Attached files
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2011
------------------
-OR-
[ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to .
----------- -------------
CORNERSTONE FINANCIAL CORPORATION
-------------------------------------------------------
(Exact name of registrant, as specified in its charter)
NEW JERSEY 80-0282551
-------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6000 MIDLANTIC DRIVE, SUITE 120 S, MOUNT LAUREL, NEW JERSEY 08054
--------------------------------------------------------------------------------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (856) 439-0300
--------------
Securities registered pursuant to Section 12(b) of the Act:
NONE
----------------
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
--------------------------
(Title of Class)
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 past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO .
--- ---
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation SD-T during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). YES X NO .
--- ---
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
the definitions of "large accelerated filer", "accelerated filer", and "smaller
reporting company" in rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by checkmark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) YES NO X
--- ---
As of May 12, 2011 there were 1,954,428 outstanding shares of the registrant's
Common Stock.
CORNERSTONE FINANCIAL CORPORATION
CONTENTS
PAGES
-----
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements ................................. 1
Consolidated Statements of Financial Condition at
March 31, 2011 (unaudited) and December 31, 2010 ...................... 1
Consolidated Statements of Operations (unaudited)
for the three months ended March 31, 2010 and 2009 .................... 2
Consolidated Statement of Changes in Stockholders' Equity
(unaudited) for the three months ended March 31, 2011 ................ 3
Consolidated Statements of Cash Flows (unaudited) for the
three months ended March 31, 2011 and 2010 ............................ 4
Notes to Consolidated Financial Statements (unaudited) ................. 5
Item 2. Management's Discussion and Analysis or Plan of Operation ......... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........ 28
Item 4. Controls and Procedures ........................................... 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 29
Item 1A. Risk Factors ..................................................... 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ....... 29
Item 3. Defaults upon Senior Securities ................................... 29
Item 4. Submission of Matters to a Vote of Security Holders ............... 29
Item 5. Other Information ................................................. 29
Item 6. Exhibits .......................................................... 29
Signatures .................................................................. 30
Exhibit 31.1 ................................................................ 31
Exhibit 31.2 ................................................................ 32
Exhibit 32.1 ................................................................ 33
Exhibit 32.2 ................................................................ 34
PART I. FINANCIAL INFORMATION
Item 1 -- Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data) March 31, 2011 December 31, 2010
--- --------------------- -----------------
Assets: (unaudited)
Cash and due from banks $ 5,786 $ 5,331
Federal funds sold 10,000 3,700
--------------------- --- -------------
Cash and cash equivalents 15,786 9,031
--------------------- --- -------------
Investment securities:
Held to maturity (fair value 2011 - $39,726; 2010 - $39,520) 40,158 40,435
Available for sale (amortized cost 2011-$47,946; 2010- $47,945) 44,780 44,635
Loans receivable 238,002 242,856
Less allowance for loan losses 2,962 3,826
--------------------- --- -------------
Loans receivable, net 235,040 239,030
--------------------- --- -------------
Federal Home Loan Bank stock 1,435 1,435
Premises and equipment, net 7,773 7,806
Accrued interest receivable 1,930 2,152
Bank owned life insurance 4,725 4,685
Deferred taxes 2,149 2,600
Other Real Estate Owned 830 830
Other assets 1,589 1,378
--------------------- --- -------------
Total Assets $ 356,195 $ 354,017
===================== === =============
Liabilities:
Non-interest bearing deposits $ 28,069 $ 40,514
Interest bearing deposits 169,106 148,259
Certificates of deposit 106,998 113,497
--------------------- --- -------------
Total deposits 304,173 302,270
--------------------- --- -------------
Advances from the Federal Home Loan Bank 25,000 25,000
Line of Credit 4,929 4,877
Subordinated debt 3,000 3,000
Other liabilities 1,147 1,122
--------------------- --- -------------
Total Liabilities 338,249 336,269
--------------------- --- -------------
Commitments and Contingencies (Note 4)
Stockholders' Equity:
Preferred stock:
$0 par value; $1,000 per share stated value, authorized 1,000,000
shares; issued and outstanding 1,900 at March 31, 2011 and
December 31, 2010 respectively 1,900 1,900
Common stock:
$0 par value: authorized 10,000,000 shares; issued and
outstanding 1,954,428 at March 31, 2011 and 1,954,428 at
December 31, 2010 - -
Additional paid-in capital 17,631 16,727
Accumulated other comprehensive loss (1,901) (1,988)
Retained earnings 316 1,109
--------------------- --- -------------
Total Shareholders' Equity 17,946 17,748
--------------------- --- -------------
Total Liabilities and Shareholders' Equity $ 356,195 $ 354,017
===================== === =============
See accompanying notes to consolidated financial statements
1
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
--- ------------------------------------------------
(In thousands, except per share data) March 31, 2011 March 31,2010
--- ---------------------- --- ---------------------
Interest Income (Unaudited) (Unaudited)
Interest and fees on loans $ 3,385 $ 3,373
Interest on investment securities 886 547
Interest on federal funds 3 2
--- ---------------------- --- ---------------------
Total interest income 4,274 3,922
Interest Expense
Interest on deposits 905 938
Interest on borrowings 176 184
--- ---------------------- --- ---------------------
Total interest expense 1,081 1,122
--- ---------------------- --- ---------------------
Net interest income 3,193 2,800
Provision for loan losses 953 109
--- ---------------------- --- ---------------------
Net interest income after loan loss provision 2,240 2,691
--- ---------------------- --- ---------------------
Non-Interest Income
Service charges on deposit accounts 43 49
Bank owned life insurance income 40 41
Gain on sale of loans 156 39
Miscellaneous fee income 54 25
--- ---------------------- --- ---------------------
Total non-interest income 293 154
--- ---------------------- --- ---------------------
Non-Interest Expense
Salaries and employee benefits 1,377 1,200
Net occupancy 367 321
Data processing and other service costs 119 100
Professional services 158 138
Advertising and promotion 37 26
Other real estate owned expense 29 9
FDIC expense 133 109
Other operating expenses 148 167
--- ---------------------- --- ---------------------
Total non-interest expense 2,368 2,070
--- ---------------------- --- ---------------------
Income before income taxes 165 775
Income tax expense 56 300
--- ---------------------- --- ---------------------
Net income 109 475
Preferred stock dividends 33 33
--- ---------------------- --- ---------------------
Net income available to common
shareholders $ 76 $ 442
=== ====================== === =====================
Earnings per share
Basic $ 0.04 $ 0.22 (1)
Diluted $ 0.04 $ 0.22 (1)
Weighted average shares outstanding
Basic 1,954 1,954 (1)
Diluted 1,962 1,954 (1)
(1) All share and per share amounts have been restated to reflect the 8.0%
common stock dividend payable on May 16, 2011 to common shareholders of record
as of April 15, 2011.
See accompanying notes to consolidated financial statements
2
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands, except per share data)
Accumulated
Additional Other
Comprehensive Preferred Common Paid-in Accumulated Comprehensive
Income Stock Stock Capital Earnings Loss Total
------------- ------------ -------- ---------- --- ------------- ----------------- --------
Balance at
December 31, 2010 $ 1,900 $ - $ 16,727 $ 1,109 $ (1,988) $ 17,748
============ ======== ========== ============= ================= ========
Comprehensive
income
Net Income $ 109 - - - 109 - 109
-------------
Unrealized gain on
securities available
for sale, net of tax 87 87 87
=============
Comprehensive
income $ 196
=============
Stock based
compensation - - 35 - - 35
Preferred Stock
Dividend
($35 per share) - - - (33) - (33)
Declaration of 8%
Common Stock
Dividend - - 869 (869) - -
------------ -------- ---------- ------------- ----------------- --------
Balance at
March 31, 2011 $ 1,900 $ - $ 17,631 $ 316 $ (1,901) $ 17,946
============ ======== ========== ============= ================= ========
See accompanying notes to consolidated financial statements.
3
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
--- -------------------------------------------------
(In thousands) March 31, 2011 March 31, 2010
--- ---------------------- --- ----------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net Income(loss) $ 109 $ 475
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Provision for loan losses 953 109
Depreciation 108 94
Amortization of premiums and discounts, net 9 25
Stock option expense 35 33
Gain on sale of loans (156) (39)
Deferred tax expense (benefit) 394 (81)
Income on Bank Owned Life Insurance (40) (41)
Decrease (increase) in accrued interest receivable
and other assets 11 (4)
Increase (decrease) in other liabilities 25 (67)
--- ---------------------- --- ----------------------
Net cash provided by operating activities 1,448 504
Cash flows from investing activities:
Purchases of investments held to maturity - (5,652)
Purchases of securities available for sale - -
Repayment of investments held to maturity 267 2,828
Redemption (purchase) of FHLB Stock - 219
Net decrease in loans 3,193 1,035
Purchases of premises and equipment (75) (24)
--- ---------------------- --- ----------------------
Net cash provided (used in) investing activities 3,385 (1,594)
Cash flows from financing activities:
Net increase in deposits 1,903 20,294
Proceeds from borrowings 52 242,650
Principal payments on borrowings - (247,483)
Cash dividend paid for preferred stock (33) (33)
--- ---------------------- --- ----------------------
Net cash provided by financing activities 1,922 15,428
Net increase in cash and cash equivalents 6,755 14,338
Cash and cash equivalents at the beginning of the period 9,031 4,742
--- ---------------------- --- ----------------------
Cash and cash equivalents at the end of the period 15,786 $ 19,080
=== ====================== === ======================
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 1,066 $ 1,137
Cash paid during the period for income taxes 96 126
Net change in unrealized gain on securities, net of tax 87 -
Supplemental non-cash investing and financing activities:
Unsettled AFS investment security $ - $ 1,000
See accompanying notes to consolidated financial statements.
4
CORNERSTONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Cornerstone
Financial Corporation and its wholly owned subsidiary, Cornerstone Bank
(together, the "Company"). These interim statements, which are unaudited, were
prepared in accordance with instructions for Form 10-Q. In the opinion of
management, all adjustments, consisting of normal recurring accruals, necessary
for fair presentation of the interim financial statements have been included.
Cornerstone Financial Corporation was formed in 2008 at the direction of the
Board of Directors of Cornerstone Bank to serve as a holding company for the
Bank. The holding company reorganization was completed in January 2009. The
statement of financial condition as of December 31, 2010 has been derived from
audited financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in Cornerstone
Financial Corporation's Annual Report on Form 10-K for the year ended December
31, 2010 as filed with the United States Securities and Exchange Commission.
NOTE 2 -- USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to significant change in the near-term relate
to the allowance for loan losses and the evaluation of deferred taxes.
NOTE 3 - CONTINGENCIES
The Company, from time to time, is a party to routine litigation that arises in
the normal course of business. Management does not believe the resolution of
this litigation, either any individual case or in the aggregate, would have a
material adverse effect on the Company's financial condition or results of
operations. However, the ultimate outcome of any such matter, as with
litigation generally, is inherently uncertain and it is possible that some of
these matters may be resolved materially adverse to the Company.
NOTE 4 - EARNINGS PER SHARE
Basic earnings per share is calculated on the basis of net income divided by
the weighted average number of shares outstanding. Diluted earnings per share
includes dilutive potential common shares as computed under the treasury stock
method using average common stock prices.
All share and per share amounts have been restated to reflect the 8.0% common
stock dividend, declared on March 17, 2011, and payable on May 16, 2011 to
common shareholders of record as of April 15, 2011. This stock dividend
resulted in the issuance of 144,772 additional shares and resulted in $869
thousand being transferred from retained earnings to additional paid in
capital.
5
NOTE 5 -- STOCK OPTIONS
The Company accounts for stock options in accordance with FASB Accounting
Standards Codification (ASC) Topic 718 Stock Compensation. The Company
recognizes the grant-date fair-value of stock options and other equity-based
compensation issued to employees in the statement of operations. The Company
had $229 thousand in unrecognized compensation costs relating to non-vested
stock based compensation awards at March 31, 2011.
On July 16, 2009, options to purchase a total of 48,600 shares of common stock
were granted with an exercise price of $4.63 per share. These options will
expire ten years from the date of the grant and vest on a one-third per year
basis beginning on July 16, 2010, with vesting accelerating in certain
circumstances such as change in control of the Company. The exercise price of
each option equals the market price of the common stock on the date of the
grant.
On January 16, 2010, options to purchase a total of 119,880 shares of common
stock were granted with an exercise price of $4.17 per share. These options
will expire ten years from the date of the grant and vest on a one-third per
year basis beginning on January 21, 2011, with vesting accelerating in certain
circumstances such as change in control of the Company. The exercise price of
each option equals the market price of the common stock on the date of the
grant.
NOTE 6 - INVESTMENT SECURITIES
A comparison of amortized cost and approximate fair value of investment
securities held to maturity at March 31, 2011 and December 31, 2010 is as
follows (in thousands):
March 31, 2011
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
--- -------- --- -------------- --- ----------- --- ---------
Investments held to maturity:
Government agency obligations $ 32,707 $ 51 $ (1,056) $ 31,702
Mortgage backed securities 7,451 123 - 7,574
--- -------- --- -------------- --- ----------- --- ---------
Total $ 40,158 $ 174 $ (1,056) $ 39,276
--- -------- --- -------------- --- ----------- --- ---------
Investments available for sale:
Government agency obligations $ 38,056 $ - $ (2,201) $ 35,855
US Treasury Securities 9,890 - (965) 8,925
--- -------- --- -------------- --- ----------- --- ---------
Total $ 47,946 $ - $ (3,166) $ 44,780
--- -------- --- -------------- --- ----------- --- ---------
December 31, 2010
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
--- -------- --- -------------- --- ----------- --- ---------
Investments held to maturity:
Government agency obligations $ 32,706 $ 68 $ (1,131) $ 31,643
Mortgage backed securities 7,729 148 - 7,877
--- -------- --- -------------- --- ----------- --- ---------
Total $ 40,435 $ 216 $ (1,131) $ 39,520
--- -------- --- -------------- --- ----------- --- ---------
Investments available for sale:
Government agency obligations $ 38,056 $ - $ (2,496) $ 35,560
US Treasury Securities 9,889 - (814) 9,075
--- -------- --- -------------- --- ----------- --- ---------
Total $ 47,945 $ - $ (3,310) $ 44,635
--- -------- --- -------------- --- ----------- --- ---------
The following table sets forth information regarding the fair value and
unrealized losses on the Company's temporarily impaired investment securities
at March 31, 2011 and December 31, 2010 for the time periods shown (in
thousands):
6
March 31, 2011
Less than 12 months 12 months or longer Total
--- --------------------- --- ------------------- --- --- ------------ -------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
------------ ------------ ----------- ----------- --- ----------- ------------
Investments held to maturity:
Government Agency Obligations $ 27,407 $ (1,056) $ - $ - $ 27,407 $ ( 1,056)
Investments available for sale:
Government agency obligations 35,855 (2,201) - - 35,855 (2,201)
US Treasury Securities 8,925 (965) 8,925 (965)
--- -------- --- -------- --- ------- ----------- --- --- ------- ---- -------
Total temporarily impaired
investment securities $ 72,187 $ ( 4,222) $ - $ - $ 72,187 $ (4,222)
--- -------- --- -------- --- ------- ----------- --- --- ------- ---- -------
December 31, 2010
Less than 12 months 12 months or longer Total
--- --------------------- --- ------------------- --- --- ------------ -------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
------------ ------------ ----------- ----------- --- ----------- ------------
Investments held to maturity:
Government Agency Obligations $ 27,132 $ 1,131 $ - $ - $ 27,132 $ 1,131
Mortgage Backed Securities - - - - - -
Investments available for sale:
Government agency obligations $ 35,560 $ 2,496 $ - $ - $ 35,560 $ 2,496
US Treasury Securities 9,075 814 - - 9,075 814
--- -------- --- -------- --- ------- ----------- --- --- ------- ---- -------
Total temporarily impaired
investment securities $ 71,767 $ 4,441 $ - $ - $ 71,767 $ 4,441
--- -------- --- -------- --- ------- ----------- --- --- ------- ---- -------
Management has taken into consideration the following information in reaching
the conclusion that the impairment of the securities listed in the table above
is not other than temporary. The unrealized losses disclosed above are the
result of fluctuations in market interest rates currently offered on like
securities and do not reflect a deterioration or downgrade of the investment
issuer's credit-worthiness or ability to meet its cash flow requirements. The
Company believes that it is probable that it will receive all future
contractual cash flows and does not intend to sell and will not be required to
sell these investment securities until recovery or maturity. The U.S.
Government agency sponsored securities which are listed have call provisions
priced at par if called prior to their respective maturity dates.
Other Comprehensive Income (Loss)
The change in other comprehensive income (loss) components and related tax
benefit are as follows for the three months ended March 31, 2011. The Company
had no unrealized gains or losses on available for sale securities at March 31,
2010. (In thousands):
March 31,
2011
------------ --- ------------- --- ------------
Before-Tax Net-of-Tax
Unrealized gain on securities available for sale: Amount Tax Benefit Amount
------------ ------------- ------------
Unrealized holding gain arising during the year $ 144 $ (57) $ 87
------------ ------------- ------------
Other comprehensive income $ 144 $ (57) $ 87
------------ ------------- ------------
NOTE 7 -- LOANS RECEIVABLE
The Company monitors and asses the credit risk of its loan portfolio using the
classes set forth below. These classes also represent the segments by which the
company monitors the performance of its loan portfolio and estimates its
allowance for loan losses.
7
Commercial loans include short and long-term business loans and commercial
lines of credit for the purposes of providing working capital, supporting
accounts receivable, purchasing inventory and acquiring fixed assets. The loans
generally are secured by these types of assets as collateral and/or by personal
guarantees provided by principals of the borrowers.
Commercial real estate loans are generally originated in amounts up to the
lower of 75% of the appraised value or cost of the property and are secured by
improved property such as multi-family dwelling units, office buildings, retail
stores, warehouses, church buildings and other non-residential buildings, most
of which are located in the Company's market area. Commercial real estate loans
are generally made with fixed interest rates which mature or reprice in five to
seven years with principal amortization of up to 25 years.
Residential real estate loans consist of loans secured by one- to four-family
residences located in the Bank's market area. The Bank has originated one- to
four-family residential mortgage loans in amounts up to 80% of the lesser of
the appraised value or selling price of the mortgaged property without
requiring mortgage insurance. A mortgage loan originated by the Bank, for owner
occupied property, whether fixed rate or adjustable rate, can have a term of up
to 30 years. Non-owner occupied property, whether fixed rate or adjustable
rate, can have a term of up to 25 years. Adjustable rate loan terms limit the
periodic interest rate adjustment and the minimum and maximum rates that may be
charged over the term of the loan based on the type of loan.
Construction Loans will be made only if there is a permanent mortgage
commitment in place. Interest rates on commercial construction loans are
typically in line with normal commercial mortgage loan rates, while interest
rates on residential construction loans are slightly higher than normal
residential mortgage loan rates. These loans usually are adjustable rate loans
and generally have terms of up to one year.
Consumer Loans includes installment loans and home equity loans, secured by
first or second mortgages on homes owned or being purchased by the loan
applicant. Home equity term loans and credit lines are credit accommodations
secured by either a first or second mortgage on the borrower's residential
property. Interest rates charged on home equity term loans are generally fixed;
interest on credit lines is usually a floating rate related to the prime rate.
The Bank generally requires a loan to value ratio of less than or equal to 80%
of the appraised value, including any outstanding prior mortgage balance.
Loans receivable consist of the following (in thousands):
March 31, 2011 December 31, 2010
--------------------------------------------------------- --- -------------------- -----------------
Commercial $ 94,883 $ 95,441
Real estate -- commercial 109,211 112,217
Real estate -- residential 13,463 14,780
Construction 13,515 13,177
Consumer loans 7,143 7,450
Net deferred loan fees (213) (209)
--- -------------------- --- -------------
238,002 242,856
Allowance for loan losses (2,962) (3,826)
--- -------------------- --- -------------
Loans receivable, net $ 235,040 $ 239,030
--- -------------------- --- -------------
Under New Jersey banking laws, the Bank is subject to a loans-to-one-borrower
limitation of 15% of capital funds for most loans. At March 31, 2011, the
loans-to-one-borrower limitation was approximately $4.6 million; this excludes
an additional 10% of capital funds, or approximately $3.0 million which may be
loaned if collateralized by readily marketable securities. At March 31, 2011,
there were no loans outstanding or committed to any one borrower which
individually or in the aggregate exceeded the Bank's loans-to-one-borrower
limitation of 15% of capital funds.
A summary of the Company's credit quality indicators is as follow:
8
Pass - A credit which is assigned a rating of Pass shall exhibit some or all of
the following characteristics:
a. Loans that present an acceptable degree of risk associated
with the financing being considered as measured against
earnings and balance sheet trends, industry averages, etc.
Actual and projected indicators and market conditions provide
satisfactory evidence that the credit will perform as agreed.
b. Loans to borrowers that display acceptable financial
conditions and operating results. Debt service capacity is
demonstrated and future prospects are considered good.
c. Loans to borrowers where a comfort level is achieved by the
strength of the cash flows from the business or project and
the strength and quantity of the collateral or security
position (i.e.: receivables, inventory and other readily
marketable securities) as supported by a current valuation
and/or the strong capabilities of a guarantor.
Special Mention - Loans on which the credit risk requires more than ordinary
attention by the Loan Officer. This may be the result of some erosion in the
borrower's financial condition, the economics of the industry, the capability
of management, or changes in the original transaction. Loans which are
currently sound yet exhibit potentially unacceptable credit risk or
deteriorating long term prospects, will receive this classification. Loans
which deviate from loan policy or regulations will not generally be classified
in this category, but will be separately reported as an area of concern
Classified -- Classified loans include those considered by the Company to be
substandard, doubtful or loss.
An asset is considered "substandard" if it involves more than an acceptable
level of risk due to a deteriorating financial condition, unfavorable history
of the borrower, inadequate payment capacity, insufficient security or other
negative factors within the industry, market or management. Substandard loans
have clearly defined weaknesses which can jeopardize the timely payment of the
loan.
Assets classified as "doubtful" exhibit all of the weaknesses defined under the
substandard category but with enough risk to present a high probability of some
principal loss on the loan, although not yet fully ascertainable in amount.
Assets classified as "loss" are those considered uncollectible or of little
value, even though a collection effort may continue after the classification
and potential charge-off.
Non Performing Loans
Non-performing loans consist of non-accrual loans (loans on which the accrual
of interest has ceased), loans over ninety days delinquent and still accruing
interest, renegotiated loans and impaired loans. Loans are generally placed on
non-accrual status if, in the opinion of management, collection is doubtful, or
when principal or interest is past due 90 days or more, unless the collateral
is considered sufficient to cover principal and interest and the loan is in the
process of collection. At March 31, 2011 the Company had thirteen loan
relationships totaling $10.1 million in non-accrual loans compared to twelve
relationships totaling $9.8 million in non-accrual loans at December 31, 2010
The Company recognized no interest income on non-accrual loans during the three
month period ended March 31, 2011 as compared to $17 thousand for the three
month period ended March 31, 2010.
The following table represents loans by credit quality indicator at March 31,
2011.
\
(In thousands) Special Non
Mention Classified Performing
Pass Loans Loans Loans Total
----------- ------------ ------------ ------------- ----------
Commercial $ 89,837 $ 838 $ 3,013 $ 1,112 $ 94,800
Real Estate, Commercial 99,208 2,175 - 7,702 109,085
Real Estate, Residential 12,489 - - 964 13,453
Construction 13,485 - - - 13,485
Consumer 6,598 243 50 288 7,179
----------- --- ------------ ------------ ------------- ----------
Total Loans $221,617 $ 3,256 $ 3,063 $10,066 $ 238,002
=========== === ============ ============ ============= ==========
9
The following table represents loans by credit quality indicator at December
31, 2010.
(In thousands) Special Non
Mention Classified Performing
Pass Loans Loans Loans Total
--------- ------------ -------------- ---------- --------
Commercial $ 93,209 $ 845 $ - $ 1,296 $ 95,350
Real Estate, Commercial 101,718 2,175 - 8,213 112,106
Real Estate, Residential 13,596 - 1,170 - 14,766
Construction 13,145 - - - 13,145
Consumer 6,905 244 51 289 7,489
--- --------- ---- --- -------- --- ---------- --- ---------- --- --------
Total Loans $ 228,572 $ 3,264 $ 1,221 $ 9,798 $ 242,856
=== ========= ==== === ======== === ========== === ========== ============
The following table represents past-due loans and leases as of March 31, 2011.
(In thousands) 30-89 Days 90 Days or Total Past
Past Due more Past Due and Accruing Non-
and Still Due and Still Current Accrual Total Loan
Accruing Still Accruing Accruing Balances Balances Balances
--------------- ------------------ ------------ -------------- -------------- ------------
Commercial $ 1,179 $ 634 $ 1,813 $ 93,688 $ 1,112 $ 94,800
Real Estate, Commercial - - - 101,383 7,702 109,085
Real Estate, Residential - - - 12,489 964 13,453
Construction 556 - 556 13,485 - 13,485
Consumer - 243 243 6,891 288 7,179
--- --------------- --- --------- ---- --- -------- --- ---------- --- ---------- --- --------
Total Loans and Leases $ 1,735 $ 877 $ 2,612 $ 227,936 $ 10,066 $ 238,002
=== =============== === ========= ==== === ======== === ========== === ========== === ========
Percentage of Total loans 0.73% 0.37% 1.10% 95.77% 4.23%
The following table represents past-due loans and leases as of December 31, 2010.
(In thousands)
30-89 Days 90 Days or Total Past
Past Due more Past Due and Accruing Non-
and Still Due and Still Current Accrual Total Loan
Accruing Still Accruing Accruing Balances Balances Balances
--------------- ------------------ ------------ -------------- -------------- ------------
Commercial $ 209 $ 634 $ 843 $ 94,054 $ 1,296 $ 95,350
Real Estate, Commercial - - - 103,893 8,213 112,106
Real Estate, Residential - 244 244 14,766 - 14,766
Construction - - - 13,145 - 13,145
Consumer - - - 7,200 289 7,489
--- --------------- --- --------- ---- --- -------- --- ---------- --- ---------- --- --------
Total Loans $ 209 $ 878 $ 1,087 $ 233,058 $ 9,798 $ 242,856
=== =============== === ========= ==== === ======== === ========== === ========== === ========
Percentage of Total loans 0.09% 0.36% 0.45% 95.97% 4.03%
Impaired loans are measured based on the present value of expected future
discounted cash flows, the fair value of the loan or the fair value of the
underlying collateral if the loan is collateral dependent. The recognition of
interest income on impaired loans is the same as for non-accrual loans
discussed above. At March 31, 2011, the Company
10
had eighteen impaired loan relationships totaling $11.0 million (included
within the non-accrual loans discussed above) in which $3.8 million in impaired
loans had a related allowance for credit losses of $1.1 million and $7.2
million in impaired loans in which there is no related allowance for credit
losses. The average balance of impaired loans totaled $11.4 million as of March
31, 2011, and interest income recorded on impaired loans during the three
months ended March 31, 2011 totaled $13 thousand, as compared to $30 thousand
for the three months ended March 31, 2010.
At March 31, 2011 the Company had two loan relationships totaling $877 thousand
which were delinquent ninety days or more and still accruing interest. At
December 31, 2010, the Company two loan relationships totaling $878 million
which were delinquent ninety days or more and still accruing interest.
The following table represents data on impaired loans at March 31, 2011 and
March 31, 2010.
(In thousands) 2011 2010
--------------- --- -----------
Impaired loans for which a valuation allowance has been provided $ 3,781 $ 3,214
Impaired loans for which no valuation allowance has been provided 7,212 4,298
--- ----------- --- -----------
Total Loans determined to be impaired 10,993 7,512
=== =========== === ===========
Allowance for loan losses related to impaired loans 1,096 1,507
=== =========== === ===========
Average recorded investment in impaired loans 11,391 8,443
=== =========== === ===========
Cash basis interest income recognized on impaired loans $ 13 $ 30
=== =========== === ===========
The following table presents impaired loans by portfolio class at March 31, 2011
Interest
(In thousands) Average Income
Unpaid Related Annual Recognized
Recorded Principal Valuation Recorded While
Investment Balance Allowance Investment Impaired
-------------- --------------- --------------- --------------- ---------------
Impaired loans with a valuation allowance:
Commercial $ 1,069 $ 1,069 $ 392 $ 1,070 $ -
Real Estate, Commercial 1,551 1,551 520 1,806 -
Real Estate, Residential 964 964 86 1,104 -
Construction - - - - -
Consumer 197 197 98 198 -
----- -------- ---- ---------- --- ----------- --- ----------- --- ----------- ---
Subtotal 3,781 3,781 1,096 4,178 -
----- -------- ---- ---------- --- ----------- --- ----------- --- ----------- ---
Impaired loans with no valuation allowance:
Commercial 676 676 - 676 11
Real Estate, Commercial 6,151 6,151 - 6,152 -
Real Estate, Residential - - - - -
Construction - - - - -
Consumer 385 385 - 385 2
----- -------- ---- ---------- --- ----------- --- ----------- --- ----------- ---
Subtotal 7,212 7,212 - 7,213 13
----- -------- ---- ---------- --- ----------- --- ----------- --- ----------- ---
Total Impaired loans:
Commercial 1,745 1,745 392 1,746 11
Real Estate, Commercial 7,702 7,702 520 7,958 -
Real Estate, Residential 964 964 86 1,104 -
Construction - - - - -
Consumer 582 582 98 583 2
----- -------- ---- ---------- --- ----------- --- ----------- --- ----------- ---
Total $ 10,993 $ 10,993 $ 1,096 $ 11,391 $ 13
===== ======== ==== ========== === =========== === =========== === =========== ===
11
The following table presents impaired loans by portfolio class at December 31,
2010.
Interest
(In thousands) Average Income
Unpaid Related Annual Recognized
Recorded Principal Valuation Recorded While
Investment Balance Allowance Investment Impaired
------------ -------------- ------------- ---------------- ---------------
Impaired loans with a valuation allowance:
Commercial $ 1,198 $ 1,198 $ 962 $ 1,209 $ 6
Real Estate, Commercial 2,060 2,060 1,020 2,064 -
Real Estate, Residential - - - - -
Construction - - - - -
Consumer 199 199 99 200 5
--- -------- --- ---------- ------------- --- ------------ --- -----------
Subtotal 3,457 3,457 2,081 3,473 11
--- -------- --- ---------- ------------- --- ------------ --- -----------
Impaired loans with no valuation allowance:
Commercial 732 732 - 1,341 2
Real Estate, Commercial 6,153 6,153 - 7,085 10
Real Estate, Residential - - - - -
Construction - - - - -
Consumer 385 385 - 381 13
--- -------- --- ---------- ------------- --- ------------ --- -----------
Subtotal 7,271 7,271 - 8,807 25
--- -------- --- ---------- ------------- --- ------------ --- -----------
Total Impaired loans:
Commercial 1,930 1,930 962 2,550 8
Real Estate, Commercial 8,213 8,213 1,020 9,149 10
Real Estate, Residential - - - - -
Construction - - - - -
Consumer 584 584 99 581 18
--- -------- --- ---------- ------------- --- ------------ --- -----------
Total $ 10,728 $ 10,728 $ 2,081 $ 12,280 $ 36
=== ======== === ========== ============= === ============ === ===========
Included in the balance of the loans past due 90 days or more is a principal
balance of $634 thousand dollars representing the Bank's participation interest
in two loans originated by another New Jersey based institution. Although the
borrowers have ceased making payments on these loans, we have received a legal
opinion from our legal counsel that the Bank has valid claims against the
lead/originating bank for violations of the participation agreements, and we
have filed suit asserting these claims. In the event the lead bank is unable to
collect from the borrowers, we believe, based on said legal opinion, that we
may collect our principal and interest from the lead/originating bank. However,
in that case our ability to collect on these loans will depend upon the outcome
of our legal action against the lead/originating bank.
12
The following table provides information regarding risk elements in the loan
portfolio as of March 31, 2011 and December 31, 2010
(In thousands) March 31, 2011 December 31, 2010
------------------ ---------------------
Non-performing assets:
Loans past due 90 days or more and accruing
Commercial $ 634 $ 634
Consumer 243 244
--- -------------- --- ---------------------
Total loans past due 90 days or more and accruing 877 878
--- -------------- --- ---------------------
Non-accrual loans:
Commercial 1,112 1,296
Commercial real estate 7,702 8,213
Residential Real Estate 964 -
Consumer 288 289
--- -------------- --- ---------------------
Total non-accrual loans 10,066 9,798
Impaired loans 50 51
--- -------------- --- ---------------------
Total non-performing loans 10,116 9,849
Real estate owned 830 830
--- -------------- --- ---------------------
Total non-performing assets $ 11,823 11,557
--- -------------- --- ---------------------
Non-performing loans as a percentage of loans 4.25% 4.06%
--- -------------- --- ---------------------
Non-performing assets as a percentage of loans and
real estate owned 4.97% 4.76%
--- -------------- --- ---------------------
Non-performing assets as a percentage of total assets 3.32% 3.26%
--- -------------- --- ---------------------
During the period ended March 31, 2011 the Company experienced a $268 thousand
net increase in non-accrual loans. This change reflects the downgrading of four
loan relationships to non-accrual status totaling $2.1 million partially offset
by total charge offs of four loans relationships representing nine loans in the
amount of $1.8 million during the three month period ended March 31, 2011. The
downgraded loans consisted of two relationships representing residential
mortgages loans totaling $964 thousand and two commercial relationships
representing six loans totaling $1.1 million.
The following table sets forth with respect to the Bank's allowance for losses on loans:
(In thousands) March 31, 2011 March 31, 2010
--------------------- ---------------------
Balance at beginning of year $ 3,826 $ 3,432
Provision:
Commercial 943 109
Commercial real estate (344) -
Residential real estate 323 -
Consumer 31 -
--- ----------------- --- ---------------------
Total Provision 953 109
Charge-offs:
Commercial 1,536 -
Residential real estate 281 -
Recoveries - -
Total Net Charge-offs 1,817 -
--- ---------------- === =====================
Balance at end of period $ 2,962 $ 3,541
--- ---------------- === =====================
Period-end loans outstanding $ 238,002 $ 237,428
--- ---------------- === =====================
Average loans outstanding $ 239,449 $ 235,172
--- ---------------- === =====================
Allowance as a percentage of period-end loans 1.24% 1.51%
Net charge-offs as a percentage of average loans 0.76% 0.00%
Additional details for changes in the allowance for loan and leases by loan
portfolio as of March 31, 2011 are as follows:
Commercial Residential
Allowance for Loan and Lease Losses Commercial Real Estate Real Estate Consumer Total
---------------------------------------- ----------- ------------ ----------- ------------- --------
Beginning Balance, December 31, 2010 $ 1,743 $ 1,527 $ 417 $ 139 $ 3,826
Charge-off (1,536) - (281) - (1,817)
Provision 943 (344) 323 31 953
--- ------- --- -------- --- ------- ------------- --- --------
Ending Balance $ 1,150 $ 1,183 $ 459 $ 170 $ 2,962
=== ======= === ======== === ======= ============= === ========
13
The Company prepares an allowance for loan loss model on a quarterly basis to
determine the adequacy of the allowance. Management considers a variety of
factors when establishing the allowance, such as the impact of current economic
conditions, diversification of the loan portfolio, delinquency statistics,
results of independent loan review and related classifications. The Bank's
historic loss rates and the loss rates of peer financial institutions are also
considered. In evaluating the Company's allowance for loan loss the Company
maintains a Criticized Asset Committee ("CAC") consisting of senior management
that monitors problem loans and formulates collection efforts and resolution
plans for each borrower. On a monthly basis the CAC meets to review each
problem loan and determines if there has been any change in collateral value
due to changes in market conditions. Each quarter, when calculating the
allowance for loan loss, the CAC reviews an updated loan impairment analysis on
each problem loan to determine if a specific provision for loan loss is
warranted. Management reviews the most recent appraisal on each loan adjusted
for holding and selling costs. In the event there is not a recent appraisal on
file, the Company will use the aged appraisal and apply a discount factor to
the appraisal then adjust the holding and selling costs from the discounted
appraisal value. At March 31, 2011, the Company maintained an allowance for
loan loss ratio of 1.24% to period end loans outstanding. On a linked basis,
our non-performing assets have increased by $266 thousand over their stated
levels at December 31, 2010 representing a non-performing asset to total asset
ratio of 3.32% at March 31, 2011 as compared to a non-performing asset to total
asset ratio 3.26% at December 31, 2010.
The Company's charge-off policy states any asset classified loss shall be
charged-off within thirty days of such classification unless the asset has
already been eliminated from the books by collection or other appropriate
entry. On a quarterly basis the Board Loan Committee ("BLC") will review past
due, classified, non-performing and other loans, as it deems appropriate, to
determine the collectability of such loans. If the BLC determines a loan to be
uncollectible, the loan shall be charged to the allowance for loan loss. In
addition, upon reviewing the collectability of a loan, the BLC may determine a
portion of the loan to be uncollectible; in which case that portion of the loan
deemed uncollectable will be partially charged-off against the allowance for
loan loss.
For the three month period ending March 31, 2011 the Company experienced six
charge offs relating to three loan relationships totaling $1.0 million and
three partial charge-offs relating to two loan relationships totaling $782
thousand as compared to charge-offs of four loans representing one relationship
totaling $382 thousand for the period ended December 31, 2010.
NOTE 8 -- Bank Owned Life Insurance
Bank Owned Life Insurance ("BOLI") is carried at its aggregate cash surrender
value less surrender charges and totaled $4.7 million at March 31, 2011. Income
of $40 thousand was recognized on BOLI during the three month period ended
March 31, 2011 as compared to $41 thousand for the three month period ended
March 31, 2010. The Bank is the sole owner and beneficiary of the BOLI.
NOTE 9 -- Deferred Compensation Plans
Effective January 1, 2006, the Bank adopted a Nonqualified Deferred
Compensation Plan (The "Executive Plan") and the Directors' Fee Deferral and
Death Benefit Plan (the "Directors' Plan"). Both plans provide for payments of
deferred compensation to participants. The Company recorded $79 thousand in
deferred compensation expense during the three month period ended March 31,
2011 as compared to $43 thousand for the three month period ended March 31,
2010.
NOTE 10 -- Income Taxes
The Company accounts for uncertainties in income taxes in accordance with
Financial ASC Topic 740, Accounting for Uncertainty in Income Taxes. ASC Topic
740 prescribes a threshold and measurement process for recognizing in the
financial statements a tax position taken or expected to be taken in a tax
return. ASC Topic 740 also provides
14
guidance on derecognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition. The Company has determined that
there are no significant uncertain tax positions requiring recognition in its
financial statements.
Federal tax years 2007 through 2009 remain subject to examination as of March
31, 2011, while tax years 2006 through 2009 remain subject to examination by
state taxing jurisdictions. In the event the Company is assessed for interest
and/or penalties by taxing authorities, such assessed amounts will be
classified in the financial statements as income tax expense.
The ability to realize deferred tax assets is dependent upon a variety of
factors, including the generation of future taxable income, the existence of
taxes paid and recoverable, the reversal of deferred tax liabilities, and tax
planning strategies. Based upon these and other factors, the Company determined
that it is more likely than not that its deferred tax asset will be realized.
As such, no valuation allowance was established for the deferred tax asset as
of March 31, 2011 or December 31, 2010. The Company will continue to reassess
the realizability of the deferred tax asset in future periods. If, in the
future, it is determined that the Company's deferred tax asset is not
realizable, a valuation allowance may be established against the deferred tax
asset, which may have a material impact on the Company's net income in the
period in which it is recorded.
NOTE 11 -- Fair Value of Financial Instruments
ASC Topic 820 Fair Value Measurements and Disclosures establishes a framework
for measuring fair value under U.S. generally accepted accounting principles,
and expands disclosure requirements for fair value measurements. ASC Topic 820
does not require any new fair value measurements. The adoption of ASC Topic 820
did not have a material impact on the Company's consolidated financial
statements.
ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value into three broad levels, as
described below:
o Level 1. Level 1 inputs are unadjusted quoted prices in active markets
for identical assets or liabilities.
o Level 2. Level 2 inputs are inputs other than quoted prices included
in Level 1 that are observable, either directly or indirectly. Level 2
inputs include quoted prices for similar assets, quoted prices in
markets that are not considered to be active, and observable inputs
other than quoted prices such as interest rates.
o Level 3. Level 3 inputs are unobservable inputs.
The fair value of securities available for sale are determined by obtaining
quoted prices on a nationally recognized securites exchange ( Level 1 inputs)
or matrix pricing, which is a mathematical technique widely used in the
industry to value debt securities without relying exclusively on quoted prices
for the specific securities but rather by relying on the securities'
relationship to other benchmark quoted securities( Level 2 inputs).
A financial instrument's level within the fair value hierarchy is based upon
the lowest level of any input significant to the fair value measurement.
15
ASSETS AND LIABILITIES MEASURED ON A RECURRING BASIS
Assets and liabilities measured at fair value on a recurring basis are
summarized below:
FAIR VALUE MEASUREMENTS FAIR VALUE MEASUREMENTS
AT MARCH 31, 2011 AT DECEMBER 31, 2010
--------------------------------------------- ---------------------------------------------
QUOTED PRICES QUOTED PRICES
IN ACTIVE SIGNIFICANT SIGNIFICANT IN ACTIVE SIGNIFICANT SIGNIFICANT
MARKETS OTHER OTHER MARKETS OTHER OTHER
FOR IDENTICAL OBSERVABLE UNOBSERVABLE FOR IDENTICAL OBSERVABLE UNOBSERVABLE
ASSETS INPUTS INPUTS ASSETS INPUTS INPUTS
(LEVEL 1) (LEVEL 2) (LEVEL 3) (LEVEL 1) (LEVEL 2) (LEVEL 3)
-------------- ----------- ------------ -------------- ------------ -----------
(IN THOUSANDS) (IN THOUSANDS)
Assets:
Investment Securities
US Government Obligations $ -- $ 35,855 $ -- $ -- $35,560 $ --
US Treasury Securities $ 8,925 $ -- $ -- $9,075 $ -- $ --
------- -------- ------- ------ ----- -----
Total assets on a recurring
basis at fair value $ 8,925 $ 35,855 $ -- $9,075 $35,560 $ --
======= ======== ======= ====== ===== =====
ASSETS AND LIABILITIES MEASURED ON A NON-RECURRING BASIS
Assets and liabilities measured at fair value on a non-recurring basis are
summarized below:
FAIR VALUE MEASUREMENTS FAIR VALUE MEASUREMENTS
AT MARCH 31, 2011 AT DECEMBER 31, 2010
------------------------------------------------ ----------------------------------------------
QUOTED PRICES QUOTED PRICES
IN ACTIVE SIGNIFICANT SIGNIFICANT IN ACTIVE SIGNIFICANT SIGNIFICANT
MARKETS OTHER OTHER MARKETS OTHER OTHER
FOR IDENTICAL OBSERVABLE UNOBSERVABLE FOR IDENTICAL OBSERVABLE UNOBSERVABLE
ASSETS INPUTS INPUTS ASSETS INPUTS INPUTS
(LEVEL 1) (LEVEL 2) (LEVEL 3) (LEVEL 1) (LEVEL 2) (LEVEL 3)
-------------- ----------- ------------ -------------- ------------ -----------
(IN THOUSANDS) (IN THOUSANDS)
Assets:
Impaired loans $ -- $10,993 $ -- $ -- $10,728 $ --
Other Real Estate Owned -- 830 -- -- 830 --
Total assets
measured on a
non-recurring basis
at fair value $ -- $11,823 $ -- $ -- $ 11,558 $ --
======= ======== ======= ====== ======= =====
The fair value of impaired loans with specific allocations of the allowance for
loan losses is generally based on recent real estate appraisals. These
appraisals may utilize a single valuation approach or a combination of
approaches including comparable sales and the income approach.
16
The following required disclosure of the estimated fair value of financial
instruments has been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
As required by ASC topic 825-10-65, the estimated fair value of financial
instruments at March 31,2011 and December 31, 2010 was as follows:
March 31, 2011 December 31, 2010
--- ----------------------------- --- ------------------------------
Carrying Estimated Carrying Estimated
(in thousands) amount fair value amount fair value
--- ----------- --- ------------- --- ----------- --- --------------
Financial assets:
Cash and cash equivalents $ 15,786 $ 15,786 $ 9,031 $ 9,031
Investments held to maturity
Federal Agency Securities 32,707 31,702 32,706 31,643
Mortgage-backed Securities 7,451 7,574 7,729 7,877
Investments available for sale
US Treasury Securities 8,925 8,925 9,075 9,075
Federal Agency Securities 35,855 35,855 35,560 35,560
Loans receivable 238,002 265,571 242,856 265,397
FHLB stock 1,435 1,435 1,435 1,435
Bank Owned Life Insurance 4,725 4,725 4,685 4,685
Accrued interest receivable 1,930 1,930 2,152 2,152
----------- ------------- ----------- --------------
Total financial assets $ 346,816 $ 373,503 $ 345,229 $ 366,855
----------- ------------- ----------- --------------
Financial Liabilities:
Checking Accounts $ 45,744 $ 45,744 $ 59,625 $ 59,625
Statement savings accounts 3,285 3,285 3,203 3,203
Money market accounts 14,959 14,959 10,248 10,248
Index Accounts 133,187 133,187 115,697 115,697
Certificates of deposit 106,998 105,702 113,497 112,495
FHLB advances 25,000 25,000 25,000 25,000
Line of Credit 4,929 4,929 4,877 4,877
Subordinated Debt 3,000 3,000 3,000 3,000
Accrued interest payable 202 202 187 187
----------- ------------- ----------- --------------
Total financial liabilities $ 337,304 $ 336,008 $ 335,334 $ 334,332
----------- ------------- ----------- --------------
Contract Estimated Contract Estimated
Value Fair Value Value Fair Value
--- ----------- --- ------------- --- ----------- --- --------------
Off-balance sheet instruments:
Commitments to extend credit $ 54,153 $ - $ 58,051 $ -
----------- ------------- ----------- --------------
NOTE 12 -- Recent Accounting Pronouncements
Below is a discussion of recent accounting pronouncements. Recent
pronouncements not discussed below were deemed to not be applicable to the
Company.
In January 2011, the FASB issued (ASU) 2011-01 Receivables (Topic 310)
Deferral of the Effective Date of Disclosures about Troubled Debt
Restructurings in Update No. 2010-20. This Update temporarily delays the
effective date of the disclosures about troubled debt restructurings in Update
2010-20 for public entities. The amendments in this Update delay the effective
date of the new disclosures about troubled debt restructurings for public
entities and
17
the coordination of the guidance for determining what constitutes a troubled
debt restructuring until interim and annual periods ending after June 15, 2011.
No significant impact to amounts reported in the consolidated financial
position or results of operations are expected for the Company from the
adoption of ASU 2011-01.
NOTE 13-- Private Placement Common Stock Offering and Preferred Stock Issuance
In June 2009, the Board of Directors of the Company approved a private
placement common stock offering to accredited investors. In connection with
this offering, the Board of Directors approved the issuance of common stock
purchase warrants. As part of the offering, one warrant was issued for each
share of Company common stock, no par, sold in the stock offering. Each warrant
issued under the offering will allow the holder of the warrant to purchase one
share of Company common stock, for a price of $9.00 per share through June 26,
2013. For the year ended December 31, 2009, the Company sold 153,889 shares
under this offering and issued 153,889 common stock warrants. The $1.1 million
proceeds received from the common stock offering were recorded as additional
paid in capital.
In December 2009, the Company authorized the establishment of 2,000 shares of
no par, $1,000 stated value, Perpetual Non-Cumulative Convertible Preferred
Stock. The preferred stock is entitled to receive, as and when declared by the
Company's Board of Directors, non-cumulative cash dividends at an annual rate
of 7% of the stated value. In December 2009, the Company sold 1,900 preferred
shares. The preferred stock is redeemable at the Company's option at any time
after six months from the issue date at the stated value plus any dividends
declared but unpaid. The preferred shares have priority of dividends such that
no dividends or distributions shall be declared or paid to common shareholders
unless full dividends on all outstanding preferred shares have been declared
and paid for the most recently completed calendar quarter.
NOTE 14 -- Subsequent Events
The Company has evaluated subsequent events through the filing date of this
report, and determined that there were no recognized or unrecognized subsequent
events to report.
Item 2. Management's Discussion and Analysis
Forward-Looking Statements
Cornerstone Financial Corporation (the "Company") may from time to time make
written or oral "forward-looking statements," including statements contained in
the Company's filings with the Securities and Exchange Commission (including
this Quarterly Report on Form 10-Q and the exhibits hereto), in its reports to
shareholders and in other communications by the Company, which are made in good
faith by the Company pursuant to the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such as
statements of the Company's plans, objectives, expectations, estimates and
intentions that are subject to change based on various important factors (many
of which are beyond the Company's control). Forward-looking statements may be
identified by the use of words such as "expects," "subject," "believe," "will,"
"intends," "will be," or "would." The factors which could cause the Company's
financial performance to differ materially from the plans, objectives,
expectations, estimates and intentions expressed in such forward-looking
statements include those items listed under "Item 1A-Risk Factors" in our
Annual Report on Form 10-K for the year ended December 31, 2010 and the
following factors, among others: the strength of the United States economy in
general and the strength of the local economies in which the Company conducts
operations; the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Board of Governors of the
Federal Reserve System ("Federal Reserve"); inflation; interest rates; market
and monetary fluctuations; the timely development of new products and services
by the Company and the perceived overall value of these products and services
by users, including the features, pricing and quality compared to competitors'
products and services; the success of the Company in gaining regulatory
approval of its products, services, dividends and of new branches, when
required; the impact of changes in financial services laws and
18
regulations (including laws concerning taxes, banking, securities and
insurance); technological changes; acquisitions; the ability to continue to
effectively manage costs, including the costs incurred in connection with the
opening of new branches; changes in consumer spending and saving habits; the
Company's ability to access the capital markets to maintain its regulatory
capital standing and the success of the Company at managing the risks resulting
from these factors.
The Company cautions that the above listed factors are not exclusive. The
Company does not undertake to update any forward-looking statement, whether
written or oral, that may be made from time to time by or on behalf of the
Company.
Overview
Cornerstone Financial Corporation
The Company was formed in 2008 at the direction of the Board of Directors of
Cornerstone Bank (the "Bank") to serve as a holding company for the Bank. The
Board believed that establishing a holding company would provide greater
flexibility in raising capital and conducting the Bank's business. The holding
company reorganization was completed in January 2009.
At March 31, 2011, we had total assets of $356.2 million, total loans, gross of
$238.0 million, total investment securities of $84.9 million and total deposits
of $304.2 million compared to total assets of $354.0 million, total loans, net
of $242.3 million, total investment securities of $89.1 million and total
deposits of $302.3 million at December 31, 2010. Our growth in assets and
deposits reflects our commitment to provide outstanding customer service and a
broad array of banking products driven by our customers' needs. We believe our
strategy provides us with a competitive advantage over other financial
institutions by developing lasting customer relationships that will enable us
to continue to attract core deposits and loans within our market area.
Interest Rate Risk
Our primary objective in managing interest rate risk is to minimize the adverse
impact of changes in interest rates on our net interest income while creating
an asset/liability structure that maximizes earnings. Our Asset Liability
Management Committee actively monitors and manages our interest rate exposure
using gap analysis and interest rate simulation models.
Gap analysis measures the difference between volumes of rate-sensitive assets
and liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at a point
in time. However, gap analysis alone does not accurately measure the potential
magnitude of changes in net interest income since changes in interest rates do
not affect assets and liabilities at the same rate, to the same extent, or on
the same basis. Furthermore, static gap analysis does not consider future
growth or changes in the asset mix.
A positive gap (asset sensitive) indicates that more assets reprice during a
given period compared to liabilities, while a negative gap (liability
sensitive) indicates that more liabilities reprice during a given period
compared to assets.
Generally, during a period of falling interest rates, a positive gap would tend
to adversely affect net interest income, while a negative gap would tend to
result in an increase in net interest income. During a period of rising
interest rates, in general, a positive gap would tend to result in an increase
in net interest income while a negative gap would tend to affect net interest
income adversely. However, certain assets and liabilities may react differently
to changes in interest rates even though they reprice or mature in the same or
similar time periods. The interest rates on certain assets and liabilities may
change at different times than changes in market interest rates, with some
changing in advance of changes in market rates and some lagging behind changes
in market rates. Also, certain assets (e.g., adjustable rate mortgages) often
have provisions that may limit changes both each time the interest rate changes
and on a cumulative basis over the life of the loan. Additionally, the actual
prepayments and withdrawals in the event of a change in interest rates may
differ significantly from those assumed in the calculations shown in the table
below. Finally, the ability of borrowers to service their debt may decrease in
the event of an interest rate increase.
19
Consequently, any model used to analyze interest rate sensitivity will be
vulnerable to the assumptions made with respect to the foregoing factors.
We use a computer-based simulation model to assess the impact of changes in
interest rates on net interest income. The model incorporates management's
business plan assumptions and related asset and liability yields/costs, deposit
sensitivity and the size, composition and maturity or repricing characteristics
of our assets and liabilities. The assumptions are based on what management
believes at that time to be the most likely interest rate environment. Actual
results may differ from simulated results due to the various factors discussed
above.
The following table sets forth the amount of our interest-earning assets and
interest-bearing liabilities at March 31, 2011, which are expected to mature or
reprice in each of the time periods shown:
Non-Rate
Sensitive
(Dollars in thousands) One Year One-Five Over Assets/
or Less Years Five Years Liabilities Total
------------- ------------ ------------- ----------- --------------------------------
Interest-earning assets:
-----------------------------------------
Short term investments $ 10,000 $ - $ - $ - $ 10,000
Investment securities held to maturity - 5,000 35,158 - 40,158
Investment securities available for sale 44,780 - 44,780
--------- ------- --------------------------------
Loans receivable 117,798 69,840 50,364 - 238,002
-------- -------- --------- ------- --------------------------------
Total interest-earning assets 127,798 74,840 130,302 - 332,940
-------- -------- --------- ------- --------------------------------
Non-rate sensitive assets:
Other assets - - - 23,255 23,255
-------- --- -------- --- --------- ------- --------------------------------
Total assets $ 127,798 $ 74,840 $ 130,302 $ 23,255 $ 356,195
============= === ======== ============= === ======= ================================
Interest-bearing liabilities:
-----------------------------------------
Interest-bearing demand $ 17,675 $ - $ - $ - $ 17,675
Statement savings 3,285 - - - 3,285
Money market 148,146 - - - 148,146
Certificates of deposit 78,952 28,046 - - 106,998
Subordinated debt - 3,000 - - 3,000
Borrowings 25,000 4,929 - - 29,929
-------- -------- --------- ------- --------------------------------
Total interest-bearing liabilities 273,058 35,975 - - 309,033
-------- -------- --------- ------- --------------------------------
Non-rate sensitive liabilities:
Non-interest bearing deposits - - - 28,069 28,069
Other liabilities - - - 1,147 1,147
Capital - - - 17,946 17,946
-------- -------- --------- ------- --------------------------------
Total liabilities and capital $ 273,058 $ 35,975 $ - $ 47,162 $ 356,195
==== ======== === ======== === ========= === ======= ================================
Period GAP $ (145,260) $ 38,865 $ 130,302 $ (23,907)
Cumulative interest-earning assets $ 127,798 $ 202,638 $ 332,940
Cumulative interest-bearing liabilities $ 273,058 $ 309,033 $ 309,033
Cumulative GAP $ (145,260) $ (106,395) $ 23,907
Cumulative RSA/RSL (1) 46.80% 65.57% 107.74%
(1) Cumulative rate sensitive (interest-earning) assets divided by cumulative rate sensitive (interest-bearing) liabilities.
At March 31, 2011, our interest rate sensitivity gap was within Board approved
guidelines.
Gap analysis and interest rate simulation models require assumptions about
certain categories of assets and deposits. For purposes of these analyses,
assets and liabilities are stated at their contractual maturity, estimated
likely call date, or earliest repricing opportunity. Interest-bearing demand
deposits, statement savings and money market accounts do not have a stated
maturity or repricing term and can be withdrawn or repriced at any time. This
may impact our net interest income if more expensive alternative sources of
deposits are required to fund loan growth or deposit runoff.
20
Management projects the repricing characteristics of these accounts based on
historical performance and assumptions that it believes reflect their rate
sensitivity.
The following discussion focuses on the major components of our operations and
presents an overview of the significant changes in our financial condition at
March 31, 2011 as compared to December 31, 2010 and our results of operations
for the three month periods ended March 31, 2011 as compared to the same period
in 2010.
Comparison of Financial Condition at March 31, 2011 and December 31, 2010
Total assets at March 31, 2011 were $356.2 million, an increase of $2.2 million
or 0.62% over December 31, 2010. This change was primarily due to increases in
cash and cash equivalents of $6.8 million, bank owned life insurance of $40
thousand, investment securities available for sale of $145 thousand and other
assets of $211 thousand, partially offset by decreases in investment securities
held to maturity of $277 thousand, loans receivable, net, of $4.0 million,
accrued interest receivable of $222 thousand, deferred taxes of $451 thousand,
and premises and equipment of $33 thousand.
Gross loans receivable at March 31, 2011, totaled $238.0 million, a decrease of
$4.9 million or 2.0% from December 31, 2010. This change was attributable to
decreases of $558 thousand in commercial loans, $2.7 million in commercial real
estate loans, $1.3 million in residential real estate loans and $307 thousand
in consumer loans. The decline in gross loans represents significant payoffs
received during the first quarter of 2011 coupled with recording $1.8 million
in loan charge-offs. See Footnote 7 to our Consolidated Financial Statements
for a breakdown of the components of our loan portfolio.
Non-performing assets consists of non-accrual loans (loans on which the accrual
of interest has ceased) loans over ninety days delinquent and still accruing
interest, renegotiated loans, impaired loans, and real estate owned. Loans are
generally placed on non-accrual status if, in the opinion of management,
collection is doubtful, or when principal or interest is past due 90 days or
more unless the collateral is considered sufficient to cover principal and
interest and the loan is in the process of collection. The Company recognized
no interest income on non-accrual loans during the three month period ended
March 31, 2011 as compared to $17 thousand for the three month period ended
March 31, 2010.
Impaired loans are measured based on the present value of expected future
discounted cash flows, the fair value of the loan or the fair value of the
underlying collateral if the loan is collateral dependent. The recognition of
interest income on impaired loans is the same as for non-accrual loans
discussed above. At March 31, 2011 the Company had thirteen loan relationships
totaling $10.1 million on non-accrual status compared to twelve relationships
totaling $9.8 million on non-accrual status at December 31, 2010. At March 31,
2011, the Company had eighteen impaired loan relationships totaling $11.0
million (included within the non-accrual loans discussed above) in which $3.8
million in impaired loans had a related allowance for credit losses of $1.1
million and $7.2 million in impaired loans in which there is no related
allowance for credit losses. The average balance of impaired loans totaled
$11.4 million as of March 31, 2011, and interest income recorded on impaired
loans during the three months ended March 31, 2011 totaled $13 thousand, as
compared to $30 thousand for the three months ended March 31, 2010.
The balance in commercial loans 90-days past due and still accruing remained
unchanged as of March 31, 2011 from the reported levels at December 31, 2010.
Included in the balance of the loans past due 90 days or more is a principal
balance of $634 thousand dollars representing the Bank's participation interest
in two loans originated by another New Jersey based institution. Although the
borrowers have ceased making payments on these loans, we have received a legal
opinion from our legal counsel that the Bank has valid claims against the
lead/originating bank for violations of the participation agreements, and we
have filed suit asserting these claims. In the event the lead bank is unable to
collect from the borrowers, we believe, based on said legal opinion that we
will collect our investment from the lead/originating bank. However, in that
case our ability to collect on these loans will depend upon the outcome of our
legal action against the lead/originating bank.
21
During the period ended March 31, 2011 the Company experienced a $268 thousand
net increase in non-accrual loans. This change reflects the downgrading of four
loan relationships to non-accrual status totaling $2.1 million partially offset
by total charge offs of four loan relationships representing nine loans in the
amount of $1.8 million during the three month period ended March 31, 2011. The
downgraded loans consisted of two relationships representing residential
mortgages loans totaling $964 thousand and two commercial relationships
representing six loans totaling $1.1 million.
The Company prepares an allowance for loan loss model on a quarterly basis to
determine the adequacy of the allowance. Management considers a variety of
factors when establishing the allowance, such as the impact of current economic
conditions, diversification of the loan portfolio, delinquency statistics,
results of independent loan review and related classifications. The Bank's
historic loss rates and the loss rates of peer financial institutions are also
considered. In evaluating the Company's allowance for loan loss the Company
maintains a Criticized Asset Committee ("CAC") consisting of senior management
that monitors problem loans and formulates collection efforts and resolution
plans for each borrower. On a monthly basis the CAC meets to review each
problem loan and determines if there has been any change in collateral value
due to changes in market conditions. Each quarter, when calculating the
allowance for loan loss, the CAC reviews an updated loan impairment analysis on
each problem credit to determine if a specific provision for loan loss is
warranted. Management reviews the most recent appraisal on each loan, adjusted
for holding and selling costs. In the event there is not a recent appraisal on
file, the Company will use the aged appraisal and apply a discount factor to
the appraisal then adjust the holding and selling costs from the discounted
appraisal value. At March 31, 2011, the Company maintained an allowance for
loan loss ratio of 1.24% to period end loans outstanding.
Any asset classified as loss is charged-off within thirty days of such
classification unless the asset has already been eliminated from the books by
collection or other appropriate entry. On a quarterly basis the BLC will review
past due, classified, non-performing and other loans, as it deems appropriate,
to determine the collectability of such loans. If the BLC determines a loan to
be uncollectible, the loan is charged to the allowance for loan loss. In
addition, upon reviewing the collectability of a loan, the BLC may determine a
portion of the loan to be uncollectible; in which case that portion of the loan
deemed uncollectable will be partially charged-off against the allowance for
loan loss.
For the three month period ending March 31, 2011 the Company experienced six
charge offs relating to three loan relationships totaling $1.0 million and
three partial charge-offs relating to two loan relationships totaling $782
thousand as compared to charge-offs of four loans representing one relationship
totaling $382 thousand for the period ended December 31, 2010.
Real estate acquired by foreclosure or by deed in lieu of foreclosure is
classified as real estate owned until it is sold. At March 31, 2011 and
December 31, 2010 the Company had $830 thousand in real estate owned.
Our investment securities are classified as either held to maturity or
available for sale. Our investment portfolio decreased by $132 thousand or
0.37% to $84.9 million at March 31, 2011, from $85.1 million at December 31,
2010. The change in our investment portfolio is related to pay downs in our
mortgage backed securities portfolio along with the associated premium and
discount amortization associated with the portfolio. There were no security
purchases, calls or maturities for the period ended March 31, 2011. See
Footnote 6 to our Consolidated Financial statements for more information
regarding our investment securities portfolio.
Our cash and cash equivalents increased by $6.8 million to $15.8 million at
March 31, 2011 from $9.0 million at December 31, 2010. The increase reflects
cash inflows from an increase in deposits, repayments of higher yielding
investment securities in a lower rate environment and loan re- and prepayments
exceeding current loan funding demands. The increase in deposits reflects, in
part, the Bank benefiting from merger activity involving competing institutions
and resulting customer dislocation. Management has elected to keep excess cash
flow in short term, liquid assets to fund anticipated loan demand over the next
several quarters.
22
Total liabilities at March 31, 2011 amounted to $338.2 million, an increase of
$2.0 million or 0.59% from December 31, 2010. This change was primarily due to
increases in total deposits of $1.9 million and line of credit borrowings from
Atlantic Central Bankers Bank (ACBB) of $52 thousand, and other liabilities of
$25 thousand.
Total deposits at March 31, 2011 were $304.2 million, an increase of $1.9
million or 0.63% from December 31, 2010. The increase in deposits was
attributable to an increase of $20.8 million in interest bearing deposit
accounts which was fueled by the migration of $12.4 million from non-interest
bearing deposit accounts and the migration of $6.5 million from certificates of
deposit. The change in deposits was primarily related to the competitive
pricing of deposit products coupled with the continued development of
relationships with local small businesses along with the high level of
individualized service provided by our team of retail branch managers, which
together fostered growth in deposits.
At March 31, 20101 and December 31, 2010 respectively, we had advances from the
FHLB in the amount of $25.0 million. The weighted average interest rate on
these borrowings from the FHLB was 1.49% at March 31, 2011 and 1.49% at
December 31, 2010.
On February 17, 2009, the Company entered into a non-revolving line of credit
loan agreement with Atlantic Central Bankers Bank in an amount up to $5.0
million. The term of the debt is for a three year period with a maturity date
of February 17, 2012. The interest rate adjusts at a variable rate equal to
prime plus 25 basis points with a floor of 4.25% . The Company has an
outstanding balance on the line of credit of $4.9 million and has contributed
$4.4 million as additional capital to the Bank.
On November 1, 2010, the Bank modified the terms of the hybrid capital
instrument originally issued on October 31, 2008, in the aggregate amount of
$3.0 million in the form of subordinated debt. This instrument qualifies as
Tier II capital. The new term of the debt is for a ten year period with a
maturity date of November 1, 2020. The interest rate is at a variable rate
equal to the prime rate plus 100 basis points for the entire ten year term. The
debt security is redeemable, at the Bank's option, at par on any January
31(st), April 30(th), July 31(st), or October 31(st) that the debt security
remains outstanding however, the Bank shall not have the right to redeem the
debt security prior to April 30, 2011.
Stockholders' equity at March 31, 2011 amounted to $17.9 million, an increase
of $198 thousand or 1.1% over December 31, 2010. This increase reflects net
income of $109 thousand, other comprehensive income of $87 thousand and stock
based compensation expense of $35 thousand partially offset by $33 thousand in
cash paid for the declaration of dividends on preferred stock for the three
month period ended March 31, 2011.
Results of Operations
Net Income. We recorded net income for the three month period ended March 31,
2011 of $109 thousand or $0.04 per common and diluted share, respectively
(after preferred stock dividend) as compared to net income of $475 thousand or
$0.22 per common and diluted share, respectively for the same period in 2010.
The change in net income for the three-month period compared to the prior
period was attributable to increases of $393 thousand in net interest income
and $139 thousand in non interest income due to a $156 thousand increase in
gain on sale of loans, offset by an increase of $844 thousand in the provision
for loan losses. Non- interest expenses increase by $298 thousand due to
increased salary and benefit costs of $177 thousand, net occupancy costs of $46
thousand, data processing costs of $19 thousand, professional services of $20
thousand, other real estate owned expense of $20 thousand and FDIC insurance
premium expenses of $24 thousand and advertising and promotion of $11 thousand,
partially offset by a decrease of $19 thousand in other operating expenses. The
net interest margin for the three-month period ended March 31, 2011 decreased
by 7 basis points to 3.86% as compared to 3.93% for the same period in 2010.
Interest Income. Total interest income amounted to $4.3 million for the
three-month period ended March 31, 2011, an increase of $352 thousand or 9.0%
when compared to the same period in 2010. The increase in interest income was
due to volume increases in our interest-bearing assets, partiallyoffset by a
reduction in the average yield. The average
23
yield on our interest-earning assets was 5.14% for the three month period ended
March 31, 2011 compared to 5.45% during the same period in 2010. The reduction
in yield in the quarterly period reflects generally reduced market rates of
interest, as the Federal Reserve has maintained a low interest rate policy to
help stimulate the U.S. economy.
Interest Expense. Total interest expense amounted to $1.1 million for the
three-month period ended March 31, 2011, a decrease of $41 thousand or 3.7 %
when compared to the same period in 2010. The decrease in interest expense
resulted from lower rates paid on deposit and borrowing products when compared
to the same period in 2010. The average cost of interest-bearing liabilities
was 1.38% for the three-month period ended March 31, 2011 compared to 1.70%
during the same period in 2010. The reduction in rate was partially offset by
the increased volume of interest bearing liabilities.
The reduction in rates paid on deposit liabilities and borrowings reflects the
same factors, discussed above, affecting the yield on our earning assets.
Allowance for Loan Losses. During the first quarter of 2011, we recorded a
provision for loan losses of $953 thousand compared to a provision of $109
thousand for the same period in 2010. As a result of the $1.8 million in
charge-offs recorded during the first quarter of 2011, the Company's historical
loss rates within the respective portfolios have increased and have resulted in
an increased provision for loan loss in the first quarter of 2011. At March 31,
2011, our allowance for loan losses represented 1.24% of total loans
outstanding and 29.3% of non-performing loans.
Non-Interest Income. For the three-months ended March 31, 2011, non-interest
income, which is comprised principally of service charges on deposit accounts,
gain on sale of loans, origination fees on residential mortgage loans sold,
bank owned life insurance income, ATM fees and other miscellaneous fee income
totaled $293 thousand. This represents an increase of $139 thousand or 90.3%
when compared to the same period in 2010. This increase resulted from increases
of $156 thousand in gain on loans sold and miscellaneous fee income of $29
thousand, offset by decreases of $6 thousand on service charges on deposit
accounts and a $1 thousand decrease in Bank owned life insurance.
Non-Interest Expense. Non-interest expense, which is comprised principally of
salaries and employee benefits, net occupancy costs, FDIC insurance premium
expense, advertising costs, data processing costs and professional services and
other operating costs, totaled $2.4 million for the three months ended March
31, 2011. This represents an increase of $298 thousand or 14.4% when compared
to the same period in 2010. The increase in non-interest expense was primarily
the result of increased salary and benefit costs of $177 thousand, net
occupancy costs of $46 thousand, data processing costs of $19 thousand,
professional services costs of $20 thousand, FDIC expense of $ 24 thousand,
other real estate owned expense of $20 thousand, and advertising and promotions
of $11 thousand, partially offset by a decrease in other operating expenses of
$19 thousand.
Income Taxes. We recorded a federal and state income tax expense of $56
thousand during the three month period ended March 31, 2011 compared to an
income tax expense of $300 thousand for the same period in 2010. The effective
tax rate for the three month period ended March 31, 2011 was 33.9% compared to
38.7% for the three month period ended March 31, 2010. The decrease in the
effective tax rate for the three month period ended March 31, 2011 is due to
tax exempt income comprising a larger portion of pretax income as compared to
the three month period ended March 31, 2010.
Liquidity and Capital Resources
Liquidity. Liquidity represents our ability to meet our normal cash flow
requirements for the funding of loans, repayment of deposits and payment of
operating costs. Our primary sources of liquidity include growth in deposits,
amortization and prepayment of loans, maturities of investment securities, and
our borrowing capability. Management monitors liquidity daily, and on a monthly
basis incorporates liquidity analysis into its asset/liability management
program.
24
In addition to using growth in deposits, loan repayments and the investment
portfolio as a source of liquidity, we also have access to unsecured, overnight
lines of credit aggregating $58.7 million, consisting of $3.0 million, on an
uncommitted basis, through ACBB and $55.7 million through the FHLB of New York.
The arrangements with ACBB are for the sale of federal funds to the Bank,
subject to the availability of such funds. Pursuant to a collateral agreement
with the FHLB, advances under this line of credit are secured by a blanket lien
on our residential mortgage loan portfolio. At March 31, 2011, we had no
outstanding balance against the overnight line of credit at ACBB. In addition,
the Company has a non revolving line of credit with ACBB for up to $5.0 million
and as of March 31, 2011 there is an outstanding balance of $4.9 million. In
addition, the Bank's membership in the FHLB provides the Bank with additional
secured borrowing capacity of up to a maximum of 25% of the Bank's total
assets, subject to certain conditions.
We had cash and cash equivalents of $15.8 million at March 31, 2011 in the form
of cash and due from banks. At March 31, 2011, unused lines of credit available
to our customers, committed undisbursed loan proceeds and standby letters of
credit totaled $54.1 million. Certificates of deposit scheduled to mature in
one year or less totaled $78.9 million at March 31, 2011. We anticipate that we
will continue to have sufficient funds available to meet the needs of our
customers for deposit repayments and loan fundings.
Our ability to generate deposits depends on the success of our branches. Our
success is dependent on a number of factors, including our ability to establish
branches in favorable locations, our ability to meet the needs of our customers
through personalized services and a broad array of financial products, and the
general economic conditions of the market area in which they are located.
Unexpected changes in the national and local economy may also adversely affect
our ability to attract or retain deposits and foster new loan relationships.
Capital Resources. Capital adequacy is the ability to support growth while
protecting the interests of depositors and the deposit insurance fund. Bank
regulatory agencies have developed certain capital ratio requirements, which
are used to assist them in monitoring the safety and soundness of financial
institutions. Management continually monitors these capital requirements.
The Bank is subject to risk-based capital guidelines promulgated by the FDIC
that are designed to make regulatory capital requirements more sensitive to
differences in risk profile among banks, to account for off-balance sheet
exposure, and to minimize disincentives for holding liquid assets. Under the
guidelines, assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate weights. The resulting capital ratios
represent capital as a percentage of total risk-weighted assets and off-balance
sheet items. The minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) is 8%. At least 4% of total risk-weighted capital must consist of "Tier
I Capital," consisting of common stockholders' equity and qualifying hybrid
instruments, less certain goodwill items and other intangible assets. The
remainder ("Tier II Capital") may consist of (a) the allowance for loan losses
of up to 1.25% of risk-weighted assets, (b) excess of qualifying hybrid
instruments, (c) perpetual debt (d) mandatory convertible securities, and (e)
qualifying subordinated debt and intermediate-term preferred stock up to 50% of
Tier I capital. Total capital is the sum of Tier I and Tier II capital less
reciprocal holdings of other banking organizations, capital instruments,
investments in unconsolidated subsidiaries and any other deductions as
determined by the FDIC (determined on a case-by-case basis or as a matter of
policy after formal rule-making).
In addition to the risk-based capital guidelines, the FDIC has adopted a
minimum Tier I capital (leverage) ratio, under which banks must maintain a
minimum level of Tier I capital to average total consolidated assets of at
least 3% in the case of a bank that has the highest regulatory examination
rating and is not contemplating significant growth or expansion. All other
banks are expected to maintain a leverage ratio of at least 1% to 2% above the
stated minimum.
The Bank was in compliance with all applicable minimum capital requirements for
all periods presented. At March 31, 2011 the Bank maintained a Tier I leverage
ratio of 6.92%, a Tier I risk-based capital ratio of 9.01% and a total
risk-based capital ratio of 11.18% . The Bank's management believes that the
Bank would be categorized as well capitalized under applicable FDIC capital
adequacy regulations.
25
The Board of Governors of the Federal Reserve System has established similar
capital requirements for bank holding companies, on a consolidated basis.
However, these requirements only apply to bank holding companies with assets of
$500 million or more. As such, the Company is not subject to these
requirements.
On February 17, 2009, the Company entered into a non-revolving line of credit
loan agreement with Atlantic Central Bankers Bank in an amount up to $5.0
million. The term of the debt is for a three year period with a maturity date
of February 17, 2012. The interest rate adjusts at a variable rate equal to
prime plus 25 basis points with a floor of 4.25% . The Company has an
outstanding balance on the line of credit of $4.9 million and has contributed
$4.4 million as additional capital to the Bank.
On November 1, 2010, the Bank modified the terms of the hybrid capital
instrument originally issued on October 31, 2008, in the aggregate amount of
$3.0 million in the form of subordinated debt. This instrument qualifies as
Tier II capital. The new term of the debt is for a ten year period with a
maturity date of November 1, 2020. The interest rate is at a variable rate
equal to the prime rate plus 100 basis points for the entire ten year term. The
debt security is redeemable, at the Bank's option, at par on any January
31(st), April 30(th), July 31(st), or October 31(st) that the debt security
remains outstanding however, the Bank shall not have the right to redeem the
debt security prior to April 30, 2011.
In June 2009, the Board of Directors of the Company approved a private
placement common stock offering to accredited investors. In connection with
this offering, the Board of Directors approved the issuance of common stock
purchase warrants. As part of the offering, one warrant was issued for each
share of common stock, no par, sold in the stock offering. Each warrant issued
under the offering will allow the holder of the warrant to purchase one share
of common stock for a price of $9.00 per share through June 26, 2013. For the
year ended December 31, 2009, the Company sold 153,889 shares under this
offering and issued 153,889 common stock warrants. The $1.1 million proceeds
received from the common stock offering were recorded as additional paid in
capital.
In December 2009, the Company authorized the establishment of 2,000 shares of
no par, $1,000 stated value, Perpetual Non-Cumulative Convertible Preferred
Stock. The preferred stock is entitled to receive, as and when declared by the
Company's Board of Directors, non-cumulative cash dividends at the annual rate
of 7% of the stated value. In December 2009, the Company sold 1,900 preferred
shares. The preferred stock is redeemable at the Company's option at any time
after six months from the issue date at the stated value plus any dividends
declared but unpaid. The preferred shares have priority of dividends such that,
no dividends or distributions shall be declared or paid to common shareholders
unless full dividends on all outstanding preferred shares have been declared
and paid for the most recently completed calendar quarter.
The Bank's capital ratios at March 31, 2011 and December 31, 2010 are presented
in the following table
March 31, 2011 December 2010
-------------- -------------
Shareholders' equity to total assets 5.6% 5.6%
Leverage ratio 6.9% 6.9%
Risk-based capital ratios:
Tier 1 9.0% 8.9%
Total Capital 11.2% 11.2%
Off-Balance Sheet Arrangements. We are party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of our customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve, to
varying degrees, elements of credit risk in excess of the amount recognized in
the statements of financial condition.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the agreement.
Commitments generally have fixed dates or other termination clauses and may
require
26
the payment of a fee. Some of the commitments are expected to expire without
being drawn upon, and the total commitments do not necessarily represent future
cash requirements. Total commitments to extend credit at March 31 2011 were
$54.1 million. We evaluate each customer's creditworthiness on a case by case
basis. Collateral obtained, if deemed necessary, is based on management's
credit evaluation of the customer. Collateral varies but may include accounts
receivable, marketable securities, inventory, property, plant and equipment,
residential and commercial real estate.
Standby letters of credit are conditional commitments issued to a third party
for a customer. The credit risk involved in issuing standby letters of credit
is similar to that involved in extending credit to customers. We evaluate each
customer's creditworthiness on a case by case basis. Collateral obtained, if
deemed necessary, is based on management's credit evaluation of the customer.
Collateral varies, but may include accounts receivable, marketable securities,
inventory, property, plant and equipment, and residential and commercial real
estate. At March 31, 2011, our obligations under standby letters of credit
totaled $2.8 million.
Critical Accounting Policies
Allowance for Losses on Loans
The allowance for losses on loans is based on management's ongoing evaluation
of the loan portfolio and reflects an amount considered by management to be its
best estimate of known and inherent losses in the loan portfolio. Management
considers a variety of factors when establishing the allowance, such as the
impact of current economic conditions, diversification of the loan portfolio,
delinquency statistics, results of independent loan review and related
classifications. Our historic loss rates and the loss rates of peer financial
institutions are also considered. In addition, certain individual loans which
management has identified as problematic are specifically provided for, based
upon an evaluation of the borrower's perceived ability to pay, the estimated
adequacy of the underlying collateral and other relevant factors. Consideration
is also given to examinations performed by regulatory agencies. Although
provisions have been established and segmented by type of loan, based upon
management's assessment of their differing inherent loss characteristics, the
entire allowance for losses on loans is available to absorb loan losses in any
category.
Management uses significant estimates to determine the allowance for loan
losses. Since the allowance for loan losses is dependent, to a great extent, on
conditions that may be beyond our control, it is possible that management's
estimate of the allowance for loan losses and actual results could differ
materially in the near term.
In addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for loan losses. They may require additions
to the allowance based upon their judgments about information available to them
at the time of examination.
The Company utilizes its own loss experience to estimate inherent losses on
loans. Internal risk ratings are assigned to each commercial, real estate
commercial, real estate construction and land development loan.
A portion of the allowance is allocated to the remaining loans by applying
projected rate loss ratios, based on numerous factors such as recent charge-off
experience, trends with respect to adversely risk rated commercial, real estate
commercial, real estate construction and land development loans, trends with
respect to past due and nonaccrual loans, changes in economic conditions and
trends, changes in the value of underlying collateral and other credit risk
factors.
Historical loss rates are calculated using the last nine quarters of a variable
factor analysis. The analysis consists of economic conditions, concentrations
of industry, quality management and systems, general collateral quality,
delinquency trends over the last four quarters, loan grade trends over the past
four quarters, annual portfolio growth and credit/borrower concentration.
The loans are grouped into the following categories. Commercial loans and
Letters of Credit, Commercial Mortgage Loans, Residential Mortgage Loans,
Installment Loan, Home Equity and Credit Lines and Lease Backed Term Loans.
27
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as operating loss carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is established against deferred tax
assets when, in the judgment of management, it is more likely than not that
such deferred tax assets will not become available. Because the judgment about
the level of future taxable income is dependent to a great extent on matters
that may, at least in part, be beyond the our control, it is at least
reasonably possible that management's judgment about the need for a valuation
allowance for deferred taxes could change in the near term.
Impact of Inflation and Changing Prices
The consolidated financial statements of the Company and the footnotes thereto,
presented elsewhere herein, have been prepared in accordance with the standards
of the Public Company Accounting Oversight Board (United States), which require
the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of our operations.
Unlike most industrial companies, nearly all of our assets and liabilities are
monetary. As a result, interest rates have a greater impact on our performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods and services.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable to smaller reporting companies.
Item 4. Controls and Procedures
The Registrant's chief executive officer and chief financial officer, after
evaluating the effectiveness of the Registrant's "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this quarterly report,
have concluded that as of such date, the Registrant's disclosure controls and
procedures were effective to ensure at a reasonable assurance level that
material information relating to the Registrant is recorded, processed,
summarized and reported in a timely manner. There were no changes in the
Registrant's internal control over financial reporting that occurred during the
Registrant's third fiscal quarter of 2010 that have materially affected, or are
reasonably likely to materially affect, the Registrant's internal control over
financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company, from time to time, is a party to routine litigation that arises in
the normal course of business. Management does not believe the resolution of
this litigation, if any, would have a material adverse effect on the Company's
financial condition or results of operations. However, the ultimate outcome of
any such matter, as with litigation generally, is inherently uncertain and it
is possible that some of these matters may be resolved adversely to the
Company.
28
Item 1A. Risk Factors
Not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Reserved
Item 5. Other Information
Not applicable.
Item 6. Exhibits
(a) The following are filed as exhibits to this report:
31.1 Certification of Chief Executive Officer required under Section 302 of the
Sarbanes -- Oxley Act of 2002
31.2 Certification of Chief Financial Officer required under Section 302 of the
Sarbanes -- Oxley Act of 2002
32.1 Certification of Chief Executive Officer required under Section 906 of the
Sarbanes -- Oxley Act of 2002
32.2 Certification of Chief Financial Officer required under Section 906 of the
Sarbanes -- Oxley Act of 2002
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CORNERSTONE FINANCIAL CORPORATION
Date: May 12, 2011 By: /s/ George W. Matteo, Jr.
------------------------------------------
George W. Matteo, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 12, 2011 By: /s/ Keith Winchester
------------------------------------------------
Keith Winchester
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
30
