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EX-21 - SUBSIDIARIES OF THE REGISTRANT - TWO RIVER BANCORPex21.htm
EX-32 - TWO RIVER BANCORPex32.htm
EX-31.2 - TWO RIVER BANCORPex31_2.htm
EX-31.1 - TWO RIVER BANCORPex31_1.htm
EX-99.2 - CERTIFICATIONS - TWO RIVER BANCORPex99_2.htm
EX-99.1 - CERTIFICATIONS - TWO RIVER BANCORPex99_1.htm
EX-23 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - TWO RIVER BANCORPex23.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K
 
(Mark One)
x          ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
 
o          TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to _______
 
Commission file number:  000-51889

COMMUNITY PARTNERS BANCORP
(Exact Name of Registrant as Specified in Its Charter)


New Jersey
 
20-3700861
(State or Other Jurisdiction of
Incorporation or Organization)
 
I.R.S. Employer Identification Number)

 
1250 Highway 35 South, Middletown, NJ 07748
 
 
(Address of Principal Executive Offices, including Zip Code)
 

 
(732) 706-9009
 
 
(Registrant’s telephone number, including area code)
 
     
 
Securities registered pursuant to Section 12(b) of the Act:
 

Title of each class
 
 Name of each exchange on which  registered
Common Stock, no par value
 
The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.     Yes o   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 o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes o        No o
 

 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o
       
Non-accelerated filer
(Do not check if a smaller reporting company)
o
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o    No x
 
The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common stock was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter, is $26,412,796.
 
As of March 15, 2010, 7,182,497 shares of the registrant’s common stock were outstanding.
 
Documents incorporated by reference
 
Portions of the registrant’s definitive Proxy Statement for its 2010 Annual Meeting of Shareholders are incorporated by reference into Part III of this report and will be filed within 120 days of December 31, 2009.
 
 
 



 
FORM 10-K


 
PART I
     
Item 1.
1
Item 1A.
17
Item 1B.
22
Item 2.
23
Item 3.
24
Item 4.
24
     
PART II
     
Item 5.
24
Item 6.
24
Item 7.
 
25
Item 7A.
47
Item 8.
47
Item 9.
 
47
Item 9A(T).
47
Item 9B.
48
     
PART III
     
Item 10.
48
Item 11.
48
Item 12.
 
49
   
 
Item 13.
49
Item 14.
49
     
PART IV
     
Item 15.
50
     
 
51
 
i

 
PART I

Forward-Looking Statements
 
When used in this and in future filings by us with the Securities and Exchange Commission (the “SEC”), in our press releases and in oral statements made with the approval of an authorized executive officer of ours, the words or phrases “will,” “will likely result,” “could,” “anticipates,” “believes,” “continues,” “expects,” “plans,” “will continue,” “is anticipated,” “estimated,” “project” or “outlook” or similar expressions (including confirmations by an authorized executive officer of ours of any such expressions made by a third party with respect to us) are intended to identify statements constituting “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and that are intended to come within the safe harbor protection provided by these sections. We wish to caution readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made, even if subsequently made available on our website or otherwise. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The forward-looking statements are and will be based on management’s then-current views and assumptions regarding future events and operating performance, and are applicable only as of the dates of such statements.
 
Factors that may cause actual results to differ from those results expressed or implied, include, but are not limited to, those listed in this report under the heading “Risk Factors”; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; developments in the financial services industry and U.S. and global credit markets; changes in the direction of the economy nationally or in New Jersey; changes in interest rates; competition; loss of management and key personnel; government regulation; environmental liability; failure to implement new technologies in our operations; changes in our liquidity; changes in our funding sources; failure of our controls and procedures; disruptions of our operational systems and relationships with vendors; and our success in managing risks involved in the foregoing. Although management has taken certain steps to mitigate any negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on profitability. Such risks and other aspects of our business and operations are described in Item 1. “Business”, Item 1A. “Risk Factors” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report. We have no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.
 
 
The disclosures set forth in this item are qualified by Item 1A. “Risk Factors”, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other statements set forth in this report.
 
Community Partners Bancorp
 
Community Partners Bancorp, which we refer to herein as “Community Partners,” the “Company,” “we,” “us” and “our,” is a business corporation organized under the laws of the State of New Jersey in August 2005. The principal place of business of Community Partners is located at 1250 Highway 35 South, Middletown, New Jersey 07748 and its telephone number is (732) 706-9009.
 
Effective December 31, 2008, Community Partners consolidated its two wholly owned bank subsidiaries, The Town Bank (“Town Bank”), based in Westfield, New Jersey, and Two River Community Bank (“Two River”), based in Middletown, New Jersey. The two banks have been under common partnership since Community Partners was organized to acquire them, in a transaction that took place in April 2006. The consolidation streamlined operations and created administrative efficiencies and reductions in overhead costs. For legal and regulatory purposes, there is now only one New Jersey state-chartered commercial bank, Two River Community Bank, which we also refer to herein as the “Bank.”  The Town Bank branches have used the Town Bank name and have operated as a division of Two River Community Bank. On or about April 1, 2010, the Town Bank branches will operate under the Two River Community Bank title. The entire branch network comprises 15 branches in Monmouth and Union counties, New Jersey.
 
 
Other than its investment in the Bank, Community Partners currently conducts no other significant business activities. Community Partners may determine to operate its own business or acquire other commercial banks, thrift institutions or bank holding companies, or engage in or acquire such other activities or businesses as may be permitted by applicable law, although it has no present plans or intentions to do so. When we refer to the business conducted by Community Partners in this document, including any lending or other banking activities, we are referring to the business that Community Partners conducts through the Bank.
 
As of December 31, 2009, the Company had consolidated assets of $640.0 million, total deposits of $535.4 million and shareholders’ equity of $76.8 million.
 
Employees
 
As of December 31, 2009, the Company and its subsidiaries had 158 employees, of whom 141 were full-time and 17 were part-time. None of the Company's employees are represented by a union or covered by a collective bargaining agreement. Management of the Company and the Bank believe that, in general, their employee relations are good.
 
Two River Community Bank
 
Two River Community Bank was organized in January 2000 as a New Jersey state-chartered commercial bank to engage in the business of commercial and retail banking. As a community bank, the Bank offers a wide range of banking services including demand, savings and time deposits and commercial and consumer/installment loans to small and medium-sized businesses, not-for-profit organizations, professionals and individuals principally in Monmouth and Union counties, New Jersey. The Bank also offers its customers numerous banking products such as safe deposit boxes, a night depository, wire transfers, money orders, travelers checks, automated teller machines, direct deposit, telephone and internet banking and corporate business services. The Bank currently operates 15 banking offices in Monmouth and Union counties, New Jersey and a non-banking operations facility. The Bank’s principal banking office is located at 1250 Highway 35 South, Middletown, New Jersey. Other banking offices are located in Allaire, Atlantic Highlands, Cliffwood, Manasquan, Navesink, Port Monmouth, Red Bank, Tinton Falls (2), West Long Branch, Westfield (2), Cranford and Fanwood, New Jersey.
 
We believe that the Bank’s customers still want to do business with a banker and that they want to feel that they are important to that banker. To accomplish this objective, we emphasize to our employees the importance of delivering exemplary customer service and seeking out opportunities to build further relationships with the Bank’s customers. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the statutory limits.
 
Competition
 
The Bank faces substantial competition for deposits and creditworthy borrowers. It competes with New Jersey and regionally based commercial banks, savings banks and savings and loan associations, as well as national financial institutions, most of which have assets, capital and lending limits greater in amount than that of the Bank. Other competitors include money market mutual funds, mortgage bankers, insurance companies, stock brokerage firms, regulated small loan companies, credit unions and issuers of commercial paper and other securities.
 
Products and Services
 
The Bank offers a full range of banking services to our customers. These services include a wide variety of business and consumer lending products as well as corporate services for businesses and professionals. We offer a range of deposit products including checking, savings and money market accounts plus certificates of deposit. In addition, the Bank participates in the Certificate of Deposit Account Registry Service (“CDARS”), a service that enables us to provide our customers with additional FDIC insurance on certificate of deposit (“CD”) products. Other products and services include remote deposit capture, safe deposit boxes; ACH services; debit and ATM card services and Visa gift cards. Other service products include traveler’s checks, money orders, treasurer’s checks, and direct deposit facilities. We also offer customers the convenience of a full complement of internet banking services that allow them to check account balances, receive email alerts, transfer funds, initiate stop payment requests, and pay their bills.
 
 
Lending Activities
 
The Bank engages in a variety of lending activities, which are primarily categorized as either commercial or residential real estate-consumer lending. The strategy is to focus our lending activities on small and medium-sized business customers and retain customers by offering them a wide range of products and personalized service. Commercial and real estate mortgage lending (consisting of commercial real estate, commercial business, construction and other commercial lending, including medical lending and private banking) are currently our main lending focus. Sources to fund loans are derived primarily from deposits, although we do occasionally borrow to fund loan growth or meet deposit outflows.
 
The Bank presently generates the vast majority of our loans in the State of New Jersey, with a significant portion in Union and Monmouth counties. Loans are generated through marketing efforts, the Bank’s present customers, walk-in customers, referrals, the directors, founders and members of advisory boards of the Bank. The Bank strives to maintain a high overall credit quality through the establishment of and adherence to prudent lending policies and practices and sound management. The Bank has an established written loan policy that has been adopted by the board of directors and is reviewed annually. Any loan to Bank or Company directors or their affiliates must be reviewed and approved by the Bank’s board of directors in accordance with the loan policy for such loans as well as applicable state and federal law. Under our loan policies, approvals of affiliate transactions are made only by independent board members.
 
In managing the growth and quality of the Bank’s loan portfolio, we have focused on: (i) the application of prudent underwriting criteria; (ii) the active involvement by senior management and the Bank’s board of directors in the loan approval process; (iii) the active monitoring of loans to ensure timely repayment and early detection of potential problems; and (iv) a loan review process by an independent loan review firm, which conducts in-depth reviews of portions of the loan portfolio on a quarterly basis.
 
 Our principal earning assets are loans originated or participated in by the Bank. The risk that certain borrowers will not be able to repay their loans under the existing terms of the loan agreement is inherent in the lending function. Risk elements in a loan portfolio include non-accrual loans (as defined below), past due and restructured loans, potential problem loans, loan concentrations (by industry or geographically) and other real estate owned, acquired through foreclosure or a deed in lieu of foreclosure. Because the vast majority of the loans are made to borrowers located in Union and Monmouth counties, New Jersey, each loan or group of loans presents a geographical risk and credit risk based upon the condition of the local economy. The local economy is influenced by conditions such as housing prices, employment conditions and changes in interest rates.
 
Construction Loans
 
We originate fixed-rate and adjustable-rate loans to individuals and builders to finance the construction of residential dwellings. We also originate construction loans for commercial development projects, including apartment buildings, restaurants, shopping centers and owner-occupied properties used for businesses. Our construction loans generally provide for the payment of interest only during the construction phase which is usually twelve months for residential properties and twelve to eighteen months for commercial properties. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Before making a commitment to fund a construction loan, we require an appraisal of the property by a bank approved independent licensed appraiser, an inspection of the property before disbursement of funds during the stages of the construction process, and approval from an identified source for the permanent takeout.

Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
 
 
Commercial Loans
 
We make commercial business loans to professionals, sole proprietorships and small businesses in our market area. We extend commercial business loans on an unsecured and secured basis. Secured commercial loans are generally collateralized by nonresidential real estate, marketable securities, accounts receivable, inventory, industrial/commercial machinery and equipment and furniture and fixtures. To further enhance our security position, we generally require personal guarantees of the principal owners of the entities to which we lend. These loans are made on both a line of credit basis and on a fixed-term basis ranging from one to five years in duration. When making commercial business loans, we consider the financial statements and/or tax returns of the borrower, the borrower’s payment history of corporate debt and its principal owners’ payment history of personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates, the value of the collateral and the financial strength of the guarantor.

Commercial real estate loans are made to local commercial, retail and professional firms and individuals for the acquisition of new property or the refinancing of existing property. These loans are typically related to commercial businesses and secured by the underlying real estate used in these businesses or real property of the principals. These loans are generally offered on a fixed or variable rate basis, subject to rate re-adjustments every five years and amortization schedules ranging from 10 to 20 years.

Our established written underwriting guidelines for commercial loans are periodically reviewed and enhanced as needed. Pursuant to these guidelines, in granting commercial loans we look primarily to the borrower’s cash flow as the principal source of loan repayment. To monitor cash flows on income properties, we require borrowers and loan guarantors of loan relationships to provide annual financial statements and/or tax returns. Collateral and personal guarantees of the principals of the entities to which we lend are consistent with the requirements of our loan policy.

Commercial loans are often larger and may involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation of the business involved, repayment of such loans may be more sensitive than other types of loans subject to adverse conditions in the real estate market or the economy. We are also involved with off-balance sheet financial instruments, which include collateralized commercial and standby letters of credit. We seek to minimize these risks through our underwriting guidelines and prudent risk management techniques. Any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. Environmental surveys and inspections are obtained when circumstances suggest the possibility of the presence of hazardous materials. There can be no assurances, however, of success in the efforts to minimize these risks.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property the value of which tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

Residential Real Estate and Consumer Loans

We offer a full range of residential real estate and consumer loans. These loans consist of residential mortgages, home equity lines of credit and loans, personal loans, automobile loans and overdraft protection. We do not originate subprime or negative amortization loans.

Our home equity revolving lines of credit come with a floating interest rate tied to the prime rate. Lines of credit are available to qualified applicants in amounts up to $500,000 for up to 15 years. We also offer fixed rate home equity loans in amounts up to $350,000 for a term of up to 20 years. Credit is based on the income and cash flow of the individual borrowers, real estate collateral supporting the mortgage debt and past credit history.

 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

Participation Loans

We underwrite all loan participations to our own underwriting standards and will not participate in a loan unless each participant has a substantial interest in the loan relationship with the borrower. In addition, we also consider the financial strength and reputation of the lead lender. To monitor cash flows on loan participations, we look for the lead lender to provide annual financial statements for the borrower. Generally, we also conduct an annual internal loan review for loan participations.

Asset Quality

We believe that high asset quality is a key to long-term financial success. We have sought to grow and diversify the loan portfolio, while maintaining a high level of asset quality and moderate credit risk, using underwriting standards that we believe are conservative and diligent monitoring and collection efforts. As we continue to grow and leverage our capital, we envision that loans will continue to be our principal earning assets. An inherent risk in lending is the borrower’s ability to repay the loan under its existing terms. Risk elements in a loan portfolio include non-accrual loans (as defined below), past due and restructured loans, potential problem loans, loan concentrations (by industry or geographically) and other real estate owned, acquired through foreclosure or a deed in lieu of foreclosure.

Non-performing assets include loans that are not accruing interest (non-accrual loans) as a result of principal or interest being in default for a period of 90 days or more, loans past due 90 days or more and still accruing, and other real estate owned, which consists of real estate acquired as the result of a defaulted loan. When a loan is classified as non-accrual, interest accruals cease and all past due interest is reversed and charged against current income. Until the loan becomes current as to principal or interest, as applicable, any payments received from the borrower are applied to outstanding principal, fees and costs to the Bank, unless we determine that the financial condition of the borrower and other factors merit recognition of such payments as interest. Non-performing assets are further discussed within the “Asset Quality” section under Item 7 of this report.

We utilize a risk system, as described below under the section titled “Allowance for Loan Losses”, as an analytical tool to assess risk and set appropriate reserves. In addition, the FDIC has a classification system for problem loans and other lower quality assets, classifying them as “substandard,” “doubtful” or “loss.” A loan is classified as “substandard” when it is inadequately protected by the current value and paying capacity of the obligor or of the collateral pledged, if any. Loans with this classification have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that some loss may occur if the deficiencies are not corrected. A loan is classified “doubtful” when it has all the weaknesses inherent in a loan classified as substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing factors, conditions, and values, highly questionable and improbable. A loan is classified as “loss” when it is considered uncollectible and of such little value that the asset’s continuance as an asset on the balance sheet is not warranted.

In addition to categories for non-accrual loans and loans past due 90 days or more that are still accruing interest, we maintain a “watch list” of performing loans where management has identified conditions which potentially could cause such loans to be downgraded into higher risk categories in future periods. Loans on this list are subject to heightened scrutiny and more frequent review by management.

 
Allowance for Loan Losses

We maintain an allowance for loan losses at a level that we believe is adequate to provide for probable losses inherent in the loan portfolio. Loan losses are charged directly to the allowance when they occur and any recovery is credited to the allowance when realized. Risks from the loan portfolio are analyzed on a continuous basis by loan officers, and periodically by our outside independent loan reviewers, directors on the Bank’s Loan Committee and the Bank’s board of directors as a whole.
 
The level of the allowance is determined by assigning specific reserves to individually identified problem credits or impaired loans and general reserves on all other loans. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of the underlying collateral. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and set appropriate general reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are realized in the periods in which they become known. Additions to the allowance are made by provisions charged to expense and the allowance is reduced by net charge-offs (i.e., loans judged to be uncollectible and charged against the reserve, less any recoveries on such loans).
 
Although management attempts to maintain the allowance at a level deemed sufficient to cover any losses, future additions to the allowance may be necessary based upon any changes in market conditions. In addition, various regulatory agencies periodically review our allowance for loan losses, and may require us to take additional provisions based on their judgments about information available to them at the time of their examination.
 
Risk Management

Managing risk is an essential part of a successful financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available for sale securities that are accounted for on a fair value basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, and technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.
 
Credit Risk Management

Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. To further enhance our credit risk management strategy, we engage an industry standard third party loan review firm to provide greater portfolio surveillance. When a borrower fails to make a required loan payment, we take a number of steps to attempt to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a late charge notice is generated and sent to the borrower and a series of phone calls are made under payment resolution. If payment is not then received by the 30th day of delinquency, a further notification is sent to the borrower. If no successful resolution can be achieved, after a loan becomes 90 days delinquent, we may commence foreclosure or other legal proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. We may consider loan workout arrangements with certain borrowers under certain circumstances.
 
Management reports to the board of directors monthly regarding the amount of loans delinquent more than 30 days, all loans in foreclosure and all foreclosed and repossessed property that we own.

 
Investment Portfolio
 
Our investment portfolio consists primarily of obligations of U.S. Government sponsored agencies as well as municipal and government authority bonds, with high grade corporate bonds accounting for less than 10% of the portfolio. Government regulations limit the type and quality of instruments in which the Company may invest its funds.

We conduct our asset/liability management through consultation with members of our board of directors, senior management and an outside financial advisor. The asset/liability investment committee, commonly known as an ALCO committee, is comprised of the president, senior officers and certain members of our board of directors. The ALCO committee, in consultation with our board of directors, is responsible for the review of interest rate risk and evaluates future liquidity needs over various time periods.

We have established a written investment policy which is reviewed annually by the ALCO committee and our board of directors that applies to Community Partners and the Bank. The investment policy identifies investment criteria and states specific objectives in terms of risk, interest rate sensitivity and liquidity and emphasizes the quality, term and marketability of the securities acquired for its investment portfolio.

The ALCO committee is responsible for monitoring the investment portfolio and ensuring that investments comply with the investment policy. The ALCO committee may from time to time consult with investment advisors.  The Bank’s president and its chief financial officer working with the financial advisor may purchase or sell securities in accordance with the guidelines of the ALCO committee. The board of directors review the components, including new transactions of the investment portfolio on a monthly basis.

Deposit Products

We emphasize relationships with commercial and individual customers and seek to obtain transaction accounts, which are frequently non-interest bearing deposits or lower cost interest bearing checking, savings and money market deposit accounts.

Deposits are the primary source of funds used in lending and other general business purposes. In addition to deposits, we may derive additional funds from principal repayments on loans, the sale of investment securities and borrowings from other financial institutions. Loan amortization payments have historically been a relatively predictable source of funds. The level of deposit liabilities can vary significantly and is influenced by prevailing interest rates, money market conditions, general economic conditions and competition.

The Bank’s deposits consist of checking accounts, savings accounts, money market accounts and certificates of deposit. Deposits are obtained from individuals, partnerships, corporations and unincorporated businesses in our market area. The Bank participates in CDARS, a service that enables us to provide our customers with additional FDIC insurance on CD products. We attempt to control the flow of deposits primarily by pricing our accounts to remain generally competitive with other financial institutions in our market area.
 
Business Growth Strategy
 
Our current plan for growth emphasizes expanding our market presence in the communities located between Union County and Monmouth County, New Jersey by adding strategically located new offices and considering selective acquisitions that would be accretive to earnings within the first full year of combined operations. We believe that this strategy will continue to build shareholder value and increase revenues and earnings per share by creating a larger base of lending and deposit relationships and achieving economies of scale and other efficiencies. Our efforts include opening retail banking offices in Middlesex County, New Jersey and other attractive markets where we have established lending relationships, as well as exploring opportunities to grow and add other profitable banking-related businesses. We believe that by establishing banking offices and making selective acquisitions in attractive growth markets while providing exemplary customer service, our core deposits will naturally increase.
 
 
Supervision and Regulation
 
Overview
 
Community Partners operates within a system of banking laws and regulations intended to protect bank customers and depositors and these laws and regulations govern the permissible operations and management, activities, reserves, loans and investments of the Company.
 
Community Partners Bancorp is a bank holding company under the Federal Bank Holding Company Act of 1956 (“BHCA”), as amended by the Financial Modernization Act of 1999, known as the Gramm-Leach-Bliley Act, and is subject to the supervision of the Board of Governors of the Federal Reserve System. In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks, and performing certain servicing activities for subsidiaries and, as a result of the Gramm-Leach-Bliley Act amendments, permits bank holding companies that are also financial holding companies to engage in any activity, or acquire and retain the shares of any company engaged in any activity, that is either (1) financial in nature or incidental to such financial activity or (2) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In order for a bank holding company to engage in the broader range of activities that are permitted by the BHCA for bank holding companies that are also financial holding companies, upon satisfaction of certain regulatory criteria, the bank holding company must file a declaration with the Federal Reserve Board that it elects to be a “financial holding company.” Community Partners does not presently intend to seek a “financial holding company” designation at this time, and does not believe that the current decision not to seek a financial holding company designation will adversely affect its ability to compete in its chosen markets. We believe that seeking such a designation for Community Partners would not position it to compete more effectively in the offering of products and services currently offered by the Bank. Community Partners is also subject to other federal laws and regulations as well as the corporate laws and regulations of New Jersey, the state of its incorporation.
 
The BHCA prohibits the Company, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks. The BHCA requires prior approval by the Federal Reserve Board of the acquisition by the Company of more than five percent of the voting stock of any other bank. Satisfactory capital ratios, Federal Community Reinvestment Act ratings and anti-money laundering policies are generally prerequisites to obtaining federal regulatory approval to make acquisitions.
 
The Bank is a commercial bank chartered under the laws of the State of New Jersey and is subject to the New Jersey Banking Act of 1948 (the “Banking Act”). As such, it is subject to regulation, supervision and examination by the New Jersey Department of Banking and Insurance and by the FDIC. Each of these agencies regulates aspects of activities conducted by the Bank and Community Partners, as discussed below. The Bank is not a member of the Federal Reserve Bank of New York.
 
The following descriptions summarize the key laws and regulations to which the Bank is subject, and to which Community Partners is subject as a registered bank holding company. These descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations. Future changes in these laws and regulations, or in the interpretation and application thereof by their administering agencies, cannot be predicted, but could have a material effect on the business and results of Community Partners and the Bank.

Troubled Asset Relief Program Capital Purchase Program

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the United States Department of the Treasury (the “Treasury”) was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
 
 
On October 14, 2008, the Secretary of the Treasury announced that the Treasury will purchase equity stakes in a wide variety of banks and thrifts. Under the program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), from the $700 billion authorized by the EESA, the Treasury made $250 billion of capital available to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury received, from participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment.  Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.
 
At the invitation of the Treasury, we decided in January 2009 to enter into a Securities Purchase Agreement with the Treasury that provides for our participation in the TARP Capital Purchase Program. On January 30, 2009, the Company issued and sold to the Treasury 9,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Senior Preferred Stock”), with a liquidation preference of $1,000 per share, and a ten-year warrant to purchase up to 297,116 shares of the Company’s common stock at an exercise price of $4.54 per share, as adjusted for the 3% stock dividend declared in August 2009. Under the terms of the TARP Capital Purchase Program, the Treasury’s consent will be required for the payment of any cash dividends to common stockholders, or the Company’s redemption, purchase or acquisition of common stock of the Company until the third anniversary of the issuance of the Senior Preferred Stock to the Treasury unless prior to such third anniversary the Senior Preferred Stock are redeemed in whole or the Treasury has transferred all of these shares to third parties.
 
Participants in the TARP Capital Purchase Program were required to accept several compensation-related limitations associated with this program. Each of our senior executive officers in January 2009 agreed in writing to accept the compensation standards in existence at that time under the program and thereby cap or eliminate some of their contractual or legal rights. The provisions agreed to were as follows:

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No golden parachute payments. “Golden parachute payment” under the TARP Capital Purchase Program means a severance payment resulting from involuntary termination of employment, or from bankruptcy of the employer, that exceeds three times the terminated employee’s average annual base salary over the five years prior to termination. Our senior executive officers have agreed to forego all golden parachute payments for as long as two conditions remain true: They remain “senior executive officers” (CEO and the next two highest-paid executive officers), and the Treasury continues to hold our equity or debt securities we issued to it under the TARP Capital Purchase Program (the period during which the Treasury holds those securities is the “TARP Capital Purchase Program Covered Period.”).

·    
Recovery of EIP Awards and Incentive Compensation if Based on Certain Material Inaccuracies. Our senior executive officers have also agreed to a “clawback provision,” which means that we can recover incentive compensation paid during the TARP Capital Purchase Program Covered Period that is later found to have been based on materially inaccurate financial statements or other materially inaccurate measurements of performance.

·    
No Compensation Arrangements That Encourage Excessive Risks. During the TARP Capital Purchase Program Covered Period, we are not allowed to enter into compensation arrangements that encourage senior executive officers to take “unnecessary and excessive risks that threaten the value” of our Company.  To make sure this does not happen, the Company’s Compensation Committee is required to meet at least once a year with our senior risk officers to review our executive compensation arrangements in the light of our risk management policies and practices. Our senior executive officers’ written agreements include their obligation to execute whatever documents we may require in order to make any changes in compensation arrangements resulting from the Compensation Committee’s review.

·    
Limit on Federal Income Tax Deductions. During the TARP Capital Purchase Program Covered Period, we are not allowed to take federal income tax deductions for compensation paid to senior executive officers in excess of $500,000 per year, with certain exceptions that do not apply to our senior executive officers.

 
On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”) into law. The Stimulus Act modified the compensation-related limitations contained in the TARP Capital Purchase Program, created additional compensation-related limitations and directed the Secretary of the Treasury to establish standards for executive compensation applicable to participants in TARP, regardless of when participation commenced. Thus, the newly enacted compensation-related limitations are applicable to the Company and to the extent the Treasury may implement these restrictions unilaterally, the Company will apply these provisions. The provisions may be retroactive. In their January 2009 agreements, our senior executive officers   waived their contract or legal rights with respect to these new and retroactive provisions. The compensation-related limitations applicable to the Company which have been added or modified by the Stimulus Act are as follows, which provisions must be included in standards established by the Treasury:

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No severance payments. Under the Stimulus Act “golden parachutes” were redefined as any severance payment resulting from involuntary termination of employment, or from bankruptcy of the employer, except for payments for services performed or benefits accrued. Consequently under the Stimulus Act the Company is prohibited from making any severance payment to our “senior executive officers” (defined in the Stimulus Act as the CEO and the next two highest-paid executive officers) and our next five most highly compensated employees during the TARP Capital Purchase Program Covered Period.

·    
Recovery of Incentive Compensation if Based on Certain Material Inaccuracies. The Stimulus Act also contains the “clawback provision” discussed above but extends its application to any bonus awards and other incentive compensation paid to any of our senior executive officers or the next 20 most highly compensated employees during the TARP Capital Purchase Program Covered Period that is later found to have been based on materially inaccurate financial statements or other materially inaccurate measurements of performance.

·    
No Compensation Arrangements That Encourage Earnings Manipulation. Under the Stimulus Act, during the TARP Capital Purchase Program Covered Period, we are not allowed to enter into compensation arrangements that encourage manipulation of the reported earnings of the Company to enhance the compensation of any of our employees.

·    
Limit on Incentive Compensation. The Stimulus Act contains a provision that prohibits the payment or accrual of any bonus, retention award or incentive compensation to the Company’s most highly compensated employee during the TARP Capital Purchase Program Covered Period other than awards of long-term restricted stock that (i) do not fully vest during the TARP Capital Purchase Program Covered Period, (ii) have a value not greater than one-third of the total annual compensation of the awardee and (iii) are subject to such other restrictions as determined by the Secretary of the Treasury. We do not know whether the award of incentive stock options are covered by this prohibition. The prohibition on bonus, incentive compensation and retention awards does not preclude payments required under written employment contracts entered into on or prior to February 11, 2009.

·    
Compensation Committee Functions. The Stimulus Act requires that our Compensation Committee be comprised solely of independent directors and that it meet at least semiannually to discuss and evaluate our employee compensation plans in light of an assessment of any risk posed to us from such compensation plans.

·    
Compliance Certifications. The Stimulus Act also requires a written certification by our Chief Executive Officer and Chief Financial Officer of our compliance with the provisions of the Stimulus Act. These certifications must be contained in the Company’s Annual Report on Form 10-K for the fiscal year ending December 31, 2009.

·    
Treasury Review Excessive Bonuses Previously Paid. The Stimulus Act directs the Secretary of the Treasury to review all compensation paid to our senior executive officers and our next 20 most highly compensated employees to determine whether any such payments were inconsistent with the purposes of the Stimulus Act or were otherwise contrary to the public interest. If the Secretary of the Treasury makes such a finding, the Secretary of the Treasury is directed to negotiate with the TARP Capital Purchase Program recipient and the subject employee for appropriate reimbursements to the federal government with respect to the compensation and bonuses.

·    
Say on Pay. Under the Stimulus Act, the SEC is required to promulgate rules requiring a non-binding say on pay vote by the shareholders on executive compensation at the annual meeting during the TARP Capital Purchase Program Covered Period.


Incentive Compensation

On October 22, 2009, the Federal Reserve issued a comprehensive proposal on incentive compensation policies (the “Incentive Compensation Proposal”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other actions. The Incentive Compensation Proposal provides that enforcement actions may be taken against a banking organization if its incentive compensation arrangements or related risk-management control or governance processes pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies. In addition, on January 12, 2010, the FDIC announced that it would seek public comment on whether banks with compensation plans that encourage risky behavior should be charged higher deposit assessment rates than such banks would otherwise be charged.

The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future. It cannot be determined at this time whether compliance with such policies will adversely affect the ability of the Company and the Bank to hire, retain and motivate their key employees.

Dividend Restrictions
 
The primary source of cash to pay dividends, if any, to the Company’s shareholders and to meet the Company’s obligations is dividends paid to the Company by the Bank. Dividend payments by the Bank to the Company are subject to the laws of the State of New Jersey, the Banking Act, the Federal Deposit Insurance Act (“FDIA”) and the regulation of the New Jersey State Department of Banking and Insurance and of the Federal Reserve. Under the Banking Act and the FDIA, a bank may not pay any dividends if, after paying such dividends, it would be undercapitalized under applicable capital requirements. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in unsafe or unsound banking practices. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
 
It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available from the immediately preceding year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividend that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiary. A bank holding company may not pay dividends when it is insolvent.
 
Community Partners did not pay any cash dividends to common shareholders in 2009 and does not contemplate the payment of cash dividends to common shareholders in 2010. On August 25, 2009, Community Partners declared a 3% stock dividend, which was distributed on October 23, 2009 to common shareholders of record as of September 25, 2009.
 
Transactions with Affiliates
 
Banking laws and regulations impose certain restrictions on the ability of bank holding companies to borrow from and engage in other transactions with their subsidiary banks. Generally, these restrictions require that any extensions of credit must be secured by designated amounts of specified collateral and be limited to (i) 10% of the bank’s capital stock and surplus per non-bank affiliated borrower, and (ii) 20% of the bank’s capital stock and surplus aggregated as to all non-bank affiliated borrowers. In addition, certain transactions with affiliates must be on terms and conditions, including credit standards, at least as favorable to the institution as those prevailing for arms-length transactions.
 
 
FIRREA
 
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. These provisions have commonly been referred to as FIRREA’s “cross guarantee” provisions.  Further, under FIRREA, the failure to meet capital guidelines could subject a bank to a variety of enforcement remedies available to federal regulatory authorities.
 
FIRREA also imposes certain independent appraisal requirements upon a bank’s real estate lending activities and further imposes certain loan-to-value restrictions on a bank’s real estate lending activities. The bank regulators have promulgated regulations in these areas.
 
Deposit Insurance
 
The Bank is a member of the Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund was formed in 2006 when the FDIC merged the Bank Insurance Fund with the Savings Association Insurance Fund as a requirement of the Federal Deposit Insurance Reform Act of 2005.
 
The Bank’s deposits are insured up to a maximum of $250,000 per depositor through December 31, 2013 under the Deposit Insurance Fund. The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) is applicable to depository institutions and deposit insurance. The FDICIA required the FDIC to establish a risk-based assessment system for all insured depository institutions. Under this legislation, the FDIC was required to establish an insurance premium assessment system. Under this ruling, the initial assessment rates will be based on the following components: (i) the probability that the insurance fund will incur a loss with respect to the institution, (ii) the likely amount of the loss, and (iii) the revenue needs of the insurance fund. In compliance with this mandate, the FDIC has developed a matrix that sets the assessment premium for a particular institution in accordance with its capital level and overall rating by the primary regulator. The Bank is also subject to a quarterly FICO assessment.
 
In May 2009, the FDIC adopted a final special assessment rule that assessed the industry 5 basis points on total assets less Tier 1 capital. The Company was required to accrue the charge during the second quarter of 2009, which amounted to approximately $288,000, even though the FDIC collected the fee at the end of the third quarter when the regular quarterly assessments for the second quarter were collected.
 
On November 12, 2009, the FDIC Board approved the final ruling for the risk-based deposit insurance assessment system. Under this ruling, the initial assessment rates will be based on the following components: 1) Weighted average CAMEL ratings, 2) Tier 1 leverage ratio, 3) Loans past due 30-89 days/gross assets, 4) Nonperforming assets/gross assets, 5) Net loan charge-offs/gross assets, 6) Net income before taxes/risk-weighted assets, 7) Adjusted brokered deposit ratio. The component data was collected as of September 30, 2009. In addition, on November 17, 2009, the FDIC implemented a final rule requiring insured institutions, like the Bank, to prepay their estimated quarterly risk based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. This prepaid assessment, which amounted to approximately $3.2 million, was collected by the FDIC on December 30, 2009 and will be amortized over the period beginning the fourth quarter of 2009 through December 2012. In October 2009, as part of its extension of the restoration plan for the Deposit Insurance Fund for eight years, the FDIC implemented a uniform three basis point increase in assessment rates, effective January 1, 2011, to help ensure that the reserve ratio of the Deposit Insurance Fund returns to normal levels at the end of the eight year period of the restoration plan.
 
Capital Adequacy
 
The Federal Reserve Board has adopted risk-based capital guidelines for banks and bank holding companies. The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is to be comprised of common stock, retained earnings, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and certain other intangibles (“Tier 1 Capital”). The remainder may consist of other preferred stock, certain other instruments and a portion of the loan loss allowance (“Tier II and Tier III Capital”). “Total Capital” is the sum of Tier I Capital and Tier II and Tier III Capital.
 
 
In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for banks and bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average total  assets of 3% for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks and bank holding companies generally are required to maintain a leverage ratio of at least 3% plus an additional cushion of 100 to 200 basis points. At December 31, 2009, Community Partners’ leverage ratio was 9.28%.
 
Prompt Corrective Action
 
The Federal Deposit Insurance Act (FDIA) requires federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Failure to meet minimum requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on Community Partners’ financial condition. Under the FDIA’s Prompt Corrective Action Regulations, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.
 
The Prompt Corrective Action Regulations define specific capital categories based on an institution’s capital ratios. The capital categories, in declining order, are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” The FDIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the capital category by which the institution is classified. Institutions categorized as “undercapitalized” or worse may be subject to requirements to file a capital plan with their primary federal regulator, prohibitions on the payment of dividends and management fees, restrictions on asset growth and executive compensation, and increased supervisory monitoring, among other things. Other restrictions may be imposed on the institution by the regulatory agencies, including requirements to raise additional capital, sell assets or sell the entire institution. Once an institution becomes “critically undercapitalized,” it generally must be placed in receivership or conservatorship within 90 days.
 
The Prompt Corrective Action Regulations provide that an institution is “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier I risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater. The institution also may not be subject to an order, written agreement, and capital directive or prompt corrective action directive to meet and maintain a specific level for any capital measure. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater (or a leverage ratio of 3.0% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of a well-capitalized institution. An institution is deemed “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0% (or a leverage ratio of 3.0% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of a significantly undercapitalized or critically undercapitalized institution. An institution is “significantly undercapitalized” if the institution has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio of less than 3.0%, or a leverage ratio less than 3.0% and the institution does not meet the definition of a critically undercapitalized institution, and is “critically undercapitalized” if the institution has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
 
The appropriate federal banking agency may, under certain circumstances, reclassify a well-capitalized insured depository institution as adequately capitalized. The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not to treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than an institution’s capital levels.
 
 
Unsafe and Unsound Practices
 
Notwithstanding its Prompt Corrective Action Regulations category dictated by risk-based capital ratios, the FDIA permits the appropriate bank regulatory agency to reclassify an institution if it determines, after notice and a hearing, that the condition of the institution is unsafe or unsound, or if it deems the institution to be engaging in an unsafe or unsound practice. Also, if a federal regulatory agency with jurisdiction over a depository institution believes that the depository institution will engage, is engaging, or has engaged in an unsafe or unsound practice, the regulator may require that the bank cease and desist from such practice, following notice and a hearing on the matter.
 
The USA PATRIOT Act
 
On October 26, 2001, the President of the United States signed into law certain comprehensive anti-terrorism legislation known as the USA PATRIOT Act of 2001. Title III of the USA PATRIOT Act substantially broadened the scope of the U.S. anti-money-laundering laws and regulations by imposing significant new compliance and due diligence obligations on financial institutions, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The Treasury has issued a number of implementing regulations which apply various requirements of the USA PATRIOT Act to financial institutions such as the Bank. Those regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
 
Failure of a financial institution to comply with the USA PATRIOT Act’s requirements could have serious legal consequences for the institution and adversely affect its reputation. Community Partners and the Bank adopted appropriate policies, procedures and controls to address compliance with the requirements of the USA PATRIOT Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA PATRIOT Act and by Treasury regulations.
 
Community Reinvestment Act
 
The Federal Community Reinvestment Act (“CRA”) requires banks to respond to the full range of credit and banking needs within their communities, including the needs of low and moderate-income individuals and areas. A bank’s failure to address the credit and banking needs of all socio-economic levels within its markets may result in restrictions on growth and expansion opportunities for the bank, including restrictions on new branch openings, relocation, formation of subsidiaries, mergers and acquisitions. Upon completion of a CRA examination, an overall CRA rating is assigned using a four-tiered rating system. These ratings are:  Outstanding, Satisfactory, Needs to Improve, and Substantial Noncompliance.
 
In the latest CRA performance evaluation examination report with respect to the Bank, dated April 2, 2009, the Bank received a rating of Satisfactory.

Consumer Privacy

In addition to fostering the development of “financial holding companies,” the Gramm-Leach-Bliley Act modified laws relating to financial privacy. Its financial privacy provisions generally prohibit financial institutions, including Community Partners and the Bank, from disclosing or sharing nonpublic personal financial information to third parties for marketing or other purposes not related to transactions, unless customers have an opportunity to “opt out” of authorizing such disclosure, and have not elected to do so. It has never been the policy of Community Partners or the Bank, to release such information except as may be required by law.

 
Loans to One Borrower

Federal banking laws limit the amount a bank may lend to a single borrower to 15% of the bank’s capital base, unless the entire amount of the loan is secured by adequate amounts of readily marketable collateral. However, no loan to one borrower may exceed 25% of a bank’s statutory capital, notwithstanding collateral pledged to secure it.
 
New Jersey banking law limits the total loans and extensions of credit by a bank to one borrower at one time to 15% of the capital funds of the bank when the loan is fully secured by collateral having a market value at least equal to the amount of the loans and extensions of credit. Such loans and extensions of credit are limited to 10% of the capital funds of the bank when the total loans and extensions of credit by a bank to one borrower at one time are fully secured by readily available marketable collateral having a market value (as determined by reliable and continuously available price quotations) at least equal to the amount of funds outstanding. This 10% limitation shall be separate from and in addition to the 15% limitation noted in the beginning of this paragraph. If a bank’s lending limit is less than $500,000, the bank may nevertheless have total loans and extensions of credit outstanding to one borrower at one time not to exceed $500,000.
 
Depositor Preference Statute
 
In 1993, the United States enacted amendments to the FDIA that created a preference for depositors in the distribution of the assets of a failed bank. Section 11(d)(11)(A) of the FDIA, also known as the National Depositor Preference Statute, states that depositors and certain claimants for administrative expenses and employee compensation against an insured depository institution are afforded a priority over other general unsecured claims against the institution, in the event of a “liquidation or other resolution” of the institution by a receiver.
 
Gramm-Leach-Bliley Act
 
The Financial Modernization Act of 1999, or Gramm-Leach-Bliley Act, became effective in early 2000. The Gramm-Leach-Bliley Act:
 
 
·
allows bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than is permissible for a bank holding company, including insurance underwriting and making merchant banking investments in commercial and financial companies; if a bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals;
 
 
·
allows banks to establish subsidiaries to engage in certain activities which a financial holding company could engage in, if the bank meets certain management, capital and Community Reinvestment Act standards; and
 
 
·
allows insurers and other financial services companies to acquire banks and removed various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and established the overall regulatory structure applicable to financial holding companies that also engage in insurance and securities operations.
 
The Gramm-Leach-Bliley Act modified other financial laws, including laws related to financial privacy and community reinvestment.
 
The Gramm-Leach-Bliley Act also amended the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these acts.
 
 
Additional proposals to change the laws and regulations governing the banking and financial services industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on the Company cannot be determined at this time.
 
Sarbanes-Oxley Act of 2002
 
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which became law on July 30, 2002, created new legal requirements affecting corporate governance, accounting and corporate reporting for companies with publicly traded securities.
 
The Sarbanes-Oxley Act provides for, among other things:
 
 
·
a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);
 
 
·
independence requirements for audit committee members;
 
 
·
disclosure of whether at least one member of the audit committee is a “financial expert” (as such term is defined by the SEC) and if not, why not;
 
 
·
independence requirements for outside auditors;
 
 
·
a prohibition by a company’s registered public accounting firm from performing statutorily mandated audit services for the company if the company’s chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions had been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date;
 
 
·
certification of financial statements and reports on Forms 10-K and 10-Q by the chief executive officer and the chief financial officer;
 
 
·
the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement due to corporate misconduct;
 
 
·
disclosure of off-balance sheet transactions;
 
 
·
two-business day filing requirements for insiders filing Forms 4;
 
 
·
disclosure of a code of ethics for financial officers and filing a Form 8-K for a change or waiver of such code;
 
 
·
“real time” filing of periodic reports;
 
 
·
posting of certain SEC filings and other information on the company website;
 
 
·
the reporting of securities violations “up the ladder” by both in-house and outside attorneys;
 
 
·
restrictions on the use of non-GAAP financial measures;
 
 
·
the formation of a public accounting oversight board; and
 
 
·
various increased criminal penalties for violations of securities laws.
 
 
Additionally, Section 404 of the Sarbanes-Oxley Act requires that a public company subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), include in its annual report (i) a management’s report on internal control over financial reporting assessing the company’s internal controls, and (ii) an auditor’s attestation report, completed by the independent registered public accounting firm that prepares or issues an accountant’s report that is included in the company’s annual report, attesting to the effectiveness of management’s internal controls over financial reporting. Because we are neither a “large accelerated filer” nor an “accelerated filer”, under current rules, we are required to provide management’s report on internal control over financial reporting with our annual report, and compliance with the auditor’s attestation report requirement is not required until we file our 2010 annual report in 2011.
 
All of the national stock exchanges, including the Nasdaq Capital Market where our common stock is listed, have implemented corporate governance rules, including rules strengthening director independence requirements for boards, and the adoption of charters for the nominating, corporate governance, and audit committees. The rule changes are intended to, among other things, make the board of directors independent of management and allow shareholders to more easily and efficiently monitor the performance of companies and directors. These increased burdens have increased our legal and accounting fees and the amount of time that our board of directors and management must devote to corporate governance issues.
 
Overall Impact of New Legislation and Regulations
 
Various legislative initiatives are from time to time introduced in Congress and in the New Jersey State Legislature. It cannot be predicted whether or to what extent the business and condition of Community Partners or the Bank will be affected by new legislation or regulations, and legislation or regulations as yet to be proposed or enacted.
 
Available Information
 
The Company maintains a website at www.tworiverbank.com. The Company makes available on its website free of charge its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports which are filed with or furnished to the SEC pursuant to Section 13(a) of the Securities Exchange Act of 1934. These documents are made available on the Company’s website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Also available on the website are our Code of Conduct, our Luxury Expenditure Policy, our Shareholder Communications Policy and the charters of our Nominating and Corporate Governance Committee, Audit Committee, and Compensation.

 
The following are some important factors that could cause the Company’s actual results to differ materially from those referred to or implied in any forward-looking statement. These are in addition to the risks and uncertainties discussed elsewhere in this Annual Report on Form 10-K and the Company’s other filings with the SEC.

We may suffer losses in our loan portfolio despite our underwriting practices.

We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices.  Although we believe that our underwriting criteria are appropriate for the various kinds of loans that we make, we may still incur losses on loans that meet our underwriting criteria due to current economic conditions. A significant part of our loan portfolio is secured by real restate. As real estate values in New Jersey decline, our ability to recover on defaulted loans by selling the underlying real estate is reduced, which increases the possibility that we may suffer losses on defaulted loans. This may result in significant loan losses, which may exceed the amounts, set aside in our allowance for loan losses and have a material adverse effect on our operating results.

 
Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance.
 
Despite our underwriting criteria, we may experience loan delinquencies and losses. In order to absorb losses associated with non-performing loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as non-performing or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become non-performing assets or that we will be able to limit losses on those loans that are identified.
 
We may be required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.

Recent negative developments in the financial services industry and the U.S. and global credit markets may adversely impact our operations and results.

Negative developments in the latter half of 2007, the years of 2008 and 2009 in the capital markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing through much of 2010. Loan portfolio performances have deteriorated at many institutions resulting from, amongst other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for our deposits has increased significantly due to liquidity concerns at many of these same institutions.  Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.

Economic conditions either locally or regionally in areas in which our operations are concentrated may adversely affect our business.

Deterioration in local or regional economic conditions in Monmouth or Union counties in New Jersey could cause us to experience a reduction in deposits and new loans, an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, all of which could adversely affect our performance and financial condition. Unlike larger banks that are more geographically diversified, we provide banking and financial services in the State of New Jersey, primarily within Monmouth and Union counties.  Therefore, we are particularly vulnerable to adverse local economic conditions.

If economic conditions further deteriorate, particularly in the market areas of the Bank, our results of operations and financial condition could be adversely affected as borrowers’ ability to repay loans declines and the value of the collateral securing our loans decreases.

Our financial results may be adversely affected by changes in prevailing economic conditions, particularly in the market areas of the Bank, including decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events.  Decreases in local real estate values would adversely affect the value of property used as collateral for our loans. Adverse changes in the economy also may have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
 
 
Our agreements with the Treasury impose restrictions and obligations on us that limit our ability to pay cash dividends and repurchase our common stock.
 
On January 30, 2009, we issued Senior Preferred Stock and a warrant to purchase our common stock to the Treasury as part of its TARP Capital Purchase Program. Prior to January 30, 2012, unless we have redeemed all of the Senior Preferred Stock or the Treasury has transferred all of the Senior Preferred Stock to a third party, the consent of the Treasury will be required for us to, among other things, pay cash dividends on our common stock or repurchase our common stock (with certain exceptions, including the repurchase of our common stock in connection with an employee benefit plan in the ordinary course of business and consistent with past practice).
 
Our preferred shares impact net income available to our common stockholders and our earnings per share.
 
As long as there are shares of Senior Preferred Stock outstanding, no cash dividends may be paid on our common stock unless all dividends on the Senior Preferred Stock have been paid in full. The dividends declared on the Senior Preferred Stock will reduce the net income available to common shareholders and our earnings per common share. Additionally, warrants to purchase the Company’s common stock issued to the Treasury, in conjunction with the issuance of the Senior Preferred Stock, may be dilutive to our earnings per share. The Senior Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.
 
We are not required to declare cash dividends on our common stock. We have not paid any cash dividends to shareholders since the date of our incorporation on August 8, 2005. Until the earlier of (i) January 30, 2012 or (ii) the date the Treasury no longer owns any shares of Senior Preferred Stock, we may not pay any dividends on our common stock without obtaining the prior consent of the Treasury.

Changes in interest rates could reduce our income, cash flows and asset values.
 
Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.

Competition may decrease our growth or profits.
 
We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service area. Our competitors may have greater resources, higher lending limits or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can.

In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions such as the Bank. As a result, those non-bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.


We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.

We are and will continue to be dependent upon the services of our executive management team. The Company’s performance is largely dependent on the talents and efforts of highly skilled individuals. There is intense competition in the financial services industry for qualified employees. In addition, the Company faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. The EESA, the Stimulus Act and the agreements between the Company and the Treasury related to the purchase of the Company’s Senior Preferred Stock and common stock warrants place restrictions on the Company’s ability to pay compensation to its senior officers. The Company’s business operations could be adversely affected if it were unable to attract new employees and retain and motivate its existing employees.
 
We may be adversely affected by government regulation.
 
The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.
 
The anti-money laundering or AML, and bank secrecy, or BSA, laws have imposed far-reaching and substantial requirements on financial institutions. The enforcement policy with respect to AML/BSA compliance has been vigorously applied throughout the industry, with regulatory action taking various forms. We believe that our policies and procedures with respect to combating money laundering are effective and that our AML/BSA policies and procedures are reasonably designed to comply with applicable standards. We cannot provide assurance that in the future we will not face a regulatory action, adversely affecting our ability to acquire banks or open new branches. However, we are not prohibited from acquiring banks or opening branches based upon the results of our most recently completed regulatory examination.

Environmental liability associated with lending activities could result in losses.
 
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
 
Failure to implement new technologies in our operations may adversely affect our growth or profits.
 
The market for financial services, including banking services and consumer finance services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.

 
A limited market exists for our common stock.

Our common stock commenced trading on the NASDAQ Capital Market on April 4, 2006 and trading volumes since that time have been modest. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market. Accordingly, you may have difficulty selling our common stock at prices which you find acceptable or which accurately reflect the value of the Company.

We are subject to liquidity risk.

Liquidity risk is the potential that we will be unable to meet our obligations as they become due, capitalize on growth opportunities as they arise, or pay regular cash dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.

Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, dividends to shareholders, operating expenses and capital expenditures.

Liquidity is derived primarily from retail deposit growth and retention; principal and interest payments on loans; principal and interest payments; sale, maturity and prepayment of investment securities; net cash provided from operations and access to other funding sources.
 
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as evidenced by turmoil faced by banking organizations in 2008 in the domestic and worldwide credit markets.
 
Future offerings of debt or other securities may adversely affect the market price of our stock.
 
In the future, we may attempt to increase our capital resources or, if our or the Bank’s capital ratios fall below the required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
 
The Company may lose lower-cost funding sources.

Checking, savings, and money market deposit account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, the Company could lose a relatively low-cost source of funds, increasing its funding costs and reducing the Company’s net interest income and net income.

The Company is subject to operational risk.

The Company faces the risk that the design of its controls and procedures, including those to mitigate the risk of fraud by employees or outsiders, may prove to be inadequate or are circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures.  Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.  Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
 
 
The Company may also be subject to disruptions of its systems arising from events that are wholly or partially beyond its control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.

 
Not applicable.
 
 
 
 
 
 
 
The following table provides certain information with respect to properties:
 
Office Location
 
Address
 
Description
 
Opened
The Bank’s Main Office:
 
1250 Highway 35 South
Middletown, NJ
 
5,300 sq. ft. first-floor stand-
alone building (leased)
 
02/00
             
Operations Center:
 
178 Office Max Plaza
Suite 3-A
Eatontown, NJ
 
7,200 sq. ft.
shopping center (leased)
 
06/02
             
Allaire:
 
Monmouth Executive Airport
229 Airport Road, Bldg 13
Farmingdale, NJ
 
3,800 sq. ft. building (leased)
 
02/04
             
Atlantic Highlands:
 
84 First Avenue
Atlantic Highlands, NJ
 
700 sq. ft. store front (leased)
 
03/02
             
Cliffwood:
 
Angel Street & Route 35
Aberdeen, NJ
 
2,500 sq. ft. building (leased)
 
11/04
             
Cranford Office:
 
104 Walnut Avenue
Cranford, NJ
 
800 sq. ft. storefront
(leased)
 
11/07
             
Fanwood:
 
328 South Avenue
Fanwood, NJ
 
2,966 sq. ft. stand-alone
building (leased)
 
03/08
             
Manasquan:
 
240 Route 71
Manasquan, NJ
 
4,300 sq. ft. stand-alone
building (leased)
 
06/08
             
Navesink:
 
East Pointe Shopping Center
2345 Route 36
Atlantic Highlands, NJ
 
2,080 sq. ft in strip shopping
center (leased)
 
09/05
             
Port Monmouth:
 
357 Highway 36
Port Monmouth, NJ
 
2,180 sq. ft. stand-alone
building (leased)
 
06/01
             
Red Bank:
 
City Centre Plaza
100 Water Street
Red Bank, NJ
 
512 sq. ft. in strip shopping
center (leased)
 
09/02
             
Tinton Falls:
 
4050 Asbury Avenue
Tinton Falls, NJ
 
3,400 sq. ft. stand-alone
building (leased)
 
10/06
             
Tinton Falls:
 
656 Shrewsbury Avenue
Tinton Falls, NJ
 
3,650 sq. ft. stand-alone
building (leased)
 
08/00
             
West Long Branch:
 
359 Monmouth Road
West Long Branch, NJ
 
3,100 sq. ft. in strip shopping
center (leased)
 
01/04
             
Westfield:
 
520 South Avenue
Westfield, NJ
 
3,000 sq. ft. stand-alone
building (leased)
 
10/98
             
Westfield:
 
44 Elm Street
Westfield, NJ
 
3,000 sq. ft. downtown
building (owned)
 
04/01
             
The Company owns property located at 245-249 North Avenue in Cranford, NJ, which has been reclassified to assets held for sale in other assets. This property is currently under negotiations to be sold.
 
 
 
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. The Company may also have various commitments and contingent liabilities which are not reflected in the accompanying consolidated balance sheet. At December 31, 2009, we were not involved in any material legal proceedings.
 
 
PART II
 
 
The common stock of the Company trades on the Nasdaq Capital Market under the trading symbol “CPBC”. The following are the high and low sales prices per share, which have been adjusted for the 3% stock dividend declared August 25, 2009 and the 3% stock dividend declared August 29, 2008.
 
 
   
2009
   
2008
 
   
High
   
Low
   
High
   
Low
 
First Quarter
  $ 4.37     $ 2.43     $ 9.45     $ 6.36  
Second Quarter
    4.61       3.08       8.43       6.17  
Third Quarter
    4.47       3.40       8.25       5.66  
Fourth Quarter
    4.25       3.00       7.28       2.18  

As of March 15, 2010, there were approximately 529 record holders of the Company’s common stock.

On August 25, 2009, Community Partners declared a 3% stock dividend, which was paid on October 23, 2009 to shareholders of record as of September 25, 2009.

Community Partners did not pay any cash dividends to common shareholders in 2009 and does not contemplate the payment of cash dividends to common shareholders in 2010. In addition, please refer to the discussion above of the Senior Preferred Stock under the heading “Troubled Asset Relief Program Capital Purchase Program” and the discussion under the heading “Dividend Restrictions” for additional restrictions on the payment of cash dividends.

As a result of the Company’s issuance on January 30, 2009 of Senior Preferred Stock and a warrant to purchase common stock to the Treasury as part of its TARP Capital Purchase Program, the Company may not repurchase its common stock or other equity securities except under certain limited circumstances. Please refer to the discussion above of the Senior Preferred Stock under the heading “Troubled Asset Relief Program Capital Purchase Program” and the discussion under the heading “Dividend Restrictions” for additional restrictions on the Company’s repurchase of its common stock or other equity securities.

 
Not required.
 
 
 
The following management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes and trends relating to the financial condition, results of operations, capital resources, liquidity and interest rate sensitivity of Community Partners Bancorp as of December 31, 2009 and 2008 and for the years then ended. The following information should be read in conjunction with the audited consolidated financial statements as of and for the years ended December 31, 2009 and 2008, including the related notes thereto.
 
Critical Accounting Policies and Estimates
 
The following discussion is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.
 
Note 1 to our audited consolidated financial statements for December 31, 2009 contains a summary of the Company’s significant accounting policies. Management believes the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our consolidated financial statements.
 
Allowance for Loan Losses. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact the results of operations. This critical policy and its application are reviewed quarterly with our audit committee and board of directors.
 
Management is responsible for preparing and evaluating the ALLL on a quarterly basis in accordance with Bank policy, and the Interagency Policy Statement on the ALLL released by the Board of Governors of the Federal Reserve System on December 13, 2006 as well as GAAP. We believe that our allowance for loan losses is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable. The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance account, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management utilizes the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short term change. Various regulatory agencies may require us and our banking subsidiaries to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of our loans are secured by real estate in New Jersey, primarily in Monmouth and Union counties. Accordingly, the collectability of a substantial portion of the carrying value of our loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the New Jersey and/or our local market areas experience economic shock.
 
Stock Based Compensation. Stock based compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.
 
Goodwill Impairment. Although goodwill is not subject to amortization, the Company must test the carrying value for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. Our reporting unit was identified as our community bank operations. If the fair value of the reporting unit exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less than book value, an expense may be required on the Company’s books to write-down the related goodwill to the proper carrying value. Impairment testing for 2009 for goodwill and intangibles was completed and the Company recorded a goodwill impairment charge of $6.7 million  during the year ended December 31, 2009.
 
 
Investment Securities Impairment Valuation. Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. The analysis of other-than-temporary impairment requires the use of various assumptions including, but not limited to, the length of time the investment’s book value has been greater than fair value, the severity of the investment’s decline and the credit deterioration of the issuer. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment.
 
In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
 
Deferred Tax Assets and Liabilities. We recognize deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management determines that we 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 expected realizable amount.
 
Executive Summary
 
The Company reported a net loss to common shareholders of $5.7 million for the year ended December 31, 2009, compared to net income of $798,000 in 2008. Basic and diluted loss per common share after preferred stock dividends and accretion were both ($0.79) for the year ended December 31, 2009 compared to basic and diluted earnings of $0.11 per common share for the same period in 2008. For the year ended December 31, 2009, net interest income increased by $2.5 million, or 13.2%, to $21.3 million from $18.8 million recorded for the year ended December 31, 2008. Our results for 2009 were primarily affected by increased provisions for loan losses, increased FDIC insurance premiums and the goodwill impairment charge. All per share amounts have been retroactively adjusted to reflect the 3% stock dividends paid by Community Partners in 2009 and 2008.
 
Total assets increased by $69.8 million, or 12.2%, to $640.0 million at December 31, 2009 from $570.2 million at December 31, 2008. The increase in total assets was primarily the result of growth in our primary source of funding, which are customer deposits. We used our increases in deposits to fund our loan growth and to provide additional liquidity in the form of federal funds sold.
 
The loan portfolio, net of the allowance for loan losses, amounted to $507.2 million at December 31, 2009, which was an increase of $65.2 million, or 14.8%, over the December 31, 2008 amount of $442.0 million. The loan growth experienced during 2009 reflects our desire to provide commercial and consumer lending to our market’s customers in addition to maintaining our high credit standards in a challenging market. The allowance for loan losses totaled $6.2 million, or 1.20% of total loans, at December 31, 2009, compared to $6.8 million, or 1.52% of loans outstanding, at December 31, 2008. The decrease of $631,000 in the allowance for loan losses is primarily due to the net loan charge-offs of $2.8 million offset in part by the additional provision of $2.2 million during 2009.
 
Deposits increased to $535.4 million at December 31, 2009 from $474.8 million at December 31, 2008, an increase of $60.6 million, or 12.8%. The increase in deposits is primarily attributable to our strategic initiative to increase our customer base by greater penetration of existing markets.
 
 
The following table provides certain performance ratios for the dates indicated.

                   
   
2009
   
2008
   
2007
 
   
 
   
 
   
 
 
Return on average assets
    (0.82%)       0.15%       0.68%  
Return on average tangible assets
    (0.85%)       0.15%       0.72%  
Return on average shareholders’ equity
    (6.29%)       1.09%       5.19%  
Return on average tangible shareholders’ equity
    (8.95%)       1.69%       8.30%  
Net interest margin
    3.69%        3.73%       4.07%  
Average equity to average assets
    13.03%        13.35%       13.14%  
Average tangible equity to average tangible assets assets
    9.54%        9.03%       8.63%  
 
We anticipate that our performance ratios will remain challenged as we expect income from continuing operations in 2010 to continue to be impacted by poor economic conditions in the New Jersey real estate market. In addition, should a further general decline in economic conditions in New Jersey continue throughout 2010 and beyond, the Company may suffer higher default rates on its loans, decreased value of assets it holds as collateral, and reduced loan originations as we continue to pursue only quality loans based on our guidelines.

Results of Operations
 
Our principal source of revenue is net interest income, the difference between interest income on interest earning assets and interest expense on deposits and borrowings. Interest earning assets consist primarily of loans, investment securities and federal funds sold. Sources to fund interest earning assets consist primarily of deposits and borrowed funds. Our net income is also affected by our provision for loan losses, other income and other expenses.  Other income consists primarily of service charges, commissions and fees, while other expenses are comprised of salaries and employee benefits, occupancy costs and other operating expenses.
 
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
 
Net (Loss) Income
 
The Company reported a net loss to common shareholders of $5.7 million for the year ended December 31, 2009, compared to net income of $798,000 in 2008. Basic and diluted loss per common share after preferred stock dividends and accretion were both ($0.79) for the year ended December 31, 2009 compared to basic and diluted earnings of $0.11 per common share for the same period in 2008. Our net income for the year ended December 31, 2009 was negatively impacted as we faced the financial challenges resulting from the downturn in the general economy. We recorded $2.2 million in provision for loan losses in 2009 similar to the provision of $2.3 million in 2008, primarily as a result of an increase in impaired loans due to deteriorating economic conditions. During 2009, our non-interest expenses increased $7.9 million, or 46.4%, from $17.2 million during 2008 to $25.1 million during 2009. The primary reason for this increase was due to the goodwill impairment charge of $6.7 million occurring during 2009. Conversely, our net interest income increased by $2.5 million, or 13.2%, in 2009 over 2008, primarily due to the growth in our loan portfolio.
 
Net Interest Income
 
For the year ended December 31, 2009, we recognized net interest income of $21.3 million, as compared to $18.8 million for the year ended December 31, 2008. Our net interest income increased $2.5 million, or 13.2%, as a result of the balance sheet growth and lower deposit costs during 2009. As general economic conditions continued to deteriorate, the Federal Reserve kept short term interest rates at 0.25% throughout 2009. We increased our earning asset average balance by $72.6 million, or 14.4%, to $577.4 million for the year ended December 31, 2009 from $504.8 million for the year ended December 31, 2008, while our net interest spread increased by 24 basis points to 3.34% for year ended December 31, 2009 as compared to 3.10% for the same period in 2008. The net interest margin declined by 4 basis points to 3.69% for year ended December 31, 2009 as compared to 3.73% for the same period in 2008, primarily as a result of increasingly competitive market conditions, changing market rates and a higher level of excess liquidity residing in Federal funds sold due to the strong deposit growth.
 
 
For the year ended December 31, 2009, our total interest income decreased to $30.2 million from $30.8 million for the year ended December 31, 2008. This decrease of $628,000, or 2.0%, was driven primarily by lower interest rates on earning assets, as rate-related decreases in interest income of $4.1 million were partially offset by volume-related increases of $3.5 million for the year ended December 31, 2009 as compared to the prior year. Our average loans outstanding increased by $50.5 million, or 11.6%, to $484.3 million for the year ended December 31, 2009 from $433.8 million for the year ended December 31, 2008. The average yield on our interest-earning assets decreased by 87 basis points to 5.23% for the fiscal year ended December 31, 2009 from 6.10 % for the prior fiscal year.
 
Total interest expense decreased by $3.1 million, or 26.0%, to $8.9 million for the year ended December 31, 2009 when compared to $12.0 million for the year ended December 31, 2008. This decrease is primarily due to general decrease in market interest rates as previously described. This decrease resulted from a rate related decrease of $5.1 million, offset in part by volume-related increases in interest expense amounting to $2.0 million. The average balance of interest-bearing liabilities increased to $467.9 million for the year ended December 31, 2009 from $399.7 million for the year ended December 31, 2008. Our average balance in certificates of deposit decreased by $15.0 million, or 10.3%, to $130.4 million with an average yield of 2.44% for 2009 from $145.4 million with an average yield of 3.57% for 2008. This average balance decrease was more than offset by increases of $99.3 million of savings deposits, which increased from $76.9 million with an average yield of 3.08% during 2008, to $176.2 million with an average yield of 1.81% during 2009. Additionally, NOW deposits increased by $2.7 million to $40.8 million with an average yield of 0.78% during 2009 from $38.0 million with an average yield of 1.04% during 2008.  For the year ended December 31, 2009, the average yield on our interest-bearing liabilities was 1.89% compared to 3.00% in the prior fiscal year.
 
 
 
 
The following table reflects, for the periods presented, the components of our net interest income, setting forth: (1) average assets, liabilities, and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) our net interest spread (i.e., the average yield on interest-earning assets less the average rate on interest-bearing liabilities), and (5) our yield on interest-earning assets. There have been no tax equivalent adjustments made to yields.
 
   
Years ended December 31,
 
   
2009
 
2008
   
2007
 
   
Average
 balance
   
Interest
 income/
 expense
 
Average
 rates
 earned/
 paid
 
Average
 balance
   
Interest
 income/
 expense
 
Average
 rates
 earned/
 paid
   
Average
 balance
   
Interest
income/
expense
 
Average
 rates
 earned/
 paid
 
   
(in thousands, except for percentages)
 
ASSETS
                                                         
Interest-Earning Assets:
                                                         
Federal funds sold
 
$
35,610
   
$
59
 
0.17%
 
$
8,306
   
$
144
 
1.73
%
 
$
15,567
   
$
820
 
5.27
%
Investment securities
   
57,512
     
2,397
 
4.17%
   
62,665
     
2,927
 
4.67
%
   
60,374
     
3,008
 
4.98
%
Loans, net of unearned fees (1) (2)
   
484,258
     
27,726
 
5.73%
   
433,784
     
27,739
 
6.39
%
   
414,215
     
32,021
 
7.73
%
                                                           
Total Interest-Earning Assets
   
577,380
     
30,182
 
5.23%
   
504,755
     
30,810
 
6.10
%
   
490,156
     
35,849
 
7.31
%
                                                           
Non-Interest-Earning Assets:
                                                         
Allowance for loan loss
   
(6,887
)
             
(5,172
)
               
(4,618
)
           
Other assets
   
53,913
               
50,425
                 
50,367
             
                                                           
Total Assets
 
$
624,406
             
$
550,008
               
$
535,905
             
 
       
 
 
 
 
         
 
 
 
 
           
 
 
 
 
 
 
LIABILITIES & SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
   
 
 
 
 
 
 
 
     
 
 
 
 
 
 
 
 
 
Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
   
 
 
 
 
 
 
 
     
 
 
 
 
 
 
 
 
 
NOW deposits
 
$
40,763
 
 
 
       318
 
0.78%
 
$
38,030
 
 
 
        395
 
1.04
%
 
$
39,026
 
 
 
763
 
1.96
%
Savings deposits
 
 
176,199
 
 
 
    3,186
 
1.81%
 
 
76,882
 
 
 
     2,369
 
3.08
%
 
 
32,423
 
 
 
783
 
2.41
%
Money market deposits
 
 
97,794
 
 
 
    1,592
 
1.63%
 
 
114,247
 
 
 
3,268
 
2.86
%
 
 
103,133
 
 
 
4,183
 
4.06
%
Time deposits
 
 
130,373
 
 
 
    3,186
 
2.44%
 
 
145,416
 
 
 
5,188
 
3.57
%
 
 
196,546
 
 
 
9,579
 
4.87
%
Securities sold under agreements to repurchase
 
 
15,233
 
 
 
       273
 
1.79%
 
 
16,957
 
 
 
438
 
2.58
%
 
 
14,384
 
 
 
539
 
3.75
%
Short-term borrowings
 
 
-
 
 
 
           -
 
-
 
 
715
 
 
 
20
 
2.80
%
 
 
129
 
 
 
7
 
5.08
%
Long-term debt
   
7,500
     
       302
 
4.03%
   
7,500
     
299
 
3.98
%
   
658
     
25
 
3.87
%
 
       
 
               
 
                 
 
         
Total Interest-Bearing Liabilities
 
 
467,862
 
 
 
    8,857
 
1.89%
 
 
399,747
 
 
 
11,977
 
3.00
%
 
 
386,299
 
 
 
15,879
 
4.11
%
 
       
 
               
 
                 
 
   
 
   
Non-Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
   
 
 
 
 
 
 
 
     
 
 
 
 
 
 
 
   
Demand deposits
 
 
71,189
 
 
 
 
 
   
 
73,458
 
 
 
 
 
     
 
75,833
 
 
 
 
 
   
Other liabilities
 
 
3,992
 
 
 
 
 
   
 
3,354
 
 
 
 
 
     
 
3,365
 
 
 
 
 
   
 
       
 
               
 
                 
 
   
 
   
Total Non-Interest-Bearing Liabilities
 
 
75,181
 
 
 
 
 
   
 
76,812
 
 
 
 
 
     
 
79,198
 
 
 
 
 
   
 
       
 
               
 
                 
 
   
 
   
Shareholders’ Equity
 
 
81,363
 
 
 
 
 
   
 
73,449
 
 
 
 
 
     
 
70,408
 
 
 
 
 
   
 
       
 
               
 
                 
 
   
 
   
Total Liabilities and Shareholders’ Equity 
 
$
624,406
 
 
 
 
 
   
$
550,008
 
 
 
 
 
     
$
535,905
 
 
 
 
 
   
 
       
 
               
 
                 
 
   
 
   
 
NET INTEREST INCOME
 
 
 
 
 
$
21,325
 
   
 
 
 
 
$
18,833
 
       
 
 
 
$
19,970
 
     
 
       
 
               
 
                 
 
   
 
   
 
NET INTEREST SPREAD (3)
 
 
 
 
 
 
 
 
3.34%
 
 
 
 
 
 
 
 
3.10
%
   
 
 
 
 
 
 
3.20
%
                                                           
NET INTEREST MARGIN (4)
                 3.69%                  3.73                  4.07
 
(1)
Included in interest income on loans are loan fees.
(2)
Includes non-performing loans.
(3)
The interest rate spread is the difference between the weighted average yield on average interest-earning
assets and the weighted average cost of average interest-bearing liabilities.
(4)
The interest rate margin is calculated by dividing net interest income by average interest-earning assets.
 
 
Analysis of Changes in Net Interest Income
 
The following table sets forth for the periods indicated the amounts of the total change in net interest income that can be attributed to changes in the volume of interest-earning assets and interest-bearing liabilities and the amount of the change that can be attributed to changes in interest rates.
 
   
Years ended December 31,
 
   
 2009 vs. 2008
 
 2008 vs. 2007
 
   
Increase (decrease) due to change in
 
   
 
Average
 volume
 
Average
 rate
   
Net
   
Average
volume
   
Average
 rate
   
Net
 
   
(in thousands)
Interest Earned On:
                                             
 
Federal funds sold
 
$
473
   
$
(558
)
 
$
(85
)
 
$
(382
)
 
$
(294
)
 
$
(676
)
Investment securities
   
(241
)    
(289
)
   
(530
)
   
114
     
(195
)
   
(81
)
Loans, net of unearned fees
   
3,228
     
(3,241
)
   
(13
)
   
1,513
     
(5,795
)
   
(4,282
)
                                                 
Total Interest Income
   
3,460
     
(4,088
)
   
(628
)
   
1,245
     
(6,284
)
   
(5,039
)
 
       
 
                     
 
             
Interest Paid On:
                                               
NOW deposits
   
28
     
(105
)
   
(77
)
   
(19
)
   
(349
)
   
(368
)
Savings deposits
   
3,060
     
 (2,243
)
   
817
     
1,074
     
512
     
1,586
 
Money market deposits
   
(471
   
(1,205
)
   
(1,676
)
   
451
     
(1,366
)
   
(915
)
Time deposits
   
(537
)    
(1,465
)
   
(2,002
)
   
(2,492
)
   
(1,899
)
   
(4,391
)
Securities sold under agreements to repurchase
   
(45
   
(120
)
   
(165
)
   
96
     
(197
)
   
(101
)
Short-term borrowing
   
(20
)    
-
     
(20
)
   
29
     
(16
)
   
13
 
Long-term debt
   
-
     
3
     
3
     
266
     
8
     
274
 
                                                 
Total Interest Expense
   
       2,015
     
(5,135
)
   
(3,120
)
   
(595
)
   
(3,307
)
   
(3,902
)
                                                 
Net Interest Income
 
$
       1,445
   
$
1,047
   
$
2,492
   
$
1,840
   
$
(2,977
)
 
$
(1,137
)
 
 
Provision for Loan Losses
 
Our provision for loan losses, recorded for the year ended December 31, 2009, was $2.2 million, compared to $2.3 million for the year ended December 31, 2008. The $2.2 million provision for 2009 was due to the assessment and evaluation of risk elements inherent in the loan portfolio, an increase in non-performing or impaired loans due to the current economic environment and the overall portfolio growth experienced during 2009. The provision for loan losses is determined by an allocation process whereby an estimated allowance is allocated to impaired loans and to pools of loans. The allocation reflects management’s assessment of economic conditions, credit quality and other risk factors inherent in the loan portfolio. The provision for loan losses also reflects higher loan balances, which increased $64.6 million, or 14.4%, to $513.4 million at December 31, 2009, from $448.8 million at December 31, 2008. The allowance for loan losses totaled $6.2 million, or 1.20% of total loans at December 31, 2009, compared to $6.8 million, or 1.52% of total loans, at December 31, 2008. The decrease of $631,000 in the allowance for loan losses is primarily due to the net loan charge-offs of $2.8 million partially offset by the additional provision of $2.2 million during 2009. In management’s opinion, the allowance for loan losses, totaling $6.2 million at December 31, 2009, is adequate to cover losses inherent in the portfolio. We anticipate increased loan volume during 2010 as we continue to target credit worthy customers that have become dissatisfied with their relationships with larger institutions. Management will continue to review the need for additions to our allowance for loan losses based upon our review of the loan portfolio, the level of delinquencies and general market and economic conditions.
 
Non-Interest Income
 
Non-interest income amounted to $2.2 million for the year ended December 31, 2009, compared to $1.7 million for the year ended December 31, 2008. The increase of $583,000, or 35.0%, was primarily attributable to the recording of $703,000 of net realized gains from the sale of securities available for sale. Excluding net realized securities gains, non-interest income declined $120,000, or 7.2%, from 2008. Service fees on deposit accounts declined by $49,000 primarily due to less fee income revenue. Other loan customer service fees declined by $96,000 primarily due to a decrease in loan prepayment penalty fees. Additionally, a $156,000 other-than-temporary impairment credit charge was recorded on an investment security. Management evaluates securities for other-than-temporary impairments at least on a quarterly basis, and more frequently when the economic and market concerns warrant such evaluations. These decreases in other income were partially offset by a $187,000 increase in other income, which was primarily due to higher fees generated by our residential mortgage department.
 
 
Non-Interest Expenses
 
The following table provides a summary of non-interest expenses by category for the years ended December 31, 2009 and 2008.

   
Years ended
December 31,
             
(dollars in thousands)
 
 
2009
 
   
2008
 
   
Increase
(Decrease)
   
%
Increase
(Decrease)
 
Salaries and employee benefits
  $ 9,509     $ 9,076     $ 433       4.8 %
Occupancy and equipment
    3,311       3,350       (39 )     -1.2 %
Professional fees
    851       927       (76 )     -8.2 %
Advertising and marketing
    251       339       (88 )     -26.0 %
Data processing
    844       579       265       45.8 %
Insurance
    309       332       (23 )     -6.9 %
FDIC insurance assessment
    1,114       293       821       280.2 %
Outside service fees
    519       568       (49 )     -8.6 %
Goodwill impairment charge
    6,725       -       6,725       100.0 %
Amortization of identifiable intangibles
    278       316       (38 )     -12.0 %
Other operating
    1,426       1,390       36       2.6 %
                                 
Total non-interest expenses
  $ 25,137     $ 17,170     $ 7,967       46.4 %

Non-interest expense was $25.1 million for the year ended December 31, 2009, compared to $17.2 million for the year ended December 31, 2008, an increase of $7.9 million, or 46.4%. The increase is primarily due to the $6.7 million goodwill impairment charge recorded by the Bank during 2009 as compared to no impairment charge required during 2008. Additionally, FDIC insurance assessments increased by $821,000, or 280.2%, primarily due to the one-time special assessment of $288,000 recognized during the quarter ended June 30, 2009, and increased risk-based assessment rates applicable to the Company’s deposit liabilities in 2009. In addition, salaries and employee benefits increased $433,000, or 4.8%, of which $150,000 pertains to stock option compensation expense, to $9.5 million for the year ended December 31, 2009 from $9.1 million for the year ended December 31, 2008 primarily as a result of additions to staff to support our growth, along with higher salaries and health insurance costs.  The number of our full-time equivalent employees increased from 148 at December 31, 2008 to 150 at December 31, 2009. Data processing expenses increased $265,000, or 45.8%, primarily due to the database conversion of a former banking subsidiary into the Two River operations. Professional fees decreased by $76,000 or 8.2%, to $851,000 for the year ended December 31, 2009 from $927,000 for the year ended December 31, 2008 due to a stabilization of non-recurring expenses associated with the Company’s status as a public company. Advertising expenses decreased by $88,000, or 26.0%, to $251,000 for the year ended December 31, 2009 from $339,000 for the year ended December 31, 2008 as we continued to identify those expenses that could be reduced during slower economic activity. Insurance costs, exclusive of the FDIC insurance premiums and assessments, decreased by $23,000, or 6.9%, to $309,000 for the year ended December 31, 2009 from $332,000 for the year ended December 31, 2008. Subsequent to the acquisition of Town Bank as of April 1, 2006, we began amortizing identifiable intangible assets and incurred $278,000 in costs during 2009 compared to $316,000 in costs during 2008. At December 31, 2009, the balance of $871,000 in core deposit intangibles remains to be amortized through March 2016.

Income Tax Expense
 
 For the year ended December 31, 2009, the Company recorded $1.4 million in income tax expense, compared to $230,000 for the year ended December 31, 2008. The effective tax rate for 2009, excluding the goodwill impairment charge of $6.7 million, which is a permanent difference, was higher in 2009 compared to 2008 due to lower tax-exempt income as a proportion of total pre-tax income earned during 2009 compared to the prior year.
 
 
Financial Condition
 
December 31, 2009 Compared to December 31, 2008
 
Assets
 
At December 31, 2009, our total assets were $640.0 million, an increase of $69.8 million, or 12.2%, over total assets of $570.2 million at December 31, 2008. At December 31, 2009, our total loans were $513.4 million, an increase of $64.6 million from the $448.8 million reported at December 31, 2008. Investment securities were $49.3 million at December 31, 2009 as compared to $64.7 million at December 31, 2008, a decrease of $15.4 million, or 23.7%. At December 31, 2009, Federal funds sold totaled $35.9 million compared to $14.9 million at December 31, 2008, an increase of $21.0 million, as our liquidity position increased due to the strong deposit growth experienced during 2009. At December 31, 2009, goodwill totaled $18.1 million from an original amount of $24.8 million. The decrease of $6.7 million is due to the $6.7 million goodwill impairment charge recorded by the bank during 2009.
 
Liabilities
 
Total deposits increased $60.6 million, or 12.8%, to $535.4 million at December 31, 2009, from $474.8 million at December 31, 2008. Deposits are the Company’s primary source of funds. The deposit increase during 2009 was primarily attributable to the Company’s strategic initiative to continue to grow our market presence. The Company anticipates continued loan demand increases during 2010 and beyond, and will depend on the expansion and maturation of the branch network as the primary funding source. As a secondary funding source, the Company intends to utilize borrowed funds at opportune times during changing rate cycles. The Company also experienced a positive change in the mix of the deposit products through promotional activities at the branches, which were targeted to gain market penetration. In order to fund future quality loan demand, the Company intends to raise the most cost-effective funding available within the market area.
 
Securities Portfolio
 
Investment securities, including restricted stock, totaled $49.3 million at December 31, 2009 compared to $64.7 million at December 31, 2008, a decrease of $15.4 million, or 23.7%. Investment securities purchases amounted to $31.6 million, while repayments and maturities amounted to $35.7 million and sales of securities available for sale amounted to $11.4 million during 2009.
 
The Company maintains an investment portfolio to fund increased loans and liquidity needs (resulting from decreased deposits or otherwise) and to provide an additional source of interest income. The portfolio is composed of obligations of the U.S. Government agencies and U.S. Government-sponsored entities, municipal securities and a limited amount of corporate debt securities. All of our mortgage-backed investment securities are collateralized by pools of mortgage obligations that are guaranteed by privately managed, U.S. Government-sponsored enterprises (“GSE”), such as Fannie Mae, Freddie Mac and Government National Mortgage Association. Due to these GSE guarantees, these investment securities are susceptible to less risk of non-performance and default than other corporate securities which are collateralized by private pools of mortgages. At December 31, 2009, the Company maintained $19.6 million of GSE mortgage-backed securities in the investment portfolio, all of which are current as to payment of principal and interest and are performing to the terms set forth in their respective prospectuses.
 
Included within the Company’s investment portfolio are trust preferred securities, which consists of four single issue securities and one pooled issue security. These securities have an amortized cost value of $3.1 million and a fair value of $2.1 million at December 31, 2009. The unrealized loss on these securities is related to general market conditions, the widening of interest rate spread and downgrades in credit ratings. The single issue securities are from large money center banks. The pooled instrument consists of securities issued by financial institutions and insurance companies and we hold the mezzanine tranche of such security. Senior tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches. The Company holds a mezzanine tranche. For the pooled trust preferred security, management reviewed expected cash flows and credit support and determined it was not probable that all principal and interest would be repaid. Total impairment on this security was $360,000 at December 31, 2009.  As the Company does not intend to sell this security and it is more likely than not that the Company will not be required to sell this security, only the credit loss portion of other-than-temporary impairment in the amount of $156,000 was recognized on the income statement for 2009. The Company recognized the remaining $204,000 of the other-than-temporary impairment in other comprehensive income.
 
 
 Management evaluates all securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluations. As of December 31, 2009, all of these securities are current with their scheduled interest payments, with the exception of the one pooled trust preferred security which has been remitting reduced amounts of interest as some individual participants of the pool have deferred interest payments. Future deterioration in the cash flow of these instruments or the credit quality of the financial institution issuers could result in additional impairment charges in the future.
 
The Company accounts for its investment securities as available for sale or held to maturity. Management determines the appropriate classification at the time of purchase. Based on an evaluation of the probability of the occurrence of future events, we determine if we have the ability and intent to hold the investment securities to maturity, in which case we classify them as held to maturity. All other investments are classified as available for sale.
 
Securities classified as available for sale must be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of taxes. Gains or losses on the sales of securities available for sale are recognized upon realization utilizing the specific identification method. The net effect of unrealized gains or losses, caused by marking our available for sale portfolio to fair value, could cause fluctuations in the level of shareholders’ equity and equity-related financial ratios as changes in market interest rates cause the fair value of fixed-rate securities to fluctuate.
 
Securities classified as held to maturity are carried at cost, adjusted for amortization of premium and accretion of discount over the terms of the maturity in a manner that approximates the interest method.
 
The following table sets forth the carrying value of the securities portfolio as of December 31, 2009, 2008 and 2007 (in thousands).
 
   
December 31,
 
   
2009
   
2008
   
2007
 
Investment securities available for sale at fair value:
 
 
   
 
   
 
 
                   
U.S. Government agency securities
  $ 11,102     $ 23,927     $ 30,031  
Municipal securities
    2,025       2,267       1,081  
U.S. Government-sponsored enterprises
                       
            (“GSE”) - Mortgage-backed securities
    19,606       27,829       21,180  
            Corporate debt securities
    3,816       1,948       2,525  
            Mutual fund
    1,141              
 
                       
 
  $ 37,690     $ 55,971     $ 54,817  
                         
                         
Investment securities held to maturity at amortized cost:
                       
                         
U.S. Government agency securities
  $ 1,000     $     $  
Municipal securities
    6,802       6,139       5,758  
Corporate debt securities and other
    2,816       1,801       1,799  
 
                       
 
  $ 10,618     $ 7,940     $ 7,557  

 
The contractual maturity distribution and weighted average yields, calculated on the basis of the stated yields to maturity, taking into account applicable premiums or discounts, of the securities portfolio at December 31, 2009 is set forth in the following table (excluding restricted stock and mutual fund). Securities available for sale are carried at amortized cost in the table for purposes of calculating the weighted average yield. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. There have been no tax equivalent adjustments made to the yields on tax-exempt securities.
 
December 31, 2009
 
Due within 1
year
   
Due 1 – 5 years
   
Due  5 –  10 years
   
Due after 10
years
   
Total
(dollars in thousands)
 
 
 
Amortized
 cost
 
Wtd
Avg
 Yield
   
Amortized
 cost
 
Wtd
Avg
 Yield
   
Amortized
 cost
 
Wtd
Avg
 Yield
   
Amortized
 cost
 
Wtd
Avg
 Yield
   
Amortized
 cost
 
Wtd
Avg
 Yield
Investment securities available for sale:
                                                           
    U.S. Government agency securities
 
$
2,000
 
3.04
%
 
$
7,000
 
2.14
%
 
$
-
 
-
   
$
2,068
 
5.95
%
 
$
11,068
 
3.01
%
    Municipal securities
   
-
 
-
     
100
 
2.00
%
   
-
 
-
     
1,911
 
4.51
%
   
2,011
 
4.39
%
    U.S. Government-sponsored
                                                           
    enterprises (“GSE”) - Mortgage-
                                                           
    backed securities
   
261
 
4.00
%
   
858
 
4.50
%
   
1,440
 
4.83
%
   
16,210
 
5.17
%
   
18,769
 
5.10
%
    Corporate debt securities
   
458
 
3.51
%
   
529
 
7.30
%
   
-
 
-
     
3,297
 
2.90
%
   
4,284
 
3.51
%
                                                             
   
$
2,719
 
3.21
%
 
$
8,487
 
2.70
%
 
$
1,440
 
4.83
%  
$
23,486
 
4.86
%
 
$
36,132
 
4.21
%
                                                             
Investment securities held to maturity:
                                                           
    U.S. Government agency securities
 
$
-
 
-
   
$
-
 
-
   
$
1,000
 
3.00
%
 
$
-
 
-
   
$
1,000
 
3.00
%
    Municipal securities
   
-
 
-
     
1,387
 
3.91
%
   
1,059
 
4.40
%
   
4,356
 
4.35
%
   
6,802
 
4.27
%
    Corporate debt securities and other
   
500
 
4.00
%
   
511
 
6.75
%
   
-
 
-
     
    1,805
 
0.80
%
   
2,816
 
2.45
%
                                                             
   
$
500
 
4.00
%
 
$
    1,898
 
4.68
%
 
$
2,059
 
3.72
%
 
$
    6,161
 
3.31
%
 
$
10,618
 
3.67
%
 
Loan Portfolio
 
The following table summarizes total loans outstanding by loan category and amount, excluding net unearned fees, on the dates indicated.
 
 
 
December 31,
 
   
2009
   
2008
   
2007
 
 
 
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
 
 
(in thousands, except for percentages)
 
                                     
Commercial and industrial
  $ 133,916       26.1 %   $ 120,404       26.8 %   $ 114,657       27.5 %
Real estate - construction
    67,011       13.0 %     76,128       17.0 %     86,937       20.8 %
Real estate - commercial
    228,818       44.5 %     177,650       39.6 %     167,404       40.1 %
Real estate - residential
    19,381       3.8 %     19,860       4.4 %     4,955       1.2 %
Consumer
    64,547       12.6 %     54,890       12.2 %     42,627       10.2 %
Other
    176       0.0 %     119