UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
-------------------------------------------------
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------------- ----------------------
Commission file number 0 - 20957
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SUN BANCORP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 52-1382541
- --------------------------------------------- ----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification)
226 Landis Avenue, Vineland, New Jersey 08360
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(856) 691 - 7700
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(Registrant's telephone number,
including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
$ 1.00 Par Value Common Stock 18,131,831 May 9, 2005
- ----------------------------- ---------- -----------
Class Number of shares outstanding Date
SUN BANCORP, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Condensed Consolidated Statements of Financial Condition
at March 31, 2005 and December 31, 2004 3
Unaudited Condensed Consolidated Statements of Income
for the Three Months Ended March 31, 2005 and 2004 4
Unaudited Condensed Consolidated Statement of Shareholders' Equity
for the Three Months Ended March 31, 2005 5
Unaudited Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2005 and 2004 6
Notes to Unaudited Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 22
ITEM 4. CONTROLS AND PROCEDURES 23
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 24
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
ITEM 3. Defaults upon Senior Securities 24
ITEM 4. Submission of Matters to a Vote of Security Holders 24
ITEM 5. Other Information 24
ITEM 6. Exhibits 24
SIGNATURES 25
CERTIFICATIONS 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands except par value amounts)
March 31, December 31,
2005 2004
---- ----
ASSETS
Cash and due from banks $ 71,487 $ 69,022
Interest-bearing bank balances 4,220 1,878
Federal funds sold 3,393 4,002
----------- -----------
Cash and cash equivalents 79,100 74,902
Investment securities available for sale (amortized cost -
$784,057; 3/05 and $823,896; 12/04) 774,688 819,424
Investment securities held to maturity 40,575 43,048
Loans receivable (net of allowance for loan losses -
$22,237; 3/05 and $22,037; 12/04) 1,885,347 1,847,721
Restricted equity investments 16,657 15,405
Bank properties and equipment, net 36,970 36,830
Real estate owned, net 1,437 2,911
Accrued interest receivable 14,365 12,519
Goodwill 104,606 104,969
Intangible assets, net 33,291 34,753
Deferred taxes, net 6,128 4,626
Bank owned life insurance 47,585 47,179
Other assets 9,992 9,300
----------- -----------
TOTAL $ 3,050,741 $ 3,053,587
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits $ 2,384,948 $ 2,430,363
Advances from the Federal Home Loan Bank (FHLB) 169,717 144,669
Federal funds purchased 2,000 -
Securities sold under agreements to repurchase - FHLB 50,000 50,000
Securities sold under agreements to repurchase - customers 74,057 59,641
Junior subordinated debentures 77,322 77,322
Other liabilities 11,010 12,372
----------- -----------
Total liabilities 2,769,054 2,774,367
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value, 1,000,000 shares authorized, none issued - -
Common stock, $1 par value, 25,000,000 shares authorized,
issued: 18,215,672; 3/05 and 17,205,245; 12/04 18,216 17,205
Additional paid in capital 264,075 244,108
Retained earnings 6,517 21,718
Accumulated other comprehensive loss (6,075) (2,765)
Treasury stock at cost, 90,562 shares (1,046) (1,046)
Total shareholders' equity 281,687 279,220
----------- -----------
TOTAL $ 3,050,741 $ 3,053,587
=========== ===========
- --------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
3
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
For the Three Months
Ended March 31,
-------------------------
2005 2004
----------- -----------
INTEREST INCOME:
Interest and fees on loans $ 29,076 $ 21,050
Interest on taxable investment securities 6,128 6,329
Interest on non-taxable investment securities 468 506
Interest and dividends on restricted equity investments 188 106
Interest on federal funds sold 40 62
----------- -----------
Total interest income 35,900 28,053
----------- -----------
INTEREST EXPENSE:
Interest on deposits 8,124 5,440
Interest on short-term borrowed funds 2,422 1,800
Interest on junior subordinated debentures 1,126 809
----------- -----------
Total interest expense 11,672 8,049
----------- -----------
Net interest income 24,228 20,004
PROVISION FOR LOAN LOSSES 525 625
----------- -----------
Net interest income after provision for loan losses 23,703 19,379
----------- -----------
NON-INTEREST INCOME:
Service charges on deposit accounts 2,238 2,162
Other service charges 45 96
Gain on sale of bank properties and equipment 100 -
Gain on sale of loans 341 6
Gain on sale of investment securities - 325
Other 1,461 1,185
----------- -----------
Total non-interest income 4,185 3,774
----------- -----------
NON-INTEREST EXPENSES:
Salaries and employee benefits 10,244 9,516
Occupancy expense 3,079 2,463
Equipment expense 1,978 1,545
Data processing expense 931 965
Amortization of intangible assets 1,147 1,160
Other 3,055 2,842
----------- -----------
Total non-interest expenses 20,434 18,491
----------- -----------
INCOME BEFORE INCOME TAXES 7,454 4,662
INCOME TAXES 2,341 1,241
----------- -----------
NET INCOME $ 5,113 $ 3,421
=========== ===========
Basic earnings per share $ 0.28 $ 0.23
=========== ===========
Diluted earnings per share $ 0.26 $ 0.21
=========== ===========
Weighted average shares - basic 18,010,434 14,660,369
=========== ===========
Weighted average shares - diluted 19,371,080 15,960,719
=========== ===========
- -----------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
4
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For The Three Months Ended March 31, 2005
(In thousands)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
Stock Capital Earnings Loss Stock Total
----- ------- -------- ---- ----- -----
BALANCE, JANUARY 1, 2005 $17,205 $244,108 $21,718 $(2,765) $(1,046) $279,220
Comprehensive income:
Net income - - 5,113 - - 5,113
Net change in unrealized gain on
securities available for sale,
net of taxes of $1,587 - - - (3,310) - (3,310)
--------
Comprehensive income - - - - - 1,803
--------
Exercise of stock options 147 343 - - - 490
Issuance of common stock 8 166 - - - 174
Stock dividends 856 19,458 (20,314) - - -
------- -------- ------- ------- ------- --------
BALANCE, MARCH 31, 2005 $18,216 $264,075 $ 6,517 $(6,075) $(1,046) $281,687
======= ======== ======= ======= ======= ========
- -------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
5
SUN BANCORP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Three Months
Ended March 31,
-----------------------
2005 2004
--------- ---------
OPERATING ACTIVITIES:
Net income $ 5,113 $ 3,421
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 525 625
Depreciation 1,128 810
Net amortization of investments securities 248 454
Amortization of intangible assets 1,147 1,160
Write down of book value of fixed assets 24 -
Gain on sale of investment securities available for sale - (325)
Gain on sale of bank properties and equipment (100) -
Gain on sale of loans (341) -
Increase in cash value of bank owned life insurance (BOLI) (406) (433)
Deferred income taxes 85 (163)
Change in assets and liabilities which (used) provided cash:
Accrued interest receivable (1,846) (652)
Other assets (1,102) (28,541)
Other liabilities (637) 29,379
--------- ---------
Net cash provided by operating activities 3,838 5,735
--------- ---------
INVESTING ACTIVITIES:
Purchases of investment securities (36,744) (187,624)
Purchases of restricted equity securities (1,252) (694)
Proceeds from maturities, prepayments or calls of investment securities 78,808 261,881
Proceeds from sale of investment securities available for sale - 30,131
Proceeds from the sale of loans 3,678 -
Net increase in loans (41,488) (47,816)
Purchase of bank properties and equipment (1,292) (893)
Proceeds from the sale of bank properties and equipment 100 -
Proceeds from sale of real estate owned 1,474 -
--------- ---------
Net cash provided by investing activities 3,284 54,985
--------- ---------
FINANCING ACTIVITIES:
Net decrease in deposits (45,415) (38,346)
Purchase price adjustment of branch assets purchased 363 22
Net borrowings (repayments) under line of credits, advances and repurchase agreements 41,464 (3,691)
Proceeds from exercise of stock options 490 162
Proceeds from issuance of common stock 174 110
--------- ---------
Net cash used in financing activities (2,924) (41,743)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,198 18,977
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 74,902 82,117
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 79,100 $ 101,094
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 10,681 $ 7,539
Income taxes paid $ 750 -
See notes to the unaudited condensed consolidated financial statements.
6
SUN BANCORP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(All dollar amounts presented in the tables, except per share amounts, are in
thousands.)
(1) Summary of Significant Accounting Policies
Basis of Financial Statement Presentation - The unaudited condensed
consolidated financial statements include the accounts of Sun Bancorp,
Inc. (the Company) and its subsidiaries. Its principally owned
subsidiary is Sun National Bank (the Bank). All significant
intercompany balances and transactions have been eliminated in
consolidation.
The accompanying unaudited condensed consolidated financial statements
were prepared in accordance with instructions to Form 10-Q, and
therefore, do not include information or footnotes necessary for a
complete presentation of financial position, results of operations,
changes in equity and cash flows in conformity with accounting
principles generally accepted in the United States of America. However,
all normal recurring adjustments that, in the opinion of management,
are necessary for a fair presentation of the consolidated financial
statements have been included. These financial statements should be
read in conjunction with the audited consolidated financial statements
and the accompanying notes thereto included in the Company's Annual
Report on Form 10-K for the period ended December 31, 2004. The results
for the three months ended March 31, 2005 are not necessarily
indicative of the results that may be expected for the fiscal year
ending December 31, 2005 or any other period.
Use of Estimates in the Preparation of Financial Statements - The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
reporting period. The significant estimates include the allowance for
loan losses, goodwill, core deposit and other intangible assets,
deferred tax asset valuation allowance and derivative financial
instruments. Actual results could differ from those estimates.
Investment Securities - The Company accounts for debt securities as
follows:
Held to Maturity - Debt securities that management has the
positive intent and ability to hold until maturity are classified as
held to maturity and carried at their remaining unpaid principal
balance, net of unamortized premiums or unaccreted discounts. Premiums
are amortized and discounts are accreted using the interest method over
the estimated remaining term of the underlying security.
Available for Sale - Debt securities that will be held for
indefinite periods of time, including securities that may be sold in
response to changes to market interest or prepayment rates, needs for
liquidity, and changes in the availability of and the yield of
alternative investments, are classified as available for sale. These
assets are carried at fair value. Fair value is determined using
published quotes as of the close of business. Unrealized gains and
losses are excluded from earnings and are reported net of tax as other
comprehensive income or loss until realized. Realized gains and losses
on the sale of investment securities are recorded as of trade date,
reported in the consolidated statement of income and determined using
the adjusted cost of the specific security sold.
Stock Dividend - On March 17, 2005, the Company's Board of Directors
declared a 5% stock dividend paid on April 20, 2005 to shareholders of
record on April 6, 2005. Accordingly, per share data have been adjusted
for all periods presented.
Stock Based Compensation - In December 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting
Standard (SFAS) No. 148, Accounting for Stock-Based Compensation
--Transition and Disclosure, an amendment of FASB Statement No. 123.
SFAS No. 148 amends SFAS No. 123 to provide alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Prior to the fourth
quarter of 2003, the Company accounted for its granted stock options
according to Accounting Principles Board Opinion (APB) No. 25,
Accounting for Stock Issued to Employees and related interpretations.
All options granted prior to 2003 had an intrinsic value of zero on the
date
7
of grant under APB No. 25, and, therefore, no stock-based employee
compensation expense was recognized in the Company's consolidated
financial statements. During the fourth quarter of 2003, the Company
adopted, effective January 1, 2003, the fair value recognition
provisions of SFAS No. 123. Under the prospective method provisions of
SFAS No. 148, the recognition provisions of SFAS No. 123 were applied
to all option awards granted, modified or settled after January 1,
2003.
In addition, SFAS No. 148 amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results. This Statement is effective for financial statements for
fiscal years ending after December 15, 2002. The Company has provided
the required disclosures in the tables below.
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 using the Black-Scholes option pricing model
to stock-based employee compensation.
For the
Three Months Ended
March 31,
-------------------
2005 2004
------ ------
Reported net income available to shareholders $5,113 $3,421
Add: Total stock-based employee compensation
expense included in reported net income
(net of tax) 5 10
Deduct: Total stock-based employee
compensation expense determined under
fair value method (net of tax) (105) (206)
------ ------
Pro forma net income available to shareholders $5,013 $3,225
====== ======
Earnings per share:
Basic - as reported $0.28 $0.23
Basic - pro forma $0.28 $0.22
Diluted - as reported $0.26 $0.21
Diluted - pro forma $0.26 $0.20
Recent Accounting Pronouncements - In December 2004, the FASB issued
SFAS No. 123R (revised 2004), Share-Based Payment, which revises SFAS
No. 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. This
Statement requires an entity to recognize the cost of employee services
received in share-based payment transactions and measure the cost on a
grant-date fair value of the award. That cost will be recognized over
the period during which an employee is required to provide service in
exchange for the award. The provisions of SFAS No. 123R will become
effective for the Company's consolidated financial statements issued
for the fiscal year beginning January 1, 2006. The Company is currently
evaluating the effects of the adoption of this Statement on its
financial statements.
8
In March 2004, the FASB ratified the consensus reached by the EITF in
Issue 03-1, The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments. EITF 03-1 provides guidance for
determining when an investment is considered impaired, whether
impairment is other-than-temporary, and measurement of an impairment
loss. In September 2004, the FASB issued FASB Staff Position (FSP)
03-1-1, which delayed the effective date for the measurement and
recognition guidance contained in paragraphs 10-20 of Issue 03-1 due to
additional proposed guidance. The Company is continuing to evaluate the
impact of EITF 03-1. The amount of other-than-temporary impairment to
be recognized depends on market conditions, management's intent and
ability to hold investments until a forecasted recovery and the
finalization of the proposed guidance by the FASB. The Company does not
anticipate that the finalization of the proposed guidance will have a
material impact on the Company.
The following table provides the gross unrealized losses and fair
value, aggregated by investment category and length of time the
individual securities have been in a continuous unrealized loss
position at March 31, 2005:
Less than 12 Months 12 Months or Longer Total
--------------------- --------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
U.S. Treasury obligations $ 49,630 $ (35) $ 9,834 $ (221) $ 59,464 $ (256)
U.S. Government agencies and
mortgage-backed securities 566,831 (7,674) 82,288 (2,505) 649,119 (10,179)
State and municipal obligations 21,770 (187) - - 21,770 (187)
Other securities 23,880 (199) - - 23,880 (199)
-------- ------- ------- ------- -------- --------
Total $662,111 $(8,095) $92,122 $(2,726) $754,233 $(10,821)
======== ======= ======= ======= ======== ========
At March 31, 2005, 99.7% of the unrealized losses in the security
portfolio were comprised of securities issued by U.S. Government
agencies, U.S. Government sponsored agencies and other securities rated
investment grade by at least one bond credit rating service. The
Company believes that the price movements in these securities are
dependent upon the movement in market interest rates particularly given
the negligible inherent credit risk for these securities. At March 31,
2005, the unrealized loss in the category 12 months or longer of $2.7
million consisted of 14 securities having an aggregate depreciation of
2.9%. The securities represented U.S. Treasury, Federal Agency issues
and one security currently rated Aaa by three rating services. At March
31, 2005, securities in a gross unrealized loss position for less than
twelve months consisted of 115 securities having an aggregate
depreciation of 1.2% from the Bank's amortized cost basis.
(2) Loans
The components of loans as of March 31, 2005 and December 31, 2004 were
as follows:
March 31, 2005 December 31, 2004
-------------- -----------------
Commercial and industrial $1,631,717 $1,603,868
Home equity 128,045 122,735
Second mortgages 48,643 50,541
Residential real estate 27,630 26,117
Other 71,549 66,497
Total gross loans 1,907,584 1,869,758
Allowance for loan losses (22,237) (22,037)
---------- ----------
Net Loans $1,885,347 $1,847,721
========== ==========
Non-accrual loans $ 13,461 $ 13,457
========== ==========
9
(3) Allowance for Loan Losses
Changes in the allowance for loan losses were as follows:
For the three month
period ended For the year ended
March 31, 2005 December 31, 2004
-------------- -----------------
Balance, beginning of period $22,037 $17,614
Charge-offs (516) (1,382)
Recoveries 191 793
------- -------
Net charge-offs (325) (589)
Provision for loan losses 525 2,075
Purchased allowance from bank acquisition - 2,937
------- -------
Balance, end of period $22,237 $22,037
======= =======
The provision for loan losses charged to expense is based upon past
loan loss experience and an evaluation of estimated losses in the
current loan portfolio, including the evaluation of impaired loans
under SFAS Nos. 114 and 118. A loan is considered to be impaired when,
based upon current information and events, it is probable that the
Company will be unable to collect all amounts due according to the
contractual terms of the loan.
An insignificant delay or insignificant shortfall in amount of payments
does not necessarily result in a loan being identified as impaired. For
this purpose, delays less than 90 days are considered to be
insignificant.
Impairment losses are included in the provision for loan losses. Large
groups of smaller balance, homogeneous loans are collectively evaluated
for impairment, except for those loans restructured under a troubled
debt restructuring. Loans collectively evaluated for impairment include
consumer loans and residential real estate loans, and are not included
in the data that follow:
March 31, 2005 December 31, 2004
-------------- -----------------
Impaired loans with related reserve for loan
losses calculated under SFAS No. 114 $29,702 $31,533
Impaired loans with no related reserve for loan
losses calculated under SFAS No. 114 3,823 1,588
------- -------
Total impaired loans $33,525 $33,121
======= =======
Valuation allowance related to impaired loans $ 3,275 $ 3,332
======= =======
For the three For the
months ended year ended
March 31, 2005 December 31, 2004
-------------- -----------------
Average impaired loans $35,419 $35,991
======= =======
Interest income recognized on impaired loans $ 304 $ 2,315
======= =======
Cash basis interest income recognized on impaired loans $ 258 $ 2,111
======= =======
10
(4) Real Estate Owned
Real estate owned at March 31, 2005 and December 31, 2004 was as
follows:
March 31, 2005 December 31, 2004
-------------- -----------------
Commercial properties $1,066 $2,424
Residential properties 62 178
Bank properties 309 309
------ ------
Total $1,437 $2,911
====== ======
The decrease in real estate owned was due primarily to the sale of one
commercial property which resulted in a pre-tax gain of $200,000. The
remaining $1.1 million in commercial properties consists of one
property which is currently listed for sale. It is anticipated that the
sale proceeds of this property will exceed its carrying value.
(5) Deposits
Deposits consist of the following major classifications:
March 31, 2005 December 31, 2004
-------------- -----------------
Demand deposits - interest bearing $ 794,475 $ 793,290
Demand deposits - non-interest bearing 492,143 543,601
Savings deposits 437,250 452,726
Time certificates under $100,000 423,781 410,632
Time certificates $100,000 or more 237,299 230,114
---------- ----------
Total $2,384,948 $2,430,363
========== ==========
(6) Junior Subordinated Debentures Held by Trusts that Issued Capital Debt
The following is a summary of the outstanding capital securities issued
by each Issuer Trust and the junior subordinated debentures issued by
the Company to each Trust as of March 31, 2005:
Capital Securities Junior Subordinated Debentures
---------------------------------------------------------------------------------------------------
Stated Distribution Principal Redeemable
Issuer Trust Issuance Date Value Rate Amount Maturity Beginning
------------ ------------- ----- ---- ------ -------- ---------
6-mo LIBOR
Sun Trust III April 22, 2002 $20,000 plus 3.70% $20,619 April 22, 2032 April 22, 2007
3-mo LIBOR
Sun Trust IV July 7, 2002 10,000 plus 3.65% 10,310 October 7, 2032 July 7, 2007
3-mo LIBOR
Sun Trust V December 18, 2003 15,000 plus 2.80% 15,464 December 30, 2033 December 30, 2008
3-mo LIBOR
Sun Trust VI December 19, 2003 25,000 plus 2.80% 25,774 January 23, 2034 January 23, 2009
3-mo LIBOR
CBNJ Trust I December 19, 2002 5,000 plus 3.35% 5,155 January 7, 2033 January 7, 2008
------- -------
$75,000 $77,322
======= =======
11
While the capital securities have been deconsolidated in accordance
with Generally Accepted Accounting Principles (GAAP), they continue to
qualify as Tier 1 capital under federal regulatory guidelines. The
change in accounting guidance did not have an impact on the current
Tier 1 regulatory capital of either the Company or the Bank. In March
2005, the Federal Reserve amended its risk-based capital standards to
expressly allow the continued limited inclusion of outstanding and
prospective issuances of trust preferred securities in a bank holding
company's Tier 1 capital, subject to tightened quantitative limits. The
Federal Reserve's amended rule will, effective March 31, 2009, limit
capital securities and other restricted core capital elements to 25% of
all core capital elements, net of goodwill less any associated deferred
tax liability. Management has developed a capital plan for the Company
and the Bank that should allow the Company and the Bank to maintain
"well-capitalized" regulatory capital levels.
The Issuer Trusts are wholly owned unconsolidated subsidiaries of the
Company and have no independent operations. The obligations of Issuer
Trusts are fully and unconditionally guaranteed by the Company. The
debentures are unsecured and rank subordinate and junior in right of
payment to all indebtedness, liabilities and obligations of the
Company. Interest on the debentures is cumulative and payable in
arrears. Proceeds from any redemption of debentures would cause a
mandatory redemption of capital securities having an aggregate
liquidation amount equal to the principal amount of debentures
redeemed.
Sun Trust III variable annual rate will not exceed 11.00% through five
years from its issuance. Sun Trust IV variable annual rate will not
exceed 11.95% through five years from its issuance. Sun Trust V and Sun
Trust VI do not have interest rate caps. CBNJ Trust I was acquired in
the July 2004 acquisition of Community Bancorp of New Jersey. CBNJ
Trust I variable annual rate will not exceed 12.5% through five years
from its issuance.
(7) Comprehensive Income
The Company classifies items of other comprehensive income by their
nature and displays the accumulated balance of other comprehensive
income separately from retained earnings and additional paid in capital
in the equity section of the statement of financial condition. Amounts
categorized as other comprehensive income represent net unrealized
gains or losses on investment securities available for sale, net of
income taxes. Total comprehensive income for the three-months ended
March 31, 2005 and 2004 amounted to $1,803,000 and $6,903,000,
respectively.
12
(8) Earnings Per Share
Basic earnings per share is computed by dividing net income, by the
weighted average number of shares of common stock net of treasury
shares outstanding during the period. Diluted earnings per share is
calculated by dividing net income by the weighted average number of
shares of common stock net of treasury shares outstanding increased by
the weighted average dilutive common stock options outstanding reduced
by the number of common shares that are assumed to have been purchased
by the Company with the proceeds from the exercise of the options
(treasury stock method) along with the assumed tax benefit from the
exercise of non-qualified options. These purchases were assumed to have
been made at the average market price of the common stock, which is
based on the daily closing price. Retroactive recognition has been
given to market values, common stock outstanding and potential common
shares for periods prior to the date of the Company's stock dividends.
Earnings per share for the periods presented are as follows:
For the
Three Months
Ended March 31,
--------------------------
2005 2004
---- ----
Net income $5,113 $3,421
Dilutive stock options outstanding 3,228,851 2,984,522
Average exercise price per share $9.30 $9.27
Average market price $22.64 $23.47
Average common shares outstanding 18,010,434 14,660,369
Increase in shares due to exercise of
options - diluted basis 1,360,646 1,300,350
---------- ----------
Adjusted shares outstanding - diluted 19,371,080 15,960,719
========== ==========
Net earnings per share - basic $0.28 $0.23
Net earnings per share - diluted $0.26 $0.21
Options that could potentially dilute basic EPS in the
future that were not included in the computation of
diluted EPS because to do so would have been
antidilutive for the period presented 2,744 -
========== ==========
13
THE COMPANY MAY FROM TIME TO TIME MAKE WRITTEN OR ORAL "FORWARD-LOOKING
STATEMENTS," INCLUDING STATEMENTS CONTAINED IN THE COMPANY'S FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION (INCLUDING THIS QUARTERLY REPORT ON FORM 10-Q
AND THE EXHIBITS THERETO), IN ITS REPORTS TO SHAREHOLDERS AND IN OTHER
COMMUNICATIONS BY THE COMPANY, WHICH ARE MADE IN GOOD FAITH BY THE COMPANY
PURSUANT TO THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND
INTENTIONS, THAT ARE SUBJECT TO CHANGE BASED ON VARIOUS IMPORTANT FACTORS (SOME
OF WHICH ARE BEYOND THE COMPANY'S CONTROL). THE FOLLOWING FACTORS, AMONG OTHERS,
COULD CAUSE THE COMPANY'S FINANCIAL PERFORMANCE TO DIFFER MATERIALLY FROM THE
PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS EXPRESSED IN SUCH
FORWARD-LOOKING STATEMENTS: THE STRENGTH OF THE UNITED STATES ECONOMY IN GENERAL
AND THE STRENGTH OF THE LOCAL ECONOMIES IN WHICH THE COMPANY CONDUCTS
OPERATIONS; THE EFFECTS OF, AND CHANGES IN, TRADE, MONETARY AND FISCAL POLICIES
AND LAWS, INCLUDING INTEREST RATE POLICIES OF THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM, INFLATION, INTEREST RATE, MARKET AND MONETARY
FLUCTUATIONS; THE TIMELY DEVELOPMENT OF AND ACCEPTANCE OF NEW PRODUCTS AND
SERVICES OF THE COMPANY AND THE PERCEIVED OVERALL VALUE OF THESE PRODUCTS AND
SERVICES BY USERS, INCLUDING THE FEATURES, PRICING AND QUALITY COMPARED TO
COMPETITORS' PRODUCTS AND SERVICES; THE IMPACT OF CHANGES IN FINANCIAL SERVICES'
LAWS AND REGULATIONS (INCLUDING LAWS CONCERNING TAXES, BANKING, RISK-BASED
CAPITAL GUIDELINES AND REPORTING INSTRUCTIONS, SECURITIES AND INSURANCE);
TECHNOLOGICAL CHANGES; ACQUISITIONS; CHANGES IN CONSUMER SPENDING AND SAVING
HABITS; AND THE SUCCESS OF THE COMPANY AT MANAGING THE RISKS INVOLVED IN THE
FOREGOING.
THE COMPANY CAUTIONS THAT THE FOREGOING LIST OF IMPORTANT FACTORS IS NOT
EXCLUSIVE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING
STATEMENT, WHETHER WRITTEN OR ORAL, THAT MAY BE MADE FROM TIME TO TIME BY OR ON
BEHALF OF THE COMPANY.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies, Judgments and Estimates
The discussion and analysis of the financial condition and results of
operations are based on the unaudited Consolidated Financial Statements, which
are prepared in conformity with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions affecting the reported amounts of
assets, liabilities, revenue and expenses. Management evaluates these estimates
and assumptions on an ongoing basis, including those described below. Management
bases its estimates on historical experience and various other factors and
assumptions that are believed to be reasonable under the circumstances. These
form the bases for making judgments on the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Allowance for Loan Losses. Through the Bank, the Company originates
loans that it intends to hold for the foreseeable future or until maturity or
repayment. The Bank may not be able to collect all principal and interest due on
these loans. Allowance for loan losses represents management's estimate of
probable credit losses inherent in the loan portfolio as of the balance sheet
date. The determination of the allowance for loan losses requires management to
make significant estimates with respect to the amounts and timing of losses and
market and economic conditions. The allowance for loan losses is maintained at a
level that management considers adequate to provide for estimated losses and
impairment based upon an evaluation of known and inherent risk in the loan
portfolio. Loan impairment is evaluated based on the fair value of collateral or
estimated net realizable value. A provision for loan losses is charged to
operations based on management's evaluation of the estimated losses that have
been incurred in the Company's loan portfolio. It is the policy of management to
provide for losses on unidentified loans in its portfolio in addition to
classified loans.
Management monitors its allowance for loan losses on a quarterly basis
and makes adjustments to the allowance through the provision for loan losses as
economic conditions and other pertinent factors indicate. In this context, a
series of qualitative factors are used in a methodology as our measurement of
how current circumstances are affecting the loan portfolio. Included in these
qualitative factors are:
o Levels of past due, classified and non-accrual loans, troubled debt
restructurings and modifications;
o Nature and volume of loans;
o Changes in lending policies and procedures, underwriting standards,
collections, charge offs and recoveries;
o National and local economic and business conditions, including various
market segments;
o Concentrations of credit and changes in levels of such concentrations;
and
o Effect of external factors on the level of estimated credit losses in
the current portfolio.
Additionally, historic loss experience over the trailing eight quarters
is taken into account. In determining the allowance for loan losses, management
has established both specific and general pooled allowances. Values assigned to
the qualitative factors and those developed from historic loss experience
provide a dynamic basis for the calculation of reserve factors for both
pass-rated loans (general pooled allowance) and those criticized and classified
loans without SFAS No. 114 reserves (specific allowance). The amount of the
specific allowance is determined through a loan-by-loan analysis of certain
large dollar commercial loans. Loans not individually reviewed are evaluated as
a group using reserve factor percentages based on historic loss experience and
the qualitative factors described above. In determining the appropriate level of
the general pooled allowance, management makes estimates based on internal risk
ratings, which take into account such factors as debt service coverage, loan to
value ratios, and external factors. Estimates are periodically measured against
actual loss experience.
15
As changes in the Company's operating environment occur and as recent
loss experience ebbs and flows, the factors for each category of loan based on
type and risk rating will change to reflect current circumstances and the
quality of the loan portfolio.
Although the Company maintains its allowance for loan losses at levels
considered adequate to provide for the inherent risk of loss in its loan
portfolio, if economic conditions differ substantially from the assumptions used
in making the evaluations there can be no assurance that future losses will not
exceed estimated amounts or that additional provisions for loan losses will not
be required in future periods. Accordingly, a decline in the national economy or
the local economies of the areas in which the loans are concentrated could
result in an increase in loan delinquencies, foreclosures or repossessions
resulting in increased charge-off amounts and the need for additional loan loss
allowances in future periods. In addition, the Company's determination as to the
amount of its allowance for loan losses is subject to review by its primary
regulator, the Office of the Comptroller of the Currency (the OCC), as part of
its examination process. This may result in the establishment of an additional
allowance based upon the judgment of the OCC after a review of the information
available at the time of the OCC examination.
Accounting for Income Taxes. The Company accounts for income taxes in
accordance with SFAS No. 109, which requires the recording of deferred income
taxes that reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Management exercises significant
judgment in the evaluation of the amount and timing of the recognition of the
resulting tax assets and liabilities. The judgments and estimates required for
the evaluation are updated based upon changes in business factors and the tax
laws.
Valuation of Goodwill. The Company assesses the impairment of goodwill
at least annually and whenever events or significant changes in circumstance
indicate that the carrying value may not be recoverable. Factors that the
Company considers important in determining whether to perform an impairment
review include significant under-performance relative to forecasted operating
results and significant negative industry or economic trends. If the Company
determines that the carrying value of goodwill may not be recoverable, then the
Company will assess impairment based on a projection of undiscounted future cash
flows and measure the amount of impairment based on fair value.
Financial Condition
Total assets at March 31, 2005 of $3.05 billion remained level with
December 31, 2004. Cash and cash equivalents increased $4.2 million, net loans
receivable increased $37.6 million and investment securities available for sale
decreased $44.7 million.
Investment securities available for sale decreased $44.7 million or
5.5%, from $819.4 million at December 31, 2004 to $774.7 million at March 31,
2005. The decrease was primarily the result of the planned reduction of
investment securities with the proceeds used to supplement loan funding. This
reduction of investment securities is expected to continue during 2005 to
further supplement the Bank's loan portfolio growth.
Net loans receivable at March 31, 2005 were $1.89 billion, an increase
of $37.6 million from $1.85 billion at December 31, 2004. This increase (net of
prepayments approximating $40 million) was the result of continuing robust
internal loan growth primarily in commercial and industrial loans. The ratio of
allowance for loan losses to total loans was 1.17% at March 31, 2005 compared to
1.18% at December 31, 2004.
Non-performing loans were $13.7 million at March 31, 2005 compared to
$14.3 million at December 31, 2004. The ratio of allowance for loan losses to
total non-performing loans was 161.7% at March 31, 2005 compared to 153.6% at
December 31, 2004. Non-performing assets were $15.2 million at March 31, 2005
compared to $17.3 million at December 31, 2004. The ratio of non-performing
assets to total loans and real estate owned was 0.80% at March 31, 2005 compared
to 0.92% at December 31, 2004.
Total deposits were $2.38 billion at March 31, 2005, reflecting a $45.4
million decrease from
16
December 31, 2004. The decrease in deposits reflects the expected attrition of
deposits from the recently completed branch rationalization program and seasonal
declines, primarily in public funds deposits. Core deposits represented 72.3%
and 73.6% of total deposits at March 31, 2005 and December 31, 2004,
respectively.
Total shareholders' equity increased $2.5 million, from $279.2 million
at December 31, 2004, to $281.7 million at March 31, 2005. The increase was
primarily the result of net income amounting to $5.1 million, offset by a $3.3
million increase in accumulated other comprehensive loss resulting from an
increased unrealized net loss on available for sale securities due to market
interest rates.
Liquidity and Capital Resources
Liquidity management is a daily and long-term business function. The
Company's liquidity, represented in part by cash and cash equivalents, is a
product of its operating, investing and financing activities. Proceeds from
repayment and maturities of loans, sales and maturities of investment
securities, net income and increases in deposits and borrowings are the primary
sources of liquidity of the Company.
The Company anticipates that cash and cash equivalents on hand, the
cash flow from assets as well as other sources of funds will provide adequate
liquidity for the Company's future operating, investing and financing needs. In
addition to cash and cash equivalents of $79.1 million at March 31, 2005, the
Company had additional secured borrowing capacity with the FHLB of approximately
$48 million and other sources of approximately $45 million.
A major source of the Company's funding is deposits, which management
believes will be sufficient to meet the Company's long-term daily operating
liquidity needs. The ability of the Company to retain and attract new deposits
is dependent upon the variety and effectiveness of its customer account
products, customer service and convenience, and rates paid to customers. The
Company also obtains funds from the repayment and maturities of loans as well as
sales and maturities of investment securities. Additional funds can be obtained
from a variety of sources including federal funds purchased, securities sold
under agreements to repurchase, FHLB advances, loan sales or participations and
other secured and unsecured borrowings. It is anticipated that FHLB advances and
securities sold under agreements to repurchase will be secondary sources of
funding, and management expects there to be adequate collateral for such funding
requirements.
The Company's primary uses of funds are the origination of loans, the
funding of the Company's maturing certificates of deposit, deposit withdrawals
and the repayment of borrowings. Certificates of deposit scheduled to mature
during the 12 months ending March 31, 2006 total $376.1 million. The Company has
implemented a core deposit relationship strategy that has placed less reliance
on certificates of deposits as a funding source. In the current and expected
continuing rising interest rate environment, the Company will extend its
relationship strategy to retail certificates of deposit in selected terms to
provide fixed rate funding. However, based on market conditions and other
liquidity considerations, it may avail itself of the secondary borrowings
discussed above.
During the quarter ended March 31, 2005, net loans grew approximately
$37.6 million or 2.0%. The Company anticipates that cash and cash equivalents on
hand, the cash flow from assets, particularly investment securities, as well as
other sources of funds will provide adequate liquidity for the Company's future
operating, investing and financing needs. In addition to cash and cash
equivalents of $79.1 million at March 31, 2005, the Company's estimated cash
flow from securities with maturities of less than one year and principal
payments from mortgage-backed securities over the next twelve months totals
$230.6 million. In addition, the FHLB provides a reliable source of funds with a
wide variety of terms and structures. Management will continue to monitor the
Company's liquidity and maintain it at a level deemed adequate but not
excessive.
Management has developed a capital plan for the Company and the Bank
that should allow the Company and the Bank to grow capital internally at levels
sufficient for achieving its internal growth projections while managing its
operating and financial risks. The Company has also considered a contingent
capital plan, and when appropriate, the Company's Board of Directors may
consider various capital raising alternatives. The principle components of the
capital plan are to generate additional capital through retained earnings from
internal growth, access the capital markets for external sources of capital,
such as common
17
equity and trust preferred securities, when necessary or appropriate, redeem
existing capital instruments and refinance such instruments at lower rates when
conditions permit and maintain sufficient capital for safe and sound operations.
The capital plan is not expected to have a material impact on our liquidity. It
is the Company's intention to maintain "well-capitalized" risk-based capital
levels.
While the capital securities have been deconsolidated in accordance
with GAAP, they continue to qualify as Tier 1 capital under federal regulatory
guidelines. The change in accounting guidance did not have an impact on the
current Tier 1 regulatory capital of either the Company or the Bank. In March
2005, the Federal Reserve amended its risk-based capital standards to expressly
allow the continued limited inclusion of outstanding and prospective issuances
of trust preferred securities in a bank holding company's Tier 1 capital,
subject to tightened quantitative limits. The Federal Reserve's amended rule
will, effective March 31, 2009, limit capital securities and other restricted
core capital elements to 25% of all core capital elements, net of goodwill less
any associated deferred tax liability.
As part of its capital plan, the Company, through its deconsolidated
trust subsidiaries, issued trust preferred securities that qualify as Tier 1 or
core capital of the Company, subject to a 25% capital limitation under
risk-based capital guidelines developed by the Federal Reserve Board. The
portion that exceeds the 25% capital limitation qualifies as Tier 2, or
supplementary capital of the Company. At March 31, 2005, the full amount of the
Company's $75.0 million in trust preferred securities qualify as Tier 1.
Disclosures about Commercial Commitments
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. The
guarantees are primarily issued to support private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. In the event of a draw
by the beneficiary that complies with the terms of the letter of credit, the
Company would be required to honor the commitment. The Company takes various
forms of collateral, such as real estate assets and customer business assets to
secure the commitment. Additionally, all letters of credit are supported by
indemnification agreements executed by the customer. The maximum undiscounted
exposure related to these commitments at March 31, 2005 was $50.6 million, and
the portion of the exposure not covered by collateral was approximately $15.8
million. The Company believes that the utilization rate of these letters of
credit will continue to be substantially less than the amount of these
commitments, as has been our experience to date.
Comparison of Operating Results for the Three Months Ended March 31, 2005 and
2004
Net income increased by $1.7 million, or 50.0% for the three months
ended March 31, 2005 to $5.1 million from $3.4 million for the three months
ended March 31, 2004. The increase in net income was primarily due to an
increase in net interest income of $4.2 million and an increase in non-interest
income of $411,000, offset by increases in non-interest expense of $1.9 million
and income taxes of $1.1 million. The three month ended comparisons were
materially impacted by the acquisition of Community Bank of New Jersey in July
2004 as discussed below.
Net Interest Income. Net interest income (on a tax-equivalent basis)
increased $4.2 million, or 20.7% to $24.5 million for the three months ended
March 31, 2005 from $20.3 million for the same period in 2004. Net interest
income (on a tax-equivalent basis) increased $5.2 million due to volume, the
majority of which was due to an increase of $414.5 million in the average
balance of interest-earning assets. The rate component offset this increase in
net interest income by $1.0 million which was due to an increase of 42 basis
points in the average cost of interest-bearing deposits and an increase of 25
basis points in the average cost of borrowings.
The interest rate spread and margin (on a tax-equivalent basis) for the
three months ended March 31, 2005 was 3.20% and 3.55%, respectively, compared to
3.22% and 3.46%, respectively, for the same period in 2004. The yield on the
average interest-earning assets increased 41 basis points from 4.84% for the
three months ended March 31, 2004 to 5.25% for the same period in 2005, while
the cost of funds on average interest-bearing liabilities increased 43 basis
points from 1.62% for the three months ended March 31, 2004 to 2.05% for the
same period in 2005.
18
The following table sets forth a summary of average balances with
corresponding interest income (on a tax-equivalent basis) and interest expense
as well as average yield and cost information for the periods presented. Average
balances are derived from daily balances.
At or for the three months ended At or for the three months ended
March 31, 2005 March 31, 2004
------------------------------- -------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Interest-earning assets:
Loans receivable (1), (2):
Commercial and industrial $1,617,334 $25,135 6.22 % $1,187,246 $17,921 6.04 %
Home equity 126,069 1,499 4.76 82,843 797 3.85
Second mortgage 49,210 756 6.15 50,442 798 6.33
Residential real estate 26,241 475 7.24 30,623 515 6.73
Other 67,606 1,211 7.17 51,721 1,019 7.88
---------- ------- ---------- -------
Total loans receivable 1,886,460 29,076 6.17 1,402,875 21,050 6.00
Investment securities (3) 855,347 6,993 3.27 904,036 7,192 3.18
Interest-bearing deposit with banks 6,428 31 1.93 6,697 9 0.54
Federal funds sold 6,666 40 2.40 26,818 62 0.92
---------- ------- ---------- -------
Total interest-earning assets 2,754,901 36,140 5.25 2,340,426 28,313 4.84
---------- ------- ---------- -------
Cash and due from banks 78,500 70,673
Bank properties and equipment 36,792 34,229
Goodwill and intangible assets 134,789 76,353
Other assets 53,663 74,689
---------- ----------
Non-interest-earning assets 303,744 255,944
---------- ----------
Total Assets $3,058,645 $2,596,370
========== ==========
Interest-bearing liabilities:
Interest-bearing deposit accounts:
Interest-bearing demand deposits $ 804,275 2,708 1.35 % $ 777,699 1,525 0.78 %
Savings deposits 442,588 1,121 1.01 386,269 729 0.75
Time deposits 653,212 4,295 2.63 525,901 3,186 2.42
---------- ------- ---------- -------
Total interest-bearing deposit
accounts 1,900,075 8,124 1.71 1,689,869 5,440 1.29
---------- ------- ---------- -------
Borrowed money:
Federal funds purchased 9,587 68 2.84 2,939 11 1.50
Securities sold under agreements to
repurchase 69,793 320 1.83 59,886 54 0.36
FHLB advances 219,130 2,034 3.71 160,837 1,735 4.31
Junior subordinated debentures 77,322 1,126 5.82 72,234 809 4.48
---------- ------- ---------- -------
Total borrowings 375,832 3,548 3.78 295,896 2,609 3.53
---------- ------- ---------- -------
Total interest-bearing liabilities 2,275,907 11,672 2.05 1,985,765 8,049 1.62
---------- ------- ---------- -------
Non-interest-bearing demand deposits 487,915 389,393
Other liabilities 13,316 32,581
---------- ----------
Non-interest-bearing liabilities 501,231 421,974
---------- ----------
Total liabilities 2,777,138 2,407,739
Shareholders' equity 281,507 188,631
---------- ----------
Total liabilities and shareholders'
equity $3,058,645 $2,596,370
========== ==========
Net interest income $24,468 $20,264
======= =======
Interest rate spread (4) 3.20 % 3.22 %
====== ======
Net interest margin (5) 3.55 % 3.46 %
====== ======
Ratio of average interest-earning assets to
average interest-bearing liabilities 121.05 % 117.86 %
====== ======
- -------------------------------------------------------------------------------
(1) Average balances include non-accrual loans.
(2) Loan fees are included in interest income and the amount is not material
for this analysis.
(3) Interest earned on non-taxable investment securities is shown on a tax
equivalent basis assuming a 34% marginal federal tax rate for all periods.
(4) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
19
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate) and (ii) changes in rate
(changes in rate multiplied by old average volume). The combined effect of
changes in both volume and rate has been allocated to volume or rate changes in
proportion to the absolute dollar amounts of the change in each.
Three Months Ended March 31,
2005 vs. 2004
-------------------------------------
Increase (Decrease)
Due to
-------------------------------------
Volume Rate Net
------ ---- ---
Interest income
Loans receivable:
Commercial and industrial $ 6,669 $ 545 $ 7,214
Home equity 482 220 702
Second mortgage (19) (23) (42)
Residential real estate (77) 37 (40)
Other 290 (98) 192
------- ------- -------
Total loans receivable 7,345 681 8,026
------- ------- -------
Investment securities (395) 196 (199)
Interest-bearing deposits accounts - 22 22
Federal funds sold (70) 48 (22)
------- ------- -------
Total interest-earning assets $ 6,880 $ 947 $ 7,827
------- ------- -------
Interest expense
Interest-bearing deposit accounts:
Interest-bearing demand deposit $ 54 $ 1,129 $ 1,183
Savings deposits 115 277 392
Time deposits 820 289 1,109
------- ------- -------
Total interest-bearing deposit accounts 989 1,695 2,684
Borrowed money:
Federal funds purchased 41 16 57
Securities sold under agreements to
repurchase 10 256 266
FHLB advances 565 (266) 299
Junior Subordinated Debentures 60 257 317
------- ------- -------
Total borrowed money 676 263 939
------- ------- -------
Total interest-bearing liabilities $ 1,665 $ 1,958 $ 3,623
------- ------- -------
Net change in net interest income $ 5,215 $(1,011) $ 4,204
======= ======= =======
Interest income (on a tax-equivalent basis) increased by $7.8 million,
to $36.1 million for the three months ended March 31, 2005 from $28.3 million
for the same period in 2004. The increase in interest income was due to a 17.7%
increase in the average balance of interest-earning assets which produced an
increase in interest income of $6.9 million along with an increase in interest
rates, which increased the yield on average interest-earning assets by 41 basis
points, or $947,000. In July 2004, the Company acquired approximately $345
million in interest-earning assets from the Community Bank of New Jersey
(Community) acquisition.
Interest expense increased $3.6 million, or 44.4%, to $11.7 million for
the three months ended March 31, 2005 compared to $8.1 million for the same
period in 2004. The increase in interest expense was due to a 14.6% increase in
the average balance of interest-bearing liabilities which produced an increase
in
20
interest expense of $1.7 million and an increase in interest rates, which
increased the cost of average interest-bearing liabilities by 43 basis points,
or $1.9 million. In July 2004, the Company acquired approximately $357 million
in interest bearing liabilities from the Community acquisition.
Provision for Loan Losses. For the three months ended March 31, 2005,
the provision for loan losses was $525,000, compared to $625,000 for the same
period in 2004. The Company focuses on its loan portfolio management and credit
review process to address the current risk profile of the portfolio and manage
troubled credits. This analysis includes evaluations of concentrations of
credit, past loss experience, current economic conditions, amount and
composition of the loan portfolio, estimated fair value of underlying
collateral, loan commitments outstanding, delinquencies and other factors.
Non-Interest Income. Non-interest income increased $411,000 for the
three-month period ended March 31, 2005 compared to the three-month period ended
March 31, 2004. The increase was primarily the result of an increase in gains on
sale of SBA loans of $335,000 and an increase in other income of $276,000
comprised mainly of increases in ATM/debit card fees, investment company income,
and customer derivative income. These increases were partially offset by an
decrease in gains on sale of investment securities of $325,000.
Non-Interest Expenses. Non-interest expenses increased $1.9 million, or
10.3% to $20.4 million for the three months ended March 31, 2005 as compared to
$18.5 million for the same period in 2004. Of this increase, approximately $1.8
million is due to the July 2004 Community acquisition consisting primarily of
the following:
For the Expenses Of Internally
Three Months Ended Newly Acquired Generated
March 31, Branches Variance
--------------------------------------------------------
NON-INTEREST EXPENSES: 2005 2004
---- ----
Salaries and employee benefits $10,244 $9,516 $568 $160
Occupancy expense 3,079 2,463 393 223
Equipment expense 1,978 1,545 174 259
Data processing expense 931 965 - (34)
Amortization of intangible assets 1,147 1,160 396 (409)
Other 3,055 2,842 257 (44)
------- ------- ------ ----
Total non-interest expenses $20,434 $18,491 $1,788 $155
======= ======= ====== ====
Of the internally generated $155,000 increase, $160,000 was in salaries
and employee benefits due to increased staffing and merit increases, $223,000
was in occupancy expense resulting primarily from increases in grounds
maintenance (snow removal) and security system upgrades, and $259,000 was in
equipment expense resulting from increases in equipment depreciation expense and
communication expenses relating to computer upgrades. These increases were
partially offset by a $409,000 decrease in the amortization of intangible
expenses due to 2004 branch closures made in conjunction with the Company's
recently completed branch rationalization program.
Income Taxes. Income taxes increased $1.1 million for the three months
ended March 31, 2005 as compared to the same period in 2004. The increase
resulted from higher pre-tax earnings and an increase in the Company's effective
tax rate. The Company's effective tax rate increased from 26.6% at March 31,
2004 to 31.4% at March 31, 2005. This increase was due primarily to an increase
in the Company's pre-tax earnings while the Company's non-taxable income, mainly
BOLI income and tax exempt investment securities income, remained flat.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset and Liability Management
Interest rate, credit and operational risks are among the most
significant market risks impacting the performance of the Company. Interest rate
risk is reviewed monthly by the Asset Liability Committee (ALCO), composed of
senior management representatives from a variety of areas within the Company.
ALCO devises strategies and tactics to maintain the net interest income of the
Company within acceptable ranges over a variety of interest rate scenarios.
Should the Company's risk modeling indicate an undesired exposure to changes in
interest rates, there are a number of remedial options available including
changing the investment portfolio characteristics, and changing loan and deposit
pricing strategies. Two of the tools used in monitoring the Company's
sensitivity to interest rate changes are gap analysis and net interest income
simulation.
Gap Analysis. Banks are concerned with the extent to which they are
able to match maturities or repricing characteristics of interest-earning assets
and interest-bearing liabilities. Such matching is facilitated by examining the
extent to which such assets and liabilities are interest-rate sensitive and by
monitoring the bank's interest rate sensitivity gap. An asset or liability is
considered to be interest-rate sensitive if it will mature or reprice within a
specific time period, over the interest-bearing liabilities maturing or
repricing within that same time period. On a monthly basis, the Company and the
Bank monitor their gap, primarily cumulative through both nine months and one
year maturities.
At March 31, 2005, total interest-earning assets maturing or repricing
within one year exceeded interest-bearing liabilities maturing or repricing
during the same time period by $28.3 million, representing a positive one-year
gap ratio of 0.93%. All amounts are categorized by their actual maturity,
anticipated call or repricing date with the exception of interest-bearing demand
deposits and savings deposits. Though the rates on interest bearing demand and
savings deposits generally trend with open market rates, they often do not fully
adjust to open market rates and frequently adjust with a time lag. As a result
of prior experience during periods of rate volatility and management's estimate
of future rate sensitivities, the Company allocates the interest-bearing demand
deposits and savings deposits based on an estimated decay rate for those
deposits.
Net Interest Income Simulation. Due to the inherent limitations of gap
analysis, the Company also uses simulation models to measure the impact of
changing interest rates on its operations. The simulation model attempts to
capture the cash flow and repricing characteristics of the current assets and
liabilities on the Company's balance sheet. Assumptions regarding such things as
prepayments, rate change behaviors, level and composition of new balance sheet
activity and new product lines are incorporated into the simulation model. Net
interest income is simulated over a twelve month horizon under a variety of
linear yield curve shifts, subject to certain limits agreed to by ALCO. The
Company uses a base interest rate scenario provided by a third party econometric
modeling service.
Actual results may differ from the simulated results due to such
factors as the timing, magnitude and frequency of interest rate changes, changes
in market conditions, management strategies and differences in actual versus
forecasted balance sheet composition and activity.
The following table shows the Company's estimated earnings sensitivity
profile versus the most likely rate forecast from Global Insights as of March
31, 2005:
Change in Interest Rates Percentage Change in Net Interest Income
------------------------ ----------------------------------------
(Basis Points) Year 1
+200 +1.7%
+100 +0.9%
-100 -0.6%
-200 -1.2%
22
Derivative Financial Instruments. The Company utilizes certain
derivative financial instruments to enhance its ability to manage interest rate
risk that exists as part of its ongoing business operations. As of March 31,
2005, all derivative financial instruments have been entered into to hedge the
interest rate risk associated with the Bank's commercial lending activity. In
general, the derivative transactions fall into one of two types, a bank hedge of
a specific fixed rate loan or a hedged derivative offering to a Bank customer.
In those transactions in which the Bank hedges a specific fixed rate loan, the
derivative is executed for periods and terms that match the related underlying
exposures and do not constitute positions independent of these exposures. For
derivatives offered to Bank customers, the economic risk of the customer
transaction is offset by a mirror position with an non-affiliated third party.
Interest rate swaps are agreements with a counterparty to exchange
periodic fixed and floating interest payments calculated on a notional amount.
The floating rate is based on a money market index, primarily short-term LIBOR.
Financial derivatives involve, to varying degrees, interest rate,
market and credit risk. For interest rate swaps, only periodic cash payments are
exchanged. Therefore, cash requirements and exposure to credit risk are
significantly less than the notional amount.
Not all elements of interest rate, market and credit risk are addressed
through the use of financial or other derivatives, and such instruments may be
ineffective for their intended purposes due to unanticipated market
characteristics, among other reasons.
The notional amount of interest rate swap agreements at March 31, 2005
was $79.0 million compared to $44.4 million at December 31, 2004. The total
unrealized gain (loss) on these agreements at March 31, 2005 and December 31,
2004 amounted to $237,000 and ($283,000), respectively.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their evaluation
------------------------------------------------
of the Company's disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")), the
Company's principal executive officer and principal financial officer have
concluded that as of the end of the period covered by this Quarterly Report on
Form 10-Q such disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.
(b) Changes in internal control over financial reporting. During the quarter
-------------------------------------------------------
under report, there was no change in the Company's internal control over
financial reporting that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
23
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company is not engaged in any legal proceedings of a material
nature at March 31, 2005. From time to time, the Company is a party
to legal proceedings in the ordinary course of business wherein it
enforces its security interest in loans.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable
ITEM 3. Defaults upon Senior Securities
Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable
ITEM 5. Other Information
Not applicable
ITEM 6. Exhibits
Exhibit 31 Certification Pursuant to ss.302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32 Certification Pursuant to ss.906 of the Sarbanes-Oxley Act
of 2002.
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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.
Sun Bancorp, Inc.
-----------------
(Registrant)
/s/Thomas A. Bracken
-------------------------------------
Date: May 9, 2005 Thomas A. Bracken
President and Chief Executive Officer
/s/Dan A. Chila
-------------------------------------
Date: May 9, 2005 Dan A. Chila
Executive Vice President and
Chief Financial Officer
25