UNITED STATES SECURITIES & 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 September 30, 2003
Or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From __________to___________
COMMISSION FILE NUMBER 2-81353
CENTER BANCORP, INC.
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(Exact name of registrant as specified in its charter)
NEW JERSEY 52-1273725
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
2455 MORRIS AVENUE, UNION, NEW JERSEY 07083
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(Address of principal executives offices) (Zip Code)
(908) 688-9500
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(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-12 of the Exchange Act).
Yes |X| No |_|
COMMON STOCK, NO PAR VALUE: 8,511,367
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(Title of Class) (Outstanding at October 31, 2003)
1
CENTER BANCORP, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Condition
at September 30, 2003 (Unaudited), December 31, 2002
and September 30,2002(Unaudited) 4
Consolidated Statements of Income for the
three and nine months ended September 30, 2003 and 2002 5
(Unaudited)
Consolidated Statements of Cash Flows for the
Nine months ended September 30, 2003 and 2002 6
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7-9
HISTORICAL DEVELOPMENT OF BUSINESS/COMPETITION 9-11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11-26
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT 26
MARKET RISKS
ITEM 4. CONTROLS AND PROCEDURES 27
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 27
ITEM 2. Changes In Securities 27
ITEM 3. Defaults Upon Senior Securities 27
ITEM 4. Submission of Matters to Vote of
Security Holders 27
ITEM 5. Other Information 28
ITEM 6. Exhibits and Reports on Form 8-K 28
Signatures 29
Management Certifications 30-32
2
PART I- FINANCIAL INFORMATION
The following unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X, and accordingly do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. However, in
the opinion of management, all adjustments (consisting only of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and nine months ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2003. The Center Bancorp Inc. 2002 annual report on form
10-K should be read in conjunction with these statements.
3
CENTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CONDITION SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2003 2002 2002
(Dollars in thousands) (unaudited) (unaudited)
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Assets:
Cash and due from banks $ 25,344 $ 23,220 $ 19,351
Investment securities held to maturity
(approximate market value of $172,365 in 2003 and $219,921
at December 31, 2002 and $ 227,328 at September 30, 2002.) 167,578 214,902 220,730
Investment securities available-for-sale 321,420 322,717 263,440
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TOTAL INVESTMENT SECURITIES 488,998 537,619 484,170
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Loans, net of unearned income 308,634 229,051 226,656
Less - Allowance for loan losses 2,751 2,498 2,381
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NET LOANS 305,883 226,553 224,275
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Premises and equipment, net 13,499 12,976 12,582
Accrued interest receivable 4,952 4,439 5,078
Bank owned separate account life insurance 14,443 14,143 13,946
Other assets 1,941 2,395 1,974
Goodwill 2,091 2,091 2,091
=================================================================================================================
TOTAL ASSETS $ 857,151 $ 823,436 $ 763,467
=================================================================================================================
LIABILITIES
Deposits:
Non-interest bearing $ 124,236 $ 116,984 110,437
Interest bearing:
Certificates of deposit $100,000 and over 49,083 33,396 30,862
Savings and time deposits 406,698 465,971 409,246
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TOTAL DEPOSITS 580,017 616,351 550,545
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Federal Home Loan Bank advances 125,000 65,000 65,000
Federal funds purchased and securities sold under
agreements to repurchase 87,195 75,431 81,494
Corporation - obligated mandatorily redeemable
trust preferred securities of subsidiary
trust holding solely junior subordinated debentures
of Corporation 10,000 10,000 10,000
Accounts payable and accrued liabilities 3,554 5,600 6,392
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TOTAL LIABILITIES 805,766 772,382 713,431
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STOCKHOLDERS' EQUITY
Preferred Stock, no par value, authorized 5,000,000 shares;
None Issued 0 0 0
Common stock, no par value: authorized 20,000,000 shares;
issued 9,522,244 at September 30, 2003, 9,499,114 shares at
Decemeber 31, 2003 and 9,490,534 shares at September 30, 2002 19,317 18,984 18,893
Additional paid in capital 4,632 4,562 4,392
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Retained earnings 32,323 29,863 28,792
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SUBTOTAL 56,272 53,409 52,077
Treasury stock at cost (1,037,094 at September 30, 2003 1,078,404
shares at December 31, 2002 and 1, 080,604 shares
at September 30, 2002 (4,091) (4,254) (4,129)
Restricted stock (14) (285) (28)
Accumulated other comprehensive (loss) income (782) 2,184 2,116
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TOTAL STOCKHOLDERS' EQUITY 51,385 51,054 50,036
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 857,151 $ 823,436 $ 763,467
=================================================================================================================
All common stock share and per common share amounts have been restated to
reflect the 2- for- 1common stock split declared on April 15, 2003, issued June
2, 2003 to common stockholders of record May 19, 2003.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
CENTER BANCORP, INC.
Consolidated Statements of Income
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
September 30, September 30,
(Dollars in thousands, except per share data) 2003 2002 2003 2002
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Interest income:
Interest and fees on loans $ 3,840 $ 3,816 $ 10,948 $ 11,245
Interest and dividends on investment securities:
Taxable interest income 3,432 6,226 13,851 19,149
Nontaxable interest income 880 150 1,867 451
Interest on Federal funds sold and securities
purchased under agreement to resell -- 50 -- 59
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TOTAL INTEREST INCOME 8,152 10,242 26,666 30,904
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Interest expense:
Interest on certificates of deposit $100,000 or more 117 94 355 383
Interest on other deposits 1,570 2,350 5,033 6,706
Interest on short-term borrowings 1,424 1,340 4,165 3,983
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Total interest expense 3,111 3,784 9,553 11,072
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Net interest income 5,041 6,458 17,113 19,832
Provision for loan losses 103 90 262 270
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Net interest income after provision for loan losses 4,938 6,368 16,851 19,562
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Other income:
Service charges, commissions and fees 401 409 1,239 1,183
Other income 268 193 627 564
BOLI 173 114 420 279
Gain (loss) on securities sold (17) 203 220 445
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TOTAL OTHER INCOME 825 919 2,506 2,471
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Other expense:
Salaries and employee benefits 2,507 2,373 7,834 6,955
Occupancy expense, net 393 395 1,365 1,233
Premises and equipment expense 384 388 1,278 1,172
Stationery and printing expense 131 115 436 419
Marketing and advertising 120 122 409 478
Other expenses 880 792 2,439 2,600
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TOTAL OTHER EXPENSE 4,415 4,185 13,761 12,857
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Income before income tax expense 1,348 3,102 5,596 9,176
Income tax expense (provision) (167) 998 888 2,950
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Net income (benefit) $ 1,515 $ 2,104 $ 4,708 $ 6,226
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Earnings per share
Basic $ 0.18 $ 0.25 $ 0.56 $ 0.74
Diluted $ 0.18 $ 0.25 $ 0.55 $ 0.74
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Average weighted common shares outstanding
Basic 8,480,651 8,425,730 8,462,345 8,389,248
Diluted 8,570,874 8,488,768 8,551,586 8,455,536
=========================================================================================================================
All common share and per common share amounts have been adjusted to reflect the
2-for-1 common split declared April 15, 2003 and issued June 2, 2003 to common
stockholders of record May 19, 2003.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
CENTER BANCORP, INC.
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended
September 30
(Dollars in thousands) 2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,708 $ 6,226
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,272 1,256
Provision for loan losses 262 270
Gain on sales of investment securities available-for-sale (220) (445)
Increase in accrued interest receivable (513) (536)
Decrease (Increase) in other assets 454 (58)
Increase in Cash Surrender Value of Bank Owned Life Insurance (300) (564)
(Decrease) Increase in other liabilities (2,046) 1,214
Amortization of premium and accretion of
discount on investment securities, net 5,482 966
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NET CASH PROVIDED BY OPERATING ACTIVITIES 9,099 8,329
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities available-for-sale 194,878 147,379
Proceeds from maturities of securities held-to-maturity 124,908 72,018
Proceeds from sales of securities available-for-sale 104,923 38,667
Purchase of securities available-for-sale (303,399) (228,957)
Purchase of securities held-to-maturity (77,584) (95,427)
Purchase of FRB & FHLB stock (3,340) (100)
Net increase in loans (79,583) (15,500)
Property and equipment expenditures, net (1,797) (2,153)
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NET CASH PROVIDED BY INVESTING ACTIVITIES (40,994) (84,073)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits (36,334) 52,712
Dividends paid (2,248) (2,033)
Proceeds from issuance of common stock 837 876
Net increase in borrowings 71,764 14,198
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NET CASH PROVIDED BY FINANCING ACTIVITIES 34,019 65,427
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Net increase (decrease) in cash and cash equivalents 2,124 (10,317)
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Cash and cash equivalents at beginning of period $ 23,220 $ 29,668
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 25,344 $ 19,351
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Supplemental disclosures of cash flow information:
Interest paid on deposits and short-term borrowings $ 9,203 $ 10,997
Income taxes $ 861 $ 3,410
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of Center Bancorp, Inc. (the Corporation)
are prepared on the accrual basis and include the accounts of the Corporation
and its wholly owned subsidiaries, Union Center National Bank (the Bank) and
Center Bancorp Statutory Trust I. All significant inter-company accounts and
transactions have been eliminated from the accompanying consolidated financial
statements.
BUSINESS
The Bank provides a full range of banking services to individual and corporate
customers through branch locations in Union and Morris Counties, New Jersey. The
Bank is subject to competition from other financial institutions, is subject to
the regulations of certain federal agencies and undergoes periodic examinations
by those regulatory authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. In
preparing the consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, as of the date of the statement of condition, and revenues and
expenses for the applicable period. Actual results could differ significantly
from those estimates.
In the opinion of Management, all adjustments necessary for a fair presentation
of the Corporation's financial condition and results of operations for the
interim periods have been made. Such adjustments are of a normal recurring
nature. Certain reclassifications have been made for 2002 to conform to the
classifications presented in 2003. Results for the period ended September 30,
2003 are not necessarily indicative of results for any other interim period or
for the entire fiscal year. Reference is made to the Corporation's Annual
Report on Form 10-K for the year ended December 31, 2002 for information
regarding accounting principles.
NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
SFAS NO. 149
Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," was issued on April 30, 2003.
The Statement amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement 133. This statement is effective for
contracts entered into or modified after June 30, 2003. The adoption of this
Statement did not have a significant effect on the Corporation's consolidated
financial statements.
SFAS NO. 150
The Financial Accounting Standards Board (FASB) has issued Statement No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity". The Statement improves the accounting for certain
financial instruments that, under previous guidance, issuers could account for
as equity. The new Statement requires that those instruments be classified as
liabilities in statements of financial position.
Statement 150 affects the issuer's accounting for three types of freestanding
financial instruments. One type is mandatorily redeemable shares, which the
issuing company is obligated to buy back in exchange for cash or other assets. A
second type, which includes put options and forward purchase contracts, involves
instruments that do or may require the issuer to buy back some of its shares in
exchange for cash or other assets. The third type of instruments that are
liabilities under this Statement is obligations that can be settled with shares,
the monetary value of which is fixed, tied solely or predominantly to a variable
such as a market index, or varies inversely with the value of the issuers'
shares. Statement 150 does not apply to features embedded in a financial
instrument that is not a derivative in its entirety.
7
In addition to its requirements for the classification and measurement of
financial instruments in its scope, Statement 150 also requires disclosures
about alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. Statement 150 is
effective for all financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The initial adoption of Statement 150 did not
have an impact on the Corporation's consolidated financial statements.
CONSOLIDATION OF VARIABLE INTEREST- ENTITIES
On January 17, 2003 the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 changes the method of determining
whether certain entities should be included in the consolidated financial
statements. A variable interest entity ("VIE") is an entity that either (a) does
not have equity investors with voting rights or (b) has equity investors that do
not provide sufficient financial resources for the entity to support its
activities. A company that consolidates a VIE is called the "primary
beneficiary" of that entity. The primary beneficiary of a VIE is the party that
absorbs a majority of the entity's expected losses or receives a majority of its
expected residual returns. The provisions of FIN 46 are effective in the first
fiscal year or interim period beginning after June 15, 2003, for VIE's in which
an enterprise holds a VIE that it acquired before February 1, 2003. The
Corporation adopted FIN 46 on July 1, 2003. In its current form, FIN 46 may
require the Corporation to de-consolidate its investment in Center Bancorp
Statutory Trust I in future financial statements. The potential de-consolidation
of subsidiary trusts of bank holding companies formed in connection with the
issuance of trust preferred securities, like Center Bancorp Statutory Trust I,
appears to be an unintended consequence of FIN 46. In July 2003, the Board of
Governors of the Federal Reserve System instructed bank holding companies to
continue to include the trust preferred securities in their Tier 1 capital for
regulatory capital purposes until notice is given to the contrary. There can be
no assurance that the Federal Reserve will continue to allow institutions to
include trust preferred securities in Tier 1 capital for regulatory purposes. As
of September 30, 2003, assuming the Corporation were not allowed to include the
$10 million in trust preferred securities issued by Center Bancorp Statutory
Trust I in Tier 1 capital, the Corporation would remain "Well Capitalized".
GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING
INDIRECT GUARANTEES OF INDEBTEDNESS OR OTHERS.
In 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). The disclosure requirements of FIN 45 were
effective for the year ended December 31, 2002 and require disclosure of the
nature of the guarantee, the maximum potential amount of future payments that
the guarantor could be required to make under the guarantee, and the current
amount of the liability, if any, for the guarantor's obligations under the
guarantee. Significant guarantees that have been entered into by the Corporation
include standby letters of credits with a total of $15.5 million as of September
30, 2003. The adoption of FIN 45 did not have a material impact on the
consolidated financial statements.
COMPREHENSIVE INCOME THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2003 2002 2003 2002
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Net Income $ 1,515 $ 2,104 $ 4,708 $ 6,226
Other comprehensive income
Unrealized holding (losses) gains arising
during the period, net of taxes (5,486) 104 (2,822) 1,290
Less reclassification adjustment for loss (gains)
included in net income (net of taxes) 11 (134) (145) (294)
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Other total comprehensive (loss) income (5,497) (30) (2,967) 996
Total comprehensive (loss) income ($3,982) $ 2,074 $ 1,741 $ 7,222
===============================================================================================
8
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
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Net Income $1,515 $2,104 $4,708 $6,226
Weighted Average Shares 8,481 8,426 8,462 8,389
Effect of Dilutive Stock Options 90 63 90 67
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Total Weighted Average Dilutive Shares 8,571 8,489 8,552 8,456
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Basic Earnings per Share $ 0.18 $ 0.25 $ 0.56 $ 0.74
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Diluted Earnings per Share $ 0.18 $ 0.25 $ 0.55 $ 0.74
======================================================================================================
All common share and per common share amounts have been adjusted to reflect the
2-for-1 common split declared April 15, 2003 and issued June 2, 2003 to common
stockholders of record May 19, 2003.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value recognition provision of FASB
Statement No. 123, Accounting for Stock Based Compensation, to the Corporation's
stock option plans. Stock-based employee compensation cost under the fair value
method was measured using the following weighted-average assumptions for options
granted: dividend yield of 2.73 percent; risk-free interest rate of 4.05
percent; expected volatility of 30.6 percent; expected term of 6.0 years; and
turnover rate of 0.0 percent.
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------
Net Income, as reported $ 1,515 $ 2,104 $ 4,708 $ 6,226
Add: Compensation expense
recognized for restricted stock award,
net of related tax effect -- -- 9 9
Deduct: total stock -
based employee compensation expense
determined under fair,
value based method, all awards
Net of related tax effect 11 16 42 42
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Pro forma net income $ 1,504 $ 2,088 $ 4,675 $ 6,193
Earnings per share:
Basic - as reported $ 0.18 $ 0.25 $ 0.56 $ 0.74
Basic - pro forma $ 0.18 $ 0.25 $ 0.55 $ 0.74
- --------------------------------------------------------------------------------------------------------
Diluted - as reported $ 0.18 $ 0.25 $ 0.56 $ 0.74
Diluted - pro forma $ 0.18 $ 0.25 $ 0.55 $ 0.73
All common share and per common share amounts have been adjusted to reflect the
2-for-1 common split declared April 15, 2003 and issued June 2, 2003 to common
stockholders of record May 19, 2003.
ITEM I. Historical Development of Business
Center Bancorp, Inc., a one-bank holding company, was incorporated in the state
of New Jersey on November 12, 1982. Center Bancorp, Inc. commenced operations on
May 1, 1983, upon the acquisition of all outstanding shares of The Union Center
National Bank (the "Bank"). The holding company's sole activity, at this time,
is to act as a holding company for the Bank. As used herein, the term
"Corporation" shall refer to Center Bancorp, Inc. and its subsidiaries and the
term "Parent Corporation" shall refer to Center Bancorp, Inc. on an
unconsolidated basis.
The Bank was organized in 1923 under the law of the United States of America.
The Bank operates five offices in Union Township, Union County, New Jersey, one
office in Summit, Union County, New Jersey, one office in Springfield Township,
Union County, New Jersey, one office in Berkeley Heights, Union County, New
Jersey, one office in Madison, Morris County, New Jersey and two offices in
Morristown, Morris County, New Jersey and currently employs 181 full-time
equivalent persons. The Bank is a full service commercial bank offering a
complete range of individual and commercial services.
9
During 2001, the Corporation formed a statutory business trust under the laws of
the State of Connecticut, which exists for the exclusive purpose of (i) issuing
Trust Securities representing undivided beneficial interests in certain assets
of the Trust; (ii) investing the gross proceeds of the Trust securities in
junior subordinated deferrable interest debentures (subordinated debentures) of
the Corporation; and (iii) engaging in only those activities necessary or
incidental thereto. These subordinated debentures and the related income effects
are eliminated in the consolidated financial statements. Distributions on the
mandatorily redeemable securities of subsidiary trusts below have been
classified as interest expense in the Consolidated Statement of Income.
On December 11, 2001, the Corporation completed an issuance of $10.0 million in
floating rate Capital Trust Preferred Securities, through a pooled offering with
First Tennessee Capital Markets. The securities are included as a component of
Tier I capital for regulatory capital purposes. The Tier I Leverage capital
ratio was 7.77 percent of total assets at December 31, 2001, 7.29 percent at
December 31, 2002 and 6.79 percent at September 30, 2003.
NARRATIVE DESCRIPTION OF BUSINESS
The Bank offers a broad range of lending, depository and related financial
services including trust, to commercial, industrial and governmental customers.
In 1999, the Bank obtained full trust powers enabling it to offer a variety of
trust services to its customers. In the lending area, the Bank's services
include short and medium term loans, lines of credit, letters of credit, working
capital loans, real estate construction loans and mortgage loans. In the
depository area, the Bank offers demand deposits, savings accounts and time
deposits. In addition, the Bank offers collection services, wire transfers,
night depository and lock box services.
The Bank offers various money market services. It deals in U.S. Treasury and
U.S. Governmental agency securities, certificates of deposits, commercial paper
and repurchase agreements.
Competitive pressures affect the Corporation's manner of conducting business.
Competition stems not only from other commercial banks but also from other
financial institutions such as savings banks, savings and loan associations,
mortgage companies, leasing companies and various other financial service and
advisory companies. Many of the financial institutions operating in the
Corporation's primary market are substantially larger and offer a wider variety
of products and services than the Corporation.
The Parent Corporation is subject to regulation by the Board of Governors of the
Federal Reserve System and the New Jersey Department of Banking. As a national
bank, the Bank is subject to regulation and periodic examination by the Office
of the Comptroller of the Currency (the "OCC"). Deposits in the Bank are insured
by the Federal Deposit Insurance Corporation (the "FDIC").
The Parent Corporation is required to file with the Federal Reserve Board an
annual report and such additional information as the Federal Reserve Board may
require pursuant to the Bank Holding Company Act of 1956, as amended (the
"Act"). In addition, the Federal Reserve Board makes periodic examinations of
bank holding companies and their subsidiaries. The Act requires each bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire substantially all of the assets of any bank, or before it may
acquire ownership or control of any voting shares of any bank, if, after such
acquisition, it would own or control, directly or indirectly, more than 5
percent of the voting shares of such bank. The Act also restricts the types of
businesses and operations in which a bank holding company and its subsidiaries
may engage.
The operations of the Bank are subject to requirements and restrictions under
federal law, including requirements to maintain reserves against deposits,
restrictions on the types and amounts of loans that may be granted, limitations
on the types of investments that may be made and the types of services, which
may be offered. Various consumer laws and regulations also affect the operations
of the Bank. Approval of the Comptroller of the Currency is required for
branching, bank mergers in which the continuing bank is a national bank and in
connection with certain fundamental corporate changes affecting the Bank.
Federal law also limits the extent to which the Parent Corporation may borrow
from the Bank and prohibits the Parent Corporation and the Bank from engaging in
certain tie-in arrangements.
COMPETITION
The market for banking and bank related services is highly competitive. The
Corporation and the bank compete with other providers of financial services such
as other bank holding companies, commercial and savings banks, savings and loan
associations, credit unions, money market and mutual funds, mortgage companies,
title agencies, asset managers, insurance companies and a growing list of other
local, regional and national institutions which offer financial services.
10
Mergers between financial institutions within New Jersey and in neighboring
states have added competitive pressure. Competition intensified as a consequence
of the Gramm-Leach-Bliley Act (discussed below) and interstate banking laws now
in effect. The Corporation and the bank compete by offering quality products and
convenient services at competitive prices. In order to maintain and enhance its
competitive position, the corporation regularly reviews its products, locations,
alternative delivery channels and various acquisition prospects and periodically
engages in discussions regarding possible acquisitions.
ITEM 2-MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, both in the Management's Analysis and
Discussion and elsewhere, contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Such statements are not
historical facts and include expressions about management's confidence and
strategies and management's expectations about new and existing programs and
products, acquisitions, relationships, opportunities, taxation, technology and
market conditions. These statements may be identified by an (*) or such
forward-looking terminology as "expect," "anticipate," "look," "view,"
"opportunities," "allow," "continues," "reflects," "believe," "may," "will" or
similar statements or variations of such terms. Such forward-looking statements
involve certain risks and uncertainties. Factors that may cause actual results
to differ materially from those contemplated by such forward-looking statements
include, but are not limited to, unanticipated deposit out flows, deposit
growth, the direction of the economy in New Jersey, continued levels of loan
quality and origination volume, continued relationships with major customers, as
well as the effects of general economic conditions and legal and regulatory
barriers and the development of new tax strategies or the disallowance of prior
tax strategies. Actual results may differ materially from such forward-looking
statements. The Corporation assumes no obligation for updating any such
forward-looking statement at any time.
CRITICAL ACCOUNTING POLICIES
The Corporation's business is dynamic and complex. Consequently, management must
exercise judgment in choosing and applying accounting policies and
methodologies. These choices are important; not only are they necessary to
comply with accounting principles generally accepted in United States, they also
reflect the exercise of management's judgment in determining the most
appropriate manner in which to record and report the Corporation's overall
financial performance. All accounting policies are important, and all policies
contained in Note 1 ("Summary of Significant Accounting Policies") of the
Corporation's 2002 Annual Report on Form 10K, should be reviewed for greater
understanding of how the Corporation's financial performance is recorded and
reported.
In management's opinion, some areas of accounting are likely to have a more
significant effect than others on the Corporation's financial results and expose
those results to potentially greater volatility. This is because they apply to
areas of relatively greater business importance and/or require management to
exercise judgment in making assumptions and estimates that affect amounts
reported in the financial statements. Because these assumptions and estimates
are based on current circumstances, they may change over time or prove to be
inaccurate based on actual experience. For the Corporation, the area that relies
most heavily on the use of assumptions and estimates includes but is not limited
to accounting for the allowance for loan losses. The Corporation's accounting
policies related to this area are discussed in Note 1 of the Corporation's 2002
Annual Report on Form 10 K, and further described on page 19 of this Quarterly
Report on Form 10-Q under "Allowance for Loan Losses and Related Provision."
EARNINGS ANALYSIS
Net income for the nine months ended September 30, 2003 amounted to $4,708,000
compared to $6,226,000 earned for the comparable nine-month period ended
September 30, 2002. On a per diluted share basis, earnings decreased to $0.55
per share as compared with $0.74 per share for the nine-months ended September
30, 2002. All common stock per share amounts have been restated to reflect the 2
for 1 common stock split declared April 15, 2003, to stockholders of record May
19, 2003 and distributed June 2, 2003. The annualized return on average assets
decreased to 0.73 percent compared with 1.13 percent for the comparable
nine-month period in 2002. The annualized return on average stockholders' equity
was 12.09 percent for the nine-month period ended September 30, 2003 as compared
to 17.37 percent for the nine-months ended September 30, 2002. Earnings
performance for the first nine months of 2003 primarily reflects a lower level
of net interest income due to margin compression and increased non-interest
expense offset in part by a reduction in the effective tax rate.
11
Net income for the three-months ended September 30, 2003 amounted to $1,515,000
as compared to $2,104,000 earned for the comparable three-month period ended
September 30, 2002. On a per diluted share basis, earnings decreased to $0.18
per share as compared with $0.25 per share for the three-months ended September
30, 2002. The annualized return on average assets decreased to 0.68 percent
compared with 1.12 percent for the comparable three-month period in 2002. The
annualized return on average stockholders' equity was 11.67 percent for the
three-month period ended September 30, 2003 as compared to 16.89 percent for the
three months ended September 30, 2002. As with the nine month comparisons,
earnings performance for the three months ended September 30, 2003 primarily
reflects a lower level of net interest income due to margin compression and
increased non-interest expense offset in part by a reduction in the effective
tax rate.
NET INTEREST INCOME/ MARGIN
Net interest income is the difference between the interest earned on the
portfolio of earning-assets (principally loans and investments) and the
interest paid for deposits and short-term borrowings, which support these
assets. Net interest income is presented below first on a fully tax-equivalent
basis by adjusting tax-exempt income (primarily interest earned on various
obligations of state and political subdivisions) by the amount of income tax
which would have been paid had the assets been invested in taxable issues and
then in accordance with the Corporation's consolidated financial statements.
Financial institutions typically analyze earnings performance on a tax
equivalent basis as a result of certain disclosure obligations, which require
the presentation of tax equivalent data and in order to assist financial
statement readers in comparing data from period to period. The following table
presents the components of net interest income (on a tax equivalent basis) for
the three and nine months ended September 30, 2003 and 2002.
NET INTEREST INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, PERCENT SEPTEMBER 30, PERCENT
(dollars in thousands) 2003 2002 CHANGE 2003 2002 CHANGE
------------------------------------------------------------------------------------
Interest income:
Investments $ 4,765 $ 6,453 (26.16) $ 16,680 $ 19,832 (15.89)
Loans, including fees 3,840 3,816 0.62 10,948 11,245 (2.64)
Federal funds sold and securities sold
under agreements to repurchase 0 50 (100.00) 0 59 (100.00)
- -------------------------------------------------------------------------------------------------------------------------------
Total interest income 8,605 10,319 (16.61) 27,628 31,136 (11.27)
- -------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Certificates $100,000 or more 117 94 24.47% 355 383 (7.31)
Savings and Time Deposits 1,570 2,350 (33.19) 5,033 6,706 (24.95)
FHLB advances 1,072 849 26.27 3,049 2,503 21.81
Borrowings 352 491 (28.31) 1,116 1,480 (24.59)
- -------------------------------------------------------------------------------------------------------------------------------
Total interest expense 3,111 3,784 (17.79) 9,553 $ 11,072 (13.72)
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income on a fully
tax-equivalent basis 5,494 6,535 (15.92) 18,075 20,064 (9.91)
- -------------------------------------------------------------------------------------------------------------------------------
Tax-equivalent adjustment (453) (77) 488.31% (962) (232) 314.66%
NET INTEREST INCOME * $ 5,041 $ 6,458 (21.94) $ 17,113 $ 19,832 (13.71)
- -------------------------------------------------------------------------------------------------------------------------------
* Before the provision for loan losses. NOTE: The tax-equivalent adjustment was
computed based on an assumed statutory Federal income tax rate of 34 percent.
Adjustments were made for interest accrued on securities of state and political
subdivisions.
Net interest income on a fully tax-equivalent basis decreased $1.989 million or
9.91 percent to approximately $18.075 million for the nine months ended
September 30, 2003, from $20.064 million for the comparable period in 2002. For
the nine months ended September 30, 2003, the net interest margin decreased 92
basis points to 3.00 percent from 3.92 percent due primarily to lower rates
earned on interest earning assets. For the nine months ended September 30, 2003,
a decrease in the average yield on interest earning assets of 149 basis points
was only partially offset by a decrease in the average cost of interest-bearing
liabilities of 73 basis points, which was not sufficient to sustain the
Corporation's net interest margins.
Net interest income on a fully tax-equivalent basis decreased $1.041 million or
15.92 percent to $5.494 million for the three months ended September 30, 2003,
from $6.535 million for the comparable period in 2002. For the three months
ended September 30, 2003, the net interest margin decreased 107 basis points to
2.67 percent from 3.74 percent due primarily to lower rates earned on
12
interest-earning assets. For the three-months ended September 30, 2003, a
decrease in the average yield on interest earning assets of 172 basis points was
only partially offset by a decrease in the average cost of interest-bearing
liabilities of 83 basis points, which was not sufficient to sustain the
Corporation's net interest margins.
Interest income on a full-tax-equivalent basis for the nine-month period ended
September 30, 2003 decreased by $3.508 million or 11.27 percent, versus the
comparable period ended September 30, 2002. This decrease, reflecting the
decline in the yield on interest earning assets, occurred notwithstanding an
increase in average earning assets. The Corporation's loan portfolio increased
on average $36.5 million to $258.1 million from $221.6 million in the same
period of 2002. This growth was primarily driven by growth in commercial loans
and commercial and residential mortgages. The loan portfolio represented 32.2
percent of the Corporation's interest earning assets (on average) during the
first nine months of 2003 and 32.5 percent in the same period in 2002. Average
investment volume during the period increased $87.9 million on average compared
to 2002. The growth in earning assets was funded primarily through increased
levels of money market and savings deposits, and borrowings.
For the three-month period ended September 30, 2003 interest income on a
tax-equivalent basis decreased by $1.714 million or 16.61 percent over the
comparable three-month period in 2002. This decrease, also reflecting the
decline in the yield on this portfolio, occurred notwithstanding an increase in
average earning assets. The Corporation's loan portfolio increased on average
$60.0 million to $288.8 million from $228.8 million in the same quarter in 2002,
primarily driven by growth in commercial loans and commercial and residential
mortgages. The loan portfolio represented approximately 35.1 percent of the
Corporation's interest earning assets (on average) during the third quarter of
2003 and 39.8 percent in the same quarter in 2002. Average investment volume
increased during the period $75.1 million on average compared to 2002. The
growth in earning assets was funded primarily through increased levels of money
market and savings deposits, and borrowings.
The factors underlying the year-to year changes in net interest income are
reflected in the tables appearing on pages 12, 14, 15 and 16, each of which has
been presented on a tax-equivalent basis (assuming a 34 percent tax rates). The
table on pages 14-16 (Average Balance Sheet with Interest and Average Rates)
shows the Corporation's consolidated average balance of assets, liabilities, and
stockholders' equity, the amount of income produced from interest-earning assets
and the amount of expense resulting from interest-bearing liabilities and the
interest income as a percentage of average interest-earning assets, for the nine
and three month periods ended September 30, 2003 and 2002. The table presented
on page 14 (Analysis of Variance in Net Interest Income Due to Volume and Rates)
quantifies the impact on net interest income resulting from changes in average
balances and average rates over the periods presented; any change in interest
income or expense attributable to both changes in volume and changes in rate has
been allocated in proportion to the relationship of the absolute dollar amount
of change in each category.
Average Federal funds sold and securities purchased under agreements to resell
decreased both for the nine and three month periods in 2003 compared to 2002.
For the nine months ended September 30, 2003 the decrease amounted to
approximately $4.6 million. For the three months ended September 30, 2003 the
decrease amounted to approximately $11.6 million.
Interest expense for the nine months ended September 30, 2003 decreased $1.519
million or 13.72 percent from the comparable nine-month period ended September
30, 2002, as a result of a decline in interest rates coupled with higher average
volumes of lower cost interest-bearing liabilities and borrowings. A $3.898
million decrease in interest expense attributable to decreased rates brought
about by the actions of the Federal Reserve in lowering interest rates was
offset in part by a $2.379 million increases in interest expense attributable to
volume related factors.
Interest expense for the three months ended September 30, 2003 decreased
$673,000 or 17.79 percent from the comparable three-month period ended September
30, 2002, as a result of a decline in interest rates coupled with higher average
volumes of lower cost interest-bearing liabilities and borrowings. A $1.488
million decrease in interest expense attributable to decreased rates brought
about by the actions of the Federal Reserve in lowering interest rates was
offset in part by an $815,000 increase in interest expense attributable to
volume related factors.
For both the three and nine month periods, short-term interest rates have
decreased as a result of monetary policy promulgated by the Federal Reserve Open
Market Committee. The Fed has lowered the Federal Funds index rate on November
6, 2002 and June 25, 2003. Since September of 2002 the Federal Funds rate has
fallen 75 basis points.
For the nine months ended September 30, 2003, the Corporation's net interest
spread on a tax-equivalent basis (i.e. interest income on a tax-equivalent basis
as a percent of average interest-earning-assets less interest expense as a
percent of total interest bearing liabilities) decreased to 2.74 percent from
3.50 percent for the nine months ended September 30, 2002. The decrease
reflected a narrowing of spreads between yields earned on loans and investments
13
and rates paid for supporting funds. Net interest margins contracted due in part
to a decline in interest rates, despite the volumes of interest-bearing
checking, money market and savings deposits in addition to short-term
borrowings.
The Federal Reserve open market committee lowered interest rates for a
thirteenth time on June 25, 2003, 25 basis points to a 45-year low of 1.00
percent. Although the yield on interest-earning assets declined to 4.59 percent
from 6.08 percent in 2002 (a change of 149 basis points), this change was
partially offset by lower rates paid for interest-bearing liabilities coupled
with a change in the mix of interest-bearing liabilities. The total cost of
interest-bearing liabilities decreased to 1.85 percent, a change of 73 basis
points, for the nine months ended September 30, 2003 from 2.58 percent for the
nine months ended September 30, 2002.
For the three months ended September 30, 2003, the Corporation's net interest
spread on a tax-equivalent basis decreased to 2.42 percent from 3.31 percent for
the three months ended September 30, 2002. The decrease reflected a narrowing of
spreads between yields earned on loans and investments and rates paid for
supporting funds. Net interest margins compressed due primarily to a continued
decline in interest rates. The protracted lower interest rate environment has
had a negative effect on interest margins. Rates fell an additional 25 basis
point during the second quarter as the Federal Reserve lowered the target
Federal Funds rate on June 25. The Fed had lowered the federal funds index 13
times from 6.50% over the past two years. Although the yield on interest-earning
assets declined to 4.18 percent from 5.90 percent in 2002 (a change of 172 basis
points), this change was offset in part by lower rates paid for interest-bearing
liabilities coupled with a change in the mix of interest-bearing liabilities.
The total cost of interest-bearing liabilities decreased to 1.76 percent or 83
basis points, for the three months ended September 30, 2003 from 2.59 percent
for the three months ended September 30, 2002.
The trend is primarily due to the previously discussed change in the mix and
decrease in rates paid on certain interest-bearing liabilities. The decrease in
these funding costs continues to change disproportionately to the rates on new
loans and investments.
The following table "Analysis of Variance in Net Interest Income due to Volume
and Rates" analyzes net interest income by segregating the volume and rate
components of various interest-earning assets and liabilities and the changes in
the rates earned and paid by the Corporation.
Analysis of Variance in Net Interest Income on a Tax Equivalent Basis Due to
Volume and Rates
(Tax-Equivalent Basis) Three Months Ended 9/30/03 Nine Months Ended 9/30/03
2003/2002 Increase/(Decrease) 2003/2002 Increase/(Decrease)
Due to Change in: Due to Change in:
---------------------------------------------------------------------
(dollars in thousands) Average Average Net Average Average Net
Interest-earning assets Volume Rate Change Volume Rate Change
- ---------------------------------------------------------------------------------------------------------
Investment Securities
Taxable $ (110) $(2,684) $(2,794) $ 1,507 ($6,805) ($5,298)
Non-taxable 1,162 (56) 1,106 2,263 (117) 2,146
Federal funds sold and securities
purchased under agreement to resell (50) 0 (50) (59) 0 (59)
Loans, net of unearned discount 887 (863) 24 1,698 (1,995) (297)
- ---------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 1,889 $(3,603) $(1,714) $ 5,409 ($8,917) ($3,508)
- ---------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Money Market deposits $ (9) $ (222) $ (231) $ (53) $ (588) $ (641)
Savings deposits (15) (149) (164) (23) (1,028) (1,051)
Time deposits 153 (450) (297) 709 (465) 244
Other interest-bearing deposits 21 (86) (65) 41 (294) (253)
Borrowings 665 (561) 104 1,705 (1,470) 235
Trust Preferred 0 (20) (20) 0 (53) (53)
- ---------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 815 $(1,488) $ (673) $ 2,379 $(3,898) $(1,519)
- ---------------------------------------------------------------------------------------------------------
Change in net interest income $ 1,074 $(2,115) $(1,041) $ 3,030 ($5,019) $(1,989)
- ---------------------------------------------------------------------------------------------------------
14
The following table, "Average Balance Sheet with Interest and Average Rates",
presents for the nine months ended September 30, 2003 and 2002 the Corporation's
average assets, liabilities and stockholders' equity. The Corporation's net
interest income, net interest spreads and net interest income as a percentage of
interest-earning assets are also reflected.
Average Balance Sheet with Interest and Average Rates
NINE MONTH
PERIOD ENDED SEPTEMBER 30,
2003 2002
- ------------------------------------------------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(TAX EQUIVALENT BASIS, DOLLARS IN THOUSANDS) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- ------------------------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets:
Investment securities:(1)
Taxable $ 480,843 $ 13,851 3.84% $ 443,427 $ 19,149 5.76%
Non-taxable 63,548 2,829 5.94% 13,053 683 6.98%
Federal funds sold and securities
purchased under agreement to resell 0 0 0 4,565 59 1.72%
Loans, net of unearned income (2) 258,070 10,948 5.66% 221,614 11,245 6.77%
- -----------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 802,461 $ 27,628 4.59% 682,659 31,136 6.08%
=======================================================================================================================
Non-interest earning assets
Cash and due from banks 21,961 18,293
BOLI 14,350 13,641
Other assets 27,698 23,771
Allowance for possible loan losses (2,608) (2,296)
- -----------------------------------------------------------------------------------------------------------------------
Total non-interest earning assets 61,401 53,409
- -----------------------------------------------------------------------------------------------------------------------
Total assets $ 863,862 $ 736,068
=======================================================================================================================
Liabilities and stockholders' equity
Interest-bearing liabilities:
Money Market deposits $ 93,063 779 1.12% $ 96,805 1,420 1.96%
Savings deposits 155,416 1,462 1.25% 156,854 2,513 2.14%
Time deposits 144,540 2,836 2.62% 110,677 2,592 3.12%
Other interest bearing deposits 69,448 311 0.60% 64,480 564 1.17%
Borrowings 215,247 3,798 2.35% 133,518 3,563 3.56%
Trust Preferred 10,000 367 4.89% 10,000 420 5.60%
- -----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 687,714 9,553 1.85% 572,334 11,072 2.58%
=======================================================================================================================
Noninterest-bearing liabilities:
Demand deposits 118,736 109,331
Other noninterest-bearing deposits 452 569
Other liabilities 4,852 6,035
- -----------------------------------------------------------------------------------------------------------------------
Total noninterest-bearing liabilities 124,040 115,935
- -----------------------------------------------------------------------------------------------------------------------
Stockholders' equity 52,108 47,799
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $ 863,862 $ 736,068
- -----------------------------------------------------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $ 18,075 $ 20,064
Net Interest Spread 2.74% 3.50%
- -----------------------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets 3.00% 3.92%
- -----------------------------------------------------------------------------------------------------------------------
Tax equivalent adjustment (3) (962) (232)
- -----------------------------------------------------------------------------------------------------------------------
Net interest income $ 17,113 $ 19,832
=======================================================================================================================
(1) Average balances for available-for-sale securities are based on amortized
cost
(2) Average balances for loans include loans on non-accrual status
(3) The tax-equivalent adjustment was computed based on a statutory Federal
income tax rate of 34 percent
15
The following table, "Average Balance Sheet with Interest and Average Rates",
presents for the three months ended September 30, 2003 and 2002 the
Corporation's average assets, liabilities and stockholders' equity. The
Corporation's net interest income, net interest spreads and net interest income
as a percentage of interest-earning assets are also reflected.
AVERAGE BALANCE SHEET WITH INTEREST AND AVERAGE RATES
THREE MONTH
PERIOD ENDED SEPTEMBER 30,
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(TAX EQUIVALENT BASIS, DOLLARS IN THOUSANDS) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets:
Investment securities:(1)
Taxable $438,432 $3,432 3.13% $446,434 $6,226 5.58%
Non-taxable 96,115 1,333 5.55% 13,020 227 6.97%
Federal funds sold and securities
purchased under agreement to resell 0 0 0 11,583 50 1.73%
Loans, net of unearned income (2) 288,810 3,840 5.32% 228,764 3,816 6.67%
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $823,357 $8,605 4.18% 699,801 10,319 5.90%
===================================================================================================================================
Non-interest earning assets
Cash and due from banks 22,068 18,107
BOLI 14,446 13,831
Other assets 29,549 24,889
Allowance for possible loan losses (2,680) (2,368)
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-interest earning assets 63,383 54,459
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $886,740 $754,260
===================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Money Market deposits $88,561 209 0.94% $90,362 440 1.95%
Savings deposits 153,381 423 1.10% 157,546 587 1.49%
Time deposits 145,831 969 2.66% 128,624 1,266 3.94%
Other interest bearing deposits 68,686 86 0.50% 59,431 151 1.02%
Borrowings 242,338 1,304 2.15% 139,459 1,200 3.44%
Trust Preferred 10,000 120 4.80% 10,000 140 5.60%
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 708,797 3,111 1.76% 585,422 3,784 2.59%
===================================================================================================================================
Noninterest-bearing liabilities:
Demand deposits 121,518 111,858
Other noninterest-bearing deposits 422 684
Other liabilities 4,066 6,472
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest-bearing liabilities 126,006 119,014
- -----------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity 51,937 49,824
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $886,740 $754,260
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $5,494 $6,535
Net Interest Spread 2.42% 3.31%
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets 2.67% 3.74%
- -----------------------------------------------------------------------------------------------------------------------------------
Tax equivalent adjustment (3) (453) (77)
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income $5,041 $6,458
===================================================================================================================================
(1) Average balances for available-for-sale securities are based on amortized
cost
(2) Average balances for loans include loans on non-accrual status
(3) The tax-equivalent adjustment was computed based on a statutory Federal
income tax rate of 34 percent
16
INVESTMENTS
For the nine months ended September 30, 2003, the average volume of investment
securities increased to approximately $544.4 million, or 67.8 percent of average
earning assets, an increase of $87.9 million on average as compared to the same
period in 2002. The tax-equivalent yield on investments decreased by 170 basis
points to 4.09 percent from a yield of 5.79 percent during the nine month period
ended September 30, 2003. The 170 basis points decline in yield on the portfolio
was attributable to lower rates that prevailed for both additional volume added
to the portfolio coupled with purchases made to replace maturing and called
investments made at lower rates. Heightened prepayment speeds also contributed
to the acceleration of the downward repricing of yield on mortgage-related
securities in the portfolio. The volume related figures during the nine month
period ended September 30, 2003 contributed an increase in revenue of $3.770
million, while rate related changes amounted to a decline in revenue of $6.922
million. The increased size of the investment portfolio for both the nine and
three months ended September 30, 2003 largely reflects the investment of
funding.
For the three months ended September 30, 2003, the average volume of investment
securities, increased to approximately $534.5 million, or 64.9 percent of
average earning assets, an increase of $75.1 million on average as compared to
the same period in 2002. The tax-equivalent yield on investments decreased by
205 basis points to 3.57 percent from a yield of 5.62 percent during the three
month period ended September 30, 2002. The 205 basis points decline in yield on
the portfolio was attributable primarily to the lower interest rate environment
which increased the volume of securities called from the portfolio coupled with
extraordinary prepayment levels negatively affecting the returns on mortgage
related securities. Heightened prepayment levels during 2003 have led to
accelerated prepayments on these securities and the increased volume of
additional cash flow was reinvested at lower rates than in comparable periods.
The volume related figures during the three-month period ended September 30,
2003 contributed an increase in revenue of $1.052 million, while rate related
changes amounted to a decline of $2.740 million. At September 30, 2003, the
principal components of the investment portfolio are U.S. Government Federal
Agency callable and non-callable securities, including agency issued
collateralized mortgage obligations, corporate securities and municipals.
The impact of repricing activity on investment yields was increased to some
extent, for both the three and nine month periods ended September 30, 2003, by
the change in portfolio mix and shortening of portfolio duration. In addition,
there was some portfolio extension where risk is relatively minimal within the
portfolio, resulting in wider spreads. The Corporation also carried on average
$5.9 million and $14.0 million, in short-term overnight money market and federal
funds as compared with $22.9 million and $18.4 million for the comparable three
and nine month periods in 2002, respectively. These funds carried significantly
lower rates than other securities in the portfolio (on average 1.00 percent and
1.18 percent for the three and nine month periods, respectively, compared to
1.84 percent and 1.92 percent earned on these overnight funds for the comparable
period in 2002.) and contributed to the decline in yield as compared to the
comparable periods in 2002. The increased volume of such overnight funds in both
the nine and three month periods was for liquidity purposes.
Securities available-for-sale is a part of the Corporation's interest rate risk
management strategy and may be sold in response to changes in interest rates,
changes in prepayment risk, liquidity management and other factors. For the
three and nine-month period ended September 30, 2003 the Corporation sold from
its available-for-sale portfolio securities totaling approximately $47.2 million
and $104.9 million, respectively.
At September 30, 2003 the net unrealized loss carried as a component of other
comprehensive income and included in shareholders' equity net of tax amounted to
a net unrealized loss of $782,000 as compared with an unrealized gain of $2.116
million at September 30, 2002, resulting from a decline in interest rates
fostered by the Federal Open Market Committee's actions to continue to lower the
Federal Funds target rate, most recently by 25 basis points on June 25, as an
economic stimulus.
LOANS
Loan growth during the nine months ended September 30, 2003 occurred primarily
in the residential 1-4 family home equity loans and commercial loan portfolio.
This growth resulted from the Corporation's business development efforts,
aggressive marketing campaigns on its home equity and 10- year residential
mortgage loan products. These have been enhanced in recent years by the
Corporation's expanded branch network. The decrease in the loan portfolio yields
for the three and nine month periods was the result of the decline in interest
rates as compared with the comparable period in 2002, coupled with a competitive
rate pricing structure maintained by the Corporation to attract new loans and
further by the heightened competition for lending relationships that exists in
the Corporation's market.
17
The Corporation's desire to grow this segment of the earning-asset mix is
reflected in its current business development plan and marketing plans, as well
as its short-term strategic plan. Analyzing the loan portfolio for the
nine-month period ended September 30, 2003, average loan volume increased $36.5
million or 16.45 percent, while portfolio yield decreased by 111 basis points as
compared with the same period in 2002. The volume related factors during the
period-contributed increased revenue of $1.698 million while rate related
changes amounted to a reduction in income of $1.995 million. Total average loan
volume increased to $258.1 million with a net interest yield of 5.66 percent, as
compared to $221.6 million with a yield of 6.77 percent for the nine months
ended September 30, 2002.
For the three months ended September 30, 2003, average loan volume increased
$60.0 million or 26.25 percent, while portfolio yield decreased by 135 basis
points as compared with the same period in 2002. The volume related factors
during the period-contributed increased revenue of $887,000 while rate related
changes amounted to a decline in revenue of $863,000. Total average loan volume
increased to $288.8 million with a net interest yield of 5.32 percent, as
compared to $228.8 million with a yield of 6.67 percent for the three months
ended September 30, 2002.
The decline in portfolio yield was a result of prepayments and rate
modifications of higher yielding loans coupled with lower yields on new volume
added to the portfolio in 2003 compared with 2002.
ALLOWANCE FOR LOAN LOSSES
The purpose of the allowance for loan losses is to absorb the impact of losses
inherent in the loan portfolio. Additions to the allowance are made through
provisions charged against current operations and through recoveries made on
loans previously charged-off. The allowance for loan losses is maintained at an
amount considered adequate by management to provide for potential credit losses
inherent in the loan portfolio based upon a periodic evaluation of the risk
characteristics of the loan portfolio. The amount of the loan loss provision and
the level of the allowance for loan losses are critical accounting policies of
the Corporation. In establishing an appropriate allowance, an assessment of the
individual borrowers, a determination of the value of the underlying collateral,
a review of historical loss experience, a review of peer group loss experience
and an analysis of the levels and trends of loan categories, delinquencies, and
problem loans are considered. Such factors as the level and trend of interest
rates and current economic conditions are also reviewed. At September 30, 2003,
the allowance amounted to $2,751,000 as compared to $2,498,000 at December 31,
2002, and $2,381,000 at September 30, 2002. The Corporation had a provision to
the allowance for loan losses during the nine and three month periods ended
September 30, 2003 amounting to $262,000 and $103,000, respectively, compared to
$270,000 and $90,000 during the nine and three month periods ended September 30,
2002, respectively. The additions to the allowance during the nine and three
month periods of 2003 reflective of the loan volume recorded during the periods
and the Corporation's focus on the changing composition of the commercial and
residential real estate loan portfolios.
At September 30, 2003, the allowance for loan losses amounted to .89 percent of
total loans, as compared with 1.05 percent at September 30, 2002. In
management's view, the level of the allowance as of September 30, 2003 is
adequate to cover the risk of loss inherent in the loan portfolio. The
Corporation's statements herein regarding the adequacy of the allowance for loan
losses constitute "Forward-Looking Statement's" under the Private Securities
Litigation Reform Act of 1995. Actual results could differ materially from
management's analysis, based principally upon factors considered by management
in establishing the allowance.
Although management uses the best information available, the level of the
allowance for loan losses remains anestimate, which is subject to significant
judgment and short-term changes. Various regulatory agencies, as an integral
part of their examination process, periodically review the Corporation's
allowance for loan losses. Such agencies may require the Corporation to increase
the allowance based on their analysis of information available to them at the
time of their examinations. Future adjustments to the allowance may be necessary
due to economic, operating, regulatory, and other conditions beyond the
Corporation's control. To the extent actual results differ from forecasts or
management's judgment, the allowance for loan losses may be greater or less than
future charge-offs.
During the nine and three-month periods ended September 30, 2003 and 2002, the
Corporation did not experience any substantial credit problems within its loan
portfolio. Net charge-offs were approximately $9,000 and were comprised of
installment loans as compared with net charge-offs of $80,000 for the comparable
nine-month period in 2002, which were comprised of a commercial loan and
installment loans.
At September 30, 2003 the Corporation had non-accrual loans amounting to $37,000
as compared with $229,000 at December 31, 2002 and $233,000 of non-accrual loans
at September 30, 2002. The Corporation continues to aggressively pursue
collections of principal and interest on loans previously charged-off. The
decrease in such loans
18
in 2003 compared to September 30, 2002 was attributable to three home equity
loans, which were re-paid in full by the borrower.
The value of impaired loans is based on the present value of expected future
cash flows discounted at the loan's effective interest rate or as a practical
expedient, at the loan's observable market price or at the fair value of the
collateral if the loan is collateral dependant. Impaired loans consist of
non-accrual loans and loans internally classified as substandard or below, in
each instance above an established dollar threshold of $200,000. All loans below
the established dollar threshold are considered homogenous and are collectively
evaluated for impairment. At September 30, 2003, total impaired loans were
approximately $395,000 compared to $175,000 at December 31, 2002 and $2,234,000
at September 30, 2002. The reserves allocated to such loans at September 30,
2003, December 31, 2002 and September 30, 2002, were $6,300, $1,000 and $36,900,
respectively. Although classified as substandard, impaired loans (other than
those in non-accrual status) were current with respect to principal and interest
payments.
Changes in the allowance for possible loan losses for the nine-month periods
ended September 30, 2003 and 2002, respectively, are set forth below.
ALLOWANCE FOR LOAN LOSSES
(DOLLARS IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
- --------------------------------------------------------------------------------------------------
Average loans outstanding $258,070 $221,614
- --------------------------------------------------------------------------------------------------
Total loans at end of period 308,634 226,656
- --------------------------------------------------------------------------------------------------
Analysis of the allowance for loan losses
Balance at the beginning of year 2,498 2,191
Charge-offs:
Commercial 0 48
Real estate-mortgage 0 0
Installment loans 25 45
- --------------------------------------------------------------------------------------------------
Total charge-offs 25 93
Recoveries:
Commercial 0 0
Real estate-mortgage 0 0
Installment loans 16 13
- --------------------------------------------------------------------------------------------------
Total recoveries 16 13
Net Charge-offs: 9 80
Provision for Loan Losses 262 270
Balance at end of period $2,751 $2,381
- --------------------------------------------------------------------------------------------------
Ratio of net charge-offs during the period to
average loans outstanding during the period n/m 0.00036%
- --------------------------------------------------------------------------------------------------
Allowance for loan losses as a percentage of total loans 0.89% 1.05%
- ---------------------------------------------------------------------------------------------------
ASSET QUALITY
The Corporation manages asset quality and credit risk by maintaining
diversification in its loan portfolio and through review processes that include
analysis of credit requests and ongoing examination of outstanding loans and
delinquencies, with particular attention to portfolio dynamics and mix. The
Corporation strives to identify loans experiencing difficulty early enough to
correct the problems, to record charge-offs promptly based on realistic
assessments of current collateral values, and to maintain an adequate allowance
for loan losses at all times. These practices have protected the Corporation
during economic downturns and periods of uncertainty.
It is generally the Corporation's policy to discontinue interest accruals once a
loan is past due as to interest or principal payments for a period of ninety
days. When a loan is placed on non-accrual status, interest accruals cease and
uncollected accrued interest is reversed and charged against current income.
Payments received on non-accrual loans are applied against principal. A loan may
only be restored to an accruing basis when it again becomes well secured and in
the process of collection or all past due amounts have been collected. Loan
origination fees and certain direct loan origination costs are deferred and
recognized over the life of the loan as an adjustment to the loan's yield.
Accruing loans past due 90 days or more are generally well secured and in the
process of collection.
19
At September 30, 2003, December 31, 2002 and September 30, 2002, the Corporation
had no restructured loans. Non-accrual loans amounted to $37,000 at September
30, 2003, and were comprised of three consumer loans and two home equity loans.
At December 31, 2002, non-accrual loans amounted to $229,000 and were comprised
of first and second lien residential mortgages. At September 30, 2002,
non-accrual loans amounted to $233,000 and were comprised of three home equity
and two auto loans. At September 30, 2003, December 31, 2002 and at September
30, 2002, the Corporation did not have any loans 90 days past due and still
accruing.
The outstanding balances of accruing loans, which are 90 days or more past due
as to principal or interest payments and non-accrual loans at September 30,
2003, December 31, 2002 and September 30, 2002, were as follows:
NON-PERFORMING LOANS AT
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
(Dollars in thousands) 2003 2002 2002
- -------------------------------------------------------------------------------------------------------
Loans past due 90 days and still accruing $0 $0 $0
Non-accrual loans 37 229 233
Total non-performing loans 37 229 233
Total non-performing assets $37 $229 $233
- ------------------------------------------------------------------------------------------------------
At September 30, 2003, non-performing assets, consisting of loans on non-accrual
status plus other real estate owned (OREO), amounted to $37,000 or .01 percent
of total loans outstanding as compared to $229,000 or .10 percent at December
31, 2002 and $233,000 or .10 percent at September 30, 2002.
At September 30, 2003, other than the loans set forth above, the Corporation is
not aware of any loans which present serious doubts as to the ability of its
borrowers to comply with the present loan and repayment terms and which are
expected to fall into one of the categories set forth in the table above. At
September 30, 2003, December 31, 2002 and September 30, 2002 the Corporation did
not have any other real estate owned or restructured loans.
OTHER NON-INTEREST INCOME
The following table presents the principal categories of non-interest income for
the three and nine month periods ended September 30, 2003 and 2002.
Three Months Ended Nine Months Ended
SEPTEMBER 30, SEPTEMBER 30,
(dollars in thousands) 2003 2002 % change 2003 2002 % change
- ----------------------------------------------------------------------------------------------------------------------------
Other non-interest income:
Service charges, commissions and fees $401 $409 (1.96) $1,239 $1,183 4.73%
Other income. 173 114 51.75 420 279 50.54%
Bank Owned Life Insurance 268 193 38.86 627 564 11.17
Net (loss) gain on securities sold (17) 203 n/m 220 445 (50.56)
- ----------------------------------------------------------------------------------------------------------------------------
Total other non-interest income $825 $919 (10.23)% $2,506 $2,471 1.42%
- ----------------------------------------------------------------------------------------------------------------------------
For the nine-month period ended September 30, 2003, total other (non-interest)
income increased $35,000 or 1.42 percent as compared to the comparable
nine-month period in 2002. Other non-interest income, exclusive of gains on
securities sold (which decreased $225,000 or 50.56 percent), reflects an
increase of $260,000 or 12.83 percent compared with the comparable nine-month
period ended September 30, 2002. This increased revenue was primarily driven by
the increase in other income which reflected an increase of $141,000 or 50.54
percent due primarily to increased letter of credit fees and fees from secondary
market activity on mortgage loans during the nine months ended September 30,
2003 as compared with the comparable period in 2002. Service charges,
commissions and fees, which amounted to $1.239 million, increased $56,000 or
4.73 percent for the nine months ended September 30, 2003 as compared to $1.183
million for the comparable period in 2002. This increase primarily related to
increased business service charges and ATM fee revenue.
For the three month period ended September 30, 2003, total other (non-interest)
income decreased $94,000 or 10.23 percent as compared to the comparable
three-month period in 2002. Other non-interest income, exclusive of net gains on
securities sold (which decreased $220,000 or 108.4 percent), reflects an
increase of $126,000 or 17.6 percent compared with the comparable three month
period ended September 30, 2002. This increased revenue was primarily driven by
higher level of other income which reflected an increase of $59,000 or 51.8
percent due primarily to increased letter of credit fees and increased loan
servicing, and loan documentation fees and gains on sale of loans during the
nine months ended September 30, 2003 as compared with the comparable period in
2002.
20
For the three and nine month periods ended September 30, 2003, the Corporation
recorded a net loss of $17,000 and net gains of $220,000 respectively, on
securities sold from the available-for-sale investment portfolio compared to
gains of $203,000 and $445,000 recorded in the 2002 comparable periods. These
sales were made in the normal course of business and proceeds were reinvested in
securities.
OTHER NON-INTEREST EXPENSE
The following table presents the principal categories of non-interest expense
for the three and nine month periods ended September 30, 2003 and 2002.
THREE MONTHS ENDED NINE MONTHS ENDED
September 30, September 30,
(dollars in thousands) 2003 2002 % change 2003 2002 % change
- --------------------------------------------------------------------------------------------------------------------------------
Other expense:
Salaries and employee benefits $2,507 $2,373 5.65% $7,834 $6,955 12.64%
Occupancy expense, net 393 395 (0.51) 1,365 1,233 10.71%
Premise & equipment expense 384 388 (1.03) 1,278 1,172 9.04%
Stationery and printing expense 131 115 13.91 436 419 4.06
Marketing & Advertising 120 122 (1.64) 409 478 (14.44)
Legal and Consulting 94 86 9.30 290 331 (12.39)
Other expenses 786 706 11.33 2,149 2,269 (5.29)
- -------------------------------------------------------------------------------------------------------------------------------
Total other expense $4,415 $4,185 5.50 $13,761 $12,857 7.03
- -------------------------------------------------------------------------------------------------------------------------------
For the nine month period ended September 30, 2003 total other (non-interest)
expenses increased $904,000 or 7.03 percent over the comparable nine months
ended September 30, 2002, with increased salary and benefit expense, occupancy
expenses and Bank premise and equipment expense accounting for most of the
increase. Effective January 1, 2002, the Corporation adopted SFAS No. 142
"Goodwill and Intangible Assets", under which periodic goodwill amortization has
ceased. Accordingly there was no amortization expense in 2002 or 2003.
For the three months ended September 30, 2003 total other (non-interest)
expenses increased $230,000 or 5.50 percent over the comparable three-months
ended September 30, 2002, with increased salary and benefit expense, occupancy
expense and Bank premise and equipment expense accounting for most of the
increase.
The year to year increase in expenses is primarily attributable to the
Corporation's continued investment in technology and expanded facilities and the
need to attract, develop, and retain high caliber employees. The Corporation's
ratio of other expenses (annualized) to average assets decreased to 2.12 percent
in the first nine months of 2003 from 2.33 percent for the first nine months of
2002.
Salaries and employee benefits increased $879,000 or 12.64 percent in the nine
months of 2003 over the comparable nine month period ended September 30, 2002.
This increase is primarily attributable to normal merit increases, promotional
raises and higher benefit costs. Staffing levels remained relatively steady at
181 full-time equivalent employees at September 30, 2003 compared to 180
full-time equivalent employees at September 30, 2002. For the three months ended
September 30, 2003 salaries and benefits increased $134,000 or 5.65 percent.
Also, primarily attributable to higher benefit costs.
For the nine months ended September 30, 2003, occupancy and premises and
equipment expense increased $238,000 or 9.90 percent over the comparable
nine-month period in 2002. The increase in occupancy and Bank premise and
equipment expenses reflects the expense associated with higher operating costs
(utilities, rent, real-estate taxes and general repair and maintenance) of the
Corporation's expanded facilities, as well as higher equipment and maintenance
cost and depreciation expense of the expanded bank facilities. For the three
months ended September 30, 2003, such expenses decreased $6,000 or 0.77 percent
as compared with the comparable three month period in 2002.
PROVISION FOR INCOME TAXES
For the three and nine-month periods ended September 30, 2003, the effective tax
(benefit) rate was 12.39 percent and 15.87 percent, respectively, compared to
32.17 percent and 32.15 percent, respectively, for the three and nine month
periods ended September 30, 2002. The effective tax rate continues to be less
than the combined statutory Federal tax rate of 34.0 percent and the New Jersey
State tax rate of 9 percent. The difference between the statutory and effective
tax rates primarily reflects the tax-exempt status of interest income on
obligations of states and political subdivisions, an increase in the cash
surrender value of bank owned life insurance and disallowed expense items for
tax purposes,
21
such as travel and entertainment expense. Tax-exempt interest income on a
tax-equivalent basis increased by $376,000 or 488.31 percent and $730,000 or
314.66 percent for the three and nine months ended September 30, 2003,
respectively, as compared to the comparable periods in 2002.
ASSET LIABILITY MANAGEMENT
The composition and mix of the Corporation's assets and liabilities is planned
and monitored by the Asset and Liability Committee (ALCO). Asset and Liability
management encompasses the control of interest rate risk (interest sensitivity
management) and the ongoing maintenance and planning of liquidity and capital.
In general, management's objective is to optimize net interest income and
minimize interest rate risk by monitoring these components of the statement of
condition.
INTEREST SENSITIVITY
MARKET RISK
"Market risk" represents the risk of loss from adverse changes in market prices
and rates. The Corporation's market rate risk arises primarily from interest
rate risk inherent in its investing, lending and deposit taking activities. To
that end, management actively monitors and manages its interest rate risk
exposure.
The Corporation's profitability is affected by fluctuations in interest rates. A
sudden and substantial increase or decrease in interest rates may adversely
affect the Corporation's earnings to the extent that the interest rates borne by
assets and liabilities do not similarly adjust. The Corporation's primary
objective in managing interest rate risk is to minimize the adverse impact of
changes in interest rates on the Corporation's net interest income and capital,
while structuring the Corporation's asset-liability structure to obtain the
maximum yield-cost spread on that structure. The Corporation relies primarily on
its asset-liability structure to control interest rate risk. The Corporation
continually evaluates interest rate risk management opportunities, including the
use of derivative financial instruments. The management of the Corporation
believes that hedging instruments currently available are not cost-effective,
and, therefore, has focused its efforts on increasing the Corporation's
yield-cost spread through wholesale and retail growth opportunities.
The Corporation monitors the impact of changes in interest rates on its net
interest income using several tools. One measure of the Corporation's exposure
to differential changes in interest rates between assets and liabilities is the
Corporation's analysis of its interest rate sensitivity. This test measures the
impact on net interest income and on net portfolio value of an immediate change
in interest rates in 100 basis point increments. Net portfolio value is defined
as the net present value of assets, liabilities and off-balance sheet contracts.
The primary tool used by management to measure and manage interest rate exposure
is a simulation model. Use of the model to perform simulations reflecting
changes in interest rates over one and two-year time horizons has enabled
management to develop and initiate strategies for managing exposure to interest
rate risk. In its simulations, management estimates the impact on net interest
income of various changes in interest rates. Projected net interest income
sensitivity to movements in interest rates is modeled based on both an immediate
rise and fall in interest rates ("rate shock"), as well as gradual changes in
interest rates over a 12 month time period. The model is based on the actual
maturity and repricing characteristics of interest-rate sensitive assets and
liabilities. The model incorporates assumptions regarding earning-asset and
deposit growth, prepayments, interest rates and other factors. Management
believes that both individually and taken together, these assumptions are
reasonable, but the complexity of the simulation modeling process results in a
sophisticated estimate, not an absolutely precise calculation, of exposure. For
example, estimates of future cash flows must be made for instruments without
contractual maturity or payment schedules.
The Corporation's rate sensitivity position in each time frame may be expressed
as assets less liabilities, as liabilities less assets, or as the ratio between
rate sensitive assets (RSA) and rate sensitive liabilities (RSL). For example, a
short funded position (liabilities repricing before assets) would be expressed
as a net negative position, when period gaps are computed by subtracting
repricing liabilities from repricing assets. When using the ratio method, a
RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1
indicates an asset sensitive position and a ratio less than 1 indicates a
liability sensitive position.
A negative gap and/or a rate sensitivity ratio less than 1, tends to expand net
interest margins in a falling rate environment and to reduce net interest
margins in a rising rate environment. Conversely, when a positive gap occurs,
generally margins expand in a rising rate environment and contract in a falling
rate environment. From time to time, the Corporation may elect to deliberately
mismatch liabilities and assets in a strategic gap position.
22
At September 30, 2003, the Corporation reflects a positive interest sensitivity
gap (or an interest sensitivity ratio) of 1.15:1.00 at the cumulative one-year
position. During most of 2002, the Corporation had a negative interest
sensitivity gap. The maintenance of a liability-sensitive position during 2002
had a favorable impact on the Corporation's net interest margins. Conversely, at
September 30, 2003 the Corporation maintained an asset-sensitive position which
has had a negative impact on net interest margins; based on management's
perception that interest rates will continue to be volatile, emphasis has been,
and is expected to continue to be, placed on interest-sensitivity matching with
the objective of stabilizing the net interest spread during 2004. However, no
assurance can be given that this objective will be met.
ESTIMATES OF FAIR VALUE
The estimation of fair value is significant to a number of the Corporation's
assets, including trading account assets, loans held for sale, available for
sale investment securities, mortgage servicing rights ("MSR's"), other real
estate owned and other repossessed assets. These are all recorded at either fair
value or lower of cost or fair value. Fair values are volatile and may be
influenced by a number of factors. Circumstances that could cause estimates of
the fair value of certain assets and liabilities to change include a change in
prepayment in speeds, discount rates, or market interest rates. Fair values for
trading account assets, most available for sale investment securities and most
derivative financial instruments are based on quoted market prices. If quoted
market prices are not available, fair values are based on judgments regarding
future expected loss experience, current economic condition risk characteristics
of various financial instruments, and other factors. These estimates are
subjective in nature, involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and notes thereto, presented elsewhere herein, have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation. The impact of inflation is reflected
in the increased cost of the operations, unlike most industrial companies,
nearly all of the company's assets and liabilities are monetary. As a result,
interest rates have a greater impact on performance than do the effects of
general levels of inflation. Interest rates do not necessarily more in the same
direction or to the same extent as the prices of goods and services.
LIQUIDITY MANAGEMENT
Liquidity risk is the risk of being unable to timely meet obligations as they
come due at reasonable cost. The corporation manages this risk by maintaining
borrowing resources to find increases in assets and replace maturing obligations
or deposit withdrawals, both in the normal course of business and in times of
unusual events. ALCO sets the policies and reviews adherence to these policies.
The Company's sources of funds include a large, stable deposit base, secured
advances from the Federal Home Loan Bank of New York, and access to capital
markets.
Increases in rates, economic activity and confidence in the financial markets,
may lead to disintermediation of deposits which may need to be replaced with
higher cost borrowings.
The Company manages reliance on short-term unsecured borrowings as well as total
wholesale funding though policy limits reviewed at ALCO.
The Company maintains access to a diversified base of wholesale funding sources.
These sources include Federal Funds purchased; securities sold under agreements
to repurchase, jumbo certificates of deposit and Federal Home Loan bank
advances. Liquidity is also available through un pledged securities in the
investment portfolio and capacity to securities, loans, including single family
mortgage loans.
The low rate environment has created heavy refinance activity and offer to some
degree by the amount of mortgage loans originated by the Company. The Company
sells a portion of these loans into the secondary market and such loans are
included in loans held for sale. At September 30, 2003 here were no loans
available for sale. For the nine months ended September 30 the company
originated $14.198 million in loans held for sale compared with $8.796 million
for the nine months ended September 30, 2002.
Management believes that the Corporation has the funding capacity to meet the
liquidity needs arising from potential
23
events. In addition to pledgeable securities, the Corporation also maintains
borrowing capacity through the Federal Discount Window and the Federal Home Loan
Bank of New York secured with loans and marketable securities.
Liquidity is measured and monitored for the bank and holding company. The
Corporation reviews the parent holding company's net short-term mismatch. This
measures the ability of the holding company to meet obligations should access to
bank dividends be constrained.
At September 30, 2003, the parent Company had $1.234 million in cash compared to
$ 3.881 million at December 31, 2002. The decrease in cash at the parent company
was due to increased capitalization of the subsidiary bank. Expenses at the
parent company are minimal and management believes that the parent company has
adequate liquidity to find its obligations.
Certain provisions of long-term debt agreements prevent the Corporation from
creating liens on, disposing of or issuing voting stock of subsidiaries. As of
September 30, 2003 the Corporation was in compliance with all covenants and
provisions of these agreements.
OFF BALANCE SHEET LENDING RELATED COMMITMENTS
(DOLLARS IN THOUSANDS) (UNAUDITED) AT SEPTEMBER 30, 2003
- --------------------------------------------------------------------------------
Financial Standby Letters of credit $15,501
Home equity Lines $45,354
Commercial Credit Lines $20,736
Commercial Real Estate Construction $4,159
Mortgage Commitments:
Residental $8,551
Commercial $4,382
- --------------------------------------------------------------------------------
Total Lines of Credit $70,249
- --------------------------------------------------------------------------------
Total Commitments $98,683
- --------------------------------------------------------------------------------
Management monitors current and projected cash flows, and adjusts positions as
necessary to maintain adequate levels of liquidity. By using a variety of
potential funding sources and staggering maturities, the risk of potential
funding pressure is somewhat reduced. Management also maintains a detailed
liquidity contingency plan designed to adequately respond to situations which
could lead to liquidity concerns.
Anticipated cash-flows at September 30, 2003, projected to October of 2004,
indicates that the Bank's liquidity should remain strong, with an approximate
projection of $200.2 million in anticipated cash flows over the next twelve
months. This projection represents a forward-looking statement under the Private
Securities Litigation Reform Act of 1995. Actual results could differ materially
from this projection depending upon a number of factors, including the liquidity
needs of the Bank's customers, the availability of sources of liquidity and
general economic conditions.
The Corporation derives a significant proportion of its liquidity from its core
deposit base. For the nine-month period ended September 30, 2003, core deposits
(comprised of total demand, savings accounts (excluding Super Max and money
market accounts under $100,000) remained relatively stable and represented 51.4
percent of total deposits as compared with 49.1 percent at September 30, 2002.
The following table depicts the Corporations Core Deposit Mix as of September
30, 2003 and 2002.
CORE DEPOSIT MIX
SEPTEMBER 30, 2003 SEPTEMBER 30 2002
Net Change
(dollars in thousands) Balance % Balance % in Variance
- -------------------------------------------------------------------------------------------------------------------
Demand Deposits $124,236 41.7% $110,437 40.9% 12.5%
Now and ATS Accounts 70,894 23.8% 60,729 22.5% 16.7%
Clubs 602 0.2% 600 0.2% 0.3%
Savings 79,849 26.8% 72,879 27.0% 9.6%
MMA Accounts <$100 22,258 7.5% 25,420 9.4% -12.4%
- -------------------------------------------------------------------------------------------------------------------
Total Core Deposits $297,840 $270,065 10.3%
- -------------------------------------------------------------------------------------------------------------------
Total Deposits $580,017 $550,545 5.4%
- -------------------------------------------------------------------------------------------------------------------
Core deposits to total deposits 51.40% 49.1% 2.3%
- -------------------------------------------------------------------------------------------------------------------
24
More volatile rate sensitive deposits, concentrated in time certificates of
deposit greater than $100,000, for the nine-month period ended September 30,
2003, increased to 8.46 percent of total deposits from 5.61 percent during the
nine-months ended September 30, 2002. This change has resulted from a $33.9
million increase in time deposits on average for the nine-months ended September
30, 2003 compared to the prior year period.
Short-term borrowings can be used to satisfy daily funding needs. Balances in
these accounts fluctuate significantly on a day-to-day basis. The Corporation's
principal short-term funding sources are securities sold under agreements to
repurchase, advances from the Federal Home Loan Bank and Federal funds
purchased. Average borrowings during the nine-months ended September 30, 2003
were $215.2 million, an increase of $81.7 million or 61.21 percent from $133.5
million in average borrowings during the comparable nine-months ended September
30, 2002.
During the nine-months ended September 30, 2003, average funding sources
increased by approximately $124.7 million or 18.3 percent, compared to the same
period in 2002. Interest-bearing deposit liabilities increased approximately
$33.7 million on average and were comprised primarily of increases in time
deposits, other then interest bearing deposits and borrowings and an increase in
time deposits greater than $100,000. Non-interest bearing funding sources as a
percentage of the total funding mix decreased to 14.8 percent on average as
compared to 16.1 percent for the nine-month period ended September 30, 2002.
This reflects a more rapid growth in non-deposit funding sources as a percentage
of the funding base as compared with overall deposit growth.
CASH FLOW
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities. During the nine
months ended September 30, 2003, cash and cash equivalents (which increased
overall by $2.1 million) were provided (on a net basis) by financing activities
of approximately $34.0 million primarily due to an increase in borrowings of
$71.8 million offset in part by a $36.3 million net decrease in deposits, and by
operating activities (approximately $9.1 million). Approximately $41.0 million
was used in net investing activities, principally a $79.6 million increase in
loans and a $40.4 million decrease in the investment portfolio.
STOCKHOLDERS' EQUITY
Total stockholders' equity averaged $52.1 million or 6.03 percent of average
assets for the nine month period ended September 30, 2003, as compared to $47.8
million, or 6.49 percent, during the same period in 2002. The Corporation's
dividend reinvestment and optional stock purchase plan contributed $837,000 in
new capital for the nine-months ended September 30, 2003 as compared with
$876,000 for the comparable period in 2002. Book value per common share was
$6.06 at September 30, 2003 as compared to $5.95 at September 30, 2002. Tangible
book value (i.e., book value less goodwill) per common share was $5.81 at
September 30, 2003 and $5.70 at September 30, 2002.
CAPITAL
The maintenance of a solid capital foundation continues to be a primary goal for
the Corporation. Accordingly, capital plans and dividend policies are monitored
on an ongoing basis. The most important objective of the capital planning
process is to balance effectively the retention of capital to support future
growth and the goal of providing stockholders with an attractive long-term
return on their investment.
RISK-BASED CAPITAL/LEVERAGE
Banking regulations require banks to maintain minimum levels of regulatory
capital. Under the regulations in effect at September 30, 2003, the Bank was
required to maintain (i) a minimum leverage ratio of Tier 1 capital to total
adjusted assets of 4.00%, and (ii) minimum ratios of Tier 1 and total capital to
risk-weighted assets of 4.00% and 8.00%, respectively.
At September 30, 2003, total Tier 1 capital (defined as tangible stockholders'
equity for common stock and certain perpetual preferred stock) amounted to $60.1
million or 7.01 percent of total assets. Tier I capital excludes the effect of
SFAS No. 115, $782,000 of net unrealized losses, after tax, on securities
available-for-sale (included as a component of other comprehensive income) and
goodwill of approximately $2.1 million as of September 30, 2003. At September
30, 2003, the Corporation's estimated Tier I risk-based and total risk-based
capital ratios were 11.75 percent and 12.28 percent, respectively. These ratios
are well above the minimum guidelines of capital to risk-adjusted assets in
effect as of September 30, 2003.
25
Under prompt corrective action regulations, bank regulators are required to take
certain supervisory actions and may take additional discretionary actions) with
respect to an undercapitalized institution. Such actions could have a direct
material effect on the institution's financial statements. The regulations
establish a framework for the classification of financial institutions into five
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. Generally, an
institution is considered well capitalized if it has a leverage (Tier 1) capital
ratio of at least 5.0%; a Tier 1 risk-based capital ratio of at least 6.0%; and
a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative measures
of assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by the bank regulators about capital
components, risk weightings and other factors. As of September 30, 2003,
management believes that each of the Bank and the Corporation meet all capital
adequacy requirements to which it is subject.
TRUST PREFERRED SECURITIES
On December 18, 2001 Center Bancorp statutory trust I a statutory business trust
and wholly-owned subsidiary of Center Bancorp, Inc issued $10.0 million of
floating rate capital trust pass through securities to investors due on December
18, 2031. The capital securities have preference over the common securities with
respect to liquidation and other disturbances and qualify as Tier 1 capital. The
subordinate debentures are redeemable in whole or part, prior to maturity but
after December 18, 2006. The floating interest rate on the subordinate
debentures is three month labor plus 3.60% and reprices quarterly. The rate at
September 30, 2003 was 4.74 %. The additional capital raised with respect to the
issuance of the floating rate capital pass through securities was used to
bolster the corporation's capital and for general corporate purposes, including,
capital contributions to the subsidiary bank Union Center National Bank.
Additional information regarding securities is continued herein reference to
disclosure on page 8.
REGULATORY CAPITAL
The Corporation's capital amounts and ratios are presented in the following
table:
FDIC REQUIREMENTS
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CENTER BANCORP, INC MINIMUM CAPITAL FOR CLASSIFICATION
ACTUALS ADEQUACY AS WELL CAPITALIZED
- ------------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2003
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Leverage (Tier 1) capital $60,076 6.79% 35,501 4.00% $44,272 5.00%
- ------------------------------------------------------------------------------------------------------------------------------------
RISK-BASED CAPITAL:
Tier 1 $60,076 11.75% 20,460 4.00% 30,690 6.00%
Total $62,827 12.28% $40,920 8.00% $51,150 10.00%
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Leverage (Tier 1) capital $55,827 7.42% $30,086 4.00% $37,503 5.00%
- ------------------------------------------------------------------------------------------------------------------------------------
RISK-BASED CAPITAL:
Tier 1 55,827 11.57% 19,303 4.00% 29,954 6.00%
Total $58,208 12.06% $38,606 8.00% $48,257 10.00%
====================================================================================================================================
The Bank's capital amounts and ratios are presented on the following table:
CAPITAL RATIOS FOR UNION CENTER NATIONAL BANK
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(DOLLARS IN THOUSANDS)
MINIMUM AS OF STATUTORY
AS OF SEPTEMBER 30, REQUIRED WELL SEPTEMBER 30 MINIMUM
2003 2002 CAPITAL CAPITALIZED 2003 CAPITAL
-------------------------------------------------------------------------------------
Tier I Leverage 6.60% 6.86% 4.00% 5.00% $58,544 $35,613
Tier I Risk-Based Capital 11.45% 10.68% 4.00% 6.00% $58,544 $20,460
Total Risk-Based Capital 11.98% 11.18% 8.00% 10.00% $61,295 $40,920
- ------------------------------------------------------------------------------------------------------------------------------------
ITEM 3 - QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS
The primary market risk faced by the Corporation is interest rate risk. The
Corporation's Asset/Liability Committee ("ALCO") monitors the changes in the
movement of funds and rate and volume trends to enable appropriate management
response to changing market and rate conditions.
26
The Corporation's income simulation model analyzes interest rate sensitivity by
projecting net interest income over the next 24 months in a flat rate scenario
versus net interest in alternative interest rate scenarios. Management reviews
and refines its interest rate risk management process in response to the
changing economic climate. The low level of interest rates necessitated a
modification of the Corporation's standard rate scenario of a shock down 200
basis points over 12 months to down 100 basis points over a 12-month period.
Based on the results of the interest simulation model as of September 30, 2003,
and assuming that management does not take action to alter the outcome, the
Corporation would expect an increase of 1.10 percent in net interest income if
interest rates decreased 100 basis points from the current rates in an immediate
and parallel shock over a 12-month period. In a rising rate environment, based
on the results of the model as of September 30, 2003, the Corporation would
expect a decrease of 4.05% percent in net interest income if interest rates
increased by 200 basis points from current rates in an immediate and parallel
shock over a twelve month period.
The statements in this Quarterly Report regarding the effects of hypothetical
interest rate changes represent forward- looking statements under the Privacy
Securities Litigation Reform Act of 1995. Actual results could differ materially
from these statements. Computation of prospective effects of hypothetical
interest rate changes are based on numerous assumptions, including relative
levels of market interest rates, loan prepayments and duration of deposits, and
should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions that ALCO could undertake in
response to changes in interest rates.
ITEM 4 - CONTROLS AND PROCEDURES
(A) Disclosure controls and procedures. As of the end of the Company's most
recently completed fiscal quarter (the registrant's fourth fiscal quarter
in the case of an annual report) covered by this report, the Company
carried out an evaluation, with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Company's disclosure
controls and procedures pursuant to Securities Exchange Act Rule 13a-15.
Based upon that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC's rules and forms.
(B) Changes in internal controls over financial reporting. There have been no
changes in the Company's internal controls over financial reporting that
occurred during the company's last fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The Corporation is subject to claims and lawsuits, which arise primarily in the
ordinary course of business. Based upon the information currently available, it
is the opinion of management that the disposition or ultimate determination of
such claims will not have a material adverse impact on the consolidated
financial position, results of operations, or liquidity of the Corporation. This
statement represents a forward-looking statement under the Private Securities
Litigation Reform Act of 1995. Actual results could differ materially from this
statement, primarily due to the uncertainties involved in the legal processes.
ITEM 2-CHANGES IN SECURITIES
None
ITEM 3-DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4- SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
See Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.
27
ITEM 5 - OTHER INFORMATION
None
ITEM 6- EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBITS:
31.1 Certification of the Chief Executive Officer under section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer under section 906 of the
Sarbanes-Oxley act of 2002.
32.2 Certification of the Chief Financial Officer under section 906 of the
Sarbanes-Oxley act of 2002.
10.1 Amendment to the 1993 Outside Director Stock Option Plan
B) REPORTS ON FORM 8-K
Current Report on Form 10-Q on July 25 and August 1, 2003 reporting (under
Items 7 and 12) the filing of a press release containing quarterly results
of operations.
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SIGNATURE
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.
CENTER BANCORP, INC.
DATE: November 14, 2003 /s/: Anthony C. Weagley
------------------------------------
Anthony C. Weagley, Treasurer
(Chief Financial Officer)
29