest income on Federal funds sold and interest bearing deposits was $46,000 for the six months ended June 30, 2011, representing a decrease of $8,000, or 14.8%, from $54,000 for the six months ended June 30, 2010. For the six months ended June 30, 2011, Federal funds sold had an average balance of $6.3 million with an average annualized yield of 0.22%, as compared to $18.5 million with an average annualized yield of 0.17% for the six months ended June 30, 2010. During the first quarter 2010, in order to maximize earnings on excess liquidity and increase the safety of our funds, the Bank transferred the majority of its cash balances to the Federal Reserve Bank of New York, which paid approximately 10 basis points more than our correspondent banks. Additionally, during the second quarter 2011, the Bank transferred its entire Fed funds sold balance to the Federal Reserve Bank of New York, which paid a higher return than our correspondent banks. For the six months ended June 30, 2011, interest bearing deposits had an average balance of $31.4 million and an average annualized yield of 0.25% as compared to an average balance of $30.5 million and an average annualized yield of 0.25% for the same period in 2010.
Interest income on investment securities totaled $767,000 for the six months ended June 30, 2011 compared to $861,000 for the six months ended June 30, 2010, a decrease of $94,000, or 10.9%. The decrease in interest income on investment securities was primarily attributable to the partial replacement of maturities, calls and principal paydowns of existing securities with new purchases that had generally lower rates resulting from the lower rate environment. For the six months ended June 30, 2011, investment securities had an average balance of $48.4 million with an average annualized yield of 3.17% compared to an average balance of $47.7 million with an average annualized yield of 3.61% for the six months ended June 30, 2010.
Interest expense on interest-bearing liabilities amounted to $2.7 million for the six months ended June 30, 2011 compared to $3.4 million for the corresponding period in 2010, a decrease of $737,000, or 21.7%. Of this decrease in interest expense, $714,000 was due to rate-related decreases primarily resulting from lower deposit costs, and $23,000 was due to volume-related decreases.
The average balance of interest-bearing liabilities decreased to $486.7 million for the six months ended June 30, 2011 from $498.7 million for the same period last year, a decrease of $12.0 million, or 2.4%. The average balance in certificates of deposit decreased by $8.1 million, or 6.6%, to $115.1 million with an average annualized yield of 1.89% for the second quarter of 2011 from $123.2 million with an average annualized yield of 1.97% for the same period in 2010. Average money market deposits decreased by $12.8 million over this same period while the average annualized yield declined by 40 basis points. Additionally, average savings deposits decreased by $3.4 million over this same period and the average annualized yield declined by 35 basis points. These average balance decreases were partially offset by increases of $5.9 million in average NOW deposits, which increased from $48.6 million with an average annualized yield of 0.69% during the second quarter of 2010, to $54.5 million with an average annualized yield of 0.46% during the second quarter of 2011. During the second quarter of 2011, our average demand deposits reached $84.0 million, an increase of $7.8 million, or 10.3%, over the same period last year. For the six months ended June 30, 2011, the average annualized cost for all interest-bearing liabilities was 1.10%, compared to 1.37% for the six months ended June 30, 2010, a decrease of 27 basis points.
Our strategies for increasing and retaining core relationship deposits, managing loan originations within our acceptable credit criteria and loan category concentrations, and our planned branch network growth have combined to meet our liquidity needs. The Company also offers agreements to repurchase securities, commonly known as repurchase agreements, to its customers as an alternative to other insured deposits. Average balances of repurchase agreements for the six months ended June 30, 2011 were $15.6 million, with an average interest rate of 0.81%, compared to $15.3 million, with an average interest rate of 1.25%, for the same period in 2010.
The Company also utilizes FHLB term borrowings as an additional funding source. The average balance of such borrowings for the six months ended June 30, 2011 were $13.5 million, with an average interest rate of 3.21%, compared to $7.5 million, with an average interest rate of 4.03%, for the six months ended June 30, 2010.
Provision for Loan Losses
The provision for loan losses for the six months ended June 30, 2011 decreased to $1.1 million, as compared to a provision for loan losses of $1.4 million for the corresponding 2010 period. The $1.1 million provision for the six months ended June 30, 2011 was primarily due to our assessment of the current state of the economy, prolonged high levels of unemployment in our market, allowances related to impaired loans and loan growth.
Non-Interest Income
For the six months ended June 30, 2011, non-interest income amounted to $1.3 million compared to $1.0 million for the corresponding period in 2010. The increase of $298,000 was primarily due to the $300,000 of net gains resulting from the sale of four OREO properties totaling $1.3 million and the $81,000 gain on the sale of SBA loans recorded during the six moths ended June 30, 2011. Other increases included $12,000 in service fees on deposit accounts and higher bank-owned life insurance income of $10,000, resulting from increased purchases of such investments during 2010, as well as an increase of $15,000 in other income primarily due to higher debit card activity. These increases were partially offset by a decrease of $72,000 in other loan fees, primarily due to lower fees generated by our residential mortgage department.
Non-Interest Expenses
Non-interest expenses for the six months ended June 30, 2011 increased $473,000, or 5.1%, to $9.8 million compared to $9.4 million for the six months ended June 30, 2010. This increase was primarily due to salaries and employee benefits increasing $538,000, or 11.2%, resulting in part to the expansion of our lending division, annual salary merit increases and rising medical insurance costs. Loan workout and OREO expenses increased $145,000, or 59.9% primarily due to a $100,000 write-down to an existing OREO property as well as an increase in carrying costs and workout expenses relating to our impaired loans and OREO assets. Other operating expense increased by $103,000, or 15.2% primarily due to the $75,000 write-down recorded on a property held for sale. These increases were partially offset by decreases in occupancy and equipment expense of $67,000, or 4.0%, primarily due to lower depreciation on capitalized expenditures. FDIC insurance and assessments decreased by $126,000, or 24.4%, primarily due to the change in assessment calculation from a deposit based calculation to an asset based less Tier 1 capital calculation. Outside service fees decreased $37,000, or 15.9% due to lower network processing charges and appraisal costs. Amortization of intangible assets, which was the result of The Town Bank acquisition in 2006, amounted to $106,000 for the six months ended June 30, 2011 compared to $124,000 for the corresponding period in 2010.
Income Taxes
The Company recorded income tax expense of $1.2 million for the six months ended June 30, 2011 compared to $819,000 for the six months ended June 30, 2010. The effective tax rate for the three months ended June 30, 2011 was 36.9%, compared to 35.8% for the corresponding period in 2010.
FINANCIAL CONDITION
Assets
At June 30, 2011, our total assets were $676.8 million, an increase of $40.0 million, or 6.3%, over total assets of $636.8 million at December 31, 2010. At June 30, 2011, our total loans were $520.4 million, an increase of $7.4 million, or 1.5%, from the $513.0 million reported at December 31, 2010. Investment securities were $51.2 million at June 30, 2011 as compared to $47.3 million at December 31, 2010, an increase of $3.8 million, or 8.1%. At June 30, 2011, cash and cash equivalents totaled $64.3 million compared to $34.4 million at December 31, 2010, an increase of $29.9 million, or 86.7%, as our liquidity position continues to be strong at June 30, 2011. Goodwill totaled $18.1 million at both June 30, 2011 and December 31, 2010.
Liabilities
Total deposits increased $36.5 million, or 7.0%, to $561.0 million at June 30, 2011, from $524.5 million at December 31, 2010. Deposits are the Company’s primary source of funds. The deposit increase during the six month period ending June 30, 2011 was primarily attributable to the Company’s strategic initiative to continue to grow market share through core deposit relationships. The Company anticipates continued loan demand increases during 2011 and beyond and will depend on the expansion and maturation of our branch network as the primary funding source. As a secondary funding source, the Company intends to utilize borrowed funds at opportune times during changing rate cycles. The Company continues to experience change in the mix of the deposit products through its branch sales efforts, which are targeted to gain market penetration. In order to fund future quality loan demand, the Company intends to raise the most cost-effective funding available within the market area.
Securities Portfolio
Investment securities, including restricted stock, totaled $51.2 million at June 30, 2011 compared to $47.3 million at December 31, 2010, an increase of $3.9 million, or 8.2%. During the six months ended June 30, 2011, investment securities purchases amounted to $15.0 million, while repayments, calls and maturities amounted to $11.6 million. There were no sales of securities available for sale during the six months ended June 30, 2011 and 2010.
The Company maintains an investment portfolio to fund increased loans and liquidity needs (resulting from decreased deposits or otherwise) and to provide an additional source of interest income. The portfolio is composed of obligations of the U.S. Government agencies and U.S. Government-sponsored entities, municipal securities and a limited amount of corporate debt securities. All of our mortgage-backed investment securities are collateralized by pools of mortgage obligations that are guaranteed by privately managed, U.S. Government-sponsored enterprises (“GSE”), such as Fannie Mae, Freddie Mac and Government National Mortgage Association. Due to these GSE guarantees, these investment securities are susceptible to less risk of non-performance and default than other corporate securities which are collateralized by private pools of mortgages. At June 30, 2011, the Company maintained $19.0 million of GSE mortgage-backed securities in the investment portfolio, all of which are current as to payment of principal and interest and are performing in accordance with the terms set forth in their respective prospectuses.
Included within the Company’s investment portfolio are trust preferred securities, which consists of four single issue securities and one pooled issue security. These securities have an amortized cost value of $3.1 million and a fair value of $2.4 million at June 30, 2011. The unrealized loss on these securities is related to general market conditions, the widening of interest rate spread and downgrades in credit ratings. The single issue securities are from large money center banks. The pooled instrument consists of securities issued by financial institutions and insurance companies, and we hold the mezzanine tranche of such security. Senior tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches. For the pooled trust preferred security, management reviewed expected cash flows and credit support and determined it was not probable that all principal and interest would be repaid. Total impairment on this security was $426,000 at June 30, 2011. As the Company does not intend to sell this security and it is more likely than not that the Company will not be required to sell this security, only the credit loss portion of other-than-temporary impairment in the amount of $0 and $72,000 was recognized on the statement of operations during the six month period ending June 30, 2011 and for the year ended 2010, respectively. The Company recognized $198,000 and $243,000 of the other-than-temporary impairment in other comprehensive income at June 30, 2011 and December 31, 2010, respectively. The Company had no other-than-temporary impairment charge to earnings during the six months ended June 30, 2011 and 2010, respectively.
Management evaluates all securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluations. As of June 30, 2011, all of these securities are current with their scheduled interest payments, with the exception of the one pooled trust preferred security with an amortized cost basis of $272,000 at June 30, 2011, which has been remitting reduced amounts of interest as some individual participants of the pool have deferred interest payments. Future deterioration in the cash flow of these instruments or the credit quality of the financial institution issuers could result in additional impairment charges in the future.
The Company accounts for its investment securities as available for sale or held to maturity. Management determines the appropriate classification at the time of purchase. Based on an evaluation of the probability of the occurrence of future events, we determine if we have the ability and intent to hold the investment securities to maturity, in which case we classify them as held to maturity. All other investments are classified as available for sale.
Securities classified as available for sale must be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of taxes. Gains or losses on the sales of securities available for sale are recognized upon realization utilizing the specific identification method. The net effect of unrealized gains or losses, caused by marking our available for sale portfolio to fair value, could cause fluctuations in the level of shareholders’ equity and equity-related financial ratios as changes in market interest rates cause the fair value of fixed-rate securities to fluctuate.
Securities classified as held to maturity are carried at cost, adjusted for amortization of premium and accretion of discount over the terms of the maturity in a manner that approximates the interest method.
Loan Portfolio
The following table summarizes total loans outstanding, by loan category and amount as of June 30, 2011 and December 31, 2010.
| | | June 30, | | | December 31, | |
| | | 2011 | | | 2010 | |
| | | Amount | | | Percent | | | Amount | | | Percent | |
| | | (in thousands, except for percentages) | |
| | | | |
| Commercial and industrial | | $ | 136,028 | | | | 26.1% | | | $ | 134,266 | | | | 26.1% | |
| Real estate – construction | | | 33,387 | | | | 6.4% | | | | 33,909 | | | | 6.6% | |
| Real estate – commercial | | | 273,938 | | | | 52.6% | | | | 262,996 | | | | 51.2% | |
| Real estate – residential | | | 19,507 | | | | 3.7% | | | | 21,473 | | | | 4.2% | |
| Consumer | | | 58,158 | | | | 11.2% | | | | 60,879 | | | | 11.9% | |
| Unearned fees | | | (600 | ) | | | 0.0% | | | | (529 | ) | | | 0.0% | |
| Total loans | | $ | 520,418 | | | | 100.0% | | | $ | 512,994 | | | | 100.0% | |
For the six months ended June 30, 2011, total loans increased by $7.4 million, or 1.5%, to $520.4 million from $513.0 million at December 31, 2010. Adverse credit conditions have created a difficult environment for both borrowers and lenders.
Real estate commercial loans increased $10.9 million, or 4.2%, to $273.9 million at June 30, 2011 from $263.0 million at December 31, 2010. Commercial and industrial loans increased by $1.7 million, or 1.3%, to $136.0 million at June 30, 2011 from $134.3 million at December 31, 2010. These increases were partially offset by decreases in real estate construction loans which decreased $522,000, or 1.5%, to $33.4 million at June 30, 2011 from $33.9 million at December 31, 2010, real estate residential loans which decreased by $2.0 million, or 9.2%, to $19.5 million at June 30, 2011 from $21.5 million at December 31, 2010, and consumer loans which decreased $2.7 million, or 4.5%, to $58.2 million at June 30, 2011 from $60.9 million at December 31, 2010.
Other Real Estate Owned (“OREO”)
OREO represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. When a property is acquired, the excess of the loan balance over fair value is charged to the allowance for loan losses. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred. At June 30, 2011, the Bank had $7.6 million in other real estate owned as compared to $8.1 million in other real estate owned at December 31, 2010.
The decrease of $467,000 is due to the sale of a single family property located in Middlesex County for $407,000, for which the Company recorded a $5,000 loss, a sale of a single family property located in Middlesex County for $400,000, for which the Company recorded a $25,000 loss, a sale of a medical building located in Union County for $613,000, for which the Company recorded a gain of $290,000, a sale of a three parcel vacant lot located in Union County for $187,000, for which the Company recorded a $40,000 gain and a $100,000 write-down on an existing OREO, primarily due to the Company obtaining an updated collateral valuation which reflected a depreciation of value on the OREO property. Consistent with the Company’s prudent risk management practice, the value of the property was adjusted accordingly. These sales were partially offset by the addition of two new properties totaling $588,000 and $352,000 of capitalized construction costs related to the buildout of our five unit residential property project. The OREO balance at June 30, 2011 includes our single largest OREO asset in the amount of $3.3 million, which was a commercial construction loan taken into OREO as a result of Deeds-in-Lieu. Our second largest OREO is related to a $2.0 million commercial time note, which was comprised of five pieces of collateral, subsequent to the sale of the aforementioned properties. This OREO is now comprised of three pieces of collateral. The remaining $2.3 million is comprised principally of real estate construction and residential real estate properties obtained in partial or total satisfaction of loan obligations. All of our OREO are being aggressively marketed, and are monitored on a regular basis to ensure valuations are in line with current fair market values.
Asset Quality
One of our key operating objectives has been, and continues to be, to maintain a high level of credit quality. Through a variety of strategies, we have been proactive in addressing problem and non-performing assets. These strategies, as well as our prudent maintenance of sound credit standards for new loan originations, have resulted in relatively low levels of non-performing loans and charge-offs. Our loan portfolio composition generally consists of loans secured by commercial real estate, development and construction of real estate projects in the Union and Monmouth County New Jersey area. We continue to have lending success and growth in the Medical markets through our Private Banking Department. Since the later part of 2008, the financial and capital markets have been faced with significant disruptions and volatility. The weakened economy has contributed to an overall challenge in building loan volume and we continue to be faced with declines in real estate values, which tend to reduce the collateral coverage of our existing loans. Efficient and effective asset-management strategies reflect the type and quality of assets being originated.
There is continued weakness in the real estate and housing markets as well as the prolonged high unemployment rate. We closely monitor local and regional real estate markets and other factors related to risks inherent in our loan portfolio.
At June 30, 2011, commercial and industrial loans accounted for 26.1% of total loans, real estate - construction loans accounted for 6.4% of total loans and real estate – commercial loans accounted for 52.6% of total loans. Real estate - residential accounted for 3.7% of total loans and consumer loans accounted for 11.2% of total loans. These percentages are well below our policy limits.
The Bank does not originate or purchase loans with payment options, negative amortization loans or sub-prime loans. For loans involved in a workout situation, a new or updated appraisal or evaluation, as appropriate, is ordered to address current project plans and market conditions that were considered in the development of the workout plan. The consideration include whether there has been material deterioration in the following factors: the performance of the project; conditions for the geographic market and property type; variances between actual conditions and original appraisal assumptions; changes in project specifications (e.g., changing a planned condominium project to an apartment building); loss of a significant lease or a take-out commitment; or increases in pre-sales fallout. A new appraisal may not be necessary in instances where an internal evaluation is used and appropriately updates the original appraisal assumptions to reflect current market conditions and provides an estimate of the collateral’s fair value for impairment analysis.
Non-Performing Assets
Loans are considered to be non-performing if they are on a non-accrual basis or past due 90 days or more and still accruing. A loan is placed on non-accrual status when collection of all principal or interest is considered unlikely or when principal or interest is past due for 90 days or more, unless the loan is well-secured and in the process of collection, in which case, the loan will continue to accrue 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 income on other non-accrual loans is recognized only to the extent of interest payments received. At June 30, 2011 and December 31, 2010, the Company had $6.0 million and $5.6 million, respectively, in non-accrual loans. The increase of $348,000 in non-performing loans at June 30, 2011 from December 31, 2010 was due primarily to the addition of a $582,000 commercial and industrial loan in the first quarter, and three additional loans in the second quarter totaling $1.0 million. The three additional loans represent two commercial and industrial loans totaling $738,000 and one residential loan for $263,000. These increases were partially offset by the transfer of one construction loan for $523,000 and one commercial and industrial loan for $147,000 to OREO, as well as the principal write-down of $191,000 on one consumer loan. Further offsets were attributed to one consumer loan for $100,000 and one commercial real estate loan for $275,000 that were both transferred back into active status. Both loans are paying under the Chapter 13 Bankruptcy Code and have been over the last twelve months. Management believes that this is not indicative of any systemic trends that we are aware of. All of the non-performing loans are secured by real estate. There were no loan balances past due 90 days or more and still accruing at June 30, 2011 and December 31, 2010.
The following table summarizes our non-performing assets as of June 30, 2011 and December 31, 2010.
| (dollars in thousands) | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | |
| Non-Performing Assets: | | | | | | |
| | | | | | | |
| Non-Performing Loans: | | | | | | |
| Commercial and industrial | | $ | 1,966 | | | $ | 792 | |
| Real estate-construction | | | - | | | | 523 | |
| Real estate-commercial | | | 330 | | | | 605 | |
| Real estate – residential | | | 263 | | | | - | |
| Consumer | | | 3,438 | | | | 3,729 | |
| | | | | | | | | |
| Total Non-Performing Loans | | | 5,997 | | | | 5,649 | |
| | | | | | | | | |
| Other Real Estate Owned | | | 7,631 | | | | 8,098 | |
| | | | | | | | | |
| Total Non-Performing Assets | | $ | 13,628 | | | $ | 13,747 | |
| | | | | | | | | |
| Ratios: | | | | | | | | |
| | | | | | | | | |
| Non-Performing loans to total loans | | | 1.15 | % | | | 1.10 | % |
| | | | | | | | | |
| Non-Performing assets to total assets | | | 2.01 | % | | | 2.16 | % |
| | | | | | | | | |
| Restructured Loans | | $ | 7,887 | | | $ | 5,435 | |
At June 30, 2011, non-performing commercial and industrial loans increased by $1.2 million and real estate residential loans increased by $263,000. Real estate construction loans and real estate commercial loans decreased by $523,000 and $275,000, respectively, from December 31, 2010, as well as consumer loans which decreased $291,000. During the six month period ending June 30, 2011, there were four commercial and industrial loans totaling $2.0 million. Real estate commercial loans consisted of one loan totaling $330,000, one real estate residential loan totaling $263,000 and consumer loans totaled $3.4 million consisting of two loans.
At June 30, 2011, OREO balance was at $7.6 million as compared to $8.1 at December 31, 2010. Our single largest OREO asset in the amount of $3.3 million, which was a commercial construction loan taken into OREO as a result of Deeds-in-Lieu. Our second largest OREO is related to a $2.0 million commercial time note, which was comprised of five pieces of collateral, subsequent to the sale of the aforementioned properties. This OREO is now comprised of three pieces of collateral. The remaining $2.3 million is comprised principally of real estate construction and residential real estate properties obtained in partial or total satisfaction of loan obligations.
At June 30, 2011, non-performing commercial and industrial loans increased by $1.2 million from December 31, 2010, due to the addition of three loans totaling $1.4 million which was partially offset by the transfer of one loan for $147,000 from non-performing into OREO.
At June 30, 2011, non-performing real estate construction loans decreased by $523,000 from December 31, 2010, due to one loan which was transferred from non-performing into OREO.
At June 30, 2011, non-performing real-estate commercial loans decreased by $275,000 from December 31, 2010, due to one loan which was transferred back into active status.
At June 30, 2011, non-performing real estate residential loans increased by $263,000 from December 31, 2010, due to the addition of one residential loan.
At June 30, 2011, non-performing consumer loans decreased by $291,000 from December 31, 2010, due to the partial principal write-down of $191,000 on one loan and the transfer of one loan for $100,000 from non-performing to active status during the period ending June 30, 2011.
Restructured loans are primarily commercial loans for which the Bank granted a concession to the borrower for economic or legal reasons due to the borrower’s financial difficulties. The Bank continues to work with all the related restructured loans and, at June 30, 2011, all such loans continued to pay as agreed under the terms of the restructuring agreement.
Allowance for Loan Losses
The following table summarizes our allowance for loan losses for the six months ended June 30, 2011 and 2010 and for the year ended December 31, 2010.
| | | June 30, | | | December 31, | |
| | | 2011 | | | 2010 | | | 2010 | |
| | | (in thousands, except percentages) | |
| | | | | | | | | | |
| Balance at beginning of year | | $ | 6,246 | | | $ | 6,184 | | | $ | 6,184 | |
| Provision charged to expense | | | 1,125 | | | | 1,400 | | | | 3,100 | |
| Loans charged off, net | | | (569 | ) | | | (895 | ) | | | (3,038 | ) |
| | | | | | | | | | | | | |
| Balance of allowance at end of period | | $ | 6,802 | | | $ | 6,689 | | | $ | 6,246 | |
| | | | | | | | | | | | | |
Ratio of net charge-offs to average loans outstanding | | | 0.11 | % | | | 0.18 | % | | | 0.59 | % |
| | | | | | | | | | | | | |
Balance of allowance as a percent of loans at period-end | | | 1.31 | % | | | 1.31 | % | | | 1.22 | % |
| | | | | | | | | | | | | |
At June 30, 2011, the Company’s allowance for loan losses was $6.8 million, compared with $6.2 million at December 31, 2010. Loss allowance as a percentage of total loans at June 30, 2011 was 1.31%, compared with 1.22% at December 31, 2010. The Company had total provisions to the allowance for loan losses for the six month period ended June 30, 2011 in the amount of $1.1 million as compared to $1.4 million for the comparable period in 2010. There was $569,000 in net charge-offs for the six months ended June 30, 2011, compared to $895,000 for the same period in 2010. During the six months period ended June 30, 2011, the Company recorded gross charge-offs of $605,000, which represents $82,000 against one construction loan, $288,000 against three consumer loans and $235,000 for one commercial and industrial loan, all of which has been previously reserved for. Non-performing loans at June 30, 2011 are either well-collateralized or adequately reserved for in the allowance for loan losses.
Management maintains the allowance for credit losses at a level estimated to absorb probable loan losses of the loan portfolio. The allowance is based on ongoing evaluations of the probable estimated losses inherent in the loan portfolio. Our methodology for evaluating the appropriateness of the allowance includes segmentation of the loan portfolio into its various asset components, tracking the historical levels of criticized loans and delinquencies, and assessing the nature and trend of loan charge-offs. Additionally, the volume of non-performing loans, concentration risks by size, type, and geography, new products and markets, collateral adequacy, credit policies and procedures, staffing, underwriting consistency, and economic conditions are taken into consideration. Risks within the loan portfolio are analyzed on a continuous basis by the Bank’s senior management, outside independent loan review auditors, directors’ loan committee, and board of directors. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and set appropriate reserves.
While there are some signs of economic stability in our market areas, the economy continues to remain sluggish, and as such prudent risk management practices must be maintained. Along with this conservative approach, we have further stressed our qualitative and quantitative allowance factors to primarily reflect the current state of the economy, the weak housing market and prolonged high levels of unemployment. Collectively, these actions have resulted in an increase in our allowance levels. We apply this process and methodology in a consistent manner and reassess and modify the estimation methods and assumptions on a regular basis.
We attempt to maintain an allowance for loan losses at a sufficient level to provide for probable losses in the loan portfolio. Risks within the loan portfolio are analyzed on a continuous basis by the Bank’s senior management, outside independent loan review auditors, directors’ loan committee, and board of directors. The level of the allowance is determined by assigning specific allowances to impaired loans and general allowances on all other loans. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of the underlying collateral. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and set appropriate reserves. Along with the risk system, senior management evaluates risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors management feels deserve recognition in establishing an appropriate allowance. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are realized in the periods in which they become known. Although management attempts to maintain the allowance at a level deemed adequate to cover any losses, future additions to the allowance may be necessary based upon changes in market conditions, either generally or specific to our area, or changes in the circumstances of particular borrowers. In addition, various regulatory agencies periodically review our allowance for loan losses. These agencies may require the Company to take additional provisions based on their judgments about information available to them at the time of their examination.
Bank-Owned Life Insurance
In November of 2004, the Company invested in $3.5 million of bank-owned life insurance as a source of funding for additional life insurance benefits for officers and employee benefit expenses related to the Company’s non-qualified Supplemental Executive Retirement Plan (“SERP”) for certain executive officers implemented in 2004 that provides for payments upon retirement, death or disability. In 2009 and 2010, the Company purchased an additional $3.5 million and $1.0 million, respectively, of bank-owned life insurance in order to provide additional life insurance benefits for additional officers upon death or disability and to provide a source of funding for future enhancements of the benefits under the SERP. Expenses related to the SERP were approximately $46,000 and $60,000 for the six months ended June 30, 2011 and 2010. Bank-owned life insurance involves our purchase of life insurance on a selected group of officers. The Company is the owner and beneficiary of the policies. Increases in the cash surrender values of this investment are recorded in other income in the statement of operations. Income on bank-owned life insurance amounted to $186,000 and $176,000 for the six months ended June 30, 2011 and 2010, respectively.
Premises and Equipment
Premises and equipment totaled approximately $2.8 million and $3.1 million at June 30, 2011 and December 31, 2010, respectively. The Company purchased premises and equipment amounting to $141,000 primarily to replace fully depreciated and un-repairable equipment, while depreciation expenses totaled $381,000 and $482,000 for the six months ended June 30, 2011 and 2010, respectively.
Goodwill and Other Intangible Assets
Intangible assets totaled $18.6 million at June 30, 2011 and $18.7 million at December 31, 2010. The Company’s intangible assets at June 30, 2011 were comprised of $18.1 million of goodwill and $526,000 of core deposit intangibles, net of accumulated amortization of $1.6 million. At December 31, 2010, the Company’s intangible assets were comprised of $18.1 million of goodwill and $632,000 of core deposit intangibles, net of accumulated amortization of $1.5 million.
Deposits
Deposits are the primary source of funds used by the Company in lending and for general corporate purposes. In addition to deposits, the Company may derive funds from principal repayments on loans, the sale of loans and securities designated as available for sale, maturing investment securities and borrowing from financial intermediaries. The level of deposit liabilities may vary significantly and is dependent upon prevailing interest rates, money market conditions, general economic conditions and competition. The Company’s deposits consist of checking, savings and money market accounts along with certificates of deposit and individual retirement accounts. Deposits are obtained from individuals, partnerships, corporations, unincorporated businesses and non-profit organizations throughout the Company’s market area. We attempt to control the flow of deposits primarily by pricing our deposit offerings to be competitive with other financial institutions in our market area, but not necessarily offering the highest rate.
At June 30, 2011, total deposits amounted to $561.0 million, reflecting an increase of $36.5 million, or 7.0%, from December 31, 2010. Core checking deposits increased $23.8 million, or 18.4%, savings accounts, inclusive of money market deposits, increased $1.5 million, or 0.5%, and time deposits increased $11.1 million, or 10.2%, during the six month period ended June 30, 2011. The Bank has continued to focus on building non-interest-bearing deposits, as this lowers the institution’s costs of funds. Additionally, our savings accounts and other interest-bearing deposit products, excluding high-cost certificates of deposit, provide an efficient and cost-effective source to fund our loan originations.
One of the primary strategies is the accumulation and retention of core deposits. Core deposits consist of all deposits, except certificates of deposit in excess of $100,000. Core deposits at June 30, 2011 accounted for 88.9% of total deposits, compared to 89.8% at December 31, 2010. The balance in our certificates of deposit (“CD’s”) over $100,000 at June 30, 2011 totaled $62.3 million as compared to $53.5 million at December 31, 2010. During the first quarter of 2011, the Company placed $5.0 million in brokered CD’s. The term on these CD’s range from 54 to 66 months with interest rates ranging from 2.15% to 2.25%. The Company found this strategy was able to provide a more cost-effective source of longer-term funding as the rates paid for these brokered CD’s were lower than current fixed rate term advances at the FHLB of New York.
Borrowings
The Bank utilizes its account relationship with Atlantic Central Bankers Bank to borrow funds through its Federal funds borrowing line in an aggregate amount up to $10.0 million. The Bank also established a $7.0 million credit facility with another correspondent bank during the first quarter of 2011. These borrowings are priced on a daily basis. There were no outstanding borrowings under these lines at June 30, 2011 and December 31, 2010. The Bank also has a remaining borrowing capacity with the FHLB of approximately $44.9 million based on current collateral pledged. At June 30, 2011 and December 31, 2010, the Bank had no short-term borrowings outstanding under this line.
Long-term debt consisted of the following FHLB fixed rate advances at June 30, 2011 and at December 31, 2010:
| | | Amount | | | Rate | | | Original Term | | | | Maturity |
| (dollars in thousands) |
| | | | | | | | | | | | | | | | |
| Convertible Note | | $ 7,500 | | | | 3.97% | | | | 10 years | | | | November 2017 | |
| Fixed Rate Note | | 1,500 | | | | 1.67% | | | | 4 years | | | | August 2014 | |
| Fixed Rate Note | | 1,500 | | | | 2.00% | | | | 5 years | | | | August 2015 | |
| Fixed Rate Note | | 1,500 | | | | 2.41% | | | | 6 years | | | | August 2016 | |
| Fixed Rate Note | | 1,500 | | | | 2.71% | | | | 7 years | | | | August 2017 | |
| | | | | | | | | | | | | | | | |
| | | $ 13,500 | | | | 3.18% | | | | | | | | | |
The $7.5 million convertible note contains an option which allows the FHLB to adjust the rate on the note in November 2012 to the then current market rate offered by the FHLB. The Company has the option to repay this advance, if converted, without penalty.
Repurchase Agreements
Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days after the transaction date. Securities sold under agreements to repurchase are reflected as the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. Securities sold under agreements to repurchase increased to $16.4 million at June 30, 2011 from $14.9 million at December 31, 2010, an increase of $1.5 million, or 10.2%.
Liquidity
Liquidity defines the Company’s ability to generate funds to support asset growth, meet deposit withdrawals, maintain reserve requirements and otherwise operate on an ongoing basis. An important component of the Company’s asset and liability management structure is the level of liquidity available to meet the needs of our customers and requirements of our creditors. The liquidity needs of the Bank are primarily met by cash on hand, Federal funds sold position, maturing investment securities and short-term borrowings on a temporary basis. The Bank invests the funds not needed to meet its cash requirements in overnight Federal funds sold and an interest bearing account with the Federal Reserve Bank of New York. With adequate deposit inflows coupled with the above-mentioned cash resources, management is maintaining short-term assets which we believe are sufficient to meet our liquidity needs.
At June 30, 2011, the Company had $64.3 million in cash and cash equivalents as compared to $34.4 million at December 31, 2010. Cash and cash equivalent balances consisted of no Federal funds sold at June 30, 2011 as compared to $7.0 million at December 31, 2010, and $54.8 million and $21.3 million at the Federal Reserve Bank of New York at June 30, 2011 and December 31, 2010, respectively. It was determined by management during 2010 to transfer most of the Bank’s investable funds out of the Federal funds sold position and into the interest bearing deposit account at the Federal Reserve Bank of New York due primarily to a higher rate of return, which averages approximately 10 basis points higher. During the second quarter of 2011, the remaining $7.0 million in Federal funds sold was transferred to the Federal Reserve Bank of New York primarily due to the above-mentioned reasons. Additionally, balances at the Federal Reserve Bank of New York provide the highest level of safety for our investable funds.
Off-Balance Sheet Arrangements
The Company’s financial statements do not reflect off-balance sheet arrangements that are made in the normal course of business. These off-balance sheet arrangements consist of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. These instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company.
Management believes that any amounts actually drawn upon these commitments can be funded in the normal course of operations. The following table sets forth the Bank’s off-balance sheet arrangements as of June 30, 2011 and December 31, 2010:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | (dollars in thousands) | |
| | | | |
| Home equity lines of credit | | $ | 28,979 | | | $ | 27,897 | |
| Commitments to fund commercial real estate and construction loans | | | 60,909 | | | | 32,908 | |
| Commitments to fund commercial and industrial loans | | | 40,323 | | | | 43,734 | |
| Commercial and financial letters of credit | | | 5,198 | | | | 5,661 | |
| | | $ | 135,409 | | | $ | 110,200 | |
Capital
Shareholders’ equity increased by approximately $2.3 million, or 2.8%, to $82.5 million at June 30, 2011 compared to $80.2 million at December 31, 2010. Net income for the six month period ended June 30, 2011 added $2.0 million to shareholders’ equity. Additionally, stock option compensation expense of $76,000, $136,000 in options exercised and $269,000 in the net unrealized gains on securities available for sale, net of tax, all contributed to the increase. These increases were partially offset by $225,000 relating to the dividends on the preferred stock.
The Company and the Bank are subject to various regulatory and capital requirements administered by the Federal banking agencies. Our federal banking regulators, the Board of Governors of the Federal Reserve System (which regulates bank holding companies) and the Federal Deposit Insurance Corporation (which regulates the Bank), have issued guidelines classifying and defining capital. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions 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 Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios, set forth in the following tables of Tier 1 Capital to Average Assets (Leverage Ratio), Tier 1 Capital to Risk Weighted Assets and Total Capital to Risk Weighted Assets. Management believes that, at June 30, 2011, the Company and the Bank met all capital adequacy requirements to which they are subject.
The capital ratios of the Company and the Bank, at June 30, 2011 and December 31, 2010, are presented below.
| | | Tier I Capital to Average Assets Ratio (Leverage Ratio) | | Tier I Capital to Risk Weighted Assets Ratio | | Total Capital to Risk Weighted Assets Ratio |
| | | June 30, 2011 | | December 31, 2010 | | June 30, 2011 | | December 31, 2010 | | June 30, 2011 | | December 31, 2010 |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Community Partners | | | 9.76 | % | | | 9.75 | % | | | 11.44 | % | | | 11.19 | % | | | 12.67 | % | | | 12.33 | % |
| Two River | | | 9.75 | % | | | 9.73 | % | | | 11.43 | % | | | 11.16 | % | | | 12.65 | % | | | 12.31 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
“Adequately capitalized” institution (under Federal regulations) | | | 4.00 | % | | | 4.00 | % | | | 4.00 | % | | | 4.00 | % | | | 8.00 | % | | | 8.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
“Well capitalized” institution (under Federal regulations) | | | 5.00 | % | | | 5.00 | % | | | 6.00 | % | | | 6.00 | % | | | 10.00 | % | | | 10.00 | % |
Capital Resource
During the first quarter of 2011, the Company applied to the U.S. Department of the Treasury for $12 million under the SBLF program. On July 20, 2011, the Company announced that it had received preliminary approval of its SBLF application. The SBLF is a voluntary program intended to encourage small business lending by providing capital to qualified community banks at favorable rates. In connection with the investment, the Company will use $9.0 million of the SBLF funds to redeem all of the outstanding shares of preferred stock issued to the U.S. Treasury under TARP. It is also the intention of the Company to redeem at a to-be-determined price the 311,972 warrants to purchase additional shares of preferred stock issued to the U.S. Treasury as part of the original TARP funding. On August 11, 2011, the Company received the $12 million under the SBLF program and simultaneously, redeemed the full $9.0 million of its outstanding shares of preferred stock issued to the U.S. Treasury under TARP. In exchange for the $12 million, the Company will issue 12,000 shares of a newly created Senior Non-Cumulative Perpetual Preferred Stock, Series C, to the Treasury, each having a liquidation preference of $1,000.
On July 20, 2011, the Company’s board of directors declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's common stock, to shareholders of record at the close of business on August 1, 2011 (the “Record Date”). Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series B Junior Participating Preferred Stock, at a purchase price of $25.00, subject to adjustment, (as so adjusted, the “Exercise Price”). The description and terms of the Rights are set forth in the Rights Agreement (the "Rights Agreement") between the Company and Registrar and Transfer Company, as Rights Agent, which is attached as Exhibit 4.1 to the Company’s 8-K filed with the SEC on July 21, 2011. The Rights Agreement is designed to protect shareholders from abusive takeover tactics and attempts to acquire control of the Company at an inadequate price. The Rights are not exercisable or transferable unless certain specified events occur.
Not required.
The Company has established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
The Company’s principal executive officer and principal financial officer, with the assistance of other members of the Company’s management, have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report. Based upon such evaluation, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this quarterly report.
The Company’s principal executive officer and principal financial officer have also concluded that there was no change in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 6. Exhibits.
| | | |
| 31.1 | * | Certification of principal executive officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) |
| | | |
| 31.2 | * | Certification of principal financial officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) |
| | | |
| 32 | * | Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, signed by the principal executive officer of the Company and the principal financial officer of the Company |
| | | |
| 10.1 | | Change in Control Agreement, effective as of April 20, 2011, by and between Community Partners Bancorp, Two River Community Bank and Robert C. Werner (incorporated by reference to Exhibit 10.1 to the Registrant’s Report on Form 8-K filed with the SEC on April 21, 2011) |
| | | |
| 101.INS** | | XBRL Instance Document |
| | | |
| 101.SCH** | | XBRL Taxonomy Extension Schema |
| | | |
| 101.CAL** | | XBRL Taxonomy Extension Calculation Linkbase |
| | | |
| 101.DEF** | | XBRL Taxonomy Extension Definition Linkbase |
| | | |
| 101.LAB** | | XBRL Taxonomy Extension Label Linkbase |
| | | |
| 101.PRE** | | XBRL Taxonomy Extension Presentation Linkbase |
* Filed herewith. |
| |
| ** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | COMMUNITY PARTNERS BANCORP | |
| | | | |
| | | | |
| Date: August 12, 2011 | By: | /s/ WILLIAM D. MOSS | |
| | | William D. Moss | |
| | | President and Chief Executive Officer | |
| | | (Principal Executive Officer) | |
| | | | |
| | | | |
| Date: August 12, 2011 | By: | /s/ A. RICHARD ABRAHAMIAN | |
| | | A. Richard Abrahamian | |
| | | Executive Vice President and Chief Financial Officer | |
| | | (Principal Financial and Accounting Officer) | |
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