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 September 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.
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(Exact name of registrant as specified in its charter)
NEW JERSEY 52-1273725
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
2455 MORRIS AVENUE, UNION, NEW JERSEY 07083
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(Address of principal executives offices) (Zip Code)
(908) 688-9500
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes|X| No|_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-12 of the Exchange Act).
Yes|X| No|_|
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: 9,910,562
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(Title of Class) (Outstanding at October 31, 2004)
CENTER BANCORP, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Consolidated Statements of Condition
September 30, 2004 (unaudited), and December 31, 2003 (audited) 4
Consolidated Statements of Income for the
Three and Nine months ended September 30, 2004 and 2003 (unaudited) 5
Consolidated Statements of Cash Flows for the
Nine months ended September 30, 2004 and 2003 (unaudited) 6
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-25
Item 3. Qualitative and Quantitative Disclosures about Market Risks 26
Item 4. Controls and Procedures 26-27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to Vote of
Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
Certifications 30-33
PART I- FINANCIAL INFORMATION
The following unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X, and accordingly do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. However, in
the opinion of management, all adjustments (consisting only of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and nine months ended September 30, 2004 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2004 or for any other interim 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
SEPTEMBER 30, DECEMBER 31,
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(DOLLARS IN THOUSANDS) 2004 2003
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(UNAUDITED)
ASSETS
Cash and due from banks $ 17,257 $ 16,509
Investment securities held to maturity (approximate market
value of $132,035 in 2004 and $159,989 in 2003) 127,899 155,149
Investment securities available-for-sale 364,623 364,085
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Total investment securities 492,522 519,234
Loans, net of unearned income 379,097 349,525
Less-Allowance for loan losses 3,644 3,002
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Net loans 375,453 346,523
Premises and equipment, net 16,933 15,610
Accrued interest receivable 4,943 4,485
Bank owned separate account life insurance 17,660 14,614
Other assets 4,106 2,758
Goodwill 2,091 2,091
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Total assets $ 930,965 $ 921,824
=========================================================================================================
LIABILITIES
Deposits:
Non-interest bearing $ 124,746 $ 120,526
Interest bearing:
Certificates of deposit $100,000 and over 91,354 58,245
Savings and time deposits 392,849 454,150
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Total deposits 608,949 632,921
Federal funds purchased and securities sold under agreements to
repurchase 132,360 99,724
Federal Home Loan Bank advances 100,000 115,000
Subordinated debentures 15,000 15,000
Accounts payable and accrued liabilities 6,943 4,999
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Total liabilities 863,252 867,644
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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
10,919,418 and 10,003,580 shares in 2004 and 2003, 30,326 19,405
respectively
Additional paid in capital 4,524 4,677
Retained earnings 35,900 33,268
Treasury stock at cost (1,009,055 and 1,059,138 shares in 2004 and
2003 respectively) (3,783) (3,978)
Restricted stock 0 (14)
Accumulated other comprehensive income 746 822
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Total stockholders' equity 67,713 54,180
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Total liabilities and stockholders' equity $ 930,965 $ 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 NINE MONTHS ENDED
(Unaudited) SEPTEMBER 30, SEPTEMBER 30,
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(IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003
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INTEREST INCOME:
Interest and fees on loans $4,705 $3,840 $13,571 $10,948
Interest and dividends on investment securities:
Taxable interest income 4,167 3,063 12,267 13,186
Non-taxable interest income 925 880 2,658 1,867
Dividends 324 369 927 665
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Total interest income 10,121 8,152 29,423 26,666
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INTEREST EXPENSE:
Interest on certificates of deposit $100,000 and 345 117 538 355
over
Interest on other deposits 1,490 1,570 4,692 5,033
Interest on borrowings 1,696 1,424 4,721 4,165
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Total interest expense 3,531 3,111 9,951 9,553
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Net interest income 6,590 5,041 19,472 17,113
Provision for loan losses 205 103 615 262
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Net interest income after provision for loan losses 6,385 4,938 18,857 16,851
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OTHER INCOME:
Service charges, commissions and fees 513 401 1,471 1,239
Other income 133 173 344 420
Annuity & Insurance 5 0 25 0
Bank Owned Life Insurance 188 268 546 627
Gain (Loss) on securities sold 0 (17) 157 220
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TOTAL OTHER INCOME 839 825 2,543 2,506
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Other expense:
Salaries and employee benefits 2,685 2,507 7,963 7,834
Occupancy, net 455 393 1,477 1,365
Premises and equipment 457 384 1,377 1,278
Stationery and printing 127 131 423 436
Marketing and advertising 112 120 408 409
Other 914 880 2,997 2,439
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TOTAL OTHER EXPENSE 4,750 4,415 14,645 13,761
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Income before income tax expense 2,474 1,348 6,755 5,596
Income tax expense (benefit) 457 (167) 1,232 888
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Net income $2,017 $1,515 $5,523 $4,708
=========================================================================================================
EARNINGS PER SHARE: (Note 4)
Basic $0.22 $0. 17 $0.61 $0.53
Diluted $0.22 $0. 17 $0.61 $0.52
Weighted average common shares outstanding:
Basic 9,033,839 8,904,684 8,986,150 8,885,462
Diluted 9,076,188 8,999,418 9,045,639 8,979,165
==========================================================================================================
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
NINE MONTHS ENDED
(Unaudited) SEPTEMBER 30,
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(DOLLARS IN THOUSANDS) 2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 5,523 $ 4,708
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization 1,140 1,272
Provision for loan losses 615 262
Gain on sales of investment securities available for sale (157) (220)
Increase in accrued interest receivable (458) (513)
(Increase)/decrease in other assets (1,348) 454
Increase in Cash Surrender Value of Bank Owned Life Insurance (546) (300)
Increase/(decrease) in other liabilities 1,944 (2,046)
Amortization of premium and accretion of discount on
investment securities, net 655 5,482
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NET CASH PROVIDED BY OPERATING ACTIVITIES 7,368 9,099
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities available for sale 66,491 194,878
Proceeds from redemption of FRB & FHLB stock 3,250 0
Proceeds from maturities of securities held-to-maturity 30,029 124,908
Proceeds from sales of securities available-for-sale 34,501 104,923
Purchase of securities available-for-sale (101,540) (303,399)
Purchase of securities held-to-maturity (3,218) (77,584)
Purchase of FRB and FHLB stock (3,920) (3,340)
Net increase in loans (29,545) (79,583)
Bank owned life insurance (2,500) 0
Property and equipment expenditures, net (2,463) (1,797)
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NET CASH USED IN INVESTING ACTIVITIES (8,915) (40,994)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) in deposits (23,972) (36,334)
Dividends paid (2,346) (2,248)
Proceeds from issuance of common stock 10,977 837
Net increase in borrowings 17,636 71,764
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NET CASH PROVIDED BY FINANCING ACTIVITIES 2,295 34,019
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NET INCREASE IN CASH AND CASH EQUIVALENTS 748 2,124
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Cash and cash equivalents at beginning of period $ 16,509 $ 23,220
Cash and cash equivalents at end of period $ 17,257 $ 25,344
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
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Interest paid on deposits and short-term borrowings $ 9,801 $ 9,203
Income Taxes $ 1,297 $ 861
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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.
BASIS OF FINANCIAL STATEMENT PRESENTATION AND USE OF ESTIMATES
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 September 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003 2004 2003
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Net income, as reported $ 2,017 $ 1,515 $ 5,523 $ 4,708
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Add: compensation expense recognized for restricted stock
award, net of related tax effect 0 0 9 9
Deduct: Total Stock-based employee compensation
expense determined under fair value based method
all awards, net of related tax effects 27 11 73 42
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Pro forma net income $ 1,990 $ 1,504 $ 5,459 $ 4,675
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Earnings per share:
Basic - as reported $ 0.22 $ 0.17 $ 0.61 $ 0.53
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Basic - pro forma $ 0.22 $ 0.17 $ 0.61 $ 0.53
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Diluted - as reported $ 0.22 $ 0.17 $ 0.61 $ 0.52
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Diluted - pro forma $ 0.22 $ 0.17 $ 0.60 $ 0.52
===============================================================================================================================
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 - RECENT ACCOUNTING PRONOUNCEMENTS
OTHER-THAN-TEMPORARY IMPAIRMENT
In March 2004, the Emerging Issues Task Force ("EITF"), a standard setting body
working under the auspices of the Financial Accounting Standards Board ("FASB"),
revised ETIF No.03-01, "The Meaning of Other than temporary Impairment and its
Application to Certain Investments." In the revised guidance the EITF reached a
consensus regarding the model to be used in determining whether an investment is
other-than-temporarily impaired, and the required disclosures about unrealized
losses on available-for-sale debt and equity securities. The
other-than-temporary impairment accounting guidance would have been effective
for reporting periods beginning after June 15, 2004; the disclosure requirements
for annual reporting periods ending after June 15, 2004. In September, FASB
approved to delay the requirement to record impairment losses under EITF 03-1
and is expected to issue final guidance by December 31, 2004. Management is
currently evaluating the effect of this guidance on the Corporation's
consolidated financial statements and results of operations.
NOTE 3 - COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
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(DOLLARS IN THOUSANDS) 2004 2003 2004 2003
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Net Income $ 2,017 $ 1,515 $ 5,523 $ 4,708
OTHER COMPREHENSIVE INCOME
Unrealized holding gains/(losses)
arising during the period, net of 5,428 (5,486) (76) (2,822)
taxes
Less reclassification adjustment for
(gains)/losses
included in net income (net of taxes) 0 11 (104) (145)
- -----------------------------------------------------------------------------------------------------------------
Other total comprehensive income (loss) 5,428 (180) (2,967)
(5,497)
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Total comprehensive income (loss) $ 7,445 $(3,982) $ 5,343 $ 1,741
=================================================================================================================
NOTE 4 - EARNINGS PER SHARE RECONCILEMENT
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
- ----------------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------
Net income $2,017 $1,515 $5,523 $4,708
- ----------------------------------------------------------------------------------------------------------------
Average number of common shares outstanding 9,034 8,905 8,986 8,885
Effect of dilutive options 42 94 59 91
Effect of restricted stock awards 0 0 1 3
- ----------------------------------------------------------------------------------------------------------------
Average number of common shares outstanding used to
calculate diluted earnings per common share 9,076 8,999 9,046 8,979
- ----------------------------------------------------------------------------------------------------------------
Net income per share:
Basic $ .22 $ .17 $ .61 $ .53
Diluted $ .22 $ .17 $ .61 $ .52
================================================================================================================
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.
8
NOTE 5 - COMPONENTS OF NET PERIOD BENEFIT COST
NINE MONTHS ENDED SEPTEMBER 30,
PENSION BENEFIT OTHER POSTRETIREMENT BENEFITS
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(DOLLARS IN THOUSANDS) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Service Cost $ 509 $ 450 $ 33 $ 57
Interest Cost 372 318 48 60
Expected return on plan assets (333) (288) 0 0
Amortization of prior service cost 3 3 9 9
Amortization of the net loss 33 18 30 87
- -----------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 584 $ 501 $ 120 $ 213
=====================================================================================================
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 September 30, 2004, $550,000 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 6 - VARIABLE 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 September 30, 2004, assuming the
Corporation was not allowed to include the $15 million in subordinated
debentures in Tier 1 capital, the Corporation had a Tier 1 capital ratio of
6.95% and a total risk based capital ratio of 13.30%.
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.
9
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.
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 17 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 22 of this Quarterly Report on Form 10-Q.
10
EARNINGS ANALYSIS
Net income for three-months ended September 30, 2004 amounted to $2.017 million
compared to $1.515 million earned for the comparable three-month period ended
September 30, 2003. On a fully diluted per share basis, earnings increased to
$.22 per fully diluted share as compared with $.17 per fully diluted share for
the three months ended September 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 .86 percent compared with .68 percent for the comparable
three-month period in 2003. The annualized return on average stockholders'
equity was 14.88 percent for the three-month period ended September 30, 2004 as
compared to 11.67 percent for the three-months ended September 30, 2003.
Earnings performance for the third quarter 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 nine-months ended September 30, 2004 amounted to $5.523
million compared to $4.708 million earned for the comparable nine-month period
ended September 30, 2003. On a fully diluted per share basis, earnings increased
to $.61 per share as compared with $.52 per fully diluted share for the nine
months ended September 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 .80
percent compared with .73 percent for the comparable nine month period in 2003.
The annualized return on average stockholders' equity was 13.52 percent for the
nine month period ended September 30, 2004 as compared to 12.05 percent for the
nine months ended September 30, 2003. Earnings performance for the first nine
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 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.
NET INTEREST INCOME
(DOLLARS IN THOUSANDS) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
PERCENT PERCENT
2004 2003 CHANGE 2004 2003 CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
Interest income:
Investments $ 5,893 $ 4,765 23.67 $ 17,221 $ 16,680 3.24
Loans, including fees 4,705 3,840 22.53 13,571 10,948 23.96
- --------------------------------------------------------------------------------------------------------------------------------
Total interest income 10,598 8,605 23.16 30,792 27,628 11.45
- --------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Certificates $100,000 or more 345 117 194.87 538 355 51.55
Deposits 1,490 1,570 (5.10) 4,692 5,033 (6.78)
Borrowings 1,503 1,304 15.26 4,186 3,798 10.22
Subordinated Debentures 193 120 60.83 535 367 45.78
- --------------------------------------------------------------------------------------------------------------------------------
Total interest expense 3,531 3,111 13.50 9,951 9,553 4.17
- --------------------------------------------------------------------------------------------------------------------------------
Net interest income on a fully
tax-equivalent basis 7,067 5,494 28.63 20,841 18,075 15.30
- --------------------------------------------------------------------------------------------------------------------------------
Tax-equivalent adjustment (477) (453) 5.30 (1,369) (962) 42.31
- --------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME * $ 6,590 $ 5,041 30.73 $ 19,472 $ 17,113 13.78
================================================================================================================================
* 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 September 30, 2004 interest income on a
tax-equivalent basis increased by $2.0 million or 23.16 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 $81.8 million to $370.6 million from $288.8 million in the same
quarter in 2003, primarily driven by growth in commercial loans and residential
mortgages. The loan portfolio represented approximately 42.4 percent of the
Corporation's interest earning-assets (on average) during the third quarter of
2004 and 35.1 percent in the same quarter in 2003. Average investment volume
decreased during the period by $30.9 million on average compared to 2003. The
growth in loan volume was funded primarily through cash flow from the
Corporation's investment portfolio.
11
For the nine-month period ended September 30, 2004 interest income on a
tax-equivalent basis increased by $3.2 million or 11.45 percent over the
comparable nine-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 $101.9 million to $360.0 million from $258.1
million in the same period in 2003, primarily driven by growth in commercial
loans and commercial and residential mortgages. The loan portfolio represented
approximately 41.7 percent of the Corporation's interest earning assets (on
average) during the first nine months of 2004 and 32.2 percent in the same
period in 2003. Average investment volume decreased during the period by $40.9
million compared to 2003. The growth in loan volume was funded primarily through
cash flow from the Corporation's investment portfolio.
Net interest income on a fully tax-equivalent basis increased $1.6 million or
28.63 percent to approximately $7.1 million for the three-months ended September
30, 2004, from $5.5 million for the comparable period in 2003. For the three
months ended September 30, 2004, the net interest margin increased 56 basis
points to 3.23 percent from 2.67 percent due primarily to an increase in the
yield on earning-assets coupled with the increased volume of loans. For the
three-months ended September 30, 2004, the average cost of interest-bearing
liabilities increased by 13 basis points while the average yield on interest
earning-assets increased by 67 basis points, which resulted in an improvement in
the Corporation's net interest margins.
Net interest income on a fully tax-equivalent basis increased $2.8 million or
15.30 percent to approximately $20.841 million for the nine-months ended
September 30, 2004, from approximately $18.1 million for the comparable period
in 2003. For the nine months ended September 30, 2004, the net interest margin
increased 22 basis points to 3.22 percent FROM 3.00 percent due primarily to the
increased volume of loans and a decline in the cost of total interest bearing
liabilities. For the nine months ended September 30, 2004, a decrease in the
average cost of interest-earning liabilities of 5 basis points and an increase
in the average yield of interest-earning assets of 16 basis points 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 interest income as a percentage of average
interest-earning assets, for the three and nine month periods ended September
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.
For the three-months ended September 30, 2004, the Corporation's net interest
spread on a tax-equivalent basis increased by 54 basis points to 2.96 percent
from 2.42 percent for the three months ended September 30, 2003. The increase in
spreads was due primarily to a decline in exceptionally high levels of
prepayments and resultant premium amortization on the taxable investment
portfolio and prepayments on the loan portfolios as a result of the lower
interest rate environment in 2003 as compared to 2004. To a lesser extent, the
steepening of the yield curve and bias toward a higher Federal funds target rate
by the Federal Reserve Bank also affected the spread for the period. The rate
was raised on June 30, August 10 and September 21, 2004 from 1.00% to 1.75%.
Cash flow from earning assets was invested at higher rates, while the cost of
funds continued to remain stable.
For the nine months ended September 30, 2004, the Corporation's net interest
spread on a tax-equivalent basis increased by 21 basis points to 2.95 percent
from 2.74 percent for the nine months ended September 30, 2003. The increase in
spreads was due primarily to a decline in exceptionally high levels of
prepayments and resultant premium amortization on the taxable investment
portfolio and prepayments on the loan portfolios as a result of the lower
interest rate environment in 2003 as compared to 2004. To a lesser extent, the
steepening of the yield curve and bias toward a higher Federal funds target rate
by the Federal Reserve Bank also affected the spread for the period. In June
2004, the Federal Reserve Bank began a series of increases in the benchmark
funds rate, increasing it for the third time on September 21, 2004 to 1.75%.
Cash flow from earning assets was invested at higher rates, while the cost of
funds continued to remain stable. The protracted lower interest rate environment
that has prevailed throughout much of 2004 had a dampening effect on interest
margins.
12
The Federal Reserve Open Market Committee increased the Federal funds rate by 25
basis points on September 21, following increases of 25 basis points at each of
the last Federal Open Market Committee meetings on June 30, and August 10, 2004.
This marked the third time in 45 months since the Fed had raised interest rates
following a protracted low interest rate environment and a period during which
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 for the three months ended September 30, 2004 increased to 4.85 percent
from 4.18 percent in 2003, a change of 67 basis points. The total cost of
interest-bearing liabilities increased to 1.89 percent, a change of 13 basis
points, for the three months ended September 30, 2004 from 1.76 percent for the
three months ended September 30, 2003.
For the nine months ended September 30, 2004, the Corporation's yield on
interest-earning assets increased to 4.75 percent from 4.59 percent in 2003, a
change of 16 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 1.80 percent, a change of 5 basis points, for the nine months ended
September 30, 2004 from 1.85 percent for the nine months ended September 30,
2003.
For both the three and nine month periods this trend is primarily due to the
decrease in rates paid on certain interest-bearing liabilities.
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 9/30/04 NINE MONTHS ENDED 9/30/04
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 $ (241) $ 1,300 $ 1,059 $ (2,122) $ 1,465 $ (657)
Non-Taxable (26) 95 69 1,245 (47) 1,198
Loans, net of unearned discounts 1,045 (180) 865 3,948 (1,325) 2,623
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 778 1,215 1,993 3,071 93 3,164
Interest-bearing liabilities:
Money market deposits 1 20 21 34 (85) (51)
Savings deposits (42) (46) (88) (121) (314) (435)
Time deposits 265 (90) 175 409 (88) 321
Other interest-bearing deposits 6 34 40 19 (12) 7
Subordinated Debentures 64 9 73 179 (11) 168
Short-term Borrowings 13 186 199 482 (94) 388
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 307 113 420 1,002 (604) 398
- ------------------------------------------------------------------------------------------------------------------------------------
Change in net interest income $ 471 $ 1,102 $ 1,573 $ 2,069 $ 697 $ 2,766
====================================================================================================================================
13
The following table, "Average Balance Sheet with Interest and Average Rates",
presents for the nine months ended September 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
NINE MONTH PERIOD ENDED SEPTEMBER 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 $ 411,559 $ 13,194 4.27% $ 480,843 $ 13,851 3.84%
Non-taxable 91,973 4,027 5.84% 63,548 2,829 5.94%
Loans, net of unearned income (2) 360,002 13,571 5.03% 258,070 10,948 5.66%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 863,534 30,792 4.75% $ 802,461 27,628 4.59%
====================================================================================================================================
Non-interest earning assets
Cash and due from banks 19,477 21,961
BOLI 16,562 14,350
Other assets 27,320 27,698
Allowance for possible loan losses (3,310) (2,608)
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest earning assets 60,049 61,401
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 923,583 $ 863,862
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Money market deposits $ 97,195 728 1.00% $ 93,063 779 1.12%
Savings deposits 141,663 1,027 0.97% 155,416 1,462 1.25%
Time deposits 165,898 3,157 2.54% 144,540 2,836 2.62%
Other interest - bearing deposits 73,856 318 0.57% 69,448 311 0.60%
Short-term Borrowings 243,122 4,186 2.30% 215,247 3,798 2.35%
Subordinated Debentures 15,000 535 4.76% 10,000 367 4.89%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 736,734 9,951 1.80% 687,714 9,553 1.85%
====================================================================================================================================
Non-interest-bearing liabilities:
- ------------------------------------------------------------------------------------------------------------------------------------
Demand deposits 126,056 118,736
Other non-interest-bearing deposits 906 452
Other liabilities 5,407 4,852
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest-bearing liabilities 132,369 124,040
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity 54,480 52,108
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 923,583 $ 863,862
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $ 20,841 $ 18,075
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Spread 2.95% 2.74%
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets (net interest margin) 3.22% 3.00%
- ------------------------------------------------------------------------------------------------------------------------------------
Tax equivalent adjustment (3) (1,369) (962)
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 19,472 $ 17,113
====================================================================================================================================
(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 September 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 SEPTEMBER 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 $ 409,360 $ 4,491 4.39% $ 438,432 $ 3,432 3.13%
Non-taxable 94,303 1,402 5.95% 96,115 1,333 5.55%
Loans, net of unearned income (2) 370,562 4,705 5.08% 288,810 3,840 5.32%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 874,225 10,598 4.85% $ 823,357 8,605 4.18%
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest earning assets
Cash and due from banks 18,759 22,068
BOLI 17,551 14,446
Other assets 28,119 29,549
Allowance for possible loan losses (3,519) (2,680)
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest earning assets 60,910 63,383
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 935,135 $ 886,740
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Money market deposits $ 88,863 230 1.04% $ 88,561 209 0.94%
Savings deposits 137,358 335 0.98% 153,381 423 1.10%
Time deposits 188,675 1,144 2.43% 145,831 969 2.66%
Other interest - bearing deposits 73,508 126 0.69% 68,686 86 0.50%
Short-term Borrowings 244,704 1,503 2.46% 242,338 1,304 2.15%
Subordinated Debentures 15,000 193 5.15% 10,000 120 4.80%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing 748,108 3,531 1.89% 708,797 3,111 1.76%
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest-bearing liabilities:
- ------------------------------------------------------------------------------------------------------------------------------------
Demand deposits 127,616 121,518
Other non-interest-bearing deposits 285 422
Other liabilities 4,915 4,066
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest-bearing liabilities 132,816 126,006
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity 54,211 51,937
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 935,135 $ 886,740
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $ 7,067 $ 5,494
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Spread 2.96% 2.42%
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income as percent
of earning-assets (net interest margin) 3.23% 2.67%
- ------------------------------------------------------------------------------------------------------------------------------------
Tax equivalent adjustment(3) (477) (453)
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 6,590 $ 5,041
====================================================================================================================================
(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 September 30, 2004, the average volume of investment
securities decreased to approximately $503.7 million, or 57.6 percent of average
earning assets, a decrease of $30.9 million on average as compared to the same
period in 2003. The tax-equivalent yield on investments however increased by 111
basis points to 4.68 percent from a yield of 3.57 percent during the three month
period ended September 30, 2003. The 111 basis points increase in yield on the
portfolio was attributable to a sharp decline in prepayment speeds in 2004 in
comparison to the comparable period in 2003, which had contributed to the
acceleration of premium amortization on mortgage-related securities in the
portfolio in 2003 further impacting portfolio yields. To a lesser extent, an
improved interest rate environment in 2004, steeper yield curve coupled with a
change in mix in the portfolio to higher yielding tax-free securities positively
impacted the change in portfolio yield. 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 September 30, 2004
contributed a decrease in revenue of $267,000, while rate related changes
produced an increase of $1.4 million. At September 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 nine-months ended September 30, 2004, the average volume of investment
securities amounted to approximately $503.5 million, or 58.3 percent of average
earning assets, a decrease of $40.9 million on average as compared to the same
period in 2003. The tax-equivalent yield on investments increased by 47 basis
points to 4.56 percent from a yield of 4.09 percent during the nine month period
ended September 30, 2003. The 47 basis points increase in yield on the portfolio
was attributable to the sharp decline in prepayment speeds in 2004 in comparison
to the comparable period in 2003, which had contributed to the acceleration of
premium amortization on mortgage-related securities in the portfolio in 2003
further impacting portfolio yields. To a lesser extent, higher rates prevailed
during the nine month period in 2004 as compared to 2003. Additional volume
added to the portfolio during the period comprised of purchases made to replace
maturing and called investments, benefited from the positive changes in rates.
The volume related figures during the nine month period ended September 30, 2004
contributed a decrease in revenue of $877,000, while rate related changes
amounted to an increase in revenue of $1.4 million. The decline in the average
size of the investment portfolio for both the nine and three months ended
September 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 September 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 $1.7 and
$8.5 million, respectively, of short-term money market funds for the three and
nine month period ended September 30, 2004 as compared with $5.9 million and
$14.0 million, respectively, for the comparable three and nine month periods in
2003. These funds carried significantly lower rates than other securities in the
portfolio (on average 1.39 and 1.14 percent, respectively, for the three and
nine-month periods in 2004, compared to 1.00 and 1.18 percent on these overnight
funds, respectively, for the comparable three and nine month periods in 2003)
and contributed to the decline in yield as compared to the comparable period in
2003.
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 September 30, 2004, the Corporation sold from its
available-for-sale portfolio securities totaling approximately $34.5 million.
At September 30, 2004 the net unrealized gain carried as a component of other
comprehensive income and included in stockholders' equity net of tax amounted to
a net unrealized gain of $746,000 as compared with an unrealized gain of
$822,000 at December 31, 2003 and unrealized loss of $782,000 at September 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
during the third quarter of 2004 to raise the Federal Funds target rate to
1.75%.
LOANS
Loan growth during the nine months ended September 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 and aggressive marketing campaigns on its home equity and adjustable
rate residential mortgage loan products. These have been enhanced in recent
years by the Corporation's expanded branch network. The decrease in the loan
portfolio yields for the three and nine month period was the result of the
continued impact of repricing activity coupled with the addition of lower
yielding adjustable rate mortgages to the loan portfolio as compared with the
comparable period in 2003. To a lesser extent, yields on new volume were
affected by 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 September 30, 2004, average loan volume increased
$81.7 million or 28.3 percent, while portfolio yield decreased by 24 basis
points as compared with the same period in 2003. The volume related factors
during the period-contributed increased revenue of $1.045 million while rate
related changes led to a decline in revenue of $180,000. Total average loan
volume increased to $370.6 million with a net interest yield of 5.08 percent, as
compared to $288.8 million with a net interest yield of 5.32 percent for the
three months ended September 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 nine months ended September 30, 2004, average loan volume increased
$101.9 million or 39.5 percent, while portfolio yield decreased by 63 basis
points as compared with the same period in 2003. The volume related factors
during the period contributed increased revenue of $3.948 million while rate
related changes led to a decline in revenue of $1.325 million. Total average
loan volume increased to $360.0 million with a net interest yield of 5.03
percent, as compared to $258.1 million with a net interest yield of 5.66 percent
for the nine months ended September 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 September 30, 2004,
the allowance amounted to $3,644,000 as compared to $3,002,000 at December 31,
2003, and $2,751,000 at September 30, 2003. The Corporation had a provision to
the allowance for loan losses during the three and nine month periods ended
September 30, 2004 amounting to $205,000 and $615,000 respectively, compared to
$103,000 and $262,000 during the three and nine month periods ended September
30, 2003, respectively. The additions to the allowance during the respective
nine and three-month periods of 2004 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 September 30, 2004, the allowance for loan losses amounted to .96 percent of
total loans, as compared with .89 percent at September 30, 2003. In management's
view, the level of the allowance as of September 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 nine-month periods ended September 30, 2004 and 2003, the
Corporation did not experience any substantial credit problems within its loan
portfolio. Net recoveries for the nine months ended September 30, 2004 were
approximately $27,000 and were comprised of a home equity and installment loan
as compared with net charge offs of $9,000 for the comparable period ended
September 30, 2003, which were comprised of installment loans.
At September 30, 2004 the Corporation had non-accrual loans amounting to $24,000
as compared with $26,000 at December 31, 2003 and $37,000 of non-accrual loans
at September 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 September 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 September 30, 2004, total impaired loans were
approximately $24,000 compared to $358,000 at December 31, 2003 and $395,000 at
September 30, 2003. The reserves allocated to such loans at September 30, 2004,
December 31, 2003 and September 30, 2003, were $0, $6,000 and $6,300,
respectively. Although classified as substandard, impaired loans (other than
those in non-accrual status) were current with respect to principal and interest
payments.
Changes in the allowance for possible loan losses for the nine month period
ended September 30, 2004 and 2003, respectively, are set forth below.
ALLOWANCE FOR LOAN LOSSES
NINE
MONTHS
ENDED SEPTEMBER 30,
- ----------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003
- ----------------------------------------------------------------------------------------
Average loans outstanding $ 360,002 $ 258,070
- ----------------------------------------------------------------------------------------
Total loans at end of period $ 379,097 $ 308,634
- ----------------------------------------------------------------------------------------
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 25
- ----------------------------------------------------------------------------------------
Total charge-offs 10 25
- ----------------------------------------------------------------------------------------
Recoveries:
Commercial 0 0
Installment loans 37 16
- ----------------------------------------------------------------------------------------
Total recoveries 37 16
- ----------------------------------------------------------------------------------------
Net (recoveries) charge-offs: (27) 9
Provision for loan losses 615 262
- ----------------------------------------------------------------------------------------
Balance at end of year $ 3,644 $ 2,751
- ----------------------------------------------------------------------------------------
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 0.96% 0.89%
========================================================================================
N/M - Not meaningful
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 September 30, 2004, December 31, 2003 and September 30, 2003, the Corporation
had no restructured loans. Non-accrual loans amounted to $24,000 at September
30, 2004, and was comprised of one fixed rate home equity loan and a personal
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 September 30, 2003, non-accrual loans amounted to $37,000 and were
comprised of three consumer loans and two home equity loans. At September 30,
2004, December 31, 2003, and September 30, 2003 the Corporation did not have any
loans 90 days past due and still accruing.
18
The outstanding balances of accruing loans which are 90 days or more past due as
to principal or interest payments, other real estate owned and non-accrual loans
at September 30, 2004, December 31, 2003 and September 30, 2003, were as
follows:
NON-PERFORMING LOANS AT
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
- ----------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 2003
- ----------------------------------------------------------------------------------------------
Non-accrual loans $24 $26 $37
Accruing loans past due 90 days or more 0 0 0
Other real estate owned 0 0 0
- ----------------------------------------------------------------------------------------------
Total non-performing assets $24 $26 $37
==============================================================================================
At September 30, 2004, non-performing assets, consisting of loans on non-accrual
status plus other real estate owned (OREO), amounted to $24,000 or .006 percent
of total loans outstanding as compared to $26,000 or .007 percent at December
31, 2003 and $37,000 or .01 percent at September 30, 2003.
At September 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
September 30, 2004, December 31, 2003 and September 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 nine months ended September 30, 2004 and 2003.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
- ------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 % CHANGE 2004 2003 % CHANGE
- ------------------------------------------------------------------------------------------------------------------
Service charges, commissions and fees $513 $401 27.93 $1,471 $1,239 18.72
Annuity and Insurance 5 0 100.00 25 0 100.00
Bank Owned Life Insurance 188 268 (29.85) 546 627 (12.92)
Gain (loss) on securities sold 0 (17) 100.00 157 220 (28.64)
Other income 133 173 (23.12) 344 420 (18.10)
- ------------------------------------------------------------------------------------------------------------------
Total other non-interest income $839 $825 1.70 $2,543 $2,506 1.48
==================================================================================================================
For the three-month period ended September 30, 2004, total other (non-interest)
income increased $14,000 or 1.70 percent as compared to the comparable
three-month period in 2003. This increased revenue was primarily driven by the
increase in service charges, commissions and fees which increased $112,000 or
27.9% 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 $5,000 from annuity
and insurance sales, which began in the fourth quarter of 2003, and a decrease
in the cash surrender value of bank owned life insurance, which amounted to
$188,000 or a decrease of $80,000 for the third quarter in comparison to
$268,000 for the comparable quarter in 2003. This decrease was attributable to a
death benefit payment of $97,000 paid in the third quarter of 2003. The decrease
in other income is attributable to a fee related item recorded in the second
quarter of 2003.
For the nine-month period ended September 30, 2004, total other (non-interest)
income increased $37,000 or 1.48 percent as compared to the comparable
nine-month period in 2003. Other non-interest income, exclusive of gains on
securities sold (which decreased $63,000), reflects an increase of $115,000 or
5.03 percent compared with the comparable nine-month period ended September 30,
2003. This increased revenue was primarily driven by an increase in service
charges, commissions and fees, which increased $232,000 or 18.72% as compared to
the comparable nine 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. To a lesser extent there was a $25,000 increase from annuity
and insurance sales as compared with the comparable period in 2003. The decrease
in other income is attributable primarily to a nonrecurring 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 nine months ended September 30, 2004, as compared
with the comparable period in 2003. The decrease of $81,000 in cash surrender
value of Bank Owned Life Insurance is attributable to a death benefit payment of
$97,000 paid in the third quarter of 2003.
For the three-month period ended September 30, 2004, the Corporation recorded a
net gain of $0 on securities sold from the available-for-sale investment
portfolio compared to a loss of $17,000 for the three-month period ended
September 30, 2003. During the nine month period ended September 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 $220,000 for the
nine-month period ended September 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 nine-months ended September 30, 2004 and 2003.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
- --------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 2003 % CHANGE 2004 2003 % CHANGE
- --------------------------------------------------------------------------------------------------------------
S Salaries and employee $ 2,685 $ 2,507 7.10 $7,963 $ 7,834 1.65
benefits
Occupancy expense, net 455 393 15.78 1,477 1,365 8.21
Premises & equipment expense 457 384 19.01 1,377 1,278 7.75
Stationery & printing expense 127 131 (3.05) 423 436 (2.98)
Marketing & advertising expense 112 120 (6.67) 408 409 (0.24)
Other expense 914 880 3.86 2,997 2,439 22.88
- --------------------------------------------------------------------------------------------------------------
Total other non-interest expense $4,750 $ 4,415 7.59 $14,645 $13,761 6.42
==============================================================================================================
Total other non-interest expense for the three-months ended September 30, 2004,
increased $335,000 or 7.59 percent over the comparable three-months ended
September 30, 2003. This increase is primarily attributable to a $178,000
increase in personnel expense for the three month period ended September 30,
2004, as compared to the comparable quarter in 2003. The Corporation's ratio of
other expenses (annualized) to average assets remained relatively stable at 2.03
percent in the third quarter of 2004 from 1.99 percent for the three-months
ended September 30, 2003.
For the three-months ended September 30, 2004, salaries and employee benefits
increased $178,000 or 7.10 percent as compared to the comparable three-month
period ended September 30, 2003. This increase is primarily attributable to
costs associated with increased staffing levels. Staffing levels increased to
187 full-time equivalent employees at September 30, 2004 compared to 181
full-time equivalent employees at September 30, 2003.
For the three-months ended September 30, 2004, occupancy and premises and
equipment expense increased $135,000 or 17.37 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 relating to the expanded Corporation's facilities, which includes a
20,000 square foot operations center acquired during the fourth quarter of 2003.
Total other non-interest expense for the nine-months ended September 30, 2004,
increased $884,000 or 6.42 percent over the comparable nine-months ended
September 30, 2003. This increase is primarily attributable to a $558,000
increase in other expense for the nine-month period ended September 30, 2004 as
compared to the comparable nine months in 2003 and was attributable to increased
computer, telephone, audit, legal and consulting fees coupled with a expense
reduction of $136,000 recorded in 2003. The Corporation's ratio of other
expenses (annualized) to average assets remains stable at 2.11 percent for the
nine months ended September 30, 2004 in comparison to 2.12 percent for the nine
months ended September 30, 2003.
Salaries and employee benefits increased $129,000 or 1.65 percent for the
nine-months ended September 30, 2004 as compared to the comparable nine-month
period ended September 30, 2003. This increase is primarily attributable to
costs associated with increased staffing levels.
For the nine-months ended September 30, 2004, occupancy and premises and
equipment expenses increased $211,000 or 7.98 percent over the comparable
nine-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 September 30, 2004, the effective tax rate was 18.5
percent as compared to a tax benefit rate of 12.4 percent for the three-months
ended September 30, 2003. For the nine-months ended September 30, 2004 the
effective tax rate was 18.2 percent as compared with 15.9 percent for the
comparable period in 2003. The effective tax rate for the three and nine month
periods ended September 30, 2004 and 2003, while increased due to higher levels
of taxable income, 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 increased by $45,000 or 5.11 percent for the
three-month period ended September 30, 2004, and increased by $791,000 or 42.4
percent for the nine-month period ended September 30, 2004, as compared to the
comparable three and nine 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 September 30, 2004, the Corporation reflects a negative interest sensitivity
gap (or an interest sensitivity ratio) of
..70:1.00 at the cumulative one-year position. Accordingly, based on its interest
simulation models at September 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
September 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 September 30, 2004 there were no
loans available for sale. For the three months ended September 30, 2004 the
Corporation had $761,000 in originations of loans for sale compared with $7.9
million for the three months ended September 30, 2003. For the nine months ended
September 30, 2004 the Corporation had originated $2.3 million in loans held for
sale as compared to $14.2 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 pledge able
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 its
net short-term mismatch. This measures the ability of the Corporation to meet
obligations should access to bank dividends be constrained. At September 30,
2004, the holding company had $11.778 million in cash compared to $6.207 million
at December 31, 2003. The increase in cash at the holding company level was due
to the proceeds received from the private placement of 888,888 shares of the
Corporation's common stock on September 29, 2004. 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
September 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 September 30, 2004, projected to October 2005,
indicates that the Bank's liquidity should remain strong, with an approximate
projection of $187.6 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 September 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 49.4 percent of total deposits as compared with 51.4 percent at
September 30, 2003.
The following table depicts the Corporation's core deposit mix at September 30,
2004 and 2003:
CORE DEPOSIT MIX
SEPTEMBER 30, NET CHANGE IN
2004 2003 VOLUME 2004
-----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) BALANCE % BALANCE % VS. 2003
- ----------------------------------------------------------------------------------------------------------------------
Demand Deposits $124,743 41.5 $124,236 41.7 $ 507
Interest-Bearing Demand 72,833 24.2 70,894 23.8 1,939
Regular Savings 78,051 26.0 80,451 27.0 (2,400)
Money Market Deposits under $100 24,890 8.3 22,258 7.5 2,632
- ----------------------------------------------------------------------------------------------------------------------
Total core deposits $300,517 100.0 $297,839 100.0 $ 2,678
- ----------------------------------------------------------------------------------------------------------------------
Total deposits $608,949 $580,017 $ 28,932
- ----------------------------------------------------------------------------------------------------------------------
Core deposits to total deposits 49.4% 51.4%
======================================================================================================================
More volatile rate sensitive deposits, concentrated in time certificates of
deposit greater than $100,000, for the nine-month period ended September 30,
2004, increased to 15.00 percent of total deposits from 8.46 percent during the
nine-months ended September 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 nine-months ended September 30, 2004
were $243.1 million, an increase of $27.9 million or 12.96 percent from $215.2
million in average borrowings during the nine-months ended September 30, 2003.
Average outstanding subordinated debentures during the nine-months ended
September 30, 2004 were $15.0 million, an increase of $5.0 million or 50.0
percent from $10.0 million on average outstanding subordinated debentures during
the comparable nine-months ended September 30, 2003. 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.
23
During the nine-months ended September 30, 2004, average funding sources
increased by approximately $56.8 million or 7.04 percent, compared to the same
period in 2003. Interest-bearing deposit liabilities increased approximately
$16.1 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 $27.9
million and $5.0 million, respectively. Non-interest bearing funding sources as
a percentage of the total funding mix remained stable at 14.7 percent on average
as compared to 14.8 percent for the nine-month period ended September 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
nine-months ended September 30, 2004, cash and cash equivalents (which increased
overall by $748,000) were provided (on a net basis) by operating activities in
the amount of approximately $7.4 million. The largest component of the cash flow
from operating activities is net income of $5.5 million. Approximately $2.3
million in cash flow was provided by financing activities, principally a net
increase of $17.6 million in borrowings and $10.9 million from the proceeds from
the issuance of common stock. The borrowings were comprised of a reduction of
$15.0 million in advances from the Federal Home Loan Bank of New York and an
increase in securities sold under agreement to repurchase. These activities were
offset by the net decline in deposits. Investing activities, principally
securities available for sale, used $8.9 million of the cash flow provided by
operating and financing activities.
STOCKHOLDERS' EQUITY
Total stockholders' equity averaged $54.5 million or 5.90 percent of average
assets for the nine-month period ended September 30, 2004, as compared to $52.1
million, or 6.03 percent, during the same period in 2003. The Corporation's
dividend reinvestment and optional stock purchase plan contributed $981,000 in
new capital for the nine-months ended September 30, 2004 as compared with
$837,000 for the comparable period in 2003.
At September 30, 2004 the total Tier 1 capital leverage ratio was 8.56% as
compared to 6.79 % for the comparable period in 2003. Total Tier 1 capital
increased to approximately $79.9 million at September 30, 2004 from $66.3
million at December 31, 2003 and $ 60.1 at September 30, 2003. The increase in
Tier 1 capital reflects the issuance of 888,888 common shares to a limited
number of accredited investors in a private placement of the Corporation's
securities on September 29, 2004. These shares were issued at a purchase price
of $11.25 per share. Net proceeds to the Corporation were approximately $9.4
million, after commissions and expenses. The growth in Tier 1 capital
additionally reflects the cumulative issuance of $15.0 million in subordinated
debentures which are included in Tier 1 capital for regulatory purposes.
Book value per common share was $6.83 at September 30, 2004 as compared to $5.77
at September 30, 2003. Tangible book value (i.e., book value less goodwill) per
common share was $6.62 at September 30, 2004 and $5.53 at September 30, 2003.
The change in book value for the period resulted primarily from the issuance of
additional common stock on September 29, 2004 and a $1.5 million increase in
"accumulated other comprehensive income" which primarily reflects the effects of
SFAS No. 115. The effect of SFAS No. 115 represents the change in unrealized
holding losses, after tax, on the Corporation's securities available-for-sale
investment portfolio which increased by $1.5 million for the nine months ended
September 30, 2004 as compared with the comparable period ended September 30,
2003.
From January 24, 2002 through September 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 nine month periods ended September 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.
24
RISK-BASED CAPITAL/LEVERAGE
Banking regulations require banks to maintain minimum levels of regulatory
capital. Under the regulations in effect at September 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 September 30, 2004, total Tier 1 capital (defined as tangible stockholders'
equity for common stock and certain perpetual preferred stock) amounted to $79.9
million or 8.56 percent of total average assets for the third quarter. Tier I
capital excludes the effect of SFAS No. 115, $746,000 of net unrealized gains,
after tax, on securities available-for-sale (included as a component of other
comprehensive income) and goodwill of approximately $2.1 million as of September
30, 2004. At September 30, 2004, the Corporation's estimated Tier I risk-based
and total risk-based capital ratios were 15.51 percent and 16.22 percent,
respectively. These ratios are well above the minimum guidelines of capital to
risk-adjusted assets in effect as of September 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%.
The foregoing capital ratios are based in part on specific quantitative measures
of assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by the bank regulators about capital
components, risk weightings and other factors. As of September 30, 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 September
30, 2004 was 4.53 %.
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 September 30, 2004 was 5.51 %.
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."
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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 September 30,
2004, and assuming that management does not take action to alter the outcome,
the Corporation would expect an increase of 2.34 percent in net interest income
if interest rates decreased 100 basis points from the current rates in an
immediate and parallel shock over a 12-month period. In a rising rate
environment, based on the results of the model as of September 30, 2004, the
Corporation would expect a decrease of 4.85% 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.
(C) Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with
the Company's Annual Report on Form 10-K for the fiscal year ending
December 31, 2004, the Company will be required to furnish a report by
management on the Company's internal control over financial reporting.
Such report will contain, among other matters, an assessment of the
effectiveness of the Company's internal control over financial reporting
as of December 31, 2004, including a statement as to whether or not the
Company's internal control over financial reporting is effective. This
assessment must include disclosure of any material weaknesses in the
Company's internal control over financial reporting identified by
management. Such report must also contain a statement that the Company's
auditors have issued an attestation report on management's assessment of
such internal controls. Public Company Oversight Board Auditing Standard
No. 2 provides the professional standards and related performance guidance
for auditors to attest to, and report on, management's assessment of the
effectiveness of internal control over financial reporting under Section
404.
The standards that must be met for management to assess the internal
control over financial reporting as effective are new and complex, and
require significant documentation, testing and possible remediation to
meet the detailed standards. We may encounter problems or delays in
completing activities necessary to make an assessment of our internal
control over financial reporting. In addition, the attestation process by
our independent registered public accountants is new and we may encounter
problems or delays in completing the implementation of any requested
improvements and receiving an attestation of our assessment by our
independent registered public accountants. If the Company is unable to
assert that its internal control over financial reporting is effective as
of December 31, 2004 or if the Company's auditors are unable to attest
that the Company's management's report is fairly stated or are unable to
express an opinion on the effectiveness of the Company's internal
controls, the Company could lose investor confidence in the accuracy and
completeness of its financial reports, which could have an adverse effect
on the Company's stock price.
26
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-UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Reference is made to the Corporation's Current Report on Form 8-K filed on
October 1, 2004.
ITEM 3-DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 - OTHER INFORMATION
None
ITEM 6- 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.
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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.
DATED: November 9, 2004 /s/ Anthony C. Weagley
------------------------------------
Anthony C. Weagley, Treasurer
(Chief Financial Officer)
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