UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2010
------------------
-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
-------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6000 MIDLANTIC DRIVE, SUITE 120 S, MOUNT LAUREL, NEW JERSEY 08054
--------------------------------------------------------------------------------
(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 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 whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation SD-T during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). YES X NO .
--- ---
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or 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
--- ---
As of November 10, 2010, there were 1,809,656 outstanding shares of the
registrant's Common Stock.
CORNERSTONE FINANCIAL CORPORATION
CONTENTS
PAGES
-----
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements ................................. 1
Consolidated Statements of Financial Condition at
September 30, 2010 (unaudited) and December 31, 2009 .................. 1
Consolidated Statements of Operations (unaudited)
for the three months ended September 30, 2010 and 2009 ................ 2
Consolidated Statements of Operations (unaudited) for
the nine months ended September 30, 2010 and 2009 ..................... 3
Consolidated Statement of Changes in Stockholders' Equity
(unaudited) for the nine months ended September 30, 2010 ............. 4
Consolidated Statements of Cash Flows (unaudited) for the
nine months ended September 30, 2010 and 2009 ......................... 5
Notes to Consolidated Financial Statements (unaudited) ................. 6
Item 2. Management's Discussion and Analysis or Plan of Operation ......... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........ 27
Item 4. Controls and Procedures ........................................... 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 28
Item 1A. Risk Factors ..................................................... 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ....... 28
Item 3. Defaults upon Senior Securities ................................... 28
Item 4. Submission of Matters to a Vote of Security Holders ............... 28
Item 5. Other Information ................................................. 28
Item 6. Exhibits .......................................................... 28
Signatures .................................................................. 29
Exhibit 31.1 ................................................................ 30
Exhibit 31.2 ................................................................ 31
Exhibit 32.1 ................................................................ 32
Exhibit 32.2 ................................................................ 33
PART I. FINANCIAL INFORMATION
ITEM 1 -- CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, DECEMBER 31,
(In thousands, except share data) 2010 2009
-------------- ------------
ASSETS: (unaudited)
Cash and due from banks $ 7,576 $ 4,742
Federal funds sold 26,500 -
---------- -----------
Cash and cash equivalents 34,076 4,742
---------- -----------
Investment securities:
Held to maturity (fair value 2010 - $45,025; 2009 - $47,294) 44,209 48,059
Available for sale (amortized cost 2010-$32,519; 2009- $0) 32,689 0
Loans receivable 242,125 238,424
Less allowance for loan losses 3,663 3,432
---------- -----------
Loans receivable, net 238,462 234,992
---------- -----------
Federal Home Loan Bank stock 1,435 1,572
Premises and equipment, net 7,737 7,871
Accrued interest receivable 1,719 1,484
Bank owned life insurance 4,644 4,521
Deferred taxes 1,138 1,154
Other assets 1,420 1,749
---------- -----------
Total Assets $ 367,529 $ 306,144
========== ===========
LIABILITIES:
Non-interest bearing deposits $ 32,629 $ 37,500
Interest bearing deposits 151,964 99,132
Certificates of deposit 125,240 112,861
---------- -----------
Total deposits 309,833 249,493
---------- -----------
Advances from the Federal Home Loan Bank 25,000 29,883
Line of Credit 4,825 4,672
Subordinated debt 3,000 3,000
Unsettled Securities payable 4,000 0
Other liabilities 1,480 1,283
---------- -----------
Total Liabilities 348,138 288,331
---------- -----------
Commitments and Contingencies (Note 4)
STOCKHOLDERS' EQUITY:
Preferred stock:
$0 par value; $1,000 per share stated value, authorized
1,000,000 shares; issued and outstanding 1,900 at September
30, 2010 and December 31, 2009, respectively 1,900 1,900
Common stock:
$0 par value: authorized 10,000,000 shares; issued and
outstanding 1,809,656 at September 30, 2010 and December
31, 2009, respectively - -
Additional paid-in capital 16,691 16,623
Accumulated other comprehensive income 101 -
Retained earnings (deficit) 699 (710)
---------- -----------
Total Shareholders' Equity 19,391 17,813
---------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 367,529 $ 306,144
========== ===========
See accompanying notes to consolidated financial statements
1
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
---------------------------------------------------
(In thousands, except per share data) SEPTEMBER 30, 2010 SEPTEMBER 30,2009
------------------ -----------------
INTEREST INCOME (Unaudited) (Unaudited)
Interest and fees on loans $ 3,460 $ 3,303
Interest on investment securities 593 569
Interest on federal funds 16 1
-------- ---------
TOTAL INTEREST INCOME 4,069 3,873
INTEREST EXPENSE
Interest on deposits 991 1,185
Interest on borrowings 171 317
-------- ---------
TOTAL INTEREST EXPENSE 1,162 1,502
-------- ---------
Net interest income 2,907 2,371
Provision for loan losses 235 131
-------- ---------
NET INTEREST INCOME AFTER LOAN LOSS PROVISION 2,672 2,240
-------- ---------
NON-INTEREST INCOME
Service charges on deposit accounts 50 67
Origination fees on mortgage loans sold - 7
Bank owned life insurance income 41 44
Gain on sale of loans 291 -
Miscellaneous fee income 30 19
-------- ---------
TOTAL NON-INTEREST INCOME 412 137
-------- ---------
NON-INTEREST EXPENSE
Salaries and employee benefits 1,231 1,121
Net occupancy 298 291
Data processing and other service costs 115 96
Professional services 322 93
Advertising and promotion 26 50
Other real estate owned expense 10 7
FDIC expense 131 118
Other operating expenses 161 179
-------- ---------
TOTAL NON-INTEREST EXPENSE 2,294 1,955
-------- ---------
Income before income taxes 790 422
Income tax expense 311 153
-------- ---------
NET INCOME 479 269
Preferred stock dividends 33 -
-------- ---------
Net income(loss) available to common
shareholders $ 446 $ 269
======== =========
EARNINGS PER SHARE
Basic $ 0.25 $ 0.15
Diluted $ 0.24 $ 0.15
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 1,810 1,741
Diluted 1,833 1,741
See accompanying notes to consolidated financial statements
2
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED
----------------------------------------------
(In thousands, except per share data) SEPTEMBER 30, 2010 SEPTEMBER 30, 2009
------------------ ------------------
INTEREST INCOME (Unaudited) (Unaudited)
Interest and fees on loans $ 10,248 $ 9,402
Interest on investment securities 1,781 1,433
Interest on federal funds 24 6
---------- --------
TOTAL INTEREST INCOME 12,053 10,841
INTEREST EXPENSE
Interest on deposits 2,932 3,700
Interest on borrowings 523 934
---------- --------
TOTAL INTEREST EXPENSE 3,455 4,634
---------- --------
Net interest income 8,598 6,207
Provision for loan losses 382 2,351
---------- --------
NET INTEREST INCOME AFTER LOAN LOSS PROVISION 8,216 3,856
---------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 148 148
Origination fees on mortgage loans sold - 18
Bank owned life insurance income 123 130
Gain on sale of Loans 330 -
Miscellaneous fee income 85 62
---------- --------
TOTAL NON-INTEREST INCOME 686 358
---------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 3,648 3,282
Net occupancy 925 1,043
Data processing and other service costs 352 303
Professional services 609 312
Advertising and promotion 99 136
Other real estate owned expense 24 24
FDIC expense 355 422
Other operating expenses 476 462
---------- --------
TOTAL NON-INTEREST EXPENSE 6,488 5,984
---------- --------
Income(loss) before income taxes 2,414 (1,770)
Income tax expense (benefit) 939 (745)
---------- --------
NET INCOME(LOSS) 1,475 (1,025)
Preferred stock dividends 99 -
---------- --------
Net income(loss) available to common
shareholders $ 1,376 $ (1,025)
========== ========
EARNINGS PER SHARE
Basic $ 0.76 $ (0.61)
Diluted $ 0.76 $ (0.61)
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 1,810 1,686
Diluted 1,821 1,686
See accompanying notes to consolidated financial statements
3
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands, except per share data)
ACCUMULATED
ADDITIONAL ACCUMULATED OTHER
COMPREHENSIVE PREFERRED COMMON PAID-IN EARNINGS COMPREHENSIVE
INCOME STOCK STOCK CAPITAL (DEFICIT) INCOME TOTAL
------------- --------- ------ ---------- ------------- -------------- -----
Balance at
December 31, 2009 $ 1,900 $ - $ 16,623 $ (710) $ - $ 17,813
======= ======= ======== ====== ======= ========
Comprehensive
income
Net Income $ 1,475 - - - 1,475 - 1,475
-------
Unrealized gain on
securities available
for sale, net of tax 101 101 101
=======
Comprehensive
income $ 1,576
=======
Stock based
compensation - - 101 - - 101
Preferred Stock
Dividend
($35 per share) - - (33) (66) - (99)
------- ------ -------- ------ ------- --------
Balance at
September 30,
2010 $ 1,900 $ - $ 16,691 $ 699 $ 101 $ 19,391
======= ====== ======== ====== ======= ========
See accompanying notes to consolidated financial statements.
4
CORNERSTONE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
-------------------------------------------
(In thousands) SEPTEMBER 30, 2010 SEPTEMBER 30, 2009
------------------ ------------------
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income(loss) $ 1,475 $ (1,025)
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Provision for loan losses 382 2,351
Depreciation 293 600
Amortization of premiums and discounts, net 39 25
Stock option expense 101 18
Deferred tax expense (benefit) (54) (837)
Decrease in other real estate owned - 83
Loans originated for sale - (6,399)
Proceeds from sales of loans held for sale - 6,399
Income on Bank Owned Life Insurance (123) (130)
Decrease (increase) in accrued interest receivable
and other assets 94 (251)
Increase in other liabilities 4,197 317
--------- ---------
Net cash used by operating activities 6,404 1,151
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments held to maturity (44,509) (45,285)
Purchases of securities available for sale (32,519) -
Maturity and calls of investments held to maturity 48,320 27,350
Redemption (purchase) of FHLB Stock 137 (199)
Net increase in loans (3,851) (40,977)
Purchases of premises and equipment (159) (80)
--------- ---------
Net cash used in investing activities (32,581) (59,191)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 60,340 46,790
Proceeds from borrowings 242,753 651,420
Principal payments on borrowings (247,483) (643,101)
Net Proceeds from issuance of stock - 1,077
Cash dividend paid for preferred stock (99) -
--------- ---------
Net cash provided by financing activities 55,511 56,186
Net increase (decrease) in cash and cash equivalents 29,334 (1,854)
Cash and cash equivalents at the beginning of the period 4,742 9,368
--------- ---------
Cash and cash equivalents at the end of the period $ 34,076 $ 7,514
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 3,466 $ 4,651
Cash paid during the period for income taxes 991 90
Net change in unrealized gain on securities, net of tax 101 -
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
Unsettled AFS investment security $ 4,000 $ -
See accompanying notes to consolidated financial statements.
5
CORNERSTONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Cornerstone
Financial Corporation and its wholly owned subsidiary, Cornerstone Bank
(together, the "Company"). These interim statements, which are unaudited, were
prepared in accordance with instructions for Form 10-Q. In the opinion of
management, all adjustments, consisting of normal recurring accruals, necessary
for fair presentation of the interim financial statements have been included.
Cornerstone Financial Corporation was formed in 2008 at the direction of the
Board of Directors of Cornerstone Bank to serve as a holding company for the
Bank. The holding company reorganization was completed in January 2009. The
statement of financial condition as of December 31, 2009 has been derived from
audited financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in Cornerstone
Financial Corporation's Annual Report on Form 10-K for the year ended December
31, 2009 as filed with the United States Securities and Exchange Commission.
NOTE 2 -- USE OF ESTIMATES
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 deferred taxes.
NOTE 3 -- RECENT LEGISLATIVE DEVELOPMENTS
DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the
"Act") was signed into law on July 21, 2010. Generally, the Act is effective
the day after it was signed into law, but different effective dates apply to
specific sections of the law, many of which will not become effective until
various Federal regulatory agencies have promulgated rules implementing the
statutory provisions. Uncertainty remains as to the ultimate impact of the Act,
which could have a material adverse impact on the financial services industry.
The Act, among other things:
o Directs the Federal Reserve to issue rules which are expected to limit
debit-card interchange fees;
o Provides for an increase in the FDIC assessment for depository
institutions with assets of $10 billion or more, increases in the minimum
reserve ratio for the deposit insurance fund from 1.15% to 1.35% and
changes the basis for determining FDIC premiums from deposits to assets;
o Permanently increases the deposit insurance coverage to $250 thousand and
allows depository institutions to pay interest on checking accounts;
o Creates a new consumer financial protection bureau that will have
rulemaking authority for a wide range of consumer protection laws that
would apply to all banks and would have broad powers to supervise and
enforce consumer protection laws directly for large institutions;
6
o Provides for new disclosure and other requirements relating to executive
compensation and corporate governance;
o Changes standards for Federal preemption of state laws related to
federally chartered institutions and their subsidiaries;
o Provides mortgage reform provisions regarding a customer's ability to
repay, restricting variable-rate lending by requiring the ability to repay
to be determined for variable-rate loans by using the maximum rate that
will apply during the first five years of a variable-rate loan term, and
making more loans subject to provisions for higher cost loans, new
disclosures, and certain other revisions; and
o Creates a financial stability oversight council that will recommend to the
Federal Reserve increasingly strict rules for capital, leverage, liquidity,
risk management and other requirements as companies grow in size and
complexity.
o Creates a permanent exemption for non-accelerated filer to obtain an
internal control audit under section 404(b) of the Sarbanes Oxley Act of
2002.
NOTE 4 - CONTINGENCIES
The Company, 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 would have a material adverse effect on the Company'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 materially adverse to the
Company.
NOTE 5 - 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 common shares as computed under the treasury stock
method using average common stock prices.
NOTE 6 -- STOCK OPTIONS
The Company accounts for stock options in accordance with FASB Accounting
Standards Codification (ASC) Topic 718 STOCK COMPENSATION. The Company
recognizes the grant-date fair-value of stock options and other equity-based
compensation issued to employees in the statement of operations. The Company
had $299 thousand in unrecognized compensation costs relating to non-vested
stock based compensation awards at September 30, 2010.
On July 16, 2009, options to purchase a total of 45,000 shares of common stock
were granted with an exercise price of $5.00 per share. These options will
expire ten years from the date of the grant and vest on a one-third per year
basis beginning on July 16, 2010, with vesting accelerating in certain
circumstances such as change in control of the Company. The exercise price of
each option equals the market price of the common stock on the date of the
grant.
On January 16, 2010, options to purchase a total of 111,000 shares of common
stock were granted with an exercise price of $4.50 per share. These options
will expire ten years from the date of the grant and vest on a one-third per
year basis beginning on January 21, 2011, with vesting accelerating in certain
circumstances such as change in control of the Company. The exercise price of
each option equals the market price of the common stock on the date of the
grant.
7
NOTE 7 - INVESTMENT SECURITIES
A comparison of amortized cost and approximate fair value of investment
securities held to maturity at September 30, 2010 and December 31, 2009 is as
follows (in thousands):
SEPTEMBER 30, 2010
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ------------------ ---------- -----
INVESTMENTS HELD TO MATURITY:
Government agency obligations $ 36,354 $ 532 $ 52 $ 36,834
Mortgage backed securities 7,855 336 - 8,191
-------- ------ ------ --------
Total $ 44,209 $ 868 $ 52 $ 45,025
======== ====== ====== ========
INVESTMENTS AVAILABLE FOR SALE:
Government agency obligations $ 26,562 $ 48 $ 120 $ 26,490
US Treasury Securities 5,957 242 - 6,199
-------- ------ ------ --------
Total $ 32,519 $ 290 $ 120 $ 32,689
======== ====== ====== ========
DECEMBER 31, 2009
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ------------------ ---------- -----
INVESTMENTS HELD TO MATURITY:
Government agency obligations $ 39,019 $ 42 $ (721) $ 38,340
Mortgage backed securities 9,040 46 (132) 8,954
-------- ------ ------ --------
Total $ 48,059 $ 88 $ (853) $ 47,294
======== ====== ====== ========
INVESTMENTS AVAILABLE FOR SALE:
US Treasury Securities $ - $ - $ - $ -
Government agency obligations - - - -
-------- ------ ------ --------
Total $ - $ - $ - $ -
======== ====== ====== ========
The following table sets forth information regarding the fair value and
unrealized losses on the Company's temporarily impaired investment securities
at September 30, 2010 and December 31, 2009 for the time periods shown (in
thousands):
SEPTEMBER 30, 2010
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ---------------------- -------------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
INVESTMENTS HELD TO MATURITY:
Government Agency Obligations $ 3,637 $ 52 $ - $ - $ 3,637 $ 52
Mortgage Backed Securities - - - - - -
INVESTMENTS AVAILABLE FOR SALE:
US Treasury Securities - - - - - -
Government agency obligations 9,044 120 9,044 120
-------- ----- ----- ----- -------- -------
Total temporarily impaired
investment securities $ 12,681 $ 172 $ - $ - $ 12,681 $ 172
======== ===== ===== ===== ======== =======
8
DECEMBER 31, 2009
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ---------------------- -------------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
INVESTMENTS HELD TO MATURITY:
Government Agency Obligations $ 33,940 $ 721 $ - $ - $ 33,940 $ 721
Mortgage Backed Securities 4,715 132 - - 4,715 132
INVESTMENTS AVAILABLE FOR SALE:
US Treasury Securities $ - $ - $ - $ - $ - $ -
Government agency obligations - - - - - -
-------- ----- ----- ----- -------- -------
Total temporarily impaired
investment securities $ 38,655 $ 853 $ - $ - $ 38,655 $ 853
======== ===== ===== ===== ======== =======
Management has taken into consideration the following information in reaching
the conclusion that the impairment of the securities listed in the table above
is not other than temporary. 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
Company believes that it is probable that it will receive all future
contractual cash flows and does not intend to sell and will not be required to
sell 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.
NOTE 8 -- LOANS RECEIVABLE
Loans receivable consist of the following (in thousands):
SEPTEMBER 30, 2010 DECEMBER 31, 2009
------------------ -----------------
Commercial $ 93,563 $ 91,717
Real estate -- commercial 112,425 105,702
Real estate -- residential 15,970 19,137
Construction 12,035 12,104
Consumer loans 8,426 9,875
Net deferred loan fees (294) (111)
---------- ---------
242,125 238,424
Allowance for loan losses (3,663) (3,432)
---------- ---------
Loans receivable, net $ 238,462 $ 234,992
========== =========
Under New Jersey banking laws, the Bank is subject to a loans-to-one-borrower
limitation of 15% of capital funds for most loans. At September 30, 2010, the
loans-to-one-borrower limitation was approximately $4.5 million; this excludes
an additional 10% of capital funds, or approximately $3.0 million which may be
loaned if collateralized by readily marketable securities. At September 30,
2010, there were no loans outstanding or committed to any one borrower which
individually or in the aggregate exceeded the Bank's loans-to-one-borrower
limitation of 15% of capital funds.
Non-performing assets consist of non-accrual loans (loans on which the accrual
of interest has ceased), loans over ninety days delinquent and still accruing
interest, renegotiated loans, impaired loans and other 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. The Company recognized
$149 thousand in interest income on non-accrual loans during the nine month
period ended September 30, 2010 and $32 thousand for the nine month period
ended September 30, 2009.
9
Impaired loans are measured based on the present value of expected future
discounted cash flows, the fair value 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 September 30, 2010 the Company had $9.9 million in
non-accrual loans compared to $8.1 million in non-accrual loans at December 31,
2009. At September 30, 2010, the Company had sixteen impaired loan
relationships totaling $11.7 million (included within the non-accrual loans
discussed above) in which $3.7 million in impaired loans had a related
allowance for credit losses of $1.8 million and $8.0 million in impaired loans
in which there is no related allowance for credit losses. The average balance
of impaired loans totaled $12.7 million as of September 30, 2010, and interest
income recorded on impaired loans during the nine months ended September 30,
2010 totaled $149 thousand, as compared to $32 thousand for the nine months
ended September 30, 2009.
The balance in commercial loans 90-days past due and still accruing remained
unchanged as of September 30, 2010 from the reported levels at December 31,
2009. During the period ended September 30, 2010, the balance in commercial
real estate loans 90-days past due and still accruing decreased by $1.5 million
and represented two loan relationships totaling $1.8 million which moved into
the non-accrual loan category partially offset by the addition of one loan in
this category totaling $270 thousand. Lastly, the increase in residential real
estate loans 90 days past due and still accruing reflects one loan relationship
totaling $244 thousand.
Included in the balance of the loans past due 90 days or more is a principal
balance of $634 thousand dollars representing the Bank's participation interest
in two loans originated by another New Jersey based institution. Although the
borrowers have ceased making payments on these loans, we have received a legal
opinion from our legal counsel that the Bank has valid claims against the
lead/originating bank for violations of the participation agreements, and we
have filed suit asserting these claims. In the event the lead bank is unable to
collect from the borrowers, we believe, based on said legal opinion, that we
may collect our principal and interest from the lead/originating bank. However,
in that case our ability to collect on these loans will depend upon the outcome
of our legal action against the lead/originating bank.
The following table provides information regarding risk elements in the loan
portfolio as of September 30, 2010 and December 31, 2009
(In thousands) SEPTEMBER 30, 2010 DECEMBER 31, 2009
------------------ -----------------
Non-performing assets:
Loans past due 90 days or more and accruing
Commercial $ 634 $ 634
Commercial real estate 270 1,765
Residential real estate 244 -
-------- --------
Total loans past due 90 days or more and accruing 1,148 2,399
-------- --------
Non-accrual loans:
Commercial 1,232 1,401
Commercial real estate 6,185 3,722
Construction 2,480 -
Residential real estate - 3,020
-------- --------
Total non-accrual loans 9,897 8,143
Impaired loans 654 -
-------- --------
Total non-performing loans 10,551 8,143
Real estate owned - -
-------- --------
Total non-performing assets $ 11,699 $ 10,542
======== ========
Non-performing loans as a percentage of loans 4.83% 4.42%
======== ========
Non-performing assets as a percentage of loans and
real estate owned 4.83% 4.42%
======== ========
Non-performing assets as a percentage of total assets 3.16% 3.44%
======== ========
10
During the period ended September 30, 2010 the Company experienced a $1.8
million net increase in non-accrual loans. This change reflects the downgrading
of five loan relationships to non-accrual status totaling $4.9 million
partially offset by the reduction of two residential real estate loans in the
aggregate amount of $3.1 million. The reduction of the two residential real
estate loans was related to the pay-off of one residential real estate loan in
the amount of $1.9 million, which did not require the recognition of any
additional write down, coupled with one residential real estate loan in the
amount of $1.2 million which returned to performing status.
The following table sets forth with respect to the Bank's allowance for losses
on loans:
(In thousands) SEPTEMBER 30, 2010 SEPTEMBER 30, 2009
------------------ ------------------
Balance at beginning of year $ 3,432 $ 1,133
Provision:
Commercial 157 1,149
Commercial real estate 323 1,135
Residential real estate (61) -
Consumer (37) 68
--------- ---------
Total Provision 382 2,351
Charge-offs:
Commercial 149 -
Recoveries - -
Total Net Charge-offs 149 -
========= =========
Balance at end of period $ 3,663 $ 3,484
========= =========
Period-end loans outstanding $ 242,125 $ 225,573
========= =========
Average loans outstanding $ 237,288 $ 224,284
========= =========
Allowance as a percentage of period-end loans 1.51% 1.54%
Net charge-offs as a percentage of average loans 0.06% 0.00%
The Company prepares an allowance for loan loss model on a quarterly basis to
determine the adequacy of the allowance. 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. In evaluating the Company's allowance for loan loss the Company
maintains a Criticized Asset Committee ("CAC") consisting of senior management
that monitors problem loans and formulates collection efforts and resolution
plans for each borrower. On a monthly basis the CAC meets to review each
problem loan and determines if there has been any change in collateral value
due to changes in market conditions. Each quarter, when calculating the
allowance for loan loss, the CAC reviews an updated loan impairment analysis on
each problem loan to determine if a specific provision for loan loss is
warranted. Management reviews the most recent appraisal on each loan adjusted
for holding and selling costs. In the event there is not a recent appraisal on
file, the Company will use the aged appraisal and apply a discount factor to
the appraisal then adjust the holding and selling costs from the discounted
appraisal value. While the Company has increased its allowance for loan loss
for the nine month period ended September 30, 2010 by $382 thousand, management
believes the credit quality of the loan portfolio remains stable. On a linked
basis, our non-performing assets have shown a modest increase of $512 thousand
over their stated levels at December 31, 2009 representing a non-performing
asset to total asset ratio of 2.99% at September 30, 2010 as compared to a
non-performing asset to total asset ratio 3.44% at December 31, 2009.
The Company's charge-off policy states any asset classified loss shall be
charged-off within thirty days of such classification unless the asset has
already been eliminated from the books by collection or other appropriate
entry. On a quarterly basis the Board Loan Committee ("BLC") will review past
due, classified, non-performing and other loans, as it deems appropriate, to
determine the collectability of such loans. If the BLC determines a loan to be
11
uncollectible, the loan shall be charged to the allowance for loan loss. In
addition, upon reviewing the collectability of a loan, the BLC may determine a
portion of the loan to be uncollectible; in which case that portion of the loan
deemed uncollectable will be partially charged-off against the allowance for
loan loss.
For the nine month period ending September 30, 2010 the Company experienced one
charge off relating to one loan relationship totaling $149 thousand and no
partial charge-offs as compared to four loans representing one relationship
totaling $462 thousand that were determined to have a portion deemed
uncollectable which resulted in the company recognizing a partial charge-off of
$231 thousand for the period ended December 31, 2009.
NOTE 9 -- BANK OWNED LIFE INSURANCE
Bank Owned Life Insurance ("BOLI") is carried at its aggregate cash surrender
value less surrender charges and totaled $4.6 million at September 30, 2010.
Income of $123 thousand was recognized on the BOLI during the nine month period
ended September 30, 2010 as compared to $130 thousand for the nine month period
ended September 30, 2009. The Bank is the sole owner and beneficiary of the
BOLI.
NOTE 10 -- 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 Company recorded $128 thousand in
deferred compensation expense during the nine month period ended September 30,
2010 as compared to $95 thousand for the nine month period ended September 30,
2009.
NOTE 11 -- INCOME TAXES
The Company accounts for uncertainties in income taxes in accordance with
Financial ASC Topic 740, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES. ASC Topic
740 prescribes a threshold and measurement process for recognizing in the
financial statements a tax position taken or expected to be taken in a tax
return. ASC Topic 740 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. The Company has determined that there are no significant uncertain
tax positions requiring recognition in its financial statements.
Federal tax years 2007 through 2009 remain subject to examination as of
September 30, 2010, while tax years 2006 through 2009 remain subject to
examination by state taxing jurisdictions. In the event the Company is assessed
for interest and/or penalties by taxing authorities, such assessed amounts will
be classified in the financial statements as income tax expense.
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, the Company determined
that it is more likely than not that its deferred tax asset will be realized.
As such, no valuation allowance was established for the deferred tax asset as
of September 30, 2010 or December 31, 2009. The Company will continue to
reassess the realizability of the deferred tax asset in future periods. If, in
the future, it is determined that the Company's deferred tax asset is not
realizable, a valuation allowance may be established against the deferred tax
asset, which may have a material impact on the Company's net income in the
period in which it is recorded.
NOTE 12 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC Topic 820 FAIR VALUE MEASUREMENTS AND DISCLOSURES establishes a framework
for measuring fair value under U.S. generally accepted accounting principles,
and expands disclosure requirements for fair value measurements. ASC Topic 820
does not require any new fair value measurements. The adoption of ASC Topic 820
did not have a material impact on the Company's consolidated financial
statements.
12
ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value into three broad levels, as
described below:
o Level 1. Level 1 inputs are unadjusted quoted prices in active markets for
identical assets or liabilities.
o 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.
o Level 3. Level 3 inputs are unobservable inputs.
The fair value of securities available for sale are determined by obtaining
quoted prices on a nationally recognized securites exchange ( Level 1 inputs)
or matrix pricing, which is a mathematical technique widelyused in the industry
to value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities' relationship to
other benchmark quoted securities( Level 2 inputs).
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.
As of September 30, 2010, the Company had investment securities available for
sale carried at fair value as compared to December 31, 2009, where the Company
did not have any assets or liabilities measured at fair value on a recurring
basis.
ASSETS AND LIABILITIES MEASURED ON A RECURRING BASIS
Assets and liabilities measured at fair value on a recurring basis are
summarized below:
FAIR VALUE MEASUREMENTS FAIR VALUE MEASUREMENTS
AT SEPTEMBER 30, 2010 AT DECEMBER 31, 2009
--------------------------------------------- ---------------------------------------------
QUOTED PRICES QUOTED PRICES
IN ACTIVE SIGNIFICANT SIGNIFICANT IN ACTIVE SIGNIFICANT SIGNIFICANT
MARKETS OTHER OTHER MARKETS OTHER OTHER
FOR IDENTICAL OBSERVABLE UNOBSERVABLE FOR IDENTICAL OBSERVABLE UNOBSERVABLE
ASSETS INPUTS INPUTS ASSETS INPUTS INPUTS
(LEVEL 1) (LEVEL 2) (LEVEL 3) (LEVEL 1) (LEVEL 2) (LEVEL 3)
-------------- ----------- ------------ -------------- ------------ -----------
(IN THOUSANDS) (IN THOUSANDS)
Assets:
Investment Securities
US Government Obligations $ -- $ 26,490 $ -- $ -- $ -- $ --
US Treasury Securities $ 6,199 $ -- $ -- $ -- $ -- $ --
------- -------- ------- ------ ----- -----
Total assets on a recurring
basis at fair value $ 6,199 $ 26,490 $ -- $ -- $ -- $ --
======= ======== ======= ====== ===== =====
13
ASSETS AND LIABILITIES MEASURED ON A NON-RECURRING BASIS
Assets and liabilities measured at fair value on a non-recurring basis are
summarized below:
FAIR VALUE MEASUREMENTS FAIR VALUE MEASUREMENTS
AT SEPTEMBER 30, 2010 AT DECEMBER 31, 2009
------------------------------------------------ ----------------------------------------------
QUOTED PRICES QUOTED PRICES
IN ACTIVE SIGNIFICANT SIGNIFICANT IN ACTIVE SIGNIFICANT SIGNIFICANT
MARKETS OTHER OTHER MARKETS OTHER OTHER
FOR IDENTICAL OBSERVABLE UNOBSERVABLE FOR IDENTICAL OBSERVABLE UNOBSERVABLE
ASSETS INPUTS INPUTS ASSETS INPUTS INPUTS
(LEVEL 1) (LEVEL 2) (LEVEL 3) (LEVEL 1) (LEVEL 2) (LEVEL 3)
-------------- ----------- ------------ -------------- ------------ -----------
(IN THOUSANDS) (IN THOUSANDS)
Assets:
Impaired loans $ -- $ 1,847 $ -- $ -- $ 2,611 $ --
------- -------- ------- ------ ------- -----
Total assets
measured on a
non-recurring basis
at fair value $ -- $ 1,847 $ -- $ -- $ 2,611 $ --
======= ======== ======= ====== ======= =====
The fair value of impaired loans with specific allocations of the allowance for
loan losses is generally based on recent real estate appraisals. These
appraisals may utilize a single valuation approach or a combination of
approaches including comparable sales and the income approach.
The following required disclosure of the estimated fair value of financial
instruments has been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
As required by ASC topic 825-10-65, the estimated fair value of financial
instruments at September 30, 2010 and December 31, 2009 was as follows:
SEPTEMBER 30, 2010 DECEMBER 31, 2009
--------------------------- ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(in thousands) AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ----------- -------- -----------
Financial assets:
Cash and cash equivalents $ 34,076 $ 34,076 $ 4,742 $ 4,742
Investments held to maturity
Federal Agency Securities 36,354 36,834 39,019 38,340
Mortgage-backed Securities 7,855 8,191 9,040 8,954
Investments available for sale
US Treasury Securities 6,199 6,199 - -
Federal Agency Securities 26,490 26,490 - -
Loans receivable 242,125 264,978 238,424 266,399
FHLB stock 1,435 1,435 1,572 1,572
Bank Owned Life Insurance 4,644 4,644 4,521 4,521
Accrued interest receivable 1,719 1,719 1,484 1,484
--------- --------- --------- ---------
Total financial assets $ 360,897 $ 384,566 $ 298,802 $ 326,012
========= ========= ========= =========
Financial Liabilities:
Checking Accounts $ 48,953 $ 48,953 $ 56,783 $ 56,783
Statement savings accounts 3,142 3,142 3,430 3,430
Money market accounts 31,813 31,813 19,658 19,658
Index Accounts 100,685 100,685 56,761 56,761
Certificates of deposit 125,240 124,248 112,861 111,908
FHLB advances 25,000 25,000 29,883 29,883
Line of Credit 4,825 4,825 4,672 4,672
Subordinated Debt 3,000 3,000 3,000 3,000
Accrued interest payable 210 210 222 222
--------- --------- --------- ---------
Total financial liabilities $ 342,868 $ 341,876 $ 287,270 $ 286,317
========= ========= ========= =========
14
CONTRACT ESTIMATED CONTRACT ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
--------- ---------- --------- ----------
Off-balance sheet instruments:
Commitments to extend credit $ 56,590 $ - $ 45,684 $ -
========= ========= ========= =========
NOTE 13 -- RECENT ACCOUNTING PRONOUNCEMENTS
Below is a discussion of recent accounting pronouncements. Recent
pronouncements not discussed below were deemed to not be applicable to the
Company.
In January 2010, the Financial Accounting Standards Board (FASB) issued an
Accounting Standard Codification Update (ASU) for improving disclosures about
fair value measurements. This update requires companies to disclose, and
provide the reasons for, all transfers of assets and liabilities between the
Level 1 and 2 fair value categories. It also clarifies that companies should
provide fair value measurement disclosures for classes of assets and
liabilities which are subsets of line items within the balance sheet, if
necessary. In addition, the update clarifies that companies provide disclosures
about the fair value techniques and inputs for assets and liabilities
classified within Level 2 or 3 categories. The disclosure requirements
prescribed by this update are effective for fiscal years beginning after
December 31, 2009, and for interim periods within those fiscal years, or March
31, 2010 for the Corporation. This update also requires companies to reconcile
changes in Level 3 assets and liabilities by separately providing information
about Level 3 purchases, sales, issuances and settlements on a gross basis.
This provision of this update is effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years, or March
31, 2011 for the Corporation. The adoption of this update did not materially
impact the Corporation's current fair value measurement disclosures.
In July 2010, the FASB issued ASU No. 2010-20, "Disclosures about the Credit
Quality of Financing Receivables and the Allowance for Credit Losses," which
will require the Company to provide a greater level of disaggregated
information about the credit quality of the Company's loans and leases and the
allowance for loan and lease losses. This ASU will also require the Company to
disclose additional information related to credit quality indicators, past due
information, and information related to loans modified in a troubled debt
restructuring. The provisions of this ASU are effective for the Company's
reporting period ending December 31, 2010. As this ASU amends only the
disclosure requirements for loans and leases and the allowance, the adoption
will have no impact on the Company's statements of operation and condition.
NOTE 14-- PRIVATE PLACEMENT COMMON STOCK OFFERING AND PREFERRED STOCK ISSUANCE
In June 2009, the Board of Directors of the Company approved a private
placement common stock offering to accredited investors. In connection with
this offering, the Board of Directors approved the issuance of common stock
purchase warrants. As part of the offering, one warrant was issued for each
share of Company common stock, no par, sold in the stock offering. Each warrant
issued under the offering will allow the holder of the warrant to purchase one
share of Company common stock, for a price of $9.00 per share through June 26,
2013. For the year ended December 31, 2009, the Company sold 153,889 shares
under this offering and issued 153,889 common stock warrants. The $1.1
million proceeds received from the common stock offering were recorded as
additional paid in capital.
15
In December 2009, the Company authorized the establishment of 2,000 shares of
$0 par, $1,000 stated value, Perpetual Non-Cumulative Convertible Preferred
Stock. The preferred stock is entitled to receive, as and when declared by the
Company's Board of Directors, non-cumulative cash dividends at the annual rate
equal to 7% of the stated value. In December 2009, the Company sold 1,900
preferred shares. The preferred stock is redeemable at the Company's option at
any time after six months from the issue date at the stated value plus any
dividends declared but unpaid. The preferred shares have priority of dividends
such that no dividends or distributions shall be declared or paid to common
shareholders unless full dividends on all outstanding preferred shares have
been declared and paid for the most recently completed calendar quarter.
NOTE 15 -- SUBSEQUENT EVENTS
The Company has evaluated subsequent events through the filing date of this
report, and determined that there were no recognized or nonrecognized
subsequent events to report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
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 Quarterly Report on Form 10-Q 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 factors which could cause the Company's
financial performance to differ materially from the plans, objectives,
expectations, estimates and intentions expressed in such forward-looking
statements include those items listed under "Item 1A-Risk Factors" in our
Annual Report on Form 10-K for the year ended December 31, 2009 and the
following factors, among others: 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; the Company's
ability to access the capital markets to maintain its regulatory capital
standing: 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.
16
OVERVIEW
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.
We have adopted a strategy of continued growth. In furtherance of that
strategy, we opened our eighth office in Marlton, New Jersey. At September 30,
2010, we had total assets of $367.5 million, total loans, net of $238.4
million, total investment securities of $76.9 million and total deposits of
$309.8 million compared to total assets of $306.1 million, total loans, net of
$235.0 million, total investment securities of $48.1 million and total deposits
of $249.5 million at December 31, 2009. Our growth in assets and deposits
reflects our commitment to provide outstanding customer service and a broad
array of banking products driven by our customers' needs. We believe our
strategy provides us with a competitive advantage over other financial
institutions by developing lasting customer relationships that will enable us
to continue to attract core deposits and loans within our market area.
INTEREST RATE RISK
Our primary objective in managing interest rate risk is to minimize the adverse
impact of changes in interest rates on our net interest income while creating
an asset/liability structure that maximizes earnings. Our Asset Liability
Management Committee actively monitors and manages our 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 or changes in the asset mix.
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 both 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
below. 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.
We use 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 our 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 discussed
above.
17
The following table sets forth the amount of our interest-earning assets and
interest-bearing liabilities at September 30, 2010, which are expected to
mature or reprice in each of the time periods shown:
NON-RATE
SENSITIVE
(DOLLARS IN THOUSANDS) ONE YEAR ONE-FIVE OVER ASSETS/
OR LESS YEARS FIVE YEARS LIABILITIES TOTAL
-------- -------- ---------- ----------- ---------
INTEREST-EARNING ASSETS:
------------------------
Short term investments $ 26,500 $ - $ - $ - $ 26,500
Investment securities held to maturity - 5,898 38,311 - 44,209
Investment securities available for sale 32,689 32,689
--------- ---------
Loans receivable 111,532 75,267 55,326 - 242,125
--------- -------- --------- -------- ---------
Total interest-earning assets 138,032 81,165 126,326 - 345,523
--------- -------- --------- -------- ---------
Non-rate sensitive assets:
Other assets - - - 22,006 22,006
--------- -------- --------- -------- ---------
Total assets $ 138,032 $ 81,165 $ 126,326 $ 22,006 $ 367,529
========= ======== ========= ======== =========
INTEREST-BEARING LIABILITIES:
-----------------------------
Interest-bearing demand $ 16,324 $ - $ - $ - $ 16,324
Statement savings 3,142 - - - 3,142
Money market 132,498 - - - 132,498
Certificates of deposit 94,889 30,351 - - 125,240
Subordinated debt 3,000 - - - 3,000
Borrowings - 29,825 - - 29,825
--------- -------- --------- -------- ---------
Total interest-bearing liabilities 249,853 60,176 - - 310,029
--------- -------- --------- -------- ---------
NON-RATE SENSITIVE LIABILITIES:
Non-interest bearing deposits - - - 32,629 32,629
Other liabilities - - - 5,480 5,480
Capital - - - 19,391 19,391
--------- -------- --------- -------- ---------
Total liabilities and capital $ 249,853 $ 60,176 $ - $ 57,500 $ 367,529
========= ======== ========= ======== =========
Period GAP $(111,821) $ 20,989 $ 126,326 $(35,494)
Cumulative interest-earning assets $ 138,032 $219,197 $ 345,523
Cumulative interest-bearing liabilities $ 249,853 $310,029 $ 310,029
Cumulative GAP $(111,821) $(90,832) $ 35,494
Cumulative RSA/RSL (1) 55.25% 70.70% 111.45%
(1) Cumulative rate sensitive (interest-earning) assets divided by cumulative
rate sensitive (interest-bearing) liabilities.
At September 30, 2010, our interest rate sensitivity gap was within Board
approved guidelines.
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 our 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 discussion focuses on the major components of our operations and
presents an overview of the significant changes in our financial condition at
September 30, 2010 as compared to December 31, 2009 and our results of
operations for the three and nine month periods ended September 30, 2010 as
compared to the same period in 2009.
18
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
Total assets at September 30, 2010 were $367.5 million, an increase of $61.4
million or 20.1% over December 31, 2009. This change was primarily due to
increases in cash and cash equivalents of $29.3 million, bank owned life
insurance of $123 thousand, investment securities available for sale of $32.7
million, loans receivable, net, of $3.5 million, and accrued interest
receivable of $235 thousand, partially offset by decreases in deferred taxes of
$16 thousand, Federal Home Loan Bank ("FHLB") stock of $137 thousand, other
assets of $ 329 thousand, securities held to maturity of $3.9 million and
premises and equipment of $134 thousand.
Gross loans receivable at September 30, 2010, totaled $242.1 million, an
increase of $3.7 million or 1.6% from December 31, 2009. This increase was
attributable to increases in commercial loans of $1.8 million and commercial
real estate loans of $6.7 million partially offset by decreases in construction
loans of $69 thousand, real estate loans secured by residential properties of
$3.2 million and consumer loans of $1.5 million. The reduction in residential
real estate loans reflects the payoff of a non-accrual loan relationship
totaling $1.8 million. See Footnote 8 to our Consolidated Financial Statements
for a breakdown of the components of our loan portfolio.
Non-performing assets consists of non-accrual loans, (loans on which the
accrual of interest has ceased) loans over ninety days delinquent and still
accruing interest, renegotiated loans, impaired 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. The
Company recognized $149 thousand in interest income on non-accrual loans during
the nine month period ended September 30, 2010 and $32 thousand for the nine
month period ended September 30, 2009.
Impaired loans are measured based on the present value of expected future
discounted cash flows, the fair value of the loan or the fair value of the
underlying collateral if the loan is collateral dependent. At September 30,
2010, we had a total of $9.9 million in non accrual loans as compared to $8.1
million in non-accrual loans at December 31, 2009. At September 30, 2010, the
Company had sixteen impaired loan relationships totaling $11.7 million
(included within the non-accrual loans discussed above) in which $3.7 million
in impaired loans had a related allowance for credit losses of $1.8 million and
$8.0 million in impaired loans in which there is no related allowance for
credit losses as compared to seven impaired loan relationship totaling $8.1
million at December 31, 2009 in which $4.9 million in impaired loans had a
related allowance for credit losses totaling $2.1 million and $7.3 million in
impaired loans in which there is no related allowance for credit losses. The
average balance of impaired loans totaled $12.7 million as of September 30,
2010, and interest income recorded on impaired loans during the nine months
ended September 30, 2010, totaled $149 thousand as compared to $32 thousand for
the nine month period ended September 30, 2009.
The balance in commercial loans 90-days past due and still accruing remained
unchanged as of September 30, 2010 from the reported levels at December 31,
2009. During the period ended September 30, 2010, the balance in commercial
real estate loans 90-days past due and still accruing decreased by $1.5 million
and represented two loan relationships totaling $1.8 million which moved into
the non-accrual loan category partially offset by the addition of one loan in
this category totaling $270 thousand. Lastly the increase in residential real
estate loans 90 days past due and still accruing reflects one loan relationship
totaling $244 thousand.
Included in the balance of the loans past due 90 days or more is a principal
balance of $634 thousand dollars representing the Bank's participation interest
in two loans originated by another New Jersey based institution. Although the
borrowers have ceased making payments on these loans, we have received a legal
opinion from our legal counsel that the Bank has valid claims against the
lead/originating bank for violations of the participation agreements, and we
have filed suit asserting these claims. In the event the lead bank is unable to
collect from the borrowers, we believe, based on said legal opinion that we
will collect our investment from the lead/originating bank.
19
However, in that case our ability to collect on these loans will depend upon
the outcome of our legal action against the lead/originating bank.
During the period ended September 30, 2010 the Company experienced a $1.8
million net increase in non-accrual loans. This change reflects the downgrading
of five loan relationships to a non-accrual status totaling $4.9 million
partially offset by the reduction of two residential real estate loans in the
aggregate of $3.1 million. The reduction of the two residential real estate
loans was related to the pay-off of one residential real estate loan in the
amount of $1.9 million, which did not require the recognition of any additional
write down, coupled with one residential real estate loan in the amount of $1.2
million which returned to performing status.
The Company prepares an allowance for loan loss model on a quarterly basis to
determine the adequacy of the allowance. 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. In evaluating the Company's allowance for loan loss the Company
maintains a Criticized Asset Committee ("CAC") consisting of senior management
that monitors problem loans and formulates collection efforts and resolution
plans for each borrower. On a monthly basis the CAC meets to review each
problem loan and determines if there has been any change in collateral value
due to changes in market conditions. Each quarter, when calculating the
allowance for loan loss, the CAC reviews an updated loan impairment analysis on
each problem credit to determine if a specific provision for loan loss is
warranted. Management reviews the most recent appraisal on each loan, adjusted
for holding and selling costs. In the event there is not a recent appraisal on
file, the Company will use the aged appraisal and apply a discount factor to
the appraisal then adjust the holding and selling costs from the discounted
appraisal value. Although the Company has increased its allowance for loan loss
for the nine month period ended September 30, 2010 by $382 thousand, management
believes the credit quality of the loan portfolio remains stable. On a linked
quarterly basis non performing assets have shown a modest increase of $512
thousand over their stated levels at December 31, 2009.
Any asset classified loss are charged-off within thirty days of such
classification unless the asset has already been eliminated from the books by
collection or other appropriate entry. On a quarterly basis the BLC will review
past due, classified, non-performing and other loans, as it deems appropriate,
to determine the collectability of such loans. If the BLC determines a loan to
be uncollectible, the loan is charged to the allowance for loan loss. In
addition, upon reviewing the collectability of a loan, the BLC may determine a
portion of the loan to be uncollectible; in which case that portion of the loan
deemed uncollectable will be partially charged-off against the allowance for
loan loss.
For the period ending September 30, 2010 the Company recognized one charge off
relating to one loan relationship totaling $149 thousand and no partial
charge-offs as compared to four loans representing one relationship totaling
$462 thousand that were determined to have a portion deemed uncollectable which
resulted in the company recognizing a partial charge-off of $231 thousand for
the period ended December 31, 2009.
Real estate acquired by foreclosure or by deed in lieu of foreclosure is
classified as real estate owned until it is sold. At September 30, 2010 and
December 31, 2009 we had no real estate owned.
Our investment securities are classified as either held to maturity or
available for sale. Our investment portfolio increased by $28.8 million or
60.0% to $76.9 million at September 30, 2010, from $48.1 million at December
31, 2009. The change in our investment portfolio is related to the purchase of
$32.7 million in US Treasury and US Government Agency securities classified as
available for sale partially offset by a reduction of $3.9 million related to
calls of US Government Agency securities classified held to maturity. See
Footnote 7 to our Consolidated Financial statements for more information
regarding our investment securities portfolio. The increase in investment
securities reflects management's efforts to further diversify its growing
balance sheet and to more prudently manage its capital base by investing in
lower risk weighted assets.
20
Our cash and cash equivalents increased by $29.3 million to $34.1 million at
September 30, 2010 from $4.7 million at year end 2009. The increase reflects
cash inflows from an increase in deposits, calls and repayments of higher
yielding investment securities in a lower rate environment and loan re- and
prepayments exceeding current loan funding demands. The increase in deposits
reflects, in part, the Bank benefiting from merger activity involving competing
institutions and resulting customer dislocation. Management has elected to keep
excess cash flow in short term, liquid assets to fund anticipated loan demand
over the next several quarters.
Total liabilities at September 30, 2010 amounted to $348.1 million, an increase
of $59.8 million or 20.7% from December 31, 2009. This change was primarily due
to increases in total deposits of $60.3 million and line of credit borrowings
from Atlantic Central Bankers Bank (ACBB) of $153 thousand, unsettled
securities payable of $4.0 million and other liabilities of $197 thousand,
offset by a decrease of $4.9 million in advances from Federal Home Loan Bank.
Total deposits at September 30, 2010 were $309.8 million, an increase of $60.3
million or 24.2% from December 31, 2009. The change in total deposits was
related to a significant increase of $52.8 million in interest bearing core
deposits (i.e. all interest bearing deposit accounts other then certificate of
deposit accounts), coupled with an increase of $12.4 million in certificates of
deposit, partially offset by a decrease in non-interest bearing accounts of
$4.9 million. The change in deposits was primarily related to the competitive
pricing of our deposit products coupled with the continued development of
relationships with local small businesses and the high level of individualized
service provided by our team of retail branch managers. Consumer and commercial
deposits are attracted principally from within our primary market area. We do
not obtain funds through brokers, nor do we solicit funds outside the State of
New Jersey, although we do accept deposits from residents of other states.
At September 30, 2010, we had advances from the FHLB in the amount of $25.0
million, a decrease of $4.9 million or 16.3 % from December 31, 2009. The
weighted average interest rate on these borrowings from the FHLB was 1.49% at
September 30, 2010 as compared to 2.03% at December 31, 2009.
On October 31, 2008, the Bank issued a hybrid capital instrument in the
aggregate amount of $3.0 million in the form of subordinated debt. A portion of
this instrument qualifies as Tier II capital. The term of the debt is for a six
year period with a maturity date of November 1, 2014. The initial interest rate
was 5.00% fixed for the first year then adjusted to a variable rate equal to
prime rate for the remaining five years. The debt security is redeemable, at
the Bank's option, at par on any April 30(th) or October 31(st) through the
maturity date. For the quarter ended September 30, 2010, the interest rate on
this instrument was 3.25% .
On February 17, 2009, the Company entered into a non-revolving line of credit
loan agreement with ACBB in an amount up to $5.0 million. The term of the debt
is for a three year period with a maturity date of February 17, 2012. The
interest rate adjusts at a variable rate equal to prime rate plus 25 basis
points with a floor of 4.25% . The Company has an outstanding balance on the
line of credit of $4.8 million and has contributed $4.4 million as additional
capital to the Bank. For the quarter ended September 30, 2010, the interest
rate on this borrowing was 4.25% .
Stockholders' equity at September 30, 2010 amounted to $19.4 million, an
increase of $1.6 million or 8.9% over December 31, 2009. This increase reflects
net income of $1.5 million, other comprehensive income of $101 thousand and
stock based compensation expense of $101 thousand partially offset by $99
thousand in cash paid for the declaration of dividends on preferred stock for
the nine month period ended September 30, 2010.
21
RESULTS OF OPERATIONS
NET INCOME. We recorded net income for the three month period ended September
30, 2010 of $479 thousand or $0.25 and $0.24 per common and diluted share
respectively (after preferred stock dividend) as compared to a net income of
$269 thousand or $0.15 per share for the same period in 2009. The change in net
income for the three-month period compared to the prior period was attributable
to increases of $536 thousand in net interest income and $275 thousand in non
interest income due to a $291 thousand increase in gain on sale of loans,
partially offset by an increase of $104 thousand in the provision for loan
losses. Non- interest expenses increase by $339 thousand due to increased
salary and benefit costs of $110 thousand, net occupancy costs of $7 thousand,
data processing costs of $19 thousand, professional services of $229 thousand,
other real estate owned expense of $3 thousand and FDIC expenses of $13
thousand, partially offset by decreases in advertising and promotion of $24
thousand and other operating expenses of $18 thousand. The increase in
professional services includes a charge of $203 thousand, or $.07 per share for
audit, legal and investment banking fees associated with a proposed capital
transaction terminated by the Company. The net interest margin for the
three-month period ended September 30, 2010 increased by 8 basis points to
3.57% as compared to 3.49% for the same period in 2009.
We recorded net income for the nine month period ended September 30, 2010 of
$1.5 million or $0.76 per common and diluted share respectively (after
preferred stock dividend) as compared to a net loss of $1.0 million or $0.61
per share for the same period in 2009. The change in net income for the
nine-month period compared to the prior period was attributable to increases of
$2.4 million in net interest income and $328 thousand in non-interest income
coupled with a decrease of $1.9 million in provision for loan losses, $67
thousand in FDIC insurance premium expense, and $118 thousand in net occupancy
cost. In addition, employee salaries and benefits increased by $366 thousand,
professional services increased by $297 thousand and other non interest
expenses increased by $26 thousand. The decrease in net occupancy costs was the
result of costs associated with the closing of the Moorestown Route 38 Branch
during the first quarter of 2009. The net interest margin for the nine-month
period ended September 30, 2010 increased by 42 basis points to 3.70% as
compared to 3.28% for the same period in 2009.
INTEREST INCOME. Total interest income amounted to $4.1 million for the
three-month period ended September 30, 2010, an increase of $196 thousand or
5.1% when compared to the same period in 2009. The increase in interest income
was due to volume increases in our interest-bearing assets, partially offset by
a reduction in the average yield. The average yield on our interest-earning
assets was 4.80% for the three month period ended September 30, 2010 compared
to 5.50% during the same period in 2009. The reduction in yield in the
quarterly period reflects generally reduced market rates of interest, as the
Federal Reserve has maintained a low interest rate policy to help stimulate the
U.S. economy.
Total interest income amounted to $12.1 million for the nine-month period ended
September 30, 2010, an increase of $1.2 million or 11.2% when compared to the
same period in 2009. The increase in interest income was related to volume
increases of $19.3 million in average loans, $18.6 million in Fed Funds Sold
and $12.2 million in average investment securities, partially offset by a
reduction in the average yield. The average yield on our interest-earning
assets was 5.14% for the nine month period ended September 30, 2010 compared to
5.53% during the same period in 2009. The reduction in yield in the year to
date period reflects generally reduced market rates of interest, as the Federal
Reserve has maintained a low interest rate policy to help stimulate the U.S.
economy.
INTEREST EXPENSE. Total interest expense amounted to $1.2 million for the
three-month period ended September 30, 2010, a decrease of $340 thousand or
22.6 % when compared to the same period in 2009. The decrease in interest
expense resulted from lower rates paid on deposit and borrowing products when
compared to the same period in 2009. The average cost of interest-bearing
liabilities was 1.48% for the three-month period ended September 30, 2010
compared to 2.28% during the same period in 2009.
22
Total interest expense amounted to $3.5 million for the nine-month period ended
September 30, 2010, a decrease of $1.2 million or 25.4 % when compared to the
same period in 2009. The decrease in interest expense resulted from a
decrease of $2.9 million in average borrowed funds and lower rates paid on
deposit and borrowing products when compared to the same period in 2009,
offsetting the growth in average interest bearing deposits of $43.4 million.
The average cost of interest-bearing liabilities was 1.61% for the nine-month
period ended September 30, 2010 compared to 2.57% during the same period in
2009.
The reduction in rates paid on deposit liabilities and borrowings reflects the
same factors, discussed above, affecting the yield on our earning assets.
ALLOWANCE FOR LOAN LOSSES. During the third quarter of 2010, we recorded a
provision for loan losses of $235 thousand compared to a provision of $131
thousand for the same period in 2009.We recorded a provision for loan losses
for the nine-month period ended September 30, 2010 of $382 thousand compared to
a provision of $2.4 million for the same period in 2009. A provision for loan
losses is charged to operations based on management's evaluation of the
estimated and inherent losses in our loan portfolio. While management has
increased its allowance for loan loss for the three-month and six-month periods
ended September 30, 2010, management believes the credit quality of our loan
portfolio has stabilized. On a linked quarterly basis, our non-performing
assets were stable from December 31, 2009 to September 30, 2010. We have not
engaged in any sub prime lending activities that have plagued the banking
industry. At September 30, 2010, our allowance for loan losses represented
1.51% of total loans outstanding and 34.7% of non-performing loans.
NON-INTEREST INCOME. For the three-months ended September 30, 2010,
non-interest income, which is comprised principally of service charges on
deposit accounts, gain on sale of loans, origination fees on residential
mortgage loans sold, bank owned life insurance income, ATM fees and other
miscellaneous fee income totaled $412 thousand. This represents an increase of
$275 thousand or 200.7% when compared to the same period in 2009. This increase
resulted from increases of $291 thousand in gain on loans sold and
miscellaneous fee income of $11 thousand, offset by decreases of $17 thousand
on service charges on deposit accounts, $7 thousand in origination fees on
mortgage loans sold and a $3 thousand decrease in Bank owned life insurance.
Non-interest income for the nine-months ended September 30, 2010 totaled $686
thousand, an increase of $328 thousand or 91.6% when compared to the same
period in 2009. This change reflects an increase of $330 thousand in gain on
sale of loans coupled with an increase of $23 thousand in miscellaneous income,
partially offset by decreases of $18 thousand in origination fees on mortgage
loans sold and $7 thousand in Bank owned life insurance.
NON-INTEREST EXPENSE. Non-interest expense, which is comprised principally of
salaries and employee benefits, net occupancy costs, FDIC insurance premium
expense, advertising costs, data processing costs and professional services and
other operating costs, totaled $2.3 million for the three months ended
September 30, 2010. This represents an increase of $339 thousand or 17.3% when
compared to the same period in 2009. The increase in non-interest expense was
primarily the result of increased salary and benefit costs of $110 thousand,
net occupancy costs of $7 thousand, data processing costs of $19 thousand,
professional services of $229 thousand, and FDIC expenses of $13 thousand,
partially offset by decreases in advertising and promotion of $24 thousand and
other operating expenses of $18 thousand. The increase in professional services
includes a charge of $203 thousand for audit, legal and investment banking fees
associated with a proposed capital transaction terminated by the Company.
Non-interest expense for the nine months ended September 30, 2010 totaled $6.5
million, an increase of $504 thousand or 8.4% when compared to the same period
in 2009. The increase in non-interest expense was primarily the result of
increases in salary and benefit costs of $366 thousand, data processing costs
of $49 thousand, professional services of $297 thousand and other operating
expenses of $14, partially offset by decreases in net occupancy costs of $118
thousand, advertising and promotion expense of $37 thousand, and FDIC deposit
insurance premium expense of $67 thousand. The decrease in occupancy costs is
attributable to $135 thousand associated with the retirement of certain fixed
assets in connection with the closing of the Moorestown Route 38 branch on
April 1, 2009.
23
INCOME TAXES. We recorded a federal and state income tax expense of $311
thousand during the three month period ended September 30, 2010 compared to an
income tax expense of $153 thousand for the same period in 2009. The effective
tax rate for the three month period ended September 30, 2010 was 39.4% compared
to 36.3% for the three month period ended September 30, 2009.
We recorded a federal and state income tax expense of $939 thousand during the
nine month period ended September 30, 2010 compared to an income tax benefit of
$745 thousand for the same period in 2009. The effective tax rate for the nine
month period ended September 30, 2010 was 38.9% compared to 42.1% for the nine
month period ended September 30, 2009.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. Liquidity represents our ability to meet our normal cash flow
requirements for the funding of loans, repayment of deposits and payment of
operating costs. Our primary sources of liquidity include growth in deposits,
amortization and prepayment of loans, maturities of investment securities, and
our 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, we also have access to unsecured, overnight
lines of credit aggregating $58.7 million, consisting of $3.0 million, on an
uncommitted basis, through ACBB and $55.7 million through the FHLB of New York.
The arrangements with ACBB are 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 our residential mortgage loan portfolio. At September 30, 2010, we had no
outstanding balance against the overnight line of credit at ACBB. In addition,
the Company has a non revolving line of credit with ACBB for up to $5.0 million
and as of September 30, 2010 there is an outstanding balance of $4.8 million.
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.
We had cash and cash equivalents of $34.1 million at September 30, 2010 in the
form of cash and due from banks. At September 30, 2010, unused lines of credit
available to our customers, committed undisbursed loan proceeds and standby
letters of credit totaled $56.6 million. Certificates of deposit scheduled to
mature in one year or less totaled $94.9 million at September 30, 2010. We
anticipate that we will continue to have sufficient funds available to meet the
needs of our customers for deposit repayments and loan fundings.
Our ability to generate deposits depends on the success of our branches. Our
success is dependent on a number of factors, including our ability to establish
branches in favorable locations, our ability to meet the needs of our 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
our ability to attract or retain deposits and foster new loan relationships.
CAPITAL RESOURCES. Capital adequacy is the ability to support growth while
protecting the interests of depositors and the deposit insurance fund. Bank
regulatory agencies have developed certain capital ratio requirements, which
are used to assist them in monitoring the safety and soundness of financial
institutions. Management continually monitors these capital requirements.
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
24
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8%. At least 4% of total risk-weighted capital
must consist of "Tier I Capital," consisting of common stockholders' equity and
qualifying hybrid instruments, 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
hybrid instruments, (c) perpetual debt (d) mandatory convertible securities,
and (e) 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 banks 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 1% to 2% above the
stated minimum.
The Bank was in compliance with all applicable minimum capital requirements for
all periods presented. At September 30, 2010 the Bank maintained a Tier I
leverage ratio of 6.76%, a Tier I risk-based capital ratio of 8.69% and a total
risk-based capital ratio of 10.81% . The Bank's management believes that the
Bank would be categorized as well capitalized under applicable FDIC capital
adequacy regulations.
The Board of Governors of the Federal Reserve System has established similar
capital requirements for bank holding companies, on a consolidated basis.
However, these requirements only apply to bank holding companies with assets of
$500 million or more. As such, the Company is not subject to these
requirements.
On October 31, 2008, the Bank issued a hybrid capital instrument in the
aggregate amount of $3.0 million in the form of subordinated debt. A portion of
this instrument qualifies as Tier II capital. The term of the debt is for a six
year period with a maturity date of November 1, 2014. The initial interest rate
was 5.00% fixed for the first year then adjusted to a variable rate equal to
prime rate for the remaining five years. The debt security is redeemable, at
the Bank's option, at par on any April 30(th) or October 31(st) through the
maturity date. For the quarter ended September 30, 2010, the rate on this
instrument was 3.25% .
On February 17, 2009, the Company entered into a non-revolving line of credit
loan agreement with ACBB in an amount up to $5.0 million. The term of the debt
is for a three year period with a maturity date of February 17, 2012. The
interest rate adjusts at a variable rate equal to prime rate plus 25 basis
points with a floor of 4.25% . The Company has an outstanding balance on the
line of credit of $4.8 million and has contributed $4.4 million as additional
capital to the Bank. For the quarter ended September 30, 2010, the interest
rate on this borrowing was 4.25% .
In June 2009, the Board of Directors of the Company approved a private
placement common stock offering to accredited investors. In connection with
this offering, the Board of Directors approved the issuance of common stock
purchase warrants. As part of the offering, one warrant was issued for each
share of common stock, no par, sold in the stock offering. Each warrant issued
under the offering will allow the holder of the warrant to purchase one share
of common stock for a price of $9.00 per share through June 26, 2013. For the
year ended December 31, 2009, the Company sold 153,889 shares under this
offering and issued 153,889 common stock warrants. The $1.1 million proceeds
received from the common stock offering were recorded as additional paid in
capital.
In December 2009, the Company authorized the establishment of 2,000 shares of
$0 par, $1,000 stated value, Perpetual Non-Cumulative Convertible Preferred
Stock. The preferred stock is entitled to receive, as and when declared by the
Company's Board of Directors, non-cumulative cash dividends at the annual rate
equal to 7% of the stated value. In December 2009, the Company sold 1,900
preferred shares. The preferred stock is redeemable at the
25
Company's option at any time after six months from the issue date at the stated
value plus any dividends declared but unpaid. The preferred shares have
priority of dividends such that, no dividends or distributions shall be
declared or paid to common shareholders unless full dividends on all
outstanding preferred shares have been declared and paid for the most recently
completed calendar quarter.
The Bank's capital ratios at September 30, 2010 and December 31, 2009 are
presented in the following table
SEPTEMBER 2010 DECEMBER 2009
-------------- -------------
Shareholders' equity to total assets 5.3% 5.8%
Leverage ratio 6.7% 7.3%
Risk-based capital ratios:
Tier 1 8.7% 8.5%
Total Capital 10.8% 10.7%
OFF-BALANCE SHEET ARRANGEMENTS. We are party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of our 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. 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
September 30, 2010 were $56.6 million. We evaluate each customer's
creditworthiness on a case by case basis. Collateral obtained, if deemed
necessary, 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 to a third party
for a customer. The credit risk involved in issuing standby letters of credit
is similar to that involved in extending credit to customers. We evaluate each
customer's creditworthiness on a case by case basis. Collateral obtained, if
deemed necessary, is based on management's credit evaluation of the customer.
Collateral varies, but may include accounts receivable, marketable securities,
inventory, property, plant and equipment, and residential and commercial real
estate. At September 30, 2010, our obligations under standby letters of credit
totaled $2.1 million.
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 loan 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. Our 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 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 our control, it is possible that management's
estimate of the allowance for loan losses and actual results could differ
materially in the near term.
26
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, 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 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.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of the Company and the footnotes thereto,
presented elsewhere herein, have been prepared in accordance with the standards
of the Public Company Accounting Oversight Board (United States), which require
the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of our operations.
Unlike most industrial companies, nearly all of our assets and liabilities are
monetary. As a result, interest rates have a greater impact on our performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods and services.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable to smaller reporting companies.
ITEM 4. CONTROLS AND PROCEDURES
The Registrant's chief executive officer and chief financial officer, after
evaluating the effectiveness of the Registrant's "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 Rules13a-15(e)
and 15d-15(e)) as of the end of the period covered by this quarterly report,
have concluded that as of such date, the Registrant's disclosure controls and
procedures were effective to ensure at a reasonable assurance level that
material information relating to the Registrant is recorded, processed,
summarized and reported in a timely manner. There were no changes in the
Registrant's internal control over financial reporting that occurred during the
Registrant's third fiscal quarter of 2010 that have materially affected, or are
reasonably likely to materially affect, the Registrant's internal control over
financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company, 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 Company'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
Company.
ITEM 1A. RISK FACTORS
Not applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. RESERVED
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS
(a) The following are filed as exhibits to this report:
31.1 Certification of Chief Executive Officer required under Section
302 of the Sarbanes -- Oxley Act of 2002
31.2 Certification of Chief Financial Officer required under Section
302 of the Sarbanes -- Oxley Act of 2002
32.1 Certification of Chief Executive Officer required under Section
906 of the Sarbanes -- Oxley Act of 2002
32.2 Certification of Chief Financial Officer required under Section
906 of the Sarbanes -- Oxley Act of 2002
28
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CORNERSTONE FINANCIAL CORPORATION
Date: November 10, 2010 By: /S/ GEORGE W. MATTEO, JR.
-------------------------------------
George W. Matteo, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 10, 2010 By: /S/ KEITH WINCHESTER
--------------------------------------
Keith Winchester
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
29