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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Amendment No. 1
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
Commission file number 000-13580
SUFFOLK BANCORP
(Exact Name of Registrant as Specified in Its Charter)
New York State | 11-2708279 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
4 West Second Street, Riverhead, New York | 11901 | |
(Address of Principal Executive Offices) | (Zip Code) |
(631) 727-5667
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
9,684,950 SHARES OF COMMON STOCK OUTSTANDING AS OF November 1, 2010
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EXPLANATORY NOTE
Suffolk Bancorp (“Suffolk”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the period ended September 30, 2010, originally filed with the Securities and Exchange Commission (the “SEC”) on November 9, 2010. This Amendment is being filed to amend and restate our unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2010 and related disclosures to correct for a misstatement in the provision and allowance for loan losses.
This quarterly report on Form 10-Q/A for the quarterly period ended September 30, 2010 is being filed to reflect the financial statement restatement. In summary, as of and for the three and nine months ended September 30, 2010, this financial statement restatement has resulted in:
• | No impact on our cash and cash equivalents or overall cash flow. |
• | Increases in our provision for loan losses of $12.1 million (461%; 84%) and decreases in our net income of $7.8 million (167%; 71%) and our basic earnings-per-share by $0.81 (165%;71%) for the three and nine months ended September 30, 2010, respectively. |
• | Decreases in our total loans of $7.4 million (0.65%), our total assets, retained earnings and total stockholders’ equity of $7.8 million (0.46%; 8.0% and 5.2%), respectively, increases in our allowance for loan losses of $4.7 million (21.4%) and our other assets of $4.3 million (21.2%) as of September 30, 2010. |
For a more detailed description of the financial statement restatement, see Note 2, “Restatement of Financial Statements” to our notes to the unaudited consolidated financial statements.
Suffolk has not modified or updated the information in the initial Form 10-Q, except as necessary to reflect the effects of the restatement which took into consideration subsequent additional information about conditions that existed at September 30, 2010, and to reflect legal proceedings and subsequent events as disclosed in Note 12 and Note 13, respectively. This Amendment continues to speak as of the dates described herein, and we have not updated the disclosures contained in the initial Form 10-Q to reflect any events that occurred subsequent to such dates except with regard to the restatement. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the filing of the initial Form 10-Q on November 9, 2010. Accordingly, this Amendment should be read in conjunction with our subsequent filings with the SEC, as information in such filings may update or supersede certain information contained in this Amendment.
In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by our principal executive officer and principal financial officer are filed herewith as Exhibits 31.1, 31.2, 32.1 and 32.2.
For the convenience of the reader, this Amendment sets forth the initial Form 10-Q in its entirety, although Suffolk is only amending and restating Items 1, 2 and 4 of Part 1 and Item 6 of Part II of the initial Form 10-Q affected by the corrected financial information.
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SUFFOLK BANCORP AND SUBSIDIARIES
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2 | ||||
2 | ||||
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED | 3 | |||
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED | 4 | |||
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED | 5 | |||
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Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 21 | |||
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Item 3 - Quantitative and Qualitative Disclosures about Market Risk | 35 | |||
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Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds | 40 | |||
40 | ||||
40 |
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SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION AS OF
(in thousands of dollars, except for share data)
September 30, 2010 | December 31, 2009 | |||||||
unaudited Restated | ||||||||
ASSETS | ||||||||
Cash & Due from Banks | $ | 58,028 | $ | 37,007 | ||||
Federal Reserve Bank Stock | 652 | 652 | ||||||
Federal Home Loan Bank Stock | 3,531 | 8,346 | ||||||
Investment Securities: | ||||||||
Available for Sale, at Fair Value | 446,399 | 437,000 | ||||||
Held to Maturity (Fair Value of $11,085 and $10,096, respectively) | ||||||||
Obligations of States & Political Subdivisions | 10,050 | 9,243 | ||||||
Other Securities | 100 | 100 | ||||||
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| |||||
Total Investment Securities | 456,549 | 446,343 | ||||||
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| |||||
Total Loans | 1,134,457 | 1,160,379 | ||||||
Less: Allowance for Loan Losses | 26,659 | 12,333 | ||||||
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Net Loans | 1,107,798 | 1,148,046 | ||||||
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| |||||
Premises & Equipment, Net | 22,368 | 23,346 | ||||||
Accrued Interest Receivable, Net | 7,895 | 7,223 | ||||||
Goodwill | 814 | 814 | ||||||
Other Assets | 24,465 | 22,719 | ||||||
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| |||||
TOTAL ASSETS | $ | 1,682,100 | $ | 1,694,496 | ||||
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LIABILITIES & STOCKHOLDERS’ EQUITY | ||||||||
Demand Deposits | $ | 521,527 | $ | 487,648 | ||||
Saving, N.O.W. & Money Market Deposits | 629,126 | 578,551 | ||||||
Time Certificates of $100,000 or more | 214,064 | 211,898 | ||||||
Other Time Deposits | 110,561 | 107,181 | ||||||
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|
|
| |||||
Total Deposits | 1,475,278 | 1,385,278 | ||||||
Federal Home Loan Bank Borrowings | 40,000 | 150,800 | ||||||
Dividend Payable on Common Stock | 2,126 | 2,115 | ||||||
Accrued Interest Payable | 650 | 829 | ||||||
Other Liabilities | 20,418 | 18,303 | ||||||
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| |||||
TOTAL LIABILITIES | 1,538,472 | 1,557,325 | ||||||
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STOCKHOLDERS’ EQUITY | ||||||||
Common Stock (par value $2.50; 15,000,000 shares authorized; 9,665,245 and 9,615,494 shares outstanding at September 30, 2010 and December 31, 2009, respectively) | 34,169 | 34,031 | ||||||
Surplus | 22,784 | 21,685 | ||||||
Treasury Stock at Par (4,002,158 and 3,996,878 shares, respectively) | (10,005 | ) | (9,992 | ) | ||||
Retained Earnings | 89,835 | 93,154 | ||||||
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136,783 | 138,878 | |||||||
Accumulated Other Comprehensive Income (Loss), Net of Tax | 6,845 | (1,707 | ) | |||||
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| |||||
TOTAL STOCKHOLDERS’ EQUITY | 143,628 | 137,171 | ||||||
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TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY | $ | 1,682,100 | $ | 1,694,496 | ||||
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See accompanying notes to consolidated financial statements.
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SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED
(in thousands of dollars except for share and per share data)
September 30, 2010 | September 30, 2009 | |||||||
unaudited Restated | unaudited | |||||||
INTEREST INCOME | ||||||||
Federal Funds Sold & Interest from Bank Deposits | $ | 3 | $ | 44 | ||||
United States Treasury Securities | 71 | 94 | ||||||
Obligations of States & Political Subdivisions | 1,979 | 1,804 | ||||||
Mortgage-Backed Securities | 1,888 | 1,836 | ||||||
U.S. Government Agency Obligations | 202 | 354 | ||||||
Other Securities | 95 | 123 | ||||||
Loans | 17,464 | 17,261 | ||||||
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| |||||
Total Interest Income | 21,702 | 21,516 | ||||||
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| |||||
INTEREST EXPENSE | ||||||||
Saving, N.O.W. & Money Market Deposits | 827 | 934 | ||||||
Time Certificates of $100,000 or more | 709 | 960 | ||||||
Other Time Deposits | 436 | 584 | ||||||
Borrowings | 363 | 564 | ||||||
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| |||||
Total Interest Expense | 2,335 | 3,042 | ||||||
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Net-interest Income | 19,367 | 18,474 | ||||||
Provision for Loan Losses | 14,729 | 975 | ||||||
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Net-interest Income After Provision for Loan Losses | 4,638 | 17,499 | ||||||
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OTHER INCOME | ||||||||
Service Charges on Deposit Accounts | 1,215 | 1,354 | ||||||
Other Service Charges, Commissions & Fees | 1,007 | 929 | ||||||
Fiduciary Fees | 243 | 237 | ||||||
Other Operating Income | 202 | 246 | ||||||
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Total Other Income | 2,667 | 2,766 | ||||||
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OTHER EXPENSE | ||||||||
Salaries & Employee Benefits | 7,457 | 7,190 | ||||||
Net Occupancy Expense | 1,336 | 1,250 | ||||||
Equipment Expense | 511 | 586 | ||||||
FDIC Assessments | 862 | 517 | ||||||
Other Operating Expense | 2,855 | 2,491 | ||||||
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Total Other Expense | 13,021 | 12,034 | ||||||
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(Loss) Income Before Income Taxes | (5,716 | ) | 8,231 | |||||
(Benefit) Provision for Income Taxes | (2,579 | ) | 2,203 | |||||
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NET (LOSS) INCOME | $ | (3,137 | ) | $ | 6,028 | |||
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Weighted Average:Common Shares Outstanding | 9,662,328 | 9,607,023 | ||||||
Dilutive Stock Options | — | 19,286 | ||||||
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Weighted Average Total Common Shares and Dilutive Options | 9,662,328 | 9,626,309 | ||||||
(LOSS) EARNINGS PER COMMON SHAREBasic | $ | (0.32 | ) | $ | 0.63 | |||
Diluted | $ | (0.32 | ) | $ | 0.63 | |||
DIVIDENDS PER COMMON SHARE | $ | 0.22 | $ | 0.22 |
See accompanying notes to consolidated financial statements.
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SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED
(in thousands of dollars except for share and per share data)
September 30, 2010 | September 30, 2009 | |||||||
unaudited Restated | unaudited | |||||||
INTEREST INCOME | ||||||||
Federal Funds Sold & Interest from Bank Deposits | $ | 8 | $ | 48 | ||||
United States Treasury Securities | 213 | 292 | ||||||
Obligations of States & Political Subdivisions | 5,818 | 5,254 | ||||||
Mortgage-Backed Securities | 5,957 | 5,382 | ||||||
U.S. Government Agency Obligations | 607 | 1,797 | ||||||
Other Securities | 320 | 334 | ||||||
Loans | 52,545 | 52,137 | ||||||
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Total Interest Income | 65,468 | 65,244 | ||||||
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INTEREST EXPENSE | ||||||||
Saving, N.O.W. & Money Market Deposits | 2,551 | 2,732 | ||||||
Time Certificates of $100,000 or more | 2,271 | 2,591 | ||||||
Other Time Deposits | 1,365 | 2,002 | ||||||
Federal Funds Purchased and Repurchase Agreements | 2 | 120 | ||||||
Borrowings | 1,322 | 2,277 | ||||||
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Total Interest Expense | 7,511 | 9,722 | ||||||
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Net-interest Income | 57,957 | 55,522 | ||||||
Provision for Loan Losses | 26,549 | 3,000 | ||||||
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Net-interest Income After Provision for Loan Losses | 31,408 | 52,522 | ||||||
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OTHER INCOME | ||||||||
Service Charges on Deposit Accounts | 3,745 | 4,019 | ||||||
Other Service Charges, Commissions & Fees | 2,591 | 2,586 | ||||||
Fiduciary Fees | 760 | 779 | ||||||
Net Security Gains | 12 | — | ||||||
Other Operating Income | 689 | 969 | ||||||
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Total Other Income | 7,797 | 8,353 | ||||||
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OTHER EXPENSE | ||||||||
Salaries & Employee Benefits | 21,682 | 20,892 | ||||||
Net Occupancy Expense | 4,030 | 3,837 | ||||||
Equipment Expense | 1,576 | 1,719 | ||||||
FDIC Assessments | 2,089 | 2,202 | ||||||
Other Operating Expense | 7,926 | 7,591 | ||||||
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Total Other Expense | 37,303 | 36,241 | ||||||
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Income Before Income Taxes | 1,902 | 24,634 | ||||||
(Benefit) Provision for Income Taxes | (1,285 | ) | 7,239 | |||||
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NET INCOME | $ | 3,187 | $ | 17,395 | ||||
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Weighted Average:Common Shares Outstanding | 9,649,550 | 9,598,583 | ||||||
Dilutive Stock Options | 6,408 | 17,976 | ||||||
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Weighted Average Total Common Shares and Dilutive Options | 9,655,958 | 9,616,559 | ||||||
EARNINGS PER COMMON SHAREBasic | $ | 0.33 | $ | 1.81 | ||||
Diluted | $ | 0.33 | $ | 1.81 | ||||
DIVIDENDS PER COMMON SHARE | $ | 0.66 | $ | 0.66 |
See accompanying notes to consolidated financial statements.
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SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
(in thousands of dollars)
September 30, 2010 | September 30, 2009 | |||||||
unaudited Restated | unaudited | |||||||
NET INCOME | $ | 3,187 | $ | 17,395 | ||||
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Provision for Loan Losses | 26,549 | 3,000 | ||||||
Depreciation & Amortization | 1,881 | 1,896 | ||||||
Net Security Gains | (12 | ) | — | |||||
Stock Based Compensation | 8 | 105 | ||||||
Accretion of Discounts | (118 | ) | (196 | ) | ||||
Amortization of Premiums | 2,122 | 973 | ||||||
Increase in Accrued Interest Receivable | (672 | ) | (893 | ) | ||||
Increase in Other Assets | (7,594 | ) | (440 | ) | ||||
Decrease in Accrued Interest Payable | (179 | ) | (1,338 | ) | ||||
Increase (Decrease) in Other Liabilities | 2,075 | (90 | ) | |||||
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Net Cash Provided by Operating Activities | 27,247 | 20,412 | ||||||
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CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Principal Payments on Investment Securities Available for Sale | 22,689 | 26,398 | ||||||
Proceeds from Sale of Investment Securities Available for Sale | 1,232 | — | ||||||
Maturities of Investment Securities Available for Sale | 2,000 | 102,500 | ||||||
Purchases of Investment Securities Available for Sale | (22,904 | ) | (185,506 | ) | ||||
Maturities of Investment Securities Held to Maturity | 6,836 | 8,503 | ||||||
Purchases of Investment Securities Held to Maturity | (2,833 | ) | (7,369 | ) | ||||
Loan (Disbursements) & Repayments, Net | 13,740 | (27,994 | ) | |||||
Purchases of Premises & Equipment, Net | (904 | ) | (2,679 | ) | ||||
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Net Cash Provided by (Used in) Investing Activities | 19,856 | (86,147 | ) | |||||
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CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Net Increase in Deposit Accounts | 90,000 | 190,818 | ||||||
Dividends Paid to Shareholders | (6,361 | ) | (6,330 | ) | ||||
Stock Options and Stock Appreciation Rights Exercised | 209 | — | ||||||
Dividend Reinvestment in Common Stock, Net | 870 | 574 | ||||||
Short-term Borrowings and Repayments, Net | (110,800 | ) | (121,520 | ) | ||||
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Net Cash (Used in) Provided by Financing Activities | (26,082 | ) | 63,542 | |||||
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Net Increase (Decrease) in Cash & Cash Equivalents | 21,021 | (2,193 | ) | |||||
Cash & Cash Equivalents Beginning of Period | 37,007 | 41,513 | ||||||
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Cash & Cash Equivalents End of Period | $ | 58,028 | $ | 39,320 | ||||
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Supplemental Disclosure of Cash Flow Information | ||||||||
Cash Received During the Nine Month Period for Interest | $ | 64,797 | $ | 64,303 | ||||
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Cash Paid During the Nine Month Period for: | ||||||||
Interest | $ | 7,689 | $ | 11,060 | ||||
Income Taxes | 8,020 | 8,687 | ||||||
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Total Cash Paid for Interest & Income Taxes | $ | 15,709 | $ | 19,747 | ||||
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See accompanying notes to consolidated financial statements.
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SUFFOLK BANCORP AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited consolidated financial statements of Suffolk Bancorp (“Suffolk”) and its consolidated subsidiaries, primarily Suffolk County National Bank (the “Bank”), have been prepared to reflect all adjustments (consisting solely of normally recurring accruals) necessary for a fair presentation of the financial condition and results of operations for the periods presented. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted. Notwithstanding, management believes that the disclosures are adequate to prevent the information from misleading the reader, particularly when the accompanying consolidated financial statements are read in conjunction with the audited consolidated financial statements and notes thereto included in the Registrant’s Annual Report on Form 10-K, for the year ended December 31, 2009. Certain reclassifications have been made to the prior year’s consolidated financial statements that conform to the current year’s presentation. Such reclassifications had no impact on net income.
(2) Restatement of Financial Statements
In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses, overstated net income and earnings-per-common share; understated other assets; and overstated the capital ratios. The tables below detail the restated financial statement line items and Suffolk’s regulatory capital ratios. See Note 7 on page 15.
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The effects of the restatement by line item for the periods presented in this Amendment No. 1 to its Quarterly Report on Form 10-Q follow: (in thousands, except per share and capital ratios)
Effect of Restatement on Consolidated Statements of Condition | ||||||||||||
September 30, 2010 | ||||||||||||
As Originally Reported | As Restated | Effect of Change | ||||||||||
Total loans | $ | 1,141,866 | $ | 1,134,457 | $ | (7,409 | ) | |||||
Allowance for loan losses | 21,964 | 26,659 | 4,695 | |||||||||
Other assets | 20,186 | 24,465 | 4,279 | |||||||||
Total assets | 1,689,925 | 1,682,100 | (7,825 | ) | ||||||||
Retained earnings | 97,660 | 89,835 | (7,825 | ) | ||||||||
Total stockholders’ equity | 151,453 | 143,628 | (7,825 | ) | ||||||||
Effect on Consolidated Statements of Operations | ||||||||||||
Three Months Ended September 30, 2010 | ||||||||||||
As Originally Reported | As Restated | Effect of Change | ||||||||||
Provision for loan losses | $ | 2,625 | $ | 14,729 | $ | 12,104 | ||||||
Net interest income after provision for loan losses | 16,742 | 4,638 | (12,104 | ) | ||||||||
Income (loss) before income taxes | 6,388 | (5,716 | ) | (12,104 | ) | |||||||
Provision (benefit) for income taxes | 1,700 | (2,579 | ) | (4,279 | ) | |||||||
Net income (loss) | 4,688 | (3,137 | ) | (7,825 | ) | |||||||
Earnings (loss) per common share | ||||||||||||
Basic | $ | 0.49 | $ | (0.32 | ) | $ | (0.81 | ) | ||||
Diluted | $ | 0.48 | $ | (0.32 | ) | $ | (0.80 | ) | ||||
Effect on Consolidated Statements of Operations | ||||||||||||
Nine Months Ended September 30, 2010 | ||||||||||||
As Originally Reported | As Restated | Effect of Change | ||||||||||
Provision for loan losses | $ | 14,445 | $ | 26,549 | $ | 12,104 | ||||||
Net interest income after provision for loan losses | 43,512 | 31,408 | (12,104 | ) | ||||||||
Income before income taxes | 14,006 | 1,902 | (12,104 | ) | ||||||||
Provision (benefit) for income taxes | 2,994 | (1,285 | ) | (4,279 | ) | |||||||
Net income | 11,012 | 3,187 | (7,825 | ) | ||||||||
Earnings per common share | ||||||||||||
Basic | $ | 1.14 | $ | 0.33 | $ | (0.81 | ) | |||||
Diluted | $ | 1.14 | $ | 0.33 | $ | (0.81 | ) | |||||
Effect on Consolidated Statements of Cash Flows | ||||||||||||
Nine Months Ended September 30, 2010 | ||||||||||||
As Originally Reported | As Restated | Effect of Change | ||||||||||
Net income | $ | 11,012 | $ | 3,187 | $ | (7,825 | ) | |||||
Provision for loan losses | 14,445 | 26,549 | 12,104 | |||||||||
Increase in other assets | (3,315 | ) | (7,594 | ) | (4,279 | ) | ||||||
Effect on Suffolk’s Capital Ratios | ||||||||||||
September 30, 2010 | ||||||||||||
As Originally Reported | As Restated | Effect of Change | ||||||||||
Tier 1 Leverage Ratio | 8.49 | % | 8.03 | % | -0.46 | % | ||||||
Tier 1 Risk-based Capital Ratio | 11.56 | % | 11.00 | % | -0.56 | % | ||||||
Total Risk-based Capital Ratio | 12.82 | % | 12.26 | % | -0.56 | % |
At September 30, 2010, Suffolk had one stock-based employee compensation plan, the Suffolk Bancorp 2009 Stock Incentive Plan (“the Plan”), under which 500,000 shares of Suffolk’s common stock were originally reserved for issuance to key employees and directors, and of which none had yet been issued at that date. Options are awarded by a committee
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appointed by the Board of Directors. The Plan provides that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. The Plan provides for but does not require the grant of stock appreciation rights that the holder may exercise instead of the underlying option. When the stock appreciation right is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of stock appreciation rights is treated as the exercise of the underlying option. Options vest after one year and expire after ten years except as otherwise specified in the option agreement.
Stock-based compensation for all share-based payments to employees, including grants of employee stock options, is recorded in the financial statements based on their fair values. During the three months ended September 30, 2010, no compensation expense was recorded for stock-based compensation. During the nine months ended September 30, 2010, $8,000 of compensation expense, net of a tax benefit of $3,000, was recorded for stock-based compensation. As of September 30, 2010, there was no unrecognized compensation cost related to non-vested options under the Plan.
The following table presents the options granted, exercised, or expired from the 1999 Plan during the nine months ended September 30, 2010:
Shares | Wtd. Avg. Exercise | |||||||
Balance at December 31, 2009 | 154,500 | $ | 27.81 | |||||
Options granted | — | — | ||||||
Options exercised | (25,000 | ) | 14.27 | |||||
Options expired or terminated | (36,000 | ) | 32.32 | |||||
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Balance at September 30, 2010 | 93,500 | $ | 29.69 | |||||
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The following table presents certain information about the valuation of vested options outstanding on September 30, 2010 and December 31, 2009:
At, or during, | 9/30/2010 | 12/31/2009 | ||||||
Exercisable options (vested) | 93,500 | 139,500 | ||||||
Weighted average fair value of options (Black-Scholes model) at date of grant: | $ | 9.24 | $ | 9.24 | ||||
Black-Scholes Assumptions: | ||||||||
Risk-free interest rate | 3.17 | % | 3.17 | % | ||||
Expected dividend yield | 3.06 | % | 3.06 | % | ||||
Expected life in years | 10 | 10 | ||||||
Expected volatility | 36.90 | % | 36.90 | % |
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The following table details contractual weighted-average lives of outstanding options at various prices:
By range of exercise prices | ||||||||||||
from | $ | 13.13 | $ | 28.30 | $ | 34.39 | ||||||
to | 15.50 | 32.90 | 34.95 | |||||||||
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Outstanding stock options | 14,000 | 57,000 | 22,500 | |||||||||
Weighted-average remaining life | 0.30 | 5.96 | 4.66 | |||||||||
Weighted-average exercise price | $ | 15.50 | $ | 31.17 | $ | 34.76 | ||||||
Exercisable stock options | 14,000 | 57,000 | 22,500 | |||||||||
Weighted-average remaining life | 0.30 | 5.96 | 4.66 | |||||||||
Weighted-average exercise price | $ | 15.50 | $ | 31.17 | $ | 34.76 | ||||||
Weighted-average | ||||||||||||
At all prices | Options | price | life (yrs) | |||||||||
Total outstanding (1) | 93,500 | $ | 29.69 | 4.80 | ||||||||
Total exercisable | 93,500 | $ | 29.69 | 4.80 |
(1) | Options to purchase 87,092 shares of common stock at a range of $28.30 - $34.95 per share were outstanding during the first nine months of 2010, and options to purchase 136,524 shares of common stock at a range of $31.18 - $34.95 per share were outstanding during the first nine months of 2009, but were not included in the computation of diluted Earnings-Per-Share (“EPS”) on the Consolidated Statement of Operations because the exercise price was greater than the average market price of the common shares. Options to purchase 93,500 shares of common stock at a range of $13.13 - $34.95 per share were outstanding during the quarter ended September 30, 2010, and options to purchase 135,214 shares of common stock at a range of $31.18 - $34.95 per share were outstanding during the quarter ended September 30 2009, but were not included in the computation of diluted EPS on the Consolidated Statement of Operations because of the net loss and the exercise price was greater than the average market price of the common shares. These options expire beginning in 2013. |
Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is management’s position that no valuation allowance is necessary against any of Suffolk’s deferred tax assets. Suffolk accounts for income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, “Income Taxes,” which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. Suffolk had unrecognized tax benefits including interest of approximately $37,000 as of September 30, 2010. Suffolk recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.
Suffolk records investments available for sale and impaired loans at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. Suffolk uses three levels of the fair value inputs to measure assets, as described below.
Basis of Fair Value Measurement:
Level 1 - Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 - Quoted prices in markets that are not active, or inputs that use pricing models or matrix pricing;
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
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The following table presents the carrying amounts and fair values of Suffolk’s financial instruments. FASB ASC 825, “Financial Instruments”, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation: (in thousands)
September 30, 2010 Restated | December 31, 2009 | |||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||
Cash & cash equivalents | $ | 58,028 | $ | 58,028 | $ | 37,007 | $ | 37,007 | ||||||||
Investment securities available for sale | 446,399 | 446,399 | 437,000 | 437,000 | ||||||||||||
Investment securities held to maturity | 10,150 | 11,085 | 9,343 | 10,096 | ||||||||||||
Total loans | 1,134,457 | 1,166,671 | 1,160,379 | 1,178,429 | ||||||||||||
Deposits | 1,475,278 | 1,477,839 | 1,385,278 | 1,387,241 | ||||||||||||
Borrowings | 40,000 | 41,688 | 150,800 | 152,328 |
Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.
Short-term financial instruments are valued at the carrying amounts included in the consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term of the instruments. This approach applies to cash and cash equivalents; accrued interest receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; and accrued interest payable. Federal Home Loan Bank borrowings are measured using a discounted replacement cost of funds approach.
Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type. The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk of the loan. Estimated maturity is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of the current economy. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.
The carrying amount and fair value of loans were as follows: (in thousands)
September 30, 2010 Restated | December 31, 2009 | |||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||
Commercial, financial & agricultural | $ | 250,182 | $ | 254,249 | $ | 259,565 | $ | 261,333 | ||||||||
Commercial real estate | 422,158 | 440,688 | 375,652 | 383,392 | ||||||||||||
Real estate construction loans | 101,535 | 101,882 | 133,431 | 133,996 | ||||||||||||
Residential mortgages (1st & 2nd liens) | 203,847 | 211,907 | 214,501 | 221,502 | ||||||||||||
Home equity loans | 85,800 | 85,773 | 82,808 | 82,779 | ||||||||||||
Consumer loans, net of unearned discounts | 69,991 | 71,228 | 80,352 | 81,357 | ||||||||||||
Other loans | 944 | 944 | 14,070 | 14,070 | ||||||||||||
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Totals | $ | 1,134,457 | $ | 1,166,671 | $ | 1,160,379 | $ | 1,178,429 | ||||||||
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Other assets measured at fair value were as follows: (in thousands)
Fair Value Measurements Using | ||||||||||||||||
Description | September 30, 2010 Restated | Active Markets for Identical Assets Quoted Prices (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Impaired loans | $ | 79,838 | $ | — | $ | — | $ | 79,838 | ||||||||
Mortgage servicing rights (1) | 1,515 | — | — | 1,515 | ||||||||||||
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Total | $ | 81,353 | $ | — | $ | — | $ | 81,353 | ||||||||
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(1) | Mortgage servicing rights are measured at fair value on a recurring basis. |
Fair Value Measurements Using | ||||||||||||||||
Description | December 31, 2009 | Active Markets for Identical Assets Quoted Prices (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Impaired loans | $ | 29,309 | $ | — | $ | — | $ | 29,309 | ||||||||
Mortgage servicing rights (1) | 1,444 | — | — | 1,444 | ||||||||||||
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Total | $ | 30,753 | $ | — | $ | — | $ | 30,753 | ||||||||
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(1) | Mortgage servicing rights are measured at fair value on a recurring basis. |
Impaired loans are evaluated and valued at the time the loan is identified as impaired. The loans are measured based on the value of the collateral securing these loans less disposal costs, or techniques that are not supported by market activity for loans that are not collateral dependent and require management’s judgment. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by Suffolk. The value of business equipment may be based on an appraisal by qualified licensed appraisers hired by Suffolk if significant, or may be valued based on the equipment’s net book value on the business’ financial statements. Inventory and accounts receivable collateral may be valued based on independent field examiner review or aging reports, if significant. Reviews by field examiners may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
The fair value of the investment portfolio, including mortgage-backed securities, was based on quoted market prices or market prices of similar instruments.
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The following tables summarize the valuation of financial instruments measured at fair value on a recurring basis in the consolidated statements of condition at September 30, 2010 and December 31, 2009, including the additional requirement to segregate classifications to correspond to the major security type classifications utilized for disclosure purposes: (in thousands)
Fair Value Measurements Using | ||||||||||||||||
Description | September 30, 2010 | Active Markets for Identical Assets Quoted Prices (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
U.S. Treasury securities | $ | 8,176 | $ | 8,176 | $ | — | $ | — | ||||||||
U.S. government agency debt | 42,634 | 42,634 | — | — | ||||||||||||
Collateralized mortgage obligations | 173,904 | — | 173,904 | — | ||||||||||||
Mortgage-backed securities | 533 | — | 533 | — | ||||||||||||
Obligations of states and political subdivisions | 221,152 | — | 221,152 | — | ||||||||||||
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Total | $ | 446,399 | $ | 50,810 | $ | 395,589 | $ | — | ||||||||
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Fair Value Measurements Using | ||||||||||||||||
Description | December 31, 2009 | Active Markets for Identical Assets Quoted Prices (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
U.S. Treasury securities | $ | 8,318 | $ | 8,318 | $ | — | $ | — | ||||||||
U.S. government agency debt | 43,205 | 43,205 | — | — | ||||||||||||
Collateralized mortgage obligations | 192,393 | — | 192,393 | — | ||||||||||||
Mortgage-backed securities | 599 | — | 599 | — | ||||||||||||
Obligations of states and political subdivisions | 192,485 | — | 192,485 | — | ||||||||||||
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Total | $ | 437,000 | $ | 51,523 | $ | 385,477 | $ | — | ||||||||
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The types of instruments valued based on quoted market prices in active markets include most U.S. government debt and agency debt securities. Such instruments are generally classified within level 1 and level 2 of the fair value hierarchy. Suffolk does not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include state and municipal obligations, mortgage-backed securities and collateralized mortgage obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.
FASB ASC 820, “Fair Value Measurements and Disclosures,” provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive. Suffolk adopted this codification effective April 1, 2009. The adoption did not have a material impact on Suffolk’s financial condition and results of operations. The additional disclosures are included herein.
The fair value of certificates of deposit is calculated by discounting cash flows with applicable origination rates. At September 30, 2010, the fair value of certificates of deposit less than $100,000 totaling $112,052,000 had a carrying value of $110,561,000. At September 30, 2010, the fair value of certificates of deposit of $100,000 or more totaling $215,133,000 had a carrying value of $214,064,000.
The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counterparties.
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Credit in the form of revolving open-end lines secured by one-to-four-family residential properties, commercial real estate, construction and land development loans, and lease financing arrangements was $126,233,000 and $148,309,000 as of September 30, 2010 and December 31, 2009, respectively.
The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The contractual amounts of these commitments were $61,842,000 and $70,654,000 at September 30, 2010 and December 31, 2009, respectively. The fees charged for the commitments were not material in amount.
The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolk’s investment securities available for sale and held to maturity at September 30, 2010 and December 31, 2009, respectively, were: (in thousands)
September 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||
Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | |||||||||||||||||||||||||
Available for sale: | ||||||||||||||||||||||||||||||||
U.S. Treasury securities | $ | 8,022 | $ | 8,176 | $ | 154 | $ | — | $ | 8,016 | $ | 8,318 | $ | 302 | $ | — | ||||||||||||||||
U.S. government agency debt | 42,289 | 42,634 | 345 | — | 42,607 | 43,205 | 598 | — | ||||||||||||||||||||||||
Collateralized mortgage obligations | 168,386 | 173,904 | 7,245 | (1,727 | ) | 192,143 | 192,393 | 4,026 | (3,776 | ) | ||||||||||||||||||||||
Mortgage-backed securities | 477 | 533 | 56 | — | 546 | 599 | 53 | — | ||||||||||||||||||||||||
Obligations of states and political subdivisions | 203,769 | 221,152 | 17,386 | (3 | ) | 184,636 | 192,485 | 8,304 | (455 | ) | ||||||||||||||||||||||
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Balance | 422,943 | 446,399 | 25,186 | (1,730 | ) | 427,948 | 437,000 | 13,283 | (4,231 | ) | ||||||||||||||||||||||
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Held to maturity: | ||||||||||||||||||||||||||||||||
Obligations of states and political subdivisions | 10,050 | 10,985 | 935 | — | 9,243 | 9,996 | 755 | (2 | ) | |||||||||||||||||||||||
Other securities | 100 | 100 | — | — | 100 | 100 | — | — | ||||||||||||||||||||||||
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Balance | 10,150 | 11,085 | 935 | — | 9,343 | 10,096 | 755 | (2 | ) | |||||||||||||||||||||||
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Total investment securities | $ | 433,093 | $ | 457,484 | $ | 26,121 | $ | (1,730 | ) | $ | 437,291 | $ | 447,096 | $ | 14,038 | $ | (4,233 | ) | ||||||||||||||
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The amortized cost, maturities, and approximate fair value of Suffolk’s investment securities at September 30, 2010 were as follows: (in thousands)
Available for Sale | Held to Maturity | |||||||||||||||||||||||||||||||||||||||||||||||
U.S. Treasury Securities | U.S. Govt. Agency Debt | Obligations of States & Political Subdivisions | Obligations of States & Political Subdivisions | Other Securities | Total Amortized Cost | Total Fair Value | ||||||||||||||||||||||||||||||||||||||||||
(1)Maturity (in years) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||||||||||||||||||||||||||||
Within 1 | $ | 8,022 | $ | 8,176 | $ | 27,113 | $ | 27,223 | $ | 1,006 | $ | 1,019 | $ | 2,276 | $ | 2,295 | $ | — | $ | — | $ | 38,417 | $ | 38,713 | ||||||||||||||||||||||||
After 1 but within 5 | — | — | 15,176 | 15,411 | 29,036 | 31,496 | 3,888 | 4,169 | — | — | 48,100 | 51,076 | ||||||||||||||||||||||||||||||||||||
After 5 but within 10 | — | — | — | — | 161,100 | 175,129 | 3,886 | 4,521 | — | — | 164,986 | 179,650 | ||||||||||||||||||||||||||||||||||||
After 10 | — | — �� | — | — | 12,627 | 13,508 | — | — | — | — | 12,627 | 13,508 | ||||||||||||||||||||||||||||||||||||
Other Securities | — | — | — | — | — | — | — | — | 100 | 100 | 100 | 100 | ||||||||||||||||||||||||||||||||||||
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Subtotal | 8,022 | 8,176 | 42,289 | 42,634 | 203,769 | 221,152 | 10,050 | 10,985 | 100 | 100 | 264,230 | 283,047 | ||||||||||||||||||||||||||||||||||||
Collateralized mortgage obligations | 168,386 | 173,904 | ||||||||||||||||||||||||||||||||||||||||||||||
Mortgage-backed securities | 477 | 533 | ||||||||||||||||||||||||||||||||||||||||||||||
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Total | $ | 8,022 | $ | 8,176 | $ | 42,289 | $ | 42,634 | $ | 203,769 | $ | 221,152 | $ | 10,050 | $ | 10,985 | $ | 100 | $ | 100 | $ | 433,093 | $ | 457,484 | ||||||||||||||||||||||||
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(1) | Maturities shown are stated maturities. Securities backed by mortgages are expected to have substantial periodic prepayments resulting in weighted average lives considerably less than what would be surmised from the table above. |
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As a member of the Federal Reserve System, the Bank owns Federal Reserve Bank stock with a book value of $652,000. The stock has no maturity and there is no public market for the investment.
As a member of the Federal Home Loan Bank of New York (“FHLB”), the Bank owns FHLB stock with a book value of $3,531,000. As of September 30, 2010, the Bank owns 17,314 shares valued at approximately $1,731,000 as its membership portion. The remaining $1,800,000 in stock is owned based on borrowing activity requirements. The stock has no maturity and there is no public market for the investment. Assets pledged as collateral to FHLB as of September 30, 2010 and December 31, 2009 totaled $361,146,000 and $330,471,000, respectively, consisting of eligible loans and investment securities as determined under FHLB guidelines.
At September 30, 2010 investment securities carried at $380,198,000 were pledged to secure trust deposits and public funds on deposit.
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been held in a continuous unrealized loss position at the date indicated: (in thousands)
As of September 30, 2010 | Less than 12 months | 12 months or longer | Total | |||||||||||||||||||||||||
Type of securities | Number of Securities | Fair Value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | |||||||||||||||||||||
Municipal securities | 3 | $ | 511 | $ | 3 | $ | — | $ | — | $ | 511 | $ | 3 | |||||||||||||||
Collateralized mortgage obligations | 2 | — | — | 11,323 | 1,727 | 11,323 | 1,727 | |||||||||||||||||||||
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Total | 5 | $ | 511 | $ | 3 | $ | 11,323 | $ | 1,727 | $ | 11,834 | $ | 1,730 | |||||||||||||||
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As of December 31, 2009 | Less than 12 months | 12 months or longer | Total | |||||||||||||||||||||||||
Type of securities | Number of Securities | Fair Value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | |||||||||||||||||||||
Municipal securities | 48 | 17,914 | 455 | 83 | 2 | $ | 17,997 | $ | 457 | |||||||||||||||||||
Collateralized mortgage obligations | 7 | 21,207 | 170 | 19,253 | 3,606 | 40,460 | 3,776 | |||||||||||||||||||||
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Total | 55 | $ | 39,121 | $ | 625 | $ | 19,336 | $ | 3,608 | $ | 58,457 | $ | 4,233 | |||||||||||||||
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Management has considered factors such as market value, cash flows, and analysis of underlying collateral regarding other-than-temporarily impaired securities and determined that there are no other-than-temporarily impaired securities as of September 30, 2010.
The unrealized losses in collateralized mortgage obligations at September 30, 2010 were caused by volatile interest rates, a significant widening of credit spreads across markets for these securities, and illiquidity and uncertainty in the financial markets. These securities include two private issues held at a continuous, unrealized loss for more than twelve months. Each of these securities has some level of credit enhancement, and none are collateralized by sub-prime loans. With the assistance of a third party, management reviews the characteristics of these securities periodically, including levels of delinquency and foreclosure, projected losses at various degrees of severity, and credit enhancement and coverage. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.
Suffolk does not have the intent to sell these securities and does not anticipate that it will be necessary to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, Suffolk did not consider these investments to be other-than-temporarily impaired at September 30, 2010.
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In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses, overstated net income and earnings-per-common share; understated other assets; and overstated the capital ratios.
Suffolk takes into account applicable guidance under U.S. GAAP, including particularly “ASC 855 – Subsequent Events.” Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.
One result of the analysis of subsequent events is that loans which would have been downgraded or charged off during the subsequent period through the date of the filing of this Form 10-Q/A because of their continuing deterioration have been recognized in the restated ALLL for the third quarter of 2010 since the credit deterioration could be traced to the third quarter of 2010 even though it had been identified after September 30, 2010. This resulted in an increase in charged-off loans totaling approximately $7.4 million. These charge-offs were reflected in the ALLL calculations as of September 30, 2010.
The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)
Nine months ended September 30, 2010 Restated | Year Ended December 31, 2009 | |||||||
Allowance for loan losses, Beginning | $ | 12,333 | $ | 9,051 | ||||
Loans charged-off: | ||||||||
Commercial, financial & agricultural loans | 7,717 | 806 | ||||||
Commercial real estate mortgages | 230 | — | ||||||
Real estate construction loans | 3,620 | — | ||||||
Residential mortgages (1st and 2nd liens) | 492 | — | ||||||
Home equity loans | 65 | — | ||||||
Consumer loans | 286 | 404 | ||||||
Other loans | — | — | ||||||
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Total Charge-offs | $ | 12,410 | $ | 1,210 | ||||
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Loans recovered after being charged-off | ||||||||
Commercial, financial & agricultural loans | 62 | 41 | ||||||
Commercial real estate mortgages | — | — | ||||||
Real estate construction loans | — | — | ||||||
Residential mortgages (1st and 2nd liens) | — | — | ||||||
Home equity loans | — | — | ||||||
Consumer loans | 74 | 176 | ||||||
Other loans | — | — | ||||||
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Total recoveries | $ | 136 | $ | 217 | ||||
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Net loans charged-off | 12,274 | 993 | ||||||
Reclass to allowance for contingent liabilities | 51 | — | ||||||
Provision for loan losses | 26,549 | 4,275 | ||||||
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Allowance for loan losses, Ending | $ | 26,659 | $ | 12,333 | ||||
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The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)
For the three months ended September 30 | ||||||||
2010 (Restated) | 2009 | |||||||
Allowance for loan losses, Beginning | $ | 20,815 | $ | 10,873 | ||||
Loans charged-off: | ||||||||
Commercial, financial & agricultural loans | (6,350 | ) | (101 | ) | ||||
Commercial real estate mortgages | (72 | ) | — | |||||
Real estate construction loans | (2,043 | ) | — | |||||
Residential mortgages (1st and 2nd liens) | (248 | ) | — | |||||
Home equity loans | — | — | ||||||
Consumer loans | (192 | ) | (81 | ) | ||||
Other loans | — | — | ||||||
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Total charge-offs | (8,905 | ) | (182 | ) | ||||
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Loans recovered after being charged-off | ||||||||
Commercial, financial & agricultural loans | 3 | 30 | ||||||
Commercial real estate mortgages | — | — | ||||||
Real estate construction loans | — | — | ||||||
Residential mortgages (1st and 2nd liens) | — | — | ||||||
Home equity loans | — | — | ||||||
Consumer loans | 17 | 20 | ||||||
Other loans | — | — | ||||||
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Total recoveries | 20 | 50 | ||||||
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Net loans charged-off | (8,885 | ) | (132 | ) | ||||
Reclass to allowance for contingent liabilities | — | — | ||||||
Provision for loan losses | 14,729 | 975 | ||||||
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Allowance for loan losses, Ending | $ | 26,659 | $ | 11,716 | ||||
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The following table summarizes impaired loans with and without valuation reserves by loan type: (in thousands)
September 30, 2010 * | December 31, 2009 | |||||||||||||||||||||||||||||||
Impaired Loans with Valuation Reserves | Impaired Loans without Valuation Reserves | Total Impaired Loans | Total Valuation Reserves | Impaired Loans with Valuation Reserves | Impaired Loans without Valuation Reserves | Total Impaired Loans | Total Valuation Reserves | |||||||||||||||||||||||||
Commercial, financial & agricultural loans | $ | 5,221 | $ | 10,289 | $ | 15,510 | $ | 3,209 | $ | 5,983 | $ | — | $ | 5,983 | $ | 1,967 | ||||||||||||||||
Commercial real estate mortgages | 17,294 | 22,721 | 40,015 | 2,923 | 15,547 | — | 15,547 | 621 | ||||||||||||||||||||||||
Real estate construction loans | 4,829 | 23,650 | 28,479 | 573 | 10,774 | — | 10,774 | 407 | ||||||||||||||||||||||||
Residential mortgages (1st and 2nd liens) | — | 2,137 | 2,137 | — | — | 1,820 | 1,820 | — | ||||||||||||||||||||||||
Home equity loans | — | 371 | 371 | — | — | 65 | 65 | — | ||||||||||||||||||||||||
Consumer loans | — | 31 | 31 | — | — | 153 | 153 | — | ||||||||||||||||||||||||
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Total | $ | 27,344 | $ | 59,199 | $ | 86,543 | $ | 6,705 | $ | 32,304 | $ | 2,038 | $ | 34,342 | $ | 2,995 | ||||||||||||||||
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* | Restated |
Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists of unrealized holding gains or losses on securities available for sale, and gains or losses on the unfunded projected benefit obligation of the pension plan.
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The following table summarizes the changes in accumulated other comprehensive income (loss): (in thousands)
For the period ended: | September 30, 2010 | December 31, 2009 | ||||||
Balance January 1, | $ | (1,707 | ) | $ | (11,430 | ) | ||
Net Change in Unrealized Gain on Investment Securities - net of tax | 8,559 | 7,307 | ||||||
Reclassification of gains on sales of securities recognized, net of tax | (7 | ) | — | |||||
Net Change in Other Comprehensive Gain on Pension and Postretirement Plan Projected Benefit Obligation | — | 2,416 | ||||||
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Total Accumulated Other Comprehensive Income (Loss) | $ | 6,845 | $ | (1,707 | ) | |||
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The unrealized gain on investment securities at September 30, 2010 is mainly attributable to increases, net of tax, of $3,128,000 in the market value of collateralized mortgage obligations and $5,663,000 in the market value of obligations of state and political subdivisions. This is offset by decreases of $88,000 in the market value of U.S. treasury securities and $151,000 in the market value of U.S. government agency debt. Also included in accumulated other comprehensive income at September 30, 2010, is the reclassification of gain on sale of securities recognized of $7,000, net of taxes.
Suffolk accounts for its retirement plan in accordance with FASB ASC 715, “Compensation – Retirement Benefits” and FASB ASC 960, “Plan Accounting – Defined Benefit Pension Plans,” which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial condition; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligations as of the date of fiscal year-end statements of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial condition and in determining the amount of net periodic benefit cost. Suffolk has adopted the provisions of the codification, which have been recorded in the accompanying consolidated statement of condition and disclosures.
Suffolk presents information concerning net periodic defined benefit pension expense for the quarter and year to date periods ended September 30, 2010 and 2009, including the following components: (in thousands)
3 months 9/30/2010 | 3 months 9/30/2009 | 9 months 9/30/2010 | 9 months 9/30/2009 | |||||||||||||
Service cost | $ | 451 | $ | 451 | $ | 1,353 | $ | 1,244 | ||||||||
Interest cost | 510 | 505 | 1,529 | 1,393 | ||||||||||||
Expected return on plan assets | (538 | ) | (418 | ) | (1,613 | ) | (1,154 | ) | ||||||||
Amortization of prior service cost | 181 | 258 | 543 | 713 | ||||||||||||
Amortization of unrecognized net actuarial loss | — | — | ||||||||||||||
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Net periodic benefit expense | $ | 604 | $ | 796 | $ | 1,812 | $ | 2,196 | ||||||||
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There is no minimum required contribution for the pension plan year ending September 30, 2010. There were no additional contributions required to be made to the plan in the nine months ended September 30, 2010.
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(10) Recent Accounting Pronouncements
In January 2010, the FASB issued ASU No. 2010-06, which amends the authoritative accounting guidance under ASC Topic 820 “Fair Value Measurements and Disclosures.” The update requires the following additional disclosures. 1) Separately disclose the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Information about purchases, sales, issuances and settlements need to be disclosed separately in the reconciliation for fair value measurements using Level 3. The update provides for amendments to existing disclosures as follows. 1) Fair value measurement disclosures are to be made for each class of assets and liabilities. 2) Disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. The update also includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. The update is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Suffolk has evaluated the provisions of ASU No. 2010-06 and determined there is no material effect on its disclosures, results of operations or financial condition.
In February 2010, the FASB issued ASU No. 2010-09, which amends the authoritative accounting guidance under ASC Topic 855 “Subsequent Events.” The update provides that a Securities and Exchange Commission (“SEC”) filer is required to evaluate subsequent events through the date financial statements are issued. However, an SEC filer is not required to disclose the date through which subsequent events have been evaluated. The update was effective as of the date of issuance. Adoption of this update did not have a material effect on Suffolk’s disclosures, results of operations or financial condition.
In April 2010, the FASB issued ASU No. 2010-18, which provides authoritative accounting guidance on ASC Subtopic 310-30 “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality.” The update provides 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. This update is effective for modification 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. The amendments are to be applied prospectively. No additional disclosures are required. Suffolk has evaluated the provisions of this update and determined there is no material effect on its disclosures, results of operations or financial condition.
In July 2010, the FASB issued ASU No. 2010-20 which amends the authoritative accounting guidance under ASC Topic 310, “Receivables.” The update amends existing disclosures about an entity’s financing receivables on a disaggregated basis to require: (1) a roll-forward schedule of the allowance for credit losses from the beginning of the reporting period to the end of the reporting period on a portfolio segment basis, with the ending balance further disaggregated on the basis of impairment method; (2) for each disaggregated ending balance in item (1) above, the related recorded investment in financing receivables; (3) the non-accrual status of financing receivables by class of financing receivables; and (4) impaired financing receivables by class of financing receivables. In addition, the amendments require an entity to provide the following additional disclosures about its financing receivables: (1) credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; (2) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; (3) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses; (4) the nature and extent of financing receivables modified as troubled debt restructurings within the previous 12 months that defaulted during the reporting period by class of financing receivables and their effect on the allowance for credit losses; and (5) significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010. Suffolk does not expect the provisions of this update to have a material effect on its results of operations or financial condition.
On October 25, 2010, the Bank, following discussion with the Office of the Comptroller of the Currency (the “OCC”) entered into a formal agreement with the OCC (the “Agreement”). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.
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Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.
At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.87 percent, and a total risk-based capital ratio of 12.14 percent. The Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 after taking into effect the restatement and the Bank management believes the Bank met all regulatory requirements applicable at that time. Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain a Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.
At September 30, 2010, Suffolk’s Tier 1 capital ratio was 8.03 percent of adjusted total assets, Tier 1 capital ratio was 11.00 percent of risk-weighted assets, and Total Risk Based capital ratio was 12.26 percent of risk-weighted assets.
The ability of the Bank to pay dividends to Suffolk is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock of which the Bank has none as of September 30, 2010. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. In addition, under the Agreement the Bank is required to establish a dividend policy that will permit the declaration of a dividend only when the Bank is in compliance with its capital program and with the prior written determination of no supervisory objection by the OCC.
(12) Legal Proceedings (See Note 13)
On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.
On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.
On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.
Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.
The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.
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Suffolk evaluated subsequent events to determine if there was an effect on these consolidated financial statements. Events which occurred subsequent to the balance sheet date but prior to the release of these restated financial statements have been accounted for in accordance with ASC 855, “Accounting for Subsequent Events.” Suffolk considered whether there were subsequent events that have occurred and is disclosing the following as well as the matter disclosed in Note 12 – “Legal Proceedings.”
• | As part of its de-leveraging strategy, in June 2011 Suffolk pre-paid a $40 million borrowing from the Federal Home Loan Bank of New York and incurred a $1 million penalty. Suffolk also sold approximately $40 million of investment securities in June 2011, realizing a gain of $1.6 million. These transactions were recorded in the second quarter of 2011 when they occurred. |
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Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Three and Nine Months Ended September 30, 2010 and 2009
Suffolk has restated its consolidated financial statements as of September 30, 2010 and for the three and nine months then ended. See the explanatory note preceding the table of contents and Note 2 on page 6 for a detailed description of the financial statement restatement.
During the third quarter of 2010, increasing amounts of credit were available to a select group of highly-qualified borrowers as banks attempted to generate assets of high quality that would provide at least some spread over more highly liquid investments such as “fed funds” which had been priced at historically low rates of interest, typically well below one percent. However, deposits generally continued to increase as individuals and businesses hesitated either to spend or employ these funds elsewhere. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law on July 21, 2010, and established the general direction of financial regulation. Much of the law extended discretion to regulators to promulgate regulations concerning a wide variety of issues. Uncertainty as to what those regulations might be and when they might take effect amplified that hesitation as businesses waited for clarity as to how they would affect their operations. Short-term rates remained near zero, and the “yield curve” remained comparatively steep in comparison with historic averages, with the margins between short- and long-term rates unusually wide, although a rally in the bond market continued to lower long term rates more than short, suggesting to observers that the net interest margin of many banks might compress going forward, after having widened during the past several quarters. Low short-term rates were primarily the result of continuing, low short-term targets set by the Federal Reserve Board for federal funds and discount rates. It was also the result of continuing concern about the possibility of inflation over the longer term as a result of deficit spending by the federal government, and the development of an offsetting concern late during the previous quarter that the recovery might stall, leading to deflation. Rates of unemployment remained high by historic standards.
As disclosed previously, the prolonged slump in the economy has strained the resources of some of Suffolk’s borrowers. Suffolk is a community bank that relies upon net interest income generated by the relationships it builds with the owners of small and medium-sized businesses, in contrast to certain large banks that profit from the proprietary trading of securities and derivatives. Our prospects remain tied more to “Main Street” than to Wall Street. At the start of the current recession, Suffolk’s primary market area was wealthier than many other markets. Owners of small businesses and other customers appeared to have greater financial reserves than similar customers in other regions of the nation, and the development of real estate, both residential and commercial, was more mature and therefore less speculative. This contributed to a steadier and less dramatic decline than elsewhere; and Suffolk’s borrowers remained current in their obligations longer. However, as time has passed, the economy appears to have stabilized at lower levels of output and higher levels of unemployment than before 2008.
At Suffolk, interest income increased slightly, however net interest income increased primarily due to reduced interest expense. The net interest margin increased to 5.13 percent in the third quarter of 2010, up from 4.89 percent during the third quarter of 2009. Net interest income was offset, however, by a substantially higher provision for loan losses, which increased by 1,411 percent over the third quarter of 2009. The net interest margin on a year to date basis increased to 5.06 percent in 2010, up from 4.98 percent for the comparable period in 2009. Net interest income was offset by a substantially higher provision for loan losses.
At September 30, 2010, of the $32,062,000 of non-performing loans, $29,247,000 was secured by collateral valued at approximately $62,416,000, having an average loan-to-value ratio of approximately 47 percent. The unsecured portion of $2,815,000 amounted to 25 basis points of net loans at quarter end. To determine the adequacy of the allowance for loan losses Suffolk considered not only the status of non-performing loans on its books, but the performance of Suffolk’s peers. Although Suffolk continues to work with borrowers to ensure the collection of nonperforming credits, some of these loans were being paid more slowly than originally anticipated. This increased the allowance for loan losses to $26,659,000 at September 30, 2010, up from $12,333,000 at December 31, 2009. The majority of non-performing loans are commercial and industrial loans, and loans secured by commercial real estate. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors. See “Allowance for Loan Losses.”
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While non-performing assets as a percent of total assets increased much later at Suffolk than in peer banks, they increased from 144 basis points at September 30, 2009, to 173 basis points at December 31, 2009, 185 basis points at March 31, 2010, 212 basis points at June 30, 2010, and 182 basis points at September 30, 2010. Non-performing loans to total loans amounted to 215 basis points at September 30, 2009, 253 basis points at December 31, 2009, 270 basis points at March 31, 2010, 311 basis points at June 30, 2010, and 269 basis points at September 30, 2010. Of the $30,552,000 of loans not accruing interest, $7,765,000 represents credit to one borrower which, in consultation with the primary regulator of the Bank, management determined to place on non-accrual status, although all payments are current and have been since inception, and has a ratio of loan-to-current appraised-value (June 2010) of 59.7 percent. Without this credit, nonperforming assets would have totaled to $22,787,000, or 201 basis points, as a percent of total loans. As noted in the discussion above, most non-performing loans are well-collateralized. However, as they remain non-accruing over a period of time, on the basis of objective and selective criteria, Suffolk may or may not elect to charge these and other loans off prudentially, even when they remain in collection and there is the reasonable remaining expectation of the recovery of amounts owed and expenses incurred in collection. These charge-offs may or may not mirror trends, on a trailing basis, in ratios of non-performing assets to total assets and non-performing loans to total loans. The amounts charged off may be substantial in comparison with Suffolk’s past loss history, although they may result in net recoveries at some point in the future if the economy improves and borrowers’ financial conditions strengthen, although there can be no assurance that this will happen. Further discussion concerning the determination of the provision for loan losses is found in the following under the caption, “Allowance for Loan Losses.”
On October 25, 2010, the Bank, following discussion with the OCC, entered into a formal agreement with the OCC (the “Agreement”). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.
Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.
While subject to the Agreement, Suffolk expects that its and the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.
Basic Performance and Current Activities
There was no return on average equity for the third quarter of 2010 due to the net loss as compared to 19.34 percent during the third quarter of 2009, and basic earnings(loss)-per-share decreased from $0.63 in the third quarter of 2009 to ($0.32) in the third quarter of 2010. For the first nine months of 2010, return on average equity decreased to 3.01 percent, down from 19.29 percent during the comparable period of 2009.
Although Suffolk’s net interest income after the provision for loan losses decreased, Suffolk’s net interest income and core performance improved. Key to maintaining performance was disciplined management of the balance sheet. These steps included:
• | Maintaining emphasis on both commercial and personal demand deposits, and non-maturity time deposits as a key part of relationships with customers while responding as necessary to demand in Suffolk’s market for certificates of deposit of all sizes. Suffolk continues its emphasis on the profitability of the whole relationship of its customers with the Bank, seeking when possible to both make loans to and obtain funding from the best qualified customers. |
• | Managing net loan charge-offs and non-performing loans. During the third quarter of 2010, net charge-offs amounted to 318 basis points of average net loans, on an annualized basis. Non-performing loans, those more than 90 days past due, increased. Lending staff’s first efforts continue to be directed to the management of such credits, and then to developing new business with an emphasis on the most profitable customer relationships. |
• | Managing the investment portfolio in a difficult rate environment and continued purchases of municipal securities, which provide liquidity as well as higher returns net of taxes, and some protection from falling interest rates. |
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• | Pursuing the ongoing program of capital management, allowing total risk based capital (“TRBC”) to move upward to provide a greater cushion against uncertainty, and to respond to increases in regulatory requirements under discussion at various levels of government. Accordingly, maximum prudent leverage is thus applied to the shareholders’ investment while still anticipating changes in regulation through the retention of earnings when assets are growing. Growth in the core business during the quarter was sufficient to employ retained earnings and no shares were repurchased. Reinvested dividends were used to purchase additional shares from Suffolk. |
The net loss totaled $(3,137,000) for the third quarter of 2010, down 152.00 percent from net income of $6,028,000 recorded during the same period last year. The loss-per-share for the quarter was $(0.32) versus earnings-per share of $0.63, during the same period last year, a decrease of 150.80 percent. Net income was $3,187,000 for the nine months ended September 30, 2010, down from $17,395,000 posted during the same period last year. Earnings-per-share was $0.33 for the nine month period ended September 30, 2010, down from $1.81 posted last year. The key reason for the decline was an increased provision for loan losses.
Interest income was $21,702,000 for the third quarter of 2010, up 0.86 percent from $21,516,000 posted for the same quarter in 2009. Average net loans during the third quarter of 2010 totaled $1,123,851,000 compared to $1,109,161,000 for the same period of 2009. During the third quarter of 2010, the yield on a fully taxable-equivalent basis was 5.72 percent on average earning assets of $1,590,211,000, up from 5.66 percent on average earning assets of $1,587,600,000 during the third quarter of 2009. Interest income remained relatively flat from quarter to quarter. Interest income was $65,468,000 for the first nine months of 2010, up 0.3 percent from $65,244,000 recorded in the first nine months of 2009. During the first nine months of 2010, the yield on a fully taxable-equivalent basis was 5.68 percent on average earning assets of $1,607,497,000, down from 5.81 percent on average earning assets of $1,560,306,000 during the first nine months of 2009.
Interest expense for the third quarter of 2010 was $2,335,000, down 23.2 percent from $3,042,000 for the same period of 2009. During the third quarter of 2010, the cost of funds was 0.94 percent on average interest-bearing liabilities of $991,869,000, down from 1.19 percent on average interest-bearing liabilities of $1,018,949,000 during the third quarter of 2009. Interest expense was $7,511,000 for the first nine months of 2010, down 22.7 percent from $9,722,000 recorded last year to date. During the first nine months of 2010, the cost of funds was 0.96 percent on average interest-bearing liabilities of $1,042,415,000, down from 1.26 percent on average interest-bearing liabilities of $1,029,022,000 during the first nine months of 2009. Interest expense decreased due to decreased rates paid for all interest-bearing liabilities, in addition to a decrease in average borrowings outstanding.
A portion of the Bank’s demand deposits are reclassified as savings accounts on a daily basis. The purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.
Net interest income, before the provision for loan losses, is the largest component of Suffolk’s earnings. It was $19,367,000 for the third quarter of 2010, up 4.8 percent from $18,474,000 during the same period of 2009. The net interest margin for the quarter, on a fully taxable-equivalent basis, was 5.13 percent compared to 4.89 percent for the same period of 2009.
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The following table details the components of Suffolk’s net interest income for the quarter on a taxable-equivalent basis: (in thousands)
Quarters ended September 30, | 2010 | 2009 | ||||||||||||||||||||||
Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | |||||||||||||||||||
INTEREST-EARNING ASSETS | ||||||||||||||||||||||||
U.S. Treasury securities | $ | 8,231 | $ | 72 | 3.52 | % | $ | 9,784 | $ | 97 | 3.97 | % | ||||||||||||
Collateralized mortgage obligations | 179,152 | 1,879 | 4.20 | 145,479 | 1,826 | 5.02 | ||||||||||||||||||
Mortgage backed securities | 534 | 9 | 6.77 | 610 | 10 | 6.56 | ||||||||||||||||||
Obligations of states and political subdivisions | 226,280 | 3,006 | 5.31 | 197,631 | 2,739 | 5.54 | ||||||||||||||||||
U.S. government agency obligations | 42,670 | 202 | 1.90 | 62,742 | 354 | 2.26 | ||||||||||||||||||
Other securities | 4,966 | 95 | 7.65 | 6,434 | 123 | 7.65 | ||||||||||||||||||
Federal funds sold and interest bearing bank deposits | 4,527 | 3 | 0.27 | 55,759 | 44 | 0.32 | ||||||||||||||||||
Loans, net of allowance for loan losses | ||||||||||||||||||||||||
Commercial, financial & agricultural loans | 248,111 | 3,772 | 6.08 | 233,721 | 3,459 | 5.92 | ||||||||||||||||||
Commercial real estate mortgages | 406,115 | 6,716 | 6.61 | 366,682 | 6,176 | 6.74 | ||||||||||||||||||
Real estate construction loans | 112,634 | 1,706 | 6.06 | 131,561 | 2,158 | 6.56 | ||||||||||||||||||
Residential mortgages (1st and 2nd liens) | 198,383 | 3,037 | 6.12 | 208,930 | 3,148 | 6.03 | ||||||||||||||||||
Home equity loans | 85,446 | 923 | 4.32 | 80,851 | 844 | 4.18 | ||||||||||||||||||
Consumer loans | 72,244 | 1,310 | 7.25 | 83,997 | 1,476 | 7.03 | ||||||||||||||||||
Other loans (overdrafts) | 918 | — | — | 3,419 | — | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total interest-earning assets | $ | 1,590,211 | $ | 22,730 | 5.72 | % | $ | 1,587,600 | $ | 22,454 | 5.66 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Cash and due from banks | $ | 43,922 | $ | 41,381 | ||||||||||||||||||||
Other non-interest-earning assets | 58,366 | 54,935 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total assets | $ | 1,692,499 | $ | 1,683,916 | ||||||||||||||||||||
INTEREST-BEARING LIABILITIES | ||||||||||||||||||||||||
Saving, N.O.W. and money market deposits | $ | 607,447 | $ | 827 | 0.54 | % | $ | 580,544 | $ | 934 | 0.64 | % | ||||||||||||
Time deposits | 328,868 | 1,145 | 1.39 | 346,768 | 1,544 | 1.78 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total saving and time deposits | 936,315 | 1,972 | 0.84 | 927,312 | 2,478 | 1.07 | ||||||||||||||||||
Federal funds purchased and securities sold under agreement to repurchase | 344 | — | — | 16 | — | — | ||||||||||||||||||
Other borrowings | 55,210 | 363 | 2.63 | 91,621 | 564 | 2.46 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total interest-bearing liabilities | $ | 991,869 | $ | 2,335 | 0.94 | % | $ | 1,018,949 | $ | 3,042 | 1.19 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Rate spread | 4.78 | % | 4.47 | % | ||||||||||||||||||||
Non-interest-bearing deposits | $ | 523,685 | $ | 508,810 | ||||||||||||||||||||
Other non-interest-bearing liabilities | 31,029 | 31,493 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total liabilities | $ | 1,546,583 | $ | 1,559,252 | ||||||||||||||||||||
Stockholders’ equity | 145,916 | 124,664 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total liabilities and stockholders’ equity | $ | 1,692,499 | $ | 1,683,916 | ||||||||||||||||||||
Net-interest income (taxable-equivalent basis) and effective interest rate differential | $ | 20,395 | 5.13 | % | $ | 19,412 | 4.89 | % | ||||||||||||||||
Less: taxable-equivalent basis adjustment | (1,028 | ) | (938 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Net-interest income | $ | 19,367 | $ | 18,474 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
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For the nine months ended September 30, 2010, net interest income was $57,957,000, up 4.4 percent from $55,522,000 during the same period of 2009. The net interest margin on a fully taxable-equivalent basis was 5.06 percent compared to 4.98 percent for the same period of 2009.
The following table details the components of Suffolk’s net interest income for the first nine months of the year on a taxable-equivalent basis: (in thousands)
Year to date ended September 30, | 2010 | 2009 | ||||||||||||||||||||||
Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | |||||||||||||||||||
INTEREST-EARNING ASSETS | ||||||||||||||||||||||||
U.S. Treasury securities | $ | 8,271 | $ | 217 | 3.49 | % | $ | 9,962 | $ | 298 | 3.99 | % | ||||||||||||
Collateralized mortgage obligations | 185,323 | 5,929 | 4.27 | 131,515 | 5,351 | 5.42 | ||||||||||||||||||
Mortgage backed securities | 571 | 28 | 6.60 | 604 | 31 | 6.84 | ||||||||||||||||||
Obligations of states and political subdivisions | 217,706 | 8,836 | 5.41 | 191,154 | 7,979 | 5.57 | ||||||||||||||||||
U.S. government agency obligations | 42,953 | 607 | 1.89 | 88,428 | 1,797 | 2.71 | ||||||||||||||||||
Other securities | 7,376 | 320 | 5.79 | 8,359 | 334 | 5.33 | ||||||||||||||||||
Federal funds sold and interest bearing bank deposits | 5,883 | 8 | 0.18 | 25,060 | 48 | 0.26 | ||||||||||||||||||
Loans, net of allowance for loan losses | ||||||||||||||||||||||||
Commercial, financial & agricultural loans | 258,371 | 11,460 | 5.91 | 233,848 | 10,369 | 5.91 | ||||||||||||||||||
Commercial real estate mortgages | 394,155 | 19,531 | 6.61 | 362,206 | 18,501 | 6.81 | ||||||||||||||||||
Real estate construction loans | 121,034 | 5,570 | 6.14 | 133,890 | 6,821 | 6.79 | ||||||||||||||||||
Residential mortgages (1st and 2nd liens) | 203,507 | 9,261 | 6.07 | 208,604 | 9,469 | 6.05 | ||||||||||||||||||
Home equity loans | 84,117 | 2,656 | 4.21 | 77,540 | 2,446 | 4.21 | ||||||||||||||||||
Consumer loans | 76,418 | 4,067 | 7.10 | 87,135 | 4,531 | 6.93 | ||||||||||||||||||
Other loans (overdrafts) | 1,812 | — | — | 2,001 | — | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total interest-earning assets | $ | 1,607,497 | $ | 68,490 | 5.68 | % | $ | 1,560,306 | $ | 67,975 | 5.81 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Cash and due from banks | $ | 43,512 | $ | 40,557 | ||||||||||||||||||||
Other non-interest-earning assets | 61,554 | 55,347 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total assets | $ | 1,712,563 | $ | 1,656,210 | ||||||||||||||||||||
INTEREST-BEARING LIABILITIES | ||||||||||||||||||||||||
Saving, N.O.W. and money market deposits | $ | 602,044 | $ | 2,551 | 0.56 | % | $ | 567,270 | $ | 2,732 | 0.64 | % | ||||||||||||
Time deposits | 329,926 | 3,636 | 1.47 | 320,462 | 4,593 | 1.91 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total saving and time deposits | 931,970 | 6,187 | 0.89 | 887,732 | 7,325 | 1.10 | ||||||||||||||||||
Federal funds purchased and securities sold under agreement to repurchase | 561 | 2 | 0.48 | 6,501 | 120 | 2.46 | ||||||||||||||||||
Other borrowings | 109,884 | 1,322 | 1.60 | 134,789 | 2,277 | 2.25 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total interest-bearing liabilities | $ | 1,042,415 | $ | 7,511 | 0.96 | % | $ | 1,029,022 | $ | 9,722 | 1.26 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Rate spread | 4.72 | % | 4.55 | % | ||||||||||||||||||||
Non-interest-bearing deposits | $ | 494,627 | $ | 470,598 | ||||||||||||||||||||
Other non-interest-bearing liabilities | 34,483 | 36,376 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total liabilities | $ | 1,571,525 | $ | 1,535,996 | ||||||||||||||||||||
Stockholders’ equity | 141,038 | 120,214 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total liabilities and stockholders’ equity | $ | 1,712,563 | $ | 1,656,210 | ||||||||||||||||||||
Net-interest income (taxable-equivalent basis) and effective interest rate differential | $ | 60,979 | 5.06 | % | $ | 58,253 | 4.98 | % | ||||||||||||||||
Less: taxable-equivalent basis adjustment | (3,022 | ) | (2,731 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Net-interest income | $ | 57,957 | $ | 55,522 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
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The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the quarterly periods presented. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In the following tables changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)
In Third Quarter of 2010 over Third Quarter of 2009, Changes Due to | ||||||||||||
Volume | Rate | Net Change | ||||||||||
Interest-earning assets | ||||||||||||
U.S. Treasury securities | $ | (15 | ) | $ | (10 | ) | $ | (25 | ) | |||
Collateralized mortgage obligations | 382 | (329 | ) | 53 | ||||||||
Mortgage-backed securities | (1 | ) | — | (1 | ) | |||||||
Obligations of states & political subdivisions | 390 | (123 | ) | 267 | ||||||||
U.S. government agency obligations | (101 | ) | (51 | ) | (152 | ) | ||||||
Other securities | (29 | ) | 1 | (28 | ) | |||||||
Federal funds sold & interest bearing bank deposits | (38 | ) | (3 | ) | (41 | ) | ||||||
Loans, including non-accrual loans | 229 | (26 | ) | 203 | ||||||||
|
|
|
|
|
| |||||||
Total interest-earning assets | $ | 817 | $ | (541 | ) | $ | 276 | |||||
|
|
|
|
|
| |||||||
Interest-bearing liabilities | ||||||||||||
Saving, N.O.W., & money market deposits | $ | 42 | $ | (149 | ) | $ | (107 | ) | ||||
Time deposits | (76 | ) | (323 | ) | (399 | ) | ||||||
Other borrowings | (236 | ) | 36 | (200 | ) | |||||||
|
|
|
|
|
| |||||||
Total interest-bearing liabilities | $ | (270 | ) | $ | (436 | ) | $ | (706 | ) | |||
|
|
|
|
|
| |||||||
Net change in net interest income (taxable-equivalent basis) | $ | 1,087 | $ | (105 | ) | $ | 982 | |||||
|
|
|
|
|
|
The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the nine month periods presented: (in thousands)
In First Nine Months of 2010 over First Nine Months of 2009, Changes Due to | ||||||||||||
Volume | Rate | Net Change | ||||||||||
Interest-earning assets | ||||||||||||
U.S. Treasury securities | $ | (47 | ) | $ | (34 | ) | $ | (81 | ) | |||
Collateralized mortgage obligations | 1,882 | (1,304 | ) | 578 | ||||||||
Mortgage-backed securities | (2 | ) | (1 | ) | (3 | ) | ||||||
Obligations of states & political subdivisions | 1,081 | (224 | ) | 857 | ||||||||
U.S. government agency obligations | (748 | ) | (442 | ) | (1,190 | ) | ||||||
Other securities | (41 | ) | 27 | (14 | ) | |||||||
Federal funds sold & interest bearing bank deposits | (29 | ) | (11 | ) | (40 | ) | ||||||
Loans, including non-accrual loans | 1,592 | (1,184 | ) | 408 | ||||||||
|
|
|
|
|
| |||||||
Total interest-earning assets | $ | 3,688 | $ | (3,173 | ) | $ | 515 | |||||
|
|
|
|
|
| |||||||
Interest-bearing liabilities | ||||||||||||
Saving, N.O.W., & money market deposits | $ | 161 | $ | (342 | ) | $ | (181 | ) | ||||
Time deposits | 132 | (1,089 | ) | (957 | ) | |||||||
Federal funds purchased & repurchase agreements | (64 | ) | (54 | ) | (118 | ) | ||||||
Other borrowings | (373 | ) | (582 | ) | (955 | ) | ||||||
|
|
|
|
|
| |||||||
Total interest-bearing liabilities | $ | (144 | ) | $ | (2,067 | ) | $ | (2,211 | ) | |||
|
|
|
|
|
| |||||||
Net change in net interest income (taxable-equivalent basis) | $ | 3,832 | $ | (1,106 | ) | $ | 2,726 | |||||
|
|
|
|
|
|
Other income decreased to $2,667,000 for the quarter compared to $2,766,000 the previous year, down 3.6 percent. Service charges on deposits were down 10.3 percent. Service charges, including commissions and fees other than for deposits, increased by 8.4 percent. Fiduciary fees were up 2.5 percent. Other operating income decreased by 17.9 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market. Other income for the nine months ended September 30, 2010 was $7,797,000, down 6.7 percent from $8,353,000 for the comparable year to date period. Service charges on deposits were down 5.1 percent. Service charges, including commissions and fees other than for deposits, increased by 0.2 percent. Fiduciary fees were down 6.8 percent. Other operating income decreased by 28.9 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market. Proceeds received in connection with sales of securities resulted in a net gain of $12,000 during the second quarter of 2010.
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Other expense for the third quarter of 2010 was $13,021,000, up 8.2 percent from $12,034,000 for the comparable period in 2009. FDIC assessments increased by $345,000, or 66.7 percent as a result of increased deposits and higher assessment rates. Other increases include employee compensation of 3.7 percent, net occupancy expense of 6.9 percent, and other operating expense of 14.6 percent. Other operating expense for the quarter increased primarily due to increased costs associated with information technology and appraisal fees. Equipment expense decreased by 12.8 percent.
Other expense for the first nine months of 2010 was $37,303,000, up 2.9 percent from $36,241,000 compared to the first nine months of 2009. Employee compensation increased 3.8 percent, net occupancy expense increased 5.0 percent, and other operating expense increased 4.4 percent. Other operating expense increased primarily due to increased professional fees associated with collections of delinquent loans, increased costs associated with information technology and appraisal fees. The increases were partially offset by a decrease in equipment expense of 8.3 percent and in FDIC assessments, which decreased by 5.1 percent as a result of a special assessment of approximately $800,000 charged by the FDIC in June 2009. Suffolk anticipates substantial additional expenses associated with meeting the requirements of the Agreement, both non-recurring over the next one to two years and permanent increases thereafter.
Stockholders’ equity totaled $143,628,000 on September 30, 2010, an increase of 4.71 percent from $137,171,000 on December 31, 2009. This was the result of net income, as well as an increase in the appreciation in the market value of securities available for sale, offset by cash dividends declared. The ratio of equity to assets was 8.54 percent at September 30, 2010 and 8.1 percent at December 31, 2009, respectively.
The following table details amounts and ratios of Suffolk’s regulatory capital on a consolidated basis: (in thousands of dollars except ratios)
Actual | For capital adequacy | To be well capitalized under prompt corrective action provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
As of September 30, 2010(Restated) | ||||||||||||||||||||||||
Total Capital (to risk-weighted assets) | $ | 151,392 | 12.26 | % | $ | 98,770 | 8.00 | % | $ | 123,462 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk-weighted assets) | 135,817 | 11.00 | % | 49,385 | 4.00 | % | 74,077 | 6.00 | % | |||||||||||||||
Tier 1 Capital (to average assets) | 135,817 | 8.03 | % | 67,661 | 4.00 | % | 84,577 | 5.00 | % | |||||||||||||||
As of December 31, 2009 | ||||||||||||||||||||||||
Total Capital (to risk-weighted assets) | $ | 150,673 | 11.73 | % | $ | 102,760 | 8.00 | % | $ | 128,450 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk-weighted assets) | 137,921 | 10.74 | % | 51,380 | 4.00 | % | 77,070 | 6.00 | % | |||||||||||||||
Tier 1 Capital (to average assets) | 137,921 | 8.21 | % | 67,196 | 4.00 | % | 83,996 | 5.00 | % |
At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.88 percent, and a total risk-based capital ratio of 12.14 percent. The Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 and met all regulatory requirements applicable at that time. Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.
Suffolk makes loans based on its evaluation of the creditworthiness of the borrower. Even with careful underwriting, some loans may not be repaid as originally agreed. To provide for this possibility, Suffolk maintains an allowance for loan losses based on an analysis of the performance of the loans in its portfolio. The analysis includes subjective factors based on
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management’s judgment as well as quantitative evaluation. Estimates should produce an allowance that will provide for a range of losses. According to U.S. GAAP, a financial institution should record its best estimate. Appropriate factors contributing to the estimate may include changes in the composition of the institution’s assets, or potential economic slowdowns or downturns. Also important is the geographical or political environment in which the institution operates.
Suffolk’s management considers all of these factors when determining the provision for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of establishing a program to improve credit risk management and implementing an asset diversification program. Please refer to the discussion of the allowance for loan losses below.
Suffolk has financial and performance letters of credit. Financial letters of credit require Suffolk to make payments if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require Suffolk to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of September 30, 2010 is $26,410,000 and they expire as follows: (in thousands)
2010 | $ | 13,562 | ||
2011 | 12,252 | |||
2012 | 516 | |||
2013 | — | |||
Thereafter | 80 | |||
|
| |||
$ | 26,410 | |||
|
|
Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The allowance for contingent liabilities includes a provision of $40,000 for losses based on the letters of credit outstanding as of September 30, 2010.
Critical Accounting Policies, Judgments and Estimates
Suffolk’s accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses; overstated net income and earnings-per-common share; understated the deferred tax asset; and overstated the capital ratios. See Note 2 on page 6 for the tables that detail the restated financial statement line items and the regulatory capital ratios.
Suffolk considers the determination of the allowance for loan losses to involve a higher degree of judgment and complexity than its other significant accounting policies. Suffolk maintains an allowance for loan losses at a level that management believes will be adequate to absorb probable losses on existing loans that may become uncollectible based on evaluations of collectability. Suffolk’s underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. Suffolk has not been directly affected by the increase in defaults of sub-prime mortgages as Suffolk does not originate, or hold in portfolio, sub-prime mortgages. The allowance for loan losses is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, Suffolk’s own historical loan losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other factors. In assessing the adequacy of the allowance, Suffolk reviews its loan portfolio by separate categories which have similar risk and collateral characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as “Substandard” or “Doubtful” as defined by regulation, loans criticized internally or designated as “Special
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Mention,” delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the allowance which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. As required by the Agreement with the OCC, Suffolk reviewed its allowance for loan losses policy which resulted in an increase to the allowance. During 2010, Suffolk experienced an increase in classified and criticized loans based on the current condition of borrowers. This was further noted in Suffolk’s review of the report of the Bank’s third-party loan reviewer.
Impaired loans, defined as loans for which management does not believe all principal and interest will be collected under contractual terms, are segregated and reviewed separately. Impaired loans secured by collateral are reviewed based on their collateral and the estimated time required to recover Suffolk’s investment in the loan as well as the cost of doing so, and the estimate of the recovery anticipated. Reserves are allocated to impaired loans based on this review. The allocated reserve is an estimation of losses specific to individual impaired loans. Allocated reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Reserves allocated to impaired loans were $6.7 million and $3.0 million as of September 30, 2010 and December 31, 2009, respectively. While every nonperforming loan is evaluated individually, not every loan requires an allocated reserve. Allocated reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs.
The following table summarizes impaired loans with and without valuation reserves by loan type: (in thousands)
September 30, 2010 * | December 31, 2009 | |||||||||||||||||||||||||||||||
Impaired Loans with Valuation Reserves | Impaired Loans without Valuation Reserves | Total Impaired Loans | Total Valuation Reserves | Impaired Loans with Valuation Reserves | Impaired Loans without Valuation Reserves | Total Impaired Loans | Total Valuation Reserves | |||||||||||||||||||||||||
Commercial, financial & agricultural loans | $ | 5,221 | $ | 10,289 | $ | 15,510 | $ | 3,209 | $ | 5,983 | $ | — | $ | 5,983 | $ | 1,967 | ||||||||||||||||
Commercial real estate mortgages | 17,294 | 22,721 | 40,015 | 2,923 | 15,547 | — | 15,547 | 621 | ||||||||||||||||||||||||
Real estate construction loans | 4,829 | 23,650 | 28,479 | 573 | 10,774 | — | 10,774 | 407 | ||||||||||||||||||||||||
Residential mortgages (1st and 2nd liens) | — | 2,137 | 2,137 | — | — | 1,820 | 1,820 | — | ||||||||||||||||||||||||
Home equity loans | — | 371 | 371 | — | — | 65 | 65 | — | ||||||||||||||||||||||||
Consumer loans | — | 31 | 31 | — | — | 153 | 153 | — | ||||||||||||||||||||||||
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Total | $ | 27,344 | $ | 59,199 | $ | 86,543 | $ | 6,705 | $ | 32,304 | $ | 2,038 | $ | 34,342 | $ | 2,995 | ||||||||||||||||
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* | Restated |
The following table summarizes information regarding impaired loans: (in thousands)
September 30, 2010 * | ||||
Average of individually impaired loans during the period | $ | 54,697 |
* | Restated |
Collateral dependent loans are evaluated for impairment when a loan becomes ninety days past due or another impairment indicator is identified. At the time a loan secured by real estate is evaluated for impairment, an appraisal is ordered from an independent third party licensed appraiser for loans in excess of $250,000. Typically, it takes approximately 30-90 days to receive and review the appraisal on a commercial real estate mortgage. Once the updated appraisal is received, if the fair value less estimated costs to sell is less than the carrying amount of the loan, a reserve is created for the difference. We do not increase the value of any of our loans based upon an appraisal amount greater than our carrying amount. For collateral dependent loans that have not had a third party appraisal during the past twelve months, prior appraisals are discounted in value based upon the date of the appraisal. As of September 30, 2010, our impaired loans inclusive of previously recognized charge-off amounts total $53,643,000. Subsequent to charging off the difference, collateral dependent loans are deemed to be nonperforming impaired loans. As of September 30, 2010, there is one loan totaling $4,598,000 that has been restructured for which a partial charge-off has been recognized totaling $1,277,000. The terms of the restructured loan include a reduced interest rate. The loan is currently classified as non-accrual. Additional funds have been advanced for this loan, and a valuation reserve has been established for these advances.
At September 30, 2010, impaired loans totaling $59,199,000 have no associated valuation allowance. For these loans, an evaluation for impairment was completed with no measurement of impairment. The measurement is based upon the appraisal methodology described above for collateral dependent loans. For non-collateral dependent loans, measurement is based on the present value of future cash flows. As measuring impairment is an estimate which requires judgment, future results of operations may be negatively affected by outcomes different than those estimated.
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Suffolk evaluates classified and criticized loans that are not impaired by categorizing loans by type of risk and applying reserves based on loan type and corresponding risk. Suffolk also records reserves on Suffolk’s non-criticized and non-classified loan balances. This represents a general allowance for homogeneous loan pools where the loans are not individually evaluated for impairment, though rated according to loan product type and risk rating.
This amount is determined by applying historical loss factors to pools of loans within the portfolio having similar risk characteristics.
In addition, qualitative factors are considered for areas of concern that cannot be fully quantified in the allocation based on historical net charge-off ratios. Qualitative factors include:
• | Economic outlook |
• | Trends in delinquency and problem loans |
• | Changes in loan volume and nature of terms of loans |
• | Effects of changes in lending policy |
• | Experience, ability and depth of lending management and staff |
• | Concentrations of credit |
• | Board and Loan Review oversight |
• | Changes in value of underlying collateral |
• | Competition, regulation, and other external factors |
For performing loans, an estimate of adequacy is made by applying the qualitative factors above specific to the portfolio to the period-end balances. Suffolk used a higher percentage factor for criticized and classified loans, given their potential for greater loss. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Allocated and general reserves are available for any identified loss.
Delinquent, nonperforming (defined as loan past due 90 days or more and non-accrual loans), and classified loans have trended upward. These are primary factors in the determination of the allowance. At September 30, 2010, loans delinquent greater than 90 days and nonperforming loans totaled $32,062,000 as compared with $29,372,000 at December 31, 2009. When compared to total loans, nonperforming loans rose to 2.83 percent at September 30, 2010, up from 2.53 percent at December 31, 2009. Commercial mortgages and commercial real estate construction loans were primarily responsible for the increase. Non-performing loans include all non-accrual loans and loans 90 days or more delinquent.
The following table summarizes Suffolk’s non-performing loans by category: (in thousands of dollars except for ratios)
Non-performing Loans | ||||||||||||||||||||||||||||||||
9/30/2010 * | % of Total * | Total Loans 9/30/2010 * | % of Total Loans * | 12/31/2009 | % of Total | Total Loans 12/31/2009 | % of Total Loans | |||||||||||||||||||||||||
Commercial, financial & agricultural | $ | 2,784 | 8.7 | % | $ | 250,182 | 1.11 | % | $ | 7,328 | 24.9 | % | $ | 259,565 | 2.82 | % | ||||||||||||||||
Commercial real estate | 11,405 | 35.6 | % | 422,158 | 2.70 | % | 9,709 | 33.1 | % | 375,652 | 2.58 | % | ||||||||||||||||||||
Real estate construction loans | 15,805 | 49.3 | % | 101,535 | 15.57 | % | 10,774 | 36.7 | % | 133,431 | 8.07 | % | ||||||||||||||||||||
Residential mortgages (1st & 2nd liens) | 1,666 | 5.2 | % | 203,847 | 0.82 | % | 1,344 | 4.6 | % | 214,501 | 0.63 | % | ||||||||||||||||||||
Home equity loans | 371 | 1.2 | % | 85,800 | 0.43 | % | 65 | 0.2 | % | 82,808 | 0.08 | % | ||||||||||||||||||||
Consumer loans | 31 | 0.1 | % | 69,991 | 0.04 | % | 152 | 0.5 | % | 80,352 | 0.19 | % | ||||||||||||||||||||
Other loans | — | 0.0 | % | 944 | 0.00 | % | — | 0.0 | % | 14,070 | 0.00 | % | ||||||||||||||||||||
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Total non-performing loans | $ | 32,062 | 100 | % | $ | 1,134,457 | 2.83 | % | $ | 29,372 | 100 | % | $ | 1,160,379 | 2.53 | % | ||||||||||||||||
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* | Restated |
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The following table details the collateral value securing non-performing loans: (in thousands)
September 30, 2010 * | December 31, 2009 | |||||||||||||||
Principal Balance | Collateral Value (1) | Principal Balance | Collateral Value (1) | |||||||||||||
Commercial, financial & agricultural loans | $ | 2,784 | $ | — | $ | 7,328 | $ | — | ||||||||
Commercial real estate mortgages | 11,405 | 23,957 | 9,709 | 22,145 | ||||||||||||
Real estate construction loans | 15,805 | 23,740 | 10,774 | 13,140 | ||||||||||||
Residential mortgages (1st and 2nd liens) | 1,666 | 13,319 | 1,344 | 3,772 | ||||||||||||
Home equity loans | 371 | 1,400 | 65 | 657 | ||||||||||||
Consumer loans | 31 | — | 152 | — | ||||||||||||
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Total | $ | 32,062 | $ | 62,416 | $ | 29,372 | $ | 39,714 | ||||||||
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* | Restated |
(1) | Based on most recent appraisal |
For non-performing loans, cash receipts are applied entirely against principal until the loan has been collected in full, after which time, any additional cash receipts are recognized as interest income. When, in management’s judgment, the borrower’s ability to make required interest and principal payments resumes and collectability is no longer in doubt, the loan is returned to accrual status. When interest accruals are suspended, accrued interest income is reversed and charged to earnings.
During the nine months ended September 30, 2010 and 2009, interest income totaling $2,556,000 and $785,000, respectively, was recognized on impaired loans. Cash basis interest income recognized on impaired loans during the periods was immaterial.
Included in nonperforming loans are restructured loans of $8,587,000. Subsequent to restructure, there has been $231,000 in advances funded on restructured loans outstanding as of September 30, 2010.
As of September 30, 2010 and December 31, 2009, we consider the restructured loans totaling $8.59 million and $10.31 million, respectively, to be impaired loans. The loans that have been restructured have been modified as to interest rate, due dates, or extension of the maturity date. Restructured loans are considered to be non-accrual loans, if at the time of restructuring the loan was deemed non-accrual. Once a sufficient amount of time has passed, generally six months, if the restructured loan has performed under the modified terms, the loan is returned to accrual status. In addition to the passage of time, we also consider the collateral value and the ability of the borrower to continue to make payments in accordance with the modified terms. During the three months ended September 30, 2010, there were no restructured loans returned to accrual status. During the three months ended September 30, 2010, there was one restructured loan charged off totaling $76,000. During the nine month period ended September 30, 2010, a restructured loan totaling $7,275,000, had $1,400,000 of the balance charged off during the quarter ended June 30, 2010 as a result of a new appraisal indicating the fair value less estimated costs to sell was less than the carrying amount of the loan.
As of both December 31, 2009 and September 30, 2010, we have not performed any commercial real estate (CRE) or other type of loan workouts whereby an existing loan was restructured into multiple new loans.
As of September 30, 2010, classified loans amounted to 19.88 percent of total loans, as compared with 3.48 percent at December 31, 2009. The increase is attributable to the prolonged national and regional economic slowdown which has increased the amount of time necessary to work out troubled loans.
Commercial mortgages and commercial real estate construction loans totaled $523,693,000 as of September 30, 2010, up from $509,083,000 as of December 31, 2009, representing 46.2 percent and 43.8 percent of the total loan portfolio, respectively. Commercial mortgages and commercial real estate construction loans consisted of the following as of September 30, 2010: 6 percent vacant land loans, 13 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 56 percent for owner-occupied commercial mortgages. Commercial mortgages and commercial real estate construction loans consisted of the following as of December 31, 2009: 7 percent vacant land loans, 19 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 49 percent for owner-occupied commercial mortgages. Commercial real estate construction loans were generally underwritten on the basis of reasonable ratios of loan-to-value, evaluations of projected cash flows, and commitments for permanent financing in place prior to granting an interim credit. Non-performing commercial mortgages and commercial real estate construction loans have increased to $27,210,000 at September 30, 2010, up from $20,483,000 at December 31, 2009. These loans have been evaluated for impairment and appropriate provisions have been made to recognize impaired balances.
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The following table presents information regarding real estate construction loans: (in thousands)
Non-performing Real Estate Construction Loans | ||||||||||||||||||||||||||||||||
September 30, 2010 * | December 31, 2009 | |||||||||||||||||||||||||||||||
Balance Outstanding | Non- performing Balance | Impaired Balance (1) | Allowance Allocation | Balance Outstanding | Non- performing Balance | Impaired Balance (1) | Allowance Allocation | |||||||||||||||||||||||||
Real estate construction loans | $ | 101,535 | $ | 15,805 | $ | 28,479 | $ | 3,555 | $ | 133,431 | $ | 10,774 | $ | 10,774 | $ | 1,258 | ||||||||||||||||
All loans | $ | 1,134,457 | $ | 32,062 | $ | 86,543 | $ | 26,659 | $ | 1,160,379 | $ | 29,372 | $ | 34,342 | $ | 12,333 | ||||||||||||||||
Real estate construction loans as % of all loans | 8.95 | % | 49.29 | % | 32.91 | % | 13.34 | % | 11.50 | % | 36.68 | % | 31.37 | % | 10.20 | % |
* | Restated |
(1) | Includes non-performing loans |
The following table presents nonperforming and collateral value information on real estate construction loans: (in thousands)
September 30, 2010 * | December 31, 2009 | |||||||||||||||||||||||
Non- performing Balance | Total Collateral Value | Loan to Value Ratio | Non- performing Balance | Total Collateral Value | Loan to Value Ratio | |||||||||||||||||||
Real estate construction loans | $ | 15,805 | $ | 23,740 | 67 | % | $ | 10,774 | $ | 13,140 | 82 | % |
* | Restated |
Real estate construction loans as a percentage of the loan portfolio have decreased since December 31, 2009, however the nonperforming balance of real estate construction loans as a percentage of all nonperforming loans has increased during that time. Although the allowance has increased during that same period, it has not increased to the same extent as the increase in nonperforming loans. This is a result of the measurement of impairment, and because of the collateral value of the real estate construction portfolio, reserves were not required to the same level of increase as the nonperforming loans themselves.
Suffolk recorded a provision for loan losses for the third quarter of 2010 of $14,729,000. The total provision recorded for the first nine months of 2010 totaled $26,549,000, which represents an increase of $23,549,000 as compared to the first nine months of 2009. During the third quarter of 2010, Suffolk recorded $8,885,000 in net loan charge-offs compared to $132,000 for the third quarter of 2009. Suffolk believes that the allowance for loan losses of $26,659,000, or 2.35 percent of total loans at September 30, 2010, is adequate based on its review of overall credit quality indicators and ongoing loan monitoring processes.
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The following tables summarize the allowance for loan losses by category for the periods presented: (in thousands)
Impaired Allocation 9/30/2010 * | Remaining Allocation 9/30/2010 * | Total Allocation 9/30/2010 * | % of Total * | |||||||||||||
Commercial, financial & agricultural loans | $ | 3,209 | $ | 12,494 | $ | 15,703 | 58.9 | % | ||||||||
Commercial real estate mortgages | 2,923 | 1,929 | 5,030 | 18.9 | % | |||||||||||
Real estate construction loans | 573 | 3,160 | 3,555 | 13.3 | % | |||||||||||
Residential mortgages (1st and 2nd liens) | — | 753 | 753 | 2.8 | % | |||||||||||
Home equity loans | — | 832 | 832 | 3.1 | % | |||||||||||
Consumer loans | — | 786 | 786 | 3.0 | % | |||||||||||
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Allowance for loan losses | $ | 6,705 | $ | 19,954 | $ | 26,659 | 100 | % | ||||||||
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Impaired Allocation 12/31/2009 | Remaining Allocation 12/31/2009 | Total Allocation 12/31/2009 | % of Total | |||||||||||||
Commercial, financial & agricultural loans | $ | 1,967 | $ | 3,559 | $ | 5,526 | 44.8 | % | ||||||||
Commercial real estate mortgages | 621 | 3,023 | 3,644 | 29.5 | % | |||||||||||
Real estate construction loans | 407 | 851 | 1,258 | 10.2 | % | |||||||||||
Residential mortgages (1st and 2nd liens) | — | 1,154 | 1,154 | 9.4 | % | |||||||||||
Home equity loans | — | 280 | 280 | 2.3 | % | |||||||||||
Consumer loans | — | 471 | 471 | 3.8 | % | |||||||||||
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Allowance for loan losses | $ | 2,995 | $ | 9,338 | $ | 12,333 | 100 | % | ||||||||
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The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)
Nine months ended September 30, 2010 Restated | Year Ended December 31, 2009 | |||||||
Allowance for loan losses, Beginning | $ | 12,333 | $ | 9,051 | ||||
Loans charged-off: | ||||||||
Commercial, financial & agricultural loans | 7,717 | 806 | ||||||
Commercial real estate mortgages | 230 | — | ||||||
Real estate construction loans | 3,620 | — | ||||||
Residential mortgages (1st and 2nd liens) | 492 | — | ||||||
Home equity loans | 65 | — | ||||||
Consumer loans | 286 | 404 | ||||||
Other loans | — | — | ||||||
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Total Charge-offs | $ | 12,410 | $ | 1,210 | ||||
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Loans recovered after being charged-off | ||||||||
Commercial, financial & agricultural loans | 62 | 41 | ||||||
Commercial real estate mortgages | — | — | ||||||
Real estate construction loans | — | — | ||||||
Residential mortgages (1st and 2nd liens) | — | — | ||||||
Home equity loans | — | — | ||||||
Consumer loans | 74 | 176 | ||||||
Other loans | — | — | ||||||
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Total recoveries | $ | 136 | $ | 217 | ||||
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Net loans charged-off | 12,274 | 993 | ||||||
Reclass to allowance for contingent liabilities | 51 | — | ||||||
Provision for loan losses | 26,549 | 4,275 | ||||||
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Allowance for loan losses, Ending | $ | 26,659 | $ | 12,333 | ||||
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Suffolk believes the allowance is adequate to absorb inherent and known losses in the loan portfolio. However, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant change. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. In the future, the allowance for loan losses may change as a percentage of total loans. To the extent actual performance differs from management’s estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that Suffolk will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan losses.
Additional analysis of charged off loans for the quarter ended September 30, 2010 is provided below: (in thousands)
September 30, 2010 * | ||||||||||||||||
Nonperforming Loans | Impaired Loans | Restructured Loans | Total | |||||||||||||
Commercial, financial & agricultural loans | $ | 58 | $ | 6,292 | $ | — | $ | 6,350 | ||||||||
Commercial real estate mortgages | — | 72 | — | 72 | ||||||||||||
Real estate construction loans | — | 2,043 | — | 2,043 | ||||||||||||
Residential mortgages (1st and 2nd liens) | 248 | — | — | 248 | ||||||||||||
Home equity loans | — | — | — | — | ||||||||||||
Consumer loans | 192 | — | — | 192 | ||||||||||||
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Total Charge-offs | $ | 498 | $ | 8,407 | $ | — | $ | 8,905 | ||||||||
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* | Restated |
Net charge-offs in the third quarter 2010 were $9.0 million compared to $132,000 of net charge-offs in the third quarter of 2009. The increased charge-offs were realized in all of our loan categories. This increase in charge-offs reflects the deterioration of economic conditions and resulting failure of businesses, devaluation of assets, and negative impact on customers’ ability to service debt. For impaired collateral dependent loans, which include commercial real estate mortgages and real estate construction loans, charge-offs were the result of new appraisals indicating a collateral deficiency after considering costs to sell, and were therefore charged off.
Deferred Tax Assets and Liabilities
Suffolk recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk 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 amount that management expects to realize. At September 30, 2010, Suffolk believes the deferred tax asset is fully realizable.
Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and Suffolk’s intent and ability to hold the impaired investment at the time the valuation is made. If management determines that impairment in the investment’s value is other than temporary, earnings would be charged.
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Item 3 - Quantitative and Qualitative Disclosures about Market Risk
Suffolk originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. Suffolk’s operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or re-priced in any given period of time. Suffolk’s earnings or the net value of its portfolio (the present value of expected cash flows from liabilities) will change when interest rates change. The principal objective of Suffolk’s asset/liability management program is to maximize net interest income while keeping risks acceptable. These risks include both the effect of changes in interest rates, and risks to liquidity. The program also provides guidance to management in funding Suffolk’s investment in loans and securities. Suffolk’s exposure to interest-rate risk has not changed substantially since December 31, 2009.
Business Risks and Uncertainties
This report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, the economy in general, expectations of the business environment in which Suffolk operates, projections of future performance, and potential future credit experience. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond Suffolk’s control and are subject to a variety of uncertainties that could cause future results to vary materially from Suffolk’s historical performance, or from current expectations. Factors affecting Suffolk include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolk’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by us to comply with our written agreement with the OCC or the individual minimum capital ratios for the Bank established by the OCC; the cost of compliance with the Agreement; failure by Suffolk to restore effective internal controls over financial reporting; and the potential that net charge-offs are higher than expected. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operations.
Item 4 - Controls and Procedures
Suffolk’s Chief Executive Officer who is also Acting Chief Financial Officer (the “Certifying Officer”) evaluated the effectiveness of Suffolk’s disclosure controls and procedures (as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934) as of September 30, 2010 in connection with the filing of the initial Form 10-Q for that period.
In connection with the restatement of Suffolk’s financial statements for the three and nine months ended September 30, 2010, management re-evaluated the effectiveness of its disclosure controls and procedures. Based on that re-evaluation, management, including Suffolk’s Certifying Officer, has concluded that, due to the material weaknesses in internal control over financial reporting described below, Suffolk’s disclosure controls and procedures were not effective as of September 30, 2010.
Suffolk’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.
Because of their inherent limitations, systems of internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.
A “material weakness” in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected in a timely basis by Suffolk’s internal controls.
Allowance for Loan and Lease Losses
Estimating the allowance for loan losses requires credit administration staff to identify and evaluate borrowers’ ability to repay their obligations through periodic evaluation and reevaluation of cash flow and/or collateral, and, when necessary, making provision for the amount deemed being likely not to be repaid. Suffolk identified deficiencies within the credit
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administration function which compromised the operational effectiveness of the internal controls, particularly in making timely reevaluations of credit and/or collateral. This led to management’s determination that there was a material weakness in internal control over financial reporting in estimating the allowance for loan losses.
Financial Reporting Staffing Resources
Management concluded that a material weakness exists due to insufficient staffing resources that are in dedicated permanent positions within the accounting function with sufficient skills and industry knowledge of Generally Accepted Accounting Principles in the United States (“US GAAP”) and regulatory accounting, which resulted in insufficient documentation and monitoring over financial reporting, including preparing financial statements and disclosures. Among other factors identified, approximately six months have passed since the prior Chief Financial Officer resigned as of June 24, 2011 and Suffolk has yet to fill this position. Suffolk immediately engaged an interim accounting consultant to assist with financial reporting in the meantime; however, the individual is not an officer of Suffolk. Suffolk’s President and Chief Executive Officer was appointed as Acting Chief Financial Officer until a permanent Chief Financial Officer is hired, representing a significant concentration of authority in one individual.
Interdepartmental Communications
A material weakness exists due to insufficient communications at the interdepartmental levels. There was inconsistent exchange of important financial information between Suffolk’s accounting and operating functions that led to errors in classifying loans as performing loans when the loans were non-performing. That was one factor resulting in the allowance for loan and lease losses to be understated as of September 30, 2010 and December 31, 2010, as described above at “Allowance for Loan and Lease Losses.”
Governance and Management Accountability
The Board of Directors is responsible for competent and effective oversight and leadership of the Company’s management and to ensure accountability of management. The material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources and interdepartmental communications, as well as delays in processes surrounding the completion of restated and current financial statements, and the untimely correction of deficiencies previously identified by regulators, are reflective of a material weakness in the Board of Directors as it relates to the foregoing matters.
Suffolk has implemented certain changes in its internal controls as of the date of this report to address the material weaknesses. Specifically, subsequent to September 30, 2010, management took the following steps to remediate the material weaknesses set forth above:
Allowance for Loan and Lease Losses
1. | Hired a new Chief Lending Officer during the second quarter of 2011. |
2. | Improved staff by hiring a new loan administrator, additional underwriting staff and a loan workout specialist. |
3. | Reorganized the credit department to ensure appropriate separation of duties and developed expanded training for Suffolk’s lenders. |
4. | Hired a senior credit officer to run a newly created separate loan review and workout department. |
5. | Changed Suffolk’s credit policy to require identification of concentrations of risk, analysis of our customer’s global cash flows, reappraisal and re-evaluation of collateral, more accurate and timely credit-risk rating procedures and improved underwriting processes and standards. |
6. | Incorporated the results of a systematic re-appraisal of commercial real estate which secures loans in excess of $1 million. |
7. | Engaged qualified outside consultants to assist in re-evaluating risk ratings. |
8. | Improved the processes for identifying loans and the determination of the amount of impairment. |
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9. | Augmented Suffolk’s credit policy to govern loan workout. |
10. | Implemented a new procedure to ensure that OREO was accounted for in accordance with US GAAP. |
Financial Reporting Staffing Resources
11. | Initiated a search for a qualified Chief Financial Officer with sufficient knowledge of US GAAP, regulatory accounting and the banking industry, and the skills to effectively implement that knowledge. |
12. | Engaged a qualified consultant in financial reporting and the function of the Chief Financial Officer to assist the Acting Chief Financial Officer in maintaining and improving controls. |
13. | Increased oversight of the financial reporting process through the Audit Committee and the Compliance Committee, the latter of which meets at least monthly or more often. |
14. | Created and filled the new position of Treasurer to further relieve the Chief Financial Officer of day-to-day duties in asset liability management, investment portfolio management and additional treasury functions. |
15. | Enhanced the procedures to ensure that all reconciliations of all departments are completed and reviewed to ensure accuracy. |
16. | Complied individual policies into comprehensive written policies and procedures for the accounting function which will include specific policies, procedures and controls for financial reporting. |
17. | Increased automation of the accounting and financial reporting process to free staff resources to focus on financial reporting. |
Interdepartmental Communications
18. | Established a process for both credit and finance staff to review the computation of specific impairment allowances under ASC 310-10 – Receivables – Impairment of a Loan and establishing enhanced reporting from core systems available directly to personnel in accounting and finance. |
Governance and Management Accountability
19. | Formed a Compliance Committee of the Board to oversee compliance and, later, to respond to the Formal Agreement. |
20. | Implemented procedures to track all regulatory compliance through structured matrices. |
21. | Engaged qualified independent consultants to assist with compliance with the Formal Agreement, including an assessment of key management roles. |
22. | Outsourced the internal audit function to a qualified risk management firm to provide greater independence and depth to the function. |
23. | Appointed a Vice Chairman of the Board to provide daily oversight of management on behalf of the full Board and to communicate back to the Board. |
24. | Engaged a qualified independent consultant to advise the Board on various regulatory, strategic and operational issues. |
Suffolk cannot determine the impact of the remediation steps at this time.
There has been no change in Suffolk’s internal controls over financial reporting that occurred during the third quarter of 2010 that materially affected, or is reasonably likely to materially affect, Suffolk’s internal control over financial reporting.
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Part II
On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.
On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.
On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.
Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.
The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.
There are no material changes from any of the risk factors previously disclosed in Suffolk’s 2009 Form 10-K in response to Part I, Item 1A other than the addition of the following risk factors:
Our results may be adversely affected if we continue to suffer higher than expected losses on our loans or are required to further increase our allowance for loan losses.
We assume credit risk from the possibility that we will suffer losses because borrowers, guarantors, and related parties fail to perform under the terms of their loans. We try to minimize and monitor this risk by adopting and implementing what we believe are effective underwriting and credit policies and procedures, including how we establish and review the allowance for loan losses. The allowance for loan losses is determined by continuous analysis of the loan portfolio and the analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. Those policies and procedures may still not prevent unexpected losses that could adversely affect our results. Weak economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of collateral securing those loans. In addition, deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, changes in regulation and regulatory interpretation and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. See the section captioned “Allowance for Loan Losses” in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our loan portfolio and our process for determining the appropriate level of the allowance for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of reviewing its allowance for loan losses policy which may result in an increase to the allowance.
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Recent financial reforms and related regulations may affect our results of operations, financial condition or liquidity.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed into law on July 21, 2010, makes extensive changes to the laws regulating financial services firms. The Dodd-Frank Act also requires significant rulemaking and mandates multiple studies which could result in additional legislative or regulatory action. Under the Dodd-Frank Act federal banking regulatory agencies are required to draft and implement enhanced supervision, examination and capital standards for depository institutions and their holding companies. The enhanced requirements include, among other things, changes to capital, leverage and liquidity standards and numerous other requirements. The Dodd-Frank Act authorizes various new assessments and fees, expands supervision and oversight authority over non-bank subsidiaries, increases the standards for certain covered transactions with affiliates and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions. The Dodd-Frank Act also establishes a new federal Consumer Financial Protection Bureau with broad authority and permits states to adopt stricter consumer protection laws and enforce consumer protection rules issued by the Consumer Financial Protection Bureau. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact Suffolk’s business. However, compliance with these new laws and regulations will likely result in additional costs, and these additional costs may adversely impact our results of operations, financial condition or liquidity.
Failure to comply with the Bank’s written agreement with the OCC may result in our being subjected to further regulatory enforcement actions.
On October 25, 2010, the Bank, following discussion with the OCC, entered into a formal agreement (the “Agreement”) with the OCC. The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology. While subject to the Agreement, Suffolk expects that its and the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.
Further increases to our allowance for loan losses would negatively impact our capital levels causing the Bank to fail to be in compliance with the three individual minimum capital ratios set by the OCC
Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.88 percent, and a total risk-based capital ratio of 12.14 percent. However, the Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 after taking into effect the restatement and met all regulatory requirements applicable at that time. Further increases to Suffolk’s allowance for loan losses, however, would negatively impact the Bank’s capital levels and make it difficult to maintain the capital levels directed by the OCC. If the Bank fails to maintain the required capital levels, it could be subject to further regulatory enforcement actions.
A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.
During April of 2011, management identified possible deficiencies and/or weaknesses in Suffolk’s internal controls related to the design and implementation of policies to promptly identify problem loans and to quantify the elements of risk in problem loans. After conducting an internal review, management determined that there were material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources, interdepartmental communications and governance and management accountability. See Part I, Item 4 – Controls and Procedures. Suffolk has incurred costs and implemented certain changes in its internal controls over financial reporting and disclosure controls and procedures to address these material weaknesses. It is too early to determine the impact of these remediation steps and Suffolk has not yet determined that it has restored effective internal controls over financial reporting and disclosure controls and procedures. It is possible
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that additional deficiencies or weaknesses could be identified A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information about repurchases of common stock:
For the last 12 months | For the three months ended | |||||||||||||||||||
Sept. 30, 2010 | Jun. 30, 2010 | Mar. 31, 2010 | Dec.31, 2009 | |||||||||||||||||
Average price per share of quarterly repurchases | $ | 2.50 | $ | — | $ | — | $ | 2.50 | $ | — | ||||||||||
Aggregate cost of quarterly repurchases | $ | 13,200 | $ | — | $ | — | $ | 13,200 | $ | — | ||||||||||
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Repurchases of common stock | ||||||||||||||||||||
Treasury stock, beginning balance | 3,996,878 | 4,002,158 | 4,002,158 | 3,996,878 | 3,996,878 | |||||||||||||||
Repurchases (1) | 5,280 | — | — | 5,280 | — | |||||||||||||||
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Treasury stock, ending balance | 4,002,158 | 4,002,158 | 4,002,158 | 4,002,158 | 3,996,878 | |||||||||||||||
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(1) | Shares repurchased in payment of exercised employee incentive stock options. No shares were repurchased in market transactions. |
CERTIFICATION OF PERIODIC REPORT - Exhibit 31.1
CERTIFICATION OF PERIODIC REPORT - Exhibit 31.2
CERTIFICATION OF PERIODIC REPORT - Exhibit 32.1
CERTIFICATION OF PERIODIC REPORT - Exhibit 32.2
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.
SUFFOLK BANCORP | ||||
Date: December 20, 2011 | /s/ J. Gordon Huszagh | |||
J. Gordon Huszagh | ||||
President & Chief Executive Officer | ||||
Date: December 20, 2011 | /s/ J. Gordon Huszagh | |||
J. Gordon Huszagh | ||||
Acting Chief Financial Officer |
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