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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

Commission file number 000-13580

 

 

SUFFOLK BANCORP

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

New York State   11-2708279
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
4 West Second Street, Riverhead, New York   11901
(Address of Principal Executive Offices)   (Zip Code)

(631) 208-2400

(Registrant’s Telephone Number, Including Area Code)

 

 

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

9,727,031 SHARES OF COMMON STOCK OUTSTANDING AS OF May 1, 2011

 

 

 


Table of Contents

 

 

 

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Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

TABLE OF CONTENTS

 

Item 1—Financial Statements      2   

CONSOLIDATED STATEMENTS OF CONDITION AS OF

     2   

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED

     3   

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED

     4   

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

     5   

(1) Basis of Presentation

     5   

(2) Stock-based Compensation

     5   

(3) Income Taxes

     6   

(4) Fair Value

     6   

(5) Investment Securities

     10   

(6) Allowance for Loan Losses

     11   

(7) Comprehensive Income

     21   

(8) Retirement Plan

     22   

(9) Recent Accounting Pronouncements

     22   

(10) Regulatory Matters

     23   

(11) Legal Proceedings

     24   
Item 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION      26   

Recent Developments

     26   

Basic Performance and Current Activities

     26   

Net Income (Loss)

     27   

Interest Income

     27   

Interest Expense

     27   

Net Interest Income

     27   

Other Income

     29   

Other Expense

     29   

Capital Resources

     29   

Credit Risk

     30   

Critical Accounting Policies, Judgments and Estimates

     31   

Allowance for Loan Losses

     31   

Non-Performing Loans

     34   

Deferred Tax Assets and Liabilities

     37   

Investment Securities

     38   
Item 3—Quantitative and Qualitative Disclosures about Market Risk      38   

Market Risk

     38   

Business Risks and Uncertainties

     38   
Item 4—Controls and Procedures      38   

Material Weaknesses in Internal Controls

     39   

Allowance for Loan and Lease Losses

     39   

Financial Reporting Staffing Resources

     39   

Interdepartmental Communications

     39   

Governance and Management Accountability

     39   
PART II      42   
Item 1—Legal Proceedings      42   
Item 1A—Risk Factors      42   
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds      44   
Item 6—Exhibits      44   
SIGNATURES      44   


Table of Contents

Item 1—Financial Statements

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION AS OF

(in thousands of dollars except for share data)

 

     March 31,
2011
    December 31,
2010
 
     unaudited     Restated  

ASSETS

    

Cash & Due from Banks

   $ 82,117      $ 41,149   

Federal Reserve Bank Stock

     652        652   

Federal Home Loan Bank Stock

     3,531        3,531   

Investment Securities:

    

Available for Sale, at Fair Value

     391,072        396,670   

Held to Maturity (Fair Value of $10,546 and $10,703, respectively)

    

Obligations of States & Political Subdivisions

     9,713        9,936   

Other Securities

     80        80   
  

 

 

   

 

 

 

Total Investment Securities

     400,865        406,686   
  

 

 

   

 

 

 

Total Loans

     1,098,823        1,112,279   

Less: Allowance for Loan Losses

     47,539        28,419   
  

 

 

   

 

 

 

Net Loans

     1,051,284        1,083,860   
  

 

 

   

 

 

 

Premises & Equipment, Net

     25,219        25,548   

Other Real Estate Owned, Net

     3,261        5,719   

Accrued Interest and Loan Fees Receivable

     7,946        7,025   

Goodwill

     814        814   

Other Assets

     35,529        31,883   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 1,611,218      $ 1,606,867   
  

 

 

   

 

 

 

LIABILITIES & STOCKHOLDERS’ EQUITY

    

Demand Deposits

   $ 482,479      $ 493,630   

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

     629,369        601,828   

Time Certificates of $100,000 or more

     208,739        210,096   

Other Time Deposits

     94,810        97,199   
  

 

 

   

 

 

 

Total Deposits

     1,415,397        1,402,753   

Federal Home Loan Bank Borrowings

     40,000        40,000   

Dividend Payable on Common Stock

     —          1,454   

Accrued Interest Payable

     561        591   

Other Liabilities

     24,605        25,249   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     1,480,563        1,470,047   
  

 

 

   

 

 

 

STOCKHOLDERS’ EQUITY

    

Common Stock (par value $2.50; 15,000,000 shares authorized; 9,712,070 and 9,692,312 shares outstanding at March 31, 2011 and December 31, 2010, respectively)

     34,293        34,236   

Surplus

     23,788        23,368   

Retained Earnings

     83,806        91,450   

Treasury Stock at Par (4,005,270 and 4,002,158 shares, respectively)

     (10,013     (10,005
  

 

 

   

 

 

 
     131,874        139,049   

Accumulated Other Comprehensive Loss, Net of Tax

     (1,219     (2,229
  

 

 

   

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

     130,655        136,820   
  

 

 

   

 

 

 

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY

   $ 1,611,218      $ 1,606,867   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

Page 2


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED

(in thousands of dollars except for share and per share data)

 

             March 31,
2011
    March 31,
2010
 
            unaudited     unaudited  

INTEREST INCOME

       

Federal Funds Sold & Interest Due from Banks

      $ 16      $ 2   

United States Treasury Securities

        70        71   

Obligations of States & Political Subdivisions

        1,911        1,879   

Mortgage-Backed Securities

        1,636        2,090   

U.S. Government Agency Obligations

        154        202   

Other Securities

        84        100   

Loans and Loan Fees

        16,448        17,573   
     

 

 

   

 

 

 

Total Interest Income

        20,319        21,917   
     

 

 

   

 

 

 

INTEREST EXPENSE

       

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

        634        860   

Time Certificates of $100,000 or more

        582        801   

Other Time Deposits

        357        476   

Federal Funds Purchased and Repurchase Agreements

        —          1   

Borrowings

        339        533   
     

 

 

   

 

 

 

Total Interest Expense

        1,912        2,671   
     

 

 

   

 

 

 

Net Interest Income

        18,407        19,246   

Provision for Loan Losses

        19,971        8,837   
     

 

 

   

 

 

 

Net Interest Income (Loss) After Provision for Loan Losses

        (1,564     10,409   
     

 

 

   

 

 

 

OTHER INCOME

       

Service Charges on Deposit Accounts

        1,005        1,266   

Other Service Charges, Commissions & Fees

        667        664   

Fiduciary Fees

        225        307   

Other Operating Income

        324        271   
     

 

 

   

 

 

 

Total Other Income

        2,221        2,508   
     

 

 

   

 

 

 

OTHER EXPENSE

       

Salaries & Employee Benefits

        7,545        7,032   

Net Occupancy Expense

        1,534        1,428   

Equipment Expense

        482        533   

Outside Services

        888        356   

FDIC Assessments

        1,131        603   

Other Real Estate Owned Expense

        140        —     

Other Operating Expense

        2,053        1,931   
     

 

 

   

 

 

 

Total Other Expense

        13,773        11,883   
     

 

 

   

 

 

 

(Loss) Income Before Income Taxes

        (13,116     1,034   

Benefit from Income Taxes

        (5,542     (498
     

 

 

   

 

 

 

NET (LOSS) INCOME

      $ (7,574   $ 1,532   
     

 

 

   

 

 

 

Weighted Average: Common Shares Outstanding

  

     9,705,888        9,634,156   

Dilutive Stock Options

  

     —          6,665   
     

 

 

   

 

 

 

Weighted Average Total Common Shares and Dilutive Options

  

     9,705,888        9,640,821   
EARNINGS (LOSS) PER COMMON SHARE      Basic       $ (0.78   $ 0.16   
     Diluted       $ (0.78   $ 0.16   

DIVIDENDS PER COMMON SHARE

        —        $ 0.22   

See accompanying notes to consolidated financial statements.

 

Page 3


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED

(in thousands of dollars)

 

     March 31,
2011
    March 31,
2010
 
     unaudited     unaudited  

NET (LOSS) INCOME

   $ (7,574   $ 1,532   

ADJUSTMENTS TO RECONCILE NET (LOSS) INCOME TO NET CASH

    

CASH FLOWS FROM OPERATING ACTIVITIES

    

Provision for Loan Losses

     19,971        8,837   

Depreciation & Amortization

     656        639   

Stock Based Compensation

     —          8   

Accretion of Discounts

     (36     (41

Amortization of Premiums

     677        691   

Increase in Accrued Interest and Loan Fees Receivable

     (921     (744

Increase in Other Assets

     (6,503     (4,717

Decrease in Accrued Interest Payable

     (30     (148

Increase in Income Taxes Payable

     2,478        1,998   

Increase (Decrease) in Other Liabilities

     (1,141     750   
  

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     7,577        8,805   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Principal Payments on Investment Securities

     9,097        6,929   

Maturities of Investment Securities Available for Sale

     1,000        —     

Purchases of Investment Securities Available for Sale

     (3,287     (11,040

Maturities of Investment Securities Held to Maturity

     222        101   

Purchases of Investment Securities Held to Maturity

     —          (1,750

Loan (Disbursements) & Repayments, Net

     12,638        (13,643

Purchases of Premises & Equipment, Net

     (326     (183

Disposition of Other Real Estate Owned

     2,457        —     
  

 

 

   

 

 

 

Net Cash Provided by (Used in) Investing Activities

     21,801        (19,586
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net Increase (Decrease) in Deposit Accounts

     12,644        (4,407

Short-term Borrowings, Net

     —          19,600   

Dividends Paid to Shareholders

     (1,454     (2,115

Dividend Reinvestment in Common Stock, Net

     400        245   

Stock Options and Stock Appreciation Rights Exercised

     —          209   
  

 

 

   

 

 

 

Net Cash Provided by Financing Activities

     11,590        13,532   
  

 

 

   

 

 

 

Net Increase in Cash & Cash Equivalents

     40,968        2,751   

Cash & Cash Equivalents Beginning of Period

     41,149        37,007   
  

 

 

   

 

 

 

Cash & Cash Equivalents End of Period

   $ 82,117      $ 39,758   
  

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information

    

Cash Received During the Three Month Period for Interest

   $ 19,398      $ 21,173   
  

 

 

   

 

 

 

Cash Paid During the Three Month Period for:

    

Interest

   $ 1,942      $ 2,819   

Income Taxes

     191        1,697   
  

 

 

   

 

 

 

Total Cash Paid for Interest & Income Taxes

   $ 2,133      $ 4,516   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

Page 4


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

(1) Basis of Presentation

In the opinion of management, the accompanying unaudited consolidated financial statements of Suffolk Bancorp (“Suffolk”) and its consolidated subsidiaries, primarily Suffolk County National Bank (the “Bank”), have been prepared to reflect all adjustments (consisting solely of normally recurring accruals) necessary for a fair presentation of the financial condition and results of operations for the periods presented. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted. Notwithstanding, management believes that the disclosures are adequate to prevent the information from misleading the reader, particularly when the accompanying consolidated financial statements are read in conjunction with the audited consolidated financial statements and notes thereto included in the Registrant’s restated Annual Report on Form 10-K/A for the year ended December 31, 2010.

The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results of operations to be expected for the remainder of the year.

Certain prior period accounts have been reclassified to conform to the current period’s presentation.

 

(2) Stock-based Compensation

At March 31, 2011, Suffolk had one stock-based employee compensation plan, the Suffolk Bancorp 2009 Stock Incentive Plan (“the Plan”), under which 500,000 shares of Suffolk’s common stock were originally reserved for issuance to key employees and directors, of which none had yet been issued at March 31, 2011. Options are awarded by a committee appointed by the Board of Directors. The Plan provides that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. The Plan provides for but does not require the grant of stock appreciation rights that the holder may exercise instead of the underlying option. When the stock appreciation right is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of stock appreciation rights is treated as the exercise of the underlying option. Options vest after one year and expire after ten years except as otherwise specified in the option agreement.

Stock-based compensation for all share-based payments to employees, including grants of employee stock options, is recorded in the financial statements based on their fair values. During the three months ended March 31, 2011, no compensation expense was recorded for stock-based compensation. As of March 31, 2011, there was no unrecognized compensation cost related to non-vested options under the Plan.

The following table presents the options granted, exercised, or expired from the 1999 plan during the three months ended March 31, 2011:

 

     Shares     Wtd. Avg.
Exercise
 

Balance at December 31, 2010

     89,500      $ 30.32   

Options granted

     —          —     

Options exercised

     (5,000     15.50   

Options expired or terminated

     (23,000     28.67   
  

 

 

   

 

 

 

Balance at March 31, 2011

     61,500      $ 32.14   
  

 

 

   

 

 

 

 

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Table of Contents

The following table presents certain information about the valuation of options outstanding on March 31, 2011 and December 31, 2010:

 

At, or during,

   Three Months Ended
March 31, 2011
     Year Ended
December 31,  2010
 

Exercisable options (vested)

     61,500         89,500   

Weighted average fair value of options (Black-Scholes model) at date of grant:

     —           —     

Black-Scholes Assumptions:

     

Risk-free interest rate

     —           —     

Expected dividend yield

     —           —     

Expected life in years

     —           —     

Expected volatility

     —           —     

The following table details contractual weighted-average lives of outstanding options at various prices:

 

     By range of exercise prices  
from
to
          $28.30
  32.90
     $34.39
  34.95
 

Outstanding stock options

        44,500         17,000   

Weighted-average remaining life

        5.59         4.23   

Weighted-average exercise price

      $ 31.14       $ 34.79   

Exercisable stock options

        44,500         17,000   

Weighted-average remaining life

        5.59         4.23   

Weighted-average exercise price

      $ 31.14       $ 34.79   
            Weighted-average  

At all prices

   Options      price      life (yrs)  

Total outstanding(1)

     61,500       $ 32.15         5.21   

Total exercisable

     61,500       $ 32.15         5.21   
  

 

 

    

 

 

    

 

 

 

 

  (1) Options to purchase 61,500 shares of common stock at a price of $28.30 - $34.95 per share were outstanding during the three months ended March 31, 2011, and options to purchase 86,835 shares of common stock at a price of $31.18 - $34.95 per share were outstanding during the three months ended March 31, 2010, but were not included in the computation of diluted earnings per share (“EPS”) on the Consolidated Statements of Operations because of the net loss and the exercise price was greater than the average market price of the common shares, respectively. These options expire beginning in 2013.

 

(3) Income Taxes

Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is management’s position that no valuation allowance is necessary against any of Suffolk’s deferred tax assets. Suffolk accounts for income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, “Income Taxes,” which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. Suffolk had unrecognized tax benefits including interest of approximately $20,000 as of March 31, 2011. Suffolk recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.

 

(4) Fair Value

Suffolk records investments available for sale and impaired loans at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. Suffolk uses three levels of the fair value inputs to measure assets, as described below.

 

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Table of Contents

Basis of Fair Value Measurement:

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

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

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

The following table presents the carrying amounts and fair values of Suffolk’s financial instruments. FASB ASC 825, “Financial Instruments”, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation: (in thousands)

 

     March 31, 2011      December 31, 2010
Restated
 
     Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Cash & cash equivalents

   $ 82,117       $ 82,117       $ 41,149       $ 41,149   

Investment securities available for sale

     391,072         391,072         396,670         396,670   

Investment securities held to maturity

     9,793         10,546         10,016         10,703   

Total loans

     1,098,823         1,127,555         1,112,279         1,144,678   

Accrued interest and loan fees receivable

     7,946         7,946         7,025         7,025   

Deposits

     1,415,397         1,417,420         1,402,753         1,404,514   

Borrowings

     40,000         41,190         40,000         41,387   

Accrued interest payable

     561         561         591         591   

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

Short-term financial instruments are valued at the carrying amounts included in the consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term of the instruments. This approach applies to cash and cash equivalents; accrued interest and loan fees receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; and accrued interest payable. Federal Home Loan Bank advances/borrowings are measured using a discounted replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type. The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk of the loan. Estimated maturity is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of the current economy. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.

 

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Table of Contents

The carrying amount and fair value of loans were as follows: (in thousands)

 

     March 31, 2011      December 31, 2010
Restated
 
     Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Commercial, financial & agricultural

   $ 255,607       $ 259,423       $ 248,750       $ 253,153   

Commercial real estate

     437,302         453,225         431,179         449,418   

Real estate construction loans

     76,645         77,099         82,720         83,389   

Residential mortgages (1st & 2nd liens)

     183,971         191,519         195,993         203,909   

Home equity loans

     83,167         83,187         84,696         84,719   

Consumer loans, net of unearned discounts

     61,644         62,615         67,814         68,963   

Other loans

     487         487         1,127         1,127   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 1,098,823       $ 1,127,555       $ 1,112,279       $ 1,144,678   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other assets measured at fair value were as follows: (in thousands)

 

     March 31, 2011      Fair Value Measurements Using  

Description

      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Impaired loans

   $ 107,512       $ —         $ —         $ 107,512   

Other real estate owned

     3,261         —           —           3,261   

Mortgage servicing rights (1)

     1,637         —           —           1,637   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 112,410       $ —         $ —         $ 112,410   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Mortgage servicing rights are measured at fair value on a recurring basis.

 

     December 31, 2010      Fair Value Measurements Using  

Description

      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Impaired loans (restated)

   $ 90,825       $ —         $ —         $ 90,825   

Other real estate owned (restated)

     5,719         —           —           5,719   

Mortgage servicing rights (1)

     1,596         —           —           1,596   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 98,140       $ —         $ —         $ 98,140   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Mortgage servicing rights are measured at fair value on a recurring basis.

Impaired loans are evaluated and valued at the time the loan is identified as impaired. These loans are measured based on the value of the collateral securing these loans, or techniques that are not based on market activity for loans that are not collateral dependent and require management’s judgment. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by Suffolk. The value of business equipment may be based on an appraisal by qualified licensed appraisers hired by Suffolk if significant, or may be valued based on the equipment’s net book value on the business’ financial statements. Inventory and accounts receivable collateral may be valued based on independent field examiner review or aging reports, if significant. Reviews by field examiners may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

The fair value of the investment portfolio, including mortgage-backed securities, was based on quoted market prices or market prices of similar instruments.

 

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The following tables summarize the valuation of financial instruments measured at fair value on a recurring basis in the consolidated statements of condition at March 31, 2011 and December 31, 2010, including the additional requirement to segregate classifications to correspond to the major security type classifications utilized for disclosure purposes: (in thousands)

 

     March 31, 2011      Fair Value Measurements Using  

Description

      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

U.S. Treasury securities

   $ 8,030       $ 8,030       $ —         $ —     

U.S. government agency debt

     22,268         22,268         —           —     

Collateralized mortgage obligations

     152,862         —           152,862         —     

Mortgage-backed securities

     464         —           464         —     

Obligations of states and political subdivisions

     207,448         —           207,448         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 391,072       $ 30,298       $ 360,774       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
            Fair Value Measurements Using  

Description

   December 31, 2010      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

U.S. Treasury securities

   $ 8,102       $ 8,102       $ —         $ —     

U.S. government agency debt

     22,495         22,495         —           —     

Collateralized mortgage obligations

     162,323         —           162,323         —     

Mortgage-backed securities

     510         —           510         —     

Obligations of states and political subdivisions

     203,240         —           203,240         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 396,670       $ 30,597       $ 366,073       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The types of instruments valued based on quoted market prices in active markets include most U.S. government debt and agency debt securities. Such instruments are generally classified within level 1 and level 2 of the fair value hierarchy. Suffolk does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include state and municipal obligations, mortgage-backed securities and collateralized mortgage obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.

FASB ASC 820, “Fair Value Measurements and Disclosures,” provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive.

The fair value of certificates of deposit is calculated by discounting cash flows with applicable origination rates. At March 31, 2011, the fair value of certificates of deposit totaling $305,056,000 had a carrying value of $303,549,000.

The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counterparties.

 

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Credit in the form of revolving open-end lines secured by one-to-four-family residential properties, commercial real estate, construction and land development loans, and lease financing arrangements was $110,364,000 and $123,672,000 as of March 31, 2011 and December 31, 2010, respectively.

The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The contractual amounts of these commitments were $51,878,000 and $58,319,000 at March 31, 2011 and December 31, 2010, respectively. The fees charged for the commitments were not material in amount.

 

(5) Investment Securities

The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolk’s investment securities available for sale and held to maturity at March 31, 2011 and December 31, 2010, respectively, were: (in thousands)

 

     March 31, 2011     December 31, 2010  
     Amortized
Cost
     Estimated
Fair Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Amortized
Cost
     Estimated
Fair Value
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 

Available for sale:

                      

U.S. Treasury securities

   $ 8,007       $ 8,030       $ 23       $ —        $ 8,014       $ 8,102       $ 88       $ —     

U.S. government agency debt

     22,104         22,268         164           22,196         22,495         299         —     

Collateralized mortgage obligations

     147,780         152,862         6,113         (1,031     157,179         162,323         6,627         (1,483

Mortgage-backed securities

     408         464         56         —          452         510         58         —     

Obligations of states and political subdivisions

     198,672         207,448         9,160         (384     196,578         203,240         7,511         (849
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Balance

     376,971         391,072         15,516         (1,415)        384,419         396,670         14,583         (2,332)   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Held to maturity:

                      

Obligations of states and political subdivisions

     9,713         10,466         756         (3     9,936         10,623         695         (8

Other securities

     80         80         —           —          80         80         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Balance

     9,793         10,546         756         (3     10,016         10,703         695         (8
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 386,764       $ 401,618       $ 16,272       $ (1,418   $ 394,435       $ 407,373       $ 15,278       $ (2,340
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

The amortized cost, maturities, and approximate fair value of Suffolk’s investment securities at March 31, 2011 were as follows: (in thousands)

 

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

(1) Maturity (in

years)

  Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
             

Within 1

  $ 8,007      $ 8,030      $ 7,052      $ 7,143      $ —        $ —        $ 2,191        2,198      $ —        $ —        $ 17,250      $ 17,371   

After 1 but within 5

        15,052        15,125        34,385        36,605        3,718        3,947            53,155        55,677   

After 5 but within 10

            155,096        161,437        3,804        4,321            158,900        165,758   

After 10

            9,191        9,406                9,191        9,406   

Other Securities

                    80        80        80        80   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    8,007        8,030        22,104        22,268        198,672        207,448        9,713        10,466        80        80        238,576        248,292   

Collateralized mortgage obligations

  

    147,780        152,862   

Mortgage-backed securities

  

    408        464   
                     

 

 

   

 

 

 

Total

  $ 8,007      $ 8,030      $ 22,104      $ 22,268      $ 198,672      $ 207,448      $ 9,713      $ 10,466      $ 80      $ 80      $ 386,764      $ 401,618   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Maturities shown are stated maturities. Securities backed by mortgages are expected to have substantial periodic prepayments resulting in weighted average lives considerably less than what would be surmised from the table above.

 

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As a member of the Federal Reserve System, the Bank owns Federal Reserve Bank stock with a book value of $652,000. The stock has no maturity and there is no public market for the investment.

As a member of the Federal Home Loan Bank of New York (“FHLB”), the Bank owns FHLB stock with a book value of $3,531,000. As of March 31, 2011, the Bank owns 17,314 shares valued at approximately $1,731,000 as its membership portion. The remaining $1,800,000 in stock is owned based on borrowing activity requirements. The stock has no maturity and there is no public market for the investment. Assets pledged as collateral to FHLB as of March 31, 2011 and December 31, 2010 totaled $321,742,000 and $356,349,000, respectively, consisting of eligible loans and investment securities as determined under FHLB guidelines. The Bank evaluates the FHLB stock for impairment, concluding that there was no impairment as of March 31, 2011.

At March 31, 2011 investment securities carried at $328,017,000 were pledged to secure trust deposits and public funds on deposit.

The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been held in a continuous unrealized loss position at the date indicated: (in thousands)

 

As of March 31, 2011           Less than 12 months      12 months or longer      Total  

Type of securities

   Number of
Securities
     Fair
Value
     Unrealized
losses
     Fair
value
     Unrealized
losses
     Fair
value
     Unrealized
losses
 

Obligations of states and political subdivisions

     48       $ 23,878       $ 387       $ —  $         —         $ 23,878       $ 387   

Collateralized mortgage obligations

     2         —           —           11,032         1,031         11,032         1,031   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     50       $ 23,878       $ 387       $ 11,032       $ 1,031       $ 34,910       $ 1,418   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
As of December 31, 2010           Less than 12 months      12 months or longer      Total  

Type of securities

   Number of
Securities
     Fair
Value
     Unrealized
losses
     Fair
value
     Unrealized
losses
     Fair
value
     Unrealized
losses
 

Obligations of states and political subdivisions

     89       $ 39,836       $ 857       $ —         $ —         $ 39,836       $ 857   

Collateralized mortgage obligations

     2         —           —           10,981         1,483         10,981         1,483   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     91       $ 39,836       $ 857       $ 10,981       $ 1,483       $ 50,817       $ 2,340   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Management has considered factors such as market value, cash flows, and analysis of underlying collateral regarding other-than-temporarily impaired securities and determined that there are no other-than-temporarily impaired securities as of March 31, 2011.

The unrealized losses in collateralized mortgage obligations at March 31, 2011 were caused by changes in interest rates, a significant widening of credit spreads across markets for these securities, and illiquidity in the financial markets for these instruments. These securities include two private issues held at a continuous, unrealized loss for more than twelve months. Each of these securities has some level of credit enhancement, and none are collateralized by sub-prime loans. With the assistance of a third party, management reviews the characteristics of these securities periodically, including levels of delinquency and foreclosure, projected losses at various degrees of severity, and credit enhancement and coverage. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.

Suffolk does not have the intent to sell these securities and does not anticipate that it will be necessary to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, Suffolk did not consider these investments to be other-than-temporarily impaired at March 31, 2011.

 

(6) Allowance for Loan Losses

In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effect of these errors was recorded in the consolidated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010.

 

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Suffolk takes into account applicable guidance under U.S. GAAP, including particularly “ASC 855 – Subsequent Events.” Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the un-collectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

A loan is impaired when, based on current information and events, it is probable that Suffolk will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans over $250,000 are individually evaluated for impairment. However, the independent review of the loan portfolio included selected loans with balances less than $250,000. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of homogeneous loans with smaller individual balances, such as consumer and residential real estate loans, are evaluated collectively for impairment, and accordingly, are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be “collateral-dependent,” the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, Suffolk determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience, adjusted for qualitative factors. The historical loss experience is determined by portfolio segment, and is based on the actual loss history experienced by Suffolk over the historical loan loss period which is a rolling twelve month period. This actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment. These qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified:

 

   

Commercial, financial & agricultural loans

 

   

Commercial real estate mortgages

 

   

Real estate — construction loans

 

   

Residential mortgages (1st and 2nd liens)

 

   

Home equity loans

 

   

Consumer loans

 

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This amount is determined by applying historical loss factors to pools of loans within the portfolio having similar risk characteristics.

In addition, the qualitative factors are considered for areas of concern that cannot be fully quantified in the allocation based on historical net charge-off ratios. Qualitative factors include:

 

   

Economic outlook

 

   

Trends in delinquency and problem loans

 

   

Changes in loan volume and nature of terms of loans

 

   

Effects of changes in lending policy

 

   

Experience, ability, and depth of lending management and staff

 

   

Concentrations of credit

 

   

Effectiveness of loan review processes

 

   

Changes in value of underlying collateral

 

   

Competition, regulation, and other external factors

For performing loans, an estimate of adequacy is made by applying external factors specific to the portfolio to the period-end balances. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Allocated and general reserves are available for any identified loss.

Delinquent, non-performing, and classified loans have trended upward as charge-off activity has increased. These are primary factors in the determination of the allowance.

At March 31, 2011, non-performing loans and past due restructured loans totaled $48,339,000 as compared to $28,991,000 at December 31, 2010. When compared to total loans, non-performing loans rose to 4.40 percent at March 31, 2011, up from 2.61 percent at December 31, 2010. Commercial mortgages and commercial real estate construction loans were primarily responsible for the increase. Non-performing loans include all non-accrual loans.

 

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The following table presents information about the allowance for loan losses: (in thousands of dollars except for ratios)

 

Period Ended:

   Three Months Ended
March 31, 2011
     Year Ended
December 31, 2010
Restated
 

Allowance for loan losses, January 1,

   $ 28,419       $ 12,333   

Loans charged-off:

     

Commercial, financial & agricultural loans

     727         8,501   

Commercial real estate mortgages

     —           2,788   

Real estate construction loans

     —           3,548   

Residential mortgages (1st and 2nd liens)

     48         769   

Home equity loans

     70         315   

Consumer loans

     57         317   

Other loans

     —           —     
  

 

 

    

 

 

 

Total Charge-offs

   $ 902       $ 16,238   
  

 

 

    

 

 

 

 

Loans recovered after being charged-off

   Three Months Ended
March 31, 2011
     Year Ended
December 31, 2010
Restated
 

Commercial, financial & agricultural loans

     37         69   

Commercial real estate mortgages

     —           —     

Real estate construction loans

     —           —     

Residential mortgages (1st and 2nd liens)

     —           —     

Home equity loans

     —           —     

Consumer loans

     14         118   

Other loans

     —           —     
  

 

 

    

 

 

 

Total recoveries

   $ 51       $ 187   
  

 

 

    

 

 

 

Net loans charged-off

     851         16,051   

Reclass to allowance for contingent liabilities

     —           51   

Provision for loan losses

     19,971         32,086   
  

 

 

    

 

 

 

Allowance for loan losses, Ending Balance

   $ 47,539       $ 28,419   
  

 

 

    

 

 

 

Further information pertaining to the allowance for loan losses at March 31, 2011 is as follows: (in thousands)

 

    Commercial,
financial, and
agricultural
    Commercial
real estate
    Real estate
construction
loans
    Residential
mortgages (1st
and 2nd liens)
    Home equity
loans
    Consumer
loans
    Total  

Allowance for loan losses:

             

Ending balance (total allowance)

  $ 27,642      $ 10,599      $ 5,694      $ 615      $ 2,282      $ 707      $ 47,539   

Ending balance: individually evaluated for impairment

    7,764        5,934        1,578        —          —          —          15,276   

Ending balance: collectively evaluated for impairment

    19,878        4,665        4,116        615        2,282        707        32,263   

Loan balances:

             

Ending balance (loan portfolio) (1)

  $ 255,607      $ 437,302      $ 76,645      $ 183,971      $ 83,167      $ 61,644      $ 1,098,336   

Ending balance: individually evaluated for impairment

    21,317        60,299        30,648        6,845        3,508        171        122,788   

Ending balance: collectively evaluated for impairment

    234,290        377,003        45,997        177,126        79,659        61,473        975,548   

 

(1) Other loans of $487, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to period-end.

 

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Further information pertaining to the allowance for loan losses (restated) at December 31, 2010 is as follows: (in thousands)

 

    Commercial,
financial, and
agricultural
    Commercial
real estate
    Real estate
construction
loans
    Residential
mortgages (1st
and 2nd liens)
    Home equity
loans
    Consumer
loans (2)
    Total  

Allowance for loan losses:

             

Ending balance (total allowance)

  $ 13,826      $ 9,226      $ 3,177      $ 519      $ 1,392      $ 279      $ 28,419   

Ending balance: individually evaluated for impairment

    2,845        5,636        935        —          —          —          9,416   

Ending balance: collectively evaluated for impairment

    10,981        3,590        2,242        519        1,392        279        19,003   

Loan balances:

             

Ending balance (loan portfolio) (1)

  $ 248,750      $ 431,179      $ 82,720      $ 195,993      $ 84,696      $ 67,814      $ 1,111,152   

Ending balance: individually evaluated for impairment

    17,277        51,540        26,897        3,466        986        75        100,241   

Ending balance: collectively evaluated for impairment

    231,473        379,639        55,823        192,527        83,710        67,739        1,010,911   

 

(1) Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to period-end.
(2) Net of unearned discount totalling $28 at December 31, 2010.

The following is a summary of current and past due loans at March 31, 2011: (in thousands)

 

     30-59 days past
due
     60-89 days past
due
     90 days and
over past due
     Total past due      Current      Total loans  

Commercial:

                 

Commercial, financial, and agricultural

   $ 2,601       $ 1,142       $ 6,790       $ 10,533       $ 245,074       $ 255,607   

Commercial real estate

     9,494         1,857         21,720         33,071         404,231         437,302   

Real estate construction loans

     —           —           10,640         10,640         66,005         76,645   

Consumer:

                 

Residential mortgages (1st and 2nd liens)

     1,468         214         5,510         7,192         176,779         183,971   

Home equity loans

     755         107         3,508         4,370         78,797         83,167   

Consumer loans

     328         78         171         577         61,067         61,644   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total (1)

   $ 14,646       $ 3,398       $ 48,339       $ 66,383       $ 1,031,953       $ 1,098,336   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Other loans of $487, not included here, consisted of overdraft loans, nearly all of which had been repaid subsequent to period-end.

 

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The following is a summary of current and past due loans (restated) at December 31, 2010: (in thousands)

 

    30-59 days past
due
    60-89 days past
due
    90 days and
over past due
    Total past due     Current     Total loans  

Commercial:

           

Commercial, financial, and agricultural

  $ 212      $ 81      $ 2,382      $ 2,675      $ 246,075      $ 248,750   

Commercial real estate

    4,375        243        11,601        16,219        414,960        431,179   

Real estate construction loans

    —          —          10,481        10,481        72,239        82,720   

Consumer:

           

Residential mortgages (1st and 2nd liens)

    2,162        1,934        3,466        7,562        188,431        195,993   

Home equity loans

    637        1,140        986        2,763        81,933        84,696   

Consumer loans (2)

    408        108        75        591        67,223        67,814   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total (1)

  $ 7,794      $ 3,506      $ 28,991      $ 40,291      $ 1,070,861      $ 1,111,152   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Other loans of $1.127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to period-end.
(2) Net of unearned discount totalling $28 at December 31, 2010.

The following is a summary of impaired loans: (in thousands)

 

     March 31, 2011      December 31, 2010
Restated
 
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
 

Commercial, financial & agricultural loans

   $ 15,662       $ 5,655       $ 21,317       $ 7,764       $ 8,227       $ 9,050       $ 17,277       $ 2,845   

Commercial real estate mortgages

     34,556         25,743         60,299         5,934         34,301         17,239         51,540         5,636   

Real estate construction loans

     9,872         20,776         30,648         1,578         6,569         20,328         26,897         935   

Residential mortgages (1st and 2nd liens)

     —           6,845         6,845         —           —           3,466         3,466         —     

Home equity loans

     —           3,508         3,508         —           —           986         986         —     

Consumer loans

     —           171         171         —           —           75         75         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 60,090       $ 62,698       $ 122,788       $ 15,276       $ 49,097       $ 51,144       $ 100,241       $ 9,416   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Quarter  ended
March 31, 2011
     Year ended
December 31, 2010
Restated
 
       

Average investment in impaired loans

   $ 111,515       $ 63,101   

 

     Quarter ended
March 31, 2011
     Quarter ended
March 31, 2010
 

Interest income recognized on impaired loans

   $ 1,071       $ 547   

Interest income recognized on a cash basis on impaired loans

   $ —         $ —     

 

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The following is a summary of information pertaining to impaired and non-accrual loans: (in thousands)

 

     March 31,
2011
     December 31,
2010
Restated
 

Impaired loans without a valuation allowance

   $ 62,698       $ 51,144   

Impaired loans with a valuation allowance

     60,090         49,097   
  

 

 

    

 

 

 

Total impaired loans

     122,788         100,241   
  

 

 

    

 

 

 

Valuation allowance related to impaired loans

   $ 15,276       $ 9,416   

Total non-accrual loans (1)

     48,339         28,991   

Total loans past due 90 days or more and still accruing

     —           —     

Troubled debt restructurings accruing interest

     8,417         11,904   

Troubled debt restructurings - nonaccruing

     22,321         12,140   

 

(1) Includes troubled debt restructurings of $12,140 on December 31, 2010 and $22,321 on March 31, 2011

Additional interest income of approximately $801,000 and $428,000, respectively, would have been recorded during the three months ended March 31, 2011 and March 31, 2010, respectively, if the loans had performed in accordance with their original terms.

A total of $5,419,000 is committed to be advanced in connection with impaired loans as of March 31, 2011.

The following table summarizes loan balances and allocates the allowance for loan losses by risk rating as of March 31, 2011: (in thousands)

 

     Commercial,
financial, and
agricultural
    Commercial
real estate
    Real estate
construction
loans
    Residential
mortgages (1st
and 2nd liens)
    Home equity
loans
    Consumer
loans
    Total  

Unimpaired loans:

              

Total pass loans (1)

   $ 163,983      $ 259,428      $ 12,069      $ 177,126      $ 79,659      $ 61,473      $ 753,738   

Loss factor (2)

     9.13     1.22     8.93     0.35     2.86     1.15     3.03
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

     14,979        3,167        1,078        615        2,282        707        22,828   

Total special mention loans

     31,253        74,105        13,627        —          —          —          118,985   

Loss factor

     7.20     1.27     8.95           3.71
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

     2,249        944        1,220        —          —          —          4,413   

Total substandard loans

     39,054        43,470        20,301        —          —          —          102,825   

Loss factor

     6.79     1.27     8.96           4.88
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

     2,650        554        1,818        —          —          —          5,022   

Impaired loans:

              

Total substandard loans

     20,286        60,299        29,819        6,845        3,508        171        120,928   

Loss factor

     33.76     9.84     2.51 %(3)            11.19
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

     6,849        5,934        749        —          —          —          13,532   

Total doubtful loans

     1,031        —          829        —          —          —          1,860   

Loss factor

     88.75       100.00           93.76
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

     915        —          829        —          —          —          1,744   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unimpaired loans

   $ 234,290      $ 377,003      $ 45,997      $ 177,126      $ 79,659      $ 61,473      $ 975,548   

Total reserve on unimpaired loans

   $ 19,878      $ 4,665      $ 4,116      $ 615      $ 2,282      $ 707      $ 32,263   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Risk-graded loans 1 to 4. Other loans of $487, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to March 31, 2011.
(2) Loss factor calculation is specific reserves as a percentage of balance for a portfolio segment.
(3) Loss factor is driven by higher collateral positions and charge offs taken within this portfolio segment.

 

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The following table summarizes loan balances and allocates the allowance for loan losses by risk rating (restated) as of December 31, 2010: (in thousands)

 

    Commercial,
financial, and
agricultural
    Commercial
real estate
    Real estate
construction
loans
    Residential
mortgages (1st and
2nd liens)
    Home equity
loans
    Consumer
loans(4)
    Total  

Unimpaired loans:

             

Total pass loans (1)

  $ 202,926      $ 314,447      $ 39,530      $ 192,527      $ 83,710      $ 67,739      $ 900,879   

Loss factor (2)

    4.80     0.95     3.96     0.27     1.66     0.41     1.83
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

    9,731        2,996        1,567        519        1,392        279        16,484   

Total special mention loans

    6,291        28,823        1,773        —          —          —          36,887   

Loss factor

    4.43     0.91     4.12           1.67
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

    279        263        73        —          —          —          615   

Total substandard loans

    22,256        36,369        14,520        —          —          —          73,145   

Loss factor

    4.36     0.91     4.15           2.60
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

    971        331        602        —          —          —          1,904   

Impaired loans:

             

Total substandard loans

    16,792        51,540        26,226        3,466        986        75        99,085   

Loss factor

    14.37     10.94     1.01 %(3)            8.39
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

    2,413        5,636        264        —          —          —          8,313   

Total doubtful loans

    485        —          671        —          —          —          1,156   

Loss factor

    89.07       100.00           95.42
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve

    432        —          671        —          —          —          1,103   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total unimpaired loans

  $ 231,473      $ 379,639      $ 55,823      $ 192,527      $ 83,710      $ 67,739      $ 1,010,911   

Total reserve on unimpaired loans

  $ 10,981      $ 3,590      $ 2,242      $ 519      $ 1,392      $ 279      $ 19,003   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Risk-graded loans 1 to 4. Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to year-end.
(2) Loss factor calculation is specific reserves as a percentage of balance for a portfolio segment.
(3) Loss factor is driven by higher collateral positions and charge offs taken within this portfolio segment.
(4) Net of unearned discounts totalling $28 at December 31, 2010.

The following table summarizes the allowance for loan losses by loan type as of March 31, 2011: (in thousands)

 

Allowance for loan losses   Commercial,
financial &
agricultural loans
    Commercial
real
estate mortgages
    Real estate
construction
loans
    Residential
mortgages (1st and
2nd liens)
    Home equity
loans
    Consumer
loans
    Total  

Beginning balance (restated)

  $ 13,826      $ 9,226      $ 3,177      $ 519      $ 1,392      $ 279      $ 28,419   

Total charge-offs

    (727     —          —          (48     (70     (57     (902

Total recoveries

    37        —          —          —          —          14        51   

Provision for loan losses

    14,506        1,373        2,517        144        960        471        19,971   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 27,642      $ 10,599      $ 5,694      $ 615      $ 2,282      $ 707      $ 47,539   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Credit Quality Information

The Bank utilizes an eight-grade risk-rating system for commercial loans, commercial real estate and construction loans as follows:

 

  Risk Grade 1 Excellent:

Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.

 

  Risk Grade 2 Good:

Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by un-audited financial statements containing strong balance

 

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sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets, established credit history, and unquestionable character; or loans to publicly held companies with current long-term debt ratings of Baa or better.

 

  Risk Grade 3 Satisfactory:

Loans supported by financial statements (audited or un-audited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.

Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

 

   

At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory;

 

   

At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.

 

   

The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

 

   

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or

 

   

The borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

 

  Risk Grade 4 Satisfactory/Monitored:

Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than satisfactory loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision.

 

  Risk Grade 5 Special Mention:

Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment.

 

  Risk Grade 6 Substandard:

One or more of the following characteristics may be exhibited in loans classified Substandard:

 

   

Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

 

   

Loans are inadequately protected by the current net worth and paying capacity of the obligor.

 

   

The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

 

   

Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

 

   

Unusual courses of action are needed to maintain a high probability of repayment.

 

   

The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.

 

   

The lender is forced into a subordinated or unsecured position due to flaws in documentation.

 

   

Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.

 

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The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

 

   

There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

 

  Risk Grade 7 Doubtful:

One or more of the following characteristics may be present in loans classified Doubtful:

 

   

Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

 

   

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

 

   

The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

 

  Risk Grade 8 Loss:

Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The Bank considers real estate, home equity and consumer loans secured by real estate (such as mobile homes) that are contractually past due 90 days or more or where legal action has commenced against the borrower to be substandard. The Bank follows the Federal Financial Institutions Examination Council (“FFIEC”) Uniform Retail Credit Classification guidelines.

The Bank formally reviews the ratings on all commercial and industrial, commercial real estate and construction loans greater than $1 million annually. Quarterly, the Bank engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process.

The following table identifies credit risk by the internally assigned grade at March 31, 2011: (in thousands)

 

     Credit Risk Profile By Internally Assigned Grade  
     Commercial Credit Exposure      Consumer Credit Exposure         
     Commercial,
financial, and
agricultural
     Commercial
real estate
     Real estate
construction

loans
     Residential
mortgages  (1st

and 2nd liens)
     Home equity
loans
     Consumer loans      Total  

Grade:

                    

Pass (1)

   $ 163,983       $ 259,428       $ 12,069       $ 177,126       $ 79,659       $ 61,473       $ 753,738   

Special mention

     31,253         74,105         13,627         —           —           —           118,985   

Substandard

     59,340         103,769         50,120         6,845         3,508         171         223,753   

Doubtful

     1,031         —           829         —           —           —           1,860   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 255,607       $ 437,302       $ 76,645       $ 183,971       $ 83,167       $ 61,644       $ 1,098,336   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Other loans of $487, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to March 31, 2011.

 

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The following table identifies credit risk by the internally assigned grade (restated) at December 31, 2010: (in thousands)

 

     Credit Risk Profile By Internally Assigned Grade  
     Commercial Credit Exposure      Consumer Credit Exposure         
     Commercial,
financial, and
agricultural
     Commercial
real estate
     Real estate
construction

loans
     Residential
mortgages (1st
and 2nd liens)
     Home equity
loans
     Consumer
loans (2)
     Total  

Grade:

                    

Pass (1)

   $ 202,926       $ 314,447       $ 39,530       $ 192,527       $ 83,710       $ 67,739       $ 900,879   

Special mention

     6,291         28,823         1,773         —           —           —           36,887   

Substandard

     39,048         87,909         40,746         3,466         986         75         172,230   

Doubtful

     485         —           671         —           —           —           1,156   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 248,750       $ 431,179       $ 82,720       $ 195,993       $ 84,696       $ 67,814       $ 1,111,152   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to December 31, 2010.
(2) Net of unearned discounts totalling $28 at December 31, 2010.

The following table summarizes as of March 31, 2011 loans that have been restructured during the period presented: (dollars in thousands)

 

     For the three months ended March 31, 2011  

Troubled Debt Restructurings

   # of
Loans
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 

Commercial, financial, and agricultural

     15       $ 2,795       $ 2,795   

Commercial, secured by real estate

     3         3,802         3,802   

Real estate construction loans

     0         —           —     

Residential mortgages

     0         —           —     

Home Equity

     0         —           —     

Consumer

     2         34         34   
  

 

 

    

 

 

    

 

 

 
     20       $ 6,631       $ 6,631   
  

 

 

    

 

 

    

 

 

 

The following table summarizes as of March 31, 2011, loans that were restructured that have subsequently defaulted within the last twelve months: (dollars in thousands)

 

Defaulted Troubled Debt Restructurings

   # of
Loans
     Recorded
Investment
 

Commercial, financial, and agricultural

     23       $ 769   

Commercial, secured by real estate

     4         9,703   

Real estate construction loans

     1         5,875   

Residential mortgages

     3         1,169   

Home Equity

     0         —     

Consumer

     4         23   
  

 

 

    

 

 

 
     35       $ 17,539   
  

 

 

    

 

 

 

Defaulted restructured loans include 14 contracts with zero balances: 12 commercial, financial, and agricultural loans, one commercial loan secured by real estate and one consumer loan. One of the commercial, financial, and agricultural loans was paid off, the remaining 13 were charged off.

(7)    Comprehensive Income

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

 

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The following table summarizes the changes in accumulated other comprehensive loss: (in thousands)

 

For the period ended,

   March 31, 2011     December 31, 2010  

Balance January 1,

   $ (2,229   $ (1,707

Net change in unrealized net gain on investment securities, net of tax

     1,099        2,122   

Reclassification of gains on sales of securities recognized, net of tax

     —          (223

Postretirement plan projected benefit obligation

     (89     (2,421
  

 

 

   

 

 

 

Total accumulated other comprehensive loss

   $ (1,219   $ (2,229
  

 

 

   

 

 

 

The unrealized gain on investment securities at March 31, 2011 is mainly attributable to an increase of $1,255,000 in the market value of obligations of state and political subdivisions. This is offset by decreases of $80,000 in the market value of U.S. government agency debt, $38,000 in the market value of U.S. treasury securities, and $38,000 in the market value of collateralized mortgage obligations.

 

(8) Retirement Plan

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

Suffolk presents information concerning net periodic defined benefit pension expense for the three months ended March 31, 2011 and 2010, including the following components: (in thousands)

 

For the three months ended,

   March 31, 2011     March 31, 2010  

Service cost

   $ 545      $ 451   

Interest cost

     562        510   

Expected return on plan assets

     (560     (538

Amortization of prior service cost

     244        181   
  

 

 

   

 

 

 

Net periodic benefit expense

   $ 791      $ 604   
  

 

 

   

 

 

 

There is no minimum required contribution for the pension plan year ending September 30, 2011. There were no additional contributions required to be made to the plan in the three months ended March 31, 2011.

 

(9) Recent Accounting Pronouncements

In January 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-01, which temporarily delays the effective date of the required disclosures about troubled debt restructurings contained in ASU No. 2010-20. The delay is intended to allow the FASB additional time to deliberate what constitutes a troubled debt restructuring. All other amendments contained in ASU No. 2010-20 are effective as issued. Adoption of this update did not have a material effect on Suffolk’s results of operations or financial condition.

In April 2011, the FASB issued ASU No. 2011-02, which amends the authoritative accounting guidance under ASC Topic 310 “Receivables.” The update provides clarifying guidance as to what constitutes a troubled debt restructuring. The update provides clarifying guidance on a creditor’s evaluation of the following: (1) how a restructuring constitutes a concession; and (2) if the debtor is experiencing financial difficulties. The amendments in this update are effective for the first interim or

 

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annual period beginning on or after June 15, 2011, or July 1, 2011 as to Suffolk, and should be applied retrospectively to the beginning of the annual period of adoption. In addition, disclosures about troubled debt restructurings which were delayed by the issuance of ASU No. 2011-01, are effective for interim and annual periods beginning on or after June 15, 2011. Adoption of this update did not have a material effect on Suffolk’s results of operations or financial condition.

In April 2011, the FASB issued ASU No. 2011-03, which amends the authoritative accounting guidance under ASC Topic 860 “Transfers and Servicing.” The amendments in this update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this update are effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. Adoption of this update is not expected to have a material effect on Suffolk’s results of operations or financial condition.

In May 2011, the FASB issued ASU No. 2011-04, which amends the authoritative accounting guidance under ASC Topic 820 “Fair Value Measurement” to more closely align GAAP with International Financial Reporting Standards (“IFRS”). This standard requires the disclosure of: (1) the reason for the measurement for both recurring and nonrecurring fair value measurements; (2) all transfers between levels of the fair value hierarchy must be separately reported and described; (3) for all Level 2 and Level 3 fair value measurements, a description of the valuation technique(s) and the inputs used in those measurements; (4) For Level 3 measurements, the quantitative information about the significant unobservable inputs used in those measurements; and (5) A description of the valuation processes used in Level 3 fair value measurements, as well as narrative descriptions about those measurement’s sensitivity to changes in unobservable inputs if such changes would significantly alter the fair value measurement. The amendment is effective for interim and annual periods beginning after December 15, 2011 and early application is not permitted. Adoption of this update is not expected to have a material effect on Suffolk’s results of operations or financial condition.

In June 2011, the FASB issued ASU No. 2011-05 in order to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This standard eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This update requires all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. This update is effective for public companies for fiscal years ending after December 31, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, or January 1, 2012 as to Suffolk. Adoption of this update is not expected to have a material effect on Suffolk’s results of operations or financial condition.

 

(10)  Regulatory Matters

On October 25, 2010, the Bank, following discussion with the Office of the Comptroller of the Currency (the “OCC”) entered into an agreement with the OCC (the “Agreement”). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.

Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.

The Bank is subject to individual minimum capital ratios (“IMCR’s”) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. At March 31, 2011, management believes the Bank met two of the three IMCR’s: Tier 1 Capital was 10.97 percent of risk-weighted assets and Total Risk Based Capital was 12.25 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 Leverage ratio as Tier 1 capital was 7.90 percent of adjusted total assets at March 31, 2011. At June 30, 2011, the Bank met two of the IMCR’s: Tier 1 Capital was 11.59 percent of risk-weighted assets and Total Risk Based Capital was 12.88 percent

 

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of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 leverage ratio as Tier 1 capital was 7.98 percent of adjusted total assets at June 30, 2011. The Bank met all three IMCR’s at September 30, 2011: Tier 1 Capital was 8.50 percent of adjusted total assets, Tier 1 Capital was 12.53 percent of risk-weighted assets, and Total Risk Based Capital was 13.82 percent of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.

The Bank has notified its primary regulator that the Bank did not meet the IMCR for the Tier 1 Leverage ratio as of March 31, 2011 and June 30, 2011 but was in compliance as of September 30, 2011 requiring no further plan of action.

At March 31, 2011, Suffolk’s Tier 1 capital ratio was 7.94 percent of adjusted total assets, Tier 1 capital ratio was 11.04 percent of risk-weighted assets, and Total Risk Based capital ratio was 12.32 percent of risk-weighted assets.

The ability of the Bank to pay dividends to Suffolk is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock of which the Bank has none as of March 31, 2011. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the Bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. In addition, under the Agreement the Bank is required to establish a dividend policy that will permit the declaration of a dividend only when the Bank is in compliance with its capital program and with the prior written determination of no supervisory objection by the OCC.

While subject to the Agreement, Suffolk expects that its and the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.

 

(11)  Legal Proceedings

On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.

On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.

On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.

The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.

Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not

 

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asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.

 

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Item 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

For the Three Month Periods ended March 31, 2011 and 2010

Recent Developments

With respect to the first quarter of 2011, the key reason for the performance is the provision for loan losses of $19,971,000 which was an increase of 126.0 percent from the provision of $8,837,000 for the first quarter of 2010.

At Suffolk, net interest income decreased $839,000, or 4.4 percent compared to the first quarter of 2010. The decline in net interest income was driven by declines in both yields and balances of earning assets, and also by the temporary reinvestment of liquidity in low-yielding fed funds and bank deposits, offset by an improvement in the Bank’s cost of funds. See table on page 28. Interest income decreased $1,598,000, or 7.3 percent, and interest expense decreased $759,000, or 28.4 percent. The net interest margin decreased to 4.99 percent in the first quarter of 2011, down from 5.02 percent during the first quarter of 2010. The provision for loan losses increased by 126.0 percent over the first quarter of 2010, from $8,837,000 to $19,971,000.

In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effect of these errors were recorded in the consolidated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010. At March 31, 2011, Suffolk had $48,339,000 of non-performing loans, $41,378,000 of which was secured by collateral valued at approximately $73,019,000, having an average loan-to-value ratio of approximately 57 percent. The unsecured portion of $6,961,000 amounted to 66 basis points of net loans at quarter end. To determine the adequacy of the allowance for loan losses Suffolk considered the status of non-performing loans on its books. Although Suffolk continues to work with borrowers to ensure the collection of nonperforming credits, some of these loans were being paid more slowly than originally anticipated. Non-performing loans secured by commercial real estate totaled $21,721,000, or 44.9 percent of total non-performing loans. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors, including Suffolk’s own historical loan loss experience as well as Suffolk’s peer bank loss experiences.

Non-performing assets as a percent of total assets were 185 basis points at March 31, 2010; 212 basis points at June 30, 2010; 191 basis points at September 30, 2010; 216 basis points at December 31, 2010; and 320 basis points at March 31, 2011. Non-performing loans to total loans amounted to 270 basis points at March 31, 2010; 311 basis points at June 30, 2010; 283 basis points at September 30, 2010; 261 basis points at December 31, 2010; and 440 basis points at March 31, 2011. However, as they remain non-accruing over a period of time, on the basis of objective and selective criteria, Suffolk may or may not elect to charge these and other loans off prudentially, even when they remain in collection and there is the reasonable remaining expectation of the recovery of amounts owed and expenses incurred in collection. These charge-offs may or may not mirror trends, on a trailing basis, in ratios of non-performing assets to total assets and non-performing loans to total loans. The amounts charged off may be substantial in comparison with Suffolk’s past loss history, although they may result in net recoveries at some point in the future if the economy improves and borrowers’ financial conditions strengthen, although there can be no assurance that this will happen. Further discussion concerning the determination of the provision for loan losses is found in the following under the caption, “Allowance for Loan Losses.”

Basic Performance and Current Activities

There was no return on average equity for the first quarter of 2011, compared to 4.45 percent during the first quarter of 2010, and basic earnings(loss)-per-share decreased from $0.16 in the first quarter of 2010 to $(0.78) in the first quarter of 2011. The decrease was primarily driven by the increase of our provision for loan losses.

Continuing managerial emphasis included:

 

   

Maintaining emphasis on both commercial and personal demand deposits, and non-maturity time deposits as a key part of relationships with customers while responding as necessary to demand in Suffolk’s market for certificates of deposit of all sizes. Suffolk continues its emphasis on the profitability of the whole relationship of its customers with the Bank, seeking when possible to both make loans to and obtain funding from the best qualified customers.

 

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Managing net loan charge-offs and non-performing loans. During the first quarter of 2011, net charge-offs amounted to 3.38 percent of average net loans, on an annualized basis. Non-performing loans, those more than 90 days past due, increased. Lending staff’s first efforts continue to be directed to the management of such credits, and then to developing new business with an emphasis on the most profitable customer relationships.

 

   

Managing the investment portfolio in a difficult rate environment, reducing balances of municipal securities to moderate concentration risk, and paying down advances from the Federal Home Loan Bank to reduce liabilities, and increase leverage capital ratios, which was accomplished during the second quarter of 2011.

Net Income (Loss)

Net loss was $(7,574,000) for the first quarter of 2011, down 594 percent from $1,532,000 posted during the same period last year. Basic and diluted loss-per-share for the quarter was $(0.78) versus earnings-per-share of $0.16, a decrease of 588 percent. The key reason for the decline was a substantial provision for loan losses, in addition to a decline in net interest income of $839,000, from $19,246,000 to $18,407,000.

Interest Income

Interest income was $20,319,000 for the first quarter of 2011, down 7.3 percent from $21,917,000 posted for the same quarter in 2010. Average net loans during the first quarter of 2011 totaled $1,113,812,000 compared to $1,149,479,000 for the same period of 2010. During the first quarter of 2011, the yield on a fully taxable-equivalent basis was 5.48 percent on average earning assets of $1,555,324,000, down from 5.68 percent on average earning assets of $1,612,741,000 during the first quarter of 2010.

Interest Expense

Interest expense for the first quarter of 2011 was $1,912,000, down 28.4 percent from $2,671,000 for the same period of 2010. During the first quarter of 2011, the cost of funds was 0.79 percent on average interest-bearing liabilities of $970,365,000, down from 0.99 percent on average interest-bearing liabilities of $1,079,064,000 during the first quarter of 2010. Interest expense decreased due to decreased rates paid for all interest-bearing liabilities, in addition to a decrease in average borrowings outstanding.

A portion of the Bank’s demand deposits are reclassified as savings accounts on a daily basis. The purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.

Net Interest Income

Net interest income, before the provision for loan losses, is the largest component of Suffolk’s earnings. It was $18,407,000 for the first quarter of 2011, down 4.4 percent from $19,246,000 during the same period of 2010. The net interest margin for the quarter, on a fully taxable-equivalent basis, was 4.99 percent compared to 5.02 percent for the same period of 2010.

As part of its de-leveraging strategy, in June 2011 Suffolk pre-paid a $40 million borrowing from the Federal Home Loan Bank of New York and incurred a $1 million pre-payment penalty. Suffolk also sold approximately $40 million of investment securities in June 2011 realizing a gain of $1.6 million. These transactions were recorded in the second quarter of 2011.

 

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The following table details the components of Suffolk’s net interest income for the quarter on a taxable-equivalent basis: (in thousands)

 

Quarters ended March 31,    2011     2010  
     Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest     Average
Rate
 

INTEREST-EARNING ASSETS

              

U.S. Treasury securities

   $ 8,077       $ 72        3.55   $ 8,320       $ 72        3.46

Collateralized mortgage obligations

     158,526         1,628        4.11        191,561         2,080        4.34   

Mortgage backed securities

     509         8        6.34        597         10        6.70   

Obligations of states and political subdivisions

     213,246         2,904        5.45        207,369         2,854        5.51   

U.S. government agency obligations

     22,407         154        2.75        43,223         202        1.87   

Other securities

     4,397         84        7.61        9,803         100        4.08   

Federal funds sold and interest bearing bank deposits

     34,350         16        0.19        2,389         2        0.33   

Loans, net of allowance for loan losses

              

Commercial, financial & agricultural loans

     258,536         3,717        5.75        264,804         3,812        5.76   

Commercial real estate mortgages

     440,361         6,882        6.25        381,953         6,399        6.70   

Real estate construction loans

     82,420         1,133        5.50        128,307         1,988        6.20   

Residential mortgages (1st and 2nd liens)

     184,762         2,793        6.05        207,904         3,134        6.03   

Home equity loans

     83,631         831        3.97        82,502         841        4.08   

Consumer loans

     63,498         1,092        6.88        80,108         1,399        6.99   

Other loans (overdrafts)

     604         —          —          3,901         —          —     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-earning assets

   $ 1,555,324       $ 21,314        5.48   $ 1,612,741       $ 22,893        5.68
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Cash and due from banks

   $ 37,882           $ 38,854        

Other non-interest-earning assets

     53,838             73,804        
  

 

 

        

 

 

      

Total assets

   $ 1,647,044           $ 1,725,399        

INTEREST-BEARING LIABILITIES

              

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

   $ 627,944       $ 634        0.40   $ 585,181       $ 860        0.59

Time deposits

     299,158         939        1.26        326,386         1,277        1.57   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total saving and time deposits

     927,102         1,573        0.68        911,567         2,137        0.94   

Federal funds purchased and securities sold under agreement to repurchase

     280         —          0.55        1,000         —          —     

Other borrowings

     42,983         339        3.16        166,497         534        1.28   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-bearing liabilities

   $ 970,365       $ 1,912        0.79   $ 1,079,064       $ 2,671        0.99
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Rate spread

          4.69          4.69

Non-interest-bearing deposits

   $ 493,627           $ 466,490        

Other non-interest-bearing liabilities

     46,344             42,107        
  

 

 

        

 

 

      

Total liabilities

   $ 1,510,336           $ 1,587,661        

Stockholders’ equity

     136,708             137,738        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 1,647,044           $ 1,725,399        

Net-interest income (taxable-equivalent basis) and effective interest rate differential

      $ 19,402        4.99      $ 20,222        5.02

Less: taxable-equivalent basis adjustment

        (995          (976  
     

 

 

        

 

 

   

Net-interest income

      $ 18,407           $ 19,246     
     

 

 

        

 

 

   

 

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

 

     In First Quarter of 2011 over
First Quarter of 2010, Changes Due to
 
     Volume     Rate     Net Change  

Interest-earning assets

      

U.S. Treasury securities

   $ (2   $ 2      $ —     

Collateralized mortgage obligations

     (344     (108     (452

Mortgage-backed securities

     (1     (1     (2

Obligations of states & political subdivisions

     51        (1     50   

U.S. government agency obligations

     (121     73        (48

Other securities

     (73     57        (16

Federal funds sold & interest bearing bank deposits

     15        (1     14   

Loans, including non-accrual loans

     (536     (589     (1,125
  

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ (1,011   $ (568   $ (1,579
  

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities

      

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

   $ 59      $ (285   $ (226

Time deposits

     (100     (238     (338

Other borrowings

     (591     396        (195
  

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (632   $ (127   $ (759
  

 

 

   

 

 

   

 

 

 

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

   $ (379   $ (441   $ (820
  

 

 

   

 

 

   

 

 

 

Other Income

Other income decreased to $2,221,000 for the quarter compared to $2,508,000 the previous year, down 11.4 percent primarily due to a decline in service charges. Service charges on deposits were down 20.6 percent, attributable to a change in Federal Reserve Regulation E in July 2010 prohibiting banks from charging overdraft fees to consumer accounts for which debit card usage effected an overdraft. In addition, the daily administrative review fees were also terminated at this point. Prior to July 2010, the Bank charged an overdraft fee as well as a daily administrative review fee for as many days as the account remained overdrawn. Service charges, including commissions and fees other than for deposits, were virtually unchanged. Fiduciary fees were down 26.7 percent, as the result of payout commissions on terminated trusts, the settlement of an estate and final fees taken on closed accounts, in the first quarter of 2010. Other operating income increased by 19.6 percent.

Other Expense

Other expense for the first quarter of 2011 was $13,773,000, up 15.9 percent from $11,883,000 for the comparable period in 2010. FDIC assessments increased by $528,000 or 87.6 percent as a result of increased deposits and higher assessment rates. Other increases include salaries and employee benefits of 7.3 percent, net occupancy expense of 7.4 percent, and other operating expense of 6.3 percent. Equipment expense decreased by 9.6 percent, primarily due to a decrease in depreciation expense of $52,000, or 13.5 percent.

Capital Resources

Stockholders’ equity totaled $130,655,000 on March 31, 2011, a decrease of 4.51 percent from $136,820,000 on December 31, 2010. This was the result of a net loss and partially offset by an increase in the market value of securities available for sale. The ratio of equity to assets was 8.1 percent at March 31, 2011 and 8.5 percent at December 31, 2010, respectively.

 

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The following table details amounts and ratios of Suffolk’s regulatory capital: (in thousands of dollars except ratios)

 

     Actual     For capital adequacy     To be well capitalized
under prompt corrective
action provisions
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of March 31, 2011

               

Total Capital (to risk-weighted assets)

   $ 145,701         12.32   $ 94,601         8.00   $ 118,251         10.00

Tier 1 Capital (to risk-weighted assets)

     130,510         11.04     47,300         4.00     70,951         6.00

Tier 1 Capital (to average assets)

     130,510         7.94     65,787         4.00     82,234         5.00

As of December 31, 2010 (Restated)

               

Total Capital (to risk-weighted assets)

   $ 153,442         12.62   $ 97,276         8.00   $ 121,595         10.00

Tier 1 Capital (to risk-weighted assets)

     138,075         11.36     48,638         4.00     72,957         6.00

Tier 1 Capital (to average assets)

     138,075         8.26     66,848         4.00     83,560         5.00

The Bank is subject to individual minimum capital ratios (“IMCR’s”) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. At March 31, 2011, management believes the Bank met two of the three IMCR’s: Tier 1 Capital was 10.97 percent of risk-weighted assets and Total Risk Based Capital was 12.25 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 Leverage ratio as Tier 1 capital was 7.90 percent of adjusted total assets at March 31, 2011. At June 30, 2011, the Bank met two of the IMCR’s: Tier 1 Capital was 11.59 percent of risk-weighted assets and Total Risk Based Capital was 12.88 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 leverage ratio as Tier 1 capital was 7.98 percent of adjusted total assets at June 30, 2011. The Bank met all three IMCR’s at September 30, 2011: Tier 1 Capital was 8.50 percent of adjusted total assets, Tier 1 Capital was 12.53 percent of risk-weighted assets, and Total Risk Based Capital was 13.82 percent of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.

The Bank has notified its primary regulator that the Bank did not meet the IMCR for the Tier 1 Leverage ratio as of March 31, 2011 and June 30, 2011, but believes it was in compliance as of September  30, 2011 requiring no further plan of action.

Credit Risk

Suffolk makes loans based on its evaluation of the creditworthiness of the borrower. Even with careful underwriting, some loans may not be repaid as originally agreed. To provide for this possibility, Suffolk maintains an allowance for loan losses based on an analysis of the performance of the loans in its portfolio. The analysis includes subjective factors based on management’s judgment as well as quantitative evaluation. Estimates should produce an allowance that will provide for a range of losses. According to GAAP, a financial institution should record its best estimate. Appropriate factors contributing to the estimate may include changes in the composition of the institution’s assets, or potential economic slowdowns or downturns. Also important is the geographical or political environment in which the institution operates.

Suffolk’s management considers all of these factors when determining the provision for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of establishing a program to improve credit risk management and implementing an asset diversification program. Please refer to the discussion of the allowance for loan losses below.

 

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Suffolk has financial and performance letters of credit. Financial letters of credit require Suffolk to make payments if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require Suffolk to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of March 31, 2011 is $21,470,000 and they expire as follows: (in thousands)

 

2011

   $ 20,291   

2012

     711   

2013

     44   

2014

     —     

Thereafter

     424   
  

 

 

 
   $ 21,470   
  

 

 

 

Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The allowance for contingent liabilities includes a provision of $32,000 for losses based on the letters of credit outstanding as of March 31, 2011.

Critical Accounting Policies, Judgments and Estimates

Suffolk’s accounting and reporting policies conform to GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. See also the discussion on the change in estimate in “Basis of Presentation” in Note (1).

Allowance for Loan Losses

On October 25, 2010, the Bank entered into an agreement with the OCC (the “Agreement”) which required the Bank to, among other things, review its allowance for loan losses policy. In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effect of these errors was recorded in the restated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010.

Suffolk takes into account applicable guidance under GAAP, including particularly “ASC 855 – Subsequent Events.” Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.

Suffolk considers the determination of the allowance for loan losses to involve a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses (“ALLL”) is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral and other possible sources of repayment. Suffolk maintains an ALLL at a level management believes will be adequate to absorb probable losses on existing loans that may become uncollectible, based on an evaluation of their collectibility; however, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant change. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is well past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. Residential real estate and consumer loans are analyzed as a group and not individually because of the large number of loans, small balances, and historically low losses. In the future, the provision for loan losses may change as a percentage of total loans. The percentage of net charge-offs to average net loans during the three months ended March 31, 2011 was 0.31 percent compared to 1.42 percent in 2010 and 0.09 percent in 2009 for the respective

 

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three month periods ended March 31st. The ratio of the allowance for loan losses to total loans was 4.33 percent at March 31, 2011, compared to 2.56 percent at the end of 2010, and 1.06 percent in 2009.

A summary of transactions follows: (in thousands)

 

     Period Ended:    Three Months Ended
March 31, 2011
     Year Ended
December 31, 2010
Restated
 

Allowance for loan losses, January 1,

      $ 28,419       $ 12,333   

Loans charged-off:

        

Commercial, financial & agricultural loans

        727         8,501   

Commercial real estate mortgages

        —           2,788   

Real estate construction loans

        —           3,548   

Residential mortgages (1st and 2nd liens)

        48         769   

Home equity loans

        70         315   

Consumer loans

        57         317   

Other loans

        —           —     
     

 

 

    

 

 

 

Total Charge-offs

      $ 902       $ 16,238   
     

 

 

    

 

 

 

 

Loans recovered after being charged-off

   Three Months Ended
March 31, 2011
     Year Ended
December 31, 2010
Restated
 

Commercial, financial & agricultural loans

     37         69   

Commercial real estate mortgages

     —           —     

Real estate construction loans

     —           —     

Residential mortgages (1st and 2nd liens)

     —           —     

Home equity loans

     —           —     

Consumer loans

     14         118   

Other loans

     —           —     
  

 

 

    

 

 

 

Total recoveries

   $ 51       $ 187   
  

 

 

    

 

 

 

Net loans charged-off

     851         16,051   

Reclass to allowance for contingent liabilities

     —           51   

Provision for loan losses

     19,971         32,086   
  

 

 

    

 

 

 

Allowance for loan losses, Ending Balance

   $ 47,539       $ 28,419   
  

 

 

    

 

 

 

Suffolk’s underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. Suffolk has not been directly affected by the increase in defaults of sub-prime mortgages as Suffolk does not originate, or hold in portfolio, sub-prime mortgages. The allowance for loan loss analysis includes changes in the size and composition of the portfolio, Suffolk’s own historical loan losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions, and other factors. The analysis also considers the loan loss history of Suffolk’s peers with similar characteristics. In assessing the adequacy of the allowance, Suffolk reviews its loan portfolio by separate categories which have similar risk and collateral characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as “Substandard” or “Doubtful” as defined by regulation, loans criticized internally or designated as “Special Mention,” delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the allowance which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. See Note (6), “Allowance for Loan Losses”, to the notes to the unaudited consolidated financial statements.

 

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The following tables summarize the allowance for loan losses by category for the periods presented: (in thousands)

 

    Impaired Allocation
March 31, 2011
    Remaining Allocation
March 31, 2011
    Total Allocation
March 31, 2011
    % of Total  

Commercial, financial & agricultural loans

  $ 7,764      $ 19,878      $ 27,642        58.1

Commercial real estate mortgages

    5,934        4,665        10,599        22.3

Real estate construction loans

    1,578        4,116        5,694        12.0

Residential mortgages (1st and 2nd liens)

    —          615        615        1.3

Home equity loans

    —          2,282        2,282        4.8

Consumer loans

    —          707        707        1.5
 

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

  $ 15,276      $ 32,263      $ 47,539        100
 

 

 

   

 

 

   

 

 

   

 

 

 

 

    Impaired Allocation
December 31, 2010
Restated
    Remaining Allocation
December 31, 2010
Restated
    Total Allocation
December 31, 2010
Restated
    % of  Total
Restated
 

Commercial, financial & agricultural loans

  $ 2,845      $ 10,981      $ 13,826        48.6

Commercial real estate mortgages

    5,636        3,590        9,226        32.5

Real estate construction loans

    935        2,242        3,177        11.2

Residential mortgages (1st and 2nd liens)

    —          519        519        1.8

Home equity loans

    —          1,392        1,392        4.9

Consumer loans

    —          279        279        1.0
 

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

  $ 9,416      $ 19,003      $ 28,419        100
 

 

 

   

 

 

   

 

 

   

 

 

 

Suffolk believes the allowance is adequate to absorb inherent and known losses in the loan portfolio; however, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant changes. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. In the future, the allowance for loan losses may change as a percentage of total loans. To the extent actual performance differs from management’s estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that Suffolk will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan losses.

Additional analysis of charged-off loans for the quarter ended March 31, 2011 is provided below: (in thousands)

 

     March 31, 2011  
     Non-performing
Loans
     Impaired Loans      Restructured Loans      Total  

Commercial, financial & agricultural loans

   $ 624       $ —         $ 76       $ 700   

Commercial real estate mortgages

     —           —           —           —     

Real estate construction loans

     —           —           —           —     

Residential mortgages (1st and 2nd liens)

     47         —           —           47   

Home equity loans

     70         —           —           70   

Consumer loans

     57         —           —           57   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Charge-offs

   $ 798       $ —         $ 76       $ 874   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net charge-offs for the three months ended March 31, 2011 was $851,000 compared to $88,000 of net charge-offs for the three months ended March 31, 2010. The increased charge-offs were realized in all loan categories except commercial real estate mortgages and real estate construction loans. This increase in charge-offs reflects the deterioration of economic conditions and resulting failure of businesses, devaluation of assets, and negative impact on customers’ ability to service debt. For impaired collateral-dependent loans, which include commercial real estate mortgages and real estate construction loans, charge-offs were the result of new appraisals indicating a collateral deficiency after considering costs to sell.

 

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

 

     Three months ended
March 31, 2011
    Twelve months ended
December 31, 2010
Restated
 

Loans, net of discounts:

    

Average

   $ 1,113,812      $ 1,129,917   

At end of period

     1,098,823        1,112,279   

Non-performing loans/total loans, net of discounts

     4.40     2.61

Non-performing assets/total assets (1)

     3.20        2.16   

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

     0.31        1.42   

Net charge-offs (recoveries)/net loans

     0.31        1.44   

Allowance for loan losses/loans, net of discounts

     4.33        2.56   

 

(1) Non-performing assets include non-performing loans and other real estate owned (“OREO”), ratios annualized where appropriate.

Non-Performing Loans

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

The following table shows non-accrual, past due, and restructured loans past due at March 31, 2011 and December 31, 2010: (in thousands)

 

     March 31,
2011
     December 31,
2010
Restated
 

Loans accruing but past due contractually

     

90 days or more

   $ —         $ —     

Loans not accruing interest

     48,339         28,991   

Restructured loans past due

     —           493   
  

 

 

    

 

 

 

Total

   $ 48,339       $ 29,484   
  

 

 

    

 

 

 

Total non-performing loans and restructured loans past due as of March 31, 2011 amounted to $48,339,000. Of that amount, $41,378,000 was secured by collateral valued at approximately $73,019,000, having a cumulative loan-to-value of approximately 57 percent.

Interest on loans that are no longer accruing interest would have amounted to about $801,000 and $428,000, respectively, for the three months ended March 31, 2011 and 2010, under the contractual terms of those loans. Suffolk records the payment of interest on such loans as a reduction of principal. Interest income recognized on restructured and non-accrual loans was $366,000 and $247,000 for the three months ended March 31, 2011 and 2010, respectively. Suffolk has a formal procedure for internal credit review to more precisely identify risk and exposure in the loan portfolio.

Impaired loans are segregated and reviewed separately. Impaired loans secured by collateral are reviewed based on their collateral and the estimated time required to recover Suffolk’s investment in the loan as well as the cost of doing so, and the estimate of the recovery anticipated. Reserves are allocated to impaired loans based on this review. The allocated reserve is an estimation of losses specific to individual impaired loans. Allocated reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Reserves allocated to impaired loans were $15.3 million and $9.4 million as of March 31, 2011 and December 31, 2010, respectively. While every non-performing loan is evaluated individually, not every loan requires an allocated reserve. Allocated reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs.

See also summary of impaired loans in Note (6), Allowance for Loan Losses, in the financial statements.

 

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Impairment reserves were assigned to approximately $60,090,000 or 49 percent of our impaired loans as of March 31, 2011 with the assistance of a third-party appraisal. As of December 31, 2010, impairment reserves were assigned to approximately $49,097,000 or 49 percent of our impaired loans. Collateral-dependent loans are evaluated for impairment when a loan becomes 90 days past due or another impairment indicator is identified. At the time a loan is evaluated for impairment, an appraisal is ordered from an independent third-party licensed appraiser for loans in excess of $250,000. Typically, it takes approximately 30-90 days to receive and review the appraisal on a commercial real estate mortgage. To date, Suffolk has not experienced any significant delays between ordering appraisals and recognizing charge-offs. While waiting for an updated appraisal, we continue to contact the borrower to arrange a payment plan and monitor for any payment. Since the majority of the collateral securing impaired loans are within our local market, an officer of the Bank may drive by to make an initial assessment of the property’s condition.

At March 31, 2011 and December 31, 2010, impaired loans totaling $62,698,000 and $51,144,000, respectively, require no associated valuation allowance. For these loans, an evaluation for impairment was completed but, due the Bank’s collateral position, no valuation allowance was required. The required allowance is calculated based upon the appraisal methodology described above for collateral-dependent loans. For non-collateral-dependent loans, the allowance is based on the present value of future cash flows. As measuring impairment is an estimate which requires judgment, future results of operations may be negatively affected by outcomes different from those estimated.

Suffolk evaluates classified and criticized loans that are not impaired by categorizing loans by type of risk and applying reserves based on loan type and corresponding risk. Suffolk also records reserves on Suffolk’s non-criticized and non-classified loan balances. This represents a general allowance for homogeneous loan pools where the loans are not individually evaluated for impairment, though rated according to loan product type and risk rating.

The following table summarizes Suffolk’s non-performing loans by category: (in thousands of dollars except for ratios)

 

Non-performing Loans

 
     3/31/2011      % of
Total
    Total
Loans
3/31/2011
     % of
Total Loans
    12/31/2010
Restated
     % of
Total
    Total
Loans
12/31/2010
     % of
Total
Loans
 

Commercial, financial & agricultural

   $ 6,790         14.0   $ 255,607         2.66   $ 2,382         8.2   $ 248,750         0.96

Commercial real estate

     21,720         44.9     437,302         4.97     11,601         40.0     431,179         2.69

Real estate construction loans

     10,640         22.0     76,645         13.88     10,481         36.2     82,720         12.67

Residential mortgages (1st & 2nd liens)

     5,510         11.4     183,971         3.72     3,466         12.0     195,993         1.77

Home equity loans

     3,508         7.3     83,167         4.22     986         3.4     84,696         1.16

Consumer loans

     171         0.4     61,644         0.28     75         0.3     67,814         0.11

Other loans

     —           0.0     487         0.00     —           0.0     1,127         0.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total non-performing loans

   $ 48,339         100   $ 1,098,823         4.40   $ 28,991         100   $ 1,112,279         2.61
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following table details the collateral value securing non-performing loans: (in thousands)

 

     March 31, 2011      December 31, 2010 Restated  
     Non-performing Loans
Principal Balance
     Collateral
Value
     Non-performing Loans
Principal Balance
     Collateral
Value
 

Commercial, financial & agricultural loans

   $ 6,790       $ —         $ 2,382       $ —     

Commercial real estate mortgages

     21,720         28,458         11,601         16,002   

Real estate construction loans

     10,640         15,362         10,481         14,455   

Residential mortgages (1st and 2nd liens)

     5,510         18,320         3,466         10,023   

Home equity loans

     3,508         10,879         986         4,384   

Consumer loans

     171         —           75         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 48,339       $ 73,019       $ 28,991       $ 44,864   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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For non-performing loans, cash receipts are applied entirely against principal until the loan has been collected in full, after which time, any additional cash receipts are recognized as interest income. When, in management’s judgment, the borrower’s ability to make required interest and principal payments resumes and collectability is no longer in doubt, the loan is returned to accrual status. When interest accruals are suspended, accrued interest income is reversed and charged to earnings.

During the three months ended March 31, 2011 and 2010, interest income totaling $1,071,000 and $547,000, respectively, was recognized on impaired loans. Cash basis interest income recognized on those loans during that period was immaterial.

Restructured loans totaled $30,738,000 at March 31, 2011 and $24,044,000 at December 31, 2010 is considered impaired loans. Included in non-performing loans are restructured loans of $22,321,000 at March 31, 2011 that are no longer accruing interest. Subsequent to restructure, there has been $928,000 in advances funded on non-performing restructured loans outstanding as of March 31, 2011.

As of March 31, 2011 and December 31, 2010, we consider the non-performing restructured loans totaling $22.3 million and $12.1 million, respectively, to be impaired loans. The loans that have been restructured have been modified as to interest rate, due dates, or extension of the maturity date. Restructured loans are considered to be non-accrual loans, if at the time of restructuring the loan was deemed non-accrual. Once a sufficient amount of time has passed, generally six months, if the restructured loan has performed under the modified terms, the loan is returned to accrual status. In addition to the passage of time, we also consider the collateral value and the ability of the borrower to continue to make payments in accordance with the modified terms. During the three months ended March 31, 2011, there were no restructured loans returned to accrual status.

As of both March 31, 2011 and December 31, 2010, we have not performed any commercial real estate (CRE) or other type of loan workouts whereby an existing loan was restructured into multiple new loans.

The total balance of OREO, which is recorded at fair value, was $3,261,000 at March 31, 2011. Subsequently in June 2011, $1,461,000 was sold resulting in a remaining balance of $1,800,000 at June 30, 2011.

As of March 31, 2011, classified loans amounted to 31.4 percent of total loans, as compared with 15.6 percent at December 31, 2010. The increase is attributable to the prolonged national and regional economic slowdown, along with a more objective review of the portfolio noted elsewhere in this filing.

Real estate construction loans amounted to $76,645,000 as of March 31, 2011. Non-performing real estate construction loans totaled $10,640,000, which is 13.9 percent of the real estate construction portfolio.

The following table presents information regarding real estate construction loans: (in thousands)

 

Non-performing Real Estate Construction Loans  
    March 31, 2011     December 31, 2010 Restated  
    Balance
Outstanding
    Non-performing
Balance
    Impaired
Balance
    Allowance
Allocation
    Balance
Outstanding
    Non-performing
Balance
    Impaired
Balance
    Allowance
Allocation
 

Real estate construction loans

  $ 76,645      $ 10,640      $ 30,648      $ 5,694      $ 82,720      $ 10,481      $ 26,897      $ 3,177   

All loans

    1,098,823        48,339        122,788        47,539        1,112,279        28,991        100,241        28,419   

Real estate construction loans as % of all loans

    6.98     22.01     24.96     11.98     7.44     36.15     26.83     11.18

 

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The following table presents non-performing and collateral value information on real estate construction loans: (in thousands)

 

     March 31, 2011     December 31, 2010
Restated
 
     Non-performing
Balance
     Total
Collateral
Value
     Loan to Value
Ratio
    Non-performing
Balance
     Total
Collateral
Value
     Loan to Value
Ratio
 

Real estate construction loans

   $ 10,640       $ 15,362         69   $ 10,481       $ 14,455         73
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Real estate construction loans as a percentage of the loan portfolio have decreased since December 31, 2010. The non-performing balance of real estate construction loans as a percentage of all non-performing loans has also decreased from 36.15 percent at December 31, 2010 to 22.01 percent at March 31, 2011.

The following table summarizes as of March 31, 2011 loans that have been restructured during the period presented (dollars in thousands):

 

     For the three months ended
March 31, 2011
 

Troubled Debt Restructurings

   # of
Loans
     Pre-
Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
 

Commercial, financial, and agricultural

     15       $ 2,795       $ 2,795   

Commercial, secured by real estate

     3         3,802         3,802   

Real estate construction loans

     0         —           —     

Residential mortgages

     0         —           —     

Home Equity

     0         —           —     

Consumer

     2         34         34   
  

 

 

    

 

 

    

 

 

 
     20       $ 6,631       $ 6,631   
  

 

 

    

 

 

    

 

 

 

The following table summarizes as of March 31, 2011, loans that were restructured that have subsequently defaulted within the last twelve months: (dollars in thousands)

 

Defaulted Troubled Debt Restructurings

   # of
Loans
     Recorded
Investment
 

Commercial, financial, and agricultural

     23       $ 769   

Commercial, secured by real estate

     4         9,703   

Real estate construction loans

     1         5,875   

Residential mortgages

     3         1,169   

Home Equity

     0         —     

Consumer

     4         23   
  

 

 

    

 

 

 
     35       $ 17,539   
  

 

 

    

 

 

 

Defaulted restructured loans include 14 contracts with zero balances: 12 commercial, financial, and agricultural loans, one commercial loan secured by real estate and one consumer loan. One of the commercial, financial, and agricultural loans was paid off, the remaining 13 were charged off.

See also Note (6), Allowance for Loan Losses, in the financial statements.

Deferred Tax Assets and Liabilities

Suffolk recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the amount that management expects to realize. At March 31, 2011, Suffolk believes the deferred tax asset is fully realizable.

 

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Investment Securities

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

Item 3—Quantitative and Qualitative Disclosures about Market Risk

Market Risk

Suffolk originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. Suffolk’s operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or re-priced in any given period of time. Suffolk’s earnings or the net value of its portfolio (the present value of expected cash flows from liabilities) will change when interest rates change. The principal objective of Suffolk’s asset/liability management program is to maximize net interest income while keeping risks acceptable. These risks include both the effect of changes in interest rates, and risks to liquidity. The program also provides guidance to management in funding Suffolk’s investment in loans and securities. Suffolk’s exposure to interest-rate risk has not changed substantially since December 31, 2010.

Business Risks and Uncertainties

This report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, the economy in general, expectations of the business environment in which Suffolk operates, projections of future performance, and potential future credit experience. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond Suffolk’s control and are subject to a variety of uncertainties that could cause future results to vary materially from Suffolk’s historical performance, or from current expectations. Factors affecting Suffolk include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolk’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by us to comply with our written agreement with the OCC or the individual minimum capital ratios for the Bank established by the OCC; the cost of compliance with the Agreement; failure by us to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures; potential litigation or regulatory action relating to the matters resulting in our failure to file this Form 10-Q on time or resulting from the revisions to our earnings previously announced on April 12, 2011 or the restatement of our financial statements for the quarterly period ended September 30, 2011 and year ended December 31, 2010; and the potential that net charge-offs are higher than expected. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operations.

Item 4—Controls and Procedures

Suffolk’s Chief Executive Officer who is also Acting Chief Financial Officer (collectively, the “Certifying Officers”) evaluated the effectiveness of Suffolk’s disclosure controls and procedures (as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934) as of March 31, 2011 in connection with the filing of the Form 10-Q for that period.

The Certifying Officers evaluated the effectiveness of disclosure controls and procedures as of March 31, 2011. Based on that evaluation, and in light of material weaknesses in internal control over financial reporting that existed throughout this quarter as described below, management concluded that Suffolk’s disclosure controls and procedures were not effective as of March 31, 2011.

Suffolk’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.

 

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Because of their inherent limitations, systems of internal control over financial reporting may not prevent or detect misstatements. Therefore, even those system determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.

A “material weakness” in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected in a timely basis by the Suffolk’s internal controls.

Material Weaknesses in Internal Controls

Allowance for Loan and Lease Losses

Estimating the allowance for loan losses requires credit administration staff to identify and evaluate borrowers’ ability to repay their obligations through periodic evaluation and reevaluation of cash flow and/or collateral, and, when necessary, making provision for the amount deemed being likely not to be repaid. Suffolk identified deficiencies within the credit administration function which compromised the operational effectiveness of the internal controls, particularly in making timely reevaluations of credit and/or collateral. This led to management’s determination that there was a material weakness in internal control over financial reporting in estimating the allowance for loan losses.

Financial Reporting Staffing Resources

Management concluded that a material weakness exists due to insufficient staffing resources that are in dedicated permanent positions within the accounting function with sufficient skills and industry knowledge of GAAP and regulatory accounting, which resulted in insufficient documentation and monitoring over the financial reporting cycle, including preparing financial statements and disclosures. Among other factors identified, approximately six months have passed since the prior Chief Financial Officer resigned as of June 24, 2011, and Suffolk has yet to fill this position. Suffolk immediately engaged an interim accounting consultant to assist with financial reporting in the meantime; however, the individual is not an officer of Suffolk. Suffolk’s President and Chief Executive Officer was appointed as Acting Chief Financial Officer until a permanent Chief Financial officer is hired, representing a significant concentration of authority in one individual.

Interdepartmental Communications

A material weakness exists due to insufficient communications at the interdepartmental levels. There was inconsistent exchange of important financial information between Suffolk’s accounting and operating functions that led to errors in classifying loans as performing loans when the loans were non-performing. That was one factor resulting in the allowance for loan and lease losses to be understated as of September 30, 2010 and December 31, 2010, as described above at “Allowance for Loan and Lease Losses.”

Governance and Management Accountability

The Board of Directors is responsible for competent and effective oversight and leadership of Suffolk’s management and to ensure accountability of management. The material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources and interdepartmental communications, as well as delays in processes surrounding the completion of restated and current financial statements, and the untimely correction of deficiencies previously identified by regulators, are reflective of a material weakness in the Board of Directors as it relates to the foregoing matters.

Suffolk has implemented certain changes in its internal controls as of the date of this report to address the material weaknesses. Specifically, management took the following steps to remediate the material weaknesses set forth above:

Allowance for Loan and Lease Losses

 

  1. Hired a new Chief Lending Officer during the second quarter of 2011.

 

  2. Improved staff by hiring a new loan administrator, additional underwriting staff and a loan workout specialist.

 

  3. Reorganized the credit department to ensure appropriate separation of duties and developed expanded training for Suffolk’s lenders.

 

  4. Hired senior credit officer to run a newly created separate loan review and workout department.

 

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  5. Changed Suffolk’s credit policy to require identification of concentrations of risk, analysis of our customers’ global cash flows, reappraisal and re-evaluation of collateral, more accurate and timely credit-risk rating procedures and improved underwriting processes and standards.

 

  6. Incorporated the results of a systematic re-appraisal of commercial real estate which secures loans in excess of $1 million.

 

  7. Engaged qualified outside consultants to assist in re-evaluating risk ratings.

 

  8. Improved the processes for identifying impaired loans and the determination of the amount of impairment.

 

  9. Augmented Suffolk’s credit policy to govern loan workout.

 

  10. Implemented a new procedure to ensure that OREO was accounted for in accordance with GAAP.

Financial Reporting Staffing Resources

 

  11. Initiated a search for a qualified Chief Financial Officer with sufficient knowledge of GAAP, regulatory accounting and the banking industry, and the skills to effectively implement that knowledge.

 

  12. Engaged a qualified consultant in financial reporting and the function of the Chief Financial Officer to assist the Acting Chief Financial Officer in maintaining and improving controls.

 

  13. Increased oversight of the financial reporting process through the Audit Committee and the Compliance Committee, the latter of which meets at least monthly or more often.

 

  14. Created and filled the new position of Treasurer to further relieve the Chief Financial Officer of day-to-day duties in asset liability management, investment portfolio management and treasury functions.

 

  15. Enhanced procedures to ensure that all reconciliations of all departments are completed and reviewed to ensure accuracy.

 

  16. Compiled individual policies into comprehensive written policies and procedures for the accounting function which will include specific policies, procedures and controls for financial reporting.

 

  17. Increased automation of the accounting and financial reporting process to free staff resources to focus on financial reporting.

Interdepartmental Communications

 

  18. Established a process for both credit and finance staff to review the computation of specific impairment allowances under ASC 310-10 – Receivables – Impairment of a Loan, and establishing enhanced reporting from core systems available directly to personnel in accounting and finance.

Governance and Management Accountability

 

  19. Formed a Compliance Committee of the Board to oversee compliance and, later, to respond to the Formal Agreement.

 

  20. Implemented procedures to track all regulatory compliance through structured matrices.

 

  21. Engaged qualified independent consultants to assist with compliance with the Formal Agreement, including an assessment of key management roles.

 

  22. Outsourced the internal audit function to a qualified risk management firm to provide greater independence and depth to the function.

 

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  23. Appointed a Vice Chairman of the Board to provide daily oversight of management on behalf of the full Board and to communicate back to the Board.

 

  24. Engaged a qualified independent consultant to advise the Board on various regulatory, strategic and operational issues.

In connection with the remediation referred to above, certain changes to the internal control over financial reporting have occurred during the first quarter of 2011 that are reasonably likely to materially affect Suffolk’s internal control over financial reporting. These changes included the implementation of remediation steps 2, 5, and 6 described above.

Suffolk cannot determine the impact of the remediation steps at this time.

 

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PART II

Item 1—Legal Proceedings

On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.

On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.

On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.

The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.

Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.

Item 1A—Risk Factors

There are no material changes from any of the risk factors previously disclosed in Suffolk’s 2010 Form 10-K in response to Part I, Item 1A, except as follows:

As of March 31, 2011, the Bank failed to maintain a Tier 1 leverage capital ratio of at least equal to 8.00 percent of adjusted total assets as required by the OCC; further increases to Suffolk’s allowance for loan losses would negatively impact its capital levels, causing the Bank to fail to be in compliance with the ratios established by the OCC, which could result in further regulatory enforcement actions.

The Bank is subject to individual minimum capital ratios (“IMCR’s”) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. At March 31, 2011, management believes the Bank met two of the three IMCR’s: Tier 1 Capital was 10.97 percent of risk-weighted assets and Total Risk Based Capital was 12.25 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 Leverage ratio as Tier 1 capital was 7.90 percent of adjusted total assets at March 31, 2011. At June 30, 2011, the Bank met two of the IMCR’s: Tier 1 Capital was 11.59 percent of risk-weighted assets and Total Risk Based Capital was 12.88 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 leverage ratio as Tier 1 capital was 7.98 percent of adjusted total assets at June 30, 2011. The Bank met all three IMCR’s at September 30, 2011: Tier 1 Capital was 8.50 percent of adjusted total assets, Tier 1 Capital was 12.53 percent of risk-weighted assets, and Total Risk Based Capital was

 

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13.82 percent of risk-weighted assets. If the Bank fails to maintain the required capital levels, it could be subject to further regulatory enforcement actions.

The revisions to Suffolk’s earnings previously announced on April 12, 2011, and the restatement of Suffolk’s financial statements for the period ended September 30, 2010 and the year ended December 31, 2010, has resulted in additional costs to Suffolk and may cause Suffolk to incur further costs or result in regulatory action or litigation against Suffolk which could adversely affect its results of operation or financial condition.

On April 12, 2011, Suffolk released preliminary earnings for the first quarter of 2011. Following that release, but prior to the regulatory deadline to file its Form 10-Q, management identified possible deficiencies and/or weaknesses in Suffolk’s internal controls with respect to credit administration and credit risk management, financial reporting staffing resources, interdepartmental communications, and governance and management accountability, primarily with respect to the timing of the recognition of credit risk, as well as with regard to risk rating which affected the computation of the allowance for loan losses. On May 11, 2011, Suffolk announced that it would be delayed in filing its Form 10-Q. Suffolk retained independent consultants specializing in the evaluation and computation of the allowance for loan losses that conducted an independent review of Suffolk’s loan files with respect to the correct risk-rating of credits, and to the extent possible, to evaluate when that rating might correctly have been determined, and finally, where applicable, what the correct specific impairment allowance should be. The result of the reevaluation and re-computation of the allowance for loan losses was an increase in the specific impairment allowances, offset by a decrease in the qualitative reserve percentages, resulting in an overall increase in the total allowance over that announced on April 12, 2011. On August 12, 2011, Suffolk announced that the Audit Committee of the Board of Directors had concluded that Suffolk’s previously issued financial statements as of and for the year ended December 31, 2010, the quarter ended December 31, 2010 and the quarter ended September 30, 2010, as reported in Suffolk’s Annual Report on Form 10-K and Quarterly Report on Form 10-Q, respectively, should no longer be relied upon due to an understatement of its allowance for loan losses in such periods. The reevaluation and restatement process has resulted in additional costs to Suffolk and may cause Suffolk to incur further costs that could adversely affect its results of operation or financial condition. The revisions to our earnings previously announced on April 12, 2011 and the restatement of our financial statements may also result in regulatory action or litigation against Suffolk, which could adversely affect our results of operation or financial condition.

A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.

During April of 2011, management identified possible deficiencies and/or weaknesses in Suffolk’s internal controls related to the design and implementation of policies to promptly identify problem loans and to quantify the elements of risk in problem loans. After conducting an internal review, management determined that there were material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources, interdepartmental communications and governance and management accountability. See Part I, Item 4—Controls and Procedures. Suffolk has incurred costs and implemented certain changes in its internal controls over financial reporting and disclosure controls and procedures to address these material weaknesses. It is too early to determine the impact of these remediation steps and Suffolk has not yet determined that it has restored effective internal controls over financial reporting and disclosure controls and procedures. It is possible that additional deficiencies or weaknesses could be identified. A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.

 

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Item 2—Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents information about repurchases of common stock:

 

     For the last
12 months
     For the three months ended  
        Mar. 31,
2011
     Dec. 31,
2010
     Sept. 30,
2010
     Jun. 30,
2010
 

Average price per share of quarterly repurchases

   $ 2.50       $ 2.50       $ —         $ —         $ —     

Aggregate cost of quarterly repurchases

   $ 7,780       $ 7,780       $ —         $ —         $ —     

Repurchases of common stock

              

Treasury stock, beginning balance

     4,002,158         4,002,158         4,002,158         4,002,158         4,002,158   

Repurchases (1)

     3,112         3,112         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Treasury stock, ending balance

     4,005,270         4,005,270         4,002,158         4,002,158         4,002,158   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Shares repurchased in payment of exercised employee incentive stock options. No shares were repurchased in market transactions.

Item 6— Exhibits

CERTIFICATION OF PERIODIC REPORT—Exhibit 31.1

CERTIFICATION OF PERIODIC REPORT—Exhibit 31.2

CERTIFICATION OF PERIODIC REPORT—Exhibit 32.1

CERTIFICATION OF PERIODIC REPORT—Exhibit 32.2

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SUFFOLK BANCORP

 

Date: December 20, 2011

      /s/ J. Gordon Huszagh
      J. Gordon Huszagh
      President & Chief Executive Officer
     
Date: December 20, 2011       /s/ J. Gordon Huszagh
      J. Gordon Huszagh
      Acting Chief Financial Officer

 

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