Selected Financial Data
At or for the Years Ended December 31,
------------------------------------------------------------------
2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share amounts)
Selected Balance Sheet Data:
Assets $3,107,889 $3,053,587 $2,599,487 $2,112,172 $1,929,425
Cash and investments 794,537 952,779 1,058,096 800,425 739,201
Loans receivable (net) 2,027,753 1,847,721 1,364,465 1,217,008 1,089,605
Deposits 2,471,648 2,430,363 2,111,125 1,690,462 1,572,338
Borrowings and securities sold
under agreements to repurchase 243,567 254,310 222,398 205,280 160,096
Junior subordinated debentures (1) 77,322 77,322 72,167 - -
Guaranteed preferred beneficial interest in
Company's subordinated debt (1) - - - 59,274 57,327
Shareholders' equity 295,653 279,220 185,718 145,623 129,960
Selected Results of Operations:
Interest income $ 153,229 $ 124,269 $ 108,062 $ 112,894 $ 126,825
Net interest income 97,515 89,318 72,287 65,038 56,758
Provision for loan losses 2,310 2,075 4,825 4,175 7,795
Net interest income after
provision for loan losses 95,205 87,243 67,462 60,863 48,963
Non-interest income 18,291 19,119 17,356 13,178 10,516
Non-interest expense 84,663 81,152 66,036 58,965 57,695
Net income 19,521 17,629 13,336 10,378 1,328
Per Share Data:
Earnings Per Share
Basic $ 1.08 $ 1.08 $ 0.98 $ 0.74 $ 0.11
Diluted $ 1.01 $ 1.01 $ 0.91 $ 0.72 $ 0.10
Book Value $ 16.27 $ 15.53 $ 12.67 $ 11.24 $ 10.13
Selected Ratios:
Return on average assets 0.63% 0.63% 0.59% 0.50% 0.07%
Return on average equity 6.76% 7.80% 8.71% 7.63% 1.05%
Ratio of equity to assets 9.51% 9.15% 6.79% 6.55% 6.42%
(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, 2005, the Company had total assets
of $3.1 billion, total deposits of $2.5 billion and total shareholders' equity
of $295.7 million. 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.
In January 2006, the Company completed the acquisition of Advantage Bank, which
solidified our network in two key strategic counties in New Jersey, Hunterdon
and Somerset and added five new branches with approximately $149 million of
deposits.
Through the Bank, the Company provides consumer and business banking services
through its four geographic market banking groups and 80 community banking
centers located in 13 counties in Southern and Central New Jersey, in the
contiguous New Castle County market in Delaware, and in Philadelphia,
Pennsylvania.
Each Market Banking Group is staffed with local management personnel who all
have extensive local knowledge and strong ties to the communities they serve.
The organizational structure of each Market Banking Group is comprised of three
functional business lines -- commercial, small business and community banking --
that are empowered with localized decision-making authority to be more
responsive to customer needs and to reduce turnaround time.
The Bank offers a comprehensive array of lending, depository and financial
services to its business and individual customers throughout the marketplace.
The Bank's lending services to businesses include commercial and commercial real
estate loans, Small Business Administration ("SBA") guaranteed loans and small
business loans. The Bank has Preferred Lender status with the SBA, offers
equipment leasing and is a designated Preferred Lender with the New Jersey
Economic Development Authority. 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 remote
deposit and controlled disbursement services.
The Bank's lending services to retail customers include home equity loans,
residential mortgage loans, and other basic types of consumer loans. The Bank's
retail deposit services include checking accounts, savings accounts, money
market deposit accounts, 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.
2
The Bank funds its lending activities primarily through retail deposits, the
scheduled maturities of its investment portfolio, repurchase agreements with
customers and advances from the Federal Home Loan Bank.
As a financial institution with a primary focus on traditional banking
activities, the Company generates the majority of its revenue through net
interest income, which is defined as the difference between interest income
earned on loans and investments and interest paid on deposits and borrowings.
Growth in net interest income is dependent upon our ability to prudently manage
the balance sheet for growth, combined with how successfully we are able to
maintain or increase net interest margin, which is net interest income as a
percentage of average interest-earning assets.
The Company also generates revenue through fees earned on the various services
and products offered to its customers and through sales of assets, such as loans
or investments. Offsetting these revenue sources are provisions for credit
losses on loans, administrative expenses and income taxes.
The Company's net income for 2005 was a record $19.5 million, or $1.01 per
share, compared to $17.6 million, or $1.01 per share in 2004. The prior year net
income was favorably impacted by one-time net income of $844,000 ($.05 per
share) from facilities sold under the Company's now completed branch
rationalization program. Net interest income (on a tax-equivalent basis)
increased $7.9 million, or 8.7% mainly due to the Bank's continued growth in its
core lending business which contributed to overall average interest earning
asset growth of 11.5%. This growth in interest earning assets offset margin
compression resulting from increasing short-term interest rates and the
sustained low levels of longer term rates and the resultant flattening yield
curve. Non-interest income decreased 4.3% over 2004. Non-interest income,
excluding securities gains and gain on sale of branch real estate, increased
14.5% over 2004. Several key business initiatives instituted in 2005, SBA loan
sales and income from commercial loan derivative products were the drivers of
this increase. Non-interest expenses increased year over year by 4.3% primarily
reflecting a full year of expenses from the July 2004 acquisition of Community
Bank of New Jersey ("Community"). Income tax expense in 2005 increased $1.7
million in part due to increased pre-tax income and an increase in the effective
tax rate from 30.1% to 32.3% attributable to a decrease in non-taxable
investment securities.
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.
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 at least quarterly 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
3
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 fluctuates, 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.
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
4
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. This Statement will be
effective for financial statements as of the beginning of the first fiscal year
that begins after June 15, 2005. As the Company previously adopted the
prospective method for fair value recognition of SFAS No. 123 for all options
granted after January 1, 2003, options granted prior to January 1, 2003 continue
to be accounted for under APB No. 25, and related interpretations. Upon adoption
of SFAS No. 123R, the Company will be required to recognize through earnings,
the fair value of the remaining unvested portion of options granted prior to
January 1, 2003. For fiscal year 2006, the Company expects to recognize
approximately $173,000 of pre- tax expense relating to these options previously
accounted for under the provisions of APB No. 25.
In June 2005, the FASB has issued Statement No. 154, "Accounting Changes and
Error Corrections", a replacement of APB Opinion No. 20 and FASB Statement No.
3. The Statement applies to all voluntary changes in accounting principle, and
changes the requirements for accounting for and reporting of a change in
accounting principle. Statement 154 requires retrospective application to prior
periods' financial statements of a voluntary change in accounting principle
unless it is impracticable. APB Opinion 20 previously required that most
voluntary changes in accounting principle be recognized by including in net
income of the period of the change the cumulative effect of changing to the new
accounting principle. Statement 154 improves financial reporting because its
requirements enhance the consistency of financial information between periods.
Statement 154 is effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005. The impact of this new
pronouncement will depend on the Company changing an accounting principle and
will be evaluated at that time.
In November 2005, the FASB issued FASB Staff Position (FSP) 115-1/124-1, "The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments". This FSP provides additional guidance on when an investment in a
debt or equity security should be considered impaired and when that impairment
should be considered other-than-temporary and recognized as a loss in earnings.
Specifically, the guidance clarifies that an investor should recognize an
impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell has not been made. The FSP also
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. The Company applied the guidance
in this FSP in 2005 and there was no material affect to the results of
operations or the statement of financial position.
On December 19, 2005, the FASB issued FSP 94-6-1, "Terms of Loan Products That
May Give Rise to a Concentration of Credit Risk". FSP 94-6-1 addresses whether,
under existing guidance, non-traditional loan products represent a concentration
of credit risk and what disclosures are required for entities that originate,
hold, guarantee, service, or invest in loan products whose terms may give rise
to a concentration of credit risk. Non-traditional loan products expose the
originator, holder, investor, guarantor, or servicer to higher credit risk than
traditional loan products. Typical features of non-traditional loan products may
include high loan-to-value ratios and interest or principal repayments that are
less than the repayments for fully amortizing loans of an equivalent term. FSP
94-6-1 was effective upon its issuance and it did not have a material impact on
the Company's financial position or disclosures.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments. This statement amends FASB Statements No. 133, Accounting
for Derivative Instruments and Hedging Activities, and No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
This statement resolves issues addressed in Statement 133 Implementation Issue
No. D1, Application of Statement 133 to Beneficial Interest in Securitized
Financial Assets. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. The Company is still continuing to evaluate the
impact of this pronouncement and does not expect that the guidance will have a
material effect on the Company's financial position or results of operations.
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 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.
5
2005 vs. 2004
Overview. Net income for the year ended December 31, 2005 was $19.5 million, or
$1.01 per share, in comparison to $17.6 million, or $1.01 per share for the year
ended December 31, 2004. In 2004, the Company realized a $2.4 million pre-tax
gain from the sale of branch real estate. This was recorded in non-interest
income. As more fully described below, the 10.8% increase in net income for 2005
was attributable primarily to an increase in net interest income of $8.2
million, offset by an increase in the provision for loan losses of $235,000, a
decrease in non-interest income of $828,000, an increase in non-interest
expenses of $3.5 million, and an increase in income taxes of $1.7 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.
6
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,
------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
Avg. Avg.
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ----
Loans receivable (1), (2):
Commercial and industrial $1,659,713 $106,915 6.44 % $1,352,307 $82,871 6.13 %
Home equity 134,375 7,617 5.67 102,661 4,075 3.97
Second mortgage 47,670 2,979 6.25 50,352 3,193 6.34
Residential real estate 27,572 2,215 8.03 30,730 2,225 7.24
Other 72,938 5,430 7.44 57,447 4,253 7.40
---------- -------- ---------- -------
Total loans receivable 1,942,268 125,156 6.44 1,593,497 96,617 6.06
Investment securities (3) 824,755 27,412 3.32 881,547 28,134 3.19
Interest-bearing deposit with banks 6,833 195 2.85 13,737 134 0.98
Federal funds sold 34,888 1,172 3.36 29,675 385 1.30
---------- -------- ---------- -------
Total interest-earning assets 2,808,744 153,935 5.48 2,518,456 125,270 4.97
Non-interest-earning assets:
Cash and due from banks 79,713 77,050
Bank properties and equipment 37,171 35,828
Goodwill and intangible assets 136,552 100,981
Other assets, net 53,091 62,638
---------- ----------
Total non-interest-earning assets 306,527 276,497
---------- ----------
Total assets $3,115,271 $2,794,953
========== ==========
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 874,577 16,099 1.84 % $ 792,470 7,200 0.91 %
Savings deposits 423,747 4,986 1.18 429,077 3,440 0.80
Time deposits 684,892 20,342 2.97 562,265 13,421 2.39
---------- -------- ---------- -------
Total interest-bearing deposits 1,983,216 41,427 2.09 1,783,812 24,061 1.35
---------- -------- ---------- -------
Borrowed money, short-term:
Federal funds purchased 3,619 118 3.26 3,990 70 1.75
Repurchase agreements with customers 76,894 2,008 2.61 63,727 471 0.74
Borrowed money, long-term:
FHLB advances 167,830 6,996 4.17 159,466 6,734 4.22
Debentures 77,534 5,165 6.66 74,646 3,615 4.84
---------- -------- ---------- -------
Total interest-bearing liabilities 2,309,093 55,714 2.41 2,085,641 34,951 1.68
---------- -------- ---------- -------
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits 503,197 460,990
Other liabilities 14,134 22,390
---------- ----------
Non-interest-bearing liabilities 517,331 483,380
---------- ----------
Total liabilities 2,826,424 2,569,021
---------- ----------
Shareholders' equity 288,847 225,932
---------- ----------
Total liabilities and shareholders'
equity $3,115,271 $2,794,953
========== ==========
Net interest income $98,221 $90,319
======= =======
Interest rate spread (4) 3.07 % 3.29 %
====== ======
Net interest margin (5) 3.50 % 3.59 %
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 121.64 % 120.75 %
====== ======
- ---------------------------
(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.
7
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,
2005 vs. 2004
--------------------------------
Increase (Decrease)
Due to
--------------------------------
Volume Rate Net
-------- -------- --------
Interest income:
Loans receivable:
Commercial and industrial $ 19,625 $ 4,419 $ 24,044
Home equity 1,485 2,057 3,542
Second mortgage (168) (46) (214)
Residential real estate (241) 231 (10)
Other 1,154 23 1,177
-------- -------- --------
Total loans receivable 21,855 6,684 28,539
Investment securities (1,859) 1,137 (722)
Interest-bearing deposit with banks (94) 155 61
Federal funds sold 78 709 787
-------- -------- --------
Total interest-earning assets $ 19,980 $ 8,685 $ 28,665
-------- -------- --------
Interest expense:
Deposit accounts:
Demand deposits $ 816 $ 8,083 $ 8,899
Savings deposits (43) 1,589 1,546
Time deposits 3,265 3,656 6,921
-------- -------- --------
Total deposits accounts 4,038 13,328 17,366
Borrowings:
Federal funds purchased (7) 55 48
Repurchase agreements with customers 116 1,421 1,537
FHLB advances 349 (87) 262
Debentures 145 1,405 1,550
-------- -------- --------
Total borrowed money 603 2,794 3,397
Total interest-bearing liabilities $ 4,641 $ 16,122 $ 20,763
-------- -------- --------
Net change in interest income $ 15,339 $ (7,437) $ 7,902
======== ======== ========
From June 2004 to December 31, 2005, the Federal Reserve Board increased
overnight interest rates by 325 basis points to 4.25%. In contrast, long-term
interest rates have not increased by the same amount. This has resulted in a
general flattening of the interest rate yield curve during 2005. Since our
balance sheet is asset sensitive, our interest-earning assets generally reprice
more quickly than our interest-bearing liabilities. However, in the current
interest rate environment, the benefit of the Company's asset-sensitive position
has been impacted.
While we expect to benefit from additional increases in short-term interest
rates, the continued flattening and any inversion of the yield curve and
competition for both loans and deposits remain a challenge for the coming year.
In 2006, we expect our net interest margin on average to improve modestly over
the average 2005 margin, with an expected compression in the first quarter and
sequential improvements thereafter that will be influenced by loan growth,
intense competition for core funding and the sizing and timing of future
increases in interest rates.
Net interest income (on a tax-equivalent basis) increased $7.9 million or 8.7%
to $98.2 million for 2005 compared to $90.3 million for 2004. The Company's net
interest margin decreased in 2005 to 3.50% compared to 3.59% in 2004.
Through the acquisition of Community in 2004 and the Bank's continued growth in
its core lending business, average interest-earning assets increased $290.3
million or 11.5%. This significant growth in average interest-earning assets
resulted in an increase in interest income of $20.0 million. Interest income
increased an additional $8.7 million in 2005 from an increase in overall yield
on interest-earning assets of 51 basis points to 5.48% for 2005 compared to
4.97% for
8
2004. This increase is due to the impact of rising rates on the variable rate
loans, new loans and repricing on resetting loans.
Average total interest-bearing liabilities increased $223.5 million or 10.7%.
Interest-bearing deposits increased $199.4 million or 11.2%.
Non-interest-bearing deposits increased $42.2 million or 9.2%. The increase in
average deposits is partially attributable to approximately $342 million in
deposits acquired in the Community acquisition in July 2004 and a successful
deposit gathering campaign in May 2005. The campaign was designed to create new
relationships and strengthen existing relationships. As a result of this
campaign, the Bank generated approximately $200 million in deposits with over
50% coming from new customers.
This increase in average deposits increased interest expense by $4.0 million in
2005 over 2004. More significantly, the average cost of interest bearing
deposits increased 74 basis points to 2.09% for 2005 compared to 1.35% for 2004,
or an increase in interest expense of $13.3 million. This increase in the cost
of deposits reflects the increasing short-term interest rates and the intense
competitive environment for retaining and attracting deposits. Over the past two
years, the Company has supplemented its funding needs with the liquidity of the
investment portfolio and has not had to price aggressively for deposits.
Although the investment portfolio run off strategy continues into 2006, with the
competitive deposit pricing in our market, the Company will be required to price
deposits more aggressively for both deposit retention and deposit acquisition.
Provision for Loan Losses. The Company recorded a provision for loan losses of
$2.3 million in 2005, an increase of $235,000 compared to a provision of $2.1
million for 2004. The ratio of allowance for loan losses to total loans was
1.10% at December 31, 2005 compared to 1.18% at December 31, 2004. The decrease
in the 2005 ratio reflects the improved credit quality trends within the
Company's classified loan portfolio and a decrease in the Company's
non-performing loans which decreased 29.4% to $10.1 million at December 31, 2005
from $14.3 million at December 31, 2004.
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 decreased $828,000, or 4.3% for the
year ended December 31, 2005 compared to the year ended December 31, 2004. The
decrease was in part the result of a $2.4 million decrease in gain on sale of
branch real estate, and a $634,000 decrease in gain on sale of investment
securities. Partially offsetting these decreases was a combined year over year
increase of $2.2 million resulting from two of the Company's 2005 strategic
initiatives. These initiatives, sale of SBA loans and customer derivative income
produced increases of $700,000 and $1.5 million, respectively.
Management anticipates that the Company's SBA loan sales, customer derivatives,
and its third party arrangement which allows the Bank to offer mutual funds,
securities brokerage, annuities and investment advisory services, will continue
to increase our non-interest income in 2006. During the first quarter of 2006,
the Company organized a wholly-owned subsidiary of the Bank, Sun Home Loans,
Inc. ("Sun Home Loans"). Sun Home Loans will originate residential mortgages
through dedicated loan originators utilizing our existing branch network as well
as generating business through non-customers. These loans will be originated
using the Company's underwriting standards, rates and terms, and will be
approved according to the Company's lending policy prior to origination. Prior
to closing, the Company generally will have commitments to sell these loans with
servicing released, and without recourse, in the secondary market. Secondary
market sales are generally scheduled to close shortly after origination.
Non-Interest Expenses. Non-interest expenses increased approximately $3.5
million, or 4.3% to $84.7 million for the year ended December 31, 2005 as
compared to $81.2 million for 2004. Salaries and employee benefits increased
$2.5 million primarily due to a year over year increase of $1.7 million which
reflects a full year of salary expenses relating to the July 2004 Community
acquisition. The remaining $800,000 increase in salary expense was due to
increased staffing and annual merit increases. Occupancy expense increased
$772,000 of which, $967,000 was related to a full year of expenses related to
the branches purchased in Community acquisition offset by a decreased expenses
from branches sold or
9
closed during 2004 as part of the Company's branch rationalization program.
Equipment expense increased $671,000 of which $374,000 was related to a full
year of expenses related to the Community acquisition. Offsetting these
increases, amortization of intangibles decreased $769,000. During 2004,
amortization of intangible assets associated with several branches acquired in
prior years offset by a full year of amortization relating to the acquisition of
Community in July 2004.
Income Tax Expense. Income taxes increased $1.7 million from $7.6 million for
the year ended December 31, 2004 to $9.3 million for the year ended December 31,
2005. The increase was due to a larger 2005 pretax income and an increase in the
effective tax rate from 30.1% to 32.3%. The increase in the effective tax rate
was primarily due to decreased interest income from non-taxable investment
securities.
2004 vs. 2003
Overview. Net income for the year ended December 31, 2004 was $17.6 million, or
$1.01 earnings per share, in comparison to $13.3 million, or $0.91 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.
10
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 7.40 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 0.98 8,464 57 0.67
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 1.75 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 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.
11
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,
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 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 25.8%. 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.
12
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.
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 was 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.
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 was 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.
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.
13
LIQUIDITY AND CAPITAL RESOURCES
The liquidity of the Company is the ability to meet loan demand, 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 engages in liquidity
planning and management.
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, 2006 total $420.6 million. The Company has
implemented a core deposit relationship strategy that places less reliance on
certificates of deposits as a funding source. The Company will continue to price
certificates of deposit for retention as well as provide fixed rate funding in
the expected rising rate environment. However, based on market conditions and
other liquidity considerations, it may also avail itself of the secondary
borrowings discussed above.
Net loans grew approximately $180 million or 9.7% during 2005. The Company
expects to achieve similar loan growth during 2006 and 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 these funding needs. In addition to
cash and cash equivalents of $85.5 million at December 31, 2005, 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 $403.3 million. In addition, the FHLB provides a reliable source of funds
with a wide variety of terms and structures. As of December 31, 2005, the
Company had total credit availability with the FHLB of $240.7 million, of which
$192.7 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, 2005, the Company had approximately $25.5 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 2005, the Company secured a $5.0 million line of
credit with another financial institution. At December 31, 2005, the line had
not been utilized and the full $5.0 million remains available. In January 2006,
the Company issued an additional $30.0 million of Trust Preferred Securities
bringing the total outstanding Trust Preferred Securities of the Company to
$105.0 million. Of the $30.0 million, approximately $17 million was used to fund
the purchase of Advantage with the remaining $13 million being used for general
corporate purposes. The following table sets forth the regulatory capital levels
at December 31, 2005 for the Company and the Bank.
14
To Be Well-Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
At December 31, 2005 Actual Purposes Provisions
-------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $266,379 11.11% $191,814 8.00% N/A
Sun National Bank $251,410 10.50% $191,499 8.00% $239,374 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $243,196 10.14% $95,907 4.00% N/A
Sun National Bank $228,227 9.53% $95,750 4.00% $143,624 6.00%
Leverage Ratio:
Sun Bancorp, Inc. $243,196 8.20% $118,702 4.00% N/A
Sun National Bank $228,227 7.70% $118,528 4.00% $148,160 5.00%
As part of its capital plan, the Company maintained trust preferred securities
of $75.0 million at December 31, 2005 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
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 2005, 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, 2005, 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 $226.9 million, representing a positive one-year
gap ratio of 7.31%.
15
The following table sets forth the maturity and repricing characteristics of the
Company's interest-earning assets and interest-bearing liabilities at December
31, 2005. 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 $ 894,326 $ 236,441 $ 816,475 $ 102,974 $2,050,216
FHLB interest-bearing deposit 2,707 - - - 2,707
Investment securities 125,283 278,052 310,897 26,277 740,509
Federal funds sold 8,368 - - - 8,368
---------- --------- ---------- --------- ----------
Total interest-earning assets 1,030,684 514,493 1,127,372 129,251 2,801,800
---------- --------- ---------- --------- ----------
Interest-bearing demand deposits 371,848 138,459 138,916 237,550 886,773
Savings deposits 47,849 122,142 180,911 35,919 386,821
Time certificates 169,638 250,986 239,204 8,348 668,176
Federal Home Loan Bank advances 5,165 15,822 99,561 3,998 124,546
Securities sold under agreements to repurchase 119,021 - - - 119,021
Trust preferred securities 56,703 20,619 - - 77,322
---------- --------- ---------- --------- ----------
Total interest-bearing liabilities 770,224 548,028 658,592 285,815 2,262,659
---------- --------- ---------- --------- ----------
Periodic Gap $ 260,460 $ (33,535) $ 468,780 $(156,564) $ 539,141
========== ========= ========== ========= ==========
Cumulative Gap $ 260,460 $ 226,925 $ 695,705 $ 539,141
========== ========= ========== =========
Cumulative Gap Ratio 8.40% 7.31% 22.42% 17.38%
===== ===== ====== ======
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 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. While we expect to benefit from
additional raises in short-term interest rates in 2006, the continual flattening
and any inversion of the yield curve will result in further margin compression.
The following table shows the Company's estimated earnings sensitivity profile
versus the most likely rate forecast as of December 31, 2005.
Change in Interest Rates Percentage Change in Net Interest Income
- ------------------------------ --------------------------------------------
(Basis Points) Year 1
-------------- ------
+200 +0.2%
+100 +0.1%
-100 +0.1%
-200 0.0%
16
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, 2005, 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 a non-affiliated third party.
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
During 2005 and 2004, Company entered into several commercial loan interest rate
swaps in order to provide commercial loan clients the ability to swap from
variable to fixed interest rates. Under these agreements, the Company enters
into a variable rate loan agreement with a client in addition to a swap
agreement. This swap agreement effectively swaps the client's variable rate loan
into a fixed rate loan. The Company then enters into a corresponding swap
agreement with a third party in order to swap its exposure on the variable to
fixed rate swap on the commercial loan. As the interest rate swaps with the
clients and third parties are not designated as hedges under FAS No. 133, the
instruments are marked to market in earnings. As the interest rate swaps are
structured to offset each other, changes in market values will have no earnings
impact.
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.
Disclosures about Contractual Obligations and Commercial Commitments
The Company's contractual cash obligations at December 31, 2005 were as follows:
Payments Due by Period
------------------------------------------------------------------
Total 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) $366,379 $31,905 $93,363 $35,705 $205,406
Leases (Note 20) 43,488 4,425 8,503 6,448 24,112
Purchase Obligations (off balance sheet) 4,877 2,290 2,538 49 -
-------- ------- -------- ------- --------
Total Contractual Cash Obligations $414,744 $38,620 $104,404 $42,202 $229,518
======== ======= ======== ======= ========
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
17
have greater than one year remaining at December 31, 2005. 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, 2005
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 $560,895 $321,608 $ 77,849 $5,290 $156,148
Commercial Standby Letters of Credit 67,762 57,167 10,545 50 -
Construction Funding 101,838 67,676 31,066 3,096 -
Other Commitments 144,911 138,449 2,050 499 3,913
-------- -------- -------- ------- --------
Total Commitments $875,406 $584,900 $121,510 $ 8,935 $160,061
======== ======== ======== ======= ========
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, 2005 was $67.8 million,
and the portion of the exposure not covered by collateral was approximately
$17.2 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 $54.3 million, or 1.8% from $3.05 billion at
December 31, 2004 to $3.11 billion at December 31, 2005. As part of the
Company's on-going balance sheet management strategy, investment securities
declined $153.4 million or 17.8% to $709.1 million and supplemented the funding
of the Company's $180.0 million increase in net loans. Net loans at December 31,
2005 were $2.03 billion, up 9.7% over the prior year. Deposits increased $41.3
million or 1.7% to $2.47 billion and total borrowings excluding junior
subordinated debentures decreased $10.7 million or 4.2% to $243.6 million.
Loans. Loans receivable increased $180.0 million, or 9.7%, at December 31, 2005.
This growth was primarily due to increases in commercial loans of $128.3 million
or 8.0%, home equity loans of $32.8 million or 26.7%, and other loans of $11.9
million or 17.9%. The increase in commercial loans reflects the organic growth
developed through loan origination and credit professionals which has grown over
the past several years. Competition for loans was intense in 2005 across all
products and markets and is expected to continue into 2006. Despite the
competitiveness of loan pricing and terms and conditions, the Company will not
compromise underwriting credit standards in order to generate higher volume.
This increase in commercial loans is net of approximately $120 million in
unscheduled prepayments. Home equity loans increased due to the Company's
continued aggressive marketing of this product during 2005. The increase in
other loans is primarily attributable to the continuing marketing campaign
around the Company's Sun Express Small Business Line of Credit which resulted in
an $11.8 million increase over the prior year.
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, 2005, no concentration of loans
exceeded 10% of total loans outstanding. At December 31, 2004, loans
concentrated in the hotel business amounted to 10.0% of total loans outstanding.
In 2005, the Company utilized a third-party loan correspondent to originate
residential mortgages that were subsequently sold into the secondary market.
During the first quarter of 2006, the Company organized Sun Home Loans. Sun Home
Loans will originate residential mortgages through dedicated loan originators
utilizing our existing branch network as well as generating business through
non-customers. These loans will be originated using the Company's underwriting
standards, rates and terms, and will be approved according to the Company's
lending policy prior to origination. Prior to closing, the Company generally
will have commitments to sell these loans with servicing released, and without
recourse, in the secondary market. Secondary market sales are generally
scheduled to close shortly after origination.
19
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,
-------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------- -------------------- -------------------- ------------------- --------------------
Amount % Amount % Amount % Amount % Amount %
----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------
Type of Loan:
Commercial and industrial $ 1,732,202 85.42 $ 1,603,868 86.80 $ 1,169,164 85.69 $ 1,043,885 85.77 $ 911,145 83.62
Home equity 155,561 7.67 122,735 6.64 80,292 5.88 44,603 3.67 23,854 2.19
Second mortgage 53,881 2.66 50,541 2.74 51,531 3.78 47,458 3.90 49,047 4.50
Residential real estate 30,162 1.49 26,117 1.41 29,788 2.18 43,375 3.56 55,282 5.07
Other 78,410 3.87 66,497 3.60 51,304 3.76 54,095 4.45 63,609 5.84
Less: Loan loss allowance (22,463) (1.11) (22,037) (1.19) (17,614) (1.29) (16,408) (1.35) (13,332) (1.22)
----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------
Net loans $ 2,027,753 100.00 $ 1,847,721 100.00 $ 1,364,465 100.00 $ 1,217,008 100.00 $ 1,089,605 100.00
=========== ====== =========== ====== =========== ====== =========== ====== =========== ======
Type of Security:
Residential real estate:
1-4 family $ 291,602 14.38 $ 245,991 13.31 $ 185,364 13.58 $ 166,495 13.67 $ 146,157 13.41
Other 161,043 7.94 164,184 8.89 117,479 8.61 88,465 7.27 108,437 9.95
Commercial real estate 1,106,038 54.55 1,030,977 55.80 784,716 57.51 721,658 59.30 599,027 54.98
Commercial business loans 418,408 20.63 358,387 19.40 229,342 16.81 210,374 17.29 199,103 18.27
Consumer 38,492 1.90 36,831 1.99 33,642 2.47 36,333 2.99 36,640 3.36
Other 34,633 1.71 33,388 1.80 31,536 2.31 10,091 0.83 13,573 1.25
Less: Loan loss allowance (22,463) (1.11) (22,037) (1.19) (17,614) (1.29) (16,408) (1.35) (13,332) (1.22)
----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------
Net loans $ 2,027,753 100.00 $ 1,847,721 100.00 $ 1,364,465 100.00 $ 1,217,008 100.00 $ 1,089,605 100.00
=========== ====== =========== ====== =========== ====== =========== ====== =========== ======
The following table sets forth the estimated maturity of the Company's loan
portfolio at December 31, 2005. 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
------ ------- ------- --------- -----
Total
-----
Commercial and industrial $380,605 $701,787 $649,810 $(19,890) $1,712,312
Home equity 4,866 33 150,662 (1,006) 154,555
Second mortgage 516 19,570 33,795 (336) 53,545
Residential real estate 13,209 290 16,663 (258) 29,904
Other 13,184 35,267 29,959 (973) 77,437
-------- -------- -------- -------- ----------
Total $412,380 $756,947 $880,889 $(22,463) $2,027,753
======== ======== ======== ======== ==========
20
The following table sets forth the dollar amount of all loans due after December
31, 2006 which have pre-determined interest rates and which have floating or
adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Total
----- ----- -----
Commercial and industrial $687,484 $664,113 $1,351,597
Home equity 1,539 149,156 150,695
Second mortgage 53,365 - 53,365
Residential real estate 13,209 3,744 16,953
Other 34,560 30,666 65,226
-------- -------- ----------
Total $790,157 $847,679 $1,637,836
======== ======== ==========
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, 2005, there were eleven commercial loan
relationships aggregating $5.5 million for which payments are current, but where
the borrowers were experiencing financial difficulties. These loans were not
classified as non-accrual and were not considered non-performing. At December
31, 2005, these loans were current and well collateralized.
Non-Performing Assets. Total non-performing assets decreased $5.7 million from
$17.3 million at December 31, 2004 to $11.6 million at December 31, 2005. The
ratio of non-performing assets to net loans decreased to 0.57% at December 31,
2005 compared to 0.93% at December 31, 2004.
Management of the Company believes that all loans accruing interest are
adequately secured and in the process of collection.
21
Non-Performing Assets
At December 31,
---------------------------------------------------
2005 2004 2003 2002 2001
------- ------- ---------- ------- ------
Loans accounted for on a non-accrual basis:
Commercial and industrial $ 8,823 $12,263 $20,308 $ 8,879 $ 8,007
Home equity 220 208 46 14 201
Second mortgage 106 - - 100 130
Residential real estate 669 848 1,122 593 735
Other 139 138 92 377 50
------- ------- ------- ------- -------
Total $ 9,957 $13,457 $21,568 $ 9,963 $ 9,123
======= ======= ======= ======= =======
Accruing loans that are contractually past due 90 days or more:
Commercial and industrial $ 85 $ 292 $ 125 $ 1,837 $ 425
Home equity - - 47 30 42
Second mortgage - - - 122 190
Residential real estate 53 373 57 401 295
Other 30 221 19 115 146
------- ------- ------- ------- -------
Total $ 168 $ 886 $ 248 $ 2,505 $ 1,098
======= ======= ======= ======= =======
Total non-accrual and 90-day past due loans $10,125 $14,343 $21,816 $12,468 $10,221
Real estate owned 1,449 2,911 4,444 904 898
------- ------- ------- ------- -------
Total non-performing assets $11,574 $17,254 $26,260 $13,372 $11,119
======= ======= ======= ======= =======
Total non-accrual and 90-day past due loans to net loans 0.50% 0.78% 1.60% 1.02% 0.94%
Total non-accrual and 90-day past due loans to total assets 0.33% 0.47% 0.84% 0.59% 0.53%
Total non-performing assets to net loans 0.57% 0.93% 1.92% 1.10% 1.02%
Total non-performing assets to total assets 0.37% 0.57% 1.01% 0.63% 0.58%
Total allowance for loan losses to total non-performing loans 221.86% 153.64% 80.74% 131.60% 130.44%
Interest income that would have been recorded on the above non-accrual loans,
under the original terms of such loans, would have totaled $755,000 for the year
ended December 31, 2005.
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,
-------------------
2005 2004
---- ----
Commercial properties $1,066 $2,424
Residential properties 62 178
Bank properties 321 309
------ ------
Total $1,449 $2,911
====== ======
22
During the first quarter 2005, a commercial property with a December 31, 2004
carrying value of $1.4 million was sold. 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,
---------------------
2005 2004
---- ----
Balance, beginning of year $ 2,911 $ 4,444
Additions 321 1,594
Transfer to bank property (309) -
Sales (1,474) (3,127)
------- -------
Balance, end of year $ 1,449 $ 2,911
======= =======
Allowances for Losses on Loans. The Company's allowance for losses on loans
increased to $22.5 million or 1.10% of loans at December 31, 2005 compared to
$22.0 million or 1.18% at December 31, 2004. The decrease in the 2005 ratio
stems from improved credit quality trends within the Company's classified loan
portfolio and from a decrease in the Company's non-performing loans which
decreased 29.4% to $10.1 million at December 31, 2005 from $14.3 million at
December 31, 2004. Provision for loan losses was $2.3 million in 2005, $2.1
million in 2004 and $4.8 million in 2003. As a result of the July 2004 Community
acquisition, $2.9 million of additional allowance for loan losses was assumed.
The following table sets forth information with respect to the Company's
allowance for losses on loans at the dates indicated:
At December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
-------- -------- -------- -------- --------
Allowance for losses on loans, beginning of year $ 22,037 $ 17,614 $ 16,408 $ 13,332 $ 10,486
Charge-offs:
Commercial (1,928) (796) (4,010) (1,219) (4,748)
Construction Mortgage (27) - - - -
Mortgage - (84) (1) (20) (4)
Other (686) (502) (369) (371) (665)
-------- -------- -------- -------- --------
Total charge-offs (2,641) (1,382) (4,380) (1,610) (5,417)
-------- -------- -------- -------- --------
Recoveries:
Commercial 561 641 700 457 423
Construction Mortgage 84 - - - -
Mortgage 8 - - - -
Other 104 152 61 54 45
-------- -------- -------- -------- --------
Total recoveries 757 793 761 511 468
-------- -------- -------- -------- --------
Net charge-offs (1,884) (589) (3,619) (1,099) (4,949)
Purchased allowance resulting from bank acquisition - 2,937 - - -
Provision for loan losses 2,310 2,075 4,825 4,175 7,795
-------- -------- -------- -------- --------
Allowance for losses on loans, end of year $ 22,463 $ 22,037 $ 17,614 $ 16,408 $ 13,332
======== ======== ======== ======== ========
Net loans charged-off as a percent of average loans outstanding 0.10% 0.04% 0.28% 0.09% 0.47%
======== ======== ======== ======== ========
23
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,
--------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------------- ----------------- ----------------- ----------------- -----------------
Percent Percent Percent Percent Percent
of of of of of
Loans Loans Loans Loans Loans
to to to to 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 $19,890 88.54 % $19,990 90.71 % $15,885 90.19 % $14,806 90.24 % $11,457 85.94 %
Residential real estate 258 1.15 191 0.87 247 1.40 265 1.62 577 4.33
Home equity 1,006 4.48 739 3.35 483 2.74 263 1.60 268 2.01
Other 1,309 5.83 1,117 5.07 999 5.67 1,074 6.54 1,030 7.72
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total allowance $22,463 100.00 % $22,037 100.00 % $17,614 100.00 % $16,408 100.00 % $13,332 100.00 %
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
Investment Securities. A portion of the Company's investment portfolio is held
at the Bank's wholly-owned subsidiary, Med-Vine, Inc. ("Med-Vine). Investment
securities decreased $153.4 million or 17.8% from $862.5 million at December 31,
2004 to $709.1 million at December 31, 2005. During 2005, the Company continued
its strategy of redeploying maturing securities into its higher yielding loan
portfolio. The estimated average life of the investment portfolio at December
31, 2005 was 1.4 years with an estimated modified duration of 1.2 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,
-----------------------------------------------------------------------------------------------------
2005 2004 2003
---- ---- ----
Net Net
Net Estimated Unrealized Estimated Unrealized Estimated
Amortized Unrealized Fair Amortized Gains Fair Amortized Gains Fair
Cost Losses Value Cost (Losses) Value Cost (Losses) Value
---- ------ ----- ---- -------- ----- ---- -------- -----
U.S. Treasury obligations $ 59,237 $ (145) $ 59,092 $ 70,069 $ (308) $69,761 $ 70,252 $ (72) $70,180
U.S. Government agency and
mortgage-backed securities 596,823 (11,142) 585,681 662,023 (5,131) 656,892 810,453 356 810,809
State and municipal obligations 28,050 (156) 27,894 56,695 1,123 57,818 58,651 2,022 60,673
Other securities 3,963 - 3,963 35,109 (156) 34,953 21,521 245 21,766
-------- -------- -------- -------- ------- -------- -------- ------ --------
Total $688,073 $(11,443) $676,630 $823,896 $(4,472) $819,424 $960,877 $2,551 $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.
24
The amortized cost of investment securities held to maturity and the approximate
fair value were as follows:
December 31,
--------------------------------------------------------------------
2005 2004
---- ----
Net Estimated Net Estimated
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Losses Value Cost Losses Value
---- -------- ----- ---- -------- -----
U.S. Government agency and
mortgage-backed securities $32,445 $(711) $31,734 $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, 2005:
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 $ 48,963 $ (35) $ 10,129 $ (110) $ 59,092 $ (145)
U.S. Government agencies and
mortgage-backed securities 102,670 (1,003) 514,745 (10,850) 617,415 (11,853)
State and municipal obligations 15,975 (238) 3,381 (116) 19,356 (354)
-------- ------- -------- -------- -------- --------
Total $167,608 $(1,276) $528,255 $(11,076) $695,863 $(12,352)
======== ======= ======== ======== ======== ========
At December 31, 2005, 99.5% 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, 2005, the unrealized loss in the category 12 months or longer of
$11.1 million consisted of 79 securities having an aggregate unrealized loss of
2.0%. The securities represented U.S. Treasury, Federal Agency issues and nine
securities currently rated Aaa by at least one bond credit rating services. At
December 31, 2005, securities in a gross unrealized loss position for less than
twelve months consisted of 50 securities having an aggregate unrealized loss of
0.8% from the Bank's amortized cost basis. Management does not view these
unrealized losses as an other than temporary impairment.
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, 2005. 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 $59,092 3.79 % - - - - - - $59,092 3.79 %
U.S. Government agency and
mortgage-backed securities 278,071 3.07 $294,436 3.30 % $13,174 4.59 % - - 585,681 3.22
State and municipal obligations 10,671 3.12 15,587 3.73 - - $1,636 5.27 27,894 3.58 %
Other securities 1,865 3.27 2,098 4.18 - - - - 3,963 3.75
-------- -------- ------- ------ --------
Total $349,699 3.20 % $312,121 3.33 % $13,174 4.59 % $1,636 5.27 % $676,630 3.29 %
======== ======== ======= ====== ========
25
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 - - $31,344 4.01% $1,101 4.60% - - $32,445 4.03%
======= ======= ====== ======= =======
Bank Owned Life Insurance. During 2005, the Company purchased an additional $6.8
million of BOLI investments. The remaining increase of $1.6 million at December
31, 2005 represents an increase in the cash value of the BOLI, which was
recorded as other non-interest income in the consolidated statement of
operations.
Deposits. Deposits at December 31, 2005 totaled $2.47 billion, an increase of
$41.3 million, or 1.65% over the December 31, 2004 balance of $2.43 billion.
Over the past two years, the Company has supplemented its funding needs with the
liquidity of the investment portfolio, and has not had to price aggressively for
deposits. Although the investment portfolio run off strategy continues into
2006, with the competitive deposit pricing in our market, the Company will be
required to price deposits more aggressively for both deposit retention and
deposit acquisition.
December 31,
------------------------------------
2005 2004 2003
---------- ---------- ----------
Demand deposits $1,416,651 $1,336,891 $1,183,991
Savings deposits 386,821 452,726 392,784
Time deposits under $100,000 443,535 410,632 390,312
Time deposits $100,000 or more 224,641 230,114 144,038
---------- ---------- ----------
Total $2,471,648 $2,430,363 $2,111,125
========== ========== ==========
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 2005 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,
------------------------------------------------------------------------------
2005 2004 2003
---- ---- ----
Amount Percentage Amount Percentage Amount Percentage
------ ---------- ------ ---------- ------ ----------
Core deposits $1,803,472 73.0 % $1,789,617 73.6 % $1,576,775 74.7 %
Time deposits 668,176 27.0 640,746 26.4 534,350 25.3
---------- ------ ---------- ------ ---------- ------
Total deposits $2,471,648 100.00 % $2,430,363 100.00 % $2,111,125 100.00 %
========== ====== ========== ====== ========== ======
26
The following table indicates the amount of certificates of deposit of $100,000
or more by remaining maturity at December 31, 2005.
Three months or less $ 79,976
Over three through six months 40,385
Over six through twelve months 46,843
Over twelve months 57,437
--------
Total $224,641
========
Borrowings. Borrowed funds, excluding debentures held by trusts, decreased $10.7
million to $243.6 million at December 31, 2005, from $254.3 million at December
31, 2004. The decrease was primarily the result of a decrease of $20.1 million
in advances from the FHLB offset by a net increase of $10.0 million in
securities sold under agreements to repurchase with the FHLB.
For the years ended December 31, 2005 and 2004, the maximum month-end amount of
the following borrowings were:
December 31,
----------------------
2005 2004
---- ----
FHLB advances $143,024 $162,400
FHLB repurchase agreements $ 70,000 $ 50,000
FHLB overnight line of credit $ 50,000 -
Federal funds purchased $ 30,000 $ 1,000
Repurchase agreements with customers $ 87,651 $ 69,930
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,
----------------------------------
2005 2004 2003
---- ---- ----
FHLB convertible rate advances outstanding at end of year $25,000 $25,000 $25,000
Interest rate 6.49% 6.49% 6.49%
Approximate average amount outstanding $25,000 $25,000 $25,000
Approximate weighted average rate 6.49% 6.49% 6.49%
FHLB term amortizing advances outstanding at end of year $41,346 $61,469 $80,764
Interest rate 4.36% 4.58% 4.27%
Approximate average amount outstanding $50,771 $70,427 $87,890
Approximate weighted average rate 4.34% 4.31% 4.29%
FHLB term non-amortizing advances outstanding at end of year $58,200 $58,200 $58,200
Interest rate 3.87% 3.46% 3.40%
Approximate average amount outstanding $58,200 $58,200 $52,309
Approximate weighted average rate 3.71% 3.40% 4.17%
FHLB repurchase agreements outstanding at end of year $60,000 $50,000 -
Interest rate 4.22% 2.43% -
Approximate average amount outstanding $23,469 $4,440 -
Approximate weighted average rate 3.01% 1.92% -
27
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,
--------------------------------------
2005 2004 2003
-------- - -------- ----
Securities sold under agreements to repurchase with customers $59,021 $59,641 $55,934
Interest rate 3.51% 1.54% 0.35%
Approximate average amount outstanding $76,894 $63,715 $71,828
Approximate weighted average rate 2.61% 0.74% 0.48%
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, 2005:
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.
28
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, 2005.
Management's assertion as to the effectiveness of the Company's internal control
over financial reporting as of December 31, 2005 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.
29
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders 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, 2005, 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.
30
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2005, 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, 2005, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have not examined and, accordingly, we do not express an opinion or any other
form of assurance on management's statement referring to compliance with laws
and regulations.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended December 31, 2005 of the Company and our
report dated March 15, 2006 expressed an unqualified opinion on those
consolidated financial statements and included an explanatory paragraph
regarding the adoption of the provisions of Financial Accounting Standards Board
Interpretation No. 46(R) in 2003 and the change in accounting for stock-based
compensation to adopt the fair value recognition provisions of Statement of
Financial Accounting Standards Nos. 123 and 148.
/s/Deloitte & Touche LLP
Philadelphia, Pennsylvania
March 15, 2006
31
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Sun Bancorp, Inc.
Vineland, New Jersey
We have audited the accompanying consolidated statements of financial condition
of Sun Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 2005
and 2004, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2005. 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 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 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, 2005 and 2004, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2005, 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 provisions of Financial Accounting Standards Board
Interpretation No. 46(R) and the Company changed its method of accounting for
stock-based compensation to adopt the fair value recognition provisions of
Statement of Financial Accounting Standards Nos. 123 and 148.
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, 2005, 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 15, 2006, 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 15, 2006
32
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2005 AND 2004
(Dollars in thousands, except share amounts)
2005 2004
---- ----
ASSETS
Cash and due from banks $ 74,387 $ 69,022
Interest-bearing bank balances 2,707 1,878
Federal funds sold 8,368 4,002
---------- ----------
Cash and cash equivalents 85,462 74,902
Investment securities available for sale (amortized cost -
$688,073; 2005 and $823,896; 2004) 676,630 819,424
Investment securities held to maturity (estimated fair value -
$31,734; 2005 and $42,872; 2004) 32,445 43,048
Loans receivable (net of allowance for loan losses -
$22,463; 2005 and $22,037; 2004) 2,027,753 1,847,721
Restricted equity investments 19,991 15,405
Bank properties and equipment, net 42,110 36,830
Real estate owned, net 1,449 2,911
Accrued interest receivable 15,148 12,519
Goodwill 104,891 104,969
Intangible assets, net 29,939 34,753
Deferred taxes, net 6,761 4,626
Bank owned life insurance 55,627 47,179
Other assets 9,683 9,300
---------- ----------
TOTAL $3,107,889 $3,053,587
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits $2,471,648 $2,430,363
Advances from the Federal Home Loan Bank (FHLB) 124,546 144,669
Securities sold under agreements to repurchase - FHLB 60,000 50,000
Securities sold under agreements to repurchase - customer 59,021 59,641
Junior subordinated debentures 77,322 77,322
Other liabilities 19,699 12,372
---------- ----------
Total liabilities 2,812,236 2,774,367
---------- ----------
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:
18,168,530 in 2005 and 17,205,245 in 2004 18,169 17,205
Additional paid-in capital 264,152 244,108
Retained earnings 20,757 21,718
Accumulated other comprehensive loss (7,425) (2,765)
Treasury stock at cost, 90,562 shares - (1,046)
---------- ----------
Total shareholders' equity 295,653 279,220
---------- ----------
TOTAL $3,107,889 $3,053,587
========== ==========
See notes to consolidated financial statements
33
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(Dollars in thousands, except share amounts)
2005 2004 2003
---- ---- ----
INTEREST INCOME:
Interest and fees on loans $ 125,156 $ 96,617 $ 83,263
Interest on taxable investment securities 24,689 24,813 21,428
Interest on non-taxable investment securities 1,378 1,951 2,511
Dividends on restricted equity investments 834 503 559
Interest on federal funds sold 1,172 385 301
----------- ----------- -----------
Total interest income 153,229 124,269 108,062
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 41,427 24,061 23,480
Interest on funds borrowed 9,122 7,275 8,068
Interest on junior subordinated debt 5,165 3,615 4,227
----------- ----------- -----------
Total interest expense 55,714 34,951 35,775
----------- ----------- -----------
Net interest income 97,515 89,318 72,287
PROVISION FOR LOAN LOSSES 2,310 2,075 4,825
----------- ----------- -----------
Net interest income after provision for loan losses 95,205 87,243 67,462
----------- ----------- -----------
NON-INTEREST INCOME:
Service charges on deposit accounts 8,957 9,043 7,650
Other service charges 279 354 397
Gain on sale of bank properties and equipment 45 2,467 164
Gain on sale of investment securities 773 1,407 2,467
Gain on sale of loans 989 289 -
Gain on sale of branches - - 2,629
Other 7,248 5,559 4,049
----------- ----------- -----------
Total non-interest income 18,291 19,119 17,356
----------- ----------- -----------
NON-INTEREST EXPENSES:
Salaries and employee benefits 42,627 40,177 33,421
Occupancy expense 11,380 10,608 8,768
Equipment expense 7,762 7,091 5,341
Data processing expense 4,119 3,973 3,438
Amortization of intangible assets 4,499 5,268 3,696
Advertising expense 1,631 1,443 1,836
Other 12,645 12,592 9,536
----------- ----------- -----------
Total non-interest expenses 84,663 81,152 66,036
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 28,833 25,210 18,782
INCOME TAXES 9,312 7,581 5,446
----------- ----------- -----------
NET INCOME $ 19,521 $ 17,629 $ 13,336
=========== =========== ===========
Basic earnings per share $ 1.08 $ 1.08 $ 0.98
=========== =========== ===========
Diluted earnings per share $ 1.01 $ 1.01 $ 0.91
=========== =========== ===========
Weighted average shares - basic 18,154,586 16,249,956 13,034,687
===========
Weighted average shares - diluted 19,359,896 17,535,289 14,040,124
========== ========== ==========
- ------------------------------------------
See notes to consolidated financial statements
34
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
Stock Capital Earnings Income (Loss) Stock Total
----- ------- -------- ------------- ----- -----
BALANCE, JANUARY 1, 2003 $11,271 $114,930 $15,030 $5,438 $ (1,046) $145,623
Comprehensive income:
Net income - - 13,336 - - -
Net change in unrealized loss 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 loss 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
Comprehensive income:
Net income - - 19,521 - - -
Net change in unrealized loss on securities -
available for sale, net of taxes of $2,311 - - - (4,660) - -
--------
Comprehensive income - - - - - 14,861
--------
Exercise of stock options 148 349 - - - 497
Issuance of common stock 45 858 - - - 903
Stock dividends 771 18,657 (20,474) - 1,046 -
Share based compensation - 180 - - - 180
Cash paid for fractional interest
resulting from stock dividend - - (8) - - (8)
------- -------- ------- -------- ------------ --------
BALANCE, DECEMBER 31, 2005 $18,169 $264,152 $20,757 $ (7,425) $295,653
======= ======== ======= ======== ============ ========
- --------------------------------------------------
See notes to consolidated financial statements
35
SUN BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands)
2005 2004 2003
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 19,521 $ 17,629 $ 13,336
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 2,310 2,075 4,825
Depreciation and amortization 4,681 3,822 2,673
Net (accretion) amortization of investment securities (260) 1,917 2,927
Amortization of intangible assets 4,499 5,268 3,696
Write down of book value of fixed assets 65 177 -
Gain on sale of investment securities available for sale (773) (1,407) (2,467)
Gain on sale of bank properties and equipment (45) (2,467) (164)
Gain on sale of loans (989) (289) -
Increase in cash value of bank owned life insurance (1,648) (1,710) (985)
Deferred income taxes 176 6,407 342
Stock based compensation 711 316 234
Stock contributed to employee benefit plans 223 - -
Loans originated for sale (13,880) (3,199) -
Proceeds from the sale of loans 10,221 3,501 -
Change in assets and liabilities which provided (used) cash:
Accrued interest receivable (2,629) 205 (254)
Other assets (383) (921) (502)
Other liabilities 7,720 4,227 (3,454)
--------- --------- ---------
Net cash provided by operating activities 29,520 35,551 20,207
--------- --------- ---------
INVESTING ACTIVITIES:
Purchases of investment securities available for sale (253,636) (388,716) (902,019)
Purchases of investment securities held to maturity - (46,125) -
Purchase of restricted equity securities (4,586) (1,844) (941)
Proceeds from maturities, prepayments or calls of investment
securities available for sale 363,392 496,669 469,704
Proceeds from maturities, prepayments or calls of investment
securities held to maturity 10,518 3,077 -
Proceeds from sale of investment securities available for sale 27,185 143,095 185,940
Net increase in loans (177,694) (255,156) (140,928)
Purchase of bank properties and equipment (10,185) (5,160) (3,647)
Proceeds from sale of bank properties and equipment 193 7,480 34
Purchase of bank owned life insurance (6,800) (6,800) (31,800)
Proceeds from sale of real estate owned 1,473 2,907 674
Net increase in cash realized from acquisitions / sales - 7,609 238,432
--------- --------- ---------
Net cash used in investing activities (50,140) (42,964) (184,551)
--------- --------- ---------
FINANCING ACTIVITIES:
Net increase (decrease) in deposits 41,285 (22,766) 122,106
Purchase price adjustment of branch assets purchased - 219 -
Net (repayments) borrowings under line of credit and repurchase agreements (10,743) 22,212 18,278
Proceeds from exercise of stock options 497 425 420
Repayment of loan payable - - (1,160)
Proceeds from issuance of junior subordinated debt - - 40,000
Redemption of junior subordinated debt - - (29,274)
Payments for fractional interests resulting from stock dividend (8) (10) (6)
Proceeds from issuance of common stock 149 118 30,483
--------- --------- ---------
Net cash provided by financing activities 31,180 198 180,847
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,560 (7,215) 16,503
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 74,902 82,117 65,614
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 85,462 $ 74,902 $ 82,117
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 54,341 $ 34,070 $ 36,656
Income taxes paid $ 7,974 $ 4,987 $ 7,908
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS:
Transfer of loans and bank properties to real estate owned $ 321 $ 1,242 $ 4,214
Trust preferred issuance costs write-off - - $ 624
Value of shares issued for acquisition - $ 62,458 -
- ----------------------------------------
See notes to consolidated financial statements
36
SUN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(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.
The Company's principal business is to serve as a holding company for the Bank.
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. Med-Vine, Inc. is a Delaware holding company whose
principal business is investing in securities. Med-Vine, Inc. holds a portion of
the Bank's investment portfolio. 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 Company's various capital trusts,
collectively, the "Issuing Trusts" are presented on a deconsolidated basis. The
Issuing Trusts are Delaware business trusts which hold junior subordinated
debentures issued by the Company.
The Company and the Bank have their administrative offices in Vineland, New
Jersey. At December 31, 2005, the Company had 75 financial service centers
located throughout central and southern New Jersey, New Castle County, Delaware
and in Philadelphia, Pennsylvania. 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 (the
"SEC"). The Bank's primary regulatory agency is the Office of the Comptroller of
the Currency (the "OCC").
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.
Basis of 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.
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
37
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 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.
In accordance with FSP 115-1/124-1, The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments, the Company evaluates its
securities portfolio for other than temporary impairment throughout the year.
Each investment, which has an indicative market value less than the book value
is reviewed on a quarterly basis by management. Management considers at a
minimum the following factors that, both individually or in combination, could
indicate that the decline is other-than-temporary: 1) the length of time and
extent to which the market value has been less than book value; 2) the financial
condition and near-term prospects of the issuer; or 3) the intent and ability of
the Company to retain the investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value. Among the
factors that are considered in determining intent and ability is a review of
capital adequacy, interest rate risk profile and liquidity at the Company. An
impairment is recorded against individual securities if the review described
above concludes that the decline in value is other than temporary. The
securities portfolio as of December 31, 2005 contains no other-than-temporary
impaired investments.
Loans Held for Sale - Included in loans receivable is approximately $6.2 million
and $989,000 of loans held for sale at December 31, 2005 and 2004, respectively.
These loans were carried at the lower of cost or estimated fair value, on an
aggregate basis.
Loan Servicing Assets - The Company originates certain SBA loans for sale to
institutional investors. In accordance with FAS 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, the cost
of loan sold is allocated between the servicing rights, the retained portion of
the loan and the sold portion of the loan based on the relative fair values of
each. The fair value of the loan servicing rights is determined by valuation
techniques.
Loan servicing rights are amortized in proportion to, and over the period of,
estimated net servicing income. Because loans are sold individually and not
pooled, the Company does not stratify groups of loans based on risk
characteristics for purposes of measuring impairment. Impairment is measured by
estimating the fair value of each individual servicing asset.
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.
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
38
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.
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, generally as follows:
Buildings 40 years
Leasehold improvements Lesser of the useful life or the 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 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 2005
and 2004.
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 years ended December 31, 2005 and
2004 the Company recognized impairment losses of $65,000 and $177,000,
39
respectively. For the year ended December 31, 2003 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.
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 in other assets or other liabilities on the balance sheet. 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 by the weighted average number of shares of
common stock outstanding during the year. In 2003, net income was reduced by the
trust preferred issuance costs write-off to arrive at net income available to
common shareholders. Diluted earnings per share is calculated by dividing income
available to common shareholders 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 17, 2005, March 18, 2004, and March 19, 2003, the
Company's Board of Directors declared 5% stock dividends, which were paid on
April 20, 2005, April 20, 2004, and April 21, 2003, respectively, to
shareholders of record on April 6, 2005, April 6, 2004, and April 7, 2003,
respectively. Accordingly, per share information for the years ended December
31, 2004 and 2003 have been restated to reflect the increased number of shares
outstanding. All stock dividends are declared at the discretion of the Board.
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, 2005 2004 2003
- -------------------------------------------------------------------------------------------------------------------
Net unrealized loss on securities available for sale during the year $(6,198) $(5,616) $(3,221)
Reclassification adjustment for net gains included in net income (773) (1,407) (2,467)
------- ------- -------
Net change in unrealized loss on securities available for sale (6,971) (7,023) (5,688)
Tax effect 2,311 2,568 1,940
------- ------- -------
Net of tax amount $(4,660) $(4,455) $(3,748)
======= ======= =======
40
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 amended 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 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, 2005, 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 to all
share based awards.
For the Years Ended December 31,
--------------------------------
2005 2004 2003
---- ---- ----
Net income, as reported $ 19,521 $ 17,629 $ 13,336
Less: Trust preferred issuance costs write-off - - (624)
-------- -------- --------
Net income available to shareholders 19,521 17,629 12,712
Add: Total stock-based employee compensation expense
included in reported net income (net of tax) 108 29 21
Deduct: Total stock-based employee compensation expense
determined under fair value method (net of tax) (419) (616) (1,179)
-------- -------- --------
Pro forma net income $ 19,210 $ 17,042 $ 11,554
======== ======== ========
Earnings per share:
Basic - as reported $ 1.08 $ 1.08 $ 0.98
Basic - pro forma $ 1.06 $ 1.05 $ 0.89
Diluted - as reported $ 1.01 $ 1.01 $ 0.91
Diluted - pro forma $ 0.99 $ 0.97 $ 0.82
41
Significant weighted average assumptions used to calculate the above fair value
of the awards are as follows:
2005 2004 2003
---- ---- ----
Fair value of options granted during the year $ 7.04 - $ 9.00
Risk free rate of return 4.40% - 4.40%
Expected option life in months 96 - 120
Expected volatility 30% - 40%
Expected dividends - - -
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. This Statement will be effective for
financial statements as of the beginning of the first fiscal year that begins
after June 15, 2005. As the Company previously adopted the prospective method
for fair value recognition of SFAS No. 123 for all options granted after January
1, 2003, options granted prior to January 1, 2003 continue to be accounted for
under APB No. 25, and related interpretations. Upon adoption of SFAS No. 123R,
the Company will be required to recognize through earnings, the fair value of
the remaining unvested portion of options granted prior to January 1, 2003. For
fiscal year 2006, the Company expects to recognize approximately $173,000 of
pre-tax expense relating to these options previously accounted for under the
provisions of APB No. 25.
In June 2005, the FASB has issued Statement No. 154, "Accounting Changes and
Error Corrections", a replacement of APB Opinion No. 20 and FASB Statement No.
3. The Statement applies to all voluntary changes in accounting principle, and
changes the requirements for accounting for and reporting of a change in
accounting principle. Statement 154 requires retrospective application to prior
periods' financial statements of a voluntary change in accounting principle
unless it is impracticable. APB Opinion 20 previously required that most
voluntary changes in accounting principle be recognized by including in net
income of the period of the change the cumulative effect of changing to the new
accounting principle. Statement 154 improves financial reporting because its
requirements enhance the consistency of financial information between periods.
Statement 154 is effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005. The impact of this new
pronouncement will depend on the Company changing an accounting principle and
will be evaluated at that time.
In November 2005, the FASB issued FASB Staff Position (FSP) 115-1/124-1, "The
Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments". This FSP provides additional guidance on when an investment in a
debt or equity security should be considered impaired and when that impairment
should be considered other-than-temporary and recognized as a loss in earnings.
Specifically, the guidance clarifies that an investor should recognize an
impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell has not been made. The FSP also
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. The Company applied the guidance
in this FSP in 2005 and there was no material affect to the results of
operations or the statement of financial position.
On December 19, 2005, the FASB issued FSP 94-6-1, "Terms of Loan Products That
May Give Rise to a Concentration of Credit Risk". FSP 94-6-1 addresses whether,
under existing guidance, non-traditional loan products represent a concentration
of credit risk and what disclosures are required for entities that originate,
hold, guarantee, service, or invest in loan products whose terms may give rise
to a concentration of credit risk. Non-traditional loan products expose the
originator, holder, investor, guarantor, or servicer to higher credit risk than
traditional loan products. Typical features of non-traditional loan products may
include high loan-to-value ratios and interest or principal repayments that are
less than the repayments for fully amortizing loans of an equivalent term. FSP
94-6-1 was effective upon its issuance and it did not have a material impact on
the Company's financial position or disclosures.
42
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments. This statement amends FASB Statements No. 133, Accounting
for Derivative Instruments and Hedging Activities, and No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
This statement resolves issues addressed in Statement 133 Implementation Issue
No. D1, Application of Statement 133 to Beneficial Interest in Securitized
Financial Assets. This Statement is effective for all financial instruments
acquired or issued after the beginning of an entity's first fiscal year that
begins after September 15, 2006. The Company is still continuing to evaluate the
impact of this pronouncement and does not expect that the guidance will have a
material effect on the Company's financial position or results of operations.
3. ACQUISITIONS
On January 19, 2006, the Company acquired Advantage Bank ("Advantage"). The
merger agreement permitted Advantage shareholders to elect to receive either
$19.00 in cash or .87 shares of Sun common stock subject to adjustment or
proration under certain circumstances. The merger agreement also provided for an
overall requirement that 50 percent of the outstanding Advantage shares be
exchanged for the Company's common stock. Accordingly, the Company paid
Advantage stockholders $17.3 million in cash and issued approximately 832,000
shares of the Company's common stock. On December 31, 2005, Advantage's assets
totaled approximately $168 million, loan receivables, net of allowances for loan
losses, were approximately $125 million, investments securities were
approximately $29 million and total deposits were approximately $152 million.
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. 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.
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, 2005 and 2004 was $100,000.
43
5. INVESTMENT SECURITIES
The amortized cost of investment securities and the approximate fair value were
as follows:
December 31, 2005
----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Available for Sale
- ------------------
U.S. Treasury obligations $ 59,237 - $ (145) $ 59,092
U.S. Government agencies and
mortgage-backed securities 596,823 - (11,142) 585,681
State and municipal obligations 28,050 $ 198 (354) 27,894
Other 3,963 - - 3,963
-------- -------- -------- --------
Total $688,073 $ 198 $(11,641) $676,630
======== ======== ======== ========
Held to Maturity
- ----------------
Mortgage-backed securities $ 32,445 - $ (711) $ 31,734
======== ======== ======== ========
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
- ----------------
Mortgage-backed securities $ 43,048 - $ (176) $ 42,872
======== ====== ======= ========
During 2005, called or sold securities of $60.2 million resulted in a gross gain
and gross loss of $843,000 and $70,000, respectively. During 2004, called or
sold securities of $194.6 million resulted in a gross gain and gross loss of
$1.4 million and $22,000, respectively. During 2003, called or sold securities
of $215.3 million resulted in a gross gain and gross loss of $2.7 million and
$276,000, 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, 2005 and
2004:
December 31, 2005
-----------------------------------------------------------------------------------------
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 $48,963 $ (35) $ 10,129 $ (110) $59,092 $ (145)
U.S. Government agencies and
mortgage-backed securities 102,670 (1,003) 514,745 (10,850) 617,415 (11,853)
State and municipal obligations 15,975 (238) 3,381 (116) 19,356 (354)
-------- ------- -------- -------- -------- --------
Total $167,608 $(1,276) $528,255 $(11,076) $695,863 $(12,352)
======== ======= ======== ======== ======== ========
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)
======== ======= ======= ======= ======== =======
At December 31, 2005, 99.5% 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, 2005, the unrealized loss in the category 12 months or longer of
$11.1 million consisted of 79 securities having an aggregate unrealized loss of
2.0%. The securities represented U.S. Treasury, Federal Agency issues and nine
securities currently rated Aaa by at least one bond credit rating services. At
December 31, 2005, securities in a gross unrealized loss position for less than
twelve months consisted of 50 securities having an aggregate unrealized loss of
0.8% from the Bank's amortized cost basis.
The maturity schedule of the investment in debt securities at December 31, 2005
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 $266,027 $264,036 - -
Due after one year through five years 115,701 112,906 - -
Due after five years through ten years 1,226 1,256 - -
Due after ten years 8,829 8,893 - -
-------- -------- ------- -------
$391,783 $387,091 - -
Mortgage-backed securities $296,290 $289,539 $32,445 $31,734
-------- -------- ------- -------
Total $688,073 $676,630 $32,445 $31,734
======== ======== ======= =======
At December 31, 2005, $225.6 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,
-------------------------------
2005 2004
---- ----
Commercial and industrial $ 1,732,202 $ 1,603,868
Home equity 155,561 122,735
Second mortgages 53,881 50,541
Residential real estate 30,162 26,117
Other 78,410 66,497
----------- -----------
Total gross loans 2,050,216 1,869,758
Allowance for loan losses (22,463) (22,037)
----------- -----------
Loans, net $ 2,027,753 $ 1,847,721
=========== ===========
Non-accrual loans $ 9,957 $ 13,457
=========== ===========
There were no irrevocable commitments to lend additional funds on non-accrual
loans at December 31, 2005. 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 $755,000, $1.0 million, and $1.5 million for the years
ended December 31, 2005, 2004 and 2003, respectively. The amount of interest
included in net income on these loans for the years ended December 31, 2005,
2004 and 2003 was $119,000, $274,000, and $534,000, 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, 2005 and
2004, along with an analysis of the activity for the years ended December 31,
2005 and 2004, is summarized as follows:
For the Years Ended
December 31,
--------------------------
2005 2004
---- ----
Balance, beginning of year $ 43,744 $ 27,204
Additions 18,545 20,368
Repayments (2,906) (3,828)
-------- --------
Balance, end of year $ 59,383 $ 43,744
======== ========
Under approved lending decisions, the Company had commitments to lend additional
funds totaling approximately $875.4 million and $756.9 million at December 31,
2005 and 2004, 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,
--------------------------------
2005 2004 2003
---- ---- ----
Balance, beginning of year $ 22,037 $ 17,614 $ 16,408
Charge-offs (2,641) (1,382) (4,380)
Recoveries 757 793 761
-------- -------- --------
Net charge-offs (1,884) (589) (3,619)
Provision for loan losses 2,310 2,075 4,825
Purchased allowance resulting from bank acquisition - 2,937 -
-------- -------- --------
Balance, end of year $ 22,463 $ 22,037 $ 17,614
======== ======== ========
Loans collectively evaluated for impairment include consumer loans and
residential real estate loans, and are not included in the data that follow:
December 31,
----------------------
2005 2004
---- ----
Impaired loans with related allowance for loan losses
calculated under SFAS No. 114 $ 7,954 $23,346
Impaired loans with no related allowance for loan losses
calculated under SFAS No. 114 10,061 9,775
------- ------
Total impaired loans $18,015 $33,121
======= =======
Valuation allowance related to impaired loans $ 2,381 $3,332
======= ======
For the Years Ended
December 31,
----------------------------
2005 2004 2003
---- ---- ----
Average impaired loans $31,181 $35,991 $34,715
======= ======= =======
Interest income recognized on impaired loans $ 994 $ 2,315 $ 2,177
======= ======= =======
Cash basis interest income recognized on impaired loans $ 494 $ 209 $ 2,311
======= ======= =======
8. RESTRICTED EQUITY INVESTMENTS
The cost of restricted equity investments was as follows:
December 31,
----------------------
2005 2004
---- ----
Federal Reserve Bank stock $ 8,122 $ 5,563
Federal Home Loan Bank stock 11,761 9,734
Atlantic Central Bankers Bank stock 108 108
------- -------
Total $19,991 $15,405
======= =======
47
9. BANK PROPERTIES AND EQUIPMENT
Bank properties and equipment consist of the following major classifications:
December 31,
-------------------------
2005 2004
---- ----
Land $ 5,366 $ 5,366
Buildings 17,503 17,676
Capital lease 5,400 -
Leasehold improvements and equipment 34,003 29,850
-------- --------
62,272 52,892
Accumulated depreciation (20,162) (16,062)
-------- --------
Total $ 42,110 $ 36,830
======== ========
10. REAL ESTATE OWNED
Real estate owned consisted of the following:
December 31,
-----------------------
2005 2004
---- ----
Commercial properties $1,066 $2,424
Residential properties 62 178
Bank properties 321 309
------ ------
Total $1,449 $2,911
====== ======
Expenses applicable to real estate owned include the following:
For the Years Ended December 31,
-------------------------------
2005 2004 2003
---- ---- ----
Net gain on sales of real estate $(198) $(220) $(707)
Operating expenses, net of rental income 150 280 110
----- ----- -----
Total $ (48) $ 60 $(597)
===== ===== =====
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 2005 and 2004, 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, 2005 and
2004.
48
Changes in the carrying amount of goodwill are as follows:
For the Years Ended
December 31,
------------------------
2005 2004
---- ----
Balance, beginning of year $ 104,969 $ 50,600
Goodwill resulting from business combination - 54,369
Purchase price adjustments (78) -
--------- ---------
Balance, end of year $ 104,891 $ 104,969
========= =========
Information regarding the Company's intangible assets subject to amortization is
as follows:
December 31, 2005
------------------------------------
Carrying Accumulated
Amount Amortization Net
------ ------------ ---
Core Deposit Premium $46,132 $22,671 $23,461
Excess of cost over fair value of assets acquired 17,698 11,220 6,478
------- ------- -------
Total intangible assets $63,830 $33,891 $29,939
======= ======= =======
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
======= ======= =======
Changes in the carrying amount of Company's intangible assets for the year ended
December 31, 2005 are as follows:
Balance, beginning of year $34,753
Intangible assets associated with sold branch (315)
Amortization expense (4,499)
-------
Balance, end of year $29,939
=======
Information regarding the Company's amortization expense follows:
Actual for Year Ended December 31,
2003 3,696
2004 5,268
2005 4,499
Expected for Year Ending December 31,
2006 4,390
2007 4,375
2008 4,375
2009 4,119
2010 3,350
Thereafter 9,330
-------
Total $29,939
=======
49
12. DEPOSITS
Deposits consist of the following major classifications:
December 31,
-----------------------
2005 2004
---- ----
Interest bearing demand deposits $ 886,773 $ 793,290
Non-interest bearing demand deposits 529,878 543,601
Savings deposits 386,821 452,726
Time deposits under $100,000 443,535 410,632
Time deposits $100,000 or more 224,641 230,114
---------- ----------
Total $2,471,648 $2,430,363
========== ==========
A summary of time deposits by year of maturity is as follows:
Years Ending December 31,
2006 $420,624
2007 101,631
2008 57,483
Thereafter 88,438
--------
Total $668,176
========
A summary of interest expense on deposits is as follows:
For the Years Ended December 31,
------------------------------------
2005 2004 2003
---- ---- ----
Savings deposits $ 4,986 $ 3,440 $ 3,968
Time deposits 20,342 13,421 12,105
Interest-bearing demand deposits 16,099 7,200 7,407
------- ------- -------
Total $41,427 $24,061 $23,480
======= ======= =======
13. ADVANCES FROM THE FEDERAL HOME LOAN BANK
The Company's fixed rate, long-term debt of $124.5 million matures through 2018.
At December 31, 2005 and 2004, the interest rates on fixed-rate, long-term debt
ranged from 3.30% to 6.50% and 1.88% to 6.50%, repectively. At December 31, 2005
and 2004, the weighted average interest rate on fixed-rate, long-term debt was
4.56% and 4.32%, respectively. Included in the above amount was one $25.0
million fixed-rate advance which was convertible on October 12, 2005. This
advance remained fixed at December 31, 2005, however the FHLB now has the option
to convert this advance to floating at the current market rates at each quarter
until it matures in 2007. 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, 2005 are as follows:
Due in 2006 $ 5,396
Due in 2007 45,822
Due in 2008 41,368
Due in 2009 12,338
Thereafter 19,622
--------
Total long-term debt $124,546
========
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, 2005 and 2004, customer
repurchase agreements were $59.0 million and $59.6 million, respectively with
interest rates ranging from 3.13% to 3.95% and 0.93% to 2.20%, respectively.
Interest expense on customer repurchase agreements was $2.0 million, $471,000
and $348,000 for the years ended December 31, 2005, 2004 and 2003, 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, 2005 and 2004 the Company had $60.0 million and $50.0 million of
FHLB repurchase agreements with a weighted interest rate of 4.22% and 2.43%
respectively. Interest expense on FHLB repurchase agreements was $707,000 and
$68,000 for the years ended December 31, 2005 and 2004. No interest expense was
recorded for the year ended December 31, 2003. Collateral for the 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 million, are reflected in the Company's
consolidated statement of financial position in the liabilities section at both
December 31, 2005 and December 31, 2004, 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, 2005 and 2004.
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, 2005.
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 388,000
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. The Company has reissued all repurchased
shares as part of its 5% stock dividend declared and paid in 2005.
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 472,500 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 52,500 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. As of March 18, 2004, the effective date of the 2004 Stock
Plan, each director and advisory director of the Company received board meeting
fees in the form of stock awards. All awards were immediately vested upon
issuance. At December 31, 2005 there were 33,927 awards issued from the 2004
Stock Plan since it's inception. During 2005, 124,000 options were granted under
the 2004 Stock Plan. These options were granted at the then fair market value of
the Company's stock and will vest evenly over five years.
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
52
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 previously granted under the Community
Plans are both incentive and non-qualified and expire from 2007 through 2013.
There are 318,594 stock options outstanding under these plans at December 31,
2005. 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 910,414 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 generally 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, 2005, there were 905,062
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 1,309,142 shares
authorized for grants of options under the 1997 Plan. At December 31, 2005,
there were 1,295,299 options outstanding with the reload feature under the 1997
Plan.
In 1995, the Company adopted a Stock Option Plan (the "1995 Plan"). There are
523,856 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 generally 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 as of
December 31, 2005.
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, 2005 at prices ranging from $4.78 to $22.69 per share 651,401 2,515,410 3,166,811
======= ========= =========
December 31, 2004 at prices ranging from $3.53 to $22.69 per share 542,881 2,739,145 3,282,026
======= ========= =========
December 31, 2003 at prices ranging from $3.53 to $17.19 per share 559,561 2,431,275 2,990,836
======= ========= =========
53
Activity in the stock option plans for the period beginning January 1, 2003 and
ending December 31, 2005 was as follows:
Weighted
Number Exercise
of Shares Price Options
Outstanding Per Share Exercisable
----------- --------- -----------
January 1, 2003 3,023,683 $ 9.24 2,036,308
=========
Granted 16,537 $ 17.19
Exercised (38,080) $ 10.00
Expired (11,304) $ 11.34
---------
December 31, 2003 2,990,836 $ 9.26 2,279,016
--------- =========
Granted --
Assumed in connection with Community merger 350,551 $ 9.49
Exercised (45,628) $ 9.04
Expired (13,733) $ 22.13
---------
December 31, 2004 3,282,026 $ 9.23 2,802,434
--------- =========
Granted 124,000 $ 21.25
Exercised (237,717) $ 3.85
Expired (1,498) $ 14.31
---------
December 31, 2005 3,166,811 $ 10.11 2,795,205
========= =========
The following table summarizes stock options outstanding at December 31, 2005:
Options Outstanding Options Exercisable
------------------------------------------------------- -------------------------------------
Weighted
Number of Average Weighted Weighted
Range of Options Remaining Average Options Average
Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- --------------------------------------------------------------------------- -------------------------------------
$ 4.78 - $ 6.99 783,074 1.75 years $ 5.98 783,074 $ 5.98
$ 7.87 - $ 9.83 1,286,524 5.87 years $ 9.64 1,068,963 $ 9.60
$10.45 - $11.80 486,769 4.26 years $10.71 466,645 $10.68
$12.79 - $22.69 610,444 4.54 years $15.90 476,523 $14.49
--------- ---------
3,166,811 2,795,205
========= =========
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 439,049 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, 2005
and 2004, there were 7,315 shares and 7,888 shares, respectively, purchased
through the ESPP. For the years ended December 31, 2005 and 2004, there were
2,396 shares and 2,337 shares, respectively, purchased through the DSPP. At
December 31, 2005, there were 207,289 and 11,843 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. Prior to August 2005, the Company's contributions were purchased through
a broker by the directed trustee. Beginning in August 2005, the Company issued
shares of its common stock as its contribution. The Company's contribution to
the 401(k) Plan was $566,000, $486,000 and $414,000 for the years ended December
31, 2005, 2004 and 2003, respectively. The Company expensed $36,000, $26,000 and
$23,000 during 2005, 2004 and 2003, 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 $67.8 million and $51.2 million at December 31, 2005 and
2004, 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. Terms of these three agreements at December 31,
2005 are as follows.
Expiration date October 2017 March 2010 August 2025*
Annual rental payment $1,091 $40 $450
Renewal option remaining N/A N/A 4 five-year terms
Annual rental increases CPI Fixed Fixed
* This lease is recorded as a $5.4 million obligation under capital lease in
other liabilities at December 31, 2005. The following is a schedule by
years of future minimum lease payments under capital leases together with
the present value of the net minimum lease payments as of December 31,
2005.
2006 $ 450
2007 450
2008 450
2009 450
2010 450
Therafter 8,583
-------
Total $10,833
Less: amount representing interest 5,433
-------
Present value of net minimum lease payments $ 5,400
=======
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, 2005 are as follows.
Expiration date December 2011 February 2010
Annual rental payment $132 $96
Renewal option remaining 2 five-year terms N/A
Annual rental increases Fixed 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.
55
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 leases
with initial terms of one year or more at December 31, 2005. Future minimum
receipts under sub-lease agreements are not material.
2006 $ 4,791
2007 4,323
2008 4,180
2009 3,551
2010 2,896
Thereafter 24,112
-------
Total $43,853
=======
Rental expense included in occupancy expense for all operating leases was $4.8
million, $4.8 million, and $3.7 million for the years ended December 31, 2005,
2004 and 2003, 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, 2005, 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.
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.
56
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.
Information pertaining to outstanding interest rate swap agreements was as
follows:
December 31,
-----------------------------
2005 2004
---- ----
Notional Amount $36,795 $23,473
Weighted average pay rate 6.59% 6.53%
Weighted average receive rate 6.30% 4.25%
Weighted average maturity in years 7.4 8.5
Unrealized gain (loss) relating to interest rate swaps $ 450 $ (283)
Customer Derivatives
During 2005 and 2004, Company entered into several commercial loan swaps in
order to provide commercial loan clients the ability to swap from variable to
fixed interest rates. Under these agreements, the Company enters into a variable
rate loan agreement with a client in addition to a swap agreement. This swap
agreement effectively swaps the client's variable rate loan into a fixed rate
loan. The Company then enters into a corresponding swap agreement with a third
party in order to swap its exposure on the variable to fixed rate swap on the
commercial loan. At December 31, 2005 and 2004, the notional amount of such
arrangements was $290.2 million and $20.9 million respectively. As the interest
rate swaps with the clients and third parties are not designated as hedges under
FAS No. 133, the instruments are marked to market in earnings. As the interest
rate swaps are structured to offset each other, changes in market values will
have no earnings impact.
57
22. INCOME TAXES
The income tax provision consists of the following:
For the Years Ended
December 31,
--------------------------------------
2005 2004 2003
---- ---- ----
Current $9,137 $1,174 $5,104
Deferred 175 6,407 342
------ ------ ------
Total $9,312 $7,581 $5,446
====== ====== ======
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,
---------------------
2005 2004
---- ----
Deferred tax asset:
Allowance for loan losses $ 9,310 $ 8,816
Goodwill amortization 1,126 2,200
Unrealized loss on investment securities 4,017 1,707
Other 183 -
------- -------
Total deferred tax asset 14,636 12,723
Deferred tax liability:
Core deposit intangible amortization (4,691) (5,522)
Property (1,632) (1,579)
Deferred loan fees (1,552) (971)
Other - (25)
------- -------
Total deferred tax liability (7,875) (8,097)
------- -------
Net deferred tax asset $ 6,761 $ 4,626
======= =======
At December 31, 2005 and 2004, 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,
-------------------------------------------------
2005 2004 2003
---- ---- ----
Amount % Amount % Amount %
------ - ------ - ------ -
Tax computed at the statutory rate $10,090 35.0 $8,824 35.0 $6,574 35.0
Surtax exemption - - (252) (1.0) (188) (1.0)
Increase (decrease) in charge resulting from:
Tax exempt interest (net) (436) (1.5) (640) (2.5) (819) (4.4)
Bank Owned Life Insurance (673) (2.3) (628) (2.5) (345) (1.8)
Other, net 331 1.1 277 1.1 224 1.2
------- ---- ------ ---- ------ ----
Total $ 9,312 32.3 $7,581 30.1 $5,446 29.0
======= ==== ====== ==== ====== ====
58
23. EARNINGS PER SHARE
Earnings per share were calculated as follows:
For the Years Ended December 31,
------------------------------------
2005 2004 2003
---- ---- ----
Net income $19,521 $17,629 $13,336
Less: Trust Preferred issuance costs write-off -- -- 624
------- ------- -------
Net income available to common shareholders $19,521 $17,629 $12,712
======= ======= =======
Dilutive stock options outstanding 3,082,059 2,980,269 2,860,417
Average exercise price per share $ 9.53 $ 9.25 $ 9.23
Average market price - diluted $21.22 $21.63 $17.16
Average common shares outstanding 18,154,586 16,249,956 13,034,687
Increase in shares due to exercise of options - diluted 1,205,310 1,285,333 1,005,437
---------- ---------- ----------
Adjusted shares outstanding - diluted 19,359,896 17,535,289 14,040,124
========== ========== ==========
Net earnings per share - basic $1.08 $1.08 $0.98
Net earnings per share - diluted $1.01 $1.01 $0.91
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 59,752 15,201 --
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 $47.2 million at December 31, 2005.
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, 2005,
that the Company and the Bank meet all applicable capital adequacy requirements.
59
As of December 31, 2005, 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, 2005
Total Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $266,379 11.11% $191,814 8.00% N/A
Sun National Bank $251,410 10.50% $191,499 8.00% $239,374 10.00%
Tier I Capital (to Risk-Weighted Assets):
Sun Bancorp, Inc. $243,196 10.14% $95,907 4.00% N/A
Sun National Bank $228,227 9.53% $95,750 4.00% $143,624 6.00%
Leverage Ratio:
Sun Bancorp, Inc. $243,196 8.20% $118,702 4.00% N/A
Sun National Bank $228,227 7.70% $118,528 4.00% $148,160 5.00%
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%
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, 2005 December 31, 2004
-----------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Assets:
Cash and cash equivalents $ 85,462 $ 85,462 $ 74,902 $ 74,902
Investment securities available for sale 676,630 676,630 819,424 819,424
Investment securities held to maturity 32,445 31,734 43,048 42,872
Loans receivable, net 2,027,753 2,024,915 1,847,721 1,891,201
Restricted equity investments 19,991 19,991 15,405 15,405
Liabilities:
Demand deposits 1,416,651 1,416,651 1,336,891 1,336,891
Savings deposits 386,821 386,821 452,726 452,726
Time deposits 668,176 656,864 640,746 640,369
FHLB advances 124,546 122,344 144,669 148,836
Junior subordinated debentures 77,322 84,356 77,322 73,724
Securities sold under agreements to repurchase - customer 59,021 59,021 59,641 59,641
Securities sold under agreements to repurchase -FHLB 60,000 60,000 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, 2005 and 2004. 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, 2005 and 2004, 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,
2005, 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,
-----------------------
2005 2004
-------- --------
Assets
Cash $ 4,608 $ 9,544
Investments in subsidiaries:
Bank subsidiary 355,683 337,358
Non-bank subsidiaries 2,322 2,322
Accrued interest and other assets 12,138 8,983
-------- --------
Total $374,751 $358,207
======== ========
Liabilities and Shareholders' Equity
Junior subordinated debentures $ 77,322 $ 77,322
Other liabilities 1,776 1,665
-------- --------
Total liabilities 79,098 78,987
Shareholders' equity 295,653 279,220
-------- --------
Total $374,751 $358,207
======== ========
62
Condensed Statements of Income
For the Years Ended December 31,
-----------------------------------
2005 2004 2003
---- ---- ----
Net interest expense $(5,165) $(3,614) $(4,227)
Management fee 4,601 4,097 2,602
Other expenses (4,385) (3,927) (2,613)
------- ------- -------
Loss before equity in undistributed income of subsidiaries
and income tax benefit (4,949) (3,444) (4,238)
Equity in undistributed income of subsidiaries 22,747 19,892 16,427
Income tax benefit 1,723 1,181 1,147
------- ------- -------
Net income $19,521 $17,629 $13,336
======= ======= =======
Condensed Statements of Cash Flows
For the Years Ended December 31,
-----------------------------------
2005 2004 2003
---- ---- ----
Operating activities:
Net income $ 19,521 $ 17,629 $ 13,336
Adjustments to reconcile net income to
net cash used in operating activities -
Undistributed income of subsidiaries (22,747) (19,892) (16,427)
Stock based compensation 180 - -
Changes in assets and liabilities which (used) provided cash:
Accrued interest and other assets (3,079) (1,163) (2,596)
Accounts payable and accrued expenses 112 680 119
-------- -------- --------
Net cash used in operating activities (6,013) (2,746) (5,568)
-------- -------- --------
Investing activities -
Cash proceeds from bank acquisition -- 4,134 --
Dividends from subsidiary 4,685 3,454 4,189
Capital contribution to banking subsidiary (5,000) (12,007) (31,000)
-------- -------- --------
Net cash used in investing activities (315) (4,419) (26,811)
-------- -------- --------
Financing activities:
Proceeds from issuance of Trust Preferred Securities -- -- 40,000
Redemption of Trust Preferred Securities -- -- (29,274)
Cash (paid) received for exercise of stock options 497 425 420
Proceeds from issuance of common stock 903 434 30,717
Payments for fractional interests resulting from stock dividend (8) (10) (6)
-------- -------- --------
Net cash provided by financing activities 1,392 849 41,857
-------- -------- --------
2,095
(Decrease) increase in cash (4,936) (6,316) 9,478
Cash, beginning of year 9,544 15,860 6,382
-------- -------- --------
Cash, end of year $ 4,608 $ 9,544 $ 15,860
======== ======== ========
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).
Three Months Ended
------------------------------------------------------------
December 31, September 30, June 30, March 31,
------------ ------------- -------- ---------
2005
Interest income $40,335 $39,356 $37,638 $35,900
Interest expense 15,643 14,840 13,559 11,672
------- ------- ------- -------
Net interest income 24,692 24,516 24,079 24,228
Provision for loan losses 520 500 765 525
Non-interest income 4,399 4,612 5,095 4,185
Non-interest expense 21,728 21,179 21,322 20,434
------- ------- ------- -------
Income before income taxes 6,843 7,449 7,087 7,454
Income taxes 2,259 2,455 2,257 2,341
------- ------- ------- -------
Net income $ 4,584 $ 4,994 $ 4,830 $ 5,113
======= ======= ======= =======
Basic earnings per share $ 0.25 $ 0.28 $ 0.27 $ 0.28
======= ======= ======= =======
Diluted earnings per share $ 0.24 $ 0.26 $ 0.25 $ 0.26
======= ======= ======= =======
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
======= ======= ======= =======
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
---- ---
2005
Fourth Quarter $21.44 $19.12
Third Quarter $21.81 $20.36
Second Quarter $21.88 $19.79
First Quarter $23.91 $21.18
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
There were 811 holders of record of the Company's common stock as of March 9,
2006. 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 9,
2006, there were 19,109,378 shares of the Company's common stock outstanding.
The Company paid 5% stock dividends on April 20, 2005, April 20, 2004, and April
21, 2003. 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, 2005 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
John A. Fallone
Peter Galetto, Jr.
Douglas J. Heun, CPA
Charles P. Kaempffer
Anne E. Koons
Eli Kramer
Alfonse M. Mattia, CPA
George A. Pruitt, Ph.D.
Anthony Russo, III
Edward H. Salmon, Ed.D.
Howard M. Schoor
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 Louis J. Pellicori
Executive Vice President and CFO Executive Vice President
Peter G. Schoberl
Executive Vice President
Bart A. Speziali
Executive Vice President
Christopher Warren
Executive Vice President
Thomas J. Holt
Senior Vice President
Edward A. Malandro
Senior Vice President
Thomas J. Townsend
Senior Vice President
Sandy Wandelt
Senior Vice President
66