UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________________ to ____________________
Commission file number 0-20957
-------------------------
SUN BANCORP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 52-1382541
- --------------------------------------------- -----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification)
226 Landis Avenue, Vineland, New Jersey 08360
---------------------------------------------
(Address of principal executive offices)
(Zip Code)
(856) 691 - 7700
----------------
(Registrant's telephone number, including area code)
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
$ 1.00 Par Value Common Stock 11,856,541 August 13, 2003
- ----------------------------- ---------------------------- ---------------
Class Number of shares outstanding Date
SUN BANCORP, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Condensed Consolidated Statements of Financial Condition at
June 30, 2003 and December 31, 2002 3
Unaudited Condensed Consolidated Statements of Income For the Three and
Six Months Ended June 30, 2003 and 2002 4
Unaudited Condensed Consolidated Statements of Cash Flows For the Six
Months Ended June 30, 2003 and 2002 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
22
ITEM 4. CONTROLS AND PROCEDURES 23
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 24
ITEM 2. Changes in Securities and Use of Proceeds 24
ITEM 3. Defaults upon Senior Securities 24
ITEM 4. Submission of Matters to a Vote of Security Holders 24
ITEM 5. Other Information 24
ITEM 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
CERTIFICATIONS 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
2003 2002
---- ----
(Dollars in thousands)
ASSETS
Cash and due from banks $ 102,043 $ 65,476
Federal funds sold 56 138
---------- ----------
Cash and cash equivalents 102,099 65,614
Investment securities available for sale (amortized cost -
$715,832; 2003 and $714,962; 2002) 729,142 723,201
Loans receivable (net of allowance for loan losses -
$16,209; 2003 and $16,408; 2002) 1,272,621 1,217,008
Restricted equity investments 12,519 11,610
Bank properties and equipment, net 29,485 29,468
Real estate owned, net 577 904
Accrued interest receivable 10,999 11,012
Goodwill 19,672 19,672
Intangible assets, net 17,933 19,783
Deferred taxes, net 4,678 6,867
Other assets 30,926 7,033
---------- ----------
TOTAL $2,230,651 $2,112,172
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits $1,746,121 $1,690,462
Federal funds purchased 27,000
Advances from the Federal Home Loan Bank 163,311 142,260
Loans payable 1,160
Securities sold under agreements to repurchase 72,196 61,860
Other liabilities 6,599 11,533
---------- ----------
Total liabilities 2,015,227 1,907,275
---------- ----------
Guaranteed preferred beneficial interest in Company's subordinated debt 59,274 59,274
SHAREHOLDERS' EQUITY
Preferred stock, none issued
Common stock, $1 par value, 25,000,000 shares authorized,
Issued and outstanding: 11,855,241 in 2003 and 11,271,135 in 2002 11,855 11,271
Surplus 122,958 114,930
Retained earnings 13,611 15,030
Accumulated other comprehensive income 8,772 5,438
Treasury stock at cost, 90,562 shares (1,046) (1,046)
---------- ----------
Total shareholders' equity 156,150 145,623
---------- ----------
TOTAL $2,230,651 $2,112,172
========== ==========
- --------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements
3
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands, except per share amounts)
INTEREST INCOME:
Interest and fees on loans $ 20,998 $ 20,995 $ 42,104 $ 41,329
Interest on taxable investment securities 5,635 6,863 11,418 13,456
Interest on non-taxable investment securities 625 504 1,241 1,009
Interest on restricted equity investments 209 173 382 306
Interest on federal funds sold 18 80 29 133
----------- ----------- ----------- -----------
Total interest income 27,485 28,615 55,174 56,233
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 6,537 8,959 13,337 18,317
Interest on short-term borrowed funds 2,243 2,271 4,349 4,156
Interest on guaranteed preferred beneficial interest in
Company's subordinated debt 1,048 937 2,106 2,297
----------- ----------- ----------- -----------
Total interest expense 9,828 12,167 19,792 24,770
----------- ----------- ----------- -----------
Net interest income 17,657 16,448 35,382 31,463
PROVISION FOR LOAN LOSSES 710 1,110 1,385 2,185
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 16,947 15,338 33,997 29,278
----------- ----------- ----------- -----------
OTHER INCOME:
Service charges on deposit accounts 1,932 1,733 3,686 3,399
Other service charges 104 114 206 228
(Loss) gain on sale of bank properties and equipment (44) 9 (14)
Gain on sale of investment securities 825 616 870 799
Gain on sale of branches 1,315
Other 1,051 794 1,773 1,646
----------- ----------- ----------- -----------
Total other income 3,868 3,257 7,859 6,058
----------- ----------- ----------- -----------
OTHER EXPENSES:
Salaries and employee benefits 8,165 6,849 16,181 13,590
Occupancy expense 2,156 1,960 4,611 3,864
Equipment expense 1,414 1,203 2,774 2,289
Data processing expense 838 789 1,629 1,619
Amortization of intangible assets 925 1,084 1,850 2,168
Real estate owned expense, net (13) 68 (663) 33
Other 2,909 2,898 5,536 4,969
----------- ----------- ----------- -----------
Total other expenses 16,394 14,851 31,918 28,532
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 4,421 3,744 9,938 6,804
INCOME TAXES 1,294 1,171 3,053 2,094
----------- ----------- ----------- -----------
NET INCOME $ 3,127 $ 2,573 $ 6,885 $ 4,710
=========== =========== =========== ===========
Less: Trust Preferred issuance costs write-off - 777 - 777
----------- ----------- ----------- -----------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 3,127 $ 1,796 $ 6,885 $ 3,933
=========== =========== =========== ===========
Basic earnings per share $ 0.27 $ 0.15 $ 0.59 $ 0.34
=========== =========== =========== ===========
Diluted earnings per share $ 0.25 $ 0.15 $ 0.55 $ 0.32
=========== =========== =========== ===========
Weighted average shares - basic 11,750,098 11,737,553 11,747,718 11,711,772
=========== =========== =========== ===========
Weighted average shares - diluted 12,542,878 12,257,765 12,414,672 12,166,420
=========== =========== =========== ===========
- ------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements
4
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months
Ended June 30,
-----------------------------
2003 2002
---- ----
(In thousands)
OPERATING ACTIVITIES:
Net income $ 6,885 $ 4,710
Adjustments to reconcile net income to net cash (used in) provided
by operating activities:
Provision for loan losses 1,385 2,185
Provision for losses on real estate owned 117
Depreciation 1,300 1,152
Net amortization of investments securities 1,434 968
Amortization of intangible assets 1,850 2,168
Gain on sale of investment securities available for sale (870) (799)
(Gain) loss on sale of bank properties and equipment (9) 14
Gain on sale of branch (1,315)
Gain on sale of real estate owned (680) (94)
Deferred income taxes 452 (412)
Change in assets and liabilities which (used) provided cash:
Accrued interest receivable 13 (1,530)
Other assets (23,893) 1,860
Other liabilities (4,934) (1,240)
--------- --------
Net cash (used in) provided by operating activities (18,382) 9,099
--------- --------
INVESTING ACTIVITIES:
Purchases of investment securities available for sale (322,955) (344,447)
Purchases of restricted equity securities (909) (914)
Proceeds from maturities, prepayments or calls of investment securities
available for sale 300,463 287,688
Proceeds from sale of investment securities available for sale 21,058 40,152
Net increase in loans (57,276) (108,080)
Purchase of bank properties and equipment (1,429) (1,554)
Proceeds from the sale of bank properties and equipment 121
Proceeds from sale of real estate owned 1,285 806
--------- --------
Net cash used in investing activities (59,642) (126,349)
--------- --------
FINANCING ACTIVITIES:
Net increase in deposits 74,860 48,463
Decrease in deposits resulting from branch sale (17,886)
Net borrowings under line of credits, advances and repurchase agreements 58,387 66,931
Principal payments on loan payable (1,160) (20,000)
Proceeds from other borrowings 25,000
Proceeds from exercise of stock options 182 573
Proceeds from fractional interests resulting from stock dividend (7) (6)
Proceeds from the issuance of guaranteed preferred beneficial
interest in subordinated debt 20,000
Redemption of guaranteed preferred beneficial interest in subordinated debt (28,040)
Treasury stock purchased (315)
Proceeds from issuance of common stock 133 159
--------- --------
Net cash provided by financing activities 114,509 112,765
--------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 36,485 (4,485)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 65,614 79,082
--------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 102,099 $ 74,597
========= ========
- -------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements
5
SUN BANCORP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(All dollar amounts presented in the tables, except per share amounts, are in
thousands.)
(1) Summary of Significant Accounting Policies
Basis of Financial Statement Presentation
The unaudited condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries, Sun Capital
Trust ("SunTrust I") (liquidated in April 2002), Sun Capital Trust II
("SunTrust II"), Sun Capital Trust III ("SunTrust III"), Sun Capital
Trust IV ("SunTrust IV"), Sun National Bank (the "Bank") and the Bank's
wholly owned subsidiaries, Med-Vine, Inc., Sun Financial Services,
L.L.C. and 2020 Properties, L.L.C. All significant intercompany
balances and transactions have been eliminated.
The accompanying unaudited condensed consolidated financial statements
were prepared in accordance with instructions to Form 10-Q, and
therefore, do not include information or footnotes necessary for a
complete presentation of financial position, results of operations and
cash flows in conformity with accounting principles generally accepted
in the United States of America. However, all normal recurring
adjustments that, in the opinion of management, are necessary for a
fair presentation of the financial statements, have been included.
These financial statements should be read in conjunction with the
audited financial statements and the accompanying notes thereto
included in the Company's Annual Report for the period ended December
31, 2002. The results for the three and six months ended June 30, 2003
are not necessarily indicative of the results that may be expected for
the fiscal year ending December 31, 2003 or any other period.
Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of income and expenses during the reporting period. The
significant estimates include the allowance for loan losses, goodwill,
core deposit and other intangible assets, and deferred tax asset
valuation allowance. Actual results could differ from those estimates.
Stock dividend - On March 19, 2003, the Company's Board of Directors
declared a 5% stock dividend paid on April 21, 2003 to shareholders of
record on April 7, 2003. Accordingly, per share data and equity
accounts have been adjusted for all periods presented.
Goodwill and Other Intangible Assets - In June 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001 to all goodwill and other intangible assets
recognized in an entity's statement of financial position at that date,
regardless of when those assets were initially recognized. However,
SFAS No. 142 did not change the accounting prescribed for certain
acquisitions by banking and thrift institutions, resulting in continued
amortization of the excess of cost over fair value of net assets
acquired under SFAS No. 72, Accounting for Certain Acquisitions of
Banking or Thrift Institutions.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions, which allows financial institutions meeting
certain criteria to reclassify their unidentifiable intangible asset
balances to goodwill and retroactively cease amortization beginning as
of January 1, 2002. The Company adopted SFAS No. 147 on October 1,
2002, and as required by the standard, the Company restated earnings
for the quarterly periods ended March 31, 2002, June 30, 2002 and
September 30, 2002.
6
A reconciliation of previously reported net income and earnings per
share to the amounts adjusted for the exclusion of goodwill
amortization, net of tax, follows. The per share amounts have been
restated to retroactively give effect to stock dividends.
Three Months Six Months
Ended June 30, 2002 Ended June 30, 2002
(restated) (restated)
----------------------- --------------------
Net income:
Reported net income available to shareholders $1,252 $2,845
Add: goodwill amortization, net of tax 544 1,088
------ ------
Adjusted net income available to shareholders $1,796 $3,933
====== ======
Basic earnings per share:
Reported basic earnings per share $ 0.10 $ 0.25
Add: goodwill amortization, net of tax 0.05 0.09
------ ------
Adjusted basic net income per share $ 0.15 $ 0.34
====== ======
Diluted earnings per share:
Reported diluted earnings per share $ 0.10 $ 0.23
Add: goodwill amortization, net of tax 0.05 0.09
------ ------
Adjusted diluted net income per share $ 0.15 $ 0.32
====== ======
Accounting for Stock Options - The Company accounts for stock-based
compensation using the intrinsic value method that recognizes as
expense the difference between the market value of the stock and the
exercise price at grant date. The Company has not recognized any
compensation expense under this method. The Company discloses the pro
forma effects of accounting for stock-based compensation using the fair
value method (using the Black-Scholes model) as described in SFAS No.
123 issued by the FASB and the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results described in SFAS No. 148.
At June 30, 2003, the Company had three stock-based employee
compensation plans. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee
compensation.
For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------ ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Reported net income available to shareholders $3,127 $1,796 $6,885 $3,933
Deduct: Total stock-based employee
compensation expense determined under
fair value method (net of tax) (351) (763) (706) (1,531)
------ ------ ------ ------
Pro forma net income available to shareholders $2,776 $1,033 $6,179 $2,402
====== ====== ====== ======
Earnings per share:
Basic - as reported $ 0.27 $ 0.15 $ 0.59 $ 0.34
Basic - pro forma $ 0.25 $ 0.09 $ 0.53 $ 0.21
Diluted - as reported $ 0.25 $ 0.15 $ 0.55 $ 0.32
Diluted - pro forma $ 0.22 $ 0.08 $ 0.50 $ 0.20
7
Recent Accounting Principles - In November 2002, the FASB issued FASB
Interpretation ("FIN") No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others. This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees
that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. This
Interpretation also incorporates, without change, the guidance in FIN
No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others,
which is being superseded. The initial recognition and initial
measurement provisions of this Interpretation are applicable on a
prospective basis to guarantees issued or modified after December 31,
2002, irrespective of the guarantor's fiscal year-end. The disclosure
requirements in this Interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002.
The Company currently has no guarantees that would be required to be
recognized, measured or disclosed under this Interpretation.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities. The Interpretation clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties.
The Company has participated in the issue of preferred trust securities
through various trusts established for such purpose. The Company is
currently assessing the trust preferred securities structure and the
continued consolidation of the related trusts pursuant to FIN 46.
Management does not believe the results of the assessment will result
in a material change to the Company's balance sheet or income statement
upon the adoption of FIN 46 in the third quarter 2003.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This statement amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133. This statement is effective for
contracts entered into or modified after June 30, 2003, except for the
provision of this statement that relate to SFAS 133 Implementation
Issues that have been effective for fiscal quarters that began prior to
June 15, 2003 and for hedging relationships designated after June 30,
2003. All provisions are to be applied prospectively except for the
provision of this statement that relate to SFAS 133 Implementation
Issues that have been effective for fiscal quarters that began prior to
June 15, 2003. These provisions are to be applied in accordance with
their respective effective dates. The adoption of SFAS No. 149 is not
expected to have a material impact on the Company's financial position
or results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS 150 establishes standards for how an issuer measures
certain financial instruments with characteristics of both liabilities
and equity and classifies them in its statement of financial position.
It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances)
when that financial instrument embodies an obligation of the issuer.
This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003.
The Company has participated in the issue of preferred trust securities
with characteristics of both liabilities and equity and classifies them
in its statement of financial position after total liabilities and
before equity. For the quarter ending September 30, 2003, the Company
will be required to classify its trust preferred securities as
liabilities. Management does not believe the reclassification of its
trust preferred securities will result in a material change to the
Company's balance sheet upon the adoption of SFAS No. 150.
8
(2) Loans
The components of loans as of June 30, 2003 and December 31, 2002 were
as follows:
June 30, 2003 December 31, 2002
------------- -----------------
Commercial and industrial $1,082,251 $1,043,885
Home equity 62,768 44,603
Second mortgages 53,210 47,458
Residential real estate 38,071 43,375
Installment 52,530 54,095
---------- ----------
Total gross loans 1,288,830 1,233,416
Allowance for loan losses (16,209) (16,408)
---------- ----------
Net Loans $1,272,621 $1,217,008
========== ==========
Non-accrual loans $ 8,230 $ 9,963
========== ==========
(3) Allowance for Loan Losses
Changes in the allowance for loan losses were as follows:
For the six month
period ended For the year ended
June 30, 2003 December 31, 2002
------------- -----------------
Balance, beginning of period $16,408 $ 13,332
Charge-offs (1,755) (1,609)
Recoveries 171 510
------- --------
Net charge-offs (1,584) (1,099)
Provision for loan losses 1,385 4,175
------- --------
Balance, end of period $16,209 $ 16,408
======= ========
The provision for loan losses charged to expense is based upon past
loan loss experience and an evaluation of estimated losses in the
current loan portfolio, including the evaluation of impaired loans
under SFAS Nos. 114 and 118. A loan is considered to be impaired when,
based upon current information and events, it is probable that the
Company will be unable to collect all amounts due according to the
contractual terms of the loan.
An insignificant delay or insignificant shortfall in amount of payments
does not necessarily result in a loan being identified as impaired. For
this purpose, delays less than 90 days are considered to be
insignificant.
Impairment losses are included in the provision for loan losses. Large
groups of smaller balance, homogeneous loans are collectively evaluated
for impairment, except for those loans restructured under a troubled
debt restructuring. Loans collectively evaluated for impairment include
consumer loans and residential real estate loans, and are not included
in the data that follow:
June 30, 2003 December 31, 2002
------------- -----------------
Impaired loans with related reserve for loan
losses calculated under SFAS No. 114 $29,563 $25,511
Impaired loans with no related reserve for loan
losses calculated under SFAS No. 114 2,686 4,051
------- -------
Total impaired loans $32,249 $29,562
======= =======
9
For the six
months ended For the year ended
June 30, 2003 December 31, 2002
------------- -----------------
Average impaired loans $35,381 $13,471
Interest income recognized on impaired loans $ 982 $ 1,936
------- -------
Cash basis interest income recognized on impaired loans $ 1,010 $ 2,013
======= =======
The increase in average impaired loans from the year ended December 31,
2002 to the six months ended June 30, 2003 is primarily two credits
aggregating $13.5 million that were classified in September 2002 as
restructured loans within the definition of SFAS No. 15. These loans
have had a temporary modification of terms to provide near-term cash
flow relief to the borrowers. At June 30, 2003 and December 31, 2002,
these loans, as restructured, were current, and fully performing. These
loans were not classified as non-accrual and are not considered
non-performing. In addition, the increase in average impaired loans was
due to an $8.0 million commercial loan that was classified as impaired
during the six months ended June 30, 2003. At June 30, 2003, this loan
was accruing and fully performing.
(4) Deposits
Deposits consist of the following major classifications:
June 30, 2003 December 31, 2002
------------- -----------------
Demand deposits - interest bearing $ 666,468 $ 627,394
Demand deposits - non-interest bearing 353,526 322,433
Savings deposits 322,568 328,508
Time certificates under $100,000 296,534 306,622
Time certificates $100,000 or more 107,024 105,505
----------- ----------
Total $ 1,746,121 $1,690,462
=========== ==========
As previously disclosed, the Company is in the process of completing
its branch rationalization program. At June 30, 2003, the Company sold
one branch with deposits of $17.9 million and consolidated one branch
into an existing office. As of August 8, 2003, the Company completed
the first phase of the program by selling three additional branches
with deposits of $21.7 million. The Company expects a further
reduction, through sales and consolidations, of seven additional
branches by early 2004. The Company anticipates approximately $80
million of additional deposits will be sold or consolidated during the
branch rationalization program.
(5) Advances from the Federal Home Loan Bank
Federal Home Loan Bank ("FHLB") advances are collateralized under a
blanket collateral lien agreement. Advances were as follows:
June 30, 2003 December 31, 2002
------------- -----------------
Convertible rate advances $ 25,000 $ 45,000
Term amortizing advances 90,111 89,060
Term non-amortizing advances 48,200 8,200
-------- --------
Total $163,311 $142,260
======== ========
Convertible rate advances - On June 27, 2003 and June 29, 2003 two
$10,000,000 convertible rate advances matured. The interest rates on
these advances were 6.93% and 6.87% respectively.
10
Term amortizing advances - On February 21, 2003, the Company executed a
$10.0 million term advance, at a rate of 3.78%, maturing on February
21, 2013. Principal and interest monthly payments are $100,200 during
the term of the advance.
Term non-amortizing advances - On February 14, 2003, the Company
executed a $15.0 million term advance, at a rate of 3.39%, maturing on
February 14, 2008. On April 24, 2003, the Company executed a $10.0
million term advance, at a rate of 1.88%, maturing on April 25, 2005.
On April 25, 2003, the Company executed a $15.0 million term advance,
at a rate of 3.30%, maturing on April 25, 2008. Monthly payments are
interest only during the terms of these advances.
(6) Comprehensive Income
The Company classifies items of other comprehensive income by their
nature and displays the accumulated balance of other comprehensive
income separately from retained earnings and surplus in the equity
section of the statement of financial position. Amounts categorized as
other comprehensive income represent net unrealized gains or losses on
investment securities available for sale, net of income taxes. Total
comprehensive income for the three-months ended June 30, 2003 and 2002
amounted to $6,977,000 and $9,068,000, respectively. Total
comprehensive income for the six-months ended June 30, 2003 and 2002
amounted to $10,219,000 and $7,245,000, respectively.
(7) Real Estate Operations, net
The results of the Company's real estate operations were comprised of
the following:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-----------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
(Gain) loss on sales of real estate $(29) $ 77 $(680) $(94)
Operating expenses, net of rental income 16 (9) 17 127
---- ---- ----- ----
Total $(13) $ 68 $(663) $ 33
==== ==== ===== ====
(8) Earnings Per Share
Basic earnings per share is computed by dividing income available to
shareholders (net income), by the weighted average number of shares of
common stock net of treasury shares outstanding during the period.
Diluted earnings per share is calculated by dividing net income by the
weighted average number of shares of common stock net of treasury
shares outstanding increased by the number of common shares that are
assumed to have been purchased with the proceeds from the exercise of
the options (treasury stock method) along with the assumed tax benefit
from the exercise of non-qualified options. These purchases were
assumed to have been made at the average market price of the common
stock, which is based on the daily closing price. Retroactive
recognition has been given to market values, common stock outstanding
and potential common shares for periods prior to the date of the
Company's stock dividends.
11
For the For the
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
Net income $ 3,127 $ 2,573 $ 6,885 $ 4,710
Less: Trust Preferred issuance costs write-off - 777 - 777
---------- ---------- ---------- ----------
Net income available to common shareholders $ 3,127 $ 1,796 $ 6,885 $ 3,933
========== ========== ========== ==========
Dilutive stock options outstanding 2,735,530 2,329,805 2,358,734 2,249,977
Average exercise price per share $ 10.17 $ 9.06 $ 9.29 $ 8.90
Average market price $ 16.94 $ 13.01 $ 15.23 $ 12.23
Average common shares outstanding 11,750,098 11,737,553 11,747,718 11,711,771
Increase in shares due to exercise of
options - diluted basis 792,779 520,227 666,954 454,735
---------- ---------- ---------- ----------
Adjusted shares outstanding - diluted 12,542,878 12,257,781 12,414,672 12,166,507
========== ========== ========== ==========
Net earnings per share - basic $ 0.27 $ 0.15 $ 0.59 $ 0.34
Net earnings per share - diluted $ 0.25 $ 0.15 $ 0.55 $ 0.32
Options that could potentially dilute basic
EPS in the future that were not included in
the computation of diluted EPS because to
do so would have been antidilutive for the
period presented 1,319 436,814 378,667 454,580
========== ========== ========== ==========
(9) Guaranteed Preferred Beneficial Interest in Company's Subordinated Debt
Guaranteed preferred beneficial interest in Company's subordinated debt
consists of the following:
June 30, 2003 December 31, 2002
------------- -----------------
Sun Trust II $29,274 $29,274
Sun Trust III 20,000 20,000
Sun Trust IV 10,000 10,000
------- -------
$59,274 $59,274
======= =======
The sole asset of Sun Trust II is $29.9 million original principal
amount of 8.875% Junior Subordinated Debentures issued by the Company.
The Company has the right to optionally redeem Sun Trust II Debentures
prior to the maturity date of December 31, 2028, on or after December
31, 2003, at 100% of the stated liquidation amount, plus accrued and
unpaid distributions, if any, to the redemption date. At June 30, 2003
and December 31, 2002, the Company had repurchased 61,300 shares.
The sole asset of Sun Trust III is $20.0 million of Floating Rate
Junior Subordinated Debentures issued by the Company. The Coupon Rate
at June 30, 2003 was 4.99%. The Company has the right to optionally
redeem Sun Trust III Debentures prior to the maturity date of April 22,
2032, on or after April 22, 2007, at 100% of the stated liquidation
amount, plus accrued and unpaid distributions, if any, to the
redemption date.
The sole asset of Sun Trust IV is $10.0 million of Floating Rate Junior
Subordinated Debentures issued by the Company. The Coupon Rate at June
30, 2003 was 4.94%. The Company has the right to optionally redeem Sun
Trust IV Debentures prior to the maturity date of October 7, 2032, on
or after July 7, 2007, at 100% of the stated liquidation amount, plus
accrued and unpaid distributions, if any, to the redemption date.
12
THE COMPANY MAY FROM TIME TO TIME MAKE WRITTEN OR ORAL "FORWARD-LOOKING
STATEMENTS," INCLUDING STATEMENTS CONTAINED IN THE COMPANY'S FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION (INCLUDING THIS QUARTERLY REPORT ON FORM 10-Q
AND THE EXHIBITS THERETO), IN ITS REPORTS TO SHAREHOLDERS AND IN OTHER
COMMUNICATIONS BY THE COMPANY, WHICH ARE MADE IN GOOD FAITH BY THE COMPANY
PURSUANT TO THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND
INTENTIONS, THAT ARE SUBJECT TO CHANGE BASED ON VARIOUS IMPORTANT FACTORS (SOME
OF WHICH ARE BEYOND THE COMPANY'S CONTROL). THE FOLLOWING FACTORS, AMONG OTHERS,
COULD CAUSE THE COMPANY'S FINANCIAL PERFORMANCE TO DIFFER MATERIALLY FROM THE
PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS EXPRESSED IN SUCH
FORWARD-LOOKING STATEMENTS: THE STRENGTH OF THE UNITED STATES ECONOMY IN GENERAL
AND THE STRENGTH OF THE LOCAL ECONOMIES IN WHICH THE COMPANY CONDUCTS
OPERATIONS; THE EFFECTS OF, AND CHANGES IN, TRADE, MONETARY AND FISCAL POLICIES
AND LAWS, INCLUDING INTEREST RATE POLICIES OF THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM, INFLATION, INTEREST RATE, MARKET AND MONETARY
FLUCTUATIONS; THE TIMELY DEVELOPMENT OF AND ACCEPTANCE OF NEW PRODUCTS AND
SERVICES OF THE COMPANY AND THE PERCEIVED OVERALL VALUE OF THESE PRODUCTS AND
SERVICES BY USERS, INCLUDING THE FEATURES, PRICING AND QUALITY COMPARED TO
COMPETITORS' PRODUCTS AND SERVICES; THE IMPACT OF CHANGES IN FINANCIAL SERVICES'
LAWS AND REGULATIONS (INCLUDING LAWS CONCERNING TAXES, BANKING, RISK-BASED
CAPITAL GUIDELINES AND REPORTING INSTRUCTIONS, SECURITIES AND INSURANCE);
TECHNOLOGICAL CHANGES; ACQUISITIONS; CHANGES IN CONSUMER SPENDING AND SAVING
HABITS; AND THE SUCCESS OF THE COMPANY AT MANAGING THE RISKS INVOLVED IN THE
FOREGOING.
THE COMPANY CAUTIONS THAT THE FOREGOING LIST OF IMPORTANT FACTORS IS NOT
EXCLUSIVE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING
STATEMENT, WHETHER WRITTEN OR ORAL, THAT MAY BE MADE FROM TIME TO TIME BY OR ON
BEHALF OF THE COMPANY.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition
Total assets at June 30, 2003 increased by $118.5 million, or 5.7% to
$2.23 billion as compared to $2.11 billion at December 31, 2002. The increase
was primarily due to an increase in investment securities of $5.9 million, in
loans receivable of $55.6 million, in other assets, consisting of the Company's
$25.0 million BOLI investment, and in cash and cash equivalents of $36.5
million. The overall increase in total assets continues to reflect the Company's
strategy on growth of its core businesses, with emphasis on commercial lending
and retail banking, while sustaining adequate liquidity, managing interest rate
risk and maintaining strong capital.
The Company completed the first phase of its branch rationalization
program. Through August 8, 2003 four branches had been sold and one branch was
consolidated into an existing office. The Company expects a further reduction,
through sales and consolidations, of seven additional branches by early 2004.
This rationalization program is part of the Company's overall strategy to
enhance the geographic coverage and market penetration of its branch network.
This strategy could result in the addition of new branches or further
divestiture of existing branches that compliment the Company's strategic
objectives of profitable growth of its core business.
Cash and cash equivalents increased $36.5 million, from $65.6 million
at December 31, 2002 to $102.1 million at June 30, 2003. This increase in end of
period balances represents a seasonal increase.
Investment securities available for sale increased $5.9 million or
0.8%, from $723.2 million at December 31, 2002 to $729.1 million at June 30,
2003. The increase in investment securities during the first six months of 2003
was consistent with the Company's asset and liability management goals which are
designed to maintain a portfolio of high quality investments which optimizes
interest income within acceptable limits of safety and liquidity.
Net loans receivable at June 30, 2003 were $1.27 billion, an increase
of $55.6 million from $1.22 billion at December 31, 2002. The increase, net of
significant loan prepayments, was primarily in commercial and industrial loans
and home equity consumer loans.
Non-performing loans were $8.8 million at June 30, 2003 compared to
$11.1 million at June 30, 2002 and $12.5 million at December 31, 2002. The ratio
of non-performing assets to total loans and other real estate was 0.73% at June
30, 2003 compared to 0.98% at June 30, 2002 and 1.08% at December 31, 2002. The
ratio of allowance for loan losses to total non-performing loans was 183.5% at
June 30, 2003 compared to 132.9% at June 30, 2002 and 131.6% at December 31,
2002.
Other assets at June 30, 2003 were $30.9 million, an increase of $23.9
million from $7.0 million at December 31, 2002. The increase was primarily from
purchase of a $25.0 million BOLI. The Company anticipates using the BOLI income
to offset existing employee benefits.
Total deposits were $1.75 billion at June 30, 2003, reflecting a $55.7
million increase over December 31, 2002. Excluding the $17.9 million decrease in
deposits resulting from the sale of a branch, total deposits increased $73.6
million. The Company's core deposits, (demand and savings deposits) increased
$64.2 million, or 5.0% while the non-core deposits (time deposits) declined $8.6
million, or 2.1%. The Company's deposit strategy stresses the importance of
building customer relationships. The Company has continued during the second
quarter 2003 to maintain its relationship pricing strategy which has enabled the
Company to increase the deposit mix with a higher concentration of core
deposits.
Advances from the Federal Home Loan Bank at June 30, 2003 were $163.3
million, a net increase of $21.0 million from $142.3 million at December 31,
2002. This net increase reflects the origination of four advances aggregating
$50.0 million with varying terms and interest rates ranging from 1.88% to 3.78%,
offset by the maturing of two $10.0 million convertible rate advances, interest
rates on these advances were 6.93% and 6.87%, and normal principal scheduled
reductions. This is in line with the Company's ALCO interest rate sensitivity
and liquidity policies.
14
Total shareholders' equity increased by $10.5 million, from $145.6
million at December 31, 2002, to $156.1 million at June 30, 2003. The increase
was primarily the result of the six months ended net income amounting to $6.9
million, and a $3.3 million increase in accumulated other comprehensive income.
Liquidity and Capital Resources
Liquidity management is a daily and long-term business function. The
Company's liquidity, represented in part by cash and cash equivalents, is a
product of its operating, investing and financing activities. Proceeds from
repayment and maturities of loans, sales and maturities of investment
securities, net income and increases in deposits and borrowings are the primary
sources of liquidity of the Company.
The Company anticipates that cash and cash equivalents on hand, the
cash flow from assets as well as other sources of funds will provide adequate
liquidity for the Company's future operating, investing and financing needs. In
addition to cash and cash equivalents of $102.1 million at June 30, 2003, the
Company has additional secured borrowing capacity with the FHLB and other
sources. The Company plans to liquidate a portion of its short-term investment
portfolio to fund the approximately $70 million of deposits anticipated to be
sold during the branch rationalization program. Management will continue to
monitor the Company's liquidity in order to maintain it at a level that is
adequate but not excessive.
The Company's largest cash flows are both investing and financing
activities. During the six months ended June 30, 2003, the Company's primary
source of cash from investing activities was the proceeds from the sale,
maturities, prepayments or calls of investment securities. The primary use of
cash from investing activities was the purchase of investment securities and the
increase in loans. Financing activities, which provided $114.5 million of net
cash, was primarily the net increase in deposits, after a branch sale, and net
borrowings under lines of credit, advances and repurchase agreements. The
activity during this period reflects the Company's continued focus on overall
balance sheet and capital management, concentrating on growth of its core
businesses, with emphasis on commercial lending and retail banking, while
managing the Company's liquidity, interest-rate risk and capital resources.
Management has developed a capital plan for the Company and the Bank
that should allow the Company and the Bank to grow capital internally at levels
sufficient for achieving its growth projections and operating and financial
risks. It is the Company's intention to maintain "well-capitalized" risk-based
capital levels. The Company has also considered a plan for contingency capital
needs, and when appropriate, the Company's Board of Directors may consider
various capital raising alternatives.
As part of its capital plan, the Company issued trust preferred
securities that qualify as Tier 1 or core capital of the Company, subject to a
25% capital limitation under risk-based capital guidelines developed by the
Federal Reserve Board. The portion that exceeds the 25% capital limitation
qualifies as Tier 2, or supplementary capital of the Company. At June 30, 2003,
of the Company's $59.3 million trust preferred securities, $49.1 million qualify
as Tier 1 capital and $10.2 million qualify as Tier 2 capital.
Comparison of Operating Results for the Three Months Ended June 30, 2003 and
2002
Net income increased by $554,000, or 21.5% for the three months ended
June 30, 2003 to $3.1 million from $2.6 million for the three months ended June
30, 2002. As more fully described below, the increase in net income was due to
an increase of $1.2 million in net interest income, a decrease of $400,000 in
the provision for loan losses and an increase of $611,000 in non-interest
income, partially offset by an increase in non-interest expenses of $1.5
million.
Net Interest Income. The interest rate spread and margin for the three
months ended June 30, 2003 of 3.18% and 3.53%, respectively, compared to 3.10%
and 3.53%, respectively, for the same period 2002. The yield on the average
interest-earning assets declined 65 basis points from 6.11% for the three months
ended June 30, 2002 to 5.46% for the same period in 2003, while the cost of
funds on average interest-bearing liabilities decreased 73 basis points from
3.01% for the three months ended June 30, 2002 to 2.28% for the same period in
2003.
The following table sets forth a summary of average balances with
corresponding interest income (on a tax-equivalent basis) and interest expense
as well as average yield and cost information for the periods presented. Average
balances are derived from daily balances.
15
At or For the Three Months ended At or For the Three Months ended
June 30, 2003 June 30, 2002
-------------------------------- --------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- --------- -------- ----------
Interest-earning assets:
Loans receivable (1), (2):
Commercial and industrial $1,071,011 $17,726 6.62 % $996,498 $17,553 7.05 %
Home equity 57,518 588 4.09 29,293 377 5.15
Second mortgage 49,209 845 6.87 54,277 1,010 7.44
Residential real estate 40,247 762 7.57 53,111 843 6.35
Installment 52,921 1,077 8.14 56,173 1,212 8.63
---------- ------- ---------- -------
Total loans receivable 1,270,906 20,998 6.61 1,189,352 20,995 7.06
Investment securities (3) 750,665 6,773 3.61 676,721 7,779 4.60
Interest-bearing deposit with banks 9,956 16 0.66 5,442 18 1.29
Federal funds sold 6,206 18 1.14 18,966 80 1.70
---------- ------- ---------- -------
Total interest-earning assets 2,037,733 27,805 5.46 1,890,481 28,872 6.11
---------- ------- ---------- -------
Cash and due from banks 63,909 59,053
Bank properties and equipment 29,498 28,314
Goodwill and intangible assets 38,184 41,011
Other assets 61,079 10,475
---------- ----------
Non-interest-earning assets 192,670 138,853
---------- ----------
Total Assets $2,230,403 $2,029,334
========== ==========
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits $680,610 2,167 1.27 % $553,541 2,684 1.94 %
Savings deposits 322,365 1,151 1.43 308,714 1,764 2.29
Time deposits 396,680 3,219 3.25 458,475 4,511 3.94
---------- ------- ---------- -------
Total interest-bearing deposit
accounts 1,399,655 6,537 1.87 1,320,730 8,959 2.71
---------- ------- ---------- -------
Borrowed money:
Repurchase agreements with customers 75,612 111 0.59 73,194 197 1.07
FHLB advances 179,921 2,091 4.65 163,135 1,933 4.74
Federal funds purchased 9,231 41 1.76 2,033 11 2.15
Other borrowed money 8,138 130 6.38
---------- ------- ---------- -------
Total borrowed money 264,764 2,243 3.39 246,500 2,271 3.68
---------- ------- ---------- -------
Guaranteed preferred beneficial
interest in Company's subordinated debt 59,274 1,048 7.08 47,286 937 7.93
---------- ------- ---------- -------
Total interest-bearing liabilities 1,723,693 9,828 2.28 1,614,516 12,167 3.01
---------- ------- ---------- -------
Non-interest-bearing demand deposits 318,936 275,284
Other liabilities 36,283 8,993
---------- ----------
Non-interest-bearing liabilities 355,219 284,277
---------- ----------
Total liabilities 2,078,912 1,898,793
Shareholders' equity 151,491 130,541
---------- ----------
Total liabilities and shareholders'
equity $2,230,403 $2,029,334
========== ==========
Net interest income $17,977 $16,705
======= =======
Interest rate spread (4) 3.18 % 3.10 %
====== =======
Net yield on interest-earning assets (5) 3.53 % 3.53 %
====== =======
Ratio of average interest-earning assets
to average interest-bearing liabilities
118.22 % 117.09%
====== ======
- ------------------------------------------------------------------------------
(1) Average balances include non-accrual loans.
(2) Loan fees are included in interest income and the amount is not material
for this analysis.
(3) Interest earned on non-taxable investment securities is shown on a tax
equivalent basis assuming a 34% marginal federal tax rate for all periods.
(4) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
16
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate) and (ii) changes in rate
(changes in rate multiplied by old average volume). The combined effect of
changes in both volume and rate has been allocated to volume or rate changes in
proportion to the absolute dollar amounts of the change in each.
Three Months Ended June 30,
2003 vs. 2002
-----------------------------------
Increase (Decrease)
Due to
-----------------------------------
Volume Rate Net
------ ---- ---
Interest income
Loans receivable:
Commercial and industrial $1,275 $(1,102) $ 173
Home equity 302 (91) 211
Second mortgage (90) (75) (165)
Residential real estate (226) 145 (81)
Installment (68) (67) (135)
------ ------- -------
Total loans receivable 1,193 (1,190) 3
Investment securities 790 (1,795) (1,005)
Interest-bearing deposits accounts 10 (12) (2)
Federal funds sold (42) (21) (63)
------ ------- -------
Total interest-earning assets $1,951 $(3,018) $(1,067)
------ ------- -------
Interest expense
Interest-bearing deposit accounts:
Interest-bearing demand deposit $ 532 $(1,049) $ (517)
Savings deposits 75 (688) (613)
Time deposits (560) (732) (1,292)
------ ------- -------
Total interest-bearing deposit accounts 47 (2,469) (2,422)
Borrowed money:
Repurchase agreements with customers 6 (92) (86)
FHLB advances 196 (38) 158
Federal funds purchased 32 (2) 30
Other borrowed money (130) (130)
------ ------- -------
Total borrowed money 104 (132) (28)
Guaranteed preferred beneficial interest
in Company's subordinated debt 220 (109) 111
------ ------- -------
Total interest-bearing liabilities $ 371 $(2,710) $(2,339)
------ ------- -------
Net change in net interest income $1,580 $ (308) $ 1,272
====== ======= =======
Net interest income (on a tax-equivalent basis) increased $1.3 million,
or 7.8% to $18.0 million for the quarter ended June 30, 2003 compared to $16.7
million for the same period in 2002. This increase is primarily due to the
change in the volume of interest-earning assets and interest-bearing
liabilities, as well as the market rate decreases between periods. From the
volume component, net interest income (on a tax-equivalent basis) increased $1.6
million, due to an increase in the average balance of interest-earning assets
which increased interest income by $2.0 million, offset by an increase in the
average balance of interest-bearing liabilities which decreased interest income
by $371,000. The change in the average balances of the interest-earning assets
and the interest-bearing liabilities reflects the Company's continued focus on
overall balance sheet management, concentration on the growth of its core
businesses, and continued focus on liquidity management. The rate component
decreased net interest income by $308,000.
17
Interest income (on a tax-equivalent basis) decreased $1.1 million, to
$27.8 million for the three months ended June 30, 2003 compared to $28.9 million
for the same period in 2002. The decrease in interest income was due to the
continued drop in interest rates, which lowered the yield on average
interest-earning assets by 65 basis points or $3.1 million, offset by the
combined 8.3% increase in the average balance of loans receivable and investment
securities which produced an increase in interest income of $2.0 million.
Interest expense decreased $2.3 million, or 19.7%, to $9.8 million for
the three months ended June 30, 2003 from $12.2 million for the same period in
2002. The decrease in interest expense was due primarily to the overall decrease
in market interest rates, which lowered the rate on average interest-bearing
liabilities by 73 basis points or $2.7 million, of which $2.5 million was a
reduction of interest expense on deposits. The decreased interest expense on
deposit is also the result of the Company's relationship pricing strategy that
has favorably increased the deposit mix to a higher concentration of lower
costing core deposits from higher costing time deposits. The average balance of
time deposits decreased from $458.5 million at June 30, 2002 to $396.7 million
at June 30, 2003, while the average balance of core deposits increased from
$862.3 million at June 30, 2002 to $1.00 billion at June 30, 2003.
Provision for Loan Losses. For the three months ended June 30, 2003,
the provision for loan losses was $710,000, a decrease of $400,000, compared to
$1.1 million for the same period in 2002. The Company focuses on its loan
portfolio management and credit review process to effectively address the
current risk profile of the portfolio and aggressively manage troubled credits.
The result was that non-performing loans have been reduced from a high of $14.6
million during 2001 to $8.8 million at June 30, 2003. Management regularly
performs an analysis to identify the inherent risk of loss in the Company's loan
portfolio. This analysis includes evaluations of concentrations of credit, past
loss experience, current economic conditions, amount and composition of the loan
portfolio, estimated fair value of underlying collateral, loan commitments
outstanding, delinquencies and other factors. The allowance for loan losses at
June 30, 2003 was $16.2 million or 1.26% of loans. This compares to the
allowance for loan losses of $14.7 million at June 30, 2002, or 1.22% of loans.
Non-Interest Income. Non-interest income increased $611,000, or 18.8%
for the three-month period ended June 30, 2003 compared to the three-month
period ended June 30, 2002. The increase was the result of an increase in the
gain on sale of investment securities of $209,000, an increase in service
charges on deposit accounts of $199,000 primarily resulting from the Company's
overdraft privilege program and an increase of $257,000 of other income, of
which $234,000 was BOLI income.
Non-Interest Expenses. Non-interest expenses increased $1.5 million, or
10.4% to $16.4 million for the three months ended June 30, 2003 as compared to
$14.9 million for the same period in 2002. Of the increase, $1.3 million was in
salaries and employee benefits due to an increase in staffing during 2002,
$196,000 was in occupancy expense and $211,000 was in equipment expense. These
increases were partially offset by a decrease in other non-interest expense of
$117,000.
Income Taxes. Applicable income taxes increased $123,000 for the three
months ended June 30, 2003 as compared to the same period in 2002. The increase
resulted from higher pre-tax earnings, partially offset by the Company's
decreased effective tax rate due primarily to the tax-free BOLI income.
Comparison of Operating Results for the Six Months Ended June 30, 2003 and 2002
Net income increased by $2.2 million, or 46.2% for the six months ended
June 30, 2003 to $6.9 million from $4.7 million for the six months ended June
30, 2002. As more fully described below, the increase in net income was due to
an increase of $3.9 million in net interest income, a decrease of $800,000 in
the provision for loan losses and an increase of $1.8 million in non-interest
income, partially offset by an increase in non-interest expenses of $3.4
million.
Net Interest Income. The increase in the interest rate spread and
margin for the six months ended June 30, 2003 of 3.20% and 3.57%, respectively,
compared to 3.00% and 3.45%, respectively, for the same period 2002. The yield
on the average interest-earning assets declined 59 basis points from 6.12% for
the six months ended June 30, 2002 to 5.53% for the same period in 2003, while
cost of funds on average interest-bearing liabilities decreased 80 basis points
from 3.12% for the six months ended June 30, 2002 to 2.32% for the same period
in 2003.
18
The following table sets forth a summary of average balances with
corresponding interest income (on a tax-equivalent basis) and interest expense
as well as average yield and cost information for the periods presented. Average
balances are derived from daily balances.
At or For the Six Months ended At or For the Six Months ended
June 30, 2003 June 30, 2002
---------------------------------- ---------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Interest-earning assets:
Loans receivable (1), (2):
Commercial and industrial $1,065,250 $35,652 6.69 % $967,503 $34,433 7.12 %
Home equity 52,253 1,086 4.15 26,907 723 5.37
Second mortgage 47,463 1,656 6.98 51,876 1,948 7.51
Residential real estate 40,664 1,527 7.51 53,847 1,793 6.66
Installment 53,053 2,183 8.23 56,591 2,432 8.59
---------- ------ ---------- ------
Total loans receivable 1,258,683 42,104 6.69 1,156,724 41,329 7.15
Investment securities (3) 748,655 13,648 3.65 675,095 15,239 4.51
Interest-bearing deposit with banks 7,816 28 0.71 7,379 46 1.25
Federal funds sold 4,888 29 1.16 15,768 133 1.69
---------- ------ ---------- ------
Total interest-earning assets 2,020,042 55,809 5.53 1,854,966 56,747 6.12
---------- ------ ---------- ------
Cash and due from banks 62,142 60,428
Bank properties and equipment 29,500 28,224
Goodwill and intangible assets 38,642 41,971
Other assets 47,582 11,839
---------- ----------
Non-interest-earning assets 177,866 142,462
---------- ----------
Total Assets $2,197,908 $1,997,428
========== ==========
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 662,448 4,252 1.28 % $ 541,007 5,259 1.94 %
Savings deposits 323,595 2,420 1.50 301,548 3,484 2.31
Time deposits 402,951 6,665 3.31 460,782 9,574 4.16
---------- ------ ---------- ------
Total interest-bearing deposit
accounts 1,388,994 13,337 1.92 1,303,337 18,317 2.81
---------- ------ ---------- ------
Borrowed money:
Repurchase agreements with 69,261 207 0.60 76,033 381 1.00
customers
FHLB advances 177,474 4,070 4.59 148,380 3,607 4.86
Federal funds purchased 8,369 72 1.72 1,376 15 2.12
Other borrowed money 5,083 153 6.03
---------- ------ ---------- ------
Total borrowed money 255,104 4,349 3.41 230,872 4,156 3.60
---------- ------ ---------- ------
Guaranteed preferred beneficial
interest in Company's subordinated debt 59,274 2,106 7.11 52,279 2,297 8.79
---------- ------ --------- ------
Total interest-bearing liabilities 1,703,372 19,792 2.32 1,586,488 24,770 3.12
---------- ------ --------- ------
Non-interest-bearing demand deposits 311,139 270,802
Other liabilities 33,841 8,975
---------- ---------
Non-interest-bearing liabilities 344,980 279,777
---------- ---------
Total liabilities 2,048,352 1,866,265
Shareholders' equity 149,556 131,163
---------- ---------
Total liabilities and shareholders'
equity $2,197,908 $1,997,428
========== ==========
Net interest income $36,017 $31,977
======= =======
Interest rate spread (4) 3.20 % 3.00 %
====== ======
Net yield on interest-earning assets (5) 3.57 % 3.45 %
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities
118.59 % 116.92 %
====== ======
- -------------------------------------------------------------------------------
(1) Average balances include non-accrual loans.
(2) Loan fees are included in interest income and the amount is not material
for this analysis.
(3) Interest earned on non-taxable investment securities is shown on a tax
equivalent basis assuming a 34% marginal federal tax rate for all periods.
(4) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
19
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate) and (ii) changes in rate
(changes in rate multiplied by old average volume). The combined effect of
changes in both volume and rate has been allocated to volume or rate changes in
proportion to the absolute dollar amounts of the change in each.
Six Months Ended June 30,
2003 vs. 2002
-------------------------------
Increase (Decrease)
Due to
-------------------------------
Volume Rate Net
------ ---- ---
Interest income
Loans receivable:
Commercial and industrial $ 5,945 $ (4,726) $ 1,219
Home equity 820 (457) 363
Second mortgage (159) (133) (292)
Residential real estate (776) 510 (266)
Installment (149) (100) (249)
------- -------- --------
Total loans receivable 5,681 (4,906) 775
Investment securities 3,652 (5,242) (1,590)
Interest-bearing deposits accounts 7 (25) (18)
Federal funds sold (72) (33) (105)
------- -------- --------
Total interest-earning assets $ 9,268 $(10,206) $ (938)
------- -------- --------
Interest expense
Interest-bearing deposit accounts:
Interest-bearing demand deposit $306 $(1,313) $ (1,007)
Savings deposits 28 (1,092) (1,064)
Time deposits (1,105) (1,804) (2,909)
------- -------- --------
Total interest-bearing deposit accounts (771) (4,209) (4,980)
Borrowed money:
Repurchase agreements with customers (31) (143) (174)
FHLB advances 517 (54) 463
Federal funds purchased 58 (1) 57
Other borrowed money (153) (153)
------- -------- --------
Total borrowed money 391 (198) 193
Guaranteed preferred beneficial interest
in Company's subordinated debt 102 (293) (191)
------- -------- --------
Total interest-bearing liabilities $ (278) $ (4,700) $ (4,978)
------- -------- --------
Net change in net interest income $ 9,546 $ (5,506) $ 4,040
======= ======== ========
Net interest income (on a tax-equivalent basis) increased $4.0 million,
or 12.5% to $36.0 million for the six months ended June 30, 2003 from $32.0
million for the same period in 2002. From the volume component, net interest
income (on a tax-equivalent basis) increased $9.5 million, the majority of this
is due to an increase in the average balance of interest-earning assets. The
rate component decreased net interest income by $5.5 million.
Interest income (on a tax-equivalent basis) decreased by $938,000, to
$55.8 million for the six months ended June 30, 2003 compared to $56.7 million
for the same period in 2002. The decrease in interest income was due to the
continued drop in interest rates, which lowered the yield on average
interest-earning assets by 59 basis points, or a $10.2 million, offset by the
combined 9.6% increase in the average balance of loans receivable and investment
securities which produced an increase in interest income of $9.3 million.
20
Interest expense decreased $5.0 million, or 20.1%, to $19.8 million for
the six months ended June 30, 2003 compared to $24.8 million for the same period
in 2002. The decrease in interest expense was due primarily to the overall
decrease in market interest rates and the change in the mix of deposits from
higher costing time deposits to lower costing core deposits. The change in the
mix of deposits is the result of the Company's relationship pricing strategy.
Retained funds from maturing higher rate customer Certificates of Deposit have
been reinvested into a lower rate product, resulting in a decreased overall cost
of funds by 80 basis points, or a decrease in interest expense of $5.0 million.
The decrease in the average balance of time deposits from $460.8 million at June
30, 2002 to $403.0 million at June 30, 2003, resulted in the decrease in the
volume component of interest expense of $1.1 million. The time deposit decrease
was offset with an increase in the average balance of core deposits from $842.6
million at June 30, 2002 to $986.0 million at June 30, 2003, resulted in the
increase in the volume component of interest expense of $334,000.
Provision for Loan Losses. For the six months ended June 30, 2003, the
provision for loan losses was $1.4 million a decrease of $800,000, compared to
$2.2 million for the same period in 2002. The Company focuses on its loan
portfolio management and credit review process to effectively address the
current risk profile of the portfolio and aggressively manage troubled credits.
This analysis includes evaluations of concentrations of credit, past loss
experience, current economic conditions, amount and composition of the loan
portfolio, estimated fair value of underlying collateral, loan commitments
outstanding, delinquencies and other factors.
Non-Interest Income. Non-interest income increased $1.8 million, or
29.7% for the six-month period ended June 30, 2003 compared to the six-month
period ended June 30, 2002. The increase was primarily the result of a gain on
sale of a branch of $1.3 million during the first quarter 2003, a $287,000
increase in service charges on deposit accounts resulting primarily from the
Company's overdraft privilege program, and an increase of $127,000 of other
income. The branch sale was part of the first phase of the Company's branch
rationalization program mentioned earlier.
Non-Interest Expenses. Non-interest expenses increased $3.4 million, or
11.9% to $31.9 million for the six months ended June 30, 2003 as compared to
$28.5 million for the same period in 2002. Of the increase, $2.6 million was in
salaries and employee benefits due to an increase in staffing during 2002,
$747,000 was in occupancy expense and $474,000 was other non-interest expense.
These increases were partially offset by the decrease in net real estate
operations of $603,000.
Income Taxes. Applicable income taxes increased $959,000 for the six
months ended June 30, 2003 as compared to the same period in 2002. The increase
resulted from higher pre-tax earnings.
Critical Accounting Policies
In management's opinion, the most critical accounting policies
impacting the Company's consolidated financial statements are the following:
Allowance for loan losses. Management carefully monitors the credit quality of
the loan portfolio and makes estimates about the amount of credit losses that
have been incurred at each financial statement date. Management evaluates the
fair value of collateral supporting the impaired loans using independent
appraisals and other measures of fair value. This process involves subjective
judgments and assumptions and is subject to change based on factors that may be
outside the control of the Company.
Accounting for income taxes. Deferred tax assets and liabilities are determined
based upon differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Management exercises
significant judgment in the evaluation of the amount and timing of the
recognition of the resulting tax liabilities and the judgments and estimates
required for the evaluation are periodically updated based upon changes in
business factors and the tax laws.
Accounting for goodwill impairment. Goodwill must be tested annually for
impairment and any resulting impairment must be charged to net income in the
year of the impairment test. The test used to determine the existence of
impairment requires estimates in the resulting calculation of impairment. Any
resulting impairment based upon estimates used by management could have a
significant impact on the Company's financial results.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset and Liability Management
The Company's exposure to interest rate risk results from the
difference in maturities and repricing characteristics of the interest-earning
assets and interest-bearing liabilities and the volatility of interest rates. If
the Company's assets have shorter maturity or repricing terms than its
liabilities, the Company's earnings will tend to be negatively affected during
periods of declining interest rates. Conversely, this mismatch would benefit the
Company during periods of increasing interest rates. Management monitors the
relationship between the interest rate sensitivity of the Company's assets and
liabilities.
Gap Analysis
Banks have become increasingly concerned with the extent to which they
are able to match maturities or repricing characteristics of interest-earning
assets and interest-bearing liabilities. Such matching is facilitated by
examining the extent to which such assets and liabilities are interest-rate
sensitive and by monitoring a bank's interest rate sensitivity gap. An asset or
liability is considered to be interest-rate sensitive if it will mature or
reprice within a specific time period. The interest rate sensitivity gap is
defined as the excess of interest-earning assets maturing or repricing within a
specific time period over interest-bearing liabilities maturing or repricing
within that time period. On a monthly basis, the Bank monitors its gap,
primarily its six-month and one-year maturities. Management and the Board of
Directors monitor the Company's gap position quarterly.
The Asset/Liability Committee of the Bank's Board of Directors discuss,
among other things, interest rate risk. The Bank also uses simulation models to
measure the impact of potential changes of up to 300 basis points in interest
rates on net interest income. Sudden changes to interest rates should not have a
material impact to results of operations. Should the Bank experience a positive
or negative mismatch in excess of the approved range, it has a number of
remedial options. The Bank has the ability to reposition its investment
portfolio to include securities with more advantageous repricing and/or maturity
characteristics. It can attract variable- or fixed-rate loan products as
appropriate. The Bank can also price deposit products to attract deposits with
maturity characteristics that can lower their exposure to interest rate risk.
At June 30, 2003, the Company had a positive position with respect to
its exposure to interest rate risk. Total interest-earning assets maturing or
repricing within one year exceeded total interest-bearing liabilities maturing
or repricing during the same time period by $157.1 million, representing a
positive cumulative one-year gap ratio of 7.04%. As a result, the cost of
interest-bearing liabilities of the Company should adjust to changes in interest
rates at a slower rate than yield on interest-earning assets of the Company.
The following table summarizes the maturity and repricing
characteristics of the Company's interest-earning assets and interest-bearing
liabilities at June 30, 2003 All amounts are categorized by their actual
maturity or repricing date with the exception of interest-bearing demand
deposits and savings deposits. As a result of prior experience during periods of
rate volatility and management's estimate of future rate sensitivities, the
Company allocates the interest-bearing demand deposits and savings deposits into
categories noted below, based on the estimated duration of those deposits.
22
Maturity/Repricing Time Periods
--------------------------------------------------------------------
0-3 Months 4-12 Months 1-5 Years Over 5 Yrs. Total
---------- ----------- --------- ----------- -----
FHLB interest-bearing deposit $ 19,087 $ 19,087
Loans receivable 465,933 $202,620 $582,399 $ 37,879 1,288,830
Investment securities 138,836 245,082 261,102 83,331 728,351
Federal funds sold 56 56
-------- -------- -------- -------- ----------
Total interest-earning assets 623,912 447,702 843,501 121,210 2,036,324
-------- -------- -------- -------- ----------
Interest-bearing demand deposits 232,363 112,881 290,140 31,084 666,468
Savings deposits 26,759 80,273 196,702 18,834 322,568
Time certificates 144,809 140,038 117,045 1,666 403,558
Federal funds purchased 27,000 27,000
Federal Home Loan Bank Advances 4,650 14,245 133,540 10,876 163,311
Securities sold under agreements
to repurchase 72,196 72,196
Guaranteed interest in Company's
subordinated debt 9,691 49,583 59,274
-------- -------- -------- -------- ----------
Total interest-bearing liabilities 517,469 397,020 737,427 62,460 1,714,376
-------- -------- -------- -------- ----------
Periodic Gap $106,443 $50,682 $106,073 $58,750 $ 321,948
======== ======== ======== ======== ==========
Cumulative Gap $106,443 $157,124 $263,198 $321,948
======== ======== ======== ========
Cumulative Gap Ratio 4.77 % 7.04 % 11.80 % 14.43 %
======== ======== ======== ========
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their evaluation
of the Company's disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")), the
Company's principal executive officer and principal financial officer have
concluded that as of the end of the period covered by this Quarterly Report on
Form 10-Q such disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.
(b) Changes in internal control over financial reporting. During the quarter
under report, there was no change in the Company's internal control over
financial reporting that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
23
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company is not engaged in any legal proceedings of a material
nature at June 30, 2003. From time to time, the Company is a party to
legal proceedings in the ordinary course of business wherein it
enforces its security interest in loans.
ITEM 2. Changes in Securities and Use of Proceeds
Not applicable
ITEM 3. Defaults upon Senior Securities
Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of the shareholders of the Company was held on May
22, 2003 and the following matters were voted on:
1) Election of directors
FOR WITHHELD
--- --------
Thomas A. Bracken 10,184,620 311,752
Bernard A. Brown 10,108,730 387,642
Ike Brown 10,280,509 215,863
Jeffrey S. Brown 10,014,239 482,133
Sidney R. Brown 9,927,799 568,573
Peter Galetto, Jr. 10,099,815 396,557
Linwood C. Gerber 10,280,618 215,754
Douglas J. Heun 10,476,533 19,839
Anne E. Koons 10,476,182 20,190
Vito J. Marseglia 10,014,239 482,133
Alfonse M. Mattia 10,476,533 19,839
Audrey S. Oswell 10,476,418 19,954
George A. Pruitt 10,391,193 105,179
Anthony Russo, III 9,998,139 498,233
Edward H. Salmon 10,390,533 105,839
John D. Wallace 10,391,193 105,179
2) Ratification of the appointment of Deloitte & Touche
LLP as the Company's Independent auditors
FOR AGAINST ABSTAINED
--- ------- ---------
10,414,095 74,707 7,570
ITEM 5. Other Information
Not applicable
ITEM 6. Exhibits and Reports on Form 8-K
Exhibit 31 Certification Pursuant to ss.302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32 Certification Pursuant to ss.906 of the Sarbanes-Oxley Act
of 2002.
Form 8-K The Company filed a Current Report on Form 8-K on July 17,
2003 to report earnings for the quarter ended June 30, 2003
24
SIGNATURES
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.
Sun Bancorp, Inc.
-----------------
(Registrant)
/s/Thomas A. Bracken
--------------------
Date: August 13, 2003 Thomas A. Bracken
President and Chief Executive Officer
Date: August 13, 2003 /s/Dan A. Chila
---------------
Dan A. Chila
Executive Vice President and
Chief Financial Officer
25