UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: JUNE 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to_________.
STATE BANCORP, INC.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2846511
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
699 HILLSIDE AVENUE, NEW HYDE PARK, NEW YORK 11040
(Address of principal executive offices) (Zip Code)
(516) 437-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No _____
As of August 4, 2004, there were 9,027,912 shares of registrant's Common
Stock outstanding.
STATE BANCORP, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - June 30, 2004 and December 31, 2003 (Unaudited) 1.
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2004 and 2003 (Unaudited) 2.
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 (Unaudited) 3.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the Six Months Ended 4.
June 30, 2004 and 2003 (Unaudited)
Notes to Unaudited Consolidated Financial Statements 5.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10.
Item 3. Quantitative and Qualitative Disclosure About Market Risk 24.
Item 4. Controls and Procedures 27.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27.
Item 2. Changes in Securities and Use of Proceeds 28.
Item 3. Defaults upon Senior Securities - None N/A
Item 4. Submission of Matters to a Vote of Security Holders 28.
Item 5. Other Information - None N/A
Item 6. Exhibits and Reports on Form 8-K 28.
SIGNATURES 30.
PART I
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003 (UNAUDITED)
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
ASSETS:
- -------
CASH AND DUE FROM BANKS $47,996,716 $56,762,269
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL - 91,000,000
---------- ----------
TOTAL CASH AND CASH EQUIVALENTS 47,996,716 147,762,269
SECURITIES HELD TO MATURITY (ESTIMATED FAIR VALUE -
$94,991,940 IN 2004 AND $55,231,959 IN 2003) 95,001,615 55,065,400
SECURITIES AVAILABLE FOR SALE - AT ESTIMATED FAIR VALUE 551,403,670 511,964,686
----------- -----------
TOTAL SECURITIES 646,405,285 567,030,086
LOANS (NET OF ALLOWANCE FOR PROBABLE LOAN LOSSES
OF $11,042,293 IN 2004 AND $10,732,078 IN 2003) 721,119,519 700,484,056
BANK PREMISES AND EQUIPMENT - NET 6,622,559 7,083,848
RECEIVABLE - SECURITIES SALES 26,317,480 -
BANK OWNED LIFE INSURANCE 25,393,913 -
OTHER ASSETS 23,547,103 18,640,104
---------- ----------
TOTAL ASSETS $1,497,402,575 $1,441,000,363
============== ==============
LIABILITIES:
- ------------
DEPOSITS:
DEMAND $284,331,353 $265,691,712
SAVINGS 515,315,894 688,717,586
TIME 247,316,562 261,877,605
----------- -----------
TOTAL DEPOSITS 1,046,963,809 1,216,286,903
FEDERAL FUNDS PURCHASED 25,000,000 10,000,000
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 116,906,000 31,601,147
OTHER BORROWINGS 122,341,135 50,714,149
JUNIOR SUBORDINATED DEBENTURES 20,000,000 20,000,000
PAYABLE - SECURITIES PURCHASES 64,228,435 8,612,652
ACCRUED EXPENSES, TAXES AND OTHER LIABILITIES 9,067,284 9,073,990
--------- ---------
TOTAL LIABILITIES 1,404,506,663 1,346,288,841
------------- -------------
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY:
- ---------------------
PREFERRED STOCK, $.01 PAR VALUE, AUTHORIZED
250,000 SHARES; 0 SHARES ISSUED - -
COMMON STOCK, $5.00 PAR VALUE, AUTHORIZED
20,000,000 SHARES; ISSUED 9,899,463 SHARES IN 2004
AND 9,846,853 SHARES IN 2003; OUTSTANDING 8,994,398
SHARES IN 2004 AND 8,967,102 SHARES IN 2003 49,497,315 46,889,775
SURPLUS 61,830,436 53,544,877
RETAINED EARNINGS 606,237 5,189,907
TREASURY STOCK (905,065 SHARES IN 2004 AND 837,858 SHARES IN 2003) (15,003,219) (13,481,356)
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAXES (4,034,857) 2,568,319
---------- ---------
TOTAL STOCKHOLDERS' EQUITY 92,895,912 94,711,522
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,497,402,575 $1,441,000,363
============== ==============
See accompanying notes to unaudited consolidated financial statements.
1
STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED)
THREE MONTHS SIX MONTHS
------------ ----------
2004 2003 2004 2003
---- ---- ---- ----
INTEREST INCOME:
- ----------------
LOANS $11,783,335 $10,911,816 $23,413,430 $21,848,036
FEDERAL FUNDS SOLD AND SECURITIES
PURCHASED UNDER AGREEMENTS TO RESELL 67,915 139,150 247,841 324,384
SECURITIES HELD TO MATURITY AND AVAILABLE FOR SALE:
STATES AND POLITICAL SUBDIVISIONS 639,863 797,175 1,217,653 1,678,820
MORTGAGE-BACKED SECURITIES 2,620,925 1,955,097 4,676,934 4,365,865
GOVERNMENT AGENCY SECURITIES 1,666,441 2,307,177 2,874,101 4,569,776
OTHER SECURITIES 479,297 384,857 928,972 729,293
------- ------- ------- -------
TOTAL INTEREST INCOME 17,257,776 16,495,272 33,358,931 33,516,174
---------- ---------- ---------- ----------
INTEREST EXPENSE:
- -----------------
TIME CERTIFICATES OF DEPOSIT OF $100,000 OR MORE 581,016 646,863 1,109,167 1,518,594
OTHER DEPOSITS AND TEMPORARY BORROWINGS 1,957,970 2,509,659 4,054,008 4,900,440
JUNIOR SUBORDINATED DEBENTURES 248,391 137,267 495,422 278,900
------- ------- ------- -------
TOTAL INTEREST EXPENSE 2,787,377 3,293,789 5,658,597 6,697,934
--------- --------- --------- ---------
NET INTEREST INCOME 14,470,399 13,201,483 27,700,334 26,818,240
PROVISION FOR PROBABLE LOAN LOSSES 1,086,000 983,751 2,163,000 1,967,502
--------- ------- --------- ---------
NET INTEREST INCOME AFTER PROVISION
FOR PROBABLE LOAN LOSSES 13,384,399 12,217,732 25,537,334 24,850,738
---------- ---------- ---------- ----------
NONINTEREST INCOME:
- -------------------
SERVICE CHARGES ON DEPOSIT ACCOUNTS 613,480 366,144 1,172,580 757,070
NET SECURITY (LOSSES) GAINS (31,131) 1,585,472 2,590,440 3,581,550
OTHER OPERATING INCOME 722,721 542,410 1,245,296 860,871
------- ------- --------- -------
TOTAL NONINTEREST INCOME 1,305,070 2,494,026 5,008,316 5,199,491
--------- --------- --------- ---------
INCOME BEFORE OPERATING EXPENSES 14,689,469 14,711,758 30,545,650 30,050,229
---------- ---------- ---------- ----------
OPERATING EXPENSES:
- -------------------
SALARIES AND OTHER EMPLOYEE BENEFITS 5,772,454 5,559,618 11,753,320 11,119,628
OCCUPANCY 978,667 963,702 1,964,429 1,896,384
EQUIPMENT 363,982 403,669 732,936 792,196
LEGAL 917,361 819,650 1,763,213 3,152,550
MARKETING AND ADVERTISING 348,502 277,396 654,704 608,751
OTHER OPERATING EXPENSES 1,596,882 1,809,581 3,395,183 3,721,131
--------- --------- --------- ---------
TOTAL OPERATING EXPENSES 9,977,848 9,833,616 20,263,785 21,290,640
--------- --------- ---------- ----------
INCOME BEFORE INCOME TAXES 4,711,621 4,878,142 10,281,865 8,759,589
PROVISION FOR INCOME TAXES 1,346,731 1,477,630 3,021,949 2,581,197
--------- --------- --------- ---------
NET INCOME $3,364,890 $3,400,512 $7,259,916 $6,178,392
- ---------- ========== ========== ========== ==========
BASIC EARNINGS PER COMMON SHARE $0.37 $0.38 $0.81 $0.70
- ------------------------------- ===== ===== ===== =====
DILUTED EARNINGS PER COMMON SHARE $0.36 $0.38 $0.78 $0.68
- --------------------------------- ===== ===== ===== =====
See accompanying notes to unaudited consolidated financial statements.
2
STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED)
2004 2003
---- ----
OPERATING ACTIVITIES:
- ---------------------
NET INCOME $7,259,916 $6,178,392
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED BY OPERATING ACTIVITIES:
PROVISION FOR PROBABLE LOAN LOSSES 2,163,000 1,967,502
DEPRECIATION AND AMORTIZATION OF BANK PREMISES AND EQUIPMENT 759,893 818,563
AMORTIZATION OF INTANGIBLES 18,069 18,068
AMORTIZATION OF NET PREMIUM ON SECURITIES 3,044,747 4,312,264
AMORTIZATION OF UNEARNED COMPENSATION - 82,601
NET SECURITY GAINS (2,590,440) (3,581,550)
(INCREASE) DECREASE IN OTHER ASSETS (2,239,491) 7,119,752
DECREASE IN ACCRUED EXPENSES, TAXES
AND OTHER LIABILITIES (107,936) (1,206,443)
-------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 8,307,758 15,709,149
--------- ----------
INVESTING ACTIVITIES:
- ---------------------
PROCEEDS FROM MATURITIES OF SECURITIES HELD TO MATURITY 15,051,400 26,680,886
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 85,984,669 344,662,125
PROCEEDS FROM MATURITIES OF SECURITIES AVAILABLE FOR SALE 139,261,679 203,071,779
PURCHASES OF SECURITIES AVAILABLE FOR SALE AND HELD TO MATURITY (300,117,705) (506,730,599)
INCREASE IN LOANS - NET (22,798,463) (24,571,628)
PURCHASES OF BANK PREMISES AND EQUIPMENT - NET (298,604) (537,002)
INCREASE IN BANK OWNED LIFE INSURANCE (25,393,913) -
----------- ----------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (108,310,937) 42,575,561
------------ ----------
FINANCING ACTIVITIES:
- ---------------------
(DECREASE) INCREASE IN DEMAND AND SAVINGS DEPOSITS (154,762,051) 95,121,621
DECREASE IN TIME DEPOSITS (14,561,043) (139,338,307)
INCREASE IN FEDERAL FUNDS PURCHASED 15,000,000 23,250,000
INCREASE (DECREASE) IN SECURITIES SOLD UNDER AGREEMENTS
TO REPURCHASE 85,304,853 (49,983,000)
INCREASE IN OTHER BORROWINGS 71,626,986 21,341,465
CASH DIVIDENDS PAID (2,399,727) (2,236,767)
PROCEEDS FROM SHARES ISSUED UNDER DIVIDEND REINVESTMENT PLAN 1,162,708 1,275,630
PROCEEDS FROM STOCK OPTIONS EXERCISED 387,763 237,262
PROCEEDS FROM STOCK ISSUED UNDER DIRECTORS' STOCK PLAN - 17,226
PURCHASES OF TREASURY STOCK (1,521,863) (642,823)
---------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 237,626 (50,957,693)
------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (99,765,553) 7,327,017
CASH AND CASH EQUIVALENTS - JANUARY 1 147,762,269 98,586,855
----------- ----------
CASH AND CASH EQUIVALENTS - JUNE 30 $47,996,716 $105,913,872
=========== ============
SUPPLEMENTAL DATA:
- ------------------
INTEREST PAID $5,364,193 $6,967,844
INCOME TAXES PAID $3,481,634 $2,547,974
ADJUSTMENT TO UNREALIZED NET GAIN OR LOSS ON SECURITIES
AVAILABLE FOR SALE ($9,278,753) ($1,553,613)
DIVIDENDS DECLARED BUT NOT PAID AS OF QUARTER END $1,297,302 $1,136,691
See accompanying notes to unaudited consolidated financial statements.
3
STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED)
ACCUMULATED
OTHER TOTAL COMPRE-
COMPRE- UNEARNED STOCK- HENSIVE
COMMON RETAINED TREASURY HENSIVE COMPEN- HOLDERS' INCOME
STOCK SURPLUS EARNINGS STOCK INCOME (LOSS) SATION EQUITY (LOSS)
-------------------------------------------------------------------------------------------------
BALANCE, JANUARY 1, 2004 $46,889,775 $53,544,877 $5,189,907 ($13,481,356) $2,568,319 $ - $94,711,522
NET INCOME - - 7,259,916 - - - 7,259,916 $7,259,916
----------
UNREALIZED HOLDING LOSSES
ARISING DURING THE PERIOD - - - - - - (4,517,641)
RECLASSIFICATION
ADJUSTMENT FOR GAINS
INCLUDED IN NET INCOME - - - - - - (1,681,695)
CASH FLOW HEDGES - - - - - - (403,840)
----------
TOTAL OTHER
COMPREHENSIVE LOSS - - - - (6,603,176) - (6,603,176) (6,603,176)
----------
TOTAL COMPREHENSIVE
INCOME - - - - - - $656,740
========
CASH DIVIDEND
($0.28 PER SHARE) - - (2,500,958) - - - (2,500,958)
5% STOCK DIVIDEND (427,776
SHARES AT MARKET VALUE) 2,138,880 7,203,748 (9,342,628) - - - -
SHARES ISSUED UNDER THE
DIVIDEND REINVESTMENT
PLAN (51,130 SHARES AT
95% OF MARKET VALUE) 255,650 907,058 - - - - 1,162,708
STOCK OPTIONS EXERCISED 213,010 174,753 - - - - 387,763
TREASURY STOCK PURCHASED - - - (1,521,863) - - (1,521,863)
-------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2004 $49,497,315 $61,830,436 $606,237 ($15,003,219) ($4,034,857) $ - $92,895,912
===========================================================================================
BALANCE, JANUARY 1, 2003 $43,818,395 $45,714,829 $5,419,517 ($12,444,116) $5,218,101 ($44,095) $87,682,631
NET INCOME - - 6,178,392 - - - 6,178,392 $6,178,392
----------
UNREALIZED HOLDING GAINS
ARISING DURING THE PERIOD - - - - - - 1,154,864
RECLASSIFICATION
ADJUSTMENT FOR GAINS
INCLUDED IN NET INCOME - - - - - - (2,334,923)
----------
TOTAL OTHER
COMPREHENSIVE LOSS - - - - (1,180,059) - (1,180,059) (1,180,059)
----------
TOTAL COMPREHENSIVE
INCOME - - - - - - $4,998,333
==========
CASH DIVIDEND
($0.26 PER SHARE) - - (2,259,512) - - - (2,259,512)
5% STOCK DIVIDEND (401,978
SHARES AT MARKET VALUE) 2,009,890 5,587,495 (7,597,385) - - - -
SHARES ISSUED UNDER THE
DIVIDEND REINVESTMENT
PLAN (74,168 SHARES AT
95% OF MARKET VALUE) 370,840 904,790 - - - - 1,275,630
STOCK OPTIONS EXERCISED 153,965 83,297 - - - - 237,262
STOCK ISSUED UNDER
DIRECTORS' STOCK PLAN 4,785 12,441 - - - - 17,226
TREASURY STOCK PURCHASED - - - (642,823) - - (642,823)
AMORTIZATION OF UNEARNED
COMPENSATION - 38,506 - - - 44,095 82,601
-------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2003 $46,357,875 $52,341,358 $1,741,012 ($13,086,939) $4,038,042 $ - $91,391,348
===========================================================================================
See accompanying notes to unaudited consolidated financial statements.
4
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
1. FINANCIAL STATEMENT PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
- -- --------------------------------------------------------------------
In the opinion of the management of State Bancorp, Inc. (the "Company"), the
preceding unaudited consolidated financial statements contain all adjustments,
consisting of normal accruals, necessary for a fair presentation of its
consolidated balance sheets as of June 30, 2004 and December 31, 2003, its
consolidated statements of income for the three and six months ended June 30,
2004 and 2003, its consolidated statements of cash flows for the six months
ended June 30, 2004 and 2003 and its consolidated statements of stockholders'
equity and comprehensive income (loss) for the six months ended June 30, 2004
and 2003. The results of operations for the three and six months ended June 30,
2004 are not necessarily indicative of the results of operations to be expected
for the remainder of the year. For further information, please refer to the
consolidated financial statements and footnotes thereto included in the
Company's 2003 annual report on Form 10-K. Certain amounts have been
reclassified to conform to the current year's presentation.
Accounting for Stock Options
- ----------------------------
The Company accounts for stock-based compensation using the intrinsic value
method which recognizes as expense the difference between the market value of
the stock and the exercise price at grant date. The Company discloses the pro
forma effects of accounting for stock-based compensation using the fair value
method.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
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 adopted the
disclosure requirements of SFAS No. 148 as of December 31, 2002.
The estimated fair value of options granted during 2004 and 2003 was $5.95 and
$4.40 per share, respectively. The Company applies Accounting Principles Board
Opinion ("APB") No. 25 and related interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its incentive stock
option plans. Had compensation cost for the Company's four plans been determined
at the fair value on the grant dates for awards under those plans, consistent
with the method in SFAS No. 123, "Accounting for Stock-based Compensation," the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below.
5
For the Six Months Ended June 30, 2004 2003
- ------------------------------------ ---- ----
Net income, as reported $7,259,916 $6,178,392
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects (192,620) (140,975)
---------- ----------
Pro forma net income $7,067,296 $6,037,417
========== ==========
Earnings per share:
Basic - as reported $0.81 $0.70
Basic - pro forma $0.78 $0.68
Diluted - as reported $0.78 $0.68
Diluted - pro forma $0.76 $0.67
The fair value of options granted under the Company's incentive stock option
plans during 2004 and 2003 were estimated on the date of grant using the
Black-Scholes Single Option Pricing Model with the following weighted-average
assumptions used:
2004 2003
---- ----
Dividend yield 2.5% 3.1%
Expected volatility 25.5% 28.4%
Risk-free interest rate 3.55% 3.38%
Expected life of options 7.3 years 7.4 years
Accounting for Derivative Financial Instruments
- -----------------------------------------------
The Company uses interest rate swap agreements to manage its exposure to
fluctuations in interest rates on a portion of its variable rate commercial loan
portfolio. The agreements qualify as cash flow hedges. Gains and losses in the
fair value of a cash flow hedge are recorded to other comprehensive income for
the effective portion of the hedge and reclassified to earnings at a time when a
forecasted transaction affects earnings. Amounts to be received under the swap
agreement are recognized as an addition to interest income in the Company's
consolidated statements of income during the period in which they accrue. The
Company does not hold any derivative financial instruments for trading purposes.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," resulting in more consistent reporting of contracts as
either derivatives or hybrid instruments. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003, and should be
applied prospectively. Implementation issues that had been effective for fiscal
quarters that began prior to June 15, 2003 are to be applied in accordance with
their respective effective dates. The Company's adoption of SFAS No. 149 as of
July 1, 2003, did not have a material impact on the Company's financial
statements.
At June 30, 2004, the Company is party to two swap agreements with terms
expiring in September 2007 that hedge a portion of the interest rate variability
in its portfolio of prime rate loans. The agreements effectively require the
Company to pay prime interest rate and receive a fixed rate of 6.01% from the
counterparty on $50 million of loan
6
assets. The fair value of the swap agreements was ($627,950), inclusive of
accrued interest of $44,667, at June 30, 2004. For the six months ended June 30,
2004, the Company recognized interest income of $508,083 under the agreements.
The Company did not engage in derivatives activity during the first half of
2003.
Accounting for Bank Owned Life Insurance
- ----------------------------------------
In February 2004, the Company purchased $25 million in Bank Owned Life Insurance
as a mechanism for funding current and future employee benefit costs. The
Company is the beneficiary of this policy that insures the lives of certain
officers of its subsidiaries. The Company has recognized the cash surrender
value under the insurance policy as an asset in the consolidated balance sheets.
Changes in the cash surrender value are recorded in other operating income.
Recent Accounting Developments
- ------------------------------
In January 2003, the FASB issued FASB Interpretaion ("FIN") No. 46,
"Consolidation of Variable Interest Entities" which was revised in December 2003
by the issuance of FIN No. 46(R). The Interpretation clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46(R) is effective for the Company for
financial statements issued after December 15, 2003. The Company has
participated in the issue of trust preferred securities, classified as junior
subordinated debentures in the financial statements, through trusts established
for such purpose. Effective December 31, 2003, the Company adopted this
statement requiring the Company to deconsolidate the trust preferred security
trusts. Such adoption did not have a material impact on the Company's financial
statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
requires that certain financial instruments, which previously could be
designated as equity, now be classified as liabilities on the balance sheet. The
effective date of SFAS No. 150 has been indefinitely deferred by the FASB when
certain criteria are met. Although the Company's trust preferred securities meet
such criteria, the trust preferred securities have been deconsolidated under the
provision of FIN No. 46(R) and reclassified as borrowed funds as of December 31,
2003.
In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a consensus
regarding EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." The consensus provides guidance for
evaluating whether an investment is other-than-temporarily impaired and requires
certain disclosures for equity investments accounted for under the cost method.
Disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments that were required under an earlier EITF 03-1
consensus remain in effect. The EITF 03-1 guidance for determining
other-than-temporary impairment is effective for the Company's quarter ending
September 30, 2004 and the disclosures for the cost method investments are
effective for the Company's fiscal year ending December 31, 2004. The
determination of whether a decline in market value is other-than-temporary is
necessarily a matter of subjective judgment. The timing and amount of any
realized losses reported in the Company's financial statements could vary if
management's conclusions were to change as to whether an other-than-temporary
impairment exists. At June 30, 2004 compared to December 31, 2003, there have
been no material changes in the Company's investments' unrealized losses and the
length of time that individual securities have been in a continuous unrealized
loss position. The Company's management is still in the process of evaluating
the impact of applying EITF 03-1 on the Company's financial statements.
2. STOCKHOLDERS' EQUITY
- -- --------------------
The Company has 250,000 shares of preferred stock authorized. No shares were
issued as of June 30, 2004.
7
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 stockholders'
equity. During the quarter, the Company repurchased 41,736 common shares at an
average price of $21.37 per share.
3. EARNINGS PER SHARE
- -- ------------------
Basic earnings per common share is computed based on the weighted average number
of shares outstanding. Diluted earnings per share is computed based on the
weighted average number of shares outstanding, increased by the number of common
shares that are assumed to have been purchased with the proceeds from the
exercise of stock options (treasury stock method). These purchases were assumed
to have been made at the average market price of the common stock. The average
market price is based on the average closing price for the common stock.
Retroactive recognition has been given for stock dividends.
For the Six Months Ended June 30, 2004 2003
- --------------------------------- ---- ----
Net income $7,259,916 $6,178,392
Average dilutive stock options outstanding 744,048 815,714
Average exercise price per share $11.34 $13.02
Average market price - diluted basis $22.88 $17.06
Average common shares outstanding 9,013,329 8,853,033
Increase in shares due to exercise of options - diluted basis 307,989 193,141
------- -------
Adjusted common shares outstanding - diluted 9,321,318 9,046,174
========= =========
Net income per share - basic $0.81 $0.70
===== =====
Net income per share - diluted $0.78 $0.68
===== =====
4. UNREALIZED NET GAIN (LOSS) ON SECURITIES AVAILABLE FOR SALE
- -- -----------------------------------------------------------
Securities available for sale are stated at estimated fair value, and unrealized
gains and losses are excluded from earnings and reported net of tax as
accumulated other comprehensive income (loss) as a separate component of
stockholders' equity until realized. Securities held to maturity are stated at
amortized cost. Management designates each security, at the time of purchase, as
either available for sale or held to maturity depending upon investment
objectives, liquidity needs and intent.
5. LOANS
- -- -----
The recorded investment in loans that are considered to be impaired, for the
quarter ended June 30, 2004 and for the year ended December 31, 2003, is
summarized below.
8
For the Quarter Ended For the Year Ended
June 30, 2004 December 31, 2003
------------- -----------------
Amount measured using the present value of expected future
cash flows, discounted at each loan's effective interest rate $420,925 $433,088
Impaired collateral-dependent loans 2,786,053 7,747,117
--------- ---------
Total amount evaluated as impaired $3,206,978 $8,180,205
========== ==========
Average impaired loan balance $3,210,963 $7,814,272
========== ==========
As a result of the Company's evaluation of impaired loans, an allowance for
probable loan losses of approximately $659,000 and $2,755,000 was established
for $1,640,950 and $7,267,664 of the total impaired loans at June 30, 2004 and
December 31, 2003, respectively. No specific allowance was required for the
remaining balance of impaired loans at June 30, 2004 and December 31, 2003.
Interest income of $28,765 and $43,547 was recognized on impaired loans for the
six months ended June 30, 2004 and 2003, respectively, while interest income of
$8,631 and $43,547 was recognized on impaired loans for the three months ended
June 30, 2004 and 2003, respectively.
Activity in the allowance for probable loan losses for the six months ended June
30, 2004 and 2003 is as follows:
2004 2003
---- ----
Balance, January 1 $10,732,078 $10,045,516
Provision charged to income 2,163,000 1,967,502
Charge-offs, net of recoveries of $79,600 in 2004 and $148,680 in 2003 (1,852,785) (1,618,130)
----------- -----------
Balance, June 30 $11,042,293 $10,394,888
=========== ===========
6. LEGAL PROCEEDINGS
- -- -----------------
The Bank is involved in a number of legal proceedings related to Island Mortgage
Network, Inc. and certain related entities, which held deposit accounts at the
Bank during portions of 1999 and 2000. The Bank is defending these lawsuits
vigorously, and management believes that the Bank has substantial defenses, both
substantive and procedural, to the claims that have been threatened or asserted
to date. However, the ultimate outcome of litigation cannot be predicted with
certainty.
7. INCOME TAX MATTERS
- -- ------------------
The Company's New York state income tax returns are under examination for the
years ended December 31, 1999, 2000 and 2001. At this time, management cannot
determine the effects, if any, that the results of this examination will have on
the Company's consolidated financial statements.
9
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview - The Company, a one-bank holding company, was formed on June 24, 1986.
The Company operates as the parent for its wholly owned subsidiaries, State Bank
of Long Island and subsidiaries (the "Bank"), a New York state-chartered
commercial bank founded in 1966, and State Bancorp Capital Trust I and II,
entities formed in 2002 and 2003, respectively, to issue Trust Preferred
securities. These Trust Preferred securities are classified as junior
subordinated debentures in the financial statements. The income of the Company
is derived through the operations of the Bank and its subsidiaries, SB Portfolio
Management Corp. ("SB Portfolio"), SB Financial Services Corp. ("SB Financial"),
New Hyde Park Leasing Corporation ("NHPL") and its subsidiary P.W.B. Realty,
L.L.C. ("PWB"), Studebaker-Worthington Leasing Corp. ("SWLC") and SB ORE Corp.
Financial performance of State Bancorp, Inc. Over/
(dollars in thousands, except per share data) (under)
As of or for the six months ended June 30, 2004 2003 2003
- ----------------------------------------------------------------------------------------------
Revenue (1) $32,708 $32,017 2 %
Operating expenses 20,264 21,291 (5)
Provision for probable loan losses 2,163 1,968 10
Net income 7,260 6,178 18
Net income per share - diluted (2) 0.78 0.68 15
Dividend payout ratio 34.45% 36.57% (212)bp
Return on average total stockholders' equity 15.22% 13.72% 150
- ----------------------------------------------------------------------------------------------
Tier I leverage ratio 7.72% 6.82% 90 bp
Tier I capital ratio 12.13% 11.30% 83
Total capital ratio 13.30% 12.55% 75
- ----------------------------------------------------------------------------------------------
bp - denotes basis points; 100 bp equals 1%.
(1) Represents net interest income plus total noninterest income.
(2) Retroactive recognition has been given for stock dividends.
As of June 30, 2004, the Company, on a consolidated basis, had total assets of
approximately $1.5 billion, total deposits of approximately $1.0 billion and
stockholders' equity of approximately $92.9 million. Unless the context
otherwise requires, references herein to the Company include the Company and its
subsidiaries on a consolidated basis.
The Bank provides a full range of banking services to customers located
primarily in Nassau, Suffolk and Queens Counties. The Bank serves its customer
base through fifteen full-service branches in those counties and a lending
center in Jericho. The Bank's deposit products include checking, savings, time,
money market and IRA accounts. The Bank offers secured and unsecured commercial
and consumer loans. Credit services offered include commercial mortgage loans,
construction mortgage loans, other commercial installment loans and lines of
credit, home equity lines of credit, residential mortgage loans, letters of
credit, equipment leasing and auto and other personal loans. In addition, the
Bank provides safe deposit services, merchant credit card services, access to
annuity products and mutual funds and a consumer debit card with membership in a
national ATM network. Through an alliance with U.S. Trust Company, the Bank also
offers its customers access to financial planning and wealth management
services. Thirteen of the Bank's branches have ATMs. The Bank also offers its
customers on-line banking, bill payment and cash management services. The Bank's
strategy of establishing and maintaining long-term customer relationships has
contributed to the Bank's relatively stable core deposit base.
The Bank considers its business to be highly competitive in its market areas.
The Bank competes with depository financial institutions and other businesses
with respect to its lending services and/or in attracting deposits. Competitors
include commercial banks, savings banks, insurance companies, credit unions,
money market funds and affiliates of consumer goods manufacturers. The Bank's
competitors include local, regional and national depository
10
financial institutions and other businesses of varied sizes. The Bank is
considerably smaller in size than many of its major banking competitors.
Nonetheless, the Bank has demonstrated the ability to compete profitably with
larger financial institutions.
The Bank's leasing activity has been primarily conducted by its wholly owned
subsidiaries, NHPL, formed in 1979 to lease commercial equipment and SWLC,
acquired in 2001 with a thirty year history of nationwide equipment leasing
specializing in small-ticket leases for computers and office equipment.
The Bank has organized various operating subsidiaries. NHPL owns 51% of PWB,
which was formed in 2002 to own the Bank's branch premises located in Port
Washington, New York. The Bank owns 100% of SB ORE Corp., formed in 1994 to hold
foreclosed property. In 1998, the Bank established SB Portfolio and SB
Financial, two wholly owned Delaware-based subsidiaries. SB Portfolio holds and
manages a portfolio of fixed income investments while SB Financial provides
balance sheet management services such as interest rate risk modeling and
asset/liability management reporting along with general advisory services to the
Company and its subsidiaries.
Neither the Company nor any of its direct or indirect subsidiaries is dependent
upon a single customer or very few customers. No material amount of deposits is
obtained from a single depositor. The Bank does not rely on foreign sources of
funds or income and the Bank does not have any foreign commitments, with the
exception of letters of credit issued on behalf of several of its customers. The
Bank's nature and conduct of business have remained substantially unchanged
since year-end 2003.
The Company expects that compliance with provisions regulating environmental
controls will have no effect upon the capital, expenditures, earnings or
competitive position of the Company. The Company operates in the banking
industry and management considers the Company to be aggregated in one reportable
operating segment. The Bank has not experienced any material seasonal
fluctuations in its business. The Company has not had material expenditures for
research and development. The Company employed 338 full-time and part-time
officers and employees as of June 30, 2004.
The Company's Internet address is www.statebankofli.com. The Company makes
available on its Internet website its annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments thereto as soon
as reasonably practicable after the Company files such material with, or
furnishes such material to, the Securities and Exchange Commission, as
applicable.
Recent Accounting Developments - In January 2003, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities" which was revised in December 2003
by the issuance of FIN No. 46(R). The Interpretation clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46(R) is effective for the Company for
financial statements issued after December 15, 2003. The Company has
participated in the issue of trust preferred securities through trusts
established for such purpose. Effective December 31, 2003, the Company adopted
this statement requiring the Company to deconsolidate the trust preferred
security trusts. Such adoption did not have a material impact on the Company's
financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," resulting in
more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003, and should be applied prospectively.
Implementation issues that had been effective for fiscal quarters that began
prior to June 15, 2003 are
11
to be applied in accordance with their respective effective dates. The Company's
adoption of SFAS No. 149 as of July 1, 2003, did not have a material impact on
the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
requires that certain financial instruments, which previously could be
designated as equity, now be classified as liabilities on the balance sheet. The
effective date of SFAS No. 150 has been indefinitely deferred by the FASB when
certain criteria are met. Although the Company's trust preferred securities meet
such criteria, the trust preferred securities have been deconsolidated under the
provision of FIN No. 46(R) and reclassified as borrowed funds as of December 31,
2003.
In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a consensus
regarding EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." The consensus provides guidance for
evaluating whether an investment is other-than-temporarily impaired and requires
certain disclosures for equity investments accounted for under the cost method.
Disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments that were required under an earlier EITF 03-1
consensus remain in effect. The EITF 03-1 guidance for determining
other-than-temporary impairment is effective for the Company's quarter ending
September 30, 2004 and the disclosures for the cost method investments are
effective for the Company's fiscal year ending December 31, 2004. The
determination of whether a decline in market value is other-than-temporary is
necessarily a matter of subjective judgment. The timing and amount of any
realized losses reported in the Company's financial statements could vary if
management's conclusions were to change as to whether an other-than-temporary
impairment exists. At June 30, 2004 compared to December 31, 2003, there have
been no material changes in the Company's investments' unrealized losses and the
length of time that individual securities have been in a continuous unrealized
loss position. The Company's management is still in the process of evaluating
the impact of applying EITF 03-1 on the Company's financial statements.
Critical Accounting Policies, Judgments And Estimates - The discussion and
analysis of the financial condition and results of operations of the Company 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,
revenues and expenses. Management evaluates those estimates and assumptions on
an ongoing basis, including those related to the allowance for probable loan
losses and income taxes. Management bases its estimates on historical experience
and various other factors and assumptions that are believed to be reasonable
under the circumstances. These form the bases for making judgments on the
carrying value of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from those estimates under different
assumptions or conditions.
Allowance for Probable Loan Losses - In management's opinion, the most critical
accounting policy impacting the Company's financial statements is the evaluation
of the allowance for probable loan losses. Management carefully monitors the
credit quality of the loan portfolio and, on a quarterly basis, charges off the
amounts of those loans deemed uncollectible. Management evaluates the fair value
of collateral supporting the impaired loans using independent appraisals and
other measures of fair value. This process involves subjective judgments and
assumptions and is subject to change based on factors that may be outside the
control of the Company.
12
[THE FOLLOWING DATA WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIAL.]
LOAN PORTFOLIO AND THE ALLOWANCE
FOR PROBABLE LOAN LOSSES
For the Period Ended Loans(net of unearned income) Allowance as a %
(in thousands) of total loans
- --------------------------------------------------------------------------------
12/31/00 $496,992 1.85%
12/31/01 $551,598 1.68%
12/31/02 $620,384 1.62%
12/31/03 $711,216 1.51%
6/30/04 $732,162 1.51%
Management of the Company recognizes that, despite its best efforts to minimize
risk through a rigorous credit review process, losses will occur. In times of
economic slowdown, either regional or national, the risk inherent in the
Company's loan portfolio will increase. The timing and amount of loan losses
that occur are dependent upon several factors, most notably qualitative and
quantitative factors about both the micro and macro economic conditions as
reflected in the loan portfolio and the economy as a whole. Factors considered
in this evaluation include, but are not limited to, estimated losses from loan
and other credit arrangements, general economic conditions, changes in credit
concentrations or pledged collateral, historical loan loss experience and trends
in portfolio volume, maturity, composition, delinquencies and nonaccruals. The
allowance for probable loan losses is available to absorb charge-offs from any
loan category, while additions are made through the provision for probable loan
losses, which is a charge to operating earnings. The adequacy of the provision
and the resulting allowance for probable loan losses is determined by
management's continuing review of the loan portfolio, including identification
and review of individual problem situations that may affect a borrower's ability
to repay, delinquency and nonperforming loan data, collateral values, regulatory
examination results and changes in the size and character of the loan portfolio.
Thus, an increase in the size of the loan portfolio or in any of its components
could necessitate an increase in the allowance even though credit quality and
problem loan totals may be improving.
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 and the judgments and estimates required
for the evaluation are periodically updated based upon changes in business
factors and the tax laws.
The Company's New York state income tax returns are under examination for the
years ended December 31, 1999, 2000 and 2001. At this time, management cannot
determine the effects, if any, that the results of this examination will have on
the Company's consolidated financial statements.
Material Changes in Financial Condition - Total assets of the Company were $1.5
billion at June 30, 2004. When compared to December 31, 2003, total assets
increased by $56 million or 4%. The increase was primarily attributable to
growth in both the investment and loan portfolios, the purchase of Bank Owned
Life Insurance and the receivable
13
for settlements of investment securities sold of $79 million, $21 million, $25
million and $26 million, respectively. These were partially offset by a decline
in overnight securities purchased under agreements to resell of $91 million. The
growth in the investment portfolio resulted primarily from increases in U.S.
Government Agency securities. The primary factor contributing to the growth in
the loan portfolio was the increase in commercial mortgage loans.
At June 30, 2004, total deposits were $1.0 billion, a decrease of $169 million
or 14% when compared to December 31, 2003. This decline was largely attributable
to a decrease in savings deposits of $173 million, as Super NOW, regular savings
and money fund deposits decreased $140 million, $21 million and $12 million,
respectively. There was also a decrease in time deposits of $15 million.
Partially offsetting these decreases was an increase in demand deposits of $19
million. Core deposit balances, consisting of demand, savings, money fund and
Super NOW deposits, represented approximately 76% of total deposits at June 30,
2004 compared to 78% at year-end 2003. Core deposit balances provide low-cost
funding that allows the Company to reduce its funding from short-term
institutional sources. Short-term borrowed funds, primarily securities sold
under agreements to repurchase and Federal Home Loan Bank of New York ("FHLB")
advances, have been utilized for funding purposes. At June 30, 2004, total
short-term borrowings were $264 million, an increase of $172 million from
December 31, 2003.
Average interest-earning assets for the second quarter of 2004 were up by $52
million or 4% to $1.4 billion from the comparable 2003 period. This was largely
the result of an $82 million or 13% increase in average loans, primarily
commercial loans and commercial mortgages, partially offset by a $12 million or
2% decrease in average investment securities, with U.S. Government Agency
securities declining $19 million. Average money market instruments also
declined.
Funding the second quarter growth in average interest-earning assets were
increases in both average core deposits and average borrowed funds. Average core
deposits increased $27 million or 3% during the second quarter of 2004 as
compared to the same period in 2003, reflecting the 18% increase in average
demand deposits. The increase in average short-term borrowed funds during the
second quarter of 2004 as compared to the same period last year was primarily
attributable to a $78 million higher FHLB funding level, coupled with a $22
million increase in securities sold under agreements to repurchase.
These activities resulted in a second quarter net interest margin on a
tax-equivalent basis of 4.33%, up from 4.12% one year ago. The increased level
of core deposits has allowed the Company to reduce its dependence on higher-cost
funding which, combined with the continued relatively low interest rate
environment, resulted in an 18 basis points decline in the Company's second
quarter average cost of funds to 0.81% as compared to the same period in 2003.
Capital - The Company's capacity to grow its assets and earnings stems, in part,
from the significance of its capital strength. The Company strives to maintain
an optimal level of capital, commensurate with its risk profile, on which an
attractive rate of return to stockholders will be realized over both the short
and long term, while serving the needs of depositors, creditors and regulators.
In determining an optimal capital level, the Company also considers the capital
levels of its peers and the evaluations of its primary regulators. At June 30,
2004, the Company's and the Bank's capital ratios are in excess of those
necessary for classification as a "well-capitalized" institution pursuant to the
provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA).
During 2004, the Company's capital has expanded by the amount of its net income
earned and common stock issued net of cash dividends paid to stockholders and
shares repurchased. Internal capital generation, defined as earnings less cash
dividends paid on common stock, is the primary catalyst supporting the Company's
future growth of assets and stockholder value. Total stockholders' equity
amounted to $93 million at June 30, 2004, representing a $2 million (2%)
decrease and a $2 million (2%) increase, respectively, from December 31 and June
30, 2003. The Company has no plans or commitments for capital utilization or
expenditures that would affect its current capital position or would impact its
future financial performance. Table 2-1 summarizes the Company's capital ratios
as of June 30, 2004 and compares them to current regulatory guidelines and
December 31 and June 30, 2003 actual
14
results.
TABLE 2-1
Tier I Capital/ Total Capital/
Tier I Risk-Weighted Risk-Weighted
Leverage Assets Assets
-------- --------------- --------------
Regulatory Minimum 3.00%-4.00% 4.00% 8.00%
Ratios as of:
June 30, 2004 7.72% 12.13% 13.30%
December 31, 2003 8.08% 12.26% 13.46%
June 30, 2003 6.82% 11.30% 12.55%
Regulatory Criteria for a
"Well-Capitalized" Institution 5.00% 6.00% 10.00%
Management strives to provide stockholders with a competitive return on their
investment in the Company. During the second quarter of 2004, the Company's
Board of Directors declared a 5% stock dividend, the 35th consecutive year that
it will pay a stock dividend. In addition, for the first six months of 2004, the
Board of Directors declared cash dividends on the Company's common stock
amounting to $0.28 per share (as adjusted for the 5% stock dividend), increasing
its quarterly cash dividend 7% to $0.15 per share ($0.14 per share as adjusted
for the 5% stock dividend) for the second quarter.
[THE FOLLOWING DATA WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIAL.]
CASH DIVIDENDS PAID AND DIVIDEND PAYOUT RATIOS
For the Period Ended Dividends paid Payout ratio
- --------------------------------------------------------------------------------
12/31/00 $3,777,938 35.28%
12/31/01 $4,197,162 38.79%
12/31/02 $4,414,379 39.06%
12/31/03 $4,647,399 38.68%
6/30/04 $2,500,959 34.45%
The Company's stock repurchase program expended $892 thousand during the second
quarter of 2004 to repurchase 41,736 shares at an average cost of $21.37 per
share. Since 1998, a total of 905,065 shares of Company stock have been
repurchased at an average cost of $16.58 per share. Under the Board of
Directors' existing authorization, an additional 594,935 shares may be
repurchased from time to time as conditions warrant. This action will only occur
15
if management believes that the purchase will be at prices that are accretive to
earnings per share.
During the fourth quarter of 2003, the Company enhanced its Tier I capital
position through the issuance of an additional $10 million in trust preferred
securities through a pooled offering structure. The trust preferred securities,
which currently qualify as Tier I capital for regulatory capital purposes, were
issued by a newly established subsidiary, State Bancorp Capital Trust II. The
securities bear an interest rate tied to three-month LIBOR and are redeemable by
the Company in whole or in part after five years or earlier under certain
circumstances. The initial rate on the securities was 4.02%. The Company now has
a total of $20 million in trust preferred securities outstanding. During the
second quarter of 2004, the weighted average rate on all trust preferred
securities was 4.33%.
Liquidity and Off-Balance Sheet Arrangements - Liquidity management is a
fundamental component of the Company's business strategy. The objective of
liquidity management is to assure the ability of the Company and its
subsidiaries to meet their financial obligations. These obligations include the
withdrawal of deposits on demand or at their contractual maturity, the repayment
of borrowings as they mature, the ability to fund new and existing loan
commitments, the ability to meet payments under various leases and the capacity
to take advantage of business opportunities as they arise. The Board of
Directors' Funds Management Committee and Management's Asset/Liability Committee
are responsible for ensuring a stable source of funding to meet both the
expected and unexpected cash demands of loan and deposit customers. Liquidity is
composed of the maintenance of a strong base of core customer funds, maturing
short-term assets, the ability to sell marketable securities and access to lines
of credit, brokered deposits and the capital markets. The Company complements
its stable base of core deposits, provided by long-standing customer
relationships, with short-term borrowings from correspondent banks and time
deposits from other corporate customers and municipalities.
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby and
documentary letters of credit. Those instruments involve, to varying degrees,
elements of credit risk in excess of the amount recognized in the consolidated
financial statements. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
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 Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation of the customer. Collateral required varies, but may include
accounts receivable, inventory, equipment, real estate and income-producing
commercial properties. At June 30, 2004 and 2003, commitments to originate loans
and commitments under unused lines of credit for which the Bank is obligated
amounted to approximately $231 million and $221 million, respectively.
Letters of credit are conditional commitments issued by the Bank guaranteeing
payments of drafts in accordance with the terms of the letter of credit
agreements. Commercial letters of credit are used primarily to facilitate trade
or commerce and are also issued to support public and private borrowing
arrangements, bond financing and similar transactions. Collateral may be
required to support letters of credit based upon management's evaluation of the
creditworthiness of each customer. The credit risk involved in issuing letters
of credit is essentially the same as that involved in extending loan facilities
to customers. Most letters of credit expire within one year. At June 30, 2004
and 2003, the Bank had letters of credit outstanding of approximately $15
million and $12 million, respectively. At June 30, 2004, the uncollateralized
portion was approximately $3 million.
The Bank's use of derivative financial instruments, i.e. interest rate swaps, is
exposed to credit risk. This credit exposure relates to possible losses that
would be recognized if the counterparties fail to perform their obligations
16
under the contracts. To mitigate this credit exposure, the Bank deals only with
counterparties of good credit standing and requires the exchange of collateral
over a certain credit threshold. At June 30, 2004, the Bank is party to two
interest rate swap agreements to manage its exposure to fluctuations in interest
rates on $50 million of variable rate commercial loans. The Bank did not engage
in derivatives activities during the first half of 2003.
The Company is obligated under various leases covering certain equipment,
branches, office space and the land on which its head office is built. The
minimum payments under these leases, certain of which contain escalation
clauses, are as follows: in 2004, $1.2 million; in 2005, $2.3 million; in 2006,
$1.9 million; in 2007, $1.7 million; in 2008, $1.7 million; and the remainder to
2012, $4.7 million.
Liquidity at the Company is measured and monitored daily, thereby allowing
management to better understand and react to emerging balance sheet trends.
After assessing actual and projected cash flow needs, management seeks to obtain
funding at the most economical cost to the Company. Throughout the second
quarter of 2004, the Company's liquidity position remained stable and well
within acceptable industry standards. During the second quarter of 2004, the
level of core deposits, calls of U.S. Government Agency securities and paydowns
on mortgage-backed securities provided a source of readily available funds to
meet general liquidity needs. In addition, at June 30, 2004, the Company had
access to approximately $122 million in FHLB lines of credit for overnight or
term borrowings with maturities of up to thirty years. At June 30, 2004, the
Company also had approximately $10 million in formal and $47 million in informal
lines of credit extended by correspondent banks to be utilized, if needed, for
short-term funding purposes.
Tabular Disclosure of Contractual Obligations - Shown below are the amounts of
payments due under specified contractual obligations, aggregated by category of
contractual obligation, for specified time periods. All information is as of
June 30, 2004.
Payments due by period (in thousands)
-------------------------------------
Contractual obligations Total Less than 1 year 1 - 3 years 3 - 5 years More than 5 years
- ----------------------- ----- ---------------- ----------- ----------- -----------------
Leases covering various Bank equipment,
branches, office space and land $13,511 $1,186 $4,158 $3,487 $4,680
Federal funds purchased 25,000 25,000 - - -
Securities sold under agreements to
repurchase 116,906 116,906 - - -
Federal Home Loan Bank of New York
overnight and term borrowings 122,000 122,000 - - -
Obligations under equipment lease financing 341 227 114 - -
Junior subordinated debentures 20,000 - - - 20,000
------ - - - ------
$297,758 $265,319 $4,272 $3,487 $24,680
======== ======== ====== ====== =======
17
Material Changes in Results of Operations for the Six Months Ended June 30, 2004
versus 2003 - Net income for the six months ended June 30, 2004 was $7.3
million, an increase of $1.1 million or 17.5%, when compared to the same 2003
period. Improvements in net interest income to $27.7 million, higher deposit
service charges and other operating income and a 4.8% reduction in total
operating expenses were offset by lower net security gains (down $1.0 million
before taxes), a $195 thousand higher provision for probable loan losses and an
increase in the provision for income taxes. Basic earnings per common share were
$0.81 in 2004 and $0.70 in 2003, while diluted earnings per share were $0.78 and
$0.68, respectively. The Company's returns on average assets and stockholders'
equity were 1.00% and 15.22% in 2004 and 0.90% and 13.72% in 2003, respectively.
As shown in Table 2-2 following this discussion, net interest income increased
by 3.3% to $27.7 million as the result of a 5% or $62 million increase in
average interest-earning assets, primarily loans. Growth in commercial
mortgages, commercial loans and leases resulted in a 14% increase in average
loans outstanding during 2004. The newer branch locations in both Nassau and
Queens Counties are expected to provide continued opportunity for the Company to
further increase the loan portfolio. The Company, offering superior and
responsive personal customer service coupled with competitive product pricing,
has been able to steadily improve its market share through conservative
underwriting and credit standards. Products such as the Small Business Line of
Credit and the home equity product, Prime for Life, as well as the web-based
commercial cash management system and an online banking service, continue to be
well received and are generating loan volume and creating new cross-sell
opportunities for the Company's full range of deposit and credit products. In
addition, the Company has full time staff that concentrates on the marketing and
sales efforts of new and existing retail products, including a full range of
lease-financing transactions that are handled by SWLC.
The Company's investment portfolio decreased $27 million or 4%, on average,
during the first six months of 2004 as compared to 2003. This is primarily due
to average U.S. Government Agency securities declining $40 million as both
average mortgage-backed securities and average municipal obligations increased
$10 million.
Funding the growth in average interest-earning assets during the first half of
2004 as compared to the same 2003 period were higher levels of average core
deposits and borrowings. The lower-cost core deposit balances, comprised of
demand, savings, money fund and Super NOW accounts, increased $82 million or 10%
on average during 2004 and provided funding at an average cost of 48 basis
points. This has enabled the Company to reduce its funding from short-term
institutional sources. The increase in average borrowings was largely
attributable to higher FHLB funding levels and an increase in securities sold
under agreements to repurchase of $54 million and $15 million, respectively. The
Company's net interest margin on a tax-equivalent basis, while down from 4.29% a
year ago, remained strong at 4.18% during the first half of 2004.
Total noninterest income declined $191 thousand or 3.7% for the first six months
of 2004 as compared to 2003. This was due in large measure to a $1.0 million
pre-tax decrease in net security gains, offset by increases in collection of
service charges on deposit accounts and other operating income of 54.9% and
44.7%, respectively. Sales of long-term municipal notes, undertaken as a result
of the relatively low interest rate environment, coupled with a gain realized
from a tender offer on a corporate note owned by the Company, produced the
security gains realized in 2004. Management continually monitors the fixed
income markets to take advantage of any opportunities that may arise due to
movement in interest rates or other short-term anomalies in the marketplace.
Other operating income increased largely as the result of income from Bank Owned
Life Insurance purchased during the first quarter of 2004 and higher fee
generation for letters of credit, merchant services, wire transfers and foreign
exchange.
18
Revenue of State Bancorp, Inc. Over/
(dollars in thousands) (under)
For the six months ended June 30, 2004 2003 2003
- ------------------------------------------------------------------------------------------
Net interest income $27,700 $26,818 3 %
Service charges on deposit accounts 1,173 757 55
Net security gains 2,590 3,581 (28)
Other operating income 1,245 861 45
- ------------------------------------------------------------------------------------------
Total revenue $32,708 $32,017 2 %
- ------------------------------------------------------------------------------------------
The 4.8% improvement in total operating expenses during the first half of 2004
as compared to 2003 was primarily due to reductions in legal expenses and other
operating expenses, partially offset by increases in salaries and employee
benefits and marketing and advertising expenses. Legal expense decreased $1.4
million during 2004 mainly as the result of lower expenses related to the
ongoing litigation related to Island Mortgage Network and its affiliates ("IMN")
as previously discussed in detail in the Company's 2001, 2002 and 2003
Securities and Exchange Commission filings and as discussed in detail in Part
II, Item 1 herein. The Company expects to incur additional costs related to this
litigation during 2004 which are not quantifiable at this time, but the Company
believes that the first half legal expenses are generally indicative of expenses
to be incurred for the balance of the year. Other operating expenses decreased
8.8% during 2004 to $3.4 million. This decrease was largely the result of
reductions in loan collection expenses, telecommunications costs and expenses
related to meetings and seminars. The increase of $634 thousand in salaries and
benefits costs resulted primarily from normal salary adjustments, growth in
staff and higher medical and retirement plan expenses, while marketing and
advertising expenses increased $46 thousand due to costs associated with SWLC
business development efforts.
Operating expenses of State Bancorp, Inc. Over/
(dollars in thousands) (under)
For the six months ended June 30, 2004 2003 2003
- ----------------------------------------------------------------------------------------
Salaries and other employee benefits $11,753 $11,120 6 %
Occupancy 1,965 1,896 4
Equipment 733 792 (7)
Legal 1,763 3,153 (44)
Marketing and advertising 655 609 8
Other operating expenses 3,395 3,721 (9)
- ----------------------------------------------------------------------------------------
Total operating expenses $20,264 $21,291 (5)%
- ----------------------------------------------------------------------------------------
The above factors resulted in an improved operating efficiency ratio (total
operating expenses as a percentage of fully taxable equivalent net interest and
noninterest revenue, excluding securities transactions) of 65.8% for the first
six months of 2004 as compared to 72.5% in 2003. The Company's other primary
measure of expense control, the ratio of total operating expenses to average
total assets, also improved during the first six months of 2004 to 2.79% from a
level of 3.09% in 2003.
Income tax expense rose by $441 thousand for the first six months of 2004 as
compared to 2003, resulting in an effective tax rate of 29.4% as compared to
29.5% a year ago.
Material Changes in Results of Operations for the Three Months Ended June 30,
2004 versus 2003 - Net income for the three months ended June 30, 2004 was $3.4
million, a decrease of $36 thousand or 1.0%, when compared to the same 2003
period. Improvements in net interest income to $14.5 million, higher deposit
service charges and other operating income and a decrease in the effective
income tax rate were offset by lower net security gains (down $1.6 million
before taxes), a $102 thousand higher provision for probable loan losses and an
increase in total operating expenses of $144 thousand. Basic earnings per common
share were $0.37 in 2004 and $0.38 in 2003, while diluted earnings per share
were $0.36 and $0.38, respectively. The Company's returns on average assets and
stockholders' equity were 0.91% and 14.29% in 2004 and 0.97% and 14.92% in 2003,
respectively.
The reasons supporting the second quarter earnings performance are, for the most
part, similar to those already
19
discussed in the six-month analysis. The increase of $1.3 million in net
interest income resulted from a 21 basis points widening of the net interest
margin on a tax-equivalent basis to 4.33% during the second quarter of 2004,
coupled with a 4% growth in average interest-earning assets, primarily
commercial loans and commercial mortgages, funded through an expanded core
deposit base and a higher level of borrowed funds.
Total noninterest income declined $1.2 million for the second quarter of 2004 as
compared to 2003. This was due in large measure to a $1.6 million decrease in
net security gains, partially offset by increases in collection of service
charges on deposit accounts and other operating income of $247 thousand and $180
thousand, respectively.
The 1.5% growth in total operating expenses during the second quarter of 2004 as
compared to 2003 was primarily due to increases in salaries and employee
benefits (up $213 thousand), legal expenses (up $97 thousand) and marketing and
advertising expenses (up $71 thousand), partially offset by a decrease in other
operating expenses of $213 thousand.
The above factors resulted in an improved operating efficiency ratio (total
operating expenses as a percentage of fully taxable equivalent net interest and
noninterest revenue, excluding securities transactions) of 61.7% for the second
quarter of 2004 as compared to 67.7% in 2003. The Company's other primary
measure of expense control, the ratio of total operating expenses to average
total assets, also improved during the second quarter of 2004 to 2.71% from a
level of 2.82% in 2003.
Income tax expense decreased $131 thousand for the second quarter of 2004 as
compared to 2003, resulting in a decline in the Company's effective tax rate to
28.6% from 30.3% a year ago.
Asset Quality - Nonperforming assets (defined by the Company as nonaccrual loans
and other real estate owned) totaled $7 million at June 30, 2004, a $5 million
decrease from December 31, 2003 and a $6 million decrease from June 30, 2003.
The reduction in nonperforming assets at June 30, 2004 was primarily the result
of aggressive collection and charge-off efforts during 2004. The Company held
one commercial property as other real estate owned totaling $3 million at June
30, 2004 and December 31, 2003. Management of the Company expects to dispose of
this property during 2004 with no material impact on the Company's financial
statements. At June 30, 2004, December 31, 2003 and June 30, 2003, there were no
restructured accruing loans. Loans 90 days or more past due and still accruing
interest totaled $74 thousand at June 30, 2004, reflecting decreases of $75
thousand and $889 thousand when compared to year-end 2003 and June 30, 2003,
respectively.
The allowance for probable loan losses amounted to $11 million or 1.5% of total
loans at June 30, 2004 versus $10 million and 1.6%, respectively, at the
comparable 2003 date. The allowance for probable loan losses as a percentage of
nonaccrual loans and loans 90 days or more past due and still accruing,
increased to 278% at June 30, 2004 from 122% at December 31, 2003 and from 80%
one year ago.
The Company's loan portfolio is concentrated in commercial and industrial loans
and commercial mortgages, the majority of which are fully secured by collateral
with market values in excess of the carrying value of the underlying loans. The
provision for probable loan losses for the first six months of 2004 and 2003 was
$2.2 million and $2.0 million, respectively. Net loan charge-offs during the
same periods were approximately $1.9 million and $1.6 million, respectively. The
provision for probable loan losses is continually evaluated relative to
portfolio risk and regulatory guidelines considering all economic factors that
affect the loan loss reserve, such as fluctuations in the Long Island real
estate market and interest rates, economic slowdowns in industries and other
uncertainties. It will continue to be closely reviewed during the remainder of
2004. Due to the uncertain nature of the current economy, management anticipates
further loan charge-offs during the rest of 2004. A further review of the
Company's nonperforming assets may be found in Table 2-3 following this
analysis.
Forward-Looking Statements and Risk Factors - This report contains
forward-looking statements, including
20
among other things, identifications of trends, loan growth, comments on the
adequacy of the allowance for probable loan losses, effects of asset sensitivity
and interest changes, and information concerning market risk referenced in Item
3 of Part I. The words "expects," "believes," "anticipates" and other similar
expressions are intended to identify forward-looking statements. The
forward-looking statements involve certain risks and uncertainties. Factors that
may cause actual results or earnings to differ materially from such
forward-looking statements include, but are not limited to, the following: (1)
general economic conditions, (2) competitive pressure among financial services
companies, (3) changes in interest rates, (4) deposit flows, (5) loan demand,
(6) changes in legislation or regulation, (7) changes in accounting principles,
policies and guidelines, (8) litigation liabilities, including costs, expenses,
settlements and judgments and (9) other economic, competitive, governmental,
regulatory and technological factors affecting State Bancorp, Inc.'s operations,
pricing, products and services. Investors are encouraged to access the Company's
periodic reports filed with the SEC for financial and business information
regarding the Company at www.statebankofli.com/corporate. The Company undertakes
no obligation to publish revised events or circumstances after the date hereof.
21
TABLE 2 - 2
NET INTEREST INCOME ANALYSIS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(DOLLARS IN THOUSANDS)
2004 2003
---- ----
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
ASSETS:
- -------
Interest-earning assets:
Mortgage-backed securities $286,251 $4,677 3.23 % $276,454 $4,366 3.14 %
Municipal securities 88,323 1,218 2.73 78,272 1,679 4.27
Government Agency and other securities 216,914 3,787 3.45 264,007 5,291 3.99
------- ----- ---- ------- ----- ----
Total securities 591,488 9,682 3.24 618,733 11,336 3.64
------- ----- ---- ------- ------ ----
Federal funds sold 562 2 0.70 2,762 14 1.01
Securities purchased under agreements to
resell 52,627 246 0.92 51,942 310 1.19
Interest-bearing deposits 5,005 16 0.64 2,153 8 0.75
Loans 716,070 23,413 6.47 628,121 21,848 6.92
------- ------ ---- ------- ------ ----
Total interest-earning assets 1,365,752 33,359 4.83 1,303,711 33,516 5.11
--------- ------ ---- --------- ------ ----
Non-interest-earning assets 94,331 86,930
------ ------
Total Assets $1,460,083 $1,390,641
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
- -------------------------------------
Interest-bearing liabilities:
Savings deposits $660,424 $2,243 0.68 % $624,154 $2,585 0.84 %
Time deposits 263,491 2,151 1.61 340,879 3,337 1.95
------- ----- ---- ------- ----- ----
Total savings and time deposits 923,915 4,394 0.95 965,033 5,922 1.23
------- ----- ---- ------- ----- ----
Federal funds purchased 9,283 54 1.15 7,348 54 1.46
Securities sold under agreements to
repurchase 32,577 184 1.12 17,161 118 1.37
Other borrowed funds 85,246 532 1.23 33,144 325 1.95
Junior subordinated debentures 20,000 495 4.90 10,000 279 5.55
------ --- ---- ------ --- ----
Total interest-bearing liabilities 1,071,021 5,659 1.05 1,032,686 6,698 1.30
--------- ----- ---- --------- ----- ----
Demand deposits 273,484 227,555
Other liabilities 19,625 39,570
------ ------
Total liabilities 1,364,130 1,299,811
Stockholders' equity 95,953 90,830
------ ------
Total Liabilities and
Stockholders' Equity $1,460,083 $1,390,641
========== ==========
Net interest income/rate spread 27,700 3.78 % 26,818 3.82 %
Add tax-equivalent basis adjustment 686 ---- 938 ----
--- ---
Net interest margin - tax-equivalent basis $28,386 4.18 % $27,756 4.29 %
======= ==== ======= ====
22
TABLE 2 - 3
ANALYSIS OF NONPERFORMING ASSETS
AND THE ALLOWANCE FOR PROBABLE LOAN LOSSES
JUNE 30, 2004 VERSUS DECEMBER 31, 2003 AND JUNE 30, 2003
(DOLLARS IN THOUSANDS)
NONPERFORMING ASSETS BY TYPE: PERIOD ENDED:
- ----------------------------- -------------
6/30/2004 12/31/2003 6/30/2003
--------- ---------- ---------
Nonaccrual Loans $3,898 $8,666 $12,107
Other Real Estate Owned 2,697 2,697 -
----- ----- -------
Total Nonperforming Assets $6,595 $11,363 $12,107
====== ======= =======
Loans 90 Days or More Past Due
and Still Accruing $74 $149 $963
Gross Loans Outstanding $732,162 $711,216 $643,337
Total Stockholders' Equity $92,896 $94,712 $91,391
ANALYSIS OF THE ALLOWANCE FOR
PROBABLE LOAN LOSSES: QUARTER ENDED:
- --------------------- --------------
6/30/2004 12/31/2003 6/30/2003
--------- ---------- ---------
Beginning Balance $11,233 $10,597 $10,225
Provision 1,086 984 984
Net Charge-Offs (1,277) (849) (814)
------ ---- ----
Ending Balance $11,042 $10,732 $10,395
======= ======= =======
KEY RATIOS: PERIOD ENDED:
- ------------ -------------
6/30/2004 12/31/2003 6/30/2003
--------- ---------- ---------
Allowance as a % of Total Loans 1.5% 1.5% 1.6%
Nonaccrual Loans as a % of Total Loans 0.5% 1.2% 1.9%
Nonperforming Assets (1) as a % of Total
Loans and Other Real Estate Owned 0.9% 1.6% 1.9%
Allowance for Probable Loan Losses as
a % of Nonaccrual Loans 283.3% 123.8% 85.9%
Allowance for Probable Loan Losses as a %
of Nonaccrual Loans and Loans 90 days or
More Past Due and Still Accruing 278.0% 121.7% 79.5%
(1) Excludes loans 90 days or more past due and still accruing interest.
23
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Quantitative and qualitative disclosure about market risk is presented at
December 31, 2003 in the Company's Annual Report on Form 10-K. There have been
no material changes in the Company's market risk at June 30, 2004 compared to
December 31, 2003. The following is an update of the discussion provided
therein.
Asset/Liability Management and Market Risk - The process by which financial
institutions manage interest-earning assets and funding sources under different
interest rate environments is called asset/liability management. The primary
goal of asset/liability management is to increase net interest income within an
acceptable range of overall risk tolerance. Management must ensure that
liquidity, capital, interest rate and market risk are prudently managed.
Asset/liability and interest rate risk management are governed by policies
reviewed and approved annually by the Company's Board of Directors. The Board
has delegated responsibility for asset/liability and interest rate risk
management to Management's Asset/Liability Committee ("ALCO"). The ALCO meets
quarterly and sets strategic directives that guide the day to day
asset/liability management activities of the Company as well as reviewing and
approving all major funding, capital and market risk management programs. The
ALCO, in conjunction with a noted industry consultant, also focuses on current
market conditions, balance sheet management strategies, deposit and loan pricing
issues and interest rate risk measurement and mitigation.
Interest Rate Risk - Interest rate risk is the potential adverse change to
earnings or capital arising from movements in interest rates. This risk can be
quantified by measuring the change in net interest margin relative to changes in
market rates. Reviewing repricing characteristics of interest-earning assets and
interest-bearing liabilities identifies risk. The Company's Funds Management
Committee sets forth policy guidelines that limit the level of interest rate
risk within specified tolerance ranges. Management must determine the
appropriate level of risk, under policy guidelines, which will enable the
Company to achieve its performance objectives within the confines imposed by its
business objectives and the external environment within which it operates.
Interest rate risk arises from repricing risk, basis risk, yield curve risk and
options risk, and is measured using financial modeling techniques including
interest rate ramp and shock simulations to measure the impact of changes in
interest rates on earnings for periods up to two years. These simulations are
used to determine whether corrective action may be warranted or required in
order to adjust the overall interest rate risk profile of the Company.
Asset and liability management strategies may also involve the use of
off-balance sheet instruments such as interest rate swaps to hedge interest rate
risk. During 2003 the Company executed $50 million of interest rate swaps to
hedge a portion of the interest rate variability in its portfolio of prime rate
loans.
Management performs simulation analysis to assess the Company's asset/liability
position on a dynamic repricing basis using software developed by a noted
industry vendor. Simulation modeling applies alternative interest rate scenarios
and periodic forecasts of future business activity to estimate the related
impact on net interest income. The use of simulation modeling assists management
in its continuing efforts to achieve earnings stability in a variety of interest
rate environments.
The Company's asset/liability and interest rate risk management policy limits
interest rate risk exposure to -12% and -15% of the base case net income for net
earnings at risk at the 12 month and 24 month time horizons, respectively. Net
earnings at risk is the potential adverse change in net income arising from up
to +/- 200 basis point change in interest rates ramped over a 12 month period,
and measured over a 24 month time horizon.
Management also monitors equity value at risk as a percentage of market value of
portfolio equity ("MVPE"). The Company's MVPE is the difference between the
market value of its interest-sensitive assets and the market value of its
interest-sensitive liabilities. MVPE at risk is the potential adverse change in
the present value (market value) of
24
total equity arising from an immediate hypothetical shock in interest rates.
Management uses scenario analysis on a static basis to assess its equity value
at risk by modeling MVPE under various interest rate shock scenarios.
When modeling MVPE at risk, management recognizes the high degree of
subjectivity when projecting long-term cash flows and reinvestment rates, and
therefore uses MPVE at risk as a relative indicator of interest rate risk.
Simulation and scenario techniques in asset/liability modeling are influenced by
a number of estimates and assumptions with regard to embedded options,
prepayment behaviors, pricing strategies and cash flows. Such assumptions and
estimates are inherently uncertain and, as a consequence, simulation and
scenario output will neither precisely estimate the level of, or the changes in,
net interest income and MVPE, respectively.
To mitigate the impact of changes in interest rates, as a general rule, the
balance sheet should be structured so that repricing opportunities exist for
both assets and liabilities in approximately equivalent amounts at basically the
same time intervals.
In managing interest rate risk, imbalances in these repricing opportunities at
any point in time constitute an interest-sensitivity gap, which is the
difference between interest-sensitive assets and interest-sensitive liabilities.
When monitoring its interest-sensitivity gap position, management recognizes
that these static measurements do not reflect the results of any projected
activity and are best utilized as early indicators of potential interest rate
exposures.
The accompanying Table 3-1 sets forth the amounts of assets and liabilities
outstanding as of June 30, 2004 which, based upon certain assumptions, are
expected to reprice or mature in each of the time frames shown. Except as
stated, the amount of assets and liabilities shown to reprice or mature within a
particular time frame was determined in accordance with the earlier of the term
to repricing or the contractual terms of the asset or liability.
An asset-sensitive gap indicates an excess of interest-sensitive assets over
interest-sensitive liabilities, whereas a liability-sensitive gap indicates the
opposite. At June 30, 2004, the Company had a one-year cumulative
asset-sensitivity gap of $149 million. In a rising rate environment, an
asset-sensitive gap position generally indicates that increases in income from
interest-bearing assets will outpace increases in expense associated with
funding those assets. In addition, the Company's net interest margin and net
income would improve under this scenario. Conversely, in a declining interest
rate environment, the Company's cost of funds would decline more slowly than the
yield on its rate-sensitive assets and would likely result in a contraction of
net interest income.
Interest rate risk can be reduced by various strategies, including the
administration of liability costs and the investment of asset maturities and
cash flows in such a way as to insulate net interest income from the effects of
changes in interest rates. As previously mentioned, a static gap position is
best utilized as a tool for early detection of potential interest rate exposure.
Management monitors the Company's cumulative one-year gap with a view that
rate-sensitive assets and liabilities are approximately equal in that time
frame. Due to the nature of the Company's business, primarily the seasonality of
its municipal funding function, an exactly matched one-year gap is unlikely to
occur. Rather, as previously discussed, management relies on net interest income
simulation analysis to manage the Company's asset/liability position on a
dynamic repricing basis.
25
TABLE 3 - 1
LIQUIDITY AND INTEREST RATE SENSITIVITY
JUNE 30, 2004
(DOLLARS IN THOUSANDS)
Sensitivity Time Horizon (1)
------------------------------------------------------------------------------
0 - 6 6 - 12 1 - 5 Over Noninterest-
Months Months Years 5 Years Sensitive Total
------------------------------------------------------------------------------
INTEREST - SENSITIVE ASSETS:
- ----------------------------
Loans (net of unearned income) (2) $412,819 $32,454 $207,767 $75,224 $3,898 $732,162
Securities Purchased Under Agreements to Resell,
Federal Funds Sold and Interest-Bearing Deposits 3,736 - - - - 3,736
Securities Held to Maturity 70,009 - - 24,993 - 95,002
Securities Available for Sale (3) 83,436 117,217 180,652 169,223 6,518 557,046
------------------------------------------------------------------------------
Total Interest-Earning Assets 570,000 149,671 388,419 269,440 10,416 1,387,946
Unrealized Net Loss on Securities Available for Sale (5,642) - - - - (5,642)
Receivable - Securities Sales 26,317 - - - - 26,317
Noninterest-Bearing Cash and Due from Banks 44,261 - - - - 44,261
All Other Assets (7) 6,477 9,298 19,190 20 9,536 44,521
------------------------------------------------------------------------------
Total Assets 641,413 158,969 407,609 269,460 19,952 1,497,403
------------------------------------------------------------------------------
INTEREST - SENSITIVE LIABILITIES:
- ---------------------------------
Savings Accounts (4) 14,724 14,724 117,795 88,347 - 235,590
Money Fund and NOW Accounts (5) 31,086 22,386 179,239 47,015 - 279,726
Time Deposits (6) 163,305 39,968 43,619 425 - 247,317
------------------------------------------------------------------------------
Total Interest-Bearing Deposits 209,115 77,078 340,653 135,787 - 762,633
Federal Funds Purchased, Securities Sold Under
Agreements to Repurchase and Other Borrowings 264,046 87 114 - - 264,247
Junior Subordinated Debentures 20,000 - - - - 20,000
------------------------------------------------------------------------------
Total Interest-Bearing Liabilities 493,161 77,165 340,767 135,787 - 1,046,880
Payable - Securities Purchases 64,228 - - - - 64,228
All Other Liabilities, Equity and Demand Deposits(7) 19,804 15,118 103,516 154,961 92,896 386,295
------------------------------------------------------------------------------
Total Liabilities and Equity 577,193 92,283 444,283 290,748 92,896 1,497,403
------------------------------------------------------------------------------
Cumulative Interest-Sensitivity Gap (8) $76,839 $149,345 $196,997 $330,650 $341,066
===============================================================
Cumulative Interest-Sensitivity Ratio (9) 115.6 % 126.2 % 121.6 % 131.6 % 132.6 %
Cumulative Interest-Sensitivity Gap as a % of Total Assets 5.1 % 10.0 % 13.2 % 22.1 % 22.8 %
(1) Allocations to specific interest-sensitivity periods are based on the
earlier of the repricing or maturity date.
(2) Nonaccrual loans are shown in the noninterest-sensitive category.
(3) Estimated principal reductions have been assumed for mortgage-backed
securities based upon their current constant prepayment rates. Securities
containing embedded options are allocated to the interest-sensitivity period
that best reflects the anticipated repricing impact of the embedded option.
(4) Savings deposits, excluding short-term municipal deposits, are assumed to
decline at a rate of 12.5% per year over an eight-year period based upon the
nature of their historically stable core deposit relationships. Short-term
municipal deposits are included in the 0 - 6 months category.
(5) Money fund and NOW accounts of individuals, partnerships and corporations
are assumed to decline at a rate of 16.7% per year over a six-year period and
5.9% per year over a seventeen-year period, respectively, based upon the nature
of their historically stable core deposit relationships. Money fund and NOW
accounts of municipalities are assumed to decline at a rate of 20% per year over
a five-year period, except for short-term municipal deposits that are included
in the 0 - 6 months category.
(6) Reflected as maturing in each instrument's period of contractual maturity.
(7) Other assets and liabilities are shown according to their contractual
payment schedule or a reasonable estimate thereof. Demand deposits, excluding
short- term municipal deposits, are assumed to decline at a rate of 9.1% per
year over an eleven-year period based upon the nature of their historically
stable core deposit relationships. Short-term municipal deposits are included in
the 0 - 6 months category.
(8) Total interest-earning assets minus total interest-bearing liabilities.
(9) Total interest-earning assets as a percentage of total interest-bearing
liabilities.
26
ITEM 4. - CONTROLS AND PROCEDURES
The Company's management evaluated, with the participation of the Company's
Chief Executive Officer and Principal Financial Officer, the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules 13a-15(e)
or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the
period covered by this report. Based on such evaluation, the Company's Chief
Executive Officer and Principal Financial Officer have concluded that these
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and regulations and are operating in an effective manner. No
change in the Company's internal control over financial reporting (as defined in
Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934) occurred
during the most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II
ITEM 1. - LEGAL PROCEEDINGS
As previously reported, the Bank has been named (along with other defendants) in
lawsuits related to the activities of Island Mortgage Network, Inc. and certain
related companies ("IMN"). The cases pending against the Bank as of July 30,
2004 are as follows:
Blanton, et al. v. IMN Financial Corp., et al., Adv. Proc. No. 01-8096,
Bankruptcy Court for the Eastern District of New York, and Moritz, et al. v.
National Settlement Services Corp., et al., Civil Action No. 3:00 CV 426 MU,
Western District of North Carolina. While technically these cases remain
pending, the Bank has executed binding settlement agreements with the plaintiffs
in both cases, and finalization of those settlements is contingent only upon the
fulfillment of certain conditions precedent by the plaintiffs, which has not yet
occurred but is expected to occur. The cost of settling these litigations is not
material.
Broward Title Co. v. Alan Jacobs, et al., Adv. Proc. No. 01-8181, Bankruptcy
Court for the Eastern District of New York. In July, 2002, Broward's claims
against the Bank and the Duboff defendants were severed from its claims against
the remaining defendants. Since that time, Broward has been actively pursuing
its case against the remaining defendants and has not made any attempts to
prosecute its case against State Bank, although it may do so at a later date.
Household Commercial Financial Services, Inc., et al. v. Action Abstract, Inc.,
et al., Adv. Proc. No. 02-8167, Bankruptcy Court for the Eastern District of New
York. The parties have completed fact and expert discovery and filed summary
judgment motions; only State Bank's summary judgment motion is a dispositive
motion. Briefing on those motions is not yet complete, and oral argument is
presently scheduled to take place on September 14.
The Bank is defending the active lawsuits vigorously, and management believes
that the Bank has substantial defenses to the claims that have been asserted.
However, the ultimate outcome of these lawsuits cannot be predicted with
certainty. It also remains possible that other parties may later pursue
additional claims against the Bank related to the Bank's dealings with IMN and
its affiliates. The Bank's legal fees and expenses will be significant, and
those costs, in addition to any costs associated with settling the IMN-related
litigations or satisfying any adverse judgments, could have a material adverse
effect on the Bank's results of operations or financial position.
In addition to the litigations noted above, the Company and the Bank are subject
to other legal proceedings and claims that arise in the ordinary course of
business. In the opinion of management, the amount of ultimate liability,
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if any, with respect to such matters will not materially affect future
operations and will not have a material impact on the Company's financial
statements.
ITEM 2. - CHANGES IN SECURITIES AND USE OF PROCEEDS
The following table discloses the Company's repurchases of its common stock made
during the quarter.
Total number of shares Maximum number of
purchased as part of shares that may yet be
publicly announced purchased under the
Total number of Average price paid plans or programs plans or programs
Period shares purchased per share
- ----------------------------------- ---------------------- --------------------- ------------------------- -------------------------
April 1 - 30, 2004 2,605 $23.30 2,605 634,066
May 1 - 31, 2004 33,981 20.82 33,981 600,085
June 1 - 30, 2004 5,150 24.05 5,150 594,935
- ----------------------------------- ---------------------- --------------------- ------------------------- -------------------------
Total 41,736 $21.37 41,736 594,935
- ----------------------------------- ---------------------- --------------------- ------------------------- -------------------------
On February 24, 1998, the Company's Board of Directors authorized a stock
repurchase program enabling the Company to buy back up to 50,000 shares of its
common stock. Subsequently, on November 24, 1998, February 29, 2000, June 26,
2001 and April 27, 2004, the Company's Board of Directors authorized increases
in the Company's stock repurchase program under which the Company was then able
to buy back up to a cumulative total of 200,000, 500,000, 1,000,000 and
1,500,000 shares of its common stock, respectively. The repurchases may be made
from time to time as market conditions permit, at prevailing prices on the open
market or in privately negotiated transactions. The program may be discontinued
at any time.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of the shareholders of the Company, held on April 27,
2004, the following directors were elected:
Nominee Term For Withheld
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
J. Robert Blumenthal 2 years 7,315,023 142,270
Arthur Dulik, Jr. 3 years 7,287,361 169,932
Joseph F. Munson 3 years 7,330,451 126,842
Daniel T. Rowe 3 years 7,341,600 115,693
The following directors continue to serve on the Board:
Thomas E. Christman, Thomas F. Goldrick, Jr., Richard W. Merzbacher, John F.
Picciano, Suzanne H. Rueck, Jeffrey S. Wilks
There were no broker non-votes on this matter.
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
---------
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31 Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
--------------------
On April 16, 2004, the Company issued the earnings release for the period ended
March 31, 2004.
On April 27, 2004, the Company's Board of Directors authorized an increase in
its stock repurchase program under which the Registrant may now repurchase up to
1,500,000 shares of its common stock. The Board had previously authorized the
repurchase of up to 1,000,000 shares at its June 2001 meeting. The repurchases
may be made from time to time as market conditions permit, at prevailing prices
on the open market or in privately negotiated transactions. The program may be
discontinued at any time.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STATE BANCORP, INC.
8/9/04 s/Daniel T. Rowe
- -------- -------------------------
Date Daniel T. Rowe, President
8/9/04 s/Brian K. Finneran
- -------- --------------------------------------
Date Brian K. Finneran, Secretary/Treasurer
(Principal Financial Officer)
30