UNITED STATES OF AMERICA 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 June 30, 2004
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.
-------------------------------------------------------------
(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|_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
COMMON STOCK, NO PAR VALUE: 9,004,890
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(Title of Class) (Outstanding at July 30, 2004)
1
CENTER BANCORP, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Condition
June 30, 2004 (Unaudited)
and December 31, 2003 (audited) 4
Consolidated Statements of Income for the
Three and Six months ended June 30, 2004 and 2003 5
(Unaudited)
Consolidated Statements of Cash Flows for the
Six months ended June 30, 2004 and 2003
(Unaudited) 6
Notes to Consolidated Financial Statements 7-8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-25
Item 3. Qualitative and Quantitative Disclosures about 26
Market Risks
Item 4. Controls and Procedures 26
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 27
ITEM 6. Exhibits and Reports on Form 8-K 27
Signatures 28
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 six months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2004 or for any other interior period. The Center Bancorp
Inc. 2003 annual report on form 10-K should be read in conjunction with these
statements.
3
PART 1 - FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION
JUNE 30, DECEMBER 31,
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(DOLLARS IN THOUSANDS) 2004 2003
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(UNAUDITED)
ASSETS
Cash and due from banks $ 18,160 $16,509
Investment securities held to maturity (approximate market
value of $133,369 in 2004 and $159,989 in 2003) 131,891 155,149
Investment securities available-for-sale 376,490 364,085
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Total investment securities 508,381 519,234
Loans, net of unearned income 365,964 349,525
Less--Allowance for loan losses 3,436 3,002
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Net loans 362,528 346,523
Premises and equipment, net 15,988 15,610
Accrued interest receivable 4,452 4,485
Bank owned separate account life insurance 17,472 14,614
Other assets 4,283 2,758
Goodwill 2,091 2,091
- ----------------------------------------------------------------------------------------------------
Total assets $933,355 $921,824
====================================================================================================
LIABILITIES
Deposits:
Non-interest bearing $122,891 $120,526
Interest bearing:
Certificates of deposit $100,000 and over 121,054 58,245
Savings and time deposits 389,371 454,150
- ----------------------------------------------------------------------------------------------------
Total deposits 633,316 632,921
Federal funds purchased and securities sold under agreements to
repurchase 129,683 99,724
Federal Home Loan Bank advances 100,000 115,000
Subordinated debentures 15,000 15,000
Accounts payable and accrued liabilities 4,219 4,999
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Total liabilities 882,218 867,644
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STOCKHOLDERS' EQUITY
PREFERRED STOCK, NO PAR VALUE, Authorized 5,000,000 shares; None Issued 0 0
COMMON STOCK, NO PAR VALUE: Authorized 20,000,000 shares; issued
10,020,249 and 10,003,580 shares in 2004 and 2003, 19,669 19,405
respectively
Additional paid in capital 4,734 4,677
Retained earnings 35,224 33,268
Treasury stock at cost (1,015,359 and 1,059,138 shares in 2004 and
2003 respectively) (3,808) (3,978)
Restricted stock 0 (14)
Accumulated other comprehensive (loss) income (4,682) 822
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Total stockholders' equity 51,137 54,180
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Total liabilities and stockholders' equity $933,355 $921,824
====================================================================================================
All per common share amounts have been adjusted retroactively for common stock
splits and common stock dividends impacting the periods presented.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SIX MONTHS ENDED
(Unaudited) JUNE 30, JUNE 30,
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(IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans $4,490 $3,522 $8,866 $7,108
Interest and dividends on investment securities:
Taxable interest income 4,120 4,753 8,100 10,123
Non-taxable interest income 853 680 1,733 987
Dividends 269 121 603 296
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Total interest income 9,732 9,076 19,302 18,514
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INTEREST EXPENSE:
Interest on certificates of deposit $100,000 and 92 86 193 238
over
Interest on other deposits 1,561 1,666 3,202 3,463
Interest on borrowings 1,580 1,455 3,025 2,741
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Total interest expense 3,233 3,207 6,420 6,442
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Net interest income 6,499 5,869 12,882 12,072
Provision for loan losses 205 79 410 159
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Net interest income after provision for loan losses
6,294 5,790 12,472 11,913
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OTHER INCOME:
Service charges, commissions and fees 477 421 958 838
Other income 109 136 211 247
Annuity & Insurance 12 0 20 0
Bank Owned Life Insurance 192 179 358 359
Gain on securities sold 31 6 157 237
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TOTAL OTHER INCOME 821 742 1,704 1,681
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Other expense:
Salaries and employee benefits 2,641 2,676 5,278 5,327
Occupancy, net 459 444 1,022 972
Premises and equipment 475 447 920 894
Stationery and printing 144 131 296 305
Marketing and advertising 147 112 296 289
Other 1,038 803 2,083 1,559
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TOTAL OTHER EXPENSE 4,904 4,613 9,895 9,346
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Income before income tax expense 2,211 1,919 4,281 4,248
Income tax expense 429 412 775 1,055
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Net income $1,782 $1,507 $3,506 $3,193
=====================================================================================================
EARNINGS PER SHARE: (Note 4)
Basic $0.20 $0.17 $0.39 $0.36
Diluted $0.20 $0.17 $0.39 $0.36
Weighted average common shares outstanding:
Basic 8,974,248 8,889,050 8,962,305 8,875,852
Diluted 9,030,668 8,981,803 9,030,365 8,969,039
=====================================================================================================
All per common share amounts have been adjusted retroactively for common stock
splits and common stock dividends impacting the periods presented.
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
CONSOLIDATED STATEMENTS OF CASH FLOW SIX MONTHS ENDED
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(UNAUDITED) JUNE 30,
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(DOLLARS IN THOUSANDS) 2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,506 $ 3,193
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization 757 888
Provision for loan losses 410 159
Gains on sale of investment securities available-for-sale (157) (237)
Decrease (Increase) in accrued interest receivable 33 (313)
(Increase) decrease in other assets (1,525) 262
Increase in Cash Surrender value of BOLI (358) (359)
(Decrease) Increase in other liabilities (780) 944
Amortization of premium and accretion
of discount on investment securities, net 507 3,182
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Net cash provided by operating activities 2,393 7,719
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investment securities available for - sale 48,445 128,049
Purchase of FHLB and FRB Stock, net (2,190) (2,500)
Proceeds from maturities of securities held to maturity 25,430 98,193
Proceeds from sales of securities available-for-sale 29,275 57,667
Purchase of securities available-for-sale (93,470) (229,946)
Purchase of securities held to maturity (2,506) (70,411)
Net increase in loans (16,415) (39,209)
Purchase Bank Owned Life Insurance (2,500) 0
Property and equipment expenditures, net (1,135) (1,609)
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NET CASH USED IN INVESTING ACTIVITIES (15,066) (59,766)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits 395 (35,400)
Dividends paid (1,535) (1,483)
Proceeds from issuance of common stock 505 697
Net increase in borrowings 14,959 89,095
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Net cash provided by financing activities 14,324 52,909
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Net increase in cash and cash equivalents 1,651 862
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Cash and cash equivalents at beginning of year 16,509 23,220
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Cash and cash equivalents at end of year $ 18,160 $ 24,082
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
- -------------------------------------------------------------------------------------------------
Interest paid on deposits and short term borrowings $ 6,403 $ 6,291
Income taxes $ 637 $ 1,495
================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
NOTES TO CONSOLDIATED 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 subsidiary, Union Center National Bank (the Bank). All
significant inter-Corporation accounts and transactions have been eliminated
from the Corporation's 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.
ESTIMATES
Center Bancorp's accounting policies conform to accounting principles generally
accepted in the United States of America and prevailing practices within the
financial industry, Management must make certain estimates and judgments when
determining the amounts presented in its Consolidated Financial Statements and
related notes. If these same estimates prove inaccurate, actual results could
differ from those reported.
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 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 2003 to conform to the
classifications presented in 2004. Results for the period ended June 30, 2004
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, 2003 for information regarding
accounting principles.
STOCK BASED COMPENSATION
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value recognition provisions of FASB
Statement No. 123, accounting for Stock-Based Compensation, to our stock option
plans.
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Net income, as reported $1,782 $1,507 $3,506 $3,193
- -----------------------------------------------------------------------------------------------------
Add: compensation expense recognized for restricted stock
award, net of related tax effect 9 9 9 9
Deduct: Total Stock-based employee compensation
expense determined under fair value based method
all awards, net of related tax effects 24 15 46 31
- -----------------------------------------------------------------------------------------------------
Pro forma net income $1,767 $1,501 $3,469 $3,171
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Earnings per share:
Basic - as reported $0.20 $0.17 $0.39 $0.36
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Basic - pro forma $0.20 $0.17 $0.39 $0.36
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Diluted - as reported $0.20 $0.17 $0.39 $0.36
- -----------------------------------------------------------------------------------------------------
Diluted - pro forma $0.20 $0.17 $0.38 $0.35
=====================================================================================================
All common stock and per share amounts have been restated to reflect the 5%
common stock dividend declared April 20, 2004, to common stockholders of record
May 18, 2004 and distributed on June 1, 2004.
7
NOTE 2 - COMPREHENSIVE INCOME (LOSS)
Total comprehensive income includes all changes in equity during a period from
transactions and other events and circumstances from non-owner sources. The
Bank's other comprehensive income (loss) is comprised of unrealized holding
gains and losses on securities available-for-sale.
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
- -----------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Net Income $1,782 $1,507 $3,506 $3,193
OTHER COMPREHENSIVE INCOME
Unrealized holding (losses) gains arising
during the period, net of taxes (8,048) 2,637 (5,608) 2,686
Less reclassification adjustment for gains
Included in net income (net of taxes) (20) (4) (104) (156)
- -----------------------------------------------------------------------------------------------------
Other total comprehensive (loss) income (8,028) 2,633 (5,504) 2,530
Total comprehensive (loss) income $(6,246) $4,140 $ (1,998) $5,723
=====================================================================================================
NOTE 3 - EARNINGS PER SHARE RECONCILEMENT
All common share and per common share amounts have been restated to reflect the
5% common stock dividend declared April 20, 2004, to common stockholders of
record May 18, 2004 and distributed on June 1, 2004.
Basic Earnings per Share (EPS) is computed by dividing income available to
common shareholders by the weighted-average number of common shares outstanding.
Diluted EPS includes any additional common shares as if all potentially dilutive
common shares were issued (e.g. stock options). The Corporation's weighted
average common shares outstanding for diluted EPS include the effect of stock
options outstanding using the Treasury Stock Method, which are not included in
the calculation of basic EPS.
Earnings per common share have been computed based on the following:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
- -----------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Net income $1,782 $1,507 $3,506 3,193
- -----------------------------------------------------------------------------------------------------
Average number of common shares outstanding 8,974 8,889 8,962 8,876
Effect of dilutive options 56 90 66 90
Effect of restricted stock awards 1 3 2 3
- -----------------------------------------------------------------------------------------------------
Average number of common shares outstanding used to
calculate diluted earnings per common share 9,031 8,982 9,030 8,969
- -----------------------------------------------------------------------------------------------------
Net income per share;
Basic $.20 $.17 $0.39 $.36
Diluted $.20 $.17 $0.39 $.36
=====================================================================================================
All common stock and per share amounts have been restated to reflect the 5%
common stock dividend declared April 20, 2004, to common stockholders of record
May 18, 2004 and distributed on June 1, 2004.
NOTE 4 - COMPONENTS OF NET PERIOD BENEFIT COST
THREE MONTHS ENDED JUNE 30,
PENSION BENEFIT OTHER POSTRETIREMENT BENEFITS
- -----------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Service Cost $172 $150 $194 $188
Interest Cost 124 106 157 147
Expected return on plan assets (111) (96) (111) (96)
Amortization of prior service cost 0 0 0 0
Amortization of the net (gain) loss 12 7 37 72
- -----------------------------------------------------------------------------------------------------
Net periodic benefit cost $197 $167 $277 $311
=====================================================================================================
CONTRIBUTIONS
The Corporation previously disclosed in its financial statements for the year
ended December 31, 2003, that it expected to contribute $760,000 to its Pension
Trust in 2004. As of June 30, 2004, $350,000 of contributions has been made. The
Company presently does not anticipate increasing its total contributions for the
year to fund its pension plan obligations in 2004.
NOTE 5 - VALUABLE INTEREST ENTITIES
During 2001 and 2003, the Corporation issued $10.0 million and $5.0 million,
respectively, of subordinated debentures and formed statutory business trusts,
which exist for the exclusive purpose of (i) issuing trust securities
representing undivided beneficial interests in the assets of the trusts; (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 not eliminated in the
consolidated financial statements as the statutory business trusts are not
consolidated in accordance with FASB interpretation No.46 "Consolidation of
Variable interest Entities." Distributions on the subordinated debentures owned
by the subsidiary trusts below have been classified as interest expense in the
Consolidated Statement of Income.
In July 2003, the Board of Governors of the Federal Reserve System instructed
bank holding companies to continue to include 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 capital purposes. As of June 30, 2004, assuming the Corporation
was not allowed to include the $15 million in subordinated debentures in Tier 1
capital, the Corporation have a Tier 1 capital ratio of 5.84% and a total risk
based capital ratio of 11.21%.
8
ITEM 2-MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements within the meaning of Sections
27A of the Securities Act of 1933, as amended, and 21E of the Securities
Exchange Act of 1934, as amended, with respect to the financial condition,
results of operations, plans, objectives, future performance and business of
Center Bancorp, including statements preceded by, followed by or that include
words or phrases such as "believes," "expects," "anticipates," "plans," "trend,"
"objective," "continue," "remain," "pattern" or similar expressions or future or
conditional verbs such as "will," "would," "should," "could," "might," "can,"
"may" or similar expressions. Such forward-looking statements involve inherent
risks and uncertainties. There are a number of important factors that could
cause actual results to differ materially from historical performance and from
these forward-looking statements. Factors that might cause such a difference
include, but are not limited to: (1) competitive pressures among depository
institutions may increase significantly; (2) changes in the interest rate
environment may occur more rapidly or more significantly than anticipated; (3)
prepayment speeds, loan origination and sale volumes, charge-offs and loan loss
provisions may reduce interest margins; (4) general economic conditions may be
less favorable than expected; (5) political developments, wars or other
hostilities may disrupt or increase volatility in securities markets; (6)
legislative or regulatory changes or actions may adversely affect the businesses
in which Center Bancorp is engaged; (7) changes and trends in the securities
markets may affect the Corporation's common stock; (8) a delayed or incomplete
resolution of regulatory issues may negatively impact the services provided by
the Bank; (9) the developments discussed above may have a material adverse
effect on the Corporation's business generation and retention, funding and
liquidity; and (10) the outcome of regulatory and legal investigations and
proceedings cannot always be predicted accurately. Further information on other
factors that could affect the financial results of Center Bancorp are included
in Center Bancorp's filings with the Securities and Exchange Commission. These
documents are available free of charge at the Commission's website at
http://www.sec.gov and/or from Center Bancorp. The Corporation assumes no
obligation for updating any such forward-looking statement at any time.
LOOKING FORWARD
One of the Corporation's primary objectives is to achieve balanced asset and
revenue growth, and at the same time expand market presence and diversify its
financial products. However, it is recognized that objectives, no matter how
focused, are subject to factors beyond the control of the Corporation, which can
impede its ability to achieve these goals. The following factors should be
considered when evaluating the Corporation's ability to achieve its objectives:
The financial market place is rapidly changing. Banks are no longer the only
place to obtain loans, nor the only place to keep financial assets. The banking
industry has lost market share to other financial service providers. The future
is predicated on the Corporation's ability to adapt its products, provide
superior customer service and compete in an ever-changing marketplace.
Net interest income, the primary source of earnings, is impacted favorably or
unfavorably by changes in interest rates. Although the impact of interest rate
fluctuations is mitigated by ALCO strategies, significant changes in interest
rates can have an adverse impact on profitability.
The ability of customers to repay their obligations is often impacted by changes
in the regional and local economy. Although the Corporation sets aside loan loss
provisions toward the allowance for loan losses, significant unfavorable changes
in the economy could impact the assumptions used in the determination of the
adequacy of the allowance.
Technological changes will have a material impact on how financial service
companies compete for and deliver services. It is recognized that these changes
will have a direct impact on how the marketplace is approached and ultimately on
profitability. The Corporation has already taken steps to improve its
traditional delivery channels. However, continued success will likely be
measured by the ability to react to future technological changes.
This "Looking Forward" description constitutes a forward-looking statement under
the Private Securities Litigation Reform Act of 1995. Actual results could
differ materially from those projected in the Corporation's forward-looking
statements due to numerous known and unknown risks and uncertainties, including
the factors referred to above and in other sections of this quarterly report and
the Corporation's Annual report on Form 10-K for the year ended December 31,
2003.
9
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 the United States of
America, but 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 2003 Annual Report on Form 10-K,
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 accounting
issues that are most directly impacted by the use of assumptions and estimates
is the accounting for the allowance for loan losses. The Corporation's
accounting policies related to this issue are discussed in Note 1 of the
Corporation's Consolidated Financial Statements included in the Corporation's
Annual Report on Form 10-K for the year ended December 31, 2003 and further
described on page 18 of this Quarterly Report on Form 10-Q under "Allowance for
Loan Losses and Related Provision." See also "Estimates of Fair Value" set forth
on page 23 of this Quarterly Report on Form 10-Q.
EARNINGS ANALYSIS
Net income for three-months ended June 30, 2004 amounted to $1.782 million
compared to $1.507 million earned for the comparable three-month period ended
June 30, 2003. On a fully diluted per share basis, earnings increased to $.20
per fully diluted share as compared with $.17 per fully diluted share for the
three months ended June 30, 2003. All common stock per share amounts have been
restated to reflect all previously declared and paid common stock splits and
common stock dividends. The annualized return on average assets increased to .77
percent compared with .69 percent for the comparable three-month period in 2003.
The annualized return on average stockholders' equity was 13.25 percent for the
three-month period ended June 30, 2004 as compared to 11.39 percent for the
three-months ended June 30, 2003. Earnings performance for the first three
months of 2004 primarily reflects a higher level of net interest income, net of
the provision for loan losses, offset in part by increased non-interest expense
Net income for the six-months ended June 30, 2004 amounted to $3.506 million
compared to $3.193 million earned for the comparable six-month period ended June
30, 2003. On a fully diluted per share basis, earnings increased to $.39 per
share as compared with $.36 per fully diluted share for the six months ended
June 30, 2003. All common stock per share amounts have been restated to reflect
all previously declared and paid common stock splits and common stock dividends.
The annualized return on average assets increased to .76 percent compared with
..75 percent for the comparable six month period in 2003. The annualized return
on average stockholders' equity was 12.84 percent for the six month period ended
June 30, 2004 as compared to 12.23 percent for the six months ended June 30,
2003. Earnings performance for the first six months of 2004 primarily reflects a
higher level of net interest income, net of the provision for loan losses, and
reduction in the effective tax rate, offset in part by increased non-interest
expense.
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.
10
NET INTEREST INCOME
(DOLLARS IN THOUSANDS) THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
PERCENT PERCENT
2004 2003 CHANGE 2004 2003 CHANGE
- ---------------------------------------------------------------------------------------------------
Interest income:
Investments $ 5,681 $ 5,904 (3.78)$ 11,329 $ 11,914 (4.91)
Loans, including fees 4,490 3,522 27.48 8,866 7,108 24.73
- ---------------------------------------------------------------------------------------------------
Total interest income 10,171 9,426 7.90 20,195 19,022 6.17
- ---------------------------------------------------------------------------------------------------
Interest expense:
Certificates $100,000 or more 92 86 6.98 193 238 (18.91)
Deposits 1,561 1,666 (6.30) 3,202 3,463 (7.53)
Borrowings 1,411 1,333 5.85 2,683 2,494 7.58
Subordinated Debentures 169 122 38.52 342 247 38.46
- ---------------------------------------------------------------------------------------------------
Total interest expense 3,233 3,207 0.81 6,420 6,442 (0.34)
- ---------------------------------------------------------------------------------------------------
Net interest income on a fully
tax-equivalent basis 6,938 6,219 11.56 13,775 12,580 9.50
- ---------------------------------------------------------------------------------------------------
Tax-equivalent adjustment (439) (350) 25.43 (893) (508) 75.79
NET INTEREST INCOME * $ 6,499 $ 5,869 10.73 $ 12,882 $ 12,072 6.71
===================================================================================================
* 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 EARNED
ON SECURITIES OF STATE AND POLITICAL SUBDIVISIONS.
For the three-month period ended June 30, 2004 interest income on a
tax-equivalent basis increased by $745,000 or 7.90 percent over the comparable
three-month period in 2003. This increase primarily reflects an increase in
average earning assets. The Corporation's loan portfolio increased on average
$112.2 million to $361.5 million from $249.3 million in the same quarter in
2003, primarily driven by growth in commercial loans and commercial and
residential mortgages. The loan portfolio represented approximately 42.0 percent
of the Corporation's interest earning-assets (on average) during the second
quarter of 2004 and 30.6 percent in the same quarter in 2003. Average investment
volume decreased during the period by $65.8 million on average compared to 2003.
The growth in earning-assets was funded primarily through cash flow from the
Corporation's investment portfolio.
For the six-month period ended June 30, 2004 interest income on a
tax-equivalent basis increased by $1.2 million or 6.17 percent over the
comparable six-month period in 2003. This increase primarily reflects an
increase in the level and mix of average earning assets. The Corporation's loan
portfolio increased on average $112.2 million to $354.7 million from $242.4
million in the same period in 2003, primarily driven by growth in commercial
loans and commercial and residential mortgages. The loan portfolio represented
approximately 41.3 percent of the Corporation's interest earning assets (on
average) during the first six months of 2004 and 30.6 percent in the same period
in 2003. Average investment volume decreased during the period by $45.9 million
compared to 2003. The growth in earning-assets was funded primarily through cash
flow from the Corporation's investment portfolio.
Net interest income on a fully tax-equivalent basis increased $719,000 or 11.56
percent to approximately $6.9 million for the three-months ended June 30, 2004,
from $6.2 million for the comparable period in 2003. For the three months ended
June 30, 2004, the net interest margin increased 17 basis points to 3.22 percent
from 3.05 percent due primarily to a decline in the cost of total
interest-bearing liabilities and an increase in the yield on earning-assets. For
the three-months ended June 30, 2004, the average cost of interest-bearing
liabilities decreased 9 basis points coupled with an increase in the yield on
interest earning-assets of 10 basis points, which resulted in an improvement in
the Corporation's net interest margins
Net interest income on a fully tax-equivalent basis increased $1.2 million or
9.50 percent to approximately $13.775 million for the six-months ended June 30,
2004, from $12.580 million for the comparable period in 2003. For the six months
ended June 30, 2004, the net interest margin increased 3 basis points to 3.21
percent from 3.18 percent due primarily to the increased level of earning-assets
and a decline in the cost of total interest bearing liabilities. For the six
months ended June 30, 2004, a decrease in the average cost of interest-earning
liabilities of 14 basis points was sufficient to offset the decline in yield on
interest earning assets of 9 basis points, which resulted in an improvement in
the Corporation's net interest margins.
The factors underlying the year-to year changes in net interest income are
reflected in the tables appearing on pages 13,14 and 15, each of which has been
presented on a tax-equivalent basis (assuming a 34 percent tax rates). The
tables on pages 14 and 15 (Average Statements of Condition 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 three and six month periods ended June 30, 2004
and 2003. 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.
11
For the three-months ended June 30, 2004, the Corporation's net interest spread
on a tax-equivalent basis increased by 19 basis points to 2.97 percent from 2.78
percent for the three months ended June 30, 2003. The increase reflected a
widening of spreads between yields earned on loans and investments and rates
paid for supporting funds. Net interest margins widened during the three-month
period due primarily to a steepening of the yield curve and bias toward higher
rates in anticipation of an increase in the Federal funds rate by the Federal
Reserve Bank on June 30, 2004. Cash flow from earning assets was invested at
higher rates, while the cost of funds continued to decline.
For the six months ended June 30, 2004, the Corporation's net interest spread on
a tax-equivalent basis increased by 5 basis points to 2.95 percent from 2.90
percent for the six months ended June 30, 2003. The increase reflected a small
widening of spreads between yields earned on loans and investments and rates
paid for supporting funds. This was primarily due to a steepening of the yield
curve which began in the latter part of the second quarter of 2004 with a bias
toward higher rates in anticipation of an increase in the Federal funds rate by
the Federal Reserve Bank in June. Cash flow from earning assets was invested at
higher rates, while the cost of funds continued to decline. The protracted lower
interest rate environment that has prevailed throughout much of the beginning of
the year had a dampening effect on interest margins.
The Federal Reserve Open Market Committee increased the Federal funds rate by 25
basis points on June 30, 2004. This marked the first time in 42 months since the
Fed had raised interest rates following a protracted low interest rate
environment and a period during with it had lowered interest rates thirteen
times, most recently prior to June 30 on June 25, 2003, (a 45-year low of 1.00
percent). The yield on interest-earning assets increased to 4.73 percent from
4.63 percent in 2003 (a change of 10 basis points), and 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 1.76 percent, a change of 9 basis points, for the three
months ended June 30, 2004 from 1.85 percent for the three months ended June 30,
2003.
For the six months ended June 30, 2004, the Corporation's yield on
interest-earning assets declined to 4.71 percent from 4.80 percent in 2003 (a
change of 9 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 1.76 percent, a change of 14 basis points, for the six months ended
June 30, 2004 from 1.90 percent for the six months ended June 30, 2003.
For both the three and six month periods this trend is primarily due to the
decrease in rates paid on certain interest-bearing liabilities.
12
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 DUE TO VOLUME AND RATES
(TAX EQUIVALENT BASIS)
THREE MONTHS ENDED 6/30/04 SIX MONTHS ENDED 6/30/04
2004/2003 INCREASE (DECREASE) 2004/2003 INCREASE (DECREASE)
DUE TO CHANGE IN: DUE TO CHANGE IN:
- ---------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE NET AVERAGE AVERAGE NET
(DOLLARS IN THOUSANDS) VOLUME RATE CHANGE VOLUME RATE CHANGE
- ---------------------------------------------------------------------------------------------------------
Interest-earning assets:
Investment securities:
Taxable $ (895) $ 410 $ (485) $(1,853) $ 137 $(1,716)
Non-Taxable 293 (31) 262 1,220 (89) 1,131
Loans, net of unearned discounts 1,433 (465) 968 2,925 (1,167) 1,758
- ---------------------------------------------------------------------------------------------------------
Total interest-earning assets 831 (86) 745 2,292 (1,119) 1,173
- ---------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Money market deposits 14 (43) (29) 35 (107) (72)
Savings deposits (50) (130) (180) (79) (268) (347)
Time deposits 113 (8) 105 137 9 146
Other interest-bearing deposits 11 (6) 5 13 (46) (33)
Subordinated Debentures 57 (10) 47 115 (20) 95
Short-term Borrowings 111 (33) 78 471 (282) 189
- ---------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 256 (230) 26 692 (714) (22)
- ---------------------------------------------------------------------------------------------------------
Change in net interest income $ 575 $ 144 $ 719 $ 1,600 $ (405) $ 1,195
=========================================================================================================
13
The following table, "Average Balance Sheet with Interest and Average Rates",
presents for the six months ended June 30, 2004 and 2003 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 STATEMENTS OF CONDITION WITH INTEREST AND AVERAGE RATES
SIX MONTH PERIOD ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------------------
2004 2003
- -------------------------------------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
(tax-equivalent basis, Average Income/ Yield/ Average Income/ Yield/
dollars in thousands) Balance Expense Rate Balance Expense Rate
- -------------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets:
Investment securities: (1)
Taxable $412,670 $8,703 4.22% $500,617 $10,419 4.16%
Non-taxable 90,795 2,626 5.78% 48,778 1,495 6.13%
Loans, net of unearned income (2) 354,665 8,866 5.00% 242,445 7,108 5.86%
- -------------------------------------------------------------------------------------------------------------
Total interest-earning assets $858,130 20,195 4.71% $791,840 19,022 4.80%
=============================================================================================================
Non-interest earning assets
Cash and due from banks 19,841 21,907
BOLI 17,361 14,301
Other assets 25,617 26,756
Allowance for possible loan losses (3,205) (2,571)
- -------------------------------------------------------------------------------------------------------------
Total non-interest earning assets 59,614 60,393
- -------------------------------------------------------------------------------------------------------------
Total assets $917,744 $852,233
=============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Money market deposits $101,407 498 0.98% $95,351 570 1.20%
Savings deposits 143,840 692 0.96% 156,450 1,039 1.33%
Time deposits 154,383 2,013 2.61% 143,884 1,867 2.60%
Other interest - bearing deposits 74,032 192 0.52% 69,835 225 0.64%
Short-term Borrowings 242,323 2,683 2.21% 201,477 2,494 2.48%
Subordinated Debentures 15,000 342 4.56% 10,000 247 4.94%
- -------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 730,985 6,420 1.76% 676,997 6,442 1.90%
=============================================================================================================
Non-interest-bearing liabilities:
- -------------------------------------------------------------------------------------------------------------
Demand deposits 125,268 117,322
Other non-interest-bearing deposits 1,220 468
Other liabilities 5,655 5,251
- -------------------------------------------------------------------------------------------------------------
Total
non-interest-bearing liabilities 132,143 123,041
- -------------------------------------------------------------------------------------------------------------
Stockholders' equity 54,616 52,195
- -------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' $917,744 $852,233
- -------------------------------------------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $13,775 $12,580
- -------------------------------------------------------------------------------------------------------------
Net Interest Spread 2.95% 2.90%
- -------------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets (net interest margin) 3.21% 3.18%
- -------------------------------------------------------------------------------------------------------------
Tax equivalent adjustment (893) (508)
- -------------------------------------------------------------------------------------------------------------
Net interest income $12,882 $12,072
=============================================================================================================
(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
14
The following table, "Average Balance Sheet with Interest and Average Rates",
presents for the three months ended June 30, 2004 and 2003 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 STATEMENTS OF CONDITION WITH INTEREST AND AVERAGE RATES
THREE MONTH PERIOD ENDED JUNE 30,
- ------------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
(tax-equivalent basis, Average Income/ Yield/ Average Income/ Yield/
dollars in thousands) Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------
Assets
Interest-earning assets:
Investment securities: (1)
Taxable $409,893 $4,389 4.28% $495,838 $4,878 3.93%
Non-taxable 89,277 1,292 5.79% 69,097 1,030 5.96%
Loans, net of unearned income (2)361,523 4,490 4.97% 249,340 3,522 5.65%
- ------------------------------------------------------------------------------------------------------
Total interest-earning assets 860,693 10,171 4.73% $814,275 9,426 4.63%
======================================================================================================
Non-interest earning assets
Cash and due from banks 18,743 20,930
BOLI 16,062 14,395
Other assets 29,562 27,338
Allowance for
possible loan losses (3,315) (2,609)
- ------------------------------------------------------------------------------------------------------
Total non-interest earning assets 61,052 60,054
- ------------------------------------------------------------------------------------------------------
Total assets $921,745 $874,329
======================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Money market deposits $95,255 235 0.99% $90,331 264 1.17%
Savings deposits 141,138 339 0.96% 157,419 519 1.32%
Time deposits 151,299 977 2.58% 133,797 872 2.61%
Other interest
- bearing deposists 75,424 102 0.54% 67,461 97 0.58%
Short-term Borrowings 255,941 1,411 2.21% 235,974 1,333 2.26%
Subordinated Debentures 15,000 169 4.51% 10,000 122 4.88%
- ------------------------------------------------------------------------------------------------------
Total interest-bearing 734,057 3,233 1.76% 694,982 3,207 1.85%
- ------------------------------------------------------------------------------------------------------
Non-interest-bearing liabilities:
- ------------------------------------------------------------------------------------------------------
Demand deposits 127,222 120,611
Other
non-interest-bearing deposits 631 453
Other liabilities 6,047 5,369
- ------------------------------------------------------------------------------------------------------
Total non-interest-bearing
liabilities 133,900 126,433
==========================================================================================------------
Stockholders' equity 53,788 52,914
- ------------------------------------------------------------------------------------------------------
Total liabilities
and stockhoquity $921,745 $874,329
- ------------------------------------------------------------------------------------------------------
Net interest income
(tax-equivalent basis) $6,938 $6,219
- ------------------------------------------------------------------------------------------------------
Net Interest Spread 2.97% 2.78%
- ------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets
(net interest margin) 3.22% 3.05%
- ------------------------------------------------------------------------------------------------------
Tax equivalent adjustment (439) (350)
Net interest income $6,499 $5,869
======================================================================================================
(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
INVESTMENTS
For the three-months ended June 30, 2004, the average volume of investment
securities decreased to approximately $499.2 million, or 58.0 percent of average
earning assets, a decrease of $65.8 million on average as compared to the same
period in 2003. The tax-equivalent yield on investments however increased by 37
basis points to 4.55 percent from a yield of 4.18 percent during the three month
period ended June 30, 2003. The 37 basis points increase in yield on the
portfolio was attributable to an improved interest rate environment and a
steeper yield curve coupled with a change in mix in the portfolio to higher
yielding tax-free securities. Despite the decrease in average volume, the cash
flow which was invested back into the portfolio, resulting from securities which
were called from the portfolio coupled with prepayments on mortgage related
securities, benefited from the positive changes in rates. The volume related
figures during the three-month period ended June 30, 2004 contributed a decrease
in revenue of $602,000, while rate related changes amounted to an increase of
$379,000. At June 30, 2004, 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.
For the six-months ended June 30, 2004, the average volume of investment
securities amounted to approximately $503.5 million, or 58.7 percent of average
earning assets, a decrease of $45.9 million on average as compared to the same
period in 2003. The tax-equivalent yield on investments increased by 16 basis
points to 4.50 percent from a yield of 4.34 percent during the six month period
ended June 30, 2003. The 16 basis points increase 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 six month
period ended June 30, 2004 contributed a decrease in revenue of $633,000, while
rate related changes amounted to an increase in revenue of $48,000. The decline
in the average size of the investment portfolio for both the six and three
months ended June 30, 2004 was due to the funding of loan growth in the
Corporation's earning-asset portfolio.
The impact of repricing activity on investment yields was increased to some
extent, for the three-month period ended June 30, 2004, 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 $11.9 and
$4.2 million , respectively for the three and six month period ended June 30,
2004 in short-term money market funds as compared with $15.3 million and $18.0
million, respectively for the comparable three and six month periods in 2003.
These funds carried significantly lower rates than other securities in the
portfolio (on average 1.02 and 1.00 percent, respectively for the three and
six-month period, compared to 1.63 and 1.47 percent on these overnight funds,
respectively, for the comparable three and six month periods in 2003) and
contributed to the decline in yield as compared to the comparable period in
2003. The volume of such funds for the three-month period ended June 30, 2004
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-month period ended June 30, 2004 the Corporation sold from its
available-for-sale portfolio securities totaling approximately $29.3 million.
At June 30, 2004 the net unrealized loss carried as a component of other
comprehensive income and included in stockholders' equity net of tax amounted to
a net unrealized loss of $4.682 million as compared with an unrealized gain of
$822,000 at December 31, 2003 and $4.715 million at June 30, 2003. The decrease
resulted from an increase in interest rates fostered by the Federal Open Market
Committee's bias toward higher rates and subsequent action on June 30 to raise
the Federal Funds target rate to 1.25%. This decrease in market value of
securities lead to a 5.6% decrease in the Corporation's stockholders' equity,
due to the change in accumulated other comprehensive income from December 31,
2003, to $51.1 million at June 30, 2004.
LOANS
Loan growth during the six months ended June 30, 2004 occurred primarily in the
residential 1-4 family home equity loans and commercial loan portfolio. This
growth resulted primarily 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 six month period was the result of the decline in interest
rates as compared with the comparable period in 2003, 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. 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.
16
For the three months ended June 30, 2004, average loan volume increased $112.2
million or 45.0 percent, while portfolio yield decreased by 68 basis points as
compared with the same period in 2003. The volume related factors during the
period-contributed increased revenue of $1.433 million while rate related
changes amounted to a decline in revenue of $465,000. Total average loan volume
increased to $361.5 million with a net interest yield of 4.97 percent, as
compared to $249.3 million with a yield of 5.65 percent for the three months
ended June 30, 2003. 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 2004 compared with 2003.
For the six months ended June 30, 2004, average loan volume increased $112.2
million or 46.3 percent, while portfolio yield decreased by 86 basis points as
compared with the same period in 2003. The volume related factors during the
period-contributed increased revenue of $2.925 million while rate related
changes amounted to a decline in revenue of $1.167 million. Total average loan
volume increased to $354.7 million with a net interest yield of 5.00 percent, as
compared to $242.4 million with a yield of 5.86 percent for the six-months ended
June 30, 2003. 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 2004 compared with 2003.
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 June 30, 2004, the
allowance amounted to $3,436,000 as compared to $3,002,000 at December 31, 2003,
and $2,655,000 at June 30, 2003. The Corporation had a provision to the
allowance for loan losses during the three month period ended June 30, 2004
amounting to $205,000 compared to $79,000 during the three-month period June 30,
2003. The additions to the allowance during the respective three-month periods
of 2004 and 2003 are 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 June 30, 2004, the allowance for loan losses amounted to .94 percent of total
loans, as compared with .99 percent at June 30, 2003. In management's view, the
level of the allowance as of June 30, 2004 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 an estimate, 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 three and six-month periods ended June 30, 2004 and 2003, the
Corporation did not experience any substantial credit problems within its loan
portfolio. Net recoveries for the six months ended June 30, 2004 were
approximately $24,000 and were comprised of a home equity and installment loan
as compared with net charge offs of $2,000 for the comparable period ended June
30, 2003, which were comprised of installment loans.
At June 30, 2004 the Corporation had non-accrual loans amounting to $23,000 as
compared with $26,000 at December 31, 2003 and $69,000 of non-accrual loans at
June 30, 2003. The Corporation continues to aggressively pursue collections of
principal and interest on loans previously charged-off. The decrease in such
loans in 2004 compared to June 30, 2003 was attributable to three home equity
loans, which were re-paid in full by the borrower.
17
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 June 30, 2004, total impaired loans were
approximately $279,000 compared to $358,000 at December 31, 2003 and $69,000 at
June 30, 2003. The reserves allocated to such loans at June 30, 2004, December
31, 2003 and June 30, 2003, were $2,000, $6,000 and $1,000, 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 six month period ended
June 30, 2004 and 2003, respectively, are set forth below.
ALLOWANCE FOR LOAN LOSSES
SIX MONTHS
ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003
- -------------------------------------------------------------------------------------------------
Average loans outstanding $354,665 $242,445
- -------------------------------------------------------------------------------------------------
Total loans at end of period $365,964 $268,260
- -------------------------------------------------------------------------------------------------
Analysis of the Allowance for Loan Losses
Balance at the beginning of year $3,002 $ 2,498
Charge-offs:
Commercial 0 0
Installment loans 10 10
- -------------------------------------------------------------------------------------------------
Total charge-offs 10 10
- -------------------------------------------------------------------------------------------------
Recoveries:
Commercial 0 0
Installment loans 34 8
- -------------------------------------------------------------------------------------------------
Total recoveries 34 8
Net (recoveries) charge-offs: (24) 2
Provision for loan losses 410 159
Balance at end of year $3,436 $ 2,655
- -------------------------------------------------------------------------------------------------
Ratio of net charge-offs during the year to
average loans outstanding during the year N/M N/M
- -------------------------------------------------------------------------------------------------
Allowance for loan losses as a percentage
of total loans at end of year 0.94% 0.99%
=================================================================================================
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.
At June 30, 2004, December 31, 2003 and June 30, 2003, the Corporation had no
restructured loans. Non-accrual loans amounted to $23,000 at June 30, 2004, and
was comprised of one fixed rate home equity loan. At December 31, 2003,
non-accrual loans amounted to $26,000 and were comprised of a consumer loan, a
fixed rate home equity loan and a commercial loan. At June 30, 2003, non-accrual
loans amounted to $69,000 and were comprised of three consumer loans and two
home equity loans. At June 30, 2004 and December 31, 2003, the Corporation did
not have any loans 90 days past due and still accruing, while at June 30, 2003
such loans amounted to $11,000.
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 June 30, 2004,
December 31, 2003 and June 30, 2003, were as follows: NON-PERFORMING LOANS AT
18
JUNE 30, DECEMBER 31, JUNE 30,
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 2003
- ------------------------------------------------------------------------------
Non-accrual loans $23 $26 $69
Accruing loans past due 90 days or more 0 0 11
Other real estate owned 0 0 0
- ------------------------------------------------------------------------------
Total non-performing assets $23 $26 $80
==============================================================================
At June 30, 2004, non-performing assets, consisting of loans on non-accrual
status plus other real estate owned (OREO), amounted to $23,000 or .002 percent
of total loans outstanding as compared to $26,000 or .007 percent at December
31, 2003 and $69,000 or .026 percent at June 30, 2003.
At June 30, 2004, 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
June 30, 2004, December 31, 2003 and June 30, 2003 the Corporation did not have
any other real estate owned (OREO) or restructured loans.
OTHER NON-INTEREST INCOME
The following table presents the principal categories of non-interest income
during the three and six months ended June 30, 2004 and 2003.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
- ------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 % CHANGE 2004 2003 % CHANGE
- ------------------------------------------------------------------------------------------------------------------
Service charges, commissions and fees $477 $421 13.30 $958 $838 14.32
Annuity and Insurance 12 0 100.0 20 0 100.0
Bank Owned Life Insurance 192 179 7.26 358 359 (.28)
Gain on securities sold 31 6 416.67 157 237 (33.76)
Other income 109 136 (19.85) 211 247 (14.57)
- ------------------------------------------------------------------------------------------------------------------
Total other non-interest income $821 $742 10.65 $1,704 $1,681 1.37
==================================================================================================================
For the three-month period ended June 30, 2004, total other (non-interest)
income increased $79,000 or 10.65 percent as compared to the comparable
three-month period in 2003. Other non-interest income, exclusive of gains on
securities sold (which increased $25,000), reflects an increase of $54,000 or
7.34 percent compared with the comparable three-month period ended June 30,
2003. This increased revenue was primarily driven by the increase in service
charges, commissions and fees which increased $56,000 or 13.3% as compared to
the comparable quarter in 2003. This increase was attributable to the
introduction of the check safe program that was introduced during the fourth
quarter of 2003, which has resulted in increased overdraft related fees. To a
lesser extent there was an increase of $12,000 from annuity and insurance sales,
which began in the fourth quarter of 2003, and an increase in the cash surrender
value of bank owned life insurance, which amounted to $192,000 or an increase of
$13,000 for the second quarter in comparison to $179,000 for the comparable
quarter in 2003. The decrease in other income is attributable to a fee related
item recorded in the second quarter of 2003.
For the six-month period ended June 30, 2004, total other (non-interest) income
increased $23,000 or 1.37 percent as compared to the comparable six-month period
in 2003. Other non-interest income, exclusive of gains on securities sold (which
decreased $80,000), reflects an increase of $103,000 or 7.13 percent compared
with the comparable six-month period ended June 30, 2003. This increased revenue
was primarily driven by an increase in service charges, commissions and fees,
which increased $120,000 or 14.32% as compared to the comparable six month
period in 2003. This increase was attributable to the introduction of the check
safe program that was introduced during the fourth quarter of 2003. The decrease
in other income is attributable primarily to a fee related item recorded in the
second quarter of 2003 and, to a lesser extent, a decrease in letter of credit
fees and fees from secondary market activity on mortgage loans originated for
sale during the six months ended June 30, 2004, as compared with the comparable
period in 2003.
For the three-month period ended June 30, 2004, the Corporation recorded a net
gain of $31,000 on securities sold from the available-for-sale investment
portfolio compared to gains of $6,000 for the three-month period ended June 30,
2003. During the six month period ended June 30, 2004, the Corporation recorded
a net gain of $157,000 on securities sold from the available-for-sale investment
portfolio compared to gains of $237,000 for the six-month period ended June 30,
2003. These sales, in both the 2004 and 2003 periods, were made in the normal
course of business and proceeds were reinvested in securities.
19
OTHER NON-INTEREST EXPENSE
The following table presents the principal categories of non-interest expense
during the three and six-months ended June 30, 2004 and 2003.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 % CHANGE 2004 2003 % CHANGE
- -------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $2,641 $ 2,676 (1.31) $5,278 $ 5,327 (.92)
Occupancy expense, net 459 444 3.38 1,022 972 5.14
Premises & equipment expense 475 447 6.26 920 894 2.91
Stationery & printing expense 144 131 9.92 296 305 (2.95)
Marketing & advertising expense 147 112 31.25 296 289 2.42
Other expense 1,038 803 29.27 2,083 1,559 33.61
- -------------------------------------------------------------------------------------------------------------
Total other non-interest expense $4,904 $ 4,613 6.31 $9,895 $9,346 5.87
=============================================================================================================
Total non-interest expense for the three-months ended June 30, 2004, increased
$291,000 or 6.31 percent over the comparable three-months ended June 30, 2003.
This increase is primarily attributable to a $235,000 increase in other expense
for the three month period ended June 30, 2004, as compared to the comparable
quarter in 2003 and was attributable to increased computer, telephone, audit,
legal and consulting fees. The Corporation's ratio of other expenses
(annualized) to average assets remained relatively stable at 2.13 percent in the
second quarter of 2004 from 2.11 percent for the three-months ended June 30,
2003.
For the three-months ended June 30, 2004, salaries and employee benefits
decreased $35,000 or 1.31 as compared to the comparable three-month period ended
June 30, 2003. This decrease is primarily attributable to the Corporation's
efforts to control employee benefit costs, such as employee health insurance
costs, which decreased $83,000 or 39.0 percent for the three-month period as
compared to the comparable period in 2003, which was offset in part by increased
salary expense related to normal merit increases and promotional raises . This
increase is primarily driven by the need to attract, and retain high caliber
employees. Staffing levels decreased to 189 full-time equivalent employees at
June 30, 2004 compared to 194 full-time equivalent employees at June 30, 2003.
For the three-months ended June 30, 2004, occupancy and premises and equipment
expense increased $43,000 or 4.83 percent over the comparable three-month period
in 2003. The increase in such expenses reflects the higher operating costs
(utilities, rent, real-estate taxes and general repair and maintenance) of the
Corporation's expanded facilities, as well as depreciation expense of the
expanded Corporation's facilities, which includes a 20,000 square foot
operations center acquired during the fourth quarter of 2003.
Total non-interest expense for the six-months ended June 30, 2004, increased
$549,000 or 5.87 percent over the comparable six-months ended June 30, 2003.
This increase is primarily attributable to a $524,000 increase in other expense
for the six-month period ended June 30, 2004 as compared to the comparable six
months in 2003 and was attributable to increased computer, telephone, audit,
legal and consulting fees coupled with a nonrecurring expense reduction of
$136,000 recorded in 2003. The Corporation's ratio of other expenses
(annualized) to average assets decreased to 2.16 percent for the six months
ended June 30, of 2004 from 2.19 percent for the six months ended June 30, 2003.
Salaries and employee benefits decreased $49,000 or .92 percent for the
six-months ended June 30, 2004 as compared to the comparable six-month period
ended June 30, 2003. This decrease is primarily attributable to the
Corporation's efforts to control employee benefit costs, such as employee health
insurance costs, which decreased $115,755 or 31% for the six month period as
compared to the comparable period in 2003, which was offset in part by increased
salary expense related to normal merit increases and promotional raises. This
increase in expense is primarily driven by the need to attract, and retain high
caliber employees.
For the six-months ended June 30, 2004, occupancy expenses increased $76,000 or
4.07 percent over the comparable six-month period in 2003. The increase in
occupancy expenses reflects higher operating costs (utilities, rent, real-estate
taxes and general repair and maintenance) of the Corporation's expanded
facilities, as well as depreciation expense of the expanded Corporation's
facilities, which includes a 20,000 square foot operations center acquired
during the fourth quarter of 2003.
20
PROVISION FOR INCOME TAXES
For the three-months ended June 30, 2004, the effective tax rate was 19.4
percent as compared to 21.5 percent for the three-months ended June 30, 2003.
For the six-months ended June 30, 2004 the effective tax rate was 18.1 percent
as compared with 24.8 percent for the comparable period in 2003. The effective
tax rate for the three and six month periods ended June 30, 2004 and 2003 was
less than the combined statutory Federal tax rate of 34.0 percent and the New
Jersey State tax rate of 9.0 percent. The difference between the statutory and
effective tax rates, for the periods cited, primarily reflects the tax-exempt
status of interest income on obligations of states and political subdivisions,
the tax-exempt status of the income recorded as a result of a change in cash
surrender value of bank owned life insurance and disallowed expense items for
tax purposes, such as travel and entertainment expense. Tax-exempt interest
income, the largest contributing component to the decline in the effective tax
rate from prior periods, increased by $173,000 or 25.4 percent for the
three-month period ended June 30, 2004, and increased by $746,000 or 75.6
percent for the six- month period ended June 30, 2004, as compared to the
comparable three and six month periods in 2003, respectively.
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.
21
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.
At June 30, 2004, the Corporation reflects a negative interest sensitivity gap
(or an interest sensitivity ratio) of .62:1.00 at the cumulative one-year
position. Accordingly, based on its interest simulation models at June 30, 2004,
the Corporation believes that it would be adversely affected by an increase in
interest rates. See Item 3, "Qualitative and Quantitative disclosures about
Market Risks" During most of 2003 and at June 30, 2004 the Corporation had a
negative interest sensitivity gap. Management's perception is that interest
rates will continue to be volatile, therefore 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 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, since unlike most industrial companies,
nearly all of the Corporation'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 move 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 fund 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 Corporation'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 Corporation manages reliance on short-term unsecured borrowings as well as
total wholesale funding though policy limits reviewed at ALCO. The Corporation
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 unpledged securities in the investment
portfolio and capacity to offer securities and loans, including single-family
mortgage loans.
The low rate environment has created heavy refinance activity and prepayments to
the Corporation's asset portfolios. The intense competition in the market
competing for the subsequent loan re-finance business has affected to some
degree the amount of mortgage loans originated by the Corporation. The
Corporation sells a portion of these loans into the secondary market and such
loans are included in loans held for sale. At June 30, 2004 there were no loans
available for sale. For the three months ended June 30, 2004 the Corporation had
no originations of loans for sale compared with $1.5 million for the three
months ended June 30, 2003. For the six months ended June 30, 2004 the
Corporation had originated $1.5 million in loans held for sale as compared to
$6.3 million for the comparable period in 2003.
22
Management believes that the Corporation has the funding capacity to meet the
liquidity needs arising from potential 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. The Corporation reviews the
holding Company's net short-term mismatch. This measures the ability of the
holding Corporation to meet obligations should access to bank dividends be
constrained. At June 30, 2004, the holding company had $2.388 million in cash
compared to $6.207 million at December 31, 2003. The decrease in cash at the
holding company level was due to increased capitalization of the subsidiary
bank. Expenses at the holding company are minimal and management believes that
the parent Corporation has adequate liquidity to fund 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
June 30, 2004 the Corporation was in compliance with all covenants and
provisions of these agreements.
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 June 30, 2004, projected to July 2005, indicates that
the Bank's liquidity should remain strong, with an approximate projection of
$179.8 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 three-month period ended June 30, 2004, core deposits
(comprised of total demand, savings accounts (excluding Super Max and money
market accounts under $100,000) remained relatively stable and represented 43.6
percent of total deposits as compared with 51.1 percent at June 30, 2003.
The following table depicts the Corporation's core deposit mix at June 30, 2004
and 2003:
CORE DEPOSIT MIX
JUNE 30, NET CHANGE IN
2004 2003 VOLUME 2004
(DOLLARS IN THOUSANDS) BALANCE % BALANCE % VS. 2003
- -----------------------------------------------------------------------------------------------------------------
Demand Deposits $122,891 44.5 $122,429 41.2 $462
Interest-Bearing Demand 67,393 24.4 69,247 23.3 (1,854)
Regular Savings 59,781 21.6 79,925 26.9 (20,144)
Money Market Deposits under $100 26,240 9.5 25,199 8.6 1,041
- -----------------------------------------------------------------------------------------------------------------
Total core deposits $276,305 100.0 $296,800 100.0 $(20,495)
- -----------------------------------------------------------------------------------------------------------------
Total deposits $633,316 $580,951 $52,365
- -----------------------------------------------------------------------------------------------------------------
Core deposits to total deposits 43.6% 51.1%
=================================================================================================================
More volatile rate sensitive deposits, concentrated in time certificates of
deposit greater than $100,000, for the six-month period ended June 30, 2004,
increased to 19.04 percent of total deposits from 9.54 percent during the
six-months ended June 30, 2003. This increase is attributable to increases in
municipal deposits.
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 six-months ended June 30, 2004 were
$242.3 million, an increase of $40.8 million or 20.27 percent from $201.5
million in average borrowings during the six-months ended June 30, 2003.
Average outstanding subordinated debentures during the six-months ended June 30,
2004 were $15.0 million, an increase of $5.0 million or 50.0 percent from $10.0
million in average outstanding subordinated debentures during the comparable
six-months ended June 30, 2003.
23
During the six-months ended June 30, 2004, average funding sources increased by
approximately $62.7 million or 7.89 percent, compared to the same period in
2003. Interest-bearing deposit liabilities increased approximately $8.1 million
on average and were comprised primarily of increases in money market, time
deposits, and other interest bearing deposits, offset by a decline in savings
deposits. Borrowings and subordinated debentures increased by $40.8 million and
$5.0 million, respectively. Non-interest bearing funding sources as a percentage
of the total funding mix decreased to 14.5 percent on average as compared to
14.9 percent for the six-month period ended June 30, 2003. This reflects a more
rapid growth in non-deposit funding sources as a percentage of the funding base
as compared with overall deposit growth.
OPERATING, INVESTING AND FINANCING CASH FLOW
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities. During the
six-months ended June 30, 2004, cash and cash equivalents (which increased
overall by $1.65 million) were provided (on a net basis) by operating activities
in the amount of approximately $2.4 million. The largest component of the cash
flow from operating activities is net income of $3.5 million. Approximately
$14.3 million in cash flow was provided by financing activities, principally an
increase of $15.0 million in borrowings. The borrowings were comprised of $5.0
million in proceeds from the issuance of subordinated debentures in December of
2003 and an increase in advances from the Federal Home Loan Bank of New York.
Investing activities, principally loans, used $15.1 million of the cash flow
provided by operating and financing activities.
STOCKHOLDERS' EQUITY
Total stockholders' equity averaged $54.6 million or 5.95 percent of average
assets for the six-month period ended June 30, 2004, as compared to $52.2
million, or 6.12 percent, during the same period in 2003. The Corporation's
dividend reinvestment and optional stock purchase plan contributed $505,000 in
new capital for the six-months ended June 30, 2004 as compared with $228,000 for
the comparable period in 2003. Book value per common share was $5.68 at June 30,
2004 as compared to $6.29 at June 30, 2003. Tangible book value (i.e., book
value less goodwill) per common share was $5.45 at June 30, 2004 and $6.06 at
June 30, 2003. The change in book value for the period resulted primarily from a
$9.4 million increase in "accumulated other comprehensive income" which
primarily reflects the effects of SFAS No. 115, which represents to the change
in unrealized holding losses, after tax, on the Corporation's securities
available-for-sale investment portfolio for the six months ended June 30, 2004
as compared with the comparable period ended June 30, 2003.
From January 24, 2002 through June 30, 2004 the Corporation has purchased 54,600
common shares at an average cost per share of $9.85 under the stock buyback
program announced on January 24, 2002 for the repurchase of up to 253,575 shares
(as adjusted for the stock splits and stock dividends) of the Corporation's
outstanding common stock. The repurchased shares were recorded as Treasury
Stock, which resulted in a decrease in stockholder's equity. For the three and
six month periods ended June 30, 2004 there were no repurchases made.
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 June 30, 2004, 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 June 30, 2004, total Tier 1 capital (defined as tangible stockholders' equity
for common stock and certain perpetual preferred stock) amounted to $67.7
million or 7.36 percent of total average assets for the second quarter. Tier I
capital excludes the effect of SFAS No. 115, $4.682 million 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
June 30, 2004. At June 30, 2004, the Corporation's estimated Tier I risk-based
and total risk-based capital ratios were 13.27 percent and 13.94 percent,
respectively. These ratios are well above the minimum guidelines of capital to
risk-adjusted assets in effect as of June 30, 2004.
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%.
24
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 June 30, 2004, management
believes that each of the Bank and the Corporation meet all capital adequacy
requirements to which it is subject.
SUBORDINATED DEBENTURES
On December 19, 2003 Center Bancorp Statutory Trust II, a statutory business
trust and wholly-owned subsidiary of Center Bancorp, Inc., issued $5.0 million
of MMCapS capital securities to investors due on January 23, 2034. The capital
securities have preference over the common securities issued by the trust with
respect to liquidation and other distributions and qualify as Tier 1 capital.
The trust loaned the proceeds of this offering to the Corporation and received
in exchange $5.0 million of the Corporation's subordinated debentures. The
subordinate debentures are redeemable in whole or part, prior to maturity but
after January 23, 2009. The floating interest rate on the subordinate debentures
is three-month LIBOR plus 2.85% and reprices quarterly. The rate at June 30,
2004 was 4.02 %.
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
issued by the trust with respect to liquidation and other distributions and
qualify as Tier 1 capital. The subordinated debentures are redeemable in whole
or part, prior to maturity but after December 18, 2006. The floating interest
rate on the subordinated debentures is three-month LIBOR plus 3.60% and reprices
quarterly. The rate at June 30, 2004 was 5.13 %.
The additional capital raised with respect to the issuance of the
above-mentioned securities was used to bolster the Corporation's capital and for
general corporate purposes, including capital contributions to Union Center
National Bank.
For information regarding certain developments that could impact the treatment
of the Corporation's subordinated debentures for regulatory capital purposes,
see "Recent Accounting Pronouncements - Consolidation of variable - interest
entities."
25
ITEM 3 - QUANTITATIVE AND QUALITATIVE 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
responses to changing market and rate conditions.
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 in
recent periods 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 June 30, 2004,
and assuming that management does not take action to alter the outcome, the
Corporation would expect an increase of 2.38 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 June 30, 2004, the Corporation would expect a
decrease of 6.58% percent in net interest income if interest rates increased by
200 basis points from current rates in an immediate 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 Private 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 Corporation's most
recently completed fiscal quarter (the registrant's fourth fiscal quarter
in the case of an annual report) covered by this report, the Corporation
carried out an evaluation, with the participation of the Corporation's
management, including the Corporation's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Corporation's disclosure
controls and procedures pursuant to Securities Exchange Act Rule 13a-15.
Based upon that evaluation, the Corporation's Chief Executive Officer and
Chief Financial Officer concluded that the Corporation's disclosure
controls and procedures are effective in ensuring that information required
to be disclosed by the Corporation 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 Corporation's internal controls over financial reporting
that occurred during the Corporation's last fiscal quarter to which this
report relates that have materially affected, or are reasonably likely to
materially affect, the Corporation's internal control over financial
reporting.
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PART II 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 proving facts within
the context of the legal processes.
ITEM 2-CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3-DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
For information regarding the Corporation's 2004 annual meeting of shareholders,
see the Corporation's quarterly Report on FORM 10-Q for the quarter ended March
31, 2004.
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.
B) REPORTS ON FORM 8-K
None (Other than a current report "submitted" but not "filed").
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf, by the
undersigned, thereunto duly authorized.
CENTER BANCORP, INC.
DATE: August 9, 2004 /s/: Anthony C. Weagley
-----------------------
Anthony C. Weagley, Treasurer
(Chief Financial Officer)
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