SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 2)
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
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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 No. 0-20957
Sun Bancorp, Inc.
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(Exact Name of Registrant as Specified in Its Charter)
New Jersey 52-1382541
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
226 Landis Avenue, Vineland, New Jersey 08360
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (856) 691-7700
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Securities registered pursuant to Section 12(b) of the Exchange Act: None
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Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $1.00 par value
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(Title of Class)
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 .
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES X NO .
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The aggregate market value of the voting stock held by non-affiliates of
the registrant, based on the closing price of the registrant's Common Stock on
June 28, 2002, was approximately $98.3 million.
As of March 21, 2003 there were issued and outstanding 11,185,561 shares of
the registrant's Common Stock.
PART I
SUN BANCORP, INC. (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
ANNUAL REPORT ON FORM 10-K AND THE EXHIBITS HERETO), 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, 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, 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.
Item 1. Business
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General
The Company, a New Jersey corporation, is a bank holding company
headquartered in Vineland, New Jersey. The Company's principal subsidiary is Sun
National Bank (the "Bank"). At December 31, 2002, the Company had total assets
of $2.1 billion, total deposits of $1.7 billion
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and total shareholders' equity of $145.6 million. Substantially all of the
Company's deposits are federally insured by the Bank Insurance Fund ("BIF"),
which is administered by the Federal Deposit Insurance Corporation ("FDIC"). The
Company's remaining deposits are federally insured by the Savings Association
Insurance Fund ("SAIF"), administered by the FDIC. The Company's principal
business is to serve as a holding company for the Bank. As a registered bank
holding company, the Company is subject to the supervision and regulation of the
Board of Governors of the Federal Reserve System (the "Federal Reserve").
Through the Bank, the Company provides consumer and business banking
services through five Regional Banking Groups and 75 Community Banking Centers
in Southern and Central New Jersey, in the contiguous New Castle County market
in Delaware, and in Philadelphia, Pennsylvania. The Bank offers comprehensive
lending, depository and financial services to its customers and marketplace. The
Bank's lending services to businesses include commercial and industrial loans
and commercial real estate loans. The Bank's commercial deposit services include
checking accounts and cash management products such as electronic banking, sweep
accounts, lockbox services, Internet banking, PC banking and controlled
disbursement services. The Bank's lending services to consumers include
residential mortgage loans, home equity loans and installment loans. The Bank's
consumer services include checking accounts, savings accounts, money market
deposits, certificates of deposit and individual retirement accounts. Through a
third party arrangement, the Bank also offers mutual funds, securities
brokerage, annuities and investment advisory services. The Bank also offers
equipment leasing and SBA loans and is a designated Preferred Lender with the
New Jersey Economic Development Authority.
The Company's website address is www.sunnb.com. The Company's annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and other documents filed by the Company with the Securities and Exchange
Commission are available free of charge on the Company's website under the
Investor Relations menu.
Market Area
The Bank provides a wide variety of financial services through 75 Community
Banking Centers in five Regional Banking Groups that strategically define its
market area. The Bank's Southern Region consists of Atlantic, Cape May,
Cumberland and Salem Counties in southern New Jersey; the Eastern Region
includes Ocean and Monmouth Counties; the Northern Region includes Mercer,
Middlesex, Somerset and Hunterdon Counties in central New Jersey; the Western
Region consists of Burlington, Camden and Gloucester Counties in New Jersey and
Philadelphia, Pennsylvania; and the Delaware Region is New Castle County in
Delaware. Together these counties constitute the Bank's "primary market area."
The Bank's deposit gathering base and lending area is concentrated in the
communities surrounding its offices.
The Bank is headquartered in Cumberland County, New Jersey. The city of
Vineland is approximately 30 miles southeast of Philadelphia, Pennsylvania, and
30 miles southeast of Camden, New Jersey. The Philadelphia International Airport
is approximately 45 minutes from Vineland.
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The central and southern New Jersey areas are among the fastest growing
population areas in New Jersey and have a significant number of retired
residents who have traditionally provided the Bank with a stable source of
deposit funds. The economy of the Bank's primary market area is based upon a
mixture of the agriculture, transportation, manufacturing and tourism trade -
including a substantial casino industry in Atlantic City, New Jersey and support
businesses throughout the Bank's primary market area. These areas are also home
to commuters working in New Jersey suburban areas and in Atlantic City, as well
as in New York and Philadelphia.
Of the Bank's Delaware branches, three are in Wilmington, Delaware which is
approximately 25 miles southwest of Philadelphia, Pennsylvania. The Philadelphia
International Airport is approximately 30 minutes from Wilmington.
Employment is concentrated in the services, manufacturing, retail trade,
finance, insurance and real estate sectors of the economy. The county contains a
disproportionate share of the state's employment and payroll.
Management considers the Bank's strategic positioning to be the
decentralizing of management and authority into five Regional Banking Groups.
Regional teams of experienced managers, lenders and relationship officers from
the Bank's three divisions, Commercial, Small Business and Community Banking,
are headquartered within each region and are empowered with resources and local
decision-making authority. They work together as a team, in partnership with
local Community Banking Centers in the region, to coordinate a high level of
service to local consumer, business, government and institutional customers.
Each Regional Banking Group operates essentially as a local community bank with
a local community focus on serving the specific needs of the local area and
building lasting relationships with customers.
Lending Activities
General. The principal lending activity of the Bank is the origination of
commercial real estate loans, commercial business and industrial loans, home
equity loans, mortgage loans and, to a much lesser extent, installment loans.
Substantially all loans are originated in the Bank's primary market area.
Commercial and Industrial Loans. The Bank originates several types of
commercial, industrial, and small business loans. Included as commercial and
small business loans are short- and long-term business loans, lines of credit,
non-residential mortgage and small business loans and real estate construction
loans. The Bank's Commercial Banking division serves companies with annual
revenue in excess of $5 million and credit needs over $1.5 million. The Bank's
Small Business Banking division serves business with annual revenues of up to $5
million and credit needs up to $1.5 million. The Bank's primary focus is the
origination of commercial loans secured by real estate. The majority of the
Bank's customers for these loans are small- to medium-sized businesses located
in the southern and central parts of New Jersey and New Castle County, Delaware.
4
A significant portion of the Bank's commercial and industrial loans are
concentrated in the hospitality, entertainment and leisure industries. Many of
these industries are dependent upon seasonal business and other factors beyond
the control of the industries, such as weather and beach conditions along the
New Jersey seashore. Any significant or prolonged adverse weather or beach
conditions along the New Jersey seashore could have an adverse impact on the
borrowers' ability to repay loans. In addition, because these loans are
concentrated in southern and central New Jersey, a decline in the general
economic conditions of southern or central New Jersey and the impact on
discretionary consumer spending could have a material adverse effect on the
Company's financial condition, results of operations and cash flows.
Commercial Real Estate Loans. Loans secured by commercial properties
generally involve a greater degree of risk than residential mortgage loans and
carry larger loan balances. This increased credit risk is a result of several
factors, including the concentration of principal in a limited number of loans
and borrowers, the effects of general economic conditions on income- producing
properties and the greater difficulty of evaluating and monitoring these types
of loans. A significant portion of the Bank's commercial real estate and
commercial and industrial loan portfolios includes a balloon payment or
repricing feature. A number of factors may affect a borrower's ability to make
or refinance a balloon payment, including without limitation the financial
condition of the borrower at the time, the prevailing local economic conditions,
and the prevailing interest rate environment. There can be no assurance that
borrowers will be able to make or refinance balloon payments when due.
Furthermore, the repayment of loans secured by commercial real estate is
typically dependent upon the successful operation of the related real estate or
commercial project. If the cash flow from the project is reduced, the borrower's
ability to repay the loan may be impaired. This cash flow shortage may result in
the failure to make loan payments. In such cases, the Bank may be compelled to
modify the terms of the loan. In addition, the nature of these loans is such
that they are generally less predictable and more difficult to evaluate and
monitor. As a result, repayment of these loans may be subject to a greater
extent than residential loans to adverse conditions in the real estate market or
economy.
Home Equity Loans. The Bank originates home equity loans, secured by first
or second mortgages owned or being purchased by the loan applicant. Home equity
loans are consumer revolving lines of credit. The interest rate charged on such
loans is usually a floating rate related to the prime lending rate. Home equity
loans may provide for interest only payments for the first two years with
principal payments to begin in the third year. A home equity loan is typically
originated as a fifteen-year note that allows the borrower to draw upon the
approved line of credit during the same period as the note. The Bank generally
requires a loan-to-value ratio in the range of 70% to 80% of the appraised
value, less any outstanding mortgage. Although home equity lines of credit
expose the Company to the risk that falling collateral values may leave it
inadequately secured, the Company has not had any significant adverse experience
to date.
Residential Real Estate Loans. The Bank uses outside loan correspondents to
originate residential mortgages. These loans are originated using the Investor's
underwriting standards, rates and terms, and are approved according to the
Purchaser/Investor's lending policy prior to origination. Prior to closing, the
Bank usually has commitments to sell these loans, at par and without recourse,
in the secondary market. Secondary market sales are generally scheduled to close
shortly after the origination of the loan.
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The majority of the Bank's residential mortgage loans consist of loans
secured by owner- occupied, single-family residences. The Bank's mortgage loan
portfolios consist of both fixed-rate and adjustable-rate loans secured by
various types of collateral as discussed below. Management generally originates
residential mortgage loans in conformity with Federal National Mortgage
Association ("FNMA") standards so that the loans will be eligible for sale in
the secondary market. Management expects to continue offering mortgage loans at
market interest rates, with substantially the same terms and conditions as it
currently offers.
The retention of adjustable-rate mortgage loans in the Bank's loan
portfolio helps mitigate risk to changes in interest rates. However, there are
unquantifiable credit risks resulting from potential increased costs to the
borrower as a result of repricing adjustable-rate mortgage loans. It is possible
that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest costs to the borrower. Further, although adjustable-rate mortgage loans
allow the Bank to increase the sensitivity of its asset base to changes in
interest rates, the extent of this interest sensitivity is limited by the
periodic and lifetime interest rate adjustment limitations. Accordingly, there
can be no assurance that yields on adjustable-rate mortgages will adjust
sufficiently to compensate for increases in the Bank's cost of funds during
periods of extreme interest rate increases.
The Bank's residential mortgage loans customarily include due-on-sale
clauses, which are provisions giving the Bank the right to declare a loan
immediately due and payable in the event, among other things, that the borrower
sells or otherwise disposes of the real property serving as security for the
loan. Due-on-sale clauses are an important means of adjusting the rates on the
Bank's fixed-rate mortgage portfolios. The Bank usually exercises its right
under these clauses.
Installment Loans. The Bank also originates installment or consumer loans
secured by a variety of collateral, such as new and used automobiles. At
December 31, 2002, the Bank had $6,151,519 of unsecured installment loans.
Installment or consumer loans may entail greater risk than residential
loans, particularly in the case of consumer loans that are unsecured or secured
by assets that depreciate rapidly. Repossessed collateral for a defaulted
consumer loan may not be sufficient for repayment of the outstanding loan, and
the remaining deficiency may not be collectible.
Third Party Consumer Portfolio. The Bank has a Modular Housing Portfolio
with $25,468,069 in loans outstanding as of December 31, 2002. This activity is
generated through a third party arrangement, which began in 1990. These loans
are originated using the Bank's underwriting standards, rates and terms and are
approved according to the Bank's policies.
The credit quality risk in the Modular home portfolio is managed like any
other consumer portfolio through Loan to Value requirements, Debt to Income
ratios and credit history of the borrower. Historically, the Modular home
business was viewed as a high risk lending with dealers with little to no net
worth, although this view is changing. The newer Modular parks, many of which
are retirement communities are well managed and the quality of the credit
suggest that there is good business when properly structured. The risk is
further mitigated with having the full recourse of the vendor and reserves to
support possible charge backs. The Bank anticipates the outstanding balances of
the Modular home portfolio to decrease with normal loan repayments and does not
anticipate significant originations of modular home lending in the future.
The Bank has a mature portfolio from previous third party relationships
that are no longer active in generating new business. These loans are centered
in manufactured homes, campgrounds and recreational vehicles. At December 31,
2002, the Bank had $3,823,521 of loans outstanding.
Loan Solicitation and Processing. Loan originations are derived from a
number of sources such as loan officers, customers, borrowers and referrals from
real estate brokers, accountants, attorneys and regional advisory boards.
Upon receipt of a loan application, a credit report is ordered and reviewed
to verify specific information relating to the loan applicant's
creditworthiness. For residential mortgage loans, written verifications of
employment and deposit balances are requested by the Bank. The Bank requires
that an appraisal of the real estate intended to secure the proposed loan is
undertaken by a certified independent appraiser approved by the Bank and
licensed by the state. After all of the required information is obtained, a
credit decision is made. Depending on the type, collateral and amount of the
credit request, various levels of approval may be necessary. The Bank has
implemented a Loan Approval Matrix (LAM) which was devised to facilitate the
timely approval of commercial loans in an environment that promotes responsible
use of lending authority by groups of loan and credit officers acting in
concert. In terms of control, the LAM is structured to provide for at least two
signatures for every action.
On an annual basis, the Chief Executive Officer presents to the Board of
Directors the recommended structure of the LAM in terms of the amounts of
lending authority granted to combining levels. On that same occasion, the Chief
Executive Officer also recommends levels of
6
lending authority within the matrix for individual loan and credit officers.
Between the annual reviews of lending authorities by the Board of Directors, the
Chief Executive Officer assigns interim lending authorities within the LAM to
individual loan and credit officers and reports his actions to the Board in a
timely fashion.
Levels of individual lending authority are based on the functional
assignment of a loan officer as well as the officer's perceived level of
expertise and areas of experience.
The positions of credit officer (CO) and senior credit officer (SCO) are an
integral feature of the LAM process. CO's and SCO's are granted substantial
levels of authority but do not carry a portfolio. These individuals are
collectively responsible for maintaining the quality and soundness of the Bank's
loan portfolio.
Title insurance policies are generally required on all first mortgage
loans. Hazard insurance coverage is required on all properties securing loans
made by the Bank. Flood insurance is also required, when applicable.
Loan applicants are notified of the credit decision by letter. If the loan
is approved, the loan commitment specifies the terms and conditions of the
proposed loan including the amount, interest rate, amortization term, a brief
description of the required collateral, and the required insurance coverage. The
borrower must provide proof of fire, flood (if applicable) and casualty
insurance on the property serving as collateral, which insurance must be
maintained during the full term of the loan.
Loan Commitments. When a commercial loan is approved, the Bank issues a
written commitment to the loan applicant. The commitment indicates the loan
amount, term and interest rate and is valid for approximately 45 days.
Approximately 90% of the Bank's commitments are accepted or rejected by the
customer before the expiration of the commitment. At December 31, 2002, the Bank
had approximately $215.0 million in commercial loan commitments outstanding.
Credit Risk, Credit Administration and Loan Review. Credit risk represents
the possibility that a customer or counterparty may not perform in accordance
with contractual terms. The Bank incurs credit risk whenever it extends credit
to, or enters into other transactions with, customers. The risks associated with
extensions of credit include general risk, which is inherent in the lending
business, and risk specific to individual borrowers. The credit administration
department is responsible for the overall management of the Bank's credit risk
and the development, application and enforcement of uniform credit policies and
procedures the principal purpose of which is to minimize such risk. One
objective of credit administration is to identify and, to the extent feasible,
diversify extensions of credit by industry concentration, geographic
distribution and the type of borrower. Loan review and other loan monitoring
practices provide a means for management to ascertain whether proper credit,
underwriting and loan documentation policies, procedures and practices are being
followed by the Bank's loan officers and are being applied uniformly. While
management continues to review these and other related functional areas, there
can be no assurance that the steps the Bank has taken to date will be sufficient
to enable it to identify, measure, monitor and control all credit risk.
Item 3. Legal Proceedings
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The Company or the Bank is periodically involved in various claims and
lawsuits, such as claims to enforce liens, condemnation proceedings on
properties in which the Bank holds security interests, claims involving the
making and servicing of real property loans, and other issues incident to the
Company's and the Bank's business. While the ultimate outcome of these
proceedings cannot be predicated with certainty, management, after consultation
with counsel representing the Company in these proceedings, does not expect that
the resolution of these proceedings will have a material effect on the Company's
financial condition, results of operations or cash flows. In addition,
management was not aware of any pending or threatened material litigation as of
December 31, 2002.
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PART II
Item 6. Selected Financial Data
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At or for the Years Ended December 31,
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2002 2001 2000 1999 1998
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(Dollars in thousands, except per share amounts)
Selected Balance Sheet Data:
Assets $2,112,172 $1,929,425 $2,002,529 $1,980,861 $1,515,404
Cash and investments 800,425 739,201 848,421 948,898 739,274
Loans receivable (net) 1,217,008 1,089,605 1,031,844 901,211 690,002
Deposits 1,690,462 1,572,338 1,410,867 1,291,326 1,025,398
Borrowings and securities sold
under agreements to repurchase 205,280 160,096 407,279 528,752 337,665
Guaranteed preferred beneficial
interest in Company's
subordinated debt 59,274 57,327 57,327 57,838 58,650
Shareholders' equity 145,623 129,960 117,634 91,104 78,333
Selected Results of Operations:
Interest income $112,894 $126,825 $150,656 $114,254 $82,789
Net interest income 65,038 56,758 61,248 53,174 37,695
Provision for loan losses 4,175 7,795 2,580 1,989 2,133
Net interest income after
provision for loan losses 60,863 48,963 58,668 51,185 35,562
Non-interest income 13,178 10,516 8,183 9,751 7,400
Non-interest expense 58,965 57,695 54,447 46,955 30,447
Net income 10,378 1,328 8,780 9,714 8,784
Per Share Data:
Net earnings
Basic (1) $ 0.86 $ 0.12 $ 0.82 $0.98 $1.12
Diluted (1) $ 0.83 $ 0.12 $ 0.81 $0.91 $0.99
Book Value $13.02 $11.73 $10.91 $8.57 $9.01
Selected Ratios:
Return on average assets 0.50% 0.07% 0.43% 0.58% 0.75%
Return on average equity 7.63% 1.05% 8.85% 11.08% 14.29%
Ratio of average equity to average assets 6.55% 6.42% 4.86% 4.26% 5.24%
(1) - Beginning in 2002, new accounting standards eliminated the amortization of
goodwill, which is included in previous years' net earnings and returns. See
Note 2 of the Notes to Consolidated Financial Statements contained herein for
further discussion.
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(All dollar amounts presented in the tables,
except per share amounts, are in thousands)
Critical Accounting Policies, Judgments and Estimates
The discussion and analysis of the financial condition and results of operations
are based on the Consolidated Financial Statements, which are prepared in
conformity with generally accepted accounting principles. The preparation of
these financial statements requires management to make estimates and assumptions
affecting the reported amounts of assets, liabilities, revenue and expenses.
Management evaluates these estimates and assumptions on an ongoing basis,
including those related to the allowance for loan losses, income taxes and
goodwill. Management bases its estimates on historical experience and various
other factors and assumptions that are believed to be reasonable under the
circumstances. These form the bases for making judgments on the carrying value
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Allowance for loan losses. Through the Bank, the Company originates loans that
it intends to hold for the foreseeable future or until maturity or repayment.
The Bank may not be able to collect all principal and interest due on these
loans. Allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan portfolio as of the balance sheet date.
Management performs regular reviews in order to identify inherent losses and to
assess the overall credit risk of the portfolio. The allowance for loan losses
is determined by management based upon past experience, evaluation of estimated
loss and impairment in the loan portfolio, current economic conditions and other
pertinent factors. The allowance for loan losses is maintained at a level that
management considers adequate to provide for estimated losses and impairment
based upon an evaluation of known and inherent risk in the loan portfolio. Loan
impairment is evaluated based on the fair value of collateral or estimated net
realizable value. While management uses the best information available to make
such evaluations, future adjustments to the allowance may be necessary if
economic conditions differ substantially from the assumptions used in making the
evaluations. The determination of the allowance for loan losses involves the
monitoring of delinquency, default and historical loss experience. Management
makes estimates and assumptions regarding existing but yet unidentified losses
caused by current economic conditions and other factors. If the Bank does not
adequately reserve for these uncollectible loans, it may incur additional
charges to loan losses in the consolidated financial statements.
In determining our allowance for loan losses, management has established both
specific and general pooled allowances. The amount of the specific allowance is
determined through a loan-by-loan analysis of certain large dollar commercial
loans. Loans not individually reviewed are evaluated as a group using expected
loss ratios, which are based on our historical charge-off experience and current
market and economic conditions. In determining the appropriate level of the
general pooled allowance and projecting losses management makes estimates based
on internal risk ratings, which take into account such factors as debt service
coverage, loan to value ratios and cost and timing of collateral repossession
and disposal. Estimates are periodically measured against actual loss
experience. Adjustments are made to future projections as assumptions are
revised.
The determination of the allowance for loan losses requires management to make
significant estimates with respect to the amounts and timing of losses and
market and economic conditions. Accordingly, a decline in the national economy
or the local economies of the areas in which the Bank's loans are concentrated
could result in an increase in loan delinquencies, foreclosures or repossessions
resulting in increased charge-off amounts and the need for additional loan loss
allowances in future periods. The Bank will continue to monitor its allowance
for loan losses and make future adjustments to the allowance through the
provision for loan losses as economic conditions and other factors dictate.
Although the Bank maintains its allowance for loan losses at levels considered
adequate to provide for the inherent risk of loss in its loan portfolio, there
can be no assurance that future losses will not exceed estimated amounts or that
additional provisions for loan losses will not be required in future periods. In
addition, the Bank's determination as to the amount of its allowance for loan
losses is subject to review by its primary regulator, the Office of the
Comptroller of the Currency (the "OCC"), as part of its examination process,
which may result in the establishment of an additional allowance based upon the
judgment of the OCC after a review of the information available at the time of
the OCC examination.
In July 2001, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 102, Selected Loan Loss Allowance Methodology
and Documentation Issues. SAB No. 102 expresses the SEC staff's views on the
development, documentation and application of a systematic methodology for
determining the allowance for loan losses in accordance with accounting
principles generally accepted in the United States of America. In addition, in
July 2001, the federal banking agencies issued guidance on this topic through
the Federal Financial Institutions Examination Council interagency guidance,
Policy Statement on Allowance for Loan and Lease Losses Methodologies and
Documentation for Banks and Savings Institutions. In management's opinion, the
Bank's methodology and documentation of the allowance for loan losses meets the
guidance issued.
Accounting for income taxes. The Company accounts for income taxes in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 109, which
requires the recording of deferred income taxes that reflect the net tax effects
of temporary differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax purposes.
Management exercises significant judgment in the evaluation of the amount and
timing of the recognition of the resulting tax assets and liabilities and the
judgments and estimates required for the evaluation are periodically updated
based upon changes in business factors and the tax laws.
Valuation of goodwill. The Company assessed the impairment of goodwill at least
annually, and whenever events or significant changes in circumstance indicate
that the carrying value may not be recoverable. Factors that the Company
considers important in determining whether to perform an impairment review
include significant under performance relative to forecasted operating results
and significant negative industry or economic trends. If the Company determines
that the carrying value of goodwill may not be recoverable, then the Company
will assess impairment based on a projection of undiscounted future cash flows
and measure the amount of impairment based on fair value. In the fourth quarter
2002, the Company performed, with the assistance of an independent third party
other than its independent auditors, its annual impairment test of goodwill as
required under the SFAS Nos. 142 and 147. Such testing is based upon a number of
factors, which are based upon assumptions and management judgments. These
factors include among other things, future growth rates, discount rates and
earnings capitalization rates. The test indicated that no impairment charge was
necessary for the year ending December 31, 2002.
Overview
Sun Bancorp, Inc. (the "Company") is a bank holding company headquartered in
Vineland, New Jersey. The Company's principal subsidiary is Sun National Bank
(the "Bank"). At December 31, 2002, the Company had total assets of $2.1
billion, total deposits of $1.7 billion and total shareholders' equity of $145.6
million. The Company's principal business is to serve as a holding company for
the Bank. As a registered bank holding company, the Company is subject to the
supervision and regulation of the Board of Governors of the Federal Reserve
System (the "Federal Reserve").
Through the Bank, the Company provides consumer and business banking services
through five regional banking groups and 75 community banking centers located in
13 counties in Southern and Central New Jersey, in the contiguous New Castle
County market in Delaware, and in Philadelphia, Pennsylvania. Through local
management personnel with community knowledge, each regional banking group is
comprised of three functional business lines, commercial, small business and
community banking that are empowered with localized decision-making to better
serve their communities.
The Bank offers comprehensive lending, depository and financial services to its
customers and marketplace. The Bank's lending services to businesses include
commercial, commercial real estate, and small business loans. The Bank's
commercial deposit services include business checking accounts, and cash
management services such as electronic banking, sweep accounts, lock box
services, Internet banking, PC banking and controlled disbursement services. The
Bank's lending services to retail customers include home equity loans,
residential mortgage loans, and installment loans. The Bank funds these lending
activities primarily through retail deposits, repurchase agreements with
customers and advances from the Federal Home Loan Bank. The Bank's retail
deposit services include checking accounts, savings accounts, money market
deposits, certificates of deposit and individual retirement accounts. Through a
third-party arrangement, the Bank also offers mutual funds, securities
brokerage, annuities and investment advisory services. The Bank also offers
equipment leasing and SBA loans and is a designated Preferred Lender with the
New Jersey Economic Development Authority.
The Bank made significant progress in 2002 and management believes that the Bank
is positioned to become a top performing regional community bank. Difficult
economic times for the banking industry during 2002 were compounded by record
low rates and shrinking margins that tested balance sheets and portfolios. The
Bank not only weathered these challenges but also saw the success of its
repositioning strategy improve performance across the Company. The Bank's
regionalized and relationship banking approach combined with basic banking
fundamentals are reflected by the improved performance in growth of loans,
deposits and non-interest income.
The following discussion focuses on the major components of the Company's
operations and presents an overview of the significant changes in the results of
operations for the past three years and financial condition during the past two
fiscal years. This discussion should be reviewed in conjunction with the
Consolidated Financial Statements and notes thereto presented elsewhere in this
Annual Report.
RESULTS OF OPERATIONS
Net income for the year ended December 31, 2002 was $10.4 million, or $0.83 per
share, in comparison to $1.3 million, or $0.12 per share for the year ended
December 31, 2001. As more fully described below, the 681.5% increase in net
income was attributable to an increase in net interest income of $8.3 million, a
decrease in provision for loan losses of $3.6 million, an increase in
non-interest income of $2.7 million and the elimination of goodwill amortization
during 2002 of $3.6 million. These increases to net income were partially offset
by an increase in non-interest expense of $970,000 and an increase in income tax
expense of $4.5 million compared to the results of operations for 2001.
Net income for the year ended December 31, 2001 was $1.3 million, or $0.12 per
share, in comparison to $8.8 million, or $0.81 per share for the year ended
December 31, 2000. The decrease in net income was attributable to a decrease in
net interest income of $4.5 million, an increase in provision for loan losses of
$5.2 million and an increase in non-interest expense of $3.5 million. These
decreases to net income were partially offset by an increase in non-interest
income of $2.3 million and a decrease in income tax expense of $3.5 million.
Net Interest Income. Net interest income is the most significant component of
the Company's income from operations. Net interest income is the difference
between interest earned on interest-earning assets (primarily loans and
investment securities)
9
and interest paid on interest-bearing liabilities (primarily deposits and
borrowed funds). Net interest income depends on the volume and interest rate
earned on interest-earning assets and the volume and interest rate paid on
interest-bearing liabilities.
The following table sets forth a summary of average daily balances with
corresponding interest income and interest expense as well as average yield and
cost information for the periods presented.
Years Ended December 31,
------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------- ---------------------------- ----------------------------
Avg. Avg. Avg.
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- ------- ----- ------- -------- ---- ------- -------- ----
Loans receivable (1), (2):
Commercial and industrial $991,715 $70,134 7.07% $882,464 $71,866 8.14% $824,669 $73,834 8.95%
Home equity 32,756 1,651 5.04 23,847 1,956 8.20 25,370 2,621 10.33
Second mortgage 51,751 3,874 7.49 41,847 3,392 8.11 31,054 2,553 8.22
Residential real estate 50,542 3,384 6.70 53,572 3,985 7.44 52,122 4,171 8.00
Installment 55,508 4,779 8.61 60,118 5,401 8.98 54,106 5,174 9.56
--------- ------- ---------- ------- ---------- -------
Total loans receivable 1,182,272 83,822 7.09 1,061,848 86,600 8.16 987,321 88,353 8.95
Investment securities (3) 682,433 29,346 4.30 692,927 39,423 5.69 893,268 62,661 7.01
Interest-bearing deposit with banks 10,318 88 0.85 12,013 323 2.69 5,095 417 8.18
Federal funds sold 44,891 703 1.57 39,388 1,468 3.73 8,779 595 6.78
--------- ------- ---------- ------- ---------- -------
Total interest-earning assets 1,919,914 113,959 5.94 1,806,176 127,814 7.08 1,894,463 152,026 8.02
Non-interest-earning assets:
Cash and due from banks 60,705 62,837 62,443
Bank properties and equipment 28,634 28,865 30,570
Goodwill and intangible assets 40,076 49,071 57,039
Other assets, net 28,366 17,746 (4,625)
---------- ---------- ----------
Total non-interest-earning assets 157,781 158,519 145,427
---------- ---------- ----------
Total assets $2,077,695 $1,964,695 $2,039,890
========== ========== ==========
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 584,808 10,789 1.84 $ 431,196 12,412 2.88 $ 336,773 12,321 3.66
Savings deposits 314,208 6,821 2.17 214,849 5,929 2.76 154,091 3,418 2.22
Time deposits 449,438 17,493 3.89 593,352 33,917 5.72 643,971 37,310 5.79
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
deposits 1,348,454 35,103 2.60 1,239,397 52,258 4.22 1,134,835 53,049 4.67
---------- ------- ---------- ------- ---------- -------
Borrowed money:
Repurchase agreements with
customers 74,602 739 0.99 82,318 2,436 2.96 79,224 4,446 5.61
Repurchase agreements with FHLB - - - 129,098 6,456 5.00 334,007 21,354 6.39
FHLB advances 147,130 7,347 4.99 52,789 3,413 6.47 73,101 4,629 6.33
Federal funds purchased 682 15 2.20 534 30 5.62 5,790 441 7.62
Other borrowed money 3,242 171 5.27 1,160 36 3.10 1,160 52 4.48
---------- ------- ---------- ------- ---------- -------
Total borrowed money 225,656 8,272 3.67 265,899 12,371 4.65 493,282 30,922 6.27
Guaranteed preferred beneficial
interest in Company's
subordinated debt 55,536 4,481 8.07 57,327 5,438 9.49 57,344 5,437 9.48
---------- ------- ---------- ------- ---------- -------
Total interest-bearing
liabilities 1,629,646 47,856 2.94 1,562,623 70,067 4.48 1,685,461 89,408 5.30
---------- ------- ---------- ------- ---------- -------
Non-interest-bearing demand deposits 287,164 265,569 245,989
Other liabilities 24,788 10,299 9,273
---------- ---------- ----------
Non-interest-bearing
liabilities 311,952 275,868 255,262
---------- ---------- ----------
Total liabilities 1,941,598 1,838,491 1,940,723
---------- ---------- ----------
Shareholders' equity 136,097 126,204 99,167
---------- ---------- ----------
Total liabilities and
shareholders' equity $2,077,695 $1,964,695 $2,039,890
========== ========== ==========
Net interest income $66,103 $57,747 $62,618
======= ======= =======
Interest rate spread (4) 3.00% 2.60% 2.72%
====== ====== ======
Net yield on interest-earning assets(5) 3.44% 3.20% 3.31%
====== ====== ======
Ratio of average interest-earning
assets to average interest-bearing
liabilities 117.81% 115.59% 112.40%
====== ====== ======
- --------------------------------------------------------------------------------
(1) Average balances include non-accrual loans (see "Non-Performing and Problem
Assets").
(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.
10
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.
Years Ended December 31,
-------------------------------------------------------------------------
2002 vs. 2001 2001 vs. 2000
------------------------------------- ---------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------- ---------------------------------
Volume Rate Net Volume Rate Net
-------- -------- -------- -------- -------- --------
Interest income:
Loans receivable:
Commercial and industrial $ 8,330 $(10,062) $ (1,732) $ 4,970 $ (6,938) $ (1,968)
Home equity 592 (897) (305) (150) (515) (665)
Second mortgage 756 (274) 482 876 (37) 839
Residential real estate (217) (384) (601) 114 (300) (186)
Installment (403) (219) (622) 553 (326) 227
-------- -------- -------- -------- -------- --------
Total loans receivable 9,058 (11,836) (2,778) 6,363 (8,116) (1,753)
Investment securities (589) (9,488) (10,077) (12,613) (10,625) (23,238)
Interest-bearing deposit with banks (40) (195) (235) 311 (405) (94)
Federal funds sold 182 (947) (765) 1,248 (375) 873
-------- -------- -------- -------- -------- --------
Total interest-earning assets $ 8,611 $(22,466) $(13,855) $ (4,691) $(19,521) $(24,212)
-------- -------- -------- -------- -------- --------
Interest expense:
Deposit accounts:
Demand deposits $ 301 $ (1,924) $ (1,623) $ 3,036 $ (2,945) $ 91
Savings deposits 1,043 (151) 892 1,551 960 2,511
Time deposits (7,093) (9,331) (16,424) (2,899) (494) (3,393)
-------- -------- -------- -------- -------- --------
Total deposits accounts (5,749) (11,406) (17,155) 1,688 (2,479) (791)
Borrowings:
Repurchase agreements with customers (210) (1,487) (1,697) 167 (2,177) (2,010)
Repurchase agreements with FHLB (6,456) -- (6,456) (10,994) (3,904) (14,898)
FHLB advances 3,834 100 3,934 (1,312) 96 (1,216)
Federal funds purchased (2) (13) (15) (316) (95) (411)
Other borrowed money 97 38 135 -- (16) (16)
-------- -------- -------- -------- -------- --------
Total borrowed money (2,737) (1,362) (4,099) (12,455) (6,096) (18,551)
Guaranteed preferred beneficial
interest in Company's subordinated debt (166) (791) (957) 1 -- 1
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ (8,652) $(13,559) $(22,211) $(10,766) $ (8,575) $(19,341)
-------- -------- -------- -------- -------- --------
Net change in interest income $ 17,263 $ (8,907) $ 8,356 $ 6,075 $(10,946) $ (4,871)
======== ======== ======== ======== ======== ========
The increase in net interest income (on a tax-equivalent basis) of $8.4 million
from the year ended December 30, 2002 compared to the year ended December 30,
2001 was due to a $22.2 million decrease in interest expense partially offset by
a $13.9 million decrease in interest income (on a tax-equivalent basis). Net
yield on interest-earning assets increased to 3.44% in 2002 from 3.20% in 2001.
Net interest spread increased 40 basis points in 2002 compared to 2001. In the
lower interest rate environment which characterized 2002 compared to 2001, the
Company achieved a decline in funding cost of 154 basis points which exceeded
the decline in earning asset yields of 114 basis points.
Net interest income (on a tax-equivalent basis) increased $8.4 million or 14.5%
to $66.1 million for 2002 compared to $57.7 million for 2001. This increase was
due to a combination of decreased interest rates, increased average
interest-earning assets and decreased average time deposits and total borrowed
money. The decline in interest rates contributed to a decrease of $22.5 million
of interest income on total interest-earning assets, offset by a decrease of
$13.6 million of interest expense on total interest-bearing liabilities, for a
net decrease in net interest income of $8.9 million. Of the total increase in
net interest income, $17.3 million was from the volume component. An increase in
average interest-earning assets from $1.8 billion for 2001 to $1.9 billion for
2002 increased net interest income by $8.6 million. An increase of $7.1 million
was due to the decrease in average time deposits from $593.4 million for 2001 to
$449.4 million for 2002 and a $2.7 million increase was due to the decrease in
average total borrowed money from $265.9 million for 2001 to $225.7 million for
2002. These increases were partially offset by a decrease of $1.3 million due to
an increase in average core deposit accounts from $646.0 million for 2001 to
$899.0 million for 2002.
11
Interest income (on a tax-equivalent basis) decreased $13.9 million, or 10.8% to
$114.0 million for the year ended December 31, 2002 compared to $127.8 million
for the same period in 2001. The decrease in interest income was due to the
continued decline in interest rates, which lowered the yield on average
interest-earning assets by 114 basis points. Interest income (on a
tax-equivalent basis) on investment securities decreased $10.1 million caused by
a decrease in yield of 139 basis points and a decrease in the average balance
from $692.9 million for 2001 to $682.4 million for 2002. The increase in average
balance of loans receivable from $1.06 billion for 2001 to $1.20 billion for
2002 produced an increase in interest income of $9.1 million, which was offset
by the decrease in yield of 107 basis points with a decrease in interest income
of $11.8 million. In addition, interest income on interest-bearing deposits with
banks and federal funds sold decreased an aggregate $1.0 million primarily due
to a decrease in yield of 184 and 216 basis points, respectively.
Interest expense decreased $22.2 million, or 31.7% to $47.9 million for the year
ended December 31, 2002 compared to $70.1 million for the same period in 2001.
The decrease in interest expense was due primarily to the overall decrease in
market interest rates, the change in the mix of deposits between core and time
deposits, and the mix of borrowed money. The change in interest rates decreased
overall cost of funds by 154 basis points, or $13.6 million. The change in the
mix of deposits is 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. The decrease in the average balance of time deposits from
$593.4 million for 2001 to $449.4 million for 2002 resulted in the decrease in
the volume component of interest expense of $7.1 million. The decrease in the
average balance of time deposits was partially offset with an increase in the
average balance of core deposits from $646.0 million for 2001 to $899.0 million
for 2002, resulting in the increase in the volume component of interest expense
of $1.3 million. A $4.1 million decrease in the borrowed money component of
interest expense was the result of the change in interest rates that decreased
the overall cost of funds by 98 basis points, or $1.4 million, and the planned
lengthening of the aggregate terms of borrowed money, primarily FHLB advances,
to match the longer-term assets added during the period. During 2001, the
Company fully paid off repurchase agreements with the FHLB, resulting in a
decrease of interest expense of $6.5 million.
For 2001, net interest income (on a tax-equivalent basis) decreased $4.9
million, or 7.8% to $57.7 million for 2001 compared to $62.6 million for 2000.
This decrease was primarily due to the rate component that decreased net
interest income by $10.9 million, due to the market interest rate declines
during 2001. From the volume component, a $6.1 million increase was due
primarily to the decrease in average interest-bearing liabilities from $1.7
billion for 2000 to $1.6 billion for 2001, partially offset by the decrease in
average interest-earning assets from $1.9 billion for 2000 to $1.8 billion for
2001. Additionally, the net yield on interest-earning assets of 3.20% for 2001
decreased from 3.31% for 2000. This was due to the effect of market interest
rate decreases and the mix of interest-earning assets and interest-bearing
liabilities which reduced the interest rate spread to 260 basis points in 2001
from 272 basis points in 2000.
Provision for Loan Losses. The Company recorded a provision for loan losses of
$4.2 million for 2002, a decrease of $3.6 million compared to a provision of
$7.8 million for 2001. The larger 2001 provision was primarily a result of loan
portfolio growth ($216,000) and deterioration of several loans ($3.1 million)
and to a lesser extent, portfolio maturation and the impact on the Company of
the overall slowing trends of the national and regional economy. In addition to
providing for the deterioration of several loans, the Company subsequently
charged off these loans in 2001, as described in the following paragraph. In
developing the allowance, values are assigned to the qualitative factors such as
the nature and volume of loans, the levels of past due, classified and non-
accrual loans and the national and local economic and business conditions.
During 2001, as the portfolio matured and the national and regional economy
demonstrated signs of an overall slowing trend, there was an overall increase in
the level of loan delinquencies from 48 basis points at December 31, 2000 to 147
basis points at December 31, 2001, which was a primary factor for management to
increase the qualitative factors used in calculating the allowance.
Net charge-offs were $4.9 million for the year ended December 31, 2001 compared
to net charge-offs of $1.1 million for the year ended December 31, 2002. The
significant increase in the 2001 charge- offs was primarily the result of four
credits. The Company charged off $2.0 million related to a start- up computer
software company. The company was not generating the expected cash flows and the
collateral for these loans was equity securities which suffered considerable
loss in value in late 2001. The Company charged off $613,000 related to a loan
collateralized by a development of intercity single family residential units due
to chronic delinquencies, declining property values, nonpayment of property
taxes and lack of on-site management of the properties. The Company charged off
$520,000 related to a series of loans to a farmer who converted a large portion
of his acreage to a different crop. Subsequent to conversion of acreage, the
price of the new crop collapsed and the borrower died without a management
succession plan. Additionally, the Company charged off $483,000 related to a
multi-unit, intercity modular townhouse development financed in participation
with an agency of the State of New Jersey due to mismanagement on the part of
the developer that resulted in the failure to complete the project.
The ratio of allowance for loan losses to total loans increased to 1.33% at
December 31, 2002 compared to 1.21% at December 31, 2001 and 1.01% at December
31, 2000. Management regularly performs an analysis to identify the inherent
risk of loss in its loan portfolio. This analysis includes evaluation of
concentrations of credit, past loss experience, current economic conditions,
amount and composition of the loan portfolio (including loans being specifically
monitored by management), estimated fair value of underlying collateral,
delinquencies, and other factors.
The Bank will continue to monitor its allowance for loan losses and make future
adjustments to the allowance through the provision for loan losses as economic
conditions dictate. Although the Bank maintains its allowance for loan losses at
levels considered adequate to provide for the inherent risk of loss in its loan
portfolio, there can be no assurance that future losses will not exceed
estimated amounts or that additional provisions for loan losses will not be
required in future periods. In addition, the Bank's determination as to the
amount of its allowance for loan losses is subject to review by its primary
regulator, the Office of the Comptroller of the Currency (the "OCC"), as part of
its examination process, which may result in the establishment of an additional
allowance based upon the judgment of the OCC after a review of the information
available at the time of the OCC examination.
Non-Interest Income. Non-interest income increased $2.7 million, or 25.3% for
the year ended December 31, 2002 compared to the year ended December 31, 2001.
The increase was primarily due to a $2.1 million increase in gain on sale of
investment securities. The Company reported a $2.5 million gain on sale of
investment securities during 2002 compared to a $396,000 gain on sale of
investment securities during 2001.
Non-interest income increased $2.3 million, or 28.5% for the year ended December
31, 2001 compared to the year ended December 31, 2000. The increase was
primarily due to a $1.7 million increase in service charges on deposit accounts
resulting primarily from the 9.2% increase in average balance of deposits and
increased fees. During 2001, the Company continued to focus on reducing
borrowings and increasing liquidity and capital primarily through a reduction of
its securities portfolio. The Company reported a $396,000 gain on sale of
investment securities during 2001 and reported a $311,000 loss on sale of
investment securities during 2000.
The respective increases to non-interest income of 28.5% and 25.3% for the years
ended December 31, 2001 and 2002 were due to non-recurring items as explained
above. Management believes that these increases due to non-recurring do not
indicate a trend that will have a material impact on the future operations or
financial condition of the Company. While it is management's objective to grow
non-interest income, the Company cannot predict with any certainty the future
levels of non-interest income.
12
Non-Interest Expenses. Non-interest expenses increased approximately $970,000,
or 1.7% to $59.0 million for the year ended December 31, 2002 as compared to
$58.0 million for the same period for 2001. Salaries and employee benefits
increased $4.0 million, reflecting the effect of the increased staffing in 2001
and early 2002. This was partially offset by the reduction of amortization of
goodwill of $3.6 million due to the Company adopting Statement of Financial
Accounting Standards ("SFAS") No. 147 in the fourth quarter of 2002. The
adoption of SFAS No. 147 results in the Company ceasing amortization on
approximately $19.7 million of goodwill. For additional information about the
adoption of SFAS 147, see Notes 2 and 10 of the Notes to Consolidated Financial
Statements.
Non-interest expenses increased approximately $3.5 million, or 6.5% to $58.0
million for the year ended December 31, 2001 as compared to $54.4 million for
the same period for 2000. This increase is primarily due to an increase in other
expenses of $1.9 million, salaries and employee benefits of $1.2 million, and
occupancy expense of $646,000. Included in other expenses is $1.0 million in
consulting fees relating to 2001 management initiatives for technology, risk
management, branch optimization and the Company's Process & Profit Improvement
program. Salaries and benefits increased due to additional key positions hired
during the year reflecting the Company's focus on building a business banking
team to meet the needs of the small business market, expansion of the Commercial
and Retail Banking Divisions, additional support within Credit Administration
and other various operational and administrative support staff. The increase in
occupancy expense is a result of a bank wide branch maintenance program
initiated in 2001.
Income Tax Expense. Income taxes increased $4.5 million, from $156,000 for year
ended December 31, 2001 to $4.7 million for the year ended December 31, 2002.
The increase was due to a larger 2002 pretax income. In addition, the Company's
effective tax rate increased due the proportion of tax-free municipal income to
income before taxes. Due to a decrease in pretax income in 2001, income taxes
decreased $3.5 million, from $3.6 million to $156,000 for the years ended
December 31, 2000 and December 31, 2001, respectively.
LIQUIDITY AND CAPITAL RESOURCES
A major source of the Company's funding is its retail deposit branch network,
which management believes will be sufficient to meet the Company's long-term
liquidity needs. The ability of the Company to retain and attract new deposits
is dependent upon the variety and effectiveness of its customer account
products, customer service and convenience, and rates paid to customers. The
Company also obtains funds from the repayment and maturities of loans as well as
sales and maturities of investment securities, while additional funds can be
obtained from a variety of sources including federal funds purchased, securities
sold under agreements to repurchase, Federal Home Loan Bank ("FHLB") advances,
loan sales or participations and other secured and unsecured borrowings. It is
anticipated that FHLB advances and securities sold under agreements to
repurchase will be secondary sources of funding, and management expects there to
be adequate collateral for such funding requirements.
The Company's primary uses of funds are the origination of loans, the funding of
the Company's maturing certificates of deposit, deposit withdrawals and the
repayment of borrowings. Certificates of deposit scheduled to mature during the
12 months ending December 31, 2003 total $286.5 million. The Company has
implemented a core deposit relationship strategy that places less reliance on
certificates of deposits as a funding source. The Company will continue to price
certificates of deposit for retention, however, based on market conditions and
other liquidity considerations, it may avail itself of the secondary borrowings
discussed above.
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 $65.6 million at December 31, 2002, the Company
has additional secured borrowing capacity with the FHLB of approximately $75
million and other sources of approximately $57 million. Management will continue
to monitor the Company's liquidity and maintain it at a level that is adequate
but not excessive.
13
Net cash provided by operating activities for the year ended December 31, 2002
totaled $23.2 million, compared to $23.3 million for the year ended December 31,
2001 and $16.3 million for the year ended December 31, 2000.
During 2002, the primary source of funds for the increase in lending activities
of $132.7 million was an increase in deposits of $118.1 million and an increase
in net borrowings of $45.2 million. Net cash used in investing activities for
the year ended December 31, 2002 totaled $202.1 million, compared to net cash
provided by investing activities for the year ended December 31, 2001 of $71.0
million. The change was primarily due to an increase in the purchase of
investment securities of $113.0 million, a decrease in the maturities,
prepayments and calls of securities of $131.7 million and a net increase in
loans of $67.1 million. These were partially offset by an increase in the
proceeds from the sale of securities of $58.2 million. Net cash provided by
financing activities for the year ended December 31, 2002 totaled $165.4
million, compared to net cash used by financing activities of $84.9 million for
the year ended December 31, 2001. The change was primarily a result of an
increase of $292.4 million of net repayments under lines of credit and
repurchase agreements, partially offset by a reduced net increase in deposits of
$57.7 million.
Net cash provided by investing activities for the year ended December 31, 2001
totaled $71.0 million, an increase of $79.9 million compared to net cash used
for the year ended December 31, 2000 of $8.9 million. This continued to reflect
the Company's overall balance sheet and liquidity management process. The
increase was primarily due to an increase in the maturities, prepayments and
calls of investment securities of $519.7 million, an increase in the sale of
investment securities of $40.4 million and a reduced net increase in loans of
$69.1 million. These increases in cash provided were partially offset by a
$552.9 million increase in the purchase of investment securities.
Net cash used by financing activities for the year ended December 31, 2001
totaled $84.9 million, compared to net cash provided by financing activities of
$7.2 million for the year ended December 31, 2000. The increase was primarily
the result of an increase of $120.0 million of net repayments under lines of
credit and repurchase agreements and a decrease in deposits resulting from a
branch sale in the fourth quarter 2001 of $14.3 million. These were partially
offset by an increase in deposits of $56.3 million. The increase in deposits
reflects the Company's successful implementation of a customer relationship
strategy for both loans and deposits.
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. The
principal components of the capital plan are to generate additional capital
through retained earnings through internal growth, access the capital markets
for external sources of capital such as common equity or trust preferred
securities when necessary or appropriate, redeem existing capital instruments
and refinance such instruments at lower rates when conditions permit and
maintain capital sufficient for safe and sound operations. 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. Our capital plan is not expected to have a material impact on our
liquidity. The following table sets forth the risk-based capital levels at
December 31, 2002 for the Company and the Bank.
To Be Well-Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
At December 31, 2002 Actual Purposes Provisions
------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc $176,688 12.15% $116,224 8.00% N/A
Sun National Bank $165,322 11.39% $116,021 8.00% $145,026 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc $147,459 10.14% $ 58,112 4.00% N/A
Sun National Bank $148,639 10.24% $ 58,010 4.00% $ 87,016 6.00%
Leverage Ratio:
Sun Bancorp, Inc $147,459 6.84% $ 86,291 4.00% N/A
Sun National Bank $148,639 6.97% $ 85,244 4.00% $106,556 5.00%
As part of its capital plan, the Company maintains trust preferred securities of
$46.7 million at December 31, 2002 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. The portion that exceeds the 25% capital
limitation amounting to $12.6 million at December 31, 2002 qualifies as Tier 2,
or supplementary capital of the Company.
14
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 is asset sensitive and its 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. During 2002, while the Company was asset
sensitive for the majority of the year and interest rates were declining, the
interest rate component negatively affected net interest income by $8.9 million.
This decrease in net interest income was exceeded by the increase in the volume
component positively affecting net interest income by $17.2 million, resulting
in a net increase of net interest income of $8.3 million.
Gap Analysis
Banks are 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 Company and Bank monitor their gap, primarily their six-month
and one-year maturities.
The Asset/Liability Committee of the Board of Directors discuss, among other
things, interest rate risk of the Company and the Bank. Management 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 its exposure to interest
rate risk.
During most of 2002, the Company was asset sensitive. At December 31, 2002, the
Company had a negative position with respect to its exposure to interest rate
risk maturing or repricing within one year. Total interest-bearing liabilities
maturing or repricing within one year exceeded interest-earning assets maturing
or repricing during the same time period by $33.4 million, representing a
negative cumulative one-year gap ratio of 1.58%. As a result, the cost of
interest-bearing liabilities of the Company should adjust to changes in interest
rates at a faster rate than yield on interest-earning assets of the Company.
15
The following table the maturity and repricing characteristics of the Company's
interest-earning assets and interest-bearing liabilities at December 31, 2002.
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.
Maturity/Repricing Time Periods
0-3 Months 4-12 Months 1-5 Years Over 5 Years Total
---------- ----------- --------- ------------ -----
Loans receivable $386,191 $187,385 $608,907 $ 50,933 $1,233,416
FHLB interest-bearing deposit 2,435 - - - 2,435
Investment securities 142,194 126,667 355,978 101,733 726,572
Federal funds sold 138 - - - 138
-------- -------- -------- -------- ----------
Total interest-earning assets 530,958 314,052 964,885 152,666 1,962,561
-------- -------- -------- -------- ----------
Interest-bearing demand deposits 234,220 91,014 273,407 28,753 627,394
Savings deposits 28,133 77,480 203,666 19,229 328,508
Time certificates 111,217 176,337 123,248 1,325 412,127
Federal Home Loan Bank advances 4,349 33,322 96,825 7,764 142,260
Other borrowed funds 1,160 - - - 1,160
Securities sold under agreements to
repurchase 61,860 - - - 61,860
Guaranteed preferred beneficial interest in
Company's subordinated debt - 59,274 - - 59,274
-------- -------- -------- -------- ----------
Total interest-bearing liabilities 440,939 437,427 697,146 57,071 1,632,583
-------- -------- -------- -------- ----------
Periodic Gap $ 90,019 $ (123,375) $267,739 $ 95,595 $ 329,978
======== ========== ======== ======== =========
Cumulative Gap $ 90,019 $ (33,356) $234,383 $329,978
======== ========== ======== ========
Cumulative Gap Ratio 4.26% (1.58%) 11.10% 15.63%
======== ========== ======== ========
16
Impact of Inflation and Changing Prices
The consolidated financial statements of the Company and notes thereto,
presented elsewhere herein, have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
measurement of financial position and operating results without considering the
change in the relative purchasing power of money over time and due to inflation.
The impact of inflation is reflected in the increased cost of the Company's
operations. Nearly all the assets and liabilities of the Company are monetary.
As a result, interest rates have a greater impact on the Company's performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods and services.
FINANCIAL CONDITION
The Company's assets increased by $182.7 million, or 9.5% from $1.93 billion at
December 31, 2001 to $2.11 billion at December 31, 2002. In 2002, the Company
continued to reposition and control the growth of the balance sheet while
enhancing its overall liquidity, interest rate risk profile and capital
position, and continuing the growth of its core businesses through an increase
in loans and deposits. The Company increased net loans receivable by $127.4
million, investment securities by $75.6 million, deposits by $118.1 million, and
advances from the FHLB by $68.3 million, while decreasing federal funds sold by
$11.4 million and repurchase agreements by $23.1 million. Total capital
increased by $15.7 million, or 12.1% from $130.0 million at December 31, 2001 to
$145.6 million at December 31, 2002.
Loans. Net loans receivable increased $127.4 million, or 11.7%, from December
31, 2001 to December 31, 2002, due primarily to internally generated growth in
commercial loans, small business loans and home equity loans, offset by a
decrease in mortgage loans and installment loans. Commercial and small business
loans increased $132.7 million, or 14.6% and home equity loans increased $20.7
million. The increase in commercial and small business loans was a result of a
total team effort from three major business lines across five regional community
banking groups. These groups emphasize quick-response and local decision-making
resulting in continued competitive pricing and servicing of all commercial
loans. As interest rates continued to decline during 2002, the Bank's mostly
fixed rate products, mortgages and installment loans, have decreased by $23.0
million, partially offset by floating or adjustable rate home equity products
which increased $20.7 million.
The Company uses third-party loan correspondents to originate residential
mortgages that are subsequently sold into the secondary market. These loans are
originated using the investor's underwriting standards, rates and terms, and are
approved according to the investor's lending policy prior to origination. Prior
to closing, the Company generally has commitments to sell these loans with
servicing released, at par and without recourse, in the secondary market.
Secondary market sales are generally scheduled to close shortly after
origination. Set forth below is selected data relating to the composition of the
Company's loan portfolio by type of loan and type of security on the dates
indicated.
ANALYSIS OF LOAN PORTFOLIO
At December 31,
--------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------- ------------------- ----------------- --------- ----- -------------------
Amount % Amount % Amount % Amount % Amount %
---------- ------ ---------- ----- -------- ----- -------- ------ -------- ------
Type of Loan:
Commercial and
industrial $1,043,885 85.77 $ 911,145 83.62 $ 869,088 84.23 $750,707 83.32 $548,646 79.52
Home equity 44,603 3.67 23,854 2.19 24,613 2.38 26,619 2.96 31,068 4.50
Second mortgage 47,458 3.90 49,047 4.50 35,056 3.40 27,448 3.05 21,803 3.16
Residential real estate 43,375 3.56 55,282 5.07 54,140 5.25 52,986 5.88 48,119 6.97
Installment 54,095 4.45 63,609 5.84 59,433 5.76 51,633 5.73 47,359 6.86
Less: Loan loss
allowance (16,408) (1.35) (13,332) (1.22) (10,486) (1.02) (8,472) (0.94) (6,993) (1.01)
---------- ------ ---------- ----- ---------- ------ -------- ------ -------- ------
Net loans $1,217,008 100.00 $1,089,605 100.00 $1,031,844 100.00 $900,921 100.00 $690,002 100.00
========== ====== ========== ====== ========== ====== ======== ====== ======== ======
Type of Security:
Residential real estate:
1-4 family $ 166,495 13.67 $ 146,157 13.41 $ 143,973 13.96 $118,837 13.19 $123,263 17.87
Other 88,465 7.27 108,437 9.95 83,615 8.10 8,954 0.99 9,726 1.41
Commercial real estate 721,658 59.30 599,027 54.98 576,365 55.86 199,437 22.14 242,700 35.17
Commercial business loans 210,374 17.29 199,103 18.27 183,130 17.75 528,513 58.66 269,406 39.06
Consumer 36,333 2.99 36,640 3.36 40,879 3.96 38,817 4.31 40,362 5.85
Other 10,091 0.83 13,573 1.25 14,368 1.39 14,835 1.65 11,538 1.67
Less: Loan loss
allowance (16,408) (1.35) (13,332) (1.22) (10,648) (1.02) (8,472) (0.94) (6,993) (1.01)
---------- ------ ---------- ------ ---------- ------ -------- ------ -------- ------
Net loans $1,217,008 100.00 $1,089,605 100.00 $1,031,844 100.00 $900,921 100.00 $690,002 100.00
========== ====== ========== ====== ========== ====== ======== ====== ======== ======
17
The following table sets forth the estimated maturity of the Company's loan
portfolio at December 31, 2002. The table does not include prepayments or
scheduled principal payments. Adjustable rate mortgage loans are shown as
maturing based on contractual maturities.
Due Due after Allowance
Within 1 through Due after for
1 year 5 years 5 years Loan Loss Total
----------- ---------- ----------- --------- ----------
Commercial and industrial $210,781 $452,716 $380,388 $(14,806) $1,029,079
Home equity 79 1,044 43,480 (263) 44,340
Second mortgage 1,272 18,514 27,672 (277) 47,181
Residential real estate 5,534 1,100 36,741 (265) 43,110
Installment 10,098 13,000 30,997 (797) 53,298
-------- -------- -------- -------- ----------
$227,764 $486,374 $519,278 $(16,408) $1,217,008
======== ======== ======== ======== ==========
The following table sets forth the dollar amount of all loans due after December
31, 2003 which have pre-determined interest rates and which have floating or
adjustable interest rates.
Floating or
Adjustable
Fixed Rates Rates Total
----------- ----------- ----------
Commercial and industrial $404,564 $428,540 $ 833,104
Home equity - 44,524 44,524
Second mortgage 46,186 - 46,186
Residential real estate 30,243 7,598 37,841
Installment 39,512 4,485 43,997
-------- -------- ----------
$520,505 $485,147 $1,005,652
======== ======== ==========
Non-Performing and Problem Assets
Loan Delinquencies. The Company's collection procedures provide for a late
charge assessment after a commercial loan is 10 days past due, or a residential
mortgage loan is 15 days past due. The Company contacts the borrower by mail or
telephone and payment is requested. If the delinquency continues, subsequent
efforts are made to contact the borrower. If the loan continues to be delinquent
for 90 days or more, the Company usually initiates foreclosure proceedings
unless other repayment arrangements are made. Delinquent loans are reviewed on a
case-by-case basis in accordance with the lending policy.
Interest accruals are generally discontinued when a loan becomes 90 days past
due or when collection of principal or interest is considered doubtful. When
interest accruals are discontinued, interest credited to income in the current
year is reversed, and interest accrued in the prior year is charged to the
allowance for loan losses. Generally, commercial loans are charged off no later
than 120 days delinquent unless the loan is well secured and in the process of
collection or other extenuating circumstances support collection. Residential
real estate loans are typically charged off at 90 days delinquent. In all cases,
loans must be placed on non-accrual or charged off at an earlier date if
collection of principal or interest is considered doubtful.
Restructured Loans. During 2002, the Company classified two credits aggregating
$13.5 million 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 December 31, 2002, these loans, as restructured,
were current, fully performing and well collateralized. These loans were not
classified as non-accrual and were not considered non-performing. Interest
income that would have been recorded on these restructured loans, under the
original terms of such loans, would have totaled $390,000 for the year ended
December 31, 2002. Interest income recognized on these loans was $263,000 for
the year ended December 31, 2002.
Potential Problem Loans. At December 31, 2002, there were two commercial loan
relationships aggregating $7.0 million for which payments are current, but where
the borrowers were experiencing financial difficulties, that were not classified
as non-accrual and were not considered non-performing. At December 31, 2002,
these loans were current and well collateralized.
Non-Performing Assets. Total non-performing assets increased $2.4 million from
$11.0 million at December 31, 2001 to $13.4 million at December 31, 2002. The
ratio of non-performing assets to net loans increased to 1.10% at December 31,
2002 compared to 1.02% at December 31, 2001. The following table sets forth
information regarding loans that are delinquent 90 days or more. Management of
the Company believes that all loans accruing interest are adequately secured and
in the process of collection.
18
Non-Performing Assets
At December 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Loans accounted for on a non-accrual basis:
Commercial and industrial $ 8,879 $ 8,007 $ 2,933 $ 2,085 $ 979
Home equity 14 201 65 8 241
Second mortgage 100 130 38 5 81
Residential real estate 593 735 430 250 182
Installment 377 50 240 232 125
------- ------- ------- ------- -------
Total $ 9,963 $ 9,123 $ 3,706 $ 2,580 $ 1,608
======= ======= ======= ======= =======
Accruing loans that are contractually past due 90 days or more:
Commercial and industrial $ 1,837 $ 425 $ 114 $ 880 $ 202
Home equity 30 42 36 339 252
Second mortgage 122 190 153 54 134
Residential real estate 401 295 540 303 230
Installment 115 146 332 226 68
------- ------- ------- ------- -------
Total $ 2,505 $ 1,098 $ 1,175 $ 1,802 $ 886
======= ======= ======= ======= =======
Total non-accrual and 90-day past due loans $12,468 $10,221 $ 4,881 $ 4,382 $ 2,494
Real estate owned 904 898 1,179 535 292
------- ------- ------- ------- -------
Total non-performing assets $13,372 $11,119 $ 6,060 $ 4,917 $ 2,786
======= ======= ======= ======= =======
Total non-accrual and 90-day past due loans to net loans 1.02% 0.94% 0.47% 0.49% 0.36%
Total non-accrual and 90-day past due loans to total assets 0.59% 0.53% 0.24% 0.22% 0.16%
Total non-performing assets to net loans 1.10% 1.02% 0.59% 0.55% 0.40%
Total non-performing assets to total assets 0.63% 0.58% 0.30% 0.25% 0.18%
Total allowance for loan losses to total non-performing loans 131.60% 130.44% 214.83% 193.34% 280.39%
Interest income that would have been recorded on loans on non-accrual status,
under the original terms of such loans, would have totaled $984,000 for the year
ended December 31, 2002.
Real Estate Owned. Real estate acquired by the Company as a result of
foreclosure and bank properties and equipment that the Company is holding for
sale is classified as real estate owned until such time as it is sold. When real
estate is acquired or transferred, it is recorded at the lower of the unpaid
principal balance of the related loan or its fair value less estimated disposal
costs. Any subsequent write-down of real estate owned is charged to operations.
Real estate owned consisted of the following:
December 31,
-----------------------
2002 2001
---- ----
Commercial properties $447 $254
Residential properties 148 35
Bank properties 309 609
---- ----
Total $904 $898
==== ====
An analysis of the activity in real estate owned is as follows:
For the Years Ended
December 31,
-------------------------
2002 2001
------- -------
Balance, beginning of year $ 898 $ 1,179
Additions 1,111 391
Sales (988) (363)
Write down (117) (309)
------- -------
Balance, end of year $ 904 $ 898
======= =======
Allowances for Losses on Loans. The Company's allowance for losses on loans
increased to $16.4 million or 1.33% of loans at December 31, 2002. Due to loan
portfolio growth, portfolio maturation, the deterioration of several loans and
the impact on the Company of the national and local economies during 2001, the
Company's allowance for losses on loans increased to $13.3 million or 1.21% of
loans at December 31, 2001 compared to $10.5 million or 1.01% of loans at
December 31, 2000. Provision for loan losses was $4.2 million in 2002, $7.8
million in 2001 and $2.6 million in 2000. Net charge-offs were $1.1 million in
2002, $4.9 million in 2001 and $566,000 in 2000.
It is the policy of management to provide for losses on unidentified loans in
its portfolio in addition to classified loans. A provision for loan losses is
charged to operations based on management's evaluation of the estimated losses
that have been incurred in the Company's loan portfolio. Management monitors its
allowance for loan losses and on a quarterly basis and makes adjustments to the
allowance through the provision for loan losses as economic conditions and other
factors indicate. In this context, a series of qualitative factors are used in a
methodology as a measurement of how current circumstances are affecting the loan
portfolio. Included in these qualitative factors are
o Levels of past due, classified and non-accrual loans, troubled debt
restructurings and modifications
o Nature and volume of loans
o Changes in lending policies and procedures, underwriting standards,
collections, charge offs and recoveries
o National and local economic and business conditions, including various
market segments
o Concentrations of credit and changes in levels of such concentrations
o Effect of external factors on the level of estimated credit losses in the
current portfolio.
Additionally, historic loss experience over the trailing eight quarters is taken
into account. Values assigned to the qualitative factors and those developed
from historic loss experience provide a dynamic basis for the calculation of
reserve factors for both pass-rated loans (SFAS No. 5) and those criticized and
classified loans without SFAS No. 114 reserves. As changes in the Company's
operating environment occur and as recent loss experience ebbs and flows, the
factors for each category of loan based on type and risk rating will change to
reflect current circumstances and the quality of the loan portfolio.
Although the Company maintains its allowance for loan losses at levels
considered adequate to provide for the inherent risk of loss in its loan
portfolio, there can be no assurance that future losses will not exceed
estimated amounts or that additional provisions for loan losses will not be
required in future periods. In addition, the Company's determination as to the
amount of its allowance for loan losses is subject to review by its primary
regulator, the Office of the Comptroller of the Currency (the "OCC"), as part of
its examination process, which may result in the establishment of an additional
allowance based upon the judgment of the OCC after a review of the information
available at the time of the OCC examination.
19
The following table sets forth information with respect to the Company's
allowance for losses on loans at the dates indicated:
At December 31,
---------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Allowance for losses on loans, beginning of year $13,332 $10,486 $ 8,472 $ 6,993 $ 4,124
Charge-offs:
Commercial 1,219 4,748 209 15 26
Mortgage 20 4 8 210 203
Installment 371 665 384 311 68
------- ------- ------- ------- -------
Total charge-offs 1,610 5,417 601 536 297
------- ------- ------- ------- -------
Recoveries:
Commercial 457 423 - - 18
Mortgage - - 25 10 -
Installment 54 45 10 16 15
------- ------- ------- ------- -------
Total recoveries 511 468 35 26 33
------- ------- ------- ------- -------
Net charge-offs 1,099 4,949 566 510 264
Allowance acquired with branch purchase 1,000
Provision for loan losses 4,175 7,795 2,580 1,989 2,133
------- ------- ------- ------- -------
Allowance for losses on loans, end of year $16,408 $13,332 $10,486 $ 8,472 $ 6,993
======= ======= ======= ======= =======
Net loans charged off as a percent of average loans outstanding 0.09% 0.47% 0.06% 0.06% 0.05%
======= ======= ======= ======= =======
The following table sets forth the allocation of the Company's allowance for
loan losses by loan category and the percent of loans in each category to total
loans receivable at the dates indicated. The portion of the loan loss allowance
allocated to each loan category does not represent the total available for
future losses that may occur within the loan category since the total loan loss
allowance is a valuation reserve applicable to the entire loan portfolio.
At December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ---------------- ------------------ -------------------- -------------------
Percent of Percent of Percent of Percent of Percent of
Loans to Loans to Loans to Loans to Loans to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Balance at end of year
applicable to:
Commercial and industrial $14,806 84.63% $11,457 82.62% $ 8,676 83.38% $6,994 82.55% $5,981 78.72%
Residential real estate 265 3.52 577 5.01 391 5.19 327 5.83 164 6.90
Home equity 263 3.62 268 2.16 343 2.36 254 2.93 382 4.46
Installment 1,074 8.23 1,030 10.21 1,076 9.07 897 8.69 466 9.92
------- ------ ------- ------ ------- ------ ------ ------ ------ ------
Total allowance $16,408 100.00% $13,332 100.00% $10,486 100.00% $8,472 100.00% $6,993 100.00%
======= ====== ======= ====== ======= ====== ====== ====== ====== ======
Investment Securities. A portion of the Company's investment portfolio is held
at the Bank's wholly owned subsidiary, Med-Vine, Inc. ("Med-Vine"). Total
investment securities, excluding restricted equity securities, increased $75.6
million or 11.7% from $647.6 million at December 31, 2001 to $723.2 million at
December 31, 2002.
The Company's investment policy is established by senior management and approved
by the Board of Directors. Med-Vine's investment policy is identical to that of
the Company. It is based on asset and liability management goals and is designed
to provide a portfolio of high quality investments that optimizes interest
income within acceptable limits of safety and liquidity. The Company has
classified its entire portfolio of debt investment securities as available for
sale. As a result, these securities are carried at their estimated fair value
based on quoted market prices.
20
The following table sets forth the carrying value of the Company's portfolio of
investment securities available for sale.
At December 31,
----------------------------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Net Net Net
Unrealized Estimated Unrealized Estimated Unrealized Estimated
Amortized Gains Fair Amortized Gains Fair Amortized Gains Fair
Cost (Losses) Value Cost (Losses) Value Cost (Losses) Value
-------- -------- -------- -------- -------- -------- -------- -------- --------
U.S. Treasury obligations $ 54,400 $1,144 $ 55,544 $ 51,809 $ 580 $ 52,389 $ 69,406 $ 53 $ 69,459
Government agency and
mortgage-backed 567,200 6,111 573,311 551,584 (481) 551,103 645,090 (15,738) 629,352
securities
Municipal obligations 70,672 996 71,668 43,692 (881) 42,811 49,267 (467) 48,800
Other securities 22,690 (12) 22,678 1,255 - 1,255 948 - 948
-------- ------ -------- -------- -------- -------- -------- -------- --------
Total $714,962 $8,239 $723,201 $648,340 $ (782) $647,558 $764,711 $(16,152) $748,559
======== ====== ======== ======== ======== ======== ======== ======== ========
During 2002, the Company invested $19.7 million in a Pooled Floating Rate
Capital Security, which were classified as other securities.
The following table sets forth certain information regarding the carrying
values, weighted average yields and maturities of the Company's portfolio of
investment securities available for sale at December 31, 2002. All debt
securities are classified as available for sale; therefore, the carrying value
is the estimated fair value. Yields on tax-exempt obligations have been
calculated on a tax-equivalent basis.
One Year or Less One to Five Years Five to Ten Years More than Ten Years Total
---------------- ----------------- ----------------- -------------------- -----------------
Wtd. Wtd. Wtd. Wtd. Wtd.
Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg.
Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
U.S. Treasury obligations $ 27,506 3.09% $ 22,406 2.90% $ 5,632 5.11% - - $ 55,544 3.20%
Government agency and
mortgage-backed securities 186,006 2.82 349,748 4.00 32,663 4.83 $ 4,894 6.64% 573,311 3.69
Municipal obligations 15,818 1.95 14,646 4.01 25,328 3.97 15,877 5.07 71,668 3.78
Other securities 2,604 0.96 20,074 2.11 - - - - 22,678 1.97
-------- -------- ------- ------- --------
Total $231,934 2.77% $406,873 3.65% $63,623 4.51% $20,771 5.44% $723,201 3.62%
======== ======== ======= ======= ========
Deposits. Consumer and commercial deposits are attracted principally from within
the Company's primary market area through offering a wide compliment of deposit
products that include checking, savings, money market, certificates of deposits
and individual retirement accounts. The deposit strategy stresses the importance
of building a relationship with each and every customer. To help facilitate
these relationships, the Bank continued during 2002 its relationship pricing
strategy that has helped to dramatically increase core deposit growth. Deposit
account terms vary according to the minimum balance required, the time periods
the funds must remain on deposit and the interest rate, among other factors. The
relationship strategy has enabled the Bank to continue to favorably increase the
deposit mix with a higher concentration of core deposits. Management regularly
meets to evaluate internal cost of funds, to analyze the competition, to review
the Company's cash flow requirements for lending and liquidity and executes any
appropriate pricing changes when necessary. The Company does not obtain funds
through brokers, nor does it solicit funds outside the states of New Jersey,
Delaware or Pennsylvania.
Deposits at December 31, 2002 totaled $1.69 billion, an increase of $118.1
million, or 7.5% over the December 31, 2001 balance of $1.57 billion. Demand
deposits, including NOW accounts and money market accounts, increased $145.9
million, or 18.1%, at December 31, 2002, to $949.8 million, compared with
December 31, 2001. Savings deposits increased $53.4 million, or 19.4% to $328.5
million at December 31, 2002, from $275.1 million at December 31, 2001. Total
certificates of deposit decreased $81.1 million, or 16.4% from December 31,
2001, to $412.1 million at December 31, 2002. The increase in core deposits
during 2002 was due to internal growth from the Company's relationship strategy,
which during the year included promotional rates on selected money market
accounts, as represented in the following table.
21
For the Years Ended December 31,
-------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Amount % Amount % Amount %
---------- ------ ---------- ------ ---------- ------
Core deposits $1,278,355 75.6 % $1,079,079 68.6 % $781,920 55.4 %
Time deposits 412,127 24.4 % 493,259 31.4 % 628,972 44.6 %
---------- ------ ---------- ------ ---------- ------
Total deposits $1,690,462 100.00 % $1,572,338 100.00 % $1,410,867 100.00 %
========== ====== ========== ====== ========== ======
The following table sets forth average deposits by various types of demand and
time deposits:
For the Years Ended December 31,
------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Amount Avg. Cost Amount Avg. Cost Amount Avg. Cost
------ --------- ------ --------- ------ ---------
Non-interest-bearing demand deposits $287,164 $265,510 $245,989
Interest-bearing demand deposits 584,808 1.84% 431,196 2.88% 336,772 3.66%
Savings deposits 314,208 2.17 214,849 2.76 154,091 2.22
Time deposits 449,438 3.89 593,351 5.72 643,972
------- ------- -- --------
5.79
Total $1,635,618 2.60% $1,504,906 3.47% $1,380,824 3.84%
========== ========== ==========
The following table indicates the amount of certificates of deposit of $100,000
or more by remaining maturity at December 31, 2002.
Three months or less $43,565
Over three through six months 21,361
Over six through twelve months 18,733
Over twelve months 21,846
--------
Total $105,505
========
Borrowings. Borrowed funds increased $45.2 million in 2002, to $205.3 million at
December 31, 2002, from $160.1 million at December 31, 2001. The increase was a
result of a net increase of $68.3 million in advances from the FHLB offset by a
decrease of $23.1 million in securities sold under agreements to repurchase with
customers. The additional advances from the FHLB were used to match fund loans
originated during 2002.
For the years ended December 31, 2002 and 2001, the maximum month-end amount of
advances borrowed from the FHLB was $193.4 million and $30.0 million,
respectively. The Company sells U.S. Treasury securities to customers under
agreements to repurchase them, at par, on the next business day. For the years
ended December 31, 2002 and 2001, the maximum month-end amount of securities
sold under agreements to repurchase with customers was $86.2 million and $93.5
million, respectively. The Company also purchased overnight federal funds from
correspondent banks. For the years ended December 31, 2002 and 2001, the maximum
month-end amount of federal funds purchased from correspondent banks was $20.0
million and $0, respectively. During 2001, the Company paid off in full its FHLB
repurchase agreements.
22
The following table sets forth certain information regarding FHLB advances,
interest rates, approximate average amounts outstanding and their approximate
weighted average rates at the dates indicated.
December 31,
------------------------------------
2002 2001 2000
---- ---- ----
FHLB convertible rate advances outstanding at end of year $45,000 $ 45,000 $ 45,000
Interest rate 6.76% 6.76% 6.76%
Approximate average amount outstanding $45,000 $ 45,000 $ 41,138
Approximate weighted average rate 6.76% 6.76% 6.85%
FHLB term amortizing advances outstanding at end of year $89,060 $ 29,008 $ 4,133
Interest rate 4.33% 4.19% 5.68%
Approximate average amount outstanding $92,191 $ 7,285 $ 4,192
Approximate weighted average rate 4.31% 4.88% 5.68%
FHLB term non-amortizing advances outstanding at end of year $ 8,200 - -
Interest rate 4.85% - -
Approximate average amount outstanding $ 4,695 - -
Approximate weighted average rate 4.92% - -
FHLB repurchase agreements outstanding at end of year - - $255,145
Interest rate - - 6.45%
Approximate average amount outstanding - $129,097 $332,981
Approximate weighted average rate - 5.00% 6.43%
FHLB overnight line of credit advances outstanding at end of year - - -
Interest rate - - -
Approximate average amount outstanding $5,244 $ 504 $ 27,759
Approximate weighted average rate 1.88% 2.29% 6.67%
The following table sets forth certain information regarding securities sold
under agreements to repurchase with customers, interest rates, approximate
average amounts outstanding and their approximate weighted average rates at the
dates indicated.
December 31,
------------------------------------
2002 2001 2000
---- ---- ----
Securities sold under agreements to repurchase with customers
outstanding at end of year $61,860 $84,928 $101,841
Interest rate 0.61% 0.59% 5.68%
Approximate average amount outstanding $74,602 $82,318 $79,310
Approximate weighted average rate 0.99% 2.96% 5.55%
Deposits are the primary source of funds for the Company's lending activities,
investment activities and general business purposes. Should the need arise, the
Company has the ability to access lines of credit from various sources including
the Federal Reserve Bank, the FHLB and various other correspondent banks. In
addition, on an overnight basis, the Company has the ability to sell securities
under agreements to repurchase.
Guaranteed Preferred Beneficial Interest in Company's Subordinated Debt
Guaranteed preferred beneficial interest in Company's subordinated debt consists
of the following:
December 31, 2001
-------------------
2002 2001
------- -------
Sun Trust I - $28,040
Sun Trust II $29,274 29,287
Sun Trust III 20,000 -
Sun Trust IV 10,000 -
------- -------
$59,274 $57,327
======= =======
23
In 1997, the Company's subsidiary, Sun Capital Trust ("Sun Trust I") issued
$28.75 million of 9.85% Preferred Securities ("Sun Trust I Preferred
Securities") with a stated value and liquidation preference of $25 per share.
The proceeds from the sale of Sun Trust I Preferred Securities were utilized by
Sun Trust I to invest in $28.75 million of 9.85% Junior Subordinated Debentures
(the "Sun Trust I Debentures") of the Company, due March 2027.
In 1998, the Company's subsidiary, Sun Capital Trust II ("Sun Trust II") issued
$29.9 million of 8.875% Preferred Securities ("Sun Trust II Preferred
Securities") with a stated value and liquidation preference of $10 per share.
The proceeds from the sale of Sun Trust II Preferred Securities were utilized by
Sun Trust II to invest in $29.9 million of 8.875% Junior Subordinated Debentures
(the "Sun Trust II Debentures") of the Company, due December 2028.
During 2002, the Company notified the holders of the outstanding $28.0 million
of 9.85% Sun Trust I Preferred Securities of its intention to call these
securities contemporaneously with the redemption of the Sun Trust I 9.85% Junior
Subordinated Debentures on April 1, 2002. As a result, the Company wrote down
the unamortized debt issuance costs of the called securities in the amount of
$777,000, net of income tax, through a charge to equity. The Company funded this
call with short-term borrowings of $25.0 million and a $3.0 million dividend
from Sun. On April 10, 2002, the Company issued $20.0 million Pooled Floating
Rate Capital Securities ("Sun Trust III Capital Securities"). The interest rate
resets every six months to LIBOR plus 3.70%, with an initial rate of 6.02%, and
will not exceed 11.00% through five years from its issuance. The proceeds were
used to pay down $20.0 million of short-term borrowings.
On July 11, 2002, the Company issued $10.0 million Pooled Floating Rate Capital
Securities ("Sun Trust IV Capital Securities"). The interest rate resets every
three months to LIBOR plus 3.65%, with an initial rate of 5.51%, and will not
exceed 11.95% through five years from its issuance. The proceeds were used to
pay down $5.0 million of short-term borrowings and for general corporate
purposes.
During 2002, the Company repurchased 1,300 shares of Sun Trust II preferred
securities for approximately $13,000. During 2000, the Company repurchased
22,800 shares of Sun Trust II preferred securities for approximately $228,000.
For more information regarding guaranteed preferred beneficial interest in
Company's subordinated debt, refer to Note 25 of the Notes to Consolidated
Financial Statements contained herein.
Disclosures about Contractual Obligations and Commercial Commitments
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 adoption of FIN No. 45 did not have a
material impact on the consolidated financial statements.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. The guarantees are
primarily issued to support private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. In the event of a draw by the
beneficiary that complies with the terms of the letter of credit, the Company
would be required to honor the commitment. The Company takes various forms of
collateral, such as real estate assets and customer business assets to secure
the commitment. Additionally, all letters of credit are supported by
indemnification agreements executed by the customer. The maximum undiscounted
exposure related to these commitments at December 31, 2002 was $42.8 million,
and the portion of the exposure not covered by collateral was approximately
$14 million. We believe that the utilization rate of these letters of credit
will continue to be substantially less than the amount of these commitments, as
has been our experience to date.
24
The Company's contractual cash obligations (see Notes 11 and 19) at December 31,
2002 were as follows:
Payments Due by Period
--------------------------------------------------------------------------
Less than One to Four to After
Contractual Cash Obligations Total One Year Three Years Five Years Five Years
- ---------------------------- -------- -------- ----------- ---------- ----------
Long-Term Debt $159,894 $43,891 $46,003 $62,978 $7,022
Operating Leases 31,369 3,528 6,627 5,894 15,320
-------- ------- ------- ------- -------
Total Contractual Cash Obligations $191,263 $47,419 $52,630 $68,872 $22,342
======== ======= ======= ======= =======
The Company's contractual commitments (see Note 19) at December 31, 2002 were as
follows:
Amount of Commitment Expiration Per Period
----------------------------------------------------------
Unfunded Less than One to Three Four to After
Commitments Commitments One Year Years Five Years Five Years
- ----------- ----------- -------- ----- ---------- ----------
Lines of Credit $196,775 $130,900 $15,798 - $50,077
Commercial Letters of Credit 42,757 18,303 24,454 - -
Construction Funding 75,956 56,237 19,719 - -
Other Commitments 2,245 20 410 $19 1,796
-------- -------- ------- --- -------
Total Commitments $317,733 $205,460 $60,381 $19 $51,873
======== ======== ======= === =======
25
Forward-Looking Statements
The Company may from time to time make written or oral "forward-looking
statements" including statements contained in this annual report and in other
communications by the Company which are made in good faith pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements, such as statements of the Company's plans,
objectives, expectations, estimates and intentions, involve risks and
uncertainties and are subject to various important factors, some of which are
beyond the Company's control, including interest rate fluctuations, changes in
financial services' laws and regulations and competition, and which could cause
the Company's actual results to differ materially from the forward-looking
statements. The Company does not undertake, and specifically disclaims any
obligation, 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.
26
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- -------------------------------------------------------------------------
(c) Exhibits
The following exhibits are filed as part of this report:
31 Certifications Pursuant to ss.302 of the Sarbanes-Oxley Act
of 2002.
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: December 2, 2003 By: /s/Thomas A. Bracken
-----------------------------------------------
Thomas A. Bracken
President and Chief Executive Officer
(Duly Authorized Representative)