ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
The Company currently conducts business from its main office located at 225 North Main Street, Cape May Court House, New Jersey, 08210, from its additional 15 branch offices located throughout Atlantic and Cape May Counties, New Jersey, and from a loan production office located in Burlington County, New Jersey (opened in February 2011). At December 31, 2010, the aggregate net book value of premises and equipment was $25.2 million. With the exception of the potential remodeling of certain facilities to provide for the efficient use of work space and/or to maintain an appropriate appearance, each property is considered reasonably adequate for current and anticipated needs.
Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) No equity securities were sold during the year ended December 31, 2010 that were not registered under the Securities Act.
Stock Performance Graph
The following Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
We completed our initial public offering on January 31, 2008. In the offering, we sold 7,820,000 shares of our common stock at $10.00 per share to Cape Bank’s depositors, Cape Bank’s tax qualified employee benefit plans and the general public in subscription, community and syndicated offerings. We also issued 547,400 shares of our common stock and contributed $782,000 in cash to The CapeBank Charitable Foundation. In addition, we issued 4,946,121 shares of our common stock to former shareholders of Boardwalk Bancorp as merger consideration. As a result of the transactions, we have 13,313,521 issued and outstanding shares.
Our common stock began trading on the Nasdaq Stock Market under the symbol “CBNJ” on February 1, 2008, and the per share closing price of one share of the Company’s common stock on that date was $10.05. The following graph represents $100 invested in our common stock at the $10.05 per share closing price on February 1, 2008. The graph illustrates the comparison of the cumulative total returns on the common stock of the Company with (a) the cumulative total return on stocks included in the NASDAQ Composite Index; and (b) the cumulative total return on stocks included in the SNL Mid-Atlantic Thrift Index.
There can be no assurance that our stock performance will continue in the future with the same or similar trend depicted in the graph below. We will not make or endorse any predictions as to future stock performance.
CAPE BANCORP
The following table sets forth the range of high and low bid information for the Company’s common stock as reported on NASDAQ for the period beginning January 1, 2009. Quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions.
(b) Not applicable
(c) There were no issuer repurchases of securities during the fourth quarter of the December 31, 2010 fiscal year.
The following information is derived from the audited consolidated financial statements of Cape Bancorp. For additional information, reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of Cape Bancorp and related notes included elsewhere in this Annual Report.
(1)
Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(2)
Represents net interest income as a percent of average interest-earning assets.
(3)
Represents non-interest expense divided by the sum of net interest income and non-interest income. Recalculating the 2008 efficiency ratio excluding the Goodwill Impairment ($31.751 million) and CapeBank Charitable Foundation Contribution ($6.2 million) results in an efficiency ratio of 69.2%
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Cape Bank was organized in 1923. Over the years, we have expanded primarily through internal growth. On January 31, 2008, we completed our mutual-to-stock conversion and initial public stock offering, and our acquisition of Boardwalk Bancorp and Boardwalk Bank. The merger of Cape Savings Bank (now Cape Bank) and Boardwalk Bancorp on January 31, 2008 created the largest community bank headquartered in Atlantic and Cape May Counties, with a total of 18 branches providing complimentary branch coverage. At December 31, 2010, we had total assets of $1.061 billion. The merger resulted in a well-capitalized community oriented bank with a significant commercial loan presence and an experienced executive management team. For the three years prior to the merger both banks had experienced strong asset quality and financial performance. The severe economic recession has affected the merged financial institution as a whole, as well as the loan portfolios of each of the constituent banks to the merger.
Our principal business is acquiring deposits from individuals and businesses in the communities surrounding our offices and using these deposits to fund loans and other investments. We also offer personal and business checking accounts, commercial mortgage loans, residential mortgage loans, construction loans, home equity loans and lines of credit and other types of commercial and consumer loans. Our customers consist primarily of individuals and small and mid-sized businesses. At December 31, 2010, our retail market area primarily included the area surrounding our 17 offices located in Cape May and Atlantic Counties, New Jersey.
During 2011, Cape Bank will emphasize the following:
1)
Managing our credit underwriting and administration through the economic recovery.
2)
Managing non-performing assets to performing status or disposal.
3)
Managing net interest income in a potentially rising rate environment.
Managing our credit underwriting and administration through the economic recovery:
Based on our experience during the credit crisis and economic downturn, we have taken steps to improve our credit underwriting and administration. Changes in the Commercial Loan and Credit Departments were significant during the most recent quarter as each of our new Chief Lending Officer (CLO) and Chief Credit Officer (CCO) had the opportunity to introduce their new approaches and credit culture. The CLO has undertaken a review of all credit files to update and reanalyze the credits to achieve an “audit ready” credit file. The CCO has taken over the active management of all credits that are rated “Substandard.”
The two new lending executives’ assessment of the existing loan risk rating system resulted in the process being significantly revised to a more traditional bank loan rating scheme, which has also led to some additional consideration of troubled credits. Performing loans with a solid history of payment would not have been adversely classified in the past. Under the new approach, global cash flow analysis dictates loan classification (with some adjustment made for collateral value), which has resulted in more “Classified” loans. As a result, there are loans placed in the Substandard category despite the fact that they are still performing according to their terms; such loans had not been so designated in the past.
The Bank’s management also has a “Watch List” meeting two months every quarter to review criticized loans over $500 thousand, in addition to presenting a quarterly report to the Board of Directors.
The CLO has introduced a more rigorous program of external credit training and has actively mentored our relationship managers. The training has inculcated the cash flow approach to the credit culture and created a more uniform approach to credit presentations.
Beginning in 2009, the Bank has continued to de-emphasize extensions of credit to both the hospitality and restaurant industries. The current loan portfolio has high concentrations in both segments which have experienced considerable weakness during the economic downturn.
For 2011, we anticipate a gradual decrease in the amount of problem assets based on improvement of national and local economic trends, including the local unemployment rate declining, residential building permits leveling off and the economic activity occurring in the Atlantic City area related to casinos that was previously discussed in this document. The Bank’s local market has had specific economic development with the Revel Casino Hotel obtaining permanent financing with expected completion by the summer of 2012. It is anticipated that this construction project may produce approximately 2,000 jobs and the finished project may result in approximately 5,500 jobs within the Bank’s market area.
Loan demand within our market area is expected to remain moderate during 2011. Median home sales prices in Atlantic County declined from 2009 to 2010 by 5.3% while in Cape May County the median home sales price increased by 13.1%. The number of home sales in both counties decreased from the third quarter of 2009 compared to the third quarter of 2010. Additionally we have been able to sell some of our other real estate owned properties, which may indicate that potential purchasers believe that market values are not likely to decrease further.
Managing non-performing assets to performing status or disposal:
Our non-performing assets began to increase in 2008, and continued to increase through 2010. The deterioration in our local real estate market began during the first quarter of 2008 and continued to decline through 2009. Median home sales prices are mixed within our market area as noted previously. Residential building permits for Atlantic and Cape May Counties have leveled off for both Atlantic and Cape May Counties in 2010 at 2009 levels, although still below 2008 levels, which may be an indication that a floor has been reached. Unemployment has also affected non-performing assets and has increased from December 2008 to December 2010 in both Atlantic and Cape May Counties by 31% and 10% respectively, although the unemployment rate did decline in such counties from 2009 to 2010. These negative economic trends have contributed to a significant increase in non-performing assets from $3.95 million at December 31, 2007 to $46.8 million at December 31, 2010. This increase was affected by the sustained national recession and by the significant increase in our total loan portfolio during the period. The ratio of our allowance for loan losses to non-performing loans decreased from 102.85% in 2007 to 28.84% in 2010; net charge-offs to average loans increased from 0.06% in 2007 to 1.05% in 2010; impaired loans increased from $4.0 million in 2007 to $59.7 million in 2010; and delinquent loans increased from $15.7 million at December 31, 2007 to $34.7 million at December 31, 2010. Delinquent loans also increased in number during this same time period.
Management has given significant attention to these assets during the past year, including adding experienced staff, and has developed processes to actively manage delinquencies from their inception at 15 days delinquent to their resolution, either through charge-off or foreclosure or working with borrowers to bring their loans current. Our approach is to identify impaired loans, determine the loss amount if any, and recognize the appropriate loss at that time.
Reducing the level of non-performing assets during the upcoming year will improve our results of operations by converting non-earning assets to earning assets and reducing the expense of managing non-performing assets, which will benefit our interest income, net interest margin and net income. While loan demand is expected to remain moderate during 2011, there is some evidence that continued economic deterioration may have leveled off or slightly improved during the fourth quarter of 2010 through the beginning of 2011. Moreover, residential building permits have stabilized and unemployment within Atlantic and Cape May Counties did decline from 2009 to 2010 by 10.1% and 19.5% respectively.
Managing net interest income in a potentially rising rate environment:
The potential exists for the Federal Reserve Bank to raise the target Fed Funds rate in 2011. An increase in interest rates will present us with the challenge of managing interest rate risk with a cumulative one year liability sensitive balance sheet. As detailed in “-Net Interest Income Analysis”, a rising interest rate environment indicates that net interest income would decrease over a one-year horizon. This analysis assumes instantaneous and sustained rate shock intervals of 100 and 200 basis points on a static balance sheet. Management will focus on several strategies to negate such effects, such as extending long-term liabilities, increasing core deposit balances, reducing the amount of long term fixed rate loans in the portfolio, and shortening the average life of investments within the investment portfolio. These strategies are discussed in more detail in the “Management of Market Risk” herein.
2011 Outlook
Our market area has been significantly affected by the severe economic recession which has affected unemployment and real estate values. Unemployment in Atlantic and Cape May County was 12.5% and 13.2% respectively as of December 2010. Median home sales prices have declined in Atlantic County but increased in Cape May County when comparing Q3 2009 to Q3 2010, while residential building permits, which have been declining since 2008, have leveled off in both counties from 2009 to 2010.
During 2011, Cape Bank will be focusing on core banking practices with an emphasis on managing non-performing assets. We intend to adhere to our existing loan underwriting practices, which we believe are appropriate in the current market. The recognition of additional goodwill impairment is dependent on many variables, some of which are not directly controllable by Cape Bank. However, with expected decreases in non-performing assets and a steady net interest margin and efficiency ratio, additional goodwill impairment is not probable. Our capital remains strong at Cape Bank and there is no expectation of raising additional capital through government programs or by any other means during 2011.
Income. Our primary source of income is net interest income. Net interest income is the difference between interest income (which is the income that we earn on our loans and investments) and interest expense (which is the interest that we pay on our deposits and borrowings). Changes in levels of market interest rates affect our net interest income. During the past three years the Bank’s yield curve has steepened as rates tied to the prime rate have decreased as the Federal Reserve has decreased the targeted Fed Funds Rate from a high of 5.25% in 2007 to its current low of 0.25%. Mid and long-term rates have remained in a tighter range than short-term rates during the past three years. As the Bank’s yield curve steepened during the past three years, our net interest margin increased each year; although we incurred a loss in both 2008 and 2009 we did record net income of $4.0 million for 2010. These losses were primarily the result of expenses related to OTTI, goodwill impairment, provision for loan losses and a deferred tax asset valuation allowance. These items and others are discussed in more detail within the Management Discussion and Analysis section of this report.
The Bank’s net interest margin has trended upward from 3.48% in 2008 to 3.54% in 2009, and to 3.66% in 2010. This improvement is the result of the yield on our earning assets declining 84 basis points from 2008 to 2010 and our cost of funds declining 116 basis points during the same time period. During the period from 2008 to 2010 our yield curve steepened as a result of short term rates dropping consistent with the decline in the Fed Funds rate. During this three year period the Commercial, Residential Mortgage and Consumer loan portfolios all decline in yield from 2008 to 2010 by 22 basis points, 45 basis points and 49 basis points respectively. The investment portfolio declined in yield from 2008 to 2010 from 4.31% to 2.62% or 169 basis points. This significant decline of yield within the investment portfolio was contributed to by the sale of high yielding investment to garner gains while the reinvestment of these proceeds were into short-term investments anticipating a rise in interest rates in the future. The cost of funds during the same three year period dropped significantly in conjunction with the decrease in the Fed Funds Rate. For the period from 2008 to 2010 the cost of interest-bearing demand accounts decreased 62 basis points, savings accounts decreased 91 basis points, money market accounts decreased 144 basis points and certificates of deposit decreased 179 basis points.
The historically low interest rate environment, which has been significantly influenced by the target Fed Funds rate of 0.0% to 0.25% set by the Federal Reserve in the fourth quarter of 2008, has benefitted the Bank’s net interest income as our cost of funds decreased more than the decrease in the yield on our assets during the twelve month period ended December 31, 2010. We do not expect to continue to benefit significantly from the downward repricing of our liabilities during 2011; however we do expect our net interest margin to be maintained at or near its current level. The full positive impact of the variable yield curve has been mitigated by the significant increase in our nonperforming loans and assets, which has reduced our net interest income.
The anticipated increase in market interest rates, driven by the target Fed Funds rate set by the Federal Reserve, would cause compression in the Bank’s net interest margin. The magnitude of this potential change is discussed in more detail in the “Management of Market Risk” herein.
A secondary source of income is non-interest income, which is revenue that we receive from providing other products and services. Most of our non-interest income consists of service charges (primarily service charges on deposit accounts, which include overdraft charges). We also recognize non-interest income/loss from the sale or other-than-temporary-impairment of loans and securities.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a monthly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings. In accordance with FASB ASC Topic No. 450 Contingencies, we establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, external factors such as competition and regulatory, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans.
Generally, loans are placed on non-accrual status when payment of principal or interest is 90 days or more delinquent unless the loan is considered well-secured and in the process of collection. Loans are also placed on non-accrual status when they are less than 90 days delinquent, if collection of principal or interest in full is in doubt. This determination is normally the result of the review of the borrower’s financial statements or other information that is obtained by the Bank.
All loans that are on non-accrual status are reviewed by management monthly to determine if a specific reserve or charge-off is appropriate. At this point in the delinquency collection efforts, the primary consideration is collateral value. When the Bank has a current appraisal, generally less than 12 months old, and management agrees that the property has not deteriorated in value since the appraisal, then management will analyze the loan in accordance with FASB ASC Topic No. 310 Receivables. When a current appraisal is not available, the Bank will request one. Upon receipt of the appraisal, we will review the loan in accordance with FASB ASC Topic No. 310 Receivables. Prior to receipt of an appraisal, management will consider, based on its knowledge of the market and other available information pertinent to the particular loan being reviewed, allocating a specific reserve for that loan. Loans are charged off partially or in full based on upon the results of a completed FASB ASC Topic No. 310 Receivables analysis.
The amount of the allowance is based on management’s judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a quarterly basis.
Expenses. The non-interest expenses we incur in operating our business consist of salaries and employee benefits expenses, data processing expenses, occupancy expenses, depreciation, amortization and maintenance expenses and other miscellaneous expenses, such as advertising, insurance, professional services and printing and supplies expenses.
Our largest non-interest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We will recognize additional annual employee compensation expenses from our employee stock ownership plan, our Equity Incentive Plan and any additional stock-based benefit plans that we may adopt in the future.
In 2007, the FDIC began assessing most insured banks and savings banks deposit insurance premiums ranging from five cents to seven cents for every $100 of deposits. Assessment credits have been provided to institutions that paid high premiums in the past. According to information provided by the FDIC, in 2008 Cape Bank received an assessment credit of approximately $390,000. The amount of the credit that offset our deposit insurance premium expense in 2008 was $213,500 which represented the remaining balance of the credit. The FDIC imposed a special 5 basis point assessment on total assets as of June 30, 2009, which was paid on September 30, 2009 and totaled $499,000.
Anticipated Increase in Non-Interest Expense
As a result of our public offering in 2008, our non-interest expense increased because of the increased costs associated with operating as a public company. These additional expenses consist primarily of accounting and legal fees, expenses of shareholder communications and meetings, and increased compensation expenses associated with our employee stock ownership plan (“ESOP”) and any additional stock-based benefit plans that are approved by our shareholders. On August 25, 2008, our shareholders approved the Cape Bancorp, Inc. 2008 Equity Incentive Plan. The Equity Incentive Plan authorizes up to 1,863,892 shares of Company common stock pursuant to grants of restricted stock awards, incentive stock options, non-qualified stock options and stock appreciation rights; provided, however, that no more than 1,331,352 shares may be issued or delivered in the aggregate pursuant to the exercise of stock options or stock appreciation rights, and no more than 532,540 shares may be issued or delivered pursuant to restricted stock awards. During 2010, the Company issued 740,000 incentive stock options to certain employees at prices ranging from $7.27 per share to $8.50 per share. In addition, in 2010, 23,600 non-qualified stock options were issued to directors at a price of $7.68 per share. See “Note 13 - Benefit Plans”.
The actual expense that will be recorded for the ESOP will be determined by the market value of our common stock as shares are released to employees over the term of the loan, and whether the loan is repaid faster than its contractual term. Accordingly, any increases in our stock price above $10.00 per share and any accelerated repayment of the loan will increase the annual ESOP expense. Similarly, any decrease in our stock price would decrease the annual ESOP expense. Further, the actual expense of the stock awards under the 2008 Equity Incentive Plan will be determined by the fair market value of the common stock on the grant date, which may be greater or less than $10.00 per share, and the actual expense of stock options under the 2008 Equity Incentive Plan will be based on the grant-date fair value of the options, which will be affected by a number of factors, including the market value of our common stock, the term and vesting period of the stock options, our dividend yield and other valuation assumptions contained in the option pricing model that we ultimately use.
Critical Accounting Policies
In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses. We consider the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment.
In evaluating the allowance for loan losses, management considers historical loss factors, the mix of the loan portfolio (types of loans and amounts), geographic and industry concentrations, current national and local economic conditions and other factors related to the collectability of the loan portfolio, including underlying collateral values and estimated future cash flows. All of these estimates are susceptible to significant change. Groups of homogenous loans are evaluated in the aggregate under FASB ASC Topic No. 450 Contingencies, using historical loss factors adjusted for economic conditions and other environmental factors. Other environmental factors include trends in delinquencies and classified loans, loan concentrations by loan category and by property type, seasonality of the portfolio, internal and external analysis of credit quality, and single and total credit exposure. Certain loans that indicate underlying credit or collateral concerns may be evaluated individually for impairment in accordance with FASB ASC Topic No. 310 Receivables. If a loan is impaired and repayment is expected solely from the collateral, the difference between the outstanding balance and the value of the collateral will be charged off. For potentially impaired loans where the source of repayment may include other sources of repayment, the evaluation may factor these potential sources of repayment and indicate the need for a specific reserve for any potential shortfall. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available or as projected events change.
Management reviews the level of the allowance quarterly. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the New Jersey Department of Banking and Insurance, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 2 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
Securities Impairment. The Company’s investment portfolio includes 24 securities in pooled trust preferred collateralized debt obligations, 16 of which have been principally issued by bank holding companies, and 8 of which have been principally issued by insurance companies. The portfolio also includes 2 private label (non-agency) collateralized mortgage obligations (“CMO”). With the exception of 1 non-agency collateralized mortgage obligation, all of the aforementioned securities have below investment grade credit ratings. These investments may pose a higher risk of future impairment charges by the Company as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of the bank issuers and underlying mortgage loan collateral.
Through December 31, 2010 all 16 of the bank-issued pooled trust preferred collateralized debt obligation securities have had OTTI recognized in earnings due to credit impairment. Of those securities, 11 have been completely written off and the 5 remaining bank-issued CDOs have a total book value of $2.0 million and a fair value of $71,000 at December 31, 2010. These write-downs were a direct result of the impact that the credit crisis has had on the underlying collateral of the securities. Consequently many bank issuers have failed causing them to default on their security obligations while recent stress tests and potential recommendations by the U.S. Government and the banking regulators have resulted in some bank trust preferred issuers electing to defer future payments of interest on such securities. At December 31, 2010 the CDO securities principally issued by insurance companies, none of which have been OTTI, had an aggregate book value of $7.7 million and a fair value of $1.1 million. A continuation of issuer defaults and elections to defer payments could adversely affect valuations and result in future impairment charges.
Approximately $4.5 million of the collateralized mortgage obligations are non-agency and consist of 2 securities. One of those securities had an unrealized loss of $39,000 at December 31, 2010. While we have determined this unrealized loss to be temporary, a continued downturn in the financial markets could cause us to reassess our determination. Deteriorating financial conditions may cause delinquencies in the underlying mortgage loan collateral to deteriorate such that we no longer receive monthly payments on the security, thereby increasing the likelihood of OTTI.
Income Taxes. The Company is subject to the income and other tax laws of the United States and the State of New Jersey. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provisions for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Company provision and tax returns, management attempts to make reasonable interpretations of applicable tax laws. These interpretations are subject to challenge by the taxing authorities upon audit or to reinterpretation based on management’s ongoing assessment of facts and evolving case law.
The Company and its subsidiaries file a consolidated federal income tax return and separate entity state income tax returns. The provision for federal and state income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Company’s federal and state income tax returns. When income and expenses are recognized in different periods for tax purposes than for book purposes, applicable deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Deferred federal and state tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2010, a valuation allowance in the amount of approximately $13.7 million had been established against the Company’s deferred tax assets.
On a quarterly basis, management assesses the reasonableness of its effective federal and state tax rate based upon its current best estimate of net income and the applicable taxes expected for the full year.
Business Strategy
Our business strategy is to operate and grow a profitable community-oriented financial institution. We believe that we have created an infrastructure within the organization to address the issues surrounding our troubled credits which will afford the opportunity to return more aggressively to servicing the traditional banking needs of our customers. We plan to achieve this by:
•
Pursuing loan growth, particularly commercial loans. Efforts will focus on both Atlantic and Cape May counties and Burlington and Camden counties with the new loan production office
•
Using underwriting standards that will minimize the potential for future problem loans
•
Returning to active engagement with both existing relationships and potential customers
•
Being alert to opportunities to maintain non-interest income
•
Originating residential mortgages both for sale and for the portfolio
Pursuing loan growth, particularly commercial loans. Efforts will focus on both Atlantic and Cape May counties and Burlington and Camden counties with the new loan production office.
We have been growing our commercial loan portfolio over the past several years. This includes loans for the operation of customers’ businesses (lines of credit, equipment loans, working capital) and loans for commercial real estate (often the operating headquarters of a customer in a service business). This focus stems in part from management’s belief that community banking can successfully fulfill a need by providing services to small and mid-sized businesses. In the process of fulfilling this community need, commercial relationships also provide great benefit to the community bank. Commercial loans can be priced attractively with variable rate features that ameliorate interest rate risk. Commercial relationships often include demand accounts which offer value both in interest rate risk management and in net interest margin. We believe that this strategy has a likelihood of success due the knowledge of the local market and connections to the local business community provided by both management and the board of directors.
Our recent experience with troubled credits has provided valuable lessons and led to improvements in our underwriting and credit administration. We control risk through underwriting and collateral requirements. Credit administration monitors concentrations of credit by industry, collateral type and location of collateral. Regular financial reporting from borrowers is required and monitored and most credits require annual reviews through the loan committees.
At December 31, 2010, we had $428.7 million and $48.2 million of commercial real estate loans (including commercial construction loans) and commercial business loans, representing 54.6% and 6.1% of total loans, respectively. At December 31, 2009, we had $441.3 million and $62.7 million of commercial real estate loans (including commercial construction loans) and commercial business loans, representing 55.0% and 7.8% of total loans, respectively. Commercial loans help diversify our loan portfolio and help improve the interest rate sensitivity of our assets. Our maximum loans-to-one borrower limit was $17.0 million at December 31, 2010, although we do not expect to have any lending relationship that would reach this limit.
Using underwriting standards that will minimize the potential for future problem loans
The changes in credit management brought about through the new CLO and CCO managers are the direct result of the Bank’s intention to improve the underwriting standards of the bank. Credits are evaluated on the strength of traditional cash flows, and to a lesser extent, the value of any collateral whether real estate or other. Under this newer model, the CCO is a direct report to the Chief Executive Officer (CEO) and is responsible for loan policy and the quality of credit underwriting and administration. The credit culture being introduced by the new team should provide greater protection for the bank from risks inherent in commercial lending.
Returning to active engagement with both existing relationships and potential customers
The recent economic downturn impacted both the focus of the bank and businesses within our market. The Bank’s energies were focused on dealing with troubled credits. Customers of the bank were frightened by developments and unwilling or unable to consider new ventures. There are indications that this is changing. The bank has quantified and segregated problem credits and put them under the direction of a qualified team of work out officers. With this issue contained, it allows for the bank to refocus on engaging with existing customers to expand our relationship both through products and credits. For our customers, a return to a more normal economy appears to have generated a cautious optimism that may prompt plans for new ventures or business expansion. We believe that these changes coupled with a renewed engagement with our customers will increase the potential for expanding profitable relationships.
Being alert to opportunities to maintain non-interest income
Community banks primarily rely on interest income. Non-interest income is a welcome secondary source of revenue although opportunities for such income are limited. Recent regulation has created situations that could limit non-interest income, particularly as it relates to overdraft fees. Management feels that regulatory pressure will continue as the regulatory environment seeks to control or minimize fees assessed to consumers.
Originating residential mortgages both for sale and for the portfolio
Cape Bank has always been active in residential lending in its market. The residential loan portfolio has had a good credit performance and the origination efforts has provided a source of non-interest income through sales in the secondary market. These efforts will continue both as a means to service the needs of the retail customer and as a source of fee income through the sales of loans. While more attention will be given to sales, management anticipates some production to result in loans that will be housed in the bank’s loan portfolio.
Comparison of Financial Condition at December 31, 2010 and December 31, 2009
The Company’s total assets decreased by $11.8 million, or 1.1%, to $1.061 billion at December 31, 2010 from $1.073 billion at December 31, 2009.
Cash and cash equivalents increased $1.5 million or 11.0%, to $15.0 million at December 31, 2010 from $13.5 million at December 31, 2009.
Interest-bearing time deposits increased to $9.4 million at December 31, 2010 from $7.5 million at December 31, 2009, an increase of $1.9 million or 25.6%. The Company invests in time deposits of other banks generally for terms of one year and not to exceed $250,000, which is the amount currently insured by the Federal Deposit Insurance Corporation.
Total loans decreased $17.9 million, or 2.2%, to $784.9 million at December 31, 2010 from $802.8 million at December 31, 2009. Net loans decreased by $17.2 million, net of a decrease in the allowance for loan losses of $773,000. Delinquent loans increased $248,000 to $34.7 million or 4.4% of total loans at December 31, 2010 from $34.4 million, or 4.3% of total loans, at December 31, 2009. Total delinquent loans by portfolio at December 31, 2010 were $19.6 million of commercial mortgages, $5.9 million of residential mortgages, $4.0 million of construction loans, $4.0 million of commercial business loans, $1.1 million of home equity loans and $16,000 of other consumer loans. Delinquent loan balances by number of days delinquent were: 31 to 59 days - $2.3 million; 60 to 89 days - $690,000; and 90 days and greater - $31.7 million.
At December 31, 2010, the Company had $43.5 million in non-performing loans, or 5.54% of total loans, compared to $33.2 million, or 4.14% of total loans, at December 31, 2009. This increase resulted from the classification to non-performing loans of $11.8 million in troubled debt restructurings that were performing in accordance with their repayment terms at December 31, 2010. At December 31, 2010, non-performing loans by loan portfolio category were as follows: $27.8 million of commercial mortgage loans; $2.4 million of residential mortgage loans; $4.0 million of construction loans; $6.2 million of commercial business loans; and $363,000 of home equity loans.
At December 31, 2010, commercial loans that were non-performing loans had collateral type concentrations of $12.5 million (11 loans or 33%) secured by B&B and hotels, $11.4 million (24 loans or 30%) secured by commercial buildings and equipment, $5.1 million (11 loans or 13%) secured by restaurant properties, $3.5 million (20 loans or 9%) secured by residential, duplex and multi-family properties, $3.4 million (10 loans or 9%) secured by land and building lots, $1.6 million (6 loans or 4%) secured by retail stores, and $646,000 (2 loans or 2%) secured by marina properties. The three largest relationships in this category of non-performing loans are $11.8 million, $4.1 million, and $2.5 million.
We believe we have appropriately charged-off or established adequate loss reserves on problem loans that we have identified. For 2011, we anticipate a gradual decrease in the amount of problem assets. This improvement is due, in part, to our disposing of assets collateralizing loans that have gone through foreclosure. We are aggressively managing all loan relationships, and where necessary, we will continue to apply our loan work-out experience to protect our collateral position and actively negotiate with mortgagors to resolve these non-performing loans.
Total investment securities increased by $4.6 million, or 3.0%, to $157.4 million at December 31, 2010 from $152.8 million at December 31, 2009. At December 31, 2010, all of the Company’s investment securities were classified as available-for-sale (AFS). Effective December 31, 2009, the Company reclassified the held-to-maturity (HTM) portion of its portfolio to AFS. HTM securities with a market value of $44.5 million and an amortized cost of $43.0 million were reclassified to AFS. This change in classification provides flexibility and enables the Company to respond more effectively to changes in market value of the investment portfolio as well as enhancing its sources of liquidity. The increase in the portfolio occurred primarily from reinvesting some of the funds generated from the decline in loans. Increases of $25.8 million in U.S. Government and agency obligations and $7.1 million in corporate bonds were partially offset by declines of $9.0 million in municipal bonds, $19.0 million in mortgage-backed securities and $300,000 in CDOs. The decrease in municipal bonds and mortgage-backed securities is largely the result of selling securities. Management’s decision to sell those securities was driven by 2 objectives: 1) a desire to recognize gains before market prices were adversely impacted by rising interest rates and 2) the Company’s strategy to manage interest rate risk by replacing longer duration securities with shorter duration securities. By doing so the Company realized gains of $832,000 in 2010 while shortening the duration of the portfolio and positioning the Company to capitalize in anticipation of rising interest rates. The Company also experienced additional OTTI related to its CDO portfolio during the year. This segment of the portfolio has been adversely impacted by the continued downturn in the economy which has caused many bank issuers to fail and therefore default on their obligations while others have elected to defer future payments of interest on such securities. At December 31, 2010, these securities had a cost basis of $9.7 million and a fair market value of $1.1 million. The Company also recorded a $3.4 million charge to earnings during the year related to the credit loss portion of impairment.
Total deposits increased by $16.5 million, or 2.2%, to $753.1 million at December 31, 2010, from $736.6 million at December 31, 2009.
Certificates of deposit decreased $30.1 million, or 8.9%, to $306.8 million at December 31, 2010 from $336.9 million at December 31, 2009, and NOW and money market accounts increased $35.8 million, or 13.9%, to $293.7 million at December 31, 2010 from $257.9 million at December 31, 2009. Non-interest bearing deposits increased $5.9 million, or 9.5%, to $68.3 million at December 31, 2010 from $62.4 million at December 31, 2009. Savings deposits increased $4.9 million or 6.2% to $84.3 million at December 31, 2010 from $79.4 million at December 31, 2009.
Total borrowings decreased $34.3 million, or 16.8%, to $169.6 million at December 31, 2010 from $203.9 million at December 31, 2009. At December 31, 2010, our borrowings to assets ratio decreased to 16.0% from 19.0% at December 31, 2009. Borrowings to total liabilities decreased to 18.3% at December 31, 2010 from 21.6% at December 31, 2009.
Stockholders’ equity increased $5.6 million, or 4.4%, to $132.1 million at December 31, 2010, from $126.5 million at December 31, 2009. The increase in equity was primarily attributable to the net income of $4.0 million and a decrease in accumulated other comprehensive loss, net of tax, of $1.1 million. At December 31, 2010, stockholders’ equity totaled $132.1 million, or 12.46% of total assets, and tangible equity totaled $109.1 million or 10.51% of total tangible assets.
Comparison of Operating Results for the Years Ended December 31, 2010 and 2009
General. The Company recorded net income of $4.0 million, or $.33 per share for the year ended December 31, 2010 compared to a net loss of $17.9 million, or $1.45 per share for the year ended December 31, 2009. The $21.9 million year over year increase in net income is primarily attributable to reductions in the following expenses: $5.7 million in the loan loss provision, $1.7 million in OTTI charges, $973,000 in salaries and employee benefits, and $462,000 in Federal Deposit Insurance premiums. In addition, the year ended December 31, 2009 included a one-time $12.0 million tax expense related to the establishment of a deferred tax asset valuation allowance. Net interest income increased $225,000, or 0.63%, to $35.7 million for the year ended December 31, 2010 compared to $35.5 million for the year ended December 31, 2009 due to an increase in the net interest margin to 3.66% for the year ended December 31, 2010 from 3.54% for the year ended December 31, 2009.
Interest Income. Interest income decreased $4.3 million, or 7.8%, to $50.2 million for the year ended December 31, 2010, from $54.5 million for the year ended December 31, 2009. The decrease for the year resulted primarily from a $2.8 million, or 35.7%, decrease in interest income on investments, and a $1.4 million, or 3.1%, decrease on interest income on loans. Average loan balances for the year ended December 31, 2010, decreased $17.5 million, or 2.2% to $789.1 million from $806.6 million for the year ended December 31, 2009. Due to the economic downturn, loan demand has not been sufficient to offset monthly principal reductions, pay-offs, charge-offs and the transfer of loans to OREO resulting in the decline in average loan balances. The average yield on the loan portfolio decreased 5 basis points to 5.72% for the year ended December 31, 2010 from 5.77% for the year ended December 31, 2009, primarily due to competition for new loan originations in a lower interest rate environment.
The average balance of the investment portfolio decreased $13.4 million, or 7.2%, to $171.2 million for the year ended December 31, 2010 from $184.6 million for the year ended December 31, 2009. The average yield on investments decreased 128 basis points to 2.91% for the year ended December 31, 2010 from 4.19% for the year ended December 31, 2009. The decrease in average balance is primarily a result of the impact from the sale of $31.7 million in mortgage-backed securities during June and August of 2009. The decline in yield is largely due to the first quarter 2010 write-off of $590,000 in accrued interest receivable related to bank-issued CDO securities and the implementation of a strategy to shorten the duration of the investment portfolio. Interest income was adversely impacted by this strategy in the short-term because longer duration, higher yielding mortgage-backed securities and municipal bonds were sold in 2009 and 2010 and partially replaced with callable, short-term U.S. Government and agency obligations and corporate bonds, which have yields that are below the portfolio average. Other contributing factors include interest rates on adjustable mortgage-backed securities repricing down, and callable U.S. Government and agency obligations being called and replaced at lower coupon rates.
Interest Expense. Interest expense decreased $4.5 million, or 23.6%, to $14.5 million for the year ended December 31, 2010, from $19.0 million for the year ended December 31, 2009. The decrease in interest expense resulted from lower rates on all interest-bearing deposit products, particularly certificates of deposit.
Interest expense on certificates of deposit decreased $3.8 million, or 37.9%, to $6.1 million for the year ended December 31, 2009, from $9.9 million for the year ended December 31, 2008. The average rate paid on certificates of deposit decreased 89 basis points to 1.77% for the year ended December 31, 2010, from 2.66% for the year ended December 31, 2009, while the average balance of certificates of deposit decreased $25.4 million, or 6.8% to $346.3 million for the year ended December 31, 2010, from $371.7 million for the year ended December 31, 2009. Interest expense on NOW (interest-bearing demand accounts) and money market accounts increased $49,000, or 2.3%, to $2.2 million for the year ended December 31, 2010, from $2.1 million for the year ended December 31, 2009. The average rate paid on NOW and money market accounts decreased 9 basis points to 0.80% for the year ended December 31, 2010, from 0.89% for the year ended December 31, 2009. The average balance of NOW and money market accounts increased $33.2 million, or 14.0%, to $270.2 million for the year ended December 31, 2010, from $237.0 million for the year ended December 31, 2009. Interest expense on savings accounts decreased $69,000 to $316,000 for the year ended December 31, 2010, from $385,000 for the year ended December 31, 2009. The average rate paid on savings deposits decreased 10 basis points to 0.38% for the year ended December 31, 2010, from 0.48% for the year ended December 31, 2009, while the average balance of savings accounts increased $1.9 million, or 2.4% to $82.1 million for the year ended December 31, 2010, from $80.2 million for the year ended December 31, 2009. The average balance of NOW and money market accounts includes both indexed priced and fixed rate municipal account relationships for the year ended December 31, 2010, with an average balance of $28.5 million and an average rate of 0.49%, compared to an average balance of $24.4 million and an average rate of 0.43% for the year ended December 31, 2009.
Interest expense on borrowings (primarily Federal Home Loan Bank of New York advances) decreased $721,000, or 10.9%, to $5.9 million for the year ended December 31, 2010 from $6.6 million for the year ended December 31, 2009. The average balance of borrowings declined $30.4 million, or 15.9%, to $160.9 million for the year ended December 31, 2010, from $191.3 million for the year ended December 31, 2009. The average rate paid on borrowings increased 21 basis points to 3.68% for the year ended December 31, 2010, from 3.47% for the year ended December 31, 2009. This increase is primarily attributable to a decline in the average balance of lower costing overnight advances for the year ended December 31, 2010 compared to the year ended December 31, 2009.
Net Interest Income. Net interest income increased $225,000, or 0.6%, to $35.7 million for the year ended December 31, 2010, from $35.5 million for the year ended December 31, 2009. Our net interest margin increased by 12 basis points to 3.66% for the year ended December 31, 2010, from 3.54% for the year ended December 31, 2009. The increase in net interest income resulted from having more rate sensitive liabilities tied to short term interest rates reprice to lower rates than rate sensitive assets. In particular, significant interest expense savings was realized from all deposit products due to pricing strategies implemented during the year. The ratio of average interest earning assets to average interest bearing liabilities decreased to 113.67% during the year ended December 31, 2010, from 114.11% for the year ended December 31, 2009.
Provision for Loan Losses. In accordance with FASB ASC Topic No. 450 Contingencies, we establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, external factors such as competition and regulatory, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans.
Generally, loans are placed on non-accrual status when payment of principal or interest is 90 days or more delinquent unless the loan is considered well secured and in the process of collection. Loans are also placed on non-accrual status when they are less than 90 days delinquent, if collection of principal or interest in full is in doubt. This determination is normally the result of the review of the borrower’s financial statements or other information that is obtained by the Bank.
All loans that are on non-accrual status are reviewed by management monthly to determine if a specific reserve or charge-off is appropriate. At this point in the delinquency collection efforts, the primary consideration is collateral value. When the Bank has a current appraisal, generally less than six months old, and management agrees that the property has not deteriorated in value since the appraisal, then management will analyze the loan in accordance with FASB ASC Topic No. 310 Receivables. When a current appraisal is not available, the Bank will request one. Upon receipt of the appraisal, we will review the loan in accordance with FASB ASC Topic No. 310 Receivables. Prior to receipt of an appraisal, management will consider, based on its knowledge of the market and other available information pertinent to the particular loan being reviewed, allocating a specific reserve for that loan. Loans are charged-off partially or in full based on upon the results of a completed FASB ASC Topic No. 310 Receivables analysis. We also perform a FASB ASC Topic No. 310 Receivables analysis on loans that are not collateralized by real estate.
The amount of the allowance is based on management’s judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a quarterly basis.
We recorded a provision for loan losses of $7.5 million for the year ended December 31, 2010 compared to $13.2 million for the year ended December 31, 2009 resulting from lower charge-offs in 2010 compared to 2009. The ratio of the allowance for loan losses to non-performing loans (coverage ratio) decreased to 28.84% at December 31, 2010, from 40.04% at December 31, 2009 primarily due to the classification of $11.8 million in troubled debt restructurings as non-performing loans. For the year ended December 31, 2010, charge-offs were $8.8 million compared to $11.7 million for the year ended December 31, 2009, resulting primarily from lower charge-offs on real estate-related loans. Included in the 2010 charge-offs of $8.8 million were partial charge-offs totaling $4.5 million. The amount of non-performing loans for which the full loss has been charged-off to total loans is 0.51%. The amount of non-performing loans for which the full loss has been charged-off to total non-performing loans is 9.9%. The coverage ratio is already net of loan charge-offs. Loan loss recoveries were $568,000 for both the year ended December 31, 2010 and the year ended December 31, 2009.
Our allowance for loans losses decreased by $773,000 or 5.8%, to $12.5 million at December 31, 2010, from $13.3 million at December 31, 2009. The ratio of our allowance for loan loss to total loans decreased to 1.60% at December 31, 2010, from 1.66% at December 31, 2009.
Non-Interest Income. Non-interest income increased $1.9 million to $2.8 million for the year ended December 31, 2010, from $932,000 for the year ended December 31, 2009. The increase resulted from the Bank recognizing a reduced other-than-temporary impairment charge on investment securities which totaled $3.4 million for the year ended December 31, 2010 compared to an impairment charge of $5.1 million for the year ended December 31, 2009. Net gains on sales of investment securities totaled $832,000 for the year ended December 31, 2010 compared to $1.2 million for the year ended December 31, 2009 and net gains on sales of loans totaled $168,000 for the 2010 period compared to $130,000 for the 2009 period. Net gains on the sale of other real estate owned totaled $271,000 for the year ended December 31, 2010 compared to net losses of $323,000 for the year ended December 31, 2009. Additionally, the year ended December 31, 2009 included $464,000 of BOLI insurance proceeds.
Non-Interest Expense. Non-interest expense decreased $634,000 to $28.5 million for the year ended December 31, 2010 from $29.2 million for the year ended December 31, 2009. For the year ended December 31, 2010, salaries and employee benefits decreased $973,000, or 6.5%. This resulted primarily from a $1.3 million charge for the year ended December 31, 2009 related to payments made under the employment agreement of the Company’s former President and Chief Executive Officer. For the year ended December 31, 2010, FDIC insurance premiums were $1.3 million compared to $1.7 for the year ended December 31, 2009, a decrease of $462,000, or 26.7%. Loan related expenses increased $193,000 for the year ended December 31, 2010 resulting from increased expenses related to non-performing loans. In addition, year-to-year, occupancy and equipment expenses increased $179,000, data processing expenses increased $182,000, telecommunication expenses increased $133,000 and expenses related to other real estate owned increased $328,000. Costs related to professional services (audit and legal) declined $192,000.
Income Tax Expense. For the year ended December 31, 2010 income tax expense was a benefit of $1.5 million, compared to tax expense of $12.0 million for the year ended December 31, 2009. The 2010 tax benefit is primarily due to the release of a $2.0 million valuation allowance. The release of the valuation allowance was due to estimated taxable income through December 31, 2010 and the anticipated implementation of a business planning strategy which would result in the recognition of a capital gain. Tax expense for 2009 is primarily a result of recording a deferred tax asset valuation allowance of $16.0 million after it was determined that it was “more likely than not” that a portion of the deferred tax assets of the Company would not be realized.
Comparison of Operating Results for the Years Ended December 31, 2009 and 2008
General. The Company recorded a net loss of $17.9 million for the year ended December 31, 2009 compared to a net loss of $42.5 million for the year ended December 31, 2008. The 2009 loss primarily resulted from a $12.0 million tax expense related to the establishment of a deferred tax asset valuation allowance, a $13.2 million provision for loan losses, and an other-than-temporary impairment charge of $5.1 million on our investment securities. The loss for 2008 was primarily the result of a non-cash goodwill impairment charge of $31.8 million, an other-than-temporary impairment charge of $15.6 million on our investment securities, a $9.0 provision for loan losses, our contribution of $3.8 million to The CapeBank Charitable Foundation, net of taxes, and approximately $785,000 of expenses, net of taxes, that resulted from the acquisition of Boardwalk Bancorp and name changes. These expenses were partially offset by a tax benefit of $8.2 million and increased net interest income resulting from the acquisition of Boardwalk Bancorp.
Interest Income. Interest income decreased $3.6 million, or 6.2%, to $54.5 million for the year ended December 31, 2009, from $58.1 million for the year ended December 31, 2008. The decrease for the year resulted primarily from a $1.9 million, or 38.5%, decrease in interest income on taxable investments and a $1.4 million, or 3.0%, decrease on interest income on loans. Average loans for the year ended December 31, 2009, increased $38.1 million, or 5.0% to $806.6 million from $768.5 million for the year ended December 31, 2008. The average yield on the loan portfolio decreased 48 basis points to 5.77% for the year ended December 31, 2009 from 6.25% for the year ended December 31, 2008, resulting from a decline in short term interest rates, higher levels of non-performing loans, indexed loans repricing at lower rates, and competition for new loan originations in a lower interest rate environment.
The average balance of the investment portfolio decreased $9.3 million, or 4.8%, to $184.6 million for the year ended December 31, 2009 from $193.9 million for the year ended December 31, 2008. The average yield on investments decreased 89 basis points to 4.19% for the year ended December 31, 2009 from 5.08% for the year ended December 31, 2008. The decrease in average balance is primarily a result of the sale of adjustable rate agency MBS securities, which had a carrying value of $31.7 million, during the second and third quarters of 2009. The decline in the average yield reflects a lower interest rate environment which negatively affected both the repricing of our adjustable rate MBS portfolio and U.S. Government and agency obligations where called securities were replaced at substantially lower coupon rates. Additionally, interest income includes $333,000 in charged off interest receivables related to 6 CDO securities which were fully written off.
Interest Expense. Interest expense decreased $5.2 million, or 21.5%, to $19.0 million for the year ended December 31, 2009, from $24.2 million for the year ended December 31, 2008. The decrease in interest expense resulted from the bank lowering interest rates on all interest-bearing deposit products in response to the decline in short term interest rates that occurred at the end of 2008.
Interest expense on NOW (interest-bearing demand accounts) and money market accounts decreased $2.0 million, or 47.8%, to $2.1 million for the year ended December 31, 2009, from $4.1 million for the year ended December 31, 2008, and interest expense on certificates of deposit decreased $2.7 million, or 21.3%, to $9.9 million for the year ended December 31, 2009, from $12.6 million for the year ended December 31, 2008. The average rate paid on NOW and money market accounts decreased 92 basis points to 0.89% for the year ended December 31, 2009, from 1.81% for the year ended December 31, 2008. The average balance of NOW and money market accounts increased $12.4 million, or 5.5%, to $237.0 million for the year ended December 31, 2009, from $224.6 million for the year ended December 31, 2008. The average rate paid on certificates of deposit decreased 89 basis points to 2.66% for the year ended December 31, 2009, from 3.55% for the year ended December 31, 2008, while the average balance of certificates of deposit increased $18.2 million, or 5.1% to $371.7 million for the year ended December 31, 2009, from $353.5 million for the year ended December 31, 2008. Interest expense on savings accounts decreased $677,000 to $385,000 for the year ended December 31, 2009, from $1.1 million for the year ended December 31, 2008. The average rate paid on savings deposits decreased 81 basis points to 0.48% for the year ended December 31, 2009, from 1.29% for the year ended December 31, 2008, while the average balance of savings accounts decreased $2.1 million, or 2.5% to $80.2 million for the year ended December 31, 2009, from $82.3 million for the year ended December 31, 2008. The average balance of NOW and money market accounts includes indexed priced municipal accounts for the year ended December 31, 2009, with an average balance of $24.4 million and an average rate of 0.43%, compared to an average balance of $20.3 million and an average rate of 1.94% for the year ended December 31, 2008.
Interest expense on borrowings (primarily Federal Home Loan Bank of New York advances) increased $68,000, or 1.0%, to $6.638 million for the year ended December 31, 2009 from $6.657 million for the year ended December 31, 2008. The average balance of borrowings declined $1.9 million, or 1.0%, to $191.3 million for the year ended December 31, 2009, from $193.2 million for the year ended December 31, 2008. The average rate paid on borrowings increased 7 basis points to 3.47% for the year ended December 31, 2009, from 3.40% for the year ended December 31, 2008.
Net Interest Income. Net interest income increased $1.6 million, or 4.8%, to $35.5 million for the year ended December 31, 2009, from $33.9 million for the year ended December 31, 2008. Our net interest margin increased by 6 basis points to 3.54% for the year ended December 31, 2009, from 3.48% for the year ended December 31, 2008. The increase in net interest income resulted from having more rate sensitive liabilities tied to short term interest rates reprice to lower rates than rate sensitive assets. In particular, significant interest expense savings was realized from all deposit products due to pricing strategies implemented during the year. The ratio of average interest earning assets to average interest bearing liabilities increased to 114.1% during the year ended December 31, 2009, from 113.9% for the year ended December 31, 2008.
Provision for Loan Losses. In accordance with FASB ASC Topic No. 450 Contingencies, we establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, external factors such as competition and regulatory, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans.
Generally, loans are placed on non-accrual status when payment of principal or interest is 90 days or more delinquent unless the loan is considered well secured and in the process of collection. Loans are also placed on non-accrual status when they are less than 90 days delinquent, if collection of principal or interest in full is in doubt. This determination is normally the result of the review of the borrower’s financial statements or other information that is obtained by the Bank.
All loans that are on non-accrual status are reviewed by management monthly to determine if a specific reserve or charge-off is appropriate. At this point in the delinquency collection efforts, the primary consideration is collateral value. When the Bank has a current appraisal, generally less than six months old, and management agrees that the property has not deteriorated in value since the appraisal, then management will analyze the loan in accordance with FASB ASC Topic No. 310 Receivables. When a current appraisal is not available, the Bank will request one. Upon receipt of the appraisal, we will review the loan in accordance with FASB ASC Topic No. 310 Receivables. Prior to receipt of an appraisal, management will consider, based on its knowledge of the market and other available information pertinent to the particular loan being reviewed, allocating a specific reserve for that loan. Loans are charged off partially or in full based on upon the results of a completed FASB ASC Topic No. 310 Receivables analysis. We also perform a FASB ASC Topic No. 310 Receivables analysis on loans that are not collateralized by real estate.
The amount of the allowance is based on management’s judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a quarterly basis.
We recorded a provision for loan losses of $13.2 million for the year ended December 31, 2009 compared to $9.0 million for the year ended December 31, 2008. The increase in the provision for losses over the prior year reflected the continued credit deterioration in our market area. The ratio of the allowance for loan losses to non-performing loans decreased to 40.0% at December 31, 2009, from 53.4% at December 31, 2008. This ratio is negatively affected when a loan is charged-off. For the year ended December 31, 2009, charge-offs were $11.7 million compared to $5.7 million for the year ended December 31, 2008, resulting primarily from increased charge-offs on real estate-related loans. Included in the 2009 charge-offs of $11.7 million were partial charge-offs totaling $6.5 million. The amount of non-performing loans for which the full loss has been charged-off to total loans was 0.0063%. The amount of non-performing loans for which the full loss has been charged-off to total non-performing loans was 13.2%. This 13.2% represents the charge-off rate for non-performing loans for which the full loss has been charged-off. The coverage ratio is already net of loan charge-offs. Loan loss recoveries for the year ended December 31, 2009 were $568,000 compared to $27,000 for the year ended December 31, 2008.
Our allowance for loans losses increased by $2.1 million, or 18.8%, to $13.3 million at December 31, 2009, from $11.2 million at December 31, 2008. The ratio of our allowance for loan loss to total loans increased to 1.66% at December 31, 2008, from 1.41% at December 31, 2008.
Non-Interest Income. Non-interest income increased $11.7 million to $932,000 for the year ended December 31, 2009, from $(10.8) million for the year ended December 31, 2008. The increase resulted from the Bank recognizing an other-than-temporary impairment charge on investment securities totaling $5.1 million for the year ended December 31, 2009 compared to an impairment charge of $15.6 million for the year ended December 31, 2008 of which $14.5 million related to collateralized debt obligations and $1.1 million related to Fannie Mae and Freddie Mac preferred stock. Gains on sales of investment securities totaled $1.2 million for the year ended December 31, 2009 compared to $40,000 for the year ended December 31, 2008 and net gains on sales of loans totaled $130,000 for the 2009 period compared to $36,000 for the 2008 period. Net losses on the sale of other real estate owned totaled $323,000 for the year ended December 31, 2009. In addition, for the year ended December 31, 2008, a $149,000 charge to non-interest income was recognized resulting from the retirement of old equipment and replacement of signage associated with the acquisition of Boardwalk Bank.
Non-Interest Expense. Non-interest expense decreased $35.5 million to $29.2 million for the year ended December 31, 2009 from $64.7 million for the year ended December 31, 2008. The year-to-year decrease resulted primarily from a non-cash goodwill impairment charge totaling $31.8 million for the year ended December 31, 2008 and a $6.3 million expense related to the formation of The CapeBank Charitable Foundation in 2008. For the year ended December 31, 2009, salaries and employee benefits increased $599,000, or 4.2%. This resulted primarily from a $1.3 million charge related to payments made under the employment agreement of the Company’s former President and CEO, partially offset by reduced pension plan costs of $605,000. For the year ended December 31, 2009, FDIC insurance premiums were $1.7 million compared to $525,000 for the year ended December 31, 2008, an increase of $1.2 million, or 229.3%. Loan related expenses increased $1.5 million for the year ended December 31, 2009 resulting from increased expenses related to non-performing loans. In addition, year-to-year, advertising costs declined $219,000, professional services (audit and legal) declined $172,000 and consulting fees declined $242,000.
Income Tax Expense. For the year ended December 31, 2009 income tax expense was $12.0 million, compared to a tax benefit of $8.2 million for the year ended December 31, 2008. Tax expense for 2009 is primarily a result of recording a deferred tax asset valuation allowance of $16.0 million after it was determined that it was “more likely than not” that a portion of the deferred tax assets of the Company will not be realized. The 2008 tax benefit resulted from a pre-tax loss that was partially offset by the disallowance of the $31.8 million goodwill impairment charge.
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.
Management of Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, interest rate risk is a significant risk to our net interest income and earnings. Our assets, consisting primarily of mortgage-related assets, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Accordingly, we have an Interest Rate Risk Committee of the Board, which meets quarterly, as well as an Asset/Liability Committee. The Asset/Liability Committee meets monthly and is comprised of our Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Lending Officer, Senior Vice President of Residential Lending, Senior Vice President of Retail Banking and our Controller. The Interest Rate Risk Committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for recommending to our Board of Directors the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we currently use the following strategies to manage our interest rate risk:
•
originating commercial loans that generally tend to have shorter repricing or reset periods and higher interest rates than residential mortgage loans;
•
investing in shorter duration investment grade corporate securities, U.S. Government agency obligations and mortgage-backed securities;
•
obtaining general financing through lower cost deposits, brokered deposits and advances from the Federal Home Loan Bank;
•
originating adjustable rate and short-term consumer loans;
•
selling a portion of our long-term residential mortgage loans; and
•
lengthening the terms of borrowings and deposits.
By shortening the average maturity of our interest-earning assets by increasing our investments in shorter term loans, as well as loans with variable interest rates, it helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates.
Net Portfolio Value Analysis. We compute amounts by which the net present value of our interest-earning assets and interest-bearing liabilities (net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. Our simulation model uses a discounted cash flow analysis to measure the interest rate sensitivity of net portfolio value. We estimate the economic value of these assets and liabilities under the assumption that interest rates experience an instantaneous and sustained increase of 100 or 200 basis points or decrease of 100 or 200 basis points.
Net Interest Income Analysis. In addition to NPV calculations, we analyze our sensitivity to changes in interest rates through our net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a twelve-month period. We then calculate what the net interest income would be for the same period under the assumption that interest rates experience an instantaneous and sustained increase of 100 or 200 basis points or decrease of 100 or 200 basis points.
The table below sets forth, as of December 31, 2010, our calculation of the estimated changes in our net portfolio value and net interest income that would result from the designated instantaneous and sustained changes in interest rates. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
(1)
Assumes an instantaneous and sustained uniform change in interest rates at all maturities.
(2)
NPV is the discounted present value of expected cash flows from interest-earning assets and interest-bearing liabilities.
The table above indicates that at December 31, 2010, in the event of a 100 basis point increase in interest rates, we would experience a 1.5% decrease in net portfolio value and a $1.0 million decrease in net interest income. In the event of a 100 basis point decrease in interest rates, we would experience an 8.6% decrease in net portfolio value and a $1.4 million increase in net interest income.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value and net interest income. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value and net interest income information presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured, and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although interest rate risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Liquidity and Capital Resources
Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. We generate funds to meet these needs primarily through our core deposit base and the maturity or repayment of loans and other interest-earning assets, including investments. Proceeds from the maturity, redemption, and return of principal of investment securities totaled $112.0 million during 2010 and were used either for liquidity or to invest in securities of similar quality as our current investment portfolio. We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the FHLB of New York, borrowings through the discount window at the Federal Reserve Bank of Philadelphia and access to certificates of deposit through brokers. We can also raise cash through the sale of earning assets, such as loans and marketable securities. As of December 31, 2010, the Company’s entire investment portfolio, with a fair market value of $157.4 million, was classified as available-for-sale. Effective December 31, 2009, the Company reclassified its held-to-maturity securities, which had a fair market value of $44.5 million and an amortized cost of $43.0 million, as available-for-sale.
Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has established a Liquidity Management Policy and Contingency Funding Plan that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements based on limits approved by our Board of Directors. This policy designates our Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO, which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by our Chief Financial Officer and the Treasury Department. Liquidity stress testing is performed annually, useless circumstance dictate more frequently, and all testing results are reported to the Board of Directors.
Cape Bank’s long-term liquidity source is a large core deposit base and a strong capital position. Core deposits are the most stable source of liquidity a bank can have due to the long-term relationship with a deposit customer. The level of deposits during any period is sometimes influenced by factors outside of management’s control, such as the level of short-term and long-term market interest rates and yields offered on competing investments, such as money market mutual funds. Deposits increased $16.5 million, or 2.2%, during 2010, and comprised 81.1% of total liabilities at December 31, 2010, as compared to 77.8% at December 31, 2009.
Cape Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2010, Cape Bank exceeded all regulatory capital requirements. Cape Bank is considered “well capitalized” under regulatory guidelines. Capital stress testing is performed annually, useless circumstance dictate more frequently, and all testing results are reported to the Board of Directors. See “Supervision and Regulation-Federal Banking Regulation-Capital Requirements” and Note 15, “Regulatory Matters” of the Notes to Consolidated Financial Statements.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we originate. In addition, we routinely enter into commitments to sell mortgage loans; such amounts are not significant to our operations. For additional information, see Note 12, “Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk” of the Notes to Consolidated Financial Statements.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities and agreements with respect to investments.
The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at December 31, 2010. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.
Impact of Inflation and Changing Prices
Our consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles. Generally accepted accounting principles generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on our performance than the effects of inflation.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
For information regarding market risk see Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operation”.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are included in Part III, Item 15 of this Form 10-K.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal year (the “Evaluation Date”). Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal controls
There were no significant changes made in our internal control over financial reporting during the Company’s fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
(c) Management report on internal control over financial reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system is a process designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the Directors of Cape Bancorp, Inc.; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Cape Bancorp, Inc.’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment we believe that, as of December 31, 2010, the Company’s internal control over financial reporting is effective based on those criteria.
Cape Bancorp’s independent registered public accounting firm that audited the consolidated financial statements has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. This report appears on page.
The Sarbanes-Oxley Act Section 302 Certifications have been filed with the SEC as exhibit 31.1 and exhibit 31.2 to this Annual Report on Form 10-K.
Not Applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors and executive officers of Cape Bancorp is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Proposal I-Election of Directors”.
Information concerning executive compensation is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Executive Compensation”.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain owners and management is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Voting Securities and Principal Holder Thereof”.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning relationships and transactions is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons”.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Proposal II-Ratification of Appointment of Auditors”.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following documents are filed as part of this Form 10-K.
(A)
Report of Independent Registered Public Accounting Firm
(F)
Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
3.1
Articles of Incorporation of Cape Bancorp, Inc. (1)
3.2
Amended and Restated Bylaws of Cape Bancorp, Inc. (2)
Form of Common Stock Certificate of Cape Bancorp, Inc. (1)
10.1
Form of Employee Stock Ownership Plan (1)
10.2
Employment Agreement for Robert J. Boyer (3)
10.3
Employment Agreement for Michael D. Devlin (4)
10.4
Change in Control Agreement for Guy Hackney (4)
10.5
Change in Control Agreement for James McGowan, Jr. (4)
10.6
Change in Control Agreement for Michele Pollack (4)
10.7
Change in Control Agreement for Donald Dodson (4)
10.8
Form of Director Retirement Plan (1)
10.9
2008 Equity Incentive Plan (5)
Code of Ethics (6)
Subsidiaries of Registrant
23.1
Consent of KPMG LLP
23.2
Consent of Crowe Horwath LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CAPE BANCORP, INC.
Date: March 11, 2011 By: /s/ Michael D. Devlin
Michael D. Devlin
Chief Executive Officer and President
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF
CAPE BANCORP AND SUBSIDIARIES
* * *
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Cape Bancorp, Inc.:
We have audited Cape Bancorp, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2010, and our report dated March 11, 2011 expressed an unqualified opinion on those consolidated financial statements.
Philadelphia, Pennsylvania
March 11, 2011
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Cape Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Cape Bancorp, Inc. and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for other-than-temporary impairments of debt securities due to the adoption of FASB Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” (included in FASB ASC Topic 320, Investments - Debt and Equity Securities), as of April 1, 2009.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Philadelphia, Pennsylvania
March 11, 2011
Crowe Horwath LLP
Independent Member Crowe Horwath International
Report of Independent Registered Public Accounting Firm
Cape Bancorp, Inc.
Cape May Court House, New Jersey
We have audited the accompanying consolidated statement of income, changes in stockholders’ equity, and cash flows for the year ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of the Company’s operations and its cash flows for year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
Crowe Horwath LLP
Livingston, New Jersey
March 16, 2009
CAPE BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CAPE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
CAPE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years ended December 31, 2010, 2009 and 2008
See accompanying notes to consolidated financial statements.
CAPE BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
NOTES TO AUDITED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION
Cape Bancorp (“Company”) is a Maryland corporation that was incorporated on September 14, 2007 for the purpose of becoming the holding company of Cape Bank (formerly Cape Savings Bank) in connection with Cape Bank’s mutual-to-stock conversion, Cape Bancorp’s initial public offering and simultaneous acquisition of Boardwalk Bancorp, Inc. (“Boardwalk Bancorp”), Linwood, New Jersey and its wholly-owned New Jersey chartered bank subsidiary, Boardwalk Bank. As a result of these transactions, Boardwalk Bancorp was merged with, and into, Cape Bancorp and Boardwalk Bank was merged with, and into, Cape Bank. As of January 31, 2008, Cape Savings Bank changed its name to Cape Bank.
Cape Bank (“Bank”) is a New Jersey-chartered stock savings bank. The Bank provides a complete line of business and personal banking products through its sixteen full service branch offices located throughout Atlantic and Cape May counties in southern New Jersey and a loan production office in Burlington County (opened in February 2011). The Bank received regulatory approval for the closing of two branches in Cape May County. These closings were effective as of the close of business December 3, 2010 and the close of business February 4, 2011.
The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.
The Bank is subject to regulations of certain state and federal agencies, and accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation: The accounting and reporting policies of the Bank conform to accounting principles generally accepted in the United States of America (US GAAP).
We have prepared the consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).
The consolidated financial statements include the accounts of Cape Bancorp, Inc. and its subsidiaries, all of which are wholly-owned. Significant intercompany balances and transactions have been eliminated. In the opinion of management, all accounting entries and adjustments, including normal recurring accruals, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been made. Events occurring subsequent to the date of the balance sheet have been evaluated for potential recognition or disclosure in the consolidated financial statements through the date of the filing of the consolidated financial statements with the SEC.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America (or with U.S. generally accepted accounting principles), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, deferred taxes, evaluation of investment securities for other-than-temporary impairment and fair values of financial instruments are particularly subject to change.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, overnight deposits, federal funds sold and interest-bearing bank balances. The Federal Reserve Bank required reserves of $657,000 as of December 31, 2010 and $668,000 as of December 31, 2009 are included in these balances.
Interest-Bearing Time Deposits: Interest-bearing time deposits are held to maturity, are carried at cost and have original maturities greater than three months.
Investment Securities: Effective December 31, 2009, all held to maturity securities were reclassified as available for sale. Investment securities classified as available for sale are carried at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of equity, net of related income tax effects. Gains and losses on sales of investment securities are recognized upon realization utilizing the specific identification method.
When the fair value of a debt security has declined below the amortized cost at the measurement date, an entity that intends to sell a security or is more likely than not to sell the security before the recovery of the security’s cost basis, the entity must recognize the other-than-temporary impairment (OTTI) in earnings. For a debt security with a fair value below the amortized cost at the measurement date where it is more likely than not that an entity will not sell the security before the recovery of its cost basis, but an entity does not expect to recover the entire cost basis of the security, the security is considered other-than-temporarily impaired. The related other-than-temporary impairment loss on the debt security will be recognized in earnings to the extent of the credit losses with the remaining impairment loss recognized in accumulated other comprehensive income. In estimating other-than-temporary losses, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, cash flow, stress testing analysis on securities when applicable, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans and Allowance for Loan Losses: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by an allowance for loan losses. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. The allowance for loan losses is established through a provision for loan losses charged to operations. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.
Recognition of interest income is discontinued when, in the opinion of management, the collectability of such interest becomes doubtful. A commercial loan is classified as non-accrual when the loan is 90 days or more delinquent, or when in the opinion of management, the collectability of such loan is in doubt. Consumer and residential loans are classified as non-accrual when the loan is 90 days or more delinquent with a loan to value ratio greater than 70 percent. Loan origination fees and certain direct origination costs are deferred and amortized over the life of the related loans as an adjustment to the yield on loans receivable in a manner which approximates the interest method.
All interest accrued, but not received, for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash basis or cost-recovery method, until qualifying for return to accrual. Commercial loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Payments are generally applied to reduce the principal balance but, in certain situations, the application of payments may vary. Consumer and residential loans are returned to accrual status when their delinquency becomes less than 90 days and/or the loan to value ratio is less than 70%.
The allowance for loan losses is maintained at an amount management deems adequate to cover probable incurred losses. In determining the level to be maintained, management evaluates many factors including current economic trends, industry experience, historical loss experience, industry loan concentrations, the borrowers’ ability to repay and repayment performance, estimated collateral values, changes in loan policies and procedures, changes in loan volume, delinquency and troubled asset trends, loan management and personnel, internal and external loan review, total credit exposure of the individual or entity, and external factors including competition, legal, regulatory and seasonal factors. In the opinion of management, the allowance is adequate to absorb probable loan losses. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary based on changes in economic conditions or any of the other factors used in management’s determination. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgment about information available to them at the time of their examination. Charge-offs to the allowance are made when the loan is transferred to other real estate owned or a determination of loss is made.
A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Included in the allowance for loan losses at December 31, 2010 was an impairment reserve for troubled debt restructurings (TDRs) in the amount of $431,000.
Other Real Estate Owned: Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned and is initially recorded at the lower of cost or estimated fair market value, less the estimated cost to sell, at the date of foreclosure, thereby establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 10 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 7 years.
Federal Home Loan Bank of New York (FHLB) Stock: The Bank is a member of the FHLB of New York. Members are required to own a certain amount of stock based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Cash dividends are reported as income.
Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which range from 5 to 13 years. Other intangible assets are assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Bank Owned Life Insurance (BOLI): The Bank has an investment of bank owned life insurance (BOLI). BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees and directors. The Bank is the owner and beneficiary of the policies and in accordance with FASB Accounting Standards Codification (ASC) Topic 325 “Investments in Insurance Contracts”, the amount recorded is the cash surrender value, which is the amount realizable.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Defined Benefit Plan: The Bank participates in a multi-employer defined benefit plan. The plan was amended to freeze participation to new employees commencing January 1, 2008. Employees who became eligible to participate prior to January 1, 2008, will continue to accrue a benefit under the plan. The Bank accrues pension costs as incurred. The plan was further amended to freeze benefits as of December 31, 2008 for all employees eligible to participate prior to January 1, 2008.
401(k) Plan: The Bank maintains a tax-qualified defined contribution plan for all salaried employees of Cape Bank who have satisfied the 401(k) Plan’s eligibility requirements. The Bank’s matching contribution under the Plan is equal to 100% of the participant’s contribution on up to 3% of the participant’s salary contributed to the plan and 50% of contributions on the next 2% of salary contributed by the participant, with a maximum potential matching contribution of 4%.
Employee Stock Ownership Plan (ESOP): The cost of shares issued to the ESOP, but not yet earned is shown as a reduction of equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts and the shares become outstanding for earnings per share computations. As of December 31, 2010, 127,809 shares have been allocated to eligible participants in the Cape Bank Employee Stock Ownership Plan.
Stock Benefit Plan: The Company has an Equity Incentive Plan (the “Stock Benefit Plan”) under which incentive and non-qualified stock options, stock appreciation rights (SARs) and restricted stock awards (RSAs) may be granted periodically to certain employees and directors. Under the fair value method of accounting for stock options, the fair value is measured on the date of grant using the Black-Scholes option pricing model with market assumptions. This amount is amortized as salaries and employee benefits expense on a straight-line basis over the vesting period. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which, if changed, can significantly affect fair value estimates.
Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax purposes are the allowance for loan losses, deferred compensation, deferred loan fees, charitable contributions, depreciation and other-than-temporary impairment charges. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded against net deferred tax assets when management has concluded that it is not more likely than not that a portion or all will be realized.
Beginning with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, included in FASB ASC Subtopic 740-10 - Income Taxes - Overall, the Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of Interpretation 48, the Company recognized the effect of income tax positions only if such positions were probable of being sustained.
The Company records interest and penalties related to uncertain tax positions as non-interest expense.
Earnings Per Share: Basic earnings (loss) per common share is the net income (loss) divided by the weighted average number of common shares outstanding during the period. ESOP shares are not considered outstanding for this calculation unless earned. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock option and restricted stock awards, if any.
Comprehensive Income (Loss): Comprehensive income (loss) includes net income as well as certain other items which result in a change to equity during the period. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity as follows:
Operating Segments: While the chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Effect of Newly Issued Accounting Standards:
In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements (ASU 2010-06). ASU 2010-06 requires reporting entities to make new disclosures about recurring and nonrecurring fair value measurements, including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances and settlements, on a gross basis, in the reconciliation of Level 3 fair value measurements. ASU 2010-06 also requires disclosure of fair value measurements by “class” instead of by “major category” as well as any changes in valuation techniques used during the reporting period. For disclosures of Level 1 and Level 2 activity, fair value measurements by “class” and changes in valuation techniques, ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, with disclosures for previous comparative periods prior to adoption not required. The adoption of this portion of ASU 2010-06 on January 1, 2010 did not have a material impact on the Company’s financial condition or results of operations. For the reconciliation of Level 3 fair value measurements, ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2010. The adoption of this portion of ASU 2010-06 is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
In December 2010, the FASB issued ASU No. 2010-28, Intangibles (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (ASU 2010-28). ASU 2010-28 provides guidance on (i) the circumstances under which step 2 of the goodwill impairment test must be performed for reporting units with zero or negative carrying amounts, and (ii) the qualitative factors to be taken into account when performing step 2 in determining whether it is more likely than not that an impairment exists. ASU 2010-28 is effective for public entities with fiscal years beginning after December 15, 2010, with early adoption prohibited. Upon initial application, all entities having reporting units with zero or negative carrying amounts are required to assess whether it is more likely than not that impairment exists and any resulting goodwill impairment should be recognized as a cumulative-effect adjustment to opening retained earnings in the period of adoption. The adoption of ASU 2010-28 is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
In December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (ASU 2010-29). ASU 2010-29 clarifies that pro forma revenue and earnings for a business combination occurring in the current year should be presented as though the business combination occurred as of the beginning of the year or, if comparative financial statements are presented, as though the business combination took place as of the beginning of the comparative year. ASU 2010-29 also amends existing guidance to expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring adjustments directly attributable to the business combination included in the pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations consummated on or after the start of the first annual reporting period beginning after December 15, 2010, with early adoption permitted. The adoption of ASU 2010-29 is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
In January 2011, the FASB issued ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (ASU 2011-01). For public entities, ASU 2011-01 delays the effective date for certain disclosures about loans modified under troubled debt restructurings included in ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). The new effective date for the loans modified under troubled debt restructuring disclosures will be concurrent with the effective date of FASB’s proposed ASU, Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors. ASU 2011-01 does not change the effective date for other disclosures required by public entities in ASU 2010-20. The adoption of ASU 2011-01 once effective is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
In April 2009, FASB issued new authoritative accounting guidance under FASB ASC Topic 320, “Investments-Debt and Equity Securities” regarding the recognition and presentation of other-than-temporary impairments, which modified the requirement in existing accounting guidance to demonstrate the intent and ability to hold an investment security for a period of time sufficient to allow for any anticipated recovery in fair value. When the fair value of a debt security has declined below the amortized cost at the measurement date, an entity that intends to sell a security or is more-likely-than-not to sell the security before the recovery of the security’s cost basis, must recognize the other-than-temporary impairment in earnings. For a debt security with a fair value below the amortized cost at the measurement date where it is more-likely-than-not that an entity will not sell the security before the recovery of its cost basis, but an entity does not expect to recover the entire cost basis of the security, the security is considered other-than-temporarily impaired. The related other-than-temporary impairment loss on the debt security will be recognized in earnings to the extent of the credit losses with the remaining impairment loss recognized in accumulated other comprehensive income. This standard is effective for interim and annual periods ending after June 15, 2009. As a result of this standard the Company recorded a cumulative effect adjustment net of tax of $4.1 million to retained earnings for the non-credit portion of OTTI previously recognized as well as recognized a charge to earnings for credit losses incurred in the period of adoption.
NOTE 3 - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains or losses and the fair value of the Bank’s investment securities available for sale at December 31, 2010 and December 31, 2009 are as follows:
Effective December 31, 2009 the Company reclassified the Held-to-Maturity (HTM) portion of its investment portfolio, which had a market value of $44.5 million and an amortized cost of $43.0 million, to Available-for-Sale (AFS). This change in classification provides flexibility and enables the Company to respond more effectively to changes in market value of the investment portfolio as well as enhances its sources of liquidity.
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2010.
The table below indicates the length of time individual securities, both held to maturity and available for sale, have been in a continuous unrealized loss position at December 31, 2009.
Management evaluates investment securities to determine if they are other-than-temporarily impaired on at least a quarterly basis. The evaluation process applied to each security includes, but is not limited to, the following factors: whether the security is performing according to its contractual terms, determining if there has been an adverse change in the expected cash flows for investments within the scope of FASB Accounting Standards Codification (ASC) Topic 325, “Investments Other”, the length of time and the extent to which the fair value has been less than cost, whether the Company intends to sell, or would more likely than not be required to sell an impaired debt security before a recovery of its amortized cost basis, credit rating downgrades, the percentage of performing collateral that would need to default or defer to cause a break in yield and/or a temporary interest shortfall, and a review of the underlying issuers.
At December 31, 2010, the Company’s investment securities portfolio consisted of 332 securities, 31 of which were in an unrealized loss position. The gross unrealized losses in the Company’s investment securities portfolio related primarily to the collateralized debt obligation securities, which are discussed in detail below, and accounted for 82.3% of the gross unrealized losses at December 31, 2010. The remaining securities consist of investments that are backed by the U.S. Government or U.S. sponsored agencies which the government has affirmed its commitment to support, municipal obligations and corporate bonds which had unrealized losses that were caused by changing credit spreads in the market as a result of the current economic environment and an increase in mid to long-term interest rates in the latter part of 2010. Because the Company has no intention to sell these securities, nor is it more likely than not that we will be required to sell these securities, the Company does not consider those investments to be OTTI.
As of December 31, 2010, the book value of our pooled trust preferred collateralized debt obligations totaled $9.7 million with an estimated fair value of $1.1 million and is comprised of 24 securities. Of those, 16 have been principally issued by bank holding companies (PreTSL deals, MM Comm I, and Alesco VI), and 8 have been principally issued by insurance companies (I-PreTSL deals). All of our pooled securities are mezzanine tranches and possess credit ratings below investment grade. As of December 31, 2010, 16 of our securities had no excess subordination and 8 of our securities had excess subordination which ranged from 2.8% to 14.3% of the current performing collateral. Excess subordination is the amount by which the underlying performing collateral exceeds the outstanding bonds in the current class, plus all senior classes. It is a static measure of credit enhancement, but does not incorporate structural elements of the CDO. Management utilizes excess subordination as a measure to identify which tranches are at a greater risk for a future break in cash flows. However, a current subordination deficit or “zero excess subordination” does not indicate the tranche will not ultimately receive all principal and interest due. For example, this measure does not consider the potential for recovery of issuers that are currently deferring payments. Some issuers have elected to defer payments, which contractually they are permitted to do for a period of up to 5 years, even though going concern issues may not exist. This supports management’s position that a deferral is not necessarily indicative of a default or that a default is imminent. On average, deferring issuers within our CDO portfolio comprise approximately 60% of the total dollar value related to issuer defaults and deferrals. As such, our assumptions used in the calculation of discounted cash flows anticipate a 15% recovery rate on deferring issuers as compared to no recovery of issuers that have defaulted. The recovery rate assumption represents management’s best estimate based on current facts and circumstances. In addition, due to projected discounted cash flows that do not support the receipt of interest, the Company is not accruing interest on any of the bank issued CDO securities. Accordingly, these securities are considered non-performing assets.
The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of December 31, 2010:
Pooled Trust Preferred Collateralized Debt Obligations
(dollars in thousands)
Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment on these securities. The table above excludes 11 CDO securities which have been completely written-off and, therefore, have no book value. The realized loss associated with these securities is $14.5 million.
The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of December 31, 2009:
Pooled Trust Preferred Collateralized Debt Obligations
(dollars in thousands)
On a quarterly basis, we evaluate our investment securities for other-than-temporary impairment. As required by FASB ASC Topic No. 320, “Investments - Debt and Equity Securities”, if we do not intend to sell a debt security, and it is not more likely than not that we will be required to sell the security, an OTTI write-down is separated into a credit loss portion and a portion related to all other factors. The credit loss portion is recognized in earnings as net OTTI losses, and the portion related to all other factors is recognized in accumulated other comprehensive income, net of taxes. The credit loss portion is defined as the difference between the amortized cost of the security and the present value of the expected future cash flows for the security. The Company has evaluated these securities and determined that the decreases in estimated fair value are temporary with the exception of 16 bank issued pooled trust preferred CDO securities. The Company’s estimate of projected cash flows it expected to receive was less than the securities’ carrying value resulting in a net credit impairment charge to earnings for the year ending December 31, 2010 of $3.4 million. As a result of adopting certain provisions of FASB ASC Topic No. 320 (formerly FASB Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”) in 2009, we were required to record a cumulative effect adjustment to reclassify the portion of previously recorded other-than-temporary impairment charges that were not related to credit losses from retained earnings to accumulated other comprehensive income. Impairment charges related to these securities were recorded during 2008 and the first quarter of 2009 in the amount of $14.5 million and $1.5 million, respectively. We reclassified $6.1 million, $4.0 million net of tax, of these previously recorded OTTI charges from retained earnings to accumulated other comprehensive income as a cumulative effect adjustment.
Our CDOs are beneficial interests in securitized financial assets within the scope of FASB ASC Topic No. 325, “Investments - Other”, and are therefore evaluated for OTTI using management’s estimate of future cash flows. If these estimated cash flows determine that it is probable an adverse change in cash flows has occurred, then OTTI would be recognized in accordance with FASB ASC Topic No. 320. The Company uses a third party model (“model”) to assist in calculating the present value of current estimated cash flows to the previous estimate. The present value of the expected cash flows is calculated based on the contractual terms of the security, and is discounted at a rate equal to the effective interest rate implicit in the security at the date of acquisition.
The model also takes into account individual defaults and deferrals that have already occurred by any participating issuer within the pool of entities that make up the security’s underlying collateral. With regard to expected defaults and deferrals, the Company performs an ongoing analysis of these securities utilizing both readily available market data and analytical models obtained from the third party. On a quarterly basis we evaluate the underlying collateral of each pooled trust preferred security in our portfolio to determine the appropriate default/deferral assumptions to use in our calculation of discounted cash flows. This process entails obtaining each security’s issuer list which include the most recent financial and credit quality metrics. We then identify issuers that have metrics that are similar to those that have defaulted or are deferring payments. As part of our evaluation we consider such measures as liquidity, capital adequacy, profitability, and credit quality and analyze ratios such as ROAA, net interest margin, tier 1 risk based capital, tangible equity to tangible assets, Texas ratio, reserves to loans and non-performing loans to loans. Our evaluation also takes into consideration current economic indicators as well as recent default/deferral trends of underlying issuers. Management then develops a projected default/deferral rate for each security based on this analysis. This rate is then applied to the cash flow model developed by the third party to calculate the present value of discounted cash flows for each security. The model assumptions relative to expected recoveries of defaulted issuers and deferring issuers were discussed earlier in this Note. Furthermore, we perform back-testing by comparing actual default/deferral rates to previous projections. The results are used to refine future projections on a continuous basis. Lastly, we continually evaluate the securities for the potential of future impairment by reviewing the FDIC failed bank list and deferral announcements made by the underlying issuers of each CDO security in our portfolio.
In general, CDOs are callable within five to ten years of issuance with a quarterly call frequency. Due to current market conditions, the cost to refinance or issue capital at a lower rate than what is currently outstanding, and the limited history of CDOs, prepayments are difficult to predict. The model assumes that prepayments will be limited to those issuers that are acquired by large banks with low financing costs. A 1% annual prepayment assumption has been used in the model and is indicative of management’s belief that consolidation in the banking industry will occur over the next several years as market conditions begin to improve. Additionally, commencing with a date ten years from the issuance date, the Trustee can solicit bids in an auction format for the purchase of all the outstanding collateral securities. The highest bid will be accepted that is at least equal to the sum of the outstanding liabilities at par plus accrued and unpaid interest. However, given the uncertain future of the CDO market, credit quality issues with the underlying issuers, and a decline in market value, the model assumes that a successful call auction is highly unlikely. Therefore, the model expects that the securities will extend through their full 30-year maturity.
The amortized cost and fair value of debt securities and mortgage-backed securities available for sale at December 31, 2010, by contractual maturities, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The following table presents a summary of the cumulative credit related OTTI charges recognized as components of earnings for CDO securities still held by the Company at December 31, 2010 and 2009 (in thousands):
(1)
On April 1, 2009, we recognized a cumulative effect adjustment based upon FASB guidance regarding the recognition and presentation of other-than-temporary impairment and determined that $9.9 million of previously recorded OTTI write-downs represented credit losses.
Gross realized gains on sales of investment securities during 2010 were $962,000, compared to $1.2 million during 2009. The Company also realized gross losses of $130,000 during 2010 from the sale of a corporate bond security. There were no losses realized by the Company in 2009 related to security sales. Proceeds were $16.9 million in 2010 related to sales of municipal bonds, corporate bonds, agency MBS and CMO securities, and a private label CMO, and $31.7 million in 2009 related to sales of FHLMC and FNMA adjustable rate MBS securities.
As of December 31, 2010, the fair value of all securities available for sale that were pledged to secure public fund deposits, short-term borrowings, repurchase agreements, and for other purposes required by law, was $57.2 million. At December 31, 2009 the corresponding amount was $57.5 million.
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
Activity in the allowance for loan losses is as follows:
The following table summarizes activity related to the allowance for loan losses by category for the year ended December 31, 2010:
Impaired loans at December 31, 2010 and 2009 were as follows:
(1)
includes $11.8 million in non-accruing TDRs paying in accordance with restructured terms.
As of December 31, 2010 and 2009, non-performing loans had a principal balance of approximately $43.5 million and $33.2 million respectively. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to approximately $2.6 million and $1.3 million at December 31, 2010 and 2009, respectively. The amount of interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $1.9 million, $1.8 million, and $1.2 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The following table presents impaired loans at December 31, 2010.
The following table presents loans by past due status at December 31, 2010.
Our policies provide for the classification of loans based on an analysis of the credit conditions of the borrower and the value of the collateral when appropriate. There is no specific credit metrics used to determine the risk rating.
Risk Rating 1-5 - Acceptable credit quality ranging from High Pass (cash or near cash as collateral) to Management Attention/Pass (acceptable risk) with some deficiency in one or more of the following areas: management experience, debt service coverage levels, balance sheet leverage, earnings trends and the industry of the borrower.
Risk Rating 6 - Watch List reflects loans that management believes warrant special consideration and may be loans that are delinquent or current in their payments. These loans have potential weakness which increases their risk to the bank and have shown some signs of weakness but have fallen short of being a Substandard loan.
Management believes that the Substandard category is best considered in three discrete classes: RR 7.0 “performing substandard loans;” RR 7.5; and RR 7.9
Risk Rating 7.0 - The class is mostly populated by customers that have a history of repayment (less than 2 delinquencies in the past year) but exhibit some signs of weakness manifested in either cash flow or collateral. In some cases, while cash flow is below the policy levels, the customer is in a cash business and has never presented financial reports that reflect sufficient cash flow for a global cash flow coverage ratio of 1.20.
Risk Rating 7.5 - These are loans that share many of the characteristics of the RR 7.0 loans as they relate to cash flow and/or collateral, but have the further negative of historic delinquencies. These loans have not yet declined in quality to require a FASB ASC Topic No. 310 Receivables analysis, but nonetheless this class has a greater likelihood of migration to a more negative risk rating.
Risk Rating 7.9 - These loans have undergone a FASB ASC Topic No. 310 Receivables analysis or have a specific reserve. For those that have a FASB ASC Topic No. 310 Receivables analysis, no general reserve is allowed. More often than not, those loans in this class with specific reserves have had the reserve placed by Management pending information to complete a FASB ASC Topic No. 310 Receivables analysis. Upon completion of the FASB ASC Topic No. 310 Receivables analysis reserves are adjusted or charged off.
The following table presents commercial loans by credit quality indicator at December 31, 2010.
The following table presents consumer loans by credit quality indicator at December 31, 2010.
Mortgage loans serviced for others are not reported as assets. The principal balances of these loans at December 31, 2010 and 2009 are as follows:
Custodial escrow balances maintained in connection with serviced loans were $19,000 and $27,000 at December 31, 2010 and 2009, respectively.
Loans to principal officers, directors, and their affiliates were as follows:
NOTE 5 - FAIR VALUE
FASB ASC Topic No. 820, “Fair Value Measurements and Disclosures” establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
Collateralized debt obligation securities which are issued by financial institutions and insurance companies were historically priced using Level 2 inputs, the decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, these investments are now priced using Level 3 inputs.
The Company obtained the pricing for these securities from an independent third party who prepared the valuations using a market valuation approach. Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies, are utilized in determining individual security valuations. Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. When the fair value of the collateral is based on an observable market price or current appraised value, the Company records the impaired loans as a Level 2 valuation. When management determines the fair value of the collateral is further impaired below the appraised value, or there is no observable market price or appraised value, the Company records the loan as a Level 3 valuation. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2010 and 2009:
(1)
Increase is due to FASB guidance regarding the recognition and presentation of other-than-temporary impairments.
Assets and Liabilities Measured on a Non-Recurring Basis
Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
(1)
Includes loans delinquent 90 days, loans less than 90 days delinquent but not accruing and troubled debt restructured loans.
Other real estate owned properties are recorded at the lower of cost or estimated fair market value at the date of foreclosure, less the estimated cost to sell. Fair market value is estimated by using professional real estate appraisals.
The following disclosure of estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, and accrued interest receivable and payable.
Investment securities - The fair value is determined as previously described.
Loans held for sale - The fair value is equal to the carrying value since the time from when a loan is closed and settled is generally not more than two weeks.
Loans - The fair values of all loans are estimated by discounting the estimated future cash flows using the Company’s interest rates currently offered for loans with similar terms to borrowers of similar credit quality which is not an exit price under FASB ASC Topic No. 820, “Fair Value Measurements and Disclosures”. The carrying value and fair value of loans include the allowance for loan losses.
FHLB stock - Ownership in equity securities of FHLB of New York is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.
Deposits - The fair value of deposits with no stated maturity, such as money market deposit accounts, checking accounts and savings accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered by the Company for deposits of similar size, type and maturity.
Borrowings - The fair value of borrowings, which includes Federal Home Loan Bank of New York advances and securities sold under agreement to repurchase, is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered for borrowings of similar maturity and terms.
The Company’s unused loan commitments, standby letters of credit and undisbursed loans have no carrying amount and have been estimated to have no realizable fair value. Historically, a majority of the unused loan commitments have not been drawn upon. See Note 12, “Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk” of Notes to Consolidated Financial Statements, for additional information.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2010 and 2009. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date; and therefore, current estimates of fair value may differ significantly from the amounts presented herein.
NOTE 6 - OTHER REAL ESTATE OWNED
At December 31, 2010, other real estate owned totaled $3.3 million and consisted of three residential properties and eight commercial properties. At December 31, 2009, other real estate owned totaled $4.8 million and consisted of three residential properties and seven commercial properties. Other real estate owned is presented net of an allowance for losses, if any. At December 31, 2010 the allowance for losses on foreclosed real estate totaled $305,000. At December 31, 2009 there was no allowance for losses on foreclosed real estate.
For the twelve months ended December 31, 2010, the Company added $3.8 million of property to OREO and sold eight commercial OREO properties and four residential OREO properties with an aggregate carrying value totaling $4.8 million, including three commercial OREO properties and one residential OREO property with an aggregate carrying value of $862,000 sold in the fourth quarter of 2010. Net gains on the sale of OREO totaled $271,000 for the twelve months ended December 31, 2010, of which $16,000 was recorded in the fourth quarter, compared to net losses on OREO sales of $323,000 for the twelve months ended December 31, 2009.
Net expenses applicable to OREO for the twelve months ended December 31, 2010 and 2009 totaled $669,000 and $946,000, respectively, which included provisions for losses on the sale of OREO of $501,000 for the twelve months ended December 31, 2010, and $513,000 for the twelve months ended December 31, 2009.
As of the date of this filing, the Company has agreements of sale for two OREO properties with an aggregate carrying value totaling $454,000. In 2011, the Company has added two commercial OREO properties with a carrying value of $1.1 million. In addition, in 2011, three commercial OREO properties with an aggregate carrying value of $716,000 and one residential OREO property with an aggregate carrying value of $86,000 were sold. The Company recorded a net gain in the amount of $75,000 related to the sales in 2011.
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment, summarized by major classification, are as follows:
Depreciation expense for the years ended December 31, 2010, 2009, and 2008 was approximately $1.4 million, $1.5 million, and $1.6 million, respectively.
NOTE 8 - GOODWILL AND INTANGIBLE ASSETS
The change in the balance for goodwill during the year is as follows:
FASB ASC Topic No. 350-20, “Goodwill” requires a company to perform an impairment test on goodwill annually, or more frequently if events or changes in circumstance indicate that the asset might be impaired, by computing the fair value of such goodwill to its recorded or carrying amount. If the carrying amount of goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess.
The Company tested goodwill for impairment during the fourth quarter of 2010. The Company has one reporting unit, Community Banking, and as such evaluated goodwill at the Community Banking reporting unit level. This test involved estimating the fair value of the Company using financial data and market prices as of December 31, 2010 and utilizing the control premium approach. The results of this test indicated that goodwill was not impaired. The Company continues to evaluate goodwill on a quarterly basis.
Due to credit deterioration in the Company’s loan and securities portfolio, the Company determined that it was appropriate to test for goodwill impairment during the fourth quarter of 2008. The company used a three step valuation approach of the Company. These three measurements included the comparable transaction approach including applications of various metrics from bank sale transactions for institutions comparable to the Company; the control premium approach including application of a market-derived multiple of tangible book value; and the discounted cash flow approach, including estimations of the present value of future cash flows.
Once it is determined that the fair value is materially less than the carrying value, FASB ASC Topic No. 350-20 requires a company to calculate the implied fair value of goodwill and compare it to the carrying amount of goodwill. At December 31, 2008, the amount of excess of the carrying amount of goodwill over the implied amount of goodwill is the amount of the impairment loss, which was calculated at $31.8 million by management.
Acquired intangible assets at year end are as follows:
The aggregate amortization expense for the years ended December 31, 2010, 2009 and 2008 was $140,000, $201,000 and $264,000, respectively.
The estimated amortization expense for each of the next five years and thereafter is as follows:
NOTE 9 - DEPOSITS
Deposits are as follows:
Interest expense by deposit type was as follows:
Certificates of deposit were scheduled to mature contractually within the following periods:
Deposits held at the Bank by related parties, which include officers, directors, and companies in which directors of the Board have a significant ownership interest, approximated $7.0 million and $3.4 million at December 31, 2010 and 2009, respectively.
NOTE 10 - BORROWINGS
At December 31, 2010, the Bank had available borrowing capacity under a continuing borrowing agreement with the Federal Home Loan Bank of New York (FHLB) to borrow up to 100% of the book value of qualified 1 to 4 family loans secured by residential properties and various commercial loans secured by commercial real estate subject to FHLB approval. At December 31, 2010 and 2009, $11.5 million of these advances were callable on various dates. Interest rates ranged from 0.36% to 5.31% at December 31, 2010, and from 0.32% to 5.31% at December 31, 2009.
Outstanding borrowings mature as follows:
At December 31, 2010 and 2009, the Bank had qualified 1 to 4 family loans and commercial loans of approximately $199.2 million and $193.8 million, respectively, which served as collateral to cover outstanding advances on the Federal Home Loan Bank of New York borrowings.
Securities sold under agreement to repurchase totaled $37.5 million at December 31, 2010 are fixed rate, and are collateralized by securities with a carrying amount of $42.5 million. At December 31, 2009, securities sold under agreements to repurchase totaled $37.5 million, were fixed rate, and were collateralized by securities with a carrying amount of $43.0 million. At maturity, the securities underlying the agreement are returned to the Company. At December 31, 2010 and 2009, repurchase agreements totaling $37.5 million were callable on various dates, at par by the repurchase agreement counter-party.
The following table sets forth fixed and variable rate FHLB borrowings and the respective weighted average interest rate at December 31, 2010 and 2009.
Additional information regarding FHLB Borrowings and securities sold under agreements to repurchase is as follows:
NOTE 11 - INCOME TAXES
Income tax benefit for the year ended December 31, 2010 was primarily impacted by the release of a $2.0 million valuation allowance. The release of the valuation allowance was due to estimated taxable income through December 31, 2010 and the anticipated implementation of a business planning strategy which would result in the recognition of a capital gain. These items allowed for additional deferred tax assets to be realizable.
Income tax expense (benefit) was as follows:
Effective tax rate differs from the federal statutory rate of 34% applied to income before income taxes due to the following:
Year-end deferred tax assets and liabilities were due to the following:
As a result of adopting certain provisions of FASB ASC Topic No. 320 (formerly FASB Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”) in April 2009, we were required to record a cumulative effect adjustment to reclassify the portion of previously recorded other-than-temporary impairment charges that were not related to credit losses from retained earnings to accumulated other comprehensive income. The tax effect of this adjustment, a $2.1 million deferred tax asset related to previously recorded OTTI, was reclassified as a deferred tax asset on net unrealized losses on available for sale securities.
During the third quarter of 2009, the Company established a valuation allowance of approximately $16.0 million against a significant portion of its deferred tax assets after concluding that it was more likely than not that a portion of the deferred tax asset would not be realized. A valuation allowance was not necessary for the deferred tax asset related to the unrealized investment losses as the realization of this component of the deferred tax assets is not dependent on future taxable income. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment. In recording the valuation allowance in the third quarter of 2009, Management considered both the positive and negative evidence available related to these factors and the cumulative loss position for the most recent three years ended December 31, 2009. This cumulative loss was primarily caused by the significant loan loss provisions and OTTI charges made during recent periods.
At December 31, 2010, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowances.
The Company has approximately $7.4 million of state net operating losses that will expire between 2015 and 2029. Additionally, the Company has approximately $169,000 of AMT tax credits to offset the difference between regular tax and alternative minimum tax. The deferred tax assets related to these items are subject to a valuation allowance as noted above.
Pursuant to FASB ASC Topic No. 740, “Income Taxes” the Company is not required to provide deferred taxes on its tax loan loss reserve as of the base year. The amount of this reserve on which no deferred taxes have been provided is $7,878,000 for 2010 and 2009. This reserve could be recognized as taxable income and create a current and/or deferred tax liability using the income tax rates then in effect if any portion of this tax reserve is subsequently used for purposes other than to absorb loan losses. The related amount of deferred tax liability is approximately $3,146,000 for 2010 and 2009.
The following is a roll-forward of the Bank’s FASB ASC Topic No. 740 unrecognized tax benefits:
Of this total, $353,000 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The Bank does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
The total amount of interest and penalties recorded in the income statement for the year ended December 31, 2010 and 2009 was $56,000 and $52,000 and the amount accrued for interest and penalties at December 31, 2010 and 2009 was $108,000 and $52,000, respectively.
The Bank is subject to U.S. federal income tax as well as income tax of the state of New Jersey. The Bank is no longer subject to examination by the Internal Revenue Service for years before 2007 and by the state of New Jersey for years before 2006.
NOTE 12 -
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheets.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.
At December 31, 2010 and 2009, the Bank had outstanding commitments (substantially all of which expire within one year) to originate residential mortgage loans, construction loans, commercial real estate and consumer loans. These commitments were comprised of fixed and variable rate loans.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. At December 31, 2010 the Bank had $1.2 million of letters of credit outstanding to borrowers of non-performing loans. The Bank defines the fair value of these letters of credit as the fees paid by the customer or similar fees collected on similar instruments.
The Bank amortizes the fees collected over the life of the instrument. The Bank generally obtains collateral, such as real estate or liens on customer assets for these types of commitments. The Bank’s potential liability would be reduced by proceeds obtained in liquidation of the collateral held.
The Bank had the following off-balance sheet financial instruments whose contract amounts represent credit risk:
Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments have interest rates ranging from 3.75% to 6.25% and maturities ranging from one to thirty years.
The Bank provides loans primarily in Atlantic and Cape May counties, New Jersey, to borrowers that share similar attributes. In addition, in February 2011, the Bank opened a loan production office in Burlington County.
A substantial portion of the Bank’s debtors’ ability to honor their contracts is dependent upon the economic conditions of these regions of New Jersey.
NOTE 13 - BENEFIT PLANS
Defined Benefit Plan
The Bank participates in a multi-employer defined benefit plan. Contributions to this plan by the Bank during the years ended December 31, 2010, 2009 and 2008 were $195,000, $164,000, and $817,000, respectively. Total compensation expense recorded under this plan during the years ended December 31, 2010, 2009 and 2008, was approximately $219,000, $476,000, and $975,000, respectively. During 2007, the plan was amended to freeze participation to new employees effective January 1, 2008. The plan was further amended to freeze benefits as of December 31, 2008 for all employees eligible to participate prior to January 1, 2008.
401K Plan
The Bank maintains a 401(k) plan for employees, a tax-qualified defined contribution plan, for all employees of the Bank who have satisfied the 401(k) plan’s eligibility requirements. Prior to January 1, 2008, the Bank made matching contributions to the accounts of plan participants in an amount equal to 100% of the participants’ contributions, up to 6% of their salary. The Bank charged approximately $287,000, $304,000, and $324,000, to employer contributions for the 401(k) plan for the years ended December 31, 2010, 2009 and 2008, respectively. Effective January 1, 2008, the Bank amended the matching contribution formula so that matching contributions will be equal to 100% of the participants’ contributions on up to 3% of the participants’ salary contributed to the plan and 50% of the participants’ contributions on the next 2% of salary contributed by the participants, with a maximum potential matching contribution of 4%.
Employee Stock Ownership Plan
On January 1, 2008, the Bank adopted an Employee Stock Ownership Plan (“ESOP”). The ESOP borrowed $10.7 million from the Company and used the funds to purchase 1,065,082 shares of the Company. The loan has an interest rate that is determined January 1st of each year and is based on the prime rate as published in The Wall Street Journal on the first business day of the calendar year. The interest rate for 2010 and 2009 was 3.25% and has an amortization schedule of 25 years. The loan is secured by the shares. Shares purchased are held by the trustee in a loan suspense account and are released from the suspense account on a pro rata basis as the loan is repaid by the Bank over a period not to exceed 25 years. The trustee allocates shares to participants based on compensation as described in the Cape Bank Employee Stock Ownership Plan, in the year of allocation. Employees are eligible to participate in the ESOP after attainment of age 21 and completion of one year of service.
The Company has not declared a dividend and as a result, no dividend income was recorded for the years ended December 31, 2010 and 2009. The Company recorded ESOP compensation expense of $319,000 and $320,000 for the years ended December 31, 2010 and 2009, respectively.
Shares held by the ESOP were as follows:
Director Retirement Plan
The Bank maintains an amended and restated director retirement plan for its directors, represented by individual agreements with the directors. In accordance with each director’s retirement agreement, the director is entitled to a normal retirement benefit upon termination of service on or after the director’s normal retirement age, equal to 2.5% times the director’s years of service with Cape Bank (not to exceed a benefit equal to 50%) of the average of the greatest fees earned by a director during any five consecutive calendar years. This benefit is payable to the director in equal monthly installments for a period of 10 years or the director’s lifetime, whichever is greater. In December 2008, the individual agreements were amended to comply with the final regulations issued under Section 409A of the Internal Revenue Code and to freeze future benefit accruals as of October 31, 2008. In accordance with these amendments, the agreements were modified to require a specified dollar amount to be paid to the director in January 2009, in complete satisfaction of all rights under the director retirement plan. Accordingly, in January 2009, the directors received $8,604 from the plan. In addition, the individual agreements were also modified to specify the total benefit that would be paid to each director and to specify that the total benefit would be paid in 120 monthly installments upon the occurrence of retirement, death or a change in control. The director could elect a lump sum benefit in the event of death or a change in control if such election was made prior to December 31, 2008.
Expense for these plans related to both active and retired participants totaled $46,000, $52,000, and $216,000, for the years ended December 31, 2010, 2009 and 2008, respectively. The total compensation liability for these plans was $1,054,000 and $1,135,000 at December 31, 2010 and 2009, respectively. On January 4, 2008, $4,596,000 related to the phantom restricted stock and phantom stock option plans was disbursed. In addition, $127,000 in payments were made to retired directors.
Equity Incentive Plan
The Company has an Equity Incentive Plan under which incentive and non-qualified stock options, stock appreciation rights (SARs), and restricted stock awards (RSAs) may be granted periodically to certain employees and directors. Generally, stock options are granted with an exercise price equal to fair market value at the date of grant and expire in 10 years from the date of grant. Generally, stock options granted vest over a five-year period commencing on the first anniversary of the date of grant. Under the plan, 1,331,352 stock options are available to be issued.
Under the fair value method of accounting for stock options, the fair value for all stock options granted under the Equity Incentive Plan is measured on the date of grant using the Black-Scholes option pricing model with market assumptions. This amount is amortized as salaries and employee benefits on a straight-line basis over the vesting period. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which, if changed, can significantly affect fair value estimates.
During 2010, the Company issued 740,000 incentive stock options to certain employees at prices ranging from $7.27 per share to $8.50 per share. In addition, in 2010, 23,600 non-qualified stock options were issued to directors at a price of $7.68 per share. The following table presents the weighted average per share fair value of options granted and the assumptions used, based on the Black-Scholes option pricing methodology:
Stock option activity for the twelve months ended December 31, 2010 was as follows:
The expected average risk-free rate is based on the U.S. Treasury yield curve on the day of grant. The expected average life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and expected option exercise activity. Expected volatility is based on historical volatilities of the Company’s common stock as well as the historical volatility of the stocks of the Company’s peer banks. The expected dividend yield is based on the expected dividend yield over the life of the option and the Company’s historical information.
On July 1, 2010, the Company issued 11,000 restricted stock awards to directors at a price of $7.68 per share. The restricted stock awards will vest in five equal annual installments, with the first installment becoming exercisable on the first anniversary of the date of grant, or July 1, 2011.
Restricted stock activity for the twelve months ended December 31, 2010 was as follows:
At December 31, 2010, unrecognized compensation costs on unvested stock options and restricted stock awards was $2.3 million which will be amortized on a straight-line basis over the remaining vesting period.
Stock-based compensation expense and related tax effects recognized for the twelve months ended December 31, 2010 was as follows. There were no stock-based compensation expenses for the twelve month periods ended December 31, 2009 and 2008:
At December 31, 2010, 763,600 options were outstanding, leaving 567,752 options available to be issued. Based on the option agreements, there were no vested or exercisable options as of December 31, 2010.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
Leases: Lessor - the Bank leases portions of three of its buildings to various lessees under noncancelable operating leases with the following minimum future rentals due at December 31, 2010:
Lessees are also responsible for their proportionate share of common area maintenance expenses. These leases convert to a month-to-month tenancy agreement after completion of the original lease term.
Lessee - A subsidiary, Cape Delaware Investment Company, whose office is in the state of Delaware, leases its office space under a cancelable lease agreement. In addition, in 2008, the Bank leased office space in New Jersey for two loan production offices. Rent expense for the years ended December 31, 2010, 2009 and 2008, approximated $10,000, $14,000, and $58,000, respectively.
From time to time, the Bank may be a defendant in legal proceedings arising out of the normal course of business. In management’s opinion, the financial position and results of operations of the Bank would not be affected materially by the outcome of such legal proceedings.
NOTE 15 - REGULATORY MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of December 31, 2010, the Company and Bank meet all capital adequacy requirements to which it is subject.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly, additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).
As of December 31, 2010 and 2009, the Bank was categorized as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.
The actual capital amounts, ratios and minimum regulatory guidelines for Cape Bank are as follows:
Management believes that under the current and proposed regulations, the Company and the Bank will continue to meet its minimum capital requirements in the foreseeable future.
Regulatory capital levels reported above differ for both Cape Bancorp and Cape Bank from their total capital respectively, computed in accordance with accounting principles general accepted in the United States (GAAP), as follows:
NOTE 16 - EARNINGS PER SHARE
Earnings Per Common Share: Basic earnings per common share is the net income (loss) divided by the weighted average number of common shares outstanding during the period. ESOP shares are not considered outstanding for this calculation unless earned. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock option and restricted stock awards, if any. Earnings per share for the year ended December 31, 2008 is calculated on earnings since the date of conversion on January 31, 2008.
The following is the earnings per share calculation for the periods ended December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, options to purchase 763,600 shares were dilutive, and accordingly were included in determining diluted earnings per common share. Restricted stock was dilutive and is included in the earnings per share calculation. There were no potentially dilutive common shares at or for the periods ended December 31, 2009 and 2008.
NOTE 17 - ACQUISITION OF BOARDWALK BANCORP
On January 31, 2008, Cape Bancorp, Inc. acquired Boardwalk Bancorp, Inc, as previously discussed in Note 1 -Organization. Boardwalk Bancorp Inc.’s results of operations have been reflected in Cape Bancorp’s consolidated statements of income beginning as of the acquisition date, January 31, 2008. The pro forma condensed consolidated income statement for the year ended December 31, 2008 is shown as if the merger occurred as of January 1, 2008:
Non-interest expense for the year ended December 31, 2008 includes a $31.8 million non-cash goodwill impairment charge and a $6.3 million expense for a contribution to the charitable foundation established and funded in connection with the stock conversion. Non-interest income for the year ended December 31, 2008 includes a $15.6 million charge for other-than-temporary impairment on investment securities.
NOTE 18 - CAPE BANCORP (PARENT COMPANY)
The Parent Company’s condensed balance sheets at December 31, 2010 and 2009 and the related condensed statements of income and cash flows for the years ended December 31, 2010, 2009 and 2008 follow:
Condensed Balance Sheets
Condensed Statements of Income
Condensed Statements of Cash Flows
Under the New Jersey Banking Act, a stock savings bank may declare and pay a dividend on its capital stock only to the extent that the payment of the dividend would not impair the capital stock of the savings bank. In addition, a stock savings bank may not pay a dividend unless the savings bank would, after the payment of the dividend, have a surplus of not less than 50% of its capital stock, or the payment of the dividend would not reduce the surplus. Federal law may also limit the amount of dividends that may be paid by Cape Bank. See “-Federal Banking Regulation-Prompt Corrective Action”.
NOTE 19 - SELECTED QUARTERLY DATA (UNAUDITED)
EXHIBIT INDEX