UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X| Annual report pursuant to section 13 or 15 (d) of the Securities
Exchange Act of 1934 For the fiscal year ended December 31, 2008
-OR-
|_| Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to _____________.
CORNERSTONE FINANCIAL CORPORATION
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(Exact name of registrant, as specified in its charter)
New Jersey 80-0282551
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
6000 Midlantic Drive, Suite 120 S, New Jersey 08054
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(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (856) 439-0300
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Securities registered pursuant to Section 12(b) of the Act:
None
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
YES __ NO X
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act [ ]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO __.
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, am
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer", "accelerated filer", and "smaller
reporting company" in rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by checkmark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act.) YES __ NO X
State the aggregate market value of the voting stock and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and ask price of such common
equity as of the last business day of the registrant's most recently completed
second fiscal quarter $9,753,384.
As of March 17, 2009, there were 1,655,767 outstanding shares of the
registrant's Common Stock.
1
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be sent to shareholders in
connection with the 2009 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Form 10-K, which is expected to be filed with
the FDIC not later than 120 days after the end of the registrant's last fiscal
year.
PART I
Forward-Looking Statements
Cornerstone Financial Corporation (the "Company") may from time to time
make written or oral "forward-looking statements," including statements
contained in the Company's filings with the Securities and Exchange Commission
(including this annual report on Form 10-K and the exhibits hereto), in its
reports to shareholders and in other communications by the Company, which are
made in good faith by the Company pursuant to the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such
as statements of the Company's plans, objectives, expectations, estimates and
intentions that are subject to change based on various important factors (many
of which are beyond the Company's control). Forward-looking statements may be
identified by the use of words such as "expects," "subject," "believe," "will,"
"intends," "will be," or "would." The following factors, among others, along
with those items disclosed herein under the caption "Risk Factors", could cause
the Company's financial performance to differ materially from the plans,
objectives, expectations, estimates and intentions expressed in such
forward-looking statements: the strength of the United States economy in general
and the strength of the local economies in which the Company conducts
operations; the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Board of Governors of the
Federal Reserve System ("Federal Reserve"); inflation; interest rates; market
and monetary fluctuations; the timely development of new products and services
by the Company and the perceived overall value of these products and services by
users, including the features, pricing and quality compared to competitors'
products and services; the success of the Company in gaining regulatory approval
of its products, services, dividends and of new branches, when required; the
impact of changes in financial services laws and regulations (including laws
concerning taxes, banking, securities and insurance); technological changes;
acquisitions; the ability to continue to effectively manage costs, including the
costs incurred in connection with the opening of new branches; changes in
consumer spending and saving habits; and the success of the Company at managing
the risks resulting from these factors.
The Company cautions that the above listed factors are not exclusive.
The Company does not undertake to update any forward-looking statement, whether
written or oral, that may be made from time to time by or on behalf of the
Company.
Item 1. Description of Business
Cornerstone Financial Corporation
The Company was formed in 2008 at the direction of the Board of
Directors of Cornerstone Bank (the "Bank") to serve as a holding company for the
Bank. The Board believed that establishing a holding company would provide
greater flexibility in raising capital and conducting the Bank's business. The
holding company reorganization was completed in January, 2009. As such, the
Company did not have any operations in 2008, other than obtaining regulatory
approval for the holding company reorganization, and the results of operations,
and all financial and trading market data presented herein, are those of the
Bank on a stand alone basis. Ownership and control of the Bank is the only
activity of the Company, and as of the date of this Annual Report, the Company
did not have any subsidiaries other than the Bank.
2
The Company's offices are located at 6000 Midlantic Drive, Suite 120 S,
New Jersey, 08054 and its phone number is (856) 439-0300.
Cornerstone Bank
The Bank is a New Jersey state chartered commercial bank headquartered
in Moorestown, New Jersey. The Bank commenced operations on October 4, 1999, and
conducts business from its main office in Moorestown and from five additional
branch offices located in Medford, New Jersey, Burlington, New Jersey, Cherry
Hill, New Jersey , Voorhees, New Jersey and Moorestown, New Jersey. The Bank
provides a broad range of lending, deposit and financial products. The Bank
emphasizes commercial real estate and commercial lending to small businesses and
professionals. At December 31, 2008, the Bank had total assets of $247.5
million, total deposits of $202.0 million and shareholders' equity of $15.4
million.
The Bank offers a broad range of deposit and loan products and banking
services, including personal and business checking accounts, individual
retirement accounts, business money market accounts, certificates of deposit,
wire transfers, automated teller services, night depository and drive-through
banking. The Bank also offers a three-tiered form of personal demand account,
paying progressively higher rates of interest as account balances increase. The
Bank's deposit accounts are insured by the Federal Deposit Insurance Corporation
(the "FDIC") up to the legal maximum amount.
As an enhancement to its traditional banking services, the Bank also
provides and services a fully transactional website under the domain name
www.cornerstonebanknj.com. Customers have access to current rates and terms on
deposit and loan products, and may make balance inquiries, request stop
payments, reorder checks, pay bills and transfer funds between existing accounts
within the Bank. The information included on the Bank's website is not part of
this report.
The Bank has one subsidiary, Cornerstone Realty Holdings, Inc., a New
Jersey corporation, which was formed during the second quarter of 2005 to
acquire and sell real property that has been previously foreclosed upon by the
Bank.
Market Area
The Bank's market area is comprised of approximately 300 square miles
in western Burlington County and northern Camden County, New Jersey. The Bank
has chosen this market because it believes it contains a stable, diversified
economy. Within this market area, the Bank presently focuses its activities in
the suburban communities of Moorestown, Mount Laurel, Medford, Burlington City,
Cherry Hill, Mount Holly, Maple Shade, Medford Lakes, Evesham, Gibbsboro and
Voorhees, New Jersey. The deposit and loan activities of the Bank are
significantly affected by economic conditions it its market area. The Bank
believes that its market area provides strong opportunities in which to develop
a banking franchise. The Bank's strategy for future growth is to selectively
expand its present market into locations where it can build upon the
relationships the members of the Bank's Board of Directors and management team
have with community members to best utilize our community oriented approach to
our competitive advantage. The establishment of branches is subject to approval
by the NJDOBI.
In June 2008, the Bank opened a new facility in Moorestown, New Jersey,
where the Bank has built and operates its sixth branch. In February 2009, the
Bank has filed an application with the NJDOBI for the approval to establish a
mini branch of the bank located at 6000 Midlantic Drive, Suite 90, in Mount
Laurel, New Jersey. The new branch in Mount Laurel is expected to open during
the second quarter of 2009.
Competition
The banking business is highly competitive. The Bank faces substantial
competition both in attracting deposits and in originating loans. The Bank
competes primarily with both local and regionally-based commercial banks,
savings banks and savings and loan associations, most of which have greater
assets, capital and lending limits. Other competitors include mutual funds,
mortgage bankers, insurance companies, stock brokerage firms, regulated small
loan companies, credit unions and issuers of commercial paper and other
securities.
The Bank's larger competitors have greater financial resources than the
Bank to finance wide-ranging advertising campaigns. The Bank conducts only
limited media advertising, and its initial marketing efforts have depended
heavily upon its Board of Directors' and shareholders' referrals and employee
calling programs.
The Bank's core business consists of providing responsive, high quality
banking services to small businesses, professionals and retail customers living
and working in the Bank's market area. The Bank's officers and directors are
active in the Bank's market area and management believes that these communities
have supported, and will continue to support, a locally owned and managed
community bank committed to providing outstanding customer service and a broad
array of banking products driven by the Bank's customers' needs. The Bank
believes that this strategy provides the Bank with a competitive advantage over
other financial institutions by developing lasting customer relationships that
will enable the Bank to continue to attract core deposits and loans within the
Bank's market area.
3
Lending Activities
General. The Bank offers business and personal loans generally on a
secured basis, including: commercial loans (term and time); commercial lines of
credit; mortgage loans (conventional 30-year, commercial and jumbo real estate);
commercial and residential construction loans; letters of credit; and consumer
loans (home equity and installment). The Bank makes commercial loans to small
businesses primarily in the Bank's market area. The Bank's legal lending limit
to any one borrower is 15% of capital for most loans, and 25% of capital for
loans secured by certain types of readily marketable collateral. At December 31,
2008, all of the Bank's loans were below these limits to foster diversity within
the Bank's loan portfolio by avoiding undue concentration with any one borrower.
The Bank's ability to originate loans is dependent upon customer
demand, which is affected by the current and expected future level of interest
rates. Interest rates are affected by the demand for loans, the supply of money
available for lending purposes and the rates offered by competitors. Among other
things, these factors are, in turn, affected by economic conditions, monetary
policies of the federal government, including the Federal Reserve, and
legislative tax policies.
Commercial Loans. Commercial loans include short and long-term business
loans and commercial lines of credit for the purposes of providing working
capital, supporting accounts receivable, purchasing inventory and acquiring
fixed assets. The loans generally are secured by these types of assets as
collateral and/or by personal guarantees provided by principals of the
borrowers. The majority of the Bank's customers for these loans are small and
medium sized businesses located in the Bank's market area.
At December 31, 2008, commercial loans totaled $60.7 million or 31.2%
of the total loan portfolio, including $13.9 million in lines of credit.
Commercial business loans typically are made on the basis of the
borrower's ability to make repayment from the cash flow of the borrower's
business. As a result, the availability of funds for the repayment of commercial
business loans generally is substantially dependent on the success of the
business itself and the general economic environment. If the cash flow from
business operations is reduced, the borrower's ability to repay the loan may be
impaired.
Mortgage Loans. The Bank originates mortgage loans secured by real
estate primarily located in the Bank's market area. Included as mortgage loans
are commercial real estate, residential real estate and jumbo real estate loans.
At December 31, 2008, the Bank had $110.5 million, or 56.9% of the total loan
portfolio invested in commercial and residential real estate loans. The Bank's
real estate loans are primarily secured by first mortgages and to a lesser
extent by junior liens and consist of fixed-rate loans secured by various types
of real estate collateral as discussed below.
Commercial Real Estate
The Bank emphasizes the origination of commercial real estate loans
within its real estate portfolio. Loans on commercial properties are generally
originated in amounts up to the lower of 75% of the appraised value or cost of
the property and are secured by improved property such as multi-family dwelling
units, office buildings, retail stores, warehouse, church buildings and other
non-residential buildings, most of which are located in the Bank's market area.
Commercial real estate loans are generally made with fixed interest rates which
mature or reprice in five to seven years with principal amortization of up to 25
years.
Loans secured by commercial real estate are generally larger and
involve a greater degree of risk than one- to four-family residential mortgage
loans. Of primary concern, in commercial and multi-family real estate lending,
in addition to the borrower's creditworthiness, is the feasibility and cash flow
potential of the project. Payments on loans secured by income properties are
often dependent on successful operation or management of the properties. As a
result, repayment of such loans may be subject, to a greater extent than
residential real estate loans, to adverse conditions in the real estate market
or the economy.
Residential Real Estate
The majority of the Bank's residential mortgage loans consist of loans
secured by one- to four-family residences located in the Bank's market area. The
Bank generally originates one- to four-family residential mortgage loans in
amounts up to 80% of the lesser of the appraised value or selling price of the
mortgaged property without requiring mortgage insurance. A mortgage loan
originated by the Bank, for owner occupied property, whether fixed rate or
adjustable rate, can have a term of up to 30 years. Non-owner occupied property,
whether fixed rate or adjustable rate, can have a term of up to 25 years.
4
The Bank offers adjustable rate loans with fixed rate periods of up to
5 years, with principal and interest calculated using a maximum 30-year (owner
occupied) or 25-year (non-owner occupied) amortization period. In all cases, the
rates and terms for these loans follow Federal National Mortgage Association
("FNMA") guidelines and vary based on those guidelines. Adjustable rate loan
terms limit the periodic interest rate adjustment and the minimum and maximum
rates that may be charged over the term of the loan based on the type of loan.
All of the Bank's residential mortgages include "due on sale" clauses,
which are provisions giving the Bank the right to declare a loan immediately due
and payable if the borrower sells or otherwise transfers to a third party an
interest in the property serving as security for the loan. Due-on-sale clauses
are an important means of adjusting the rates on the Bank's fixed-rate mortgage
portfolio.
In some instances, the Bank charges a fee equal to a percentage of the
loan amount (commonly referred to as "points"). The Bank generally originates
residential mortgage loans in conformity with FNMA standards so that the loans
will be eligible for sale in the secondary market. The majority, but not all, of
the residential mortgage loans originated by the Bank historically have been
sold and have not been serviced by the Bank.
Appraisals
Property appraisals on real estate securing the Bank's loans are made
by state certified and licensed independent appraisers approved by the Board
Loan Committee, which is made up of members of the Board of Directors.
Appraisals are performed in accordance with applicable regulations and policies.
It is the Bank's policy to obtain title insurance policies on first mortgage
loans originated by the Bank.
Construction Loans. The Bank may originate loans to finance the
construction of commercial real estate and to a limited extent residential real
estate in the Bank's market area. Generally, the Bank will make construction
loans only if there is a permanent mortgage commitment in place. Interest rates
on commercial construction loans are typically in line with normal commercial
mortgage loan rates, while interest rates on residential construction loans are
slightly higher than normal residential mortgage loan rates. These loans usually
are adjustable rate loans and generally have terms of up to one year.
Construction financing is generally considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction and development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of construction costs proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the development. If the estimate of
value proves to be inaccurate, the Bank may be confronted, at or prior to the
maturity of the loan, with a project having a value which is insufficient to
assure full repayment. At December 31, 2008, construction loans totaled $12.3
million, or 6.3% of the total loan portfolio.
Letters of Credit. Standby letters of credit are conditional
commitments issued by the Bank to a third party on behalf of a customer. The
credit risk involved in issuing standby letters of credit is similar to that
involved in extending credit to customers. The Bank evaluates each customer's
creditworthiness on a case by case basis. Collateral obtained, if deemed
necessary by the Bank, is based on management's credit evaluation of the
customer. Collateral varies but may include accounts receivable, marketable
securities, inventory, property, plant and equipment, residential and commercial
real estate. At December 31, 2008, the Bank's obligations under standby letters
of credit totaled $718,000.
Consumer Loans. The Bank originates consumer loans, including
installment loans and home equity loans, secured by first or second mortgages on
homes owned or being purchased by the loan applicant.
5
Home equity term loans and credit lines are credit accommodations
secured by either a first or second mortgage on the borrower's residential
property. Interest rates charged on home equity term loans are generally fixed;
interest on credit lines is usually a floating rate related to the prime rate.
Home equity term loans are offered with terms of 5 to 15 years; home equity
lines are repaid at 1/180th of the outstanding principal balance each month. The
Bank generally requires a loan to value ratio in the range of 85% to 90% of the
appraised value, including any outstanding prior mortgage balance. At December
31, 2008, home equity loans totaled $10.5 million or 5.4% of the total loan
portfolio.
The Bank originates installment loans secured by a variety of
collateral, such as new and used automobiles. The Bank makes a very limited
number of unsecured installment loans, which includes unsecured revolving credit
reserve accounts. As of December 31, 2008, installment loans totaled $252,000,
or 0.1% of the total loan portfolio.
Loan Solicitation and Processing. Loan originations are derived from a
number of sources such as loan officers, the Board of Directors, customers,
borrowers and referrals from real estate brokers, accountants, attorneys and
shareholders.
Upon receipt of a loan application, a credit report is ordered and
reviewed to verify specific information relating to the loan applicant's
creditworthiness. Depending on the type, collateral and amount of the credit
request, various levels of internal approval may be necessary.
Loan Commitments. When a loan is approved, the Bank generally issues a
written commitment to the loan applicant. The commitment indicates the loan
approval terms and is generally valid for a period of up to 45 days. Most of the
Bank's commitments are accepted or rejected by the customer before the
expiration of the commitment. At December 31, 2008, the Bank had approximately
$42.5 million in loan commitments outstanding.
Loans to One Borrower. Under New Jersey banking law, the Bank is
generally subject to a loans-to-one-borrower limitation of 15% of capital funds.
At December 31, 2008, this loan to one borrower limit was approximately $2.9
million. This loans-to-one-borrower limit may be increased by an additional 10%
of adjusted capital funds, which at December 31, 2008 was approximately $1.9
million, if collateralized by readily marketable securities as defined by
regulation. At December 31, 2008, there were no loans outstanding or committed
to any borrower which individually or in the aggregate exceeded the applicable
limits.
Non-Performing and Problem Assets
Loan Delinquencies. The Bank's collection procedures provide that after
a loan is 15 days past due a late charge is added. The borrower is contacted by
mail or telephone and payment is requested. If the delinquency continues,
subsequent efforts are made to contact the borrower. If the loan continues to be
delinquent for 90 days or more, the Bank usually initiates foreclosure
proceedings unless other repayment arrangements are made. Each delinquent loan
is reviewed on a case-by-case basis in accordance with the Bank's lending
policy.
Delinquent loans 90 days or more past due at December 31, 2008,
consisted of three loans totaling $2,375,000 as compared to five loans totaling
$971,000 at December 31, 2007. The delinquent loans as of December 31, 2008 and
2007, were considered well collateralized and in the process of collection and
were therefore still accruing interest.
Non-Performing Assets. Non-performing assets consist of non-accrual
loans, loans over ninety days delinquent and still accruing interest,
renegotiated loans and other real estate owned ("OREO"). Non-accrual loans are
those on which the accrual of interest has ceased. Loans are generally placed on
non-accrual status if, in the opinion of management, collection is doubtful, or
when principal or interest is past due 90 days or more, unless the collateral is
considered sufficient to cover principal and interest and the loan is in the
process of collection. Interest accrued, but not collected at the date a loan is
placed on non-accrual status, is reversed and charged against interest income.
Subsequent cash receipts are applied either to the outstanding principal or
recorded as interest income, depending on management's assessment of the
ultimate collectability of principal and interest. Loans are returned to an
accrual status when the borrower's ability to make periodic principal and
interest payments has returned to normal (i.e., brought current with respect to
principal or interest or restructured) and the paying capacity of the borrower
and/or the underlying collateral is deemed sufficient to cover principal and
interest.
Impaired loans are measured based on the present value of expected
future discounted cash flows, the market price of the loan or the fair value of
the underlying collateral if the loan is collateral dependent. The recognition
of interest income on impaired loans is the same as for non-accrual loans
discussed above. At December 31, 2008 and 2007, the Bank did not have any
non-accrual loans. At December 31, 2008, the Bank had three impaired loans
totaling $2,375,000 which are sufficiently collateralized and therefore no
specific reserves have been recorded against them. The average balance of
impaired loans totaled $2,383,000 for 2008, interest income recorded on impaired
loans during the year ended December 31, 2008 totaled $69,000. The Bank had no
impaired loans at December 31, 2007.
6
Classified Assets. Federal regulations provide for a classification
system for problem assets of insured institutions. Under this classification
system, problem assets of insured institutions are classified as "substandard,"
"doubtful" or "loss."
An asset is considered "substandard" if it involves more than an
acceptable level of risk due to a deteriorating financial condition, unfavorable
history of the borrower, inadequate payment capacity, insufficient security or
other negative factors within the industry, market or management. Substandard
loans have clearly defined weaknesses which can jeopardize the timely payments
of the loan.
Assets classified as "doubtful" exhibit all of the weaknesses defined
under the substandard category but with enough risk to present a high
probability of some principal loss on the loan, although not yet fully
ascertainable in amount.
Assets classified as "loss" are those considered uncollectible or of
little value, even though a collection effort may continue after the
classification and potential charge-off.
The Bank also internally classifies certain assets as "special
mention." Such assets do not demonstrate a current potential for loss but are
monitored in response to negative trends which, if not reversed, could lead to a
substandard rating in the future.
When an insured institution classifies problem assets as either
"substandard" or "doubtful," it may establish specific allowances for loan
losses in an amount deemed prudent by management. When an insured institution
classifies problem assets as "loss," it is required either to establish an
allowance for losses equal to 100% of that portion of the assets so classified
or to charge off such amount.
At December 31, 2008 the Bank had two loans totaling $261,000
classified as substandard constituting 0.1% of the Bank's loan portfolio,
compared to five loans totaling $777,000 classified as substandard at December
31, 2007, representing 0.5% of the Bank's then current loan portfolio. No loans
were classified as doubtful or loss at December 31, 2008 and 2007.
Foreclosed Real Estate. Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as Real Estate Owned
until such time as it is sold. When real estate owned is acquired, it is
recorded at the lower of the unpaid principal balance of the related loan or its
fair value, less disposal costs. Any write-down of real estate owned is charged
to operations. At December 31, 2008 the Bank had one property classified as real
estate owned with a carrying value of $281,000 as compared to one property with
a carrying value $466,000 at December 31, 2007. The change reflects adjustments
made to the carrying value during 2008.
Allowance for Losses on Loans and Real Estate Owned. It is the policy
of management to provide for inherent losses on unidentified loans in its
portfolio in addition to classified loans. A provision for loan losses is
charged to operations based on management's evaluation of the estimated and
inherent losses in the Bank's loan portfolio. Management also periodically
performs valuations of real estate owned and establishes allowances to reduce
book values of the properties to their lower of cost or fair value, less
disposal costs, when necessary.
Although provisions have been established and segmented by type of
loan, based upon management's assessment of their differing inherent loss
characteristics, the entire allowance for losses on loans is available to absorb
further loan losses in any category.
Investment Securities Activities
The investment policy of the Bank is established by senior management
and approved by the Board of Directors. It is based on asset and liability
management goals and is designed to provide a portfolio of high quality
investments that optimize interest income and provide acceptable limits of
safety and liquidity. At December 31, 2008, the Bank's investment policy allowed
investments in instruments such as: (i) U.S. Treasury obligations, (ii) U.S.
federal agency or federally sponsored agency obligations, (iii) state and
municipal obligations, (iv) mortgage-backed securities, (v) banker's
acceptances, (vi) certificates of deposit, and (vii) investment grade corporate
bonds and commercial paper. The Board of Directors may authorize additional
investments.
7
The Bank invests in securities based on their investment grade. The
investment portfolio predominantly consists of securities issued or guaranteed
by the United States Government and its agencies. In accordance with Statement
of Financial Accounting Standard (SFAS) No. 115, the Bank classifies its
investment securities at the time of purchase as either "trading," "available
for sale" ("AFS") or "held to maturity" ("HTM"). To date, management has not
purchased any securities for trading purposes. Management classifies most
securities as HTM, and to a lesser extent, AFS. AFS securities are carried at
fair value in the statements of financial condition with an adjustment to
equity, for changes in the fair value of securities, net of tax. The adjustment
to equity, net of tax, is presented in the caption "Accumulated other
comprehensive loss."
At December 31, 2008, the Bank held an HTM investment portfolio with
an amortized cost of $28.4 million, or 11.5% of total assets, with an estimated
fair market value of $28.5 million. The Bank had no AFS investments as of
December 31, 2008.
Sources of Funds
General. Deposits are the major external source of the Bank's funds for
lending and investment activities as well as for general business purposes. In
addition to deposits, the Bank derives funds from the amortization, prepayment
or sale of loans, maturities and repayments of investment securities and
operations. Scheduled loan principal repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are
significantly influenced by general interest rates and market conditions.
Deposits. The Bank offers a broad range of deposit instruments, including
personal and business checking accounts, individual retirement accounts,
business money market accounts, statement savings, and term certificate accounts
at competitive interest rates. Deposit account terms vary according to the
minimum balance required, the time periods that the funds must remain on deposit
and the interest rate, among other factors. The Bank also offers a three-tiered
form of personal demand account, paying progressively higher rates of interest
as account balances increase. The Bank regularly evaluates the internal cost of
funds, surveys rates offered by competing institutions, reviews the Bank's cash
flow requirements for lending and liquidity and executes rate changes when
deemed appropriate.
Consumer and commercial deposits are attracted principally from within
the Bank's market area. The Bank does not obtain funds through brokers, nor does
it solicit funds outside the State of New Jersey.
Borrowings. Deposits are the primary source of funds for the Bank's
lending and investment activities as well as for general business purposes.
However, should the need arise, the Bank has access to unsecured, overnight
lines of credit in the amount of $3.0 million, on an uncommitted basis through
Atlantic Central Bankers Bank. This arrangement is for the sale of federal funds
to the Bank subject to the availability of such funds. At December 31, 2008 and
2007, the Bank had no balances outstanding against this line of credit.
The Bank also has an available credit line under the Overnight Repricing
Advance Program with the Federal Home Loan Bank ("FHLB") in the aggregate amount
of $41.0 million. At December 31, 2008 and 2007, the Bank had no advances
outstanding against the credit line under the Overnight Repricing Advance
Program.
The Bank's membership in the FHLB also provides the Bank with additional
secured borrowing capacity of up to a maximum of 25% of the Bank's total assets,
subject to certain conditions. At December 31, 2008, the Bank was eligible to
borrow an additional $10.2 million. At December 31, 2008, the Bank had advances
outstanding with the FHLB in the amount of approximately $26.3 million at a
weighted average interest rate of 3.62%.
On February 17, 2009, the Company entered into a non-revolving line of
credit loan agreement with Atlantic Central Bankers Bank for an amount up to
$5,000,000. The Company has drawn $4,500,000 under the loan and has contributed
$4,400,000 as additional capital to the Bank.
8
Personnel
At March 13, 2009, the Bank had 57 full-time and 9 part-time employees.
None of the Bank's employees are represented by a collective bargaining group.
The Bank believes that its relationship with its employees is good.
Regulation
Bank holding companies and banks are extensively regulated under both
federal and state law. These laws and regulations are intended to protect
depositors, not stockholders. To the extent that the following information
describes statutory and regulatory provisions, it is qualified in its entirety
by reference to the particular statutory and regulatory provisions. Any change
in the applicable law or regulation may have a material effect on the business
and prospects of the Company and the Bank.
Bank Holding Company Regulation
General
As a bank holding company registered under the Bank Holding Company Act
of 1956, as amended, (the BHCA), we are subject to the regulation and
supervision of the Board of Governors of the Federal Reserve System (FRB). We
are required to file with the FRB annual reports and other information regarding
our business operations and those of our subsidiaries.
The BHCA requires, among other things, the prior approval of the FRB in
any case where a bank holding company proposes to (i) acquire all or
substantially all of the assets of any other bank, (ii) acquire direct or
indirect ownership or control or more than 5% of the outstanding voting stock of
any bank (unless it owns a majority of such bank's voting shares) or (iii) merge
or consolidate with any other bank holding company. The FRB will not approve any
acquisition, merger, or consolidation that would have a substantially
anti-competitive effect, unless the anti-competitive impact of the proposed
transaction is clearly outweighed by a greater public interest in meeting the
convenience and needs of the community to be served. The FRB also considers
capital adequacy and other financial and managerial resources and future
prospects of the companies and the banks concerned, together with the
convenience and need of the community to be served when reviewing acquisitions
or mergers.
The BHCA also generally prohibits a bank holding company, with certain
limited exceptions, from (i) acquiring or retaining direct or indirect ownership
or control of more than 5% of the outstanding voting stock of any company which
is not a bank or bank holding company; or (ii) engaging directly or indirectly
in activities other than those of banking, managing or controlling banks, or
performing services for its subsidiaries, unless such non-banking business is
determined by the FRB to be so closely related to banking or managing or
controlling banks as to be properly incident thereto. In making such
determinations, the FRB is required to weigh the expected benefits to the
public; such as, greater convenience, increased competition or gains in
efficiency, against the possible adverse effects; such as, undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound
banking practices.
In addition, the BHCA was amended through the Gramm-Leach-Bliley
Financial Modernization Act of 1999 (the "GLBA"). Under the terms of the GLBA,
bank holding companies whose subsidiary banks meet certain capital, management
and Community Reinvestment Act standards are permitted to apply to become
financial holding companies, which may engage in a substantially broader range
of non-banking activities than is permissible for bank holding companies under
the BHCA. These activities include certain insurance, securities and merchant
banking activities. In addition, the GLBA amendments to the BHCA remove the
requirement for advance regulatory approval for a variety of activities and
acquisitions by financial holding companies. As our business is currently
limited to activities permissible for a bank, we have not elected to become a
financial holding company.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance fund in the event the
depository institution becomes in danger of default. Under a policy of the FRB
with respect to bank holding company operations, a bank holding company is
required to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The FRB also has the
authority under the BHCA to require a bank holding company to terminate any
activity or to relinquish control of a non-bank subsidiary upon the FRB's
determination that such activity or control constitutes a serious risk to the
financial soundness and stability of any bank subsidiary of the bank holding
company.
9
Capital Adequacy Guidelines for Bank Holding Companies
The FRB has adopted risk-based capital guidelines for bank holding
companies. The risk-based capital guidelines are designed to make regulatory
capital requirements more sensitive to differences in risk profile among banks
and bank holding companies, to account for off-balance sheet exposure and to
minimize disincentives for holding liquid assets. Under these guidelines, assets
and off-balance sheet items are assigned to broad risk categories each with
appropriate weights. The resulting capital ratios represent capital as a
percentage of total risk-weighted assets and off-balance sheet items. The
risk-based guidelines apply on a consolidated basis to bank holding companies
with consolidated assets of $500 million or more, and to certain bank holding
companies with less then $500 million in assets if they are engaged in
substantial non-banking activity or meet certain other criteria. We do not meet
these criteria, and so are not subject to a minimum consolidated capital
requirement. In addition to the risk-based capital guidelines, the FRB has
adopted a minimum Tier I capital (leverage) ratio, under which a bank holding
company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company that
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a leverage ratio of at least 100 to 200 basis points above the
stated minimum. The leverage requirement also only applies on a consolidated
basis if the risk based capital requirements discussed above apply to a holding
company on a consolidated basis. We do not have a minimum consolidated capital
requirement at the holding company level at this time.
Bank Regulation
General. As a New Jersey-chartered commercial bank, the Bank is subject
to the regulation, supervision, and control of the New Jersey Department of
Banking and Insurance. As an FDIC-insured institution, the Bank is subject to
the regulation, supervision and control of the FDIC, an agency of the federal
government. The regulations of the FDIC and the New Jersey Department of Banking
and Insurance affect virtually all activities of the Bank, including the minimum
level of capital the Bank must maintain, the ability of the Bank to pay
dividends, the ability of the Bank to expand through new branches or
acquisitions and various other matters.
Insurance of Deposits. . During the third quarter of 2008, Congress
instituted the Emergency Economic Stabilization Act (the "EESA") to address the
dysfunctional credit markets. Among other things, the Act authorized a temporary
increase in the FDIC insurance limit to $250 thousand from $100 thousand per
account. In addition, the FDIC implemented a program to insure all deposits held
in noninterest-bearing transactional accounts, regardless of amount, at
institutions which do not opt out of the program and which pay an additional
assessment to the FDIC. Both increases in deposit insurance will expire on
December 31, 2009, unless extended, and the prior limits, described below, will
go back into effect. The Bank elected not to opt out of this program, and is
paying the required additional assessment.
Prior to the fall of 2008, the Bank's deposits were insured up to a
maximum of $100 thousand per depositor ($250 thousand per IRA account) under the
Deposit Insurance Fund of the FDIC. Pursuant to the Federal Deposit Insurance
Corporation Improvements Act of 1991 ("FDICIA"), the FDIC has established a
risk-based assessment system. Premium assessments under this system are based
upon: (i) the probability that the insurance fund will incur a loss with respect
to the institution; (ii) the likely amount of the loss; and (iii) the revenue
needs of the insurance fund. To effectuate this system, the FDIC has developed a
matrix that sets the assessment premium for a particular institution in
accordance with its capital level and overall rating by the primary regulator.
The FDIC has significantly increased deposit insurance assessment
rates, commencing in the second quarter of 2009. As increased, the adjusted base
assessment rates will range from 12 to 77.5 basis points of deposits, a
significant increase over premium rates for the past several years. In addition,
the Bank will pay a special assessment of 10 basis points of the amount of
deposits in excess of $250,000 held in non-interest bearing transactional
accounts under the enhanced insurance program discussed above. Finally, the FDIC
has proposed a special assessment equal to twenty (20) basis points of insured
deposits as of June 30, 2009, to be paid on September 30, 2009. This proposal
has not yet been finalized. The FDIC in this proposal has also reserved the
right to impose one or more additional special assessments of ten (10) basis
points if needed to recapitalize the Deposit Insurance Fund.
10
Dividends. Under the New Jersey Banking Act of 1948, as amended, a bank
may declare and pay dividends only if (i) after payment of the dividend the
capital stock of the bank will be unimpaired, and (ii) either the bank will have
a surplus of not less than 50% of its capital stock or the payment of the
dividend will not reduce the bank's surplus. The Federal Deposit Insurance Act
generally prohibits the payment of dividends by an insured bank if, after making
the distribution, the bank would be undercapitalized or if the bank is in
default of any assessment to the FDIC. Additionally, either the New Jersey
Department of Banking and Insurance or the FDIC may prohibit a bank from
engaging in unsafe or unsound practices, and it is possible that under certain
circumstances such entities could claim that a dividend payment constitutes an
unsafe or unsound practice and therefore is prohibited.
The Bank has never paid a cash dividend, and the Company will not
likely pay a cash dividend in the foreseeable future. On May 15, 2007, the Bank
paid a 5% stock dividend on all outstanding shares of its common stock. On
February 20, 2008, the Bank's Board of Directors declared a 7.5% stock dividend
on all outstanding shares of its common stock, subject to regulatory approval by
the New Jersey Department of Banking and Insurance. The stock dividend was paid
on May 15, 2008 to common shareholders of record as of the close of business on
April 2, 2008.
Capital Adequacy Guidelines. The Bank is subject to risk-based capital
guidelines promulgated by the FDIC that are designed to make regulatory capital
requirements more sensitive to differences in risk profile among banks, to
account for off-balance sheet exposure, and to minimize disincentives for
holding liquid assets. Under the guidelines, assets and off-balance sheet items
are assigned to broad risk categories, each with appropriate weights. The
resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items.
The minimum ratio of total capital to risk-weighted assets (including
certain off-balance sheet activities, such as standby letters of credit) is 8%.
At least 4% of the total capital is required to be "Tier I Capital," consisting
of common shareholders' equity and qualifying preferred stock, less certain
goodwill items and other intangible assets. The remainder ("Tier II Capital")
may consist of (a) the allowance for loan losses of up to 1.25% of risk-weighted
assets, (b) excess of qualifying preferred stock, (c) hybrid capital
instruments, (d) perpetual debt, (e) mandatory convertible securities, and (f)
qualifying subordinated debt and intermediate-term preferred stock up to 50% of
Tier I capital. Total capital is the sum of Tier I and Tier II capital less
reciprocal holdings of other banking organizations, capital instruments,
investments in unconsolidated subsidiaries and any other deductions as
determined by the FDIC (determined on a case-by-case basis or as a matter of
policy after formal rule-making).
In addition to the risk-based capital guidelines, the FDIC has adopted
a minimum Tier I capital (leverage) ratio, under which a bank must maintain a
minimum level of Tier I capital to average total consolidated assets of at least
3% in the case of a bank that has the highest regulatory examination rating and
is not contemplating significant growth or expansion. All other banks are
expected to maintain a leverage ratio of at least 100 to 200 basis points above
the stated minimum.
The Bank was in compliance with the applicable minimum capital
requirements at December 31, 2008 and 2007. As of December 31, 2008, the Bank's
management believes that the Bank was "adequately-capitalized" under applicable
FDIC capital adequacy regulations.
On October 31, 2008, the Bank issued a hybrid capital instrument
in the form of subordinated debt which qualifies as Tier II capital in the
aggregate amount of $3.0 million. The term of the debt is for a six year period
with a maturity date of November 1, 2014, and the interest rate is fixed at
5.00% for the first year and then adjusts to a variable rate equal to the prime
rate for the remaining five years. The debt security is redeemable at par after
April 30, 2009 at the Bank's option.
Additional information regarding the Bank's capital is referenced in
Note 17, "Regulatory Matters," to Notes To Consolidated Financial Statements in
the financial statements appearing in this Form 10-K.
Community Reinvestment Act. Under the Community Reinvestment Act, as
amended ("CRA"), as implemented by Federal regulations, a bank has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. CRA does not establish specific lending requirements or programs
for financial institutions nor does it limit an institution's discretion to
develop the types of products and services that it believes are best suited to
its particular community, consistent with CRA. CRA requires the institution's
primary Federal regulator to assess an institution's record of meeting the
credit needs of its community and to take such record into account in its
evaluation of certain applications by such institution. The CRA requires public
disclosure of an institution's CRA rating and requires that the institution's
primary Federal regulator provide a written evaluation of an institution's CRA
performance utilizing a four-tiered descriptive rating system. An institution's
CRA rating is considered in determining whether to approve, branches and other
deposit facilities, relocations, mergers, consolidations and acquisitions.
Performance less than satisfactory may be the basis for denying an application.
On December 4, 2007, the last examination date, the Bank received a CRA rating
of satisfactory.
11
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 ("Interstate Act"), among other things, permits bank
holding companies to acquire banks in any state. A bank may merge with a bank in
another state so long as both states have not opted out of interstate branching.
New Jersey and Pennsylvania enacted laws permitting interstate merger and
interstate branching transactions. Interstate acquisitions and mergers are
subject, in general, to certain concentration limits and state entry rules
relating to the age of the bank.
Under the Interstate Act, the responsible federal regulatory agency is
permitted to approve the acquisition of a branch of an insured bank by an
out-of-state bank or bank holding company without the acquisition of the entire
bank or the establishment of a "de novo" branch only if the law of the state in
which the branch is located permits out-of-state banks to acquire a branch of a
bank without acquiring the bank or permits out-of-state banks to establish "de
novo" branches. Pennsylvania passed such a law. The corresponding New Jersey law
does not authorize establishment of interstate branches other than by means of
acquiring such branches from another institution.
Under the Interstate Act, branches of state-chartered banks that
operate in other states are covered by the laws of the chartering state, rather
than the host state.
Gramm-Leach-Bliley Act. In 1999, federal legislation was enacted that
allows bank holding companies to engage in a wider range of non-banking
activities, including greater authority to engage in securities and insurance
activities. The Gramm-Leach-Bliley Act ("GLB Act") provides that state banks may
invest in financial subsidiaries (assuming they have the requisite investment
authority under applicable state law) subject to the same conditions that apply
to national bank investments in financial subsidiaries. National banks are also
authorized by the GLB Act to engage, through "financial subsidiaries," in any
activity that is permissible for a financial holding company and any activity
that the Secretary of the Treasury, in consultation with the Federal Reserve
Board, determines is financial in nature or incidental to any such financial
activity, except (1) insurance underwriting, (2) real estate development or real
estate investment activities (unless otherwise permitted by law), (3) insurance
company portfolio investments, and (4) merchant banking.
The GLB Act also contains a number of other provisions that affect the
Bank's operations and the operations of all financial institutions. One of the
provisions relates to the financial privacy of consumers, authorizing federal
banking regulators to adopt rules that limit the ability of banks and other
financial entities to disclose non-public information about consumers to
non-affiliated entities. These limitations require more disclosure to consumers,
and in some circumstances, require consent by the consumer before information is
allowed to be provided to a third party.
USA Patriot Act. On October 26, 2001, an anti-terrorism bill, the
International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001,
was signed into law. This law restricts money laundering by terrorists in the
United States and abroad. This Act specifies new "know your customer"
requirements that obligate financial institutions to take actions to verify the
identity of the account holders in connection with opening an account at any
financial institution. Banking regulators consider compliance with the Act's
money laundering provisions in making decisions regarding approval of
acquisitions and mergers. In addition, sanctions for violations of the Act can
be imposed in an amount equal to twice the sum involved in the violating
transactions, up to $1 million.
Sarbanes-Oxley Act. On July 30, 2002, the Sarbanes-Oxley Act of 2002
was signed into law. This Act addresses many aspects of financial reporting,
corporate governance and disclosure by publicly-held companies, including banks
and bank holding companies. Among other things, it establishes a comprehensive
framework for the oversight of public company auditing and for strengthening the
independence of auditors and the audit committees of boards of directors. Under
the Act, audit committees are responsible for the appointment, compensation and
oversight of the work of the independent auditors. Both audit and non-audit
services to be provided to a company by its independent auditor must be approved
in advance by the audit committee and the independent auditors are prohibited
from performing certain types of non-audit services for companies which they
audit. As directed by Section 404 of the Sarbanes-Oxley Act, the SEC adopted
rules requiring public companies to include a report of management on the
company's internal control over financial reporting in their annual reports on
Form 10-K that contains an assessment by management of the effectiveness of the
company's internal control over financial reporting. This requirement was
effective for fiscal year 2007. In addition, in the future, the independent
registered public accounting firm auditing the Bank's financial statements must
attest to the effectiveness of the Bank's internal control over financial
reporting. This requirement is not yet effective for smaller companies like the
Company. The Act also imposes significant responsibilities on officers,
auditors, boards of directors and board committees. The Act imposes restrictions
on and accelerated reporting requirements for certain trading activities by
insiders.
12
On October 8, 2008, the Emergency Economic Stabilization Act (the
"EESA") was signed into law. On October 14, 2008, the United States Treasury
(the "UST") announced its Troubled Assets Relief Program ("TARP") Capital
Purchase Program ("CPP"). Under the CPP, the UST will purchase shares of senior
preferred stock in insured depository institutions or their holding companies,
bearing a dividend rate of 5%. In addition, participating institutions must
issue to the UST common stock purchase warrants, permitting the UST to purchase
common stock with a value equal to 15% of the UST's preferred stock investment.
The Company applied for participation in the CPP. However, the Company's Board
of Director's has elected not to participate in the CPP due to a number of
factors, including the changed public perception of the CPP and changes to the
terms of the CPP.
On February 16, 2009, the American Recovery and Reinvestment Act of
2009 (the "ARRA") was adopted. Among other things, the ARRA amended various
provisions of the EESA to, among other things, substantially restrict executive
compensation for those entities that participate in the CPP, including those
institutions that participated prior to the adoption of the ARRA, impose more
stringent reporting requirements on such institutions and requires such
institutions to permit their shareholders to have a non-binding, advisory vote
on executive compensation.
ITEM 1-A - Risk Factors
Potential investors in the Company should carefully consider the
following risk factors prior to making any investment decisions regarding the
Company's securities.
Our FDIC deposit insurance premiums have increased and may continue to
increase, substantially increasing our non-interest expense.
During 2008 and 2009, the FDIC has significantly increased its assessments for
deposit insurance due to the weakness in the economy and the increased number of
bank failures. In 2007, we paid $127,000 in deposit insurance assessments, and
in 2008 this increased to $201,000. Premium assessment rates in 2007 ranged from
5 to 43 basis points. The FDIC has recently announced an increased assessment,
to go into effect for the second quarter of 2009, which will raise insurance
premiums for the healthiest banks by 7 basis points, with the new assessments
ranging from 12 to 77.5 basis points. Banks like the Bank that have opted to
remain eligible for the FDIC's increased insurance program for non-interest
bearing deposit must also pay an assessment of 10 basis points of the amount of
non-interest bearing deposits in excess of $250,000. Finally, the FDIC has
proposed a special assessment of 20 basis points of insured deposits as of June
30, 2009, to be paid September 30, 2009, with the possibility of additional 10
basis point special assessments if needed to recapitalize the Deposit Insurance
Fund. This proposal is still under review and may be modified. However, had the
special assessment been in effect on our deposits at December 31, 2008 at the
proposed rate, we would have paid approximately $404,000. These additional costs
will adversely affect our results of operations.
The nationwide recession may adversely affect our business by reducing
real estate values in our trade area and stressing the ability of our
customers to repay their loans.
Our trade area, like the rest of the United States, is currently experiencing
economic contraction. As a result, many companies have experienced reduced
revenues and have laid off employees. These factors have stressed the ability on
both commercial and consumer customers to repay their loans, and have, and may
in the future, result in higher levels of non-accrual loans. In addition, real
estate values have declined in our trade area. Since the majority of our loans
are secured by real estate, declines in the market value of real estate impact
the value of the collateral securing our loans, and could lead to greater losses
in the event of defaults on loans secured by real estate.
Our success will depend upon our ability to effectively manage our
future growth.
The Bank currently expects to open an additional branch in mid-2009.
This new branch will place an additional burden on the Bank's management and
systems, including data processing systems and internal controls. The Bank's
continued growth and profitability depend on the ability of its officers and key
employees to manage such growth effectively, to attract and retain skilled
employees and to maintain adequate internal controls. Accordingly, there can be
no assurance that the Bank will be successful in managing its expansion, and the
failure to do so would adversely affect its financial condition and results of
operations.
13
If the Bank is unable to continue to grow, its long term profitability
and financial condition may be adversely affected.
The Bank has been successful at opening new branch locations over the
past several years and anticipates the opening of an additional branch in
mid-2009. The Bank's future profitability will depend in part on its continued
ability to grow. Various factors, such as economic conditions, regulatory and
legislative considerations and competition, may impede or prohibit the Bank's
ability to open or acquire new branch offices.
If we experience loan losses in excess of our allowance, our earnings
will be adversely affected.
The risk of credit losses on loans varies with, among other things,
general economic conditions, the type of loan being made, the creditworthiness
of the borrower over the term of the loan and, in the case of a collateralized
loan, the value and marketability of the collateral for the loan. Management
maintains an allowance for loan losses based upon, among other things,
historical experience, an evaluation of economic conditions and regular reviews
of delinquencies and loan portfolio quality. Based upon such factors, management
makes various assumptions and judgments about the ultimate collectability of the
loan portfolio and provides an allowance for loan losses based upon a percentage
of the outstanding balances and for specific loans when their ultimate
collectability is considered questionable. If management's assumptions and
judgments prove to be incorrect and the allowance for loan losses is inadequate
to absorb future losses, or if the bank regulatory authorities require it to
increase the allowance for loan losses as a part of their examination process,
our earnings and capital could be significantly and adversely affected.
Our business is geographically concentrated and is subject to regional
economic factors that could have an adverse impact on our business.
Substantially all of the Bank's business is with customers in its
market area of southern New Jersey. The Bank emphasizes commercial real estate
and commercial lending to small businesses and professionals, many of which are
dependent upon the regional economy. Adverse changes in economic and business
conditions in the Bank's markets could adversely affect its borrowers, their
ability to repay their loans and to borrow additional funds, and consequently
our financial condition and performance.
The loss of our executive officers and certain other key personnel
would hurt our business.
Our success depends, to a great extent, upon the services of our
executive officers. From time to time, we also need to recruit personnel to fill
vacant positions for experienced lending and credit administration officers.
Competition for qualified personnel in the banking industry is intense, and
there can be no assurance that we will continue to be successful in attracting,
recruiting and retaining the necessary skilled managerial, marketing and
technical personnel for the successful operation of our existing lending,
operations, accounting and administrative functions or to support the expansion
of the functions necessary for its future growth. Our inability to hire or
retain key personnel could have a material adverse effect on our results of
operations.
There is a limited trading market for the Company's common stock, which
may adversely impact an investor's ability to sell shares and the price
it received for shares.
There is no established and liquid trading market for our common stock.
Although our common stock is approved for quotation on the OTC Bulletin Board,
an electronic inter-dealer trading market, trading our common stock is limited,
sporadic and volatile. This means that there is limited liquidity for our common
stock, which may make it difficult for investors to buy or sell our common
stock, may negatively affect the price of our common stock and may cause
volatility in the price of our common stock.
The Bank operates in a competitive market which could constrain its
future growth and profitability.
The Bank operates in a competitive environment, competing for deposits
and loans with commercial banks, savings associations and other financial
entities. Competition for deposits comes primarily from other commercial banks,
savings associations, credit unions, money market and mutual funds and other
investment alternatives. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries. Many of the financial intermediaries
operating in the Bank's market area offer certain services, which the Bank does
not offer. Moreover, banks with a larger capitalization and financial
intermediaries not subject to bank regulatory restrictions, have larger lending
limits and are thereby able to serve the needs of larger customers. If the Bank
is not able to attract new deposit and lending customers, its future growth and
profitability will be adversely impacted.
14
We realizes income primarily from the difference between interest
earned on loans and investments and interest paid on deposits and
borrowings, and changes in interest rates may adversely affect our
profitability and assets.
Changes in prevailing interest rates may hurt our business. We derive
our income mainly from the difference or "spread" between the interest earned on
loans, securities and other interest-earning assets, and interest paid on
deposits, borrowings and other interest-bearing liabilities. In general, the
larger the spread, the more we earn. When market rates of interest change, the
interest the Bank receives on its assets and the interest it pays on its
liabilities will fluctuate. This can cause decreases in our spread and can
adversely affect our income.
Interest rates affect how much money the Bank can lend. For example,
when interest rates rise, the cost of borrowing increases and loan originations
tend to decrease. In addition, changes in interest rates can affect the average
life of loans and investment securities. A reduction in interest rates generally
results in increased prepayments of loans and mortgage-backed securities, as
borrowers refinance their debt in order to reduce their borrowing cost. This
causes reinvestment risk, because the Bank generally is not able to reinvest
prepayments at rates that are comparable to the rates it earned on the prepaid
loans or securities. Changes in market interest rates could also reduce the
value of the Bank's financial assets. If we are unsuccessful in managing the
effects of changes in interest rates, our financial condition and results of
operations could suffer.
As a public company, our business is subject to numerous reporting
requirements that are currently evolving and could substantially
increase its operating expenses and divert management's attention from
the operation of its business.
The Sarbanes-Oxley Act of 2002 has required changes in some of our
corporate governance, securities disclosure and compliance practices. In
response to the requirements of that Act, the Securities and Exchange Commission
("SEC") has promulgated rules covering a variety of subjects. Compliance with
these rules has significantly increased our legal and financial and accounting
costs, and we expect these increased costs to continue. In addition, compliance
with the requirements has taken a significant amount of management's and the
Board of Directors' time and resources. Likewise, these developments may make it
more difficult for us to attract and retain qualified members of our board of
directors, particularly independent directors, or qualified executive officers.
Future governmental regulation and legislation could negatively effect
our future results of operation.
We are subject to extensive state and federal regulation, supervision
and legislation that govern almost all aspects of our operations. These laws may
change from time to time and are primarily intended for the protection of
consumers and depositors. Any changes to these laws may increase our costs and
negatively impact our business. While we cannot predict what effect any
presently contemplated or future changes in the laws or regulations or their
interpretations would have on us, these changes could be materially adverse to
our shareholders.
We cannot predict how changes in technology will impact our business.
The financial services market, including banking services, is
increasingly affected by advances in technology, including developments in: o
telecommunications; o data processing;
o automation;
o internet-based banking;
o tele-banking; and
o debit cards and so-called "smart cards."
15
Our ability to compete successfully in the future will depend on
whether we can anticipate and respond to technological changes. To develop these
and other new technologies, we will likely have to make additional capital
investments. Although we continually invest in new technology, we cannot assure
you that we will have sufficient resources or access to the necessary
proprietary technology to remain competitive in the future.
Item 2. Description of Property
(a) Properties.
Corporate Headquarters. On October 11, 2007, the Bank entered into
a Lease with 6000 Midlantic Drive Associates, L.L.C. for the lease of
approximately 8,121 rentable square feet of office space located at 6000
Midlantic Drive in Mount Laurel, New Jersey. This office serves as the corporate
headquarters, but does not include a banking facility. The term of the lease is
ten (10) years beginning on February 1, 2008 and expiring on January 31, 2018.
The base monthly rent is initially set at $10,828 per month, and increases
incrementally to $12,182 per month over the ten (10) year term. The Bank must
also pay additional rent in the form of its pro rata share of taxes and
operating costs for the building in which the offices are located, which the
landlord initially estimates to be $7,607 per month. Upon expiration of the
initial ten (10) year term, the Bank may choose to extend the lease for up to
two more five (5) year terms at base monthly rental rates of $12,858 per month
for the first option term and $13,535 per month for the second option term.
Moorestown, Route 38, NJ Branch. This retail branch facility is located
at 300 West Route 38, Moorestown, New Jersey. The Bank leases this facility
which consists of approximately 6,000 square feet plus two adjoining
drive-through lanes. The facility includes teller windows, a lobby area,
drive-through windows, an automated teller machine, and a night depository.
The Bank's lease had an initial term of five years and commenced April
1, 1999, with three five-year renewal options. The Bank exercised its first
lease renewal option leaving two five-year renewal options remaining. Since the
Bank will not exercise the remaining renewal options, the current lease term
will expire on March 31, 2009. The rental expense was $6,324 per month during
the initial five-year term ending March 31, 2004 and is $9,034 per month during
the current five-year renewal term.
Medford, NJ Branch. On October 10, 2002, the Bank opened a new branch
office located at 170 Himmelein Road, Medford, New Jersey in a stand-alone
office facility of approximately 3,000 square feet plus two adjoining
drive-through lanes. The branch includes teller windows, a lobby area,
drive-through windows, an automated teller machine, a night depository and a
safe deposit vault.
The Bank's lease for this location has an initial term of ten years and
commenced November 1, 2002, with four five-year renewal options. If the Bank
does not exercise its renewal options, the current lease term will expire on
October 31, 2012. The rental expense was $7,916 per month for the first five
years and increased to $8,750 per month for the remaining five years of the
initial ten-year lease term.
Burlington, NJ Branch. On August 4, 2003, the Bank opened a new branch
office located at 115 East Broad Street, Burlington City, New Jersey. The Bank
moved from this office to a new branch office on 353 High Street in Burlington
City in February 2008. The new branch office includes approximately 1,800 square
feet of rentable area and is being leased pursuant to a Lease Agreement, dated
October 10, 2007. The lease is for an initial term of one hundred twenty (120)
months commencing February 2008. The monthly rental rate is initially set at
$3,800 per month, and increases incrementally over the one hundred twenty (120)
month lease term to a maximum of $4,218 per month. At the end of the initial
term, the Bank may extend the lease for up to an additional three terms of one
hundred twenty (120) months each, at rental rates ranging from $4,682 to $7,889
per month.
Cherry Hill, NJ Branch. On February 10, 2006, the Bank opened a new
branch office located at 1405 Route 70 East, Cherry Hill, New Jersey in a
stand-alone office facility of approximately 3,000 square feet plus two
adjoining drive-through lanes. The branch includes teller windows, a lobby area,
drive-through windows, an automated teller machine, a night depository and a
safe deposit vault.
16
Voorhees, NJ Branch. On October 18, 2006, the Bank opened a new branch
office located at 133 Route 73, Voorhees, New Jersey in a stand-alone office
facility of approximately 3,000 square feet plus two adjoining drive-through
lanes. The branch includes teller windows, a lobby area, drive-through windows,
an automated teller machine and a night depository.
Moorestown, NJ Main Street Branch . In November 2006, the Bank acquired
a site in Moorestown, New Jersey for a purchase price of $445,000, where the
Bank built and now operates a full service branch. The new branch located at 253
West Main Street in Moorestown, a stand-alone- facility opened in June 2008.
The branch includes teller windows, a lobby area, drive-through windows, an
automated teller machine and a night depository.
Item 3. Legal Proceedings
The Bank, from time to time, is a party to routine litigation that
arises in the normal course of business. Management does not believe the
resolution of this litigation, if any, would have a material adverse effect on
the Bank's financial condition or results of operations. However, the ultimate
outcome of any such matter, as with litigation generally, is inherently
uncertain and it is possible that some of these matters may be resolved
adversely to the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
On October 28, 2008, the Bank held a special meeting of its
shareholders for the purpose of voting upon a Plan of Acquisition, whereby a
holding company, Cornerstone Financial Corporation, a New Jersey Corporation
will acquire 100% of the outstanding stock of the Bank. The Plan was adopted by
a two-thirds majority of the Bank's shareholders. The vote was as follows: for:
1,137,828 against: 33,073 abstain: 5,348 broker non-votes: 0.
PART II
Item 5. Market for Common Equity and Related Shareholder Matters
The Company's common stock is quoted on the OTC Bulletin Board under
the symbol "CBKJ". There are currently eight market makers in Cornerstone Bank
stock including: Automated Trading Desk Financial Services, LLC; Boenning &
Scattergood, Inc.; Domestic Securities Inc.; Ferris, Baker Watts Inc.; Hudson
Securities Inc.; Hill Thompson Magid & Company, Inc.; Monroe Securities, Inc.;
Knight Equity Markets, L.P.; Pershing, LLC; and Stifel, Nicholas & Company,
Incorporated.
The following sets forth the high and low bid prices of the common
stock on the OTC Bulletin Board for each of the quarters outlined below:
2008 2007
----------------------------------- -----------------------------------
High Low High Low
--------------- --------------- --------------- ----------------
First Quarter $ 8.51 $ 6.84 $ 12.05 $ 10.86
Second Quarter $ 8.45 $ 6.60 $ 11.80 $ 11.14
Third Quarter $ 7.50 $ 6.25 $ 11.50 $ 9.90
Fourth Quarter $ 7.55 $ 6.55 $ 11.00 $ 9.15
The quotations reflect inter-dealer bids, without retail mark-up,
mark-down or commission, and may not represent actual transactions. As of March
16, 2009, there were approximately 432 shareholders of record of the Company's
common stock, according to information provided by the Company's transfer agent.
Stock prices have been restated to reflect the 7.5% common stock
dividend paid on May 15, 2008 to shareholders of record as of the close of
business on April 2, 2008 and the 5.00% common stock dividend paid on May 15,
2007 to shareholders of record as of the close of business on April 2, 2007.
17
Item 6. Selected Financial Data
Not Applicable
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Summary
On July 17, 2008, the Board of Directors of the Bank approved a Plan of
Acquisition ("Plan"), which provided for the establishment of a bank holding
company to serve as the parent of the Bank. The Plan provided for the transfer
and contribution of all of the Bank's common stock held by shareholders to the
Company in a one-for-one exchange for the common stock of the Company.
The Plan was adopted by a two-thirds majority of the Bank's shareholders
on October 28, 2008. The holding company reorganization was consummated as of
the close of business on January 30, 2009. Therefore, the financial statements
and all other operating information contained in this annual report on Form 10-K
for the year ending December 31, 2008 are of the Bank on a stand alone basis.
The Bank engages in the business of commercial banking, primarily
within a geographic market area centered around its executive offices located at
300 West Route 38, Moorestown, New Jersey and its branch locations at 170
Himmelein Road, Medford, New Jersey, which opened in October 2002, 353 High
Street, Burlington City, New Jersey, which Burlington City branch originally
opened in August 2003 at another location (see "Description of Property" above),
1405 Route 70 East, Cherry Hill, New Jersey, which opened in February 2006, 133
Route 73, Voorhees, New Jersey which opened in October 2006 and 253 West Main
Street, Moorestown, New Jersey which opened in June 2008. The Bank operates as
an independent community bank offering a broad range of deposit and loan
products and services to the general public, and in particular, to small
businesses, local professionals and individuals residing and working in the
Bank's market area.
The operations of the Bank are substantially dependent on its net
interest income, which is the difference between the interest income received
from its interest-earning assets, such as loans and investment securities, and
the interest expense incurred in connection with the Bank's interest-bearing
liabilities, such as interest on deposit accounts and borrowed money. Net
interest income is affected by changes in both interest rates and the amounts
and types of interest-earning assets and interest-bearing liabilities
outstanding. The Bank also generates non-interest income such as service charges
on deposit accounts, fees from residential mortgage loans sold and other
miscellaneous income. The Bank's non-interest expense primarily consists of
employee compensation and benefits, net occupancy, data processing and
professional services, marketing and other operating costs. In addition, the
Bank is subject to losses from its loan and investment portfolios if borrowers
fail to meet their obligations or if the value of the securities is permanently
impaired. The results of the Bank's operations are also significantly affected
by general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory agencies.
Critical Accounting Policies
Allowance for Losses on Loans
The allowance for losses on loans is based on management's ongoing
evaluation of the loan portfolio and reflects an amount considered by management
to be its best estimate of known and inherent losses in the portfolio.
Management considers a variety of factors when establishing the allowance, such
as the impact of current economic conditions, diversification of the loan
portfolio, delinquency statistics, results of independent loan review and
related risk classifications. The Bank's historic loss rates and the loss rates
of peer financial institutions are also considered. In addition, certain
individual loans which management has identified as problematic are specifically
provided for, based upon an evaluation of the borrower's perceived ability to
pay, the estimated adequacy of the underlying collateral and other relevant
factors. Consideration is also given to the findings of examinations performed
by regulatory agencies. Although provisions have been established and segmented
by type of loan, based upon management's assessment of their differing inherent
loss characteristics, the entire allowance for losses on loans is available to
absorb further loan losses in any category.
18
Management uses significant estimates to determine the allowance for
loan losses. Since the allowance for loan losses is dependent, to a great
extent, on conditions that may be beyond the Bank's control, it is possible that
management's estimate of the allowance for loan losses and actual results could
differ materially in the near term.
In addition, regulatory authorities, as an integral part of their
examinations, periodically review the allowance for loan losses. They may
require additions to the allowance based upon their judgments about information
available to them at the time of examination.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is established
against deferred tax assets when, in the judgment of management, it is more
likely than not that such deferred tax assets will not become available. Because
the judgment about the level of future taxable income is dependent to a great
extent on matters that may, at least in part, be beyond our control, it is at
least reasonably possible that management's judgment about the need for a
valuation allowance for deferred taxes could change in the near term.
The following discussion focuses on the major components of the
Bank's operations and presents an overview of the significant changes in the
results of operations and financial condition. This section should be read in
conjunction with the Consolidated Financial Statements and accompanying Notes to
Consolidated Financial Statements.
Operating Results
The Bank recorded a net loss of $87,000 or $0.05 per share for the
year ended December 31, 2008, compared to a net loss of $88,000 or $0.05 per
share for the year ended December 31, 2007. The change in net income recorded
during the year ended December 31, 2008 reflects higher net interest income
primarily due to increased average interest earning asset balances along with
increased non-interest income offset by an impairment loss on other real estate
owned and increases in other real estate owned expenses and FDIC premium
expense. The Bank also experienced higher non-interest expense related to adding
necessary key administrative and branch personnel to staff throughout 2008 to
sustain the banks continued growth, coupled with the effect of operating
expenses related to the Main Street Branch office which opened in June 2008.
Net Interest Income/Margins
Net interest income is the difference between interest earned on loans
and investments and interest incurred on deposits and borrowed funds. Net
interest income is affected by changes in both interest rates and the amounts of
interest-earning assets and interest-bearing liabilities outstanding. Net
interest income is the principal source of income for the Bank. Net interest
income for the year ended December 31, 2008 was $6.7 million compared to $5.0
million for the year ended December 31, 2007. The increase in net interest
income for the year 2008 is directly related to the $31.6 million or 18.0%
increase in average interest-earning assets as compared to 2007. The increase in
average interest-earning assets during 2008 as compared to 2007 was attributable
to $35.1 million or 26.2% growth in average loans, partially offset by a decline
of $3.5 million or 8.2% in average investment securities. As a result of these
increases in interest earning assets, our total interest income increased by
$1.0 million or 9.0% to $12.5 million for 2008 from $11.5 million for 2007.
Average interest bearing deposits increased in 2008 by $16.7 million and average
borrowed funds increased by $19.2 million over 2007 levels. The yield on average
interest-earning assets decreased by 49 basis points to 6.02% for 2008, compared
to 6.51% for 2007, and the cost of interest-bearing liabilities decreased by 127
basis points to 3.00% in 2008, compared to 4.27% in 2007, and was directly
responsible for the 46 basis point increase to the Bank's net yield on average
interest-earning assets (the net interest margin) between 2008 and 2007. As a
result, our total interest expense declined by $833,000 or 13.0% to $5.6 million
for 2008 from $6.4 million for 2007. The net interest margin for 2008 was 3.32%
compared to 2.86% for 2007. The net interest margin improvement experienced
during 2008 was caused by a favorable and competitive interest rate environment,
which compelled the Bank to price loans and deposits as such to remain
competitive within the Bank's primary market area.
19
The following table indicates the average volume of interest-earning
assets and interest-bearing liabilities and average yields and rates for the
Bank for the years ended December 31, 2008, 2007 and 2006.
2008 2007 2006
--------------------------- ---------------------------- -----------------------------
(dollars in thousands)
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Assets Balance Interest Cost Balance Interest Cost Balance Interest Cost
------ ------ ------- ------- ----- ------- ------- ----- --------
Loans:
Commercial $ 44,536 2,699 6.06 $ 28,046 2,197 7.83 % $ 25,683 2,042 7.95%
Commercial mortgage 93,215 6,074 6.52 74,929 5,336 7.12 58,735 4,168 7.10
Mortgage 20,795 1,293 6.22 22,063 1,383 6.27 11,743 758 6.46
Consumer 10,145 523 5.16 8,588 608 7.08 8,489 613 7.22
------- ------ ------ ------- ----- ------- ------- ------ -------
Total loans 168,691 10,589 6.28 133,626 9,524 7.13 104,650 7,581 7.24
Investments:
Federal funds sold 4,874 108 2.22 2,281 113 4.95 4,349 223 5.13
Interest-bearing balances - - - - - - - - -
Securities available for sale 2,329 113 4.86 6,178 263 4.26 7,803 315 4.04
Securities held to maturity 31,540 1,670 5.29 33,745 1,548 4.59 34,656 1,485 4.28
------
------- ------ ------ ------- ----- ------- ------- ------ -------
Total investments 38,743 1,891 4.88 42,204 1,924 4.56 46,808 2,023 4.32
------ -------
------- ------ ------ ------- ----- ------- ------ -------
Total interest-earning assets 207,434 12,480 6.02% 175,830 11,448 6.51% 151,458 $ 9,604 6.34%
------- ------ ------ ------- ----- ------- ------- ------ -------
Allowance for loan losses (1,208) (1,066) (1,056)
Cash and due from banks 4,883 4,412 3,711
Fixed assets (net) 8,007 6,941 5,239
REO 369 351 -
Other assets 7,564 5,395 4,865
-------
------- -------
Total Assets $227,049 $ 191,863 $ 164,217
======= ======= =======
Liabilities and Shareholders' Equity
Deposits:
Interest-bearing demand $ 18,245 211 1.16 $ 21,071 581 2.76 $ 24,328 703 2.88%
Money market deposits 59,754 1,481 2.48 31,289 1,092 3.49 19,754 617 3.12
Statement savings 4,248 57 1.35 5,055 164 3.24 3,544 113 3.19
Certificates of deposit 71,391 2,757 3.86 79,480 3,937 4.95 65,707 2,854 4.34
------- ------ ------ ------- ----- ------- ------- ------ -------
Total interest-bearing deposits 153,638 4,506 2.93 136,895 5,774 4.22 113,333 4,287 3.78
Borrowed funds 32,625 1,083 3.32 13,465 648 4.81 12,263 469 3.83
------- ------ ------ ------- ----- ------- ------- ------ -------
Total interest-bearing liabilities 186,263 5,589 3.00 150,360 6,422 4.27 125,596 4,756 3.79
------- ------ ------ ------- ----- ------- ------- ------ -------
Non-interest bearing deposits 24,742 25,454 22,812
Other liabilities 603 568 577
Shareholders' equity 15,441 15,481 15,232
------- ------- -------
Total Liabilities and $ 227,049 $ 191,863 $ 164,217
Shareholders' Equity
======= ======= =======
Net interest income $6,891 $5,026 $ 4,848
====== ===== ======
Interest rate spread (1) 3.02% 2.24% 2.55%
====== ======= =======
Net interest margin (2) 3.32% 2.86% 3.20%
====== ======= =======
Ratio of average interest-earning
assets to interest-bearing
liabilities 111.37% 116.94% 120.59%
====== ======= =========
Return on average assets -0.03% -0.05% 0.22%
====== ======= =======
Return on average equity -0.44% -0.57% 2.42%
====== ======= =======
(1) Interest rate spread represents the difference between the average
yield on interest-earning assets and the average cost of
interest-bearing liabilities.
(2) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
The level of net interest income is determined primarily by the average
balances ("volume") and the rate spreads between the Bank's interest-earning
assets and the Bank's funding sources. The Bank's ability to maximize its net
interest income depends on the volume of its interest-earning assets and
interest-bearing liabilities, and increases or decreases in the average rates
earned and paid on such assets and liabilities.
The following table presents the dollar amount of changes in interest
income and interest expense for interest earning assets and interest-bearing
liabilities. The table distinguishes between changes attributable to volume
(changes in volume multiplied by the prior period's rate) and changes
attributable to rate (changes in rate multiplied by the prior period's volume).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated to volume.
20
As shown below, the increase in net interest income was due to volume
increases in the Bank's earning assets, which were funded by the Bank's deposit
growth.
----------------------------------------------
Year Ended December 31, 2008 vs.
Year Ended December 31, 2007
----------------------------------------------
(dollars in thousands) Volume Rate Total Increase
(Decrease)
------------- ------------- -------------
Interest income:
Commercial $ 999 $ (496) $ 503
Commercial Mortgage 1,191 (454) 737
Mortgage (79) (11) (90)
Consumer 81 (166) (85)
Federal funds sold 57 (62) (5)
Investment securities available for
sale (187) 36 (151)
Investment securities held to maturity (117) 239 122
----------- ----------- -----------
Total interest-earning assets 1,945 (914) 1,031
Interest expense:
Interest-bearing demand (33) (337) (370)
Money market 705 (317) 388
Statement savings (11) (96) (107)
Certificates of deposit (312) (868) (1,180)
Borrowings 636 (201) 435
----------- ----------- -----------
Total interest-bearing liabilities 985 (1,819) (834)
----------- ----------- -----------
Net change in net interest income $ 961 $ 904 $ 1,865
=========== =========== ===========
Provision For Loan Losses
The Bank recorded a provision for loan losses of $221,000 for the year
ended December 31, 2008 compared to no provision for loan losses for the year
ended December 31, 2007. A provision for loan losses is charged to operations
based on management's evaluation of the estimated and inherent losses in the
Bank's loan portfolio. While management has increased its allowance for loan
loss for the year ended December 31, 2008, management believes the credit
quality of the Bank's loan portfolio continues to remain strong during this
turbulent time in the market. The increase in the provision for loan losses
recorded in 2008 reflects the continued growth of our loan portfolio.
Non-Interest Income
Non-interest income, which is comprised principally of service charges
on deposit accounts, ATM fees, origination fees from residential mortgage loans
sold, bank owned life insurance income and other miscellaneous fee income, was
$419,000 for the year ended December 31, 2008 compared to $324,000 for the year
ended December 31, 2007. The increase in non-interest income during 2008 is the
result of increases of $17,000 in bank owned life insurance income, $17,000 in
service charges on deposit accounts, $5,000 in origination fees on residential
mortgage loans sold and a $57,000 gain on sale of fixed assets related to the
sale of the Bank's Burlington Branch office in March 2008, partially offset by a
decrease in miscellaneous fee income of $1,000.
Non-Interest Expense
Non-interest expense, which is comprised principally of salaries and
employee benefits, net occupancy, advertising, data processing, professional
services and other operating costs, increased by $1.7 million to $7.3 million
for the year ended December 31, 2008 as compared to $5.6 million for the year
ended December 31, 2007. This increase was primarily the result of increased
salary and benefit costs attributable to staff expansion to sustain the Bank's
continued growth, net occupancy costs, and other operating expenses incurred in
connection with the Bank's expansion coupled with the operational costs relating
to the Bank's Main Street office which opened in June 2008 and the relocation of
the Bank's administrative offices in January of 2008. At December 31, 2008, the
Bank had 61 full time equivalent ("FTE") employees compared to 56 FTE employees
ad December 31, 2007. The Bank also incurred one time costs of $46,000 relating
to the formation of its holding company. The Bank also experienced higher
non-interest expense related to an impairment loss on other real estate owned
and an increase in other real estate owned expenses and FDIC premium expense.
21
Income Taxes
The Bank recorded an income tax benefit of $164,000 for the year ended
December 31, 2008, compared to an income tax benefit of $135,000 for the year
ended December 31, 2007. The change in income tax benefit in 2008 is primarily
the result of increased tax exempt income from Bank Owned Life Insurance as well
as a higher pre tax loss for December 31, 2008 compared to December 31, 2007.
Financial Condition
Total assets at December 31, 2008 were $247.5 million, an increase of
$35.0 million or 16.5% over total assets at December 31, 2007. This change was
due to increases in loans receivable, net of allowance for loan losses, of $48.0
million; premises and equipment of $1.1 million; bank owned life insurance of
$563,000; Federal Home Loan Bank of New York ("FHLB") stock of $656,000;
deferred taxes of $ 149,000 and accrued interest receivable and other assets in
the aggregate amount of $340,000. These increases were partially offset by
decreases in cash and cash equivalents of $4.7 million, investment securities
available for sale of $3.0 million, investment securities held to maturity of
$7.9 million and other real estate owned of $185,000.
Total shareholders' equity at December 31, 2008 amounted to $15.4
million, a decrease of $85,000 or .55% over December 31, 2007. The change in
shareholders equity is attributable to a net loss of $87,000, cash in lieu of
fractional shares totaling $3,000 relating to the payment of the 7.5% stock
dividend, the unrealized loss of $4,000 on securities available for sale, net of
tax, which caused an overall decrease to accumulated other comprehensive income
and stock based compensation expense of $7,600.
Loan Portfolio
The Bank offers business and personal loans generally on a secured
basis, including: commercial loans (term and time); commercial lines of credit;
mortgage loans (conventional 30-year, commercial and jumbo residential real
estate); commercial and residential construction loans; letters of credit; and
consumer loans (home equity and installment). The Bank makes commercial loans to
small and medium-sized businesses primarily in the Bank's market area for
purposes of providing working capital, supporting accounts receivable,
purchasing inventory and acquiring fixed assets.
Loans receivable at December 31, 2008 reached $194.1 million, an
increase of $48.1 million or 32.9% from December 31, 2007. This increase was
attributable to increases in commercial loans of $29.3 million, commercial real
estate loans of $17.2 million, construction loans of $1.4 million and loans to
consumers of $2.2 million, partially offset by a decrease in residential real
estate loans of $ 2.0 million. The increases in loans receivable are due
primarily related to the competitive pricing of the Bank's loan products along
with the continued development of relationships with local small businesses,
which management believes are attracted to the Bank by the high level of
individualized service provided by the Bank through its growing team of lenders.
The following table sets forth-selected data relating to the
composition of the Bank's loan portfolio, net of deferred loan fees, at the
dates indicated.
(dollars in thousands) 2008 2007 2006 2005 2004
---- ---- ---- ---- ----
Type of Loans: Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------------
Commercial $60,669 31.3% $31,417 21.5% $27,581 23.5% $22,791 24.7% $19,057 25.3%
Real Estate, Commercial 91,036 46.9% 73,863 50.6% 53,856 45.9% 44,125 47.9% 35,536 47.3%
Real Estate, 19,326 10.0% 21,303 14.6% 15,068 12.8% 7,621 8.3% 8,489 11.3%
Residential
Construction 12,309 6.3% 10,864 7.4% 11,783 10.0% 9,074 9.8% 3,813 5.1%
Consumer 10,764 5.5% 8,594 5.9% 9,044 7.7% 8,549 9.3% 8,261 11.0%
----------- -------- --------- --------- --------- -------- --------- ---------- -------- ---------
Total $194,104 100.0% $146,041 100.0% $117,332 100.0% $92,160 100.0% $75,156 100.0%
=========== ======== ========= ========= ========= ======== ========= ========== ======== =========
22
See Note 5 to Consolidated Notes to Financial Statements for additional
information regarding loans.
The following table sets forth the contractual maturity of the Bank's
loan portfolio, net of deferred loan fees, at December 31, 2008. The table does
not include prepayments or scheduled principal repayments.
(dollars in thousands) One year or One - Five Over Five Total
Less Years Years
-------------- --------------- --------------- -------------
Commercial $ 13,554 $ 26,572 $ 20,543 $ 60,669
Real Estate Commercial 9,741 33,401 47,894 91,036
Real Estate Residential - 927 18,399 19,326
Construction 10,150 1,175 984 12,309
Consumer 71 749 9,944 10,764
------------- -------------- -------------- -------------
------------- -------------- -------------- -------------
Total amount due $ 33,516 $ 62,824 $ 97,764 $ 194,104
============= ============== ============== =============
The following table sets forth loan maturities by interest rate type at
December 31, 2008.
(dollars in thousands) Maturities Maturities Total
less than 1 Greater than
Year 1 Year
---------------- ----------------- -------------
Fixed Interest Rate Loans $ 10,917 $ 119,555 $ 130,472
Variable Rate Interest Loans 22,451 41,033 63,484
Overdrawn Accounts 148 - 148
------------- ----------------- -------------
$ 33,516 $ 160,588 $ 194,104
============= ================ =============
Non-Performing Assets
Non-performing assets include non-accrual loans, which are loans on
which the accrual of interest has ceased, impaired loans, restructured loans and
real estate owned. Loans are generally placed on non-accrual status if, in the
opinion of management, collection is doubtful, or when principal or interest is
past due 90 days or more unless the collateral is considered sufficient to cover
principal and interest and the loan is in the process of collection. Impaired
loans are measured based on the present value of expected future discounted cash
flows, the market price of the loan or the fair value of the underlying
collateral if the loan is collateral dependent. At December 31, 2008 and 2007,
the Bank did not have any non-accrual loans. At December 31, 2008, the Bank had
three impaired loans totaling $2,375,000 which are sufficiently collateralized
and therefore no specific reserves have been recorded against them. The average
balance of impaired loans totaled $2,383,000 for 2008, interest income recorded
on impaired loans during the year ended December 31, 2008 totaled $69,000. The
Bank had no impaired loans at December 31, 2007.
Real estate acquired by foreclosure or by deed in lieu of foreclosure
is classified as real estate owned until it is sold. At December 31, 2008, the
Bank had $281,000 in real estate owned compared to $466,000 in real estate owned
at December 31, 2007. The change reflects adjustments made to the carrying value
during 2008.
The following table provides information regarding risk elements in the
loan and securities portfolio as of December 31, 2004 through 2008.
(dollars in thousands) December 31, December 31, December 31, December 31, December 31,
------------- ----------- ------------- ------------- -------------
2008 2007 2006 2005 2004
---- -------- ---- ---- ----
Loans past due 90 days or more and accruing
Commercial $ - $ 357 $ 718 $ 336 $ 282
Real Estate 2,375 7 - - -
Construction - 607 - - -
Consumer - - - - 1
--------------- ------------- --------------- ---------------- --------------
Total loans past due 90 days or more and 2,375 971 718 336 283
accruing
=============== ============= =============== ================ ==============
Non-performing assets:
Non-accrual loans:
Commercial - - - - 478
Real Estate - - - - -
Construction - - - - -
Consumer - - - - -
--------------- ------------- --------------- ---------------- --------------
Total - - - - 478
Restructured loans - - - - -
--------------- ------------- --------------- ---------------- --------------
Total non-performing loans
- - - - 478
Real estate owned 281 466 - - -
--------------- ------------- --------------- ---------------- --------------
Total non-performing assets $ 281 $ 466 $ - $ - $ 478
=============== ============= =============== ================ ==============
Non-performing loans as a percentage of loans 0.00% 0.00% 0.00% 0.00% 0.64%
=============== ============= =============== ================ ==============
Non-performing assets as a percentage of
loans and real estate owned 0.14% 0.32% 0.00% 0.00% 0.64%
=============== ============= =============== ================ ==============
Non-performing assets as a percentage of 0.11% 0.22% 0.00% 0.00% 0.35%
total assets
=============== ============= =============== ================ ==============
23
Allowance for Losses on Loans
The allowance for losses on loans is based on management's ongoing
evaluation of the loan portfolio and reflects an amount considered by management
to be its best estimate of known and inherent losses in the portfolio.
Management considers a variety of factors when establishing the allowance, such
as the impact of current economic conditions, diversification of the loan
portfolio, delinquency statistics, results of independent loan review and
related classifications. The Bank's historic loss rates and the loss rates of
peer financial institutions are also considered. During 2008, the Bank further
refined its loan loss assumptions by re-evaluating the average lives of the
various components of its loan portfolio and adjusted them to reflect the
current average life cycle attributes that the bank had been experiencing. In
addition, certain individual loans which management has identified as
problematic are specifically provided for, based upon an evaluation of the
borrower's perceived ability to pay, the estimated adequacy of the underlying
collateral and other relevant factors. Consideration is also given to the
findings of examinations performed by regulatory agencies.
The following table sets forth information with respect to the Bank's
allowance for losses on loans:
(dollars in thousands) December 31, December 31, December 31, December 31, December 31,
------------- --------- ------------- ------------- ------------
2008 2007 2006 2005 2004
---- -------- ---- ---- ----
Balance at beginning of year $1,050 $1,050 $948 $1,005 $903
Provision:
Commercial 85 - - 153 100
Real Estate 22 - - (15) 10
Construction 114 - - 101 16
Consumer - - - 4 1
Unallocated - - - - -
--------------- ------------- --------------- ---------------- --------------
--------------- ------------- --------------- ---------------- --------------
Total Provision 221 - - 243 127
--------------- ------------- --------------- ---------------- --------------
--------------- ------------- --------------- ---------------- --------------
Charge-offs:
Commercial 138 - - 311 25
Real Estate - - - - -
Construction - - - - -
Consumer - - - 4 -
--------------- ------------- --------------- ---------------- --------------
Total Charge-offs 138 - - 315 25
--------------- ------------- --------------- ---------------- --------------
Recoveries:
Commercial - - 100 15 -
Real estate - - - - -
Construction - - - - -
Consumer - - 2 - -
--------------- ------------- --------------- ---------------- --------------
Total Recoveries - - 102 15 -
--------------- ------------- --------------- ---------------- --------------
Net charge-offs - - 102 330 25
=============== ============= =============== ================ ==============
Balance at end of period $1,133 $1,050 $1,050 $948 $1,005
=============== ============= =============== ================ ==============
Period-end loans outstanding $194,104 $146,041 $117,332 $92,160 $75,156
=============== ============= =============== ================ ==============
Average loans outstanding $168,691 $133,625 $104,650 $84,213 $71,704
=============== ============= =============== ================ ==============
Allowance as a percentage of period-end loans 0.58% 0.72% 0.89% 1.03% 1.34%
Net charge-offs as a percentage of average 0.08% NA NA 0.39% 0.03%
loans
24
Allocation of Allowance for Losses on Loans
The following table sets forth the allocation of the Bank's allowance
for loan losses by loan category at the dates indicated. Although loss
provisions have been established and segmented by type of loan, based upon
management's assessment of their differing inherent loss characteristics, the
entire allowance for losses on loans is available to absorb further loan losses
in any category:
At December 31,
-------------------------------------------------------------------------
2008 2007
-------------------------------- ---------------------------------
(dollars in thousands) Amount Percent of Amount Percent of
Loans in Each Loans in Each
Category to Category to
Total Loans Total Loans
------------- --------------- -------------- ---------------
Commercial $ 492 31.3 % $ 460 21.5 %
Real Estate Commercial 336 46.9 251 50.6
Real Estate Residential 126 10.0 173 14.6
Construction 101 6.3 113 7.4
Consumer 78 5.5 53 5.9
---------- ----------- ---------- -----------
Total $ 1,133 100.0 % $ 1,050 100.0 %
========== =========== ========== ===========
At December 31,
-------------------------------------------------------------------------
2006 2005
-------------------------------- ---------------------------------
(dollars in thousands) Amount Percent of Amount Percent of
Loans in Each Loans in Each
Category to Category to
Total Loans Total Loans
------------- --------------- -------------- ---------------
Commercial $ 441 23.% $ 474 24.7%
Real Estate Commercial 294 45.9 241 47.9
Real Estate Residential 90 12.8 24 8.3
Construction 177 10.1 179 9.8
Consumer 48 7.70 30 9.3
---------- ------------- ---------- -----------
Total $ 1,050 100.0% $ 948 100.0%
========== ============= ========== ===========
At December 31,
--------------------------------
2004
--------------------------------
(dollars in thousands) Amount Percent of
Loans in Each
Category to
Total Loans
------------- ---------------
Commercial $ 617 25.%
Real Estate Commercial 248 47.3
Real Estate Residential 32 11.3
Construction 78 5.1
Consumer 30 11.0
---------- -----------
---------- -----------
Total $ 1,005 100.%
========== ===========
25
Investment Securities
The investment portfolio predominantly consists of securities issued or
guaranteed by the U.S. Government and its agencies. Management classifies
investment securities at the time of purchase by one of three categories:
trading, held to maturity and available for sale. To date, management has not
purchased any securities for trading purposes. Management classifies most
securities as held to maturity, and to a lesser extent, available for sale. The
available for sale designation affords management the flexibility to sell
securities and adjust the balance sheet in response to liquidity needs and of
changes in market conditions. Available for sale securities are carried at fair
value in the statements of financial condition with an adjustment to equity for
changes in the fair value of the securities, net of tax. The adjustment to
equity, net of tax, is presented in the caption "Accumulated other comprehensive
income (loss)."
Investment securities held to maturity and investment securities
available for sale totaled $28.4 million at December 31, 2008, a decrease of
$10.9 million or 21.8% from December 31, 2007. The estimated fair value of the
held to maturity investment portfolio was $28.5 million at December 31, 2008 and
$36.3 million at December 31, 2007.
At December 31, 2008, the Bank did not hold any investment securities
in the available for sale investment portfolio as compared to investments
available for sale with a fair value of $3.0 million at December 31, 2007.
During 2008, held to maturity investment purchases totaled $27.7
million and were concentrated in U.S. Government agency securities. The Bank did
not purchase any available for sale securities during 2008. During this same
period, the Bank received $38.6 in investment repayments in U.S. Government
agency and mortgage backed securities.
The following table sets forth the carrying value of the Bank's
investment portfolio at the dates indicated:
(dollars in thousands) 2008 2007 2006
---- ---- ----
Investment securities held to maturity
Government agency obligations $26,653 $33,915 $28,442
Mortgage backed securities 1,745 2,412 2,963
--------------- ------------- ---------------
Total investment securities held to maturity $28,398 $36,327 $31,405
=============== ============= ===============
Investment securities available for sale:
Government agency obligations $ $2,984 $6,946
-
--------------- ------------- ---------------
Total investment securities available for $ - $2,984 $6,946
sale
=============== ============= ===============
Investment Portfolio Maturities
The following table sets forth information regarding the carrying
values, estimated fair values, and weighted average yields for the Bank's
investments securities portfolio at December 31, 2008 by contractual maturity.
The following table does not take into consideration the effects of
unscheduled repayments or the effects of possible prepayments on securities with
call provisions.
Under 1 - 5 5 - 10 Over 10
(dollars in thousands) 1 Year Years Years Years Total
------------ --------- ---------- ---------- -------------
Investment securities held to
maturity
U.S. government agency obligations:
Carrying value - $ - 13,662 $ 12,991 26,653
Weighted average yield - % - % 4.87 % 5.22 % 5.05 %
Mortgage backed securities:
Carrying value - - - 1,745 1,745
Weighted average yield - - - 6.15 % 6.15 %
------- ------- ------- ------- --------
Total carrying value $ - $ - $ 13,162 $ 15,236 28,398
======= ======= ======= ======= ========
Total fair value $ - $ - $ 13,236 $ 15,251 28,487
======= ======= ======= ======= ========
Weighted average yield - % - % 4.87 % 5.32 % 5.11 %
======= ======= ======= ======= ========
26
Sources of Funds
General
Deposits are the primary source of funds for the Bank's lending and
investment activities as well as for general business purposes. In addition to
deposits, the Bank derives funds from: the amortization, prepayment or sale of
loans; maturities and repayments of investment securities; and operations.
Scheduled loan principal repayments are a relatively stable source of funds,
while deposit inflows and outflows and loan prepayments are significantly
influenced by general interest rate market conditions.
Deposits
The Bank offers a broad range of deposit instruments, including
personal and business checking accounts, individual retirement accounts,
business and personal money market accounts, statement savings and term
certificate accounts at competitive interest rates. Deposit account terms vary
according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. The Bank regularly
evaluates the internal cost of funds, surveys rates offered by competing
institutions, reviews the Bank's cash flow requirements for lending and
liquidity and executes rate changes when deemed appropriate. The Bank does not
obtain funds through brokers, nor does it solicit funds outside the State of New
Jersey.
Total deposits at December 31, 2008 were $202.0 million, an increase
of $17.9 million or 9.8% from December 31, 2007. This increase in deposits was
reflected in interest bearing deposits of $10.9 million and an increase in
certificates of deposit $10.2 million, partially offset by a decrease in
non-interest bearing deposits of $3.2 million. The change in deposits was
primarily related to the competitive pricing of the Bank's deposit products
coupled with the continued development of relationships with local small
businesses which fostered the growth in deposits along with the high level of
individualized service provided by the Bank's team of retail branch managers.
The following table sets forth the distribution of the Bank's average
balance of deposit accounts for the years ended December 31, 2008, 2007 and 2006
and the weighted average cost for each category of deposit.
2008 2007 2006
-------------------------------------- ---------------------------------- ----------------------------------
Percent Weighted Percent Weighted Percent Weighted
Average of Total Average Average of Total Average Average of Total Average
Balance Deposits Cost Balance Deposits Cost Balance Deposits Cost
------------------------------------------------------------------------------------------------------------------
(dollars in
thousands)
Checking $ 42,987 24.1% .48% $ 46,525 28.7 % 1.24% $ 47,140 34.6% 1.49%
Money market deposit 59,754 33.5 2.48 31,289 19.3 3 49 19,754 14.5 3.13
Statement savings 4,248 2.4 1.35 5,055 3.0 3 24 3,544 2.6 3.20
Certificates of
deposit 71,391 40.0 3.86 79,480 49.0 4 95 65,707 48.3 4.34
-------- ------- ------ ------ ------ ---- ------ ----- -----
Total deposits $ 178,380 100.0% 2.52% $ 162,34 100.0% 3.55 $ 136,14 100.0% 3.15%
======== ====== ===== ====== ====== ==== ========= ===== =====
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of December 31,
2008 and 2007.
(dollars in thousands) 2008 2007
Certificates of Certificates of
Deposit Deposit
--------------------- -----------------
Maturity Period
Within three months $ 6,483 $ 18,945
Three through six months 5,285 6,588
Six through twelve months 16,818 904
Over twelve months 4,499 1,152
----------------- --------------
$ 33,085 $ 27,589
================= ==============
See Note 7 to Notes to Consolidated Financial Statements for additional
information regarding deposits.
27
Borrowings
Although deposits are the primary source of funds for the Bank's
lending and investment activities as well as for general business purposes, the
Bank also utilizes borrowings to supplement deposits when deposit funding is not
adequate or when borrowing costs are more favorable than comparable deposits.
At December 31, 2008, the Bank had borrowings in the form of advances
with the FHLB in the amount of $26.3 million, an increase of $13.9 million from
December 31, 2007. The weighted average interest rate on borrowings from FHLB
was 3.62% at December 31, 2008 compared to 4.57% at December 31, 2007. Pursuant
to collateral agreements with the FHLB, advances are secured by a blanket lien
on the Bank's residential mortgage loan portfolio.
The following table sets forth the contractual maturity and the
weighted average interest rate of the Bank's borrowings at December 31, 2008:
(dollars in Under 1 - 5 5 - 10 Over 10
thousands) 1 Year Years Years Years Total
------------- ---------- ----------- ------------- ------------
Advances from the FHLB $ 11,074 $ 15,183 $ - $ - $ 26,257
Weighted average interest
rate 4.69% 2.85 - % - % 3.62%
On October 31, 2008, the Bank issued a hybrid capital instrument
in the form of subordinated debt which qualifies as Tier II capital in the
aggregate amount of $3.0 million. The term of the debt is for a six year period
with a maturity date of November 1, 2014, and the interest rate is 5.00% fixed
for the first year then adjusts at a variable rate equal to prime rate for the
remaining five years. The debt security is redeemable at par after April 30,
2009 at the Bank's option.
On February 17, 2009, the Company entered into a non-revolving line of
credit loan agreement with Atlantic Central Bankers Bank for an amount up to
$5,000,000. The Company has drawn $4,500,000 under the loan and has contributed
$4,400,000 as additional capital to the Bank.
Interest Rate Risk
The Bank's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Bank's net
interest income while creating an asset/liability structure that maximizes
earnings. The Asset Liability Management Committee actively monitors and manages
the Bank's interest rate exposure using gap analysis and interest rate
simulation models.
Gap analysis measures the difference between volumes of rate-sensitive
assets and liabilities and quantifies these repricing differences for various
time intervals. Static gap analysis describes interest rate sensitivity at a
point in time. However, gap analysis alone does not accurately measure the
potential magnitude of changes in net interest income since changes in interest
rates do not affect assets and liabilities at the same rate, to the same extent,
or on the same basis. Furthermore, static gap analysis does not consider future
growth.
A positive gap (asset sensitive) indicates that more assets reprice
during a given period compared to liabilities, while a negative gap (liability
sensitive) indicates that more liabilities reprice during a given period
compared to assets.
Generally, during a period of falling interest rates, a positive gap
would tend to adversely affect net interest income, while a negative gap would
tend to result in an increase in net interest income. During a period of rising
interest rates, in general, a positive gap would tend to result in an increase
in net interest income while a negative gap would tend to affect net interest
income adversely. However, certain assets and liabilities may react differently
to changes in interest rates even though they reprice or mature in the same or
similar time periods. The interest rates on certain assets and liabilities may
change at different times than changes in market interest rates, with some
changing in advance of changes in market rates and some lagging behind changes
in market rates. Also, certain assets (e.g., adjustable rate mortgages) often
have provisions that may limit changes in interest rates each time the interest
rate changes and on a cumulative basis over the life of the loan. Additionally,
the actual prepayments and withdrawals in the event of a change in interest
rates may differ significantly from those assumed in the calculations shown in
the table above. Finally, the ability of borrowers to service their debt may
decrease in the event of an interest rate increase. Consequently, any model used
to analyze interest rate sensitivity will be vulnerable to the assumptions made
with respect to the foregoing factors.
28
The Bank uses a computer-based simulation model to assess the impact of
changes in interest rates on net interest income. The model incorporates
management's business plan assumptions and related asset and liability
yields/costs, deposit sensitivity and the size, composition and maturity or
repricing characteristics of the Bank's assets and liabilities. The assumptions
are based on what management believes at that time to be the most likely
interest rate environment. Actual results may differ from simulated results due
to the various factors described above.
Gap analysis and interest rate simulation models require assumptions
about certain categories of assets and deposits. For purposes of these analyses,
assets and liabilities are stated at their contractual maturity, estimated
likely call date, or earliest repricing opportunity. Interest-bearing demand
deposits, statement savings and money market accounts do not have a stated
maturity or repricing term and can be withdrawn or repriced at any time. This
may impact the Bank's net interest income if more expensive alternative sources
of deposits are required to fund loan growth or deposit runoff. Management
projects the repricing characteristics of these accounts based on historical
performance and assumptions that it believes reflect their rate sensitivity.
The following table sets forth the amount of the Bank's
interest-earning assets and interest-bearing liabilities at December 31, 2008,
which are expected to mature or reprice in each of the time periods shown:
Non-Rate
Sensitive
One Year One-Five Over Assets/
(dollars in thousands) Or Less Years Five Years Liabilities Total
------------- ------------ ------------- ------------- --------------
Interest-earning assets:
Short term investments $ 4,335 $ - $ - $ - $ 4,335
Investment securities held to
maturity - 600 27,798 - 28,398
Investment securities available
for sale - - - - -
Loans receivable 77,108 62,960 54,036 - 194,104
----------- ----------- -----------
----------- -----------
Total interest-earning assets 81,443 63,560 81,834 - 226,837
----------- ----------- ----------- -----------
Non-rate sensitive assets:
Other Assets - - - 20,698 20,698
----------- ----------- ----------- ----------- -----------
Total assets $ 81,443 $ 63,560 $ 81,834 $ 20,698 $ 247,535
=========== =========== =========== =========== ===========
Interest-bearing liabilities:
Interest-bearing demand $ 26,845 $ - $ - $ - $ 26,845
Statement savings 3,401 - - - 3,401
Money market 59,204 - - - 59,204
Certificates of deposit 78,443 12,950 - - 91,393
Subordinated Debt 3,000 - - - 3,000
Borrowings 11,074 15,183 - - 26,257
----------- ----------- ----------- ----------- -----------
Total interest-bearing
liabilities 181,967 28,133 - - 210,100
----------- ----------- ----------- ----------- -----------
Non-rate sensitive liabilities:
Non-interest bearing deposits - - - 21,187 21,187
Other liabilities - - - 870 870
Capital - - - 15,378 15,378
------------ ----------- ----------- ----------- -----------
Total liabilities and capital $ 181,967 $ 28,133 $ - $ 37,435 $ 247,535
=========== =========== =========== =========== ===========
Period GAP $ (100,524 ) $ 35,427 $ 81,834 $ (16,737 )
Cumulative interest-earning assets $ 81,443 $ 145,003 $ 226,837
Cumulative interest-bearing
liabilities $ 181,967 $ 210,100 $ 210,100
Cumulative GAP $ (100,524) $ (65,097) $ 16,737
Cumulative RSA/RSL (1) 44.76% 69.26% 107.76%
(1) Cumulative interest-earning assets divided by cumulative
interest-bearing liabilities.
29
Based upon the above gap analysis and other modeling techniques utilized by the
Bank, the interest rate risk profile of the Bank is within Board approved
tolerance limits.
Liquidity
Liquidity represents the Bank's ability to meet its normal cash flow
requirements for the funding of loans, repayment of deposits and payment of
operating costs. The Bank's primary sources of liquidity include deposits,
amortization and prepayment of loans, maturities and repayments of investment
securities, and the Bank's borrowing capability. Management monitors liquidity
daily, and on a monthly basis incorporates liquidity analysis into its
asset/liability management program.
In addition to using growth in deposits, loan repayments and the
investment portfolio as a source of liquidity, the Bank has access to unsecured,
overnight lines of credit in the aggregate total of $44.0 million, consisting of
$3.0 million, on an uncommitted basis through Atlantic Central Bankers Bank and
$41.0 million through the FHLB of New York. The arrangement with Atlantic
Central Bankers Bank is for the sale of federal funds to the Bank subject to the
availability of such funds. Pursuant to a collateral agreement with the FHLB,
advances under this line of credit are secured by a blanket lien on the Bank's
residential mortgage loan portfolio. At December 31, 2008 and 2007, the Bank had
no balances outstanding against those lines of credit. In addition, the Bank's
membership in the FHLB provides the Bank with additional secured borrowing
capacity of up to a maximum of 25% of the Bank's total assets, subject to
certain conditions.
The Bank had cash and cash equivalents of $9.4 million at December 31,
2008 and $14.1 million at December 31, 2007 in the form of cash, due from banks
and federal funds sold. At December 31, 2008, unused lines of credit available
to the Bank's customers and committed, undisbursed loan proceeds including
letters of credit totaled $42.5 million. Certificates of deposit scheduled to
mature in one year or less totaled $78.4 million at December 31, 2008. Based on
the Bank's experience, management believes that a substantial amount of these
certificates of deposit will remain with the Bank upon maturity. The Bank
anticipates that it will continue to have sufficient funds available to meet the
needs of its customers for deposit repayments and loan fundings.
The Bank's ability to generate deposits depends on the success of its
branches and the continued expansion of its branch network. The Bank opened its
branch locations in Medford, New Jersey during the fourth quarter of 2002, in
Burlington City, New Jersey during the third quarter of 2003, in Cherry Hill,
New Jersey in the first quarter of 2006, in Voorhees, New Jersey during the
fourth quarter of 2006 and in Moorestown, New Jersey during the second quarter
of 2008. The Bank's success and, in particular, the success of these and any
other new branches, is dependent on a number of factors, including the Bank's
ability to establish branches in favorable locations, recruit and hire
experienced managers and staff to meet the needs of its customers through
personalized services and a broad array of financial products, and the general
economic conditions of the market area in which they are located. Unexpected
changes in the national and local economy may also adversely affect the
branches' ability to attract or retain deposits and foster new loan
relationships. In addition, because the Bank will incur start-up and operating
costs associated with expansion, the opening of new branches is expected to
adversely affect future profitability in the short term.
Capital Resources
The maintenance of appropriate levels of capital in excess of
regulatory minimums is an important objective of the Bank's asset and liability
management process. The Bank met the definition of an "adequately-capitalized"
institution at December 31, 2008 and "well capitalized as December 31, 2007. See
Note 17 of "Notes to Financial Statements" (regulatory matters) for additional
information regarding the Bank's regulatory capital requirements.
The Bank's capital ratios at December 31, 2008, 2007 and 2006 are presented in
the following table:
2008 2007 2006
------------- ------------- -------------
Shareholders' equity to total assets 6.2% 7.3% 8.4%
Leverage ratio 6.2% 7.5% 8.8%
Risk-based capital ratios:
Tier 1 7.2% 9.4% 11.3%
Total Capital 9.1% 10.0% 12.1%
30
On October 31, 2008, the Bank issued a hybrid capital instrument
in the form of subordinated debt which qualifies as Tier II capital in the
aggregate amount of $3.0 million. The term of the debt is for a six year period
with a maturity date of November 1, 2014, and the interest rate is 5.00% fixed
for the first year then adjusts at a variable rate equal to prime rate for the
remaining five years. The debt security is redeemable at par after April 30,
2009 at the Bank's option.
On February 17, 2009, the Company entered into a non-revolving line of
credit loan agreement with Atlantic Central Bankers Bank for an amount up to
$5,000,000. The Company has drawn $4,500,000 under the loan and has contributed
$4,400,000 as additional capital to the Bank.
Off-Balance Sheet Arrangements
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 include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit risk in excess of the amount recognized in the statements of
financial condition.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the agreement.
Commitments generally have fixed dates or other termination clauses and may
require the payment of a fee by the customer. Some of the commitments are
expected to expire without being drawn upon, and the total commitments do not
necessarily represent future cash requirements. Total commitments to extend
credit at December 31, 2008 were $42.5 million. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. Collateral obtained, if
deemed necessary by the Bank, is based on management's credit evaluation of the
customer. Collateral varies but may include accounts receivable, marketable
securities, inventory, property, plant and equipment, residential and commercial
real estate.
Standby letters of credit are conditional commitments issued by the
Bank to a third party on behalf of a customer. The credit risk involved in
issuing standby letters of credit is similar to that involved in extending
credit to customers. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. Collateral obtained, if deemed necessary by the Bank, is
based on management's credit evaluation of the customer. Collateral varies but
may include accounts receivable, marketable securities, inventory, property,
plant and equipment, residential and commercial real estate. At December 31,
2008, the Bank's obligations under standby letters of credit totaled $718,000.
The Bank has also entered into long term operating lease obligations
for some of its premises and equipment, the terms of which generally include
options to renew. These instruments involve, to varying degrees, elements of
off-balance sheet risk in excess of the amount recognized in the statements of
financial condition. At December 31, 2008, the Bank's future minimum operating
lease obligations totaled $2.8 million.
The off-balance sheet arrangements discussed above did not have, and
the Bank believes are not reasonably likely to have in the foreseeable future, a
material impact on the Bank's financial condition or liquidity.
See Note 12 to Notes to Consolidated Financial Statements for additional
information regarding operating leases.
See Note 13 to Notes to Consolidated Financial Statements for additional
information regarding off-balance sheet arrangements.
Contractual Obligations
The following table represents the Bank's aggregate contractual
obligations to make future payments as of December 31, 2008.
One year or One - Five Over Five
(dollars in thousands) Less Years Years Total
-------------- --------------- --------------- -------------
Time deposits $ 78,443 $ 12,950 $ - $ 91,393
Long term debt 11,074 15,183 - 26,257
Operating lease 422 1,799 606 2,827
----------- ------------ ------------ ----------
----------- ------------ ------------ ----------
Total $ 89,939 $ 29,932 $ 606 $120,477
=========== ============ ============ ==========
31
Item 7. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
Item 8. Financial Statements and Supplementary Data
The following audited financial statements and related documents are
set forth in this Annual report on form 10-K on the following pages:
Page
Report of Independent Registered Public Accounting Firm 33
Consolidated Statements of Financial Condition 34
Consolidated Statements of Operations 35
Consolidated Statements of Changes in Shareholders Equity 36
Consolidated Statements of Cash Flows 37
Notes to Financial Statements 38
32
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Cornerstone Financial Corporation:
We have audited the accompanying consolidated statements of financial condition
of Cornerstone Financial Corporation and subsidiary (the Company) as of December
31, 2008 and 2007, and the related consolidated statements of operations,
changes in shareholders' equity, and cash flows for the years then ended. 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 Cornerstone
Financial Corporation and subsidiary as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for the years then ended, in
conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Philadelphia, PA
March 30, 2009
33
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share data) December 31, 2008 December 31, 2007
---------------------- -----------------------
Assets:
Cash and due from banks $ 5,033 $ 5,209
Federal funds sold 4,335 8,875
------------------ -------------------
Cash and cash equivalents 9,368 14,084
------------------ -------------------
Investment securities:
Held to maturity (fair value 2008 - $28,487; 2007 -
$36,297) 28,398 36,327
Available for sale (amortized cost 2008- $0; 2007 -
$2,977) - 2,984
Loans receivable 194,104 146,041
Less allowance for loan losses 1,133 1,050
------------------ -------------------
Loans receivable, net 192,971 144,991
------------------ -------------------
Federal Home Loan Bank stock 1,377 721
Premises and equipment, net 8,469 7,319
Accrued interest receivable 1,217 1,009
Bank owned life insurance 4,348 3,785
Deferred taxes 462 313
Other Real Estate Owned 281 466
Other assets 644 512
------------------ -------------------
Total Assets $ 247,535 $ 212,511
================== ===================
Liabilities:
Non-interest bearing deposits $ 21,187 $ 24,432
Interest bearing deposits 89,450 78,501
Certificates of deposit 91,393 81,157
------------------ -------------------
Total deposits 202,030 184,090
------------------ -------------------
Advances from the Federal Home Loan Bank 26,257 12,288
Subordinated debt 3,000 -
Other liabilities 870 670
------------------ -------------------
Total Liabilities 232,157 197,048
------------------ -------------------
Commitments and Contingencies (Note 13)
Shareholders' Equity:
Common stock, $5 par value:
authorized 7,000,000 shares;
issued and outstanding 1,655,767 shares at December
31, 2008
and 1,540,543 shares at December 31, 2007 8,279 7,703
Additional paid-in capital 7,244 7,316
Accumulated (deficit) earnings (145)0 440
Accumulated other comprehensive income - 4
------------------ -------------------
Total Shareholders' Equity 15,378 15,463
------------------ -------------------
Total Liabilities and Shareholders' Equity $ 247,535 $ 212,511
================== ===================
See accompanying notes to consolidated financial statements
34
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the Year Ended For the Year Ended
December 31, 2008 December 31, 2007
---------------------- ----------------------
Interest Income
Interest and fees on loans $ 10,589 $ 9,524
Interest on investment securities 1,783 1,811
Interest on federal funds 108 113
----------------- -----------------
Total interest income 12,480 11,448
Interest Expense
Interest on deposits 4,506 5,774
Interest on borrowings 1,083 648
----------------- -----------------
Total interest expense 5,589 6,422
----------------- -----------------
Net interest income 6,891 5,026
Provision for loan losses 221 -
----------------- -----------------
Net interest income after loan loss provision 6,670 5,026
----------------- -----------------
Non-Interest Income
Service charges on deposits 104 87
Origination fees on mortgage loans sold 8 3
Bank owned life insurance income 163 146
Gain on sale of fixed assets 57 -
Miscellaneous fee income 87 88
----------------- -----------------
Total non-interest income 419 324
----------------- -----------------
Non-Interest Expense
Salaries and employee benefits 4,011 3,288
Net occupancy 1,272 921
Data processing and other service costs 372 290
Professional services 491 319
Advertising and promotion 141 127
Other real estate owned expense 69 -
Impairment loss on other real estate owned 155 -
FDIC expense 201 127
Other operating expenses 628 501
----------------- -----------------
Total non-interest expense 7,340 5,573
----------------- -----------------
Income before income taxes (251) (223)
Income tax benefit (164) (135)
----------------- -----------------
Net loss $ (87) $ (88)
================= =================
Earnings per share
Basic $ (0.05) $ (0.05(1)
Diluted $ (0.05) $ (0.05(1)
Weighted average shares outstanding
Basic 1,656 1,656(1)
Diluted 1,656 1,656(1)
(1) Earnings per share have been restated to reflect the 7.5% common stock
dividend paid on May 15, 2008 to common shareholders of record as of
April 2, 2008.
See accompanying notes to consolidated financial statements
35
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands, except share data)
Accumulated
Comprehensive Additional Accumulated Other
Income Paid-in Earnings Comprehensive
(Loss) Common Stock Capital (Deficit) Income (Loss) Total
------------ ------------ ------------ ----------- ------------- -----------
Balance at $ 7,336 $ 6,851 $ 1,365 $ (72) $ 15,480
December 31, 2006
========= ========= ======== ========= =========
Comprehensive income/ (loss)
Net loss $ (88) $ - $ - $ (88) $ - $ (88)
Unrealized gain on securities
available for sale, net of
tax 76 - - - 76 76
----------
Comprehensive loss $ (12)
==========
Non-vested stock based - (5) - - (5)
compensation
Stock Dividends 367 470 (837) - -
--------- --------- -------- --------- ---------
Balance at $ 7,703 $ 7,316 $ 440 $ 4 $ 15,463
December 31, 2007
========= ========= ======== ========= =========
Comprehensive income/ (loss)
Net loss $ (87) $ - $ - $ (87) ) $ - $ (87)
Unrealized loss on securities - ) )
available for sale, net of
tax (4) - - (4 (4
----------
Comprehensive loss $ (91)
==========
Stock based compensation - 9 - - 9
Declaration of 7.5% common
stock dividend 576 (81) (498) - (3)
--------- --------- -------- --------- ---------
Balance at
December 31, 2008 $ 8,279 $ 7,244 $ (145) $ - $ 15,378
========= ========= ======== ========= =========
See accompanying notes to consolidated financial statements.
36
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Year Ended For the Year Ended
December 31, 2008 December 31, 2007
-------------------- ---------------------
Cash flows from operating activities:
Net (loss) income $ (87) $ (88)
Adjustments to reconcile net income to net cash
provided by
(used for) operating activities:
Provision for loan losses 221 -
Income on Bank Owned Life Insurance (163) (146)
Gain on sale of fixed assets (57) -
Depreciation 422 345
Amortization of premiums and discounts, net 4 20
Stock option expense 9 5
Deferred tax benefit (146) (48)
Impairment loss on other real estate owned 155 -
Loans originated for sale (2,488) (808)
Proceeds from sales of loans held for sale 2,488 808
Increase in accrued interest receivable and
other assets (340) (314)
Increase (decrease) in other liabilities 200 (75)
----------------- -----------------
Net cash (used) provided by operating activities 218 (301)
Cash flows from investing activities:
Purchases of investments held to maturity (27,714) (13,050)
Repayment of investments held to maturity 35,636 8,089
Repayment of investments available for sale 2,980 4,100
Purchase of Federal Home Loan Bank Stock (656) (224)
Purchase of Bank Owned Life Insurance (400) -
Proceeds from sale of fixed assets 582 -
Insurance proceeds on other real estate owned 30 -
Net increase in loans (48,201) (29,175)
Purchases of premises and equipment (2,097) (995)
----------------- -----------------
Net cash used by investing activities (39,840) (31,255)
Cash flows from financing activities:
Net increase in deposits 17,940 22,799
Proceeds from borrowings 1,438,990 1,508,585
Principal payments on borrowings (1,422,021) (1,504,277)
Cash paid in lieu of fractional shares on stock
dividend (3) -
----------------- -----------------
Net cash provided by financing activities 34,906 27,107
Net (decrease) in cash and cash equivalents (4,716) (4,449)
Cash and cash equivalents at the beginning of the year 14,084 18,533
----------------- -----------------
Cash and cash equivalents at the end of the year $ 9,368 $ 14,084
================= =================
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 5,572 $ 6,453
Cash paid during the year for income taxes 10 60
Net change in unrealized gain (loss)on securities
available for sale, net of tax (4) 76
Issuance of stock dividend 576 -
Transfer from loans receivable to other real
estate owned - 466
See accompanying notes to consolidated financial statements
37
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(1) Nature of Operations
Cornerstone Bank (the "Bank") is a state-chartered commercial bank that
offers a variety of traditional commercial banking products and services
to small and medium-sized businesses, local professionals and
individuals, throughout Burlington and northern Camden counties in New
Jersey. The Bank is supervised and regulated by the New Jersey State
Department of Banking and Insurance and the Federal Deposit Insurance
Corporation ("FDIC"). The Bank's deposits are insured by the FDIC to the
extent provided by law. The Bank is managed as one business segment.
(2) Summary of Significant Accounting Policies
(a) Basis of Presentation
The consolidated financial statements include the accounts of
Cornerstone Bank and its one subsidiary, Cornerstone Realty
Holdings Inc.
(b) Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with U. S.
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change
in the near-term relate to the allowance for loan losses and the
evaluation of income taxes.
(c) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash and amounts due from banks, interest-bearing deposits
and federal funds sold. Generally, federal funds sold are
repurchased the following day.
(d) Investment Securities
Debt securities that management has the positive intent and
ability to hold until maturity are classified as held to maturity
and are carried at their remaining unpaid principal balance, net
of unamortized premiums or unaccreted discounts. Premiums are
amortized and discounts are accreted using a method that produces
results which approximate level yield over the estimated remaining
term of the underlying security.
Securities not classified as held to maturity are classified as
available for sale, and are stated at fair value. Changes in
unrealized gains and losses relating to available for sale
securities are excluded from earnings and reported as accumulated
other comprehensive loss, a separate component of shareholders'
equity, net of tax. Gains and losses are determined using the
specific-identification method and are accounted for on a
trade-date basis.
We evaluate securities for other-than-temporary impairment at
least quarterly. When evaluating a security for impairment, we
consider the length of time and the amount to which the fair value
is less than the amortized cost, the investment issuer's
credit-worthiness and ability to meet its cash flow requirements,
and our intent and ability to hold until its fair value has
recovered.
(e) Loans Held for Sale
The Bank originates and sells residential mortgage loans (without
recourse) on a servicing released basis to the secondary market.
This activity enables the Bank to fulfill the credit needs of the
community while reducing its overall exposure to interest rate and
credit risk. These loans are reported at the lower of their cost
or fair market value.
38
(f) Loans
Loan origination fees and related direct loan origination costs of
completed loans are deferred, and then recognized over the life of
the loan as an adjustment of yield reflected as interest income in
the statements of operations. The unamortized balances of such net
deferred loan origination fees/costs are reported on the Bank's
statements of financial condition as a component of loans
receivable.
Interest income is recorded on the accrual basis. Loans are
reported as non-accrual if they are past due as to principal or
interest payments for a period of ninety days or more. Exceptions
may be made if a loan is deemed by management to be well
collateralized and in the process of collection. Loans that are on
a current payment status may also be classified as non-accrual if
there is serious doubt as to the borrower's ability to continue
interest or principal payments. When a loan is placed in the
non-accrual category, interest accruals cease and uncollected
accrued interest receivable is reversed and charged against
current interest income. Non-accrual loans are generally not
returned to accruing status until principal and interest payments
have been brought current and full collectibility is reasonably
assured.
Impaired loans are measured based on the present value of expected
future discounted cash flows, the market price of the loan or the
fair value of the underlying collateral if the loan is collateral
dependent. For purposes of applying the measurement criteria for
impaired loans, the Bank excludes large groups of smaller balance
homogeneous loans, primarily consisting of residential real estate
and consumer loans, as well as commercial loans with balances of
less than $100,000. The recognition of interest income on impaired
loans is the same as for non-accrual loans discussed above.
(g) Allowance for Loan Losses
The allowance for losses on loans is based on management's ongoing
evaluation of the loan portfolio and reflects an amount considered
by management to be its best estimate of known and inherent losses
in the portfolio. Management considers a variety of factors when
establishing the allowance, such as the impact of current economic
conditions, diversification of the loan portfolio, delinquency
statistics, results of loan review and related classifications,
and historic loss rates. In addition, certain individual loans
which management has identified as problematic are specifically
provided for, based upon an evaluation of the borrower's perceived
ability to pay, the estimated adequacy of the underlying
collateral and other relevant factors. Consideration is also given
to examinations performed by regulatory agencies. Although
provisions have been established and segmented by type of loan,
based upon management's assessment of their differing inherent
loss characteristics, the entire allowance for losses on loans is
available to absorb loan losses in any category.
Management uses significant estimates to determine the allowance
for loan losses. Since the allowance for loan losses is dependent,
to a great extent, on conditions that may be beyond the Bank's
control, it is at least reasonably possible that management's
estimate of the allowance for loan losses and actual results could
differ in the near term.
In addition, regulatory authorities, as an integral part of their
examinations, periodically review the allowance for loan losses.
They may require additions to the allowance based upon their
judgments about information available to them at the time of
examination.
(h) FHLB Stock
The Bank carries its investment in Federal Home Loan Bank (FHLB)
Stock at its amortized cost. The Bank had $1,377,000 in FHLB stock
at December 31, 2008 compared to $721,000 at December 31, 2007.
(i) Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the expected useful
lives of the assets. Amortization of leasehold improvements is
computed using the straight-line method over the shorter of the
useful lives or the remaining lease terms. No events have
occurred, or changes in management's intentions, that would impact
the amortization period or recoverability of premises and
equipment, including leasehold improvements. Software costs,
furniture and equipment have depreciable lives of 3 to 10 years.
The costs of maintenance and repairs are expensed as they are
incurred and renewals and betterments are capitalized.
39
(j) Bank Owned Life Insurance
The Bank purchased an additional $400,000 of Bank Owned Life
Insurance ("BOLI") on selected directors and officers for the year
ended December 31, 2008. The Bank initially purchased $2,890,000
of Bank Owned Life Insurance on December 31, 2005 and $610,000 on
March 3, 2006. BOLI is carried at its aggregate cash surrender
value less surrender charges and totaled $4,348,000 at December
31, 2008. Income of $163,000 was recognized on the BOLI during the
year ended December 31, 2008. The Bank recognized $146,000 of
income on the BOLI during the year ended December 31, 2007. The
Bank is the sole beneficiary of the BOLI.
(k) Real Estate Owned
Real estate owned is comprised of properties acquired through
foreclosure proceedings or acceptance of a deed in lieu of
foreclosure. Real estate owned is recorded at the lower of the
carrying value of the loan or the fair value of the property, net
of estimated selling costs. Costs relating to the development or
improvement of the properties are capitalized while expenses
related to the operation and maintenance of properties are
recorded as an expense as incurred. Gains or losses upon
dispositions are reflected in earnings as realized. The Bank had
$281,000 in real estate owned at December 31, 2008 compared to
$466,000 of real estate owned at December 31, 2007.
(l) Earnings Per Share
Basic earnings per share is calculated on the basis of net income
divided by the weighted average number of shares outstanding.
Diluted earnings per share includes dilutive potential shares as
computed under the treasury stock method using average common
stock prices. Diluted earnings per share is calculated on the
basis of the weighted average number of shares outstanding plus
the weighted average number of additional dilutive shares that
would have been outstanding had all common stock options granted
been exercised.
(m) Income Taxes
Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases, as well as operating loss carry
forwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered
or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that
includes the enactment date. A valuation allowance is established
against deferred tax assets when in the judgment of management, it
is more likely than not that such deferred tax assets will not
become available. Because the judgment about the level of future
taxable income is dependent to a great extent on matters that may,
at least in part be beyond the Bank's control, it is at least
reasonably possible that management's judgment about the need for
a valuation allowance for deferred taxes could change in the near
term.
(n) Stock Options
On January 1, 2006, the Bank adopted Statement of Financial
Accounting Standard (SFAS) No. 123(R), "Share-based Payment"
(Statement 123R). This Statement establishes the standards for
accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for equity
instruments of the enterprise or liabilities that are based on the
fair value of the enterprise's equity instruments or that may be
settled by the issuance of such equity instruments. Statement No.
123(R) requires an entity to recognize the grant-date fair-value
of stock options and other equity-based compensation issued to
employees in the statement of operations. The revised Statement
generally requires that an entity account for those transactions
using the fair-value based method and eliminates an entity's
ability to account for share-based compensation transactions using
the intrinsic value method of accounting provided in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which was permitted under Statement No. 123, as
originally issued.
40
Recent Accounting Pronouncements
(o) FIN 48 Accounting for Uncertainty in Income Taxes
In June 2006, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes" (FIN 48). The interpretation clarifies the
accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB
Statement No. 109, "Accounting for Income Taxes". Specifically,
the interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of an income tax position taken or expected to be
taken in a tax return. This interpretation is effective for fiscal
years beginning after December 15, 2006, or January 1, 2007 for
the Bank. The Bank adopted this statement in 2007 and there was no
effect on its results of operations or financial position.
(p) SFAS 157 Fair Value Measurement
In September 2006, the FASB issued Statement of Financial
Accounting Standards No. 157, "Fair Value Measurement" (Statement
157). Statement 157 defines fair value, establishes a framework
for measuring fair value in U.S. generally accepted accounting
principles, and expands disclosure requirements for fair value
measurements. Statement 157 does not require any new fair value
measurements. The Bank adopted this statement on January 1, 2008
and it did not have a material impact on the consolidated
financial statements.
In conjunction with the adoption of Statement 157, the Bank also
adopted FASB Position No. FAS 157-2, "Effective Date of FASB
Statement No. 157" (FSP FAS 157-2) on January 1, 2008. FSP FAS
157-2 amends Statement 157 to defer its effective date for all
nonfinancial assets and nonfinancial liabilities, except those
that are recognized or disclosed at fair value in the financial
statements on a recurring basis, to fiscal years beginning after
November 15, 2008, or January 1, 2009 for the Bank.
Statement 157 establishes a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value into
three broad levels, as described below:
Level 1. Level 1 inputs are unadjusted quoted prices in
active markets for identical assets or liabilites.
Level 2. Level 2 inputs are inputs other than quoted prices
included in Level 1 that are observable, either directly
or indirectly. Level 2 inputs include quoted prices for
similar assets, quoted prices in markets that are not
considered to be active, and observable inputs other than
quoted prices such as interest rates.
Level 3. Level 3 inputs are unobservable inputs.
A financial instrument's level within the fair value hierarchy is
based upon the lowest level of any input significant to the fair
value measurement.
41
(q) EITF 06-4 Accounting for Deferred Compensation and Postretirement
Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements
In September 2006, the FASB ratified Emerging Issues Task Force
(EITF) 06-4, "Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements" (EITF 06-4). EITF 06-4 addresses
accounting for endorsement split-dollar life insurance
arrangements that provide a benefit to an employee that extends to
post-retirement periods. EITF 06-4 requires that the
post-retirement benefit aspects of an endorsement-type
split-dollar life insurance arrangement be recognized as a
liability by the employer and that the obligation is not settled
upon entering into an insurance arrangement. EITF 06-4 is
effective for fiscal years beginning after December 15, 2007, or
January 1, 2008 for the Bank. The Bank adopted this ETIF in 2008,
and it did not have a material effect on the Bank's financial
position or result of operations.
(r) SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities - Including an amendment of FASB Statement
No. 115
In February 2007, the FASB issued SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities--Including
an amendment of FASB Statement No. 115 (Statement 159). Statement
159 permits entities to choose to measure many financial
instruments and certain other items at fair value and amends FASB
Statement 115 to, among other things, require certain disclosures
for amounts for which the fair value option is applied.
Additionally, this Statement provides that an entity may
reclassify held-to-maturity and available-for-sale securities to
the trading account when the fair value option is elected for such
securities, without calling into question the intent to hold other
securities to maturity in the future. This Statement is effective
as of the beginning of an entity's first fiscal year that begins
after November 15, 2007. The Bank adopted this Statement in 2008,
and it did not have a material effect on the Bank's financial
position or result of operations.
(3) Investment Securities
A comparison of amortized cost and approximate fair value of investment
securities held to maturity and available for sale at December 31, 2008
and 2007 is as follows:
December 31, 2008
--------------- -- ------------------ -- --------------- -- ---------------
(in thousands) Gross
Gross Unrealized
Amortized Cost Unrealized Gains Losses Fair Value
--------------- ------------------ --------------- ---------------
Investments held to maturity:
Government agency obligations $ 26,653 $ 108 $ - $ 26,761
Mortgage backed securities 1,745 - (19) 1,726
------------ --------------- ------------ ------------
Total $ 28,398 $ 108 $ (19) $ 28,487
============ =============== ============ ============
December 31, 2007
--------------- -- ------------------ -- --------------- -- ----------------
(in thousands) Amortized Cost Gross Gross Fair Value
Unrealized
Unrealized Gains Losses
--------------- ------------------ --------------- ----------------
Investments held to maturity:
Government agency obligations $ 33,915 $ 38 $ (18) $ 33,935
Mortgage backed securities 2,412 - (50) 2,362
------------ --------------- ------------ -------------
Total $ 36,327 $ 38 $ (68) $ 36,297
============ =============== ============ =============
Investments available for sale:
Government agency obligations $ 2,977 $ 11 $ (4) $ 2,984
------------ --------------- ------------ -------------
Total $ 2,977 $ 11 $ (4) $ 2,984
============ =============== ============ =============
At December 31, 2008, the Bank had Federal agency securities with
aggregate amortized costs totaling $201,000 pledged to collateralize
public deposits under the Governmental Unit Deposit Protection Act as
compared to $950,000 pledged at December 31, 2007.
The following table sets forth the scheduled contractual maturities of
investment securities held to maturity at December 31, 2008:
42
Held to Maturity
--------------- -- ---------------
(in thousands) Amortized Cost Fair Value
--------------- ---------------
Within one year $ - $ -
After one year through five years - -
After five years through ten
years 13,662 13,736
After ten years 14,736 14,751
------------ ------------
Total $ 28,398 $ 28,487
============ ============
The following table sets forth information regarding the fair value and
unrealized losses on the Bank's temporarily impaired investment
securities at December 31, 2008 and 2007 for the time periods shown:
December 31, 2008
(in thousands) Less than 12 months 12 months or longer Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ---------- ---------- ---------- ---------- ----------
Held to maturity
Mortgage Backed Securities $ - - $ 1,726 $ 19 $ 1,726 $ 19
------- ------- ------- ------- ------- -------
Total temporarily impaired
investments securities $ - $ - $ 1,726 $ 19 $ 1,726 $ 19
======= ======= ======= ======= ======= =======
December 31, 2007
(in thousands) Less than 12 months 12 months or longer Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ---------- ---------- ---------- ---------- ----------
Held to maturity
Government agency
obligations $ 6,000 $ 1 $ 8,780 $ 17 $ 14,780 $ 18
Mortgage Backed Securities - - 2,362 50 2,362 50
Available for sale
Government agency
obligations - - 994 4 994 4
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
Total temporarily impaired $ 6,000 $ 1 $ 12,136 $ 71 $ 18,136 $ 72
investments securities
======= ======= ======= ======= ======= =======
Management has taken into consideration the following information in
reaching the conclusion that the impairment of the securities listed in
the table above are not other than temporarily impaired. The unrealized
losses disclosed above are the result of fluctuations in market interest
rates currently offered on like securities and do not reflect a
deterioration or downgrade of the investment issuer's credit-worthiness
or ability to meet its cash flow requirements. The Bank believes that it
is probable that it will receive all future contractual cash flows and
has the ability and intent to hold these investment securities until
recovery or maturity. The U.S. Government agency sponsored securities
which are listed have call provisions priced at par if called prior to
their respective maturity dates.
(4) Other Comprehensive Income (Loss)
The change in other comprehensive income (loss) components and related
tax (expense) benefit are as follows for the years ended December 31,
2008 and 2007 (in thousands):
2008
-------------- -- -------------- --- --------------
Before-Tax Net-of-Tax
Unrealized gains on securities available for sale: Amount Tax Benefit Amount
-------------- -------------- --------------
Unrealized holding losses arising during the year $ (7) $ 3 $ (4)
-------------- -------------- --------------
Other comprehensive income $ (7) $ 3 $ (4)
============== ============== ==============
2007
-------------- -- -------------- --- --------------
Before-Tax Net-of-Tax
Unrealized gains on securities available for sale: Amount Tax Expense Amount
-------------- -------------- --------------
Unrealized holding gains arising during the year $ 127 (51) $ 76
-------------- -------------- --------------
Other comprehensive income $ 127 (51) $ 76
============== ============== ==============
43
(5) Loans Receivable
Loans receivable consist of the following:
(in thousands) December 31, 2008 December 31, 2007
----------------------- -----------------------
Commercial $ 60,646 $ 31,385
Real estate - commercial 91,105 73,879
Real estate - residential 19,346 21,327
Construction 12,323 10,899
Consumer loans 10,721 8,555
-------------------- --------------------
Subtotal 194,141 146,045
Allowance for loan losses (1,133) (1,050)
Net deferred loan fees (37) (4)
-------------------- --------------------
-------------------- --------------------
Loans receivable, net $ 192,971 $ 144,991
==================== ====================
Under the New Jersey Banking Act of 1948, the Bank is subject to a
loans-to-one-borrower limitation of 15% of capital funds. At December 31,
2008, the loans-to-one-borrower limitation was $2.9 million; this
excluded an additional 10% of adjusted capital funds or $1.9 million,
which may be loaned if collateralized by readily marketable securities as
defined by regulations. At December 31, 2008 there were no loans
outstanding or committed to any one borrower, which individually or in
the aggregate exceeded that limit.
The Bank lends primarily to customers in its primary market area. The
majority of loans are mortgage loans secured by real estate. Included as
mortgage loans are commercial real estate, residential real estate and
jumbo real estate loans. Accordingly, lending activities could be
affected by changes in the general economy, the regional economy or real
estate values. At December 31, 2008 and 2007 mortgage loans secured by
real estate totaled $110.5 million and $95.2 million, respectively.
Mortgage loans represented 56.9% and 65.2% of total loans at December 31,
2008 and 2007, respectively.
Non-performing assets include non-accrual loans, loans on which the
accrual of interest has ceased, and impaired loans. At December 31, 2008
and 2007, the Bank had no non-accrual loans. At December 31, 2008, the
Bank had three impaired loans totaling $2,375,000 which are sufficiently
collateralized and therefore no specific reserves have been recorded
against them. The average balance of impaired loans totaled $2,383,000
for 2008, interest income recorded on impaired loans during the year
ended December 31, 2008 totaled $69,000. The Bank had no impaired loans
at December 31, 2007.
The following is a summary of the activity of the allowance for loan
losses:
(in thousands) 2008 2007
-------------- --------------
Balance, beginning of year $ 1,050 $ 1,050
Provision for loan losses 221 -
Recoveries (charge-offs), net (138) -
----------- -----------
----------- -----------
Balance, end of year $ 1,133 $ 1,050
=========== ===========
(6) Premises and Equipment
Premises and equipment at December 31, 2008 and 2007, stated at cost less
accumulated depreciation and amortization, are summarized as follows:
(in thousands) 2008 2007
------------------ -------------------
Land $ 2,534 $ 2,694
Buildings 4,493 3,271
Furniture and equipment 1,457 846
Automobiles 36 32
Leasehold improvements 1,183 836
Construction in progress - 678
--------------- ---------------
Cost 9,703 8,357
Accumulated depreciation and amortization (1,234) (1,038)
--------------- ---------------
Total $ 8,469 $ 7,319
=============== ===============
44
Depreciation and amortization expense was $422,000 for the year ended
December 31, 2008 and $345,000 for the year ended December 31, 2007.
During 2008 the Bank sold fixed assets that had a total of $89,000 in
accumulated depreciation, coupled with the retirement of fully
depreciated assets of $137,000.
At December 31, 2008, the Moorestown, Burlington and Medford offices were
leased; these leases include options for renewal. See Note 12 to
Consolidated Notes to Financial Statements for additional information
regarding operating leases.
(7) Deposits
Deposits consist of the following major classifications:
(in thousands) December 31, 2008 December 31, 2007
----------------------------- ------------------------------
Interest bearing checking accounts $ 26,845 13.3 % $ 32,718 17.8%
Non-interest bearing checking accounts 21,187 10.5 24,432 13.3
Statement savings 3,401 1.7 4,720 2.6
Money market demand accounts 59,204 29.3 41,063 22.3
---------- --------- ------------ --------
Total core deposits $ 110,637 54.8 % $ 102,933 55.9%
---------- --------- ------------ --------
Jumbo certificates of one hundred 0
thousand or more 33,085 16.4 27,589 15.
Non-jumbo certificates:
Original maturities of six months or 1
less 25,566 12.6 48,021 26.
Original maturities of more than six 0
months 32,742 16.2 5,547 3.
---------- --------- ------------ --------
Total time deposits 91,393 45.2 81,157 44.1
---------- --------- ------------ --------
Total deposits $ 202,030 100.0 % $ 184,090 100.0%
========== ========= ============ ========
The weighted average rate on certificates of deposit was 3.86% and 4.95%
at December 31, 2008 and 2007, respectively.
Interest expense on deposits for the years ended December 31, 2008 and
2007 consisted of the following:
(in thousands) 2008 2007
---------------- ----------------
Checking and money market demand accounts $ 1,692 $ 1,673
Statement savings 57 164
Certificates of deposit 2,757 3,937
------------ ------------
Total $ 4,506 $ 5,774
============ ============
The following is a schedule of certificates of deposit by maturities as
of December 31, 2008:
Year ending December 31,
------------------------
(in thousands)
2009 $ 78,443
2010 3,519
2011 9,398
2012 33
2013 -
----------------
----------------
Total $ 91,393
================
(8) Borrowings
The Bank is a member of the FHLB. Membership provides the Bank with
additional secured borrowing capacity of up to a maximum of 25% of the
Bank's total assets, subject to certain conditions. At December 31, 2008,
the Bank was eligible to borrow an additional $10.2 million. At December
31, 2008, the Bank had advances outstanding with the FHLB in the amount
of approximately $26.3 million at a weighted average interest rate of
3.62%. Pursuant to collateral agreements with the FHLB, advances are
secured by a blanket lien on the Bank's residential mortgage loan
portfolio as well as bank owned securities. At December 31, 2008, the
Bank had an available line of credit under the Overnight Repricing
Advance Program with the FHLB in the aggregate amount of $41.0 million.
In addition, the Bank also has access to an unsecured overnight line of
credit in the amount of $3.0 million, on an uncommitted basis through
Atlantic Central Bankers Bank. This arrangement is for the sale of
federal funds to the Bank subject to the availability of such funds. At
December 31, 2008 and 2007, the Bank had no balances outstanding against
those lines of credit.
45
The following is a schedule of advances by maturities as of December 31,
2008:
Year ending December 31,
------------------------
(in thousands)
2009 11,074
2010 15,183
----------------
Total $ 26,257
================
On October 31, 2008, the Bank issued a hybrid capital instrument in the
form of subordinated debt which qualifies as Tier II capital in the
aggregate amount of $3.0 million. The term of the debt is for a six year
period with a maturity date of November 1, 2014, and the interest rate is
5.00% fixed for the first year then adjusts at a variable rate equal to
prime rate for the remaining five years. The debt security is redeemable
at par after April 30, 2009 at the Bank's option.
(9) Earnings Per Share
The following is a reconciliation of the numerators and denominators of
the basic and dilutive earnings per share calculation for the years ended
December 31, 2008 and 2007:
--------------- -- ----------------
2008 2007
--------------- ----------------
(in thousands, except per share data)
Net loss $ (87) $ (88)
Weighted average basic number of shares 1,656 1,656
Dilutive effect of options - -
Weighted average diluted number of shares 1,656 1,656
Basic (loss) earnings per share (0. 05) (0. 05)
Diluted (loss) earnings per share $ (0. 05) (0. 05)
For the year ended December 31, 2008, there were stock options on 67,899
shares which were anti-dilutive due to the Bank's net loss for the period
ending December 31, 2008.
For the year ended December 31, 2007, there were stock options on 61,409
shares which were anti-dilutive due to the Bank's net loss for the period
ending December 31, 2007.
(10) Fair Value of Financial Instruments
The following required disclosure of the estimated fair value of
financial instruments has been determined by the Bank using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts.
The methods and assumptions used to estimate the fair values of each
class of financial instruments are as follows:
(a) Cash and Cash Equivalents, Accrued Interest Receivable, and
Accrued Interest Payable
The items are generally short-term in nature and, accordingly, the
carrying amounts reported in the consolidated statements of
financial condition are reasonable approximations of their fair
values.
(b) Investment Securities
Fair values for investment securities are based on quoted market
prices, if available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable
instruments.
46
(c) Loans
For variable rate loans that reprice frequently and with no
significant change in credit risk, fair value is based on carrying
value. The fair value for other loans receivable was estimated
using a discounted cash flow analysis, which uses interest rates
currently being offered for loans with similar terms to borrowers
of similar credit quality. Consideration was given to the rates of
prepayment, economic conditions, risk characteristics and other
factors considered appropriate.
(d) FHLB Stock
The carrying value of FHLB Stock in the accompanying
statements of financial condition approximates fair value.
(e) Deposits
The fair values of deposits subject to immediate withdrawal, such
as interest and non-interest checking, statement savings, and
money market deposit accounts are equal to their carrying amounts
in the accompanying statements of financial condition. Fair values
for time deposits are estimated by discounting future cash flows
using interest rates currently offered on time deposits with
similar remaining maturities.
(f) FHLB Advances
Rates currently available to the Bank for debt with similar terms
and remaining maturities are used to estimate fair value of
existing FHLB Advances.
(g) Subordinated Debenture
For variable rate subordinated debentures that reprices frequently
and with no significant change in credit risk, fair value is based
on carrying value.
(h) Off-balance sheet instruments
Off-balance sheet instruments are primarily comprised of loan
commitments and unfunded lines of credit which are generally
priced at market rate at the time of funding. Therefore, these
instruments have nominal value prior to funding.
The estimated fair value of the Bank's financial instruments at December
31, 2008 and 2007 was as follows:
2008 2007
------------------------------------ -----------------------------------
(in thousands) Carrying amount Estimated Carrying amount Estimated
fair value fair value
---------------- ---------------- ---------------- ---------------
Financial assets:
Cash and cash equivalents $ 9,368 $ 9,368 $ 14,084 $ 14,084
Investments held to maturity 28,398 28,487 36,327 36,297
Investments available for sale - - 2,984 2,984
Loans receivable 194,104 193,861 146,041 145,064
FHLB stock 1,377 1,377 721 721
Accrued interest receivable 1,217 1,217 1,009 1,009
------------- ------------- ------------- -------------
Total financial assets $ 234,464 $ 234,310 $ 201,166 200,789
============= ============= ============= =============
Financial Liabilities:
Checking Accounts $ 48,032 $ 48,032 $ 57,150 57,150
Statement savings accounts 3,401 3,401 4,720 4,720
Money market accounts 9,110 9,110 15,040 15,040
Index Accounts 50,094 50,094 26,023 26,023
Certificates of deposit 91,393 91,674 81,157 81,450
FHLB advances 26,257 26,257 12,288 12,288
Subordinated Debt 3,000 3,000 0 0
Accrued interest payable 278 278 260 260
------------- ------------- ------------- -------------
Total financial liabilities $ 231,565 $ 231,846 $ 196,638 196,631
============= ============= ============= =============
Contract Estimated Contract Estimated
Value Fair Value Value Fair Value
---------------- ---------------- ---------------- ---------------
Off-balance sheet instruments:
Commitments to extend credit $ 42,514 $ - $ 33,867 $ -
============= ============= ============= =============
47
(11) Income Taxes
Income tax expense (benefit) for the years ended December 31, 2008 and
2007 consisted of the following:
(in thousands) 2008 2007
---------------- ----------------
Federal:
Current $ (20) $ (88)
Deferred (122) (16)
State:
Current 4 1
Deferred (26) ( 32)
------------ ------------
------------ ------------
$ (164) $ (135)
============ ============
The following is a reconciliation between expected tax expense (benefit)
at the statutory rate of 34% and actual tax expense:
(in thousands) 2008 2007
----------------- ---------------
At federal statutory rate $ (85) $ (76)
Adjustments resulting from:
State tax, net of federal benefit (23) (20)
Bank owned life insurance (55) (50)
Other (1) 11
-------------- ------------
-------------- ------------
$ (164) $ (135)
-------------- ------------
A summary of deferred tax assets and liabilities of the Bank at December
31, 2008 and 2007, are as follows:
(in thousands) 2008 2007
-------------------- -------------------
Deferred tax assets:
Book bad debt reserves - loans $ 452 $ 419
NJ depreciation 2 3
Net Operating Loss- State 22 18
Deferred Compensation 42 20
OREO Impairment 62 -
FASB 123R Options 5 2
Charitable Contribution Carryforward 22 22
Depreciation 79 22
---------------
---------------- ---------------
Total deferred tax assets 686 506
---------------- ---------------
Deferred tax liabilities:
Tax bad debts ( 41) ( 78)
Deferred loan costs (183) (112)
Unrealized losses on AFS securities - (3)
---------------
----------------
Total deferred tax liabilities (224) (193)
---------------- ---------------
---------------- ---------------
Net deferred tax asset $ 462 $ 313
================ ===============
The ability to realize deferred tax assets is dependent upon a variety of
factors, including the generation of future taxable income, the existence
of taxes paid and recoverable, the reversal of deferred tax liabilities
and tax planning strategies. Based upon these and other factors,
management determined that it is more likely than not that the Bank will
realize the benefits of these deferred tax assets and, therefore, there
is no valuation allowance required.
As of January 1, 2008 and December 31, 2008, the Bank had no material
unrecognized tax benefits or accrued interest and penalties. The Bank's
policy is to account for interest as a component of interest expense and
penalties as a component of other expense. Federal tax years 2005 through
2008 were open for examination as of December 31, 2008.
48
As of December 31, 2008, the Bank has charitable contribution
carryforwards of $54,593 that will expire after December 31, 2012 if
unutilized. In addition, the Bank has state net operating loss
carryforwards of $370,398 which will begin to expire after December 31,
2014 if not utilized.
(12) Operating Leases
At December 31, 2008, the Bank was obligated under non-cancelable
operating leases, which generally include options to renew, for the
Bank's premises in Moorestown, Medford, Burlington and Mt. Laurel, New
Jersey and for certain equipment.
Future minimum payments, including anticipated renewals, under these
leases for the years 2009 through 2013 and thereafter are as follows (in
thousands):
2009 $ 422
2010 424
2011 430
2012 403
2013 and thereafter 1,148
----------
Total $ 2,827
==========
Total lease expense for all leases for the years ended December 31, 2008
and 2007 was $376,000 and $274,000, respectively.
(13) Commitments and Contingencies
Financial Instruments with Off-balance Sheet Risk
The Bank is a party to financial instruments with off-balance sheet risk
in the normal course of business. These financial instruments include
commitments to extend credit to meet the financing needs of its
customers. Commitments issued to potential borrowers of the Bank amounted
to approximately $42.5 million at December 31, 2008 and $33.9 million at
December 31, 2007. Such commitments have been made in the normal course
of business and at current prevailing market terms. The commitments, once
funded, are principally to originate commercial loans and other loans
secured by real estate.
Legal Proceedings
At December 31, 2008 and 2007, the Bank was neither engaged in any
existing nor aware of any significant pending legal proceedings. From
time to time, the Bank is a party to litigation that arises in the normal
course of business. Management does not believe the resolution of this
litigation, if any, would have a material adverse effect on the Bank's
financial condition or results of operation. However, the ultimate
outcome of any such matter, as with litigation generally, is inherently
uncertain and it is possible that some of these matters may be resolved
adversely to the Bank.
(14) Related Party Transactions
At December 31, 2008 and 2007 and for the periods then ended, the Bank
has made no extensions of credit to any director or officer of the Bank.
The Bank obtained certain legal, engineering and 401(k) plan investment
services from other entities which are or were affiliated with directors
of the Bank. Such aggregate services amounted to fees of $51,000 for the
year ended December 31, 2008 and $214,000 for the year ended December 31,
2007. In management's opinion, the terms of such services were
substantially equivalent to those which would have been obtained from
unaffiliated parties.
(15) Stock Option Plan
In April 2000, the Bank's Shareholders approved the Bank's 2000 Stock
Option Plan A and Plan B (together the "Stock Option Plans"). Pursuant to
the Stock Option Plans, a total of 77,382 shares of common stock have
been reserved for issuance by the Bank upon exercise of stock options to
be granted to officers, directors, key employees and other persons from
time to time.
49
In May 2000, options to purchase a total of 73,467 shares of common stock
were granted under the Stock Option Plans at an exercise price of $10.00
per share, of which 51,800 shares became vested immediately and 21,667
shares became vested on a one-third per year basis, with one-third being
immediately vested. In July 2001, options to purchase a total of 1,600
shares of common stock were granted at an exercise price of $10.00 per
share, with vesting on a one-third per year basis, with one-third being
immediately vested. In August 2004, options to purchase a total of 2,250
shares of common stock were granted at an exercise price of $12.00 per
share, with vesting on a one-third per year basis, with one-third being
immediately vested. In October 2007, options to purchase a total of 2,430
shares of common stock were granted at an exercise price of $10.10 per
share, with vesting on a one-third per year basis, with one-third being
immediately vested. In March 2008, options to purchase a total of 1,750
shares of common stock were granted at an exercise price of $8.05 per
share, with vesting on a one-third per year basis, with one-third being
immediately vested.
All options expire ten years from the date of the grant. The exercise
price of each option equals the market price of the Bank's common stock
on the date of grant.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing model. The fair value of options
granted in 2008 was $2.65 and fair value of options granted in 2007 was
$3.53. Significant assumptions used in the model for 2008 grants included
a risk-free interest rate of 3.53%; an expected life of five years; and
expected volatility of 30%. Assumptions used in the model for 2007 grants
included a risk-free interest rate of 4.54%; an expected life of ten
years; and expected volatility of 30%.
The remaining unrecognized compensation cost relating to non-vested stock
based compensation awards at December 31, 2008 is $8,400 which will be
recognized over the next two years.
A summary status of the Bank's Stock Option Plans as of December 31, 2008
and 2007 and the changes during the years ended is as follows:
2008 2007 (1)
-------------------------- ---------------------------
Shares Weighted Shares Weighted
Average Average
Price Price
---------- ------------ ----------- ------------
Outstanding, beginning of year 66,015 $ 8.88 68,958 $ 8.92
Granted 1,884 7.49 2,612 -
Forfeited - - (5,555) 9.67
Exercised - - - -
---------- -- --------- ----------- -- ---------
Outstanding, end of year 67,899 $ 8.63 66,015 $ 8.88
========== == ========= =========== == =========
---------- -- --------- ----------- -- ---------
Options exercisable at December 65,775 $ 8.86 64,273 $ 8.86
31,
========== == ========= =========== == =========
(1) December 31, 2007 stock option share information has been restated
to reflect the 7.5% common stock dividend paid on May 15, 2008 to
common shareholders of record as of April 2, 2008.
A summary status of all stock options outstanding and exercisable for the
Stock Option Plans as of December 31, 2008, segmented by range of
exercise prices is as follows:
Outstanding Exercisable
-------------------------------------------------- -------------------------------
Weighted
Average
Weighted Remaining Weighted
Number of Average Contractual Number of Average
Shares Exercise Price Life Shares Exercise Price
------------ --------------- --------------- ------------ ---------------
Stock Options:
$7.49 - $9.40 67,889 $ 8.63 1.6 years 65,775 $ 8.86
In 2008, the Bank had stock based compensation expense of $7,600 compared
to a benefit of $5,000 in 2007. The Bank recorded no tax benefit from
stock based compensation during the years ended December 31, 2008 and
December 31, 2007, respectively.
50
(16) Deferred Compensation Plans
Effective January 1, 2006, the Bank adopted a Nonqualified Deferred
Compensation Plan (the "Executive Plan") and the Directors' Fee Deferral
and Death Benefit Plan (the "Directors' Plan"). Both plans provide for
payments of deferred compensation to participants. The Bank recorded
$67,000 and $0 in deferred compensation expense during the years ended
December 31, 2008 and 2007, respectively.
(17) Regulatory Matters
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). Management believes, as of
December 31, 2008 and 2007, the Bank met all capital adequacy
requirements to which it was subject.
As of December 31, 2008, the Bank's management believes that the Bank
would be "adequately-capitalized" under applicable FDIC capital adequacy
regulations. 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. As of December 31, 2008, the most
recent notification from the FDIC categorized the Bank as
"adequately-capitalized" under the regulatory framework for prompt
corrective action.
As discussed in Footnote 19, the Company has contributed $4,400,000 in
additional capital to the Bank and is now considered to be "well
capitalized" under applicable FDIC capital adequacy regulations.
The Bank's actual capital amounts and ratios at December 31, 2008 and
2007 are presented in the following table:
To be well capitalized
For capital adequacy under prompt corrective
Actual purposes action provisions
------------------------ ------------------------ ------------------------
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At December 31, 2008:
Total Capital (to risk
weighted assets) $ 19,511 9.1% $ 17,065 8.0% $ 21,331 10.0 %
Tier I Capital (to risk
weighted assets) $ 15,378 7.2% $ 8,533 4.0% $ 12,799 6.0 %
Tier I Capital (to
average assets) $ 15,378 6.2% $ 9,861 4.0% $ 12,327 5.0 %
At December 31, 2007:
Total Capital (to risk
weighted assets) $ 16,509 10.0% $ 13,186 8.0% $ 16,483 10.0 %
Tier I Capital (to risk
weighted assets) $ 15,459 9.4% $ 6,593 4.0% $ 9,890 6.0 %
Tier I Capital (to
average assets) $ 15,459 7.5% $ 8,203 4.0% $ 10,254 5.0 %
51
(18) Dividend Policy
The future dividend policy of the Bank is subject to the discretion of
the Board of Directors and will be dependent upon a number of factors,
including operating results, financial condition and general business
conditions. Holders of common stock are entitled to receive dividends as,
if and when declared by the Board of Directors of the Bank out of funds
legally available for that purpose.
Under New Jersey law, the directors of a New Jersey state-chartered bank,
such as the Bank, are permitted to declare dividends on common stock only
if, after payment of the dividend, the capital stock of the Bank will be
unimpaired and either the Bank will have surplus (additional paid-in
capital) of not less than 50% of its capital stock or the payment of the
dividend will not reduce the Bank's surplus.
(19) Subsequent Event
On July 17, 2008, the Board of Directors of the Bank approved a Plan of
Acquisition ("Plan"), which provides for the establishment of a bank
holding company structure. Pursuant to the Plan, the Bank became a
wholly-owned subsidiary of Cornerstone Financial Corporation ("CFC"), a
New Jersey corporation formed solely for the purpose of becoming the
holding company of the Bank. The Plan provided for the transfer and
contribution of all of the Bank's common stock held by shareholders to
CFC in a one-for-one exchange for the common stock of CFC.
The Plan was adopted by a two-thirds majority of the Bank's shareholders
on October 28, 2008. The Plan was approved by the New Jersey Department
of Banking and Insurance ("NJDOBI") on August 15, 2008 and was also
approved by the Federal Reserve Bank of Philadelphia as of December 30,
2008. The holding company reorganization was consummated as of the close
of business on January 30, 2009, therefore, the financial statements and
all other operating information contained in this annual report on Form
10-K for the year ending December 31, 2008 are of the Bank on a stand
alone basis.
On February 17, 2009, Cornerstone Financial Corporation ("CFC") entered
into a non-revolving line of credit loan agreement with Atlantic Central
Bankers Bank for an amount up to $5,000,000. CFC has drawn $4,500,000
under the Loan and has contributed $4,400,000 as additional capital to
its wholly-owned subsidiary, Cornerstone Bank.
As a result of the additional capital received from CFC, Cornerstone
Bank, has now returned to "Well Capitalized Status" with capital ratios
effective February 17, 2009 as follows:
Tier I capital to risk weighted assets: 8.95%
Total capital to risk weighted assets: 10.82%
Tier I capital to average assets: 7.95%
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. Controls and Procedures
Not applicable.
Item 9A(T). Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Bank's chief executive officer and chief financial officer, after
evaluating the effectiveness of the Bank's "disclosure controls and procedures"
(as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and
15d-15(e)) as of the end of the period covered by this annual report, have
concluded that as of such date, the Bank's disclosure controls and procedures
were effective to ensure at a reasonable assurance level that material
information relating to the Bank is recorded, processed, summarized and reported
in a timely manner.
52
Management's Report on Internal Control over Financial Reporting
The management of the Bank is responsible for establishing and
maintaining adequate internal control over financial reporting (as defined in
Rule 13a-15(f) of the Securities Exchange Act of 1934). The Bank'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 accounting
principles generally accepted in the United States of America.
Internal control over financial reporting cannot provide absolute
assurance of achieving financial reporting objectives because of its inherent
limitations. Internal control over financial reporting is a process that
involves human diligence and compliance and is subject to lapses in judgment and
breakdowns resulting from human failures. Internal control over financial
reporting can also be circumvented by collusion or improper management override.
Because of such limitations, there is a risk that material misstatements may not
be prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, risk. 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.
Management assessed the effectiveness of the Bank's internal control
over financial reporting as of December 31, 2008. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated
Framework. Based on this assessment using the COSO criteria, management
concluded that the Bank's internal control over financial reporting was
effective as of December 31, 2008.
This Annual Report on Form 10-K does not include an attestation report
of the Bank's independent registered public accounting firm regarding internal
control over financial reporting. Management's report was not subject to
attestation by the Bank's independent registered public accounting firm pursuant
to temporary rules of the Securities and Exchange Commission that permit the
Bank to provide only management's report in this Annual Report on Form 10-K.
There were no changes in the Bank's internal control over financial
reporting that occurred during the Bank's fourth fiscal quarter of 2008 that
have materially affected, or are reasonably likely to materially affect, the
Bank's internal control over financial reporting.
Item 9B. Other Information
Not Applicable
PART III
Item 10. Directors, Executive Officers, and Corporate Governance
The information contained under the sections captioned "Election of
Directors," "Corporate Governance" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement for the Annual Meeting of
Shareholders scheduled to be held on May 20, 2009 (the "Proxy Statement") is
incorporated herein by reference.
Code of Ethics. The Company has adopted a Code of Ethics for the Bank's chief
executive officer and principal financial and accounting officers. A copy of the
Code of Ethics can be found on the Company's internet website at
www.cornerstonebanknj.com. The Company intends to disclose any amendments to its
Code of Ethics, and any waiver from a provision of the Code of Ethics granted to
the Company's principal executive officer, principal financial officer,
principal accounting officer, or persons performing similar functions, on the
Company's internet website within four business days following such amendment or
waiver. The information contained on or connected to the Company's internet
website is not incorporated by reference into this Form 10-K and should not be
considered part of this or any other report that the Company files with or
furnishes to the SEC.
53
Item 11. Executive Compensation
The information contained in the section captioned "Director and
Executive Officer Compensation" in the Proxy Statement is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters
The information contained in the section captioned "Security Ownership
of Certain Beneficial Owners and Management" in the Proxy Statement is
incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth summary information regarding the Bank's
equity compensation plans:
( c )
Number of securities
( a ) remaining available
Number of securities ( b ) for future issuance
to be issued upon Weighted-average under equity
exercise of exercise price of compensation plans
outstanding options, outstanding (excluding securities
warrants, and rights options, warrants reflected
As of December 31, 2008 (#) and rights ($) in column ( a )
----------------------- ----------------------- -------------------- -----------------------
Equity compensation plans
approved by security holders 67,899 $8.63 1,135
(1)
Equity compensation plans
not approved by security - - -
holders
----------------------- -------------------- -----------------------
Total 67,899 $8.63 1,135
======================= ==================== =======================
(1) Represents shares of the Company's common stock which may be issued upon
the exercise of options granted under the Company's 2000 Stock Option
Plans.
Item 13. Certain Relationships and Related Party Transactions
The information contained under the sections captioned "Certain
Business Relationships," "Corporate Governance - Director Independence,"
"Corporate Governance - Audit Committee" and "Corporate Governance -
Compensation Committee" in the Proxy Statement is incorporated herein by
reference.
Item 14. Principal Accountant Fees and Services
The information contained under the section captioned "Relationship with
Independent Registered Public Accounting Firm" in the Proxy Statement is
incorporated herein by reference.
Item 15. Exhibits
(a) Financial Statements. Listed below are all financial statements filed
as part of this report.
1. The statements of financial condition of Cornerstone Bank as of
December 31, 2008 and 2007 and the related statements of operations,
changes in shareholders' equity and cash flows for the years ended
December 31, 2008 and 2007, together with the related notes.
2. Schedules omitted as they are not applicable.
(b) Exhibits. The following exhibits are included in this Report or
incorporated herein by reference:
3.(i) Certificate of Incorporation (1)
3.(ii) By-laws (1)
10.(a) Employment Agreement with Keith Winchester dated February 15, 1999
(1)
10.(b) The Bank's Stock Option Plan dated May 8, 2000 (1)
10.(c) Director Fee Deferral and Death Benefit Plan dated December 30, 2005,
as amended by Amendment No. 1 to the Director Fee Deferral and Death
Benefit Plan dated June 20, 2007 (1)
10.(d) Employment Agreement with George W. Matteo, Jr. dated January 10,
2008 (1)
54
10.(e) Amended and Restated Non-Qualified Deferred Compensation Plan
dated September 9, 2008 (1)
10.(f) Loan Agreement with Atlantic Central Bankers Bank ("ACBB") dated
February 17, 2009 (2)
10.(g) Line of Credit Note with ACBB dated February 17, 2009 (2)
10.(h) Stock Pledge Agreement with ACBB dated February 17, 2009 (2)
21 Subsidiaries of the Registrant
31.1 CEO Certification required under section 302 of Sarbanes -
Oxley Act of 2002
31.2 CFO Certification required under section 302 of Sarbanes -
Oxley Act of 2002
32.1 CEO Certification required under section 906 of Sarbanes -
Oxley Act of 2002
32.2 CFO Certification required under section 906 of Sarbanes -
Oxley Act of 2002
(1) Incorporated by reference to the Company's Current
Report on Form 8-K filed with the SEC on February 2,
2009.
(2) Incorporated by reference to the Company's Current
Report on Form 8-K filed with the SEC on February 2,
2009.
55
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, as amended, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CORNERSTONE BANK
By:/s/ George W. Matteo, Jr.
-------------------------------------
George W. Matteo, Jr.
Chairman of the Board,
President and Chief Executive Officer
Date: March 30, 2009
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities
indicated on March 27, 2009.
/s/ George W. Matteo, Jr. /s/ Keith Winchester
--------------------------- -----------------------
George W. Matteo, Jr. Keith Winchester
Chairman of the Board, Executive Vice President and
President and Chief Executive Officer Chief Financial Officer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
/s/ J. Richard Carnall /s/ J. Mark Baiada
---------------------- ------------------
J. Richard Carnall J. Mark Baiada
Vice Chairman Director
/s/ Gaetano P. Giordano /s/ Robert A. Kennedy, Jr.
------------------------ --------------------------
Gaetano P. Giordano Robert A. Kennedy, Jr.
Director Director
/s/ Ronald S. Murphy /s/ Bruce Paparone
------------------------------------ ------------------
Ronald S. Murphy Bruce Paparone
Director Director
56