Selected Financial Data
At or for the Years Ended December 31,
---------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands, except per share amounts)
Selected Balance Sheet Data:
Assets $3,053,587 $2,599,487 $2,112,172 $1,929,425 $2,002,529
Cash and investments 952,779 1,058,096 800,425 739,201 848,421
Loans receivable (net) 1,847,721 1,364,465 1,217,008 1,089,605 1,031,844
Deposits 2,430,363 2,111,125 1,690,462 1,572,338 1,410,867
Borrowings and securities sold
under agreements to repurchase 254,310 222,398 205,280 160,096 407,279
Junior subordinated debentures (1) 77,322 72,167 - - -
Guaranteed preferred beneficial interest
in Company's subordinated debt (1) - - 59,274 57,327 57,327
Shareholders' equity 279,220 185,718 145,623 129,960 117,634
Selected Results of Operations:
Interest income $124,269 $108,062 $112,894 $126,825 $150,656
Net interest income 89,318 72,287 65,038 56,758 61,248
Provision for loan losses 2,075 4,825 4,175 7,795 2,580
Net interest income after
provision for loan losses 87,243 67,462 60,863 48,963 58,668
Non-interest income 19,119 17,356 13,178 10,516 8,183
Non-interest expense 81,152 66,036 58,965 57,695 54,447
Net income 17,629 13,336 10,378 1,328 8,780
Per Share Data:
Earnings Per Share
Basic $ 1.14 $ 1.02 $ 0.78 $ 0.11 $ 0.74
Diluted $ 1.06 $ 0.95 $ 0.75 $ 0.10 $ 0.73
Book Value $ 16.31 $ 13.30 $ 11.81 $ 10.64 $ 9.90
Selected Ratios:
Return on average assets 0.63% 0.59% 0.50% 0.07% 0.43 %
Return on average equity 7.80% 8.71% 7.63% 1.05% 8.85 %
Ratio of equity to assets 9.15% 6.79% 6.55% 6.42% 4.86 %
(1) Effective December 31, 2003, the Company adopted new accounting standards
which required the deconsolidation of the Company's wholly-owned trusts
which issued capital securities.
1
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)
ORGANIZATION OF INFORMATION
Management's Discussion and Analysis provides a narrative on the Company's
financial condition and results of operations that should be read in conjunction
with the accompanying consolidated financial statements. It includes the
following sections:
o OVERVIEW
o CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
o RECENT ACCOUNTING PRINCIPLES
o RESULTS OF OPERATIONS
o LIQUIDITY AND CAPITAL RESOURCES
o FINANCIAL CONDITION
o FORWARD-LOOKING STATEMENTS
OVERVIEW
Sun Bancorp, Inc. (the "Company") is a multi-state Bank Holding Company
headquartered in Vineland, New Jersey. The Company's principal subsidiary is Sun
National Bank (the "Bank"). At December 31, 2004, the Company had total assets
of $3.1 billion, total deposits of $2.4 billion and total shareholders' equity
of $279.2 million. In July 2004, the Company acquired Community Bancorp of New
Jersey ("Community") which added eight new branches with approximately $342
million of deposits. The Company's principal business is to serve as a holding
company for the Bank. As a registered holding company, the Company is subject to
the supervision and regulation of the Board of Governors of the Federal Reserve
System.
Through the Bank, the Company provides consumer and business banking services
through its regional banking groups and 73 Full Service Community Banking
Centers located in 12 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, SBA loans and small business loans. The
Bank's commercial deposit services include business checking accounts, and cash
management services such as electronic banking, sweep accounts, lockbox
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 other 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 recently
achieved Preferred Lender status with the SBA, offers equipment leasing and is a
designated Preferred Lender with the New Jersey Economic Development Authority.
2
The Company has a specific strategic plan for delivering profitable growth. The
key priorities that guide decisions and the focus of corporate resources are:
o Branch Franchise Strategy
o Relationship Banking
o Fee Income
o Infrastructure
Branch Franchise Strategy. Beginning in 2001, the Company began to implement a
strategy to maximize its market coverage and improve branch profitability with
the most efficient number of branches. Selling, consolidating or closing under
performing branches and adding branches in more attractive markets was
accomplished in the successful execution of this strategy. Through December 31,
2004, we have sold six branches and consolidated fourteen branches into existing
offices. These twenty branches had an average deposit size of approximately
$11.5 million. In addition, over that same period we opened seven de novo branch
offices. We have also had several recent acquisitions that have enhanced our
franchise and strengthened our market position in four strategic counties in New
Jersey. In December 2003, the Bank acquired eight branches with approximately
$340 million of deposits from New York Community Bank. In July 2004, the Bank
acquired Community Bancorp of New Jersey which added eight new branches with
approximately $342 million of deposits.
As a result of this branch rationalization program over the past four years, as
the table below demonstrates, the number of branch offices increased by a net by
three while total deposits have grown 71.4% from $1.4 billion at December 31,
2000 to total deposits at December 31, 2004 of $2.4 billion. More importantly,
the average deposit size per branch has grown by 64.9% from $20.2 million to
$33.3 million over this same period.
Total Avg. Deposits
No. of Deposits /Branch
Branches ($ Millions) ($ Millions)
- -------------------------------------------------------------------------------
Dec. 31, 2000 70 $1,411 $20.2
Dec. 31, 2001 (+3/-1) 72 1,572 21.8
Dec. 31, 2002 (+2/-1) 73 1,690 23.2
Dec. 31, 2003 (+8(1)/-5) 76 2,111 27.8
- -------------------------------------------------------------------------------
Dec. 31, 2004 (+10(2)/-13(3)) 73 $2,430 $33.3
- -------------------------------------------------------------------------------
(1) Eight branches were acquired from New York Community Bancorp in December
2003
(2) Acquisition of Community Bank of New Jersey in July 2004
(3) Branch rationalization consolidations and closings in 2004
While the Company has successfully completed its branch rationalization program
during 2004, our strategic efforts surrounding our branch franchise will be
ongoing. We will continue to take advantage of opportunities in our marketplace
to grow our core businesses. We expect that the continued consolidation of the
banking industry and the customer disruption caused by larger regional bank
mergers will provide opportunities to expand our operations and increase our
market share through branch and whole bank acquisitions as w ell as from
internal growth and de novo branching. We will also continue to evaluate the
profitability of our existing branch network for efficiencies that may be gained
from sales, consolidations or closures of underperforming branches.
3
Growth of Relationship Banking Business. As part of the implementation of our
strategic plan, it is our goal to provide our customers with value driven
products and services designed to create long-term, profitable relationships.
Our business is organized across three functional business lines which deliver
our products and services on a coordinated basis through our Regional Banking
Groups. Each Regional Banking Group focuses on serving the specific needs of its
market area and building lasting and profitable relationships with customers. In
this way, we are able to deliver to customers the full range of our products and
services through business line management and experienced loan origination and
credit professionals who operate solely within that market and are responsive,
flexible and highly customer focused.
Growth in Fee Income. We believe that we can better serve our customers, achieve
our goal of becoming the lead bank for all of our customers' banking needs,
increase our profitability and diversify our income stream by delivering a wider
range of fee-based financial services products. We intend to increase both our
customer base and our share of customers' financial services business by
offering a diverse range of products and services. The fee income strategy is
designed to provide a more diverse menu of products to our increasing customer
base. During 2004, we have enhanced our existing fee-generating products through
SBA loan sales, customer derivatives, and leasing. The Company, is exploring
additional products and services as part of our ongoing process of innovation.
In addition, we have hired new relationship managers with extensive experience
in lending and cross-selling these products and services in our market area.
Infrastructure. Since 2001, the Company has invested significant resources into
its infrastructure, including capital expenditures for technology hardware and
software, facilities improvements and security systems. We have also hired
additional people in our lending, regional banking and corporate locations. The
improvements to our technology and facilities have created an infrastructure
which complements our branch franchise strategy and enables us to more
efficiently deliver products and services.
Since 2001 through year end 2004, the Company has invested approximately $5.0
million in technology hardware and software upgrades. During 2004, we
successfully completed our most significant remaining project of fully
automating the branch network. Also during the above period, the Company has
committed to its focus on commercial banking and has increased its staff of
seasoned relationship officers by approximately 50 people.
We believe that the ongoing investment in infrastructure both in technology and
people has met our strategic objectives set out in 2001. We will continue to
prudently evaluate our ongoing capital spending and human resources in
accordance with our strategic needs.
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 accounting principles generally accepted in the United States of
America. 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 basis 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.
4
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. 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. 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. 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. It is the policy of management to
provide for losses on unidentified loans in its portfolio in addition to
classified loans.
Management monitors its allowance for loan losses on a quarterly basis and makes
adjustments to the allowance through the provision for loan losses as economic
conditions and other pertinent factors indicate. In this context, a series of
qualitative factors are used in a methodology as our 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. In determining the allowance for loan losses, management has
established both specific and general pooled allowances. 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
(general pooled allowance) and those criticized and classified loans without
Statement of Financial Accounting Standards ("SFAS") No. 114 reserves (specific
allowance). 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 reserve factor percentages
based on historic loss experience and the qualitative factors described above.
In determining the appropriate level of the general pooled allowance, management
makes estimates based on internal risk ratings, which take into account such
factors as debt service coverage, loan to value ratios, and external factors.
Estimates are periodically measured against actual loss experience.
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, if economic conditions differ substantially from the assumptions used
in making the evaluations 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. Accordingly, a decline in the national economy or
the local economies of the areas in which the 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. 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.
5
Accounting for Income Taxes. The Company accounts for income taxes in accordance
with 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. The judgments and estimates required for the
evaluation are updated based upon changes in business factors and the tax laws.
Valuation of Goodwill. The Company assesses 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.
RECENT ACCOUNTING PRINCIPLES
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123R (revised 2004), "Share-Based Payment," which revises SFAS No. 123,
"Accounting for Stock-Based Compensation," and supersedes Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." This
Statement requires an entity to recognize the cost of employee services received
in share-based payment transactions and measure the cost on a grant-date fair
value of the award. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award. The
provisions of SFAS No. 123R will be effective for the Company's financial
statements issued for periods beginning after June 15, 2005. The Company is
currently evaluating the effects of the adoption of this Statement on its
financial statements.
In March 2004, the FASB ratified the consensus reached by the Emerging Issues
Task Force in Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments" (EITF 03-1). EITF 03-1 provides guidance
for determining when an investment is considered impaired, whether impairment is
other-than-temporary, and measurement of an impairment loss. In September 2004,
the FASB issued FASB Staff Position 03-1-1, which delayed the effective date for
the measurement and recognition guidance contained in paragraphs 10-20 of Issue
03-1 due to additional proposed guidance. The amount of other-than-temporary
impairment to be recognized depends on market conditions, management's intent
and ability to hold investments until a forecasted recovery and the finalization
of the proposed guidance by the FASB. The Company does not anticipate that the
finalization of the proposed guidance will have a material impact on the
Company.
In March 2004, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 105, "Application of Accounting Principles to Loan
Commitments" (SAB 105). This bulletin was issued to inform registrants of the
SEC's view that the fair value of the recorded loan commitments, which are
required to follow derivative accounting under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," should not consider the expected
future cash flows related to the associated servicing of the future loan. The
provisions of SAB 105 must be applied to loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The provisions of this
Staff Accounting Bulletin did not have a material impact on the Company.
6
In December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued AICPA Statement of Position No.
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
(SOP 03-3), to address accounting for differences between the contractual cash
flows of certain loans and debt securities and the cash flows expected to be
collected when loans or debt securities are acquired in a transfer and those
cash flow differences are attributable, at least in part, to credit quality. As
such, SOP 03-3 applies to such loans and debt securities purchased or acquired
in purchase business combinations and does not apply to originated loans. It
applies to loans with evidence of deterioration of credit quality since
origination acquired by completion of a transfer for which it is probable, at
acquisition, that the investor will be unable to collect all contractually
required payments receivable. The application of SOP 03-3 limits the interest
income, including accretion of purchase price discounts that may be recognized
for certain loans and debt securities. Additionally, SOP 03-3 requires that the
excess of contractual cash flows over cash flows expected to be collected
(nonaccretable difference) not be recognized as an adjustment of yield or
valuation allowance, such as the allowance for loan losses. Subsequent to the
initial investment, increases in expected cash flows generally should be
recognized prospectively through adjustment of the yield on the loan or debt
security over its remaining life. Decreases in expected cash flows should be
recognized as impairment. SOP 03-3 is effective for loans and debt securities
acquired in fiscal years beginning after December 15, 2004, with early
application encouraged. The impact of this new pronouncement will depend on the
Company's activity in purchasing loans or acquiring loans in a business
combination.
RESULTS OF OPERATIONS
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.
2004 vs. 2003
Overview. Net income for the year ended December 31, 2004 was $17.6 million, or
$1.06 earnings per share, in comparison to $13.3 million, or $0.95 earnings per
share for the year ended December 31, 2003. As more fully described below, the
32.3% increase in net income was attributable to an increase in net interest
income of $17.0 million, a decrease in the provision for loan losses of $2.8
million, and an increase in non-interest income of $1.8 million, partially
offset by an increase in non-interest expenses of $15.1 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) 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.
7
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,
------------------------------------------------------------------------------
2004 2003
-------------------------------------- --------------------------------------
Avg. Avg.
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ----
Loans receivable (1), (2):
Commercial and industrial $1,352,307 $ 82,871 6.13 % $1,087,067 $ 70,437 6.48 %
Home equity 102,661 4,075 3.97 62,194 2,452 3.94
Second mortgage 50,352 3,193 6.34 50,302 3,369 6.70
Residential real estate 30,730 2,225 7.24 37,315 2,778 7.45
Other 57,447 4,253 7.41 52,365 4,227 8.07
---------- -------- ---------- --------
Total loans receivable 1,593,497 96,617 6.06 1,289,243 83,263 6.46
Investment securities (3) 881,547 28,134 3.19 732,821 25,726 3.51
Interest-bearing deposit with banks 13,737 134 0.97 8,464 57 0.68
Federal funds sold 29,675 385 1.30 31,599 301 0.95
---------- -------- ---------- --------
Total interest-earning assets 2,518,456 125,270 4.97 2,062,127 109,347 5.30
Non-interest-earning assets:
Cash and due from banks 77,050 63,963
Bank properties and equipment 35,828 29,661
Goodwill and intangible assets 100,981 39,016
Other assets, net 62,638 59,329
---------- ----------
Total non-interest-earning assets 276,497 191,969
---------- ----------
Total assets $2,794,953 $2,254,096
========== ==========
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 792,470 7,200 0.91 $ 684,162 7,407 1.08
Savings deposits 429,077 3,440 0.80 326,012 3,968 1.22
Time deposits 562,265 13,421 2.39 408,264 12,105 2.96
---------- -------- ---------- --------
Total interest-bearing deposits 1,783,812 24,061 1.35 1,418,438 23,480 1.66
---------- -------- ---------- --------
Borrowed money, short-term:
Federal funds purchased 3,990 70 1.76 4,653 81 1.74
Repurchase agreements with customers 63,727 471 0.74 71,828 348 0.48
Borrowed money, long-term:
FHLB advances 159,466 6,734 4.22 170,844 7,639 4.47
Debentures and trust securities 74,646 3,615 4.84 60,660 4,227 6.97
---------- -------- ---------- --------
Total interest-bearing liabilities 2,085,641 34,951 1.68 1,726,423 35,775 2.07
---------- -------- ---------- --------
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits 460,990 338,385
Other liabilities 22,390 36,171
---------- ----------
Non-interest-bearing liabilities 483,380 374,556
---------- ----------
Total liabilities 2,569,021 2,100,979
---------- ----------
Shareholders' equity 225,932 153,117
---------- ----------
Total liabilities and shareholders' equity $2,794,953 $2,254,096
========== ==========
Net interest income $90,319 $73,572
======= =======
Interest rate spread (4) 3.29 % 3.23 %
====== == ====
Net interest margin (5) 3.59 % 3.57 %
====== == ====
Ratio of average interest-earning assets
to average interest-bearing liabilities 120.75 % 119.45 %
====== ======
- --------------------------------------------------------------------------------
(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 interest margin represents net interest income as a percentage of
average interest-earning assets.
8
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 the prior year rate) and (ii) changes
in rate (changes in rate multiplied by the prior year 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,
2004 vs. 2003
--------------------------------
Increase (Decrease)
Due to
--------------------------------
Volume Rate Net
-------- -------- --------
Interest income:
Loans receivable:
Commercial and industrial $ 16,423 $ (3,989) $ 12,434
Home equity 1,606 17 1,623
Second mortgage 3 (179) (176)
Residential real estate (478) (75) (553)
Other 392 (365) 27
-------- -------- --------
Total loans receivable 17,946 (4,591) 13,355
Investment securities 4,893 (2,486) 2,407
Interest-bearing deposit with banks 45 32 77
Federal funds sold (19) 103 84
-------- -------- --------
Total interest-earning assets $ 22,865 $ (6,942) $ 15,923
-------- -------- --------
Interest expense:
Deposit accounts:
Demand deposits $ 1,079 $ (1,286) $ (207)
Savings deposits 1,049 (1,577) (528)
Time deposits 3,979 (2,662) 1,317
-------- -------- --------
Total deposits accounts 6,107 (5,525) 582
Borrowings:
Federal funds purchased (12) 1 (11)
Repurchase agreements with customers (43) 166 123
FHLB advances (494) (411) (905)
Debentures and trust securities 846 (1,459) (613)
-------- -------- --------
Total borrowed money 297 (1,703) (1,406)
Total interest-bearing liabilities $ 6,404 $ (7,228) $ (824)
-------- -------- --------
Net change in interest income $ 16,461 $ 286 $ 16,747
======== ======== ========
Net interest income (on a tax-equivalent basis) increased $16.7 million or 22.7%
to $90.3 million for 2004 compared to $73.6 million for 2003. The Company's net
interest margin increased in 2004 to 3.59% compared to 3.57% in 2003. Through
the acquisition of Community in 2004 and the Bank's continued growth in its core
lending business, average interest-earning assets increased $456.3 million or
22.1%. This significant growth in average interest-earning assets resulted in an
increase in interest income of $22.9 million. Partially offsetting the positive
volume variance was a decrease in interest income of $6.9 million due to a
decrease of 33 basis points in the yield on interest-earning assets to 4.97% for
2004 compared to 5.30% for 2003. The decrease in yields occurred primarily in
the loan portfolio and reflects the ongoing loan repricing of both new and
resetting loans.
Average interest-bearing liabilities increased $359.2 million or 20.8%. This
increase was primarily in interest-bearing deposits which increased $365.4
million or 25.7%. This increase is also due to the Community acquisition in 2004
and the branch acquisition in the fourth quarter 2003. This increase in total
interest-bearing liabilities increased interest expense by $6.4 million in 2004
over 2003. Offsetting this increase was a decrease in the average cost of funds
of 39 basis points to 1.68% for 2004 compared to 2.07% for 2003. This decrease
in the cost of funds contributed to a decline in interest expense of $7.2
million. This reduction in the cost of funds reflects the Company's continued
management of deposit pricing and the December 2003 refinancing of the Trust
Preferred Securities.
9
Although the Company expects that interest rates will increase throughout 2005
with a continued trend of a flattening yield curve, the Company believes that in
2005 its earning assets and funding mix should contribute to continued growth in
both net interest income and a sustained or moderately increased margin.
Provision for Loan Losses. The Company recorded a provision for loan losses of
$2.1 million in 2004, a decrease of $2.8 million compared to a provision of $4.8
million for 2003. The ratio of allowance for loan losses to total loans was
1.18% at December 31, 2004 compared to 1.27% at December 31, 2003. The decrease
in the 2004 provision was primarily the result of the third quarter 2004
complete repayment of the Company's largest non-performing loan which had a
recorded balance of $9.1 million. At least quarterly, management performs an
analysis to identify the inherent risk of loss in the Company's loan portfolio.
This analysis includes a qualitative 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.
Non-Interest Income. Non-interest income increased $1.8 million, or 10.2% for
the year ended December 31, 2004 compared to the year ended December 31, 2003.
The increase was in part the result of a $2.3 million increase in gain on sale
of branch real estate during the second quarter 2004, a $1.4 million increase in
service charges on deposit accounts, an increase in the gain on sale of SBA
loans of $289,000, and an increase of $809,000 in BOLI investment income. The
increase in service charges resulted primarily from the Company's overdraft
privilege program, changes in ATM pricing, and a $1.1 million increase in
service charges on deposit accounts resulting from a higher number of charges
following the July 2004 and December 2003 acquisitions. The increase in BOLI
investment income is primarily the result of the purchase of an additional $6.8
million of BOLI investments and an additional $5.1 million assumed in the
Community acquisition. Partially offsetting these increases was a decrease in
gain on sale of investment securities of $1.1 million and a prior period gain on
sale of branches of $2.6 million with no related gain in 2004. Many factors are
considered before an investment security is sold, including the market interest
rates, duration of remaining portfolio and capital and liquidity needs of the
Company.
Management anticipates that the Company's overdraft privilege program, BOLI
investments, and its third party arrangement that allows the Bank to offer
mutual funds, securities brokerage, annuities and investment advisory services,
will continue to increase our non-interest income in 2005. In addition, other
programs initiated during the year that may contribute to increased fee income
include SBA loans sales and customer derivatives.
Non-Interest Expenses. Non-interest expenses increased approximately $15.2
million, or 23.0% to $81.2 million for the year ended December 31, 2004 as
compared to $66.0 million for 2003. Of this increase, $8.5 million of
non-interest expenses is attributable to the July 2004 and December 2003
acquisitions. These expenses consist of the following:
For the 2004 Expenses
Year Ended of Acquired
December 31, Entities Variance
----------------------------------------------------------
2004 2003
---- ----
NON-INTEREST EXPENSES:
Salaries and employee benefits $40,177 $33,421 $3,667 $3,089
Occupancy expense 10,608 8,768 1,355 485
Equipment expense 7,091 5,341 960 790
Data processing expense 3,973 3,438 69 466
Amortization of intangible assets 5,268 3,696 1,786 (214)
Other 14,035 11,372 660 2,003
------- ------- ------ ------
Total non-interest expenses $81,152 $66,036 $8,497 $6,619
======= ======= ====== ======
Of the remaining $6.6 million increase, $3.1 million was in salaries and
employee benefits due to increased staffing and annual merit increases. The
increase in occupancy expense includes $684,000 in lease buyout costs for closed
branches. Equipment expense increased as a result of continued system upgrades
primarily in computers and telephone systems. The increase in other expenses was
due to an increase of $657,000 in real estate owned expense, a litigation
settlement of $458,000 and increased professional fees related to Sarbanes-Oxley
compliance.
10
Income Tax Expense. Income taxes increased $2.2 million from $5.4 million for
the year ended December 31, 2003 to $7.6 million for the year ended December 31,
2004. The increase was due to a larger 2004 pretax income and an increase in the
effective tax rate from 29.0% to 30.1%. The increase in the effective tax rate
was primarily due to decreased interest income from non-taxable investment
securities.
2003 vs. 2002
Overview. Net income for the year ended December 31, 2003 was $13.3 million, or
$0.95 earnings per share, in comparison to $10.4 million, or $0.75 earnings per
share for the year ended December 31, 2002. As more fully described below, the
28.5% increase in net income was attributable to an increase in net interest
income of $7.2 million and an increase in non-interest income of $4.2 million,
partially offset by an increase in non-interest expenses of $7.1 million.
11
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,
------------------------------------------------------------------------------
2003 2002
-------------------------------------- --------------------------------------
Avg. Avg.
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ----
Loans receivable (1), (2):
Commercial and industrial $1,087,067 $ 70,437 6.48 % $ 991,715 $ 70,134 7.07 %
Home equity 62,194 2,452 3.94 32,756 1,651 5.04
Second mortgage 50,302 3,369 6.70 51,751 3,874 7.49
Residential real estate 37,315 2,778 7.45 50,542 3,384 6.70
Other 52,365 4,227 8.07 55,508 4,779 8.61
---------- -------- ---------- --------
Total loans receivable 1,289,243 83,263 6.46 1,182,272 83,822 7.09
Investment securities (3) 732,821 25,726 3.51 682,433 29,346 4.30
Interest-bearing deposit with banks 8,464 57 0.68 10,318 88 0.85
Federal funds sold 31,599 301 0.95 44,891 703 1.57
---------- -------- ---------- --------
Total interest-earning assets 2,062,127 109,347 5.30 1,919,914 113,959 5.94
Non-interest-earning assets:
Cash and due from banks 63,963 60,705
Bank properties and equipment 29,661 28,634
Goodwill and intangible assets 39,016 40,076
Other assets, net 59,329 28,366
---------- ----------
Total non-interest-earning assets 191,969 157,781
---------- ----------
Total assets $2,254,096 $2,077,695
========== ==========
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 684,162 7,407 1.08 $ 584,808 10,789 1.84
Savings deposits 326,012 3,968 1.22 314,208 6,821 2.17
Time deposits 408,264 12,105 2.96 449,438 17,493 3.89
---------- -------- ---------- --------
Total interest-bearing deposits 1,418,438 23,480 1.66 1,348,454 35,103 2.60
---------- -------- ---------- --------
Borrowed money, short-term:
Federal funds purchased 4,653 81 1.74 682 15 2.20
Repurchase agreements with customers 71,828 348 0.48 74,602 739 0.99
Borrowed money, long-term:
FHLB advances 170,844 7,639 4.47 147,130 7,347 4.99
Debentures and trust securities (4) 60,660 4,227 6.97 55,536 4,481 8.07
Other borrowed money - - 3,242 171 5.27
---------- -------- ---------- --------
Total interest-bearing liabilities 1,726,423 35,775 2.07 1,629,646 47,856 2.94
---------- -------- ---------- --------
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits 338,385 287,164
Other liabilities 36,171 24,788
---------- ----------
Non-interest-bearing liabilities 374,556 311,952
---------- ----------
Total liabilities 2,100,979 1,941,598
---------- ----------
Shareholders' equity 153,117 136,097
---------- ----------
Total liabilities and shareholders' equity $2,254,096 $2,077,695
========== ==========
Net interest income $73,572 $66,103
======= =======
Interest rate spread (5) 3.23 % 3.00 %
====== ======
Net interest margin (6) 3.57 % 3.44 %
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 119.45 % 117.81 %
====== ======
- --------------------------------------------------------------------------------
(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) Represents junior subordinated debentures in 2003 and guaranteed preferred
beneficial interest in Company's subordinated debt in 2002. (See Note 15 of
the Consolidated Financial Statements).
(5) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(6) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
12
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,
2003 vs. 2002
-------------------------------------------
Increase (Decrease)
Due to
-------------------------------------------
Volume Rate Net
Interest income:
Loans receivable:
Commercial and industrial $ 6,427 $ (6,124) $ 303
Home equity 1,224 (423) 801
Second mortgage (106) (399) (505)
Residential real estate (952) 346 (606)
Other (262) (290) (552)
-------- -------- --------
Total loans receivable 6,331 (6,890) (559)
Investment securities 2,053 (5,673) (3,620)
Interest-bearing deposit with banks (14) (17) (31)
Federal funds sold (172) (230) (402)
-------- -------- --------
Total interest-earning assets $ 8,198 $(12,810) $ (4,612)
-------- -------- --------
Interest expense:
Deposit accounts:
Demand deposits $ 1,630 $ (5,013) $ (3,383)
Savings deposits 246 (3,099) (2,853)
Time deposits (1,493) (3,895) (5,388)
-------- -------- --------
Total deposits accounts 383 (12,007) (11,624)
Borrowings:
Federal funds purchased 70 (4) 66
Repurchase agreements with customers (26) (365) (391)
FHLB advances 1,107 (814) 293
Debentures and trust securities 391 (645) (254)
Other borrowed money (171) -- (171)
-------- -------- --------
Total borrowed money 980 (1,183) (203)
Total interest-bearing liabilities $ 1,754 $(13,835) $(12,081)
-------- -------- --------
Net change in interest income $ 6,444 $ 1,025 $ 7,469
======== ======== ========
Net interest income (on a tax-equivalent basis) increased $7.5 million, or 11.3%
to $73.6 million for 2003 compared to $66.1 million for 2002. Of this amount,
$8.2 million was due to the 7.4% increase in the average balance of
interest-earning assets. The continued low interest rate environment resulted in
a decrease in both interest income and expense, netting to a $1.0 million
increase in net interest income. Partially offsetting these increases was the
$1.8 million increase in interest expense attributed to the 5.9% increase in the
average balance of interest-bearing liabilities. Net interest spread increased
23 basis points in 2003. In the lower interest rate environment which
characterized 2003 compared to 2002, the Company achieved a decline in funding
cost of 87 basis points which exceeded the decline in interest-earning asset
yield of 64 basis points.
While a large number of depository institutions reported a decreased net
interest margin for 2003, the Company increased its net interest margin to 3.57%
for 2003 from 3.44% for 2002. The increase in net interest margin was due to the
Company continuing to employ its relationship pricing strategy which facilitated
a favorable change in the mix of deposits between core and time deposits,
resulting in an increase of higher concentration, lower costing core deposits.
Also contributing to the increase was the Company's ability during 2003 to
reprice its deposit liabilities quicker than its loan products. The
repositioning of the Company's capital securities with the redemption of the
capital securities issued by Sun Capital Trust II and the issuance of new
capital securities also aided the improvement in net interest margin.
13
Provision for Loan Losses. The Company recorded a provision for loan losses of
$4.8 million in 2003, an increase of $650,000 compared to a provision of $4.2
million for 2002. The larger 2003 provision was primarily the result of loan
portfolio growth. The ratio of allowance for loan losses to total loans was
1.27% at December 31, 2003 compared to 1.33% at December 31, 2002.
Non-Interest Income. Non-interest income increased $4.2 million, or 31.7% for
the year ended December 31, 2003 compared to the year ended December 31, 2002.
The increase was primarily due to the $2.6 million gain on sale of branches.
Additionally, the Company recorded gain on sale of investment securities of $2.5
million for the years ended December 31, 2003 and 2002. Many factors are
considered before an investment security is sold, including the market interest
rates, duration of remaining portfolio and capital and liquidity needs on the
Company.
One of the Company's key strategic goals is building fee income by introducing
new products. Two new products introduced in 2003 contributed to the increase in
non-interest income. The Bank's overdraft privilege program increased service
charges by approximately $479,000 and the income recorded from the Company's
first year of Bank Owned Life Insurance ("BOLI") was $984,700.
Non-Interest Expenses. Non-interest expenses increased approximately $7.0
million, or 12.0% to $66.0 million for the year ended December 31, 2003 as
compared to $59.0 million for the same period for 2002. Salaries and employee
benefits increased $5.2 million, reflecting the effect of the increased staffing
in early 2002. Occupancy expense increased $875,000, due primarily to additional
branches, snow removal and security. Advertising increased $682,000 as a result
of continued and increased branding efforts and the conversion of the New York
Community branches.
Income Tax Expense. Income taxes increased $748,000 to $5.4 million for the year
ended December 31, 2003 due to the increase in 2003 pretax income, partially
offset by decrease in the effective tax rate from 31.2% to 29.0%. The 2.2%
decrease in the effective tax rate, is principally due to an increase in tax
exempt BOLI income.
LIQUIDITY AND CAPITAL RESOURCES
Management of liquidity is of continuing importance to the Company. The
liquidity of the Company reflects its ability to meet loan requests, to
accommodate possible outflows of deposits and to take advantage of interest rate
market opportunities. The ability of the Company to meet its current financial
obligations is a function of balance sheet structure, the ability to liquidate
assets and the availability of alternative sources of funds. To meet the needs
of the clients and manage the risk of the Bank, the Company has developed
innovative ways to meet our clients needs while at the same time manage both
liquidity and interest rate risk. This is being done primarily through liquidity
management and the balance of deposit growth and alternative sources of
borrowing.
A major source of the Company's funding is deposits, which management believes
will be sufficient to meet the Company's long-term daily operating 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, 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, 2005 total $346.4 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
14
certificates of deposit for retention as well as provide fixed rate funding in
the expected rising rate environment. However, based on market conditions and
other liquidity considerations, it may avail itself of the secondary borrowings
discussed above.
Excluding approximately $230 million in net loans acquired in the July 2004
Community acquisition, net loans grew approximately $253 million or 18.6% during
2004. The Company expects to maintain a similar level of loan growth during
2005. As such, 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 $74.9 million at December 31,
2004, the Company's estimated cash flow from securities with maturities of less
than one year and principal payments from mortgage-backed securities over the
next twelve months totals $221.5 million. In addition, the FHLB provides a
reliable source of funds with a wide variety of terms and structures. As of
December 31, 2004, the Company had total credit availability with the FHLB of
$250.9 million, of which $202.9 million was outstanding. This credit
availability with the FHLB can be increased with the additional pledging of the
Company's qualified assets as collateral. At December 31, 2004, the Company had
approximately $225 million in assets that were available and would qualify as
collateral at the FHLB. Management will continue to monitor the Company's
liquidity and maintain it at a level that they deem adequate but not excessive.
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 managing its financial risks. It is
the Company's intention to maintain "well-capitalized" regulatory 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. During 2003, this included the calling of
approximately $30 million of Trust Preferred Securities, the issuance of $40
million of Trust Preferred Securities and the issuance of 1,495,000 shares of
common stock. The following table sets forth the regulatory capital levels at
December 31, 2004 for the Company and the Bank.
To Be Well-Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
At December 31, 2004 Actual Purposes Provisions
----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $239,830 10.80% $177,732 8.00% N/A
Sun National Bank $222,968 10.06% $177,260 8.00% $221,575 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $217,263 9.78% $88,866 4.00% N/A
Sun National Bank $200,401 9.04% $88,630 4.00% $132,945 6.00%
Leverage Ratio:
Sun Bancorp, Inc. $217,263 7.51% $115,792 4.00% N/A
Sun National Bank $200,401 6.94% $115,518 4.00% $144,397 5.00%
As part of its capital plan, the Company maintained trust preferred securities
of $75.0 million at December 31, 2004 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.
Asset and Liability Management
Interest rate, credit and operational risks are among the most significant
market risks impacting the performance of the Company. Interest risk is reviewed
monthly by the Asset Liability Committee ("ALCO"), composed of senior management
representatives from a variety of areas within the Company. ALCO devises
strategies and tactics to maintain the net interest income of the Company within
acceptable ranges over a variety of interest rate scenarios. Should the
15
Company's risk modeling indicate an undesired exposure to changes in interest
rates, there are a number of remedial options available including changing the
investment portfolio characteristics, and changing loan and deposit pricing
strategies. Two of the tools used in monitoring the Company's sensitivity to
interest rate changes are gap analysis and net interest income simulation.
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 the bank's
interest rate sensitivity gap. Interest-earning assets are considered to be
interest-rate sensitive if they will mature or reprice within a specific time
period, over the interest-bearing liabilities maturing or repricing within that
same time period. On a monthly basis the Company and the Bank monitor their gap,
primarily cumulative through both six months and one year maturities.
During most of 2004, the Company was asset sensitive, that is, the Company's
interest-earning assets had shorter maturity or repricing terms than its
interest-bearing liabilities. At December 31, 2004, the Company had a positive
position with respect to its exposure to interest rate risk maturing or
repricing within one year. Total interest-earning assets maturing or repricing
within one year exceeded interest-bearing liabilities maturing or repricing
during the same time period by $131.9 million, representing a positive one-year
gap ratio of 4.32%.
The following table sets forth the maturity and repricing characteristics of the
Company's interest-earning assets and interest-bearing liabilities at December
31, 2004. 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 $729,560 $191,909 $ 854,250 $ 94,039 $1,869,758
FHLB interest-bearing deposit 1,878 - - - 1,878
Investment securities 133,769 144,855 563,614 40,111 882,349
Federal funds sold 4,002 - - - 4,002
-------- -------- ---------- -------- ----------
Total interest-earning assets 869,209 336,764 1,417,864 134,150 2,757,987
--------- -------- ---------- -------- ---------
Interest-bearing demand deposits 287,992 73,182 346,390 85,726 793,290
Savings deposits 53,919 88,461 270,315 40,031 452,726
Time certificates 155,315 198,136 275,863 11,432 640,746
Federal Home Loan Bank advances 4,953 25,171 109,330 5,215 144,669
Securities sold under agreements to repurchase 109,641 - - - 109,641
Trust preferred securities 56,703 20,619 - - 77,322
--------- -------- ---------- -------- ----------
Total interest-bearing liabilities 668,523 405,569 1,001,898 142,404 2,218,394
--------- -------- ---------- -------- ----------
Periodic Gap $200,686 ($68,805) $ 415,966 ($8,254) $ 539,593
======== ======== ========== ======== ==========
Cumulative Gap $200,686 $131,881 $ 547,847 $539,593
======== ======== ========== ========
Cumulative Gap Ratio 6.57% 4.32% 17.94% 17.67%
======== ======== ========== ========
Net Interest Income Simulation
Due to the inherent limitations of gap analysis, the Company also uses
simulation models to measure the impact of changing interest rates on its
operations. The simulation model attempts to capture the cash flow and repricing
characteristics of the current assets and liabilities on the Company's balance
sheet. Assumptions regarding such things as prepayments, rate change behaviors,
level and composition of new balance sheet activity and new product lines are
incorporated into the simulation model. Net interest income is simulated over a
twelve month horizon under a variety of linear yield curve
16
shifts, subject to certain limits agreed to by ALCO. The Company uses a base
interest rate scenario provided by a third party econometric modeling service.
Actual results may differ from the simulated results due to such factors as the
timing, magnitude and frequency of interest rate changes, changes in market
conditions, management strategies and differences in actual versus forecasted
balance sheet composition and activity.
The following table shows the Company's estimated earnings sensitivity profile
versus the most likely rate forecast as of December 31, 2004.
Change in Interest Rates Percentage Change in Net Interest Income
------------------------ ----------------------------------------
(Basis Points) Year 1
-------------- ------
+200 +0.2%
+100 0.0%
-100 +1.5%
-200 +1.0%
Derivative Financial Instruments
The Company utilizes certain derivative financial instruments to enhance its
ability to manage interest rate risk that exists as part of its ongoing business
operations. As of December 31, 2004, all derivative financial instruments have
been entered into to hedge the interest rate risk associated with the Bank's
commercial lending activity. In general, the derivative transactions fall into
one of two types, a bank hedge of a specific fixed rate loan or a hedged
derivative offering to a Bank customer. In those transactions in which the Bank
hedges a specific fixed rate loan, the derivative is executed for periods and
terms that match the related underlying exposures and do not constitute
positions independent of these exposures. For derivatives offered to Bank
customers, the economic risk of the customer transaction is offset by a mirror
position with an non-affiliated third party.
Interest rate swaps are agreements with a counterparty to exchange periodic
fixed and floating interest payments calculated on a notional amount. The
floating rate is based on a money market index, primarily short-term LIBOR.
Financial derivatives involve, to varying degrees, interest rate, market and
credit risk. For interest rate swaps, only periodic cash payments are exchanged.
Therefore, cash requirements and exposure to credit risk are significantly less
than the notional amount.
Not all elements of interest rate, market and credit risk are addressed through
the use of financial or other derivatives, and such instruments may be
ineffective for their intended purposes due to unanticipated market
characteristics, among other reasons.
Disclosures about Contractual Obligations and Commercial Commitments
The Company's contractual cash obligations at December 31, 2004 were as follows:
Payments Due by Period
-----------------------------------------------------------------------
Less than One to Four to Five After
Contractual Cash Obligations Total One Year Three Years Years Five Years
- ---------------------------- ------------- -------- ----------- ------------ ----------
Long-Term Debt (Notes 13 and 15) $349,223 $39,861 $77,454 $57,889 $174,019
Operating Leases (Note 20) 33,483 4,407 6,877 6,361 15,838
Purchase Obligations (off balance sheet) 7,315 3,230 4,085 - -
-------- ------- ------- ------- --------
Total Contractual Cash Obligations $390,021 $47,498 $88,416 $64,250 $189,857
======== ======= ======= ======= ========
17
Purchase Obligations include significant contractual cash obligations. Included
in the table above are the minimum contractual obligations under legally
enforceable contracts with contract terms that are both fixed and determinable
and have greater than one year remaining at December 31, 2004. The majority of
these amounts are primarily for services, including core processing systems and
telecommunications maintenance.
The Company's contractual commitments (see Notes 6 and 20) at December 31, 2004
were as follows:
Amount of Commitment Expiration Per Period
--------------------------------------------------------------------------
Unfunded Less than One to Four to After
Commitments Commitments One Year Three Years Five Years Five Years
- ----------- ----------- -------- ----------- ---------- ----------
Lines of Credit $435,636 $289,395 $21,975 $ 4 $124,262
Commercial Standby Letters of Credit 51,226 40,936 10,201 - 89
Construction Funding 82,169 81,871 16 282 -
Other Commitments 187,828 183,147 721 42 3,918
-------- -------- ------- ---- --------
Total Commitments $756,859 $595,349 $32,913 $328 $128,269
======== ======== ======= ==== ========
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, 2004 was $51.2 million,
and the portion of the exposure not covered by collateral was approximately
$15.9 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.
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.
18
FINANCIAL CONDITION
The Company's assets increased by $454 million, or 17.5% from $2.60 billion at
December 31, 2003 to $3.05 billion at December 31, 2004. In July 2004, the
Company acquired assets of approximately $374 million and recorded purchase
adjustments of approximately $69 million from the Community acquisition. The
table below summarizes the effects of the Community transaction immediately
following the merger:
(Dollars in millions) Internal
--------
ASSETS 2004 2003 Community Variance
---- ---- --------- --------
Cash and cash equivalents $ 74.9 $ 82.1 $ 12.0 $ (19.2)
Investment securities 862.5 963.4 114.6 (215.5)
Loans receivable net of allowance for loan losses 1,847.7 1,364.5 229.9 253.3
Restricted equity investments 15.4 12.5 1.0 1.9
Bank properties and equipment, net 36.8 34.1 6.9 (4.2)
Real estate owned, net 2.9 4.4 - (1.5)
Accrued interest receivable 12.5 11.3 1.5 (0.3)
Goodwill 105.0 50.6 54.6 (0.2)
Intangible assets, net 34.8 26.2 13.8 (5.2)
Deferred taxes, net 4.6 8.5 (4.3) 0.4
Bank owned life insurance 47.2 32.8 5.9 8.5
Other assets 9.3 9.1 0.9 (0.7)
-------- -------- -------- --------
TOTAL $3,053.6 $2,599.5 $ 436.8 $ 17.3
======== ======== ======== ========
LIABILITIES
Deposits $2,430.4 $2,111.1 $ 341.6 $ (22.3)
Borrowings and Federal funds purchased 194.7 166.5 9.7 18.5
Securities sold under agreements to repurchase - 59.6 55.9 - 3.7
customer
Junior subordinated debentures 77.3 72.2 5.1 -
Other liabilities 12.4 8.1 0.9 3.4
-------- -------- -------- --------
Total liabilities 2,774.4 2,413.8 357.3 3.3
-------- -------- -------- --------
SHAREHOLDERS' EQUITY
Common stock, $1 par value, 25,000,000 shares
authorized and issued 17.2 13.4 3.1 0.7
Additional paid-in capital 244.1 151.6 76.4 16.1
Retained earnings 21.7 20.0 - 1.7
Accumulated other comprehensive (loss) income (2.8) 1.7 - (4.5)
Treasury stock at cost, 90,562 shares (1.0) (1.0) - -
-------- -------- -------- --------
Total shareholders' equity 279.2 185.7 79.5 14.0
-------- -------- -------- --------
TOTAL $3,053.6 $2,599.5 $ 436.8 $ 17.3
======== ======== ======= ======
Loans. Excluding the Community acquisition, net loans receivable increased
$253.3 million, or 18.6%, at December 31, 2004. This growth was primarily due to
increases in commercial loans of $229.3 million or 19.6%, home equity loans of
$22.2 million or 27.7%, and other loans of $13.7 million or 26.7% offset by a
decrease in mortgage and second mortgage loans of $10.3 million. The increase in
commercial loans was a result of organic growth as well as the continued hiring
of experienced loan origination and credit professionals. This increase in
commercial loans is net of approximately $105 million in unscheduled
prepayments. The increase in the home equity loans is driven from the Company's
goal to increase residential lending through relationship products. During 2004,
the Company offered promotional rates on the home equity products. The increase
in other loans is primarily attributable a marketing campaign around the
Company's Sun Express Small Business Line of Credit which resulted in a $14.4
million increase over the prior year.
19
The trend of the Bank's lending over the past several years has been
diversification of commercial and industrial loans. A large but declining
portion of the total portfolio is concentrated in the hospitality, entertainment
and leisure industries and general office space. 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. At December 31, 2004, 10.3% of total loans
outstanding were concentrated in hotel loans compared to 11.5% at December 31,
2003.
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 Company's underwriting standards, rates and terms, and are
approved according to the Company'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,
-------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------- ------------------- ------------------- --------------------- -------------------
Amount % Amount % Amount % Amount % Amount %
------ -- ------ -- ------ -- ------ -- ------ --
Type of Loan:
Commercial and industrial $1,603,868 86.80 $1,169,164 85.69 $1,043,885 85.77 $ 911,145 83.62 $ 869,088 84.23
Home equity 122,735 6.64 80,292 5.88 44,603 3.67 23,854 2.19 24,613 2.38
Second mortgage 50,541 2.74 51,531 3.78 47,458 3.90 49,047 4.50 35,056 3.40
Residential real estate 26,117 1.41 29,788 2.18 43,375 3.56 55,282 5.07 54,140 5.25
Other 66,497 3.60 51,304 3.76 54,095 4.45 63,609 5.84 59,433 5.76
Less: Loan loss allowance (22,037) (1.19) (17,614) (1.29) (16,408) (1.35) (13,332) (1.22) (10,486) (1.02)
---------- ------ ---------- ------ ---------- ------ ---------- ------ --------- ------
Net loans $1,847,721 100.00 $1,364,465 100.00 $1,217,008 100.00 $1,089,605 100.00 $1,031,844 100.00
========== ====== ========== ====== ========== ====== ========== ====== ========== ======
Type of Security:
Residential real estate:
1-4 family $ 245,991 13.31 $ 185,364 13.58 $ 166,495 13.67 $ 146,157 13.41 $ 143,973 13.96
Other 164,184 8.89 117,479 8.61 88,465 7.27 108,437 9.95 83,615 8.10
Commercial real estate 1,030,977 55.80 784,716 57.51 721,658 59.30 599,027 54.98 576,365 55.86
Commercial business loans 358,387 19.40 229,342 16.81 210,374 17.29 199,103 18.27 183,130 17.75
Consumer 36,831 1.99 33,642 2.47 36,333 2.99 36,640 3.36 40,879 3.96
Other 33,388 1.80 31,536 2.31 10,091 0.83 13,573 1.25 14,368 1.39
Less: Loan loss allowance (22,037) (1.19) (17,614) (1.29) (16,408) (1.35) (13.332) (1.22) (10,486) (1.02)
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Net loans $1,847,721 100.00 $1,364,465 100.00 $1,217,008 100.00 $1,089,605 100.00 $1,031,844 100.00
========== ====== ========== ====== ========== ====== ========== ====== ========== ======
20
The following table sets forth the estimated maturity of the Company's loan
portfolio at December 31, 2004. 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 $339,564 $673,598 $590,706 $(19,990) $1,583,878
Home equity 6,440 714 115,581 (739) 121,996
Second mortgage 768 19,897 29,876 (277) 50,264
Residential real estate 8,874 597 16,646 (191) 25,926
Other 17,404 19,122 29,971 (840) 65,657
-------- -------- -------- -------- ----------
Total $373,050 $713,928 $782,780 $(22,037) $1,847,721
======== ======== ======== ========= ==========
The following table sets forth the dollar amount of all loans due after December
31, 2005 which have pre-determined interest rates and which have floating or
adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Total
-------- -------- ----------
Commercial and industrial $751,016 $513,288 $1,264,304
Home equity 2,580 113,715 116,295
Second mortgage 49,773 - 49,773
Residential real estate 14,125 3,118 17,243
Other 22,843 26,250 49,093
-------- -------- ----------
Total $840,337 $656,371 $1,496,708
======== ======== ==========
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 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. If the loan continues to be delinquent for 90
days or more, the Company usually declares the loan to be in default, payment in
full is demanded and steps are taken to liquidate any collateral taken as
security for the loan. 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 and residential real estate loans are typically
charged-off at 90 days delinquent, unless the loan is well secured and in the
process of collection or other extenuating circumstances support collection. 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.
Potential Problem Loans. At December 31, 2004, there were two commercial loan
relationships aggregating $2.0 million for which payments are current, but where
the borrowers were experiencing financial difficulties. These relationships
include a restaurant/recreation facility and a motel. These loans were not
classified as non-accrual and were not considered non-performing. At December
31, 2004, these loans were current and well collateralized.
21
Non-Performing Assets. Total non-performing assets decreased $9.0 million from
$26.3 million at December 31, 2003 to $17.3 million at December 31, 2004. The
ratio of non-performing assets to net loans decreased to 0.93% at December 31,
2004 compared to 1.92% at December 31, 2003. The decrease in non-performing
loans represents the complete repayment of the Company's largest non-performing
loan which had a carrying amount of $9.1 million. Real estate owned decreased
$1.5 million to $2.9 million at December 31, 2004.
Management of the Company believes that all loans accruing interest are
adequately secured and in the process of collection.
Non-Performing Assets
At December 31,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Loans accounted for on a non-accrual basis:
Commercial and industrial $12,263 $20,308 $ 8,879 $ 8,007 $2,933
Home equity 208 46 14 201 65
Second mortgage - - 100 130 38
Residential real estate 848 1,122 593 735 430
Other 138 92 377 50 240
------- ------- ------- ------- ------
Total $13,457 $21,568 $ 9,963 $ 9,123 $3,706
======= ======= ======= ======= ======
Accruing loans that are contractually past due 90 days or more:
Commercial and industrial $ 292 $ 125 $ 1,837 $425 $114
Home equity - 47 30 42 36
Second mortgage - - 122 190 153
Residential real estate 373 57 401 295 540
Other 221 19 115 146 332
------- ------- ------- ------- ------
Total $ 886 $ 248 $ 2,505 $ 1,098 $1,175
======= ======= ======= ======= ======
Total non-accrual and 90-day past due loans $14,343 $21,816 $12,468 $10,221 $4,881
Real estate owned 2,911 4,444 904 898 1,179
------- ------- ------- ------- ------
Total non-performing assets $17,254 $26,260 $13,372 $11,119 $6,060
======= ======= ======= ======= ======
Total non-accrual and 90-day past due loans to net loans 0.78% 1.60% 1.02% 0.94% 0.47%
Total non-accrual and 90-day past due loans to total assets 0.47% 0.84% 0.59% 0.53% 0.24%
Total non-performing assets to net loans 0.93% 1.92% 1.10% 1.02% 0.59%
Total non-performing assets to total assets 0.57% 1.01% 0.63% 0.58% 0.30%
Total allowance for loan losses to total non-performing loans 153.64% 80.74% 131.60% 130.44% 214.83%
Interest income that would have been recorded on loans on non-accrual status,
under the original terms of such loans, would have totaled $1.4 million for the
year ended December 31, 2004.
22
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,
- ---------------------
2004 2003
---- ----
Commercial properties $2,423 $4,013
Residential properties 179 122
Bank properties 309 309
------ ------
Total $2,911 $4,444
====== ======
One commercial property with a December 31, 2004 carrying value of $1.4 million
was sold during the first quarter 2005. The sale proceeds of this property
exceeded its carrying value.
An analysis of the activity in real estate owned is as follows:
For the Years Ended
December 31,
------------------------
2004 2003
---- ----
Balance, beginning of year $4,444 $ 904
Additions 1,594 4,214
Sales (3,127) (674)
------ ------
Balance, end of year $2,911 $4,444
====== ======
Allowances for Losses on Loans. The Company's allowance for losses on loans
increased to $22.0 million or 1.18% of loans at December 31, 2004 compared to
$17.6 million or 1.27% at December 31, 2003. The decrease in ratio of the
allowance for loan loss to total loans is primarily due to the $7.5 million
decrease in the Company's non-performing loans. Provision for loan losses was
$2.1 million in 2004, $4.8 million in 2003 and $4.2 million in 2002. As a result
of the July 2004 Community acquisition, $2.9 million of additional allowance for
loan losses was assumed. Net charge-offs were $589,000 in 2004, $3.6 million in
2003 and $1.1 million in 2002.
23
The following table sets forth information with respect to the Company's
allowance for losses on loans at the dates indicated:
At December 31,
-----------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Allowance for losses on loans, beginning of year $17,614 $16,408 $13,332 $10,486 $ 8,472
Charge-offs:
Commercial 796 4,010 1,219 4,748 209
Mortgage 84 1 20 4 8
Other 502 369 371 665 384
------- ------- ------- ------- -------
Total charge-offs 1,382 4,380 1,610 5,417 601
------- ------- ------- ------- -------
Recoveries:
Commercial 641 700 457 423 -
Mortgage - - - - 25
Other 152 61 54 45 10
------- ------- ------- ------- -------
Total recoveries 793 761 511 468 35
------- ------- ------- ------- -------
Net charge-offs 589 3,619 1,099 4,949 566
Purchased allowance resulting from bank acquisition 2,937 - - - -
Provision for loan losses 2,075 4,825 4,175 7,795 2,580
------- ------- ------- ------- -------
Allowance for losses on loans, end of year $22,037 $17,614 $16,408 $13,332 $10,486
======= ======= ======= ======= =======
Net loans charged-off as a percent of average loans outstanding 0.04% 0.28% 0.09% 0.47% 0.06%
======= ======= ======= ======= =======
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,
--------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ----------------- ----------------- -----------------
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 $19,990 90.71 % $15,885 90.19 % $14,806 84.63 % $11,457 82.62 % $ 8,676 83.38 %
Residential real estate 191 0.87 247 1.40 265 3.52 577 5.01 391 5.19
Home equity 739 3.35 483 2.74 263 3.62 268 2.16 343 2.36
Other 1,117 5.07 999 5.67 1,074 8.23 1,030 10.21 1,076 9.07
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total allowance $22,037 100.00 % $17,614 100.00 % $16,408 100.00 % $13,332 100.00 % $10,486 100.00 %
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
Investment Securities. A portion of the Company's investment portfolio is held
at the Bank's wholly owned subsidiary, Med-Vine, Inc. ("Med-Vine"). Excluding
the $114.6 million acquired in the July 2004 Community acquisition, investment
securities decreased $215.5 million or 22.4% from $963.4 million at December 31,
2003 to $862.5 million at December 31, 2004. In connection with the December
2003 acquisition of branches from New York Community Bank, the Company purchased
approximately $300 million of short and intermediate term investments, which the
Company is currently redeploying into its higher yielding loan portfolio. In
addition, of the $114.6 million in investment securities acquired in the July
2004 Community acquisition, approximately $60 million was immediately sold, with
the proceeds thereof used to pay down $50.0 million of the Company's short term
borrowings.
24
The estimated average life of the investment portfolio at December 31, 2004 was
3.0 years with an estimated modified duration of 2.0 years. The relatively short
duration is expected to result in the Company's continued redeployment of
portfolio maturities into loans.
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 risk and liquidity.
The following table sets forth the carrying value of the Company's portfolio of
investment securities available for sale.
At December 31,
----------------------------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
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 $ 70,069 $ (308) $ 69,761 $ 70,252 $ (72) $ 70,180 $ 54,400 $1,144 $55,544
U.S. Government agency and
mortgage-backed securities 662,023 (5,131) 656,892 810,453 356 810,809 567,200 6,111 573,311
State and municipal
obligations 56,695 1,123 57,818 58,651 2,022 60,673 70,672 996 71,668
Other securities 35,109 (156) 34,953 21,521 245 21,766 22,690 (12) 22,678
-------- ------- -------- -------- ------ -------- -------- ------ --------
Total $823,896 $(4,472) $819,424 $960,877 $2,551 $963,428 $714,962 $8,239 $723,201
======== ======= ======== ======== ====== ======== ======== ====== ========
During 2004, the Company established a held to maturity investment portfolio.
Investments classified as held to maturity are carried at amortized cost. The
securities designated as held to maturity will have characteristics consistent
with the Company's investment policy guidelines.
The amortized cost of investment securities held to maturity and the approximate
fair value were as follows:
December 31, 2004
---------------------------------
Net
Unrealized Estimated
Amortized Gains Fair
Cost (Losses) Value
---- -------- -----
U.S. Government agency and
mortgage-backed securities $43,048 $ (176) $42,872
======= ======= =======
The following table provides the gross unrealized losses and fair value,
aggregated by investment category and length of time the individual securities
have been in a continuous unrealized loss position at December 31, 2004:
Less than 12 Months 12 Months or Longer Total
--------------------------- --------------------------- ---------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
---------- ------ ---------- ------ ---------- ----------
U.S. Treasury obligations $ 59,881 $ (121) $ 9,880 $ (187) $ 69,761 $ (308)
U.S. Government agencies and
mortgage-backed securities 559,499 (4,280) 62,323 (1,617) 621,822 (5,897)
State and municipal obligations 13,883 (92) 512 (53) 14,395 (145)
Other securities 23,903 (195) - - 23,903 (195)
-------- ------- ------ ------- -------- -------
Total $657,166 $(4,688) $72,715 $(1,857) $729,881 $(6,545)
======== ======= ======= ======= ======== =======
25
At December 31, 2004, 99.4% of the unrealized losses in the security portfolio
were comprised of securities issued by U.S. Government agencies, U.S. Government
sponsored agencies and other securities rated investment grade by at least one
bond credit rating service. The Company believes that the price movements in
these securities are dependent upon the movement in market interest rates
particularly given the negligible inherent credit risk for these securities. At
December 31, 2004, the unrealized loss in the category 12 months or longer of
$1.9 million consisted of 14 securities having an aggregate depreciation of
2.5%. The securities represented U.S. Treasury, Federal Agency issues and one
security currently rated Aaa by three rating services. At December 31, 2004,
securities in a gross unrealized loss position for less than twelve months
consisted of 87 securities having an aggregate depreciation of 0.7% from the
Bank's amortized cost basis.
The following table sets forth certain information regarding the carrying
values, weighted average yields and maturities of the Company's portfolio of
investment securities at December 31, 2004. For all debt securities classified
as available for sale, 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.
Available for Sale Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg.
- ------------------- Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
U.S. Treasury obligations $59,881 1.50 % $ 9,880 1.50 % - - - - $69,761 1.50 %
U.S. Government agency and
mortgage-backed securities 29,765 2.65 258,314 3.05 $ 18,197 3.24 % $350,616 3.35 % 656,892 3.20
State and municipal obligations 17,729 1.90 17,055 3.03 1,887 4.42 21,147 4.99 57,818 3.45
Other securities 9,895 1.00 2,138 4.37 - - 22,920 3.89 34,953 3.10
-------- -------- ------- -------- --------
Total $117,270 1.81 % $287,387 3.01 % $20,084 3.35 % $394,683 3.47 % $819,424 2.93 %
======== ======== ======= ======== ========
One Year or Less One to Five Years Five to Ten Years More than Ten Years Total
---------------------------------------------------------------------------------------------------
Wtd. Wtd. Wtd. Wtd. Wtd.
Held-To-Maturity Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg. Carrying Avg.
- ---------------- Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
U.S. Government agency and
mortgage-backed securities - - - - - - $43,048 4.08% $43,048 4.08%
======= =======
Bank Owned life Insurance. During 2004, the Company purchased an additional $6.8
million of BOLI investments. The remaining increase of $7.6 million at December
31, 2004 represents $5.9 million which was assumed in the Community acquisition
and a $1.7 million increase in the cash value of the BOLI, which was recorded as
other non-interest income in the consolidated statement of operations.
26
Deposits. Deposits at December 31, 2004 totaled $2.43 billion, an increase of
$319.2 million, or 15.1% over the December 31, 2003 balance of $2.11 billion. In
July 2004, the Bank acquired approximately $342 million of deposits as a result
of the Community acquisition. During 2004, deposits were impacted by the
following: (1) deposit attrition of approximately $40 million from the December
2003 branch acquisition (2) deposit attrition of approximately $40 million
related to branch consolidations (3) deposit attrition of approximately $40
million from the Community acquisition. Realized deposit run-off on each of the
above has stabilized and was within the range of the Company's projections.
Management feels that the successful completion of the above branch
rationalization transactions has strengthened the Company's branch network and
will contribute to future deposit growth.
December 31,
-------------------------------------------
2004 2003 2002
---- ---- ----
Demand deposits $1,336,891 $1,183,991 $949,827
Savings deposits 452,726 392,784 328,508
Time deposits under $100,000 410,632 390,312 306,622
Time deposits $100,000 or more 230,114 144,038 105,505
---------- ---------- ----------
Total $2,430,363 $2,111,125 $1,690,462
========== ========== ==========
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 Company continued during 2004 its relationship pricing
strategy that has helped to increase core deposit growth (savings and demand).
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 Company to maintain a 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.
The following table sets forth the distribution of total deposits between core
and non-core:
For the Years Ended December 31,
--------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Amount Percentage Amount Percentage Amount Percentage
------ ---------- ------ ---------- ------ ----------
Core deposits $1,789,617 73.6 % $1,576,775 74.7 % $1,278,355 75.6 %
Time deposits 640,746 26.4 534,350 25.3 412,127 24.4
---------- ------ ---------- ------ ---------- ------
Total deposits $2,430,363 100.00 % $2,111,125 100.00 % $1,690,462 100.00 %
========== ====== ========== ====== ========== ======
The following table indicates the amount of certificates of deposit of $100,000
or more by remaining maturity at December 31, 2004.
Three months or less $81,247
Over three through six months 31,050
Over six through twelve months 44,520
Over twelve months 73,297
--------
Total $230,114
========
27
Borrowings. Borrowed funds, excluding debentures held by trusts, increased $31.9
million to $254.3 million at December 31, 2004, from $222.4 million at December
31, 2003. The increase was primarily the result of a net increase of $50.0
million in securities sold under agreements to repurchase with the FHLB offset
by a decrease of $19.3 million in advances from the FHLB.
For the years ended December 31, 2004 and 2003, the maximum month-end amount of
advances borrowed from the FHLB was $162.4 million and $199.4 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, 2004 and 2003, the maximum month-end amount of securities
sold under agreements to repurchase with customers was $69.9 million and $78.0
million, respectively. The Company also purchases overnight federal funds from
correspondent banks. For the years ended December 31, 2004 and 2003, the maximum
month-end amount of federal funds purchased from correspondent banks was
approximately $1 million and $42 million, respectively.
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,
--------------------------------------
2004 2003 2002
---- ---- ----
FHLB convertible rate advances outstanding at end of year $25,000 $25,000 $45,000
Interest rate 6.49% 6.49% 6.76%
Approximate average amount outstanding $25,000 $25,000 $45,000
Approximate weighted average rate 6.49% 6.49% 6.76%
FHLB term amortizing advances outstanding at end of year $61,469 $80,764 $89,060
Interest rate 4.58% 4.27% 4.33%
Approximate average amount outstanding $70,427 $87,890 $92,191
Approximate weighted average rate 4.31% 4.29% 4.31%
FHLB term non-amortizing advances outstanding at end of year $58,200 $58,200 $8,200
Interest rate 3.46% 3.40% 4.85%
Approximate average amount outstanding $58,200 $52,309 $4,695
Approximate weighted average rate 3.40% 4.17% 4.92%
FHLB repurchase agreements outstanding at end of year $50,000 - -
Interest rate 2.43% - -
Approximate average amount outstanding $4,440 - -
Approximate weighted average rate 1.92% - -
FHLB overnight line of credit advances outstanding at end of year - - -
Interest rate - - -
Approximate average amount outstanding - - $5,244
Approximate weighted average rate - - 1.88%
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,
-------------------------------------
2004 2003 2002
-------- ---- ----
Securities sold under agreements to repurchase with customers $59,641 $55,934 $61,860
Interest rate 1.54% 0.35% 0.61%
Approximate average amount outstanding $63,715 $71,828 $74,602
Approximate weighted average rate 0.74% 0.48% 0.99%
28
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.
Junior Subordinated Debentures Held by Trusts that Issued Capital Debt
The following is a summary of the outstanding capital securities issued by each
Issuer Trust and the junior subordinated debenture issued by the Company to each
Issuer Trust as of December 31, 2004:
Capital Securities Junior Subordinated Debentures
---------------------------------------------------------------------------------------------------
Stated Distribution Principal Redeemable
Issuer Trust Issuance Date Value Rate Amount Maturity Beginning
------------ ------------- ----- ---- ------ -------- ---------
6-mo LIBOR
Sun Trust III April 22, 2002 $20,000 plus 3.70% $20,619 April 22, 2032 April 22, 2007
3-mo LIBOR
Sun Trust IV July 7, 2002 10,000 plus 3.65% 10,310 October 7, 2032 July 7, 2007
3-mo LIBOR
Sun Trust V December 18, 2003 15,000 plus 2.80% 15,464 December 30, 2033 December 30, 2008
3-mo LIBOR
Sun Trust VI December 19, 2003 25,000 plus 2.80% 25,774 January 23, 2034 January 23, 2009
3-mo LIBOR
CBNJ Trust I December 19, 2002 5,000 plus 3.35% 5,155 January 7, 2033 January 7, 2008
------- -------
$75,000 $77,322
======= =======
For more information regarding junior subordinated debentures held by trusts
that issued capital debt, refer to Note 15 of the notes to consolidated
financial statements contained herein.
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.
29
Management's Annual Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting, as such term is
defined in Securities Exchange Act of 1934 Rules 13(a)- 15(f). The Company's
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
U.S. generally accepted accounting principles.
Management, including the chief executive officer and chief financial
officer, conducted an evaluation of the effectiveness of the Company's internal
control over financial reporting based on the framework in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Because management's assessment was also conducted to meet
the reporting requirements of Section 112 of the Federal Deposit Insurance
Corporation Improvement Act (FDICIA), management's assessment of the Company's
internal control over financial reporting also included controls over the
preparation of the schedules equivalent to the basic financial statements in
accordance with the instructions for Consolidated Reports of Condition and
Income for Schedules RC, RI, RI-A. Based on our evaluation under the framework
in Internal Control - Integrated Framework, we concluded that the Company's
internal control over financial reporting was effective as of December 31, 2004.
Management's assertion as to the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004 has been
audited by Deloitte & Touche LLP, an independent registered public accounting
firm, as stated in their report which is included in the following pages.
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Sun Bancorp, Inc.
Vineland, New Jersey
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control Over Financial Reporting, that
Sun Bancorp, Inc. and subsidiaries (the "Company") maintained effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Because management's
assessment and our audit were conducted to meet the reporting requirements of
Section 112 of the Federal Deposit Insurance Corporation Improvement Act
(FDICIA), management's assessment and our audit of the Company's internal
control over financial reporting included controls over the preparation of the
schedules equivalent to the basic financial statements in accordance with the
instructions for Consolidated Reports of Condition and Income for Schedules RC,
RI, RI-A. The Company's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management's assessment and an opinion on the
effectiveness of the Company's internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing, and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also, in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
31
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statements of
financial condition of the Company as of December 31, 2004 and 2003, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 2004 and our report
dated March 14, 2005 expressed an unqualified opinion on those financial
statements and included an explanatory paragraph regarding the adoption of the
provisions of Financial Accounting Standards Board Interpretation No. 46(R) in
2003, the change in accounting for stock-based compensation to adopt the fair
value recognition provisions of Statements of Financial Accounting Standards
Nos. 123 and 148 in 2003, and the change in the Company's method of accounting
for goodwill to conform to Statement of Financial Accounting Standards No. 147
in 2002.
/s/DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
March 14, 2005
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Sun Bancorp, Inc.
Vineland, New Jersey
We have audited the accompanying consolidated statement of financial condition
of Sun Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 2004
and 2003, and the related consolidated statements of income, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sun Bancorp, Inc. and subsidiaries
as of December 31, 2004 and 2003, and the results of its operations and its cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, in 2003, the
Company adopted the provision of Financial Accounting Standards Board
Interpretation No. 46 (R) and the Company changed its method of accounting for
stock-based compensation adopting the fair value recognition provisions of
Statements of Financial Accounting Standards Nos. 123 and 148. In 2002, the
Company changed its method of accounting for goodwill to conform to Statement of
Financial Accounting Standards No. 147.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on the
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 14, 2005 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
March 14, 2005
33
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2004 AND 2003
(Dollars in thousands, except share amounts)
2004 2003
---- ----
ASSETS
Cash and due from banks $ 69,022 $ 78,841
Interest-bearing bank balances 1,878 2,789
Federal funds sold 4,002 487
---------- ----------
Cash and cash equivalents 74,902 82,117
Investment securities available for sale (amortized cost -
$823,896; 2004 and $960,877; 2003) 819,424 963,428
Investment securities held to maturity 43,048 -
Loans receivable (net of allowance for loan losses -
$22,037; 2004 and $17,614; 2003) 1,847,721 1,364,465
Restricted equity investments 15,405 12,551
Bank properties and equipment, net 36,830 34,093
Real estate owned, net 2,911 4,444
Accrued interest receivable 12,519 11,266
Goodwill 104,969 50,600
Intangible assets, net 34,753 26,195
Deferred taxes, net 4,626 8,465
Bank owned life insurance 47,179 32,785
Other assets 9,300 9,078
---------- ----------
TOTAL $3,053,587 $2,599,487
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits $2,430,363 $2,111,125
Advances from the Federal Home Loan Bank (FHLB) 144,669 163,964
Federal funds purchased - 2,500
Securities sold under agreements to repurchase - FHLB 50,000 -
Securities sold under agreements to repurchase - customer 59,641 55,934
Junior subordinated debentures 77,322 72,167
Other liabilities 12,372 8,079
---------- ----------
Total liabilities 2,774,367 2,413,769
---------- ----------
Commitments and contingencies (see note 20)
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value, 1,000,000 shares authorized, none issued - -
Common stock, $1 par value, 25,000,000 shares authorized and issued:
17,205,245 in 2004 and 13,381,310 in 2003 17,205 13,381
Additional paid-in capital 244,108 151,631
Retained earnings 21,718 20,062
Accumulated other comprehensive (loss) income (2,765) 1,690
Treasury stock at cost, 90,562 shares (1,046) (1,046)
---------- ----------
Total shareholders' equity 279,220 185,718
---------- ----------
TOTAL $3,053,587 $2,599,487
========== ==========
See notes to consolidated financial statements
34
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share amounts)
2004 2003 2002
---- ---- ----
INTEREST INCOME:
Interest and fees on loans $ 96,617 $ 83,263 $ 83,822
Interest on taxable investment securities 24,813 21,428 25,693
Interest on non-taxable investment securities 1,951 2,511 2,085
Dividends on restricted equity investments 503 559 591
Interest on federal funds sold 385 301 703
-------- -------- --------
Total interest income 124,269 108,062 112,894
-------- -------- --------
INTEREST EXPENSE:
Interest on deposits 24,061 23,480 35,104
Interest on funds borrowed 7,275 8,068 8,271
Interest on junior subordinated debt 3,615 4,227 4,481
-------- -------- --------
Total interest expense 34,951 35,775 47,856
-------- -------- --------
Net interest income 89,318 72,287 65,038
PROVISION FOR LOAN LOSSES 2,075 4,825 4,175
-------- -------- --------
Net interest income after provision for loan losses 87,243 67,462 60,863
-------- -------- --------
NON-INTEREST INCOME:
Service charges on deposit accounts 9,043 7,650 6,940
Other service charges 354 397 441
Gain (loss) on sale of bank properties and equipment 2,467 164 (4)
Gain on sale of investment securities 1,407 2,467 2,517
Gain on sale of loans 289 - -
Gain on sale of branches - 2,629 -
Other 5,559 4,049 3,284
-------- -------- --------
Total non-interest income 19,119 17,356 13,178
-------- -------- --------
NON-INTEREST EXPENSES:
Salaries and employee benefits 40,177 33,421 28,208
Occupancy expense 10,608 8,768 7,893
Equipment expense 7,091 5,341 5,041
Data processing expense 3,973 3,438 3,428
Amortization of intangible assets 5,268 3,696 4,182
Advertising expense 1,443 1,836 1,154
Other 12,592 9,536 9,059
-------- -------- --------
Total non-interest expenses 81,152 66,036 58,965
-------- -------- --------
INCOME BEFORE INCOME TAXES 25,210 18,782 15,076
INCOME TAXES 7,581 5,446 4,698
-------- -------- --------
NET INCOME $17,629 $13,336 $10,378
======= ======= =======
Basic earnings per share $ 1.14 $ 1.02 $ 0.78
======= ======= ======
Diluted earnings per share $ 1.06 $ 0.95 $ 0.75
======= ======= ======
Weighted average shares - basic 15,476,149 12,413,987 12,312,706
========== ========== ==========
Weighted average shares - diluted 16,700,276 13,371,546 12,785,554
========== ========== ==========
- --------------------------------------------------------------------
See notes to consolidated financial statements
35
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(In thousands)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
Stock Capital Earnings Income (Loss) Stock Total
----- ------- -------- ------------- ----- -----
BALANCE, JANUARY 1, 2002 $10,554 $108,058 $11,864 $ (516) - $129,960
Comprehensive income:
Net income - - 10,378 - - -
Net change in unrealized loss on securities
available for sale, net of taxes of $3,067 - - - 5,954 - -
--------
Comprehensive income - - - - - 16,332
--------
Exercise of stock options 160 708 - - - 868
Issuance of common stock 24 268 - - - 292
Stock dividends 533 6,673 (7,206) - - -
Cash paid for fractional interest
resulting from stock dividend - - (6) - - (6)
Trust preferred issuance costs write-off - (777) - - - (777)
Treasury stock purchased - - - - $(1,046) (1,046)
------- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2002 11,271 114,930 15,030 5,438 (1,046) 145,623
Comprehensive income:
Net income - - 13,336 - - -
Net change in unrealized gain on securities -
available for sale, net of taxes of $1,940 - - - (3,748) - -
--------
Comprehensive income - - - - - 9,588
--------
Exercise of stock options 34 386 - - - 420
Issuance of common stock 1,513 29,204 - - - 30,717
Stock dividends 563 7,735 (8,298) - - -
Cash paid for fractional interest
resulting from stock dividend - - (6) - - (6)
Trust preferred issuance costs write-off - (624) - - - (624)
------- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2003 13,381 151,631 20,062 1,690 (1,046) 185,718
======= ======== ======= ======== ======= ========
Comprehensive income:
Net income - - 17,629 - - -
Net change in unrealized gain on securities
available for sale, net of taxes of $2,568 - - - (4,455) - -
--------
Comprehensive income - - - - - 13,174
--------
Exercise of stock options 43 382 - - - 425
Issuance of common stock 3,116 76,797 - - - 79,913
Stock dividends 665 15,298 (15,963) - - -
Cash paid for fractional interest
resulting from stock dividend - - (10) - - (10)
------- -------- ------- -------- ------- --------
- -
BALANCE, DECEMBER 31, 2004 $17,205 $244,108 $21,718 $ (2,765) $(1,046) $279,220
======= ======== ======= ======== ======= ========
- --------------------------------------------------
See notes to consolidated financial statements
36
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(In thousands)
Years Ended December 31,
--------------------------------------
2004 2003 2002
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 17,629 $ 13,336 $ 10,378
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 2,075 4,825 4,175
Depreciation and amortization 3,822 2,673 2,387
Net amortization of investment securities 1,917 2,927 3,518
Amortization of intangible assets 5,268 3,696 4,182
Write down of book value of fixed assets 177 - -
Gain on sale of investment securities available for sale (1,407) (2,467) (2,517)
(Gain) loss on sale of bank properties and equipment (2,467) (164) 4
Gain on sale of loans (289) - -
Write down of real estate owned - - 117
Increase in cash value of bank owned life insurance (1,710) (985) -
Deferred income taxes 6,407 342 (1,780)
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable 205 (254) 77
Other assets (921) (502) 851
Other liabilities 4,227 (3,454) 1,829
--------- --------- ---------
Net cash provided by operating activities 34,933 19,973 23,221
--------- --------- ---------
INVESTING ACTIVITIES:
Purchases of investment securities available for sale (434,841) (902,019) (771,157)
(Purchase) redemption of restricted equity securities (1,844) (941) 951
Proceeds from maturities, prepayments or calls of investment securities available for sale 499,746 469,704 528,918
Proceeds from sale of investment securities available for sale 143,095 185,940 174,616
Net increase in loans (254,854) (140,928) (132,689)
Purchase of bank properties and equipment (5,160) (3,647) (3,689)
Proceeds from sale of bank properties and equipment 7,260 34 10
Purchase of bank owned life insurance (6,800) (31,800) -
Proceeds from sale of real estate owned 3,127 674 988
Net increase in cash realized from acquisitions / sales 7,609 238,432 -
--------- --------- ---------
Net cash used in investing activities (42,662) (184,551) (202,052)
--------- --------- ---------
FINANCING ACTIVITIES:
Net (decrease) increase in deposits (22,766) 122,106 118,124
Purchase price adjustment of branch assets purchased 219 - -
Net borrowings under line of credit and repurchase agreements 22,212 18,278 45,184
Proceeds from exercise of stock options 425 420 868
Proceeds from loan payable - - 25,000
Repayment of loan payable - (1,160) (25,000)
Proceeds from issuance of junior subordinated debt - 40,000 30,000
Redemption of junior subordinated debt - (29,274) (28,040)
Repurchase of junior subordinated debt - - (13)
Payments for fractional interests resulting from stock dividend (10) (6) (6)
Proceeds from issuance of common stock 434 30,717 292
Treasury stock purchased - - (1,046)
--------- --------- ---------
Net cash provided by financing activities 514 181,081 165,363
--------- --------- ---------
514
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (7,215) 16,503 (13,468)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 82,117 65,614 79,082
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 74,902 $ 82,117 $ 65,614
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 34,070 $ 36,656 $ 48,862
Income taxes paid $ 4,987 $ 7,908 $ 2,770
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS:
Transfer of loans and bank properties and equipment to real estate owned $ 1,242 $ 4,214 $ 1,111
Trust preferred issuance costs write-off - $ 624 $ 777
Value of shares issued for acquisition $ 62,458 - -
- -------------------------------------------------------------------------------
See notes to consolidated financial statements
37
SUN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(All dollar amounts presented in the tables, except per share amounts,
are in thousands)
1. NATURE OF OPERATIONS
Sun Bancorp, Inc. (the "Company") is registered as a bank holding company under
the Bank Holding Company Act of 1956, as amended. The consolidated financial
statements include the accounts of the Company and its principal wholly owned
subsidiary, Sun National Bank (the "Bank") and the Bank's wholly owned
subsidiaries, Med-Vine, Inc., Sun Financial Services, L.L.C. and 2020
Properties, L.L.C. All significant intercompany balances and transactions have
been eliminated in consolidation. Effective December 31, 2003, with the adoption
of FIN 46 and FIN 46 (R), Sun Capital Trust (liquidated in April 2002), Sun
Capital Trust II (liquidated in December 2003), Sun Capital Trust III, Sun
Capital Trust IV, Sun Capital Trust V, Sun Capital Trust VI and CBNJ Trust I
collectively, the "Issuing Trusts" are presented on a deconsolidated basis.
The Company and the Bank have their administrative offices in Vineland, New
Jersey. At December 31, 2004, the Company had 73 full service financial service
centers located throughout central and southern New Jersey, New Castle County,
Delaware and in Philadelphia, Pennsylvania. The Company's principal business is
to serve as a holding company for the Bank. The Company's outstanding common
stock is traded on the Nasdaq National Market under the symbol "SNBC". The
Company is subject to reporting requirements of the Securities and Exchange
Commission ("SEC"). The Bank is in the business of attracting customer deposits
through their Community Banking Centers and investing these funds, together with
borrowed funds and cash from operations, in loans, primarily commercial real
estate, small business and non-real estate loans, as well as mortgage-backed and
investment securities. The Bank's primary regulatory agency is the Office of the
Comptroller of the Currency (the "OCC"). Med-Vine, Inc. is a Delaware holding
company that holds a portion of the Bank's investment portfolio. The principal
business of Med-Vine, Inc. is investing in securities. The principal business of
Sun Financial Services, L.L.C. is to provide annuities and insurance products in
the Bank's Community Banking Centers through a contract with a third-party
licensed insurance agent. The principal business of 2020 Properties, L.L.C. is
to acquire certain loans, judgments, real estate and other assets in
satisfaction of debts previously contracted by the Bank. The Issuing Trusts are
Delaware business trusts which hold junior subordinated debentures issued by the
Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates in the Preparation of Financial Statements - The preparation of
the consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of income and expenses during the
reporting period. The significant estimates include the allowance for loan
losses, goodwill, core deposit and other intangible assets, and deferred tax
asset valuation allowance. Actual results could differ from those estimates.
Investment Securities - The Company accounts for debt securities as follows:
Held to Maturity - Debt securities that management has the positive intent
and ability to hold until maturity are classified as held to maturity and
carried at their remaining unpaid principal balance, net of unamortized premiums
or unaccreted discounts. Premiums are amortized and discounts are accreted using
the interest method over the estimated remaining term of the underlying
security.
Available for Sale - Debt securities that will be held for indefinite
periods of time, including securities that may be sold in response to changes to
market interest or prepayment rates, needs for liquidity, and changes in the
availability of and the yield of alternative investments, are classified as
available for sale. These assets are carried at fair value. Fair value is
determined using published quotes as of the close of business. Unrealized gains
and losses are excluded from earnings and are reported net of tax as other
comprehensive income or loss until realized. Realized gains and losses on the
38
sale of investment securities are recorded as of trade date, reported in the
consolidated statement of income and determined using the adjusted cost of the
specific security sold.
Loans Purchased - The discounts and premiums resulting from the purchase of
loans are amortized to income using the interest method over the remaining
period to contractual maturity, adjusted for anticipated prepayments.
Loans Held for Sale - Included in loans receivable is approximately $989,000 and
$142,000 of loans held for sale at December 31, 2004 and 2003, respectively.
These loans were carried at the lower of cost or estimated fair value, on an
aggregate basis.
Deferred Loan Fees - Loan fees, net of certain direct loan origination costs,
are deferred and the balance is amortized to income as a yield adjustment over
the life of the loan using the interest method.
Interest Income on Loans - Interest on commercial, small business, real estate
and other loans is credited to operations based upon the principal amount
outstanding. Interest accruals are generally discontinued when a loan becomes 90
days past due or when principal or interest is considered doubtful of
collection. 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.
Allowance for Loan Losses - 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.
In July 2001, the 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.
The provision for loan losses charged to expense is based upon past loan and
loss experience and an evaluation of estimated losses in the current loan
portfolio, including the evaluation of impaired loans under SFAS Nos. 114 and
118 issued by the FASB. A loan is considered to be impaired when, based upon
current information and events, it is probable that the Company will be unable
to collect all amounts due according to the contractual terms of the loan. An
insignificant delay or insignificant shortfall in amount of payments does not
necessarily result in the loan being identified as impaired. For this purpose,
delays less than 90 days are considered to be insignificant. Impairment losses
are included in the provision for loan losses. Large groups of smaller balance,
homogeneous loans are collectively evaluated for impairment, except for those
loans restructured under a troubled debt restructuring. Interest payments on
impaired loans are typically applied to principal unless the ability to collect
the principal amount is fully assured, in which case interest is recognized on
the cash basis.
Commercial loans and commercial real estate loans are placed on non-accrual at
the time the loan is 90 days delinquent unless the credit is well secured and in
the process of collection. Generally, commercial loans and commercial real
estate 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
placed on non-accrual at the time the loan is 90 days delinquent. Other consumer
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.
39
Restricted Equity Securities - Equity securities of Bankers' banks are
classified as restricted equity securities because ownership is restricted and
there is not an established market for their resale. These securities are
carried at cost and are evaluated for impairment.
Bank Properties and Equipment - Land is carried at cost. Bank properties and
equipment are stated at cost, less accumulated depreciation. The provision for
depreciation is computed by the straight-line method based on the estimated
useful lives of the assets, as follows:
Buildings 40 years
Leasehold improvements Remaining lease term, including renewals,
if applicable
Equipment 2.5 to 10 years
Bank-Owned Life Insurance - The Company has purchased life insurance policies on
certain key employees. These policies are recorded at their cash surrender
value, or the amount that can be realized. Income from these policies and
changes in the cash surrender value are recorded in non-interest income.
Securities Sold Under Agreements to Repurchase - The Company enters into sales
of securities under agreements to repurchase with the FHLB and with its
customers. These agreements are treated as financings, and the obligations to
repurchase securities sold are reflected as a liability in the consolidated
balance sheets. Securities pledged as collateral under agreements to repurchase
are reflected as assets in the accompanying consolidated balance sheets.
Real Estate Owned - Real estate owned is comprised of property acquired through
foreclosure and bank property and equipment that is not in use. It is carried at
the lower of the related loan balance or fair value of the property based on an
appraisal less estimated cost to dispose. Losses arising from foreclosure
transactions are charged against the allowance for loan losses. Gains or losses
subsequent to foreclosure are included in operations.
Goodwill and Intangible Assets - Goodwill is the excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired in a business combination. It is not amortized but is tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value. The
Company uses a third-party appraisal to assist management in identifying
impairment. The Company believes that its goodwill was not impaired during 2004
and 2003.
Intangible assets consist of core deposit intangibles and Excess of Cost over
Fair Value of Assets Acquired ("SFAS No. 72 Intangibles"), net of accumulated
amortization. Core deposit intangibles are amortized using the straight-line
method based on the characteristics of the particular deposit type.
Long-Lived Assets - Management evaluates the carrying amount of long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Measurement of an
impaired loss for long-lived assets and intangibles with definite lives would be
based on the fair value of the asset. For the year ended December 31, 2004, the
Company recognized an impairment loss of $177,000 based on this evaluation. For
the years ended December 31, 2003 and 2002 the Company did not recognize an
impairment loss based on this evaluation.
Income Taxes - Deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities. The effect on deferred taxes
of a change in tax rates is recognized in income in the period that includes the
enactment date. A deferred tax liability is recognized for temporary differences
that will result in taxable amounts in future years. A deferred tax asset is
recognized for temporary differences that will result in deductible amounts in
future years and for carryforwards. A valuation allowance is recognized if,
based on the weight of available evidence, it is more likely than not that some
portion or all of the deferred tax asset will not be realized.
40
Treasury Stock - Stock held in treasury by the Company is accounted for using
the cost method which treats stock held in treasury as a reduction to total
shareholders' equity.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash
equivalents include cash and amounts due from banks and federal funds sold.
Accounting for Derivative Financial Instruments and Hedging Activities - The
Company recognizes all derivative instruments at fair value as either assets or
liabilities. Financial derivatives are reported at fair value in other assets or
other liabilities. The accounting for changes in the fair value of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship. For derivatives not designated as hedges, the gain or loss
is recognized in current earnings.
Earnings Per Share - Basic earnings per share is computed by dividing income
available to common shareholders (in 2003 and 2002, net income less trust
preferred issuance costs write-off), ("Income Available") by the weighted
average number of shares of common stock outstanding during the year. Diluted
earnings per share is calculated by dividing Income Available by the weighted
average number of shares of common stock and common stock equivalents
outstanding decreased by the number of common shares that are assumed to have
been repurchased with the proceeds from the exercise of the options (treasury
stock method) along with the assumed tax benefit from the exercise of
non-qualified options. These purchases were assumed to have been made at the
average market price of the common stock, which is based on the average price on
common shares sold. Retroactive recognition has been given to market values,
common stock outstanding and potential common shares for periods prior to the
date of the Company's stock dividends.
Stock Dividend - On March 18, 2004, March 19, 2003, and April 25, 2002, the
Company's Board of Directors declared 5% stock dividends, which were paid on
April 20, 2004, April 21, 2003, and May 23, 2002, respectively, to shareholders
of record on April 6, 2004, April 7, 2003, and May 2, 2002, respectively.
Accordingly, per share information for the years ended December 31, 2003 and
2002 have been restated to reflect the increased number of shares outstanding.
Other Comprehensive Income - The Company classifies items of other comprehensive
income by their nature and displays the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. Amounts
categorized as other comprehensive income represent net unrealized gains or
losses on investment securities available for sale, net of income taxes.
Reclassifications are made to avoid double counting in comprehensive income
items which are displayed as part of net income for the period. These
reclassifications are as follows:
Disclosure of reclassification amounts, net of taxes, for the years ended, 2004 2003 2002
- ---------------------------------------------------------------------------- -------- -------- -------
Net (depreciation) appreciation on securities available for sale during the year $ (5,616) $ (3,221) $11,538
Reclassification adjustment for net gains included in net income (1,407) (2,467) (2,517)
-------- -------- -------
Net change in unrealized (loss) gain on securities available for sale (7,023) (5,688) 9,021
Tax effect 2,568 1,940 (3,067)
-------- ------ -------
Net of tax amount $ (4,455) (3,748) $ 5,954
======== ====== =======
Stock Based Compensation - In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation --Transition and Disclosure, an
amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123 to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. Prior to the fourth
quarter of 2003, the Company accounted for its granted stock options according
to Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock
Issued to Employees and related interpretations. All options granted prior to
2003 had an intrinsic value of zero on the date of grant under APB No. 25, and,
therefore, no stock-based employee compensation expense was recognized in the
Company's consolidated financial statements. During the fourth quarter of 2003,
the Company adopted, effective January 1, 2003, the fair value recognition
provisions of SFAS No. 123. Under the prospective method provisions of SFAS No.
148, the recognition provisions of SFAS No. 123 were applied to all option
awards granted, modified or settled after January 1, 2003.
The grant of "reload" options is authorized in two of the stock-based employee
compensation plans. The award of a reload option allows the optionee to receive
the grant of an additional stock option, at the then current market price, in
the event that such optionee exercises all or part of an option (an "original
option") by surrendering already owned shares of
41
common stock in full or partial payment of the option price under such original
option. The Company accounts for the reload features as fixed plan accounting,
in accordance with the FASB Emerging Issues Task Force ("EITF") No. 90-7,
Accounting for a Reload Stock Option and FASB Interpretation No. 44, Accounting
for Certain Transactions involving Stock Compensation an interpretation of APB
Opinion No. 25.
In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. This Statement is effective for
financial statements for fiscal years ending after December 15, 2002. The
Company has provided the required disclosures in the tables below.
At December 31, 2004, the Company had five stock-based employee compensation
plans, which are described more fully in Note 17. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123 using the
Black-Scholes option pricing model to stock-based employee compensation.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
---- ---- ----
Net income, as reported $17,629 $13,336 $10,378
Add: Total stock-based employee compensation expense
included in reported net income (net of tax) 29 21 -
Deduct: Total stock-based employee compensation
expense determined under fair value method (net of tax) (616) (1,179) (2,368)
------- ------- -------
Pro forma net income $17,042 $12,178 $ 8,010
======= ======= =======
Earnings per share:
Basic - as reported $1.14 $1.02 $0.78
Basic - pro forma $1.10 $0.93 $0.59
Diluted - as reported $1.06 $0.95 $0.75
Diluted - pro forma $1.02 $0.87 $0.56
Significant assumptions used to calculate the above fair value of the awards are
as follows:
2004 2003 2002
---- ---- ----
Weighted average fair value of options granted during the year - $ 9.00 $ 6.58
Risk free rate of return - 4.40% 4.30%
Expected option life in months - 120 120
Expected volatility - 40% 38%
Expected dividends - 0 0
There were no stock options granted during 2004.
Recent Accounting Principles - In December 2004, the FASB issued SFAS No. 123R
(revised 2004), Share-Based Payment, which revises SFAS No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. This Statement requires an entity to recognize the
cost of employee services received in share-based payment transactions and
measure the cost on a grant-date fair value of the award. That cost will be
recognized over the period during which an employee is required to provide
service in exchange for the award. The provisions of SFAS No. 123R will be
effective for the Company's financial statements issued for periods beginning
after June 15, 2005. The Company is currently evaluating the effects of the
adoption of this Statement on its financial statements.
42
In March 2004, the FASB ratified the consensus reached by the EITF in Issue
03-1, The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments. EITF 03-1 provides guidance for determining when an
investment is considered impaired, whether impairment is other-than-temporary,
and measurement of an impairment loss. In September 2004, the FASB issued FSP
03-1-1, which delayed the effective date for the measurement and recognition
guidance contained in paragraphs 10-20 of Issue 03-1 due to additional proposed
guidance. The Company is continuing to evaluate the impact of EITF 03-1. The
amount of other-than-temporary impairment to be recognized depends on market
conditions, management's intent and ability to hold investments until a
forecasted recovery and the finalization of the proposed guidance by the FASB.
The Company does not anticipate that the finalization of the proposed guidance
will have a material impact on the Company.
In March 2004, the SEC issued SAB No. 105, Application of Accounting Principles
to Loan Commitments. This bulletin was issued to inform registrants of the SEC's
view that the fair value of the recorded loan commitments, which are required to
follow derivative accounting under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, should not consider the expected future cash
flows related to the associated servicing of the future loan. The provisions of
SAB 105 must be applied to loan commitments accounted for as derivatives that
are entered into after March 31, 2004. The provisions of this Staff Accounting
Bulletin did not have a material impact on the Company.
In December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued AICPA Statement of Position No.
03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer
(SOP 03-3), to address accounting for differences between the contractual cash
flows of certain loans and debt securities and the cash flows expected to be
collected when loans or debt securities are acquired in a transfer and those
cash flow differences are attributable, at least in part, to credit quality. As
such, SOP 03-3 applies to such loans and debt securities purchased or acquired
in purchase business combinations and does not apply to originated loans. It
applies to loans with evidence of deterioration of credit quality since
origination acquired by completion of a transfer for which it is probable, at
acquisition, that the investor will be unable to collect all contractually
required payments receivable. The application of SOP 03-3 limits the interest
income, including accretion of purchase price discounts that may be recognized
for certain loans and debt securities. Additionally, SOP 03-3 requires that the
excess of contractual cash flows over cash flows expected to be collected
(nonaccretable difference) not be recognized as an adjustment of yield or
valuation allowance, such as the allowance for loan losses. Subsequent to the
initial investment, increases in expected cash flows generally should be
recognized prospectively through adjustment of the yield on the loan or debt
security over its remaining life. Decreases in expected cash flows should be
recognized as impairment. SOP 03-3 is effective for loans and debt securities
acquired in fiscal years beginning after December 15, 2004, with early
application encouraged. The impact of this new pronouncement will depend on the
Company's activity in purchasing loans or acquiring loans in a business
combination.
3. ACQUISITIONS
On July 8, 2004, the Company acquired Community Bancorp of New Jersey
("Community") in a stock-for-stock exchange merger valued at approximately $69
million. In the merger, Community shareholders received 0.8715 shares of common
stock of the Company for each issued and outstanding share of Community common
stock. Approximately 3,096,000 shares of the Company's common stock were issued.
At July 8, 2004, Community's assets totaled $374 million, loan receivables, net
of allowances for loan losses, were $230 million, investments securities were
$115 million and total deposits were $342 million. Goodwill of approximately $55
million was recorded in conjunction with this transaction and will not be
amortized in accordance with SFAS No. 142, but will be reviewed at least
annually for impairment. Core deposit intangibles of approximately $14 million
was recorded and will be amortized over approximately nine years on a
straight-line basis.
On December 17, 2003, the Company completed the acquisition the eight branches
from New York Community Bank ("NYCB") located in Atlantic, Camden and Gloucester
Counties in New Jersey. The branch acquisition included approximately $340
million in deposits and approximately $14 million in commercial and consumer
loans. In connection with this branch acquisition, the Company paid a premium of
approximately $40 million. Of that premium, $10.1 million relates to the core
deposit intangible which is being amortized over ten years on a straight-line
basis and $30.9 million consists of goodwill which is not subject to annual
amortization.
43
4. AVERAGE RESERVE BALANCE REQUIREMENTS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain an average reserve balance with the Federal
Reserve Bank. The amount of the average reserve balance for the years ended
December 31, 2004 and 2003 was $6.3 million and $1.1 million, respectively.
5. INVESTMENT SECURITIES
The amortized cost of investment securities and the approximate fair value were
as follows:
December 31, 2004
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Available for Sale
------------------
U.S. Treasury obligations $ 70,069 - $ (308) $ 69,761
U.S. Government agencies and
mortgage-backed securities 662,023 $ 590 (5,721) 656,892
State and municipal obligations 56,695 1,268 (145) 57,818
Other 35,109 39 (195) 34,953
-------- ------ ------- --------
Total $823,896 $1,897 $(6,369) $819,424
======== ====== ======= ========
Held to Maturity
----------------
U.S. Government agencies and
mortgage-backed securities $43,048 - $(176) $42,872
======= ====== ===== =======
December 31, 2003
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Available for Sale
------------------
U.S. Treasury obligations $ 70,252 $ 46 $ (118) $ 70,180
U.S. Government agencies and
mortgage-backed securities 810,453 2,696 (2,340) 810,809
State and municipal obligations 58,651 2,137 (115) 60,673
Other 21,521 245 - 21,766
-------- ------ ------- --------
Total $960,877 $5,124 $(2,573) $963,428
======== ====== ======== ========
During 2004, the Company established a held to maturity investment portfolio.
Investments classified as held to maturity are carried at amortized cost. The
securities designated as held to maturity will have characteristics consistent
with the Company's investment policy guidelines.
During 2004, securities were called or the Company sold $194.6 million of
securities available for sale resulting in a gross gain and gross loss of $1.4
million and $22,000, respectively. During 2003, securities were called or the
Company sold $215.3 million of securities available for sale resulting in a
gross gain and gross loss of $2.7 million and $276,000, respectively. During
2002, securities were called or the Company sold $171.4 million of securities
available for sale resulting in a gross gain and gross loss of $2,546,000 and
$29,000, respectively.
44
The following table provides the gross unrealized losses and fair value,
aggregated by investment category and length of time the individual securities
have been in a continuous unrealized loss position at December 31, 2004 and
2003:
Less than 12 Months 12 Months or Longer Total
---------------------- --------------------- -----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
---------- ------ ---------- ------ ---------- ------
At December 31, 2004:
U.S. Treasury obligations $ 59,881 $ (121) $ 9,880 $ (187) $ 69,761 $ (308)
U.S. Government agencies and
mortgage-backed securities 559,499 (4,280) 62,323 (1,617) 621,822 (5,897)
State and municipal obligations 13,883 (92) 512 (53) 14,395 (145)
Other securities 23,903 (195) - - 23,903 (195)
-------- -------- -------- -------- -------- --------
Total $657,166 $ (4,688) $ 72,715 $ (1,857) $729,881 $ (6,545)
======== ======== ======== ======== ======== ========
Less than 12 Months 12 Months or Longer Total
---------------------- --------------------- -----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
---------- ------ ---------- ------ ---------- ------
At December 31, 2003:
U.S. Treasury obligations $ 39,957 $ (118) - - $ 39,957 $ (118)
U.S. Government agencies and
mortgage-backed securities 298,600 (2,340) - - 298,600 (2,340)
State and municipal obligations 7,889 (82) $ 532 $ (33) 8,421 (115)
-------- -------- -------- -------- -------- --------
Total $346,446 $ (2,540) $ 532 $ (33) $346,978 $ (2,573)
======== ======== ======== ======== ======== ========
At December 31, 2004, 99.4% of the unrealized losses in the security portfolio
were comprised of securities issued by U.S. Government agencies, U.S. Government
sponsored agencies and other securities rated investment grade by at least one
bond credit rating service. The Company believes that the price movements in
these securities are dependent upon the movement in market interest rates
particularly given the negligible inherent credit risk for these securities. At
December 31, 2004, the unrealized loss in the category 12 months or longer of
$1.9 million consisted of 14 securities having an aggregate depreciation of
2.5%. The securities represented U.S. Treasury, Federal Agency issues and one
security currently rated Aaa by three rating services. At December 31, 2004,
securities in a gross unrealized loss position for less than twelve months
consisted of 87 securities having an aggregate depreciation of 0.7% from the
Bank's amortized cost basis.
The maturity schedule of the investment in debt securities at December 31, 2004
was as follows:
Available for Sale Held to Maturity
--------------------------------------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Due in one year or less $108,043 $107,811 - -
Due after one year through five years 270,553 269,061 - -
Due after five years through ten years 803 832 - -
Due after ten years 41,010 40,969 - -
-------- -------- ------- -------
420,409 418,673 - -
Mortgage-backed securities 403,487 400,751 $43,048 $42,872
-------- -------- ------- -------
Total $823,896 $819,424 $43,048 $42,872
======== ======== ======= =======
At December 31, 2004, $228.2 million of U.S. Treasury Notes and U.S. Government
Agency securities was pledged to secure public deposits.
45
6. LOANS
The components of loans were as follows:
December 31,
---------------------------
2004 2003
----------- ------------
Commercial and industrial $ 1,603,868 $ 1,169,164
Home equity 122,735 80,292
Second mortgages 50,541 51,531
Residential real estate 26,117 29,788
Other 66,497 51,304
----------- -----------
Total gross loans 1,869,758 1,382,079
Allowance for loan losses (22,037) (17,614)
----------- -----------
Loans, net $ 1,847,721 $ 1,364,465
=========== ===========
Non-accrual loans $ 13,457 $ 21,568
=========== ===========
There were no irrevocable commitments to lend additional funds on non-accrual
loans at December 31, 2004. The gross interest income that would have been
recorded if the above non-accrual loans had been current in accordance with
their original terms was $1.0 million, $1.5 million, and $984,000 for the years
ended December 31, 2004, 2003 and 2002, respectively. The amount of interest
included in net income on these loans for the years ended December 31, 2004,
2003 and 2002 was $274,000, $534,000, and $442,000, respectively.
Certain officers, directors and their associates (related parties) have loans
and conduct other transactions with the Company. Such transactions are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for other non-related party transactions. The aggregate
dollar amount of these loans to related parties as of December 31, 2004 and
2003, along with an analysis of the activity for the years ended December 31,
2004 and 2003, is summarized as follows:
For the Years Ended
December 31,
----------------------------
2004 2003
---- ----
Balance, beginning of year $ 27,204 $ 32,330
Additions 20,368 6,159
Repayments (3,828) (11,285)
-------- --------
Balance, end of year $ 43,744 $ 27,204
======== ========
$17.8 million of the 2004 additions were loans relating to new directors who
were formerly directors of Community.
Under approved lending decisions, the Company had commitments to lend additional
funds totaling approximately $756.9 million and $532.7 million at December 31,
2004 and 2003, respectively. Commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Company evaluates each customer's creditworthiness on an individual basis. The
type and amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the borrower.
Most of the Company's business activity is with customers located within its
local market area. Generally, commercial real estate, residential real estate
and other assets secure loans. The ultimate repayment of loans is dependent, to
a certain degree, on the local economy and real estate market.
46
7. ALLOWANCE FOR LOAN LOSSES
An analysis of the change in the allowance for loan losses is as follows:
For the Years Ended December 31,
-----------------------------------
2004 2003 2002
-------- -------- --------
Balance, beginning of year $ 17,614 $ 16,408 $ 13,332
Charge-offs (1,382) (4,380) (1,609)
Recoveries 793 761 510
-------- -------- --------
Net charge-offs (589) (3,619) (1,099)
Provision for loan losses 2,075 4,825 4,175
Purchased allowance resulting from bank acquisition 2,937 - -
-------- -------- --------
Balance, end of year $ 22,037 $ 17,614 $ 16,408
======== ======== ========
Loans collectively evaluated for impairment include consumer loans and
residential real estate loans, and are not included in the data that follow:
December 31,
------------------------
2004 2003
------- -------
Impaired loans with related allowance for loan losses $31,533 $31,463
calculated under SFAS No. 114
Impaired loans with no related allowance for loan losses
calculated under SFAS No. 114 1,588 6,147
------- -------
Total impaired loans $33,121 $37,610
======= =======
Valuation allowance related to impaired loans $3,332 $3,439
====== ======
For the Years Ended
December 31,
--------------------------------------
2004 2003 2002
---- ---- ----
Average impaired loans $35,991 $34,715 $13,471
======= ======= =======
Interest income recognized on impaired loans $2,315 $2,177 $1,936
====== ====== ======
Cash basis interest income recognized on impaired loans $2,111 $2,311 $2,013
====== ====== ======
8. RESTRICTED EQUITY INVESTMENTS
The cost of restricted equity investments was as follows:
December 31,
------------------------
2004 2003
---- ----
Federal Reserve Bank stock $ 5,563 $ 4,270
Federal Home Loan Bank stock 9,734 8,198
Atlantic Central Bankers Bank stock 108 83
------- -------
Total $15,405 $12,551
======= =======
47
9. BANK PROPERTIES AND EQUIPMENT
Bank properties and equipment consist of the following major classifications:
December 31,
----------------------------
2004 2003
-------- --------
Land $ 5,366 $ 6,578
Buildings 17,676 19,801
Leasehold improvements and equipment 29,850 21,348
-------- --------
52,892 47,727
Accumulated depreciation (16,062) (13,634)
-------- --------
Total $ 36,830 $ 34,093
======== ========
10. REAL ESTATE OWNED
Real estate owned consisted of the following:
December 31,
--------------------------
2004 2003
---- ----
Commercial properties $2,424 $4,013
Residential properties 178 122
Bank properties 309 309
------ ------
Total $2,911 $4,444
====== ======
Expenses applicable to real estate owned include the following:
For the Years Ended December 31,
--------------------------------
2004 2003 2002
---- ---- ----
Net gain on sales of real estate $(220) $(707) $ (87)
Write-down of real estate owned - - 117
Operating expenses, net of rental income 280 110 145
----- ----- -----
Total $ 60 $(597) $ 175
===== ===== =====
11. GOODWILL AND INTANGIBLE ASSETS
On July 8, 2004, the Company acquired Community Bancorp of New Jersey
("Community") in a stock-for-stock exchange merger valued at approximately $69
million. Goodwill of approximately $55 million was recorded in conjunction with
this transaction and will not be amortized in accordance with SFAS No. 142, but
will be reviewed at least annually for impairment. Core deposit intangibles of
approximately $14 million was recorded and will be amortized over approximately
nine years on a straight-line basis.
In the fourth quarter 2004 and 2003, 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 years ended December 31, 2004 and
2003.
48
Changes in the carrying amount of goodwill are as follows:
For the Years Ended
December 31,
--------------------
2004 2003
-------- --------
Balance, beginning of year $ 50,600 $ 19,672
Goodwill resulting from business combination 54,369 30,928
-------- --------
Balance, end of year $104,969 $ 50,600
======== ========
Information regarding the Company's intangible assets subject to amortization is
as follows:
December 31, 2004
----------------------------
Carrying Accumulated
Amount Amortization Net
------ ------------ ---
Core Deposit Premium $46,132 $18,906 $27,226
Excess of cost over fair value of assets acquired 17,698 10,171 7,527
------- ------- -------
Total intangible assets $63,830 $29,077 $34,753
======= ======= =======
December 31, 2003
----------------------------
Carrying Accumulated
Amount Amortization Net
------ ------------ ---
Core Deposit Premium $32,306 $14,645 $17,661
Excess of cost over fair value of assets acquired 17,698 9,164 8,534
------- ------- -------
Total intangible assets $50,004 $23,809 $26,195
======= ======= =======
Changes in the carrying amount of Company's intangible assets for the year ended
December 31, 2004 are as follows:
Balance, beginning of year $26,195
Addition resulting from business combination 13,826
Amortization expense (5,268)
-------
Balance, end of year $34,753
=======
Information regarding the Company's amortization expense follows:
Actual for Year Ended December 31,
2002 $ 4,182
2003 3,696
2004 5,268
Expected for Year Ending December 31,
2005 4,499
2006 4,390
2007 4,375
2008 4,375
2009 4,375
Thereafter 12,739
------
Total $34,753
=======
49
12. DEPOSITS
Deposits consist of the following major classifications:
December 31,
----------------------------
2004 2003
---- ----
Interest bearing demand deposits $ 793,290 $ 784,453
Non-interest bearing demand deposits 543,601 399,538
Savings deposits 452,726 392,784
Time deposits under $100,000 410,632 390,312
Time deposits $100,000 or more 230,114 144,038
---------- ----------
Total $2,430,363 $2,111,125
========== ==========
A summary of time deposits by year of maturity is as follows:
Years Ending December 31,
2005 $346,392
2006 81,212
2007 71,172
Thereafter 141,970
--------
Total $640,746
========
A summary of interest expense on deposits is as follows:
For the Years Ended December 31,
--------------------------------
2004 2003 2002
---- ---- ----
Savings deposits $ 3,440 $ 3,968 $ 6,821
Time deposits 13,421 12,105 17,494
Interest-bearing demand deposits 7,200 7,407 10,789
------- ------- -------
Total $24,061 $23,480 $35,104
======= ======= =======
13. ADVANCES FROM THE FEDERAL HOME LOAN BANK
The Company's fixed rate, long-term debt of $144.7 million matures through 2018.
At December 31, 2004 and 2003, the interest rates on fixed-rate, long-term debt
ranged from 1.88% to 6.49%. At December 31, 2004 and 2003, the weighted average
interest rate on fixed-rate, long-term debt was 4.32% and 4.31%, respectively.
Included in the above amount was one $25.0 million fixed-rate advance which is
convertible on October 12, 2005. On the convertible date and each quarter
thereafter, the FHLB has the option to convert this advance to floating at then
current market rates. The Company has the option of replacing the funding or
repaying the advance.
The contractual maturities of the Company's fixed-rate, long-term debt at
December 31, 2004 are as follows:
Due in 2005 $ 10,000
Due in 2006 10,586
Due in 2007 56,158
Due in 2008 41,440
Thereafter 26,485
--------
Total long-term debt $144,669
========
50
14. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company has overnight repurchase agreements with customers as well as
repurchase agreements with the FHLB. At December 31, 2004 and 2003, customer
repurchase agreements were $59.6 million and $55.9 million, respectively with
interest rates ranging from 0.93% to 2.2% and 0.14% to 0.92%, respectively.
Interest expense on customer repurchase agreements was $471,000, $348,000 and
$739,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Collateral for customer repurchase agreements consisted of U.S. Treasury notes
or securities issued or guaranteed by one of the Government Sponsored
Enterprises. The fair value of the collateral was approximately equal to the
amounts outstanding.
At December 31, 2004, the Company had one, thirty day maturity, $50.0 million
FHLB repurchase agreement with an interest rate of 2.43%. Interest expense on
FHLB repurchase agreements was $68,000 for the year ended December 31, 2004.
Collateral for FHLB repurchase agreements consisted of securities issued or
guaranteed by one of the Government Sponsored Enterprises. The fair value of the
collateral was approximately equal to the amount outstanding. There were no FHLB
repurchase agreements outstanding at December 31, 2003.
15. JUNIOR SUBORDINATED DEBENTURES HELD BY TRUSTS THAT ISSUED CAPITAL DEBT
The Company had previously established Issuer Trusts that issued guaranteed
preferred beneficial interests in the Company's junior subordinated debentures.
Prior to FIN 46 and FIN 46 (R), the Company classified its Issuer Trusts after
total liabilities and before shareholders' equity on its consolidated statement
of financial position under the caption "Guaranteed Preferred Beneficial
Interest in Company's Subordinated Debt" and the retained common capital
securities of the Issuer Trusts were eliminated against the Company's investment
in the Issuer Trusts. Distributions on the preferred securities were recorded as
interest expense on the consolidated statement of income.
As a result of the adoption of FIN 46 and FIN 46 (R), the Company deconsolidated
all the Issuer Trusts. The junior subordinated debentures issued by the Company
to the Issuer Trusts, totaling $77.3 and $72.2 million, are reflected in the
Company's consolidated statement of financial position in the liabilities
section at December 31, 2004 and December 31, 2003, respectively, under the
caption "Junior subordinated debentures." The Company records interest expense
on the corresponding debentures in its consolidated statements of income. The
Company also recorded the common capital securities issued by the Issuer Trusts
in "Other assets" in its consolidated statement of financial position at
December 31, 2004 and 2003.
The following is a summary of the outstanding capital securities issued by each
Issuer Trust and the junior subordinated debentures issued by the Company to
each Trust as of December 31, 2004.
Capital Securities Junior Subordinated Debentures
---------------------------------------------------------------------------------------------------
Stated Distribution Principal Redeemable
Issuer Trust Issuance Date Value Rate Amount Maturity Beginning
------------ ------------- ----- ---- ------ -------- ---------
6-mo LIBOR
Sun Trust III April 22, 2002 $20,000 plus 3.70% $20,619 April 22, 2032 April 22, 2007
3-mo LIBOR
Sun Trust IV July 7, 2002 10,000 plus 3.65% 10,310 October 7, 2032 July 7, 2007
3-mo LIBOR
Sun Trust V December 18, 2003 15,000 plus 2.80% 15,464 December 30, 2033 December 30, 2008
3-mo LIBOR
Sun Trust VI December 19, 2003 25,000 plus 2.80% 25,774 January 23, 2034 January 23, 2009
3-mo LIBOR
CBNJ Trust I December 19, 2002 5,000 plus 3.35% 5,155 January 7, 2033 January 7, 2008
------- -------
$75,000 $77,322
======= =======
51
While the capital securities have been deconsolidated in accordance with GAAP,
they continue to qualify as Tier 1 capital under federal regulatory guidelines.
The change in accounting guidance did not have an impact on the current Tier 1
regulatory capital of either the Company or the Bank. In March 2005, the Federal
Reserve amended its risk-based capital standards to expressly allow the
continued limited inclusion of outstanding and prospective issuances of trust
preferred securities in a bank holding company's Tier 1 capital, subject to
tightened quantitative limits. The Federal Reserve's amended rule will,
effective March 31, 2009, limit capital securities and other restricted core
capital elements to 25% of all core capital elements, net of goodwill less any
associated deferred tax liability. Management has developed a capital plan for
the Company and the Bank that should allow the Company and the Bank to maintain
"well-capitalized" regulatory capital levels.
The Issuer Trusts are wholly owned unconsolidated subsidiaries of the Company
and have no independent operations. The obligations of Issuer Trusts are fully
and unconditionally guaranteed by the Company. The debentures are unsecured and
rank subordinate and junior in right of payment to all indebtedness, liabilities
and obligations of the Company. Interest on the debentures is cumulative and
payable in arrears. Proceeds from any redemption of debentures would cause a
mandatory redemption of capital securities having an aggregate liquidation
amount equal to the principal amount of debentures redeemed.
Sun Trust III variable annual rate will not exceed 11.00% through five years
from its issuance. Sun Trust IV variable annual rate will not exceed 11.95%
through five years from its issuance. Sun Trust V and Sun Trust VI do not have
interest rate caps. As a result of the July 2004 Community acquisition, the
Company assumed CBNJ Trust I. The CBNJ Trust I variable annual rate does not
have an interest rate cap.
During 2003, the Company notified the holders of the outstanding capital
securities of Sun Trust II of its intention to call these securities
contemporaneously with the redemption of the Sun Trust II debentures on December
31, 2003. The Company wrote off the unamortized debt issuance costs of the
called securities in the amount of $624,000, net of income tax, through a charge
to equity.
16. STOCK REPURCHASE PLAN
In February 2002, the Board of Directors of the Company authorized the
initiation of a stock repurchase plan covering up to approximately 3%, or
352,800 shares, adjusted for stock dividends, of the Company's outstanding
common stock. The repurchases were made from time to time in open-market
transactions, subject to the availability of the stock. As of December 31, 2004,
the Company had 90,562 shares repurchased for an aggregate price of
approximately $1,046,000.
17. STOCK OPTION PLANS
In March 2004, the Board of Directors of the Company adopted a Stock-Based
Incentive Plan (the "2004 Stock Plan"). The 2004 Stock Plan authorizes the
issuance of 450,000 shares of common stock pursuant to awards that may be
granted in the form of options to purchase common stock ("Options") and awards
of shares of common stock ("Stock Awards"). The maximum number of Stock Awards
may not exceed 50,000 shares. The purpose of the 2004 Stock Plan, as with all of
the Company's stock-based incentive plans, is to attract and retain personnel
for positions of substantial responsibility and to provide additional incentive
to certain officers, directors, advisory directors, employees and other persons
to promote the success of the Company. Under the 2004 Stock Plan, options expire
ten years after the date of grant, unless terminated earlier under the option
terms. For both Stock Options and Stock Awards, a Committee of non-employee
directors has the authority to determine the conditions upon which the options
granted will vest. At December 31, 2004, there were no options or awards granted
under the 2004 Stock Plan.
In July 2004, as a result of the Community acquisition, the Company assumed
stock options previously granted under the Community Plans. Upon merger, all
stock options under the Community Plans became fully vested and were converted
to Sun Bancorp Inc. stock options. The number of shares of common stock that may
be purchased pursuant to any such option is equal to the number of shares
covered by the option multiplied by the merger exchange ratio, with the exercise
price of each converted option equal to the original exercise price divided by
the merger exchange ratio. Stock options
52
previously granted under the Community Plans are both incentive and
non-qualified and expire from 2007 through 2013. There are 305,165 stock options
outstanding under these plans at December 31, 2004. No additional stock options
will be granted under these plans.
In January 2002, the Board of Directors of the Company adopted a Stock Option
Plan (the "2002 Plan"). Options granted under the 2002 Plan may be either
qualified incentive stock options or nonqualified options as determined by the
Compensation Committee of the Board of Directors or the Board of Directors.
There are 867,061 shares authorized for grants of options under the 2002 Plan.
The grant of "reload" options is authorized under the 2002 Plan. The award of a
reload option allows the optionee to receive the grant of an additional stock
option, at the then current market price, in the event that such optionee
exercises all or part of an option (an "original option") by surrendering
already owned shares of common stock in full or partial payment of the option
price under such original option. The exercise of an additional option issued in
accordance with the "reload" feature will reduce the total number of shares
eligible for award under the Plan. Under the 2002 Plan, the nonqualified options
expire ten years and ten days after the date of grant, unless terminated earlier
under the option terms. The qualified incentive options expire ten years after
the date of grant, unless terminated earlier under the option terms. The vesting
provision of the 2002 Plan allows 20% of options granted to employees to vest
six months after the date of grant, and 20% for each of the next four
anniversaries of the grant, subject to employment and other conditions. The
vesting provision of the 2002 Plan generally allows options granted to directors
to vest as of the date of grant. At December 31, 2004, there were 861,978
options outstanding with the "reload" feature under the 2002 Plan.
In 1997, the Company adopted a Stock Option Plan (the "1997 Plan"). Options
granted under the 1997 Plan may be either qualified incentive stock options or
nonqualified options as determined by the Compensation Committee of the Board of
Directors or the Board of Directors. Options granted under the 1997 Plan are at
the estimated fair value at the date of grant. There are 1,254,952 shares
authorized for grants of options under the 1997 Plan. At December 31, 2004,
there were 1,242,817 options outstanding with the "reload" feature under the
1997 Plan.
In 1995, the Company adopted a Stock Option Plan (the "1995 Plan"). There are
734,368 shares authorized for grants of options under the 1995 Plan. Options
granted under the 1995 Plan were either qualified incentive stock options or
nonqualified options as determined by the Compensation Committee of the Board of
Directors or the Board of Directors. Options granted under the 1995 Plan were at
the estimated fair value at the date of grant.
Under the 1995 and 1997 Plans, the nonqualified options expire ten years and ten
days after the date of grant, unless terminated earlier under the option terms.
The incentive options expire ten years after the date of grant, unless
terminated earlier under the option terms. The vesting provision of the 1997
Plan allows for 50% of options to vest one year after the date of grant, and 50%
two years after the date of grant, subject to employment and other conditions.
All shares granted under the 1995 Plan are fully vested.
There are no equity compensation plans issued by the Company that were not
approved by the shareholders.
Options outstanding under the 1995, 1997, 2002, 2004 and the Community Plans,
adjusted for 5% stock dividends granted where appropriate, are as follows:
Incentive Nonqualified Total
--------- ------------ -----
Options granted and outstanding:
December 31, 2004 at prices ranging from $3.71 to $23.82 per share 517,087 2,608,739 3,125,826
======= ========= =========
December 31, 2003 at prices ranging from $3.71 to $16.38 per share 502,912 2,345,571 2,848,483
======= ========= =========
December 31, 2002 at prices ranging from $3.71 to $16.38 per share 531,685 2,346,817 2,878,502
======= ========= =========
53
Activity in the stock option plans for the period beginning January 1, 2002 and
ending December 31, 2004 was as follows:
Weighted
Number Exercise
of Shares Price Options
Outstanding Per Share Exercisable
----------- --------- -----------
January 1, 2002 2,044,794 $ 9.01 1,948,590
=========
Granted 1,135,367 $10.39
Exercised (209,207) $ 5.60
Expired (92,452) $12.61
---------
December 31, 2002 2,878,502 $ 9.70 1,938,094
=========
Granted 15,750 $18.05
Exercised (36,277) $10.50
Expired (9,492) $12.12
---------
December 31, 2003 2,848,483 $ 9.72 2,170,880
--------- =========
Granted - -
Assumed in connection with Community merger 333,858 $ 9.96
Exercised (43,434) $ 9.50
Expired (13,081) $23.23
---------
December 31, 2004 3,125,826 $ 9.70 2,669,057
========= =========
The following table summarizes stock options outstanding at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------- -------------------------------------
Number of Weighted Average Weighted Weighted
Range of Options Remaining Average Exercise Options Average Exercise
Exercise Price Outstanding Contractual Life Price Exercisable Price
- --------------------------------------------------------------------------- -------------------------------------
$ 3.71 - $6.99 593,213 2.01 years $4.86 593,213 $4.86
$ 7.02 - $9.75 521,258 3.36 years $7.52 521,258 $7.52
$10.32 - $10.97 1,096,198 7.07 years $10.33 681,788 $10.34
$11.16 - $12.39 448,550 5.20 years $11.26 418,791 $11.21
$13.43 - $23.82 466,607 4.27 years $15.28 454,007 $15.21
--------- ---------
3,125,826 5.84 years $9.70 2,669,057 $9.53
========= =========
18. EMPLOYEE AND DIRECTOR STOCK PURCHASE PLANS
In 1997, the Company adopted an Employee Stock Purchase Plan ("ESPP") and a
Directors Stock Purchase Plan ("DSPP") (collectively, the "Purchase Plans")
wherein 418,142 shares were reserved for issuance pursuant to the Purchase
Plans. Under the terms of the Purchase Plans, the Company grants participants an
option to purchase shares of Company common stock with an exercise price equal
to 95% of market prices. Under the ESPP, employees are permitted, through
payroll deduction, to purchase up to $25,000 of fair market value of common
stock per year. Under the DSPP, directors are permitted to remit funds, on a
regular basis, to purchase up to $25,000 of fair market value of common stock
per year. Participants incur no brokerage commissions or service charges for
purchases made under the Purchase Plans. For the years ended December 31, 2004
and 2003, there were 7,513 shares and 6,930 shares, respectively, granted and
issued through the ESPP. For the years ended December 31, 2004 and 2003, there
were 2,226 shares and 2,758 shares, respectively, granted and issued through the
DSPP. At December 31, 2004, there were 204,386 and 13,561 shares remaining in
the ESPP and DSPP, respectively.
54
19. BENEFITS
The Company has established a 401(k) Retirement Plan (the "401(k) Plan") for all
qualified employees. Employees are eligible to participate in the 401(k) Plan
following completion of 90 days of service and attaining age 21. The Company's
match begins after one year of service. Vesting in the Company's contribution
accrues over four years at 25% each year. Pursuant to the 401(k) Plan, employees
could contribute up to 75% of their compensation to a maximum allowed by law.
The Company matches 50% of the employee contribution, up to 6% of compensation.
The Company match consists of a contribution of Company common stock, at market
value. The Company's contributions were purchased through a broker by the
directed trustee. The Company's contribution to the 401(k) Plan was $486,000,
$414,000 and $320,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. The Company expensed $26,000, $23,000 and $18,000 during 2004,
2003 and 2002, respectively, to administer and audit the 401(k) Plan.
20. COMMITMENTS AND CONTINGENT LIABILITIES
The Company, from time to time, may be a defendant in legal proceedings related
to the conduct of its business. Management, after consultation with legal
counsel, believes that the liabilities, if any, arising from such litigation and
claims will not be material to the consolidated financial statements.
Letters of Credit
In the normal course of business, the Bank has various commitments and
contingent liabilities, such as customers' letters of credit (including standby
letters of credit of $51.2 million and $38.9 million at December 31, 2004 and
2003, respectively), which are not reflected in the accompanying consolidated
financial statements. Standby letters of credit are conditional commitments
issued by the Bank to guarantee the performance of a customer to a third party.
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. In the judgment of
management, the financial position of the Company will not be affected
materially by the final outcome of any contingent liabilities and commitments.
Leases
Certain office space of the Company and the Bank is leased from companies
affiliated with the Chairman of the Company's Board of Directors under separate
agreements with the Company. The Bank is the sub-tenant of one of these leases.
Terms of these three agreements at December 31, 2004 are as follows.
Expiration date October 2017 March 2006 January 2006
Annual Rental $1,090 $40 $48
Renewal Option remaining N/A 1 five-year term 2 two-year terms
Annual Rental Increases CPI Fixed Fixed
In September 2004, the Company entered into a lease for a future branch office
and Regional Banking Center with a company controlled by the Chairman of the
Company's Board of Directors. The lease is a twenty year lease with 4 renewal
periods of 5 years each. The annual rental is fixed at $450,000 for the first 5
years, and increasing 12.5% every five years thereafter. The Company believes
that this related party lease is on terms as fair to the Company as could have
been obtained from unaffiliated third parties.
55
Certain office space of the Bank is leased from companies affiliated with
certain Directors under separate agreements with the Bank. Terms of these two
agreements at December 31, 2004 are as follows.
Expiration date December 2011 February 2005
Annual Rental $140 $96
Renewal Option remaining N/A 1 five-year term
Annual Rental Increases Fixed for 5 years Fixed
The Company believes that each of the related party transactions described above
were on terms as fair to the Company as could have been obtained from
unaffiliated third parties.
Branch Real Estate Sale
In June 2004, the Company completed the sale of the real estate associated with
its Atlantic City, New Jersey, branch office and recognized a pre-tax gain of
$2.3 million. The terms of the sale agreement provide that the Bank will operate
at the existing location until it relocates to a new location. As part of the
overall transaction, the Company acquired the rights to purchase and the
obligations to develop a certain parcel of undeveloped land located in Atlantic
City for the purpose of the new branch. In lieu of undertaking the
responsibility of acquiring and developing this parcel, the Company entered into
an Assignment and Assumption Agreement with a company controlled by the Chairman
of the Company's Board of Directors (Related Party) whereby the Company assigned
all its rights, title and interest in this real estate to the Related Party, and
the Related Party assumed all the covenants, duties and obligations with respect
to the acquisition and development of this real estate. The Company believes
that this Assignment and Assumption Agreement entered into with the Related
Party was an arms' length transaction.
The following table shows future minimum payments under non-cancelable operating
leases with initial terms of one year or more at December 31, 2004. Future
minimum receipts under sub-lease agreements are not material.
2005 $ 4,857
2006 3,999
2007 3,778
2008 3,700
2009 3,561
Thereafter 24,421
-------
Total $44,316
=======
Rental expense included in occupancy expense for all operating leases was $4.8
million, $3.7 million, and $3.6 million for the years ended December 31, 2004,
2003 and 2002, respectively.
21. DERIVATIVE INTRUMENTS AND HEDGING ACTIVITIES
Beginning in 2004, the Company utilized certain derivative financial instruments
to enhance its ability to manage interest rate risk that exists as part of its
ongoing business operations. As of December 31, 2004, all derivative financial
instruments have been entered into to hedge the interest rate risk associated
with the Bank's commercial lending activity. In general, the derivative
transactions fall into one of two types, a bank hedge of a specific fixed rate
loan or a hedged derivative offering to a Bank customer. In those transactions
in which the bank hedges a specific fixed rate loan, the derivative is executed
for periods that match the related underlying exposures and do not constitute
positions independent of these exposures. For derivatives offered to Bank
customers, the economic risk of the customer transaction is offset by a mirror
position with a non-affiliated third party.
56
The Company currently utilizes interest rate swaps to hedge specified assets.
The Company does not use derivative financial instruments for trading purposes.
Interest rate swaps were entered into as fair value hedges for the purpose of
modifying the interest rate characteristics of certain commercial loans. The
interest rate swaps involve no exchange of principal either at inception or upon
maturity; rather, it involves the periodic exchange of interest payments arising
from an underlying notional value.
Derivative instruments are recorded at their fair values. If derivative
instruments are designated as fair value hedges, both the change in the fair
value of the hedge and the hedged item are included in current earnings. Because
the hedging arrangement is considered highly effective, changes in the interest
rate swaps' fair values exactly offset the corresponding changes in the fair
value of the commercial loans and, as a result, the changes in fair value do not
result in an impact on net income. Ineffective portions of hedges, if any, would
be reflected in earnings as they occur.
Financial derivatives involve, to varying degrees, interest rate, market and
credit risk. The Company manages these risks as part of its asset and liability
management process and through credit policies and procedures. The Company seeks
to minimize counterparty credit risk by establishing credit limits, and
generally requiring bilateral netting and collateral agreements.
For those derivative instruments that are designated and qualify as hedging
instruments, the Company must designate the hedging instrument, based on the
exposure being hedged, as either a fair value hedge, a cash flow hedge or a
hedge of a net investment in a foreign operation. Currently, the Company only
participates in fair value hedges.
Fair Value Hedges - Interest Rate Swaps
The Company has entered into interest rate swap arrangements to exchange the
payments on fixed rate commercial loan receivables for variable rate payments
based on LIBOR. The interest rate swaps involve no exchange of principal either
at inception or maturity and have maturities and call options identical to the
fixed rate loan agreements. The arrangements have been designated as fair value
hedges. The swaps are carried at their fair value and the carrying amount of the
commercial loans includes the change in their fair values since the inception of
the hedge. Because the hedging arrangement is considered highly effective,
changes in the interest rate swaps' fair values exactly offset the corresponding
changes in the fair value of the commercial loans and, as a result, the changes
in fair value do not result in an impact on net income.
Customer Derivatives
To accommodate customer needs, the Company also enters into financial derivative
transactions primarily consisting of interest rate swaps. Market risk exposure
from customer positions is managed through transactions with third-party
dealers. The credit risk associated with derivatives executed with customers is
essentially the same as that involved in extending loans and is subject to
normal credit policies. Collateral may be obtained based on management's
assessment of the customer. The positions of customer derivatives are recorded
at fair value and changes in value are included in non-interest income.
At December 31, 2004, the information pertaining to outstanding interest rate
swap agreements was as follows:
Notional Amount $44,373
Weighted average pay rate 6.40%
Weighted average receive rate 4.39%
Weighted average maturity in years 7.4
Unrealized loss relating to interest rate swaps ($283)
57
22. INCOME TAXES
The income tax provision consists of the following:
For the Years Ended
December 31,
----------------------------
2004 2003 2002
---- ---- ----
Current $ 1,174 $ 5,104 $ 6,478
Deferred 6,407 342 (1,780)
------- ------- -------
Total $ 7,581 $ 5,446 $ 4,698
======= ======= =======
Of the $6.4 million deferred income tax expense for the year ended December 31,
2004, $5.5 million related to the core deposit intangible amortization for the
Community Bank of New Jersey acquisition during 2004.
Items that gave rise to significant portions of the deferred tax accounts are as
follows:
December 31,
---------------------
2004 2003
---- ----
Deferred tax asset:
Allowance for loan losses $ 8,816 $ 7,175
Goodwill amortization 2,200 3,040
Compensation - 17
Unrealized loss on investment securities 1,707 -
-------- --------
Total deferred tax asset 12,723 10,232
Deferred tax liability:
Core deposit intangible amortization (5,522) -
Property (1,579) (846)
Deferred loan fees (971) (12)
Unrealized gain on investment securities - (861)
Other (25) (48)
-------- --------
Total deferred tax liability (8,097) (1,767)
-------- --------
Net deferred tax asset $ 4,626 $ 8,465
======== ========
At December 31, 2004 and 2003, there was no valuation allowance recognized for
deferred tax assets.
The provision for income taxes differs from that computed at the statutory rate
as follows:
For the Years Ended
December 31,
--------------------------------------------------
2004 2003 2002
---------------- ---------------- ---------------
Amount % Amount % Amount %
------- ---- ------- ---- ------- ----
Tax computed at the statutory rate $ 8,824 35.0 $ 6,574 35.0 $ 5,276 35.0
Surtax exemption (252) (1.0) (188) (1.0) (150) (1.0)
Increase (decrease) in charge resulting from:
Tax exempt interest (net) (640) (2.5) (819) (4.4) (650) (4.3)
Bank Owned Life Insurance (628) (2.5) (345) (1.8) - -
Other, net 277 1.1 224 1.2 222 1.5
------- ---- ------- ---- ------- ----
Total $ 7,581 30.1 $ 5,446 29.0 $ 4,698 31.2
======= ==== ======= ==== ======= ====
58
23. EARNINGS PER SHARE
Earnings per share were calculated as follows:
For the Years Ended December 31,
---------------------------------------
2004 2003 2002
---------- ---------- ----------
Net income $ 17,629 $ 13,336 $ 10,378
Less: Trust Preferred issuance costs write-off - 624 777
---------- ---------- ----------
Net income available to common shareholders $ 17,629 $ 12,712 $ 9,601
=========== =========== ===========
Dilutive stock options outstanding 2,980,269 2,860,417 2,374,590
Average exercise price per share $ 9.71 $ 9.69 $ 8.57
Average market price - diluted $22.71 $18.02 $ 11.76
Average common shares outstanding 15,476,149 12,413,987 12,312,706
Increase in shares due to exercise of options - diluted 1,224,127 957,559 472,848
---------- ---------- ----------
Adjusted shares outstanding - diluted 16,700,276 13,371,546 12,785,554
========== ========== ==========
Net earnings per share - basic $ 1.14 $ 1.02 $ 0.78
Net earnings per share - diluted $ 1.06 $ 0.95 $ 0.75
Options that could potentially dilute basic EPS in the future that were not
included in the computation of diluted EPS because to do so
would have been antidilutive for the period presented 14,477 - 523,734
24. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators, that, if undertaken, could have a direct
material effect on the Company's and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
The ability of the Bank to pay dividends to the Company is controlled by certain
regulatory restrictions. Permission from the Office of the Comptroller of the
Currency (the "OCC") is required if the total of dividends declared in a
calendar year exceeds the total of the Bank's net profits, as defined by the
OCC, for that year, combined with its retained net profits of the two preceding
years. The amount available for payment of dividends to the Company by the Bank
totaled $34.7 million at December 31, 2004.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of capital (as defined in the regulations) to total
adjusted assets (as defined), and of risk-based capital (as defined) to
risk-weighted assets (as defined). Management believes, as of December 31, 2004,
that the Company and the Bank meet all applicable capital adequacy requirements.
59
As of December 31, 2004, the most recent notification from the OCC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum Total Capital, Tier 1 Capital and Leverage Ratios as set forth in the
table below.
To Be Well-Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
---------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At December 31, 2004
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $239,830 10.80% $177,732 8.00% N/A
Sun National Bank $222,968 10.06% $177,260 8.00% $221,575 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $217,263 9.78% $88,866 4.00% N/A
Sun National Bank $200,401 9.04% $88,630 4.00% $132,945 6.00%
Leverage Ratio:
Sun Bancorp, Inc. $217,263 7.51% $115,792 4.00% N/A
Sun National Bank $200,401 6.94% $115,518 4.00% $144,397 5.00%
At December 31, 2003
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $195,197 11.35% $137,608 8.00% N/A
Sun National Bank $172,500 10.06% $137,116 8.00% $171,395 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $168,576 9.80% $ 68,804 4.00% N/A
Sun National Bank $154,536 9.02% $ 68,558 4.00% $102,837 6.00%
Leverage Ratio:
Sun Bancorp, Inc. $168,576 7.34% $ 91,865 4.00% N/A
Sun National Bank $154,536 6.77% $ 91,291 4.00% $114,114 5.00%
60
25. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, Disclosures about Fair
Value of Financial Instruments. The estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is necessarily required
to interpret market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
December 31, 2004 December 31, 2003
-----------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Assets:
Cash and cash equivalents $ 74,902 $ 74,902 $ 82,117 $ 82,117
Investment securities available for sale 819,424 819,424 963,428 963,428
Investment securities held to maturity 43,048 42,872 - -
Loans receivable, net 1,847,721 1,891,201 1,364,465 1,408,271
Restricted equity investments 15,405 15,405 12,551 12,551
Liabilities:
Demand deposits 1,336,891 1,336,891 1,183,991 1,183,991
Savings deposits 452,726 452,726 392,784 392,784
Time deposits 640,746 640,369 534,350 534,149
FHLB advances 144,669 148,836 163,964 169,970
Junior subordinated debentures 77,322 73,724 72,167 68,392
Securities sold under agreements to repurchase - customer 59,641 59,641 55,934 55,934
Securities sold under agreements to repurchase -FHLB 50,000 50,000 - -
Cash and cash equivalents - For cash and cash equivalents, the carrying amount
is a reasonable estimate of fair value.
Investment securities - For investment securities, fair values are based on
quoted market prices.
Loans receivable - The fair value was estimated by discounting approximate cash
flows of the portfolio to achieve a current market yield.
Restricted equity securities - Ownership in equity securities of bankers' bank
is restricted and there is no established market for their resale. The carrying
amount is a reasonable estimate of fair value.
Demand deposits, savings deposits and certificates of deposit - The fair value
of demand deposits and savings deposits is the amount payable on demand at the
reporting date. The fair value of certificates of deposit is estimated using
rates currently offered for deposits of similar remaining maturities.
Securities sold under agreements to repurchase - customer and FHLB - The fair
value is estimated to be the amount payable at the reporting date.
Junior subordinated debentures and FHLB advances - The fair value was estimated
by discounting approximate cash flows of the borrowings to achieve a current
market yield.
Commitments to extend credit and letters of credit - The majority of the Bank's
commitments to extend credit and letters of credit carry current market interest
rates if converted to loans. Because commitments to extend credit and letters of
credit are generally not assignable by either the Bank or the borrowers, they
only have value to the Bank and the borrowers.
61
No adjustment was made to the entry-value interest rates for changes in credit
performing commercial loans and real estate loans for which there are no known
credit concerns. Management segregates loans in appropriate risk categories.
Management believes that the risk factor embedded in the entry-value interest
rates along with the general reserves applicable to the performing commercial
and real estate loan portfolios for which there are no known credit concerns
result in a fair valuation of such loans on an entry-value basis.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2004 and 2003. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these consolidated financial statements since December 31, 2004 and 2003, and
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
26. INTEREST RATE RISK
The Company's exposure to interest rate risk results from the difference in
maturities and repricing characteristics of the interest-bearing liabilities and
interest-earning assets and the volatility of interest rates. At December 31,
2004, the Company was asset sensitive, that is the Company's assets had shorter
maturity or repricing terms than its liabilities. Generally, an asset sensitive
position will benefit the Company's earnings during periods of rising rates and
will tend to negatively impact earnings during periods of declining interest
rates. Conversely, a liability sensitive position would benefit the Company
during periods of declining rates and negatively impact earnings in a period of
increasing interest rates. Management monitors the relationship between the
interest rate sensitivity of the Company's assets and liabilities.
27. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
The condensed financial statements of Sun Bancorp, Inc. are as follows:
Condensed Statements of Financial Condition
December 31,
------------------------
2004 2003
---- ----
Assets
Cash $ 9,544 $ 15,860
Investments in subsidiaries:
Bank subsidiary 337,358 233,021
Non-bank subsidiaries 2,322 2,167
Accrued interest and other assets 8,983 7,820
-------- --------
Total $358,207 $258,868
======== ========
Liabilities and Shareholders' Equity
Junior subordinated debentures $ 77,322 $ 72,167
Other liabilities 1,665 983
-------- --------
Total liabilities 78,987 73,150
Shareholders' equity 279,220 185,718
-------- --------
Total $358,207 $258,868
======== ========
62
Condensed Statements of Income
For the Years ended December 31,
--------------------------------
2004 2003 2002
---- ---- ----
Net interest expense $ (3,614) $ (4,227) $ (4,633)
Management fee 4,097 2,602 2,279
Other expenses (3,927) (2,613) (2,133)
-------- -------- --------
Loss before equity in undistributed income of subsidiaries
and income tax benefit
(3,444) (4,239) (4,487)
Equity in undistributed income of subsidiaries 19,892 16,427 13,520
Income tax benefit (1,181) (1,148) (1,345)
-------- -------- --------
Net income $ 17,629 $ 13,336 $ 10,378
======== ======== ========
Condensed Statements of Cash Flows
For the Years ended December 31,
---------------------------------------
2004 2003 2002
---- ---- ----
Operating activities:
Net income $ 17,629 $ 13,336 $ 10,378
Adjustments to reconcile net income to
net cash used in operating activities -
Undistributed income of subsidiaries (19,892) (16,427) (13,520)
Changes in assets and liabilities which (used) provided cash:
Accrued interest and other assets (1,163) (2,596) (2,702)
Accounts payable and accrued expenses 680 119 307
-------- -------- --------
Net cash used in operating activities (2,746) (5,568) (5,537)
-------- -------- --------
Investing activities -
Cash proceeds from bank acquisition 4,134 - -
Dividends from subsidiary 3,454 4,189 8,015
Capital contribution to banking subsidiary (12,007) (31,000) -
-------- -------- --------
Net cash (used in) provided by investing activities (4,419) (26,811) 8,015
-------- -------- --------
Financing activities:
Proceeds from other borrowings - - 25,000
Repayment of other borrowings - - (25,000)
Proceeds from issuance of Trust Preferred Securities - 40,000 30,000
Redemption of Trust Preferred Securities - (29,274) (28,000)
Exercise of stock options 425 420 868
Proceeds from issuance of common stock 434 30,717 292
Repurchase of guaranteed preferred beneficial interest
in Company's subordinated debt - - (13)
Purchase of treasury stock - - (1,046)
Payments for fractional interests resulting from stock dividend (10) (6) (6)
-------- -------- --------
Net cash provided by financing activities 849 41,857 2,095
-------- -------- --------
(Decrease) increase in cash (6,316) 9,478 4,753
Cash, beginning of year 15,860 6,382 1,809
-------- -------- --------
Cash, end of year $ 9,544 $ 15,860 $ 6,382
======== ======== ========
63
28. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized quarterly data for each of the last two
years restated for stock dividends (amounts are in thousands, except per share
amounts). On December 31, 2003, the Company wrote off the unamortized debt
issuance costs of the called securities in the amount of $624,000, net of income
tax, through a charge to equity.
Three Months Ended
-----------------------------------------------------
December 31, September 30, June 30, March 31,
------------ ------------- -------- ---------
2004
Interest income $34,870 $32,985 $28,361 $28,053
Interest expense 10,043 9,041 7,818 8,049
------- ------- ------- -------
Net interest income 24,827 23,944 20,543 20,004
Provision for loan losses 415 300 735 625
Non-interest income 4,266 4,249 6,830 3,774
Non-interest expense 22,084 21,237 19,340 18,491
------- ------- ------- -------
Income before income taxes 6,594 6,656 7,298 4,662
Income taxes 1,908 2,164 2,268 1,241
------- ------- ------- -------
Net income $ 4,686 $ 4,492 $ 5,030 $ 3,421
======= ======= ======= =======
Basic earnings per share $ 0.27 $ 0.27 $ 0.36 $ 0.25
======= ======= ======= =======
Diluted earnings per share $ 0.25 $ 0.25 $ 0.33 $ 0.23
======= ======= ======= =======
2003
Interest income $26,505 $26,383 $27,485 $27,689
Interest expense 7,886 8,097 9,828 9,964
------- ------- ------- -------
Net interest income 18,619 18,286 17,657 17,725
Provision for loan losses 1,165 2,275 710 675
Non-interest income 4,010 5,487 3,868 3,991
Non-interest expense 17,459 16,659 16,394 15,524
------- ------- ------- -------
Income before income taxes 4,005 4,839 4,421 5,517
Income taxes 871 1,522 1,294 1,759
------- ------- ------- -------
Net income, as reported 3,134 3,317 3,127 3,758
Less: Trust Preferred issuance costs write-off 624 - - -
------- ------- ------- -------
Net income available to common shareholders $ 2,510 $ 3,317 $ 3,127 $ 3,758
======= ======= ======= =======
Basic earnings per share $ 0.20 $ 0.27 $ 0.24 $ 0.30
======= ======= ======= =======
Diluted earnings per share $ 0.18 $ 0.25 $ 0.25 $ 0.29
======= ======= ======= =======
Basic and diluted earnings per share are computed independently for each of the
quarters presented. Consequently, the sum of the quarters may not equal the
annual earnings per share.
******
64
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
Shares of the Company's common stock are quoted on the Nasdaq National Market
under the symbol "SNBC". The following table sets forth the high and low closing
sale prices (adjusted for stock dividends) for the common stock for the calendar
quarters indicated, as published by the Nasdaq Stock Market. The prices reflect
inter-dealer prices, with retail markup, markdown, or commission, and may not
represent actual transactions.
High Low
---- ---
2004
Fourth Quarter $25.15 $21.94
Third Quarter $22.75 $19.63
Second Quarter $24.00 $19.00
First Quarter $26.00 $23.81
2003
Fourth Quarter $25.90 $20.53
Third Quarter $22.07 $18.26
Second Quarter $18.91 $12.61
First Quarter $13.88 $12.25
There were 564 holders of record of the Company's common stock as of March 10,
2005. This number does not reflect the number of persons or entities who held
stock in nominee or "street" name through various brokerage firms. At March 10,
2005, there were 17,127,889 shares of the Company's common stock outstanding.
The Company paid 5% stock dividends on April 20, 2004, April 21, 2003, and May
23, 2002. To date, the Company has not paid cash dividends on its common stock.
Future declarations of dividends by the Board of Directors would depend upon a
number of factors, including the Company's and the Bank's financial condition
and results of operations, investment opportunities available to the Company or
the Bank, capital requirements, regulatory limitations, tax considerations, the
amount of net proceeds retained by the Company and general economic conditions.
No assurances can be given, however, that any dividends will be paid or, if
payment is made, will continue to be paid.
The ability of the Company to pay cash dividends is dependent upon the ability
of the Bank to pay dividends to the Company. Because the Bank is a depository
institution insured by the Federal Deposit Insurance Corporation ("FDIC"), it
may not pay dividends or distribute capital assets if it is in default on any
assessment due the FDIC. In addition, the Office of the Comptroller of the
Currency regulations impose certain minimum capital requirements that affect the
amount of cash available for the payment of dividends by the Bank. Under Federal
Reserve policy, the Company is required to maintain adequate regulatory capital
and is expected to act as a source of financial strength to the Bank and to
commit resources to support the Bank in circumstances where it might not do so
absent such a policy. This policy could have the effect of reducing the amount
of cash dividends declarable by the Company.
Additional information: The Company's Annual report on Form 10-K (excluding
exhibits) for the fiscal year ended December 31, 2004 is available without
charge upon written request to Sun Bancorp, Inc. Shareholder Relations, 226
Landis Avenue, Vineland, NJ 08360.
65
CORPORATE DIRECTORY
SUN BANCORP, INC. and SUN NATIONAL BANK
DIRECTORS
Bernard A. Brown
Thomas A. Bracken
Ike Brown
Jeffrey S. Brown
Sidney R. Brown
Peter Galetto, Jr.
Douglas J. Heun, CPA
Charles P. Kaempffer, CPA
Anne E. Koons
Eli Kramer
Alfonse M. Mattia, CPA
Audrey S. Oswell
George A. Pruitt, Ph.D.
Anthony Russo, III
Edward H. Salmon, Ed.D.
Howard M. Schoor
John D. Wallace
SUN BANCORP, INC. SUN NATIONAL BANK
Executive Management Executive Management
Bernard A. Brown Thomas A. Bracken
Chairman of the Board President and CEO
Sidney R. Brown Dan A. Chila, CPA
Vice Chairman of the Board Executive Vice President, Cashier and CFO
Thomas A. Bracken A. Bruce Dansbury
President and CEO Executive Vice President
Dan A. Chila, CPA John P. Neary
Executive Vice President and CFO Executive Vice President
Louis J. Pellicori
Executive Vice President
Bart A. Speziali
Executive Vice President
Christopher Warren
Executive Vice President
Thomas J. Holt
Senior Vice President
Thomas J. Townsend
Senior Vice President
Sandy Wandelt
Senior Vice President
66