SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-------------------
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
Or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number 0-29030
SUSSEX BANCORP.
(Exact name of registrant as specified in its charter)
New Jersey 22-3475473
------------------------------- ------------------
(State of other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
399 Route 23, Franklin, New Jersey 07416
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code) (973) 827-2914
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of August 5, 2005 there were 3,018,463 shares of common stock, no par value,
outstanding.
SUSSEX BANCORP
FORM 10-QSB
INDEX
Part I - Financial Information Page(s)
Item 1. Financial Statements (Unaudited) 3
Item 2. Management's Discussion and Analysis of 10
Results of Operations and Financial Condition
Item 3. Controls and Procedures 20
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 21
Item 3. Defaults upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits 22
Signatures 22
Exhibits 22
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
SUSSEX BANCORP
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
(Unaudited)
ASSETS June 30, 2005 December 31, 2004
------ ----------------- -----------------
Cash and due from banks $ 14,186 $ 10,434
Federal funds sold 2,195 18,860
----------------- -----------------
Cash and cash equivalents 16,381 29,294
Interest bearing time deposits with other banks 500 3,900
Securities available for sale 72,652 74,736
Federal Home Loan Bank Stock, at cost 700 690
Loans receivable, net of unearned income 186,278 156,916
Less: allowance for loan losses 2,158 2,274
----------------- -----------------
Net loans receivable 184,120 154,642
Premises and equipment, net 5,830 5,618
Accrued interest receivable 1,567 1,330
Goodwill 2,334 2,334
Other assets 6,362 5,731
----------------- -----------------
Total Assets $ 290,446 $ 278,275
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Deposits:
Non-interest bearing $ 36,719 $ 34,451
Interest bearing 199,613 195,376
----------------- -----------------
Total Deposits 236,332 229,827
Borrowings 14,000 10,000
Accrued interest payable and other liabilities 2,365 1,641
Junior subordinated debentures 5,155 5,155
----------------- -----------------
Total Liabilities 257,852 246,623
Stockholders' Equity:
Common stock, no par value, authorized 5,000,000 shares;
issued and outstanding 3,017,213 in 2005 and 2,994,874
in 2004 25,580 25,397
Retained earnings 6,881 6,116
Accumulated other comprehensive income 133 139
----------------- -----------------
Total Stockholders' Equity 32,594 31,652
----------------- -----------------
Total Liabilities and Stockholders' Equity $ 290,446 $ 278,275
================= =================
See Notes to Consolidated Financial Statements
-3-
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(Dollars In Thousands Except Per Share Data)
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
INTEREST INCOME
Loans receivable, including fees $ 2,869 $ 2,161 $ 5,489 $ 4,262
Securities:
Taxable 433 419 880 885
Tax-exempt 299 205 592 413
Federal funds sold 79 17 119 31
Interest bearing deposits 4 7 27 17
-------------- -------------- -------------- --------------
Total Interest Income 3,684 2,809 7,107 5,608
-------------- -------------- -------------- --------------
INTEREST EXPENSE
Deposits 695 493 1,273 967
Borrowings 161 132 292 265
Junior subordinated debentures 86 61 164 121
-------------- -------------- -------------- --------------
Total Interest Expense 942 686 1,729 1,353
-------------- -------------- -------------- --------------
Net Interest Income 2,742 2,123 5,378 4,255
PROVISION FOR LOAN LOSSES 206 105 341 253
-------------- -------------- -------------- --------------
Net Interest Income after Provision for Loan Losses 2,536 2,018 5,037 4,002
-------------- -------------- -------------- --------------
OTHER INCOME
Service fees on deposit accounts 315 191 551 382
ATM and debit card fees 86 78 169 150
Insurance commissions and fees 622 604 1,217 1,170
Mortgage banking fees 103 161 161 326
Investment brokerage fees 66 48 130 121
Other 132 85 197 168
-------------- -------------- -------------- --------------
Total Other Income 1,324 1,167 2,425 2,317
-------------- -------------- -------------- --------------
OTHER EXPENSES
Salaries and employee benefits 1,609 1,514 3,203 3,090
Occupancy, net 233 208 488 414
Furniture, equipment and data processing 271 210 522 412
Stationary and supplies 40 46 88 83
Professional fees 134 74 249 157
Advertising and promotion 150 96 266 183
Insurance 46 49 88 84
Postage and freight 45 48 90 91
Amortization of intangible assets 63 48 127 94
Other 331 349 704 662
-------------- -------------- -------------- --------------
Total Other Expenses 2,922 2,642 5,825 5,270
-------------- -------------- -------------- --------------
Income before Income Taxes 938 543 1,637 1,049
PROVISION FOR INCOME TAXES 272 152 451 287
-------------- -------------- -------------- --------------
Net Income $ 666 $ 391 $ 1,186 $ 762
============== ============== ============== ==============
EARNINGS PER SHARE
-------------- -------------- -------------- --------------
Basic $ 0.22 $ 0.21 $ 0.39 $ 0.42
============== ============== ============== ==============
-------------- -------------- -------------- --------------
Diluted $ 0.22 $ 0.20 $ 0.39 $ 0.40
============== ============== ============== ==============
See Notes to Consolidated Financial Statements
-4-
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Six Months Ended June 30, 2005 and 2004
(Dollars in thousands, except per share amounts)
(Unaudited)
Accumulated
Number of Other Total
Shares Common Retained Comprehensive Treasury Stockholders'
Outstanding Stock Earnings Income (Loss) Stock Equity
----------- ----- -------- ------------- ----- ------
Balance December 31, 2003 1,811,460 $ 9,616 $ 5,040 $ 248 $ -- $ 14,904
Comprehensive income:
Net income -- -- 762 -- -- 762
Change in unrealized gains (losses) on
securities available
for sale, net of tax -- -- -- (667) -- (667)
----------
Total Comprehensive Income
95
Treasury shares purchased (96) -- -- -- (2) (2)
Treasury shares retired -- (2) -- -- 2 --
Exercise of stock options 17,985 167 -- -- -- 167
Income tax benefit of stock options exercised -- 35 -- -- -- 35
Shares issued through dividend reinvestment plan 5,736 97 -- -- -- 97
Dividends on common stock ($.14 per share) -- -- (255) -- -- (255)
--------------------------------------------------------------------------------
Balance June 30, 2004 1,835,085 $ 9,913 $ 5,547 ($ 419) $ -- $ 15,041
================================================================================
Balance December 31, 2004 2,994,874 $ 25,397 $ 6,116 $ 139 $ -- $ 31,652
Comprehensive income:
Net income -- -- 1,186 -- -- 1,186
Change in unrealized gains (losses) on
securities available
for sale, net of tax -- -- -- (6) -- (6)
----------
Total Comprehensive Income
1,180
Treasury shares purchased (2,000) -- -- -- (27) (27)
Treasury shares retired -- (27) -- -- 27 --
Exercise of stock options 18,931 101 -- -- -- 101
Income tax benefit of stock options exercised -- 58 -- -- -- 58
Shares issued through dividend reinvestment plan 5,408 76 -- -- -- 76
Additional expenses for stock offering -- (25) -- -- -- (25)
Dividends on common stock ($.14 per share) -- -- (421) -- -- (421)
--------------------------------------------------------------------------------
Balance June 30, 2005 3,017,213 $ 25,580 $ 6,881 $ 133 $ -- $ 32,594
================================================================================
See Notes to Consolidated Financial Statements
-5-
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six Months Ended June 30,
----------------------------
2005 2004
------------ ------------
Cash Flows from Operating Activities
Net income $ 1,186 $ 762
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 341 253
Provision for depreciation and amortization 469 351
Net amortization of securities premiums and discounts 135 352
Earnings on investment in life insurance (44) (55)
(Increase) decrease in assets:
Accrued interest receivable (237) 32
Other assets (441) (948)
Increase in accrued interest payable and other liabilities 782 499
------------ ------------
Net Cash Provided by Operating Activities 2,191 1,246
------------ ------------
Cash Flows from Investing Activities
Securities available for sale:
Purchases (4,396) (13,775)
Maturities, calls and principal repayments 6,336 14,097
Net increase in loans (30,089) (9,930)
Purchases of premises and equipment (554) (1,076)
(Increase) decrease in FHLB stock (10) 70
Net decrease in interest bearing time deposits with other banks 3,400 3,000
Purchase of investment in life insurance -- (1,500)
------------ ------------
Net Cash Used in Investing Activities (25,313) (9,114)
------------ ------------
Cash Flows from Financing Activities
Net increase in deposits 6,505 9,742
Increase in borrowings 4,000 --
Proceeds from the exercise of stock options 101 167
Purchase of treasury stock (27) (2)
Expenses paid related to stock offering (25) --
Dividends paid, net of reinvestments (345) (158)
------------ ------------
Net Cash Provided by Financing Activities 10,209 9,749
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents (12,913) 1,881
Cash and Cash Equivalents - Beginning 29,294 15,496
------------ ------------
Cash and Cash Equivalents - Ending $ 16,381 $ 17,377
============ ============
Supplementary Cash Flows Information
Interest paid $ 1,684 $ 1,353
============ ============
Income taxes paid $ 55 $ 431
============ ============
Supplementary Schedule of Noncash Investing and Financing Activities
Foreclosed real estate acquired in settlement of loans $ 270 $ --
============ ============
See Notes to Consolidated Financial Statements
-6-
Notes to Consolidated Financial Statements (Unaudited)
------------------------------------------------------
1. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of Sussex
Bancorp (the "Company") and its wholly-owned subsidiary Sussex Bank (the
"Bank"). The Bank's wholly-owned subsidiaries are Sussex Bancorp Mortgage
Company, Inc., SCB Investment Company, Inc., and Tri-State Insurance Agency,
Inc., ("Tri-State") a full service insurance agency located in Sussex County,
New Jersey. All inter-company transactions and balances have been eliminated in
consolidation. Sussex Bank is also a 49% partner of Sussex Settlement Services,
L.P, a title insurance agency whose registered office is located in King of
Prussia, Pennsylvania. During the second quarter, the Bank also became the owner
of 49% of the equity of SussexMortgage.com, LLC, an Indiana limited liability
company and mortgage banking joint venture with National City Mortgage, Inc.
SussexMortgage.com is expected to commence operations in the third quarter of
2005. The Bank operates eight banking offices all located in Sussex County, New
Jersey. The Company is subject to the supervision and regulation of the Board of
Governors of the Federal Reserve System (the "FRB"). The Bank's deposits are
insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance
Corporation ("FDIC") up to applicable limits. The operations of the Company and
the Bank are subject to the supervision and regulation of the FRB, FDIC and the
New Jersey Department of Banking and Insurance (the "Department") and the
operations of Tri-State are subject to the supervision and regulation by the
Department.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for full year
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included and are of a normal,
recurring nature. Operating results for the six-month period ended June 30,
2005, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2005. These consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
thereto that are included in the Company's Annual Report on Form 10-KSB for the
fiscal period ended December 31, 2004.
2. Earnings per Share
------------------
Basic earnings per share is calculated by dividing net income by the
weighted average number of shares of common stock outstanding during the period.
Diluted earnings per share reflects additional common shares that would have
been outstanding if dilutive potential common shares had been issued, as well as
any adjustment to income that would result from the assumed issuance of
potential common shares that may be issued by the Company relating to
outstanding stock options and guaranteed and contingently issuable shares from
the acquisition of Tri-State. Potential common shares related to stock options
are determined using the treasury stock method.
The following table sets forth the computations of basic and diluted
earnings per share.
Three Months Ended June 30, 2005 Three Months Ended June 30, 2004
----------------------------------- -------------------------------------
Per Per
Income Shares Share Income Shares Share
(In thousands, except per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
--------------------------------------------------------------------------------- -------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $ 666 3,015 $ 0.22 $ 391 1,832 $ 0.21
========== ==========
Effect of dilutive securities:
Stock options - 31 - 73
Deferred common stock payments for
purchase of insurance agency - - 1 16
-------------------------------------------------------------------- ------------------------
Diluted earnings per share:
Net income applicable to common stock-
holders and assumed conversions $ 666 3,046 $0.22 $ 392 1,921 $ 0.20
================================================================================= =====================================
Six Months Ended June 30, 2005 Six Months Ended June 30, 2004
----------------------------------- -------------------------------------
Per Per
Income Shares Share Income Shares Share
(In thousands, except per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
--------------------------------------------------------------------------------- -------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $ 1,186 3,009 $ 0.39 $ 762 1,826 $ 0.42
========== ===========
Effect of dilutive securities:
Stock options - 39 - 81
Deferred common stock payments for
purchase of insurance agency - - 1 14
-------------------------------------------------------------------- ------------------------
Diluted earnings per share:
Net income applicable to common stock-
holders and assumed conversions $ 1,186 3,048 $ 0.39 $ 763 1,921 $ 0.40
================================================================================= ======================================
-7-
3. Comprehensive Income
--------------------
The components of other comprehensive income (loss) and related tax
effects are as follows:
Three Months Ended June 30, Six Months Ended June 30,
(Dollars in thousands) 2005 2004 2005 2004
--------------------------------------------------------- ---------- ---------- ---------- ----------
Unrealized holding gains (losses) on available for
sale securities $ 859 ($ 1,802) ($ 9) ($ 1,111)
Less: reclassification adjustments for gains included
in net income -- -- -- --
--------------------------------------------------------- ---------- ---------- ---------- ----------
Net unrealized gains (losses) 859 (1,802) (9) (1,111)
Tax effect (345) 720 3 444
--------------------------------------------------------- ---------- ---------- ---------- ----------
Other comprehensive income (loss), net of tax $ 514 ($ 1,082) ($ 6) ($ 667)
========================================================= ========== ========== ========== ==========
4. Segment Information
-------------------
The Company's insurance agency operations are managed separately from the
traditional banking and related financial services that the Company also offers.
The insurance agency operation provides commercial, individual, and group
benefit plans and personal coverage.
(Dollars in thousands) Three Months Ended June 30, 2005 Three Months Ended June 30, 2004
---------------------------------------------------------------------------- ------------------------------------
Banking and Banking and
Financial Insurance Financial Insurance
Services Services Total Services Services Total
---------------------------------------------------------------------------- ------------------------------------
Net interest income from external
sources $ 2,742 $ -- $ 2,742 $ 2,123 $ -- $ 2,123
Other income from external sources 702 622 1,324 563 604 1,167
Depreciation and amortization 199 42 241 152 27 179
Income before income taxes 896 42 938 471 72 543
Income tax expense 255 17 272 123 29 152
Total assets 287,128 3,318 290,446 247,552 3,563 251,115
---------------------------------------------------------------------------- ------------------------------------
(Dollars in thousands) Six Months Ended June 30, 2005 Six Months Ended June 30, 2004
---------------------------------------------------------------------------- ------------------------------------
Banking and Banking and
Financial Insurance Financial Insurance
Services Services Total Services Services Total
---------------------------------------------------------------------------- ------------------------------------
Net interest income from external
sources $ 5,378 $ -- $ 5,378 $ 4,255 $ -- $ 4,255
Other income from external sources 1,208 1,217 2,425 1,147 1,170 2,317
Depreciation and amortization 384 85 469 299 52 351
Income before income taxes 1,573 64 1,637 913 136 1,049
Income tax expense 425 26 451 233 54 287
Total assets 287,128 3,318 290,446 247,552 3,563 251,115
---------------------------------------------------------------------------- ------------------------------------
5. Stock Option Plans
------------------
The Company accounts for stock option plans under the recognition and
measurement principles of APB Opinion No. 25. "Accounting for Stock Issued to
Employees," and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the Company's
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation for the periods presented:
-8-
Three Months Ended June 30, Six Months Ended June 30,
(Dollars in thousands) 2005 2004 2005 2004
------------------------------------------------------------------- ---------- ---------- ----------
Net income, as reported $ 666 $ 391 $ 1,186 $ 762
Total stock-based compensation expense determined
under fair value based method for all awards, net
of related tax effects (53) (35) (205) (64)
------------------------------------------------------------------- ---------- ---------- ----------
Pro forma net income $ 613 $ 356 $ 981 $ 698
=================================================================== ========== ========== ==========
Basic earnings per share:
As reported $ 0.22 $ 0.21 $ 0.39 $ 0.42
Pro forma $ 0.20 $ 0.19 $ 0.33 $ 0.38
Diluted earnings per share:
As reported $ 0.22 $ 0.20 $ 0.39 $ 0.40
Pro forma $ 0.20 $ 0.19 $ 0.32 $ 0.36
------------------------------------------------------------------- ---------- ---------- ----------
6. Guarantees
----------
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Generally, all letters of
credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Company, generally,
holds collateral and/or personal guarantees supporting these commitments. The
Company had $850,000 of standby letters of credit as of June 30, 2005.
Management believes that the proceeds obtained through a liquidation of
collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payment required under the corresponding guarantees.
The current amount of the liability as of June 30, 2005 for guarantees under
standby letters of credit issued is not material.
7. New Accounting Standards
------------------------
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) replaces
Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123(R)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements over the period that an employee provides
service in exchange for the award. Public companies are required to adopt the
new standard using a modified prospective method and may elect to restate prior
periods using the modified retrospective method. Under the modified prospective
method, companies are required to record compensation cost for new and modified
awards over the related vesting period of such awards prospectively and record
compensation cost prospectively for the unvested portion, at the date of
adoption, of previously issued and outstanding awards over the remaining vesting
period of such awards. No change to prior periods presented is permitted under
the modified prospective method. Under the modified retrospective method,
companies record compensation costs for prior periods retroactively through
restatement of such period using the exact pro forma amounts disclosed in the
companies' footnotes. Also, in the period of adoption and after, companies
record compensation cost based on the modified prospective method. Statement No.
123(R) is effective for periods beginning after December 15, 2005 (i.e. first
quarter 2006 for the Company). Early application of Statement No. 123(R) is
encouraged, but not required.
The Company will adopt the modified prospective method. Using the modified
prospective method, the Company estimates that total stock-based compensation
expense, based on awards currently outstanding that will vest in 2006, net of
related tax effects, will be $94,000 for the year ending December 31, 2006.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No.
107"), "Share-Based Payment", providing guidance on option valuation methods,
the accounting for income tax effects of share-based payment arrangements upon
adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the
adoption. The Company will provide SAB No. 107 required disclosures upon
adoption of SFAS No. 123(R) on January 1, 2006.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an interpretation of SFAS No. 143,"
("FIN 47"). This Interpretation provides clarification with respect to the
timing of liability recognition for legal obligations associated with the
retirement of tangible long-lived assets when the timing and/or method of
settlement of the obligation are conditional on a future event. FIN 47 is
effective for all fiscal years
-9-
ending after December 15, 2005 (December 31, 2005, for calendar-year companies).
Retrospective application for interim financial information is permitted but is
not required. Early adoption of this Interpretation is encouraged. We do not
expect the adoption of FIN 47 to materially impact our condensed consolidated
financial statements.
In May 2005, FASB issued SFAS 154, "Accounting Changes and Error
Corrections". The Statement requires retroactive application of a voluntary
change in accounting principle to prior period financial statements unless it is
impracticable. SFAS 154 also requires that a change in method of depreciation,
amortization, or depletion for long-lived, non-financial assets be accounted for
as a change in accounting estimate that is affected by a change in accounting
principle. SFAS 154 replaces APB Opinion 20, "Accounting Changes", and SFAS 3,
"Reporting Accounting Changes in Interim Financial Statements". SFAS 154 will be
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Management currently believes that adoption
of the provisions of SFAS 154 will not have a material impact on the Company's
condensed consolidated financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
MANAGEMENT STRATEGY
-------------------
The Company's goal is to serve as a community-oriented financial
institution serving the Northwestern New Jersey, Northeastern Pennsylvania and
New York tri-state marketplace. Our market presence has been expanded by opening
loan production offices in early 2005 in Milford, Pennsylvania and Warwick, New
York with added availability of all of our financial services in those counties
contiguous to our existing New Jersey market. While offering traditional
community bank loan and deposit products and services such as residential
mortgages originated for the Company's portfolio, the Company obtains
significant non-interest income through its Tri-State Insurance Agency, Inc.
("Tri-State") insurance brokerage operations, the sale of non-deposit products
and the residential mortgage banking/brokerage division, which offers 30-year
fixed residential mortgages that are funded by third party investors. In the
second quarter, the Company acquired a 49% equity interest in SussexMortgage.com
LLC, a mortgage banking joint venture with National City Mortgage Inc.
SussexMortgage.com LLC is expected to commence operations in the third quarter
of 2005, and substantially replace the mortgage banking business now being
undertaken by the Bank's residential mortgage banking division. Loans originated
by SussexMortgage.com LLC will be funded by third parties that will generate fee
income net of origination costs.
CRITICAL ACCOUNTING POLICIES
----------------------------
Disclosure of the Company's significant accounting policies is included in
Note 1 to the consolidated financial statements of the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2004. Some of these policies are
particularly sensitive, requiring significant judgments, estimates and
assumptions to be made by management, most particularly in connection with
determining the provision for loan losses and the appropriate level of the
allowance for loan losses. Additional information is contained on pages 13, 15
and 17 of this Form 10-QSB for the provision and allowance for loan losses.
FORWARD LOOKING STATEMENTS
--------------------------
When used in this discussion the words: "believes", "anticipates",
"contemplated", "expects" or similar expressions are intended to identify
forward looking statements. Such statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
projected. Those risks and uncertainties include changes to interest rates, the
ability to control costs and expenses, general economic conditions and economic
conditions in the Company's Sussex, New Jersey marketplace, and the success of
the Company's efforts to diversify its revenue base by developing additional
sources of non-interest income while continuing to manage its existing fee based
business. The Company undertakes no obligation to publicly release the results
of any revisions to those forward looking statements that may be made to reflect
events or circumstances after this date or to reflect the occurrence of
unanticipated events.
-10-
RESULTS OF OPERATIONS
---------------------
Three Months ended June 30, 2005 and June 30, 2004
--------------------------------------------------
Overview
--------
The Company realized net income of $666 thousand for the second quarter of
2005, an increase of $275 thousand, or 70.3%, from the $391 thousand reported
for the same period in 2004. Basic earnings per share increased from $0.21 in
the second quarter of 2004 to $0.22 for the second quarter of 2005 and diluted
earnings per share increased from $0.20 in the second quarter of 2004 to $0.22
for the quarter ended June 30, 2005.
The results reflect an increase in net interest income, primarily due to
increased loan interest income, coupled with increases in non-interest income
associated with an increase in service fees on deposit accounts, partially
offset by increases in non-interest expenses due to advertising promotions and
professional fees.
Comparative Average Balances and Average Interest Rates
-------------------------------------------------------
The following table presents, on a fully taxable equivalent basis, a
summary of the Company's interest-earning assets and their average yields, and
interest-bearing liabilities and their average costs for the three month period
ended June 30, 2005 and 2004.
Three Months Ended June 30,
(dollars in thousands) 2005 2004
-------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Earning Assets: Balance Interest (1) Rate (2) Balance Interest (1) Rate (2)
-------------------------------------------------------------------------------------------------------------------
Securities:
Tax exempt (3) $ 27,997 $ 426 6.10% $ 22,083 $ 293 5.34%
Taxable 47,033 433 3.69% 52,209 419 3.23%
-------------------------------------------------------------------------------------------------------------------
Total securities 75,030 859 4.59% 74,292 712 3.86%
Total loans receivable (4) 175,554 2,869 6.55% 142,103 2,161 6.12%
Other interest-earning assets 11,120 82 2.96% 9,107 24 1.04%
-------------------------------------------------------------------------------------------------------------------
Total earning assets 261,704 $ 3,810 5.84% 225,502 $ 2,897 5.17%
Non-interest earning assets 23,830 24,869
Allowance for loan losses (1,903) (1,907)
---------------------------------------------------- ---------
Total Assets $ 283,631 $ 248,464
==================================================== =========
Sources of Funds:
Interest bearing deposits:
NOW $ 43,490 $ 67 0.62% $ 44,319 $ 49 0.44%
Money market 21,027 107 2.04% 13,357 36 1.08%
Savings 63,977 111 0.70% 66,557 108 0.65%
Time 64,439 410 2.55% 57,879 300 2.08%
-------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 192,933 695 1.45% 182,113 493 1.09%
Borrowed funds 14,000 161 4.55% 11,000 132 4.75%
Junior subordinated debentures 5,155 86 6.60% 5,155 61 4.68%
-------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 212,088 $ 942 1.78% 198,268 $ 686 1.39%
Non-interest bearing liabilities:
Demand deposits 38,016 32,668
Other liabilities 1,530 2,231
---------------------------------------------------- ---------
Total non-interest bearing liabilities 39,546 34,899
Stockholders' equity 31,997 15,297
---------------------------------------------------- ---------
Total Liabilities and Stockholders'Equity $ 283,631 $ 248,464
==================================================== =========
---------------------------------------------------- -------------------- ----------------------
Net Interest Income and Margin (5) $ 2,868 4.40% $ 2,211 3.94%
==================================================== ==================== ======================
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for "TEFRA"(Tax and Equity Fiscal Responsibility Act) disallowance
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
-11-
Net Interest Income
-------------------
Net interest income is the difference between interest and fees on loans
and other interest-earning assets and interest paid on interest-bearing
liabilities. Net interest income is directly affected by changes in volume and
mix of interest-earning assets and interest-bearing liabilities that support
those assets, as well as changing interest rates when differences exist in
repricing dates of assets and liabilities.
Net interest income, on a fully taxable equivalent basis (a 39% tax rate),
increased $657 thousand, or 29.7%, to $2.9 million for the three months ended
June 30, 2005 compared to $2.2 million for the same three month period in 2004.
The net interest margin increased, on a fully taxable equivalent basis, by 46
basis points to 4.40% for the three months ended June 30, 2005 compared to 3.94%
for the same period in 2004.
Interest Income
---------------
Total interest income, on a fully taxable equivalent basis, increased by
$913 thousand to $3.8 million for the three months ended June 30, 2005 compared
to $2.9 million in the same period in 2004. Total average earning assets
increased by $36.2 million to $261.7 million from $225.5 million for the three
months ended June 30, 2004. The repositioning of average balances in higher
yielding loans and the increase in market rates of interest have increased the
average rate earned 67 basis points from 5.17% for the second quarter of 2004 to
5.84% in the same period in 2005.
Total interest income on securities, on a fully taxable equivalent basis,
increased $147 thousand, or 20.6%, from the three months ended June 30, 2004 to
the same period in 2005. As the average balance of total securities increased
$738 thousand, the average rate earned increased 73 basis points, from 3.86% in
the second quarter of 2004 to 4.59% for the second quarter of 2005. The increase
in the average balances of the securities portfolio reflects a $5.2 million
reduction in taxable securities and a $5.9 million increase in tax-exempt
securities. The increase in yield was accomplished through the repositioning of
these securities and the tax equivalent effect on the interest earned in an
increasing market rate environment.
Comparing the average balance in the loan portfolio for the three months
ended June 30, 2004 to same period in 2005, the average balance in loans
increased $33.5 million, or 23.5%, while the interest earned on total loans
increased $708 thousand, or 32.8%. The average rate earned on loans increased 43
basis points from 6.12% for the three months ended June 30, 2004 to 6.55% for
the same period in 2005. The increase in our loan portfolio reflects our
continuing efforts to enhance our loan origination capacity and continue to grow
our commercial portfolio.
Interest Expense
----------------
The Company's interest expense for the three months ended June 30, 2005
increased $256 thousand, or 37.3 %, to $942 thousand from $686 thousand for the
same period in 2004, as the balance in average interest-bearing liabilities
increased $13.8 million, or 7.0% to $212.1 million from $198.3 million between
the same two periods. The average rate paid on total interest-bearing
liabilities has increased by 39 basis points from 1.39% for the three months
ended June 30, 2004 to 1.78% for the same period in 2005.
The increases in both interest expense and rate reflect both a
restructuring of the deposit portfolio as time deposits continue to reprice at
higher market rates of interest and increased balances in money market accounts.
Several large municipal accounts transferred balances from our public fund NOW
account to the public fund money market account from the second quarter of 2004
to the same period in 2005. To attract municipal accounts, a higher incentive
rate was offered on the public fund money market account. As municipal balances
were transferred from NOW accounts, the NOW accounts average balance decreased
$829 thousand and the money market accounts average balance increased $7.7
million in the second quarter of 2005 compared to three month period ended June
30, 2004. The average balance in time deposits increased $6.6 million from $57.9
million in the second quarter of 2004 to $64.4 million during the same period in
2005 due to the Company actively promoting competitive market rates of interest.
For the quarter ended June 30, 2005, the Company's average borrowed funds
were $14.0 million compared to average borrowed funds of $11.0 million during
the second quarter of 2004. The balance at June 30, 2005 consisted of four
convertible notes totaling $12.0 million and $2.0 million in repurchase
agreements from the Federal Home Loan Bank. The average rate paid on total
borrowed funds has decreased 20 basis points from the second quarter of 2004 to
the same period in 2005, as the rates paid on the newer borrowings were at lower
market rates of interest. In the third quarter of 2002, the Company issued $5.2
million in junior subordinated debentures. The debentures bear a floating rate
of interest, which averaged 6.60% for the three months ended June 30, 2005, up
192 basis points from 4.68% in the same period of 2004.
-12-
Provision for Loan Losses
-------------------------
The provision for loan losses for the second quarter of 2005 was $206
thousand compared to a provision of $105 thousand in the second quarter of 2004,
an increase of $101 thousand. The increase in the provision from the second
quarter of 2004 to the same quarter in 2005 was due to substantial loan growth
mainly in commercial and non-residential real estate. The provision for loan
losses reflects management's judgment concerning the risks inherent in the
Company's existing loan portfolio and the size of the allowance necessary to
absorb the risks, as well as the average balance of the portfolio over both
periods. Management reviews the adequacy of its allowance on an ongoing basis
and will provide additional provisions, as management may deem necessary.
Non-Interest Income
-------------------
The Company's non-interest income is primarily generated through insurance
commissions earned through the operation of Tri-State, service charges on
deposit accounts and mortgage banking fees.
The Company's non-interest income increased by $157 thousand, or 13.5%, to
$1.3 million for the three months ended June 30, 2005 from $1.2 million for the
same period in 2004. In February of 2005 the Company began a new "no-return"
overdraft privilege program. Service fees on deposit accounts have consequently
increased $124 thousand, or 64.9%, to $315 thousand in the second quarter of
2005 from $191 thousand during the same period in 2004. ATM and debit card
income increased 10.25% as customer usage has increased, and investment
brokerage fee income increased 37.5% due to a slightly stronger market in the
second quarter of 2005 over the same period in 2004. Mortgage banking fee income
decreased 36.0% between the same two periods, due to a decline in originations
and greater competition. Insurance commission income from Tri-State increased by
$18 thousand to $622 thousand in the current second quarter from $604 thousand
in the second quarter of 2004.
Non-Interest Expense
--------------------
Total non-interest expense increased from $2.6 million in the second
quarter of 2004 to $2.9 million in the second quarter of 2005, an increase of
$280 thousand, or 10.6%. Salaries and employee benefits, the largest component
of non-interest expense, increased $95 thousand, or 6.3%. This increase reflects
customary annual salary increases for the Bank's and Tri-State's existing staff.
Furniture and equipment expense has increased $61 thousand, or 29.0%, to $271
thousand from the three months ended June 30, 2004 to the same period in 2005
from a major computer hardware upgrade and system software conversion in May of
2004 and the additional expenses associated with increased office locations.
Professional fees have increased $60 thousand in the second quarter of 2005 to
$134 thousand due to the preparation for implementation of the Sarbanes Oxley
Act Section 404 and the hiring of an internal audit firm to administer the
documentation and review of the Company's internal controls. Advertising and
promotion expenses have increased $54 thousand in the second quarter of 2005
over the same period in 2004 due to increased advertisements for deposit product
rate promotions and the fees associated with a new cross-selling initiative
program.
Although insurance commissions and fees increased 3.0% over the three
month period ended June 30, 2005 from 2004, our insurance operations reported
reduced net earnings in the three month period of 2005 compared to 2004. For the
three months ended June 30, 2005, our insurance operations earned income before
income taxes of $42 thousand, a decline from the $72 thousand earned in the year
ago period. The decline in reported net earnings of our insurance operations
reflects increased amortization expense of $15 thousand from the purchase of the
book of business on an acquired insurance agency in 2003. Under the terms of the
2003 purchase, the amortization expense increased to $30 thousand in the second
quarter of 2005 from $15 thousand in the second quarter of 2004. Amortization of
this book of business will end in December of 2005. In addition, net income from
insurance operations declined in the first quarter of 2005 by $18 thousand,
reflecting a more competitive insurance market and greater salary expense due to
the hiring of additional staff.
Income Taxes
------------
The Company's income tax provision, which includes both federal and state
taxes, was $272 thousand and $152 thousand for the three months ended June 30,
2005 and 2004, respectively. This increase in income taxes resulted from an
increase in income before taxes of $395 thousand, or 72.7% for the three months
ended June 30, 2005 as compared to the same period in 2004. The Company's
effective tax rate of 29% and 28% for the three months ended June 30, 2005 and
2004, respectively, is below the statutory tax rate due to tax-exempt interest
on securities and earnings on the investment in life insurance.
-13-
Six Months ended June 30, 2005 and June 30, 2004
------------------------------------------------
Overview
--------
For the six months ended June 30, 2005, net income was $1.2 million, an
increase of $424 thousand, or 55.6%, from the $762 thousand reported for the
same period in 2004. Basic earnings per share were $0.39 for the six months
ended June 30, 2005 compared to $0.42 for the six-month period ended June 30,
2004. Diluted earnings per share were $0.39 for the six months ended June 30,
2005, a decrease from $0.40 from the first six months of 2004. The decrease in
both basic earnings per share and diluted earnings per share was due to a
capital offering that closed in December 2004. As a result of the offering,
common stock outstanding increased by 1,131,150 shares, or 60.7%, to 2,994,874
shares outstanding at December 31, 2004.
Comparative Average Balances and Average Interest Rates
-------------------------------------------------------
The following table presents, on a fully taxable equivalent basis, a
summary of the Company's interest-earning assets and their average yields, and
interest-bearing liabilities and their average costs for the six month period
ended June 30, 2005 and 2004.
Six Months Ended June 30,
(Dollars in thousands) 2005 2004
------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Earning Assets: Balance Interest (1) Rate (2) Balance Interest (1) Rate (2)
------------------------------------------------------------------------------------------------------------------
Securities:
Tax exempt (3) $ 27,749 $ 845 6.14% $ 22,172 $ 589 5.34%
Taxable 47,954 880 3.70% 52,349 885 3.40%
------------------------------------------------------------------------------------------------------------------
Total securities 75,703 1,725 4.60% 74,521 1,474 3.98%
Total loans receivable (4) 169,676 5,489 6.52% 138,719 4,262 6.18%
Other interest-earning assets 11,098 146 2.64% 9,255 48 1.05%
------------------------------------------------------------------------------------------------------------------
Total earning assets 256,477 $ 7,360 5.79% 222,495 $ 5,784 5.23%
Non-interest earning assets 23,813 24,527
Allowance for loan losses (2,051) (1,842)
---------------------------------------------------- ----------
Total Assets $ 278,239 $ 245,180
==================================================== ==========
Sources of Funds:
Interest bearing deposits:
NOW $42,573 $124 0.59% $ 47,066 $ 107 0.46%
Money market 21,143 199 1.90% 8,784 42 0.97%
Savings 65,214 226 0.70% 66,097 215 0.65%
Time 62,039 724 2.35% 57,941 603 2.09%
------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 190,969 1,273 1.34% 179,888 967 1.08%
Borrowed funds 12,484 292 4.65% 11,000 265 4.77%
Junior subordinated debentures 5,155 164 6.32% 5,155 121 4.64%
------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 208,608 $ 1,729 1.67% 196,043 $ $1,353 1.39%
Non-interest bearing liabilities:
Demand deposits 36,295 31,826
Other liabilities 1,451 2,159
---------------------------------------------------- ----------
Total non-interest bearing liabilities 37,746 33,985
Stockholders' equity 31,885 15,152
---------------------------------------------------- ----------
Total Liabilities and Stockholders' Equity $ 278,239 $ 245,180
==================================================== ==========
---------------------------------------- --------------------- ---------------------
Net Interest Income and Margin (5) $ 5,631 4.43% $ 4,431 4.01%
======================================== ===================== =====================
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
Net Interest Income
-------------------
Net interest income, on a fully taxable equivalent basis (a 39% tax rate),
increased $1.2 million, or 27.1%, to $5.6 million for the six months ended June
30, 2005 compared to $4.4 million for the same six month period in 2004. The
-14-
net interest margin increased, on a fully taxable equivalent basis, by 42 basis
points to 4.43% for the six months ended June 30, 2005 compared to 4.01% for the
same period in 2004.
Interest Income
---------------
Total interest income, on a fully taxable equivalent basis, increased by
$1.6 million, or 27.2%, to $7.4 million for the six months ended June 30, 2005
compared to $5.8 million in the first six months of 2004. Total average earning
assets increased by $34.0 million to $256.5 million in the current six month
period from $222.5 million for the six months ended June 30, 2004. The growth in
higher yielding loan average balances in an increasing market rate of interest
environment have increased the average rate earned on earning assets 56 basis
points from 5.23% for the first six months of 2004 to 5.79% in the same period
in 2005.
Total interest income on securities, on a fully taxable equivalent basis,
increased $251 thousand, or 17.0%, from the six months ended June 30, 2004 to
the same period in 2005. As the average balance of total securities increased
$1.2 million, the average rate earned increased 62 basis points, from 3.98% in
the first six months of 2004 to 4.60% for the same period in 2005. The increase
in yield was accomplished by repositioning taxable securities with tax-exempt
securities and the tax equivalent effect on the interest earned in an increasing
market rate environment.
The average balance in the loan portfolio for the six months ended June
30, 2005 increased $30.1 million, or 22.3%, from the first six months of 2004.
The interest earned on total loans increased $1.2 million, or 28.8% as the
average rate earned on loans increased 34 basis points from 6.18% for the six
months ended June 30, 2004 to 6.52% for the same period in 2005. The growth in
our loan portfolio is a result of the reorganization of our loan department
undertaken after our retention of Tammy Case, our Executive Vice-President, Loan
Administration in July 2004.
Interest Expense
----------------
Interest expense increased $376 thousand to $1.7 million for the six
months ended June 30, 2005 from $1.4 million for the six months ended June 30,
2004 as the average balance in interest bearing liabilities increased $12.6
million, to $208.6 million for the first six months of 2005 from $196.0 million
in the same period in 2004 as a result of increases in market rates of interest
and time deposit promotions. The average rate paid on interest bearing
liabilities increased 28 basis points to 1.67% for the first six months of 2005
from 1.39% for the six months ended June 30, 2004.
The Company's interest expense on deposit liabilities for the six months
ended June 30, 2005 increased $306 thousand, or 31.6 %, to $1.3 million from
$967 thousand for the same period in 2004, as the balance in average
interest-bearing liabilities increased $12.6 million, or 6.4% to $208.6 million
from $196.0 million between the same two periods.
The average rate paid on total interest-bearing deposits has increased by
26 basis points from 1.08% for the six months ended June 30, 2004 to 1.34% for
the same period in 2005. The increase reflects the growth in time deposits
through promotional rate incentives and money market deposits, largely through
the increase in municipal deposits. As municipal NOW account balances were
transferred to higher incentive rate money market accounts, the NOW accounts
average balance decreased $4.5 million and the money market accounts average
balance increased $12.4 million in the first six months of 2005 compared to the
six month period ended June 30, 2004. Time deposit average balances increased by
$4.1 million, or 7.1%, to $62.0 million for the first six months of 2005 from
$57.9 million during the first half of 2004.
For the six months ended June 30, 2005, the Company's average borrowed
funds increased $1.5 million to $12.5 million from $11.0 million for the first
six months of 2004. The Company's $5.2 million in junior subordinated debentures
bear a floating rate of interest, which averaged 6.32% for the six months ended
June 30, 2005, up 168 basis points from 4.64% in the same period of 2004.
Provision for Loan Losses
-------------------------
The provision for loan losses for the first half of 2005 was $341 thousand
compared to a provision of $253 thousand in the first six months of 2004, an
increase of $88 thousand. The increase in the provision between periods was due
to substantial loan growth mainly in commercial and non-residential real estate.
Non-Interest Income
-------------------
The Company's non-interest income is primarily generated through insurance
commissions earned through the operation of Tri-State and service charges on
deposit accounts.
-15-
The Company's non-interest income increased by $108 thousand, or 4.7%, to
$2.4 million for the six months ended June 30, 2005 from $2.3 million for the
same period in 2004. Service fees on deposit accounts increased $169 thousand to
$551 thousand in the first six months of 2005 from $382 thousand during the same
period in 2004. Fees from the Company's new "no-return" overdraft privilege
program have increase overdraft fee income 44.2% in the first six months of 2005
from the same period last year. Mortgage banking fees have decreased 102.5% to
$161 thousand for the first six months of 2005 from $326 thousand during the
same period in 2004 due to a decline in originations and greater competition.
Non-Interest Expense
--------------------
Total non-interest expense increased from $5.3 million in the first six
months of 2004 to $5.8 million in the first six months of 2005, an increase of
$555 thousand, or 10.5%. The largest percent increases were in professional
fees, advertising and promotion and amortization of intangible assets.
Professional fees have increased $92 thousand or 58.6% in the first six months
of 2005 to $249 thousand due to higher costs associated with the implementation
of Sarbanes Oxley Act Section 404. Advertising and promotion expenses have
increased $83 thousand or 45.4% in the first six months of 2005 over the same
period in 2004 due to increased advertisements for deposit product rate
promotions and the fees associated with a new cross-selling initiative program.
As insurance commissions and fees increased 4.0% over the six month period
ended June 30, 2005 from the same period in 2004, our insurance operations
reported a reduction in income before income taxes of $72 thousand or 52.9% as
depreciation and amortization on intangible assets increased $33 thousand or
63.5% in the six month period ending June 30, 2005 compared to 2004. In
addition, net income from insurance operations declined in the first half of
2005 by $44 thousand, due to a competitive insurance policy renewal market and
an increase in staff resulting in higher salary and benefit expenses.
Income Taxes
------------
The Company's federal and state income tax provision was $451 thousand for
the six months ended June 30, 2005 compared to $287 thousand recorded for the
first half of 2004. This increase in income taxes resulted from an increase in
income before taxes of $588 thousand, or 56.1% for the six months ended June 30,
2005 as compared to the same period in 2004. The Company's effective tax rate of
27% for both six month periods is below the statutory tax rate due to tax-exempt
interest on securities and earnings on the investment in life insurance.
FINANCIAL CONDITION
-------------------
June 30, 2005 as compared to December 31, 2004
----------------------------------------------
At June 30, 2005 the Company had total assets of $290.4 million compared
to total assets of $278.3 million at December 31, 2004, an increase of $12.1
million. Loans receivable increased $29.4 million, or 18.7%, to $186.3 million
at June 30, 2005 from $156.9 million at December 31, 2004. Total deposits
increased to $236.3 million at June 30, 2005 from $229.8 million at December 31,
2004 and borrowings increased $4.0 million to $14.0 million at June 30, 2005.
Cash and Cash Equivalents
-------------------------
The Company's cash and cash equivalents decreased by $12.9 million at June
30, 2005 to $16.4 million from $29.3 million at December 31, 2004. This decrease
reflects the Company's decrease in federal funds sold of $16.7 million to $2.2
million at June 30, 2005 from $18.9 million at year-end 2004. This decrease in
federal funds sold funded the Company's growth in the loan portfolio.
Securities Portfolio
--------------------
The Company's securities, available for sale, at fair value, decreased
$2.1 million from $74.7 million at December 31, 2004 to $72.7 million at June
30, 2005. The Company purchased $4.4 million in new securities during the first
half of 2005, $5.3 million in available for sale securities matured or were
repaid, $1.0 million in available for sale securities were called and there were
no sales in the first six months of 2005. Six month balances increased in state
and municipal tax-exempt securities, at fair value, by $1.7 million to $27.6
million as paydowns exceeded purchases in taxable securities, at fair value, for
a net decrease of $3.8 million to $45.0 million. The securities portfolio
contained no high-risk securities or derivatives as of June 30, 2005. There were
no held to maturity securities at June 30, 2005 or at December 31, 2004.
-16-
Loans
-----
Total loans at June 30, 2005 increased $29.4 million, or 18.7% to $186.3
million from $156.9 million at year-end 2004. The Company is emphasizing the
origination of commercial, industrial, and non-residential real estate loans to
increase the yield in its loan portfolio. The Company has also increased its
activity in the loan participation market. The majority of the originated and
sold participations are commercial real estate related loans which exceed the
Company's legal lending limit. The balances in all major loan categories have
increased from December 31, 2004 to June 30, 2005. The largest increases were a
$19.3 million, or 27.7%, increase in non-residential real estate loans, a $2.9
million, or 28.5%, increase in construction and land development loans and a
$2.0 million, or 14.1%, increase in commercial and industrial loans.
The increase in loans was funded during the first six months of 2005 by a
decrease in the Company's federal funds sold, cash flows from repayments on
securities as well as increased deposits and borrowings from the Federal Home
Loan Bank. The loan to deposit ratios at June 30, 2005 and December 31, 2004
were 78.8% and 68.3%, respectively.
Loan and Asset Quality
----------------------
Non-performing assets consist of non-accrual loans and all loans over
ninety days delinquent and foreclosed real estate owned ("OREO"). The Company's
non-accrual loans decreased to $1.0 million at June 30, 2005 from $1.3 million
at December 31, 2004. There were $75 thousand in past due loans over 90 days and
still accruing and $50 thousand in renegotiated loans at June 30, 2005. The
Company had one OREO property valued at $270 thousand at June 30, 2005 and none
at December 31, 2004.
The Company seeks to actively manage its non-performing assets. In
addition to active monitoring and collecting on delinquent loans, management has
an active loan review process for customers with aggregate relationships of
$250,000 or more if the credit(s) are unsecured or secured, in whole or
substantial part, by collateral other than real estate and $1,000,000 or more if
the credit(s) are secured in whole or substantial part by real estate.
Management continues to monitor the Company's asset quality and believes
that the non-accrual loans are adequately collateralized and anticipated
material losses have been adequately reserved for in the allowance for loan
losses.
The following table provides information regarding risk elements in the
loan portfolio at each of the periods presented:
(Dollars in thousands) June 30, 2005 December 31, 2004
---------------------------------------------------------------------------------------
Non-accrual loans $1,005 $1,304
Non-accrual loans to total loans 0.54% 0.83%
Non-performing assets to total assets 0.48% 0.48%
Allowance for loan losses as a % of non-performing loans 190.97% 169.96%
Allowance for loan losses to total loans 1.16% 1.45%
---------------------------------------------------------------------------------------
Allowance for Loan Losses
-------------------------
The allowance is allocated to specific loan categories based upon
management's classification of problem loans under the bank's internal loan
grading system and to pools of other loans that are not individually analyzed.
Management makes allocations to specific loans based on the present value of
expected future cash flows or the fair value of the underlying collateral for
impaired loans and to other classified loans based on various credit risk
factors. These factors include collateral values, the financial condition of the
borrower and industry and current economic trends.
Allocations to commercial loan pools are categorized by commercial loan
type and are based on management's judgment concerning historical loss trends
and other relevant factors. Installment and residential mortgage loan
allocations are made at a total portfolio level based on historical loss
experience adjusted for portfolio activity and current conditions. Additionally,
all other delinquent loans are grouped by the number of days delinquent with
this amount assigned a general reserve amount.
In April of 2005 the Company began an allowance for overdraft losses,
providing for losses in conjunction with the new no-return overdraft privilege
program. Included in the total allowance for loan losses was a provision of $11
-17-
thousand, and net charge-offs of $9 thousand for the first six months of 2005,
as the first charge-offs were recorded under the new program.
At June 30, 2005, the allowance for loan losses was $2.2 million, a
decrease of $116 thousand from the $2.3 million at December 31, 2004. The
provision for loan losses was $341 thousand and there were $609 thousand in
charge-offs and $152 thousand in recoveries for the first six months of 2005.
The allowance for loan losses as a percentage of total loans was 1.16% at June
30, 2005 compared to 1.45% on December 31, 2004. At December 31, 2004 the
allowance held specific reserves for the potential charge off of several loans
in the loan portfolio. During the first half of 2005, $418 thousand was charged
off relating to delinquent loans, $180 thousand was charged off on the write
down of a property the Company foreclosed on and $150 thousand was recovered on
a loan previously charged off.
Management regularly assesses the appropriateness and adequacy of the loan
loss reserve in relation to credit exposure associated with individual
borrowers, overall trends in the loan portfolio and other relevant factors, and
believes the reserve is reasonable and adequate for each of the periods
presented.
Deposits
--------
Total deposits increased $6.5 million, or 2.8%, from $229.8 million at
December 31, 2004 to $236.3 million at June 30, 2005. Non-interest bearing
deposits increased $2.3 million, or 6.6% to $36.7 million at June 30, 2005 from
$34.5 million at December 31, 2004 and interest-bearing deposits increased $4.2
million, or 2.2%, to $199.6 million at June 30, 2005 from $195.4 million at
December 31, 2004. Total time deposits balances increased $8.0 million, or
12.8%, from $63.2 million at December 31, 2004 to $71.2 million at June 30, 2005
while other interest bearing deposit account balances decreased $3.8 million, or
2.9%, to $128.4 million at June 30, 2005 from $132.2 million at December 31,
2004. The shift from other interest-bearing deposits to time deposits, mainly
from public fund accounts and a select savings account product for senior
citizens, is market driven as the Company has increased interest rates paid on
short term time deposits. Management continues to monitor the shift in deposits
through its Asset/Liability Committee.
Borrowings
----------
Borrowings consist of long term advances and repurchase agreements from
the Federal Home Loan Bank. The advances are secured under terms of a blanket
collateral agreement by a pledge of qualifying investment securities and certain
mortgage loans. As of June 30, 2005 the Company had $12.0 million in notes
outstanding at an average interest rate of 4.71% compared to $10.0 million in
notes outstanding at an average rate of 4.85% for the year ended December 31,
2004. The long-term borrowings consist of three notes that mature on December
21, 2010 and one that matures on March 29, 2015 all with a convertible quarterly
option which allows the Federal Home Loan Bank to change the note to then
current market rates. The interest rate on these borrowings ranges from 3.48% to
5.14%. In March of 2005 the Company purchased $2.0 million in securities sold
under agreements to repurchase at an average rate of 3.62%; $1.0 million matures
in September of 2005 and the second $1.0 million matures in March of 2006.
Junior Subordinated Debentures
------------------------------
On July 11, 2002, the Company raised an additional $4.8 million, net of
offering costs, in capital through the issuance of junior subordinated
debentures to a statutory trust subsidiary. The subsidiary in turn issued $5.0
million in variable rate capital trust pass through securities to investors in a
private placement. The interest rate is based on the three-month LIBOR rate plus
365 basis points and adjusted quarterly. The rate at June 30, 2005 was 6.59%.
The rate is capped at 12.5% through the first five years, and the securities may
be called at par anytime after October 7, 2007 or if the regulatory capital or
tax treatment of the securities is substantially changed. These trust preferred
securities are included in the Company's and the Bank's capital ratio
calculations.
As a result of the adoption of FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities, and Interpretation of ARB No. 51", we
deconsolidated our wholly-owned subsidiary Sussex Capital Trust I, referred to
as the "Trust", from our consolidated financial statements as of March 31, 2004.
For regulatory reporting purposes, the Federal Reserve is allowing trust
preferred securities to continue to qualify as Tier 1 Capital subject to
specified limitations. The adoption of FIN 46 did not have an impact on our
results of operations or liquidity.
Interest Rate Sensitivity
-------------------------
An interest rate sensitive asset or liability is one that, within a
defined time period, either matures or experiences an interest rate change in
line with general market interest rates. Interest rate sensitivity is the
volatility of a Company's earnings from a movement in market interest rates.
Interest rate "gap" analysis is a common, though, imperfect, measure
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of interest rate risk. We do not employ gap analysis as a rate risk management
tool, but rather we rely upon earnings at risk analysis to forecast the impact
on our net interest income of instantaneous 100 and 200 basis point increases
and decreases in market rates. In assessing the impact on earnings, the rate
shock analysis assumes that no change occurs in our funding sources or types of
assets in response to the rate change.
Our board of directors has established limits for interest rate risk based
on the percentage change in interest income we would incur in differing interest
rate scenarios. Through the first six months of 2005, we sought to remain
relatively balanced, and our policies provide for a variance of no more than 25%
of net interest income, at a 100 and 200 basis point increase or decrease. At
June 30, 2005 the percentages of change were within policy limits.
Our financial modeling simulates our cash flows, interest income and
interest expense from earning assets and interest bearing liabilities for a
twelve month period in each of the different interest rate environments, using
actual individual deposit, loan and investment maturities and rates in the model
calculations. Assumptions regarding the likelihood of prepayments on residential
mortgage loans and investments are made based on historical relationships
between interest rates and prepayments. Commercial loans with prepayment
penalties are assumed to pay on schedule to maturity. In actual practice,
commercial borrowers may request and be granted interest rate reductions during
the life of a commercial loan due to competition from financial institutions and
declining interest rates.
The following table sets forth our interest rate risk profile at June 30,
2005 and 2004. The interest rate sensitivity of our assets and liabilities, and
the impact on net interest income, illustrated in the following table would vary
substantially if different assumptions were used or if actual experience differs
from that indicated by the assumptions.
June 30, 2005 June 30, 2004
----------------------------------------------------
Change in Gap as a Change in Gap as a
Net
Net Interest % of Interest % of
(Dollars in thousands) Income Total Assets Income Total Assets
--------------------------------------------------------------------------------
Down 200 basis points ($792) 13.79% ($584) 11.66%
Down 100 basis points (190) 6.62% (147) 5.86%
Up 100 basis points (58) -2.04% (70) -2.80%
Up 200 basis points (172) -2.99% (211) -4.22%
--------------------------------------------------------------------------------
Liquidity
---------
It is management's intent to fund future loan demand with deposits and
maturities and pay downs on investments. In addition, the bank is a member of
the Federal Home Loan Bank of New York and as of June 30, 2005, had the ability
to borrow up to $18.2 million against its one to four family mortgages and
selected investment securities as collateral for borrowings, of which the
Company had outstanding long-term borrowings totaling $12.0 million and $2.0
million in securities sold under an agreement to repurchase. The bank also has
available an overnight line of credit and a one-month overnight repricing line
of credit, each in an amount of $12.3 million at the Federal Home Loan Bank and
an overnight line of credit in the amount of $4.0 million at the Atlantic
Central Bankers Bank.
At June 30, 2005, the amount of liquid assets remained at a level
management deemed adequate to ensure that contractual liabilities, depositors'
withdrawal requirements, and other operational customer credit needs could be
satisfied. At June 30, 2005, liquid investments totaled $16.4 million, and all
mature within 30 days.
At June 30, 2005, the Company had $72.7 million of securities classified
as available for sale. Of these securities, $36.6 million had $456 thousand of
unrealized losses and therefore are not available for liquidity purposes because
management's intent to hold them until market recovery.
The Company has no investment in or financial relationship with any
unconsolidated entities that are reasonably likely to have a material effect on
liquidity or the availability of capital resources.
The Company is not aware of any known trends or any known demands,
commitments, events or uncertainties, which would result in any material
increase or decrease in liquidity.
Off-Balance Sheet Arrangements
------------------------------
The Company's financial statements do not reflect off-balance sheet
arrangements that are made in the normal course of business. These off-balance
sheet arrangements consist of unfunded loans and letters of credit made under
the same standards as on-balance sheet instruments. These unused commitments, at
June 30, 2005 totaled $58.1 million.
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This consisted of $32.0 million in commitments to grant commercial real estate,
construction and land development loans, $12.4 million in home equity lines of
credit, and $13.7 million in other unused commitments. These instruments have
fixed maturity dates, and because many of them will expire without being drawn
upon, they do not generally present any significant liquidity risk to the
Company.
Management believes that any amounts actually drawn upon can be funded in
the normal course of operations.
Capital Resources
-----------------
Stockholders' equity inclusive of accumulated other comprehensive income
(loss), net of income taxes, was $32.6 million at June 30, 2005, an increase of
$942 thousand from the $31.6 million at year-end 2004. Activity in stockholders'
equity consisted of net proceeds from common stock issuances of $183 thousand, a
net increase in retained earnings of $765 thousand derived from $1.2 million in
net income earned in the first half of 2005, offset by $421 thousand for the
payment of cash dividends and a $6 thousand unrealized loss on securities
available for sale, net of income tax of $3 thousand.
At June 30, 2005 the Company and the Bank both meet the well-capitalized
regulatory standards applicable to them. The table below presents the capital
ratios at June 30, 2005, for the Company and the Bank, as well as the minimum
regulatory requirements.
(Dollars in thousands) Amount Ratio Minimum Minimum
Amount Ratio
--------------------------------------------------------------------------------
The Company:
Leverage Capital $34,784 12.37% $>11,245 4%
-
Tier 1 - Risk Based 34,784 16.85% >8,258 4%
-
Total Risk-Based 36,953 17.90% >16,516 8%
-
The Bank:
Leverage Capital 27,092 9.73% >11,138 4%
-
Tier 1 Risk-Based 27,092 13.18% >8,219 4%
-
Total Risk-Based 29,261 14.24% >16,439 8%
-
--------------------------------------------------------------------------------
Effect of Inflation
-------------------
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result, the
level of interest rates has a more significant impact on a financial
institution's performance than effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or change with the same
magnitude as the price of goods and services, which prices are affected by
inflation. Accordingly, the liquidity, interest rate sensitivity and maturity
characteristics of the Company's assets and liabilities are more indicative of
its ability to maintain acceptable performance levels. Management of the Company
monitors and seeks to mitigate the impact of interest rate changes by attempting
to match the maturities of assets and liabilities to gap, thus seeking to
minimize the potential effect of inflation.
Item 3. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are, as of the end of the
period covered by this report, effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic SEC
filings.
(b) Changes in internal controls.
Not applicable
-20-
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Company and the Bank are periodically involved in various legal
proceedings as a normal incident to their businesses. In the opinion of
management, no material loss is expected from any such pending lawsuit.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
On April 16, 1999 the Company announced a stock repurchase plan whereby
the Company may purchase up to 50,000 shares of outstanding stock. There is no
expiration date to this plan. On April 27, 2005, the Company's Board increased
this plan to 100,000 shares of the Company's common stock. The Company has
previously repurchased 32,000 shares under this program.
Maximum
Total Number Number of
of Shares Shares that
Purchased as May Yet Be
Total Number Part of Publicly Purchased
of Shares Average Price Announced Plans Under the Plans
Period Purchased Paid per Share or Programs or Programs
------ --------- -------------- ----------- -----------
April 1, 2005 through
April 30, 2005 - - - -
May 1, 2005 through
May 31, 2005 2,000 $13.55 2,000 65,992
June 1, 2005 through
June 30, 2005 - - - -
-------------------------------------------------------------------
Total 2,000 $13.55 2,000 65,992
===================================================================
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
On April 27, 2005, the Registrant held its annual meeting of shareholders
to elect members of the Company's Board of Directors and approval of the
Company's 2004 Equity Incentive Plan.
Nominees for election to the Board of Directors received the following
votes:
Nominees: For Withhold Authority
-------- --- ------------------
Patrick Brady 2,705,593 60,665
Edward J. Leppert 2,728,189 38,069
Richard Scott 2,728,689 37,569
Joseph Zitone 2,475,386 290,872
Richard Branca 2,703,261 62,997
Proposal for the 2004 Equity Incentive Plan:
For Against
--- -------
1,536,144 320,224
Item 5. Other Information
-----------------
Not applicable
-21-
Item 6. Exhibits
--------
Number Description
------ -----------
31.1 Certification of Donald L. Kovach pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Candace A. Leatham pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SUSSEX BANCORP
By: /s/ Candace A. Leatham
----------------------
CANDACE A. LEATHAM
Executive Vice President and
Chief Financial Officer
Date:
-22-