Attached files

file filename
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - SUFFOLK BANCORPdex311.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - SUFFOLK BANCORPdex321.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - SUFFOLK BANCORPdex312.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - SUFFOLK BANCORPdex211.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - SUFFOLK BANCORPdex231.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - SUFFOLK BANCORPdex322.htm
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2009

-OR-

 

¨ Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             .

Commission File Number: 000-13580

 

 

SUFFOLK BANCORP

(Name of Issuer in Its Charter)

 

 

 

New York   11-2708279

(State or Other Jurisdiction of

Incorporation of Organization)

 

(I.R.S. Employer

Identification No.)

 

4 West Second Street, P.O. Box 9000, Riverhead, New York   11901
(Address of Principal Executive Offices)   (Zip Code)

Issuer’s Telephone Number, Including Area Code: (631) 727-5667

Securities registered under Section 12(b) of the Exchange Act:

 

Title of each class:

 

Name of each exchange on which registered:

Common stock, par value $2.50 per share   The NASDAQ Global Select Market

Securities registered under Section 12(g) of the Exchange Act: None

(Title of Class)

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨     NO  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    YES  ¨    NO  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark 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 the 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)    YES  ¨    NO  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller Reporting Company  ¨    

Indicate by check mark whether the Registrant is a shell company.    YES  ¨    NO  x

The aggregate market value of the common equity held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was $240.9 million.

As of January 31, 2010, there were 9,630,399 shares outstanding of the Registrant’s common stock.

 

 

 


Table of Contents

LOGO


Table of Contents

LOGO

On The Cover

Wading River

The name “Wading River” is translated from its original Algonquian name, “Pauquaconsuk,” which meant “the place where we wade for thick, round-shelled clams.” The land was conveyed to English settlers between the years 1657 and 1675 in a series of transactions with Wyandanch, the great sachem of the Montauket tribe, then the most influential tribe on Long Island, and also with the Uncachaug and Setauket tribes. The earliest records show that a settlement was founded in 1671 with eight families. The village was located carefully, with a stream with enough follow to power a mill, clean water to drink, seafood close at hand, woodland for fuel, building material, soil rich enough to grow crops, meadowland for grazing animals, and hills to offer settlers some protection from the elements. A sawmill was erected in the area and in operation as early as 1710, and the sale of cordwood later became a significant part of the local economy during the nineteenth century.

As the twentieth century approached, that industry declined as coal replaced wood as a fuel for a number of purposes, from heat to steam to power mechanical devices. General agriculture, including orchards and row crops, replaced woodland. From 1895 until 1938, the Long Island Rail Road ran as far as Wading River, and slowly, the area began to develop.

Wading River remained a small hamlet of a few hundred souls until 1947, when veterans of the Second World War began to build homes in the area, and travel to Wildwood State Park, 600 acres of woodland and meadow overlooking Long Island Sound introduced visitors to the area. It grew steadily from the 1950’s until the present day, where it is home to nearly 7,000 people.

Suffolk County National Bank opened its first branch office in Wading River on June 3, 1967, just about a mile up the hill from the original village’s iconic duck pond, where it continues to serve members of this historic community.


Table of Contents

Corporate Profile

Suffolk Bancorp does commercial banking through its wholly owned subsidiary, Suffolk County National Bank. Organized in 1890, “SCNB” is a full-service, nationally chartered commercial bank. Most of SCNB’s revenue comes from net interest income, and the remainder from charges for a variety of services. SCNB has built a good reputation for personal, attentive service, resulting in a loyal and growing clientele. SCNB operates 29 full-service offices throughout Suffolk County, New York.

The staff at SCNB works hard to develop and maintain ties to the communities it serves. SCNB’s business includes loans to small and medium-sized commercial enterprises, to professionals, and to individual consumers. Suffolk Bancorp’s main strategic focus is on small business owners and professionals and those retail customers who need a range of financial services tailored to their individual needs, and who expect the kind of personal service that is possible only through the establishment of relationships that develop over time. In recent years commercial loans of all types have increased as a percentage of the loan portfolio and have made substantial contributions to SCNB’s profitability. SCNB’s primary market is Long Island, New York. Long Island is home to approximately 2.8 million people outside of the limits of New York City and is primarily suburban in nature. Nassau County and the western end of Suffolk County are a center for commerce and are highly developed, supporting a diversified economy. The economy on eastern Long Island is based on services that support tourism, a large number of second homes, and agriculture. Together, they generate family incomes greater than the national average, providing Suffolk Bancorp with a steady and growing demand for loans and other services, and a reliable, reasonably priced supply of deposits.

Financial Highlights

 

    

(dollars in thousands, except ratios, share, and per-share information)

 
    

December 31,

   2009     2008  
EARNINGS FOR THE YEAR    Net income    $ 22,548      $ 24,688   
   Net interest income      74,336        66,219   
   Net income-per-share      2.35        2.58   
   Cash dividends-per-share      0.88        0.88   
                     

BALANCES AT YEAR-END

   Assets    $ 1,694,496      $ 1,582,819   
   Net loans      1,148,046        1,084,470   
   Investment securities      446,344        394,287   
   Deposits      1,385,278        1,216,437   
   Equity      137,171        112,401   
   Shares outstanding      9,615,494        9,582,699   
   Book value per common share    $ 14.27      $ 11.73   
                     

RATIOS

   Return on average equity      18.30     21.79
   Return on average assets      1.36        1.59   
   Average equity to average assets      7.41        7.29   
   Net interest margin (taxable-equivalent)      4.99        4.75   
   Efficiency ratio      57.11        52.81   
   Net charge-offs to average net loans      0.09        0.06   
                     


Table of Contents

LOGO

CORPORATE INFORMATION

Suffolk Bancorp Annual Meeting

Tuesday, April 13, 2010, 1:00 P.M.

Suffolk County National Bank

Administrative Center

Lower Level

Four West Second Street

Riverhead, New York

S.E.C. Form 10-K

The Annual Report to the Securities and Exchange Commission on Form

10-K and documents incorporated by reference can be obtained, without

charge, by writing to the Secretary, Suffolk Bancorp, 4 West Second Street,

Riverhead, New York 11901, or call (631) 727-5667, fax to (631) 727-3214,

or e-mail to

invest@suffolkbancorp.com

They are also available on the Internet at

www.suffolkbancorp.com

Trading

Suffolk Bancorp’s common stock is traded on the NASDAQ Global Select

Market under the symbol “SUBK.”

Registrar and Transfer Agent

Any questions about the registration or transfer of shares, the payment,

reinvestment, or direct deposit of dividends can be answered by:

American Stock Transfer

& Trust Co.

59 Maiden Lane

New York, New York 10038

1-800-937-5449

www.amstock.com

Registered Independent Public Accountant

Grant Thornton LLP

60 Broad Street

New York, New York 10004

General Counsel

Smith, Finkelstein, Lundberg,

Isler & Yakaboski, LLP

456 Griffing Avenue

Riverhead, New York 11901

FDIC Rules and Regulations, Part 350.4(d)

This statement has not been reviewed, or confirmed for accuracy or

relevance, by the Federal Deposit Insurance Corporation.

 

2


Table of Contents

TABLE OF CONTENTS

 

Corporate Profile

   1

Financial Highlights

   1

Corporate Information

   2

To Our Shareholders

   4

Price Range of Common Stock and Dividends

   6

Summary of Selected Financial Data

   6

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   7

Summary of Recent Developments and Current Trends

   7

Suffolk’s Business

   8

General Economic Conditions

   8

Results of Operations

   8

Net Income

   8

Net Interest Income

   8

Average Assets, Liabilities, Stockholders’ Equity, Rate Spread, and Effective Interest Rate Differential

   9

Analysis of Changes in Net Interest Income

   10

Interest Income

   10

Investment Securities

   10

Loan Portfolio

   12

Non-Performing Loans

   13

Summary of Loan Losses and Allowance for Loan Losses

   13

Interest Expense

   14

Deposits

   14

Borrowings

   15

Other Income

   16

Other Expense

   16

Asset/Liability Management & Liquidity

   17

Interest Rate Sensitivity

   17

Interest Rate Risk

   18

Market Risk

   19

Contractual and Off-Balance-Sheet Obligations

   20

Capital Resources

   20

Risk-Based Capital and Leverage Guidelines

   21

Discussion of New Accounting Pronouncements

   21

Critical Accounting Policies, Judgments, and Estimates

   21

Business Risks and Uncertainties

   22

Management’s Report on Internal Control over Financial Reporting

   22

Consolidated Statements of Condition

   23

Consolidated Statements of Income

   24

Consolidated Statements of Changes in Stockholders’ Equity

   25

Consolidated Statements of Cash Flows

   26

Notes to Consolidated Financial Statements

   27

Report of Independent Registered Public Accounting Firm - Internal Control

   46

Report of Independent Registered Public Accounting Firm - Financial Statements

   47

Report of Management

   47

Annual Report on Form 10-K

  

Certifications of Periodic Report

   57

Directors and Officers - Suffolk Bancorp

   59

Directors and Officers - Suffolk County National Bank

   60

Directory of Offices and Departments

   inside back cover

 

3


Table of Contents

Dear Shareholder:

In 2010, we celebrate the one-hundred-twentieth year since the founding of our banking subsidiary, formally known as The Suffolk County National Bank of Riverhead, and more familiarly as “SCNB.” For all of those years, it has operated under the same national banking charter and under the same name. During those many years, the world has witnessed great advances and innovation in technology, and many and substantial changes in our community, our nation, and the world. It has also witnessed many economic cycles, banking panics, the Great Depression, world wars and other calamities, both local and global.

I am proud to be yet one more among the leaders of an organization that has not only survived such a sweep of events but, for the most part, thrived through them as well. This sort of stability and continuity is the result of a certain kind of discipline that has been and remains a fundamental part of Suffolk’s culture, passed from one generation to the next. This leads us to assess the environment in which we conduct business continually, and then to adjust to it, as is prudent, without compromising our core objective of consistent, sustainable profitability. That profitability is what ensures our ability to meet our obligations to our shareholders, customers and the communities we serve to the best of our ability.

Accordingly, I would like to provide a brief overview of our performance during 2009. Earnings and earnings-per-share for the full year of 2009 slightly exceeded those in 2008, when adjusted for the VISA transaction in 2008. We did this while increasing our margin, from 4.75 percent to 4.99 percent, among the widest in the industry in recent times.

This was mostly the result of historically low costs of funding. We did this in the face of substantial additional expenses, including assessments which increased by $2.2 million for FDIC deposit insurance, an increase of $2.2 million in our provision for loan losses, a $2.0 million increase in our pension expense to compensate for the decreased discount rate at which the pension liability was calculated as well as declines in the market value of plan assets during 2008, and a $528,000 provision recorded in connection with a data intrusion just before the end of the year.

Book value-per-share actually increased to $14.27 at year-end, up 21.7 percent from $11.73 at December 31, 2008, as a result of net income, net of dividends, and a positive change in accumulated other comprehensive income of $9.7 million, primarily as a result of increases in the market value of investments, but also from improvements in the status of the pension plan.

Return on equity (“ROE”), the bellwether of profitability, was indeed affected by these events, declining to 15.61 percent from 20.11 percent for the quarter and 18.30 percent from 21.79 percent for the year. Also affecting ROE was an increase in total risk-based capital of more than 1 percent, to 11.73 percent from 10.60 percent, as we anticipated higher capital requirements as scrutiny of the financial services

 

4


Table of Contents

industry increases. This means that for any given level of efficiency in our underlying banking operations, ROE will be lower than it would have been under earlier standards. This is something we will share with all other banks as those standards evolve. Still, in comparison to the banking industry, which posted ROE of 1.1 percent during the previous four quarters ended September 30, 2009, and 2.6 percent during the third quarter of 2009, according to SNL Securities, we consider this a successful year under trying circumstances.

Looking back on 2009, it appears that the economy had already started to recover, but economists are nearly unanimous in their prediction that it will be a slow rebound. Our customers are not exempt from the effects of a weakened economy. At the same time, however, we can see the value of business based on relationships rather than transactions.

Our primary motto is, “Good Relationships are Good Business.” Good relationships with our customers allow us to see how they are adjusting their business models to survive the downturn, and to meet their obligations back to us. Good relationships keep lines of communications open, and help us work with our customers to meet their need for credit. Good relationships provide for long-lasting business partnerships, through all types of economic cycles.

Transactions, on the other hand, are one-time opportunities to charge interest or collect a fee that need to be replicated over and over again to sustain revenue.

Our secondary motto is, “When Our Customers Grow, We Grow.” Good relationships are the catalyst for future growth. As we continue to maintain the relationships we already have, and seek to build new ones for the future, earnings grow, and earnings are the only basis for shareholder value in the long run.

These two concepts are not difficult to articulate, but to implement them requires focus, attention, and discipline. Most of all, they require that we not allow ourselves to be distracted by glitzy but unproductive transactions. History shows that growth for the sake of growth generally hurts shareholders.

We believe that focusing on the customer will provide for future growth and increased shareholder value. The core competencies we look for in our employees include customer service, communication, flexibility, and teamwork. When we use these skills and put the customer first, we build the relationships that are so important to our future. When we put our customers first, we gain their loyalty and repeat business. That is what enables us to generate shareholder returns that are higher than most of our peers.

 

Sincerely,
LOGO
J. Gordon Huszagh
President and Chief Executive Officer

 

5


Table of Contents

PRICE RANGE OF COMMON STOCK AND DIVIDENDS

Suffolk’s common stock is traded on the NASDAQ Global Select Market under the symbol “SUBK.” Following are quarterly high and low prices of Suffolk’s common stock as reported by NASDAQ.

 

2009

   High    Low    Dividends   

2008

   High    Low    Dividends

First Quarter

   $ 36.97    $ 20.51    $ 0.22   

First Quarter

   $ 33.73    $ 28.49    $ 0.22

Second Quarter

     29.00      23.17      0.22   

Second Quarter

     35.36      28.77      0.22

Third Quarter

     31.14      24.61      0.22   

Third Quarter

     49.02      26.35      0.22

Fourth Quarter

     30.46      25.90      0.22   

Fourth Quarter

     40.00      25.68      0.22

SUMMARY OF SELECTED FINANCIAL DATA

 

FIVE-YEAR SUMMARY: (dollars in thousands except shares and per-share amounts)  
For the year ended December 31,    2009     2008     2007     2006     2005  

Interest income

   $ 87,008      $ 88,457      $ 89,081      $ 86,209      $ 75,673   

Interest expense

     12,672        22,237        25,117        20,499        11,312   
                                        

Net interest income

     74,336        66,220        63,964        65,710        64,361   

Provision for loan losses

     4,275        2,050        377        966        1,575   
                                        

Net interest income after provision

     70,061        64,170        63,587        64,744        62,786   

Other income

     11,118        14,643        10,595        10,672        10,145   

Other expense

     48,801        42,702        40,392        39,975        37,453   
                                        

Income before income taxes

     32,378        36,111        33,790        35,441        35,478   

Provision for income taxes

     9,830        11,423        11,662        12,813        13,376   
                                        

Net Income

   $ 22,548      $ 24,688      $ 22,128      $ 22,628      $ 22,102   
                                        

BALANCE AT DECEMBER 31:

          

Federal funds sold

   $ —        $ —        $ 2,700      $ —        $ —     

Investment securities – available for sale

     437,000        382,357        392,796        403,246        400,038   

Investment securities – held to maturity

     9,343        11,930        9,155        10,013        11,478   
                                        

Total investment securities

     446,343        394,287        401,951        413,259        411,516   

Net loans

     1,148,046        1,084,470        949,609        882,096        893,245   

Total assets

     1,694,496        1,582,819        1,469,062        1,390,849        1,407,902   

Total deposits

     1,385,278        1,216,437        1,143,375        1,139,075        1,158,707   

Other borrowings

     150,800        224,820        198,320        120,135        127,975   

Stockholders’ equity

   $ 137,171      $ 112,401      $ 108,981      $ 108,566      $ 102,001   
                                        

SELECTED FINANCIAL RATIOS:

          

Performance:

          

Return on average equity

     18.30     21.79     21.47     22.16     22.18

Return on average assets

     1.36        1.59        1.57        1.61        1.59   

Net interest margin (taxable-equivalent)

     4.99        4.75        5.06        5.16        5.09   

Efficiency ratio

     57.11        52.81        54.17        52.34        50.28   

Average equity to average assets

     7.41        7.29        7.30        7.25        7.19   

Dividend pay-out ratio

     37.44        34.18        39.70        39.19        37.56   

Asset quality:

          

Non-performing assets to total loans, net of discount

     2.53        0.45        0.17        0.10        0.49   

Non-performing assets to total assets

     1.73        0.31        0.11        0.06        0.32   

Allowance to non-performing assets

     41.99        185.32        459.13        846.52        220.41   

Allowance to loans, net of discount

     1.06        0.83        0.80        0.85        1.09   

Net charge-offs (recoveries) to average net loans

     0.09        0.06        (0.01     0.36        (0.01
                                        

PER-SHARE DATA:

          

Net income (basic)

     2.35        2.58        2.24        2.20        2.09   

Cash dividends

     0.88        0.88        0.88        0.88        0.79   

Book value at year-end

     14.27        11.73        11.34        10.60        9.80   

Highest market value

     36.97        49.02        38.80        38.95        37.00   

Lowest market value

     20.51        25.68        25.55        28.17        25.68   

Average shares outstanding

     9,602,802        9,580,025        9,895,301        10,279,870        10,570,896   
                                        

Number of full-time-equivalent employees

     368        362        350        357        369   

Number of branch offices

     29        29        29        27        27   

Number of automatic teller machines

     29        29        26        26        25   
                                        

 

6


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The discussion that follows analyzes Suffolk Bancorp’s (“Suffolk”) operations for each of the past three years and its financial condition as of December 31, 2009 and 2008, respectively. Selected tabular data are presented for each of the past five years.

Summary of Recent Developments and Current Trends

Suffolk Bancorp is a one-bank holding company engaged in the commercial banking business through The Suffolk County National Bank, a full-service commercial bank headquartered in Riverhead, New York. “SCNB” is Suffolk Bancorp’s wholly owned subsidiary. Organized in 1890, Suffolk County National Bank is headquartered on Long Island, with 29 offices in Suffolk County, New York.

Recent Developments

As during the prior year, credit was generally less available as banks consolidated their loan losses and attempted to increase their capital ratios in response to regulatory pressure. Equity markets, however, recovered substantially as weaker competitors were shaken out of a number of industries, and earnings started to recover among remaining competitors. Federal officials continued to preside over various of the programs intended to stabilize credit markets, including most notably the Troubled Asset Relief Program (“TARP”), and certain target rates of interest that remain near zero. The effectiveness of these steps remains unclear, although confidence in the financial markets has appeared to have improved during the year. In the absence of credit, and with widespread foreclosures, residential real estate continued to decline in value, though stabilizing in some markets during the third and fourth quarters, further diminishing investors’ confidence and resulting in significant declines in the value of banking stocks. Commercial real estate continued to decline in value as certain investors used their reserves to service debt, and a greater number of such loans defaulted throughout the nation.

The yield curve remained steep, with short-term rates very low, and with a spread of as much as 400 basis points between the short- and long-term rates.

At Suffolk, interest income was flat despite an increase in total net loans, although that was offset by lesser interest expense, resulting in higher net interest income. The net interest margin increased to 4.99 percent, up from 4.75 percent, year to year.

Return on average equity decreased to 18.30 percent for the year, down from 21.79 percent during 2008, and earnings-per-share decreased from $2.58 in 2008 to $2.35 in 2009. The decrease in return on average equity and earnings-per-share on a year-to-date basis is the result of a net gain on the sale of securities during the first quarter of 2008, the proceeds of which were realized from the sale of shares issued by Visa, Inc. in connection with its initial public offering. Please refer to “Other Income” for further discussion.

Key to maintaining performance was close management of the balance sheet. Steps included:

 

   

Managing the investment portfolio to provide downside protection from falling rates, and continued purchases of municipal securities, currently providing liquidity as well as higher returns net of taxes, and some protection from falling interest rates. During the year approximately $90 million of collateralized mortgage obligations were purchased, fully guaranteed by the U.S. government.

 

   

Pursuing the ongoing program of capital management, allowing total risk-based capital (“TRBC”) to move upward to provide a greater cushion against uncertainty, and to respond to possible increases in regulatory requirements under discussion at various levels of government. While the regulatory requirement for TRBC remains at 10.00 percent, which qualifies as “well capitalized” with regulatory agencies and still affords certain advantages to the banking subsidiary, higher ratios have been under public discussion. Accordingly, maximum prudent leverage is thus applied to the shareholders’ investment while still anticipating changes in regulation through the retention of earnings when assets are growing. Growth in the core business during the year provided some leverage to retained earnings, and TRBC climbed to 11.73 percent at December 31, 2009 from 10.60 the prior year, an increase of 10.7 percent.

 

   

Maintaining emphasis on both commercial and personal demand deposits, and non-maturity time deposits as a key part of relationships with customers while responding as necessary to demand in Suffolk’s market for certificates of deposit of all sizes. In light of increased demand for loans from customers unable to obtain financing from other banks whose capital losses reduced their lending capacity, Suffolk redoubled its emphasis on the profitability of the whole banking relationship with its customers with the Bank, seeking when possible to both make loans to and obtain funding from qualified customers.

 

   

Managing net loan charge-offs and non-performing loans. During 2009, net charge-offs amounted to 9 basis points of average net loans. Although net charge-offs remain comparatively low, non-performing loans increased during the year as a result of current economic conditions. We maintain our underwriting standards for new loans and lending staff monitor existing credits closely.

 

7


Table of Contents
   

Consistent underwriting for lending to preserve both credit quality and yields throughout the business cycle. Emphasis on preservation of margins over less profitable growth, and on allocation of capital to credits that would result in a relationship with a long-term customer rather than on a single transaction.

It has not been Suffolk’s policy to grant loans or to buy investment securities backed by loans which would be characterized as “sub-prime.”

Suffolk’s Business

Nearly all of Suffolk’s business is to provide banking services to its commercial and retail customers in Suffolk County, on Long Island, New York. Suffolk is a one-bank holding company. Its banking subsidiary, Suffolk County National Bank (the “Bank”), operates 29 full-service offices in Suffolk County, New York. It offers a full line of domestic, retail, and commercial banking services, and trust services. The Bank’s primary lending area includes all of Suffolk County, New York, and a limited number of loans or loan-participations in the adjacent markets of Nassau County and New York City. The Bank makes loans that are secured by commercial real estate and float with the prime rate and other indices, and that are retained in the Bank’s portfolio: commercial and industrial loans to small manufacturers, wholesalers, builders, farmers, and retailers, including dealer financing. The Bank serves as an indirect lender to the customers of a number of automobile dealers. The Bank also makes loans secured by residential mortgages, and both fixed and floating rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered.

Other investments are made in short-term United States Treasury debt, high-quality obligations of municipalities in New York and other states, issues of agencies of the United States government, collateralized mortgage obligations, mortgage-backed securities, and stock in the Federal Reserve Bank and the Federal Home Loan Bank of New York, each required as a condition of membership.

The Bank finances most of its activities with deposits, including demand, saving, N.O.W., and money market accounts, as well as term certificates. It also relies on other sources of funds, including inter-bank overnight loans, and sale-repurchase agreements.

General Economic Conditions

Long Island has a population of approximately 2.8 million people, about 20 percent of the population of New York State. Long Island has a number of important regional advantages, including public and private schools and universities that are ranked above national averages; an increasingly diversified economy with growing health, information, and business services; as well as hundreds of miles of coastline and other open spaces that draw tourists from within and beyond the region. However, Long Island also faces a number of challenges as a result of the historical fragmentation of governance among town villages, special authorities, and other taxing districts, and a growing disparity in incomes.

During 2007, gross metropolitan product (GMP) of $115 billion dollars ranked Long Island among the top 20 metropolitan areas in the United States. In 2009, Long Island’s total private sector gross domestic product (GDP) was approximately $128 billion in 2008 dollars, down from about $132 billion in 2008 (a decline of 3.2%). There was almost no change in private sector GDP between 2007 and 2008 (decrease of .1%). The private sector of the Long Island economy grew by 17% from 1999 to 2009. However, there was greater growth earlier in the period, slower growth more recently, and stagnation and decline during the past 24 months. Comparisons with the U.S. economy as a whole indicates that the national economy grew slightly more between 2000 and 2009 (15.2%) compared to Long Island (13.6%). In 2008 the Long Island economy was stagnant while the nation’s economy experienced almost 1% growth. In 2009, the U.S. economy contracted less than did our local economy (-2.1% versus -3.2%). (Source: Long Island Index 2010)

Results of Operations

Net Income

Net income was $22,548,000 compared to $24,688,000 in 2008 and $22,128,000 in 2007. These figures represent a decrease of 8.7 percent and an increase of 11.6 percent, respectively. Basic earnings-per-share were $2.35 during 2009, compared to $2.58 in 2008 and $2.24 in 2007.

Net Interest Income

Net interest income during 2009 was $74,336,000, up 12.3 percent from $66,220,000 in 2008, which was up 3.5 percent from $63,964,000 in 2007. Net interest income is the most important part of the net income of Suffolk. The net interest rate margin, on a taxable-equivalent basis, was 4.99 percent in 2009, 4.75 percent during 2008, and 5.06 percent in 2007. Average rates on average interest-earning assets decreased to 5.80 percent in 2009, down from 6.27 percent in 2008, and 6.96 percent in 2007. Average rates on average interest-bearing liabilities decreased to 1.24 percent in 2009, down from 2.24 percent in 2008, and 2.91 percent in 2007. Demand deposits remained a significant source of funds as a percentage of total liabilities.

 

8


Table of Contents

Average Assets, Liabilities, Stockholders’ Equity, Rate Spread, and Effective Interest Rate Differential

(on a taxable-equivalent basis)

The following table illustrates the average composition of Suffolk’s statements of condition. It presents an analysis of net interest income on a taxable-equivalent basis, listing each major category of interest-earning assets and interest-bearing liabilities, as well as other assets and liabilities: (dollars in thousands)

 

Year ended December 31,

   2009     2008     2007  
     Average
Balance
   Interest     Average
Rate
    Average
Balance
   Interest     Average
Rate
    Average
Balance
   Interest     Average
Rate
 

Interest-earning assets

                     

U.S. Treasury securities

   $ 9,577    $ 371      3.87   $ 9,988    $ 407      4.07   $ 9,526    $ 406      4.26

Collateralized mortgage obligations

     148,566      7,505      5.05        145,285      7,878      5.42        142,876      7,605      5.32   

Mortgage-backed securities

     603      41      6.80        721      49      6.80        953      67      7.03   

Obligations of states & political subdivisions

     194,089      10,762      5.54        164,296      9,570      5.82        139,429      8,234      5.91   

U.S. government agency obligations

     79,358      2,057      2.59        94,801      3,663      3.86        114,190      4,576      4.01   

Other securities

     8,029      434      5.41        9,278      482      5.20        5,727      423      7.39   

Federal funds sold & interest-bearing bank accounts

     15,170      51      0.34        17,875      314      1.76        2,637      140      5.31   

Loans, including non-accrual loans

                     

Commercial, financial & agricultural loans

     235,202      13,863      5.89        223,722      14,568      6.51        193,885      16,213      8.36   

Commercial real estate mortgages

     363,256      24,613      6.78        329,121      23,562      7.16        298,632      22,480      7.53   

Real estate construction loans

     133,894      9,000      6.72        106,608      8,594      8.06        84,610      8,786      10.38   

Residential mortgages (1st and 2nd liens)

     208,696      12,731      6.10        194,915      12,175      6.25        158,294      10,160      6.42   

Home equity loans

     78,788      3,311      4.20        68,972      3,799      5.51        68,239      5,725      8.39   

Consumer loans

     85,634      5,951      6.95        95,030      6,672      7.02        98,739      7,084      7.17   

Other loans

     1,824      —          3,108      —        —          2,489      —        —     
                                                               

Total interest-earning assets

   $ 1,562,686    $ 90,690      5.80   $ 1,463,720    $ 91,733      6.27   $ 1,320,226    $ 91,899      6.96
                                                               

Cash & due from banks

   $ 44,037        $ 45,718        $ 46,744     

Other non-interest-earning assets

     55,703          45,300          45,611     
                                 

Total assets

   $ 1,662,426        $ 1,554,738        $ 1,412,581     

Interest-bearing liabilities

                     

Saving, N.O.W. & money market deposits

   $ 563,513    $ 3,630      0.64   $ 467,180    $ 6,334      1.36   $ 417,472    $ 4,838      1.16

Time deposits

     328,853      6,068      1.85        319,888      9,852      3.08        311,098      13,275      4.27   
                                                               

Total saving & time deposits

     892,366      9,698      1.09        787,068      16,186      2.06        728,570      18,113      2.49   

Federal funds purchased & securities sold under agreements to repurchase

     4,863      120      2.47        49,260      1,417      2.88        54,531      2,876      5.27   

Other borrowings

     127,123      2,854      2.25        157,618      4,635      2.94        79,328      4,128      5.20   
                                                               

Total interest-bearing liabilities

   $ 1,024,352    $ 12,672      1.24   $ 993,946    $ 22,238      2.24   $ 862,429    $ 25,117      2.91
                                                               

Rate spread

        4.57        4.03        4.05

Non-interest-bearing deposits

   $ 478,886        $ 430,610        $ 425,553     

Other non-interest-bearing liabilities

     35,983          16,906          21,547     
                                 

Total liabilities

   $ 1,539,221        $ 1,441,462        $ 1,309,529     

Stockholders’ equity

     123,205          113,276          103,052     
                                 

Total liabilities & stockholders’ equity

   $ 1,662,426        $ 1,554,738        $ 1,412,581     

Net interest income (taxable-equivalent basis) & interest rate margin

      $ 78,018      4.99      $ 69,495      4.75      $ 66,782      5.06

Less: taxable-equivalent basis adjustment

        (3,682          (3,275          (2,818  
                                       

Net interest income

      $ 74,336           $ 66,220           $ 63,964     
                                       

Interest income on a taxable-equivalent basis includes the additional amount of interest income that would have been earned if Suffolk’s investment in nontaxable U.S. Treasury securities and states and municipal obligations had been subject to New York State and federal income taxes yielding the same after-tax income. The rate used for this adjustment was approximately 34 percent for federal income taxes and 9 percent for New York State income taxes for all periods. For each of the years 2009, 2008, and 2007, $1.00 of nontaxable income from obligations of states and political subdivisions equates to fully taxable income of $1.52, and $1.00 of nontaxable income from taxable obligations of states and political subdivisions equates to fully taxable income of $1.50. In addition, in 2009, 2008, and 2007, $1.00 of nontaxable income on U.S. Treasury securities equates to $1.02 of fully taxable income. Various loan fees included in interest income amounted to $1,594,000, $1,817,000, and $2,156,000 in 2009, 2008, and 2007, respectively.

 

9


Table of Contents

Analysis of Changes in Net Interest Income

The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the periods presented, each as compared with the preceding period. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In this table changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)

 

     In 2009 over 2008
Changes Due to
    In 2008 over 2007
Changes Due to
 
     Volume     Rate     Net Change     Volume     Rate     Net Change  

Interest-earning assets

            

U.S. Treasury securities

   $ (16   $ (20   $ (36   $ 19      $ (18   $ 1   

Collateralized mortgage obligations

     175        (548     (373     129        144        273   

Mortgage-backed securities

     (8     —          (8     (16     (2     (18

Obligations of states & political subdivisions

     1,666        (475     1,191        1,450        (113     1,337   

U.S. government agency obligations

     (532     (1,074     (1,606     (754     (159     (913

Corporate bonds & other securities

     (67     19        (48     210        (151     59   

Federal funds sold & interest-bearing bank accounts

     (41     (222     (263     324        (150     174   

Loans, including non-accrual loans

     5,595        (5,495     100        8,495        (9,574     (1,079
                                                

Total interest-earning assets

   $ 6,772      $ (7,815   $ (1,043   $ 9,857      $ (10,023   $ (166
                                                

Interest-bearing liabilities

            

Saving, N.O.W., & money market deposits

   $ 1,113      $ (3,817   $ (2,704   $ 616      $ 880      $ 1,496   

Time deposits

     269        (4,053     (3,784     365        (3,788     (3,423

Federal funds purchased & securities sold under agreements to repurchase

     (1,120     (177     (1,297     (256     (1,203     (1,459

Other borrowings

     (801     (980     (1,781     2,844        (2,337     507   
                                                

Total interest-bearing liabilities

   $ (539   $ (9,027   $ (9,566   $ 3,569      $ (6,448   $ (2,879
                                                

Net change in net interest income (taxable-equivalent basis)

   $ 7,311      $ 1,212      $ 8,523      $ 6,288      $ (3,575   $ 2,713   
                                                

Interest Income

Interest income decreased to $87,008,000 in 2009, down 1.6 percent from $88,457,000 in 2008, which was down .7 percent from $89,081,000 in 2007.

Investment Securities

SCNB purchases investment securities only after a disciplined evaluation to ensure that they are the most appropriate available given the company’s objectives. Key factors include:

 

   

Liquidity – the ease with which the security can be pledged or sold.

 

   

Credit Quality – the likelihood the security will perform according to its original terms, with timely payments of principal and interest.

 

   

Yield – the rate of return on the investment, balanced against the first two.

Investment securities are also selected in consideration of certain key risks to:

 

   

Market value – the market value of fixed-rate securities increases when interest rates fall, and decreases when interest rates rise. The longer the maturity of the security, the greater this effect.

 

   

Income risk – how long fixed payments can be assured. The shorter the duration of the portfolio, the greater this risk.

 

   

Asset liability management – seeks to limit the change in net interest income as a result of changing interest rates. For example, when the maturities or the intervals between the repricing of investments are longer than those of the liabilities that fund them, net interest income will decline when rates rise because payments from those securities will remain the same while payments to depositors or other banks from which SCNB has borrowed will increase. This is referred to as “asset-sensitive.” Conversely, when investments mature or are repriced sooner than their funding, net interest income may decline when interest rates fall as income declines the same while funding expense remains the same. Asset liability management attempts to manage the duration of the investment portfolio, as well as that of the funding to minimize the risk to net interest income while maximizing returns.

 

10


Table of Contents

The company seeks to create a portfolio that is diversified across different classes of assets. Historically, bonds have returned more than cash, and been less volatile than mortgage-backed securities (“MBS”). The steady return on bonds can also offset the decline in variable loan yields as interest rates fall. Collateralized mortgage obligations (“CMO’s”) provide more predictable cash flows because payments are assigned to specific securities (“tranches” or slices) in the order in which they are received, in contrast to a traditional security backed by a pool of mortgages in which investors share payments equally pro rata, based on the percentage of the pool they own. Analysis of CMO’s requires careful due diligence of the mortgages that serve as the underlying collateral. Suffolk has never owned mortgage obligations with underlying collateral that could be classified as “sub-prime.” Tranche structure, final maturity, and credit support also provide improved assurance of repayment. There are CMO’s which have experienced increased delinquencies in the underlying loan portfolio; however, these securities are in senior tranches where delinquencies and foreclosures result in accelerated cash flows received, and not losses. Suffolk reviews its investments for impairment regularly, and to date, none have been determined to be other-than-temporarily impaired due to credit.

Average investment in U.S. government agency securities decreased to $79,358,000 from $94,801,000 in 2008, and $114,190,000 in 2007. Average balances of CMO’s increased to $148,566,000 in 2009 from $145,285,000 in 2008, and $142,876,000 in 2007. Average investments in municipal securities increased to $194,089,000 in 2009, up from $164,296,000 in 2008 and $139,429,000 in 2007. U.S. Treasury, U.S. government agency, collateralized mortgage obligations, and municipal securities provide collateral for various liabilities to municipal depositors. Securities are Suffolk’s primary source of liquidity. With regard to securities characterized as available for sale, in general, Suffolk has the intent and ability to hold them until maturity. The following table summarizes Suffolk’s investment securities available for sale and held to maturity as of the dates indicated: (in thousands)

 

December 31,

   2009    2008    2007

Investment securities available for sale, at fair value:

        

U.S. Treasury securities

   $ 8,318    $ 10,152    $ 9,838

U.S. government agency debt securities

     43,205      76,477      105,066

Collateralized mortgage obligations

     192,393      131,841      129,562

Mortgage-backed securities

     599      595      859

Obligations of states & political subdivisions

     192,485      163,292      147,471
                    

Total investment securities available for sale

     437,000      382,357      392,796
                    

Investment securities held to maturity:

        

Obligations of states & political subdivisions

     9,243      11,830      9,055

Other securities

     100      100      100
                    

Total investment securities held to maturity

     9,343      11,930      9,155
                    

Total investment securities

   $ 446,343    $ 394,287    $ 401,951
                    

Fair value of investment securities held to maturity

   $ 10,096    $ 12,515    $ 9,743

Unrealized gains

     755      596      603

Unrealized losses

     2      11      15
                    

The amortized cost, maturities, and approximate weighted average yields, at December 31, 2009 are as follows: (in thousands)

 

     Available for Sale     Held to Maturity            
     U.S. Treasury
Securities
    U.S.
Govt. Agency
Debt
    Obligations of
States & Political
Subdivisions
    Obligations of
States & Political
Subdivisions
    Other Securities            

Maturity (in years)

   Fair
Value
   Yield     Fair
Value
   Yield     Fair
Value
   Yield     Amortized
Cost
   Yield     Amortized
Cost
   Yield    Total    Yield  

Within 1

   $ 1,996    0.32   $ 20,129    0.96   $ —      —        $ 2,079    2.85   $ —      —      $ 24,204    1.07

After 1 but within 5

     6,322    4.58     23,076    2.73     17,736    3.63     2,146    4.00     —      —      $ 49,280    3.35

After 5 but within 10

     —      —          —      —          153,687    3.72     5,018    5.56     —      —      $ 158,705    3.78

After 10

     —      —          —      —          21,062    4.06     —      —          —      —      $ 21,062    4.06

Other securities

     —      —          —      —          —      —          —      —          100    —      $ 100    —     
                                                                             

Subtotal

   $ 8,318    3.56   $ 43,205    1.91   $ 192,485    3.75   $ 9,243    4.59   $ 100    —      $ 253,351    3.46

Collateralized mortgage obligations (1)

   

                       $ 192,393    5.34

Mortgage-backed securities (1)

                             $ 599    7.36
                                                                             

Total

   $ 8,318    3.56   $ 43,205    1.91   $ 192,485    3.75   $ 9,243    4.59   $ 100    —      $ 446,343    4.27
                                                                             

 

(1) At fair value

 

11


Table of Contents

As a member of the Federal Reserve System, the Bank owns Federal Reserve Bank stock with a book value of $652,000. Being an equity investment, the stock has no maturity. There is no public market for this investment. The last dividend was 6.0 percent.

As a member of the Federal Home Loan Bank of New York, the Bank owns Federal Home Loan Bank of New York (“FHLBNY”) stock with a book value of $8,346,000. As of December 31, 2009, the Bank owns 15,600 shares valued at $1,560,000 as its membership portion. The remaining $6,786,000 in stock is owned based on borrowing activity requirements. Being an equity investment, the stock has no maturity. There is no public market for this investment. The last declared dividend was 5.6 percent. We evaluated whether or not the value of FHLBNY stock was impaired. As the FHLBNY has continued to pay dividends and has not restricted redemptions, we concluded the stock was not impaired as of December 31, 2009.

Loan Portfolio

Loans, net of unearned discounts but before the allowance for loan losses, totaled $1,160,379,000. Loans secured by commercial real estate amounted to $375,652,000 and comprise 32.4 percent of the portfolio, the largest single component, up from $352,502,000 in 2008, and $317,262,000 in 2007. Commercial, financial, and agricultural loans followed at $259,565,000, up 17.5 percent from $220,946,000 at the end of 2008. These loans are made to small local businesses throughout Suffolk County. Commercial loan balances are seasonal, particularly in the Hamptons where retail inventories rise in the spring and decline by autumn. Consumer loans are a declining part of the portfolio. Net of unearned discounts, they totaled $80,352,000 at the end of 2009, down 15.1 percent from $94,691,000 at year-end 2008. Consumer loans include indirect, dealer-generated automobile loans. Competition among commercial banks and with captive finance companies of automobile manufacturers has reduced yields and volume. Additionally, rising fuel costs and uncertainties regarding the economy have led to a decline in consumer confidence, affecting automobile sales. Regional financial institutions have tightened their lending activities as a result of turmoil in the credit markets, offering continuing opportunity for real estate construction, and residential and commercial mortgage lending.

The remaining significant components of the loan portfolio are residential mortgages at $214,501,000, down 0.8 percent from $216,127,000; home equity loans at $82,808,000, up 9.5 percent from $75,654,000; and construction loans at $133,431,000, up 1.2 percent from $131,889,000. Construction loans increased primarily because of new borrowers whose former banks were no longer in a position to lend to them as a result of the current credit crisis. These loans have been underwritten on the basis of reasonable ratios of loan to value, conservative evaluations of projected cash flows, guarantees for permanent financing in place prior to granting the interim credit, and the ability of the borrower to repay the loan from sources other than the sale of the secured property. Other loans consist of overdraft advances nearly all of which have been repaid subsequent to year-end.

The following table categorizes total loans (net of unearned discounts) at December 31: (in thousands)

 

     2009     2008     2007     2006     2005  

Commercial, financial & agricultural loans

   $ 259,565    22.4   $ 220,946    20.2   $ 204,222    21.3   $ 182,801    20.5   $ 179,522    19.9

Commercial real estate mortgages

     375,652    32.4     352,502    32.2     317,262    33.1     290,893    32.7     306,754    34.0

Real estate - construction loans

     133,431    11.5     131,889    12.1     83,715    8.7     80,687    9.1     67,411    7.5

Residential mortgages (1st and 2nd liens)

     214,501    18.5     216,127    19.8     184,599    19.3     154,959    17.4     130,853    14.5

Home equity loans

     82,808    7.1     75,654    6.9     67,081    7.0     76,361    8.6     80,775    8.9

Consumer loans

     80,352    6.9     94,691    8.7     99,298    10.4     103,054    11.6     132,802    14.7

Other loans

     14,070    1.2     1,712    0.2     1,104    0.1     892    0.1     4,956    0.5
                                                                 

Total loans (net of unearned discounts)

   $ 1,160,379    100   $ 1,093,521    100   $ 957,281    100   $ 889,647    100   $ 903,073    100
                                                                 

Commercial mortgages and commercial real estate construction loans totaled $507,516,000 as of December 31, 2009, up from $481,943,000 as of December 31, 2008, representing 43.7% and 44.1% of the total loan portfolio, respectively. Commercial mortgages and commercial real estate construction loans consist of the following as of December 31, 2009: 7% vacant land loans, 19% commercial construction loans, 25% for non-owner-occupied commercial mortgages and 49% for owner-occupied commercial mortgages. Commercial mortgages and commercial real estate construction loans consist of the following as of December 31, 2008: 7% vacant land loans, 20% commercial construction loans, 25% for non-owner-occupied commercial mortgages and 48% for owner-occupied commercial mortgages. Commercial real estate construction loans were generally underwritten on the basis of reasonable ratios of loan-to-value, evaluations of projected cash flows, and commitments for permanent financing in place prior to granting an interim credit. Non-performing commercial mortgages and commercial real estate construction loans have increased to $20,483,000 at December 31, 2009, up from $699,000 as of December 31, 2008. These loans have been evaluated for impairment and appropriate provisions have been made to recognize impaired balances. Please refer to the Summary of Loan Losses and Allowance for Loan Losses section for information regarding the provision for loan losses.

 

12


Table of Contents

Non-Performing Loans

Generally, recognition of interest income is discontinued when reasonable doubt exists as to whether interest can be collected. Ordinarily, loans no longer accrue interest when 90 days past due. When a loan stops accruing interest, all interest accrued in the current year, but not collected, is reversed against interest income in the current year. Any interest accrued in prior years is charged against the allowance for loan losses. Loans start accruing interest again when they become current as to principal and interest, and when, in the opinion of management, they can be collected in full.

The following table shows non-accrual, past due, and restructured loans past due at December 31: (in thousands)

 

     2009    2008    2007    2006    2005

Loans accruing but past due contractually

              

90 days or more

   $ 173    $ 699    $ 23    $ 68    $ —  

Loans not accruing interest

     19,124      4,185      1,648      824      4,459

Restructured loans past due

     10,075      —        —        —        —  
                                  

Total

   $ 29,372    $ 4,884    $ 1,671    $ 892    $ 4,459
                                  

Total non-performing loans as of December 31, 2009, amounted to $29,372,000. Of that amount, $23,686,000 was secured by collateral valued at approximately $39,714,000, having a cumulative loan-to-value of approximately 60 percent.

Included in non-performing loans are restructured loans past due of $10,075,000. Subsequent to restructuring, approximately $250,000 was committed to lend additional funds.

Interest on loans that are no longer accruing interest would have amounted to about $874,000 for 2009 under the contractual terms of those loans. Suffolk records the payment of interest on such loans as a reduction of principal. Interest income recognized on restructured and non-accrual loans was immaterial for the years 2009, 2008, and 2007. Suffolk has a formal procedure for internal credit review to more precisely identify risk and exposure in the loan portfolio.

Summary of Loan Losses and Allowance for Loan Losses

The allowance for loan losses is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral and other possible sources of repayment. There can be no assurance that the allowance is, in fact, adequate. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is well past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. Residential real estate and consumer loans are analyzed as a group and not individually because of the large number of loans, small balances, and historically low losses. In the future, the provision for loan losses may change as a percentage of total loans. The percentage of net charge-offs to average net loans during 2009 was 0.09 percent, compared to 0.06 percent in 2008, and net recoveries of 0.01 percent during 2007. The ratio of the allowance for loan losses to loans, net of discounts, was 1.06 percent at the end of 2009, up from 0.83 percent in 2008 and 0.80 percent in 2007. A summary of transactions follows: (in thousands)

 

Year ended December 31,

   2009    2008    2007    2006    2005

Allowance for loan losses, January 1,

   $ 9,051    $ 7,672    $ 7,551    $ 9,828    $ 8,210

Loans charged-off:

              

Commercial, financial & agricultural loans

     806      694      133      3,547      180

Commercial real estate mortgages

     —        —        —        —        —  

Real estate - construction loans

     —        —        —        —        —  

Residential mortgages (1st and 2nd liens)

     —        —        —        —        —  

Home equity loans

     —        —        —        —        —  

Consumer loans

     404      337      48      210      428

Other loans

     —        —        —        —        —  
                                  

Total Charge-offs

   $ 1,210    $ 1,031    $ 181    $ 3,757    $ 608
                                  

 

13


Table of Contents

Loans recovered after being charged-off

   2009    2008     2007     2006    2005  

Commercial, financial & agricultural loans

     41      155        79        56      46   

Commercial real estate mortgages

     —        —          —          —        —     

Real estate – construction loans

     —        —          —          —        —     

Residential mortgages (1st and 2nd liens)

     —        —          —          —        —     

Home equity loans

     —        —          —          —        —     

Consumer loans

     176      234        236        458      605   

Other loans

     —        —          —          —        —     
                                      

Total recoveries

   $ 217    $ 389      $ 315      $ 514    $ 651   
                                      

Net loans charged-off (recovered)

     993      642        (134     3,243      (43

Reclass to Allowance for Contingent Liabilities (1)

     —        (29     (390     —        —     

Provision for loan losses

     4,275      2,050        377        966      1,575   
                                      

Allowance for loan losses, December 31,

   $ 12,333    $ 9,051      $ 7,672      $ 7,551    $ 9,828   
                                      

 

(1) Prior year amounts not reclassified due to immateriality.

The following table summarizes the allowance for loan losses allocated by loan type: (dollars in thousands)

 

As of December 31,

   2009    % of
Total
    2008    % of
Total
    2007    % of
Total
    2006    % of
Total
    2005    % of
Total
 

Commercial, financial & agricultural loans

   $ 5,422    44.0   $ 3,875    42.8   $ 3,762    49.0   $ 2,852    37.7   $ 5,209    53.0

Commercial real estate mortgages

     3,644    29.5     2,780    30.7     2,264    29.5     2,139    28.3     2,431    24.7

Real estate – construction loans

     1,258    10.2     875    9.7     542    7.1     518    6.9     388    4.0

Residential mortgages (1st and 2nd liens)

     821    6.7     538    5.9     239    3.1     190    2.5     162    1.7

Home equity loans

     612    5.0     436    4.8     290    3.8     450    6.0     502    5.1

Consumer loans

     471    3.8     384    4.2     334    4.4     272    3.6     434    4.4

Allocated to general pool

     105    0.8     163    1.9     241    3.1     1,130    15.0     702    7.1
                                                                 

Allowance for loan losses

   $ 12,333    100   $ 9,051    100   $ 7,672    100   $ 7,551    100   $ 9,828    100
                                                                 

The following table presents information concerning loan balances and asset quality: (dollars in thousands)

 

Year ended December 31,

   2009     2008     2007     2006     2005  

Loans, net of discounts:

          

Average

   $ 1,107,294      $ 1,021,476      $ 904,887      $ 892,588      $ 854,158   

At end of period

     1,160,379        1,093,521        957,281        889,647        903,073   

Non-performing assets/total loans, net of discounts (1)

     2.53     0.45     0.17     0.10     0.49

Non-performing assets/total assets (1)

     1.73        0.31        0.11        0.06        0.32   

Ratio of net charge-offs (recoveries)/average net loans

     0.09        0.06        (0.01     0.36        (0.01

Net charge-offs (recoveries)/net loans at December 31,

     0.09        0.06        (0.01     0.36        (0.00

Allowance for loan losses/loans, net of discounts

     1.06        0.83        0.80        0.85        1.09   
                                        

 

(1) Non-performing assets include non-performing loans and other real estate owned (“OREO”). There was no OREO as of December 31, 2009.

Interest Expense

Interest expense in 2009 was $12,672,000, down from $22,237,000 the year before, which was down from $25,117,000 during 2007. Interest expense decreased in 2009 due to decreased rates paid for all interest-bearing liabilities. Most interest was paid for the deposits of individuals, businesses, and various governments and their agencies. The cost of funds of average interest-bearing deposits decreased from 2.06 percent during 2008 to 1.09 percent during 2009. Borrowings include federal funds purchased (short-term lending by other banks), securities sold under agreements to repurchase, and Federal Home Loan Bank borrowings. The Federal Reserve Bank discount window was available though not used during 2009. Borrowings averaged $131,986,000 during 2009, $206,878,000 during 2008, and $133,859,000 during 2007.

Deposits

Average interest-bearing deposits increased to $892,366,000 in 2009, up 13.4 percent from $787,068,000 in 2008. Saving, N.O.W., and money market deposits increased during 2009, averaging $563,513,000, up 20.6 percent from 2008 when they averaged $467,180,000. Average time certificates of less than $100,000 totaled $123,905,000, down 30.8 percent from $179,159,000 in 2008. Average time certificates of $100,000 or more totaled $204,948,000, up 45.6% from $140,729,000 during 2008. During 2008, the Bank entered into an agreement with Promontory Interfinancial Network, LLC, for the purpose of issuing certificates of deposit through their CDARS® program. As of December 31, 2009, the Bank had issued $5,046,000 in brokered certificates of deposits, down from $6,061,000 as of December 31, 2008. A portion of the Bank’s demand deposits are reclassified as saving accounts on a daily basis. The sole purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase

 

14


Table of Contents

funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.

The following table classifies average deposits for each of the periods indicated: (in thousands)

 

     2009          2008          2007       
     Average    Average
Rate Paid
    Average    Average
Rate Paid
    Average    Average
Rate Paid
 

Demand deposits

   $ 478,886      $ 430,610      $ 425,553   

Saving deposits

     250,695    0.38     240,360    0.84     255,276    0.82

N.O.W. & money market deposits

     312,818    0.85        226,820    1.90        162,196    1.70   

Time certificates of $100,000 or more

     204,948    1.73        140,729    2.89        109,157    4.67   

Other time deposits

     123,905    2.04        179,159    3.23        201,941    4.05   
                                       

Total deposits

   $ 1,371,252      $ 1,217,678      $ 1,154,123   
                           

At December 31, 2009, the remaining maturities of time certificates of $100,000 or more were as follows: (in thousands)

 

3 months or less

   $ 166,946

Over 3 through 6 months

     26,628

Over 6 through 12 months

     14,846

Over 12 months

     3,478
      

Total

   $ 211,898
      

Borrowings

Suffolk uses both short-term and long-term funding when it is advantageous to do so in comparison with the alternatives. This includes borrowings from the Federal Home Loan Bank, lines of credit for federal funds with correspondent banks, and repurchase agreements.

The following table summarizes borrowings: (dollars in thousands)

 

     Federal Home Loan
Bank Borrowings
    Repurchase
Agreements
    Federal Funds
Purchased
 
     2009     2008     2009     2008     2009     2008  

December 31, balance

   $ 150,800      $ 187,200      $ —        $ 37,620      $ —        $ —     

Weighted-average interest rate on balances outstanding

     1.62     2.32     —       2.45     —       —  

Maximum amount outstanding at any month-end

   $ 196,000      $ 219,400      $ 37,620      $ 54,820      $ 1,400      $ 15,000   

Daily average outstanding

   $ 127,123      $ 157,618      $ 4,859      $ 58,176      $ 4      $ 1,084   

Average interest rate paid

     2.24     2.94     2.48     2.87     0.50     3.01
                                                

 

15


Table of Contents

Other Income

Other income decreased to $11,118,000 during 2009, down 24.1 percent from $14,643,000 during 2008, which was up 38.2 percent from $10,595,000 during 2007. Service charges on deposit accounts decreased 3.9 percent from 2008 to 2009, and increased 2.7 percent from 2007 to 2008. Other service charges were up 8.5 percent and 2.2 percent for the same periods, respectively. Fiduciary fees in 2009 totaled $1,010,000, down 30.8 percent from 2008 when they amounted to $1,460,000, which was up 3.6 percent from 2007, at $1,409,000.

Included in other income at December 31, 2008, is net securities gains, $3,737,000, ($2,429,000, net of provision for income taxes) of which pertain to the proceeds realized from the sale of shares issued by Visa, Inc. in connection with its initial public offering. Suffolk’s subsidiary, SCNB, was a member of the former Visa, Inc. payments organization and was issued shares when Visa, Inc. was organized. Approximately 39 percent of those shares were redeemed in connection with the initial public offering. The remaining shares are restricted because of unsettled litigation pending against Visa, Inc. Accordingly, Suffolk has recorded these shares at zero in the accompanying statement of condition.

Other Expense

During 2009, other expense was $48,800,000, up 14.3 percent from 2008 when it was $42,701,000, which was up 5.7 percent from $40,392,000 in 2007. Salaries and employee benefits increased 10.2 percent, and net occupancy expense grew by 9.4 percent. Other operating expense increased 6.8 percent and equipment expense also increased 6.8 percent.

In December 2009, Suffolk’s banking subsidiary, SCNB confirmed that an unauthorized intruder accessed certain customers’ log-in information via the computer server hosting SCNB’s Online Banking system. As a result, 8,378 Online Banking customers were affected, amounting to less than 10 percent of SCNB’s total customers. To date, SCNB has found no evidence of any unauthorized access to Online Banking accounts, nor received any reports of unusual activity or reports of financial loss to its customers. SCNB took a number of additional steps to minimize any possible effect of this incident on its customers. Among other things, it launched an aggressive investigation of the incident with assistance from outside experts in forensics; notified all customers affected via first-class mail; arranged for retail credit monitoring services for two years and for certain other business services for one year, at SCNB’s expense. A provision of $528,000 was recorded during the fourth quarter of 2009 against which possible charges for the investigation, customer compensatory services, legal and other professional fees, and any other expense in connection with the intrusion will be applied.

Deposits meeting certain regulatory criteria as to size held at SCNB are insured by the Federal Deposit Insurance Corporation (“FDIC”). The Federal Deposit Insurance Reform Act of 2005 merged the Bank Insurance Fund with the Savings Association Insurance Fund to form the Deposit Insurance Fund (“DIF”). The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based upon statutory factors that include the balance of insured deposits as well as the degree of risk the institution poses to the insurance fund. SCNB is participating in the FDIC’s Transaction Account Guarantee Program. Under that program, extended through June 30, 2010, all non-interest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the $250,000 coverage available under the FDIC’s general deposit insurance rules. The FDIC has raised insurance premiums to cover substantial losses incurred by the DIF due to recent bank failures of 2009 and 2008. The increased assessment is a result of the FDIC’s anticipation of greater demands on the DIF in the future in response to the current unrest in the banking industry. As a result, SCNB expects deposit insurance premiums to be higher for the foreseeable future than they have been in the recent past. FDIC assessments increased to $2,717,000 or 459.1 percent from 2008 when it was $486,000, which was up 232.9 percent from $146,000 in 2007. In prior years, the FDIC granted a one-time initial assessment credit to recognize an institution’s past contributions to the DIF. For SCNB, this credit totaled $970,000. Up to ninety (90) percent of the credit was applied to the annual assessment with the remainder carried forward to the next year. In 2008, approximately $340,000 of the remaining one-time initial assessment credit offset DIF premiums of $777,000. In June 2009, SCNB paid a special assessment charged by the FDIC in the amount of $770,000. On November 12, 2009, the FDIC adopted a final rule imposing a 13-quarter prepayment of FDIC premiums. Suffolk’s prepayment amount totaled $7,158,000 and was paid in December 2009. This was an estimated prepayment for the fourth quarter of 2009 through the fourth quarter of 2012. The prepayment amount will be used to offset future FDIC premiums beginning in March 2010.

The provision for income taxes decreased from $11,423,000, for an effective income tax rate of 31.6 percent in 2008, to $9,830,000, for an effective income tax rate of 30.4 percent in 2009, primarily as a result of increased investments in municipal securities. Bank tax provisions of New York State Article 32 allow banking corporations to exclude from income 60 percent of the dividends it has received from subsidiaries such as a real estate investment trust (REIT). On various occasions over the course of a number of years, the tax commissioner of New York State has proposed the elimination of this provision, raising the question for New York State banking corporations as to whether this exclusion would remain in effect. Going forward, the Company may not realize the benefits of the exclusion from income of 60 percent of the dividends received from the REIT, resulting in a higher effective state income tax rate.

 

16


Table of Contents

Asset/Liability Management & Liquidity

The Asset/Liability Management Committee (“ALCO”) reviews Suffolk’s financial performance and compares it to the asset/liability management policy. The committee includes four outside directors, executive management, the senior lenders, the comptroller, and the head of risk management. It uses computer simulations to quantify interest rate risk and to project liquidity. The simulations also help the committee to develop contingent strategies to increase net interest income. The committee always assesses the impact of any change in strategy on Suffolk’s ability to make loans and repay deposits. Only strategies and policies that meet regulatory guidelines and that are appropriate under the economic and competitive circumstances are considered by the committee. Suffolk has not used forward contracts or interest rate swaps to manage interest rate risk.

Suffolk and its subsidiary manage liquidity to ensure that it has funds available, at a reasonable cost, to disburse funds as it becomes necessary, both in the ordinary course of business, and under extraordinary circumstances. These disbursements are made primarily to: depositors making withdrawals from their accounts; other banks when repaying borrowed funds; borrowers from the bank when funding loans to which the bank had previously made commitments; purchase investments; respond to unanticipated declines in deposits; take advantage of unanticipated opportunities to lend or invest which may help Suffolk to grow; and fund operations.

At the parent, Suffolk Bancorp, sources of liquidity included cash and cash equivalents of $2.7 million as of December 31, 2009, a line of credit, and dividends from the Bank. Cash available for distribution of dividends to shareholders of Suffolk is derived primarily from dividends paid by the Bank to Suffolk. Regulatory restrictions limit the amount of dividends that may be paid by the Bank (see Capital Resources). Dividends from the Bank to Suffolk at December 31, 2009, were limited to $38 million, which represented the Bank’s net income for 2009 as well as its retained earnings for the previous two years, less dividends paid. Prior approval from regulators is required if the total of all dividends declared by the Bank in any calendar year exceeds this amount. In the event that Suffolk expands its current operations, in addition to dividends from the Bank, it will need to rely on its own earnings, additional capital raised, and other borrowings to meet its need for liquidity. Suffolk currently has a secured line of credit in the amount of $6 million against which no funds have been drawn.

The Bank’s most liquid assets are cash and cash equivalents, securities available for sale, and securities held to maturity due within one year. The amounts of these assets are dependent upon the Bank’s operating, financing, lending, and investing activities during any given period. Other sources of liquidity include principal repayments and maturities of loans and investment securities, lines of credit with other financial institutions including the Federal Home Loan Bank, growth in core deposits, and sources of wholesale funding such as brokered certificates of deposit and eligibility for lines at the Federal Reserve Bank. Scheduled loan amortization, maturing securities, and short-term investments are relatively predictable sources of funds, whereas deposit flows and prepayments of loans and mortgage-backed securities are influenced by general interest rates, economic conditions, and competition, and may vary accordingly. The Bank adjusts its liquidity to fund such things as seasonal deposit outflows and loans, and to pursue asset and liability management objectives using a marginal cost of funds approach, seeking to find the lowest cost of funding possible for each additional dollar. The Bank relies primarily on its deposits, obtained through 29 full-service branches that serve its market area, as well as local municipal deposits. The Bank’s primary service area is Suffolk County, New York, where it holds approximately 4.07% of deposits in that market.

During 2009, the Bank’s core deposits increased, in demand, saving, N.O.W., and money market accounts, and in time deposits in excess of $100,000. Other time deposits decreased. The Bank borrows from the Federal Home Loan Bank as advance rates are generally lower than local rates for other time deposits offered by competitors. The Bank’s Asset/Liability and Funds Management Policy allows for wholesale borrowings of up to 25% of total assets. On December 31, 2009, the Bank had access to total lines of credit in the amount of $31 million which provide for short-term credit for liquidity. Of this total, $20 million was available on an unsecured basis. As of December 31, 2009, none of these lines had been drawn upon. The Bank is a member of the Federal Home Loan Bank of New York (“FHLBNY”) and may borrow using as collateral unencumbered investment securities and residential and commercial mortgages owned by the Bank. As of December 31, 2009, the Bank had pledged collateral giving it the capacity to borrow approximately $210.1 million from FHLBNY. As of December 31, 2009, the amount of overnight borrowings under these lines was $60.8 million. Additionally, the Bank had $90.0 million in term borrowings from the FHLBNY. There were no securities sold under agreements to repurchase from an unaffiliated primary broker as of December 31, 2009. In addition, during 2008, the Bank entered into an agreement for the purpose of issuing brokered certificates of deposit. As of December  31, 2009, the Bank had $5.0 million in brokered deposits.

Interest Rate Sensitivity

Interest rate “sensitivity” is determined by the date when each asset and liability in Suffolk’s portfolio can be repriced. Sensitivity increases when interest-earning assets and interest-bearing liabilities cannot be repriced at the same time. While this analysis presents the volume of assets and liabilities repricing in each period of time, it does not consider how quickly various assets and liabilities might actually be repriced in response to changes in interest rates. Management reviews its interest rate sensitivity regularly and adjusts its asset/liability management strategy accordingly. Because the interest rates of assets and liabilities vary according to their maturity, management may selectively mismatch the repricing of assets and liabilities to take advantage of temporary or projected differences between short- and long-term interest rates.

 

17


Table of Contents

The following table reflects the sensitivity of Suffolk’s assets and liabilities at December 31, 2009: (dollars in thousands)

 

Maturity

   Less than
3 Months
    3 to 6
Months
    7 to 12
Months
    More Than
1 Year
    Not Rate
Sensitive
    Total

Interest-earning assets

            

Domestic loans (1) (net of unearned discount)

   $ 473,055      $ 64,029      $ 100,600      $ 507,199      $ 15,496      $ 1,160,379

Federal Reserve Bank & Federal Home Loan Bank stock (2)

     8,346        —          —          652        —          8,998

Investment securities (3)

     7,954        11,006        41,505        385,878        —          446,343
                                              

Total interest-earning assets

   $ 489,355      $ 75,035      $ 142,105      $ 893,729      $ 15,496      $ 1,615,720
                                              

Demand deposits and interest-bearing liabilities

            

Demand deposits (4)

   $ 24,382      $ 24,382      $ 48,765      $ 390,118      $ —        $ 487,647

N.O.W. & money market accounts (5)

     230,211        4,986        9,973        79,781        —          324,951

Borrowings

     110,800        —          —          40,000        —          150,800

Interest-bearing deposits (6)

     211,561        38,051        25,332        297,735        —          572,679
                                              

Total demand deposits & interest-bearing liabilities

   $ 576,954      $ 67,419      $ 84,070      $ 807,634      $ —        $ 1,536,077
                                              

Gap

   $ (87,600   $ 7,615      $ 58,035      $ 86,095      $ 15,496      $ 79,643
                                              

Cumulative difference between interest-earning assets and interest-bearing liabilities

   $ (87,600   $ (79,985   $ (21,950   $ 64,145      $ 79,641     
                                          

Cumulative difference/total assets

     (5.17 %)      (4.72 %)      (1.30 %)      3.79     4.70  
                                          

Footnotes to Interest Rate Sensitivity

(1) Based on contractual maturity and instrument repricing date, if applicable; projected prepayments and prepayments of principal based on experience.
(2) FRB and FHLB stock is not considered rate-sensitive.
(3) Based on contractual maturity, and projected prepayments based on experience.
(4) Based on experience of historical stable core deposit relationships.
(5) N.O.W. and money market accounts are assumed to decline over a period of five years.
(6) Fixed-rate deposits and deposits with fixed pricing intervals are reflected as maturing in the period of contractual maturity. Saving accounts are assumed to decline over a period of five years.

At December 31, 2009, interest-bearing liabilities with maturities of less than one year exceed interest-earning assets of similar maturity. This cumulative gap might result in decreased net interest income if interest rates increase or remain stable during the next 12 months. If interest rates decline, net interest income might increase. However, interest-earning assets with maturities of greater than one year exceed interest-bearing liabilities of similar maturity. This cumulative gap might result in increased net interest income if interest rates increase beyond 12 months. If interest rates decline or remain stable, net interest income might decrease.

Interest Rate Risk

Interest rate risk is the sensitivity of earnings to changes in interest rates. As interest rates change, interest income and expense also change, thereby changing net interest income (“NII”). NII is the primary component of Suffolk’s earnings. ALCO uses a detailed and dynamic model to quantify the effect of sustained changes in interest rates on NII. While ALCO routinely monitors simulated NII sensitivity two years into the future, it uses other tools to monitor longer term interest rate risk.

The model measures the effect in the future of changing interest rates on both interest income and expense for all assets and liabilities, as well as for derivative financial instruments that do not appear on the balance sheet. The results are compared to ALCO policy limits that specify a maximum effect on NII one year in the future, assuming no growth in assets or liabilities, or a 200 basis point (“bp”) change in interest rates upward and 100 bp downward. The downward scenario was computed at 100 bp because of historically low interest rates as of the date of computation.

Following is Suffolk’s NII sensitivity as of December 31, 2009. Suffolk’s Board has approved a policy limit of 12.5 percent.

 

Rate Change

   Estimated NII Sensitivity
to December 31, 2009
 

+200 basis point rate shock

   (2.00 )% 

-100 basis point rate shock

   (0.20 )% 
      

 

18


Table of Contents

These estimates should not be interpreted as Suffolk’s forecast, and should not be considered as indicative of management’s expectations for operating results. They are hypothetical estimates that are based on many assumptions including: the nature and time of changes in interest rates, the shape of the “yield curve” (variations in interest rates for financial instruments of varying maturity at a given moment in time), prepayments on loans and securities, deposit outflows, pricing on loans and deposits, and the reinvestment of cash flows from assets and liabilities, among other things. While these assumptions are based on management’s best estimate of current economic conditions, Suffolk cannot give any assurance that they will actually predict results, nor can they anticipate how the behavior of customers and competitors may change in the future.

Factors that may affect actual results include: prepayment and refinancing of loans other than as assumed, interest rate change caps and floors, repricing intervals on adjustable rate instruments, changes in debt service on adjustable rate loans, and early withdrawal of deposits. Actual results may also be affected by actions ALCO takes in response to changes in interest rates, actual or anticipated.

When appropriate, ALCO may use off-balance-sheet instruments such as interest rate floors, caps, and swaps to hedge its position with regard to interest rate risk. The Board of Directors has approved a hedging policy statement that governs the use of such instruments. As of December 31, 2009, there were no derivative financial instruments outstanding.

The following table illustrates the contractual sensitivity to changes in interest rates of the Company’s total loans, net of discounts, not including overdrafts and loans not accruing interest, together totaling $33,194,000 at December 31, 2009: (in thousands)

 

Interest rate provision

   Due Within
1 Year
   After 1 but
Before 5 Years
   After
5 Years
   Total

Predetermined rates

   $ 147,226    $ 182,481    $ 39,818    $ 369,525

Floating or adjustable rates

     490,458      247,526      19,676      757,660
                           

Total

   $ 637,684    $ 430,007    $ 59,494    $ 1,127,185
                           

The following table illustrates the contractual sensitivity to changes in interest rates on the Company’s commercial, financial, agricultural, and real estate construction loans not including non-accrual loans totaling approximating $7,854,000 at December 31, 2009: (in thousands)

 

     Due Within
1 Year
   After 1 but
Before 5 Years
   After
5 Years
   Total

Commercial, financial & agricultural

           

Predetermined rates

   $ 33,539    $ 50,230    $ 4,142    $ 87,911

Floating or adjustable rates

     147,190      17,309      —        164,499
                           
   $ 180,729    $ 67,539    $ 4,142    $ 252,410

Real estate construction

           

Predetermined rates

     —        —        —        —  

Floating or adjustable rates

     132,732      —        —        132,732
                           
   $ 132,732    $ —      $ —      $ 132,732
                           

Total

   $ 313,461    $ 67,539    $ 4,142    $ 385,142
                           

Market Risk

Market risk is the risk that a financial instrument will lose value as the result of adverse changes in market prices, interest rates, foreign currency exchange rates, commodity prices, or the prices of equity securities. Suffolk’s primary exposure to market risk is to changing interest rates.

Monitoring and managing this risk is an important part of Suffolk’s asset/liability management process. It is governed by policies established by its Board of Directors. These policies are reviewed and approved annually. The Board delegates responsibility for asset/liability management to ALCO. ALCO then develops guidelines and strategies to implement the policy.

 

19


Table of Contents

Contractual and Off-Balance-Sheet Obligations

Following is a table describing certain liabilities not included in Suffolk’s consolidated statement of condition as well as borrowings and time deposits in the period in which they are due: (in thousands of dollars)

 

Contractual obligations

   Total    Less than 1 year    1 - 3 years    3 - 5 years    More than 5 years

Federal Home Loan Bank borrowings & repurchase agreements

   $ 150,800    $ 110,800    $ 40,000    $ —      $ —  

Time deposits

     319,079      274,942      32,012      12,125      —  

Operating lease obligations

     10,244      1,527      3,018      2,700      2,999

Purchase obligations

     4,571      1,766      1,321      605      879

Performance and financial letters of credit

     30,769      28,297      2,392      80      —  
                                  

Total

   $ 515,463    $ 417,332    $ 78,743    $ 15,510    $ 3,878
                                  

Amounts listed as purchase obligations include agreements to purchase services for Suffolk’s core banking system. Operating lease obligations do not reflect a new office scheduled to open during 2010.

Suffolk has not used, and has no intention to use, any significant off-balance-sheet financing arrangements for liquidity purposes. Its primary financial instruments with off-balance-sheet risk are limited to loan servicing for others and obligations to fund loans to customers pursuant to existing commitments.

Capital Resources

Primary capital, including stockholders’ equity, not including the net unrealized gain (loss) on securities available for sale, net of tax, the comprehensive loss on the unfunded projected benefit obligation of the pension plan, and the allowance for loan losses, amounted to $151,211,000 at year-end 2009, compared to $132,882,000 at year-end 2008 and $115,810,000 at year-end 2007.

The following table presents Suffolk’s capital ratio and other related ratios for each of the past five years: (dollars in thousands)

 

     2009 (1)     2008 (1)     2007 (1)     2006 (1)     2005 (1)  

Primary capital at year-end

   $ 151,211      $ 132,882      $ 115,810      $ 120,187      $ 114,107   

Primary capital at year-end as a percentage of year-end:

          

Total assets plus allowance for loan losses

     8.86     8.35     7.83     8.58     8.05

Loans, net of unearned discounts

     13.03     12.15     12.08     13.48     12.61

Total deposits

     10.92     10.92     10.13     10.55     9.85
                                        

 

(1) Capital ratios do not include the effect of accumulated other comprehensive income pertaining to securities available for sale, and other comprehensive loss on the unfunded projected benefit obligation of the pension plan.

The Board has adopted a policy whereby management will maximize both return on average equity and earnings-per-share, and therefore shareholder value, while maintaining the regulatory standard of “well capitalized.” That standard is currently 10 percent Total Risk-Based Capital, 6 percent Tier 1 Capital, and 5 percent Leverage Capital. However, increases in these ratios are currently under public discussion, and are expected to be implemented in the foreseeable future. Accordingly, capital will be allowed to increase to accommodate the standards now anticipated, as well as what an internal analysis indicates is necessary to allow Suffolk to operate with acceptable risk. When capital exceeds that standard meaningfully over what is expected to be required to maintain that standard during the current quarter, shares may be repurchased as they become available at prices that remain accretive to earnings-per-share in transactions under SEC rule 10-b 18 and in private purchases. When capital expected to be required during the current quarter does not exceed the standard, repurchases will not be made. Further, the dividend reinvestment program will automatically follow the same standard, purchasing shares in the market when Suffolk is in the market to repurchase shares, and issuing from the reserve when it is not. There were no repurchases during 2009.

Suffolk measures how effectively it uses capital by two widely accepted performance ratios: return on average assets and return on average equity. The return in 2009 on average assets was 1.36 percent and on average common equity was 18.30 percent, compared to 2008 returns of 1.59 percent and 21.79 percent, respectively.

All dividends must conform to applicable statutory requirements. Suffolk Bancorp’s ability to pay dividends depends on Suffolk County National Bank’s ability to pay dividends. Under 12 USC 56-9, a national bank may not pay a dividend on its common stock if the dividend would exceed net undivided profits then on hand. Further, under 12 USC 60, a national bank must obtain prior approval from the Office of the Comptroller of the Currency to pay dividends on either common or preferred stock that would exceed the bank’s net profits for the current year combined with retained net profits (net profits minus dividends paid during that period) of the prior two years. The amount the Bank currently has available to pay dividends is approximately $37,979,000.

 

20


Table of Contents

During the fourth quarter of 2008, the United States Treasury Department announced the Capital Purchase Program (“CPP”) of the Troubled Asset Relief Program (“TARP”). Under the program, banks were provided the opportunity to obtain additional capital in the form of senior preferred stock bearing an interest rate of 5% for five years and 9% thereafter and not callable for three years except in consideration of the issuance of other Tier 1 capital, along with certain warrants to purchase common stock. Suffolk analyzed it carefully and at length, and in light of satisfactory current capital and net income, neither applied for nor accepted funds from the program.

Risk-Based Capital and Leverage Guidelines

The Federal Reserve Bank’s risk-based capital guidelines call for bank holding companies to require minimum ratios of capital to risk-weighted assets, which include certain off-balance-sheet activities, such as standby letters of credit. The guidelines define capital as being “core,” or “Tier 1” capital, which includes common stockholders’ equity; a limited amount of perpetual preferred stock; minority interest in unconsolidated subsidiaries, less goodwill; or “supplementary” or “Tier 2” capital, which includes subordinated debt, redeemable preferred stock, and a limited amount of the allowance for loan losses. All bank holding companies must meet a minimum ratio of total qualifying capital to risk-weighted assets of 8.00 percent, of which at least 4.00 percent should be in the form of Tier 1 capital. At December 31, 2009 Suffolk’s ratios of core capital and total qualifying capital (core capital plus Tier 2 capital) to risk-weighted assets were 10.74 percent and 11.73 percent, respectively.

Discussion of New Accounting Pronouncements

The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) became effective for financial statements issued for interim and annual periods ending after September 15, 2009. The ASC or “codification” became FASB’s officially recognized source of authoritative accounting principles generally accepted in the United States (“U.S. GAAP”), applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All other accounting literature is considered non-authoritative. Suffolk has adopted the provisions of the codification which did not have a material impact on its consolidated financial statements. All references to accounting standards in this 10-K now refer to the relevant ASC Topic.

In October 2008, the FASB issued an update to the authoritative accounting guidance under ASC 820, “Fair Value Measurements and Disclosures.” This update describes a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The update permits, in determining fair value for a financial asset in a dislocated market, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available. This update was effective upon issuance, including prior periods for which financial statements have not been issued.

In December 2008, the FASB issued FASB Staff Position (“FSP”) Financial Accounting Standard (“FAS”) 132R-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which is codified in ASC 715, “Compensation – Retirement Benefits,” to require employers to provide expanded disclosures for the assets of postretirement benefit plans, including defined benefit pension plans. ASC 715 clarifies that the objectives of the disclosures about plan assets in an employer’s defined benefit pension or other postretirement plan are to provide users of financial statements with an understanding of: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (2) the categories of plan assets; (3) the inputs and valuation techniques used to measure the fair value of plan assets; (4) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and (5) significant concentrations of risk within plan assets. ASC 715 also expands the disclosures related to these objectives. The disclosures about plan assets required by this update are effective for fiscal years ending after December 15, 2009 (December 31, 2009 for a calendar-year entity). Suffolk has adopted the provisions ASC 715, which have been recorded in the accompanying consolidated statements of condition and related disclosures.

In May 2009, the FASB issued ASC 855, “Subsequent Events,” to incorporate the accounting and disclosure requirements for subsequent events into U.S. GAAP. ASC 855 introduces new terminology, defines a date through which management must evaluate subsequent events, and lists the circumstances under which an entity must recognize and disclose events or transactions occurring after the statement of condition date. Suffolk adopted ASC 855 as of June 30, 2009, which was the required effective date. Suffolk evaluated its financial statements as of December 31, 2009 for subsequent events through March 12, 2010, the date the financial statements were available to be issued. Suffolk is not aware of any subsequent events which would require recognition or disclosure in the financial statements.

Critical Accounting Policies, Judgments, and Estimates

The accounting and reporting policies of Suffolk conform to U.S. GAAP and general practices in the financial services industry. The preparation of financial statements in conformity with these accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results in the future could differ from those estimates.

 

21


Table of Contents

Suffolk considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated to maintain a reserve believed by management to be sufficient to absorb estimated credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. This evaluation is inherently subjective as it requires material estimates, including, among others, the expected probability of default; the amount of loss in the event of default; the expected usage of loan commitments; the amounts and timing of cash flows expected in the future from impaired loans and mortgages; and an additional factor for potential loan losses based on historical experience. Management also considers economic conditions, uncertainties in estimating losses, and inherent risks in the loan portfolio. All of these factors may change significantly in the future. To the extent that actual results differ from management’s estimates, additional provisions for loan losses may be required that could reduce earnings in future periods.

Suffolk recognizes deferred-tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the amount that management expects to realize.

Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and the Company’s intent and ability to hold the impaired investment at the time the valuation is made. If management determines that an impairment in the investment’s value is other than temporary, earnings would be charged.

Business Risks and Uncertainties

This annual report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, and the economy in general. Factors affecting Suffolk Bancorp include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolk’s market area; and variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operations. Each of these factors may change in ways that management does not now foresee. These remarks are based on current plans and expectations. They are subject, however, to a variety of uncertainties that could cause future results to vary materially from Suffolk’s historical performance, or from current expectations.

Management’s Report on Internal Control over Financial Reporting

The management of Suffolk Bancorp is responsible for establishing and maintaining adequate internal control over financial reporting. Suffolk Bancorp’s internal control system was designed to provide reasonable assurance to the company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Suffolk Bancorp management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2009. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on our assessment and those criteria we have determined that, as of December 31, 2009, the company’s internal control over financial reporting is effective.

Suffolk Bancorp’s independent registered public accounting firm has issued its report on our assessment of the company’s internal control over financial reporting. This report appears on page 46.

 

22


Table of Contents

CONSOLIDATED STATEMENTS OF CONDITION

 

     December 31,  
     2009     2008  

ASSETS

    

Cash and Due from Banks

   $ 37,006,618      $ 41,512,480   

Federal Reserve Bank Stock

     651,749        637,849   

Federal Home Loan Bank Stock

     8,345,600        9,821,100   

Investment Securities:

    

Available for Sale, at Fair Value

     437,000,346        382,357,190   

Held to Maturity (Fair Value of $10,096,295 and $12,515,008, respectively)

    

Obligations of States and Political Subdivisions

     9,243,309        11,830,259   

Other Securities

     100,000        100,000   
                

Total Investment Securities

     446,343,655        394,287,449   

Total Loans

     1,160,409,574        1,093,554,189   

Less: Unearned Discounts

     30,685        32,906   

Allowance for Loan Losses

     12,332,699        9,050,798   
                

Net Loans

     1,148,046,190        1,084,470,485   

Premises and Equipment, Net

     23,345,587        22,739,566   

Accrued Interest Receivable

     7,223,398        7,042,075   

Goodwill

     814,445        814,445   

Other Assets

     22,719,091        21,493,233   
                

TOTAL ASSETS

   $ 1,694,496,333      $ 1,582,818,682   
                

LIABILITIES & STOCKHOLDERS’ EQUITY

    

Demand Deposits

   $ 487,648,382      $ 439,380,062   

Saving, N.O.W., and Money Market Deposits

     578,551,138        482,204,209   

Time Certificates of $100,000 or more

     211,897,572        180,362,329   

Other Time Deposits

     107,181,377        114,490,893   
                

Total Deposits

     1,385,278,469        1,216,437,493   

Repurchase Agreements

     —          37,620,000   

Federal Home Loan Bank Borrowings

     150,800,000        187,200,000   

Dividend Payable on Common Stock

     2,115,409        2,108,194   

Accrued Interest Payable

     828,841        2,243,864   

Other Liabilities

     18,302,658        24,808,197   
                

TOTAL LIABILITIES

     1,557,325,377        1,470,417,748   
                

Commitments and Contingent Liabilities (see Note 11)

    

STOCKHOLDERS’ EQUITY

    

Common Stock (par value $2.50; 15,000,000 shares authorized, 9,615,494 and 9,582,699 shares outstanding at December 31, 2009 & 2008, respectively)

     34,030,931        33,945,901   

Surplus

     21,685,892        20,782,214   

Retained Earnings

     93,153,680        79,092,185   

Treasury Stock at Par (3,996,878 shares and 3,995,661 shares, respectively)

     (9,992,203     (9,989,160

Accumulated Other Comprehensive Loss, Net of Tax

     (1,707,344     (11,430,206
                

TOTAL STOCKHOLDERS’ EQUITY

     137,170,956        112,400,934   
                

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY

   $ 1,694,496,333      $ 1,582,818,682   
                

See accompanying notes to consolidated financial statements.

 

23


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME

 

     For the Years ended December 31,
     2009    2008    2007

INTEREST INCOME

        

Interest on Due from Banks

   $ 50,963    $ —      $ —  

Federal Funds Sold

     26      313,945      140,488

United States Treasury Securities

     364,012      398,540      397,637

Obligations of States and Political Subdivisions (tax exempt)

     6,579,717      5,766,450      4,914,370

Obligations of States and Political Subdivisions (taxable)

     507,237      537,007      509,259

Mortgage-Backed Securities

     7,545,964      7,926,441      7,672,224

U.S. Government Agency Obligations

     2,056,782      3,663,307      4,575,522

Corporate Bonds and Other Securities

     433,739      482,088      423,401

Loans and Loan Fees

     69,469,158      69,369,546      70,448,470
                    

Total Interest Income

     87,007,598      88,457,324      89,081,371

INTEREST EXPENSE

        

Saving, N.O.W., and Money Market Deposits

     3,629,586      6,333,647      4,838,463

Time Certificates of $100,000 or more

     3,537,129      5,344,507      5,093,827

Other Time Deposits

     2,530,579      4,507,324      8,180,878

Federal Funds Purchased and Repurchase Agreements

     120,351      1,416,534      2,876,088

Interest on Other Borrowings

     2,853,885      4,635,183      4,127,929
                    

Total Interest Expense

     12,671,530      22,237,195      25,117,185

Net Interest Income

     74,336,068      66,220,129      63,964,186

Provision for Loan Losses

     4,275,000      2,050,000      376,718
                    

Net Interest Income After Provision for Loan Losses

     70,061,068      64,170,129      63,587,468

OTHER INCOME

        

Service Charges on Deposit Accounts

     5,341,588      5,557,936      5,411,969

Other Service Charges, Commissions & Fees

     3,305,532      3,046,089      2,980,797

Fiduciary Fees

     1,010,147      1,459,849      1,408,759

Other Operating Income

     1,460,688      837,724      793,289

Net Gain on Sale of Securities Available for Sale

     —        3,741,001      —  
                    

Total Other Income

     11,117,955      14,642,599      10,594,814

OTHER EXPENSE

        

Salaries & Employee Benefits

     28,266,579      25,645,919      24,407,513

Net Occupancy Expense

     5,087,658      4,649,140      4,069,312

Equipment Expense

     2,291,104      2,145,770      2,207,888

Outside Services

     2,865,150      2,274,632      2,354,862

FDIC Assessments

     2,716,985      486,304      145,992

Other Operating Expense

     7,572,719      7,499,147      7,206,704
                    

Total Other Expense

     48,800,195      42,700,912      40,392,271

Income Before Provision for Income Taxes

     32,378,828      36,111,816      33,790,011

Provision for Income Taxes

     9,830,387      11,423,381      11,662,386
                    

NET INCOME

   $ 22,548,441    $ 24,688,435    $ 22,127,625
                    

Average: Common Shares Outstanding

     9,602,802      9,580,025      9,895,301

Dilutive Stock Options

     18,175      21,970      20,642
                    

Average Total Common Shares and Dilutive Options

     9,620,977      9,601,995      9,915,943

EARNINGS PER COMMON SHARE

        

Basic

   $ 2.35    $ 2.58    $ 2.24

Diluted

   $ 2.34    $ 2.57    $ 2.23

See accompanying notes to consolidated financial statements.

 

24


Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

     Common
Stock
   Surplus    Retained
Earnings
    Treasury
Stock
    Accumulated
Other Comprehensive

Income (Loss)
Net of Tax
    Total     Comprehensive
Income
 

Balance,

                

December 31, 2006

   $ 33,910,979    $ 19,931,465    $ 67,099,115      $ (8,305,255   $ (4,069,957   $ 108,566,347     

Cumulative Effect of Adoption of FIN 48

     —        —        2,012,657        —          —          2,012,657     

Balance,

                

January 1, 2007 as revised

   $ 33,910,979    $ 19,931,465    $ 69,111,772      $ (8,305,255   $ (4,069,957   $ 110,579,004     

Net Income

     —        —        22,127,625        —          —          22,127,625      $ 22,127,625   

Dividend - Cash

     —        —        (8,651,816     —          —          (8,651,816  

Purchase of Treasury Stock

     —        —        (18,648,400     (1,578,905     —          (20,227,305  

Stock Option Expense

     —        240,420      —          —          —          240,420     

Net Change in Unrealized Gain on Securities Available for Sale

     —        —        —          —          3,011,237        3,011,237        3,011,237   

Other Comprehensive Gain on Pension Projected Benefit Obligation

     —        —        —          —          1,902,206        1,902,206        1,902,206   
                      

Comprehensive Income

                 $ 27,041,068   
                      

Balance,

                

December 31, 2007

   $ 33,910,979    $ 20,171,885    $ 63,939,181      $ (9,884,160   $ 843,486      $ 108,981,371     

Remeasurement of Postretirement Obligation Under FAS 158

           157,137            157,137     

Remeasurement of Pension Obligation Under FAS 158

           (118,515         (118,515  

Balance,

                

January 1, 2008 as revised

   $ 33,910,979    $ 20,171,885    $ 63,977,803      $ (9,884,160   $ 843,486      $ 109,019,993     

Net Income

     —        —        24,688,435        —          —          24,688,435      $ 24,688,435   

Dividend - Cash

     —        —        (8,425,893     —          —          (8,425,893  

Purchase of Treasury Stock

     —        —        (1,148,160     (105,000     —          (1,253,160  

Stock Option Expense

     —        181,894      —          —          —          181,894     

Stock Dividend Reinvestment

     34,922      428,435      —          —          —          463,357     

Net Change in Unrealized Gain on Securities Available for Sale

     —        —        —          —          (3,603,284     (3,603,284     (3,603,284

Other Comprehensive Loss on Pension Projected Benefit Obligation

     —        —        —          —          (8,670,408     (8,670,408     (8,670,408
                      

Comprehensive Income

                 $ 12,414,743   
                      

Balance,

                

December 31, 2008

   $ 33,945,901    $ 20,782,214    $ 79,092,185      $ (9,989,160   $ (11,430,206   $ 112,400,934     

Net Income

     —        —        22,548,441        —          —          22,548,441      $ 22,548,441   

Dividend - Cash

     —        —        (8,450,631     —          —          (8,450,631  

Stock Option Expense

     —        140,025      —          —          —          140,025     

Stock Appreciation Rights and Stock Options Exercised

     7,500      31,875      (36,315     (3,043     —          17     

Stock Dividend

Reinvestment, net

     77,530      731,778      —          —          —          809,308     

Net Change in Unrealized Gain on Securities Available for Sale

     —        —        —          —          7,306,656        7,306,656        7,306,656   

Other Comprehensive Gain on Pension and Postretirement Plan Projected Benefit Obligation

     —        —        —          —          2,416,206        2,416,206        2,416,206   
                      

Comprehensive Income

                 $ 32,271,303   
                      

Balance,

                

December 31, 2009

   $ 34,030,931    $ 21,685,892    $ 93,153,680      $ (9,992,203   $ (1,707,344   $ 137,170,956     
                                                

See accompanying notes to consolidated financial statements.

 

25


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Years ended December 31,  
     2009     2008     2007  

NET INCOME

   $ 22,548,441      $ 24,688,435      $ 22,127,625   

ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH

      

CASH FLOWS FROM OPERATING ACTIVITIES

      

Provision for Loan Losses

     4,275,000        2,050,000        376,718   

Depreciation and Amortization

     2,555,327        2,468,657        2,312,684   

Stock-Based Compensation

     140,025        181,894        240,420   

Accretion of Discounts

     (233,905     (317,089     (136,959

Amortization of Premiums

     1,683,904        896,089        768,006   

(Increase) Decrease in Accrued Interest Receivable

     (181,322     317,272        249,655   

(Increase) Decrease in Other Assets

     (10,530,874     730,749        (4,283,583

Decrease in Accrued Interest Payable

     (1,415,023     (3,506     (1,125,623

(Decrease) Increase in Income Taxes Payable

     (17,057     682,182        (4,632,729

Increase in Other Liabilities

     16,334        1,701,208        3,572,497   

Net Gain on Sale of Securities

     —          (3,741,001     —     
                        

Net Cash Provided by Operating Activities

     18,840,850        29,654,890        19,468,711   
                        

CASH FLOWS FROM INVESTING ACTIVITIES

      

Principal Payments on Investment Securities

     33,258,275        35,381,854        28,170,242   

Proceeds from Sale of Investment Securities; Available for Sale

     —          3,741,001        —     

Maturities of Investment Securities; Available for Sale

     112,500,000        47,200,000        20,000,000   

Purchases of Investment Securities; Available for Sale

     (189,541,442     (78,808,947     (33,249,252

Maturities of Investment Securities; Held to Maturity

     11,421,300        2,326,400        2,919,000   

Purchases of Investment Securities; Held to Maturity

     (7,379,900     (7,104,068     (5,430,981

Loan Disbursements and Repayments, Net

     (67,630,480     (137,481,135     (67,608,733

Purchases of Premises and Equipment, Net

     (3,161,348     (3,064,990     (1,984,843
                        

Net Cash Used in Investing Activities

     (110,533,595     (137,809,885     (57,184,567
                        

CASH FLOWS FROM FINANCING ACTIVITIES

      

Net Increase in Deposit Accounts

     168,840,975        73,062,630        4,299,875   

Short-Term Borrowings and Repayments, Net

     (74,020,000     26,500,000        78,185,000   

Dividends Paid to Shareholders

     (8,443,417     (8,438,689     (8,784,131

Stock Dividend Reinvestment, Net

     809,308        463,357        —     

Stock Options and Stock Appreciation Rights Exercised

     17        —          —     

Treasury Shares Acquired

     —          (1,253,160     (20,227,305
                        

Net Cash Provided by Financing Activities

     87,186,883        90,334,138        53,473,439   
                        

Net (Decrease) Increase in Cash and Cash Equivalents

     (4,505,862     (17,820,857     15,757,583   

Cash and Cash Equivalents Beginning of Year

     41,512,480        59,333,337        43,575,754   
                        

Cash and Cash Equivalents End of Year

   $ 37,006,618      $ 41,512,480      $ 59,333,337   
                        

Supplemental Disclosure of Cash Flow Information

      

Cash Received During the Year for Interest

   $ 86,826,276      $ 88,774,596      $ 89,331,026   

Cash Paid During the Year for:

      

Interest

   $ 14,086,553      $ 22,240,700      $ 26,242,808   

Income Taxes

     11,537,211        12,638,659        14,767,686   
                        

Total Cash Paid During Year for Interest & Income Taxes

   $ 25,623,764      $ 34,879,359      $ 41,010,494   
                        

Non-Cash Investing and Financing:

      

(Increase) Decrease in Market Value of Investments

     (12,302,841     6,085,776        (5,103,793

(Decrease) Increase in Deferred Tax Asset Related to Market Value of Investments Available for Sale

     (4,996,184     2,482,492        (2,092,555

Dividends Declared But Not Paid

     2,115,409        2,108,194        2,120,989   

Stock Options and Stock Appreciation Rights Exercised for Stock

     39,375        —          —     

See accompanying notes to consolidated financial statements.

 

26


Table of Contents

Notes to Consolidated Financial Statements

Note 1 — Summary of Significant Accounting Policies

The accounting and reporting policies of Suffolk Bancorp (Suffolk) and its subsidiary conform to accounting principles generally accepted in the United States of America (U.S. GAAP) and general practices within the banking industry. The following footnotes describe the most significant of these policies.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported assets and liabilities as of the date of the consolidated statements of condition. The same is true of revenues and expenses reported for the period. Actual results could differ significantly from those estimates.

The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) became effective for financial statements issued for interim and annual periods ending after September 15, 2009. The ASC or “codification” became FASB’s officially recognized source of authoritative U.S. GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. All references to accounting standards in these financial statements now refer to the relevant ASC Topic.

(A) Consolidation — The consolidated financial statements include the accounts of Suffolk and its wholly owned subsidiary, Suffolk County National Bank (the “Bank”). In 1998, the Bank formed a Real Estate Investment Trust named Suffolk Greenway, Inc. In 2004, the Bank formed an insurance agency named SCNB Financial Services, Inc. All inter-company transactions have been eliminated in consolidation.

(B) Investment Securities — Suffolk reports debt securities and mortgage-backed securities in one of the following categories: (i) “held to maturity” (management has the intent and ability to hold to maturity), which are to be reported at amortized cost; (ii) “trading” (held for current resale), which are to be reported at fair value, with unrealized gains and losses included in earnings; and (iii) “available for sale” (all other debt securities and mortgage-backed securities), which are to be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. Accordingly, Suffolk classified all of its holdings of debt securities and mortgage-backed securities as either “held to maturity” or “available for sale.” At the time a security is purchased, a determination is made as to the appropriate classification.

Premiums and discounts on debt and mortgage-backed securities are amortized as expense and accreted as income over the estimated life of the respective security using a method that approximates the level-yield method. Gains and losses on the sales of investment securities are recognized upon realization, using the specific identification method and shown separately in the consolidated statements of income.

Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and the Company’s intent and ability to hold the impaired investment at the time the valuation is made. If management determines that an impairment in the investment’s value is other than temporary, earnings would be charged.

(C) Loans and Loan Interest Income Recognition — Loans are stated at the principal amount outstanding. Interest on loans not made on a discounted basis is credited to income, based upon the principal amount outstanding during the period. Unearned discounts on installment loans are credited to income using methods that result in a level yield. Recognition of interest income is discontinued when reasonable doubt exists as to whether interest due can be collected. Loans generally no longer accrue interest when 90 days past due. When a loan is placed on non-accrual status, all interest previously accrued in the current year, but not collected, is reversed against current-year interest income. Any interest accrued in prior years is charged against the allowance for loan losses. Loans start accruing interest again when they become current as to principal and interest, and when, in the opinion of management, the loans can be collected in full.

(D) Allowance for Loan Losses — The balance of the allowance for loan losses is determined by management’s estimate of the amount of financial risk in the loan portfolio and the likelihood of loss. The analysis also considers the Bank’s loan loss experience and is adjusted for economic conditions and other factors. Additions to the allowance are made by charges to expense, and actual losses, net of recoveries, are charged to the allowance. Regulatory examiners may require the Bank to add to the allowance based upon their judgment of information available to them at the time of their examination.

In accordance with FASB ASC 310, “Receivables,” an allowance is maintained for impaired loans to reflect the difference, if any, between the principal balance of the loan and the present value of projected cash flows, observable fair value, or collateral value. An impaired loan is defined as a loan for which it is probable that the lender will not collect all amounts due under the contractual terms of the loan.

Transfers of financial assets for which the Bank has surrendered control of the financial assets are accounted for as sales to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. Retained interests in a sale or securitization of financial assets are measured at the date of transfer by allocating the previous carrying amount between the assets transferred and based on their relative estimated fair values. The fair values of retained servicing rights and any other retained interests are determined based on the present value of expected future cash flows associated with those interests and by reference to market prices for similar assets. There were no

 

27


Table of Contents

transfers of financial assets to related or affiliated parties. At December 31, 2009 and 2008, the Bank’s servicing loan portfolio approximated $132,768,000, and $121,233,000, respectively, which are not included in the accompanying consolidated statements of condition. The carrying value which approximates the estimated fair value of mortgage servicing rights was $1,444,000 and $1,199,000 as of December 31, 2009 and 2008, respectively.

(E) Premises and Equipment — Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is calculated by the declining-balance or straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the term of the lease or the estimated life of the asset, whichever is shorter.

The Bank periodically evaluates impairment of long-lived assets to be held and used or to be disposed of by sale. There was no impairment of long-lived assets as of December 31, 2009 and 2008, respectively.

(F) Other Real Estate Owned — Property acquired through foreclosure (other real estate owned or “OREO”), is stated at the lower of cost or fair value less selling costs. Credit losses arising at the time of the acquisition of property are charged against the allowance for loan losses. Any additional write-downs to the carrying value of these assets that may be required, as well as the cost of maintaining and operating these foreclosed properties, are charged to expense. Additional write-downs are recorded in a valuation reserve account that is maintained asset by asset. There was no OREO as of December 31, 2009.

(G) Goodwill and Other Intangible Assets — Through December 31, 2001, the excess of cost over fair value of net assets acquired (goodwill) was amortized on a straight-line basis over a period of ten years. On January 1, 2002, the Bank ceased amortizing goodwill and, instead, tests goodwill for impairment annually or when there is a circumstance that would indicate the need to evaluate between annual tests. No such circumstances occurred in 2009. Accordingly, there was no impairment of goodwill as of December 31, 2009 and 2008.

(H) Allowance for Contingent Liabilities — The balance of the allowance for contingent liabilities is determined by management’s estimate of the amount of financial risk in outstanding loan commitments and contingent liabilities such as performance and financial letters of credit. The allowance for contingent liabilities was $419,000 as of December 31, 2009 and 2008.

Suffolk has financial and performance letters of credit. Financial letters of credit require the Bank to make payment if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Bank to make payments if the customer fails to perform certain nonfinancial contractual obligations. The maximum potential undiscounted amount of the future payments of these letters of credit as of December 31, 2009 is $30,769,000 and they expire as follows:

 

2010

   $ 28,297,000

2011

     1,899,000

2012

     493,000

2013 and thereafter

     80,000
      
   $ 30,769,000
      

Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The valuation of the allowance for contingent liabilities includes a provision of $46,000 for losses based on the letters of credit outstanding on December 31, 2009.

(I) Income Taxes — Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is management’s position that no valuation allowance is necessary against any of Suffolk’s deferred tax assets.

Suffolk accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return.

(J) Summary of Retirement Benefits Accounting — Suffolk’s retirement plan is noncontributory and covers substantially all eligible employees. The plan conforms to the provisions of the Employee Retirement Income Security Act of 1974, as amended, and the Pension Protection Act of 2006, which requires certain funding rules for defined benefit plans. Suffolk’s policy is to accrue for all pension costs and to fund the maximum amount allowable for tax purposes. Actuarial gains and losses that arise from changes in assumptions concerning future events are amortized over a period that reflects the long-term nature of pension expense used in estimating pension costs.

Suffolk accounts for its retirement plan in accordance with FASB ASC 715, “Compensation – Retirement Benefits” and FASB ASC 960, “Plan Accounting – Defined Benefit Pension Plans,” which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial position; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligation as of the date of fiscal year-end statement of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the

 

28


Table of Contents

gains or losses, prior service costs or credits, and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial position and in determining the amount of net periodic benefit cost. The codification also requires an employer to use the same date for the measurement of plan assets as for the statement of condition, and provides for either of two methods to make the transition. Suffolk has chosen to re-measure the obligations of the plan as of the beginning of fiscal year 2008. Under this method, 2008 net periodic pension expense was determined using the market value of plan assets and liabilities as of January 1, 2008. Accordingly, Suffolk recorded a decrease to prepaid pension cost of $1,297,000, a debit adjustment to opening retained earnings in the amount of $118,000, and a debit adjustment to accumulated other comprehensive loss in the amount of $1,140,000.

Suffolk accrues for postretirement benefits other than pensions by accruing the cost of providing those benefits to an employee during the years that the employee serves. The remeasurement of the postretirement plan resulted in a credit to the 2008 opening retained earnings in the amount of $157,000.

(K) Cash and Cash Equivalents — For purposes of the consolidated statement of cash flows, cash and due from banks, and federal funds sold are considered to be cash equivalents. Generally, federal funds are sold for one-day periods.

(L) Stock-Based Compensation — At December 31, 2009, the Bank had one stock-based employee compensation plan, which is more fully described in Note 8. Stock-based compensation for all share-based payments to employees, including grants of employee stock options, are recognized in the financial statements based on their fair values.

During 2009, 2008, and 2007, $83,000, $108,000, and $143,000 of compensation expense, net of a tax benefit of $57,000, $74,000, and $97,000, respectively, was recorded for stock-based compensation. As of December 31, 2009, there was $12,000 of total unrecognized compensation cost, net of estimated forfeitures, related to non-vested options under the stock-based employee compensation plan. That cost is expected to be recognized over a weighted average period of one month.

(M) Treasury Stock — The balance of treasury stock is computed at par value. The excess cost over par is subtracted from undivided profits.

(N) Earnings-per-share — Basic earnings-per-share are computed by dividing net income by the number of weighted-average shares outstanding during the period. Diluted earnings-per-share reflect the dilution that would occur if stock options were exercised in return for common stock that would then share in Suffolk’s earnings. It is computed by dividing net income by the sum of the weighted-average number of common shares outstanding and the weighted-average number of stock options exercisable during the period. Suffolk has no other securities that could be converted into common stock, nor any contracts that would result in the issuance of common stock.

(O) Comprehensive Income — Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists of unrealized holding gains or losses on securities available for sale, and gains or losses on the unfunded projected benefit obligation of the pension plan.

The following table summarizes comprehensive income activity : (in thousands)

 

     December 31, 2009    December 31, 2008     December 31, 2007
     Before
Tax
Amount
   Tax
(Expense)
Benefit
    Net of
Tax
Amount
   Before
Tax
Amount
    Tax
(Expense)
Benefit
   Net of
Tax
Amount
    Before
Tax
Amount
   Tax
(Expense)
Benefit
    Net of
Tax
Amount

Unrealized gains (losses) on investment securities (1)

   $ 12,303    $ (4,996   $ 7,307    $ (6,086   $ 2,483    $ (3,603   $ 5,104    $ (2,093   $ 3,011

Gains (losses) on pension andpostretirement plan projected benefit obligations

     4,052      (1,636     2,416      (14,799     6,010      (8,671     3,247      (1,344     1,903
                                                                  

Adjusted other comprehensive income (loss), net

   $ 16,355    $ (6,632   $ 9,723    $ (20,885   $ 8,493    $ (12,274   $ 8,351    $ (3,437   $ 4,914
                                                                  

 

(1) Excludes realized securities gains, during 2008, from the sale of Visa shares with a zero basis.

(P) Segment Reporting — FASB ASC 28, “Segment Reporting,” requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. Suffolk is a regional bank, which offers a wide array of products and services to its customers.

 

29


Table of Contents

Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, at December 31, 2009 and 2008, Suffolk is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Thus, all necessary requirements have been met by Suffolk as of December 31, 2009.

(Q) Fair Value Measurements — Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price, which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value, and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities.

Suffolk uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 - Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 - Quoted prices in markets that are not active, or inputs that use pricing models or matrix pricing;

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

As of January 1, 2008, Suffolk records investments and impaired loans at fair value. Please refer to Note 14 for further information regarding fair value measurements.

(R) Reclassification of Prior Year Consolidated Financial Statements — Certain reclassifications have been made to the prior year’s consolidated financial statements that conform with the current year’s presentation. Such reclassifications had no impact on net income.

Note 2 — Investment Securities

The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolk’s investment securities available for sale and held to maturity at December 31, 2009 and 2008 were: (in thousands)

 

     2009     2008  
     Amortized
Cost
   Estimated
Fair Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Amortized
Cost
   Estimated
Fair Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
 

Available for sale:

                      

  U.S. Treasury securities

   $ 8,016    $ 8,318    $ 302    $ —        $ 9,534    $ 10,152    $ 618    $ —     

  U.S. government agency debt

     42,607      43,205      598      —          75,358      76,477      1,119      —     

  Collateralized mortgage obligations

     192,143      192,393      4,026      (3,776     134,947      131,841      2,663      (5,769

  Mortgage-backed securities