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 Company’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. Impairment testing for goodwill was completed at September 30, 2011 and no goodwill impairment was recorded.
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 $703,000 for the three months ended September 30, 2011, compared to $950,000, for the same period in 2010, a decrease of 26.0%. Basic and diluted earnings per common share after preferred stock dividends and accretion were $0.09 for the quarter ended September 30, 2011 compared to $0.12 for the same period in 2010. The reported decreases in net income and earnings per share were primarily due to the fact that dividends and accretion related to the preferred stock issued to the Treasury under the TARP CPP program reduced earnings for the third quarter of 2011 by $402,000, or $0.05 per diluted common share, as compared to $145,000, $0.02 per diluted common share, for the same period in 2010. The increased dividends and accretion were primarily due to the redemption by the Company of the TARP CPP Senior Preferred Stock, Series A. On August 11, 2011, the Company sold shares of its preferred stock Series C for $12 million to the U.S. Treasury under the Small Business Lending Fund (“SBLF”), a voluntary federal government program intended to encourage small business lending by providing capital to qualified community banks. Simultaneously with the receipt of the SBLF funds, the Company redeemed the full balance of $9.0 million of its TARP CPP Senior Preferred Stock, Series A. As a result of the TARP CPP redemption, the remaining discount accretion of $301,000, or $0.04 per diluted share, on the associated Senior Preferred Stock, Series A, was recognized during the third quarter 2011. Excluding the affects of this item, net income to common shareholders for the three month period ended September 30, 2011 amounted to $1.0 million, or $0.13 per diluted common share. The annualized return on average assets decreased 3 basis points to 0.65% for the three months ended September 30, 2011 as compared to 0.68% for the same period in 2010. The annualized return on average shareholders’ equity decreased 32 basis points to 5.23% for the three month period ended September 30, 2011 as compared to 5.54% for the three months ended September 30, 2010.
The Company reported net income to common shareholders of $2.4 million for the nine months ended September 30, 2011, compared to $2.1 million, for the same period in 2010, an increase of 13.3%. Basic and diluted earnings per common share after preferred stock dividends and accretion were $0.30 for the nine months ended September 30, 2011 compared to $0.27 for the same period in 2010. Dividends and accretion related to the preferred stock issued to the Treasury reduced earnings by $688,000, or $0.09 per diluted common share, for the nine months ended September 30, 2011, and by $431,000, or $0.06 per diluted common share, for the same period in 2010. These reported decreases were primarily due to the requirement to recognize the remaining discount accretion on the TARP CPP preferred stock, as discussed above. Excluding the affects of this item, net income to common shareholders for the nine month period ended September 30, 2011 amounted to $2.7 million, or $0.34 per diluted common share. The annualized return on average assets increased to 0.62% for the nine months ended September 30, 2011 as compared to 0.52% for the same period in 2010. The annualized return on average shareholders’ equity increased to 5.03% for the nine month period ended September 30, 2011 as compared to 4.38% for the nine months ended September 30, 2010.
Net interest income decreased by $54,000, or 0.8%, for the quarter ended September 30, 2011 from the same period in 2010, primarily due to the recognition of $93,000 of interest income during the third quarter of 2010 relating to the full recovery and payoff of two non-accrual loans. On a linked quarter basis, net interest income increased by $22,000, or 0.3% from the second quarter of 2011. The Company reported a net interest margin of 4.16% for the quarter ended September 30, 2011, a decrease of 7 basis points when compared to the 4.23% for the quarter ended June 30, 2011, and decreased 19 basis points when compared to the 4.35% reported for the quarter ended September 30, 2010. The decline in both periods is primarily due to a higher cash liquidity position due to deposit growth.
Net interest income increased by $725,000, or 3.9%, for the nine months ended September 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 4.24% for the nine months ended September 30, 2011, an increase of 13 basis points when compared to the 4.11% reported for the nine months ended September 30, 2010, primarily due to an improvement in the mix of our interest earning assets as well as a 14.0% increase in core checking deposits coupled with lower funding costs.
The provision for loan losses for the three months ended September 30, 2011 was $730,000, as compared to a provision for loan losses of $950,000 for the corresponding 2010 period. The provision for loan losses for the nine months ended September 30, 2011 was $1.9 million, as compared to a provision for loan losses of $2.4 million for the corresponding 2010 period. The decrease in both the three and nine 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 September 30, 2011 totaled $899,000, an increase of $461,000, or 105.3%, compared to the same period in 2010. The increase was primarily due to $324,000 of gains on the sale of investment securities and $81,000 of gains on the sale of two OREO properties recorded during the quarter ended September 30, 2011. Additionally, higher fees were generated by our residential mortgage department coupled with an increase in service fees on deposit accounts. Non-interest income for the nine months ended September 30, 2011 totaled $2.2 million, an increase of $759,000, or 52.6%, compared to the same period in 2010. This increase for the nine month period was due primarily to $381,000 of gains on the sale of six OREO properties, $324,000 of gains on the sale of investment securities and $101,000 of gains on the sale of SBA loans. These gains were offset in part by lower fees generated by our residential mortgage department.
Non-interest expense for the quarter ended September 30, 2011 totaled $4.9 million, an increase of $495,000, or 11.2%, from the same period in 2010. The increase was due primarily to a $280,000 benefit recognized in the third quarter of 2010 relating to the forfeiture of certain benefit plans to officers whom are no longer employed by the Company coupled with higher OREO and impaired net loan expense resulting from $175,000 of impairments on two existing OREO properties during the third quarter of 2011. Non-interest expense for the nine months ended September 30, 2011 totaled $14.8 million, an increase of $968,000, or 7.0%, from the same period in 2010. This increase for the nine month period was due primarily to the year over year items discussed above.
Total assets at September 30, 2011 were $665.4 million, up 4.5% from total assets of $636.8 million at December 31, 2010. Total loans at September 30, 2011 were $516.8 million, an increase of 0.7% compared to $513.0 million at December 31, 2010. Total deposits were $544.1 million at September 30, 2011, an increase of 3.7% from total deposits of $524.5 million at December 31, 2010. Core checking deposits at September 30, 2011 increased 7.7% when compared to year-end 2010, resulting primarily from increased business and consumer activity, while savings accounts, inclusive of money market deposits, increased 0.4%. Additionally, time deposits increased 8.0% over this same period.
At September 30, 2011, the Company’s allowance for loan losses was $7.0 million, compared with $6.2 million at December 31, 2010. The allowance for loan losses as a percentage of total loans at September 30, 2011 was 1.35%, compared with 1.22% at December 31, 2010. Non-performing assets at September 30, 2011, as a percentage of total assets were 1.94%, down from 2.01% at June 30, 2011 and 2.16% reported at December 31, 2010. Non-performing assets decreased to $12.9 million at September 30, 2011 as compared with $13.6 million at June 30, 2011 and $13.7 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) Three months ended September 30, | | | (Annualized) Nine months ended September 30, | |
| | | 2011 | | 2010 | | | 2011 | | 2010 | |
| Return on average assets | | 0.65% | | 0.68% | | | 0.62% | | 0.52% | |
| Return on average tangible assets (1) | | 0.67% | | 0.70% | | | 0.64% | | 0.54% | |
| Return on average shareholders' equity | | 5.23% | | 5.54% | | | 5.03% | | 4.38% | |
| Return on average tangible shareholders' equity (1) | | 6.72% | | 7.27% | | | 6.50% | | 5.77% | |
| Net interest margin | | 4.16% | | 4.35% | | | 4.24% | | 4.11% | |
| Average equity to average assets | | 12.49% | | 12.25% | | | 12.43% | | 11.98% | |
| Average tangible equity to average tangible assets (1) | | 10.08% | | 9.61% | | | 9.89% | | 9.35% | |
| | (1) | The following table provided the reconciliation of Non-GAAP Financial Measures for the dates indicated: |
| | | For the Three months ended September 30, | | | For the Nine months ended September 30, | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| | | | | | | | | | | | | |
| Net income available to common shareholders | | $ | 703 | | | $ | 950 | | | $ | 2,418 | | | $ | 2,135 | |
| Effect of accelerated portion of discount accretion | | | 301 | | | | - | | | | 301 | | | | - | |
| Net income available to common shareholders | | | | | | | | | | | | | | | | |
| excluding accelerated discount accretion | | $ | 1,004 | | | $ | 950 | | | $ | 2,719 | | | $ | 2,135 | |
| | | | | | | | | | | | | | | | | |
| Diluted earnings per common share | | $ | 0.09 | | | $ | 0.12 | | | $ | 0.30 | | | $ | 0.27 | |
| Effect of accelerated portion of discount accretion | | | 0.04 | | | | - | | | | 0.04 | | | | - | |
| Diluted earnings per common share | | | | | | | | | | | | | | | | |
| excluding accelerated discount accretion | | $ | 0.13 | | | $ | 0.12 | | | $ | 0.34 | | | $ | 0.27 | |
| | | | | | | | | | | | | | | | | |
| Return on average assets | | | 0.65 | % | | | 0.68 | % | | | 0.62 | % | | | 0.52 | % |
| Effect of intangible assets | | | 0.02 | % | | | 0.02 | % | | | 0.02 | % | | | 0.02 | % |
| Return on average tangible assets | | | 0.67 | % | | | 0.70 | % | | | 0.64 | % | | | 0.54 | % |
| | | | | | | | | | | | | | | | | |
| Return on average equity | | | 5.23 | % | | | 5.54 | % | | | 5.03 | % | | | 4.38 | % |
| Effect of average intangible assets | | | 1.49 | % | | | 1.73 | % | | | 1.47 | % | | | 1.39 | % |
| Return on average tangible equity | | | 6.72 | % | | | 7.27 | % | | | 6.50 | % | | | 5.77 | % |
| | | | | | | | | | | | | | | | | |
| Average equity to average assets | | | 12.49 | % | | | 12.25 | % | | | 12.43 | % | | | 11.98 | % |
| Effect of intangible assets | | | (2.47 | %) | | | (2.64 | %) | | | (2.54 | %) | | | (2.63 | %) |
| Average tangible equity to average tangible assets | | | 10.02 | % | | | 9.61 | % | | | 9.89 | % | | | 9.35 | % |
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 “net income available to common shareholders excluding accelerated discount accretion,” “diluted earnings per common share excluding accelerated discount accretion,” “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 for the remainder of 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, 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 September 30, 2011 compared to September 30, 2010
Net Interest Income
Net interest income decreased by $54,000, or 0.8%, to $6.5 million for the three months ended September 30, 2011 compared to $6.6 million for the corresponding period in 2010, primarily due to recognition of $93,000 of interest income during the third quarter of 2010 relating to full recovery and payoff of two non-accrual loans. The net interest margin and net interest spread decreased to 4.16% and 3.95%, respectively, for the three months ended September 30, 2011 from 4.35% and 4.13%, respectively, for the three months ended September 30, 2010, due primarily from a higher cash liquidity position resulting from deposit growth.
Total interest income for the three months ended September 30, 2011 decreased by $168,000, or 2.1%. The decrease in interest income was primarily due to an interest rate related decrease in interest income of $240,000 partially offset by a volume related increase in interest income of $72,000 for the third quarter of 2011 as compared to the same prior year period.
Interest and fees on loans decreased $201,000, or 2.6%, to $7.4 million for the three months ended September 30, 2011 compared to $7.6 million for the corresponding period in 2010. Volume related decreases equaled $172,000 as well as an interest rate-related decrease of $29,000. The average balance of the loan portfolio for the three months ended September 30, 2011 decreased by $2.0 million, or 0.4%, to $518.2 million from $520.2 million for the corresponding period in 2010. The average annualized yield on the loan portfolio was 5.66% for the quarter ended September 30, 2011 compared to 5.79% for the quarter ended September 30, 2010. Additionally, the average balance of non-accrual loans, which amounted to $6.2 million and $11.9 million at September 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 $31,000 for the three months ended September 30, 2011, representing an increase of $7,000, or 29.2%, from $24,000 for the three months ended September 30, 2010. For the three months ended September 30, 2011, Federal funds sold had no average balance, as compared to $7.0 million with an average annualized yield of 0.34% for the three months ended September 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 September 30, 2011, interest bearing deposits had an average balance of $48.3 million and an average annualized yield of 0.25% as compared to an average balance of $28.8 million and an average annualized yield of 0.25% for the same period in 2010. This average balance increase was primarily due to an increase in deposit growth and a lower than expected loan growth.
Interest income on investment securities totaled $394,000 for the three months ended September 30, 2011 compared to $368,000 for the three months ended September 30, 2010, an increase of $26,000, or 7.1%. The increase in interest income on investment securities was primarily attributable to new purchases which replaced maturities, calls, principal paydowns and sales of existing securities as well as reinvesting a portion of our cash liquidity position. For the three months ended September 30, 2011, investment securities had an average balance of $54.7 million with an average annualized yield of 2.88% compared to an average balance of $43.5 million with an average annualized yield of 3.38% for the three months ended September 30, 2010. This decline in yield is the result of the lower rate environment.
Interest expense on interest-bearing liabilities amounted to $1.3 million for the three months ended September 30, 2011 compared to $1.4 million for the corresponding period in 2010, a decrease of $114,000, or 8.1%. This decrease in interest expense was comprised of a $170,000 rate-related decrease primarily resulting from lower deposit rates, partially offset by $56,000 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 increased to $496.0 million for the three months ended September 30, 2011 from $483.9 million for the same period last year, an increase of $12.1 million, or 2.5%. Our average NOW accounts increased $12.9 million from $47.4 million with an average annualized yield of 0.54% during the third quarter of 2010, to $60.3 million with an average annualized yield of 0.43% during the third quarter of 2011. Our average balance in certificates of deposit increased by $5.8 million, or 5.1%, to $119.1 million with an average annualized yield of 1.90% for the third quarter of 2011 from $113.3 million with an average annualized yield of 1.91% for the same period in 2010. Additionally, average savings deposits increased by $65,000 over this same period and the average annualized yield declined by 16 basis points. These average balance increases were partially offset by a decrease in our money market deposits of $10.5 million over this same period while the average annualized yield declined by 22 basis points. During the third quarter of 2011, our average demand deposits reached $90.9 million, an increase of $12.1 million, or 15.3%, over the same period last year. For the three months ended September 30, 2011, the average annualized cost for all interest-bearing liabilities was 1.04%, compared to 1.16% for the three months ended September 30, 2010, a decrease of 12 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 third quarter of 2011 were $16.9 million, with an average interest rate of 0.66%, compared to $16.2 million, with an average interest rate of 0.95%, for the third quarter of 2010.
The Company also utilizes FHLB term borrowings as an additional funding source. The average balance of such borrowings for the third quarter of 2011 were $13.5 million, with an average interest rate of 3.20%, compared to $10.3 million, with an average interest rate of 3.54%, for the third 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 September 30, 2011 | | | Three Months Ended September 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 | | $ | 48,335 | | | $ | 31 | | | | 0.25 | % | | | $ | 28,849 | | | $ | 18 | | | | 0.25 | % |
| Federal funds sold | | | - | | | | - | | | | 0.00 | % | | | | 7,000 | | | | 6 | | | | 0.34 | % |
| Investment securities | | | 54,713 | | | | 394 | | | | 2.88 | % | | | | 43,487 | | | | 368 | | | | 3.38 | % |
| Loans, net of unearned fees (1) (2) | | | 518,214 | | | | 7,394 | | | | 5.66 | % | | | | 520,229 | | | | 7,595 | | | | 5.79 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Earning Assets | | | 621,262 | | | | 7,819 | | | | 4.99 | % | | | | 599,565 | | | | 7,987 | | | | 5.29 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses | | | (6,879 | ) | | | | | | | | | | | | (7,056 | ) | | | | | | | | |
| All other assets | | | 61,550 | | | | | | | | | | | | | 52,923 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Assets | | $ | 675,933 | | | | | | | | | | | | $ | 645,432 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES & SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | $ | 60,281 | | | | 66 | | | | 0.43 | % | | | $ | 47,387 | | | | 64 | | | | 0.54 | % |
| Savings deposits | | | 199,846 | | | | 414 | | | | 0.82 | % | | | | 199,781 | | | | 492 | | | | 0.98 | % |
| Money market deposits | | | 86,384 | | | | 115 | | | | 0.53 | % | | | | 96,859 | | | | 182 | | | | 0.75 | % |
| Time deposits | | | 119,137 | | | | 570 | | | | 1.90 | % | | | | 113,337 | | | | 547 | | | | 1.91 | % |
| Repurchase agreements | | | 16,852 | | | | 28 | | | | 0.66 | % | | | | 16,223 | | | | 39 | | | | 0.95 | % |
| FHLB-term borrowings | | | 13,500 | | | | 109 | | | | 3.20 | % | | | | 10,304 | | | | 92 | | | | 3.54 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Bearing Liabilities | | | 496,000 | | | | 1,302 | | | | 1.04 | % | | | | 483,891 | | | | 1,416 | | | | 1.16 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 90,873 | | | | | | | | | | | | | 78,783 | | | | | | | | | |
| Other liabilities | | | 4,618 | | | | | | | | | | | | | 3,700 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Non-Interest Bearing Liabilities | | | 95,491 | | | | | | | | | | | | | 82,483 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' Equity | | | 84,442 | | | | | | | | | | | | | 79,058 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Liabilities and Shareholders' Equity | | $ | 675,933 | | | | | | | | | | | | $ | 645,432 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST INCOME | | | | | | $ | 6,517 | | | | | | | | | | | | $ | 6,571 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST SPREAD (3) | | | | | | | | | | | 3.95 | % | | | | | | | | | | | | 4.13 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST MARGIN(4) | | | | | | | | | | | 4.16 | % | | | | | | | | | | | | 4.35 | % |
| (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. |
| | | Nine Months Ended September 30, 2011 | | | Nine Months Ended September 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 | | $ | 37,140 | | | $ | 70 | | | | 0.25 | % | | | $ | 29,971 | | | $ | 56 | | | | 0.25 | % |
| Federal funds sold | | | 4,205 | | | | 7 | | | | 0.22 | % | | | | 14,630 | | | | 22 | | | | 0.20 | % |
| Investment securities | | | 50,539 | | | | 1,161 | | | | 3.06 | % | | | | 46,263 | | | | 1,229 | | | | 3.54 | % |
| Loans, net of unearned fees (1) (2) | | | 518,413 | | | | 22,069 | | | | 5.69 | % | | | | 514,195 | | | | 22,126 | | | | 5.75 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Earning Assets | | | 610,297 | | | | 23,307 | | | | 5.11 | % | | | | 605,059 | | | | 23,433 | | | | 5.18 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses | | | (6,550 | ) | | | | | | | | | | | | (6,813 | ) | | | | | | | | |
| All other assets | | | 59,206 | | | | | | | | | | | | | 54,326 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Assets | | $ | 662,953 | | | | | | | | | | | | $ | 652,572 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES & SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | $ | 56,477 | | | | 191 | | | | 0.45 | % | | | $ | 48,197 | | | | 230 | | | | 0.64 | % |
| Savings deposits | | | 198,593 | | | | 1,309 | | | | 0.88 | % | | | | 200,840 | | | | 1,751 | | | | 1.17 | % |
| Money market deposits | | | 88,733 | | | | 397 | | | | 0.60 | % | | | | 100,745 | | | | 707 | | | | 0.94 | % |
| Time deposits | | | 116,476 | | | | 1,650 | | | | 1.89 | % | | | | 119,876 | | | | 1,750 | | | | 1.95 | % |
| Repurchase agreements | | | 16,038 | | | | 91 | | | | 0.76 | % | | | | 15,611 | | | | 134 | | | | 1.15 | % |
| FHLB-term borrowings | | | 13,500 | | | | 324 | | | | 3.21 | % | | | | 8,445 | | | | 241 | | | | 3.82 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Bearing Liabilities | | | 489,817 | | | | 3,962 | | | | 1.08 | % | | | | 493,714 | | | | 4,813 | | | | 1.30 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 86,292 | | | | | | | | | | | | | 77,020 | | | | | | | | | |
| Other liabilities | | | 4,451 | | | | | | | | | | | | | 3,679 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Non-Interest Bearing Liabilities | | | 90,743 | | | | | | | | | | | | | 80,699 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' Equity | | | 82,393 | | | | | | | | | | | | | 78,159 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Liabilities and Shareholders' Equity | | $ | 662,953 | | | | | | | | | | | | $ | 652,572 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST INCOME | | | | | | $ | 19,345 | | | | | | | | | | | | $ | 18,620 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST SPREAD (3) | | | | | | | | | | | 4.03 | % | | | | | | | | | | | | 3.88 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| NET INTEREST MARGIN(4) | | | | | | | | | | | 4.24 | % | | | | | | | | | | | | 4.11 | % |
| (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 September 30, 2011 | | | Nine Months Ended September 30, 2011 | |
| | | Compared to Three Months Ended | | | Compared to Nine Months Ended | |
| | | September 30, 2010 | | | September 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 | | $ | 12 | | | $ | 1 | | | $ | 13 | | | $ | 13 | | | $ | 1 | | | $ | 14 | |
| Federal funds sold | | | (6 | ) | | | - | | | | (6 | ) | | | (16 | ) | | | 1 | | | | (15 | ) |
| Investment securities | | | 95 | | | | (69 | ) | | | 26 | | | | 114 | | | | (182 | ) | | | (68 | ) |
| Loans | | | (29 | ) | | | (172 | ) | | | (201 | ) | | | 182 | | | | (239 | ) | | | (57 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Income | | | 72 | | | | (240 | ) | | | (168 | ) | | | 293 | | | | (419 | ) | | | (126 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Paid On: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW deposits | | | 17 | | | | (15 | ) | | | 2 | | | | 40 | | | | (79 | ) | | | (39 | ) |
| Savings deposits | | | - | | | | (78 | ) | | | (78 | ) | | | (20 | ) | | | (422 | ) | | | (442 | ) |
| Money market deposits | | | (20 | ) | | | (47 | ) | | | (67 | ) | | | (84 | ) | | | (226 | ) | | | (310 | ) |
| Time deposits | | | 28 | | | | (5 | ) | | | 23 | | | | (50 | ) | | | (50 | ) | | | (100 | ) |
| Repurchase agreements | | | 2 | | | | (13 | ) | | | (11 | ) | | | 4 | | | | (47 | ) | | | (43 | ) |
| Long-term debt | | | 29 | | | | (12 | ) | | | 17 | | | | 144 | | | | (61 | ) | | | 83 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Expense | | | 56 | | | | (170 | ) | | | (114 | ) | | | 34 | | | | (885 | ) | | | (851 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Income | | $ | 16 | | | $ | (70 | ) | | $ | (54 | ) | | $ | 259 | | | $ | 466 | | | $ | 725 | |
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 September 30, 2011 decreased to $730,000, as compared to a provision for loan losses of $950,000 for the corresponding 2010 period. The $730,000 provision for three months ended September 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 activity. The allowance for loan loss totaled $7.0 million, or 1.35% of total loans at September 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 $7.0 million at September 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 September 30, 2011, non-interest income amounted to $899,000 compared to $438,000 for the corresponding period in 2010. The increase of $461,000 was primarily due to $324,000 of gains on the sale of investment securities resulting from taking advantage of the volatility in the bond market and $81,000 of net gains resulting from the sale of two OREO properties with a carrying value of $1.2 million recorded during the third quarter of 2011. Other increases included $20,000 of gains from the sale of SBA loans, an increase of $21,000 in other loan fees primarily due to higher fees generated by our residential mortgage department and a $14,000 increase in service fees on deposit accounts.
Non-Interest Expenses
Non-interest expenses for the three months ended September 30, 2011 increased $495,000, or 11.2%, to $4.9 million compared to $4.4 million for the three months ended September 30, 2010. This increase was primarily due to a $280,000 benefit recognized in the third quarter of 2010 relating to the forfeiture of certain plan benefits to officers whom were no longer employed by the Company coupled with higher OREO and impaired net loan expense resulting from $175,000 of impairments on two existing OREO properties during the third quarter of 2011. The write-downs were reflective of declining valuations in the current real estate markets. These increases were partially offset by decreases in professional and outside service fees, which combined declined $41,000, or 10.6%, from the same period last year. FDIC insurance and assessments decreased by $105,000, or 42.3%, 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 third quarter of 2011 compared to $58,000 for the corresponding period in 2010.
Income Taxes
The Company recorded income tax expense of $661,000 for the three months ended September 30, 2011 compared to $539,000 for the three months ended September 30, 2010. The effective tax rate for the three months ended September 30, 2011 was 37.4%, compared to 33.0% for the corresponding period in 2010. The increase in the effective tax rate resulted from a higher level of taxable income in 2011 as compared to 2010.
Nine months ended September 30, 2011 compared to September 30, 2010
Net Interest Income
Net interest income increased by $725,000, or 3.9%, to $19.3 million for the nine months ended September 30, 2011 compared to $18.6 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 4.24% and 4.03%, respectively, for the nine months ended September 30, 2011 from 4.11% and 3.88%, respectively, for the nine months ended September 30, 2010.
Total interest income for the nine months ended September 30, 2011 decreased by $126,000, or 0.5%. The decrease in interest income was primarily due to an interest rate related decrease in interest income of $419,000 partially offset by a volume related increase in interest income of $293,000 for the nine months ended September 30, 2011 as compared to the same prior year period.
Interest and fees on loans decreased $57,000, or 0.3%, to $22.1 million for the nine months ended September 30, 2011 and 2010. Of the $57,000 decrease in interest and fees on loans, $239,000 was attributable to interest rate related decreases. This decrease was partially offset by a volume related increase of $182,000. The average balance of the loan portfolio for the nine months ended September 30, 2011 increased by $4.2 million, or 0.8%, to $518.4 million from $514.2 million for the corresponding period in 2010. The average annualized yield on the loan portfolio was 5.69% for the nine months ended September 30, 2011 compared to 5.75% for the nine months ended September 30, 2010. Additionally, the average balance of non-accrual loans, which amounted to $5.9 million and $12.7 million at September 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 $77,000 for the nine months ended September 30, 2011, representing a decrease of $1,000, or 1.3%, from $78,000 for the nine months ended September 30, 2010. For the nine months ended September 30, 2011, Federal funds sold had an average balance of $4.2 million with an average annualized yield of 0.22%, as compared to $14.6 million with an average annualized yield of 0.20% for the nine months ended September 30, 2010. 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 nine months ended September 30, 2011, interest bearing deposits had an average balance of $37.1 million and an average annualized yield of 0.25% as compared to an average balance of $30.0 million and an average annualized yield of 0.25% for the same period in 2010.
Interest income on investment securities totaled $1.2 million for the nine months ended September 30, 2011 and 2010, a decrease of $68,000, or 5.5%. The decrease in interest income on investment securities was primarily attributable to new purchases which replaced maturities, calls, principal paydowns and sales of existing securities. These new purchases were made at lower rates resulting from the lower rate environment, therefore causing the decline in interest income. For the nine months ended September 30, 2011, investment securities had an average balance of $50.5 million with an average annualized yield of 3.06% compared to an average balance of $46.3 million with an average annualized yield of 3.54% for the nine months ended September 30, 2010.
Interest expense on interest-bearing liabilities amounted to $4.0 million for the nine months ended September 30, 2011 compared to $4.8 million for the corresponding period in 2010, a decrease of $851,000, or 17.7%. Of this decrease in interest expense, $885,000 was due to rate-related decreases primarily resulting from lower deposit rates, partially offset by a $34,000 volume-related increase.
The average balance of interest-bearing liabilities decreased to $489.8 million for the nine months ended September 30, 2011 from $493.7 million for the same period last year, a decrease of $3.9 million, or 0.8%. The average balance in certificates of deposit decreased by $3.4 million, or 2.8%, to $116.5 million with an average annualized yield of 1.89% for the nine months ended September 30, 2011 from $119.9 million with an average annualized yield of 1.95% for the same period in 2010. Average money market deposits decreased by $12.0 million over this same period while the average annualized yield declined by 34 basis points. Additionally, average savings deposits decreased by $2.2 million over this same period and the average annualized yield declined by 29 basis points. These average balance decreases were partially offset by increases of $8.3 million in average NOW deposits, which increased from $48.2 million with an average annualized yield of 0.64% during the nine months ended September 30, 2010, to $56.5 million with an average annualized yield of 0.45% during the nine months ended September 30, 2011. During the nine months ended September 30, 2011, our average demand deposits reached $86.3 million, an increase of $9.3 million, or 12.0%, over the same period last year. For the nine months ended September 30, 2011, the average annualized cost for all interest-bearing liabilities was 1.08%, compared to 1.30% for the nine months ended September 30, 2010, a decrease of 22 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 nine months ended September 30, 2011 were $16.0 million, with an average interest rate of 0.76%, compared to $15.6 million, with an average interest rate of 1.15%, 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 nine months ended September 30, 2011 were $13.5 million, with an average interest rate of 3.21%, compared to $8.4 million, with an average interest rate of 3.82%, for the nine months ended September 30, 2010.
Provision for Loan Losses
The provision for loan losses for the nine months ended September 30, 2011 decreased to $1.9 million, as compared to a provision for loan losses of $2.4 million for the corresponding 2010 period. The $1.9 million provision for the nine months ended September 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 activity.
Non-Interest Income
For the nine months ended September 30, 2011, non-interest income amounted to $2.2 million compared to $1.4 million for the corresponding period in 2010. The increase of $759,000 was primarily due to $381,000 of net gains resulting from the sale of six OREO properties with a carrying value of $2.5 million, $101,000 of gains on the sale of SBA loans and $324,000 of gains on the sale of investment securities recorded during the nine moths ended September 30, 2011. Other increases included $25,000 in service fees on deposit accounts and higher bank-owned life insurance income of $16,000, resulting from increased purchases of such investments during 2010. These increases were partially offset by a decrease of $51,000 in other loan fees, primarily due to lower fees generated by our residential mortgage department.
Non-Interest Expenses
Non-interest expenses for the nine months ended September 30, 2011 increased $968,000, or 7.0%, to $14.8 million compared to $13.8 million for the nine months ended September 30, 2010. This increase was primarily due to salaries and employee benefits increasing $1.0 million, or 14.4%, resulting in part to the expansion of our lending division, annual salary merit increases and rising medical insurance costs as well as a $280,000 benefit recognized in the third quarter of 2010 relating to the forfeiture of certain plan benefits to officers whom were no longer employed with the Company. Loan workout and OREO expenses increased $319,000, or 96.7% primarily due to $275,000 of impairments relating to three existing OREO properties as well as an increase in carrying costs and workout expenses relating to our impaired loans and OREO assets. Other operating expense increased by $133,000, or 13.0% primarily due to a $100,000 write-down recorded on a property held for sale. These increases were partially offset by decreases in professional and outside service fees, which combined declined $125,000, or 11.7%, from the same period last year due to lower professional costs, network processing charges and appraisal costs. FDIC insurance and assessments decreased by $231,000, or 30.2%, primarily due to the change in assessment calculation from a deposit based calculation to an asset based less Tier 1 capital calculation. Occupancy and equipment expense of $79,000, or 3.2%, primarily due to lower depreciation on capitalized expenditures. . Amortization of intangible assets, which was the result of The Town Bank acquisition in 2006, amounted to $154,000 for the nine months ended September 30, 2011 compared to $182,000 for the corresponding period in 2010.
Income Taxes
The Company recorded income tax expense of $1.8 million for the nine months ended September 30, 2011 compared to $1.4 million for the nine months ended September 30, 2010. The effective tax rate for the three months ended June 30, 2011 was 37.1%, compared to 34.6% for the corresponding period in 2010.
FINANCIAL CONDITION
Assets
At September 30, 2011, our total assets were $665.4 million, an increase of $28.6 million, or 4.5%, over total assets of $636.8 million at December 31, 2010. At September 30, 2011, our total loans were $516.8 million, an increase of $3.8 million, or 0.7%, from the $513.0 million reported at December 31, 2010. Investment securities were $58.1 million at September 30, 2011 as compared to $47.3 million at December 31, 2010, an increase of $10.8 million, or 22.7%. At September 30, 2011, cash and cash equivalents totaled $51.3 million compared to $34.4 million at December 31, 2010, an increase of $16.8 million, or 48.8%, as our liquidity position continues to be strong at September 30, 2011. Goodwill totaled $18.1 million at both September 30, 2011 and December 31, 2010.
Liabilities
Total deposits increased $19.6 million, or 3.7%, to $544.1 million at September 30, 2011, from $524.5 million at December 31, 2010. Deposits are the Company’s primary source of funds. The deposit increase during the nine month period ending September 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 the remainder of 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 $58.1 million at September 30, 2011 compared to $47.3 million at December 31, 2010, an increase of $10.8 million, or 22.8%. During the nine months ended September 30, 2011, investment securities purchases amounted to $27.9 million, while repayments, calls and maturities amounted to $13.5 million. There were nine sales of securities available for sale totaling $4.0 million resulting in a gain on sale of $324,000 during the nine months ended September 30, 2011 as compared to no sales of securities available for sale during the nine months ended September 30, 2010. These sales resulted from taking advantage of the volatility in the bond market.
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 September 30, 2011, the Company maintained $19.3 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 $2.3 million at September 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. In this pooled trust preferred security, there are 35 out of 45 banks and insurance companies that are performing at September 30, 2011. The deferrals and defaults as a percentage of original collateral at September 30, 2011 was 28.5%. Total impairment on this security was $431,000 at September 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 nine month period ending September 30, 2011 and for the year ended 2010, respectively. The Company recognized $203,000 and $243,000 of the other-than-temporary impairment in other comprehensive income at September 30, 2011 and December 31, 2010, respectively. The Company had no other-than-temporary impairment charge to earnings during the nine months ended September 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 September 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 September 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 September 30, 2011 and December 31, 2010.
| | | September 30, | | | December 31, | |
| | | 2011 | | | 2010 | |
| | | Amount | | | Percent | | | Amount | | | Percent | |
| | | (in thousands, except for percentages) | |
| | | | |
| Commercial and industrial | | $ | 133,216 | | | | 25.7% | | | $ | 134,266 | | | | 26.1% | |
| Real estate – construction | | | 39,479 | | | | 7.6% | | | | 33,909 | | | | 6.6% | |
| Real estate – commercial | | | 273,975 | | | | 53.0% | | | | 262,996 | | | | 51.2% | |
| Real estate – residential | | | 19,080 | | | | 3.7% | | | | 21,473 | | | | 4.2% | |
| Consumer | | | 51,633 | | | | 10.0% | | | | 60,879 | | | | 11.9% | |
| Unearned fees | | | (620 | ) | | | 0.0% | | | | (529 | ) | | | 0.0% | |
| Total loans | | $ | 516,763 | | | | 100.0% | | | $ | 512,994 | | | | 100.0% | |
For the nine months ended September 30, 2011, total loans increased by $3.8 million, or 0.7%, to $516.8 million from $513.0 million at December 31, 2010. Adverse credit conditions have created a difficult environment for both borrowers and lenders. The low rate environment has created a higher than anticipated level of prepayments and payoffs by borrowers looking to deleverage portions of their business and personal debts.
Real estate commercial loans increased $11.0 million, or 4.2%, to $274.0 million at September 30, 2011 from $263.0 million at December 31, 2010. Real estate construction loans increased by $5.6 million, or 16.4%, to $39.5 million at September 30, 2011 from $33.9 million at December 31, 2010. These increases were partially offset by decreases in commercial and industrial loans, which decreased $1.1 million, or 0.8%, to $133.2 million at September 30, 2011 from $134.3 million at December 31, 2010, real estate residential loans which decreased by $2.4 million, or 11.1%, to $19.1 million at September 30, 2011 from $21.5 million at December 31, 2010, and consumer loans which decreased $9.2 million, or 15.2%, to $51.6 million at September 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 September 30, 2011, the Bank had $6.6 million in other real estate owned as compared to $8.1 million in other real estate owned at December 31, 2010.
The decrease of $1.5 million is primarily due to the sale of six properties with a carrying value of $2.5 million, for which the Company recorded a net gain of $381,000. Additionally, the Company recorded $275,000 in direct impairments on existing OREO properties, primarily due to a decrease in collateral values which was supported by current appraisals. Consistent with the Company’s prudent risk management practice, the value of the properties were adjusted accordingly. These decreases were partially offset by the addition of two OREO properties totaling $588,000 as well as $652,000 of capitalized construction costs related to the buildout of our five unit residential property project located in Union County, which is our largest OREO in the portfolio. Our OREO balance at September 30, 2011 includes our single largest OREO asset in the amount of $4.0 million, a commercial construction loan taken into OREO as a result of Deeds-in-Lieu. Our second largest OREO is related to a $1.2 million multi-unit apartment complex located in Union County. The remaining $1.4 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. We continually analyze our asset quality through a variety of strategies, we have been proactive in addressing problem and non-performing assets and management believes our allowance for loan losses are adequate to cover known and potential losses. 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 September 30, 2011, commercial and industrial loans accounted for 25.7% of total loans, real estate - construction loans accounted for 7.6% of total loans and real estate - commercial loans accounted for 53.0% of total loans. Real estate - residential accounted for 3.7% of total loans and consumer loans accounted for 10.0% 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. We evaluate the classification of all our loans and the financial results of some of those loans may be adversely affected by changes in the prevailing economic conditions, either nationally or in our local Union and Monmouth County areas, including decreases in real estate values, adverse employment conditions, the monetary and fiscal policies of the federal and state government and other significant external events. 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 September 30, 2011 and December 31, 2010, the Company had $6.3 million and $5.6 million, respectively, in non-accrual loans. The increase of $646,000 in non-performing loans at September 30, 2011 from December 31, 2010 was due primarily to the addition of a $582,000 commercial and industrial loan in the first quarter, three additional loans in the second quarter totaling $1.0 million and five loans in the third quarter totaling $1.2 million. The five additional loans represent two commercial and industrial loans totaling $631,000, two consumer loans totaling $252,000 and one real estate construction loan totaling $292,000. These increases were offset by the transfer of one construction loan for $523,000 and one commercial and industrial loan for $147,000 to OREO, and the payoff of one commercial real estate loan in which the Company was repaid the full principal amount totaling $330,000. Additionally, one consumer loan for $100,000 and one commercial real estate loan for $275,000 were both transferred to active status which are paying under Chapter 13 Bankruptcy Code and have been over the last twelve months. Further decreases were as a result of two direct write-downs totaling $247,000 and $491,000, on a commercial and industrial loan as well as a consumer loan, respectively. 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 was one Consumer loan for $51,000 past due 90 days or more and still accruing at September 30, 2011 as compared to no loans at December 31, 2010.
The ultimate liquidation of our non-performing assets is subject to changes in the real estate market and future economic conditions. Since 2009, there has been a decline in home prices both nationally and locally. Housing market conditions in our lending area weakened during this period as evidenced in reduced level of sales, increasing inventories of houses on the market, declining home prices and an increase in the length of times homes remain on the market.
The following table summarizes our non-performing assets as of September 30, 2011 and December 31, 2010.
| (dollars in thousands) | | September 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Non-Performing Assets: | | | | | | | | |
| | | | | | | | | |
| Non-Performing Loans: | | | | | | | | |
| Commercial and industrial | | $ | 2,349 | | | $ | 792 | |
| Real estate-construction | | | 292 | | | | 523 | |
| Real estate-commercial | | | - | | | | 605 | |
| Real estate – residential | | | 263 | | | | - | |
| Consumer | | | 3,391 | | | | 3,729 | |
| | | | | | | | | |
| Total Non-Accrual Loans | | | 6,295 | | | | 5,649 | |
| | | | | | | | | |
| Loans 90 days or more past due and still accruing | | | 51 | | | | - | |
| | | | | | | | | |
| Total Non-Performing Loans | | | 6,346 | | | | 5,649 | |
| | | | | | | | | |
| Other Real Estate Owned | | | 6,592 | | | | 8,098 | |
| | | | | | | | | |
| Total Non-Performing Assets | | $ | 12,938 | | | $ | 13,747 | |
| | | | | | | | | |
| Ratios: | | | | | | | | |
| | | | | | | | | |
| Non-Performing loans to total loans | | | 1.23 | % | | | 1.10 | % |
| | | | | | | | | |
| Non-Performing assets to total assets | | | 1.94 | % | | | 2.16 | % |
| | | | | | | | | |
| Troubled Debt Restructured Loans | | $ | 7,618 | | | $ | 5,435 | |
At September 30, 2011, non-performing commercial and industrial loans increased by $1.6 million and real estate residential loans increased by $263,000. Real estate construction loans and real estate commercial loans decreased by $231,000 and $605,000, respectively, from December 31, 2010, as well as consumer loans which decreased $338,000. During the nine month period ending September 30, 2011, commercial and industrial loans totaled $2.3 million, which comprised of six loans. There was one real estate construction loan totaling $292,000, one real estate residential loan totaling $263,000 and consumer loans totaled $3.4 million, which consisted of four loans.
At September 30, 2011, OREO balance was at $6.6 million as compared to $8.1 at December 31, 2010. Our single largest OREO asset in the amount of $4.0 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 $1.2 million commercial time note, a multi-unit apartment complex. The remaining $1.4 million is comprised principally of real estate construction and residential real estate properties obtained in partial or total satisfaction of loan obligations.
At September 30, 2011, non-performing commercial and industrial loans increased by $1.6 million from December 31, 2010, due to the addition of five loans totaling $1.7 million which was partially offset by the transfer of one loan for $147,000 from non-performing to OREO during the second quarter of 2011. This property was subsequently sold in the second quarter, in which the Company recorded a $40,000 gain.
At September 30, 2011, non-performing real estate construction loans decreased by $231,000 from December 31, 2010, due to the addition of one loan totaling $292,000 partially offset by the transfer of one loan totaling $523,000 from non-performing into OREO.
At September 30, 2011, non-performing real-estate commercial loans decreased by $605,000 from December 31, 2010, due to one loan which was transferred back into active status which totaled $275,000 and one loan totaling $330,000 was paid in full.
At September 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 September 30, 2011, non-performing consumer loans decreased by $338,000 from December 31, 2010, due to the partial principal write-down of $491,000 on one loan, the addition of two loans totaling $253,000 and the transfer of one loan for $100,000 from non-performing to active status during the nine month period ending September 30, 2011.
Loans whose terms are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired. Modifications involving troubled borrowers may include extension of maturity date, reduction in the stated interest rate, rescheduling of future cash flows, and reduction in the face amount of the debt or reduction of past accrued interest.
The Company’s troubled debt restructured modifications are made on short terms (12 month terms) in order to aggressively monitor and track performance. The short-term modifications performances are monitored for continued payment performance for an additional period of time after the expiration of the concession. Balance reductions and annualized loss rates are also important metrics that are monitored. The main objective of the modification programs is to reduce the payment burden for the borrower and improve the net present value of the Company’s expected cash flows.
As of September 30, 2011, loans modified in a troubled debt restructuring totaled $7.6 million, including $5.3 million that are current, $2.3 million that are 60-89 days past due. There were no loans 90 days or more past due. All loans modified in a troubled debt restructuring as of September 30, 2011, were current at the time of the modifications.
Allowance for Loan Losses
The following table summarizes our allowance for loan losses for the nine months ended September 30, 2011 and 2010 and for the year ended December 31, 2010.
| | | September 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 | | | 1,855 | | | | 2,350 | | | | 3,100 | |
| Loans charged off, net | | | (1,108 | ) | | | (1,457 | ) | | | (3,038 | ) |
| | | | | | | | | | | | | |
| Balance of allowance at end of period | | $ | 6,993 | | | $ | 7,077 | | | $ | 6,246 | |
| | | | | | | | | | | | | |
Ratio of net charge-offs to average loans outstanding (annualized) | | | 0.29 | % | | | 0.28 | % | | | 0.59 | % |
| | | | | | | | | | | | | |
Balance of allowance as a percent of loans at period-end | | | 1.35 | % | | | 1.35 | % | | | 1.22 | % |
| | | | | | | | | | | | | |
At September 30, 2011, the Company’s allowance for loan losses was $7.0 million, compared with $6.2 million at December 31, 2010. Loss allowance as a percentage of total loans at September 30, 2011 was 1.35%, compared with 1.22% at December 31, 2010. The Company had total provisions to the allowance for loan losses for the nine month period ended September 30, 2011 in the amount of $1.9 million as compared to $2.4 million for the comparable period in 2010. There was $1.1 in net charge-offs for the nine months ended September 30, 2011, compared to $1.5 million for the same period in 2010. During the nine months period ended September 30, 2011, the Company recorded gross charge-offs of $1.2 million, which represents $589,000 on three consumer loans, $482,000 on two commercial and industrial loans and $82,000 on one real estate construction loan. All loans which the Company charged-off or had a direct write-down had been previously identified and specific reserves were applied. Non-performing loans at September 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 $68,000 and $96,000 for the nine months ended September 30, 2011 and 2010. During the third quarter ended September 30, 2010, the Bank recorded a $280,000 benefit due to forfeitures of certain plan benefits to officers whom are no longer employed with the Bank. 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 $278,000 and $262,000 for the nine months ended September 30, 2011 and 2010, respectively.
Premises and Equipment
Premises and equipment totaled approximately $2.7 million and $3.1 million at September 30, 2011 and December 31, 2010, respectively. The Company purchased premises and equipment amounting to $205,000 primarily to replace fully depreciated and un-repairable equipment, while depreciation expenses totaled $560,000 and $704,000 for the nine months ended September 30, 2011 and 2010, respectively.
Goodwill and Other Intangible Assets
Intangible assets totaled $18.6 million at September 30, 2011 and $18.7 million at December 31, 2010. The Company’s intangible assets at September 30, 2011 were comprised of $18.1 million of goodwill and $479,000 of core deposit intangibles, net of accumulated amortization of $1.6 million. The Company performed its annual goodwill impairment analysis as of September 30, 2011. Based on the results of the step one goodwill impairment analysis, the Company concluded that the potential for goodwill impairment existed and therefore a step two test was required to determine if there was goodwill impairment and the amount of goodwill that might be impaired. Based on the results of that analysis, the Company determined that there was no impairment on the current goodwill balance of $18.1 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 September 30, 2011, total deposits amounted to $544.1 million, reflecting an increase of $19.6 million, or 3.7%, from December 31, 2010. Core checking deposits increased $9.9 million, or 7.7%, savings accounts, inclusive of money market deposits, increased $1.0 million, or 0.4%, and time deposits increased $8.7 million, or 8.0%, during the nine month period ended September 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 September 30, 2011 accounted for 89.8% of total deposits, unchanged from December 31, 2010. The balance in our certificates of deposit (“CD’s”) over $100,000 at September 30, 2011 totaled $55.5 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 September 30, 2011 and December 31, 2010. The Bank also has a remaining borrowing capacity with the FHLB of approximately $43.7 million based on current collateral pledged. At September 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 September 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 $17.6 million at September 30, 2011 from $14.9 million at December 31, 2010, an increase of $2.7 million, or 18.1%.
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 September 30, 2011, the Company had $51.3 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 September 30, 2011 as compared to $7.0 million at December 31, 2010, and $40.9 million and $21.3 million at the Federal Reserve Bank of New York at September 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 September 30, 2011 and December 31, 2010:
| | | September 30, 2011 | | | December 31, 2010 | |
| | | (dollars in thousands) | |
| | | | | | | | | |
| Home equity lines of credit | | $ | 29,402 | | | $ | 27,897 | |
| Commitments to fund commercial real estate and construction loans | | | 69,688 | | | | 32,908 | |
| Commitments to fund commercial and industrial loans | | | 41,951 | | | | 43,734 | |
| Commercial and financial letters of credit | | | 5,181 | | | | 5,661 | |
| | | $ | 146,222 | | | $ | 110,200 | |
Capital
Shareholders’ equity increased by approximately $6.2 million, or 7.7%, to $86.4 million at September 30, 2011 compared to $80.2 million at December 31, 2010. Net income for the nine month period ended September 30, 2011 added $3.1 million to shareholders’ equity. On August 11, 2011, the Company received $12.0 million of SBLF funding and simultaneously redeemed the $9.0 million in TARP CPP funding, which increased capital by a net $3.0 million. Stock option compensation expense of $113,000, options exercised of $223,000 and net unrealized gains on securities available for sale, net of tax, of $80,000, all contributed to the increase. These increases were offset by decreases of $262,000 relating to the dividends on the preferred stock Series A, $54,000 relating to the dividends on the preferred stock series C and $48,000 in issuance costs pertaining to the preferred stock series C.
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 September 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 September 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 | |
| | | Sept. 30, 2011 | | | Dec. 31, 2010 | | | Sept. 30, 2011 | | | Dec. 31, 2010 | | | Sept. 30, 2011 | | | Dec. 31, 2010 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Community Partners | | | 10.28 | % | | | | 9.75 | % | | | | 12.26 | % | | | | 11.19 | % | | | | 13.51 | % | | | | 12.33 | % | |
| Two River | | | 10.25 | % | | | | 9.73 | % | | | | 12.23 | % | | | | 11.16 | % | | | | 13.48 | % | | | | 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 | % | |
On August 11, 2011, the Company received $12 million under the SBLF program, a voluntary program intended to encourage small business lending by providing capital to qualified community banks at favorable rates. In exchange for the $12 million, the Company issued 12,000 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series C, to the Treasury, each share having a liquidation preference of $1,000. In connection with the investment, the Company used $9.0 million of the SBLF funds to redeem all of the outstanding shares of Senior Preferred Stock, Series A, issued to the U.S. Treasury under TARP. On October 26, 2011, the Company also redeemed the outstanding warrant to purchase 311,972 additional shares of common stock issued to the U.S. Treasury as part of the original TARP funding for $460,000.
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 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 September 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
| | | | |
| | 3.1 | * | Amended and Restated Certificate of Incorporation of the Registrant |
| | | | |
| | 3.2 | * | Bylaws of Registrant |
| | | | |
| | 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 |
| | | | |
| | 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: November 10, 2011 | By: | /s/ WILLIAM D. MOSS | |
| | | William D. Moss | |
| | | President and Chief Executive Officer | |
| | | (Principal Executive Officer) | |
| | | | |
| | | | |
| Date: November 10, 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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