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EX-32.1 - EXHIBIT 32.1 - ConnectOne Bancorp, Inc.v348028_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - ConnectOne Bancorp, Inc.v348028_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - ConnectOne Bancorp, Inc.v348028_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - ConnectOne Bancorp, Inc.v348028_ex31-2.htm

 

 

UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q/A

(Amendment No.1)

 

(Mark One)

 

  x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2013

 

OR

 

  ¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to               

 

Commission File Number:  000-11486

 

 

 

CENTER BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter) 

 

 

 

New Jersey 52-1273725

(State or Other Jurisdiction of

Incorporation or Organization)

(IRS Employer

Identification No.)

 

2455 Morris Avenue

Union, New Jersey 07083-0007

(Address of Principal Executive Offices) (Zip Code)

 

(908) 688-9500

(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    x    No   ¨

 

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

 

Large accelerated filer  ¨ Accelerated filer  x

Non-accelerated filer  ¨

(Do not check if 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.

 

Common Stock, no par value: 16,348,915 shares
(Title of Class) (Outstanding as of May 6, 2013)

 

 
 

 

Explanatory Note: This Amendment has been filed solely in order to provide the conformed signatures that were inadvertently omitted from the signature page and the certifications as originally filed. No other changes have been made in the Quarterly Report.

 

Table of Contents

 

    Page
     
PART I – FINANCIAL INFORMATION 3
     
Item  1. Financial Statements  
  Consolidated Statements of Condition at March 31, 2013 (unaudited) and December 31, 2012 4
  Consolidated Statements of Income for the three months ended March 31, 2013 and 2012 (unaudited) 5
  Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012 (unaudited) 6
  Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2013 and 2012 (unaudited) 7
  Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012 (unaudited) 8
  Notes to Consolidated Financial Statements 9
     
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 38
     
Item  3. Qualitative and Quantitative Disclosures about Market Risks 57
     
Item  4. Controls and Procedures 58
     
PART II – OTHER INFORMATION  
     
Item  1. Legal Proceedings 58
     
Item  6. Exhibits 59
   
SIGNATURES 60

 

2
 

 

PART I – FINANCIAL INFORMATION

 

The following unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and, accordingly, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2013, or for any other interim period. The Center Bancorp, Inc. 2012 Annual Report on Form 10-K, should be read in conjunction with these financial statements.

 

3
 

 

Item 1. Financial Statements

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

 

( in thousands, except for share and per share data)  March 31,
2013
   December 31,
2012
 
   (Unaudited)     
ASSETS          
Cash and due from banks  $116,755   $104,134 
Interest bearing deposits with banks       2,004 
Total cash and cash equivalents   116,755    106,138 
Investment securities:          
Available-for-sale   458,004    496,815 
Held-to-maturity (fair value of $81,921 and $62,431)   78,212    58,064 
Loans held-for-sale   774    1,491 
Loans   879,387    889,672 
Less: Allowance for loan losses   10,232    10,237 
Net loans   869,155    879,435 
Restricted investment in bank stocks, at cost   8,966    8,964 
Premises and equipment, net   13,544    13,563 
Accrued interest receivable   6,423    6,849 
Bank-owned life insurance   34,935    34,961 
Goodwill and other intangible assets   16,849    16,858 
Prepaid FDIC assessments   525    811 
Other real estate owned   1,536    1,300 
Due from brokers for investment securities   718     
Other assets   3,399    4,516 
Total assets  $1,609,795   $1,629,765 
           
LIABILITIES          
Deposits:          
Non-interest bearing  $213,794   $215,071 
Interest-bearing:          
Time deposits $100 and over   99,687    110,835 
Interest-bearing transaction, savings and time deposits less than $100   968,742    981,016 
Total deposits   1,282,223    1,306,922 
Long-term borrowings   146,000    146,000 
Subordinated debentures   5,155    5,155 
Accounts payable and accrued liabilities   11,664    10,997 
Total liabilities   1,445,042    1,469,074 
           
STOCKHOLDERS’ EQUITY          
Preferred stock, $1,000 liquidation value per share, authorized 5,000,000 shares; issued and outstanding 11,250 shares of Series B preferred stock at March 31, 2013 and December 31, 2012; total liquidation value of $11,250 at March 31, 2013 and December 31, 2012   11,250    11,250 
Common stock, no par value, authorized 25,000,000 shares; issued 18,477,412 shares at March 31, 2013 and December 31, 2012; outstanding 16,348,915 shares at March 31, 2013 and 16,347,915 shares at December 31, 2012   110,056    110,056 
Additional paid-in capital   4,820    4,801 
Retained earnings   50,690    46,753 
Treasury stock, at cost (2,128,497 common shares at March 31, 2013 and 2,129,497 common shares at December 31, 2012)   (17,230)   (17,232)
Accumulated other comprehensive income   5,167    5,063 
Total stockholders’ equity   164,753    160,691 
Total liabilities and stockholders’ equity  $1,609,795   $1,629,765 

 

See accompanying notes to unaudited consolidated financial statements.

 

4
 

 

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

   Three Months Ended
March 31,
 
(in thousands, except for share and per share data)  2013   2012 
         
Interest income          
Interest and fees on loans  $9,923   $9,385 
Interest and dividends on investment securities:          
Taxable   2,972    3,088 
Tax-exempt   1,076    773 
Dividends   131    149 
Interest on federal funds sold and other short-term investment   2     
Total interest income   14,104    13,395 
Interest expense          
Interest on certificates of deposit $100 or more   239    252 
Interest on other deposits   1,045    1,156 
Interest on borrowings   1,450    1,642 
Total interest expense   2,734    3,050 
Net interest income   11,370    10,345 
Provision for loan losses       107 
Net interest income after provision for loan losses   11,370    10,238 
Other income          
Service charges, commissions and fees   406    446 
Annuities and insurance commissions   100    44 
Bank-owned life insurance   565    251 
Loan related fees   139    110 
Net gains on sale of loans held for sale   138    126 
Other   178    41 
Other-than-temporary impairment losses on investment securities   (24)   (58)
Net gains on sale of investment securities   343    995 
Net investment securities gains   319    937 
Total other income   1,845    1,955 
Other expense          
Salaries and employee benefits   3,490    3,118 
Occupancy and equipment   906    700 
FDIC insurance   313    299 
Professional and consulting   219    246 
Stationery and printing   85    84 
Marketing and advertising   101    31 
Computer expense   353    353 
Other real estate owned, net   19    62 
All other   1,052    914 
Total other expense   6,538    5,807 
Income before income tax expense   6,677    6,386 
Income tax expense   1,753    2,155 
Net Income   4,924    4,231 
Preferred stock dividends   56    141 
Net income available to common stockholders  $4,868   $4,090 
Earnings per common share          
Basic  $0.30   $0.25 
Diluted  $0.30   $0.25 
Weighted average common shares outstanding          
Basic   16,348,215    16,332,327 
Diluted   16,373,588    16,338,162 
Dividend paid per common share  $0.055   $0.030 

 

See accompanying notes to unaudited consolidated financial statements.

 

5
 

 

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three Months Ended
March 31,
 
(in thousands)  2013   2012 
Net income  $4,924   $4,231 
Other comprehensive income (loss), net of tax:          
Unrealized gains and losses on securities available-for-sale:          
Unrealized holding gains on available-for-sale securities   548    4,966 
Tax effect   (200)   (1,777)
Net of tax amount   348    3,189 
Reclassification adjustment of OTTI losses included in income   24    58 
Tax effect   (6)   (20)
Net of tax amount   18    38 
Reclassification adjustment for net gains arising during the period   (343)   (995)
Tax effect   90    335 
Net of tax amount   (253)   (660)
Amortization of unrealized holding gains on securities transferred from available-for-sale to held-to-maturity   (14)   (10)
Tax effect   5    3 
Net of tax amount   (9)   (7)
Total other comprehensive income   104    2,560 
Total comprehensive income  $5,028   $6,791 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
 

 

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

(in thousands, except for share and per share data)  Preferred
Stock
   Common
Stock
   Additional
Paid In
Capital
   Retained
Earnings
   Treasury
Stock
   Accumulated
Other
Comprehensive
Income (Loss)
   Total
Stockholders’
Equity
 
Balance as of January 1, 2012  $11,250   $110,056   $4,715   $32,695   $(17,354)  $(5,446)  $135,916 
Net income                  4,231              4,231 
Other comprehensive income, net of tax                            2,560    2,560 
Dividend on series B preferred stock                  (141)             (141)
Issuance cost of common stock                  (2)             (2)
Cash dividends declared on common stock ($0.030 per share)                  (490)             (490)
Stock-based compensation expense             7                   7 
Balance as of March 31, 2012
  $11,250   $110,056   $4,722   $36,293   $(17,354)  $(2,886)  $142,081 
Balance as of January 1, 2013  $11,250   $110,056   $4,801   $46,753   $(17,232)  $5,063   $160,691 
Net income                  4,924              4,924 
Other comprehensive income, net of tax                            104    104 
Dividend on series B preferred stock                  (85)             (85)
Issuance cost of common stock                  (3)             (3)
Cash dividends declared on common stock ($0.055 per share)                  (899)             (899)
Stock issued for options exercise (1,000 shares)             8         2         10 
Stock-based compensation expense             11                   11 
Balance as of March 31, 2013  $11,250   $110,056   $4,820   $50,690   $(17,230)  $5,167   $164,753 

 

See accompanying notes to unaudited consolidated financial statements.

 

7
 

 

CENTER BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(in thousands)  Three Months Ended
March 31,
 
   2013   2012 
Cash flows from operating activities:          
Net income  $4,924   $4,231 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization of premiums and accretion of discounts on investment securities, net   958    1,211 
Depreciation and amortization   212    210 
Stock-based compensation   11    7 
Provision for loan losses       107 
Net other-than-temporary impairment losses on investment securities   24    58 
Gains on sales of investment securities, net   (343)   (995)
Loans originated for resale   (7,605)   (6,437)
Proceeds from sale of loans held for sale   8,460    5,558 
Gains on sale of loans held for sale   (138)   (126)
Decrease in accrued interest receivable   426    255 
Decrease in prepaid FDIC insurance assessments   286    240 
Increase in cash surrender value of bank-owned life insurance   (274)   (251)
Life insurance death benefit   (291)    
Decrease (increase) in other assets   909    (647)
Increase in other liabilities   609    1,700 
Net cash provided by operating activities   8,168    5,121 
Cash flows from investing activities:          
Investment securities available-for-sale:          
Purchases   (37,204)   (88,332)
Sales   45,006    41,513 
Maturities, calls and principal repayments   14,121    8,658 
Investment securities held-to-maturity:          
Purchases   (4,996)   (4,844)
Maturities and principal repayments   689    7,288 
Net purchases of restricted investment in bank stocks   (2)    
Net decrease (increase) in loans   10,044    (33,562)
Purchases of premises and equipment   (182)   (136)
Proceeds from bank-owned life insurance death benefits   592     
Net cash provided by (used in) investing activities   28,068    (69,415)
Cash flows from financing activities:          
Net (decrease) increase in deposits   (24,699)   32,058 
Cash dividends on preferred stock   (28)   (166)
Cash dividends on common stock   (899)   (490)
Issuance cost of common stock   (3)   (2)
Proceeds from exercise of stock options   10     
Net cash (used in) provided by financing activities   (25,619)   31,400 
Net change in cash and cash equivalents   10,617    (32,894)
Cash and cash equivalents at beginning of period   106,138    111,101 
Cash and cash equivalents at end of period  $116,755   $78,207 
Supplemental disclosures of cash flow information:          
Cash payments for:          
Interest paid on deposits and borrowings  $2,727   $3,097 
Supplemental disclosures of non-cash investing activities:          
Trade date accounting settlements for investments, net  $650   $1,855 
Transfer of loans to other real estate owned  $236   $ 
Transfer from investment securities available-for-sale to investment securities held-to-maturity  $15,936   $ 

 

 See accompanying notes to unaudited consolidated financial statements.

 

8
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1.   Basis of Presentation

 

The consolidated financial statements of Center Bancorp, Inc. (the “Parent Corporation”) are prepared on the accrual basis and include the accounts of the Parent Corporation and its wholly-owned subsidiary, Union Center National Bank (the “Bank” and, collectively with the Parent Corporation and the Parent Corporation’s other direct and indirect subsidiaries, the “Corporation”). All significant intercompany accounts and transactions have been eliminated from the accompanying consolidated financial statements.

 

In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and that affect the results of operations for the periods presented. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, other-than-temporary impairment evaluation of securities, the evaluation of the impairment of goodwill and the valuation of deferred tax assets.

 

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”).

 

Note 2.  Earnings per Common Share

 

Basic earnings per common share (“EPS”) is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS includes any additional common shares as if all potentially dilutive common shares were issued (e.g., stock options). The Corporation’s weighted average common shares outstanding for diluted EPS include the effect of stock options and warrants outstanding using the Treasury Stock Method, which are not included in the calculation of basic EPS. Anti-dilutive stock option shares outstanding were 31,604 and 79,343, respectively, for the three months ended March 31, 2013 and March 31, 2012.

 

Earnings per common share have been computed based on the following:

 

   Three Months Ended
March 31,
 
(in thousands, except per share amounts)  2013   2012 
Net income  $4,924   $4,231 
Preferred stock dividends   (56)   (141)
Net income available to common shareholders  $4,868   $4,090 
Basic weighted average common shares outstanding   16,348    16,332 
Plus: effect of dilutive options   26    6 
Diluted weighted average common shares outstanding   16,374    16,338 
Earnings per common share:          
Basic  $0.30   $0.25 
Diluted  $0.30   $0.25 

 

Note 3.  Stock-Based Compensation

 

The Corporation maintains two stock-based compensation plans from which new grants could be issued. The Corporation’s stock based compensation plans permit Parent Corporation common stock to be issued to key employees and directors of the Corporation and its subsidiaries. The options granted under the plans are intended to be either incentive stock options or non-qualified options. Under the 2009 Equity Incentive Plan, a total of 392,292 shares are available for grant and issuance as of March 31, 2013. Under the 2003 Non-Employee Director Stock Option Plan, a total of 371,962 shares remain available for grant and issuance under the plan as of March 31, 2013. Such shares may be treasury shares, newly issued shares or a combination thereof.

 

Options have been granted to purchase common stock principally at the fair market value of the stock at the date of grant. Options are exercisable over a three year vesting period starting one year after the date of grant and generally expire ten years from the date of grant.

 

9
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3.  Stock-Based Compensation—(continued)

 

Stock-based compensation expense for share-based payment awards is based on the grant date fair value estimated in accordance with the provisions of FASB ASC 718-10-10 “Stock Based Compensation”. The Corporation recognizes these compensation costs net of a forfeiture rate and recognizes the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of 3 years. The Corporation estimated the forfeiture rate based on its historical experience during the preceding seven fiscal years.

 

For the three months ended March 31, 2013, the Corporation’s income before income taxes and net income were reduced by $11,000 and $7,000, respectively, as a result of the compensation expense related to stock options. For the three months ended March 31, 2012, the Corporation’s income before income taxes and net income were reduced by $7,000 and $4,000, respectively, as a result of the compensation expense related to stock options.

 

Under the principal option plans, the Corporation may also grant stock awards to certain employees. Stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the release of any applicable restrictions. Unless fully vested at the time of grant, such awards generally vest within 30 days to five years from the date of grant. During that period, ownership of the shares cannot be transferred. Restricted stock and stock awards that are fully vested at the time of grant have the same cash dividend and voting rights as other common stock and are considered to be currently issued and outstanding. The Corporation expenses the cost of stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which any restrictions lapse. There were no restricted stock awards outstanding at March 31, 2013 and March 31, 2012.

 

There were 31,257 and 27,784 shares of common stock underlying options that were granted during the three months ended March 31, 2013 and 2012, respectively. The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values at the time the grants were awarded:

 

   Three Months Ended
March 31,
 
   2013   2012 
Weighted average fair value of grants  $2.50   $2.03 
Risk-free interest rate   1.86%   2.03%
Dividend yield   1.76%   1.24%
Expected volatility   23.21%   22.04%
Expected life in months   69    68 

 

Activity under the principal option plans as of March 31, 2013 and changes during the three months ended March 31, 2013 were as follows:

 

   Shares   Weighted-
Average
Exercise
Price
   Weighted-
Average
Remaining
Contractual
Term
(Years)
   Aggregate
Intrinsic
Value
 
Outstanding at December 31, 2012   183,574   $9.92           
Granted   31,257    12.52           
Exercised   (1,000)   10.66           
Outstanding at March 31, 2013   213,831    10.40    6.37   $472,616 
Exercisable at March 31, 2013   140,902   $10.26    5.03   $341,293 

 

The aggregate intrinsic value of options above represents the total pre-tax intrinsic value (the difference between the Corporation’s closing stock price on the last trading day of the first quarter of 2013 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2013. This amount changes based on the fair value of the Corporation’s stock.

 

As of March 31, 2013, there was approximately $157,000 of total unrecognized compensation expense relating to unvested stock options. These costs are expected to be recognized over a weighted average period of 3.18 years. 

 

10
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 Note 4.  Recent Accounting Pronouncements

 

 In December 2012, the FASB issued an exposure draft of a proposed ASU of Topic 825-15, Credit Losses. The amendments of the proposed ASU would require all reporting entities, both public and nonpublic, to calculate impairment of existing financial assets on the basis of the current estimates of contractual cash flows not expected to be collected on the financial assets held at the reporting date. The proposed amendments would remove the existing “probable” threshold for recognizing credit losses and broaden the range of information that must be considered in measuring the allowance for expected credit losses. The estimate of expected credit losses would be based on relevant information about past events, including historical loss experience with similar assets, current conditions and reasonable and supportable forecasts that affect the future collectability of the assets’ remaining contractual cash flows.

 

As a result of the proposed amendments, financial assets carried at amortized cost less an allowance would reflect the current estimate of the cash flows expected to be collected at the reporting date, and the income statement would reflect credit deterioration (or improvement) that has taken place during the period. For financial assets measured at fair value with changes in fair value recognized through other comprehensive income, the balance sheet would reflect the fair value, but the income statement would reflect credit deterioration (or improvement) that has taken place during the period. An entity, however, may choose to not recognize expected credit losses on financial assets measured at fair value, with changes in fair value recognized through other comprehensive income, if both (1) the fair value of the financial asset is greater than (or equal to) the amortized cost basis and (2) expected credit losses on the financial asset are insignificant. Currently, when credit losses are measured, an entity only considers past events and current conditions; the proposed amendments would broaden the information entities are required to consider to include historical loss experience with similar assets and reasonable and supportable forecasts that affect the expected collectability of the assets’ remaining contractual cash flows. It is expected that entities will be able to leverage their current risk monitoring systems in implementing the proposed approach, however, for the inputs used to estimate the expected credit loss approach. An entity would apply the proposed amendments with a cumulative-effect adjustment to the statement of financial position beginning in the first reporting period in which the guidance is effective.

 

Both users and preparers of financial statements were requested to review and comment upon the exposure draft by April 30, 2013. The exposure draft does not include a proposed effective date of this guidance.

 

In January 2013, the FASB issued ASU No. 2013-01, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities,” which amended disclosures by requiring improved information about financial instruments and derivative instruments that are either offset on the balance sheet or subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset on the balance sheet. Reporting entities are required to provide both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements on the basis of international financial reporting standards ("IFRS"). Companies were required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those years.  The adoption of this accounting standard did not have a material impact on the Corporation's results of operation, financial position, or liquidity.

 

In February 2013, the FASB issued ASU No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income," to improve the transparency of reporting these reclassifications. ASU No. 2013-02 does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements. ASU No. 2013-02 requires an entity to disaggregate the total change of each component of other comprehensive income and separately present reclassification adjustments and current period other comprehensive income. The provisions of ASU No. 2013-02 also requires that entities present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line item affected by the reclassification. The Corporation adopted the provisions of ASU No. 2013-02 effective January 1, 2013. As the Corporation provided these required disclosures in the notes to the Consolidated Financial Statements, the adoption of ASU No. 2013-02 had no impact on the Corporation's consolidated statements of income and condition. See Note 5 to the Consolidated Financial Statements for the disclosures required by ASU No. 2013-02.

 

11
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 5.  Comprehensive Income

 

Total comprehensive income includes all changes in equity during a period arising from transactions and other events and circumstances from non-owner sources. The Corporation’s other comprehensive income is comprised of unrealized holding gains and losses on investment securities available-for-sale, and actuarial losses of defined benefit plans, net of taxes.

 

Disclosure of comprehensive income for the three months ended March 31, 2013, and 2012 is presented in the Consolidated Statements of Comprehensive Income. 

 

 Accumulated other comprehensive income at March 31, 2013 and December 31, 2012 consisted of the following:

 

   March 31,
2013
   December 31,
2012
 
   (in thousands) 
Investment securities available-for-sale, net of tax  $8,894   $8,781 
Unamortized component of securities transferred from available-for-sale to held-to-maturity, net of tax   153    162 
Defined benefit pension and post-retirement plans, net of tax   (3,880)   (3,880)
Total accumulated other comprehensive income  $5,167   $5,063 

 

12
 

 

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6.  Investment Securities

 

The Corporation’s investment securities are classified as available-for-sale and held-to-maturity at March 31, 2013 and December 31, 2012. Investment securities available-for-sale are reported at fair value with unrealized gains or losses included in equity, net of tax. Accordingly, the carrying value of such securities reflects their fair value at the balance sheet date. Fair value is based upon either quoted market prices, or in certain cases where there is limited activity in the market for a particular instrument, assumptions are made to determine their fair value. See Note 8 of the Notes to Consolidated Financial Statements for a further discussion.

 

Transfers of debt securities from the available-for-sale category to the held-to-maturity category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer remains in accumulated other comprehensive income and in the carrying value of the held-to-maturity investment security. Premiums or discounts on investment securities are amortized or accreted using the effective interest method over the life of the security as an adjustment of yield. Unrealized holding gains or losses that remain in accumulated other comprehensive income are amortized or accreted over the remaining life of the security as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount.

 

The following tables present information related to the Corporation’s investment securities at March 31, 2013 and December 31, 2012.

 

   March 31, 2013 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
   (in thousands) 
Investment Securities Available-for-Sale:                    
Federal agency obligations  $16,146   $144   $(121)  $16,169 
Residential mortgage pass-through securities   50,180    1,334        51,514 
Commercial mortgage pass-through securities   9,717    209        9,926 
Obligations of U.S. states and political subdivisions   92,384    3,865    (291)   95,958 
Trust preferred securities   21,427    489    (1,128)   20,788 
Corporate bonds and notes   227,011    10,077    (257)   236,831 
Asset-backed securities   19,236    359        19,595 
Certificates of deposit   2,853    39    (3)   2,889 
Equity securities   535        (165)   370 
Other securities   3,911    68    (15)   3,964 
Total  $443,400   $16,584   $(1,980)  $458,004 
                     
Investment Securities Held-to-Maturity:                    
Federal agency obligations  $3,893   $157   $   $4,050 
Commercial mortgage pass-through securities   5,125    141    (6)   5,260 
Obligations of U.S. states and political subdivisions   69,194    3,686    (269)   72,611 
Total  $78,212   $3,984   $(275)  $81,921 
                     
Total investment securities  $521,612   $20,568   $(2,255)  $539,925 

 

13
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   December 31, 2012 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
   (in thousands) 
Investment Securities Available-for-Sale:                    
U.S. Treasury and agency securities  $11,870   $62   $(23)  $11,909 
Federal agency obligations   20,207    333    (5)   20,535 
Residential mortgage pass-through securities   52,400    1,385    (1)   53,784 
Commercial mortgage pass-through securities   9,725    244        9,969 
Obligations of U.S. states and political subdivisions   103,193    4,653    (132)   107,714 
Trust preferred securities   22,279    144    (1,174)   21,249 
Corporate bonds and notes   228,681    9,095    (371)   237,405 
Collateralized mortgage obligations   2,120            2,120 
Asset-backed securities   19,431    311        19,742 
Certificates of deposit   2,854    21    (10)   2,865 
Equity securities   535        (210)   325 
Other securities   9,145    68    (15)   9,198 
Total  $482,440   $16,316   $(1,941)  $496,815 
Investment Securities Held-to-Maturity:                    
Federal agency obligations  $4,178   $79   $   $4,257 
Commercial mortgage-backed securities   5,501    154    (5)   5,650 
Obligations of U.S. states and political subdivisions   48,385    4,139        52,524 
Total  $58,064   $4,372   $(5)  $62,431 
Total investment securities  $540,504   $20,688   $(1,946)  $559,246 

 

 The following table presents information for investment securities available-for-sale at March 31, 2013, based on scheduled maturities. Actual maturities can be expected to differ from scheduled maturities due to prepayment or early call options of the issuer.

 

   March 31, 2013 
   Amortized
Cost
   Fair Value 
  (in thousands) 
Investment Securities Available-for-Sale :    
Due in one year or less  $20,274   $20,337 
Due after one year through five years   103,422    106,528 
Due after five years through ten years   131,744    139,112 
Due after ten years   123,617    126,253 
Residential mortgage pass-through securities   50,180    51,514 
Commercial mortgage pass-through securities   9,717    9,926 
Equity securities   535    370 
Other securities   3,911    3,964 
Total  $443,400   $458,004 
Investment Securities Held-to-Maturity :          
Due after five years through ten years  $5,195   $5,491 
Due after ten years   67,892    71,170 
Commercial mortgage pass-through securities   5,125    5,260 
Total  $78,212   $81,921 
           
Total investment securities  $521,612   $539,925 

 

14
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 During the three months ended March 31, 2013, the Corporation reclassified at fair value approximately $15.9 million in available-for-sale investment securities to the held-to-maturity category. The net unrealized losses were immaterial, remained in accumulated other comprehensive income and will be accreted over the remaining life of the securities as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount on the transferred securities. No gains or losses were recognized at the time of reclassification. Management considers the held-to-maturity classification of these investment securities to be appropriate as the Corporation has the positive intent and ability to hold these securities to maturity.

 

For the three months ended March 31, 2013, proceeds of available-for-sale investment securities sold amounted to approximately $45.0 million. 

 

The varying amount of sales from the available-for-sale portfolio over the past few years, and the significant volume of such sales in 2011, reflect the significant volatility present in the market. Given the historic low interest rates prevalent in the market, it is necessary for the Corporation to protect itself from interest rate exposure. Securities that once appeared to be sound investments can, after changes in the market, become securities that the Corporation has the flexibility to sell to avoid losses and mismatches of interest-earning assets and interest-bearing liabilities at a later time.

 

Gross gains and losses from the sales of investment securities for the three month periods ended March 31, 2013 and 2012 were as follows:

 

   Three Months Ended
March 31,
 
(in thousands)  2013   2012 
Gross gains on sales of investment securities  $432   $995 
Gross losses on sales of investment securities   89     
Net gains on sales of investment securities  $343   $995 

 

The following summarizes OTTI charges for the periods indicated.

 

   Three Months Ended 
   March 31, 
   2013   2012 
   (in thousands) 
Principal losses on a variable rate CMO  $24   $58 
Total other-than-temporary impairment charges  $24   $58 

 

The Corporation performs regular analysis on all its investment securities to determine whether a decline in fair value indicates that an investment is other-than-temporarily impaired in accordance with FASB ASC 320-10. FASB ASC 320-10 requires companies to record OTTI charges, through earnings, if they have the intent to sell, or if it is more likely than not that they will be required to sell, an impaired debt security before recovery of its amortized cost basis. If the Corporation intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current period credit loss, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its estimated fair value at the balance sheet date. If the Corporation does not intend to sell the security and it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, and it determines that a decline in fair value is other than temporary, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

 

The Corporation’s assessment of whether an impairment is other than temporary includes factors such as whether the issuer has defaulted on scheduled payments, announced a restructuring and/or filed for bankruptcy, has disclosed severe liquidity problems that cannot be resolved, disclosed a deteriorating financial condition or sustained significant losses. The Corporation maintains a watch list for the identification and monitoring of securities experiencing problems that require a heightened level of review. This could result from credit rating downgrades.

 

15
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents detailed information for each trust preferred security held by the Corporation at March 31, 2013 which has at least one rating below investment grade.

 

Deal Name  Single
Issuer or
Pooled
  Class/
Tranche
   Amortized
Cost
   Fair
Value
   Gross
Unrealized
Gain (Loss)
   Lowest
Credit
Rating
Assigned
 

Number of
Banks
Currently
Performing

   Deferrals
and Defaults
as % of
Original
Collateral
   Expected
Deferral/Defaults
as % of
Remaining
Performing
Collateral
 
   (dollars in thousands)
Countrywide Capital IV  Single      $1,770   $1,806   $36   BB+   1    None    None 
Countrywide Capital V  Single       2,747    2,808    61   BB+   1    None    None 
Countrywide Capital V  Single       250    256    6   BB+   1    None    None 
Citigroup Cap IX  Single       992    1,021    29   BB   1    None    None 
Citigroup Cap IX  Single       1,905    1,971    66   BB   1    None    None 
Citigroup Cap XI  Single       246    253    7   BB   1    None    None 
Nationsbank Cap Trust III  Single       1,572    1,245    (327)  BB+   1    None    None 
Morgan Stanley Cap Trust IV  Single       2,500    2,513    13   BB+   1    None    None 
Morgan Stanley Cap Trust IV  Single       1,742    1,758    16   BB+   1    None    None 
Saturns — GS 2004-06  Single       243    248    5   BB+   1    None    None 
Saturns — GS 2004-06  Single       313    320    7   BB+   1    None    None 
Saturns — GS 2004-04  Single       781    798    17   BB+   1    None    None 
Saturns — GS 2004-04  Single       22    22       BB+   1    None    None 
Goldman Sachs  Single       999    1,045    46   BB+   1    None    None 
Stifel Financial  Single       4,500    4,680    180   BBB-   1    None    None 
ALESCO Preferred Funding VII  Pooled   C1    845    44    (801)  Ca   47 of 61(1)    35.9%   44.5%
Total          $21,427   $20,788   $(639)                  

 

  (1) Includes banks and insurance companies.

 

16
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Corporation owns one pooled trust preferred security (“Pooled TRUP”), which consists of securities issued by financial institutions and insurances companies. The Corporation holds the mezzanine tranche of the Pooled TRUP. Senior tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches. The Corporation’s analysis of the Pooled TRUP falls within the scope of EITF 99-20, ASC 320-40 and uses a discounted cash flow model to determine the total OTTI loss. The model considers the structure, term and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers and the allocation of the payments to the note classes according to a priority of payments specified in the offering circular and indenture. The current estimate of expected cash flows is based on the most recent trustee reports and other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred security. Assumptions used in the model include defaults rates, default rate timing profiles and recovery rates. We assume no prepayments, as the Pooled TRUP was issued at comparatively tight spreads and as such, there is little incentive, if any, to prepay.

 

On March 25, 2013, the Pooled TRUP, ALESCO VII, incurred its fifteenth interruption of cash flow payments to date. Management reviewed the expected cash flow analysis and credit support to determine if it was probable that all principal and interest would be repaid, and recorded no other-than-temporary impairment charge for the three months ended March 31, 2013 and March 31, 2012.

  

At March 31, 2013, excess subordination as a percentage of remaining performing collateral for the ALESCO Preferred Funding VII investments was -49.4 percent. Excess subordination is the amount of performing collateral above the amount of outstanding collateral underlying each class of the security. The excess subordination as a percent of remaining performing collateral reflects the difference between the performing collateral and the collateral underlying each security divided by the performing collateral. A negative number results when the paying collateral is less than the collateral underlying each class of the security. A low or negative number decreases the likelihood of full repayment of principal and interest according to original contractual terms.

 

Credit Loss Portion of OTTI Recognized in Earnings on Debt Securities

 

   Three Months
Ended 
March 31,
2013
   Year
Ended
December
31, 2012
 
   (in thousands) 
Balance of credit-related OTTI at January 1,  $4,450   $6,539 
Addition:          
Credit losses on investment securities for which other-than-temporary impairment was not previously recognized   24    870 
Reduction:          
Credit losses on investment securities sold during the period   (2,114)   (2,959)
Balance of credit-related OTTI at period end  $2,360   $4,450 

 

17
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Corporation did not record other-than-temporary impairment charges relating to equity holdings in bank stocks for the three months ended March 31, 2013 and March 31, 2012.

 

Temporarily Impaired Investments

 

For all other securities, the Corporation does not believe that the unrealized losses, which were comprised of 55 investment securities as of March 31, 2013, represent an other-than-temporary impairment. The gross unrealized losses associated with federal agency obligations, mortgage-backed securities, corporate bonds and tax-exempt securities are not considered to be other than temporary because their unrealized losses are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer.

 

Factors affecting the market price include credit risk, market risk, interest rates, economic cycles, and liquidity risk. The magnitude of any unrealized loss may be affected by the relative concentration of the Corporation’s investment in any one issuer or industry. The Corporation has established policies to reduce exposure through diversification of concentration of the investment portfolio including limits on concentrations to any one issuer. The Corporation believes the investment portfolio is prudently diversified.

 

The decline in value is related to a change in interest rates and subsequent change in credit spreads required for these issues affecting market price. All issues are performing and are expected to continue to perform in accordance with their respective contractual terms and conditions. Short to intermediate average durations and in certain cases monthly principal payments should reduce further market value exposure to increases in rates.  

 

The Corporation evaluates all securities with unrealized losses quarterly to determine whether the loss is other than temporary. Unrealized losses in the collateralized mortgage obligations category consist primarily of private issue collateralized mortgage obligations. Unrealized losses in the corporate debt securities category consist of single issuer corporate trust preferred securities, pooled trust preferred securities and corporate debt securities issued by large financial institutions, insurance companies and other corporate issuers. The unrealized loss in equity securities consists of other bank equities. The decline in fair value is due in large part to the lack of an active trading market for these securities, changes in market credit spreads and rating agency downgrades. For collateralized mortgage obligations, management reviewed expected cash flows and credit support to determine if it was probable that all principal and interest would be repaid. None of the corporate issuers have defaulted on interest payments. Management concluded that these securities, other than the previously mentioned Pooled TRUP, were not other-than-temporarily impaired at March 31, 2013. Future deterioration in the cash flow on collateralized mortgage obligations or the credit quality of these large financial institution issuers of TRUP debt securities could result in impairment charges in the future.

 

In determining that the securities giving rise to the previously mentioned unrealized losses were not other-than-temporary, the Corporation evaluated the factors cited above, which the Corporation considers when assessing whether a security is other-than-temporarily impaired. In making these evaluations the Corporation must exercise considerable judgment. Accordingly there can be no assurance that the actual results will not differ from the Corporation’s judgments and that such differences may not require the future recognition of other-than-temporary impairment charges that could have a material effect on the Corporation’s financial position and results of operations. In addition, the value of, and the realization of any loss on, an investment security are subject to numerous risks as cited above.

 

18
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012:

 

   March 31, 2013 
   Total   Less than 12 Months   12 Months or Longer 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (in thousands) 
Investment Securities Available-for-Sale:                              
Federal agency obligations  $6,151   $(121)  $6,151   $(121)  $   $ 
Obligations of U.S. states and political subdivisions   15,522    (291)   15,522    (291)        
Trust preferred securities   1,289    (1,128)           1,289    (1,128)
Corporate bonds and notes   21,985    (257)   11,577    (139)   10,408    (118)
Certificates of deposit   190    (3)   190    (3)        
Equity securities   370    (165)           370    (165)
Other securities   985    (15)           985    (15)
Total   46,492    (1,980)   33,440    (554)   13,052    (1,426)
Investment Securities
Held-to-Maturity:
                              
Commercial mortgage pass-through securities   592    (6)           592    (6)
Obligations of U.S. states and political subdivisions   18,109    (269)   18,109    (269)        
Total   18,701    (275)   18,109    (269)   592    (6)
Total Temporarily Impaired Securities  $65,193   $(2,255)  $51,549   $(823)  $13,644   $(1,432)

   

   December 31, 2012 
   Total   Less than 12 Months   12 Months or Longer 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (in thousands) 
Investment Securities Available-for-Sale:                              
U.S. Treasury and agency securities  $4,460   $(23)  $4,460   $(23)  $   $ 
Federal agency obligation   877    (5)   877    (5)        
Residential mortgage
pass-through securities
   1,669    (1)   1,669    (1)        
Obligations of U.S. states and political subdivisions   18,360    (132)   18,360    (132)        
Trust preferred securities   11,740    (1,174)   10,494    (18)   1,246    (1,156)
Corporate bonds and notes   26,440    (371)   18,244    (134)   8,196    (237)
Certificates of deposit   388    (10)   388    (10)        
Equity securities   325    (210)           325    (210)
Other securities   985    (15)           985    (15)
Total   65,244    (1,941)   54,492    (323)   10,752    (1,618)
Investment Securities
Held-to-Maturity:
                              
Commercial mortgage-backed securities   932    (5)   932    (5)        
Total   932    (5)   932    (5)        
Total Temporarily Impaired Securities  $66,176   $(1,946)  $55,424   $(328)  $10,752   $(1,618)

 

19
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Investment securities having a carrying value of approximately $94.4 million and $96.1 million at March 31, 2013 and December 31, 2012, respectively, were pledged to secure public deposits, borrowings, and Federal Home Loan Bank advances and for other purposes required or permitted by law.

 

Note 7. Loans and the Allowance for Loan Losses

 

Loans are stated at their principal amounts inclusive of net deferred loan origination fees. Interest income is credited as earned except when a loan becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. Loans that are past due 90 days or more that are both well secured and in the process of collection will remain on an accruing basis. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income.

 

Portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its allowance. Management has determined that the Corporation has two portfolio segments of loans and leases (commercial and consumer) in determining the allowance. Both quantitative and qualitative factors are used by management at the portfolio segment level in determining the adequacy of the allowance for the Corporation. Classes of loans and leases are a disaggregation of the corporation's portfolio segments. Classes are defined as a group of loans and leases which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Corporation has five classes of loans and leases: commercial and industrial (including lease financing), commercial – real estate, construction, residential mortgage (including home equity) and installment.

 

Generally, all classes of commercial and consumer loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans and leases are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), when terms are renegotiated below market levels, or where substantial doubt about full repayment of principal or interest is evident. For certain installment loans the entire outstanding balance on the loan is charged-off when the loan becomes 60 days past due.

 

Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and six months of payments to demonstrate that the borrower can continue to meet the loan terms. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the loan as an adjustment to the loan’s yield using the level yield method.

 

20
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Impaired Loans

 

The Corporation accounts for impaired loans in accordance with FASB ASC 310-10-35. The value of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or at the fair value of the collateral if the loan is collateral dependent.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments. The Corporation has defined its population of impaired loans to include all classes of non-accrual and troubled debt restructuring (“TDR”) loans. As part of the evaluation of the value of impaired loans, the Corporation individually reviews for impairment all non-homogeneous loans (in each instance, above an established dollar threshold of $200,000) internally classified as substandard or below. Smaller impaired non-homogeneous loans and impaired homogeneous loans are collectively evaluated for impairment.

 

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the Allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

 

Loans Modified in a Troubled Debt Restructuring

 

Loans are considered to have been modified in a TDR when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

 

Reserve for Credit Losses

 

The Corporation's reserve for credit losses is comprised of two components, the allowance and the reserve for unfunded commitments (the "Unfunded Commitments").

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level determined adequate to provide for probable loan losses. The allowance is increased by provisions charged to operations and reduced by loan charge-offs, net of recoveries. The allowance is based on management’s evaluation of the loan portfolio considering economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit situations.

 

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

 

The ultimate collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in the real estate market and economic conditions in the State of New Jersey and the impact of such conditions on the creditworthiness of the borrowers.

 

21
 

  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Management believes that the allowance for loan losses is adequate. Management uses available information to recognize loan losses; however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.

 

Reserve for Unfunded Commitments

 

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the consolidated statements of condition. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, and credit risk. Net adjustments to the reserve for unfunded commitments are included in other expense.

 

Risk Related to Representation and Warranty Provisions

 

The Corporation sells residential mortgage loans in the secondary market primarily to Fannie Mae. The Corporation sells residential mortgage loans to Fannie Mae that include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the specific representations and warranties vary, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, and other matters.

 

As of March 31, 2013, the unpaid principal balance of the Corporation’s portfolio of residential mortgage loans sold to Fannie Mae was $9.7 million. These loans are generally sold on a non-recourse basis. The agreements under which the Corporation sells residential mortgage loans require the Corporation to deliver various documents to the investor or its document custodian. Although these loans are primarily sold on a non-recourse basis, the Corporation may be obligated to repurchase residential mortgage loans where required documents are not delivered or are defective. Investors may require the immediate repurchase of a mortgage loan when an early payment default discovered in an underwriting review reveals significant underwriting deficiencies, even if the mortgage loan has subsequently been brought current. As of March 31, 2013, there were no pending repurchase requests related to representation and warranty provisions.

 

Composition of Loan Portfolio

 

The following table sets forth the composition of the Corporation’s loan portfolio, including net deferred fees and costs, at March 31, 2013 and December 31, 2012:

 

   March 31,   December 31, 
   2013   2012 
   (in thousands) 
Commercial and industrial  $187,181   $181,682 
Commercial real estate   501,563    497,392 
Construction   35,163    40,277 
Residential mortgage   154,757    169,094 
Installment   589    1,104 
Subtotal   879,253    889,549 
Net deferred loan costs   134    123 
Total loans  $879,387   $889,672 

  

At March 31, 2013 and December 31, 2012, loans to executive officers and directors aggregated approximately $19,406,000 and $18,977,000, respectively. During the three months ended March 31, 2013, the Corporation made new loans and advances to executive officers and directors in the amount of $1,038,000. Payments by such persons during 2013 aggregated $609,000.  

 

Management is of the opinion that the above loans were made on the same terms and conditions as those prevailing for comparable transactions with non-related borrowers.

 

22
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

At March 31, 2013 and December 31, 2012, loan balances of approximately $562.8 million and $532.8 million, respectively, were pledged to secure borrowings from the Federal Reserve Bank of New York and the Federal Home Loan Bank of New York.

 

The following table presents information about loan receivables on non-accrual status at March 31, 2013 and December 31, 2012:

 

Loans Receivable on Non-Accrual Status        
   March 31,
2013
   December 31,
2012
 
   (in thousands) 
Commercial and industrial  $212   $214 
Commercial real estate   354    354 
Construction       319 
Residential mortgage   1,999    2,729 
Total loans receivable on non-accrual status  $2,565   $3,616 

  

The amount of interest income that would have been recorded on non-accrual loans during the three months ended March 31, 2013 and the year ended December 31, 2012, had payments remained in accordance with the original contractual terms, was $33,000 and $187,000, respectively.

 

The Corporation continuously monitors the credit quality of its loans receivable. In addition to the internal staff, the Corporation utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified “Pass” are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as “Special Mention” have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Corporation’s credit position at some future date. Assets are classified “Substandard” if the asset has a well defined weakness that requires management’s attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as “Doubtful” if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a “distinct possibility” that a degree of loss will occur if the inadequacies are not corrected. All loans past due 90 days or more and all impaired loans are included in the appropriate category below. The following table presents information, excluding deferred costs, about the loan credit quality at March 31, 2013 and December 31, 2012:

 

Credit Quality Indicators    
   March 31, 2013 
   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (in thousands) 
Commercial and industrial  $182,487   $3,145   $1,549   $   $187,181 
Commercial real estate   467,037    18,770    15,756        501,563 
Construction   34,316        847        35,163 
Residential mortgage   150,194    991    3,572        154,757 
Installment   456        133        589 
Total loans  $834,490   $22,906   $21,857   $   $879,253 

 

Credit Quality Indicators    
   December 31, 2012 
   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (in thousands) 
Commercial and industrial  $176,818   $3,281   $1,583   $   $181,682 
Commercial real estate   462,266    18,945    16,181        497,392 
Construction   38,303    810    1,164        40,277 
Residential mortgage   163,769    993    4,332        169,094 
Installment   967        137        1,104 
Total loans  $842,123   $24,029   $23,397   $   $889,549 

 

23
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table provides an analysis of the impaired loans at March 31, 2013 and December 31, 2012:

 

   Three Months Ended March 31, 2013 
  

 

Recorded
Investment

   Unpaid
Principal
Balance
  

 

Related
Allowance

 
 No Related Allowance Recorded  (in thousands) 
Commercial real estate  $1,500   $1,950   $ 
Total  $1,500   $1,950   $ 

With An Allowance Recorded

               
Commercial real estate  $4,180   $4,180   $474 
Residential mortgage   1,214    1,214    111 
Total  $5,394   $5,394   $585 
Total               
Commercial real estate  $5,680   $6,130   $474 
Residential mortgage   1,214    1,214    111 
Total (including related allowance)  $6,894   $7,344   $585 

 

   Year Ended December 31, 2012 
  

 

Recorded
Investment

   Unpaid
Principal
Balance
  

 

Related
Allowance

 
 No Related Allowance Recorded  (in thousands) 
Commercial real estate  $1,500   $1,950   $ 
Total  $1,500    1,950   $ 
With An Allowance Recorded               
Commercial real estate  $4,180   $4,180   $493 
Residential mortgage   1,255    1,255    152 
Total  $5,435   $5,435   $645 
Total               
Commercial real estate  $5,680   $6,130   $493 
Residential mortgage   1,255    1,255    152 
Total (including related allowance)  $6,935   $7,385   $645 

 

 

24
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   Three Months Ended
March 31,2013
   Three Months Ended
March 31,2012
 
   Average
Recorded
Investment
   Interest
Income
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
 
Impaired loans with no related allowance recorded:                    
                     
Commercial real estate  $1,500   $19   $2,105   $30 
Total  $1,500   $19   $2,105   $30 
                     
Impaired loans with an allowance recorded:                    
                     
Commercial real estate  $4,180   $34   $4,180   $35 
Construction           3,044     
Residential mortgage   1,249    10    4,469    26 
Total  $5,429   $44   $11,693   $61 
                     
Total impaired loans:                    
                     
Commercial real estate  $5,680   $53   $6,285   $65 
Construction           3,044     
Residential mortgage   1,249    10    4,469    26 
Total  $6,929   $63   $13,798   $91 

 

Included in impaired loans at March 31, 2013 are loans that are deemed troubled debt restructurings. Of these loans, $6.2 million, 90.8 percent of which are included in the tables above, are performing under the restructured terms and are accruing interest.

 

25
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table provides an analysis of the aging of loans, excluding deferred fees and costs that are past due at March 31, 2013 and December 31, 2012:

 

Aging Analysis    
   March 31, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days
   Total Past
Due
   Current   Total Loans
Receivable
   Loans
Receivable > 90
Days And
Accruing
 
   (in thousands) 
Commercial and Industrial  $7   $   $212   $219   $186,962   $187,181   $ 
Commercial Real Estate   780        354    1,134    500,429    501,563     
Construction                   35,163    35,163     
Residential Mortgage   1,136        2,054    3,190    151,567    154,757    55 
Installment   4            4    585    589     
Total  $1,927   $   $2,620   $4,547   $874,706   $879,253   $55 

 

   December 31, 2012 
   30-59 Days 
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days
   Total Past
Due
   Current   Total Loans
Receivable
   Loans
Receivable > 90
Days And
Accruing
 
   (in thousands) 
Commercial and Industrial  $590   $   $214   $804   $180,878   $181,682   $ 
Commercial Real Estate   1,012    703    354    2,069    495,323    497,392     
Construction           319    319    39,958    40,277     
Residential Mortgage   2,017    628    2,784    5,429    163,665    169,094    55 
Installment   23            23    1,081    1,104     
Total  $3,642   $1,331   $3,671   $8,644   $880,905   $889,549   $55 

 

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan loss that is allocated to each loan portfolio segment:

 

26
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Allowance for loan and lease losses
   March 31, 2013 
   C & I   Comm
R/E
   Construction   Res Mtge   Installment   Unallocated   Total 
   (in thousands) 
Allowance for loan and lease losses:                                   
Individually evaluated for impairment  $   $474   $   $111   $   $   $585 
Collectively evaluated for impairment   2,083    4,879    284    1,267    103    1,031    9,647 
                                    
Total  $2,083   $5,353   $284   $1,378   $103   $1,031   $10,232 
                                    
Loans Receivable                                   
Individually evaluated for impairment  $   $5,680   $   $1,214   $   $   $6,894 
Collectively evaluated for impairment   183,956    475,743    33,766    135,280    461        829,206 
Loans acquired with discounts related to credit quality   3,225    20,140    1,397    18,263    128        43,153 
Total  $187,181   $501,563   $35,163   $154,757   $589   $   $879,253 

 

Allowance for loan and lease losses
   December 31, 2012 
   C & I   Comm
R/E
   Construction   Res Mtge   Installment   Unallocated   Total 
   (in thousands) 
Allowance for loan and  lease losses:                                   
Individually evaluated for impairment  $   $493   $   $152   $   $   $645 
Collectively evaluated for impairment   2,424    4,830    313    1,380    113    532    9,592 
Total  $2,424   $5,323   $313   $1,532   $113   $532   $10,237 
                                    
Loans Receivable                                   
Individually evaluated for impairment  $   $5,680   $   $1,255   $   $   $6,935 
Collectively evaluated for impairment   177,644    470,797    38,172    146,930    973        834,516 
Loans acquired with discounts related to credit quality   4,038    20,915    2,105    20,909    131        48,098 
Total  $181,682   $497,392   $40,277   $169,094   $1,104   $   $889,549 

 

The Corporation’s allowance for loan losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan loss methodology as disclosed in the Corporation’s Annual Report on Form 10-K as of and for the year ended December 31, 2012.

 

 A summary of the activity in the allowance for loan losses is as follows:

 

   Three Months Ended March 31, 2013 
   C & I   Comm
R/E
   Construction   Res Mtge   Installment   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $2,424   $5,323   $313   $1,532   $113   $532   $10,237 
                                    
Charge offs                   (6)       (6)
                                    
Recoveries                   1        1 
                                    
Provision   (341)   30    (29)   (154)   (5)   499     
                                    
Balance at March 31,  $2,083   $5,353   $284   $1,378   $103   $1,031   $10,232 

  

27
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   Three Months Ended March 31, 2012 
   C & I   Comm
R/E
   Construction   Res Mtge   Installment   Unallocated   Total 
   (in thousands) 
Balance at January 1,  $1,527   $5,972   $707   $1,263   $51   $82   $9,602 
                                    
Charge offs                   (3)       (3)
                                    
Recoveries               47    1        48 
                                    
Provision   257    (96)   (70)   (76)   5    87    107 
                                    
Balance at March 31,  $1,784   $5,876   $637   $1,234   $54   $169   $9,754 

 

At March 31, 2013, there were no commitments to lend additional funds to borrowers whose loans were on non-accrual status or were contractually past due in excess of 90 days and still accruing interest, or whose terms have been modified in troubled debt restructurings.

 

The policy of the Corporation is to generally grant commercial, mortgage and installment loans to New Jersey residents and businesses within its market area. The borrowers’ abilities to repay their obligations are dependent upon various factors, including the borrowers’ income and net worth, cash flows generated by the borrowers’ underlying collateral, value of the underlying collateral, and priority of the lender’s lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Corporation. The Corporation is therefore subject to risk of loss. The Corporation believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans.

 

The Corporation had no troubled debt restructurings during the three months ended March 31, 2013.

 

Loans modified in a troubled debt restructuring totaled $8.3 million at March 31, 2013 of which $1.5 million were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement. At December 31, 2012, loans modified in a troubled debt restructuring totaled $8.3 million of which $1.5 million were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement.

 

In an effort to proactively manage delinquent loans, the Corporation has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, principal or interest forgiveness, adjusted repayment terms, forbearance agreements, or combinations of two or more of these concessions. As of March 31, 2013, loans on which concessions were made with respect to adjusted repayment terms amounted to $1.6 million. Loans on which combinations of two or more concessions were made amounted to $6.7 million. The concessions granted included principal concessions, rate reduction, adjusted repayment, extended maturity and payment deferral.

 

28
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  

Note 8.  Fair Value Measurements and Fair Value of Financial Instruments

 

Fair Value Measurements

 

Management uses its best judgment in estimating the fair value of the Corporation’s financial and non-financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial and non-financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of the respective period-end dates indicated herein and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial and non-financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.

 

U.S. GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

·Level 1: Unadjusted exchange quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

·Level 2: Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

·Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (for example, supported with little or no market activity).

 

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Corporation’s assets measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012.

 

29
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Investment Securities Available-for-Sale

 

Where quoted prices are available in an active market, investment securities are classified in Level 1 of the valuation hierarchy. Level 1 inputs include investment securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy, include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine their fair value and are classified as Level 3. Due to the inactive condition of the markets amidst the financial crisis, the Corporation treated certain investment securities as Level 3 assets in order to provide more appropriate valuations. For assets in an inactive market, the infrequent trades that do occur are not a true indication of fair value. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Corporation’s evaluations are based on market data and the Corporation employs combinations of these approaches for its valuation methods depending on the asset class. In certain cases where there were limited or less transparent information provided by the Corporation’s third-party pricing service, fair value was estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

 

On a quarterly basis, management reviews the pricing information received from the Corporation’s third-party pricing service. This review process includes a comparison to non-binding third-party broker quotes, as well as a review of market-related conditions impacting the information provided by the Corporation’s third-party pricing service.

 

Management primarily identifies investment securities which may have traded in illiquid or inactive markets by identifying instances of a significant decrease in the volume and frequency of trades, relative to historical levels, as well as instances of a significant widening of the bid-ask spread in the brokered markets. Investment securities that are deemed to have been trading in illiquid or inactive markets may require the use of significant unobservable inputs. For example, management may use quoted prices for similar investment securities in the absence of a liquid and active market for the securities being valued. As of March 31, 2013 and December 31, 2012, management made adjustments to prices provided by the third-party pricing service as a result of illiquid or inactive markets.

 

At March 31, 2013 and December 31, 2012, the Corporation’s pooled trust preferred security, ALESCO VII, was classified as Level 3. Market pricing for the Level 3 security varied widely from one pricing service to another based on the lack of trading. As such, the security was not considered to have readily observable market data that was accurate to support a fair value as prescribed by FASB ASC 820-10-05. The Corporation determined that significant adjustments using unobservable inputs are required to determine fair value at the measurement date.

 

The Corporation determined that an income approach valuation technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at the prior measurement dates. As a result, the Corporation used the discount rate adjustment technique to determine fair value.

 

The fair value of private label CMO as of March 31, 2013 and December 31, 2012 was determined by discounting the expected cash flows over the life of the security. The discount rate was determined by deriving a discount rate when the markets were considered more active for this type of security. To this estimated discount rate, additions were made for more liquid markets and increased credit risk as well as assessing the risks in the security, such as default risk and severity risk. However, the private label CMO had interruptions of its scheduled principal payments and the Corporation recorded a net settlement principal loss of $24,000 for the three months ended March 31, 2013, this security was sold at its book value on January 4, 2013.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2013 and December 31, 2012 are as follows:

 

30
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

       Fair Value Measurements at
Reporting Date Using
 
Assets Measured at Fair Value on a Recurring Basis  March 31,
2013
   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
Federal agency obligations  $16,169   $   $16,169   $ 
Residential mortgage pass-through securities   51,514        51,514     
Commercial mortgage pass-through securities   9,926        9,926     
Obligations of U.S. states and political subdivisions   95,958        95,958     
Trust preferred securities   20,788        20,744    44 
Corporate bonds and notes   236,831        236,831     
Asset-backed securities   19,595    1,465    18,130     
Certificates of deposit   2,889        2,889     
Equity securities   370    370         
Other securities   3,964    3,964         
Securities available-for-sale  $458,004   $5,799   $452,161   $44 

 

       Fair Value Measurements at
Reporting Date Using
 
Assets Measured at Fair Value on a Recurring Basis  December
31,
2012
   Quoted
Prices in
Active
Markets
for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
U.S. treasury and agency securities  $11,909   $11,909   $   $ 
Federal agency obligations   20,535        20,535     
Residential mortgage pass-through securities   53,784        53,784     
Commercial mortgage pass-through securities   9,969        9,969     
Obligations of U.S. states and political subdivisions   107,714    469    107,245     
Trust preferred securities   21,249        21,213    36 
Corporate bonds and notes   237,405        237,405     
Collateralized mortgage obligations   2,120        2,120     
Asset-backed securities   19,742        19,742     
Certificates of deposit   2,865        2,865     
Equity securities   325    325         
Other securities   9,198    9,198         
Securities available-for-sale  $496,815   $21,901   $474,878   $36 

 

The fair values used by the Corporation are obtained from an independent pricing service and represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2). The fair values of the obligations of states and political subdivisions and asset-backed securities measured at fair value using Level 1 inputs at March 31, 2013 and December 31, 2012 represented the purchase price of the securities since they were acquired near quarter-end March 31, 2013 and year-end 2012.

 

31
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 The following tables present the changes in investment securities available-for-sale with significant unobservable inputs (Level 3) for the three months ended March 31, 2013 and 2012.

 

   Three Months Ended 
   March 31, 
   2013   2012 
   (in thousands) 
Balance, beginning of the period  $36   $2,115 
Principal interest deferrals   14    34 
Principal repayments       (58)
Total net unrealized (losses) gains   (6)   (128)
Balance, end of the period  $44   $1,963 

 

For the three months ended March 31, 2013, there were no transfers of investment securities available-for-sale into or out of Level 1, Level 2, or Level 3 assets, except for securities purchased at the quarter end included in Level 1, representing purchase prices, which subsequently will be evaluated and placed in the appropriate Level depending on the observable inputs.

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

For assets measured at fair value on a non-recurring basis, the fair value measurements used at March 31, 2013 and December 31, 2012 were as follows:

 

       Fair Value Measurements at Reporting Date
Using
 
Assets Measured at Fair Value on a Non-Recurring Basis  March 31,
2013
   Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
Impaired loans  $4,809   $   $   $4,809 

 

       Fair Value Measurements at Reporting Date
Using
 
Assets Measured at Fair Value on a Non-Recurring Basis  December
31,
2012
   Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
Impaired loans  $4,790   $   $   $4,790 
Other real estate owned   1,300            1,300 

 

The following methods and assumptions were used to estimate the fair values of the Corporation’s assets measured at fair value on a non-recurring basis at March 31, 2013 and December 31, 2012.

 

Impaired Loans. The value of an impaired loan is measured based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and installment loans, are specifically excluded from the impaired loan portfolio. The Corporation’s impaired loans are primarily collateral dependent. Impaired loans are individually assessed to determine that each loan’s carrying value is not in excess of the fair value of the related collateral or the present value of the expected future cash flows. Impaired loans at March 31, 2013 that required a valuation allowance were $5,394,000 with a related valuation allowance of $585,000 compared to $5,435,000 with related valuation allowance of $645,000 at December 31, 2012. Impaired loans of $1,500,000 and $1,500,000 had no recorded valuation allowance for March 31, 2013 and December 31, 2012, respectively.

 

32
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Fair Value of Financial Instruments

 

 Other Real Estate Owned.  Other real estate owned (“OREO”) is measured at fair value less costs to sell. The Corporation believes that the fair value component in its valuation follows the provisions of FASB ASC 820-10-05. The fair value of OREO is determined by sales agreements or appraisals by qualified licensed appraisers approved and hired by the Corporation. Costs to sell associated with OREO is based on estimation per the terms and conditions of the sales agreements or appraisals.

 

FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Corporation’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Corporation’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and investment securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Corporation for the purposes of this disclosure.

 

Investment Securities Held-to-Maturity. The fair value of the Corporation’s investment securities held-to-maturity was primarily measured using information from a third-party pricing service. If quoted prices were not available, fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. In cases where there may be limited or less transparent information provided by the Corporation’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

 

Loans Held-for-Sale. Fair value is estimated using the prices of the Corporation’s existing commitments to sell such loans and/or the quoted market price for commitment to sell similar loans.

 

Loans. The fair value of the Corporation’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were segregated by types such as commercial, residential and consumer loans. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

 

Non Interest-Bearing Deposits. The fair value for non interest-bearing deposits is equal to the amount payable on demand at the reporting date.

 

Interest-Bearing Deposits. The fair values of the Corporation’s interest-bearing deposits were estimated using discounted cash flow analyses. The discounted rates used were based on rates currently offered for deposits with similar remaining maturities. The fair values of the Corporation’s interest-bearing deposits do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

 

Term Borrowings and Subordinated Debentures. The fair value of the Corporation’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities.

 

Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a level 2 or level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Corporation’s financial instruments as of March 31, 2013 and December 31, 2012.

 

33
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

           Fair Value Measurements 
   Carrying
Amount
   Fair Value   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (in thousands) 
March 31, 2013                    
Financial assets                         
    Cash and due from banks  $116,755   $116,755   $116,755   $   $ 
    Investment securities available-for-sale   458,004    458,004    5,799    452,161    44 
    Investment securities held-to-maturity   78,212    81,921        81,921     
    Restricted investment in bank stocks   8,966    8,966        8,966     
    Loans held for sale   774    774    774         
    Net loans   869,155    881,942            881,942 
    Accrued interest receivable   6,423    6,423        3,968    2,455 
                          
Financial liabilities                         
    Non interest-bearing deposits   213,794    213,794        213,794     
    Interest-bearing deposits   1,068,429    1,069,556        1,069,556     
    Long-term borrowings   146,000    161,714        161,714     
    Subordinated debentures   5,155    5,032        5,032     
    Accrued interest payable   881    881        881     
                          
December 31, 2012                         
Financial assets                         
    Cash and due from banks  $104,134   $104,134   $104,134   $   $ 
    Interest bearing deposits with banks   2,004    2,004    2,004         
    Investment securities available-for-sale   496,815    496,815    21,901    474,878    36 
    Investment securities held-to-maturity   58,064    62,431        62,431     
    Restricted investment in bank stocks   8,964    8,964        8,964     
    Loans held for sale   1,491    1,491    1,491         
    Net loans   879,435    897,030            897,030 
    Accrued interest receivable   6,849    6,849        4,465    2,384 
                          
Financial liabilities                         
    Non interest-bearing deposits   215,071    215,071        215,071     
    Interest-bearing deposits   1,091,851    1,092,822        1,092,822     
    Long-term borrowings   146,000    162,992        162,992     
    Subordinated debentures   5,155    5,046        5,046     
    Accrued interest payable   874    874        874     

 

34
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 9.  Net Investment in Direct Financing Lease

 

During the second quarter of 2010, the Corporation entered into a lease of its former operations facility under a direct financing lease. The lease has a 15 year term with no renewal options. According to the terms of the lease, the lessee has an obligation to purchase the property underlying the lease in either year seven (7), ten (10) or fifteen (15) at predetermined prices for those years as provided in the lease. The structure of the minimum lease payments and the purchase prices as provided in the lease provide an inducement to the lessee to purchase the property in year seven (7).

 

At March 31, 2013 and December 31, 2012, the net investment in direct financing lease consists of a minimum lease receivable of $4,645,000 and $4,699,000, respectively, and unearned interest income of $879,000 and $928,000, respectively, for a net investment in direct financing lease of $3,766,000 and $3,771,000, respectively. The net investment in direct financing lease is carried as a component of loans in the Corporation’s consolidated statements of condition.

 

Minimum future lease receipts of the direct financing lease are as follows:

 

   March 31, 2013 
For years ending December 31,  (in thousands) 
2013  $162 
2014   216 
2015   228 
2016   265 
2017   265 
    Thereafter   2,630 
Total minimum future lease receipts  $3,766 

 

  Note 10.  Components of Net Periodic Pension Cost

 

The Corporation maintained a non-contributory pension plan for substantially all of its employees until September 30, 2007, at which time the Corporation froze its defined benefit pension plan. The following table sets forth the net periodic pension cost of the Corporation’s pension plan for the periods indicated.

 

  Three Months Ended  
March 31,
 
   2013   2012 
   (in thousands) 
Interest cost   $132   $143 
Net amortization and deferral    (2)   (30)
   Net periodic pension cost  $130   $113 

 

Contributions

 

The Corporation presently estimates it will contribute $450,000 to its Pension Trust for the 2013 plan year.

 

 The Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010, signed into law on June 25, 2010, permits single employer and multiple employer defined benefit plan sponsors to elect to extend the plan’s amortization period of a Shortfall Amortization Base over either a nine year period or a fifteen year period, rather than the seven year period required under the Pension Protection Act of 2006. The relief was available for any two Plan Years 2008 through 2011.

 

The Bank has elected to apply the Pension Relief Act fifteen year amortization of the Shortfall Amortization Bases established for the 2009 and 2011 Plan Years.

 

The Moving Ahead for Progress in the 21st Century Act which was enacted on July 6, 2012 contained special rules related to funding stabilization for single employer defined benefit plans. Under these provisions, the interest rates used to calculate the plan’s funding percentages and minimum required contribution are adjusted as necessary to fall within a specified range that is determined based on an average of rates for the 25 year period ending on September 30 of the calendar year preceding the first day of the Plan Year. For Plan years beginning in 2012, the range is 90% - 110% of the 25 year average. The effect of the application of the adjusted rates was to reduce the 2012 required minimum contribution to the Plan to approximately $300,000. However, the actuary has recommended that the contribution for the 2013 plan year be at least $450,000 in order to continue to make progress toward fully funding Plan liabilities and that amount has been contributed for the 2012 Plan Year.

 

35
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11.  Income Taxes

 

For the three months ended March 31, 2013, the Corporation recorded income tax expense of $1.8 million, compared with a $2.2 million income tax expense for the three months ended March 31, 2012. The effective tax rates for the three-month periods ended March 31, 2013 and 2012 were 26.3 percent and 33.7 percent, respectively.

 

Note 12.  Borrowed Funds

 

Short-Term Borrowings

 

Short-term borrowings, which consist primarily of securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances and federal funds purchased, generally have maturities of less than one year. The details of these short-term borrowings are presented in the following table.

 

   March 31, 2013   March 31, 2012 
   (dollars in thousands) 
Average interest rate:          
At quarter end   %   %
For the quarter   0.21%   0.13%
Average amount outstanding during the quarter  $333   $220 
Maximum amount outstanding at any month end in the quarter  $   $ 
Amount outstanding at quarter end  $   $ 

 

Long-Term Borrowings

 

Long-term borrowings, which consist primarily of FHLB advances and securities sold under agreements to repurchase, totaled $146.0 million at March 31, 2013 and mature within four to eight years. The FHLB advances are secured by pledges of certain collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgages and commercial real estate loans.

 

At March 31, 2013, FHLB advances had a weighted average interest rate of 3.44 percent and are contractually scheduled for repayment as follows: 

 

   March 31, 2013 
   (in thousands) 
2016   20,000 
Thereafter   95,000 
   Total  $115,000 

 

The Corporation has entered into agreements under which it has sold securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Corporation may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Corporation to repurchase the assets. The obligation to repurchase the securities is reflected as a liability in the Corporation’s consolidated statement of condition, while the securities underlying the securities sold under agreements to repurchase remain in the respective asset accounts and are delivered to and held as collateral by third party trustees. At March 31, 2013, securities sold under agreements to repurchase had a weighted average interest rate of 5.90 percent and are contractually scheduled for repayment as follows:

 

   March 31, 2013 
   (in thousands) 
After 2016  $31,000 
   Total  $31,000 

 

36
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  

Note 13.  Subordinated Debentures

 

During 2003, the Corporation formed a statutory business trust, which exists for the exclusive purpose of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust securities in junior subordinated deferrable interest debentures (subordinated debentures) of the Corporation; and (iii) engaging in only those activities necessary or incidental thereto. These subordinated debentures and the related income effects are not eliminated in the consolidated financial statements as the statutory business trust is not consolidated in accordance with FASB ASC 810-10. Distributions on the subordinated debentures owned by the subsidiary trusts below have been classified as interest expense in the Consolidated Statements of Income.

 

The characteristics of the business trusts and capital securities have not changed with the deconsolidation of the trusts. The capital securities provide an attractive source of funds since they constitute Tier 1 capital for regulatory purposes and have the same tax advantages as debt for Federal income tax purposes.

 

The subordinated debentures are redeemable in whole or part prior to maturity on January 23, 2034. The floating interest rate on the subordinated debentures is three-month LIBOR plus 2.85 percent and resets quarterly. The rate at March 31, 2013 was 3.15 percent.

 

Note 14.  Stockholders’ Equity

 

On January 12, 2009, the Corporation issued $10 million in nonvoting Fixed Rate Cumulative Perpetual Preferred Stock, Series A to the U.S. Department of Treasury (“Treasury”) under its Capital Purchase Program. As part of the transaction, the Corporation also issued warrants to the Treasury to purchase 173,410 shares of common stock of the Corporation at an exercise price of $8.65 per share. As a result of the successful completion of the Corporation’s rights offering in October 2009, the number of shares underlying the warrants held by the U.S. Treasury was reduced to 86,705 shares, or 50 percent of the original 173,410 shares as outlined by the provisions of the Capital Purchase Program.

 

 On September 15, 2011, the Corporation issued $11.25 million in nonvoting senior preferred stock to the Treasury under the Small Business Lending Fund Program (“SBLF Program”). Under the Securities Purchase Agreement, the Corporation issued to the Treasury a total of 11,250 shares of the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B, having a liquidation value of $1,000 per share. Simultaneously, using the proceeds from the issuance of the SBLF Preferred Stock, the Corporation redeemed from the Treasury, all 10,000 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share, for a redemption price of $10,041,667, including accrued but unpaid dividends up to the date of redemption. The investment in the SBLF program provided the Corporation with approximately $1.25 million additional Tier 1 capital. The capital received under the program will allow the Corporation to continue to serve its small business clients through the commercial lending program.

 

On December 7, 2011, the Corporation repurchased the warrants issued on January 12, 2009 to the U.S. Treasury as part of its participation in the U.S. Treasury’s TARP Capital Purchase Program. In the repurchase, the Corporation paid the U.S. Treasury $245,000 for the warrants.

 

37
 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Corporation’s results of operations for the periods presented herein and financial condition as of March 31, 2013 and December 31, 2012. In order to fully understand this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing elsewhere in this report.

 

Cautionary Statement Concerning Forward-Looking Statements

 

This report includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Center Bancorp Inc. and its subsidiaries, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, sovereign debt problems, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which Center Bancorp is engaged, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010; (7) changes and trends in the securities markets may adversely impact Center Bancorp; (8) a delayed or incomplete resolution of regulatory issues could adversely impact planning by Center Bancorp; (9) the impact on reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; (10) Center Bancorp may experience unforeseen difficulties in integrating Saddle River Valley Bank’s operations into its own following its August 1, 2012 acquisition of certain assets and assumption of certain liabilities of Saddle River Valley Bank; and (11) the outcome of regulatory and legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of Center Bancorp is included in Item 1A. of Center Bancorp’s Annual Report on Form 10-K and in Center Bancorp’s other filings with the Securities and Exchange Commission. These documents are available free of charge at the Commission’s website at http://www.sec.gov and/or from Center Bancorp, Inc.

 

Critical Accounting Policies and Estimates

 

The accounting and reporting policies followed by Center Bancorp, Inc. and its subsidiaries (the “Corporation”) conform, in all material respects, to U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and for the periods indicated in the statements of operations. Actual results could differ significantly from those estimates.

 

The Corporation’s accounting policies are fundamental to understanding Management’s Discussion and Analysis (“MD&A”) of financial condition and results of operations. The Corporation has identified the determination of the allowance for loan losses, the other-than-temporary impairment evaluation of securities, the valuation of the impairment of goodwill and deferred tax assets to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies is provided below.

 

Allowance for Loan Losses and Related Provision

 

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated statements of condition.

 

38
 

 

 The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

 

The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.

 

Other-Than-Temporary Impairment of Investment Securities

 

Investment securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. FASB ASC 320-10-65 clarifies the interaction of the factors that should be considered when determining whether a debt security is other–than-temporarily impaired. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment.

 

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, FASB ASC 320-10-65 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

 

Fair Value of Investment Securities

 

FASB ASC 820-10-35 clarifies the application of the provisions of FASB ASC 820-10-05 in an inactive market and how an entity would determine fair value in an inactive market. The Corporation applied the guidance in FASB ASC 820-10-35 when determining fair value for the Corporation’s private label collateralized mortgage obligations, pooled trust preferred securities and single name corporate trust preferred securities. See Note 8 of the Notes to Consolidated Financial Statements for further discussion.

 

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

 

Goodwill

 

The Corporation adopted the provisions of FASB ASC 350-10, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but rather tested for impairment annually or more frequently if impairment indicators arise. No impairment charge was deemed necessary for the three months ended March 31, 2013 and 2012.

 

Income Taxes

 

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Corporation’s consolidated financial statements or tax returns.

 

Fluctuations in the actual outcome of these future tax consequences could impact the Corporation’s consolidated financial condition or results of operations.  Note 11 of the Notes to Consolidated Financial Statements includes additional discussion on the accounting for income taxes.

 

39
 

 

Earnings

 

Net income available to common stockholders for the three months ended March 31, 2013 amounted to $4,868,000 compared to $4,090,000 for the comparable three-month period ended March 31, 2012. The Corporation recorded earnings per diluted common share of $0.30 for the three months ended March 31, 2013 as compared with earnings of $0.25 per diluted common share for the same three months in 2012. Dividends relating to the preferred stock issued to the U.S. Treasury reduced earnings by approximately $0.003 and $0.009 per fully diluted common share for the three month periods ended March 31, 2013 and 2012, respectively. The annualized return on average assets was 1.23 percent for the three months ended March 31, 2013, compared to 1.16 percent for three months ended March 31, 2012. The annualized return on average stockholders’ equity was 12.09 percent for the three-month period ended March 31, 2013, compared to 12.05 percent for the three months ended March 31, 2012.

 

Net Interest Income and Margin

 

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. Net interest income is presented on a fully tax-equivalent basis by adjusting tax-exempt income (primarily interest earned on obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues. Net interest margin is defined as net interest income on a fully tax-equivalent basis as a percentage of total average interest-earning assets.

 

The following table presents the components of net interest income on a fully tax-equivalent basis for the periods indicated.

 

Net Interest Income

(tax-equivalent basis)

 

   Three Months Ended 
March 31, 2013
 
           Increase   Percent 
(dollars in thousands)  2013   2012   (Decrease)   Change 
Interest income:                    
Investment securities AFS  $3,889   $3,576   $313    8.75%
Investment securities HTM   762    729    33    4.53 
Loans, including net costs   9,923    9,385    538    5.73 
Restricted investment in bank stocks, at cost   108    121    (13)   (10.74)
Other interest-bearing deposits   2        2     
Total interest income   14,684    13,811    873    6.32 
Interest expense:                    
Time deposits $100 or more   239    252    (13)   (5.16)
All other deposits   1,045    1,156    (111)   (9.60)
Borrowings   1,450    1,642    (192)   (11.69)
Total interest expense   2,734    3,050    (316)   (10.36)
Net interest income on a fully tax-equivalent basis   11,950    10,761    1,189    11.05 
Tax-equivalent adjustment (1)   (580)   (416)   (164)   39.42 
Net interest income  $11,370   $10,345   $1,025    9.91%

  


  

(1)Computed using a federal income tax rate of 35 percent for 2013 and 2012.

 

40
 

 

Net interest income on a fully tax-equivalent basis increased $1.2 million or 11.1 percent to $12.0 million for the three months ended March 31, 2013 as compared to the same period in 2012. For the three months ended March 31, 2013, the net interest margin contracted 8 basis points to 3.31 percent from 3.39 percent during the three months ended March 31, 2012. For the three months ended March 31, 2013, a decrease in the average yield on interest-earning assets of 28 basis points was partially offset by a decrease in the average cost of interest-bearing liabilities of 17 basis points, resulting in a decrease in the Corporation’s net interest spread of 11 basis points for the period. Net interest margin compression during the first quarter period of 2013, occurred primarily as result of a high liquidity pool carried during the quarter. This, coupled with a continued high level of prepayment speeds on mortgage-backed securities in the investment portfolio and a high level of loan modifications during the quarter, dampened other actions (including a growth in the Corporation’s customer base and enhancement the Corporation’s liquidity position, effected while the Company increased its earning assets base) taken to improve the margin.

 

For the three-month period ended March 31, 2013, interest income on a tax-equivalent basis increased by $873,000 or 6.3 percent compared to the same three-month period in 2012. This increase in interest income was due primarily to a volume increase in investment securities and loans partially offset by a decline in yields due to the lower interest rate environment. Average investment securities volume increased during the current three-month period by $53.4 million, to $559.6 million, compared to the first quarter of 2012. The loan portfolio increased on average $118.1 million, to $873.9 million, from an average of $755.8 million in the same quarter in 2012, reflecting net increases in commercial loans and commercial real estate related sectors of the loan portfolio. Average loans represented approximately 60.5 percent of average interest-earning assets during the first quarter of 2013 compared to 59.5 percent in the same quarter in 2012.

 

For the three months ended March 31, 2013, interest expense decreased $316,000, or 10.4 percent from the same period in 2012. The average rate of interest-bearing liabilities decreased 17 basis points to 0.90 percent for the three months ended March 31, 2013, from 1.07 percent for the three months ended March 31, 2012. At the same time, the volume of average interest-bearing liabilities increased by $69.4 million. This increase was primarily in money market, savings, and other interest-bearing deposits of $58.3 million, $12.8 million and $38.5 million, respectively, and was partially offset by decreases in borrowings of $14.9 million and time deposits of $25.3 million. Since 2009 steps have been taken to improve the Corporation’s net interest margin by allowing the runoff of certain high rate deposits and to position the Corporation for further high-costing cash outflows. The result of these actions, together with the reduction in market interest rates, has been a decline in the Corporation’s average cost of funds. For the three months ended March 31, 2013, the Corporation’s net interest spread on a tax-equivalent basis decreased to 3.17 percent, from 3.28 percent for the three months ended March 31, 2012.

 

41
 

 

The following table quantifies the impact on net interest income on a tax-equivalent basis resulting from changes in average balances and average rates during the three month periods presented. Any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category.

 

Analysis of Variance in Net Interest Income Due to Changes in Volume and Rates

 

   Three Months Ended 
March 31, 2013 and 2012
Increase (Decrease) Due to Change in:
 
(tax-equivalent basis, in thousands)  Average
Volume
   Average
Rate
   Net 
Change
 
             
Interest-earning assets:               
Investment securities:               
Available-for-sale               
Taxable  $201   $(180)  $21 
Tax-exempt   374    (82)  292 
Held-to-maturity               
Taxable   (207)   65    (142)
Tax-exempt   233    (58)   175 
Total investment securities   601    (255)   346 
Loans   1,385    (847)   538 
Restricted investment in bank stocks   (3)   (10)   (13)
Other interest bearing deposits   2        2 
Total interest-earning assets   1,985    (1,112)   873 
                
Interest-bearing liabilities:               
Money market deposits   65    (58)   7 
Savings deposits   13    (44)   (31)
Time deposits   67    (161)   (94)
Other interest-bearing deposits   40    (46)   (6)
Total interest-bearing deposits   185    (309)   (124)
Borrowings and subordinated debentures   (145)   (47)   (192)
Total interest-bearing liabilities   40    (356)   (316)
Change in net interest income  $1,945   $(756)  $1,189 

 

42
 

 

The following tables, “Average Statements of Condition with Interest and Average Rates”, present for the three months ended March 31, 2013 and 2012, the Corporation’s average assets, liabilities and stockholders’ equity. The Corporation’s net interest income, net interest spread and net interest margin are also reflected.

 

Average Statements of Condition with Interest and Average Rates

 

   Three Months Ended March 31, 
   2013   2012 
(tax-equivalent basis)  Average
Balance
   Interest
Income/
Expense
   Average
Rate
   Average
Balance
   Interest
Income/
Expense
   Average
Rate
 
   (dollars in thousands) 
Assets                              
Interest-earning assets:                              
Investment securities (1) :                              
Available-for-sale                              
Taxable  $399,356   $2,827    2.83%  $371,766   $2,806    3.02%
Tax-exempt   94,903    1,062    4.48    62,110    770    4.96 
Held-to-maturity                              
Taxable   18,871    168    3.56    43,693    310    2.84 
Tax-exempt   46,507    594    5.11    28,708    419    5.84 
Total investment securities   559,637    4,651    3.32    506,277    4,305    3.40 
Loans (2)   873,916    9,923    4.54    755,813    9,385    4.97 
Restricted investment in bank stocks   8,964    108    4.82    9,233    121    5.24 
Other interest-bearing deposits   1,425    2    0.56             
Total interest-earning assets   1,443,942    14,684    4.07    1,271,323    13,811    4.35 
Non interest-earning assets:                              
Cash and due from banks   88,263              122,191           
Bank-owned life insurance   34,896              29,049           
Intangible assets   16,855              16,897           
Other assets   30,264              31,494           
Allowance for loan losses   (10,229)             (9,683)          
Total non interest-earning assets   160,049              189,948           
Total assets  $1,603,991             $1,461,271           
Liabilities and Stockholders’ Equity                              
Interest-bearing liabilities:                              
Money market deposits  $383,176   $398    0.42%  $324,924   $391    0.48%
Savings deposits   196,803    163    0.33    183,965    194    0.42 
Time deposits   178,650    430    0.96    203,984    524    1.03 
Other interest-bearing deposits   302,632    293    0.39    264,085    299    0.45 
Total interest-bearing deposits   1,061,261    1,284    0.48    976,958    1,408    0.58 
Short-term and long-term borrowings   146,333    1,411    3.86    161,220    1,600    3.97 
Subordinated debentures   5,155    39    3.03    5,155    42    3.26 
Total interest-bearing liabilities   1,212,749    2,734    0.90    1,143,333    3,050    1.07 
Non interest-bearing liabilities:                              
Demand deposits   212,860              167,921           
Other liabilities   15,529              9,606           
Total non interest-bearing liabilities   228,389              177,527           
Stockholders’ equity   162,853              140,411           
Total liabilities and stockholders’ equity  $1,603,991             $1,461,271           
Net interest income (tax-equivalent basis)        11,950              10,761      
Net interest spread             3.17%             3.28%
Net interest margin (3)             3.31%             3.39%
Tax-equivalent adjustment (4)        (580)             (416)     
Net interest income       $11,370             $10,345      

 

(1) Average balances are based on amortized cost.
(2) Average balances include loans on non-accrual status.
(3) Represents net interest income as a percentage of total average interest-earning assets.
(4) Computed using a federal income tax rate of 35 percent for 2013 and 2012.

 

43
 

 

Investment Portfolio

 

At March 31, 2013, the principal components of the investment securities portfolio were U.S. Government agency obligations, federal agency obligations including mortgage-backed securities, obligations of U.S. states and political subdivisions, corporate bonds and notes, trust preferred securities, asset backed securities and equity securities.

 

During the three months ended March 31, 2013, approximately $45.0 million in investment securities were sold from the available-for-sale portfolio. The cash flow from the sale of investment securities was primarily used to purchase new securities. The Corporation’s sales from its available-for-sale investment portfolio reflect continued volatility present in the market. Given the historic low interest rates prevalent in the market, it is necessary for the Corporation to protect itself from interest rate exposure. Securities that once appeared to be sound investments can, after changes in the market, become securities that the Corporation must sell in order to avoid losses and mismatches of interest-earning assets and interest-bearing liabilities.

 

For the three months ended March 31, 2013, average investment securities increased $53.4 million to approximately $559.6 million, or 38.8 percent of average interest-earning assets, from $506.3 million on average, or 39.8 percent of average interest-earning assets, for the comparable period in 2012. This increase reflects, in part, the acquisition of $37.1 million of investment securities from Saddle River Valley Bank on August 1, 2012.

 

During the three-month period ended March 31, 2013, the volume-related factors applicable to the investment portfolio increased interest income by approximately $601,000 while rate-related changes resulted in a decrease in interest income of approximately $255,000 from the same period in 2012. The tax-equivalent yield on investments decreased by 8 basis points to 3.32 percent from a yield of 3.40 percent during the comparable period in 2012. A 14 basis point decrease in taxable yield was partially offset by an increase in the purchase of tax exempt municipal securities during the period.

 

For the three months ended March 31, 2013, the Corporation recorded principal losses of $24,000 on a variable rate CMO, which was sold. See Note 6 of the Notes to the Consolidated Financial Statements for further discussion.

 

At March 31, 2013, net unrealized gains on investment securities available-for-sale, which are carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to $14.6 million as compared with net unrealized gains of $14.4 million at December 31, 2012. At March 31, 2013, the net unrealized gains on investment securities held-to-maturity that were transferred from securities available-for-sale, are carried, net of tax, as a component of accumulated other comprehensive income and included in stockholders’ equity. The gross unrealized losses associated with agency securities and federal agency obligations, mortgage-backed securities, corporate bonds and tax-exempt securities are not considered to be other than temporary because their unrealized losses are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or issuer.

 

44
 

 

Loan Portfolio

 

Lending is one of the Corporation’s primary business activities. The Corporation’s loan portfolio consists of commercial, residential and retail loans, serving the diverse customer base in its market area. The composition of the Corporation’s portfolio continues to change due to the local economy. Factors such as the economic climate, interest rates, real estate values and employment all contribute to these changes. Growth is generated through business development efforts, repeat customer requests for new financings, penetration into existing markets and entry into new markets.

 

The Corporation seeks to create growth in commercial lending by offering customer-focused products and competitive pricing and by capitalizing on the positive trends in its market area. Products offered are designed to meet the financial requirements of the Corporation’s customers. It is the objective of the Corporation’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry.

 

At March 31, 2013, total loans amounted to $879.4 million, a decrease of $10.3 million or 1.2 percent as compared to December 31, 2012. For the three-month period ended March 31, 2013, growth of $5.0 million and $3.1 million in the commercial and industrial and commercial real estate portfolios offset by decreases of $13.1 million in residential mortgage loans, $5.1 million in the construction portfolio and $126,000 in the installment loan portfolio. Total gross loans recorded in the quarter included $64.1 million of new loans and advances, offset by payoffs and principal payments of $74.2 million.

 

At March 31, 2013, the Corporation had $50.7 million in outstanding loan commitments which are expected to fund over the next 90 days.

 

Average total loans increased $118.1 million or 15.6 percent for the three months ended March 31, 2013 as compared to the same period in 2012, while the average yield on loans decreased by 43 basis points as compared with the same period in 2012. The decrease in the average yield on loans was primarily the result of lower market interest rates on the repricing of existing loans and the origination of new loans. The increase in average total loan volume was due primarily to increased customer activity and new lending relationships. The volume increase also reflects the acquisition of $52.2 million of loans from Saddle River Valley Bank on August 1, 2012. The volume-related factors during the period contributed increased interest income of $1.385 million, while the rate-related changes decreased interest income by $847,000.

 

Allowance for Loan Losses and Related Provision

 

The purpose of the allowance for loan losses (the “allowance”) is to absorb the impact of losses inherent in the loan portfolio. Additions to the allowance are made through provisions charged against current operations and through recoveries made on loans previously charged-off. The allowance for loan losses is maintained at an amount considered adequate by management to provide for probable credit losses inherent in the loan portfolio based upon a periodic evaluation of the portfolio’s risk characteristics. In establishing an appropriate allowance, an assessment of the individual borrowers, a determination of the value of the underlying collateral, a review of historical loss experience and an analysis of the levels and trends of loan categories, delinquencies and problem loans are considered. Such factors as the level and trend of interest rates and current economic conditions and peer group statistics are also reviewed. Given the extraordinary economic volatility impacting national, regional and local markets, the Corporation’s analysis of its allowance for loan losses takes into consideration the potential impact that current trends may have on the Corporation’s borrower base.

 

Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to increase the allowance based on their analysis of information available to them at the time of their examination. Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey. Future adjustments to the allowance may be necessary due to economic factors impacting New Jersey real estate and the economy in general, as well as operating, regulatory and other conditions beyond the Corporation’s control.

 

45
 

 

At March 31, 2013, the level of the allowance was $10,232,000 as compared to $10,237,000 at December 31, 2012. Provisions to the allowance for the three-month period ended March 31, 2013 totaled $0 compared to $107,000 for the same period in 2012. The net charge offs were $5,000 for the three months ended March 31, 2013 compared to $45,000 in net recoveries for the three months ended March 31, 2012. The allowance for loan losses as a percentage of total loans amounted to 1.16 percent at March 31, 2013 compared to 1.15 percent at December 31, 2012.

 

The level of the allowance for the respective periods of 2013 and 2012 reflects the credit quality within the loan portfolio, the loan volume recorded during the periods, the changing composition of the commercial and residential real estate loan portfolios and other related factors. In management’s view, the level of the allowance at March 31, 2013 is adequate to cover losses inherent in the loan portfolio. Management’s judgment regarding the adequacy of the allowance constitutes a “Forward-Looking Statement” under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from management’s analysis, based principally upon the factors considered by management in establishing the allowance.

 

Changes in the allowance for loan losses are presented in the following table for the periods indicated.

 

   Three Months Ended
March 31,
 
   2013   2012 
   (dollars in thousands) 
Average loans for the period  $873,916   $755,813 
Total loans at end of period   879,387    790,622 
           
Analysis of the Allowance for Loan Losses:          
Balance — beginning of year  $10,237   $9,602 
Charge-offs:          
Installment loans   (6)   (3)
Total charge-offs   (6)   (3)
Recoveries:          
Residential mortgage loans       47 
Installment loans   1    1 
Total recoveries   1    48 
Net recoveries (charge-offs)   (5)   45 
Provision for loan losses       107 
Balance — end of period  $10,232   $9,754 
Ratio of net (recoveries) charge-offs during the period to average loans during the period (1)   N/M    (0.02)%
Allowance for loan losses as a percentage of total loans   1.16%   1.23%

 

(1)Annualized. N/M – not meaningful.

 

46
 

 

 Asset Quality

 

The Corporation manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans, delinquencies, and potential problem loans, with particular attention to portfolio dynamics and mix. The Corporation strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values and cash flows, and to maintain an adequate allowance for loan losses at all times.

 

It is generally the Corporation’s policy to discontinue interest accruals once a loan is past due as to interest or principal payments for a period of ninety days. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may be restored to an accruing basis when it again becomes well-secured, all past due amounts have been collected and the borrower continues to make payments for the next six months on a timely basis. Accruing loans past due 90 days or more are generally well-secured and in the process of collection.

 

Non-Performing Assets and Troubled Debt Restructured Loans

 

Non-performing loans include non-accrual loans and accruing loans past due 90 days or more. Non-accrual loans represent loans on which interest accruals have been suspended. In general, it is the policy of management to consider the charge-off of loans at the point they become past due in excess of 90 days, with the exception of loans that are both well-secured and in the process of collection. Non-performing assets include non-performing loans and other real estate owned. Troubled debt restructured loans represent loans to borrowers experiencing financial difficulties on which a concession was granted, such as a reduction in interest rate which is lower than the current market rate for new debt with similar risks, or modified repayment terms, and are performing under the restructured terms. Such loans, as restructured, are not included within the Corporation’s non-performing loans.

 

The following table sets forth, as of the dates indicated, the amount of the Corporation’s non-accrual loans, accruing loans past due 90 days or more, other real estate owned and troubled debt restructured loans.

 

   March 31,
2013
   December 31,
2012
 
   (in thousands) 
Non-accrual loans  $2,565   $3,616 
Accruing loans past due 90 days or more   55    55 
Total non-performing loans   2,620    3,671 
Other real estate owned   1,536    1,300 
Total non-performing assets  $4,156   $4,971 
Troubled debt restructured loans — performing  $6,786   $6,813 

 

At March 31, 2013, non-performing assets totaled $4.2 million, or 0.26 percent of total assets, as compared with $8.7 million, or 0.59 percent, at March 31, 2012 and $5.0 million, or 0.31 percent, at December 31, 2012. The decrease from March 31, 2012 reflects the ability to satisfactorily work out the problem loans that exist. The largest component of the remaining non-accrual loans is comprised of one relationship totaling $639,000, or 24.9 percent of the total, secured by senior liens on a residential property, located in Morris County, New Jersey. This loan has been restructured and is performing and it is anticipated that it will be returned to a performing status in the second quarter of 2013. The remaining loans are primarily residential properties and are in the process of being worked out. Subsequent to March 31, 2013, a commercial property with a recorded value of $129,000 was resolved with no further loss to its recorded value.

 

The Corporation held $1.5 million in other real estate owned at March 31, 2013 and $1.3 million at December 31, 2012, respectively.

 

Troubled debt restructured loans totaled $8.3 million at March 31, 2013 and $8.3 million at December 31, 2012. A total of $6.79 million and $6.81 million of troubled debt restructured loans were performing pursuant to the terms of their respective modifications at March 31, 2013 and December 31, 2012, respectively.

 

47
 

 

Overall credit quality in the Bank’s loan portfolio at March 31, 2013 remained relatively strong. Other known “potential problem loans” (as defined by SEC regulations), some of which are non-performing loans and are included in the table above, as of March 31, 2013 have been identified and internally risk-rated as assets specially mentioned or substandard. Such loans amounted to $44.8 million and $47.4 million at March 31, 2013 and December 31, 2012, respectively. The improvement in credit quality occurred as the commercial and industrial loans decreased $136,000 in special mention and $34,000 in the substandard category. Commercial real estate loans decreased $175,000 in special mention and decreased $425,000 in the substandard category. Residential mortgage loans decreased $2,000 in special mention and decreased in the substandard category by $760,000. Construction loans decreased $810,000 in the special mention category and decreased $317,000 in the substandard category. Installment loans decreased $4,000 in the substandard category. These loans are considered potential problem loans due to a variety of changing conditions affecting the credits, including general economic conditions and/or conditions applicable to the specific borrowers. The Corporation has no foreign loans.

 

 At March 31, 2013, other than the loans set forth above, the Corporation is not aware of any loans which present serious doubts as to the ability of its borrowers to comply with present loan repayment terms and which are expected to fall into one of the categories set forth in the tables or descriptions above.

 

 

Other Income

 

The following table presents the principal categories of other income for the periods indicated.

 

   Three Months Ended
March 31,
 
           Increase   Percent 
(dollars in thousands)  2013   2012   (Decrease)   Change 
Service charges, commissions and fees  $406   $446   $(40)   (8.97)%
Annuities and insurance commission   100    44    56    127.27 
Bank-owned life insurance   565    251    314    125.10 
Net investment securities gains   319    937    (618)   (65.96)
Loan related fees   139    110    29    26.36 
Net gains on sales of loans held for sale   138    126    12    9.52 
All other   178    41    137    334.15 
Total other income  $1,845   $1,955   $(110)   (5.63)%

 

For the three months ended March 31, 2013, total other income amounted to $1.8 million, compared to total other income of $2.0 million for the same period in 2012. The decrease of $110,000 for the three months ended March 31, 2013 was primarily as a result of a reduction in net investment securities gains (decreasing to $319,000 for the three months ended March 31, 2013 from net investment gains of $937,000 for the same period last year). Excluding net investment securities gains, the Corporation recorded total other income of $1.5 million for the three months ended March 31, 2013, compared to $1.0 million for the three months ended March 31, 2012. This increase reflected increases of $56,000 in annuity and insurance commissions, $314,000 in bank-owned life insurance including $291,000 in death benefits, $29,000 in loan related fees, $12,000 in net gain on sales of loans held for sale, and $137,000 in all other, including loan purchase accounting benefits on paid off loans of $98,000, offset by a $40,000 decrease in service charges, commissions and fees.

 

48
 

 

Other Expense

 

The following table presents the principal categories of other expense for the periods indicated.

 

   Three Months Ended
March 31,
 
           Increase   Percent 
(dollars in thousands)  2013   2012   (Decrease)   Change 
Salaries and employee benefits  $3,490   $3,118   $372    11.93%
Occupancy and equipment   906    700    206    29.43 
FDIC insurance   313    299    14    4.68 
Professional and consulting   219    246    (27)   (10.98)
Stationery and printing   85    84    1    1.19 
Marketing and advertising   101    31    70    225.81 
Computer expense   353    353         
Other real estate owned, net   19    62    (43)   (69.35)
All other   1,052    914    138    15.10 
Total other expense  $6,538   $5,807   $731    12.59%

 

For the three months ended March 31, 2013, total other expense increased $731,000, or 12.6 percent, from the comparable three months ended March 31, 2012. This was primarily attributable to increases in salaries and employee benefits of $372,000, occupancy and equipment of $206,000, FDIC insurance of $14,000, marketing and advertising of $70,000, and all other of $138,000.

 

Salaries and employee benefits expense for the quarter ended March 31, 2013 increased $372,000 or 11.9 percent over the comparable period in the prior year. These increases were primarily due to additions to staff including the Saddle River Valley Bank acquisition and Englewood New Jersey branch, merit increases and higher benefit costs. Full-time equivalent staffing levels were 173 at March 31, 2013 and 170 at March 31, 2012.

 

Occupancy and equipment expense for the quarter ended March 31, 2013 increased $206,000, or 29.4 percent, from the comparable three-month period in 2012. The increase for the quarter was primarily attributable to higher rent expense of $94,000 and building and equipment expenses of $98, 000.

 

FDIC insurance expense increased $14,000, or 4.7 percent, for the three months ended March 31, 2013 compared to the same period in 2012. The increase was caused by a new assessment formula.

 

Marketing and advertising expense increased $70,000 or 225.8 percent for the three months ended March 31, 2013 compared to the same period in 2012. The increase was caused by increased print and other media expense due to Englewood Banking Center, loan product promotion and private banking wealth management promotion.

 

 Professional and consulting expense for the three months ended March 31, 2013 decreased $27,000 or 11.0 percent compared to the comparable quarter of 2012, reflecting lower expenses related to loan workout.

 

All other expense for the three months ended March 31, 2013 increased $138,000, or 15.1 percent, compared to the same quarter of 2012. 

 

49
 

 

Provision for Income Taxes

 

For the quarter ended March 31, 2013, the Corporation recorded income tax expense of $1.8 million, compared with $2.2 million of income tax expense for the quarter ended March 31, 2012. The effective tax rates for the quarterly periods ended March 31, 2013 and 2012 were 26.3 percent and 33.7 percent, respectively. The lower effective tax rate in the first quarter of 2013 was primarily due to the formation of a tax advantaged subsidiary in the fourth quarter of 2012 and a higher level of tax advantaged revenues from tax exempt investment securities and bank-owned life insurance.

 

Recent Accounting Pronouncements

 

Note 4 of the Notes to Consolidated Financial Statements discusses the expected impact of accounting pronouncements recently issued or proposed but not yet required to be adopted.

 

Asset and Liability Management

 

Asset and Liability management encompasses an analysis of market risk, the control of interest rate risk (interest sensitivity management) and the ongoing maintenance and planning of liquidity and capital. The composition of the Corporation’s statement of condition is planned and monitored by the Asset and Liability Committee (“ALCO”). In general, management’s objective is to optimize net interest income and minimize market risk and interest rate risk by monitoring the components of the statement of condition and the interaction of interest rates.

 

Short-term interest rate exposure analysis is supplemented with an interest sensitivity gap model. The Corporation utilizes interest sensitivity analysis to measure the responsiveness of net interest income to changes in interest rate levels. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different than that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different than that of an earning asset that it supports. While the Corporation matches only a small portion of specific assets and liabilities, total earning assets and interest-bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames. The difference between interest-sensitive assets and interest-sensitive liabilities is referred to as the interest sensitivity gap. At any given point in time, the Corporation may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities, or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending in part on management’s judgment as to projected interest rate trends.

 

The Corporation’s interest rate sensitivity position in each time frame may be expressed as assets less liabilities, as liabilities less assets, or as the ratio between rate sensitive assets (“RSA”) and rate sensitive liabilities (“RSL”). For example, a short-funded position (liabilities repricing before assets) would be expressed as a net negative position, when period gaps are computed by subtracting repricing liabilities from repricing assets. When using the ratio method, a RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1 indicates an asset-sensitive position and a ratio less than 1 indicates a liability-sensitive position.

 

A negative gap and/or a rate sensitivity ratio less than 1 tends to expand net interest margins in a falling rate environment and reduce net interest margins in a rising rate environment. Conversely, when a positive gap occurs, generally margins expand in a rising rate environment and contract in a falling rate environment. From time to time, the Corporation may elect to deliberately mismatch liabilities and assets in a strategic gap position.

 

At March 31, 2013, the Corporation reflected a positive interest sensitivity gap with an interest sensitivity ratio of 1.78:1.00 at the cumulative one-year position. Based on management’s perception of interest rates remaining low through 2013, emphasis has been, and is expected to continue to be, placed on controlling liability costs while extending the maturities of liabilities in order to insulate the net interest spread from rising interest rates in the future. However, no assurance can be given that this objective will be met.

 

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Estimates of Fair Value

 

The estimation of fair value is significant to a number of the Corporation’s assets, including loans held for sale and investment securities available-for-sale. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Impact of Inflation and Changing Prices

 

The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations; unlike most industrial companies, nearly all of the Corporation’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

Liquidity

 

The liquidity position of the Corporation is dependent primarily on successful management of the Bank’s assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise principally to accommodate possible deposit outflows and to meet customers’ requests for loans. Scheduled principal loan repayments, maturing investments, short-term liquid assets and deposit inflows, can satisfy such needs. The objective of liquidity management is to enable the Corporation to maintain sufficient liquidity to meet its obligations in a timely and cost-effective manner.

 

Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. Under its liquidity risk management program, the Corporation regularly monitors correspondent bank funding exposure and credit exposure in accordance with guidelines issued by the banking regulatory authorities. Management uses a variety of potential funding sources and staggering maturities to reduce the risk of potential funding pressure. Management also maintains a detailed contingency funding plan designed to respond adequately to situations which could lead to stresses on liquidity. Management believes that the Corporation has the funding capacity to meet the liquidity needs arising from potential events. In addition to pledgeable investment securities, the Corporation also maintains borrowing capacity through the Federal Reserve Bank Discount Window and the Federal Home Loan Bank of New York secured with loans and marketable securities.

 

The Corporation’s primary sources of short-term liquidity consist of cash and cash equivalents and unpledged investment securities available-for-sale.

 

At March 31, 2013, the Parent Corporation had $501,000 in cash and short-term investments compared to $629,000 at December 31, 2012. Expenses at the Parent Corporation are moderate and management believes that the Parent Corporation presently has adequate liquidity to fund its obligations.

 

Certain provisions of long-term debt agreements, primarily subordinated debt, prevent the Corporation from creating liens on, disposing of or issuing voting stock of subsidiaries. As of March 31, 2013, the Corporation was in compliance with all covenants and provisions of these agreements.

 

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Deposits

 

Total deposits decreased to $1.28 billion at March 31, 2013 from $1.31 billion at December 31, 2012. Total non interest-bearing deposits decreased from $215.1 million at December 31, 2012 to $213.8 million at March 31, 2013, a decrease of $1.3 million or 0.59 percent. Interest-bearing demand, savings and time deposits under $100,000 decreased $12.3 million to a total of $968.7 million at March 31, 2013 as compared to $981.0 million at December 31, 2012. Time deposits $100,000 and over decreased $11.1 million as compared to year-end 2012 primarily due to an outflow of municipal certificates of deposit. Time deposits $100,000 and over represented 7.8 percent of total deposits at March 31, 2013 compared to 8.5 percent at December 31, 2012.

 

Core Deposits

 

The Corporation derives a significant proportion of its liquidity from its core deposit base. Total demand deposits, savings and money market accounts of $1.13 billion at March 31, 2013 decreased by $12.5 million, or 1.1 percent, from December 31, 2012. At March 31, 2013, total demand deposits, savings and money market accounts were 88.2 percent of total deposits compared to 87.5 percent at year-end 2012. Alternatively, the Corporation uses a more stringent calculation for the management of its liquidity positions internally, which calculation consists of total demand, savings accounts and money market accounts (excluding money market accounts greater than $100,000 and time deposits) as a percentage of total deposits. This number increased by $4.0 million, or 0.57 percent, from $699.9 million at December 31, 2012 to $703.9 million at March 31, 2013 and represented 54.9 percent of total deposits at March 31, 2013 as compared with 53.6 percent at December 31, 2012.

 

The Corporation continues to place the main focus of its deposit gathering efforts in the maintenance, development, and expansion of its core deposit base. Management believes that the emphasis on serving the needs of our communities will provide a long term relationship base that will allow the Corporation to efficiently compete for business in its market. The success of this strategy is reflected in the growth of the demand, savings and money market balances during the first quarter of 2013.

 

The following table depicts the Corporation’s core deposit mix at March 31, 2013 and December 31, 2012 based on the Corporation’s alternative calculation:

 

   March 31, 2013   December 31, 2012   Dollar
Change
 
   Amount   Percentage   Amount   Percentage   2013 vs. 2012 
   (dollars in thousands) 
Non interest-bearing demand  $213,794    30.4%  $215,071    30.7%  $(1,277)
Interest-bearing demand   207,427    29.5    217,922    31.1    (10,495)
Regular savings   110,942    15.8    110,896    15.8    46 
Money market deposits under $100   171,700    24.4    156,009    22.3    15,691 
Total core deposits  $703,863    100.0%  $699,898    100.0%  $3,965 
                          
Total deposits  $1,282,223        $1,306,922        $(24,699)
Core deposits to total deposits        54.9%        53.6%     

 

Borrowings

 

Short-Term Borrowings

 

Short-term borrowings, which consist primarily of securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances and federal funds purchased, generally have maturities of less than one year. The details of these short-term borrowings are presented in the following table.

 

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   March 31, 2013 
   (dollars in thousands) 
Average interest rate:     
At quarter end   %
For the quarter   0.21%
Average amount outstanding during the quarter  $333 
Maximum amount outstanding at any month end in the quarter  $ 
Amount outstanding at quarter end  $ 

 

Long-Term Borrowings

 

Long-term borrowings, which consist primarily of FHLB advances and securities sold under agreements to repurchase, totaled $146.0 million at March 31, 2013 and December 31, 2012, and mature within three to eight years. The FHLB advances are secured by pledges of certain collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgages and commercial real estate loans. At March 31, 2013, FHLB advances and securities sold under agreements to repurchase had weighted average interest rates of 3.44 percent and 5.90 percent, respectively.

 

Subordinated Debentures

 

On December 19, 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly-owned subsidiary of Center Bancorp, Inc., issued $5.0 million of MMCapS capital securities to investors due on January 23, 2034. The trust loaned the proceeds of this offering to the Corporation and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or part. The floating interest rate on the subordinated debentures is three-month LIBOR plus 2.85 percent and reprices quarterly. The rate at March 31, 2013 was 3.15 percent. The capital securities qualify as Tier 1 capital for regulatory capital purposes.

 

Cash Flows

 

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents resulting from the Corporation’s operating, investing and financing activities. During the three months ended March 31, 2013, cash and cash equivalents increased by $10.6 million over the balance at December 31, 2012. Net cash of $8.2 million was provided by operating activities, primarily, net income as adjusted to net cash. Net income of $4.9 million was adjusted principally by net gains on sales of investment securities of $0.3 million, amortization of premiums and accretion of discounts on investment securities net of $1.0 million, a decrease in prepaid FDIC insurance assessments of $286,000, a decrease in other assets of $0.9 million and an increase in other liabilities of $609,000. Net cash provided by investing activities amounted to approximately $28.1 million, primarily reflecting a net decrease in loans of $10.0 million and a net decrease in investment securities of $17.6 million. Net cash of $25.6 million was used in financing activities, primarily from the decrease in deposits of $24.7 million and the funding of dividends.

 

Stockholders’ Equity

 

Total stockholders’ equity amounted to $164.8 million, or 10.2 percent of total assets, at March 31, 2013, compared to $160.7 million or 9.9 percent of total assets at December 31, 2012. Book value per common share was $9.39 at March 31, 2013, compared to $9.14 at December 31, 2012. Tangible book value (i.e., total stockholders’ equity less preferred stock, goodwill and other intangible assets) per common share was $8.36 at March 31, 2013, compared to $8.11 at December 31, 2012.

 

Tangible book value per share is a non-GAAP financial measure and represents tangible stockholders’ equity (or tangible book value) calculated on a per common share basis. The Corporation believes that a disclosure of tangible book value per share may be helpful for those investors who seek to evaluate the Corporation’s book value per share without giving effect to goodwill and other intangible assets. The following table presents a reconciliation of total book value per share to tangible book value per share as of March 31, 2013 and December 31, 2012.

 

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   March 31,   December 31, 
   2013   2012 
   (in thousands, except for share
data)
 
Stockholders’ equity  $164,753   $160,691 
Less: Preferred stock   11,250    11,250 
Less: Goodwill and other intangible assets   16,849    16,858 
Tangible common stockholders’ equity  $136,654   $132,583 
           
Book value per common share  $9.39   $9.14 
Less: Goodwill and other intangible assets   1.03    1.03 
Tangible book value per common share  $8.36   $8.11 

 

On September 15, 2011, the Corporation issued $11.25 million in nonvoting senior preferred stock to the U.S. Treasury (the “Treasury”) under the Small Business Lending Fund Program (“SBLF Program”). Under the Securities Purchase Agreement, the Corporation issued to the Treasury a total of 11,250 shares of the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B, having a liquidation value of $1,000 per share. Simultaneously, using the proceeds from the issuance of the SBLF Preferred Stock, the Corporation redeemed from the Treasury, all 10,000 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share, for a redemption price of $10,041,667, including accrued but unpaid dividends up to the date of redemption. The investment in the SBLF program provided the Corporation with approximately $1.25 million additional Tier 1 capital. The capital that the Corporation received under the program will allow it to continue to serve small business clients through the commercial lending program.

 

On December 7, 2011, the Corporation repurchased the warrants issued on January 12, 2009 to the Treasury as part of its participation in the U.S. Treasury’s TARP Capital Purchase Program. In the repurchase, the Corporation paid the Treasury $245,000 for the warrants.

 

During the three months ended March 31, 2013, the Corporation had no purchases of common stock associated with its stock buyback programs. At March 31, 2013, there were 652,868 shares available for repurchase under the Corporation’s stock buyback programs.

 

Regulatory Capital and Capital Adequacy

 

The maintenance of a solid capital foundation is a primary goal for the Corporation. Accordingly, capital plans and dividend policies are monitored on an ongoing basis. The Corporation’s objective with respect to the capital planning process is to effectively balance the retention of capital to support future growth with the goal of providing stockholders with an attractive long-term return on their investment.

 

The Corporation and the Bank are subject to regulatory guidelines establishing minimum capital standards that involve quantitative measures of assets, and certain off-balance sheet items, as risk-adjusted assets under regulatory accounting practices.

 

The following is a summary of regulatory capital amounts and ratios as of March 31, 2013 for the Corporation and the Bank, compared with minimum capital adequacy requirements and the regulatory requirements for classification as a well-capitalized depository institution.

 

 

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   Center Bancorp, Inc.   For Capital Adequacy
Purposes
   To Be Well-Capitalized Under
Prompt Corrective Action
Provisions
 
At March 31, 2013  Amount   Ratio   Amount   Ratio   Amount   Ratio 
   (dollars in thousands) 
                         
Tier 1 leverage capital  $147,820    9.31%  $63,510    4.00%   N/A    N/A 
Tier 1 risk-based capital   147,820    11.63%   50,841    4.00%   N/A    N/A 
Total  risk-based capital   158,262    12.46%   101,613    8.00%   N/A    N/A 

 

   Union Center
National Bank
   For Capital Adequacy
Purposes
   To Be Well-Capitalized Under
Prompt Corrective Action
Provisions
 
At March 31, 2013  Amount   Ratio   Amount   Ratio   Amount   Ratio 
   (dollars in thousands) 
                         
Tier 1 leverage capital  $147,364    9.29%  $63,451    4.00%  $79,313    5.00%
Tier 1 risk-based capital   147,364    11.60%   50,815    4.00%   76,223    6.00%
Total  risk-based capital   157,841    12.43%   101,587    8.00%   126,984    10.00%

 

 

 

N/A - not applicable

 

The Office of the Comptroller of the Currency (“OCC”) had established higher minimum capital ratios for the Bank effective as of December 31, 2009; however, those higher capital ratios were removed during the second quarter of 2012. As of March 31, 2013, management believes that each of the Bank and the Corporation meet all capital adequacy requirements to which they are subject.

 

Basel III

 

The Basel Committee on Banking Supervision (the “Basel Committee”) provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. At times, the Committee uses this common understanding to develop guidelines and supervisory standards in areas where they are considered desirable. In this regard, the Committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision.

 

The Basel Committee released a comprehensive list of proposals for changes to capital, leverage, and liquidity requirements for banks in December 2009 (commonly referred to as “Basel III”).  In July 2010, the Basel Committee announced the design for its capital and liquidity reform proposals and in September 2010, the oversight body of the Basel Committee announced minimum capital ratios and transition periods.

 

In December 2010 and January 2011, the Basel Committee published the final texts of reforms on capital and liquidity generally referred to as “Basel III.” Although Basel III is intended to be implemented by participating countries for large, internationally active banks, its provisions are likely to be considered by United States banking regulators in developing new regulations applicable to other banks in the United States, including Union Center National Bank. As of the date of this filing, final regulations have not been issued.

 

For banks in the United States, among the most significant provisions of Basel III concerning capital are the following:

 

A minimum ratio of common equity to risk-weighted assets reaching 4.5%, plus an additional 2.5% as a capital conservation buffer, by 2019 after a phase-in period.

 

A minimum ratio of Tier 1 capital to risk-weighted assets reaching 6.0% by 2019 after a phase-in period.

 

A minimum ratio of total capital to risk-weighted assets, plus the additional 2.5% capital conservation buffer, reaching 10.5% by 2019 after a phase-in period.

 

An additional countercyclical capital buffer to be imposed by applicable national banking regulators periodically at their discretion, with advance notice.

 

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Restrictions on capital distributions and discretionary bonuses applicable when capital ratios fall within the buffer zone.

 

Deduction from common equity of deferred tax assets that depend on future profitability to be realized.

 

Increased capital requirements for counterparty credit risk relating to OTC derivatives, repos and securities financing activities.

 

For capital instruments issued on or after January 13, 2013 (other than common equity), a loss-absorbency requirement such that the instrument must be written off or converted to common equity if a trigger event occurs, either pursuant to applicable law or at the direction of the banking regulator. A trigger event is an event under which the banking entity would become nonviable without the write-off or conversion, or without an injection of capital from the public sector. The issuer must maintain authorization to issue the requisite shares of common equity if conversion were required.

 

The Basel III provisions on liquidity include complex criteria establishing the LCR (liquidity coverage ratio) and NSFR (net stable funding ratio). Although Basel III is described as a “final text,” it is subject to the resolution of certain issues and to further guidance and modification, as well as to adoption by United States banking regulators, including decisions as to whether and to what extent it will apply to United States banks that are not large, internationally active banks.

 

Looking Forward

 

One of the Corporation’s primary objectives is to achieve balanced asset and revenue growth, and at the same time expand market presence and diversify its financial products. However, it is recognized that objectives, no matter how focused, are subject to factors beyond the control of the Corporation, which can impede its ability to achieve these goals. The following factors should be considered when evaluating the Corporation’s ability to achieve its objectives:

 

The financial marketplace is rapidly changing and currently is in flux. The Treasury and banking regulators have implemented, and may continue to implement, a number of programs under new legislation to address capital and liquidity issues in the banking system. In addition, new financial system reform legislation may affect banks’ abilities to compete in the marketplace. It is difficult to assess whether these programs and actions will have short-term and/or long-term positive effects.

 

Banks are not the only place to obtain loans, nor the only place to keep financial assets. The banking industry has lost market share to other financial service providers. The future is predicated on the Corporation’s ability to adapt its products, provide superior customer service and compete in an ever-changing marketplace.

 

Net interest income, the primary source of earnings, is impacted favorably or unfavorably by changes in interest rates. Although the impact of interest rate fluctuations can be mitigated by appropriate asset/liability management strategies, significant changes in interest rates can have a material adverse impact on profitability.

 

The ability of customers to repay their obligations is often impacted by changes in the regional and local economy. Although the Corporation sets aside loan loss provisions toward the allowance for loan losses when the Board determines such action to be appropriate, significant unfavorable changes in the economy could impact the assumptions used in the determination of the adequacy of the allowance.

 

Technological changes will have a material impact on how financial service companies compete for and deliver services. It is recognized that these changes will have a direct impact on how the marketplace is approached and ultimately on profitability. The Corporation has taken steps to improve its traditional delivery channels. However, continued success will likely be measured by the ability to anticipate and react to future technological changes.

 

This “Looking Forward” description constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the Corporation’s forward-looking statements due to numerous known and unknown risks and uncertainties, including the factors referred to in this quarterly report and in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

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Item 3. Qualitative and Quantitative Disclosures about Market Risks

 

Market Risk

 

The Corporation’s profitability is affected by fluctuations in interest rates. A sudden and substantial increase or decrease in interest rates may adversely affect the Corporation’s earnings to the extent that the interest rates borne by assets and liabilities do not similarly adjust. The Corporation’s primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Corporation’s net interest income and capital, while structuring the Corporation’s asset-liability structure to obtain the maximum yield-cost spread on that structure. The Corporation relies primarily on its asset-liability structure to control interest rate risk. The Corporation continually evaluates interest rate risk management opportunities and has been focusing its efforts on increasing the Corporation’s yield-cost spread through wholesale and retail growth opportunities.

 

The Corporation monitors the impact of changes in interest rates on its net interest income using several tools. One measure of the Corporation’s exposure to differential changes in interest rates between assets and liabilities is the Corporation’s analysis of its interest rate sensitivity. This test measures the impact on net interest income and on net portfolio value of an immediate change in interest rates in 100 basis point increments. Net portfolio value is defined as the net present value of assets, liabilities and off-balance sheet contracts.

 

The primary tool used by management to measure and manage interest rate exposure is a simulation model. Use of the model to perform simulations reflecting changes in interest rates over multiple-year time horizons enables management to develop and initiate strategies for managing exposure to interest rate risk. In its simulations, management estimates the impact on net interest income of various changes in interest rates. Projected net interest income sensitivity to movements in interest rates is modeled based on a ramped rise and fall in interest rates based on a parallel yield curve shift over a twelve month time horizon and then maintained at those levels over the remainder of the model time horizon, which provides a rate shock to the two-year period and beyond. The model is based on the actual maturity and repricing characteristics of interest rate-sensitive assets and liabilities. The model incorporates assumptions regarding earning asset and deposit growth, prepayments, interest rates and other factors.

 

Management believes that both individually and taken together, these assumptions are reasonable, but the complexity of the simulation modeling process results in a sophisticated estimate, not an absolutely precise calculation of exposure. For example, estimates of future cash flows must be made for instruments without contractual maturities or payment schedules.

 

Based on the results of the interest simulation model as of March 31, 2013, and assuming that management does not take action to alter the outcome, the Corporation would expect an increase of 1.33 percent in net interest income if interest rates increased by 200 basis points from current rates in a gradual and parallel rate ramp over a twelve month period. These results and other analyses indicate to management that the Corporation’s net interest income is presently minimally sensitive to rising interest rates.

 

Based on management’s perception that financial markets will continue to be volatile, interest rates that are projected to continue at low levels will generate increased downward repricing of earning assets. Emphasis has been, and is expected to continue to be, placed on interest-sensitivity matching with an overall objective of improving the net interest spread and margin over the next twelve months. However, no assurance can be given that this objective will be met.

 

Equity Price Risk

 

The Corporation is exposed to equity price risk inherent in its portfolio of publicly traded equity securities, which had an estimated fair value of approximately $370,000 and $325,000 at March 31, 2013 and December 31, 2012, respectively. We monitor equity investment holdings for impairment on a quarterly basis. In the event that the carrying value of the equity investment exceeds its fair value, and the decline in value is determined to be to be other than temporary, the carrying value is reduced to its current fair value by recording a charge to current operations. For the three months ended March 31, 2013 and 2012, the Corporation recorded no other-than-temporary impairment charges on its equity security holdings.

 

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Item 4. Controls and Procedures

 

a) Disclosure controls and procedures. As of the end of the Corporation’s most recently completed fiscal quarter covered by this report, the Corporation carried out an evaluation, with the participation of the Corporation’s management, including the Corporation’s chief executive officer and chief financial officer, of the effectiveness of the Corporation’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Corporation’s chief executive officer and chief financial officer concluded that the Corporation’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Corporation in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and are operating in an effective manner and that such information is accumulated and communicated to management, including the Corporation’s chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

b) Changes in internal controls over financial reporting : There have been no changes in the Corporation’s internal controls over financial reporting that occurred during the Corporation’s last fiscal quarter to which this report relates that have materially affected, or are reasonable likely to materially affect, the Corporation’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

 

There are no significant pending legal proceedings involving the Corporation other than those arising out of routine operations. Based upon the information currently available, it is the opinion of management that the disposition or ultimate determination of such other claims will not have a material adverse impact on the consolidated financial position, results of operations, or liquidity of the Corporation.  This statement constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from this statement as a result of various factors, including the uncertainties arising in proving facts within the context of the legal processes.

 

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Item 6. Exhibits

 

Exhibit No.   Description
     
31.1   Certification of the Chief Executive Officer of the Parent Corporation Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of the Chief Financial Officer of the Parent Corporation Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*   Certification of the Chief Executive Officer of the Parent Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*   Certification of the Chief Financial Officer of the Parent Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**   XBRL Instance Document
101.SCH**   XBRL Taxonomy Extension Schema Document
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**   Definition Taxonomy Extension Linkbase Document
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document

 

* = Furnished and not filed.

 

** = Pursuant to Rule 406T of Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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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.

 

CENTER BANCORP, INC.

(Registrant)

 

By: /s/ Anthony C. Weagley   By: /s/ Vincent N. Tozzi
  Anthony C. Weagley     Vincent N. Tozzi
  President and Chief Executive Officer     Vice President, Treasurer and Chief Financial Officer
         
  Date: May 9, 2013     Date: May 9, 2013

 

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