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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004 Commission File number 1-12811
U.S.B. HOLDING CO., INC.
(Exact name of registrant as specified in its charter)
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Delaware 36-3197969
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
100 Dutch Hill Rd., Orangeburg, New York 10962
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (845) 365-4600
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on
------------------------ which registered
Common Stock ($0.01 par value) --------------------------
------------------ New York Stock Exchange
Securities registered pursuant to section 12(g) of the Act:
Title of Class
------------------
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes: |X| No: |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes: |X| No: |_|
Class Outstanding at February 28, 2005
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Common Stock 20,459,875 shares
($0.01 par value)
The aggregate market value of the voting stock held by nonaffiliates of the
registrant on June 30, 2004 was approximately $241.5 million, computed by
reference to the closing price on the New York Stock Exchange composite tape of
$22.92 per share of Common Stock on June 30, 2004.
Documents incorporated by reference:
Portions of the registrant's Annual Report to Stockholders for the year ended
December 31, 2004 are incorporated by reference in Part II of this report.
Portions of the registrant's definitive Proxy Statement for the 2005 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 2004, are incorporated by
reference in Part III of this report.
1
PART I
ITEM 1. BUSINESS
U.S.B. Holding Co., Inc. (the "Company"), a Delaware corporation
incorporated in 1982, is a bank holding company registered under the Bank
Holding Company Act of 1956, as amended, which provides financial services
through its wholly-owned subsidiaries. The Company and its subsidiaries derive
substantially all of their revenue and income from providing banking and related
financial services, primarily to customers in Rockland, Westchester, and Orange
Counties, Manhattan, New York City, and Long Island, New York, and Southern
Connecticut, and the surrounding area.
Union State Bank (the "Bank"), the Company's commercial banking
subsidiary, is a New York chartered commercial bank established in 1969. The
Bank offers a wide range of banking services to individuals, municipalities,
corporations, and small and medium-size businesses through its 25 retail
branches in Rockland and Westchester Counties, and one branch each in Stamford,
Connecticut, Manhattan, New York City, and Goshen, Orange County, New York. The
Bank also has loan production offices located in Rockland County, Westchester
County and Orange County, New York, and Stamford, Connecticut. The Bank's
corporate offices are located in Rockland County. The Bank's products and
services include checking accounts, NOW accounts, money market accounts, savings
accounts (passbook and statement), certificates of deposit, retirement accounts,
commercial, personal, residential, construction, home equity (second mortgage),
and condominium mortgage loans, consumer loans, credit cards, safe deposit
facilities, and other consumer oriented financial services. The Bank also makes
available to its customers automated teller machines (ATMs), lock-box services,
and Internet banking. The deposits of the Bank are insured to the extent
permitted by law pursuant to the Federal Deposit Insurance Act of 1950, as
amended.
In 1997, the Bank established two nonbank wholly-owned subsidiaries. Dutch
Hill Realty Corp. owns and manages problem assets and real estate acquired in
foreclosure from the Bank. U.S.B. Financial Services, Inc. offers sales of
various financial products, such as mutual funds, stocks and bonds, annuities,
and life insurance in conjunction with an arrangement with a third party
brokerage and insurance firm specializing in bank financial product sales.
USB Delaware Inc. is a Delaware passive investment company established by
the Bank on September 12, 2003. USB Delaware Inc. was established for the
purpose of managing the Bank's investment in TPNZ Preferred Funding Corporation
("TPNZ").
TPNZ is a wholly-owned subsidiary of USB Delaware Inc. TPNZ qualifies as a
Real Estate Investment Trust for income tax purposes. TPNZ was formed in 1998 to
manage certain mortgage-backed securities and mortgage loans, substantially all
of which were previously owned by the Bank and TPNZ's former parent company,
Tarrytowns Bank, FSB ("Tarrytowns").
In February 1997, the Company established Union State Capital Trust I,
which is a Delaware business trust, in July 2001 and June 2002, established
Union State Statutory Trust II and USB Statutory Trust III, respectively, which
are Connecticut business trusts, and in March 2004, established Union State
Statutory Trust IV, a Delaware business trust, (collectively the "Trusts"). The
Trusts were established solely for the purpose of issuing Capital Securities and
purchasing subordinated debt from the Company with the proceeds. Refer to Note
10 to the Consolidated Financial Statements for further detail.
The Company also has a nonbank subsidiary, Ad Con, Inc., which is
currently inactive.
The Company fully utilizes its website, www.unionstate.com, to advertise
the Bank's products, list information about its locations, and make available,
free of charge, its Securities Exchange Act filings, including Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports as soon as reasonably practicable after they have
been electronically filed with or furnished to the Securities and Exchange
Commission ("SEC"). Such filings are also available on the SEC's website at
www.sec.gov
Employees
As of December 31, 2004, the Company employed a total of 367 full-time and
43 part-time employees. The Company and its subsidiaries provide a variety of
benefit plans, including incentive bonus, group life, health, and stock
ownership plans. Management considers its employee relations to be satisfactory.
Competition
The Bank's headquarters and fourteen of its branch offices are currently
located in Rockland County, New York. Eleven of the Bank's branch offices (as of
March 14, 2005) are located in Westchester County, New York. The Bank also has a
branch location in Stamford, Connecticut, Manhattan, New York City, and Goshen,
Orange County, New York, as well as an office that closes loans and disburses
funds in Tarrytown, New York, Goshen, Orange County, New York, and Stamford,
Connecticut. The Company's current deposits constitute a market share that are
approximately 17.2 percent and 2.3 percent of Rockland and Westchester deposits,
respectively.
2
The Bank is the largest bank headquartered in the Hudson Valley and has
been successful in its penetration of the Rockland and Westchester markets and
more recently, the Stamford, Connecticut, and Orange County, New York, markets.
The Bank believes it is able to attract and retain customers because of its
knowledge of local markets, competitive products, and the ability of
professional staff to provide a high degree of service to customers. Within its
market area, the Bank encounters competition from many other financial
institutions offering comparable products. These competitors include other
commercial banks (both locally based independent banks and major New York City
commercial banks) and savings banks, as well as mortgage bankers, savings and
loan associations, and credit unions. In addition, the Bank experiences
competition in marketing some of its services from the local operations of
insurance companies, brokerage firms, and other financial institutions.
The Company expects to continue to expand by opening new retail branches,
enhancing computerized and telephonic delivery channels, and expanding loan
originations in its market area. Acquisitions of other smaller financial
institutions and branches will be considered to supplement growth in the
Company's present and contiguous markets. Acquisitions of other nonbank
financial institutions will also be considered to expand the Company's product
offerings.
Supervision and Regulation
The references under this heading to various aspects of supervision and
regulation are brief summaries which do not purport to be complete and which are
qualified in their entirety by reference to applicable laws, rules, and
regulations.
The Company, as a "bank holding company" under the Bank Holding Company
Act of 1956 (the "BHC Act"), is regulated and examined by the Board of Governors
of the Federal Reserve System (the "FRB") and is required to file with the FRB
an annual report and other information. The BHC Act restricts the business
activities and acquisitions that may be engaged in by the Company. The FRB may
make examinations of the Company and has the authority (which it has not
exercised) to regulate provisions of certain bank holding company debt. The BHC
Act requires every bank holding company to obtain the prior approval of the FRB
before acquiring substantially all the assets of, or direct or indirect
ownership or control of more than five percent of the voting shares of, any bank
that is not already majority-owned. Subject to certain limitations and
restrictions, a bank holding company, with the prior approval of the FRB, may
acquire an out-of-state bank. A national or state bank may also establish a de
novo branch out of state if such branching is expressly permitted by the other
state.
The BHC Act also prohibits a bank holding company, with certain
exceptions, from engaging in or acquiring direct or indirect control of more
than five percent of the voting shares of any company engaged in non-banking
activities. One of the principal exceptions to these prohibitions is engaging
in, or acquiring shares of a company engaged in, activities found by the FRB, by
order or regulations, to be so closely related to banking or the management of
banks as to be a proper incident thereto. Activities determined by the FRB to be
so closely related to banking within the meaning of the BHC Act include
operating a mortgage company, finance company, credit card company, factoring
company, trust company or savings association; performing certain data
processing operations; providing limited securities brokerage services; acting
as an investment or financial advisor; acting as an insurance agent for certain
types of credit-related insurance; leasing personal property on a full-payout,
non-operating basis; providing tax planning and preparation services; operating
a collection agency; and providing certain courier services. The FRB also has
determined that under the BHC Act certain other activities, including real
estate brokerage and syndication, land development, property management, and
underwriting of life insurance unrelated to credit transactions, are not closely
related to banking and therefore are not a proper incident thereto.
Historically, the BHC Act has restricted the business activities and
acquisitions that may be engaged in or made by the Company. The enactment of the
Gramm-Leach-Bliley Act of 1999 (the "GLB Act"), which became effective on March
11, 2000, permits bank holding companies to elect to be treated as "financial
holding companies." If the Company should elect to become a financial holding
company, the business activities and acquisitions or investments that may be
engaged in will be significantly expanded. A financial holding company is
authorized to engage in any activity that is financial in nature or incidental
to an activity that is financial in nature or is a complementary activity. These
activities include insurance, securities transactions, and traditional banking
related activities.
The GLB Act also authorizes a state bank to have a financial subsidiary
that engages, as a principal, in the same activities that are permitted for a
financial subsidiary of a national bank if the state bank meets eligible
criteria and special conditions for maintaining the financial subsidiary. The
GLB Act designates the FRB as the umbrella supervisor of financial holding
companies and adopts a system of functional regulation where the primary
regulator is determined by the nature of the activity rather than the type of
institution. If the Company should elect to become a financial holding company,
the Company may be subject to supervision from different governmental agencies.
As of the date hereof, the Company has made no determination to elect to be
treated as a financial holding company and, accordingly, will still be subject
to the BHC Act.
3
The Company is a legal entity separate and distinct from its subsidiaries.
The ability of holders of debt and equity securities of the Company to benefit
from the distribution of assets from any subsidiary upon the liquidation or
reorganization of such subsidiary is subordinate to prior claims of creditors of
the subsidiary (including depositors in the case of banking subsidiaries),
except to the extent that a claim of the Company as a creditor may be
recognized.
There are various statutory and regulatory limitations regarding the
extent to which present and future banking subsidiaries of the Company can
finance or otherwise transfer funds to the Company or its nonbanking
subsidiaries, whether in the form of loans, extensions of credit, investments or
asset purchases, including regulatory limitations on the payment of dividends
directly or indirectly to the Company from the Bank. Federal and state bank
regulatory agencies also have the authority to limit further the Bank's payment
of dividends based on such factors as the maintenance of adequate capital for
such subsidiary Bank, which could reduce the amount of dividends otherwise
payable. Under applicable banking statutes, at December 31, 2004, the Bank could
declare additional dividends of $69.1 million to the Company without prior
regulatory approval.
Under the policy of the FRB, the Company is expected to act as a source of
financial strength to the Bank and to commit resources to support the Bank in
circumstances where the Company might not do so absent such policy. In addition,
any subordinated loans by the Company to the Bank would also be subordinate in
right of payment to depositors and obligations to general creditors of such
subsidiary bank.
The Bank is organized under the Banking Law of the State of New York. Its
operations are subject to Federal and state laws applicable to commercial banks
and to extensive regulation, supervision and examination by the Superintendent
of Banks and the Banking Board of the State of New York, as well as by the
Federal Deposit Insurance Corporation ("FDIC"), as its primary Federal regulator
and insurer of deposits. The New York Superintendent of Banks and the FDIC
periodically examine the affairs of the Bank for the purpose of determining its
financial condition and compliance with laws and regulations.
The New York Superintendent of Banks and the FDIC have significant
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such policies whether by the FDIC, Congress, the New
York Superintendent of Banks or the New York Legislature could have a material
adverse impact on the Bank and the Company.
The Company is subject to risk-based capital and leverage guidelines
issued by the FRB. The Bank, whose deposits are insured by the FDIC, is subject
to similar guidelines. These guidelines are utilized to evaluate capital
adequacy. The regulatory agencies are required by law to take specific prompt
corrective actions with respect to banks that do not meet minimum capital
standards. As of December 31, 2004, the Bank was classified as "well
capitalized" for regulatory purposes. See "Capital Resources" under Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
Note 12 to the Consolidated Financial Statements.
Federal laws and regulations also limit, with certain exceptions, the
ability of banks to engage in activities or make equity investments that are not
permissible for national banks. The Company does not expect such provisions to
have a material adverse effect on the Bank or the Company.
Sarbanes-Oxley Act of 2002
On July 29, 2002, Congress passed the Sarbanes-Oxley Act of 2002 (the
"Act"), which provides for extensive new regulations regarding corporate
governance, auditor independence and oversight, and other related matters. Among
other things, the Act required: the establishment of a Public Company Accounting
Oversight Board to monitor the audit profession with respect to audits of public
companies; establishment of audit independence standards; establishment of
corporate responsibility standards that include rules and regulations with
respect to audit committees and corporate responsibility for financial reports;
disclosures and assessment of internal controls; and increases in corporate and
criminal fraud accountability that sets forth white collar crime penalty
enhancements. The Act also requires the Company to name and disclose the
Company's Audit Committee financial expert or explain why no such Audit
Committee financial expert has been named.
In conjunction with the Act's requirements, the SEC and New York Stock
Exchange have issued numerous rules and regulations, which have various
implementation dates. The Company has complied with all such rules and
regulations to date and will continue to comply with all rules and regulations
as they become effective.
Government Monetary Policies and Economic Controls
The earnings and growth of the banking industry, the Company, and the Bank
are affected by general economic conditions, as well as by the policies of
monetary authorities, including the Federal Reserve System. An important
function of the Federal Reserve System is to regulate the national supply of
bank credit in order to maintain economic growth and curb inflationary
pressures. Its policies are used in varying combinations to influence overall
growth of bank loans, investments and deposits and may also affect interest
rates charged on loans or paid for deposits.
4
In view of changing conditions in the national economy and the financial
markets, as well as the effect of actions by monetary and fiscal authorities,
including the Federal Reserve System, no prediction can be made by the Company
as to possible future changes in interest rates, deposit levels, loan demand,
investments, or their effect on the business and earnings of the Company and the
Bank.
ITEM 2. PROPERTIES
The main office of the Company and the Bank, including the Executive
Offices, Finance, Commercial Loan, Residential Mortgage, Credit Administration,
Legal, Compliance, Human Resources, Facilities/Security, Internal Audit,
Operations Center, Customer Call Center, Transit and Data Processing
Departments, and Marketing Departments, is located at its Corporate Headquarters
building, which is owned by the Bank at 100 Dutch Hill Road, Orangeburg, New
York. The Bank's main branch and Consumer Loan and Credit Card departments are
located at 46 College Avenue, Nanuet, New York in premises that are leased by
the Bank. The Bank also has loan production offices that may originate loans and
disburse funds located at 660 White Plains Road in Tarrytown, New York, and 999
Bedford Street, Stamford, Connecticut, which premises are leased, and 50 North
Church Street, Goshen, New York, which premises is owned.
In addition to the main branch in Nanuet, the Bank operates 13 retail
banking branches in Rockland County, New York: 270 South Little Tor Road, New
City; 87 Route 59, Monsey; 115 South Main Street, New City; 45 Kennedy Drive,
Spring Valley; 35 South Liberty Drive, Stony Point; One Broadway, Haverstraw;
Route 9W and Railroad Avenue, West Haverstraw; 338 Route 59, Central Nyack; 230
North Middletown Road, Pearl River; 747 Chestnut Ridge Road, Chestnut Ridge; 65
Dutch Hill Road, Orangeburg; 59 Route 59, Suffern, and 4 North Main Street,
Spring Valley. The premises of the Little Tor Road, 45 Kennedy Drive, Spring
Valley, Central Nyack, Chestnut Ridge and Orangeburg branch offices are leased,
while the other Rockland branch offices are owned by the Bank.
The Bank also operates 11 retail banking branches in Westchester County,
New York (as of March 14, 2005): 131 Central Avenue, Tarrytown; 75 North
Broadway, Tarrytown; 299 Bedford Road, Bedford Hills; 3000 East Main Street,
Cortlandt Manor; 28 Le Count Place, New Rochelle; 313 Main Street, Eastchester;
270 Martine Avenue, White Plains; 88 Croton Avenue, Ossining, which are owned,
and leased locations at 76 Virginia Road, North White Plains; 1779 Central Park
Avenue, Yonkers; and 2500 Central Park Avenue, Yonkers. The Bank also operates
retail banking branches at 11 East 22nd Street, New York, New York, and 999
Bedford Street, Stamford, Connecticut, both of which are leased, and 50 North
Church Street, Goshen, New York, which is owned. During February 2005, the Bank
closed its branch at 1200 Mamaroneck Avenue, White Plains, and the deposits were
transferred to the Bank's Martine Avenue branch.
In the opinion of management, the premises, fixtures, and equipment used
by the Company and the Bank are adequate and suitable for the conduct of their
businesses. All the facilities are well maintained and provide adequate parking.
ITEM 3. LEGAL PROCEEDINGS
Various actions and proceedings are presently pending to which the Company
is a party in the ordinary course of the Company's business. Management, based
on the advice of legal counsel, is of the opinion that the aggregate
liabilities, if any, arising from such actions would not have a material adverse
effect on the consolidated financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
5
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth information with respect to purchases made
by the Company of its common stock during the year ended December 31, 2004.
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Total Number of Maximum Number of
Shares Purchased Shares that may yet
Total Number of Average Price Paid As Part of Publicly Be Purchased Under
2004 Periods Shares Purchased(2) Per Share(2) Announced Programs The Program(1)&(2)
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January 1 to January 31 5,445 $ 18.40 N/A 315,000
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February 1 to February 29 4,318 21.90 N/A 315,000
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March 1 to March 31 4,302 23.24 N/A 315,000
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April 1 to April 30 -- -- N/A 315,000
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May 1 to May 31 248,195 20.79 181,860 133,140
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June 1 to June 30 52,500 20.20 52,500 80,640
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July 1 to July 31 -- -- N/A 80,640
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August 1 to August 31 27,930 19.65 27,930 52,710
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September 1 to September 30 3,570 20.95 3,570 49,140
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October 1 to October 31 -- -- N/A 49,140
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November 1 to November 30 -- -- N/A 49,140
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December 1 to December 31 -- -- N/A 49,140
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Total 346,260 $ 20.40 265,860 49,140
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(1) The Company announced a common stock repurchase plan of up to 315,000
shares (adjusted for the five percent common stock dividend distributed in
September 2004) on December 17, 2003, which expired on December 31, 2004.
(2) Share amounts and price paid per share are adjusted for the five percent
common stock dividend distributed in September 2004.
Market Information and Holders
The Company's common stock was held of record as of February 28, 2005 by
1,316 registered stockholders and is traded on the New York Stock Exchange
("NYSE") under the symbol "UBH."
The high and low sales prices for the Company's common stock, as reported
by the NYSE, as adjusted for the 5 percent stock dividend distributed in
September 2004, for each quarter of 2004 and 2003, are as follows:
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2004 2003
High Low High Low
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First Quarter $23.37 $18.40 $16.65 $13.42
Second Quarter 23.30 19.50 16.29 14.47
Third Quarter 25.28 18.67 18.09 15.91
Fourth Quarter 28.85 24.90 19.14 17.10
First Quarter 2005 through
February 28, 2005 $24.57 $21.97
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A summary of the Company's equity compensation plans as of December 31, 2004 is
included in Item 12.
Dividends
A stock dividend of 5 percent was declared by the Company for stockholders
of record on September 10, 2004 and distributed on September 24, 2004. The
weighted average common shares outstanding and per common share amounts are
adjusted to reflect all common stock dividends.
The Board of Directors of the Company has adopted a policy of paying
quarterly cash dividends to holders of its common stock. In 2004 quarterly cash
dividends were paid as follows: $0.105 to stockholders of record on March 31 and
June 30, and $0.13 to stockholders of record on September 30 and December 31. In
2003, quarterly cash dividends per share were paid as follows: $0.09 to
stockholders of record on March 31 and June 30, and $0.095 to stockholders of
record on September 30 and December 31.
The Company expects that regular quarterly dividends will continue in the
future, depending upon the Company's earnings, financial condition, and other
factors. Any funds that the Company may require in the future to pay cash
dividends, as well as various Company expenses, are expected to be obtained by
the Company chiefly in the form of cash dividends from the Bank and secondarily
from the issuance of stock under Director and Employee Stock Option Plans. The
ability of the Company to declare and pay dividends in the future will depend
not only upon its future earnings and financial condition, but also upon the
future earnings and financial condition of the Bank and its nonbank subsidiaries
and upon the ability of the Bank to transfer funds to the Company primarily in
the form of cash dividends. The Company is a separate and distinct legal entity
from its subsidiaries. The Company's right to participate in any distribution of
the assets or earnings of its subsidiaries is subject to prior claims of
creditors of the subsidiaries.
6
Under New York Banking Law, a New York bank may declare and pay dividends
not more often than quarterly, and no dividends may be declared, credited, or
paid so long as there is any impairment of capital stock. In addition, except
with the approval of the New York State Superintendent of Banks, the total of
all dividends declared in any year may not exceed the sum of a bank's net
profits for that year and its undistributed net profits for the preceding two
years, less any required transfers to surplus. A bank may be required to
transfer to surplus up to 10 percent of its net profits in any accounting period
if its combined capital stock, surplus, and undivided profit accounts do not
equal 10 percent of its net deposit liabilities. At December 31, 2004, the Bank
could pay dividends of $69.1 million to the Company without having to obtain
prior regulatory approval.
The Company may not pay dividends on its common stock or preferred stock
if it is in default with respect to the subordinated debt or related Capital
Securities issued in March 2004, June 2002, July 2001, and February 1997, or if
the Company elects to defer payment for up to five years as permitted under the
terms of each subordinated debenture and Capital Securities. See note 10 to the
Notes to Consolidated Financial Statements.
The payment of dividends by the Company may also be limited by the FRB's
capital adequacy and dividend payment guidelines applicable to bank holding
companies (see Item 1 - Business - Supervision and Regulation). Under these
guidelines, the Company may not pay any dividends on shares of the Company's
common stock until such time as its debt to equity ratio (as defined, including
long-term debt qualifying as capital) is below 30 percent.
On June 23, 2004, the Company's Chief Executive Officer submitted his
annual certification to the NYSE indicating that he was not aware of any
violation by the Company of NYSE corporate governance listing standards.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated by reference from
the table entitled "Selected Financial Data" in the Company's 2004 Annual Report
to Stockholders, page 52.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this Item is incorporated by reference from
the Company's 2004 Annual Report to Stockholders, beginning on page 52.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated by reference from
the Company's 2004 Annual Report to Stockholders, beginning on page 71.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference from
the Company's 2004 Annual Report to Stockholders, beginning on page 13.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company has evaluated the design and operation of its disclosure
controls and procedures to determine whether they are effective in ensuring that
the disclosure of required information is timely made in accordance with the
Securities Exchange Act of 1934 ("Exchange Act") and the rules and forms of the
SEC. This evaluation was made under the supervision and with the participation
of management, including the Company's principal executive officer and principal
financial officer as of December 31, 2004. The principal executive officer and
principal financial officer have each concluded, based on their review, that, as
of December 31, 2004, the Company's disclosure controls and procedures, as
defined by Exchange Act Rules 13a- 15(e) and 15d-15(e), are effective to ensure
that information required to be disclosed by the Company in reports that it
files under the Exchange Act is recorded, processed, summarized, and reported
within the time period specified in SEC rules and forms and that such
information is accumulated and communicated to management as appropriate to
allow timely decisions regarding required disclosure. There has been no change
in the Company's internal control over financial reporting during the Company's
fourth fiscal quarter of 2004 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
7
The Company's Management Report on Internal Control over Financial
Reporting and the related report of the Company's independent registered public
accounting firm appear on pages 47 and 50, respectively, of the Company's 2004
Annual Report to Stockholders and are incorporated herein by reference.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company has named the Chairman of the Audit Committee, Mr. Edward T.
Lutz, as the Audit Committee financial expert. The Board of Directors of the
Company carefully evaluated the experience of Mr. Lutz in relation to specific
criteria established by the SEC for determination of Audit Committee financial
experts. Mr. Lutz, as well as the two other Audit Committee members, Mr. Howard
V. Ruderman and Mr. Kenneth J. Torsoe, meet the qualifications for independent
Audit Committee members as defined by the SEC.
Included as exhibits to this Annual Report on Form 10-K are the Code of
Conduct and Code of Ethics applicable to Financial Officers and the Chief
Executive Officer. Copies of the Code of Conduct, Code of Ethics applicable to
Financial Officers and the Chief Executive Officer, Corporate Governance
Practices and Principles and charters of Board committees can be obtained upon
request, free of charge, from the Company's Corporate Headquarters and are also
available on the Company's website at www.unionstate.com.
Additional information required by Item 10 is incorporated by reference to
the information in the Company's definitive Proxy Statement for its 2005 Annual
Stockholders' Meeting that will be filed with the SEC not later than 120 days
after December 31, 2004 ("2005 Proxy Statement") under the headings "Item 1:
Election of Directors," "Audit Committee Independence," and "Audit Committee
Financial Expert."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information in the Company's 2005 Proxy Statement under the headings "Executive
Compensation," "Report of the Company's Compensation Committee on Executive
Compensation," and "Item 1: Election of Directors."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information with respect to equity compensation plans as of December 31,
2004 is as follows:
Equity Compensation Plan Information
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Number of securities Weighted-average Number of securities remaining
to be issued upon exercise of exercise price of available for future issuance
Plan Category outstanding options outstanding options under equity compensation plans
- -------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security
holders:
Director plans 600,205 13.17 83,478
Employee plans 2,822,694 13.82 349,592
- -------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders 0 0 0
- -------------------------------------------------------------------------------------------------------------------------------
Total 3,422,899 13.71 433,070
- -------------------------------------------------------------------------------------------------------------------------------
Additional information required by Item 12 is incorporated by reference to
the information in the Company's 2005 Proxy Statement under the headings
"Ownership of Shares by Management" and "Principal Stockholders of the Company."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information in the Company's 2005 Proxy Statement under the heading, "Certain
Relationships and Transactions with Management."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the
information in the Company's 2005 Proxy Statement under the heading, "Principal
Accounting Firm: Fees and Policies."
8
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents Filed as a Part of this Report:
1. and 2. FINANCIAL STATEMENTS AND SCHEDULES
The following financial statements of the Company and its subsidiaries are
incorporated in Item 8 by reference to the Company's 2004 Annual Report to
Stockholders:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED STATEMENTS OF CONDITION, DECEMBER 31, 2004 AND 2003
CONSOLIDATED STATEMENTS OF INCOME, YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
CONSOLIDATED STATEMENTS OF CASH FLOWS, YEARS ENDED DECEMBER 31, 2004, 2003, AND
2002
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, YEARS ENDED
DECEMBER 31, 2004, 2003, AND 2002
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statement Schedules are omitted because of the absence of the
conditions under which they are required or because the required information is
included in the Consolidated Financial Statements and the Notes thereto.
3. EXHIBITS
Exhibit
No. Exhibit
(3)(a) Restated Certificate of Incorporation of Registrant
(incorporated herein by reference to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June
30, 2002 ("2002 Second Quarter 10-Q"), Exhibit (3)(a)).
(3)(b) Bylaws of Registrant (incorporated herein by reference
to Registrant's Registration Statement on Form S-14
(File No. 2-79734), Exhibit (3)(b)).
(4)(a) Junior Subordinated Indenture, dated February 5, 1997,
between Registrant and The Chase Manhattan Bank, as
trustee (incorporated herein by reference to
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996 (File No. 001-12811) ("1996
10-K"), Exhibit (4)(a)).
(4)(b) Guarantee Agreement, dated February 5, 1997, by and
between Registrant and The Chase Manhattan Bank, as
trustee for the holders of 9.58% Capital Securities of
Union State Capital Trust I (incorporated herein by
reference to Registrant's 1996 10-K, Exhibit (4)(b)).
(4)(c) Amended and Restated Declaration of Trust of Union State
Capital Trust I (incorporated herein by reference to
Registrant's 1996 10-K, Exhibit (4)(c)).
(4)(d) Junior Subordinated Indenture, dated July 31, 2001, between
Registrant and State Street Bank and Trust Company of
Connecticut, National Association, as trustee (incorporated
herein by reference to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001 ("2001 Third
Quarter 10-Q"), Exhibit (4)(d)).
(4)(e) Guarantee Agreement, dated July 31, 2001, by and between
Registrant and State Street Bank and Trust Company of
Connecticut, National Association, as trustee for the holders
of Capital Securities of Union State Statutory Trust II
(incorporated herein by reference to Registrant's 2001 Third
Quarter 10-Q, Exhibit (4)(e)).
(4)(f) Amended and Restated Declaration of Trust of Union State
Statutory Trust II (incorporated herein by reference to
Registrant's 2001 Third Quarter 10-Q, Exhibit (4)(f)).
(4)(g) Indenture, dated June 26, 2002, between Registrant and State
Street Bank and Trust Company of Connecticut, National
Association, as trustee, (incorporated herein by reference to
Registrant's 2002 Second Quarter 10-Q"), Exhibit (4)(g)).
(4)(h) Guarantee Agreement dated June 26, 2002, by and between
Registrant and State Street Bank and Trust Company of
Connecticut, National Association, as trustee for the holders
of Capital Securities of USB Statutory Trust III,
(incorporated herein by reference to Registrant's 2002 Second
Quarter 10-Q, Exhibit (4)(h)).
(4)(i) Amended and Restated Declaration of Trust of USB Statutory
Trust III, (incorporated herein by reference to Registrant's
2002 Second Quarter 10-Q, Exhibit (4)(i)).
(4)(j) Registrant's Dividend Reinvestment and Stock Purchase Plan
(incorporated herein by reference to Registrant's Form S-3
Registration Statement filed December 14, 1993 (file No.
33-72788)).
9
(4)(k) Amended and Restated Declaration of Trust of Union State
Statutory Trust IV dated March 25, 2004 (incorporated herein
by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2004 ("2004 First Quarter
10-Q"), Exhibit (10)(ad)).
(4)(l) Indenture dated March 25, 2004 between Registrant and
Wilmington Trust Company, as Trustee (incorporated herein by
reference to the Registrant's 2004 First Quarter 10-Q, Exhibit
(10)(ae)).
(4)(m) Guarantee Agreement dated March 24, 2004 by and between
registrant and Wilmington Trust Company, as Trustee for the
holders of Capital Securities of Union State Bank Statutory
Trust IV (incorporated herein by reference to the Registrant's
2004 First Quarter 10-Q, Exhibit (10)(af)).
(10)(a) Agreement of Employment dated as of November 16, 2003 between
the Company and the Bank and Thomas E. Hales (incorporated
herein by reference to Registrant's Annual Report on Form 10-K
for the year ended December 31, 2003, Exhibit (10)(a)).
(10)(b) Agreement of Employment dated as of July 28, 2004 between the
Company and the Bank and Raymond J. Crotty (incorporated
herein by reference to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2004 ("2004 Second Quarter
10-Q"), Exhibit (10)(b)).
(10)(c) Agreement of Employment dated as of July 28, 2004 between the
Company and the Bank and Steven T. Sabatini (incorporated
herein by reference to Registrant's 2004 Second Quarter 10-Q,
Exhibit (10)(c)).
(10)(d) Registrant's 1993 Incentive Stock Option Plan (incorporated
herein by reference to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1999 (File No.
002-79734), Exhibit (10)(e)).
(10)(e) Registrant's Employee Stock Ownership Plan (With 401(k)
Provisions) (incorporated herein by reference to Registrant's
Annual Report on Form 10-K for the year ended December 31,
2001 ("2001 10-K"), Exhibit (10)(g)).
(10)(f) Registrant's Director Stock Option Plan (incorporated herein
by reference to Registrant's 1996 10-K, Exhibit (10)(f)).
(10)(g) Registrant's 1998 Director Stock Option Plan (incorporated
herein by reference to Registrant's Form S-8 Registration
Statement, filed June 5, 1998 (File No. 333-56169), Exhibit
(99.1)).
(10)(h) Registrant's Key Employees' Supplemental Investment Plan, as
amended July 1, 1997 and September 1, 1998 (incorporated
herein by reference to the Plan's Annual Report on Form 11-K
for the year ended December 31, 1998, (File No. 001-12811,
Exhibit (10)(j)).
(10)(i) Registrant's Key Employees' Supplemental Diversified
Investment Plan dated September 1, 1998 (incorporated herein
by reference to the Plan's Annual Report on Form 11-K for the
year ended December 31, 1998 (File No. 001-12811), Exhibit
(10)(k)).
(10)(j) Registrant's 1997 Employee Stock Option Plan (incorporated
herein by reference to Exhibit A to Registrant's Proxy
Statement filed April 16, 1997 (File No. 001-12811)).
(10)(k) Tappan Zee Financial, Inc. 1996 Stock Option Plan for Officers
and Employees ("Employees Stock Option Plan") (incorporated
herein by reference to Exhibit A to Tappan Zee Financial,
Inc.'s Proxy Statement for use in connection with its 1996
Annual Meeting of Shareholders (File No. 000-26466) ("Tappan
Zee 1996 Proxy Statement")).
(10)(l) Amendment No. 1 to the Employees Stock Option Plan
(incorporated herein by reference to Tappan Zee Financial,
Inc.'s Annual Report on Form 10-K for the fiscal year ended
March 31, 1997 (File No. 000-26466) ("Tappan Zee 1997 10-K"),
Exhibit 10.1.1).
(10)(m) Amendment No. 2 to the Employees Stock Option Plan
(incorporated herein by reference to Appendix A to Tappan Zee
Financial, Inc.'s Proxy Statement for use in connection with
its 1997 Annual Meeting of Shareholders (File No. 000-26466)
("Tappan Zee 1997 Proxy Statement")).
(10)(n) Tappan Zee Financial, Inc. 1996 Stock Option Plan for Outside
Directors ("Outside Director Option Plan") (incorporated
herein by reference to Exhibit B to the Tappan Zee 1996 Proxy
Statement).
(10)(o) Amendment No. 1 to the Outside Director Option Plan
(incorporated herein by reference to the Tappan Zee 1997 10-K,
Exhibit 10.2.1).
(10)(p) Amendment No. 2 to the Outside Director Option Plan
(incorporated herein by reference to Appendix B to the Tappan
Zee 1997 Proxy Statement).
(10) (q) Loan Agreement to the Employee Stock Ownership Plan Trust of
Tappan Zee Financial, Inc. and Certain Affiliates
(incorporated herein by reference to Tappan Zee Financial,
Inc.'s Annual Report on Form 10-K for the fiscal year ended
March 31, 1996 (File No. 000-26466), Exhibit 10.7).
10
(10)(r) Deferred Compensation Plan for Directors of Tarrytowns Bank,
FSB (Incorporated herein by reference to the Registration
Statement on Form S-1 (file No. 33-94128) filed on June 30,
1995, as amended, Exhibit 10.7).
(10)(s) Forms of Stock Option Agreement by and between Tappan Zee
Financial, Inc., and recipients of stock options granted
pursuant to the Employees Stock Option Plan and the Outside
Director Option Plan (incorporated herein by reference to the
Tappan Zee 1997 10-K, Exhibit 10.16).
(10)(t) Registrant's Retirement Plan for Non-Employee Directors of
U.S.B. Holding Co., Inc. and Certain Affiliates dated
effective as of May 19, 1999, and as amended March 20, 2002
(incorporated herein by reference to the Registrant's 2001
10-K, Exhibit (10)(w)).
(10)(u) Asset Purchase and Account Assumption Agreement by and between
Union State Bank and La Jolla Bank dated May 25, 2000
(incorporated herein by reference to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2000, Exhibit (10)(oo)).
(10)(v) U.S.B. Holding Co., Inc. Severance Plan dated January 30, 2002
(incorporated herein by reference to Registrant's 2001 10-K,
Exhibit (10)(y)).
(10)(w) Asset Purchase and Liability Assumption Agreement dated as of
June 14, 2002, by and between Union State Bank and Fourth
Federal Savings Bank (incorporated herein by reference to
Registrant's 2002 Second Quarter 10-Q, Exhibit (10)(z)).
(10)(x) U.S.B. Holding Co., Inc. Executive Incentive Bonus Plan as
amended February 24, 1999 (incorporated herein by reference to
Exhibit A to Registrant's Proxy Statement filed April 27, 1999
(File No. 002-79734)).
(10)(y) Amendment No. 2 to the Key Employees' Supplemental Investment
Plan dated September 1, 2003 (incorporated herein by reference
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003 ("2003 Third Quarter 10-Q"),
Exhibit (10)(ab)).
(10)(z) Amendment No. 1 to the Key Employees' Diversified Investment
Plan dated September 1, 2003 (incorporated herein by reference
to the Registrant's 2003 Third Quarter 10-Q, Exhibit
(10)(ac)).
(10)(aa) Purchase and Assumption Agreement among the Federal Deposit
Insurance Corporation, Receiver of Reliance Bank, White
Plains, New York, and Union State Bank, Nanuet, New York,
dated as of March 19, 2004 (incorporated herein by reference
to the Registrant's 2004 First Quarter 10-Q, Exhibit
(10)(ag)).
10)(ab) Loan Sale Agreement by and between the Federal Deposit
Insurance Corporation in its Receivership Capacity and Union
State Bank, Nanuet, New York (incorporated herein by reference
to the Registrant's 2004 First Quarter 10-Q, Exhibit
(10)(ah)).
(13) Registrant's Annual Report to Stockholders for the year ended
December 31, 2004* (portions incorporated herein by
reference).
(14)(a) Business Code of Conduct.*
(14)(b) Code of Ethics applicable to Financial Officers and the Chief
Executive Officer.*
(21) Subsidiaries of the Registrant.*
(23) Consent of Deloitte & Touche LLP.*
(31.1) Certification of Chief Executive Officer Pursuant to
Exchange Act Rule 13a-14(a).*
(31.2) Certification of Chief Financial Officer Pursuant to
Exchange Act Rule 13a-14(a).*
(32) Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. Section 1350.*
* Filed Herewith
11
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 14, 2005.
U.S.B. HOLDING CO., INC.
/s/ THOMAS E. HALES
--------------------------------------------
By: Thomas E. Hales,
Chairman of the Board,
President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities indicated on March 14, 2005.
/s/ THOMAS E. HALES /s/ STEVEN T. SABATINI
- ------------------------------------------- ------------------------------------------
Thomas E. Hales, Chairman of the Board, Steven T. Sabatini, Senior Executive Vice
President and Chief Executive Officer and President, Chief Financial Officer,
Director Assistant Secretary and Director
/s/ RAYMOND J. CROTTY /s/ MICHAEL H. FURY
- ------------------------------------------- ------------------------------------------
Raymond J. Crotty, Senior Executive Vice Michael H. Fury, Esq., Director
President, Chief Credit Officer, Secretary
and Director
/s/ EDWARD T. LUTZ /s/ KEVIN J. PLUNKETT
- ------------------------------------------- ------------------------------------------
Edward T. Lutz, Director Kevin J. Plunkett, Esq., Director
/s/ HOWARD V. RUDERMAN /s/ KENNETH J. TORSOE
- ------------------------------------------- ------------------------------------------
Howard V. Ruderman, Director Kenneth J. Torsoe, Director
12
Consolidated Statements of Condition
December 31, 2004 and 2003
U.S.B. Holding Co., Inc.
- --------------------------------------------------------------------------------
(000's, except share data)
ASSETS 2004 2003
- ------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 48,295 $ 57,451
Federal funds sold 17,000 10,000
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents 65,295 67,451
Interest bearing deposits in other banks 334 25
Securities:
Available for sale (at estimated fair value) 589,572 1,081,380
Held to maturity (estimated fair value of $507,428 in 2004
and $240,752 in 2003) 502,201 237,998
Loans, net of allowance for loan losses of $15,226 in 2004
and $14,757 in 2003 1,492,872 1,433,923
Premises and equipment, net 15,616 15,353
Accrued interest receivable 17,312 15,721
Federal Home Loan Bank of New York stock 31,135 30,594
Intangible assets, net 5,087 5,600
Goodwill 1,380 --
Other assets 25,466 18,417
- ----------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 2,746,270 $ 2,906,462
==========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Non-interest bearing deposits $ 317,874 $ 296,133
Interest bearing deposits 1,540,344 1,478,916
- ----------------------------------------------------------------------------------------------------------
Total deposits 1,858,218 1,775,049
Accrued interest payable 6,782 6,599
Dividend payable 2,644 1,949
Accrued expenses and other liabilities 9,562 9,391
Securities sold under agreements to repurchase 542,323 788,632
Federal Home Loan Bank of New York advances 82,709 104,873
Subordinated debt issued in connection with Corporation-Obligated
mandatory redeemable capital securities of subsidiary trusts 61,858 51,548
- ----------------------------------------------------------------------------------------------------------
Total 2,564,096 2,738,041
- ----------------------------------------------------------------------------------------------------------
Minority-interest junior preferred stock of consolidated subsidiary 128 128
Commitments and contingencies (Notes 6 and 16)
Stockholders' equity:
Preferred stock, no par value
Authorized shares: 10,000,000; no shares outstanding in 2004 and 2003 -- --
Common stock, $0.01 par value
Authorized shares: 50,000,000
Issued shares: 22,004,701 in 2004 and 20,924,504 in 2003 220 209
Additional paid-in capital 184,166 159,628
Retained earnings 26,336 31,655
Treasury stock at cost, 1,657,887 shares in 2004 and 1,436,714 shares in 2003 (22,855) (18,225)
Common stock held for benefit plans (2,780) (2,491)
Deferred compensation obligation 2,746 2,327
Accumulated other comprehensive loss (5,787) (4,810)
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 182,046 168,293
- ----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,746,270 $ 2,906,462
==========================================================================================================
See notes to consolidated financial statements.
13
Consolidated Statements of Income
Years Ended December 31, 2004, 2003, and 2002
U.S.B. Holding Co., Inc.
- --------------------------------------------------------------------------------
(000's, except share data)
2004 2003 2002
- -----------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans $ 89,128 $ 86,056 $ 84,591
Interest on federal funds sold 347 638 822
Interest and dividends on securities:
U.S. government agencies 38,414 24,520 16,867
Mortgage-backed securities 13,469 15,583 17,822
Obligations of states and political subdivisions 3,532 3,303 3,591
Corporate and other 120 8 781
Interest on deposits in other banks 6 1 9
Dividends on Federal Home Loan Bank of New York stock 680 1,106 936
- -----------------------------------------------------------------------------------------------------
Total interest income 145,696 131,215 125,419
- -----------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits 24,225 23,793 27,624
Interest on borrowings 29,368 26,957 21,913
Interest on subordinated debt issued in connection with/and
Corporation - Obligated mandatory redeemable
capital securities of subsidiary trusts 3,968 3,441 3,367
- -----------------------------------------------------------------------------------------------------
Total interest expense 57,561 54,191 52,904
- -----------------------------------------------------------------------------------------------------
NET INTEREST INCOME 88,135 77,024 72,515
Provision for credit losses 3,687 2,513 4,109
- -----------------------------------------------------------------------------------------------------
Net interest income after provision for credit losses 84,448 74,511 68,406
- -----------------------------------------------------------------------------------------------------
NON-INTEREST INCOME:
Service charges and fees 4,256 3,940 3,343
Other income 3,542 3,725 3,018
Gains on securities transactions 1,199 8,383 6,405
- -----------------------------------------------------------------------------------------------------
Total non-interest income 8,997 16,048 12,766
- -----------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 30,858 27,081 24,070
Occupancy and equipment 7,849 6,877 6,254
Advertising and business development 2,622 2,697 2,002
Professional fees 2,796 1,414 1,391
Communications 1,506 1,306 1,092
Stationery and printing 646 774 797
FDIC insurance 291 274 271
Amortization of intangibles 1,126 1,015 923
Other expense 3,826 3,802 3,460
- -----------------------------------------------------------------------------------------------------
Total non-interest expenses 51,520 45,240 40,260
- -----------------------------------------------------------------------------------------------------
Income before income taxes 41,925 45,319 40,912
Provision for income taxes 13,860 16,031 13,878
- -----------------------------------------------------------------------------------------------------
NET INCOME $ 28,065 $ 29,288 $ 27,034
=====================================================================================================
BASIC EARNINGS PER COMMON SHARE $ 1.38 $ 1.43 $ 1.33
=====================================================================================================
DILUTED EARNINGS PER COMMON SHARE $ 1.31 $ 1.39 $ 1.29
=====================================================================================================
WEIGHTED AVERAGE COMMON SHARES 20,388,466 20,436,497 20,297,814
=====================================================================================================
ADJUSTED WEIGHTED AVERAGE COMMON SHARES 21,375,687 21,019,644 20,947,406
=====================================================================================================
See notes to consolidated financial statements.
14
Consolidated Statements of Cash Flows
Years Ended December 31, 2004, 2003, and 2002
U.S.B. Holding Co., Inc.
- --------------------------------------------------------------------------------
(000's)
2004 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 28,065 $ 29,288 $ 27,034
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 3,687 2,513 4,109
Depreciation and amortization 3,471 3,104 2,749
Amortization of (discounts) premiums on securities - net (562) 850 1,432
Deferred income tax benefit, net (3,263) (4,882) (3,256)
Gains on securities transactions (1,199) (8,383) (6,405)
Non-cash benefit plan expense 523 424 357
Proceeds from sales of loans -- -- 227
Increase in accrued interest receivable (1,548) (3,726) (1,909)
Increase (decrease) in accrued interest payable 163 861 (1,506)
Other - net (1,209) 247 1,346
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 28,128 20,296 24,178
- -------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale 105,418 423,073 207,151
Proceeds from principal paydowns, redemptions and maturities of:
Securities available for sale 892,419 495,551 215,749
Securities held to maturity 90,956 181,125 215,916
Purchases of securities available for sale (803,699) (1,540,370) (476,146)
Purchases of securities held to maturity (57,421) (96,115) (191,793)
Net purchases of Federal Home Loan Bank of New York stock (541) (5,450) (4,329)
Net proceeds from Fourth Federal Savings Bank branch
acquisition (net liabilities assumed $15,491) -- -- 14,557
Net liabilities assumed in Reliance Bank acquisition 10,697 -- --
Net (increase) decrease in interest bearing deposits in other banks (284) (5) 270
Net increase in loans outstanding (51,749) (100,163) (182,075)
Purchases of premises and equipment - net (2,533) (3,760) (1,782)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 183,263 (646,114) (202,482)
- -------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net increase in non-interest bearing deposits, NOW,
money market and savings accounts 32,261 153,325 94,935
Net increase in time deposits, net of withdrawals and maturities 26,995 69,937 15,404
Net (decrease) increase in securities sold under agreements
to repurchase - short-term (254,309) 280,427 (74)
Net (decrease) increase of Federal Home Loan Bank of
New York advances - short-term (10,500) 10,500 --
Proceeds from securities sold under agreements to repurchase - long-term 75,000 115,000 90,000
Repayment of securities sold under agreements to repurchase - long-term (67,000) -- --
Repayment of Federal Home Loan Bank of New York advances - long-term (11,664) (16,516) (3,402)
Net proceeds from issuance of Corporation-Obligated mandatory
redeemable capital securities of subsidiary trusts 9,975 -- 9,673
Redemption from sale of junior preferred stock of consolidated subsidiary -- (1) (1)
Cash dividends paid (9,579) (7,633) (6,843)
Proceeds from exercise of common stock options 740 1,652 577
Purchases of treasury stock (5,466) (4,223) (985)
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used for) provided by financing activities (213,547) 602,468 199,284
- -------------------------------------------------------------------------------------------------------------------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,156) (23,350) 20,980
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 67,451 90,801 69,821
- -------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 65,295 $ 67,451 $ 90,801
=========================================================================================================================
Supplemental Disclosures:
- -------------------------------------------------------------------------------------------------------------------------
Interest paid $ (57,398) $ (53,330) $ (54,410)
Income tax payments (17,100) (19,396) (14,587)
- -------------------------------------------------------------------------------------------------------------------------
Change in shares held in trust for deferred compensation (419) (636) (513)
- -------------------------------------------------------------------------------------------------------------------------
Change in deferred compensation obligation 419 636 513
- -------------------------------------------------------------------------------------------------------------------------
Change in accumulated other comprehensive (loss) income (977) (7,991) 456
- -------------------------------------------------------------------------------------------------------------------------
Non cash purchases of treasury stock related to exercise of stock options (1,600) (1,940) (1,493)
- -------------------------------------------------------------------------------------------------------------------------
Non-cash exercise of stock options and related tax benefit 2,181 2,834 1,702
- -------------------------------------------------------------------------------------------------------------------------
Issuance of treasury stock related to the exercise of stock options 2,436 3,715 179
- -------------------------------------------------------------------------------------------------------------------------
Purchase of held to maturity and available for sale securities
not yet settled, including interest receivable -- 924 263,090
- -------------------------------------------------------------------------------------------------------------------------
Payment for held to maturity and available for sale securities not
yet settled at beginning of period, including interest receivable (924) (263,090) --
- -------------------------------------------------------------------------------------------------------------------------
Transfer of available for sale securities to held to maturity securities 298,481 46,941 --
- -------------------------------------------------------------------------------------------------------------------------
Transfer of fixed assets under construction (other assets) at
beginning of the period to premises and equipment - net -- 2,383 --
- -------------------------------------------------------------------------------------------------------------------------
Loans acquired in acquisition of Reliance Bank, including interest receivable 10,869 -- --
- -------------------------------------------------------------------------------------------------------------------------
Deposits assumed in acquisition of Reliance Bank, including interest payable 23,933 -- --
- -------------------------------------------------------------------------------------------------------------------------
Other assets (including intangibles) acquired in acquisition of Reliance
Bank, net of other liabilities Assumed 2,367 -- --
- -------------------------------------------------------------------------------------------------------------------------
Exchange of Tappan Zee Financial, Inc. common shares
not converted to treasury stock -- -- (97)
=========================================================================================================================
See notes to consolidated financial statements.
15
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2004, 2003, and 2002
U.S.B. Holding Co., Inc.
- --------------------------------------------------------------------------------
(000's, except share data)
- ----------------------------------------------------------------------------------------------------------------------
Common Common
Stock Stock Additional
Shares Par Paid-in Retained Treasury
Outstanding Value Capital Earnings Stock
- ----------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 18,379,346 $ 195 $ 137,627 $ 8,457 $ (13,381)
Net income -- -- -- 27,034 --
Other comprehensive income:
Net unrealized securities gain
arising during the year, net of
tax of $1,643 -- -- -- -- --
Reclassification adjustment of net gain
for securities sold, net of tax
of $1,325 -- -- -- -- --
Other comprehensive income -- -- -- -- --
Total comprehensive income -- -- -- -- --
Cash dividends:
Common ($0.33 per share) -- -- -- (6,833) --
Junior preferred stock -- -- -- (10) --
Common stock options exercised and
related tax benefit 286,485 3 2,276 -- 179
Purchases of treasury stock (164,251) -- -- -- (2,575)
ESOP shares committed to be released -- -- 151 -- --
Deferred compensation obligation -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 18,501,580 198 140,054 28,648 (15,777)
Net income -- -- -- 29,288 --
Other comprehensive (loss):
Net unrealized securities (loss)
arising during the year, net of
tax benefit of $3,688 -- -- -- -- --
Reclassification adjustment of net gain
for securities sold, net of tax
of $1,835 -- -- -- -- --
Other comprehensive (loss) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Five percent common stock dividend 994,545 10 18,638 (18,663)
Five percent common sock dividend on
treasury stock (70,401) -- -- -- --
Cash dividends:
Common ($0.37 per share) -- -- -- (7,608) --
Junior preferred stock -- -- -- (10) --
Common stock options exercised and
related tax benefit 429,751 1 770 -- 3,715
Purchases of treasury stock (367,685) -- -- -- (6,163)
ESOP shares committed to be released -- -- 166 -- --
Deferred compensation obligation -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 19,487,790 209 159,628 31,655 (18,225)
Net income -- -- -- 28,065 --
Other comprehensive (loss):
Net unrealized securities (loss)
arising during the year, net of
tax benefit and adjustment of effective
tax rate of $627 -- -- -- -- --
Reclassification adjustment of net
loss for securities sold, net of
tax benefit of $130 -- -- -- -- --
Other comprehensive (loss) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Five percent common stock dividend 1,055,984 10 23,795 (23,805) --
Five percent common stock dividend on
treasury stock (88,324) -- -- -- --
Cash dividends:
Common ($0.47 per share) -- -- -- (9,569) --
Junior preferred stock -- -- -- (10) --
Common stock options exercised and
related tax benefit 221,135 1 484 -- 2,436
Purchases of treasury stock (329,771) -- -- -- (7,066)
ESOP shares committed to be released -- -- 259 -- --
Deferred compensation obligation -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 20,346,814 $ 220 $ 184,166 $ 26,336 $ (22,855)
=====================================================================================================================
(000's, except share data)
- -------------------------------------------------------------------------------------------------------------
Common
Stock Accumulated
Held for Deferred Other Total
Benefit Compensation Comprehensive Stockholders'
Plans Obligation Income (loss) Equity
- -------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 $ (1,601) $ 1,178 $ 2,725 $ 135,200
Net income -- -- -- 27,034
Other comprehensive income:
Net unrealized securities gain
arising during the year, net of
tax of $1,643 -- -- 2,346 2,346
Reclassification adjustment of net gain
for securities sold, net of tax
of $1,325 -- -- (1,890) (1,890)
- ------------------------------------------------------------------------------------------------------------
Other comprehensive income -- -- 456 456
- ------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- 27,490
Cash dividends:
Common ($0.33 per share) -- -- -- (6,833)
Junior preferred stock -- -- -- (10)
Common stock options exercised and
related tax benefit -- -- -- 2,458
Purchases of treasury stock -- -- -- (2,575)
ESOP shares committed to be released 130 -- -- 281
Deferred compensation obligation (513) 513 -- --
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 (1,984) 1,691 3,181 156,011
Net income -- -- -- 29,288
Other comprehensive (loss):
Net unrealized securities (loss)
arising during the year, net of
tax benefit of $3,688 -- -- (5,336) (5,336)
Reclassification adjustment of net gain
for securities sold, net of tax
of $1,835 -- -- (2,655) (2,655)
- ------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) -- -- (7,991) (7,991)
- ------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- 21,297
Five percent common stock dividend -- -- -- (15)
Five percent common sock dividend on
treasury stock -- -- -- --
Cash dividends:
Common ($0.37 per share) -- -- -- (7,608)
Junior preferred stock -- -- -- (10)
Common stock options exercised and
related tax benefit -- -- -- 4,486
Purchases of treasury stock -- -- -- (6,163)
ESOP shares committed to be released 129 -- -- 295
Deferred compensation obligation (636) 636 -- --
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 (2,491) 2,327 (4,810) 168,293
Net income -- -- -- 28,065
Other comprehensive (loss):
Net unrealized securities (loss)
arising during the year, net of
tax benefit and adjustment of effective
tax rate of $627 -- -- (1,164) (1,164)
Reclassification adjustment of net
loss for securities sold, net of
tax benefit of $130 -- -- 187 187
- ------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) -- -- (977) (977)
- ------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- 27,088
Five percent common stock dividend -- -- -- --
Five percent common stock dividend on
treasury stock -- -- -- --
Cash dividends:
Common ($0.47 per share) -- -- -- (9,569)
Junior preferred stock -- -- -- (10)
Common stock options exercised and
related tax benefit -- -- -- 2,921
Purchases of treasury stock -- -- -- (7,066)
ESOP shares committed to be released 130 -- -- 389
Deferred compensation obligation (419) 419 -- --
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $ (2,780) $ 2,746 $ (5,787) $ 182,046
============================================================================================================
See notes to consolidated financial statements.
16
Notes to Consolidated Financial Statements
U.S.B. HOLDING CO., INC.
- -------------------------------------------------------------------------------
Balance sheet information as of December 31, 2002, 2001, and 2000, and
income statement information for the years ended December 31, 2001 and 2000 are
not covered by the Report of Independent Registered Public Accounting Firm
included on page 13.
1. NATURE OF OPERATIONS
U.S.B. Holding Co., Inc. (the "Company"), a Delaware corporation
incorporated on July 6, 1982, is a bank holding company that provides financial
services through its wholly-owned subsidiaries. The Company and its subsidiaries
derive substantially all of their revenue and income from providing banking and
related services primarily to customers in Rockland and Westchester Counties,
New York City and Long Island, New York, and Southern Connecticut, as well as
Orange, Putnam and Dutchess Counties, New York, and the surrounding area (the
"Metropolitan area"). The Company is a separate and distinct legal entity from
its subsidiaries.
Union State Bank (the "Bank"), the Company's wholly-owned banking
subsidiary, is a New York State chartered full-service commercial bank that was
established in 1969. The Bank offers a complete range of community banking
services to individuals, municipalities, corporations, and small and medium-size
businesses at 27 locations (as of March 14, 2005) in Rockland and Westchester
counties, and one location in each of Stamford, Connecticut, Goshen, Orange
County, New York, and New York City. The Bank's services include checking
accounts, NOW accounts, money market accounts, savings accounts (passbook and
statement), certificates of deposit, retirement accounts, commercial loans,
personal loans, residential, construction, home equity (second mortgage) and
condominium mortgage loans, consumer loans, credit cards, safe deposit
facilities, and other consumer oriented financial services. The Bank also makes
available to its customers automated teller machines (ATMs), debit cards,
lock-box services, and Internet banking.
USB Delaware Inc. is a Delaware passive investment company established by
the Bank on September 12, 2003. USB Delaware Inc. was established for the
purpose of managing TPNZ Preferred Funding Corporation ("TPNZ").
TPNZ is a wholly-owned subsidiary of USB Delaware Inc. TPNZ manages
certain mortgage-backed securities and mortgage loans, substantially all of
which were previously owned by the Bank and TPNZ's former parent company,
Tarrytowns Bank, FSB ("Tarrytowns"). TPNZ qualifies as a Real Estate Investment
Trust for income tax purposes.
Dutch Hill Realty Corp. and U.S.B. Financial Services, Inc. are
wholly-owned subsidiaries of the Bank. Dutch Hill Realty Corp. manages problem
assets and real estate acquired in foreclosure by the Bank. U.S.B. Financial
Services, Inc. sells mutual funds, annuities and life insurance products in
conjunction with an agreement with a third party brokerage and insurance firm
specializing in bank financial products.
Union State Capital Trust I ("Trust I"), a Delaware business trust, Union
State Statutory Trust II ("Trust II") and USB Statutory Trust III ("Trust III"),
both Connecticut business trusts, and Union State Statutory Trust IV ("Trust
IV"), a Delaware business trust, were established by the Company in 1997, 2001,
2002, and 2004, respectively. Trust I, Trust II, Trust III, and Trust IV
(collectively, the "Trusts") were established for the purpose of issuing
Corporation-Obligated mandatory redeemable capital securities of subsidiary
trusts ("Capital Securities") and acquiring junior subordinated debt from the
Company (see Note 10).
Ad Con, Inc., currently inactive, is a nonbank subsidiary of the Company.
2. ACQUISITIONS
As of the close of business on March 19, 2004, the Bank assumed
approximately $23.9 million of deposits and acquired approximately $10.5 million
of single-family residential mortgage loans, $10.7 million of cash and cash
equivalents, $2.1 million of other assets, and $0.3 million in other loans in
connection with the acquisition of Reliance Bank. The premium paid for the
deposits assumed was $2.2 million, or 9.4 percent, and $0.2 million, or 1.6
percent, for the single-family residential loans acquired. Reliance Bank was
closed by the New York Superintendent of Banks, which appointed the FDIC as
Receiver. Reliance Bank, which operated as a one branch bank at 1200 Mamaroneck
Avenue, White Plains, New York, became a Bank branch effective immediately after
its closing. During February 2005, the Bank closed the Mamaroneck Avenue branch,
and the deposits were transferred to the Bank's Martine Avenue, White Plains
branch.
The assumption of deposits and acquisition of certain assets of Reliance
Bank has been accounted for as a business combination in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 141, "Accounting for
Business Combinations." Assets, time deposits, and other liabilities acquired
have been recorded at their estimated fair values as of March 19, 2004, and a
core deposit intangible of $0.7 million was recorded based on a core deposit
valuation study. Goodwill of $1.4 million was also recorded. In accordance with
SFAS No. 142, "Goodwill and Other Intangible Assets," the core deposit
intangible is being amortized over its estimated life of fifteen years, and the
goodwill component is tested for impairment annually at year-end. As of December
31, 2004, there was no impairment of goodwill.
The results of Reliance Bank operations related to the assets acquired and
deposits assumed are included in
17
the Company's Consolidated Statements of Income from the date of its
acquisition. Pro forma information as if the transaction occurred at the
beginning of the period is not material.
On October 31, 2002, the Bank completed the acquisition of the Yonkers,
New York, branch of Fourth Federal Savings Bank. The branch acquired had
approximately $15.5 million in deposits that were assumed by the Bank. The Bank
paid a premium of $0.9 million for the deposits acquired, which was recorded as
a core deposit intangible asset. The premium is being amortized on a
straight-line basis over an eight-year period, which is the estimated average
life of the deposits assumed in the transaction.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The Consolidated Financial Statements include
the accounts of the Company and its wholly-owned subsidiaries, the Bank
(including the Bank's wholly-owned subsidiaries: Dutch Hill Realty Corp.; U.S.B.
Financial Services, Inc.; USB Delaware Inc.; and TPNZ (which is a wholly-owned
subsidiary of USB Delaware Inc.)), and Ad Con, Inc. The Consolidated Financial
Statements also include the accounts of Trust I, Trust II, and Trust III through
the year ended December 31, 2003, but do not include Trust I, Trust II, and
Trust III as of December 31, 2003, and thereafter as a result of the
deconsolidation of the Trusts under Financial Accounting Standards Board
("FASB") Interpretation No. 46 and 46R, "Consolidation of Variable Interest
Entities." All intercompany accounts and transactions are eliminated in
consolidation.
Basis of Financial Statement Presentation: The Consolidated Financial
Statements have been prepared in accordance with accounting principles generally
accepted in the United States of America ("generally accepted accounting
principles") and predominant practices used within the banking industry. In
preparing such financial statements, management is required to make estimates
and assumptions that affect the reported amounts of actual and contingent assets
and liabilities as of the dates of the Consolidated Statements of Condition and
the revenues and expenses for the periods reported. Actual results could differ
significantly from those estimates.
Estimates that are particularly susceptible to significant change relate
to the determination of the allowance for loan losses and provision for credit
losses. In connection with the determination of the allowance for loan losses
and provision for credit losses, management obtains independent appraisals for
significant properties for loans that are collateralized by real estate.
Securities: In accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," the Company's investment policies
include a determination of the appropriate classification of securities at the
time of purchase. Securities that may be sold as part of the Company's
asset/liability or liquidity management, or in response to or in anticipation of
changes in interest rates and resulting prepayment risk, or for similar factors,
are classified as available for sale. Securities that the Company has the
ability and positive intent to hold to maturity are classified as held to
maturity and carried at amortized cost. Realized gains and losses on the sales
of all securities, determined by using the specific identification method, are
reported in earnings. Securities available for sale are shown in the
Consolidated Statements of Condition at estimated fair value and the resulting
net unrealized gains and losses, net of tax, are included in accumulated other
comprehensive income (loss).
The decision to sell securities available for sale is based on
management's assessment of changes in economic or financial market conditions,
interest rate risk, and the Company's financial position and liquidity.
Estimated fair values for securities are based on quoted market prices, where
available. If quoted market prices are not available, estimated fair values are
based on quoted market prices of comparable instruments. Securities in an
unrealized loss position are periodically evaluated for other than temporary
impairment. Management considers the effect of interest rates, credit ratings,
and other factors on the valuation of such securities, as well as the Company's
intent and ability to hold such securities until a forecasted recovery or
maturity occurs. The Company does not acquire any significant amount of
securities for the purpose of engaging in trading activities.
Derivative Instruments and Hedging Activities: In accordance with SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities
- -- Deferral of the Effective date of FASB Statement No. 133" and SFAS No. 138,
"Accounting for Derivative Instruments and Hedging Activities, an Amendment of
SFAS 133, and as further amended by SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (collectively, "SFAS No. 133"),
the Company established accounting and reporting standards for derivative
instruments and hedging activities. SFAS No. 133 requires that all derivatives
be recognized in the statement of condition, either as assets or as liabilities,
and be measured at fair value. This statement requires that changes in a
derivative's fair value be recognized in current earnings unless specific hedge
accounting criteria are met. Hedge accounting for qualifying hedges permits
changes in the fair value of derivatives to be either offset against the changes
in the fair value of the hedged item through earnings or recognized in
accumulated other comprehensive income (loss) until the hedged item is
recognized in earnings.
The Company has not entered into any derivative instruments or hedging
activities during the periods reported in the Company's Consolidated Financial
Statements included in this Annual Report.
18
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities: The Company follows the provisions of SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS No. 140"), which establishes a consistent application of a
financial-components approach that requires recognition of the financial and
servicing assets the Company controls and the liabilities it has incurred,
derecognition of financial assets when control has been surrendered and
derecognition of liabilities when extinguished. SFAS No. 140 provides consistent
guidelines for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings.
Loans: Loans are reported at the principal amount outstanding, net of
unearned income and the allowance for loan losses. Interest income on loans is
recorded on an accrual basis unless an interest or principal payment is more
than 90 days past due (with the exception of credit card loans for which the
criteria is 180 days past due) or sooner if, in the opinion of management, there
is a question as to the ability of the debtor to continue to make payments. At
the time a loan is placed on nonaccrual status, interest accrued but not
collected is reversed. Interest payments received while a loan is on nonaccrual
status are either applied to reduce principal or, based on management's estimate
of collectibility, recognized as income. Loans are returned to accrual status
when factors indicating doubtful collectibility no longer exist.
Loan origination and commitment fees and certain direct loan origination
costs are deferred, and the net amount is accreted as an adjustment of the loan
portfolio yield over the estimated expected average life of the related loan
type.
Allowance for Loan Losses: The allowance for loan losses is increased by
charges to income through the provision for credit losses and decreased by
charge-offs, net of recoveries of loans previously charged-off. Management also
provides a reserve, which is included in other liabilities, related to
contractually committed loans that have not yet been funded and standby letters
of credit.
A comprehensive evaluation of the quality of the loan portfolio is
performed by management on a quarterly basis as an integral part of the credit
administration function. Several aspects of the evaluation include: the
identification and evaluation of past due loans, non-performing loans, impaired
loans, and potential problem loans; assessment of the current economic
environment, applicable industries represented in the loan portfolio, and
geographic and customer concentrations of the loan portfolio; and review of
historical credit loss experience.
Management believes that the allowance for loan losses (the "allowance")
and reserve related to unfunded loans and standby letters of credit (the
"reserve") appropriately reflect the risk elements inherent in the credit
portfolio as of the balance sheet date. In management's judgment, the allowance
and reserve are considered appropriate to absorb losses inherent in the credit
portfolio. While management uses available information to recognize probable
credit losses, future adjustments to the allowance and reserve may be necessary
based on changes in economic conditions, particularly in the Company's primary
service areas. Regulatory agencies, as an integral part of their examination
process, periodically review the allowance and reserve. Such agencies may
require adjustments to the allowance and reserve based on their judgment of
information available to them at the time of their examination.
A loan is recognized as impaired when it is probable that either principal
and/or interest are not collectible in accordance with the terms of the loan
agreement. Measurement of the impairment is based on the present value of
expected cash flows discounted at the loan's effective interest rate, the loan's
observable market price, or the estimated fair value of the collateral if the
loan is collateral dependent. If the estimated fair value of the impaired loan
is less than the related recorded amount, a specific valuation allowance is
established or a write-down is charged against the allowance for loan losses if
the impairment is considered to be permanent. Homogenous loans such as
residential mortgage, home equity, and installment loans are collectively
evaluated for impairment.
Premises and Equipment: Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is computed on a
straight-line basis over the estimated useful lives (20 to 31 years for
buildings and 3 to 10 years for furniture, fixtures and equipment) of the
related assets. Amortization of leasehold improvements is computed on a
straight-line basis over the estimated useful lives of the assets or, if
shorter, the term of the applicable lease.
Other Real Estate Owned ("OREO"): OREO includes properties acquired in
full or partial satisfaction of loans. OREO properties are recorded at the lower
of cost or estimated fair value, less estimated costs to sell. Losses arising at
the time of acquisition of such properties are charged against the allowance for
loan losses. Net costs of maintaining and operating foreclosed properties and
any subsequent provisions for changes in valuation are charged or credited to
operations when incurred. Gains and losses realized from the sale of OREO are
included as part of other income or other non-interest expenses. Sales of OREO
financed by the Bank are required to meet the Bank's underwriting standards.
19
Income Taxes: The Company accounts for income taxes using an asset and
liability approach for financial accounting and reporting. Deferred income taxes
are based on prevailing statutory regulations. Valuation allowances for deferred
tax assets are established when, in management's judgment, it is more likely
than not that such deferred tax asset will not be realized. The Company and its
subsidiaries, with the exception of TPNZ, file a consolidated Federal income tax
return. The Company and its subsidiaries, with the exception of TPNZ and USB
Delaware Inc., file a combined New York State income tax return. The Bank files
separate Connecticut State and New York City income tax returns. TPNZ files
separate Federal and New York State income tax returns. USB Delaware Inc. is not
subject to State of Delaware income tax under current Delaware law.
Earnings per Common Share ("EPS"): The Company computes EPS based upon the
provisions of SFAS No. 128, "Earnings per Share" ("SFAS No. 128"). SFAS No. 128
establishes standards for computing and presenting "Basic" and "Diluted" EPS.
Basic EPS excludes dilution and is computed by dividing net income available to
common stockholders (net income after preferred stock dividend requirements) by
the weighted average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that would then share in the
earnings of the Company, reduced by common stock that could be repurchased by
the Company with the assumed proceeds of such exercise or conversion and related
tax benefit. Diluted EPS is based on net income available to common stockholders
divided by the weighted average number of common shares outstanding and common
equivalent shares ("adjusted weighted average common shares"). Stock options
granted but not yet exercised under the Company's stock option plans are
considered common stock equivalents for Diluted EPS calculations.
Accounting for Stock-Based Compensation: SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), establishes a fair value based
method of accounting for stock-based compensation plans and encouraged, but did
not require, entities to adopt that method in place of the intrinsic value
method under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25").
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Procedure," amended SFAS 123 to provide alternate methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based compensation. It also amended the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, SFAS No. 148 amended APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information.
The Company provides stock option plans to the Company's Board of
Directors, Tappan Zee Financial, Inc.'s ("Tappan Zee") (parent company of
Tarrytowns) former Board of Directors, and certain employees (see Note 17) for
the purchase of Company common stock at prices at least equal to the fair value
of the Company's common stock on the date of grant. All stock option plans have
been approved by the stockholders of the Company. The Company has elected to
continue to measure compensation expense for its stock-based compensation plans
under the recognition and measurement principles of APB No. 25 through the year
ended 2004 reporting period, and to provide pro forma disclosures of
compensation expense measured by the fair value based method as defined by SFAS
No. 123. No stock-based employee compensation is reflected in net income, as all
options granted under the Company's plans have an exercise price at least equal
to the market value of the underlying common stock on the date of grant.
Pro forma information of the Company's net income and basic and diluted
earnings per common share, as required by SFAS No. 123, has been determined as
if the Company had accounted for its stock options under the fair value method
of that standard. The fair value for these options was estimated at the date of
grant using a Black-Scholes option-pricing model and is recognized over the
options' vesting period.
The following table compares the Company's net income and basic
and diluted earnings per common share, as reported, to the pro forma results as
if the fair value method of accounting for options prescribed by SFAS No. 123
had been applied for the years ended December 31, 2004, 2003, and 2002.
(000's, except share data)
Years Ended
December 31,
2004 2003 2002
- ---------------------------------------------------------------------------------------
Net income, as reported $ 28,065 $ 29,288 $ 27,034
Less preferred stock
Dividends 10 10 10
Less total stock-based
compensation expense
determined under the fair
value based method for all
awards, net of tax 2,910 1,668 1,820
- --------------------------------------------------------------------------------------
Pro forma net income $ 25,145 $ 27,610 $ 25,204
available to common
stockholders
======================================================================================
Earnings per common share:
Basic - as reported $ 1.38 $ 1.43 $ 1.33
Basic - pro forma 1.23 1.35 1.24
Diluted - as reported $ 1.31 $ 1.39 $ 1.29
Diluted - pro forma 1.18 1.31 1.20
======================================================================================
20
The following weighted average assumptions were used for Director Plan
grants in 2004, 2003, and 2002, respectively: dividend yields of 2.16, 2.52, and
2.47 percent; volatility factors of the expected market price of the Company's
common stock of 40.25, 41.33, and 41.93 percent; risk free interest rates of
3.34, 2.47, and 4.55 percent; and expected lives of 7.63, 7.62, and 7.91 years.
The following weighted average assumptions were used for Employee Plan grants in
2004, 2003, and 2002, respectively: dividend yields of 2.00, 2.52, and 2.47
percent; volatility factors of the expected market price of the Company's common
stock of 39.77, 41.62, and 42.00 percent; risk-free interest rates of 3.60,
3.10, and 4.68 percent; and expected lives of 8.50, 8.96, and 8.55 years.
SFAS No. 123 was revised (SFAS No. 123R) in December 2004 to require
accounting for stock based compensation using a fair value based method in the
financial statements for the first interim or reporting period beginning after
June 15, 2005. Under the SFAS No. 123R transition method, compensation cost is
recognized on or after the required effective date for the portion of
outstanding awards for which the requisite service has not yet been rendered,
based on the grant-date fair value of those awards calculated under SFAS No.
123R for either recognition or pro forma disclosures. For periods before the
required effective date, entities may elect to apply a modified version of
retrospective application under which financial statements for prior periods are
adjusted on a basis consistent with the pro forma disclosures required for those
periods by SFAS No. 123. The effect of complying with SFAS No. 123R will have a
significant effect on the Company's net income as disclosed in the table on page
20.
Reporting Comprehensive Income: Comprehensive income is defined as the
change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. It
includes all changes in equity during a period, except those resulting from
investments by and distributions to owners.
The Company's Consolidated Statements of Comprehensive Income for the
years ended December 31, 2004, 2003, and 2002 are presented as part of the
Consolidated Statements of Changes in Stockholders' Equity.
Goodwill and Other Intangible Assets: SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"), requires, among other things, amortization
of intangibles over the estimated useful lives and the identification of
reporting units for purposes of assessing potential future impairments of
goodwill. SFAS No. 142 also requires an annual impairment test of goodwill.
At December 31, 2004, core deposit intangible assets, net of accumulated
amortization, acquired in connection with bank and branch acquisitions were $4.1
million and $0.6 million, and are being amortized over eight year and fifteen
year periods, respectively, the estimated life of the deposits assumed. In
addition, there is $0.1 million of intangible assets related to a favorable
lease acquired. The annual amortization expense for the remaining life of all
intangibles will vary throughout the amortization periods of which the maximum
amount of amortization will be $1.1 million during such periods. Gross
intangible assets related to bank and branch acquisitions, and accumulated
amortization on such intangible assets at December 31, 2004 and 2003 was $9.0
million and $4.2 million, and $8.4 million and $3.1 million, respectively. At
December 31, 2004, goodwill recorded totaled $1.4 million. The Company did not
have any goodwill recorded at December 31, 2003.
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others: In November 2002, the
FASB issued Interpretation No. 45, "Guarantors Accounting and Disclosure
Requirements for Guarantees Including Indirect Guarantees of Indebtedness of
Others" ("FIN No. 45"). FIN No. 45 requires a guarantor to recognize, at the
inception of the guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. It also provides additional guidance on the
disclosure of guarantees. The recognition and measurement provisions were
effective for guarantees made or modified after December 31, 2002. The
disclosure provisions were effective for fiscal periods ending after December
15, 2002. The recognition, measurement, and disclosure provisions do not
encompass commercial letters of credit and other loan commitments because those
instruments do not guarantee payment of a money obligation and do not provide
for payment in the event of default by the counterparty. The Company adopted the
disclosure provisions of FIN No. 45 as of December 31, 2002. The Company's
adoption of the recognition and measurement provisions of FIN No. 45 on January
1, 2003 did not have a significant impact on its Consolidated Financial
Statements.
Consolidation of Variable Interest Entities: In January 2003, the FASB
issued Interpretation No. 46, "Consolidation of Variable Interest Entities - an
interpretation of ARB No. 51" ("FIN No. 46"). FIN No. 46 provides guidance on
the consolidation of certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. Such entities are referred to as Variable
Interest Entities or "VIEs." FIN No. 46 requires the primary beneficiary of a
VIE to consolidate the entity.
Upon adoption of the provisions of FIN No. 46R, the Company was required
to deconsolidate its Trusts, which have issued Capital Securities. Accordingly,
the Consolidated Financial Statements as of December 31, 2003 and thereafter
reflect junior subordinated debt issued in connection with the Capital
Securities, as well as an investment in common equity of the Trusts. As a result
of this deconsolidation, the Federal Reserve has reevaluated the regulatory
implications of this accounting change on the capital treatment of the Capital
Securities and has issued a final rule that retains the Tier I capital treatment
of Capital Securities with certain modifications. The final rule did not have an
impact on the Company's treatment of the Capital Securities as Tier I Capital.
21
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equities: In May 2003, the FASB issued SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity" ("SFAS No. 150"). SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics for
both liabilities and equity. SFAS No. 150 requires the classification in the
Consolidated Statements of Condition of certain financial instruments that have
characteristics of both liabilities and equity but that have been presented
either entirely as equity or between the liabilities section and the equity
section of the Consolidated Statements of Condition. SFAS No. 150 was effective
for first interim period beginning after June 15, 2003. The Company's adoption
of SFAS No. 150 required the reclassification of Capital Securities to the
liability section of the Consolidated Statements of Condition. Subsequently,
upon adoption of FIN No. 46R, the Company deconsolidated the Trusts and recorded
junior subordinated debt as previously discussed. The Company's adoption of SFAS
No. 150 did not have any other impact on its Consolidated Financial Statements.
Pending Accounting Pronouncement -- Accounting for Exchanges of
Nonmonetary Assets: In December 2004, the FASB issued SFAS No. 153, "Accounting
for Exchanges of Nonmonetary Assets" ("SFAS No. 153"). SFAS No. 153 amends APB
Opinion No. 29, "Accounting for Nonmonetary Transactions." SFAS No. 153
eliminates the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for
non-monetary asset exchanges occurring in fiscal periods beginning after June
15, 2005. The Company's adoption of SFAS No. 153 on January 1, 2006 will not
have any impact on its Consolidated Financial Statements.
Consolidated Statements of Cash Flows: For purposes of presenting the
Consolidated Statements of Cash Flows, Cash and Cash Equivalents include cash
and due from banks, as well as federal funds sold.
Reclassifications: Certain reclassifications have been made to prior year
accounts to conform to the current year's presentation.
4. SECURITIES
A summary of the amortized cost, related gross unrealized gains and losses
of securities, and estimated fair value at December 31, 2004 and 2003 is as
follows:
- -----------------------------------------------------------------------------------------------------
(000's)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
Available for Sale:
U.S. government agencies $165,142 $ 99 $ 461 $164,780
Mortgage-backed securities 423,143 2,103 1,575 423,671
Obligations of states and political subdivisions 920 51 -- 971
Corporate securities 114 36 -- 150
- ----------------------------------------------------------------------------------------------------
Total securities available for sale $589,319 $ 2,289 $ 2,036 $589,572
====================================================================================================
Held to Maturity:
U.S. government agencies $418,371 $ 3,596 $ 1,521 $420,446
Obligations of states and political subdivisions 83,830 3,503 351 86,982
- ----------------------------------------------------------------------------------------------------
Total securities held to maturity $502,201 $ 7,099 $ 1,872 $507,428
====================================================================================================
22
- ------------------------------------------------------------------------------------------------------------------------
(000's)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2003 Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------
Available for Sale:
U.S. government agencies $ 637,582 $ 30 $ 6,034 $ 631,578
Mortgage-backed securities 450,381 1,000 3,295 448,086
Obligations of states and political subdivisions 1,400 84 -- 1,484
Corporate securities 152 81 1 232
- -----------------------------------------------------------------------------------------------------------------------
Total securities available for sale $1,089,515 $ 1,195 $ 9,330 $1,081,380
=======================================================================================================================
Held to Maturity:
U.S. government agencies $ 164,821 $ 748 $ 1,733 $ 163,836
Obligations of states and political subdivisions 73,177 4,118 379 76,916
- -----------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $ 237,998 $ 4,866 $ 2,112 $ 240,752
=======================================================================================================================
During the years ended December 31, 2004, 2003, and 2002, gross realized
gains from sales of securities available for sale were $1,199,000, $8,383,000,
and $6,405,000. There were no gross realized losses during 2004, 2003, and 2002.
The following tables present the amortized cost of securities at December
31, 2004, distributed based on contractual maturity or earlier call date for
securities expected to be called, and unaudited weighted average yields computed
on a tax equivalent basis. Actual maturities will differ from contractual
maturities because issuers may have the right to call or prepay obligations with
or without penalties, and due to monthly principal payments and prepayments for
mortgage-backed securities, which are distributed to a maturity category based
on estimated average lives.
Maturities of Securities Available for Sale
- -------------------------------------------------------------------------------
(000's, except percentages)
Within 1 After 1 But
Year Within 5
Years
---------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Average Average
Amt. Yield Amt. Yield Amt.
---------------------------------------------------------------------------------------------------------------------
U.S. government agencies:
Fixed rate $ 92,227 6.05% $ 72,915 5.75% $ --
Mortgage-backed securities:
Fixed rate -- -- 60,514 4.59 104,872
Adjustable rate 33,778 3.73 98,573 3.61 119,329
Obligations of states and political
subdivisions - Fixed rate -- -- 721 7.48 199
Other -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total securities available for sale $ 126,005 5.43% $ 232,723 4.55% $ 224,400
- ---------------------------------------------------------------------------------------------------------------------
Estimated fair value $ 126,072 $ 231,652 $ 225,512
=====================================================================================================================
(000's, except percentages)
After 5 But
Within 10 After 10
Years Years Total
-------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Amt. Yield Amt. Yield Amt. Yield
-------------------------------------------------------------------------------------------------------------------------------
U.S. government agencies:
Fixed rate $ -- --% $ -- --% $ 165,142 5.92%
Mortgage-backed securities:
Fixed rate 104,872 4.58 32 7.32 165,418 4.58
Adjustable rate 119,329 3.66 6,045 3.68 257,725 3.65
Obligations of states and political
subdivisions - Fixed rate 199 8.56 -- -- 920 7.71
Other -- -- 114 2.70 114 2.70
- -------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $ 224,400 4.09% $ 6,191 3.68% $ 589,319 4.55%
- -------------------------------------------------------------------------------------------------------------------------------
Estimated fair value $ 225,512 $ 6,336 $ 589,572
===============================================================================================================================
Maturities of Securities Held to Maturity
(000's, except percentages)
Within 1 After 1 But
Year Within 5
Years
- ----------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Average Average
Amt. Yield Amt. Yield Amt.
- ----------------------------------------------------------------------------------------------------------------------
U.S. government agencies:
Fixed rate $ 24,970 5.97% $ 282,185 5.55% $ 111,216
Obligations of states and political
subdivisions - Fixed rate 9,002 3.34 10,617 7.24 12,166
- ---------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $ 33,972 5.27% $ 292,802 5.61% $ 123,382
- ---------------------------------------------------------------------------------------------------------------------
Estimated fair value $ 33,929 $ 293,888 $ 125,978
=====================================================================================================================
After 5 But
Within 10 After 10
Years Years Total
- ---------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Yield Amt. Yield Amt. Yield
- ---------------------------------------------------------------------------------------------------------------
U.S. government agencies:
Fixed rate 5.27% $ -- --% $ 418,371 5.50%
Obligations of states and political
subdivisions - Fixed rate 7.01 52,045 6.21 83,830 6.15
- ---------------------------------------------------------------------------------------------------------------
Total securities held to maturity 5.44% $ 52,045 6.21% $ 502,201 5.61%
- ---------------------------------------------------------------------------------------------------------------
Estimated fair value $ 53,633 $ 507,428
===============================================================================================================
Available for sale and held to maturity obligations of states and political
subdivisions are not subject to Federal income tax, and the yields in the above
table are presented on a tax equivalent basis.
23
Securities having a total carrying amount of approximately $803.9 million
at December 31, 2004 were pledged to secure public deposits, as required or
permitted by law, letters of credit, and securities sold under agreements to
repurchase transactions.
As of July 16, 2004, the Company transferred at fair value available for
sale U.S. government agency securities with an amortized cost basis and fair
value of approximately $307.6 million and $298.2 million, respectively, to held
to maturity. The unrealized loss of $9.4 million, $6.2 million net of tax, was
included as a component of other comprehensive income (loss) and is being
accreted over the remaining life of the securities transferred. Management does
not intend to sell these securities.
The net unrealized loss on the transferred securities at December 31, 2004
was $6.0 million, net of taxes.
As of December 31, 2004, the security portfolio had gross unrealized
losses of $3.9 million, of which $2.0 million and $1.9 million were related to
available for sale securities and held to maturity securities, respectively.
A summary of gross unrealized losses on securities that are not
other-than-temporarily impaired, which have been in a continuous unrealizable
loss position for less than 12 months, and those securities, which have been in
a continuous loss position for 12 months or longer as of December 31, 2004 and
2003, is as follows
Securities in an Unrealized Loss Position that are not Other-Than-Temporarily
Impaired
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 Less Than 12 Months 12 Months or More Total
- ----------------------------------------------------------------------------------------------------------------------------------
Gross Gross Gross
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
- ----------------------------------------------------------------------------------------------------------------------------------
U.S. government agencies $119,700 $ 515 $ 93,440 $1,467 $213,140 $1,982
Mortgage backed securities 116,324 1,360 32,123 215 148,447 1,575
Obligations of states and
political subdivisions 21,995 217 2,790 134 24,785 351
Corporate securities -- -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total temporarily impaired
securities $258,019 $2,092 $128,353 $1,816 $386,372 $3,908
=================================================================================================================================
24
- -------------------------------------------------------------------------------------------------------------------------------
December 31, 2003 Less Than 12 Months 12 Months or More Total
- -------------------------------------------------------------------------------------------------------------------------------
Gross Gross Gross
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
- -------------------------------------------------------------------------------------------------------------------------------
U.S. government agencies $674,776 $ 7,767 $ -- $ -- $674,776 $ 7,767
Mortgage backed securities 301,838 3,295 -- -- 301,838 3,295
Obligations of states and
political subdivisions 10,817 379 -- -- 10,817 379
Corporate securities -- -- 31 1 31 1
- ----------------------------------------------------------------------------------------------------------------------------
Total temporarily impaired $987,431 $11,441 $ 31 $ 1 $987,462 $11,442
============================================================================================================================
The Company's U.S. government agency and mortgage-backed securities that
are in an unrealized loss position at December 31, 2004 and 2003 are credit
rated AAA or Aaa by nationally recognized statistical rating organizations.
Substantially all obligations of states and political subdivisions are credit
rated AAA or Aaa due to insurance, which guarantees the obligations against
default, by private insurance companies. At December 31, 2004 and 2003,
approximately $7.3 million and $5.8 million of issuances are bond or tax
anticipation notes from local municipalities, which are not rated, respectively.
At December 31, 2004 the number of securities in an unrealized loss
position included 8 U.S. government agencies, 17 mortgage-backed securities, and
85 obligations of states and political subdivisions. At December 31, 2003, the
number of securities in an unrealized loss position included 21 U.S. government
agencies, 24 mortgage-backed securities, 33 obligations of states and political
subdivisions, and one corporate security. The temporary impairment on securities
of less than 12 months at December 31, 2004 and 2003, and 12 months or more at
December 31, 2004, is due to the higher interest rate environment as compared to
the periods in which the securities were initially purchased. The higher
interest rates at December 31, 2004 and 2003, resulted in a decline in the
market value of the securities. The temporary impairment will fluctuate as the
interest rate environment changes. In a rising interest rate environment, the
temporary impairment will increase, while a decrease in the temporary impairment
will occur in a declining interest rate environment. Management does not
consider the temporary impairment of the securities to be severe due to the high
credit quality or insurance provided by private insurance companies, and the
intent and ability of the Company to hold such securities until a forecasted
recovery or maturity occurs.
25
The temporary impairment on securities of 12 months or more at December
31, 2003, is due to the lower market value of the common stock at December 31,
2003, as compared to the period when the common stock was purchased. The
temporary impairment will fluctuate as the common stock investment is
continually valued by factors in the market place. Management does not consider
the temporary impairment of the security to be severe due to the nominal amount
of the security.
5. LOANS
Major classifications of loans at December 31 are as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
(000's)
2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Time and demand loans $ 165,884 $ 139,018 $ 132,199 $ 125,508 $ 120,346
Installment loans 7,802 8,570 10,174 12,311 17,597
Credit card 6,400 5,631 5,760 6,577 7,273
Real estate loans
- Commercial 594,167 615,061 568,894 501,943 433,579
- Residential 248,667 238,707 230,267 211,942 195,258
- Construction and land development 401,802 381,107 348,151 266,041 269,041
- Home equity 80,199 60,539 55,190 46,607 43,855
Other 6,869 4,934 4,017 3,885 2,774
- -----------------------------------------------------------------------------------------------------------------------------------
Gross loans 1,511,790 1,453,567 1,354,652 1,174,814 1,089,723
Deferred net commitment fees (3,692) (4,887) (4,211) (3,868) (2,942)
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans 1,508,098 1,448,680 1,350,441 1,170,946 1,086,781
Allowance for loan losses (15,226) (14,757) (14,168) (12,412) (11,338)
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans, net $ 1,492,872 $ 1,433,923 $ 1,336,273 $ 1,158,534 $ 1,075,443
===================================================================================================================================
At December 31, 2004 and 2003, there were no loans or commitments to close
loans that were held for sale. The Bank sold one residential mortgage loan to
Freddie Mac totaling $0.2 million in 2002. No loans were sold during 2004 and
2003.
A substantial amount of the Company's commercial and residential lending
activities are with customers located in the Company's primary service areas of
Rockland and Westchester Counties, New York, as well as the remainder of the
Metropolitan area. A substantial portion of the Company's customers' net worth
is dependent on real estate values in the primary service areas.
Credit policies, applicable to each type of lending activity, have been
established, to evaluate the creditworthiness of each customer and, in most
cases, require collateral to be pledged and personal guarantees. Generally,
credit extension does not exceed 80 percent of the estimated fair value of the
collateral at the date of extension (with occasional exceptions at the
discretion of management), depending on the evaluation of the borrower's
creditworthiness. The fair value of collateral, primarily real estate, is
monitored on an ongoing basis. While collateral provides a secondary source of
repayment, the primary source of repayment is ordinarily based on the borrower's
ability to generate continuing cash flow, which is a principal underwriting
criteria for approving a loan.
26
An analysis of the allowance for loan losses and reserve for unfunded loan
commitments and standby letters of credit for the years ended December 31 is as
follows:
- -----------------------------------------------------------------------------------------------------------------------------------
(000's, except percentages)
2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans $ 1,508,098 $ 1,448,680 $ 1,350,441 $ 1,170,946 $ 1,086,781
- -----------------------------------------------------------------------------------------------------------------------------------
Net loans outstanding at year end 1,492,872 1,433,923 1,336,273 1,158,534 1,075,443
- -----------------------------------------------------------------------------------------------------------------------------------
Average net loans outstanding during the year 1,475,462 1,391,689 1,245,697 1,101,091 1,003,279
- -----------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses:
Balance at beginning of the year $ 14,757 $ 14,168 $ 12,412 $ 11,338 $ 10,687
Provision for credit losses charged
to expense 3,687 2,513 4,109 1,684 3,125
Reclassification of provision for
credit losses related to unfunded
loan commitments and standby letters
of credit, and classified as other
liabilities (6) (39) (161) (336) --
- -----------------------------------------------------------------------------------------------------------------------------------
18,438 16,642 16,360 12,686 13,812
- -----------------------------------------------------------------------------------------------------------------------------------
Charge-offs and recoveries during the year:
Charge-offs:
Real estate (3,179) (1,783) (1,352) (65) (2,376)
Time and demand -- -- (43) (56) (18)
Installment (130) (249) (839) (237) (229)
Recoveries:
Real estate -- 72 -- -- --
Time and demand -- -- -- 16 60
Installment 97 75 42 68 89
- -----------------------------------------------------------------------------------------------------------------------------------
Net charge-offs during the year (3,212) (1,885) (2,192) (274) (2,474)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at year end $ 15,226 $ 14,757 $ 14,168 $ 12,412 $ 11,338
- -----------------------------------------------------------------------------------------------------------------------------------
Reserve for unfunded loan commitments and
standby letters of credit $ 542 $ 536 $ 497 $ 336 $ --
- -----------------------------------------------------------------------------------------------------------------------------------
Ratio of net charge-offs to average net
loans outstanding during the year 0.22% 0.14% 0.18% 0.02% 0.25%
Ratio of allowance for loan losses to
total loans outstanding at year end 1.01% 1.02% 1.05% 1.06% 1.04%
Ratio of provision for credit losses
to net charge-offs (times) 1.15 1.33 1.87 6.15 1.26
===================================================================================================================================
A summary of the Company's nonaccrual and restructured loans, OREO, and
related interest income not recorded on nonaccrual loans as of and for the years
ended December 31 is as follows:
- -------------------------------------------------------------------------------------------------------------
(000's, except percentages)
2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------
Nonaccrual loans at year end $1,648 $6,130 $12,484 $20,703 $19,720
OREO at year end -- -- 34 34 34
Restructured loans at year end 137 142 147 152 155
Additional interest income that would have been
recorded if these borrowers had complied with
contractual loan terms 157 404 895 1,316 455
Non-performing assets to total assets at year end 0.06% 0.21% 0.49% 1.02% 1.05%
=============================================================================================================
Substantially all of the nonaccruing loans are collateralized by real
estate. At December 31, 2004, the Company had and continues to have no
commitments to lend additional funds to any customers with nonaccrual or
restructured loan balances.
At December 31, 2004, loans, which are not on nonaccrual status, that
management believes were potential problem loans that may result in their being
placed on nonaccrual status in the near future, totaled $0.5 million. Accruing
loans that are contractually past due 90 days or more at December 31, 2004 are
immaterial. Total interest income on nonaccrual loans that would have been
recorded if borrowers had complied with contractual loan terms for the years
ended December 31, 2004 and 2003 were $161,000 and $440,000, compared to actual
interest income reported with respect to such loans of $4,000 and $36,000,
respectively.
27
At December 31, 2004 and 2003, the recorded investment in loans that are
considered to be impaired approximated $1.3 million and $5.6 million, of which
$1.3 million and $5.5 million were in nonaccrual status, respectively. The
average recorded investment in impaired loans for the years ended December 31,
2004, 2003, and 2002 was approximately $4.3 million, $9.1 million, and $18.3
million, respectively. For the years ended December 31, 2004, 2003, and 2002
interest income recognized by the Company on impaired loans was not material.
As applicable, each impaired loan has a related allowance for loan losses.
The total allowance for loan losses specifically allocated to one impaired real
estate construction loan, held by the Bank's wholly owned subsidiary, Dutch Hill
Realty Corp. (the "Dutch Hill Loan") with a balance of $1.0 million and $5.5
million, as of December 31, 2004 and 2003, respectively, was $0.2 million for
both periods
In November 2000, the Company reclassified the Dutch Hill Loan in the
amount of $19.7 million as a non-performing asset and placed the loan on
nonaccrual status. As a result of the impairment of this loan, $2.2 million was
charged-off in the fourth quarter of 2000, reducing the loan balance to $17.5
million. During the year ended December 31, 2001, "protected advances" of $0.6
million were made in connection with payments of real estate taxes and common
charges and, through an agreement with the borrower, $1.4 million was loaned to
the borrower for completion of the project, which further increased the balance
to $19.5 million as of December 31, 2001.
At December 31, 2002, the recorded loan balance was $12.4 million, which
was reduced by principal payments of $9.6 million and charge-offs of $1.4
million made during 2002. Additional financing was provided on the Dutch Hill
Loan of $3.9 million in 2002.
At December 31, 2003, the recorded loan balance was $5.5 million, which
was further reduced by principal payments, partially offset by advances to
complete construction and maintain operations of the project of $5.1 million,
and charge-offs of $1.8 million during 2003.
Construction of the condominium units, which collateralized the loan, was
completed in 2004. At December 31, 2004, the recorded loan balance was $1.0
million, which was reduced by charge-offs of $3.2 million, of which $2.9 million
occurred during the 2004 fourth quarter, and principal payments. The charge-off
was recorded as a result of the Superior Court of New Jersey ruling on November
30, 2004 against Dutch Hill Realty Corp. and in favor of the defendants in
connection with the foreclosure action of two collateral security mortgages on
New Jersey properties that partially collateralized the Dutch Hill Loan. As a
result, management determined that a portion of the balance of the loans of $2.9
million, not previously charged-off or paid, and secured by the collateral
security mortgages, should be charged-off. The court also voided the personal
guarantee of one of the principals. The guarantees have not been considered in
determining the amount of charge-offs or allowance for loan losses applicable to
this loan.
As of February 3, 2005, all 83 condominium units in the project have been
sold and the remaining loan balance has been paid in full. The Bank's wholly
owned subsidiary, Dutch Hill Realty Corp, is in the process of appealing the
unfavorable ruling by the Superior Court of New Jersey. Any recovery as a result
of the appeal will be recorded when and if realized.
A summary of impaired loans by loan amount, loan type and measurement
method is as follows:
- -----------------------------------------------------------------------------------------------------------
(000's)
As of December 31,
2004 2003
Present Value Fair Value Present Value Fair Value
of Expected of of Expected of
Cash Flows Collateral Cash Flows Collateral
- -----------------------------------------------------------------------------------------------------------
Real estate - commercial $ 952 $137 $2,606 $3,042
Business Loans - commercial 203 -- -- --
- ----------------------------------------------------------------------------------------------------------
Totals $1,155 $137 $2,606 $3,042
==========================================================================================================
28
6. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 is as follows:
- -------------------------------------------------------------------------------
(000's)
2004 2003
- -------------------------------------------------------------------------------
Land $ 4,190 $ 4,190
Buildings 10,563 10,487
Leasehold improvements 136 138
Furniture, fixtures and equipment 7,967 7,141
- ------------------------------------------------------------------------------
22,856 21,956
Less accumulated depreciation and amortization 7,240 6,603
- ------------------------------------------------------------------------------
Premises and equipment, net $15,616 $15,353
==============================================================================
The Bank leases certain premises and equipment under noncancellable
operating leases. Certain of these lease agreements provide for periodic
increases in annual rental payments based on current price indices, renewal
options for varying periods and purchase options at amounts, which are expected
to approximate the fair values of the related assets at the dates the options
are exercisable.
Rent expense for premises and equipment was $1,181,000 in 2004, $999,000
in 2003, and $993,000 in 2002.
The Bank leases a portion of its owned properties to tenants under
operating leases and recorded rental income of approximately $263,000 in 2004,
$264,000 in 2003, and $237,000 in 2002.
As of December 31, 2004 future minimum lease payments are as follows:
- ------------------------------------------------------------------------------
Years Ending December 31, (000's)
- ------------------------------------------------------------------------------
2005 $ 996
2006 774
2007 702
2008 642
2009 453
After 2009 574
- ------------------------------------------------------------------------------
Total minimum lease payments $4,141
==============================================================================
As of December 31, 2004 future minimum lease receipts are as follows:
- ------------------------------------------------------------------------------
Years Ending December 31, (000's)
- ------------------------------------------------------------------------------
2005 $240
2006 114
2007 21
2008 --
2009 --
- ------------------------------------------------------------------------------
Total minimum lease receipts $375
==============================================================================
29
7. DEPOSITS
A summary of deposits at December 31 is as follows:
- -----------------------------------------------------------------------------------------------------------------
(000's)
2004 2003
- -----------------------------------------------------------------------------------------------------------------
Non-interest bearing deposits:
Individuals, partnerships, and corporations $ 295,022 $ 275,089
Certified and official checks 13,305 12,907
States and political subdivisions 9,547 8,137
- -----------------------------------------------------------------------------------------------------------------
Total non-interest bearing deposits 317,874 296,133
- -----------------------------------------------------------------------------------------------------------------
Interest bearing deposits:
NOW accounts 131,879 110,123
Money market accounts 175,435 176,132
Savings deposits 418,536 435,373
States and political subdivisions - NOW, money market, and savings deposits 60,777 43,825
Time deposits of individuals, partnerships, corporations 502,479 500,917
Brokered time deposits 49,860 25,000
States and political subdivisions - time deposits 112,880 101,041
IRA's and Keogh's 88,498 86,505
- -----------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 1,540,344 1,478,916
- -----------------------------------------------------------------------------------------------------------------
Total deposits $1,858,218 $1,775,049
=================================================================================================================
Time deposits, including IRA's and Keogh's, time deposits of states and
political subdivisions, and brokered time deposits, classified by time remaining
to maturity for each of the five years following December 31, 2004 are as
follows:
- -------------------------------------------------------------------------------
(000's)
- -------------------------------------------------------------------------------
Less than 12 months $426,398
Over 12 months through 24 months 219,569
Over 24 months through 36 months 52,535
Over 36 months through 48 months 28,017
Over 48 months through 60 months 27,198
- -------------------------------------------------------------------------------
Total $753,717
===============================================================================
At December 31, 2004 and 2003, certificates of deposit, brokered time
deposits, and other time deposits of $100,000 or more totaled $284,900,000, and
$291,300,000, respectively. These time deposits of $100,000 or more include
deposits of states and political subdivisions, which are acquired on a bid
basis.
At December 31, 2004, such deposits of $100,000 or more classified by time
remaining to maturity were as follows:
- -------------------------------------------------------------------------------
(000's)
- -------------------------------------------------------------------------------
3 months or less $125,832
Over 3 months through 6 months 44,232
Over 6 months through 12 months 30,686
Over 12 months 84,150
- -------------------------------------------------------------------------------
Total $284,900
===============================================================================
8. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31 are as follows:
- -------------------------------------------------------------------------------
(000's)
2004 2003 2002
- -------------------------------------------------------------------------------
Federal:
Current $ 16,861 $ 19,789 $ 15,000
Deferred (3,658) (5,841) (2,795)
- -------------------------------------------------------------------------------
13,203 13,948 12,205
- -------------------------------------------------------------------------------
State:
Current 262 1,124 2,134
Deferred (687) (589) (461)
Valuation
allowance 1,082 1,548 --
- -------------------------------------------------------------------------------
657 2,083 1,673
- -------------------------------------------------------------------------------
Total $ 13,860 $ 16,031 $ 13,878
===============================================================================
30
The income tax provision includes income taxes related to gains on
securities transactions of approximately $420,000, $3,426,000, and $2,638,000
for the years ended December 31, 2004, 2003, and 2002, respectively.
The income tax effects of temporary differences that give rise to the
significant portions of the cumulative deferred tax asset (liability), net at
December 31, 2004 and 2003 are as follows:
- --------------------------------------------------------------------------------------------
(000's)
2004 2003
- --------------------------------------------------------------------------------------------
Allowance for loan losses and reserve $ 6,445 $ 6,250
for unfunded loan commitments and standby letters of
credit
Deferred compensation and benefit plan expenses 2,648 2,254
Deferred loan fees, net 1,584 1,821
Sale of loans to subsidiary 1,033 1,181
Accrued dividend (3,458) (6,929)
Depreciation and other, net 1,376 1,161
Fair value adjustment, securities 3,116 3,325
State deferred tax asset valuation allowance, net of Federal
tax
benefit (1,710) (1,006)
- --------------------------------------------------------------------------------------------
Total deferred tax asset, net $ 11,034 $ 8,057
============================================================================================
The deferred tax asset, net is recorded as a component of other assets in
the Consolidated Statements of Condition.
The Company has a net operating carry forward loss ("NOL") for New York
State tax purposes of $2.7 million expiring in 2024. The income tax effect of
such NOL is included in Depreciation and other, net.
The income tax effect on the fair value adjustment of available for sale
securities and the income tax effect on securities transferred at fair value
from available for sale to held to maturity are components of accumulated other
comprehensive income (loss).
As a result of a reduction in taxable income for New York State tax
purposes, the Company has established a valuation allowance in the amount of
$2.6 million and $1.5 million as of December 31, 2004 and 2003, respectively, to
reduce the State deferred tax asset to the amount that management believes will
more likely than not be realized. As of December 31, 2004, the State deferred
tax asset, net of state deferred tax liabilities, is fully reserved by the
valuation allowance.
The following is a reconciliation of the statutory Federal income tax rate
to the effective income tax rate as a percentage of income before taxes for the
years ended December 31:
- ----------------------------------------------------------------------------------------------
2004 2003 2002
- ----------------------------------------------------------------------------------------------
Statutory Federal income tax rate 35.0% 35.0% 35.0%
Interest on tax exempt obligations of states and
political subdivisions (2.6) (2.3) (2.7)
State (benefit) income taxes, net of
Federal tax benefit (0.7) 0.8 2.7
Valuation allowance 1.7 2.2 --
Other (0.3) (0.3) (1.1)
- ----------------------------------------------------------------------------------------------
Effective tax rate 33.1% 35.4% 33.9%
==============================================================================================
The Company recently completed a tax examination by New York State through
the tax year ended December 31, 2002, which resulted in no adjustment to
previously filed tax returns. The Company is in the process of being examined by
the Internal Revenue Service for the tax year ended December 31, 2002.
The Company is under continuous examination by various tax authorities in
jurisdictions in which the Company has significant business operations. The
Company regularly evaluates the likelihood of additional assessments in each of
the tax jurisdictions resulting from these examinations. Tax reserves have been
established, which the Company believes to be adequate in relation to the
potential for additional assessments. Once established, reserves are adjusted as
information becomes available or when an event requiring a change to the reserve
occurs. The resolution of tax matters could have an impact on the Company's
effective tax rate.
9. BORROWINGS AND LONG-TERM DEBT
The Company utilizes short-term and long-term borrowings primarily to meet
funding requirements for its asset growth, balance sheet leverage, and to manage
its interest rate risk.
Short-term borrowings include securities sold under agreements to
repurchase, federal funds purchased, and short-term Federal Home Loan Bank of
New York ("FHLB") advances. Short-term securities sold under agreements to
repurchase have original maturities of between one and 365 days. The Bank has
borrowing availability under master security sale and repurchase agreements
through four primary investment firms, the FHLB, and, to a lesser extent, its
customers. At December 31, 2004, the Bank had short-term repurchase agreements
with the FHLB of $25.0 million at a weighted average interest rate of 2.10
percent. These short-term borrowings were collateralized by securities with an
aggregate carrying value and estimated fair value of $29.4 million and $29.7
million, respectively. At December 31, 2004, the Bank also had short-term
repurchase agreements with customers of $2.3 million at a weighted average
interest rate of 1.93 percent, which were collateralized by securities with an
aggregate carrying value and estimated fair value of $2.4 million. The Bank did
not have any short-term repurchase agreements outstanding with primary
investment firms at December 31, 2004. At December 31, 2003, outstanding
short-term repurchase agreements with: primary investment firms totaled $280.0
million at a weighted average interest rate of 1.16 percent that were
collateralized by securities having an aggregate carrying value of $300.3
million and estimated fair value of $300.0 million; and customers totaled $1.6
million at a weighted average interest rate of 0.84 percent that were
collateralized by securities having an aggregate carrying value and estimated
fair value of $1.7 million. There were no short-term repurchase agreements
outstanding with the FHLB at December 31, 2003.
31
Federal funds purchased represent overnight funds. The Bank has federal
funds purchase lines available with six financial institutions for a total of
$75.0 million. At December 31, 2004 and 2003, the Bank had no federal funds
purchased balances outstanding.
Short-term FHLB advances are borrowings with original maturities of
between one and 365 days. There were no short-term advances outstanding with the
FHLB at December 31, 2004. At December 31, 2003, outstanding short-term FHLB
advances totaled $10.5 million at a weighted average interest rate of 1.06
percent and were collateralized by a pledge to the FHLB of a security interest
in certain mortgage-related assets having an aggregate book value of $12.2
million.
Additional information with respect to short-term borrowings for the three
years ended December 31, 2004, 2003, and 2002 is presented in the following
table.
- ------------------------------------------------------------------------------------------
(000's, except percentages)
Short-Term Borrowings 2004 2003 2002
- ------------------------------------------------------------------------------------------
Balance at December 31 $ 27,323 $ 292,131 $ 1,205
Average balance outstanding $ 165,140 $ 63,119 $ 1,545
Weighted average interest rate
As of December 31 2.09% 1.16% 1.18%
Paid during the year 1.47% 1.17% 1.59%
===========================================================================================
The Bank has long-term borrowings, which have original maturities of over
one year, of $515.0 million and $507.0 million of securities sold under
agreements to repurchase as of December 31, 2004 and 2003, respectively. At
December 31, 2004 and 2003, these borrowings have original terms of between five
and ten years at interest rates between 1.99 percent to 6.08 percent and 1.07
percent to 6.08 percent, respectively, that are callable on certain dates after
an initial noncall period at the option of the counterparty to the repurchase
agreements. As of December 31, 2004 and 2003, these borrowings were
collateralized by securities with an aggregate carrying value of $518.8 million
and $531.6 million, and an estimated fair value of $520.3 million and $531.1
million, respectively.
At December 31, 2004, long-term FHLB advances totaled $82.7 million at
interest rates of between 4.55 percent to 6.05 percent, compared with $94.4
million at December 31, 2003, at interest rates of between 4.27 percent to 6.05
percent. Advances at December 31, 2004 include $2.7 million of amortizing
advances having scheduled periodic payments, $10.0 million that are payable at
maturity, and $70.0 million that are callable on certain dates after an initial
noncall period at the option of the issuer. At December 31, 2004 and 2003, these
borrowings were collateralized by a pledge to the FHLB of a security interest in
certain mortgage-related assets having an aggregate book value of $96.5 million
and $109.9 million, respectively.
The borrowings/advances may not be repaid by the Bank prior to the
scheduled/repurchase payment dates without penalty.
At December 31, 2004, the Bank has sufficient collateral available to
borrow approximately $496.7 million under additional collateralized transactions
through securities sold under agreements to repurchase and FHLB advances. The
Bank may also borrow an additional $75.0 million under overnight federal funds
lines on an unsecured basis.
The maximum amount of total borrowings outstanding at any month end period
during the years ended December 31, 2004, 2003, and 2002 were $926.2 million,
$893.5 million, and $504.1 million, respectively.
At December 31, 2004 and 2003, the Bank held 311,354 shares and 305,937
shares of capital stock of the FHLB with a carrying value of $31.1 million and
$30.6 million, respectively, which is required in order to borrow under the
short- and long-term advances and securities sold under agreements to repurchase
programs from the FHLB. The FHLB generally limits a bank's borrowings to an
aggregate of 30 percent of total assets, or for collateral pledged by TPNZ, 75
percent of TPNZ net equity, excluding securities sold under agreements to
repurchase, upon the prerequisite purchase of additional shares of FHLB stock.
Any advances made from the FHLB are required to be collateralized by the FHLB
stock and certain other assets of the Bank.
32
A summary of long-term, fixed-rate borrowings distributed based upon
remaining contractual payment date and expected option call date at December 31,
2004, with comparative totals for December 31, 2003 and 2002 is as follows:
- ----------------------------------------------------------------------------------------------------------------------------------
(000's, except percentages)
After 1
Within But Within After 2004 2003 2002
Long-Term Borrowings 1 Year 5 Years 5 Years Total Total Total
- ----------------------------------------------------------------------------------------------------------------------------------
Contractual Payment Date: $ 10,880 $ 135,083 $ 451,746 $ 597,709 $ 601,374 $ 502,889
Total long-term borrowings
Weighted average interest rate 4.95% 5.15% 4.07% 4.33% 4.21% 4.68%
- --------------------------------------------------------------------------------------------------------------------------------
Expected Call Date: $ 27,880 $ 291,083 $ 278,746 $ 597,709 $ 601,374 $ 502,889
Total long-term borrowings
Weighted average interest rate 3.42% 3.90% 4.86% 4.33% 4.21% 4.68%
- --------------------------------------------------------------------------------------------------------------------------------
10. SUBORDINATED DEBT ISSUED IN CONNECTION WITH/AND CORPORATION-OBLIGATED
MANDATORY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUSTS
The Company has issued approximately $61.9 million of junior subordinated
debt in connection with the issuance of $60.0 million of Capital Securities. In
accordance with FIN No. 46R, the Company, as of December 31, 2003, has
deconsolidated its investment in the subsidiary trusts, which have issued the
Capital Securities. As a result of the deconsolidation as of December 31, 2004
and 2003, the Consolidated Financial Statements reflect junior subordinated debt
issued in connection with the Capital Securities ("subordinated debt"), along
with the Company's investment in common equity of the Trusts. A description of
the terms of each issuance of Capital Securities and related subordinated debt
(which terms are substantially identical to the related Capital Securities) is
discussed below.
On February 5, 1997, the Company completed its first issuance of Capital
Securities that raised $20 million of regulatory capital ($18.8 million net
proceeds after issuance costs). The 9.58 percent Capital Securities, due
February 1, 2027, were issued by Trust I, a Delaware business trust that was
formed by the Company solely to issue the Capital Securities and related common
stock. Trust I advanced the proceeds to the Company by purchasing 9.58 percent
subordinated debt of the Company. The Capital Securities and related
subordinated debt may not be redeemed, except under limited circumstances, until
February 1, 2007, and thereafter at a premium which reduces over a ten year
period. Dividends and interest are paid semi-annually in February and August.
On July 31, 2001, the Company completed its second issuance of Capital
Securities that raised an additional $20 million of regulatory capital ($19.4
million net proceeds after issuance costs). These Capital Securities and related
subordinated debt pay dividends and interest on a floating rate basis, based on
three month LIBOR plus 358 basis points (current rate as of December 31, 2004 of
5.74 percent), which resets in October, January, April, and July of each
calendar year. These Capital Securities, due July 31, 2031, were issued by Trust
II, a Connecticut business trust that was formed by the Company solely to issue
the Capital Securities and related common stock. Trust II advanced the proceeds
to the Company by purchasing subordinated debt of the Company. These Capital
Securities and related subordinated debt may not be redeemed, except under
limited circumstances, until July 31, 2006, and thereafter at a premium which
reduces over a five year period. Dividends and interest are paid quarterly in
October, January, April, and July.
On June 26, 2002, the Company completed its third issuance of Capital
Securities that raised $10.0 million of regulatory capital (approximately $9.7
million net proceeds after issuance costs). These Capital Securities and related
subordinated debt pay dividends and interest on a floating rate basis, based on
three month LIBOR plus 345 basis points (current rate as of December 31, 2004 of
6.00 percent), which resets in September, December, March, and June of each
calendar year. These Capital Securities, which are due June 26, 2032, were
issued by Trust III, a Connecticut business trust, that was formed by the
Company solely to issue these Capital Securities and related common stock. Trust
III advanced the proceeds to the Company by purchasing subordinated debt of the
Company. These Capital Securities and related subordinated debt may not be
redeemed, except under limited circumstances, until June 26, 2007 at par.
Dividends and interest are paid quarterly in September, December, March, and
June.
On March 25, 2004, the Company completed its fourth issuance of
subordinated debt in connection with the issuance of Capital Securities totaling
$10.3 million that raised $10.0 million of regulatory capital ($9,975,000 net
proceeds after issuance costs). The Capital Securities and related subordinated
debt issued pay dividends and interest on a floating rate basis at a rate equal
to three month LIBOR plus 280 basis points (current rate as of December 31, 2004
of 4.87 percent). These Capital Securities due March 25, 2034 were issued by
Trust IV, a Delaware business trust that was formed by the Company solely to
issue the Capital Securities and related common stock. Trust IV advanced the
proceeds to the Company by purchasing subordinated debt of the Company. These
Capital Securities and related subordinated debt may not be redeemed, except
under limited circumstances, until March 25, 2009, at par. Dividend and interest
payments, as well as the reset of the interest rate, occur in April, July,
October, and January of each calendar year.
33
The Company owns 100 percent of the voting securities of each of the
Trusts. The Company has fully and unconditionally guaranteed the Capital
Securities along with all obligations of the Trusts under the trust agreements
relating to the Capital Securities. The Company's ability to make interest
payments on the subordinated debt is primarily dependent upon the receipt of
dividends from the Bank. See Note 11 for a discussion of the limits on the
Bank's ability to pay dividends to the Company.
Capital Securities qualify as Tier I or core capital for the Company under
the Federal Reserve Board's risk-based capital guidelines to the extent such
Capital Securities equal 25 percent or less of Tier I Capital. Amounts in excess
of the foregoing amount will qualify as Tier II or Total Capital. The aggregate
amount of Capital Securities issued by the Company total $60.0 million at
December 31, 2004, all of which is included in Tier I regulatory capital. As a
result of the deconsolidation of the Trusts as previously discussed, the Federal
Reserve reevaluated the regulatory implications of this accounting change on the
capital treatment of the Capital Securities and has issued a final rule that
retains the Tier I Capital treatment of Capital Securities with certain
modifications. The final rule did not affect the Company's treatment of the
Capital Securities as Tier I Capital.
Payments on the subordinated debt, which are in turn passed through the
Trusts to the Capital Securities holders, will be serviced through existing
liquidity and cash flow sources of the Company. The Company may also reduce
outstanding Capital Securities through open market purchases. The Company is
permitted to deduct dividend/interest payments on the Capital Securities under
current Federal and New York State tax law.
As long as no default has occurred and is continuing, the Company has the
right under the subordinated debt indentures to defer the payment of interest at
any time or from time to time for a period not exceeding five years for any one
extension (each such period an "Extension Period"); provided, however, that no
Extension Period may extend beyond the stated maturity of the subordinated debt
securities. During any Extension Period, the Company may not (i) declare or pay
any dividends or distributions on, or redeem, purchase, acquire or make a
liquidation payment with respect to, any of the Company's capital stock (which
includes common and preferred stock), (ii) make any payment of principal,
interest or premium, if any, on, or repay, repurchase or redeem any debt
securities of the Company that rank pari passu with or junior in interest to the
subordinated debt securities, or (iii) make any guarantee payments with respect
to any guarantee by the Company of the debt securities of any subsidiary of the
Company if such guarantee ranks pari passu with or junior in interest to the
subordinated debt securities, in each case subject to certain exceptions.
Pursuant to the terms of the documents governing the Company's
subordinated debt and the Capital Securities, if the Company is in default under
such securities, the Company is prohibited from repurchasing or making
distributions, including dividends, on or with respect to its common or
preferred stock, and from making payments on any debt or guarantees which rank
pari passu with or junior in interest to such securities.
In addition, under the terms of the indentures governing its subordinated
debt, the Company may not merge or consolidate with, or sell substantially all
of its assets to, any other corporation, person or entity unless: (a) the
surviving corporation is a domestic corporation which expressly assumes the
Company's obligations with respect to the subordinated debt and the Capital
Securities and related documents; (b) there is no, and the merger or other
transaction would not cause a, default under any of the subordinated debt; and
(c) certain other conditions are met.
34
11. STOCKHOLDERS' EQUITY
The Company distributed 5 percent common stock dividends on September 24,
2004 and September 26, 2003 to stockholders of record on September 10, 2004 and
September 12, 2003, respectively. The weighted average common shares outstanding
and per common share amounts have been adjusted to reflect all stock dividends
and splits.
The ability of the Company and the Bank to pay cash dividends in the
future is restricted by various regulatory requirements. The Company's ability
to pay cash dividends to its stockholders is primarily dependent upon the
receipt of dividends from the Bank. The Bank's dividends to the Company may not
exceed the sum of the Bank's undistributed net income for that year and its
undistributed net income for the preceding two years, less any required
transfers to additional paid-in capital. In addition, the Bank may not declare
and pay dividends more often than quarterly, and no dividends may be declared or
paid if there is any impairment of the Bank's capital stock. At December 31,
2004, the Bank could pay dividends of $69.1 million to the Company without
having to obtain prior regulatory approval.
The Company may not pay dividends on its common stock or preferred stock
if it is in default with respect to the Capital Securities or related
subordinated debt, or if the Company elects to defer payment for up to five
years as permitted under the terms of the Capital Securities and related
subordinated debt (see Note 10).
As of December 31, 2004, 200,000 shares of common stock are authorized for
issuance in connection with a Dividend Reinvestment Plan (currently suspended),
of which 98,020 shares have been issued.
During 2004, 2003, and 2002, TPNZ declared and paid dividends totaling
approximately $10,000 in each of those years to its non-affiliate
minority-interest junior preferred stockholders. Upon the voluntary or
involuntary liquidation or dissolution of TPNZ, TPNZ junior preferred
stockholders are entitled to receive $1,000 per share, plus a sum equal to all
dividends accrued and unpaid to date out of TPNZ's assets, available under
applicable law, before any payment or distribution of assets shall be made on
TPNZ's common stock.
The Company issued 188,676, 302,088, and 15,377 shares of treasury stock
in 2004, 2003, and 2002 in connection with the exercise of stock options,
respectively. In addition, the Company acquired 329,771, 367,685, and 164,251
common shares at fair value for the treasury in 2004, 2003, and 2002,
respectively. Certain treasury stock purchases were made in connection with
previously announced stock repurchase programs discussed below. The remaining
treasury stock purchases were made in connection with common stock tendered for
exercise of stock options. Treasury shares also increased 88,324 and 70,401 in
2004 and 2003, respectively, as a result of stock dividends.
On December 18, 2003, December 18, 2002, and December 18, 2001, the
Company's Board of Directors authorized the repurchase of up to 315,000,
165,375, and 363,825 (adjusted for common stock dividends) common shares, or
approximately 1.5 percent, 0.8 percent, and 1.8 percent (as determined at the
time of the authorizations), respectively, of the Company's outstanding common
stock. Repurchases of common stock had been authorized to be made from time to
time in open-market and private transactions as, in the opinion of management,
market conditions may warrant. As of December 31, 2004, all stock repurchase
plans were expired. The repurchased common shares are held as treasury stock and
are available for general corporate purposes. For the years ended December 31,
2004, 2003, and 2002, the Company purchased 253,200, 253,000, and 63,600 shares
of common stock under the repurchase plans at an aggregate cost of approximately
$5.5 million, $4.2 million, and $1.0 million, respectively.
In connection with the Bank's Key Employee Supplemental Investment Plan
("KESIP"), amounts deferred by participating employees and contributed by the
Bank are invested in Company stock. This investment in Company stock of
$2,746,000 at December 31, 2004 and $2,327,000 at December 31, 2003 is included
in common stock held for benefit plans, at cost, which is shown as a reduction
of stockholders' equity. The related deferred compensation obligation is also
shown as a component of stockholders' equity (see Note 17).
12. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory -- and possibly
additional discretionary -- actions by regulators that, if undertaken, could
have a direct material effect on the Company's Consolidated Financial
Statements. Under capital adequacy guidelines and, also with respect to the
Bank, regulatory framework for prompt corrective action, the Company and the
Bank must meet or exceed specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance sheet items, as
calculated under regulatory accounting practices and as presented in the
following table. The Company's and the Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.
35
- ----------------------------------------------------------------------------------------------------------------------------------
(000's, except percentages)
Minimum
Minimum To Be Well Capitalized
For Capital Under Prompt Corrective
Adequacy Purpose Action Provisions
- ----------------------------------------------------------------------------------------------------------------------------------
Company Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2004
Total Capital (to Risk Weighted Assets) $257,262 15.07% $136,543 8.0% N/A N/A
Tier I Capital (to Risk Weighted Assets) 241,494 14.15 68,272 4.0 N/A N/A
Tier I Capital (to Average Quarterly Assets) 241,494 8.15 118,522 4.0 N/A N/A
As of December 31, 2003
Total Capital (to Risk Weighted Assets) $232,924 13.70% $136,008 8.0% N/A N/A
Tier I Capital (to Risk Weighted Assets) 217,631 12.80 68,004 4.0 N/A N/A
Tier I Capital (to Average Quarterly Assets) 217,631 7.54 115,453 4.0 N/A N/A
- ----------------------------------------------------------------------------------------------------------------------------------
Bank
- ----------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2004
Total Capital (to Risk Weighted Assets) $253,036 14.85% $136,290 8.0% $170,362 10.0%
Tier I Capital (to Risk Weighted Assets) 237,268 13.93 68,145 4.0 102,217 6.0
Tier I Capital (to Average Quarterly Assets) 237,268 8.00 118,666 4.0 148,333 5.0
As of December 31, 2003
Total Capital (to Risk Weighted Assets) $226,446 13.39% $135,635 8.0% $169,544 10.0%
Tier I Capital (to Risk Weighted Assets) 211,689 12.49 67,817 4.0 101,726 6.0
Tier I Capital (to Average Quarterly Assets) 211,689 7.34 115,291 4.0 144,114 5.0
==================================================================================================================================
N/A - Not Applicable
Capital ratios are computed excluding net unrealized gains or losses on
available for sale securities, net of tax, which is included in the other
comprehensive income (loss) component of stockholders' equity for financial
reporting purposes.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and Bank to maintain or exceed minimum capital amounts and
ratios as defined in the regulations and set forth in the above tables.
Management believes, as of December 31, 2004, that the Company and the Bank meet
all capital adequacy requirements, to which they are subject and are considered
"well capitalized" under regulatory guidelines.
As of December 31, 2004, the most recent notification from the Federal
Deposit Insurance Corporation ("FDIC"), categorized the Bank as "well
capitalized" under the regulatory framework for prompt corrective action. There
are no conditions or events since that notification that management believes
have changed that assessment.
Total Capital and Tier I Capital for the Company includes $60 million of
Capital Securities. As discussed in Note 10, due to the deconsolidation of the
Trusts, which issued the Capital Securities, the Federal Reserve reevaluated the
regulatory implications of this accounting change on the capital treatment of
the Capital Securities and has issued a final rule that retains the Tier I
Capital treatment of Capital Securities with certain modifications. The final
rule did not have an impact on the Company's treatment of the Capital Securities
as Tier I Capital.
36
13. EARNINGS PER COMMON SHARE
The computation of basic and diluted earnings per common share for the
years ended December 31 is as follows:
- -------------------------------------------------------------------------------------------------
(000's, except share amounts)
2004 2003 2002
- -------------------------------------------------------------------------------------------------
Numerator:
Net income $ 28,065 $ 29,288 $ 27,034
Less preferred stock dividends 10 10 10
- ------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings per
common share - net income available to
common stockholders $ 28,055 $ 29,278 $ 27,024
================================================================================================
Denominator:
Denominator for basic earnings per common
share - weighted average shares 20,388,466 20,436,497 20,297,814
Effect of dilutive securities - director and
employee stock options 987,221 583,147 649,592
- ------------------------------------------------------------------------------------------------
Denominator for diluted earnings per common
share - adjusted weighted average shares 21,375,687 21,019,644 20,947,406
================================================================================================
Basic earnings per common share $ 1.38 $ 1.43 $ 1.33
Diluted earnings per common share $ 1.31 $ 1.39 $ 1.29
================================================================================================
Note 17 describes the Company's director and employee stock option plans.
14. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," as
amended by SFAS No. 119, "Disclosure about Derivative Financial Instruments and
Fair Value of Financial Instruments," requires disclosure of the estimated fair
values for certain financial instruments. The estimated fair values disclosed
below are as of December 31, 2004 and 2003, and have been determined by using
available market information and various valuation estimation methodologies.
Considerable judgment is required to interpret the effects on fair value of such
items due to changes in expected loss experience, current economic conditions,
risk characteristics of various financial instruments and other factors. The
estimates presented herein are not necessarily indicative of the amounts that
the Company would realize in a current market exchange. Also, the use of
different market assumptions and/or estimation methodologies may have a material
effect on the determination of the estimated fair values.
The fair value estimates presented in the following table are based on
pertinent information available to the Company as of December 31, 2004 and 2003.
Although the Company is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been comprehensively
revalued since December 31, 2004 and 2003, and therefore, current estimates of
fair value may differ significantly from the amounts that follow.
37
- ----------------------------------------------------------------------------------------------------------------------
As of December 31,
2004 2003
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
- ----------------------------------------------------------------------------------------------------------------------
Assets: (in millions)
Cash and cash equivalents, and interest
bearing deposits in other banks $ 65.6 $ 65.6 $ 67.5 $ 67.5
Securities, FHLB stock, and accrued interest
and dividends receivable 1,134.2 1,139.5 1,360.1 1,362.9
Loans, net, and accrued interest receivable 1,498.9 1,499.5 1,439.5 1,439.6
Liabilities:
Deposits without stated maturities and
accrued interest payable 1,104.6 1,104.6 1,061.7 1,061.7
Time deposits and accrued interest payable 756.5 754.0 715.9 720.9
Securities sold under agreements to repurchase
and accrued interest payable 544.5 563.5 791.2 823.4
FHLB advances and accrued interest payable 83.2 87.6 105.4 112.7
Subordinated debt issued in connection with Corporation -
Obligated mandatory redeemable capital securities
of subsidiary trusts and accrued interest payable 63.0 66.3 52.5 55.0
=====================================================================================================================
Fair value methods and assumptions are as follows:
Cash and Cash Equivalents and Interest Bearing Deposits in Other Banks -
The carrying amount is a reasonable estimate of fair value.
Securities, FHLB Stock, and Accrued Interest and Dividends Receivable -
The fair value of securities is estimated based on quoted market prices or
dealer quotes, if available. If a quote is not available, fair value is
estimated using quoted market prices for similar securities. The fair value of
FHLB stock is stated at redemption value, which equals its carrying value.
Accrued interest and dividends are stated at their carrying amount, which
approximates fair value.
Loans and Accrued Interest Receivable - For certain homogeneous fixed rate
categories of loans, such as residential mortgages, fair value is estimated by
using quoted market prices for securities backed by similar loans. The fair
value of other fixed rate loans has been estimated by discounting projected cash
flows using current rates for similar loans with equivalent credit risk. For
loans for which there has been no impairment in credit risk and which reprice
frequently to market rates, the carrying amount is a reasonable estimate of fair
value. The fair value of impaired and nonaccrual loans is estimated by reducing
such amounts by specific and general loan loss allowances. Accrued interest is
stated at its carrying amount, which approximates fair value.
Deposits Without Stated Maturities and Accrued Interest Payable - The
estimated fair value of deposits with no stated maturity, such as non-interest
bearing demand deposits, NOW accounts, money market accounts, and savings
accounts, is equal to the amount payable on demand. Accrued interest payable, as
applicable, is stated at its carrying amount, which approximates fair value.
Time Deposits and Accrued Interest Payable - The fair value of time
deposits is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered at the reporting
date for deposits of similar remaining maturities. Accrued interest payable is
stated at its carrying amount, which approximates fair value.
Securities Sold Under Agreements to Repurchase, FHLB Advances,
Subordinated Debt Issued in Connection with Corporation-Obligated Mandatory
Redeemable Capital Securities of Subsidiary Trusts and Accrued Interest Payable
- - The carrying amount is a reasonable estimate of fair value for borrowings
which are either short-term or for which applicable interest rates reprice based
upon changes in market rates. For medium and long-term fixed rate borrowings,
fair value is based on discounted cash flow through contractual maturity, or
earlier call date if expected to be called, at rates currently offered at the
balance sheet date for similar terms. Accrued interest payable is stated at its
carrying amount, which approximates fair value.
38
Financial Instruments with Off-Balance Sheet Risk - As described in Note
16, the Company is a party to financial instruments with off-balance sheet risk
at December 31, 2004 and 2003. Such financial instruments include commitments to
extend permanent financing and standby letters of credit. If the commitments are
exercised by the prospective borrowers, these financial instruments will become
interest-earning assets of the Company. If the commitments expire, the Company
retains any fees paid by the counter party to obtain the commitment or
guarantee.
The fair value of commitments is estimated based upon fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the present creditworthiness of the counterparties.
For fixed rate commitments, the fair value estimation takes into consideration
an interest rate risk factor. The fair value of guarantees and standby letters
of credit is based on fees currently charged for similar agreements. The fair
value of these off-balance sheet items at December 31, 2004 and 2003,
approximates the recorded amounts of the related fees, which are not material to
the consolidated financial position of the Company.
15. RELATED PARTY TRANSACTIONS
A summary of the transactions for the years ended December 31, 2004 and
2003, with respect to loans (in excess of $60,000 with respect to each party) to
directors, senior executive officers, stockholders whose ownership equals or
exceeds 10 percent, and companies in which such related party has a 10 percent
or more beneficial interest ("insiders") is as follows:
- -------------------------------------------------------------------------------
(000's)
2004 2003
- -------------------------------------------------------------------------------
Balance, January 1, $ 611 $ 753
New loans 217 247
Repayments, other reductions (56) (389)
------------------------------------------------------------------------------
Balance, December 31, $ 772 $ 611
==============================================================================
As of December 31, 2004 and 2003, deposits from insiders were $6.5 million
and $6.6 million, respectively.
The Company has made payments to organizations in which certain directors
have a beneficial interest for services rendered by such organizations. Except
as discussed below, such payments are not considered to be material in the
aggregate. Fees of approximately $420,000, $50,000, and $63,000 in 2004, 2003,
and 2002, respectively, were incurred with respect to a law firm in which a
director is a partner. This law firm also represented the Bank for loan closings
for which additional fees of approximately $301,000, $585,000, and $570,000 in
2004, 2003, and 2002, respectively, were paid by customers of the Bank. An
additional law firm in which a director is the senior partner represented the
Bank for loan closings, which resulted in fees paid by customers of the Bank of
approximately $17,000 and $30,000 in 2004 and 2003, respectively.
16. COMMITMENTS AND CONTINGENCIES
At December 31, 2004, the Company and Bank are committed under employment
agreements with the Chairman, President and Chief Executive Officer ("CEO"),
Senior Executive Vice President and Chief Credit Officer, and Senior Executive
Vice President and Chief Financial Officer requiring an annual salary of
$795,000, $225,000, and $225,000, respectively; annual bonus payments equal to
six, one, and one percent of net income (as defined) of the Company under the
Executive Incentive Bonus Plan, respectively (see Note 17); and annual stock
option grants of 135,590 shares, 50,847 shares and 50,847 shares, respectively,
issued at fair value at the date of grant (110 percent of fair value for
incentive stock options if the key officer's ownership of the Company equals or
exceeds 10 percent at the date of grant); and other benefits for the term of the
agreements.
The CEO's employment agreement, dated as of November 16, 2003, is for a
five-year term, expiring November 16, 2008, while the Senior Executive Vice
Presidents' agreements, dated as of July 28, 2004, are for three-year terms,
expiring July 28, 2007. The CEO's contract also requires minimum annual salary
increases of $30,000. All of the agreements include change in control
provisions, requiring certain payments, including an amount equal to three times
annual salary and bonus payments (as defined), in the event of a voluntary or
involuntary termination of employment with the Company or the Bank following a
change in control.
In the normal course of business, various commitments to extend credit are
made which are not reflected in the accompanying Consolidated Financial
Statements. At December 31, 2004 and 2003, formal credit line and loan
commitments, which are primarily loans collateralized by real estate and credit
card lines approximated $492.9 million and $515.5 million, and outstanding
standby letters of credit totaled $41.3 million and $39.9 million, respectively.
Such amounts represent the maximum risk of loss on these commitments.
Standby letters of credit are issued to guarantee financial performance or
obligations of the Bank's customers. Generally, standby letters of credit are
either partially or fully collateralized by cash, real estate, or other assets,
and, in some cases, are not collateralized. In most cases, personal guarantees
are obtained. At December 31, 2004 and 2003, there has been no specific
liability recorded for standby letters of credit. However, standby letters of
credit are considered in the Bank's evaluation of its reserve for unfunded loan
commitments and standby letters of credit.
39
The Bank is an approved Freddie Mac seller/servicer. At December 31, 2004,
the principal balance of the loans sold or exchanged with Freddie Mac that
remain uncollected totaled $7.4 million. The Bank is committed to service these
loans.
The Bank is required to report deposits directly to the Federal Reserve
Bank of New York and to maintain reserves on a portion of these deposits. At
December 31, 2004, the reserve requirement for the Bank totaled $21.8 million.
The Company is party to various legal proceedings arising in the ordinary
course of business, none of which, in the opinion of management based on advice
from legal counsel, will have a material adverse effect on the Company's
consolidated financial position.
Because litigation is inherently unpredictable, particularly in cases
where claimants seek substantial or indeterminate damages or where
investigations and proceedings are in the early states, the Company cannot
predict with certainty the loss or range of loss related to such matters, how
such matters will be resolved, when they will ultimately be resolved, or what
the eventual settlement, fine, penalty, or other relief might be. Consequently,
the Company cannot estimate losses or ranges of losses for matters where there
is only a reasonable possibility that a loss may have been incurred. Although
the ultimate outcome of these matters cannot be ascertained at this time, it is
the opinion of management, after consultation with counsel, that the resolution
of the foregoing matters will not have a material adverse effect on the
financial condition of the Company, taken as a whole; such resolution may,
however, have a material effect on the operating results in any future period,
depending on the level of income for such period.
The Company provides reserves for such matters in accordance with
Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies," as required. The ultimate resolution may differ from the amounts
reserved, if any.
17. EMPLOYEE BENEFIT PLANS
Executive Incentive Bonus Plan
The Company provides an Executive Incentive Bonus Plan whereby certain key
officers of the Company and/or the Bank (two of whom are directors of the
Company and the Bank and are stockholders, and one of whom is a director of the
Company and is a stockholder) are entitled to compensation in addition to their
salaries at varying percentages of the Company's or Bank's net income (as
defined). The total amount of such additional compensation cannot exceed 15
percent of the Company's net income (as defined) in any year. Incentive
compensation under the Executive Incentive Bonus Plan aggregated $3.3 million
during 2004, $3.5 million during 2003, and $3.2 million during 2002.
Employee Stock Ownership Plan (With 401(k) Provisions)
The Company maintains for the benefit of its employees an Employee Stock
Ownership Plan (With 401(k) Provisions) ("KSOP").
The 401(k) feature of the KSOP allows eligible employees of the Company
and its affiliates to elect investment of their voluntary contributions in a
fund that purchases common stock of the Company or in twelve other investment
funds. Employees may elect to defer, through voluntary contributions, up to
fifteen percent of compensation ($13,000 maximum in 2004), except for
participants that are 50 years of age or older who may contribute an additional
amount ($3,000 in 2004). The Company may elect to match fifty percent of the
employee's voluntary contributions up to an amount equal to four percent of the
employee's eligible compensation. Employer matching contributions for the years
ended December 31, 2004, 2003, and 2002 aggregated approximately $618,000,
$545,000, and $475,000, respectively.
Under the Employee Stock Ownership feature, covering substantially all of
the Company's full-time employees, the optional cash contribution determined by
the Board of Directors, intended to be invested in the Company's common stock,
was $100,000 for the year ended December 31, 2002. The Company did not make an
optional cash contribution for the years ended December 31, 2004 and 2003. The
Bank paid directly expenses attributable to the KSOP of approximately $70,000,
$82,000, and $65,000 in 2004, 2003, and 2002, respectively. Shares purchased
with the Company's contribution are allocated to participants on the basis of
their relative compensation (as defined). The cumulative amount of shares
allocated vest over the first seven years of a participant's service. After
completion of seven years of credited service, all shares allocated (and to be
allocated) are fully vested.
Tappan Zee also had an Employee Stock Ownership Plan (the "ESOP") for the
benefit of eligible Tarrytowns employees, which was assumed by the Company upon
its acquisition of and merger with Tappan Zee in 1998, and merged with the KSOP
on September 30, 1999. In 1995, the ESOP borrowed approximately $1.3 million
from Tappan Zee (assumed by the Company) and used the funds to purchase 203,318
shares (as adjusted for common stock splits and dividends) of Company common
stock. The Bank makes monthly contributions to the KSOP sufficient to fund the
debt service requirements over the ten-year term of the loan, which matures in
September 2005. The unallocated shares are held in a suspense account by the
KSOP trustee, and a portion of such shares are allocated to all KSOP
participants at each year end. Shares released from the suspense account are
allocated to participants on the basis of their eligible relative compensation
(as defined). Participants become vested in the shares allocated to their
respective accounts in the same manner as described in the preceding paragraph
for optional contributions. Any forfeited shares are allocated to other
participants based on compensation (as defined).
40
Shares allocated to participants and committed for release to participants
totaled 15,846, 17,030, and 18,241 (as adjusted for common stock splits and
dividends) for the years ended December 31, 2004, 2003, and 2002, respectively.
Expense recognized with respect to such shares allocated and released amounted
to approximately $380,000, $282,000, and $265,000 for the years ended December
31, 2004, 2003, and 2002, respectively, based on the average fair value of
Company common stock for each period. The cost of the 3,971 shares (as adjusted
for common stock splits and dividends) that have not yet been committed to be
released to participant accounts at December 31, 2004 of approximately $30,000
is included in common stock held for benefit plans, which is reflected as a
reduction of stockholders' equity. The fair value of these shares was
approximately $0.1 million at that date. Common stock cash dividends used to
reduce the principal balance of the loan received on shares not yet committed to
be released to participant's accounts were not material.
Key Employees' Supplemental Investment Plans
The Bank maintains the KESIP, established solely for the purpose of
providing, to certain key management personnel who participate in the KSOP,
benefits attributable to contribution allocations that would otherwise be made
under the KSOP except for Internal Revenue Service ("IRS") limitations. Under
the KESIP, salary reduction contributions may be made in excess of the
limitations on annual contributions imposed by Internal Revenue Code Section
415, and the Bank shall elect to match up to fifty percent of the employee's
voluntary KESIP contribution (to the extent such election is made under the
KSOP), not to exceed four percent of the employee's compensation (less the
amount of the employer matching contribution under the KSOP). The Bank must also
contribute an amount equivalent to the KSOP optional contribution that would
otherwise have been made to participating employees in the KSOP had it not been
for IRS limitations. The Bank's matching and optional contributions under the
KESIP for the years ended December 31, 2004, 2003, and 2002 were $86,000,
$68,000, and $66,000, respectively.
All compensation deferred into the KESIP is immediately invested in shares
of Company stock. In addition, distributions from the KESIP will be made in
Company stock. The deferred compensation obligation and the shares held in trust
for deferred compensation are recorded at historical cost and are included as
separate components of stockholders' equity, which is included in common stock
held for benefit plans.
The Bank also maintains a Key Employees Supplemental Diversified
Investment Plan ("KESDIP"). The KESDIP is similar in terms to the KESIP, except
that investments made by the KESDIP trust may be in diversified assets,
excluding common stock of the Company. All investments in the KESDIP are
reflected in the Consolidated Financial Statements in other assets at fair
market value. The Bank's matching and optional contributions (which are reduced
to the extent of contributions made to the KSOP and KESIP) under the KESDIP for
the years ended December 31, 2004, 2003, and 2002 were $98,000, $91,000, and
$71,000, respectively.
STOCK OPTION PLANS
Director Stock Option Plans
In 1989 and 1998, the stockholders of the Company approved Director Stock
Option Plans (the "Director Plans") for an aggregate of 883,850 and 560,291
shares (after adjustment for stock splits and dividends), respectively, of the
Company's common stock to be issued to all non-employee members of the Company's
Board of Directors.
The 1998 Director Plan has a term of ten years. Final awards under the
1989 Director Plan were made, effective with approval of the 1998 Director Plan.
Options may not be exercised prior to the first anniversary of the date of grant
and expire ten years after the date of grant. There were 70,771 shares (as
adjusted for common stock splits and dividends) remaining to be granted at
December 31, 2004 under the 1998 Director Plan.
Under the terms of the 1998 Director Plan, as amended by the Board of
Directors on March 24, 1999, each eligible director will receive, effective as
of the close of each annual meeting of stockholders of the Company, a
non-qualified option (after adjustment for stock splits and stock dividends) to
purchase a fixed number of shares of common stock at an exercise price equal to
the fair market value of such shares on the date of the grant. The number of
shares subject to the option is based on the number of years of service
completed by the eligible director. After two years of service, the eligible
director is entitled to an option covering 1,274 shares (as adjusted for common
stock splits and dividends). Each additional year of service entitles the
eligible director to an option covering an additional 1,274 shares, until the
director has completed 15 years of the eligible service, after which the
director is entitled to an option covering 23,729 shares (as adjusted for common
stock splits and dividends).
41
Under the Tappan Zee Directors' Stock Option Plan (the "Tappan Zee
Directors' Plan"), which was assumed by the Company, 76,245 shares (after
adjustment for stock splits and stock dividends) were authorized for issuance to
outside Directors for option exercises. Option terms and conditions are similar
to those under the Tappan Zee Stock Option Plan (see Employee Stock Option Plans
below), except that all director options are non-qualified options. There have
been 63,538 options (after adjustment for stock splits and dividends) issued
under this plan. Upon the change in control that resulted when Tappan Zee was
acquired by the Company, all options under this plan became vested. There are
12,707 shares (as adjusted for common stock splits and dividends) available for
future grant under this plan, which will expire in 2006
A summary of the Director Plans and the Tappan Zee Directors' Plan
activity and related information for the years ended December 31, 2004, 2003,
and 2002 follows:
- -----------------------------------------------------------------------------------------------------------------------
2004 2003 2002
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- -----------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 549,430 $ 11.38 601,274 $ 10.49 530,989 $ 9.70
Granted 87,742 21.21 85,190 15.05 82,662 14.24
Exercised 36,967 5.71 137,034 9.74 12,377 1.47
- ---------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 600,205 $ 13.17 549,430 $ 11.38 601,274 $ 10.49
- ---------------------------------------------------------------------------------------------------------------------
Exercisable at December 31, 512,463 $ 11.79 464,235 $ 10.70 518,612 $ 9.90
- ---------------------------------------------------------------------------------------------------------------------
Weighted average fair value of
options granted during the year $ 8.40 $ 5.34 $ 5.74
=====================================================================================================================
The following table summarizes the range of exercise prices on stock
options outstanding and exercisable for the Director Plans and the Tappan Zee
Directors' Plan at December 31, 2004:
- -------------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -------------------------------------------------------------------------------------------------------------------------------
$ 3.76 to $ 7.67 86,956 1.5 years $ 5.77 86,956 $ 5.77
7.68 to 12.78 186,479 5.0 10.87 186,479 10.87
12.79 to 15.34 239,028 6.6 14.70 239,028 14.70
15.35 to 21.21 87,742 9.4 21.21 -- --
- -----------------------------------------------------------------------------------------------------------------------------
$ 3.76 to $ 21.21 600,205 5.8 years $13.17 512,463 $11.79
=============================================================================================================================
Employee Stock Option Plans
Under the 1993 and 1984 Incentive Stock Option Plans, and the 2001 and
1997 Employee Stock Option Plans for key employees of the Company and its
subsidiaries, and the Tappan Zee Stock Option Plan, which were assumed by the
Company (collectively the "Employee Stock Option Plans"), options for the
issuance of both incentive and nonqualified stock options up to an aggregate of
6,271,907 shares (after adjustment for stocks splits and stock dividends) were
authorized for grant at prices at least equal to the fair value of the Company's
common stock at the time the options are granted (for incentive stock options,
110 percent of fair value, for grants to an employee who, at the time of the
grant, owns stock aggregating 10 percent or more of the combined voting power of
all classes of stock of the Company).
For the 1993 and 1984 Incentive Stock Option Plans, and the 2001 and 1997
Employee Stock Option Plans, each option holder may exercise up to 50 percent of
his or her options after a three month period subsequent to the grant date and
may exercise the remaining 50 percent six months after the grant date. The
options granted have a maximum exercisable term of ten years from the date of
grant (not more than five years in the case of incentive stock options granted
to an employee who, at the time of grant, owns stock aggregating 10 percent or
more of the total combined voting power of all classes of stock of the Company).
The option shares and related prices are adjusted for stock splits and stock
dividends. There were 298,763 shares (as adjusted for common stock splits and
dividends) remaining to be granted at December 31, 2004 under the 2001 Employee
Stock Option Plan. The 2001 Employee Stock Option Plan has a term of ten years.
No additional shares will be granted under the 1993 and 1984 Incentive Stock
Option Plans or the 1997 Employee Stock Option Plan.
42
Options under the Tappan Zee Plan have a ten-year term and vest ratably
over five years from the date of grant. Each option, however, became fully
exercisable upon the change in control of Tappan Zee. At December 31, 2004,
shares available for future grants totaled 50,829 (as adjusted for common stock
splits and dividends) for the Tappan Zee Stock Option Plan, which will expire in
2006.
A summary of the Employee Stock Option Plans' activity and related
information for the years ended December 31, 2004, 2003, and 2002 follows:
- -----------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- ----------------------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 2,581,344 $ 12.44 2,446,536 $ 11.14 2,332,767 $ 9.90
Granted 435,590 20.71 472,496 15.30 423,402 14.97
Exercised 193,927 10.97 330,220 6.84 303,469 6.76
Expired or forfeited 313 18.86 7,468 16.16 6,164 14.81
Outstanding at December 31, 2,822,694 $ 13.82 2,581,344 $ 12.44 2,446,536 $ 11.14
- --------------------------------------------------------------------------------------------------------------------------------
Exercisable at December 31, 2,822,694 $ 13.82 2,522,751 $ 12.31 2,424,588 $ 11.10
- --------------------------------------------------------------------------------------------------------------------------------
Weighted average fair value of
- --------------------------------------------------------------------------------------------------------------------------------
Options granted during the year $ 8.35 $ 5.86 $ 6.19
================================================================================================================================
The following table summarizes the range of exercise prices on stock
options outstanding and exercisable under the Employee Stock Option Plans at
December 31, 2004:
- -----------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- -----------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Cotractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------------------
$ 3.80 to $10.22 259,864 2.7 years $ 7.06 259,864 $ 7.06
10.23 to 15.34 2,015,551 5.8 13.03 2,015,551 13.03
15.35 to 20.34 181,109 8.5 17.92 181,109 17.92
20.35 to 25.56 366,170 9.2 20.90 366,170 20.90
- ---------------------------------------------------------------------------------------------------------------
$ 3.80 to $25.56 2,822,694 6.1 years $13.82 2,822,694 $13.82
===============================================================================================================
Director Retirement Plans
Effective May 19, 1999, the Company adopted the Retirement Plan for
non-employee Directors of U.S.B. Holding Co., Inc. and Certain Affiliates (the
"Director Retirement Plan"). A non-employee Director who has served for a period
of fifteen years is eligible to receive benefits. Vesting of benefits under the
Director Retirement Plan accelerate in the event of change in control. Upon
retirement, the non-employee Director shall be paid $2,000 per month for a
period not to exceed ten years. In the event of death of the non-employee
Director, after commencement of retirement payments but prior to the conclusion
of the ten year payment period, the payments shall be paid to his or her spouse
at a rate of 50 percent of the retirement payment over the remaining term of the
retirement payment period, or through the date of the spouse's death if it
occurs prior to completion of the payment period. Alternatively, the retiree may
choose a lump sum payment equivalent to the present value of $200,000 paid in
equal monthly installments over the ten year period, discounted based on an
interest rate equal to the average ten-year advance rate from the Federal Home
Loan Bank, for the thirty days prior to the election. The Director Retirement
Plan is unfunded.
At December 31, 2004 and 2003, the Company has recorded a liability of
$522,000 and $437,000 to provide for the actuarial present value of payments
expected to be made under the Director Retirement Plan. The discount rate used
to compute the present value obligation is 5.25 percent and 6.00 percent,
respectively. At December 31, 2004 and 2003, a net intangible asset of $255,000
and $304,000, respectively, is recorded, reflecting the unamortized prior
service cost, which is being amortized over the average remaining service period
of the current non-employee Directors. Benefit cost for the Director Retirement
Plan for the years ended December 31, 2004, 2003, and 2002 was approximately
$134,000, $129,000, and $76,000, of which $11,000, $10,000, and $7,000
represents current service cost, $95,000, $92,000, and $51,000 represents
amortization of prior service cost, and $28,000, $27,000, and $18,000 represents
interest, respectively. Payments made under the Director Retirement Plan to
retired non-employee Directors were approximately $107,000 and $193,000 during
the years ended December 31, 2003 and 2002, respectively.
43
Deferred Compensation Plan
The Bank has a nonqualified Deferred Compensation Plan for former
Tarrytowns Directors. Under the Deferred Compensation Plan, eligible Directors
deferred all or part of their compensation (including compensation paid to
officer-directors for service as an officer). Deferred amounts were applied to
either the purchase of (i) a life insurance policy, in which case the amount of
deferred benefits payable is based on the value of expected death benefit
proceeds, or (ii) Company common stock and other investments, in which case the
amount of deferred benefits payable is based on the investment performance of
the investments made. Deferred benefits are paid in installments over a ten year
period beginning upon termination of service. Due to a change of control, which
occurred upon the acquisition of Tappan Zee by the Company, the Deferred
Compensation Plan required full funding of any previously purchased life
insurance contracts. However, the Board of Directors of Tarrytowns waived this
requirement. The Bank has established a trust fund with an independent fiduciary
for the purpose of accumulating funds to be used to satisfy its obligations
under this plan, in addition to the proceeds from life insurance contracts.
The accumulated projected benefit obligation of the Deferred Compensation
Plan aggregated $0.7 million at December 31, 2004 and $0.8 million at December
31, 2003. The present value of the accumulated projected benefit obligation is
based on a discount rate of 5.00 percent as of both December 31, 2004 and 2003.
Expenses for this plan for the years ended December 31, 2004, 2003, and 2002
were $12,000, $96,000, and $56,000, respectively.
For financial reporting purposes, the cash surrender values of the life
insurance contracts are not considered plan assets but instead are included in
the Company's Consolidated Statements of Condition. At December 31, 2004 and
2003, the cash surrender values of purchased life insurance policies were
approximately $645,000 and $626,000, respectively. The total death benefits
payable under the insurance policies amounted to approximately $1.2 million at
December 31, 2004.
Postretirement Health Care Benefits
Substantially all Tarrytown's employees were eligible for postretirement
health care (medical and dental) benefits if they met certain age and length of
service requirements. This plan was terminated on September 1, 1998, and only
employees vested on that date will continue to receive benefits under this plan.
A liability of $0.1 million has been recorded to reflect an amount approximately
equal to the Medicare Supplemental premiums for the three remaining
participants.
The Bank also has established a Postretirement Health Care Plan. Under
this plan, eligible retirees are entitled to participate in the Bank's group
health care plan but are responsible for premium payments.
Severance Plan
On January 30, 2002, the Company's Board of Directors approved the U.S.B.
Holding Co., Inc. Severance Plan ("Severance Plan"), which provides for
severance benefits in the event of an involuntary termination in connection with
a change in control of the Company (as defined). The Severance Plan covers all
employees not otherwise covered by an employment contract. The purpose of the
Severance Plan is to attract and retain capable personnel, address concerns of
the Company's employees regarding job security and help ensure that employees
secure benefits, which they legitimately expect in the normal course of their
employment. Benefits, which range from two weeks to forty weeks of compensation
(as defined), are based on years of service.
18. SEGMENT INFORMATION
The Company has one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based upon how each of the activities of the Company supports the
others. For example, commercial lending is dependent upon the ability of the
Bank to fund itself with deposits and other borrowings, and to manage interest
rate and credit risk. This situation is also similar for consumer and
residential mortgage lending. Accordingly, all significant operating decisions
are based upon analysis of the Company as one operating segment or unit.
The Company operates only in the U.S. domestic market, specifically the
lower Hudson Valley, which includes the counties of Rockland, Westchester,
Orange, Putnam and Dutchess, New York, as well as New York City and Long Island,
New York, Southern Connecticut, and the surrounding area. For the years ended
December 31, 2004, 2003, and 2002, there is no customer that accounted for more
than 10 percent of the Company's revenue.
44
19. CONDENSED FINANCIAL INFORMATION OF U.S.B. HOLDING CO., INC. (PARENT COMPANY
ONLY)
Condensed statements of condition are as follows:
- --------------------------------------------------------------------------------------------------
(000's)
December 31,
2004 2003
- --------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 4,961 $ 4,108
Securities available for sale (at estimated fair value) 116 196
Investment in common stock of bank subsidiary 237,441 212,006
Other assets 6,094 7,227
- --------------------------------------------------------------------------------------------------
TOTAL ASSETS $248,612 $223,537
==================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 4,708 $ 3,696
Subordinated debt issued in connection with Corporation - Obligated
mandatory redeemable capital securities of subsidiary trusts 61,858 51,548
Stockholders' equity 182,046 168,293
- --------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $248,612 $223,537
==================================================================================================
Condensed statements of income are as follows:
- -----------------------------------------------------------------------------------------------------------
(000's)
Years Ended December 31,
2004 2003 2002
- -----------------------------------------------------------------------------------------------------------
Income:
Dividends from bank subsidiary $ 5,200 $ 13,300 $ 5,600
Gain on securities transactions 66 -- --
Other income 129 24 33
- ---------------------------------------------------------------------------------------------------------
Total income 5,395 13,324 5,633
- ---------------------------------------------------------------------------------------------------------
Expenses:
Interest on subordinated debt issued in connection
with/and Corporation-Obligated mandatory redeemable
capital securities of subsidiary trusts 3,968 3,441 3,367
Other expenses 1,529 944 1,033
- ---------------------------------------------------------------------------------------------------------
Total expenses 5,497 4,385 4,400
- ---------------------------------------------------------------------------------------------------------
(Loss) income before equity in undistributed income of subsidiary (102) 8,939 1,233
and benefit for income taxes
Equity in undistributed income of subsidiary 26,398 18,518 24,113
Income tax benefit 1,769 1,831 1,688
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 28,065 $ 29,288 $ 27,034
=========================================================================================================
45
Condensed statements of cash flow are as follows:
- ----------------------------------------------------------------------------------------------------
(000's)
Years Ended December 31,
2004 2003 2002
- ----------------------------------------------------------------------------------------------------
Operating activities:
Net income $ 28,065 $ 29,288 $ 27,034
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on securities transactions (66) -- --
Equity in undistributed income of subsidiary (26,398) (18,518) (24,113)
Other -- net 3,472 (1,977) 5,142
- --------------------------------------------------------------------------------------------------
Net cash provided by operating activities 5,073 8,793 8,063
- --------------------------------------------------------------------------------------------------
Investing activities:
Proceeds from sale of available for sale securities 100 -- --
Purchases of available for sale securities -- (16) (34)
Other expenses -- -- (9,000)
- --------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 100 (16) (9,034)
- --------------------------------------------------------------------------------------------------
Financing activities
Dividends paid -- common (9,569) (7,623) (6,833)
ne proceeds from exercise of common stock options 740 1,652 577
Net proceeds from issuance of subordinated debt issued in
connection with/and Corporation-Obligated mandatory
redeemable capital securities of subsidiary trusts 9,975 -- 9,673
Purchases of treasury stock (5,466) (4,223) (985)
- --------------------------------------------------------------------------------------------------
Net cash (used for) provided by financing activities (4,320) (10,194) 2,432
- --------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 853 (1,417) 1,461
Cash and cash equivalents at beginning of year 4,108 5,525 4,064
- --------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 4,961 $ 4,108 $ 5,525
==================================================================================================
46
Report of Independent Registered Public Accounting Firm
- -------------------------------------------------------------------------------
To the Board of Directors and Stockholders
U.S.B. Holding Co., Inc.
We have audited the accompanying consolidated statements of condition of U.S.B.
Holding Co., Inc. and its subsidiaries (the "Company") as of December 31, 2004
and 2003 and the related consolidated statements of income, cash flows, and
changes in stockholders' equity for each of the three years in the period ended
December 31, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes examining, on a test basis,
evidence assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of U.S.B. Holding Co., Inc. and its
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31,2004, based on the
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, and our report
dated March 14, 2005 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2005
47
Management Report on Internal Control Over Financial Reporting
- -------------------------------------------------------------------------------
March 14, 2005
To the Stockholders
U.S.B. Holding Co., Inc.
The management of U.S.B. Holding Co., Inc. (the "Company") is responsible for
the preparation, integrity, and fair presentation of its published financial
statements and all other information presented in this annual report. The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and, as
such, include amounts based on informed judgments and estimates made by
management.
The financial statements have been audited by an independent registered public
accounting firm, Deloitte & Touche LLP, which was given unrestricted access to
all financial records and related data, including minutes of all meetings of
stockholders, the Board of Directors and committees of the Board. Management
believes that all representations made to the independent registered public
accounting firm during their audit were valid and appropriate. The independent
registered public accounting firm's report is presented on page 47.
Internal Control
Management is responsible for establishing and maintaining effective internal
control over financial reporting, including safeguarding of assets, for
financial presentations in conformity with accounting principles generally
accepted in the United States of America as such term is defined in Exchange Act
Rule 13a-15(f) or 15d-15(f), and for the Company's bank subsidiary, Union State
Bank, in conformity with the Federal Financial Institutions Examination Council
instructions for Consolidated Reports of Condition and Income ("Call Report
Instructions"). The Company's internal control system is a process designed to
provide reasonable assurance to the Company's Management and Board of Directors
regarding the preparation and fair presentation of published financial
statements.
The Company's internal control over financial reporting includes policies and
procedures that pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect transactions and dispositions of assets;
provide reasonable assurances that transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America, and that receipts
and expenditures are being made only in accordance with authorizations of
Management and the Directors of the Company, and provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the Company's assets that could have a material effect on the
Company's financial statements. The internal control contains monitoring
mechanisms and actions that are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control,
including the possibility of human error and the circumvention or overriding of
controls. Accordingly, even effective internal control can provide only
reasonable assurance with respect to financial statement preparation and may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Further, because of changes in
conditions, the effectiveness of internal control may vary over time.
48
Management, including the Company's principal executive officer and principal
financial officer, assessed the Company's internal control over financial
reporting, including safeguarding of assets, for financial presentations in
conformity with accounting principles generally accepted in the United States of
America and, for Union State Bank, in conformity with the Call Report
Instructions as of December 31, 2004. This assessment was based on criteria for
effective internal control over financial reporting, including safeguarding of
assets, established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, Management believes that, as of December 31, 2004, the Company
maintained effective internal control over financial reporting, including
safeguarding of assets, for financial presentations in conformity with
accounting principles generally accepted in the United States of America, and
for Union State Bank, in conformity with the Call Report Instructions.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2004 has been audited by Deloitte &
Touche LLP, an independent registered public accounting firm, as stated in their
report, which is presented on page 50.
Compliance with Laws and Regulations
Management is also responsible for ensuring compliance with the federal laws and
regulations concerning loans to insiders, and the federal and state laws and
regulations concerning dividend restrictions, both of which are designated by
the FDIC as safety and soundness laws and regulations.
Management assessed its compliance with those designated safety and soundness
laws and regulations and has maintained records of its determinations and
assessments as required by the FDIC. Based on this assessment, management
believes that Union State Bank has complied, in all material respects, with the
designated safety and soundness laws and regulations referred to above for the
year ended December 31, 2004.
/s/ Thomas E. Hales /s/ Steven T. Sabatini
------------------------- ----------------------------
Thomas E. Hales Steven T. Sabatini
Chairman, President and Senior Executive
Chief Executive Officer Vice President and
Chief Financial Officer
49
Report of Independent Registered Public Accounting Firm
- -------------------------------------------------------------------------------
To the Board of Directors and Stockholders
U.S.B. Holding Co., Inc.
We have audited management's assessment, included in the accompanying Management
Report on Internal Control over Financial Reporting, that U.S.B. Holding Co.,
Inc. (the "Company") maintained effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Because management's assessment and
our audit were conducted to meet the reporting requirements of Section 112 of
the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management's
assessment and our audit of the Company's internal control over financial
reporting included controls over the preparation of the schedules equivalent to
the basic financial statements in accordance with the instructions for the
Federal Financial Institutions Examination Council Instructions for Consolidated
Reports of Condition and Income. The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
50
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of an evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have not examined and, accordingly, we do not express an opinion or any other
form of assurance on management's statement referring to compliance with laws
and regulations.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
condition as of December 31, 2004 and the related statements of income, cash
flows, and changes in stockholders' equity for the year ended December 31, 2004
of the Company, and our report dated March 14, 2005 expressed an unqualified
opinion on those financial statements.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2005
51
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
This section presents discussion and analysis of the financial condition
and results of operations of U.S.B. Holding Co., Inc. (the "Company") and its
subsidiaries, including Union State Bank (the "Bank") and its wholly-owned
subsidiaries, Dutch Hill Realty Corp., U.S.B. Financial Services, Inc., USB
Delaware Inc. (from the date of its incorporation, September 12, 2003), and TPNZ
Preferred Funding Corp. ("TPNZ"), a wholly-owned subsidiary of USB Delaware
Inc., and Ad Con, Inc. Union State Capital Trust I, Union State Statutory Trust
II, and USB Statutory Trust III were consolidated through the year ended
December 31, 2003 (with Union State Statutory Trust IV established in March 2004
(the "Trusts")). As required by FIN 46R on December 31, 2003, the Company
deconsolidated all of the Trusts in existence as of that date and recorded
subordinated debt issued to the Trusts and the Company's investments in the
common equity of the Trusts as of December 31, 2003. This discussion and
analysis should be read in conjunction with the Consolidated Financial
Statements and supplemental financial data contained elsewhere in this report.
Selected Financial Data (000's, except share data)
- -----------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
Operating Results:
Total interest income $ 145,696 $ 131,215 $ 125,419 $ 132,040 $ 135,320
Total interest expense 57,561 54,191 52,904 70,716 75,672
- ----------------------------------------------------------------------------------------------------------------------
Net interest income 88,135 77,024 72,515 61,324 59,648
Provision for credit losses 3,687 2,513 4,109 1,684 3,125
Gains on securities transactions 1,199 8,383 6,405 2,064 135
Income before income taxes 41,925 45,319 40,912 31,627 29,880
Net income 28,065 29,288 27,034 20,761 19,612
Basic earnings per common share* 1.38 1.43 1.33 1.03 0.98
Diluted earnings per common share* 1.31 1.39 1.29 1.00 0.95
Cash dividends per common share* 0.47 0.37 0.33 0.29 0.26
Weighted average common shares* 20,388,466 20,436,497 20,297,814 20,184,952 20,060,109
Adjusted weighted average common shares* 21,375,687 21,019,644 20,947,406 20,667,042 20,681,728
======================================================================================================================
December 31,
2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
Financial Position:
Total loans, net $ 1,492,872 $ 1,433,923 $ 1,336,273 $ 1,158,534 $ 1,075,443
Total assets 2,746,270 2,906,462 2,542,866 2,040,126 1,886,265
Total deposits 1,858,218 1,775,049 1,551,787 1,425,958 1,489,487
Borrowings 625,032 893,505 504,094 417,570 243,244
Subordinated debt issued in connection
with/and Corporation-Obligated mandatory
redeemable capital securities of
subsidiary trusts 61,858 51,548 50,000 40,000 20,000
Stockholders' equity 182,046 168,293 156,011 135,200 117,877
======================================================================================================================
2004 Quarters 2003 Quarters
Fourth Third Second First Fourth Third Second First
- ------------------------------------------------------------------------------------------------------------------------------------
Quarterly Results of Operations
(Unaudited):
Interest income $38,670 $36,750 $36,020 $34,256 $34,440 $32,871 $32,549 $31,355
Net interest income 23,509 22,492 21,817 20,317 20,506 19,230 18,994 18,294
Provision for credit losses** 3,023 110 343 211 450 391 1,333 339
Gains on securities transactions 2 -- 85 1,112 -- -- 5,351 3,032
Income before income taxes 8,778 11,355 10,761 11,031 10,297 9,850 13,310 11,862
Net income 6,152 7,519 7,037 7,357 6,692 6,286 8,690 7,620
Basic earnings per common share* 0.30 0.37 0.34 0.36 0.33 0.31 0.42 0.37
Diluted earnings per common share*
0.29 0.35 0.33 0.34 0.32 0.30 0.41 0.36
====================================================================================================================================
* Share amounts are adjusted for the five percent common stock dividend
distributed in September 2004.
** The higher level of the provision for credit losses during the fourth
quarter of 2004 and the second quarter of 2003 reflects an increase in
charge-offs. See Note 5 to the Consolidated Financial Statements.
52
(000's, except percentages)
Average Balances and Interest Rates Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2004 2003
Average
Average Yield/
Average Balance Interest Yield/Rate Average Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Interest earning assets:
Interest bearing deposits $ 474 $ 6 1.27% $ 169 $ 1 0.59%
Federal funds sold 27,458 347 1.26 61,406 638 1.04
Securities:
U.S. government agencies 784,112 38,414 4.90 537,395 24,520 4.56
Mortgage-backed securities 397,373 13,469 3.39 464,335 15,587 3.36
Obligations of states and
political subdivisions 81,644 5,439 6.66 68,560 5,127 7.48
Corporate securities,
FHLB stock and other securities 41,117 800 1.95 31,552 1,114 3.53
Loans, net 1,475,462 89,335 6.05 1,391,689 86,274 6.20
- ------------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 2,807,640 147,810 5.26% 2,555,106 133,261 5.22%
- ------------------------------------------------------------------------------------------------------------------------------
Non-interest earning assets 112,191 105,321
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL $2,919,831 $2,660,427
==============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
NOW $ 167,787 $ 739 0.44% $ 137,270 $ 581 0.42%
Money market 222,829 2,702 1.21 158,303 2,002 1.26
Savings 426,031 2,372 0.56 434,945 2,775 0.64
Time 739,379 18,412 2.49 698,372 18,435 2.64
- ------------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 1,556,026 24,225 1.56 1,428,890 23,793 1.67
Federal funds purchased,
securities sold under
agreements to repurchase
and FHLB advances 788,661 29,368 3.72 681,920 26,957 3.95
Subordinated debt issued in
connection with/and
Corporation-Obligated
mandatory redeemable capital
securities of subsidiary trusts 59,447 3,968 6.67 50,000 3,441 6.88
- ------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 2,404,134 57,561 2.39% 2,160,810 54,191 2.51%
- ------------------------------------------------------------------------------------------------------------------------------
Non-interest bearing liabilities
and stockholders' equity:
Demand deposits 322,753 282,469
Other liabilities 19,011 54,906
Stockholders' equity 173,933 162,242
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL $2,919,831 $2,660,427
==============================================================================================================================
NET INTEREST INCOME $ 90,249 $ 79,070
==============================================================================================================================
NET YIELD ON INTEREST
EARNING ASSETS (NET
INTEREST MARGIN) 3.21% 3.09%
==============================================================================================================================
(000's, except percentages)
Average Balances and Interest Rates Years Ended December 31,
- ---------------------------------------------------------------------------------------
2002
Average
Average Balance Interest Yield/Rate
- ---------------------------------------------------------------------------------------
ASSETS
Interest earning assets:
Interest bearing deposits $ 536 $ 9 1.68%
Federal funds sold 50,607 822 1.62
Securities:
U.S. government agencies 257,262 16,867 6.56
Mortgage-backed securities 392,836 17,822 4.54
Obligations of states and
political subdivisions 71,854 5,580 7.77
Corporate securities,
FHLB stock and other securities 35,345 2,011 5.69
Loans, net 1,245,697 84,803 6.81
- -------------------------------------------------------------------------------------
Total interest earning assets 2,054,137 127,914 6.23%
- -------------------------------------------------------------------------------------
Non-interest earning assets 117,368
- -------------------------------------------------------------------------------------
TOTAL $2,171,505
=====================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
NOW $ 96,654 $ 648 0.67%
Money market 89,689 1,009 1.13
Savings 432,942 4,930 1.14
Time 638,485 21,037 3.29
- -------------------------------------------------------------------------------------
Total interest bearing deposits 1,257,770 27,624 2.20
Federal funds purchased,
securities sold under
agreements to repurchase
and FHLB advances 433,048 21,913 5.06
Subordinated debt issued in
connection with/and
Corporation-Obligated
mandatory redeemable capital
securities of subsidiary trusts 45,151 3,367 7.46
- -------------------------------------------------------------------------------------
Total interest bearing liabilities 1,735,969 52,904 3.05%
- -------------------------------------------------------------------------------------
Non-interest bearing liabilities
and stockholders' equity:
Demand deposits 240,578
Other liabilities 50,481
Stockholders' equity 144,477
- -------------------------------------------------------------------------------------
TOTAL 2,171,505
=====================================================================================
NET INTEREST INCOME $ 75,010
=====================================================================================
NET YIELD ON INTEREST
EARNING ASSETS (NET
INTEREST MARGIN) 3.65%
=====================================================================================
The data contained herein has been adjusted to a tax equivalent basis, based on
the Federal statutory tax rate of 35 percent and the applicable state and local
income tax rates. The effect of adjustment to tax equivalent basis was $2.1
million, $2.0 million, and $2.5 million for the years ended December 31, 2004,
2003, and 2002, respectively. Non accruing loans are included in average
balances of loans, net. The net amount of loan origination and commitment fees,
net of certain direct loan origination costs for the years ended December 31,
2004, 2003, and 2002 of $3.1 million, $2.8 million, and $3.0 million
respectively, are included in interest income on loans, net.
53
Forward-Looking Statements: Statements contained herein, which are not
historical facts, are "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. In addition, senior management may make
forward-looking statements orally to analysts, investors, the media and others.
These forward-looking statements may be identified by the use of such words as
"believe," "expect," "anticipate," "intend," "should," "will," "would," "could,"
"may," "planned," "estimated," "potential," "outlook," "predict," "project" and
similar terms and phrases, including references to assumptions.
Forward-looking statements are based on various assumptions and analyses
made by the Company in light of management's experience and its perception of
historical trends, current conditions and expected future developments, as well
as other factors the Company believes are appropriate under the circumstances.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and other factors (many of which are beyond the Company's
control) that could cause actual results to differ materially from future
results expressed or implied by such forward-looking statements. These factors
include, without limitation, the following: the timing and occurrence or
non-occurrence of events may be subject to circumstances beyond the Company's
control; there may be increases in competitive pressure among financial
institutions or from non-financial institutions; changes in the interest rate
environment may reduce interest margins; changes in deposit flows, loan demand
or real estate values may adversely affect the Company's business; changes in
accounting principles, policies or guidelines may cause the Company's financial
condition to be perceived differently; general economic conditions, either
nationally or locally in some or all of the areas in which the Company does
business, or conditions in the securities markets or the banking industry may be
less favorable than the Company currently anticipates; legislative or regulatory
changes may adversely affect the Company's business; applicable technological
changes may be more difficult or expensive than the Company anticipates; success
or consummation of new business initiatives may be more difficult or expensive
than the Company anticipates; or litigation or matters before regulatory
agencies, whether currently existing or commencing in the future, may delay the
occurrence or non-occurrence of events longer than the Company anticipates.
The Company's forward-looking statements are only as of the date on which such
statements are made. By making any forward-looking statements, the Company
assumes no duty to update them to reflect new, changing or unanticipated events
or circumstances. These risks and uncertainties should be considered in
evaluating forward-looking statements and undue reliance should not be placed on
these statements.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The Company's
significant accounting policies are more fully described in Note 3 to the
Consolidated Financial Statements, Summary of Significant Accounting Policies.
Certain accounting policies require management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expense during the
reporting period. On an on-going basis, management evaluates its estimates and
assumptions, and the effects of revisions are reflected in the financial
statements in the period in which they are determined to be necessary.
The accounting policies described below are those that most frequently
require management to make estimates and judgments and, therefore, are critical
to understanding the Company's results of operations. The more critical policies
given the Company's current business strategy and asset/liability structure are
accounting for non-performing loans, the allowance for loan losses, reserve for
unfunded loan commitments and standby letters of credit, and provision for
credit losses, the classification of securities as either held to maturity or
available for sale and evaluation of other than temporary impairment of
securities, and the evaluation of valuation reserves for deferred tax assets. In
addition to the discussion below and Notes to the Consolidated Financial
Statements, the Company's practice on each of these accounting policies is
further described in the applicable sections of Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Loans: The Company's decision to classify loans as non-performing is
judgmental in nature, but generally loans are placed on non-performing status
when they are past due 90 days or more (180 days for credit cards) or earlier if
management determines that the loan will become non-performing in the near
future. At the time a loan is placed on non-performing status, interest accrued
but not collected is reversed. Interest payments received while a loan is on
non-performing status are either applied to reduce principal or, based on
management's estimate of collectibility, recognized as income. As reported in
the Notes to the Consolidated Financial Statements, as of December 31, 2004,
non-performing assets were $1.6 million and potential problem loans that may
result in being placed on nonaccrual status in the near future were $0.5
million.
54
Allowance for Loan Losses: The determination of the allowance for loan
losses (the "allowance"), reserve for unfunded loan commitments and standby
letters of credit (the "reserve") and provision for credit losses (the
"provision") is judgmental in nature. The process of evaluating the loan
portfolio, classifying loans and determining the allowance, reserve, and
provision is described beginning on page 66. As a substantial amount of the
Company's loan portfolio is collateralized by real estate, appraisals of the
underlying value of property securing loans and discounted cash flow valuation
of properties are critical in determining the amount of the allowance or reserve
required for specific loans. Assumptions for appraisals and discounted cash flow
valuations are instrumental in determining the value of properties. Overly
optimistic assumptions or negative changes to assumptions could significantly
impact the valuation of a property securing a loan and the related allowance
determined. The assumptions supporting such appraisals and discounted cash flow
valuations are carefully reviewed by management to determine that the resulting
values reasonably reflect amounts realizable on the related loans.
Additional changes in economic conditions, geographic and customer
concentrations and other conditions could significantly impact the allowance,
reserve, and provision. These evaluations are inherently subjective as they
require estimates that are susceptible to significant revision as more
information becomes available. As a result, future adjustments to the allowance
and reserve may be necessary.
Securities: The classification of securities is determined by management
at the time of purchase, and the reasoning and analysis of the classification is
described beginning on page 63. Securities classified as held to maturity are
carried at amortized cost, while those identified as available for sale are
carried at estimated fair value with the resulting gain or loss, net of income
tax, included in other comprehensive income (loss), which is a component of
stockholders' equity. Accordingly, a misclassification would have a direct
effect on stockholders' equity. Securities in an unrealized loss position are
periodically evaluated for other than temporary impairment. Management considers
the effect of interest rates, credit ratings and other factors on the valuation
of such securities, as well as the Company's ability to hold such securities
until a forecasted recovery or maturity occurs. A substantial amount of the
investment portfolio consists of triple-A rated credits, and, therefore,
substantially all unrealized losses are due to interest rate factors. Sales or
reclassification as available for sale (except for certain permitted reasons) of
held to maturity securities may result in the reclassification of all held to
maturity securities to available for sale. The Company has never sold or
reclassified held to maturity securities to available for sale other than in
specifically permitted circumstances.
Valuation Reserve for Deferred Tax Assets: The determination of the
valuation reserve for deferred tax assets ("Tax Valuation Reserve") is based on
an evaluation of projected taxable income in which the net deductible timing
differences are expected to reverse, and the ability to carry forward or back
losses to years in which taxable income will be or was generated. For Federal
tax purposes, losses may be carried back two years and forward 20 years. As the
Company has recorded substantial taxable income in the past two years,
significantly in excess of net Federal deferred tax assets, it is more likely
than not that any net Federal deferred tax asset will be realized. New York
State allows losses to be carried forward for 20 years but does not allow losses
to be carried back for banking institutions. Therefore, the determination of any
Tax Valuation Reserve for State deferred tax assets is based on projected
taxable income. In making this determination, management considers it more
likely than not that the current year's taxable income is indicative of the
highest level of income that will be generated in future periods when the net
timing differences reverse. If the projected amount of future taxable income
decreases or increases (based on an analysis of the current year's taxable
income), the Tax Valuation Reserve will increase or decrease, respectively.
Overview
The Company's primary business is obtaining deposits through its retail
branch system, and commercial and municipal relationships, and lending to both a
retail and commercial customer base. A substantial amount of loans are secured
by real estate, including construction projects. The Company also generally
acquires triple-A credit rated securities to invest deposits in excess of loan
production, and borrows on a wholesale basis to leverage capital and manage
interest rate risk. The Company operates through its 28 full service branches
(as of March 14, 2005) and its four loan centers in Rockland, Westchester and
Orange counties, and New York City, New York, and Stamford, Connecticut.
The Company's primary source of revenue is net interest income, which is
the difference between interest income on earning assets and interest expense on
interest bearing liabilities. The Company also derives income from non-interest
income sources such as service charges on deposit accounts, gains on sales of
securities, and other forms of income. Net interest income and non-interest
income support the Company's operating expenses and provision for credit losses.
As the Company's primary source of income is net interest income, the
interest rate environment has a significant effect on revenue, which is
discussed in greater detail under "Net Interest Income" and "Market Risk." The
market for and credit quality of loans is also impacted by interest rates, as
well as the local economy. Deposits are also sensitive to interest rates, local
economic conditions, and the attractiveness of alternative investments, such as
stocks, bonds, mutual funds, and annuities.
55
As discussed in "Net Interest Income" and "Market Risk," a declining
interest rate environment and flattening yield curve will have the effect of
reducing the net interest margin. Currently, the Company's balance sheet is in
an asset sensitive position in anticipation of higher rates as the economy
continues to expand. Continued low interest rates, a further reduction in
interest rates, and a flattening yield curve may further reduce the net interest
margin. As such, net interest income was negatively affected in 2003 due to the
low interest rate environment. An increase in interest rates and increase in the
yield curve will most likely increase the net interest margin. The second half
of 2004 was positively impacted as short-term rates were increased. Higher
interest rates may also impact credit quality and loan production, as borrowers
must pay more for debt service. Credit quality, however, has been well managed
by the Company in varying economic cycles due to strong underwriting standards
and loan monitoring processes.
Also significant to the Company's net income and earnings per common share
is the ability to generate quality interest earning assets in the form of loans
and securities at reasonable interest spreads to maintain and increase net
interest income. Due to the current low interest rate environment and the
flattening yield curve, intense competition for loans, and difficulty in
obtaining acceptable yields and structures on security investments, while
managing interest rate risk, increasing the Company's interest earning assets is
proving to be challenging. In addition, significant loan prepayments, and calls
and accelerated principal payments on securities in this low interest rate
environment are also impacting the Company's ability to increase interest
earning assets.
Comparison of Financial Condition and Results of Operations
The Company's net income was $28.1 million for the year ended December 31,
2004, a 4.2 percent decrease compared to 2003. Net income was $29.3 million for
the year ended December 31, 2003, an 8.3 percent increase over 2002 net income
of $27.0 million.
The decrease in net income for 2004, compared to 2003, primarily reflects
a significant decrease in security gains from sales of available for sale
securities, as well as an increase in the provision for credit losses and
non-interest expenses. The decrease in net income was partially offset by an
increase in net interest income and non-interest income, and a decrease in the
effective rate for the provision for income taxes. The increased net income for
2003 compared to 2002 reflects higher net interest income and non-interest
income, a lower provision for credit losses, and higher gains on sales of
available for sale securities. These increases were partially offset by an
increase in non-interest expenses and a higher effective rate for the provision
for income taxes.
Diluted earnings per common share decreased 5.8 percent to $1.31 in 2004,
compared to the $1.39 recorded in 2003, while diluted earnings per common share
increased 7.8 percent in 2003 compared to the $1.29 recorded in 2002, reflecting
lower net income in 2004 and higher net income in 2003, respectively, as
compared to the prior year periods. Return on average common stockholders'
equity was 16.13 percent in 2004, compared to 18.05 percent in 2003, and 18.70
percent in 2002. Return on average total assets in 2004 was 0.96 percent,
compared to 1.10 percent in 2003, and 1.24 percent in 2002.
Net interest income for 2004 rose to $88.1 million, a 14.4 percent
increase over the $77.0 million recorded in 2003, while 2003 net interest income
increased 6.2 percent compared to the $72.5 million recorded in 2002. These
increases result principally from continuing growth of average interest earning
assets, primarily loans and security investments. The increase in net interest
income in 2004 was also due to an increase in the net interest margin on a tax
equivalent basis to 3.21 percent compared to 3.09 percent in 2003, while the net
interest margin decreased in 2003 compared to 3.65 percent in 2002. Net interest
income during the three years was also negatively impacted by interest foregone
on non-performing assets of $0.2 million in 2004, $0.4 million in 2003, and $0.9
million in 2002.
Non-interest income for 2004 and 2003 decreased $7.1 million and increased
$3.3 million, compared to 2003 and 2002, respectively. The 2004 decrease was
primarily due to lower security gains and loan prepayment fees, partially offset
by higher fees from service charges on deposit accounts. The 2003 increase was
primarily due to higher security gains, loan prepayment fees, and fees from
service charges on deposit accounts.
The provision for credit losses increased $1.2 million and decreased $1.6
million in 2004 and 2003, respectively, as compared to the prior year periods.
The 2004 increase was primarily due to higher net charge-offs compared to 2003.
The 2003 decrease was attributable to improving loan quality, a lower level of
net loan production as a result of a significant amount of loan prepayments
compared to the prior year, and a lower level of net charge-offs compared to
2002. The level of charge-offs in all years are primarily related to one
non-performing real estate construction loan recorded by the Bank's wholly owned
subsidiary, Dutch Hill Realty Corp. (the "Dutch Hill Loan"). The Dutch Hill Loan
balance was reduced to zero as of February 2005.
56
The overall increases in revenues were partially offset by 13.9 percent
and 12.4 percent increases in non-interest expenses in 2004 and 2003,
respectively. The increases in both years primarily reflect higher costs of
salaries and employee benefits, occupancy and equipment costs, professional
fees, communication costs, intangible amortization associated with bank and
branch acquisitions, and other costs, and in 2003, higher advertising and
business development expenses. The increase in non-interest expenses in 2004
includes approximately $1.7 million of professional fees related to litigation
involving the Dutch Hill Loan, compliance with the Sarbanes-Oxley Act of 2002,
and the Company's evaluation of strategic opportunities. The increases in
non-interest expenses in both years reflect the Company's investment in people,
new products, branches, and technology.
Under the revised SFAS No. 123, "Accounting for Stock Based Compensation"
("SFAS No. 123R"), the Company will account for stock based compensation using a
fair value based method in the financial statements for the first interim or
reporting period beginning after June 15, 2005. The effect of complying with
SFAS No. 123R will have a significant impact on operating expenses, as well as
the Company's net income and earnings per common share, as disclosed in Note 3
to the Consolidated Financial Statements.
The effective rate for the provision for income taxes was 33.1 percent,
35.4 percent, and 33.9 percent for the years ended December 31, 2004, 2003, and
2002, respectively. The 2004 decrease was primarily due to lower state income
taxes and a decrease in income tax reserves as a result of the satisfactory
completion of state tax examinations of prior income tax years. The 2003
increase was primarily due to the decrease in the proportion of tax exempt
income to total income.
Each of the components of net income is discussed in further detail
throughout Management's Discussion and Analysis.
The Company's total capital ratio under the risk-based capital guidelines
exceeds regulatory guidelines of eight percent, as the total capital ratio
equaled 15.07 percent and 13.70 percent at December 31, 2004 and 2003,
respectively. The Company's leverage capital ratio was 8.15 percent at December
31, 2004 and 7.54 percent at December 31, 2003, which also exceeds regulatory
guidelines.
The Company is not aware of any factors, not otherwise disclosed, that
would significantly affect its business operations. The Company has the
liquidity to meet its obligations from stable sources of deposits and borrowings
from reliable sources of lending institutions, the assets to generate income
from stable loan production with strong credit quality, and investments in
triple-A credit rated securities, and sufficient capital to support its business
and future growth prospects.
57
Interest Differential
The following table sets forth the dollar amount of changes in interest
income, interest expense and net interest income between the years ended
December 31, 2004 and 2003, and the years ended December 31, 2003 and 2002, on a
tax equivalent basis.
- -----------------------------------------------------------------------------------------------------------------------------------
(000's)
2004 Compared to 2003 2003 Compared to 2002
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
- -----------------------------------------------------------------------------------------------------------------------------------
Total Total
Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease)
- -----------------------------------------------------------------------------------------------------------------------------------
Interest Income:
Interest bearing deposits $ 3.1 $ 1.9 $ 5.0 $ (4.1) $ (3.9) $ (8.0)
Federal funds sold (405.9) 114.9 (291.0) 150.5 (334.5) (184.0)
Securities:
U.S. government agencies 11,952.8 1,941.2 13,894.0 14,018.5 (6,365.5) 7,653.0
Mortgage-backed securities (2,256.9) 138.9 (2,118.0) 2,897.8 (5,132.8) (2,235.0)
Obligations of states and
political subdivisions 912.3 (600.3) 312.0 (249.7) (203.3) (453.0)
Corporate securities, FHLB
stock and other securities 275.8 (589.8) (314.0) (197.7) (699.3) (897.0)
Loans, net 5,161.5 (2,100.5) 3,061.0 9,447.6 (7,976.6) 1,471.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 15,642.7 (1,093.7) 14,549.0 26,062.9 (20,715.9) 5,347.0
- ---------------------------------------------------------------------------------------------------------------------------------
Interest Expense:
Deposits:
NOW 130.1 27.9 158.0 220.6 (287.6) (67.0)
Money market 782.2 (82.2) 700.0 863.2 129.8 993.0
Savings (56.8) (346.2) (403.0) 22.7 (2,177.7) (2,155.0)
Time 1,053.1 (1,076.1) (23.0) 1,834.4 (4,436.4) (2,602.0)
Federal funds purchased, securities
sold under agreements to repurchase
and FHLB advances 4,043.6 (1,632.6) 2,411.0 10,608.4 (5,564.4) 5,044.0
Subordinated debt issued in connection
with/and Corporation-Obligated
mandatory redeemable capital
securities of subsidiary trusts 630.7 (103.7) 527.0 346.8 (272.8) 74.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 6,582.9 (3,212.9) 3,370.0 13,896.1 (12,609.1) 1,287.0
- ---------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in interest
differential $ 9,059.8 $ 2,119.2 $ 11,179.0 $ 12,166.8 $ (8,106.8) $ 4,060.0
=================================================================================================================================
The variance, not solely due to rate or volume, is allocated between the
rate and volume variances based upon their absolute relative weights to the
total change. Nonaccruing loans are included in average balances for purposes of
computing changes in average volume and rate. The net amount of loan origination
and commitment fees, net of certain direct loan origination costs for the years
ended December 31, 2004 and 2003 of $3.1 million and $2.8 million, respectively,
are included in interest income on loans, net.
58
Net Interest Income
Net interest income, the difference between interest income and interest
expense, is the most significant component of the Company's consolidated
earnings. Net interest income is positively impacted by a combination of
increases in earning assets over interest bearing liabilities, and an increase
in the net interest spread between earning assets and interest bearing
liabilities. Net interest income is adversely impacted by a combination of a
decrease in earning assets over interest bearing liabilities, and a decrease in
the net interest spread between earning assets and interest bearing liabilities.
Net interest income of $90.2 million on a tax equivalent basis for 2004 reflects
a 14.1 percent increase over the $79.1 million in 2003. Net interest income on a
tax equivalent basis for 2003 rose 5.4 percent over the $75.0 million for 2002.
Net interest income benefited from the increase in the excess of average
interest earning assets over average interest bearing liabilities to $403.5
million in 2004, from $394.3 million and $318.2 million in 2003 and 2002,
respectively.
Interest income is determined by the volume of, and related interest rates
earned on, interest earning assets. Interest income on a tax equivalent basis
for 2004 increased to $147.8 million or by 10.9 percent as compared to 2003,
which increased to $133.3 million or by 4.2 percent as compared to 2002. An
overall increase in volume in all categories of interest earning assets, except
federal funds sold and mortgage-backed securities, and an increase in average
rate on U.S. government agencies, mortgage-backed securities, federal funds
sold, and interest bearing deposits, partially offset by a decrease in the
average rate on loans, obligation of states and political subdivisions, and
corporate securities, FHLB stock and other securities contributed to a higher
level of interest income in 2004, as compared to 2003. An overall increase in
volume, partially offset by a decrease in the average rate in all categories,
contributed to a higher level of interest income in 2003, as compared to 2002.
The decrease in net interest income due to changes in average rate in 2004
compared to 2003 primarily resulted from lower loan yields due to a higher level
of floating rate loans, despite an increasing interest rate environment as a
result of the Federal Reserve raising short-term interest rates a total of 125
basis points during 2004. The decrease in net interest income due to changes in
average rate in 2003 compared to 2002 resulted from the general declining
interest rate environment.
Average interest earning assets increased in 2004 to $2,807.6 million over
the $2,555.1 million in 2003 and $2,054.1 million in 2002, reflecting a 9.9
percent and 24.4 percent increase in 2004 and 2003, respectively. The Company's
ability to make changes in the asset mix enables management to capitalize on
more desirable yields, as available, related to various interest earning assets.
Interest income on federal funds sold decreased in 2004 due to lower
volume, partially offset by a higher average rate, while such income decreased
in 2003 due to a lower average rate, offset by higher volume as compared to the
prior year. The level of federal funds sold is dependent upon the amount of loan
and deposit growth, cash flow requirements, and yields on alternative security
investments. To a lesser extent, investments in interest bearing deposits are
also an alternative to federal funds sold.
The average balances of total securities increased in both 2004 and 2003,
due principally to efforts to effectively leverage capital, as well as
management's efforts to balance the risk and liquidity of the entire portfolio.
Interest income on total securities increased in both 2004 and 2003 compared to
the prior years. The increase in 2004 was primarily due to higher volume for all
categories, except mortgage-backed securities, and higher average rates on U.S.
government agencies securities and mortgage-backed securities, partially offset
by a decrease in average interest rates on obligations of states and political
subdivisions and corporate securities, FHLB stock and other securities. The
increase in 2003 was primarily due to an increase in volume from U.S. government
agencies and mortgage-backed securities, partially offset by a decrease in
average interest rates on all securities. The decrease in average rates on
securities for 2003 was also impacted by the FHLB of New York temporarily
suspending the dividend on FHLB stock for the 2003 fourth quarter (approximately
$0.4 million).
Loans are the largest component of interest earning assets and, due to
their significance, are carefully reviewed with respect to the Company's overall
interest rate sensitivity position. Interest income on loans in 2004 and 2003
increased due to higher volume, partially offset by lower average rates. In
2004, average net loan balances increased $83.8 million to $1,475.5 million
compared to 2003, while average net loans increased $146.0 million in 2003 to
$1,391.7 million compared to 2002. Net loans outstanding increased $58.9 million
to $1,492.9 million at December 31, 2004 from $1,433.9 million at December 31,
2003, or a 4.1 percent increase, compared to an increase of $97.7 million, or
7.3 percent, in 2003 compared to 2002. Loan interest income was also negatively
impacted by interest income foregone on nonaccrual loans of $157,000 in 2004,
$404,000 in 2003, and $895,000 in 2002.
Interest expense is a function of both the volume and rates paid for
interest bearing liabilities. Interest expense in 2004 increased $3.4 million,
or 6.2 percent to $57.6 million, and in 2003 increased $1.3 million to $54.2
million, or 2.4 percent, compared to $52.9 million in 2002. Average balances in
all categories increased in both 2004 and 2003, except for savings deposits in
2004. Average retail, commercial, and municipal deposits increased in 2004 and
2003 primarily due to continuing growth of deposits in existing branches from
ongoing business development efforts, acquisition of brokered deposits of $25.0
million in both years, and also in 2004, due to the acquisition of Reliance
Bank. The 2003 increase was also attributable to the opening of two new New York
branches in Goshen (Orange County) and Eastchester (Westchester County). The
increase in interest expense on interest bearing deposits in 2004 and 2003 due
to volume was partially offset by a decrease in average rate in all categories,
except NOW accounts in 2004 and money market accounts in 2003.
59
Non-interest earning deposits are an integral aspect of liability
management and have a positive impact on the determination of net interest
income. The level of non-interest bearing average demand deposits increased 14.3
percent in 2004 to $322.8 million from $282.5 million in 2003, which was a 17.4
percent increase compared to $240.6 million in 2002.
The Company utilizes federal funds purchased, securities sold under
agreements to repurchase and FHLB advances ("borrowings") to fund loan growth in
excess of deposit growth and to leverage the Company's capital by funding
security investments. Interest expense increased on borrowings in 2004 and 2003
due to increases in volume, partially offset by a decrease in rates in both
years.
Subordinated debt issued in connection with/and Corporation-Obligated
mandatory redeemable securities of subsidiary trusts are issued to provide for
Tier I regulatory capital with interest that is deductible for federal and state
income tax purposes. Such securities are issued on both a fixed and floating
rate basis. Interest expense increased on these securities in both 2004 and 2003
due to an increase in securities issued, partially offset by a decrease in
average rate.
The net interest spread on a tax equivalent basis for the years ended
December 31, 2004, 2003, and 2002 is as follows:
Net Interest Spread Analysis
2004 2003 2002
- ----------------------------------------------------------------------------
Average interest rate on:
- --------------------------------------------------------------------------
Total average interest- 5.26% 5.22% 6.23%
earning assets
Total average interest-
bearing liabilities 2.39 2.51 3.05
Total average interest-
bearing liabilities and
demand deposits 2.11 2.22 2.68
- --------------------------------------------------------------------------
Net interest spread
excluding demand
deposits 2.87% 2.71% 3.18%
- --------------------------------------------------------------------------
Net interest spread
including demand
deposits 3.15% 3.00% 3.55%
==========================================================================
In 2004, the net interest spread increased due to a modest increase of the
overall yield on interest earning assets, while yields on interest bearing
liabilities declined, partially offset by increased leveraging of the balance
sheet at narrower spreads with shorter-term low interest rate borrowings to
maximize net interest spreads. In 2003, the net interest spread decreased due to
the continued low interest rate environment, combined with an asset sensitive
balance sheet, which caused yields on assets to decrease at a faster rate than
yields on interest bearing liabilities, as well as due to increased leveraging
of the balance sheet at narrower spreads.
Management has used its strong capital position to prudently leverage the
balance sheet resulting in increased levels of net interest income without
adding significant interest rate risk or operating expenses. Management believes
leveraging the balance sheet with the addition of floating rate securities will
protect interest income in a rising interest rate environment, while the
inclusion of fixed rate securities with reasonable periods of call protection
will mitigate the adverse effects on interest income if interest rates remain
low. Although the effects of balance sheet leveraging tend to decrease the net
interest spread, it adds net interest income without adding significant
operating costs.
The Company's balance sheet at December 31, 2004 is asset sensitive during
the short-term period (one year and less). The net interest margin is positioned
to continue to increase modestly if short-term interest rates continue to rise.
This is due to the asset sensitivity of the Company's balance sheet, which is
primarily the result of investments in floating rate securities and commercial
loans, which reprice based on spreads over the London Interbank Borrowing Rate
("LIBOR"), or the prime rate. If interest rates were to decline, or if
prepayments of loans and securities accelerated, the Company's net interest
income and net interest margin would be negatively affected. The flattening of
the yield curve may also negatively affect the net interest margin.
Non-Interest Income
Non-interest income consists of gains on sales of available for sale
securities, service charges and fees on deposit accounts, and other income. The
Company generates increases in non-interest income primarily from new and larger
existing retail and commercial deposit, and loan relationships, increased bank
services offered to retail and commercial customers, and prudently managing the
security portfolio in order to recognize gains on securities when appropriate.
Non-interest income for 2004 was $9.0 million compared to $16.0 million
for 2003, and $12.8 million in 2002. Non-interest income in 2004 reflects lower
gains on sales of available for sale security transactions of $7,184,000, lower
other income of $183,000, partially offset by increases in service charges and
fees of $316,000, as compared to 2003. The increase in 2003, as compared to 2002
is primarily due to higher gains on security transactions of $1,978,000, higher
other income of $707,000, and increases in service charges and fees of $597,000.
60
Gains on securities transactions in 2004 and 2003 were the result of gains
realized on sales of available for sale securities. The gains for the 2003
period on sales of available for sale securities were significantly higher, as
compared to 2004, primarily as a result of the larger amount of securities sold
($414.7 million) at higher premiums due to declining rates in that period,
especially of securities that would have otherwise been prepaid at par.
Service charges and fees on deposit accounts increased 8.0 percent in 2004
and 17.9 percent in 2003 compared to the prior years. The increases in 2004 and
2003 reflect higher NSF (non sufficient funds) income, primarily from higher
fees generated from commercial accounts.
The decrease in other income in 2004 reflects decreases in loan prepayment
and brokered loan fees, as well as decreases in other non-interest income. The
2004 decrease was partially offset by increases in merchant credit card income
and fee income on investment product sales. The 2003 increase in other income
primarily reflects higher loan prepayment and credit card fees, income from
merchant credit card transactions, fee income from investment product sales, and
other non-interest income. The 2003 increase was partially offset by lower
mortgage servicing income and lower letter of credit fees compared to the prior
year. Loan prepayment fees decreased in 2004 and increased in 2003, as compared
to the prior periods, due to a significant level of loan refinancing in the
lower interest rate environment during 2003. Letter of credit fees fluctuate
depending on the needs of the Bank's customer base, particularly those involved
in real estate development. Increases in other fee categories reflect increased
marketing efforts.
Non-Interest Expenses
Non-interest expenses are primarily incurred to support the existing
operations and growth of the Company, to increase its market share and customer
base, support the Company's investment in people and technology, and handle
administrative functions. Non-interest expenses rose to $51.5 million for 2004,
or 13.9 percent over the $45.2 million for 2003, compared to a 12.4 percent
increase in 2003 over the $40.3 million for 2002. These increases reflect
increased business volume and investments in people and technology consistent
with the Company's business strategy, and in 2004, approximately $1.7 million
for professional fees incurred in connection with litigation costs related to
the Dutch Hill Loan, compliance with the Sarbanes-Oxley Act of 2002, and the
Company's evaluation of strategic opportunities.
The Company's efficiency ratio (a lower ratio indicates greater
efficiency) that compares non-interest expense to total adjusted revenue
(taxable equivalent net interest income, plus non-interest income, excluding net
gains on securities transactions and loans held for sale) was 52.5 percent in
2004 compared to 52.2 percent in 2003, and 49.5 percent in 2002. The increase in
the efficiency ratio in 2004 and 2003, as compared to 2002, is partially due to
a lower net interest margin.
Salaries and employee benefits, the largest component of non-interest
expenses, rose 13.9 percent in 2004 to $30.9 million, compared to a 12.5 percent
increase in 2003 to $27.1 million from the $24.1 million in 2002. The increases
in both years reflect the costs of additional personnel necessary for the
Company to accommodate the increases in both deposits and loans, as well as
annual merit increases. In addition, the Company opened two new branches and one
new loan production office in 2003, which also increased the number of employees
in both years. Increases in salaries and employee benefits in both 2004 and 2003
were also attributable to higher medical costs and bonuses as a result of the
increase in the number of employees, which are necessary to be competitive in
attracting and retaining high quality and experienced personnel, as well as
costs associated with related payroll taxes and other employee benefits.
The percentages of salaries and employee benefits as a percentage of total
non-interest expenses for 2004, 2003, and 2002 is set forth in the following
table:
- ------------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------------
Employees at December 31,
Full-time employees 367 351 334
Part-time employees 43 34 42
- ------------------------------------------------------------------------------------------
Salaries and employee benefits (000's, except percentages)
- ------------------------------------------------------------------------------------------
Salaries $17,206 $15,280 $13,788
Payroll taxes 1,774 1,588 1,429
Medical plans 3,775 2,992 2,466
Incentive compensation plans 5,542 5,411 4,842
Deferred compensation and
employee retirement plans 1,948 1,268 1,123
Other 613 542 422
- ------------------------------------------------------------------------------------------
Total $30,858 $27,081 $24,070
==========================================================================================
Percentage of salaries and
employee benefits to total non-interest expenses 59.9% 59.9% 59.8%
==========================================================================================
Occupancy and equipment expenses increased in 2004 to $7.8 million, a 14.1
percent increase over the 2003 amount of $6.9 million, which represents an
increase of 10.0 percent over 2002. The increases are due to the acquisition of
Reliance Bank and its full service branch in 2004, the opening of two new
branches and a loan center in 2003, and increased utilization of the Corporate
Headquarters in both years. Equipment expense also increased in both years as a
result of higher maintenance costs associated with the in-house IBM AS-400
computer and capital investments over the last several years in systems designed
to enhance product delivery, communications, and bank-wide operating and
processing capabilities. The 2004 increase was partially offset by adjustments
of real estate taxes on owned properties. The 2003 increases were substantially
offset by lower utility costs and less depreciation expense due to fully
depreciating certain fixed assets.
61
Advertising and business development expense decreased to $2,622,000 a 2.8
percent decrease, compared to the $2,697,000 recorded in 2003, which reflects an
increase of 34.7 percent compared to 2002. The decrease in 2004 is primarily due
to lower costs incurred for promotional and special events. The increase in 2003
is principally due to mortgage/home equity loan and deposit promotional
campaigns, the expansion of the Chairman's Council business development campaign
programs, special events, and increased advertising of the Company's brand, "Do
business with us, do better with us."
Professional fees increased 97.7 percent to $2,796,000 in 2004 from
$1,414,000 in 2003, which was a 1.7 percent increase from the $1,391,000
recorded in 2002. The increase in 2004 reflects higher professional fees in
connection with litigation related to the Dutch Hill Loan, compliance with the
Sarbanes-Oxley Act of 2002, and the evaluation of strategic opportunities
undertaken in the latter part of 2004. The 2003 increase reflects increases in
consulting fees related to corporate efficiency, security enhancement projects,
regulatory examination fees, and higher professional fees associated with
collection and loan workout efforts related to the Dutch Hill Loan.
Communications expense increased 15.3 percent in 2004 to $1,506,000 from
$1,306,000 in 2003, a 19.6 percent increase from $1,092,000 in 2002. The
increase in both 2004 and 2003 reflects increased data and telephone lines to
support business growth.
Stationery and printing expense decreased 16.5 percent to $646,000 in 2004
from $774,000 in 2003 and 2.9 percent from $797,000 recorded in 2002. The
decreases in expense in 2004 and 2003 reflect the Company's increased use of
in-house printing and technology, partially offset by higher business volume in
both years.
Amortization of intangibles increased by $111,000 to $1,126,000 in 2004
compared to 2003, and increased by $92,000 to $1,015,000 in 2003 compared to
2002. The increases in 2004 and 2003 reflect additional amortization related to
the core deposit intangible allocated in the Reliance Bank acquisition in March
2004 and in 2003 a full year amortization of the core deposit intangible
allocated to the Fourth Federal Savings Bank branch acquired in October 2002,
respectively.
Other non-interest expenses, as reflected in the following table,
increased slightly in 2004 and increased 9.9 percent in 2003 compared to 2002.
The increases in 2004 and 2003 primarily reflects higher expenses due to
increased courier fees from additional locations and customer pick-ups, Internet
related fees, outside services and consulting fees, and in 2004, fees related to
the conversion of Reliance Bank. The increased other non-interest expenses in
2004 were substantially offset by a decrease in credit card related costs due to
lower accruals for bonus awards.
(000's, except percentages)
- --------------------------------------------------------------------------------
Other non-interest
expenses 2004 2003 2002
- --------------------------------------------------------------------------------
Other insurance $ 370 $ 367 $ 236
Courier fees 615 598 540
Dues, meetings, and
seminars 528 466 443
Outside services 1,018 761 638
U.S.B. Foundation, Inc. 250 250 252
Credit card related costs 346 760 630
Other 699 600 721
- --------------------------------------------------------------------------------
Total $3,826 $3,802 $3,460
- --------------------------------------------------------------------------------
Percentage of total non-interest expenses 7.4% 8.4% 8.6%
================================================================================
To monitor and control the level of non-interest expenses and non-interest
income, the Company continually monitors the system of internal budgeting,
including analysis and follow-up of budget and prior period variances.
Income Taxes
Income tax provisions of $13,860,000, $16,031,000, and $13,878,000 were
recorded in 2004, 2003, and 2002, respectively. The Company is currently subject
to a statutory Federal tax rate of 35.0 percent, the higher of a New York State
tax of 7.5 percent of New York State income, a tax on alternative income, or a
tax on assets, and a Metropolitan Transportation tax of 17 percent of the New
York State tax (as defined), a Connecticut State tax rate of 7.5 percent of
Connecticut State income, a New York City tax rate of 9.0 percent of New York
City income, and a Delaware State Franchise tax based on the number of
authorized shares. The Company paid a New York State tax on assets in 2004. The
Company's overall effective income tax rate was 33.1 percent in 2004, 35.4
percent in 2003, and 33.9 percent for 2002.
The lower effective income tax rate in all years as compared to statutory
rates primarily reflects lower state income taxes and investments in tax exempt
municipal bonds. As a result of a reduction in taxable income for state tax
purposes, the Company has established a valuation allowance at December 31, 2004
and 2003 in the amount of $2.6 million and $1.5 million, respectively, to
reserve for that amount of the state deferred tax asset totaling $2.6 million
and $1.9 million that is more likely than not, in management's judgment, not
realizable. Other pertinent income tax information is set forth in the Notes to
the Consolidated Financial Statements.
62
Securities Portfolio
Securities are selected to provide safety of principal and liquidity,
produce income on excess funds during structural changes in the composition of
deposits during cyclical and seasonal changes in loan demand, and to leverage
capital. The amount of securities purchased and maintained in the investment
portfolio is dependent on the level of deposit growth in excess of loan growth,
the ability to leverage capital, while maintaining adequate capital ratios and
managing interest rate risk, and the ability of the Bank to borrow wholesale
funds. In order to manage liquidity and control interest rate risk, the
Company's investment strategy focuses on a combination of securities that have
short maturities, adjustable-rate securities or those whose cash flow patterns
result in a lower degree of interest rate risk, and investments in fixed rate
securities with longer-term maturities and call options by the issuer to
maximize yield.
The Bank's investment policy includes a determination of the appropriate
classification of securities at the time of purchase. If management has the
positive intent and ability to hold securities until a forecasted recovery or
maturity occurs, they are classified as held to maturity and are carried at
amortized historical cost. Securities held for indefinite periods of time and
not intended to be held to maturity include securities that management intends
to use as part of its asset/liability strategy and that may be sold in response
to changes in interest rates, prepayment risk, and other factors. Such
securities are classified as available for sale and carried at estimated fair
value.
As of July 16, 2004, the Company transferred at fair value available for
sale U.S. government agency securities with an amortized cost basis and fair
value of approximately $307.6 million and $298.2 million, respectively, to held
to maturity. The unrealized loss of $9.4 million, $6.2 million net of tax, was
included as a component of other comprehensive income (loss) and is being
accreted over the remaining life of the securities transferred. Management does
not intend to sell these securities.
The Company has continued to exercise its conservative approach to
investing by purchasing high credit quality investments and controlling interest
rate risk by investing in securities with periodic cash flow or with interest
rates that reprice periodically, and longer-term maturities to complement the
asset/liability structure of the balance sheet. Generally, most securities may
be used to collateralize borrowings and public deposits. As a result, the
investment portfolio is an integral part of the Company's funding strategy. The
securities portfolio, including the Bank's investment in FHLB stock, of $1,122.9
million and $1,350.0 million at December 31, 2004 and 2003, consists of
securities held to maturity totaling $502.2 million and $238.0 million,
securities available for sale totaling $589.6 million and $1,081.4 million, and
FHLB stock of $31.1 million and $30.6 million, respectively.
Securities, including FHLB stock, represent 46.5 percent, 43.1 percent,
and 36.9 percent of average interest earning assets in 2004, 2003, and 2002,
respectively. Emphasis on the securities portfolio will continue to be an
important part of the Company's asset/liability strategy. The size of the
securities portfolio will depend on deposit and loan growth, the ability of the
Company to take advantage of leverage opportunities, and the availability of
high quality and rated securities with acceptable yields and structures. The
carrying value, estimated fair value, weighted average yields, and maturity
distributions of securities and information on securities in a gross unrealized
loss position are included in the Notes to the Consolidated Financial
Statements.
Obligations of U.S. government agencies principally include Federal Home
Loan Bank ("FHLB"), Fannie Mae and Freddie Mac debentures and notes. At December
31, 2004 and 2003, the outstanding balances held in such U.S. government agency
securities totaled $583.2 million and $796.4 million, respectively. For 2004,
U.S. government agency securities decreased $213.2 million as purchases of
$594.7 million in U.S. government agency bonds, net discount accretion of $0.6
million, and an increase in the fair value of available for sale securities of
$5.6 million were offset by net sales and redemptions of $805.0 million and a
reduction of $9.1 million as a result of the transfer from available for sale to
held to maturity as previously discussed. For 2003, U.S. government agency
securities increased $380.9 million as purchases of $859.2 million in U.S.
government agency bonds and net discount accretion of $0.4 million were
partially offset by net sales of $84.9 million, redemptions of $387.0 million
and a decrease in the fair value of available for sale securities of $6.8
million. In 2004 and 2003, the net new purchases were mostly in fixed rate and
floating rate (which contain maximum lifetime caps) callable U.S. government
agency securities as the yields and spreads on these obligations were considered
attractive.
The Company invests in mortgage-backed securities, including
collateralized mortgage obligations ("CMOs"), which are primarily issued by
Ginnie Mae, Fannie Mae, and Freddie Mac. Ginnie Mae securities are backed by the
full faith and credit of the U.S. Treasury, assuring investors of receiving all
of the principal and interest due from the mortgages backing the securities.
Fannie Mae and Freddie Mac guarantee the payment of interest at the applicable
certificate rate and the full collection of the mortgages backing the
securities. However, these securities are not backed by the full faith and
credit of the U.S. Treasury.
63
Mortgage-backed securities, including CMOs, decreased $24.4 million to
$423.7 million, and decreased $117.0 million to $448.1 million at December 31,
2004 and 2003, respectively. The decrease in 2004 was due to sales of $104.2
million, principal paydowns and redemptions of $156.9 million, and net premium
amortization of $0.1 million, partially offset by purchases of $234.0 million
and an increase in the estimated fair value of available for sale securities of
$2.8 million. The decrease in 2003 was due to sales of $329.7 million, principal
paydowns and redemptions of $272.5 million, a decrease in fair value of
available for sale securities of $6.8 million, and net premium amortization of
$1.3 million, partially offset by purchases of $493.3 million.
The following table sets forth additional information concerning
mortgage-backed securities, including CMOs, as of the periods indicated:
- ------------------------------------------------------------------------------------
(000's)
December 31,
- ------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------
U.S. government agency:
Mortgage-backed securities:
Fixed rate $164,609 $124,958 $364,684
Adjustable rate -- 2,078 2,463
Collateralized mortgage
obligations:
Fixed rate -- -- 22,603
Adjustable rate 259,030 321,011 175,093
Other 32 39 249
- ------------------------------------------------------------------------------------
Total $423,671 $448,086 $565,092
====================================================================================
Purchases and sales of mortgage-backed securities, including CMOs, are
transacted when management considers such activities appropriate in order to
react to market conditions to restructure the portfolio and manage interest rate
risk. Fixed rate mortgage-backed securities provide a higher yield and cash flow
for reinvestment in different interest rate environments. Fixed rate CMO
obligations generally provide shorter maturities and increased cash flow.
Interest rates on floating-rate CMO securities periodically adjust at certain
spreads to market indices and typically contain maximum lifetime caps. These
investments generally result in a shortening of the portfolio's average interest
rate repricing period. Mortgage-backed securities cash flow is sensitive to
changes in interest rates as principal prepayments generally accelerate during
periods of declining interest rates and decrease during periods of rising rates.
The outstanding balances in obligations of states and political
subdivisions at December 31, 2004 and 2003 were $84.8 million and $74.7 million
with purchases of $31.5 million and $22.1 million, and maturities and other
decreases of $21.4 million and $17.1 million during 2004 and 2003, respectively.
The obligations are principally New York State political subdivisions with
diversified final maturities and substantially all are classified as held to
maturity. The Company considers such securities as core investments having
favorable tax equivalent yields.
The Company invests in medium-term corporate debt securities, bank and
other equity securities, and other securities that are rated investment grade by
nationally recognized credit rating organizations at the time of purchase. The
Company had outstanding balances in corporate securities of $0.2 million at both
December 31, 2004 and 2003, respectively, consisting of bank and other equity
securities.
The total investment in FHLB stock was $31.1 million and $30.6 million at
December 31, 2004 and 2003, respectively. The increases in 2004 and 2003 reflect
purchases of $54.2 million and $17.1 million, partially offset by redemptions of
$53.7 million and $11.6 million, respectively. The Bank is a member of the FHLB
of New York. As a prerequisite to obtaining increased funding from the FHLB of
New York, the Bank may be required to purchase additional shares of FHLB of New
York stock. Conversely, the FHLB of New York may require the Bank to redeem
shares of FHLB of New York stock if the Bank's borrowings from the FHLB of New
York decline.
Except for securities of the U. S. government agencies (principally
callable and mortgage-backed securities), Freddie Mac, Ginnie Mae, Fannie Mae,
and FHLB, there were no obligations of any single issuer that exceeded ten
percent of stockholders' equity at December 31, 2004 and 2003.
Loan Portfolio
Loans represent the largest and highest yielding earning asset of the
Company. Loan volume is dependent on the Bank's ability to originate loans in
the competitive markets in which it operates. Critical factors include the
credit worthiness of borrowers, the economy of the Bank's markets, and the level
of interest rates. Also, impacting net loan growth is the level of loan
prepayments, which occur more frequently in the current low interest rate
environment. The Company continues to originate a significant portion of loans
collateralized by real estate within the markets it primarily conducts business.
The favorable economic conditions for both commercial and residential real
estate and the credit worthiness of new and existing customers allowed the Bank
to increase net loans outstanding in 2004 and 2003, in spite of a high level of
loan prepayments.
64
The increase in the loan portfolio and maintaining the loan portfolio's
performance is an integral part of the Company's business strategy and revenue
growth. During 2004, the average balance of net loans of the Company increased
$83.8 million to $1,475.5 million, and increased $146.0 million in 2003 to
$1,391.7 million, as compared to the 2002 average balance of $1,245.7 million.
At December 31, 2004, loans outstanding increased $59.4 million to $1,508.1
million, or a 4.1 percent increase compared to loans outstanding at December 31,
2003. The 2004 loan growth resulted from: an increase in construction and land
development loans of $20.7 million; an increase in residential mortgage loans of
$10.0 million; an increase in time and demand loans of $26.9 million; an
increase in home equity loans of $19.7 million; an increase in credit card loans
of $0.8 million; and an increase in other loan categories, net of deferred
commitment fees, of $3.0 million; partially offset by decreases in commercial
mortgages and installment loans of $20.9 million and $0.8 million, respectively.
Loans outstanding at December 31, 2003 increased $98.2 million to $1,448.7
million, or 7.3 percent as compared to loans outstanding at December 31, 2002.
The 2003 loan growth resulted from: an increase in construction and land
development loans of $33.0 million; an increase in commercial real estate loans
of $46.2 million; an increase in residential mortgages of $8.4 million; an
increase in home equity loans of $5.3 million; an increase in time and demand
loans of $6.8 million; and an increase in other loan categories, net of deferred
commitment fees, of $0.2 million; partially offset by decreases in installment
loans and credit card loans of $1.6 million and $0.1 million, respectively.
Real estate collateralized loans consisting of construction mortgages,
interim and permanent commercial mortgages, home equity, and residential
mortgages represent 87.6 percent and 89.1 percent of total gross loans at
December 31, 2004 and 2003, respectively. Commercial mortgages, residential
mortgages, and construction and land development loans, which in the aggregate
increased significantly in both 2004 and 2003 will continue to be emphasized, as
these loans represent quality real estate secured loans. At December 31, 2004
and 2003, the Company had approximately $221.6 million and $267.9 million of
committed but unfunded commercial mortgage loans, construction and land
development loans, and $83.0 million and $60.6 million of committed and unfunded
residential mortgage loans (both first and junior liens), respectively.
Time and demand loans are loans to businesses and individuals that are
secured by collateral other than real estate (i.e., accounts receivable and
inventory) or are unsecured. These loans increased to $165.9 million in 2004
from $139.0 million in 2003, and $132.2 million in 2002, as the Company
continues to diversify its loan portfolio and an increasing number of commercial
customers (including commercial real estate customers) borrowed from their lines
of credit. Installment loans to individuals and businesses decreased in 2004 to
$7.8 million from $8.6 million in 2003, which was a decrease from $10.2 million
in 2002, as the Company experienced significant competition for these loans.
The Bank currently provides Union State Bank Visa and MasterCard credit
cards. At December 31, 2004 and 2003, the Bank had unused credit card lines of
$36.2 million and $34.2 million, and outstanding balances of $6.4 million and
$5.6 million, respectively. The credit card business allows the Company to
increase its consumer lending.
At December 31, 2004 and 2003, time and demand, installment, credit card,
and other loans represented 12.4 percent and 10.9 percent of gross loans,
respectively.
It is the Company's policy to discontinue the accrual of interest on loans
when, in the opinion of management, a reasonable doubt exists as to the timely
collectibility of the amounts due. Regulatory requirements generally prohibit
the accrual of interest on certain loans when principal or interest is due and
remains unpaid for 90 days or more (with the exception of credit card loans for
which the criteria is 180 days past due). Nonaccrual loans, which are primarily
collateralized by real estate, decreased at December 31, 2004 to $1.6 million
compared to $6.1 million at December 31, 2003, and $12.5 million as of December
31, 2002.
Net income is adversely impacted by the level of non-performing assets
caused by the deterioration of the borrowers' ability to meet scheduled interest
and principal payments. In addition to forgone revenue, the Company must
increase the level of provisions for credit losses, incur collection costs, and
other costs associated with the management and disposition of foreclosed
properties.
The most significant non-performing loans have typically been construction
and real estate related commercial loans, and commercial lease finance loans.
Although the Bank has an aggressive foreclosure policy, the process is often
slow and can be hampered by legal and market factors. Loans considered to be
impaired were $1.3 million and $5.6 million at December 31, 2004 and 2003,
respectively. Net loan charge-offs against the allowance for loan losses were
$3,212,000 in 2004, compared to $1,885,000 in 2003 and $2,192,000 in 2002. The
charge-offs in 2004, 2003, and 2002 reflect $3.2, million, $1.8 million, and
$1.4 million, respectively, related to the Dutch Hill Loan, and in 2002,
charge-offs of $0.6 million related to the final settlement of a lease finance
company loan. The decrease in non-performing loans in 2004 and 2003 is primarily
due to the reduction of the Dutch Hill Loan from principal payments and
charge-offs, which were partially offset by advances to complete the
construction and maintain the operations of the project. For further information
on non-performing loans, see Note 5 to the Notes to Consolidated Financial
Statements.
65
Allowance for Loan Losses
The loan portfolio is evaluated on an ongoing basis. A comprehensive
evaluation of the quality of the loan portfolio is performed by management on a
quarterly basis as an integral part of the credit administration function, which
includes the identification and evaluation of past due loans, non-performing
loans, impaired loans and potential problem loans, assessments of the expected
effects of the current economic environment, applicable industries, geographic
and customer concentrations within the loan portfolio, and a review of
historical loss experience.
The allowance for loan losses of $15.2 million and $14.8 million at
December 31, 2004 and 2003, respectively, is available to absorb charge-offs
from any loan category, while additions are made through charges to income and
recoveries of loans previously charged-off. In addition to the allowance for
loan losses (the "allowance"), a reserve for credit losses related to unfunded
loan commitments and standby letters of credit (the "reserve") at December 31,
2004 and 2003 of $542,000 and $536,000, respectively, is included in other
liabilities.
Based upon management's assessment of the degree of risk associated with
the various elements of the loan portfolio, it is estimated that at December 31,
2004 and 2003, 9 percent and 9 percent of the allowance and the reserve is
applicable to time and demand loans, 84 percent and 85 percent is related to
loans collateralized by real estate, including commercial and construction
loans, 4 percent and 4 percent is applicable to installment, credit card and
other loans, and 3 percent and 2 percent are unallocated, respectively.
As with any financial institution, poor economic conditions, and high
inflation, interest rates or unemployment may lead to increased losses in the
loan portfolio. Conversely, improvements in economic conditions tend to reduce
the amounts charged against the allowance. Management has established various
controls, in addition to Board approved underwriting standards, in order to
limit future losses, such as (1) a "watch list" of possible problem loans, (2)
various loan policies concerning loan administration (loan file documentation,
disclosures, approvals, etc.), and (3) a loan review staff employed by the
Company, as well as outside loan review consultants, to determine compliance
with established controls, and to review the quality and identify anticipated
collectibility issues of the portfolio. Management determines which loans are
uncollectible and makes additional provisions, as necessary, to state the
allowance and the reserve at the appropriate levels.
Management takes a prudent and cautious position in evaluating various
business and economic uncertainties in relation to the Company's loan portfolio.
In management's judgment, the allowance and reserve are considered adequate to
absorb losses inherent in the credit portfolio. A substantial portion (87.6
percent at December 31, 2004) of total gross loans of the Company is
collateralized by real estate, primarily located in the New York Metropolitan
area. The collectibility of the loan portfolio of the Company is subject to
changes in the real estate market in which the Company operates. The provisions
for credit losses established in 2004, 2003, and 2002, and the related allowance
and reserve reflect net charge-offs and losses incurred with respect to real
estate, time and demand, installment, credit card, and other loans, and the
effect of the real estate market and general economic conditions of the New York
Metropolitan area on the loan portfolio.
Management believes the allowance and the reserve at December 31, 2004
appropriately reflects the risk elements inherent in the total credit portfolio
at that time. There is no assurance that the Company will not be required to
make future adjustments to the allowance or the reserve in response to changing
economic conditions or regulatory examinations. During 2004, the New York State
Banking Department completed an examination of the Bank, and the Federal Reserve
completed an examination of the Company in January 2005. As a result of these
examinations, no adjustments to the allowance or the reserve were required.
Loan Maturities and Sensitivity to Changes in Interest Rates
The following table presents the maturities of loans outstanding at
December 31, 2004 (excluding installment loans to individuals and real estate
loans other than construction loans), and the amount of such loans by maturity
date that have predetermined interest rates and the amounts that have floating
or adjustable rates.
66
- -------------------------------------------------------------------------------------------------
(000's, except percentages)
After
1 But
Within Within After
1 Year 5 Years 5 Years Total Percent
- -------------------------------------------------------------------------------------------------
Loans:
Time and demand loans $102,194 $ 49,591 $ 14,099 $165,884 35%
Commercial installment loans 39 5,806 270 6,115 1
Mortgage construction loans 210,908 90,691 -- 301,599 64
- -------------------------------------------------------------------------------------------------
Total $313,141 $146,088 $ 14,369 $473,598 100%
- -------------------------------------------------------------------------------------------------
Rate Sensitivity:
- -------------------------------------------------------------------------------------------------
Fixed or predetermined interest rates $ 72,397 $ 35,446 $ 11,409 $119,252 25%
Floating or adjustable interest rates 240,744 110,642 2,960 354,346 75
- -------------------------------------------------------------------------------------------------
Total $313,141 $146,088 $ 14,369 $473,598 100%
=================================================================================================
Percent 66% 31% 3% 100%
=================================================================================================
Contractual Obligations
In the normal course of business, the Company incurs contractual
obligations. A summary of all significant contractual obligations as of December
31, 2004 are summarized below:
- --------------------------------------------------------------------------------------------
(000's, except percentages)
After 1 After 3
But But
Within Within 3 Within 5 After 5
Contractual Obligations 1 Year Years Years Years Total
- --------------------------------------------------------------------------------------------
Operating Lease Obligations $ 996 $ 1,476 $ 1,095 $ 574 $ 4,141
Borrowings 38,203 50,039 85,044 451,746 625,032
Time deposits 426,398 272,104 55,215 -- 753,717
Employment agreements 2,901 5,833 5,284 -- $ 14,018
- --------------------------------------------------------------------------------------------
Total $ 468,498 $ 329,452 $ 146,638 $ 452,320 $1,396,908
============================================================================================
Further information is included in Note 6, Note 7, Note 9, and Note 16 to
the Consolidated Financial Statements, as applicable.
Off Balance Sheet Commitments
Off balance sheet commitments incurred in the normal course of business as
of December 31, 2004 are summarized below:
- --------------------------------------------------------------------------------
(000's, except percentages)
After 1 After 3
But But
Within Within 3 Within 5 After 5
Commercial Commitments 1 Year Years Years Years Total
- --------------------------------------------------------------------------------
Lines of credit $412,227 $ -- $ -- $ -- $412,227
Standby Letters of credit 41,348 -- -- -- 41,348
Other loan commitments
-- Commercial 55,165 -- -- -- 55,165
-- Residential 25,463 -- -- -- 25,463
- --------------------------------------------------------------------------------
Total $534,203 $ -- $ -- $ -- $534,203
================================================================================
Lines of credit in the above table are available upon demand. It is not expected
that standby letters of credit will be funded. Other loan commitments represent
committed but not yet funded commercial and residential real estate loans.
67
Deposits
The Company's fundamental source of funds supporting interest earning
assets continues to be deposits, consisting of demand deposits (non-interest
bearing), NOW, money market, savings, and various forms of time deposits. Retail
deposits are obtained primarily by mass marketing efforts and are fee and
interest rate sensitive. Commercial deposits are generally obtained through
direct marketing and business relationship development efforts, as well as a
result of lending relationships. The maintenance of a strong deposit base is key
to the development of lending opportunities and creates long-term customer
relationships, which enhance the ability to cross sell services. Depositors
include individuals, small and large businesses, and governmental units. To meet
the requirements of a diverse customer base, a full range of deposit instruments
are offered, which has allowed the Company to maintain and expand the deposit
base despite intense competition from other banking institutions and non-bank
financial service providers.
Total deposits at December 31, 2004 increased 4.7 percent to $1,858.2
million from $1,775.0 million at December 31, 2003, and 14.4 percent from
$1,551.8 million as of December 31, 2002. Excluding municipal time deposits,
which are acquired on a bid basis, and brokered time deposits, total deposits
increased to $1,695.5 million or by 2.8 percent as of December 31, 2004 and to
$1,649.0 million or by 13.9 percent as of December 31, 2003. Average deposits
outstanding increased to $1,878.8 million or by 9.8 percent in 2004, and to
$1,711.4 million or by 14.2 percent in 2003 from the $1,498.3 million as of
December 31, 2002. Average deposits, excluding municipal time deposits and
brokered time deposits, increased to $1,735.3 million or by 9.8 percent in 2004
and to $1,580.1 million or by 14.1 percent in 2003 compared to the prior year.
Average non-interest bearing deposits increased 14.3 percent to $322.8
million in 2004 compared to 2003, and 17.4 percent to $282.5 million in 2003
compared to 2002, due to expansion of the branch network and business
development efforts. The 2004 increase was also attributable to $4.9 million of
non-interest bearing deposits assumed from Reliance Bank.
Average interest bearing deposits in 2004 increased $127.1 million and in
2003 increased $171.1 million, reflecting increases in all deposit categories,
except for savings deposits in 2004. Average balances in NOW deposits increased
$30.5 million in 2004 and $40.6 million in 2003, due principally to new and
increased account activity by customers and an increase in average municipal
deposits. The increase of $64.5 million in 2004 and $68.6 million in 2003 in
average money market deposit balances principally resulted from an increase due
to the offering of attractively priced accounts in select markets and branch
locations, and an increase in average municipal deposits in both years. Savings
deposits average balances decreased $8.9 million and increased $2.0 million in
2004 and 2003, respectively. The 2004 decrease was due to customers seeking more
competitive products as a result of lower yields offered during this period of
low interest rates, partially offset by $5.8 million of savings deposits assumed
in the Reliance Bank acquisition.
In 2004 and 2003, average time deposits outstanding increased $41.0
million and $59.9 million, respectively. Average time deposits increased in 2004
primarily by obtaining municipal and brokered time deposits with medium to
long-term maturities by offering attractive rates. The 2004 increase was also
due to $13.3 million of time deposits assumed in the Reliance Bank acquisition.
Average time deposits increased in 2003, primarily by obtaining retail and
brokered time deposits with medium to long-term maturities by offering
attractive rates, and in both 2003 and 2004 by offering a one time rate increase
option on retail accounts during periods of historically low interest rates.
Municipal and brokered time deposits are used to fund loan growth, in
excess of retail and commercial deposit growth, security purchases, and to
leverage the balance sheet. Average municipal deposits increased $30.2 million
in 2004 and $20.0 million in 2003 to provide funding of average earning assets
growth. In 2004 and 2003, brokered time deposits of $25.0 million were acquired
in each year as management obtained longer-term maturity deposits during a low
interest rate period. In 2004 and 2003, average time deposits over $100,000
(including municipal deposits) increased $22.0 million and $11.5 million,
respectively, compared to the prior years. Deposits of over $100,000 are
generally for maturities of 30 to 180 days and are acquired to fund loans and
securities and to leverage excess capital by matching such funds with
investments and loan production in excess of deposit growth.
Deposit costs generally decreased in 2004 and 2003 during periods of lower
interest rates. However, the Federal Reserve Bank increased short-term interest
rates 125 basis points during 2004, which caused deposit rates to begin to
increase in the latter part of the year, and, therefore, average deposit yields
decreased at a lesser rate compared to the decrease in 2003, as compared to the
prior year. At December 31, 2003, short-term rates remained low compared to
longer-term rates due to the Federal Reserve Bank lowering short-term interest
rates by 50 basis points during 2003. It is expected that depositors will
continue to favor short-term deposit products to react quickly to the uncertain
interest rate environment, which will result in higher volatility of net
interest margins due to the quick repricing of deposits during periods of both
rising and declining interest rates.
68
The following table summarizes the average amounts and rates of various
classifications of deposits for the periods indicated:
- ------------------------------------------------------------------------------------------------
(000's, except percentages)
Year Ended December 31,
2004 2003 2002
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
- ------------------------------------------------------------------------------------------------
Demand deposits $ 322,753 --% $ 282,469 --% $ 240,578 --%
NOW accounts 167,787 0.44 137,270 0.42 96,654 0.67
Money market accounts 222,829 1.21 158,303 1.26 89,689 1.13
Savings deposits 426,031 0.56 434,945 0.64 432,942 1.14
Time deposits 739,379 2.49 698,372 2.64 638,485 3.29
- ------------------------------------------------------------------------------------------------
Total $1,878,779 1.29% $1,711,359 1.39% $1,498,348 1.84%
================================================================================================
Capital Resources
Strong capitalization is fundamental to the successful operation of a
banking organization. Management believes that the Corporation-Obligated
mandatory redeemable capital securities of subsidiary trusts ("Capital
Securities") and related junior subordinated debt, future retained earnings and
stock purchases under the employee benefit plans will provide the necessary
capital for current operations and the planned growth in total assets. In
addition, capital growth can be acquired through the reinstatement of the
Company's Dividend Reinvestment and Optional Stock Purchase Plan, which has been
suspended, as well as by issuance of securities in the capital markets.
Stockholders' equity increased to $182.0 million in 2004, or 8.2 percent
compared to $168.3 million in 2003, and increased 7.9 percent in 2003 over the
$156.0 million in 2002. The increase in 2004 was attributable to net income of
$28.1 million, common stock options exercised and related tax benefit of $2.9
million, and other increases of $0.4 million, partially offset by cash dividends
of $9.6 million, purchases of treasury stock of $7.1 million, and an increase in
accumulated other comprehensive loss of $1.0 million. The increase in 2003 was
attributable to net income of $29.3 million, common stock options exercised and
related tax benefit of $4.5 million and other increases of $0.3 million,
partially offset by cash dividends of $7.6 million, purchases of treasury stock
of $6.2 million, and an increase in accumulated other comprehensive loss of $8.0
million.
The Company manages capital through its earnings, stock plans, dividend
policy, and stock repurchase programs. During 2004 and 2003, the Company
acquired 329,771 and 367,685 common shares, respectively, through stock
repurchase plans and common shares tendered in connection with stock option
exercises.
Cash dividends on the Company's common stock have been paid since 1986,
the first dividend paid in the Company's history. In the first quarter of 1988,
the Board of Directors authorized a quarterly cash dividend policy. Junior
preferred stock dividends issued by TPNZ were approximately $10,000 in 2004,
2003, and 2002.
The various components and changes in common stockholders' equity are
reflected in the Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2004, 2003, and 2002.
All banks and bank holding companies are subject to risk-based capital
guidelines. These guidelines define capital as Tier I and Total capital. Tier I
capital consists of common stockholders' equity, qualifying preferred stock and
Capital Securities, less intangibles and accumulated other comprehensive income
(loss). Total capital consists of Tier I capital plus the allowance for loan
losses and reserve related to unfunded loan commitments and standby letters of
credit up to certain limits, qualifying preferred stock and certain subordinated
and long term-debt securities. The guidelines require a minimum total risk-based
capital ratio of 8.0 percent, and a minimum Tier I risk-based capital ratio of
4.0 percent.
In accordance with new accounting principles adopted as of December 31,
2003, the Company has deconsolidated its investment in the Trusts, which have
issued Capital Securities. As a result of this deconsolidation, the financial
statements at December 31, 2004 and 2003 reflect subordinated debt issued by the
Company in connection with Capital Securities, along with the Company's
investment in common equity of the Trusts. The Federal Reserve has reevaluated
the regulatory implications of this accounting change on capital treatment of
the Capital Securities and has issued a final rule that retains the Tier I
Capital treatment of the Capital Securities with certain modifications. The
final rule will not affect the Company's treatment of the Capital Securities as
Tier I Capital.
69
The risk-based capital ratios were as follows at December 31:
- --------------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
Tier I Capital:
Company 14.15% 12.80% 12.55%
Bank 13.93% 12.49% 12.37%
- --------------------------------------------------------------------------------
Total Capital:
Company 15.07% 13.70% 13.58%
Bank 14.85% 13.39% 13.32%
================================================================================
The Bank and Company must also maintain a minimum leverage capital ratio
of at least 4 percent, which consists of Tier I capital based on risk-based
capital guidelines, divided by average quarterly tangible assets (excluding
intangible assets that were deducted to arrive at Tier I capital).
The leverage capital ratios were as follows at December 31:
- --------------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
Company 8.15% 7.54% 8.36%
Bank 8.00% 7.34% 8.48%
================================================================================
To be considered "well capitalized" under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), an institution must generally
have a leverage capital ratio of at least 5 percent, Tier I capital ratio of 6
percent, and Total capital ratio of 10 percent. The Bank exceeds all current
regulatory capital requirements and was in the "well capitalized" category at
December 31, 2004. Management fully expects that the Company and the Bank will
maintain a strong capital position in the future.
For additional information on the Company's and Bank's Regulatory Capital
requirements see Note 12 to the Consolidated Financial Statements.
Liquidity
As a banking institution, liquidity is of the utmost importance. The
Company acquires funding through its retail and commercial deposits operations
and through wholesale funding through borrowings, generally on a secured basis.
Liquidity is also provided through cash flow from loan and investment security
scheduled principal and interest payments, as well as prepayment of such assets.
The Company's contractual obligations are discussed under "Commitments and
Contractual Obligations," and, including investments in fixed assets, are not
considered significant to the Company's overall liquidity requirements.
Discussion of the various sources and uses of liquidity are discussed in detail
below.
The Asset/Liability Committee ("ALCO") establishes specific policies and
operating procedures governing the Company's liquidity levels and develops plans
to address future liquidity needs. The primary functions of asset/liability
management are to provide safety of depositor and investor funds, assure
adequate liquidity, and maintain an appropriate balance between interest earning
assets and interest bearing liabilities. Liquidity management involves the
ability to meet the cash flow requirements of customers who may be either
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. ALCO has also
established an ALCO Investment Subcommittee ("Investment Committee"), which
discusses investment and borrowing strategies on a more technical level. The
Investment Committee is critical in developing appropriate strategies to
effectively manage the Bank's investment portfolio, wholesale borrowings, and
leverage strategies.
Aside from cash on hand and due from banks, liquid assets are federal
funds sold, which are available daily, and interest bearing deposits with banks.
Excess liquid funds are invested by selling federal funds, which mature daily,
to other financial institutions in need of funds. At December 31, 2004 and 2003,
the Bank sold overnight federal funds in the amounts of $17.0 million and $10.0
million, respectively. Average balances of overnight federal funds sold for the
year ended December 31, 2004 and 2003 were $27.5 million and $61.4 million,
respectively.
Other sources of asset liquidity include maturities of and principal and
interest payments on securities and loans. The security and loan portfolios are
of high credit quality and of mixed maturity, providing a constant stream of
maturing and reinvestable assets, which can be converted into cash should the
need arise. The ability to redeploy these funds is an important source of medium
to long-term liquidity. The amortized cost of securities available for sale and
held to maturity having the earlier of contractual maturities, expected call
dates or weighted average lives of one year or less amounted to $160.0 million
at December 31, 2004. This represented 14.7 percent of the amortized cost of the
securities portfolio, compared to 6.1 percent at December 31, 2003. The
foregoing amount reflects mortgage-backed securities maturities based on a
weighted average life, which does not consider monthly principal payments and
prepayments received on these securities. Including the estimated cash flow from
principal payments of mortgage-backed securities, the total cash flow of the
security portfolio in the one year time frame is approximately $364.0 million at
December 31, 2004, or 33.3 percent of the amortized cost of the securities
portfolio. Excluding installment loans to individuals and real estate loans
other than construction loans, $313.1 million, or 66.0 percent of such loans at
December 31, 2004 mature in one year or less.
As a preferred seller of mortgages to both Freddie Mac and FNMA, the Bank
may also increase liquidity by selling residential mortgages, or exchanging them
for mortgage-backed securities that may be sold, in the secondary market.
Residential mortgages may also be used as collateral for borrowings from the
FHLB.
70
Demand deposits from individuals, businesses and institutions, as well as
other transactional accounts and retail time deposits ("core deposits") are a
relatively stable source of funds. The deposits of the Bank generally have shown
a steady growth trend. The trend of the deposit mix has generally been with a
larger percentage of funds in demand accounts, savings deposits, and
shorter-term certificates of deposit.
The Bank pledges certain of its assets as collateral for deposits of
municipalities, FHLB borrowings, and securities sold under agreements to
repurchase. The Bank had advances aggregating $82.7 million from the FHLB and
borrowed $542.3 million under securities sold under agreements to repurchase at
December 31, 2004. By utilizing collateralized funding sources, the Bank is able
to access a variety of cost effective sources of funds. However, the pledging of
assets for borrowings reduces the Bank's ability to convert such assets to cash
as the need arises. The assets pledged consisting of residential real estate
loans, U.S. government agency, obligations of states and political subdivisions,
and mortgage-backed securities totaled $900.4 million and $1,162.1 million at
December 31, 2004 and 2003, respectively.
Additional liquidity is provided by the ability to borrow from the Federal
Reserve Bank's discount window, which borrowings must be collateralized with
U.S. Treasury or government agency securities. The Bank has never used its
ability to borrow from the discount window. Management monitors its liquidity
requirements by assessing assets pledged, the level of assets available for
sale, additional borrowing capacity, and other factors. Based upon certain
assets that are available for pledge as collateral, the Bank has the potential
to borrow up to an additional $496.7 million as of December 31, 2004. The Bank
may also borrow up to $75.0 million overnight under federal funds purchase
agreements with six correspondent banks.
Another source of funding for the Company is capital market funds, which
includes preferred stock, convertible debentures, the Capital Securities, common
stock, and long-term debt qualifying as regulatory capital.
Each of the Company's sources of liquidity is vulnerable to various
uncertainties beyond the control of the Company. Scheduled loan and security
payments are a relatively stable source of funds, while loan and security
prepayments and calls, and deposit flows vary widely in reaction to market
conditions, primarily prevailing interest rates. Asset sales are influenced by
pledging activities, general market interest rates, and other unforeseen market
conditions. The Company's financial condition is affected by its ability to
borrow at attractive rates, retain deposits at market rates, and other market
conditions.
Management considers the Company's sources of liquidity to be adequate to
meet expected funding needs and also to be responsive to changing interest rate
markets.
Market Risk
Market risk is the potential for economic losses to be incurred on market
risk sensitive instruments arising from adverse changes in market indices such
as interest rates, foreign currency exchange rates, and commodity prices. Since
all Company transactions are primarily denominated in U.S. dollars with no
direct foreign exchange or changes in commodity price exposures, the Company's
primary market risk exposure is interest rate risk.
Interest rate risk is the exposure of net interest income to changes in
interest rates. Interest rate sensitivity is the relationship between market
interest rates and net interest income due to the repricing characteristics of
assets and liabilities. If more liabilities than assets reprice in a given
period (a liability-sensitive position), market interest rate changes will be
reflected more quickly in liability rates. If interest rates decline, such
positions will generally benefit net interest income, while an increase in rates
will have an adverse effect on net interest income. Alternatively, where assets
reprice more quickly than liabilities in a given period (an asset-sensitive
position), a decline in market rates would have an adverse effect on net
interest income, while an increase in rates would have a positive impact.
Changes in the shape of the yield curve will also impact net interest
income for institutions such as the Bank, which price assets at varying terms,
while liabilities are generally shorter-term. Generally, a steep yield curve
(i.e., lower short-term rates and higher medium to long-term rates) will have a
positive effect on net interest income, while a flatter or inverted yield curve
will have a negative effect. Excessive levels of interest rate risk can result
in a material adverse effect on the Company's future financial condition and
results of operations. Accordingly, effective risk management techniques that
maintain interest rate risk at prudent levels are essential to the Company's
safety and soundness.
Substantially, all market risk sensitive instruments are held to maturity
or available for sale. The Company does not acquire any significant amount of
financial instruments for trading purposes. Federal funds, both purchased and
sold, on which rates change daily, and loans and deposits tied to certain
indices, such as the prime rate and LIBOR, are the most market rate sensitive
and have the most stable fair values. The least sensitive instruments include
long-term fixed rate loans and securities, floating and fixed rate securities
with call options, and fixed rate certificates of deposits, which have the least
stable fair values. On those types falling between these extremes, the
management of maturity and repricing distributions is as important as the
balances maintained.
71
The management techniques for maturity and repricing distributions involve
the matching, or mismatching to increase net interest spreads, of interest rate
maturities, as well as principal maturities, and is a key determinant of net
interest income. In periods of rapidly changing interest rates, an imbalance
("gap") between the rate sensitive assets and liabilities can cause fluctuations
in net interest income and earnings. Establishing patterns of sensitivity that
will enhance future growth regardless of frequent shifts in market conditions is
one of the objectives of the Company's asset/liability management strategy.
Evaluating the Company's exposure to changes in interest rates is the
responsibility of ALCO and includes assessing both the adequacy of the
management process used to control interest rate risk and the quantitative level
of exposure. When assessing the interest rate risk management process, the
Company seeks to ensure that appropriate policies, procedures, management
information systems, and internal controls are in place to maintain interest
rate risk at appropriate levels. Evaluating the quantitative level of interest
rate risk exposure requires the Company to assess the existing and potential
future effects of changes in interest rates on its consolidated financial
condition, including capital adequacy, earnings, deposit base, borrowings,
liquidity, and asset quality.
The Company uses two methods to evaluate its market risk to changes in
interest rates, a "Static Gap" evaluation and a simulation analysis of the
impact of a gradual parallel shift and gradual modified shift (flattening yield
curve) in interest rates on the Company's net interest income.
As further discussed below, the "Static Gap" analysis shows the Company as
asset sensitive in the one-year time frame and the simulation analysis also
indicates an asset sensitive position. The simulation analysis more closely
reflects the expected behavior of certain deposit accounts that do not reprice
to the full extent of changes in interest rates (i.e., NOW, money market and
savings accounts). The Company believes the simulation analysis is a more
accurate analysis of its interest rate risk.
The "Static Gap" is presented in the table on page 74. Balance sheet items
are categorized by contractual maturity, expected weighted average lives for
mortgage-backed securities, or repricing dates, with floating rate securities
and loans constituting the bulk of the floating rate category. The determination
of the interest rate sensitivity of non-contractual items is arrived at in a
subjective fashion. Passbook and statement savings accounts, NOW, and money
market accounts are viewed as a relatively stable source of funds and less price
sensitive and are therefore classified partially as short-term and partially as
intermediate term funds.
At December 31, 2004, the "Static Gap" shows a positive cumulative gap of
$181.2 million or 6.9 percent of interest earning assets in the one day to one
year repricing period, due principally to a higher level of floating rate assets
and assets that reprice within one year or less, and the treatment of deposit
accounts as previously discussed above. The increase in floating rate and
short-term repricable assets reflects management's strategy of positioning the
balance sheet as asset sensitive in anticipation of an increase in interest
rates, while longer-term loans and securities are originated or purchased to
maximize yield and provide protection if rates decrease. A significant portion
of the loans in the over one year to five years category represents three and
five year adjustable rate commercial mortgages. Origination of such loans has
allowed the Company to generate an asset repriceable within three to five years
to reduce long-term interest rate risk.
The simulation analysis estimates the effect of an increase or decrease of
the yield curve on interest rates and the resulting impact on net interest
income. This analysis incorporates management's assumptions about maturities and
repricing of existing assets and liabilities, without consideration of future
growth or other actions that may be taken to react to changes in interest rates
and changing relationships between interest rates (i.e. basis risk). These
assumptions have been developed through a combination of historical analysis and
future expected pricing behavior.
For a given level of market interest rate changes, the simulation analysis
can consider the impact of the varying behavior of cash flows from principal
prepayments on the loan portfolio and mortgage-backed securities, call
activities on investment securities, and consider embedded option risk by taking
into account the effects of interest rate caps and floors. The Company assesses
the results of the simulation analysis on a quarterly basis and, if necessary,
implements suitable strategies to adjust the structure of its assets and
liabilities to reduce potential unacceptable risks to net interest income.
Net interest income is forecasted using rising and declining interest rate
scenarios. A base case scenario, in which current interest rates remain stable,
is used for comparison to other scenario simulations.
The Company's policy limit on interest rate risk, as measured by the
simulation analysis, is that if interest rates were to gradually increase 200
basis points, or decrease 100 basis points and 50 basis points in 2004 and 2003,
respectively, (normally 200 basis points during periods of higher interest
rates) from current rates ("parallel shift"), the percentage change in estimated
net interest income for the subsequent 12-month measurement period should not
decline by more than 5.0 percent. In addition, the Company has prepared the
simulation analysis in the rising rate scenario for 2004 assuming short-term
rates gradually increase 200 basis points, while medium to long-term interest
rates increase 100 basis points to illustrate the flattening of the yield curve
(modified shift).
72
The tables below illustrate the estimated exposures under the rising rate
scenario and declining rate scenario calculated as a percentage change in
estimated net interest income from the base case scenario, assuming a gradual
parallel shift for 2004 and 2003 (and modified shift for 2004), in interest
rates for the next 12 month measurement period, beginning December 31, 2004 and
2003. Information on the percentage change in estimated net cash flows from the
base case scenario is also shown. The cash flows are scheduled by expected
maturity and reflect the effects of changes in market rates.
- ----------------------------------------------------------------------------------------------
2004
- ----------------------------------------------------------------------------------------------
Percentage Change in Percentage Change in
Gradual Parallel Shift in Estimated Net Estimated Net
Interest Rates Interest Income Cash Flows
- ----------------------------------------------------------------------------------------------
+ 200 basis points 3.0% (3.8)%
- - 100 basis points (2.3)% 65.9%
- ----------------------------------------------------------------------------------------------
Gradual Shift in Interest Rates -
Flattening yield curve (Modified Shift)
- ----------------------------------------------------------------------------------------------
+ 200 basis points 1.6% (3.7)%
==============================================================================================
2003
- ----------------------------------------------------------------------------------------------
Percentage Change in Percentage Change in
Gradual Parallel Shift in Estimated Net Estimated Net
Interest Rates Interest Income Cash Flows
- ----------------------------------------------------------------------------------------------
+ 200 basis points 4.2% (9.8)%
- - 50 basis points (1.9)% 3.9%
==============================================================================================
The decrease in the percentage change of estimated net interest income in
the 2004 parallel shift rising rate scenario, as compared to 2003, reflects a
proportionate decrease of floating rate assets and assets repricable in the over
one day to one year category, while certain rate sensitive liabilities have also
decreased but at a lesser rate. This has caused the balance sheet to be less
asset sensitive. Conversely, this should also result in a less negative
percentage change of estimated net interest income in the declining rate
scenario for 2004, as compared to 2003, however, the increase in the rate shift
from 50 basis points to 100 basis points in 2004 has resulted in a greater
negative effect for 2004. Percentage changes in estimated cash flow decrease (or
become less negative) in the rising rate scenario and increase substantially in
the declining rate scenario in 2004, as compared to the prior year. Cash flow is
less negative in the rising rate scenario in 2004 compared to the prior year due
to the decrease in callable securities, which do not produce cash flow in a
rising rate scenario. The significant increase in cash flow in the declining
rate scenario in 2004 results from the higher probability of callable securities
being called as rates decline at a greater rate than 2003.
The percentage change in estimated net interest income in the modified
shift scenario for 2004 is 1.6 percent as compared to 3.0 percent in the
parallel rate shift scenario. This illustrates the effect of the flattening
yield curve and the resulting higher level of increase in the rates on shorter
term liabilities, while the medium to long term assets do not increase at the
same rate.
In all cases, the Company maintains an asset sensitive position.
As with any method of measuring interest rate risk, there are certain
limitations inherent in the method of analysis presented. Actual results may
differ significantly from simulated results should market conditions and
management strategies, among other factors, vary from the assumptions used in
the analysis. The model assumes that certain assets and liabilities of similar
maturity or period to repricing will react the same to changes in interest
rates, but, in reality, they may react in different degrees to changes in market
interest rates. Specific types of financial instruments may fluctuate in advance
of changes in market interest rates, while other types of financial instruments
may lag behind changes in market interest rates. Additionally, other assets,
such as adjustable-rate loans, have features that restrict changes in interest
rates on a short-term basis and over the life of the asset, which are assumed in
the simulation. Furthermore, in the event of a change in interest rates,
expected rates of prepayments on loans and securities and early withdrawals from
time deposits or disintermediation of core deposit accounts could deviate
significantly from those assumed in the simulation. In addition, a steepening of
the yield curve may have a positive effect on net interest income, while a
flattening or inverted yield curve will generally have a negative effect on net
interest income.
One way to minimize interest rate risk is to maintain a balanced or
matched interest rate sensitivity position. However, earnings are not always
maximized by matched funding. To increase net interest income, the Company
selectively mismatches asset and liability repricing to take advantage of
short-term interest rate movements and the shape of the U.S. Treasury yield
curve. The magnitude of the mismatch depends on a careful assessment of the
risks presented by forecasted interest rate movements. The risk inherent in such
a mismatch, or gap, is that interest rates may not move as anticipated.
Interest rate risk exposure is reviewed in weekly meetings in which
guidelines are established for the following week and the longer-term. The
interest rate gap and simulation are reviewed quarterly by ALCO and the Bank's
Board of Directors.
73
Risk can be mitigated by matching maturities or repricing more closely,
and by reducing interest rate risk by the use of interest rate contracts. The
Company does not use derivative financial instruments extensively, and no such
contracts were outstanding at December 31, 2004 and 2003. However, as
circumstances warrant, the Company may purchase derivatives such as interest
rate contracts to manage its interest rate exposure. Any derivative financial
instruments would be carefully evaluated to determine the impact on the
Company's interest rate risk in rising and declining interest rate environments,
as well as the fair value of the derivative instruments. Use of derivative
financial instruments is included in the Bank's Statement on Interest Rate Risk
Management as Related to Derivative Instruments and Hedging Activities Policy,
which has been approved by the Bank's Board of Directors.
INTEREST RATE SENSITIVITY ANALYSIS BY REPRICING DATE
The following table sets forth the interest rate sensitivity by
repricing date as of December 31, 2004:
(000's, except percentages)
- -------------------------------------------------------------------------------------------------------------------------------
One Over Over Over
Day and One Day Three One Year Over Non-
Floating to Three Months to To Five Five Interest
Rate Months One Year Years Years Bearing Total
- -------------------------------------------------------------------------------------------------------------------------------
Assets:
Loans, net $622,123 $ 41,921 $ 168,956 $ 438,255 $221,617 $ -- $1,492,872
Mortgage-backed securities -- 262,995 29,486 108,710 22,480 -- 423,671
Other securities -- 920 19,571 133,233 514,378 -- 668,102
Other earning assets 17,000 31,469 -- -- -- -- 48,469
Other -- -- -- -- -- 113,156 113,156
- -------------------------------------------------------------------------------------------------------------------------------
Total assets 639,123 337,305 218,013 680,198 758,475 113,156 2,746,270
- -------------------------------------------------------------------------------------------------------------------------------
Liabilities and Equity:
Interest bearing deposits 225,287 418,702 272,852 623,503 -- -- 1,540,344
Other borrowed funds 2,323 25,352 27,528 291,083 278,746 -- 625,032
Subordinated debt issued in
connection with Corporation-
Obligated mandatory redeemable
capital securities of subsidiary
trusts -- 41,239 -- -- 20,619 -- 61,858
Demand deposits -- -- -- -- -- 317,874 317,874
Other -- -- -- -- 128 18,988 19,116
Stockholders' equity -- -- -- -- -- 182,046 182,046
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity 227,610 485,293 300,380 914,586 299,493 518,908 2,746,270
- -------------------------------------------------------------------------------------------------------------------------------
Net interest rate sensitivity gap $411,513 $(147,988) $ (82,367) $(234,388) $458,982 $(405,752) $ --
===============================================================================================================================
Cumulative gap $411,513 $ 263,525 $ 181,158 $ (53,230) $405,752 $ -- $ --
===============================================================================================================================
Cumulative gap to
interest earning assets 15.6% 10.0% 6.9% (2.0%) 15.4% --% --%
===============================================================================================================================
74
Financial Ratios
Significant ratios of the Company for the periods indicated are as
follows:
- ---------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
Earnings Ratios Net income as a percentage of:
Average earning assets 1.00% 1.15% 1.32%
Average total assets 0.96% 1.10% 1.24%
Average common stockholders' equity 16.13% 18.05% 18.70%
Capital Ratios
Total stockholders' equity to assets 6.63% 5.79% 6.14%
Average total stockholders' equity to average total assets 5.96% 6.10% 6.65%
Average total stockholders' equity and Corporation-Obligated
mandatory redeemable capital securities of subsidiary trusts
to average total assets 7.93% 7.98% 8.73%
Average net loans as a multiple of average total stockholders' equity 8.5 8.6 8.6
Leverage capital 8.15% 7.54% 8.36%
Tier I capital (to risk weighted assets) 14.15% 12.80% 12.55%
Total risk-based capital (to risk weighted assets) 15.07% 13.70% 13.58%
Other
Allowance for loan losses as a percentage of year-end loans 1.01% 1.02% 1.05%
Loans (net) as a percentage of year-end total assets 54.36% 49.34% 52.55%
Loans (net) as a percentage of year-end total deposits 80.34% 80.78% 86.11%
Securities, including FHLB stock, as a percentage of year-end total assets 40.89% 46.45% 42.30%
Average interest earning assets as a percentage of average
interest bearing liabilities 116.78% 118.25% 118.33%
Dividends per common share as a percentage of diluted earnings per common share 35.88% 26.71% 25.74%
=====================================================================================================================
75