The FHLB borrowings are secured under terms of a blanket collateral agreement by a pledge of qualifying collateral.
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the date indicated. The estimated fair value amounts have been measured as of the respective period-end and have not been re-evaluated or updated for purposes of these financial statements subsequent to period-end. As such, the estimated fair values of these financial instruments subsequent to the period-end reporting dates may be different than the amounts reported at period-end.
The Company adopted the provisions of FASB ASC 820 “Fair Value Measurements and Disclosures” effective January 1, 2008. This guidance, which defines fair value, establishes a framework for measuring fair value under U.S. GAAP, expands disclosures about fair value measurements and applies to other accounting pronouncements that require or permit fair value measurements. Fair value is defined as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.
The fair value guidance establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Note 10 – New Accounting Standards
In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (“IASB”). Under the proposed roadmap, the Company may be required to prepare financial statements in accordance with IFRS as early as 2014. The SEC is expected to make a determination in 2011 regarding the mandatory adoption of IFRS. The Company is currently assessing the impact that this potential change would have on its consolidated financial statements, and will continue to monitor the development of the potential implementation of IFRS.
In October 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) - Accounting for Transfers of Financial Assets. The amendments in this Update improve financial reporting by eliminating the exceptions for qualifying special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Comparability and consistency in accounting for transferred financial assets will also be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This Update is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009. Early application is not permitted. The adoption did not have a material effect on the Company’s financial condition or results of operations.
The FASB has issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurements as set forth in Codification Subtopic 820-10. The FASB‘s objective is to improve these disclosures and, thus, increase transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:
| · | A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and |
| · | In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. |
In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:
| · | For purposes of reporting fair value measurements for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and |
| · | A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. |
ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuance, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years after December 15, 2010 and for interim periods within those fiscal years. Early adoption is permitted. The Company has adopted the required portions of ASU 2009-16 and has included the required disclosures.
ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset, codifies the consensus reached in EITF Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the Codification provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. ASU 201 0-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.
ASU 2010-18 is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. The adoption of this standard did not have an impact on our financial position or results of operations.
ASU 20100-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.
This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.
The amendments in this Update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.
The effective date of ASU 2010-20 differs for public and nonpublic companies. For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. For nonpublic companies, the amendments are effective for annual reporting periods ending on or after December 15, 2011.
This discussion and analysis provides an overview of the financial condition and results of operations of Highlands Bancorp, Inc. (the “Company”) and its consolidated subsidiary, Highlands State Bank (the “Bank”), as of September 30, 2010 and for the three and nine month periods ended September 30, 2010 and 2009. This discussion should be read in conjunction with the preceding financial statements and related footnotes, as well as with the audited financial statements and the accompanying notes for the year ended December 31, 2009, included in the Bank’s Annual Report on Form 10-K filed with the FDIC. Current performance does not guarantee and may not be indicative of similar performance in the future.
Critical Accounting Policies
Disclosure of the Company’s significant accounting policies is included in Note 1 to the financial statements included in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2009. Some of these policies are particularly sensitive, requiring significant judgments, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses, the determination of other-than-temporary impairment on securities, and the valuation of deferred tax assets.
Forward-looking Statements
This Quarterly Report on Form 10-Q, including this discussion and analysis, contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of the Company’s operations and policies and regarding general economic conditions. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors and other conditions that, by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty.
Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “intends”, “will”, “should”, “anticipates”, or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by forward-looking statements will be achieved. Such statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could impact the Company’s operating results include, but are not limited to, those disclosed under the heading Risk Factors in the Bank’s Annual Report on Form 10-K previously filed with the FDIC and, in addition, (i) the effects of changing economic conditions in the Company's market areas and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates, (iv) changes in federal and state banking laws and regulations which could impact the Company’s operations, and (v) other external developments which could materially affect the Company’s business and operations.
OVERVIEW
Highlands Bancorp, Inc. is a New Jersey business corporation and bank holding company registered under the Bank Holding Company Act of 1956. Highlands Bancorp Inc. was incorporated on February 2, 2010 for the purpose of acquiring Highlands State Bank (referred to in this report as the Bank), thereby enabling the Bank to operate within a holding company structure. On August 31, 2010, Highlands Bancorp, Inc. acquired 100% of the outstanding shares of the Bank.
The principal activities of Highlands Bancorp, Inc. are owning and supervising the Bank. The Bank is a community-oriented, full-service commercial bank providing commercial and consumer financial services to businesses and individuals in Sussex and Passaic Counties in New Jersey and surrounding areas. The Bank is a New Jersey state chartered commercial bank that commenced operations on October 31, 2005. The Bank’s principal office is located in Vernon, New Jersey and it operates two additional branches, one each in Sparta, New Jersey and one in Totowa, New Jersey.
The Company’s assets grew $1.1 million from $166.0 million at December 31, 2009 to $167.1 million at September 30, 2010 due to loan growth, which was funded through growth in non-interest bearing deposits and short-term borrowings. Time deposits in other banks grew $1.2 million from $26.8 million at December 31, 2009 to $28.0 million at September 30, 2010 as proceeds from the $1.3 million decline in the investment portfolio, due to calls and maturities during the first nine months of 2010, were reinvested in short-term, readily liquid, and fully insured certificates of deposits. Total deposits decreased $1.7 million from $143.6 million at December 31, 2009 to $141.9 million at September 30, 2010. Decreases in savings and certificate of deposit account balances were partially offset by growth in money market, business checking, and interest checking balances. Borrowings increased $2.4 million from $6.0 million at December 31, 2009 to $8.4 million at September 30, 2010.
The Company reported its third profitable quarter of operations, earning net income of $130 thousand for the third quarter of 2010 compared to a loss of $427 thousand for the third quarter of 2009. Net income available to common stockholders, reflecting the impact of dividends paid on the Company’s preferred stock issued to the Treasury for the three months ended September 30, 2010, was $51 thousand compared to a net loss available to common stockholders for the three months ended September 30, 2009 of $477 thousand. Net income for the nine months ended September 30, 2010 was $332 thousand compared to a net loss of $1,034 thousand in the prior year, and net income available to common stockholders for the nine month period was $94 thousand compared to a net loss to common shareholders of $1,114 thousand for the prior year period.
The cost of deposits for the third quarter of 2010 and the nine months ended September 30, 2010 continue to decrease when compared to the respective periods of 2009 as a result of the current interest rate environment. In addition, yields earned on investment securities and short-term investments have also declined but at a slower rate. Loan portfolio yields have also decreased at a slower pace than the costs of deposits over the past several quarters, declining 5 basis points. The yield on interest-earning assets declined 43 basis points for the third quarter of 2010 compared to the third quarter of 2009, while cost of funds declined 104 basis points over the comparable periods. As a result, the net interest rate spread increased 60 basis points for the three months ended September 30, 2010 to 3.25%. For the nine month period ending Sep tember 30, 2010, the yield on interest-earning assets declined 52 basis points when compared to the nine months ended September 30, 2009, while cost of funds declined 108 basis points over the comparable periods, which resulted in a 56 basis point increase in the net interest rate spread to 3.29%. The net interest margin improved to 3.51% for the third quarter of 2010 from 3.06% for the third quarter period of 2009, and increased to 3.56% for the nine months ended September 30, 2010, from 3.17% for the comparable period of 2009.
Comparison of Results of Operation for the Three Months Ended September 30, 2010 and 2009
Net Interest Income
Total interest income for the three months ended September 30, 2010 increased $84 thousand to $1.8 million as compared to the three months ended September 30, 2009 as a result of the growth in the loan portfolio. Average earning assets were $165.3 million for the three months ended September 30, 2010 compared to $143.5 million for the three months ended September 30, 2009. The average balance of loans receivable increased to $114. 7 million during the current quarter from $105.1 million in the year ago period. The yield on average earning assets was 4.40% for the third quarter of 2010 compared to 4.83% for the third quarter of 2009. The largest decline was in the investment securities portfolio, on which the yield declined to 3.15% in the three months ended September 30, 2010 f rom 3.99% in the prior year period, reflecting a lower yielding investment portfolio due to calls and maturities, while the yield on the loan portfolio declined only 5 basis points to 5.53% in the current quarter from 5.58% in the year ago period. The declines in yield reflect the current low interest rate environment.
Total interest expense for the three months ended September 30, 2010 decreased $269 thousand to $369 thousand as compared with $638 thousand for the three months ended September 30, 2009 due to decreases in rates paid on interest-bearing deposit account balances and on borrowed funds. Average interest bearing liabilities were $128.6 million for the three months ended September 30, 2010 compared to $116.7 million for the three months ended September 30, 2009, and reflected increases in money market, savings and interest checking balances. The yield on average interest bearing liabilities was 1.15% for the third quarter of 2010 compared to 2.19% for the third quarter of 2009. This decrease was the result of market conditions, deposit mix, competition, and management’s resulting adjustments to the interest rates provided to depositors .
Net interest income for the three months ended September 30, 2010 was $1.5 million compared to net interest income of $1.1 million for the three months ended September 30, 2009. The improvement in net interest income for the third quarter of 2010 is a result of growth in the loan portfolio and reduced cost of funds associated with declining interest rates paid offsetting the increase in the average balances of deposits. The Company’s net interest margin for the three months ended September 30, 2010 increased 45 basis points to 3.51% from 3.06% for the three months ended September 30, 2009.
The table below sets forth average balances and corresponding yields for the three month periods ended September 30, 2010 and September 30, 2009:
| Average Balances, Interest Income and Interest Expense, and Rates | |
| | | 2010 | | | 2009 | |
| | | Average | | | Income/ | | | Yield/ | | | Average | | | Income/ | | | Yield/ | |
| (Dollars in thousands) | | Balance | | | Expense | | | Rate | | | Balance | | | Expense | | | Rate | |
| | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans receivable | | $ | 114,732 | | | $ | 1,587 | | | | 5.53 | % | | $ | 105,056 | | | $ | 1,466 | | | | 5.58 | % |
| Securities available for sale | | | 17,520 | | | | 138 | | | | 3.15 | % | | | 20,641 | | | | 206 | | | | 3.99 | % |
| Federal funds sold | | | 3,205 | | | | 2 | | | | 0.25 | % | | | 3,203 | | | | 1 | | | | 0.12 | % |
| Deposits with other banks | | | 29,814 | | | | 92 | | | | 1.23 | % | | | 14,646 | | | | 62 | | | | 1.69 | % |
| Total interest-earning assets | | | 165,271 | | | | 1,819 | | | | 4.40 | % | | | 143,546 | | | | 1,735 | | | | 4.83 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest earning assets | | | 4,395 | | | | | | | | | | | | 5,425 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| TOTAL ASSETS | | $ | 169,666 | | | | | | | | | | | $ | 148,971 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, interest-bearing | | $ | 6,865 | | | $ | 12 | | | | 0.70 | % | | $ | 4,124 | | | $ | 12 | | | | 1.16 | % |
| Money market and savings | | | 85,512 | | | | 172 | | | | 0.80 | % | | | 66,223 | | | | 307 | | | | 1.85 | % |
| Time deposits | | | 29,623 | | | | 150 | | | | 2.03 | % | | | 39,571 | | | | 277 | | | | 2.80 | % |
| Borrowed funds | | | 6,564 | | | | 35 | | | | 2.13 | % | | | 6,732 | | | | 42 | | | | 2.50 | % |
| Total interest-bearing liabilities | | | 128,564 | | | | 369 | | | | 1.15 | % | | | 116,650 | | | | 638 | | | | 2.19 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, non-interest bearing deposits | | | 24,383 | | | | | | | | | | | | 16,454 | | | | | | | | | |
| Other liabilities | | | 428 | | | | | | | | | | | | 794 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' equity | | | 16,291 | | | | | | | | | | | | 15,073 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| TOTAL LIABILITIES AND | | | | | | | | | | | | | | | | | | | | | | | | |
| SHAREHOLDERS' EQUITY | | $ | 169,666 | | | | | | | | | | | $ | 148,971 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income/rate spread | | | | | | $ | 1,450 | | | | 3.25 | % | | | | | | $ | 1,097 | | | | 2.65 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest margin | | | | | | | | | | | 3.51 | % | | | | | | | | | | | 3.06 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Provision for Loan Losses
For the three months ended September 30, 2010, management has provided a provision for loan losses of $121 thousand, compared to $448 thousand for the three months ended September 30, 2009, reflecting a decrease in loan growth during 2010 compared to 2009. The decrease in the provision also reflects management’s view of the risks inherent in the portfolio in the current economic environment. At September 30, 2010, the allowance for loan losses of $1.7 million represented 1.48% of total outstanding loans, while the allowance represented 1.27% of total outstanding loans at December 31, 2009. Based principally on economic conditions, asset quality, and loan-loss experience including that of comparable institutions in the Company’s market area, the allowance is believed to be adequate. The Company has not participated in any sub- prime lending activity. During the third quarter of 2010, the Company charged off two home equity loans and one consumer loan totaling $66 thousand and $4 thousand respectively, in addition to writing down a commercial real estate property by $98 thousand before classification into other real estate owned (“OREO”). There were no recoveries during the third quarter of 2010, and no charge-offs or recoveries during the third quarter of 2009.
Non-interest Income
Total non-interest income was $107 thousand for the three month period ended September 30, 2010 compared to $126 thousand for the same period in 2009. The decrease for 2010 is due to a realized gain on the sale of an investment security during the third quarter of 2009 of $19 thousand.
Non-interest Expense
Non-interest expenses increased $104 thousand or 8.65% from $1.2 million for the three months ended September 30, 2009 to $1.3 million for the three month period ended September 30, 2010. The increase is due to $87 thousand in increased legal fees relating to loan workouts, compliance, and the Bank’s reorganization into a holding company structure , as well as $10 thousand in consulting charges regarding compliance with Sarbanes-Oxley 404 and other regulatory mandates, and increased equipment depreciation and maintenance, loan collection, and quarterly deposit insurance premiums, which were partially offset by lower data processing, advertising and employee compensation and benefits expenses.
Income Taxes
There was no provision for income taxes for the three months ended September 30, 2010 due to the utilization of previously unrecognized tax benefits related to the Company’s net operating loss carryforwards. There was no provision for income taxes for the three months ended September 30, 2009 due to the net operating losses incurred by the Company since inception.
Comparison of Results of Operation for the Nine Months Ended September 30, 2010 and 2009
Net Interest Income
Total interest income for the nine months ended September 30, 2010 increased $656 thousand to $5.6 million as compared with $4.9 million for the nine months ended September 30, 2009 as a result of growth in the loan portfolio and time deposits with other banks. Average earning assets were $162.6 million for the nine months ended September 30, 2010 compared to $128.9 million for the nine months ended September 30, 2009. Average loan receivables increased to $115.9 million in the first nine months of 2010 from $100.8 million in the comparable year ago period. The yield on average earning assets was 4.58% for the first nine months of 2010 as compared to 5.10% for the same period of 2009, while the yield on the loan portfolio declined by 2 basis points over the comparable nine month periods. The declines in yield reflect the continued low ma rket interest rates.
Total interest expense for the nine months ended September 30, 2010 decreased $624 thousand to $1.2 million as compared with $1.9 million for the nine months ended September 30, 2009 despite the $23.4 million increase in average interest bearing liabilities, primarily due to reductions made to rates paid on deposits and lower average borrowings. Average interest bearing liabilities were $128.3 million for the nine months ended September 30, 2010 compared to $104.8 million for the nine months ended September 30, 2009. The yield on average interest bearing liabilities was 1.29% for the first three quarters of 2010 compared to 2.37% for the first three quarters of 2009. In addition, average non-interest bearing deposits increased to $20.5 million in the current nine month period from $13.3 million in the year ago period. The decrease in rat e was the result of market conditions, deposit mix, competition, and management’s resulting adjustments to the interest rates paid to depositors.
Net interest income for the nine months ended September 30, 2010 was $4.3 million compared to net interest income of $3.1 million for the nine months ended September 30, 2009. The improvement in net interest income for the nine months ended September 30, 2010, is a result of growth in earning assets, primarily the loan portfolio and time deposits with other banks, and lower costs of funds and borrowings. The Company’s net interest margin for the nine months ended September 30, 2010 increased 39 basis points to 3.56% from 3.17% for the nine months ended September 30, 2009.
The following table sets forth average balances and corresponding yields for the nine month periods ended September 30, 2010 and September 30, 2009:
| Average Balances, Interest Income and Interest Expense, and Rates |
| | | 2010 | | | 2009 | |
| | | Average | | | Income/ | | | Yield/ | | | Average | | | Income/ | | | Yield/ | |
| (Dollars in thousands) | | Balance | | | Expense | | | Rate | | | Balance | | | Expense | | | Rate | |
| | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans receivable | | $ | 115,864 | | | $ | 4,784 | | | | 5.51 | % | | $ | 100,752 | | | $ | 4,180 | | | | 5.53 | % |
| Securities available for sale | | | 18,679 | | | | 497 | | | | 3.55 | % | | | 19,328 | | | | 671 | | | | 4.63 | % |
| Federal funds sold | | | 2,307 | | | | 4 | | | | 0.23 | % | | | 3,280 | | | | 5 | | | | 0.20 | % |
| Deposits with other banks | | | 25,724 | | | | 300 | | | | 1.55 | % | | | 5,565 | | | | 73 | | | | 1.75 | % |
| Total interest-earning assets | | | 162,574 | | | | 5,585 | | | | 4.58 | % | | | 128,925 | | | | 4,929 | | | | 5.10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest earning assets | | | 4,437 | | | | | | | | | | | | 3,627 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| TOTAL ASSETS | | $ | 167,011 | | | | | | | | | | | $ | 132,552 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, interest-bearing | | $ | 5,412 | | | $ | 29 | | | | 0.71 | % | | $ | 2,348 | | | $ | 22 | | | | 1.25 | % |
| Money market and savings | | | 84,983 | | | | 621 | | | | 0.97 | % | | | 48,503 | | | | 700 | | | | 1.92 | % |
| Time deposits | | | 30,350 | | | | 473 | | | | 2.08 | % | | | 46,643 | | | | 999 | | | | 2.86 | % |
| Borrowed funds | | | 7,518 | | | | 116 | | | | 2.06 | % | | | 7,349 | | | | 142 | | | | 2.58 | % |
| Total interest-bearing liabilities | | | 128,263 | | | | 1,239 | | | | 1.29 | % | | | 104,843 | | | | 1,863 | | | | 2.37 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, non-interest bearing deposits | | | 21,978 | | | | | | | | | | | | 13,336 | | | | | | | | | |
| Other liabilities | | | 443 | | | | | | | | | | | | 678 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders' equity | | | 16,327 | | | | | | | | | | | | 13,695 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| TOTAL LIABILITIES AND | | | | | | | | | | | | | | | | | | | | | | | | |
| SHAREHOLDERS' EQUITY | | $ | 167,011 | | | | | | | | | | | $ | 132,552 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income/rate spread | | | | | | $ | 4,346 | | | | 3.29 | % | | | | | | $ | 3,066 | | | | 2.73 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest margin | | | | | | | | | | | 3.56 | % | | | | | | | | | | | 3.17 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Provision for Loan Losses
For the nine months ended September 30, 2010, management provided a provision for loan losses of $558 thousand, compared to a provision of $808 thousand for the nine months ended September 30, 2009. The decrease is due to lower loan growth in 2010 compared to 2009 and the stabilization of non-performing loans. The Company’s non-accrual loans increased to $4.8 million at September 30, 2010 from $4.6 million at year end 2009. The provision reflects management’s view of the risks inherent in the portfolio in the current economic environment. At September 30, 2010, the allowance for loan losses totaled $1.7 million representing 1.48% of total outstanding loans, while the allowance represented 1.27% of total outstanding loans at year end 2009. Based principally on economic conditions, asset quality, and loan-loss experience includ ing that of comparable institutions in the Company’s market area, the allowance is believed to be adequate. The Company has not participated in any sub-prime lending activity. There were $274 thousand in loans charged off and $5 thousand in recoveries during the first nine months of 2010.
Non-interest Income
Total non-interest income was $398 thousand for the nine month period ended September 30, 2010 compared to $243 thousand for the same period in 2009. The increase of $155 thousand is primarily due to a realized gain on the sale of investment securities during the second quarter of 2010 of $87 thousand, growth in fee activity of $68 thousand due to deposit growth, and an increase in other income of $4 thousand. During the nine months ended September 30, 2009 the Company reflected a $15 thousand loss on the disposition of its old telephone system, and a $19 thousand realized gain from the sale of an investment security.
Non-interest Expense
Non-interest expenses increased $319 thousand or 9.0% from $3.5 million for the nine months ended September 30, 2009 to $3.9 million for the same period in 2010. The increase is primarily the result of higher legal and consulting fees for additional loan and compliance services of $181 thousand and $56 thousand, respectively, and higher deposit insurance premiums of $60 thousand, increased equipment charges and depreciation of $60 thousand, data processing charges of $21 thousand, which were partially offset by lower employee salaries and benefits due to staff attrition, and reduced advertising and promotion costs. Other expenses increased $14 thousand, which reflected higher loan-related costs
Income Taxes
There was no provision for income taxes for the nine months ended September 30, 2010 due to the utilization of previously unrecognized tax benefits related to the Company’s net operating loss carryforwards. There was no provision for income taxes for the nine months ended September 30, 2009 due to the net operating losses incurred by the Company since inception.
FINANCIAL CONDITION
Cash and Cash Equivalents
Cash and cash equivalents at September 30, 2010 decreased $1.4 million or 43.8% to $1.9 million, from $3.3 million at December 31, 2009, due to no overnight federal funds sold balances outstanding at September 30, 2010. Cash and due from banks increased $602 thousand from December 31, 2009 reflecting higher ending cash clearings. Liquidity was used to fund the growth in the Company’s loan portfolio and an increase in time deposits in other banks.
Time Deposits in Other Banks
Time deposits in other banks increased $1.3 million, or 4.8% from $26.8 million at December 31, 2009 to $28.0 million at September 30, 2010. This increase over the prior year-end is the result of the Company’s strategy to maintain a level of relative liquidity in order to fund anticipated loan growth while simultaneously earning a higher yield on excess funds beyond that available on shorter term overnight sales of federal funds. The maturities of these time deposits range from one to eleven months at September 30, 2010.
Securities
The Company’s securities portfolio continues to be classified, in its entirety, as “available for sale.” Management believes that a portfolio classification of available for sale allows greater flexibility in managing the investment portfolio. Using this classification, the Company intends to hold these securities for an indefinite amount of time, but not necessarily to maturity. Such securities are carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity. The portfolio is structured to provide a return on investment while providing a consistent source of liquidity and meeting strict risk standards. Investment securities consist primarily of U.S. agency securities, mortgage-backed securities issued by FHLMC or FNMA, and corporate bonds. The Company h olds no derivatives as of September 30, 2010.
Total securities at September 30, 2010 were $17.8 million compared to securities of $19.1 million at December 31, 2009. The carrying value of the securities portfolio as of September 30, 2010 includes a net unrealized gain of $409 thousand, which is recorded as accumulated other comprehensive income in stockholders’ equity. This compares to a net unrealized gain of $71 thousand at December 31, 2009. No securities are deemed to be other than temporarily impaired. The decline in the investment securities portfolio reflects sales, maturities, calls and principal payments received during this period exceeding purchases, as the Company used excess liquidity to fund the growth in the loan portfolio and an increase in time deposits in other banks.
Restricted Investment in Bank Stock
Restricted investment in bank stock as of September 30, 2010 was $588 thousand, increasing $66 thousand or 12.6% from $522 thousand at December 31, 2009. This balance is comprised of capital stock of correspondent banks and the Federal Home Loan Bank, and fluctuates primarily due to activity-based requirements related to borrowings from the Federal Home Loan Bank.
Loans
The loan portfolio comprises the largest component of the Company’s earning assets. All of the Company’s loans are to domestic borrowers. Total loans, net of the allowance, increased $3.3 million to $115.2 million at September 30, 2010 from $111.9 million at December 31, 2009. The loan to deposit ratio has increased from 78.0% at December 31, 2009 to 81.2% at September 30, 2010. The Company’s loan portfolio at September 30, 2010 was comprised of consumer loans of $39.9 million, a decrease of $1.8 million from December 31, 2009, and commercial loans of $77.0 million, an increase of $5.4 million from December 31, 2009, before the allowance for loan losses. The Company has not originated, nor does it intend to originate, sub-prime mortgage loans.
Credit Risk and Loan Quality
The allowance for loan losses increased $289 thousand to $1.7 million at September 30, 2010 from $1.4 million at December 31, 2009. At September 30, 2010 and December 31, 2009, the allowance for loan losses represented 1.48% and 1.27% respectively of total loans. Based upon current economic conditions, the composition of the loan portfolio, the perceived credit risk in the portfolio and loan-loss experience of comparable institutions in the Company’s market area, management feels the allowance is adequate to absorb reasonably anticipated losses.
At September 30, 2010, the Company had fifteen loans totaling $4.8 million that were in non-accrual. There was a $50 thousand loan which was past due greater than 90 days and still accruing, and no restructured loans. At December 31, 2009, the Company had $4.6 million in non-accrual loans, no loans greater than 90 days past due and still accruing interest, and no restructured loans. The Company had one commercial real estate property with a net realizable value of $415 thousand which was foreclosed upon and classified as foreclosed assets at September 30, 2010 and no similar properties at December 31, 2009. The balance of non-performing loans at September 30, 2010 includes a construction loan of $1.7 million and a participation of $745 thousand in a development loan. Both of these loans have been adversely affected by the weakened market conditions. The $1.7 million construction loan was previously in foreclosure, however, the Bank has come to an agreement with the borrowers to modify the loan and allow construction to begin. At this time management believes the equity in this project is sufficient to allow for successful completion. At September 30, 2010 five non-accrual commercial real estate loans totaling $1.9 million are in foreclosure due to poor market conditions that have affected real estate sales. The remaining non-accrual loans at September 30, 2010 consists of three home equity loans totaling $193 thousand, four commercial loans totaling $199 thousand, and one residential real estate loan of $141 thousand.
At September 30, 2010 there were impaired loans in the amount of $4.5 million compared to $4.7 million at December 31, 2009. Impaired loans requiring a specific allowance for loan loss were $4.5 million at September 30, 2010 and $3.1 million at December 31, 2009. The allowance for loan losses on the impaired loans was $359,000 at September 30, 2010 and $119,000 at December 31, 2009. The decrease in impaired loans was due primarily to the transfer of a $415,000 loan to foreclosed assets. Management recognized that collateral asset values on impaired loans have experienced added deterioration and has made the necessary adjustments to increase the specific allowances on such loans.
Management continues to monitor the Company’s asset quality and believes that the non-performing assets are adequately collateralized and anticipated material losses have been adequately reserved for in the allowance for loan losses. However, given the uncertainty of the current real estate market, additional provisions for losses may be deemed necessary in future periods.
The Company seeks to actively manage its non-performing assets. In addition to monitoring and collecting on delinquent loans, management maintains a loan review process for customers with aggregate relationships of $450 thousand or more.
Premises and Equipment
Bank premises and equipment, net of accumulated depreciation, decreased $224 thousand from December 31, 2009 to September 30, 2010. This decrease is due to depreciation expense on existing premises and equipment.
Deposits
Total deposits at September 30, 2010 decreased $1.7 million to $141.9 million from $143.6 million at December 31, 2009. Savings deposits and time deposits decreased by $19.3 million, and $1.8 million, respectively which was offset by growth in money market, non-interest bearing checking, and interest checking of $10.9 million, $4.7 million, and $3.8 million, respectively. The decline in savings deposits is attributed to decreases made to the savings rate paid beginning January 1, 2010, which caused a migration of deposits to higher paying money market accounts.
Liquidity
Liquidity represents the Company’s ability to meet the demands required for the funding of loans and to meet depositors’ requirements for use of their funds. The Company’s sources of liquidity are cash balances, due from banks, and federal funds sold. Cash and cash equivalents were $1.9 million at September 30, 2010, compared to $3.3 million at December 31, 2009.
Additional liquidity sources include maturities of time deposits in other banks, principal and interest payments from the investment security and loan portfolios. Long-term liquidity needs may be met by selling securities available for sale, selling loans or raising additional capital. At September 30, 2010, the Company had $28.0 million of time deposits with other banks that had maturities of less than twelve months, and $17.8 million of available for sale securities. Securities with carrying values of approximately $9.8 million at September 30, 2010 were pledged as collateral to secure borrowings, public deposits, and for other purposes required or permitted by law. The Company also has borrowing capacity with the Federal Home Loan Bank of New York and a line of credit with Atlantic Central Bankers Bank as discussed in Note 7 of this f iling.
Contractual Obligations
The Company currently leases its main banking office at 310 Route 94 in Vernon, New Jersey and each of its two branch locations at 351 Union Boulevard in Totowa, New Jersey and 351 Sparta Avenue in Sparta, New Jersey. These leases expire in 2016, 2012, and 2014 for each office, respectively.
Off-Balance Sheet Arrangements
The Company’s financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These off-balance sheet arrangements consist mainly of unfunded loans and lines of credit made under the same standards as on-balance sheet instruments. These unused commitments totaled $35.7 million at September 30, 2010. The Company also has letters of credit outstanding of $435 thousand at September 30, 2010. Because 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 is of the opinion that the Company’s liquidity is sufficient to meet its anticipated needs.
Capital Resources and Adequacy
Total stockholders’ equity was $16.2 million as of September 30, 2010, representing a net increase of $446 thousand from December 31, 2009. The increase in capital was a result of the change in the net unrealized holding gain on available for sale securities of $338 thousand and net income of $332 thousand for the nine months ended September 30, 2010 reduced by preferred stock dividends of $215 thousand and preferred stock issuance costs of $10 thousand.
The following table provides a comparison of the Bank’s regulatory capital ratios. Since the Company has less than $500 million in consolidated assets, it is not subject to regulatory capital requirements:
| | | September 30, | | | December 31, | |
| (In thousands except for ratios) | | 2010 | | | 2009 | |
| Tier I, common stockholders' equity | | $ | 14,982 | | | $ | 14,871 | |
| Tier II, allowable portion of allowance for loan losses | | | 1,660 | | | | 1,438 | |
| Total capital | | | 16,642 | | | | 16,309 | |
| Total risk-based capital | | | 12.5 | % | | | 12.6 | % |
| Tier I risk-based capital | | | 11.3 | % | | | 11.5 | % |
| Tier I leverage capital | | | 8.9 | % | | | 9.0 | % |
At September 30, 2010, the Bank exceeded the minimum regulatory capital requirements necessary to be considered a “well capitalized” financial institution under applicable federal banking regulations.
In the normal course of business activities, the Company is exposed to market risk, principally interest rate risk. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments. The Asset/Liability Committee, as a function of the Board of Directors, is responsible for managing the rate sensitivity position, using Board approved policies and procedures. No material changes in the market risk strategy occurred during the current period. A detailed discussion of interest rate risk is provided in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2009.
Item 4(T) – Controls and Procedures
The term “disclosure controls and procedures” is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). This term refers to the controls and procedures of a Company that are designed to ensure that information required to be disclosed by a Company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010, and they have concluded that, as of this date, our disclosure controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act.
There were no significant changes to our internal controls over financial reporting or in the other factors that could significantly affect our internal controls over financial reporting during the quarter ended September 30, 2010, including any corrective actions with regard to significant deficiencies and material weakness.
Part II - Other Information
Item 1 - Legal Proceedings
The Company is an occasional party to legal actions arising in the ordinary course of its business. In the opinion of management, the Company has adequate legal defenses and/or insurance coverage respecting any and each of these actions and does not believe that they will materially affect the Company’s operations or financial position.
On December 14, 2009, Union Center National Bank (“UCNB”) initiated an action in New Jersey Superior Court against the Bank seeking to require the Bank to repurchase UCNB’s participation interest in a loan with a total principal amount of $6.9 million. UCNB holds 85.5072% of the loan. UCNB has also asserted a claim for negligent handling and administration of the loan. The Bank intends to continue vigorously defending this lawsuit, has filed an answer contesting liability and has asserted counterclaims against UCNB. UCNB’s motion for summary judgment was denied without prejudice. The parties intend to complete discovery within the next 60 to 90 days.
Not Applicable.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
Not Applicable.
Item 3 - Defaults Upon Senior Securities
Not Applicable.
Item 4 - Reserved
Item 5 - Other Information
Not Applicable.
Item 6. Exhibits
Exhibit 31.1 – Certification of George E. Irwin pursuant to SEC Rule 13a-14(a)
Exhibit 31.2 – Certification of Eileen D. Piersa pursuant to SEC Rule 13a-14(a)
Exhibit 32.1 – Certification of George E. Irwin Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 – Certification of Eileen D. Piersa pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURE
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.
| | HIGHLANDS BANCORP, INC. | |
| | | | | |
| Date: November 10, 2010 | | By: | /s/ George E. Irwin | |
| | | George E. Irwin | |
| | | President and Chief Executive Officer | |
| | | | | |
