Notes
To Consolidated Financial Statements
September
30, 2008 (Unaudited)
(1) Summary
of Significant Accounting Policies
The
accompanying unaudited Consolidated Financial Statements have been prepared by
1st Constitution Bancorp (the “Company”) and include the Company, its
wholly-owned subsidiary, 1st
Constitution Bank (the “Bank”), and the Bank’s wholly-owned subsidiaries, 1st
Constitution Investment Company of Delaware, Inc., FCB Assets Holdings, Inc. and
1st Constitution Title Agency, LLC. 1st Constitution Capital Trust
II, a subsidiary of the Company, and 1st Constitution Capital Trust I, which was
a subsidiary of the Company until April 2007, are not included in
the Consolidated Financial Statements as they are variable interest
entities and the Company is not the primary beneficiary. All
significant inter-company accounts and transactions have been eliminated in
consolidation and certain prior period amounts have been reclassified to conform
to current year presentation. The accounting and reporting policies
of the Company and its subsidiaries conform to accounting principles generally
accepted in the United States of America and pursuant to the rules and
regulations of the Securities and Exchange Commission (the “SEC”), including the
instructions to Form 10-Q and Article 8 of Regulation S-X. Certain
information and footnote disclosures normally included in financial statements
have been condensed or omitted pursuant to such rules and
regulations. These Consolidated Financial Statements should be read
in conjunction with the audited consolidated financial statements and the notes
thereto included in the Company’s Form 10-K for the year ended December 31,
2007, filed with the SEC on April 15, 2008.
In the
opinion of the Company, all adjustments (consisting only of normal recurring
accruals) which are necessary for a fair presentation of the operating results
for the interim periods have been included. The results of operations for
periods of less than a year are not necessarily indicative of results for the
full year.
Net
Income Per Common Share
Basic net
income per common share is calculated by dividing net income by the weighted
average number of shares outstanding during each period.
Diluted
net income per share is calculated by dividing net income by the weighted
average number of shares outstanding, as adjusted for the assumed exercise of
stock options and the vesting of unvested stock awards, using the treasury stock
method. All 2007 share information has been restated for the effect of a 6%
stock dividend declared December 20, 2007 and paid on February 6, 2008 to
shareholders of record on January 23, 2008.
The
following tables illustrate the reconciliation of the numerators and
denominators of the basic and diluted earnings per share (EPS)
calculations.
|
|
Three
Months Ended September 30, 2008
|
|
|
|
Income
|
|
|
Weighted-
average
shares
|
|
|
Per
share
amount
|
|
Basic
EPS
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
|
|
$ |
782,394 |
|
|
|
3,997,217 |
|
|
$ |
0.20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and unvested stock awards
|
|
|
- |
|
|
|
35,681 |
|
|
|
(0.01 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common shareholders
plus
assumed conversion
|
|
$ |
782,394 |
|
|
|
4,032,898 |
|
|
$ |
0.19 |
|
|
|
Three
Months Ended September 30, 2007
(restated)
|
|
|
|
Income
|
|
|
Weighted-
average
shares
|
|
|
Per
share
Amount
|
|
Basic
EPS
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
|
|
$ |
1,435,730 |
|
|
|
3,968,936 |
|
|
$ |
0.36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and unvested stock awards
|
|
|
- |
|
|
|
50,180 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
plus
assumed conversion
|
|
$ |
1,435,730 |
|
|
|
4,019,116 |
|
|
$ |
0.36 |
|
|
|
Nine
Months Ended September 30, 2008
|
|
|
|
Income
|
|
|
Weighted-
average
shares
|
|
|
Per
share
Amount
|
|
Basic
EPS
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
|
|
$ |
2,302,437 |
|
|
|
3,992,232 |
|
|
$ |
0.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and unvested stock awards
|
|
|
- |
|
|
|
42,384 |
|
|
|
(0.01 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common shareholders
plus
assumed conversion
|
|
$ |
2,302,437 |
|
|
|
4,034,616 |
|
|
$ |
0.57 |
|
|
|
Nine
Months Ended September 30, 2007
(restated)
|
|
|
|
Income
|
|
|
Weighted-
average
Shares
|
|
|
Per
share
Amount
|
|
Basic
EPS
|
|
|
|
|
|
|
|
|
|
Net
income available to common stockholders
|
|
$ |
4,179,722 |
|
|
|
3,965,021 |
|
|
$ |
1.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and unvested stock awards
|
|
|
- |
|
|
|
54,476 |
|
|
|
(0.01 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common shareholders
plus
assumed conversion
|
|
$ |
4,179,722 |
|
|
|
4,019,497 |
|
|
$ |
1.04 |
|
Share-Based
Compensation
Share-based
compensation is accounted for in accordance with Statement of Financial
Accounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS No. 123R”), Share-Based
Payment. The Company adopted SFAS No. 123R on January 1, 2006
using the modified prospective approach. The Company establishes fair
value for its equity awards to determine its cost and the Company recognizes the
related expense for stock options over the vesting period using the
straight-line method. The grant date fair value for stock options is
calculated using the Black-Scholes option valuation model.
The
Company’s stock-based incentive plans (“stock plans”) authorize the issuance of
shares of common stock pursuant to awards that may be granted in the form of
stock options to purchase common stock (“options”) and awards of shares of
restricted common stock (“stock awards”). The purpose of the
Company’s stock plans is to attract and retain personnel for positions of
substantial responsibility and to provide additional incentive to certain
officers, directors, employees and other persons to promote the success of the
Company. Under the Company’s stock plans, options expire no later
than ten years after the date of grant. Options are granted with an
exercise price set at no less than the fair market value of the Company’s stock
on the date of the grant. The grant date fair value of the options is
calculated using the Black-Scholes option valuation model.
Stock-based
compensation expense related to options was $92,182 and $79,159 for the nine
months ended September 30, 2008 and 2007, respectively.
Option
transactions under the Company’s stock plans during the nine months ended
September 30, 2008 are summarized as follows:
Stock
Options
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term
(years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding
at January 1, 2008
|
|
|
156,838 |
|
|
$ |
10.43 |
|
|
|
|
|
|
|
Options
Granted
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
Options
Exercised
|
|
|
324 |
|
|
|
3.24 |
|
|
|
|
|
|
|
Options
Forfeited
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
Options
Expired
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
Outstanding
at September 30, 2008
|
|
|
156,514 |
|
|
$ |
10.44 |
|
|
|
4.5 |
|
|
$ |
263,524 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2008
|
|
|
121,789 |
|
|
$ |
8.94 |
|
|
|
3.5 |
|
|
$ |
263,524 |
|
Stock
awards generally vest over a four-year service period on the anniversary of the
grant date. Once vested, stock awards are irrevocable. The
product of the number of shares granted and the grant date market price of the
Company’s common stock determine the fair value of shares covered by the stock
award under the Company’s stock plans. Management recognizes
compensation expense for the fair value of the shares covered by the stock award
on a straight-line basis over the requisite service
period. Stock-based compensation expense related to stock awards was
$151,645 and $279,200 for the nine months ended September 30, 2008 and 2007,
respectively.
The
following table summarizes the non-vested portion of stock awards outstanding at
September 30, 2008:
Stock
Awards
|
|
Number
of
Shares
|
|
|
Average
Grant Date
Fair
Value
|
|
Non-vested
stock awards at January 1, 2008
|
|
|
47,993 |
|
|
$ |
15.35 |
|
Shares granted
|
|
|
- |
|
|
|
- |
|
Shares vested
|
|
|
13,812 |
|
|
$ |
14.95 |
|
Shares forfeited
|
|
|
- |
|
|
|
- |
|
Non-vested
stock awards at September 30, 2008
|
|
|
34,181 |
|
|
$ |
15.49 |
|
As of
September 30, 2008, there was approximately $398,572 of unrecognized
compensation cost related to non-vested share-based compensation arrangements
granted under the Company’s stock plans. That cost is expected to be
recognized over the following four years.
Benefit
Plans
The
Company provides certain retirement benefits to employees under a 401(k)
plan. The Company’s contributions to the 401(k) plan are expensed as
incurred.
The
Company also provides retirement benefits to certain employees under a
supplemental executive retirement plan. The plan is unfunded and the
Company accrues actuarial determined benefit costs over the estimated service
period of the employees in the plan. The Company follows Statement of
Financial Accounting Standards No. 132, as revised in December 2003 (“SFAS No.
132”), “Employers’ Disclosures about Pensions and Other Post-retirement
Benefits—an amendment of FASB Statements No. 87, 88, and 106” and Statement of
Financial Accounting Standards No. 158 (“SFAS No. 158”), “Employers Accounting
for Defined Benefit Pension and Other Post-retirement Plans—an amendment of FASB
Statements No. 87, 88, 106 and 132(R)”. SFAS No. 132 revised employers’
disclosures about pension and other post-retirement benefit plans. It
requires the disclosure of additional information about changes in the benefit
obligation and the fair values of plan assets. It also standardizes the
requirements for pensions and other postretirement benefit plans, to the extent
possible, and illustrates combined formats for the presentation of pension plan
and other post-retirement benefit plan disclosures. SFAS 158 requires an
employer to recognize the over funded or under funded status of a defined
benefit post-retirement plan (other than a multiemployer plan) as an asset or
liability in its statement of financial position and to recognize changes in
that funded status in the year in which the changes occur, through comprehensive
income.
The
components of net periodic expense for the Company’s supplemental executive
retirement plan for the nine months ended September 30, 2008 and 2007 are as
follows:
|
|
Three
months ended
September
30,
|
|
|
Nine
months ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
57,637 |
|
|
$ |
56,791 |
|
|
$ |
172,911 |
|
|
$ |
170,373 |
|
Interest
cost
|
|
|
39,830 |
|
|
|
32,889 |
|
|
|
119,490 |
|
|
|
98,667 |
|
Actuarial
loss recognized
|
|
|
15,375 |
|
|
|
6,217 |
|
|
|
46,125 |
|
|
|
18,651 |
|
Prior
service cost recognized
|
|
|
24,858 |
|
|
|
24,858 |
|
|
|
74,574 |
|
|
|
74,574 |
|
|
|
$ |
137,700 |
|
|
$ |
120,755 |
|
|
$ |
413,100 |
|
|
$ |
362,265 |
|
In
September 2006, the Financial Accounting
Standards Board (“FASB”) Emerging Issues Task Force finalized Issue No.
06-4, Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-dollar Life
Insurance Arrangements (“EITF 06-4”). EITF 06-4 requires that
a liability be recorded during the service period when a split-dollar life
insurance agreement continues after participants’ employment or
retirement. The required accrued liability is based on either the
post-employment benefit cost for the continuing life insurance or based on the
future death benefit depending on the contractual terms of the underlying
agreement. The Company adopted EITF 06-4 on January 1, 2008, and
recorded a cumulative effect adjustment of $329,706 as a reduction of retained
earnings effective January 1, 2008. Total compensation expense for
2008 is projected to increase by approximately $16,120 as a result of the
adoption of EITF 06-4.
Other
Comprehensive Income (Loss)
The
components of accumulated other comprehensive loss and their related income tax
effects are as
follows:
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Unrealized
holding losses (gains) on
|
|
|
|
|
|
|
securities
available for sale
|
|
$ |
(2,478 |
) |
|
$ |
30,563 |
|
Related
income tax effect
|
|
|
842 |
|
|
|
(12,880 |
) |
|
|
|
(1,636 |
) |
|
|
17,683 |
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on interest rate
|
|
|
|
|
|
|
|
|
swap
contract
|
|
|
(362,517 |
) |
|
|
(99,754 |
) |
Related
income tax effect
|
|
|
144,250 |
|
|
|
39,842 |
|
|
|
|
(218,267 |
) |
|
|
(59,912 |
) |
|
|
|
|
|
|
|
|
|
Pension
liability
|
|
|
(697,576 |
) |
|
|
(818,343 |
) |
Related
income tax effect
|
|
|
279,157 |
|
|
|
327,386 |
|
|
|
|
(418,419 |
) |
|
|
(490,957 |
) |
|
|
|
|
|
|
|
|
|
Accumulated
Other Comprehensive Loss
|
|
$ |
(638,322 |
) |
|
$ |
(533,186 |
) |
The
components of other comprehensive income (loss) and their related income tax
effects for the three and and nine
month periods ended September 30, 2008 and 2007, are as
follows:
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
gains (losses) on
|
|
|
|
|
|
|
|
|
|
|
|
|
securities
available for sale
|
|
$ |
767,537 |
|
|
$ |
723,622 |
|
|
$ |
(33,041 |
) |
|
$ |
31,857 |
|
Related
income tax effect
|
|
|
(258,475 |
) |
|
|
(207,594 |
) |
|
|
13,722 |
|
|
|
(10,194 |
) |
|
|
|
509,062 |
|
|
|
516,028 |
|
|
|
(19,319 |
) |
|
|
21,663 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
(loss) on interest rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
swap
contract
|
|
|
(151,326 |
) |
|
|
- |
|
|
|
(262,763 |
) |
|
|
- |
|
Related
income tax effect
|
|
|
60,441 |
|
|
|
- |
|
|
|
104,408 |
|
|
|
- |
|
|
|
|
(90,885 |
) |
|
|
- |
|
|
|
(158,355 |
) |
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
liability amortization
|
|
|
40,300 |
|
|
|
- |
|
|
|
120,767 |
|
|
|
|
|
Related
income tax effect
|
|
|
(16,101 |
) |
|
|
- |
|
|
|
(48,229 |
) |
|
|
|
|
|
|
|
24,199 |
|
|
|
- |
|
|
|
72,538 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Comprehensive Income (Loss)
|
|
$ |
442,376 |
|
|
$ |
516,028 |
|
|
$ |
(105,136 |
) |
|
$ |
21,663 |
|
Recent
Accounting Pronouncements
In May
2008, the FASB issued Statement of Financial Accounting Standards No 162 (“SFAS
No. 162”), “The Hierarchy of Generally Accepted Accounting
Principles.” SFAS No. 162 identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements. SFAS No. 162 is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity
with Generally Accepted Accounting Principles.” The adoption of SFAS
No. 162 will not have a material impact on the Company’s financial
statements.
In March
2008, the FASB issued Statement of Financial Accounting Standards No. 161 (“SFAS
No. 161”), “Disclosures about Derivative Instruments and Hedging Activities - an
amendment of FASB Statement No. 133.” SFAS No. 161 requires entities that
utilize derivative instruments to provide qualitative disclosures about the
objectives and strategies for using derivatives, quantitative data about the
fair value of, and gains and losses on, derivative contracts, and details of
credit-risk-related contingent features in their hedged
positions. SFAS No. 161 also requires entities to disclose
additional information about the amounts and location of derivatives located
within the financial statements, how the provisions of SFAS No. 133 have been
applied, and the impact that hedges have on an entity’s financial position,
financial performance, and cash flows. SFAS No. 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged, but not
required. The Company is currently assessing the impact of the
adoptionof SFAS No. 161 on its financial statements and
disclosures.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141(R) (“SFAS No. 141(R)”), “Business Combinations (revised
2007).” SFAS No. 141(R) significantly changes how entities apply the
acquisition method to business combinations. The new standard requires the
acquiring entity in a business combination to recognize all (and only) the
assets acquired and liabilities assumed in the transaction; establishes the
acquisition-date fair value as the measurement objective for all assets acquired
and liabilities assumed; and requires the acquirer to disclose to investors and
other users all of the information they need to evaluate and understand the
nature and financial effect of the business combination. SFAS No. 141(R) is
broader than its predecessor, SFAS No. 141, which only applied to business
combinations in which control was obtained by transferring
consideration. SFAS No. 141(R) applies to all transactions or other
events in which an entity (the acquirer) obtains control of one or more
businesses, including combinations achieved without the transfer of
consideration. SFAS No. 141(R) requires an acquirer to recognize the
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree at the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the Statement. This replaces SFAS No. 141’s
cost allocation process, which required the cost of an acquisition to be
allocated to the individual assets acquired and liabilities assumed, based on
their estimated fair values. SFAS No. 141 required the acquirer to
include the costs incurred to effect the acquisition (acquisition-related costs)
in the cost of the acquisition that was allocated to the assets acquired and the
liabilities assumed. SFAS No. 141(R) requires those costs to be
recognized separately from the acquisition. In accordance with SFAS No. 141,
restructuring costs that the acquirer expected, but was not obligated to incur,
were recognized as if they were a liability assumed at the acquisition
date. SFAS No. 141(R) requires the acquirer to recognize those
restructuring costs that do not meet the criteria in Statement of Financial
Accounting Standards No. 146, “Accounting for Costs Associated with Exit or
Disposal Activities” as an expense as incurred. Acquisition related
transaction costs will be expensed as incurred. SFAS No. 141(R) requires an
acquirer to recognize assets or liabilities arising from all other contingencies
(contractual contingencies) as of the acquisition date, measured at their
acquisition-date fair values only if it is more likely than not that they meet
the definition of an asset or a liability on the acquisition date. Under SFAS
No. 141(R), changes in deferred tax asset valuation allowances and acquired
income tax uncertainties in a business combination after the measurement period
will impact income tax expense. Additionally, under SFAS No. 141(R), the
allowance for loan losses of an acquiree will not be permitted to be recognized
by the acquirer. SFAS No. 141(R) is effective for fiscal years
beginning after December 15, 2008. This new pronouncement will impact
the Company’s accounting for business combinations beginning January 1,
2009.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160 (“SFAS No. 160”), “Noncontrolling Interest in Consolidated Financial
Statements–an amendment of Accounting Research Bulletin No. 51 (Consolidated
Financial Statements).” SFAS No. 160 requires all entities to report
noncontrolling (minority) interests in subsidiaries as equity in the
consolidated financial statements. Its intention is to eliminate the
diversity in practice regarding the accounting for transactions between an
entity and noncontrolling interests. SFAS No. 160 is effective for
fiscal years beginning after December 15, 2008. The Company is currently
assessing the impact of the adoption of SFAS No. 160 on its financial
statements.
In
November 2007, the SEC issued Staff Accounting Bulletin No. 109 (“SAB 109”),
“Written Loan Commitments Recorded at Fair Value through
Earnings.” SAB 109 revises and rescinds portions of Staff Accounting
Bulletin No. 105 (“SAB 105”), “Application of Accounting Principles to Loan
Commitments.” The SEC staff’s current view is that the expected net future cash
flows related to the associated servicing of a loan should be included in the
measurement of derivative and other written loan commitments that are accounted
for at fair value through earnings. That view is consistent with the guidance in
Statement of Financial Accounting Standards No. 156, “Accounting for Servicing
of Financial Assets —an amendment of FASB
Statement No. 140” and Statement of Financial Accounting Standards No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities—including an
amendment of FASB Statement No. 115.” SAB 109 retains the view
expressed in SAB 105 that internally developed intangible assets should not be
recorded as part of the fair value of a derivative loan commitment. The guidance
in SAB 109 is effective for derivative loan commitments issued or modified in
fiscal quarters beginning after December 15, 2007. The adoption of
SAB 109 did not have a material impact on the Company’s financial
statements.
In June
2008, the FASB issued FASB Staff Position, FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities,
FSP EITF 03-6-1 changes the way earnings per share is calculated for
share-based payments that have not vested. FSP EITF 03-6-1 is
effective for fiscal years beginning on or after December 15, 2008 and for
interim periods within those fiscal years. The Company is currently
assessing the impact of this standard on its financial statements.
In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the Fair Value of
a Financial Asset When the Market for That Asset Is Not Active” (FSP
157-3), to clarify the application of the provisions of SFAS 157 in an inactive
market and how an entity would determine fair value in an inactive
market. FSP 157-3 is effective immediately and applies to our
September 30, 2008 financial statements. The application of the
provisions of FSP 157-3 did not materially affect our results of operations or
financial conditions as of and for the periods ended September 30,
2008.
(2) Fair
Value Measurements
Effective
January 1, 2008, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements,” for
financial assets and financial liabilities. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value
measurement. In accordance with Financial Accounting Standards Board
Staff Position No. 157-2, “Effective Date of FASB Statement No. 157,” the
Company will delay application of SFAS No. 157 for non-financial assets and
non-financial liabilities until January 1, 2009.
SFAS No.
157 defines fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants. A fair value measurement assumes that the transaction
to sell the asset or transfer the liability occurs in the principal market for
the asset or liability or, in the absence of a principal market, the most
advantageous market for the asset or liability. The price in the
principal (or most advantageous) market used to measure the fair value of the
asset or liability will not be adjusted for transaction costs. An
orderly transaction is a transaction that assumes exposure to the market for a
period prior to the measurement date to allow for marketing activities that are
usual and customary for transactions involving such assets and liabilities; it
is not a forced transaction. Market participants are buyers and
sellers in the principal market that are (i) independent, (ii) knowledgeable,
(iii) able to transact and (iv) willing to transact.
SFAS No.
157 requires the use of valuation techniques that are consistent with the market
approach, the income approach and/or the cost approach. The market
approach uses prices and other relevant information generated by market
transactions involving identical or comparable assets and
liabilities. The income approach uses valuation techniques to convert
future amounts, such as cash flows or earnings, to a single present amount on a
discounted basis. The cost approach is based on the amount that
currently would be required to replace the service capacity of an asset
(replacement cost). Valuation techniques should be consistently
applied.
Inputs to
valuation techniques refer to the assumptions that market participants would use
in pricing the asset or liability. Inputs may be observable, meaning
those that reflect the assumptions market participants would use in pricing the
asset or liability developed based on market data obtained from independent
sources, or unobservable, meaning those that reflect the reporting entity’s own
assumptions about the assumptions market participants would use in pricing the
asset or liability developed based on the best information available in the
circumstances. In that regard, SFAS No. 157 establishes a fair value
hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the lowest priority to
unobservable inputs. The fair value hierarchy is as
follows:
|
·
|
Level
1 Inputs – Unadjusted quoted prices in active markets for identical assets
or liabilities that the reporting entity has the ability to access at the
measurement date.
|
|
·
|
Level
2 Inputs – Inputs other than quoted prices included in Level 1 that are
observable for the asset or liability, either directly or
indirectly. These might include quoted prices for similar
assets or liabilities in active markets, quoted prices for identical or
similar assets or liabilities in markets that are not active, inputs other
than quoted prices that are observable for the asset or liability (such as
interest rates, volatilities, prepayment speeds, credit risks, etc.) or
inputs that are derived principally from or corroborated by market data by
correlation or other means.
|
|
·
|
Level
3 Inputs – Unobservable inputs for determining the fair values of assets
or liabilities that reflect an entity’s own assumptions about the
assumptions that market participants would use in pricing the assets or
liabilities.
|
A
description of the valuation methodologies used for instruments measured at fair
value, as well as the general classification of such instruments pursuant to the
valuation hierarchy, is set forth below. These valuation
methodologies were applied to all of the Company’s financial assets and
financial liabilities carried at fair value effective January 1,
2008.
In
general, fair value is based upon quoted market prices, where
available. If such quoted market prices are not available, fair value
is based upon internally developed models that primarily use, as inputs,
observable market-based parameters. Valuation adjustments may be made
to ensure that financial instruments are recorded at fair
value. These adjustments may include amounts to reflect counterparty
credit quality, the Company’s creditworthiness, among other things, as well as
unobservable parameters. Any such valuation adjustments are applied
consistently over time. The Company’s valuation methodologies may
produce a fair value calculation that may not be indicative of net realizable
value or reflective value or reflective of future values. While
management believes the Company’s valuation methodologies are appropriate and
consistent with other market participants, the use of different methodologies or
assumptions to determine the fair value of certain financial instruments could
result in a different estimate of fair value at the reporting date.
Securities Available for
Sale. Securities classified as available for sale are reported
at fair value utilizing Level 2 Inputs. For these securities, the
Company obtains fair value measurements from an independent pricing
service. The fair value measurements consider observable data that
may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield
curve, live trading levels, trade executive data, market consensus prepayments
speeds, credit information and the bond’s terms and conditions, among other
things.
Impaired
loans. Loans included in the following table are those
accounted for under SFAS 114, “Accounting by Creditors for
Impairment of a Loan,” in which the Company has measured impairment
generally based on the fair value of the loan’s collateral. Fair
value is generally determined based upon independent third party appraisals of
the properties, or discounted cash flows based on the expected
proceeds. These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements. The fair value consists of the loan balances less
valuation allowance as determined under SFAS 114.
Derivatives. Derivatives
are reported at fair value utilizing Level 2 Inputs. The Company
obtains dealer quotations to value its interest rate swap.
The
following table summarizes financial assets and financial liabilities measured
at fair value on a recurring basis as of September 30, 2008, segregated by the
level of the valuation inputs within the fair value hierarchy utilized to
measure fair value:
|
|
Level
1
Inputs
|
|
|
Level
2
Inputs
|
|
|
Level
3
Inputs
|
|
|
Total Fair
Value
|
|
Securities
available for sale
|
|
$ |
- |
|
|
$ |
87,063,748 |
|
|
$ |
- |
|
|
$ |
87,063,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
|
- |
|
|
|
362,517 |
|
|
|
- |
|
|
|
362,517 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
Loans
|
|
|
- |
|
|
|
- |
|
|
|
1,447,000 |
|
|
|
1,447,000 |
|
Certain
financial assets and financial liabilities are measured at fair value on a
nonrecurring basis; that is, the instruments are not measured at fair value on
an ongoing basis but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of
impairment). Financial assets and financial liabilities measured at
fair value on a non-recurring basis at September 30, 2008 consist of impaired
loans. Impaired loans measured at fair value at September 30, 2008,
and included in the above table, consisted of nine loans having a principal
balance of $2,002,000 and specific loan loss allowances of $555,000. Comparable
amounts at June 30, 2008, were $1,945,000 and $521,000, respectively. During the
three months ended September 30, 2008, one loan of $58,000 was added on which a
$34,000 specific loan loss allowances was recorded, and principal repayments of
$1,000 were received.
Certain
non-financial assets and non-financial liabilities measured at fair value on a
recurring basis include reporting units measured at fair value in the first step
of a goodwill impairment test. Certain non-financial assets measured
at fair value on a non-recurring basis include non-financial assets and
non-financial liabilities measured at fair value in the second step of a
goodwill impairment test, as well as intangible assets and other non-financial
long-lived assets measured at fair value for impairment
assessment. As stated above, SFAS No. 157 will be applicable to these
fair value measurements beginning January 1, 2009.
Effective
January 1, 2008, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 159 (“SFAS No. 159”), “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115”. SFAS No. 159 permits the Company to choose to
measure eligible items at fair value at specified election
dates. Unrealized gains and losses on items for which the fair value
measurement option has been elected are reported in earnings at each subsequent
reporting date. The fair value option (i) may be applied instrument
by instrument, with certain exceptions, and thus, the Company may record
identical financial assets and liabilities at fair value or by another
measurement basis permitted under generally accepted accounting principals, (ii)
is irrevocable (unless a new election date occurs) and (iii) is applied only to
entire instruments and not to portions of instruments. Adoption of
SFAS No. 159 on January 1, 2008 did not have a significant impact on the
Company’s financial statements.
(3)
Acquisition of Unaffiliated Branch
On
February 27, 2007, the Company, through the Bank, completed its acquisition of
the Hightstown, New Jersey branch of another financial institution for a
purchase price of $747,330.
As a
result of the acquisition, the Hightstown branch became a branch of the
Bank. Included in the acquisition of the branch were deposit
liabilities of $19.5 million, mostly in certificates of deposit, and cash of
approximately $18.8 million, net of assets acquired consisting of cash on hand
of approximately $137,000, fixed and other assets of approximately $91,000 and
the assumption of the lease of the branch premises. The cash received in the
transaction was utilized to repay short term borrowings used to purchase
investment securities prior to, and in contemplation of, the completion of the
acquisition.
In
addition, the Bank recorded goodwill of $472,726 and a core deposit intangible
asset of $274,604.
The
purpose of this discussion and analysis of the operating results and financial
condition at September 30, 2008 is intended to help readers analyze the
accompanying financial statements, notes and other supplemental information
contained in this document. Results of operations for the three and nine month
periods ended September 30, 2008 are not necessarily indicative of results to be
attained for any other period.
This
discussion and analysis should be read in conjunction with the Consolidated
Financial Statements, notes and tables included elsewhere in this report and
Part II, Item 7 of the Company’s Form 10-K (Management’s Discussion and Analysis
of Financial Condition and Results of Operations) for the year ended December
31, 2007, as filed with the Securities and Exchange Commission (the “SEC”) on
April 15, 2008.
General
Throughout
the following sections, the “Company” refers to 1st Constitution Bancorp and, as
the context requires, its wholly-owned subsidiaries, 1st Constitution Bank and
1st Constitution
Capital Trust II; the “Bank” refers to 1st Constitution Bank; “Trust II” refers
to 1st Constitution Capital Trust II; and “Trust I” refers to 1st Constitution
Capital Trust I, which was a subsidiary of the Company until its termination in
April 2007. Trust II and Trust I are not included in the Company’s
consolidated financial statements as they are variable interest entities and the
Company is not the primary beneficiary.
The
Company is a bank holding company registered under the Bank Holding Company Act
of 1956, as amended. The Company was organized under the laws of the State of
New Jersey in February 1999 for the purpose of acquiring all of the issued and
outstanding stock of the Bank, a full service commercial bank which began
operations in August 1989, and thereby enabling the Bank to operate within a
bank holding company structure. The Company became an active bank holding
company on July 1, 1999. The Bank is a wholly-owned subsidiary of the Company.
Other than its ownership interest in the Bank, the Company currently conducts no
other significant business activities.
The Bank
operates eleven branches, and manages an investment portfolio through 1st
Constitution Investment Company of Delaware, Inc., its
subsidiary. FCB Assets Holdings, Inc., a subsidiary of the Bank, is
used by the Bank to manage and dispose of repossessed real estate.
Trust II,
a subsidiary of the Company, was created in May 2006 to issue trust preferred
securities to assist the Company to raise additional regulatory
capital.
Trust I,
which was a statutory business trust and a wholly-owned subsidiary of the
Company, had issued $5.0 million of variable rate trust preferred securities in
April 2002 and had held, as its sole asset, subordinated debentures issued by
the Company until such debentures were redeemed by the Company, and Trust I was
terminated, in April 2007.
The
Company’s Annual Report on Form 10-K filed with the SEC on April 15, 2008
contains restated unaudited consolidated financial information of the Company
for each of the first three quarters of 2007. To the extent that the
discussion and analysis contained herein relates or refers to the Company’s
results for the first quarter or nine months of 2007, such discussion and
analysis reflects the Company’s restated results for the three and nine months
ended September 30, 2007.
Forward-Looking
Statements
This
report contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). The Private
Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward
looking statements. When used in this and in future filings by the
Company with the SEC, in the Company’s press releases and in oral statements
made with the approval of an authorized executive officer of the Company, the
words or phrases “will,” “will likely result,” “could,” “anticipates,”
“believes,” “continues,” “expects,” “plans,” “will continue,” “is anticipated,”
“estimated,” “project” or “outlook” or similar expressions (including
confirmations by an authorized executive officer of the Company of any such
expressions made by a third party with respect to the Company) are intended to
identify forward-looking statements. The Company wishes to caution readers not
to place undue reliance on any such forward-looking statements, each of which
speak only as of the date made. Such statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected.
Factors
that may cause actual results to differ from those results expressed or implied,
include, but are not limited to, those listed under “Business”, “Risk Factors”
and “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in the Company’s Annual Report on Form 10-K filed with the SEC on
April 15, 2008, such as the overall economy and the interest rate environment;
the ability of customers to repay their obligations; the adequacy of the
allowance for loan losses; competition; significant changes in accounting, tax
or regulatory practices and requirements; certain interest rate risks; risks
associated with investments in mortgage-backed securities; and risks associated
with speculative construction lending. Although management has taken certain
steps to mitigate any negative effect of the aforementioned items, significant
unfavorable changes could severely impact the assumptions used and could have an
adverse effect on profitability. The Company undertakes no obligation to
publicly revise any forward-looking statements to reflect anticipated or
unanticipated events or circumstances occurring after the date of such
statements, except as required by law.
Recent
Developments
There
have been historical disruptions in the financial system during the past year
and many lenders and financial institutions have reduced or ceased to provide
funding to borrowers, including other lending institutions. The
availability of credit, confidence in the entire financial sector, and
volatility in financial markets have been adversely affected. These
disruptions are likely to have some impact on all institutions in the U.S.
banking and financial industries. The Federal Reserve System has been
providing vast amounts of liquidity into the banking systems to compensate for
weaknesses in short-term borrowing markets and other capital
markets. A reduction in the Federal Reserve’s activities or capacity
could reduce liquidity in the markets, thereby potentially increasing funding
costs to the Bank or reducing the availability of funds to the Bank to finance
its existing operations.
RESULTS
OF OPERATIONS
Three
Months Ended September 30, 2008 Compared to the Three Months Ended
September 30, 2007
Summary
The
Company realized net income of $782,394 for the three months ended September 30,
2008, a decrease of 45.5% from the $1,435,730 reported for the three months
ended September 30, 2007. Diluted net income per share was $0.19 for
the three months ended September 30, 2008 compared to $0.36 per diluted share
for the three months ended September 30, 2007. All prior year share
information has been restated for the effect of a 6% stock dividend declared on
December 20, 2007 and paid on February 6, 2008 to shareholders of record on
January 23, 2008.
Key
performance ratios declined for the three months ended September 30, 2008 as
compared to the three months ended September 30, 2007. Return on
average assets and return on average equity were 0.62% and 7.39% for the three
months ended September 30, 2008 compared to 1.32% and 14.84%, respectively, for
the three months ended September 30, 2007.
A
significant factor impacting the Company’s net interest income has been the
declining level of market interest rates and the resulting compression of the
Company’s net interest margin. The net interest margin for the three
months ended September 30, 2008 was 3.61% as compared to the 4.51% net interest
margin recorded for the three months ended September 30, 2007, a reduction of 90
basis points. The Federal Reserve has decreased the level of market
interest rates by 300 basis points since September 18, 2007. Since
the majority of the Company’s interest earning assets earn at floating rates,
these interest rate reductions have resulted in a decreased level of interest
income. The Company will continue to closely monitor the mix of
earning assets and funding sources to maximize net interest income during this
challenging interest rate environment.
The
Company has a significant investment in collateralized mortgage obligations and
trust preferred securities. At September 30, 2008, the Company held
collateralized mortgage obligations with an aggregate market value of $6,909,259
in the Available for Sale portfolio. These securities had an
unrealized loss of $315,982. The Company also held trust preferred
securities in the Available for Sale portfolio with an aggregate market value of
$1,876,539 and an unrealized loss of $576,140 at September 30,
2008. Several financial institutions have reported significant
write-downs of the value of mortgage-related and trust preferred
securities. Management has considered the severity and duration of
the unrealized losses within the Company’s collateralized mortgage obligations
and trust preferred securities portfolios, and evaluated recent events specific
to the issuers of these securities and their industries, as well as external
credit ratings and downgrades thereto. Based on these considerations and
evaluations, management does not believe that any of the Company’s
collateralized mortgage obligations or trust preferred securities are
other-than-temporarily impaired as of September 30, 2008. Certain of these types
of securities may also not be marketable except at significant
discounts. While management of the Company is, as of the date of this
report, unaware of any other-than-temporarily impairment in the Company’s
portfolio of these securities, market, entity or industry conditions could
further deteriorate and result in the recognition of future impairment losses
related to these securities.
Earnings
Analysis
Interest
Income
Interest
income for the three months ended September 30, 2008 was $7,389,253, decreasing
by 5.6% from the $7,825,738 reported in the three months ended September 30,
2007. The decrease in interest income was attributable to the current
period decrease in yields earned on the Bank’s interest-earning assets,
partially offset by increased average balances in those interest-earning
assets. For the three months ended September 30, 2008, average
interest earning assets increased $61.2 million or 15.0%, to $468.3 million
compared to $407.1 million for the three months ended September 30,
2007. For the three months ended September 30, 2008, the average
yield on earning assets, on a tax-equivalent basis, decreased 140 basis points
to 6.33% from 7.73% for the three months ended September 30, 2007.
Interest
Expense
Interest
expense for the three months ended September 30, 2008 was $3,201,563, a decrease
of $105,633 from $3,307,196 reported for the three months ended September 30,
2007. Total average interest bearing liabilities increased by $57.6
million to $384.4 million for the three months ended September 30, 2008 from
$326.8 million for the three months ended September 30, 2007. The
average cost of interest bearing liabilities decreased 71 basis points to 3.31%
for the three months ended September 30, 2008 from 4.02% for the three months
ended September 30, 2007. These decreases were primarily a result of
the current period decrease in market-driven rates paid on deposits and
short-term borrowed funds.
Net
Interest Income
The
Company’s net interest income for the three months ended September 30, 2008 was
$4,187,690, a decrease of 7.3% from the $4,518,542 reported for September 30,
2007. The net interest margin (on a tax-equivalent basis), which is
net interest income divided by average interest-earning assets, decreased 90
basis points to 3.61% for the three months ended September 30, 2008 from 4.51%
for the three months ended September 30, 2007. The declining level of
market interest rates on the Bank’s floating rate assets in the competitive New
Jersey marketplace has contributed significantly to this margin
compression.
Provision
for Loan Losses
Management
maintains the allowance for loan losses at a level that is considered adequate
to absorb losses on existing loans that may become uncollectible, based upon an
evaluation of known and inherent risks in the loan
portfolio. Additions to the allowance are made by charges to the
provision for loan losses. The evaluation considers a complete review
of the following specific factors: historical losses by loan
category, non-accrual and impaired loans, problem loans as identified through
internal classifications, collateral values, and the growth and size of the
portfolio. Additionally, current economic conditions and local real
estate market conditions are considered. As a result of this
evaluation process, the Company’s provision for loan losses was $175,000 for the
three months ended September 30, 2008 and $30,000 for the three months ended
September 30, 2007. See “Allowance for Loan Losses” on page
25.
Non-Interest
Income
Total
non-interest income for the three months ended September 30, 2008 was $976,211,
an increase of $330,505, or 51.2%, over non-interest income of $645,706 for the
three months ended September 30, 2007.
Service
charges on deposit accounts represent a significant source of non-interest
income. Service charge revenues increased by $89,399, or 53.0%, to
$257,977 for the three months ended September 30, 2008 from $168,578 for the
three months ended September 30, 2007. This increase was the result
of a higher volume of uncollected funds and overdraft fees collected on deposit
accounts during the third quarter of 2008 compared to the same period in
2007.
Gain on
sales of loans increased by $114,592, or 62.4%, to $298,342 for the three months
ended September 30, 2008 when compared to $183,750 for the three months ended
September 30, 2007. The Bank sells both residential mortgage loans
and Small Business Administration (“SBA”) loans in the secondary
market. The lower interest rate environment that continued into 2008
has impacted the volume of sales transactions in the mortgage loan and SBA loan
markets and resultant gains resulting from these transactions.
Non-interest
income also includes income from bank-owned life insurance (“BOLI”), which
amounted to $97,901 for the three months ended September 30, 2008 compared to
$95,446 for the three months ended September 30, 2007. The Bank
purchased tax-free BOLI assets to partially offset the cost of employee benefit
plans and reduce the Company’s overall effective tax rate.
The Bank
also generates non-interest income from a variety of fee-based
services. These include safe deposit box rental, wire transfer
service fees and Automated Teller Machine fees for non-Bank
customers. Increased customer demand for these services contributed
to the other income component of non-interest income amounting to $321,991 for
the three months ended September 30, 2008, compared to $197,932 for the three
months ended September 30, 2007.
Non-Interest
Expense
Non-interest
expenses increased by $916,873, or 30.4%, to $3,928,244 for the three months
ended September 30, 2008 from $3,011,371 for the three months ended September
30, 2007. The following table presents the major components of
non-interest expenses for the three months ended September 30, 2008 and
2007.
|
|
Three
months ended September 30,
|
|
Non-interest
Expenses
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
$ |
2,177,318 |
|
|
$ |
1,810,573 |
|
Occupancy
expenses
|
|
|
459,958 |
|
|
|
431,888 |
|
Equipment
expense
|
|
|
167,544 |
|
|
|
109,336 |
|
Marketing
|
|
|
63,825 |
|
|
|
27,141 |
|
Data
processing expenses
|
|
|
230,618 |
|
|
|
213,763 |
|
Regulatory,
professional and other fees
|
|
|
323,062 |
|
|
|
112,286 |
|
Office
expense
|
|
|
183,764 |
|
|
|
142,749 |
|
All
other expenses
|
|
|
322,155 |
|
|
|
163,635 |
|
Total
|
|
$ |
3,928,244 |
|
|
$ |
3,011,371 |
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits, which represent the largest portion of non-interest
expenses, increased by $366,745, or 20.3%, to $2,177,318 for the three months
ended September 30, 2008 compared to $1,810,573 for the three months ended
September 30, 2007. The increase in salaries and employee benefits for the three
months ended September 30, 2008 was a result of an increase in the number of
employees, regular merit increases and increased health care costs. Overall
staffing levels increased to 112 full-time equivalent employees at September 30,
2008 as compared to 104 full-time equivalent employees at September 30,
2007.
In
January 2008, the Bank established a Mortgage Warehouse Funding Group, which
introduced a revolving line of credit that is available to licensed mortgage
banking companies. This group is based in a newly leased office space
in Somerset, NJ and consists of five newly hired staff members. The
Bank’s action to establish this group and commence operations has contributed to
the 2008 third quarter increase in most components of non-interest expenses (in
particular, salaries and employee benefits, equipment expense, and all other
expenses) when compared with 2007 expenses for the same period.
Marketing
expenses increased by $36,684, or 135.2%, to $63,825 for the three months ended
September 30, 2008 compared to $27,141 for the three months ended September 30,
2007. The increase in marketing expenses was attributable to
marketing campaigns designed to increase low-cost core deposits, further develop
our brand image and continue the Bank’s support of community
activities.
Regulatory,
professional and other fees increased by $210,776, or 187.7% to $323,062 for the
three months ended September 30, 2008 compared to $112,286 for the three months
ended September 30, 2007. During 2008, the Company incurred increased
accounting and legal fees as a result of the restatement of the Company’s
financial statements for the first three quarters and the year ended December
31, 2006 and the first three quarters of the year ended December 31, 2007, as
described in Item 8 of the 2007 Form 10-K, which became payable in the three
months ended September 30, 2008. The Bank also incurred additional
professional fees for the three months ended September 30, 2008 in connection
with audits performed by independent consultants in 2008 to assess the
effectiveness of controls established over internal systems as required by the
Sarbanes-Oxley Act.
All other
expenses, which are comprised of a variety of operating expenses and fees as
well as expenses associated with lending activities, increased by $158,520, or
96.9% to $322,155 for the three months ended September 30, 2008 compared to
$163,635 for the three months ended September 30, 2007. The addition
of the Mortgage Warehouse Funding Group in January 2008, as noted above,
contributed significantly to the current period increase in this
category.
An
important financial services industry productivity measure is the efficiency
ratio. The efficiency ratio is calculated by dividing total operating expenses
by net interest income plus non-interest income. An increase in the efficiency
ratio indicates that more resources are being utilized to generate the same or
greater volume of income, while a decrease would indicate a more efficient
allocation of resources. The Company’s efficiency ratio increased to
76.1% for the three months ended September 30, 2008, compared to 58.3% for the
three months ended September 30, 2007. The increase in the efficiency
ratio is due to the above-noted increases in non-interest expenses and reduced
net interest income.
Income
Taxes
Income
tax expense decreased by $408,903 from $687,147 for the three months ended
September 30, 2007 to $278,244 for the three months ended September 30,
2008. This decrease was primarily due to a lower 2008 level of pretax
income. The decrease in the effective tax rate of 26.2% for the three
months ended September 30, 2008 as compared to 32.3% for the three months ended
September 30, 2007 can be attributed to a higher proportion of earnings from
tax-exempt assets, such as obligations of states and political subdivisions
during the 2008 period.
Nine
Months Ended September 30, 2008 Compared to the Nine Months Ended September 30,
2007
Summary
The
Company reported net income of $2,302,437 for the nine months ended September
30, 2008, a decrease of $1,877,285, or 44.9%, from the $4,179,722 reported for
the nine months ended September 30, 2007. Net income per diluted
share was $0.57 for the nine months ended September 30, 2008 compared to $1.04
per diluted share for the nine months ended September 30, 2007.
Key
performance ratios declined for the nine months ended September 30,
2008. Return on average assets and return on average equity were
0.64% and 7.36%, respectively, for the nine months ended September 30, 2008
compared to 1.33% and 15.04%, respectively, for the nine months ended September
30, 2007.
Earnings
Analysis
Interest
Income
For the
nine months ended September 30, 2008, total interest income was $21,748,439,
representing a decrease of $911,941 or 4.0%, from the total interest income of
$22,660,380 for the nine months ended September 30, 2007. The
following table sets forth the Company’s consolidated average balances of
assets, liabilities and shareholders’ equity as well as interest income and
expense on related items, and the Company’s average yields and costs, on a
tax-equivalent basis, for the nine month periods ended September 30, 2008 and
2007.
Average
Balance Sheets with Resultant Interest and Rates
|
(yields
and costs on a tax-equivalent basis)
|
|
Nine
months ended September 30, 2008
|
|
|
Nine
months ended September 30, 2007
|
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/Cost
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/Cost
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
Funds Sold/Short-Term Investments
|
|
$ |
5,984,401 |
|
|
$ |
102,571 |
|
|
|
2.28 |
% |
|
$ |
1,896,548 |
|
|
$ |
73,510 |
|
|
|
5.18 |
% |
Investment
Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
77,102,296 |
|
|
|
2,884,520 |
|
|
|
4.98 |
% |
|
|
81,190,767 |
|
|
|
3,175,138 |
|
|
|
5.21 |
% |
Tax-exempt
|
|
|
14,724,025 |
|
|
|
629,592 |
|
|
|
5.70 |
% |
|
|
22,953,730 |
|
|
|
973,635 |
|
|
|
5.66 |
% |
Total
|
|
|
91,826,321 |
|
|
|
3,514,112 |
|
|
|
5.10 |
% |
|
|
104,144,497 |
|
|
|
4,148,773 |
|
|
|
5.31 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
Portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
|
|
|
120,390,986 |
|
|
|
6,420,158 |
|
|
|
7.10 |
% |
|
|
128,836,323 |
|
|
|
8,714,805 |
|
|
|
9.04 |
% |
Residential
Real Estate
|
|
|
10,396,339 |
|
|
|
490,967 |
|
|
|
6.29 |
% |
|
|
8,457,815 |
|
|
|
499,148 |
|
|
|
7.89 |
% |
Home
Equity
|
|
|
15,187,852 |
|
|
|
734,246 |
|
|
|
6.44 |
% |
|
|
14,023,750 |
|
|
|
800,678 |
|
|
|
7.63 |
% |
Commercial
and commercial real estate
|
|
|
125,655,843 |
|
|
|
6,922,897 |
|
|
|
7.34 |
% |
|
|
115,293,035 |
|
|
|
6,734,658 |
|
|
|
7.81 |
% |
Mortgage
warehouse lines
|
|
|
51,543,319 |
|
|
|
1,870,119 |
|
|
|
4.83 |
% |
|
|
- |
|
|
|
- |
|
|
|
- |
|
Installment
|
|
|
1,338,486 |
|
|
|
79,240 |
|
|
|
7.89 |
% |
|
|
1,551,403 |
|
|
|
98,140 |
|
|
|
8.46 |
% |
All
Other Loans
|
|
|
26,743,585 |
|
|
|
1,818,322 |
|
|
|
9.06 |
% |
|
|
21,540,462 |
|
|
|
1,906,441 |
|
|
|
11.83 |
% |
Total
|
|
|
351,256,410 |
|
|
|
18,335,949 |
|
|
|
6.95 |
% |
|
|
289,702,788 |
|
|
|
18,753,870 |
|
|
|
8.66 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Interest-Earning Assets
|
|
|
449,067,132 |
|
|
|
21,952,632 |
|
|
|
6.51 |
% |
|
|
395,743,833 |
|
|
|
22,976,153 |
|
|
|
7.76 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for Loan Losses
|
|
|
(3,565,315 |
) |
|
|
|
|
|
|
|
|
|
|
(3,248,097 |
) |
|
|
|
|
|
|
|
|
Cash
and Due From Bank
|
|
|
11,661,357 |
|
|
|
|
|
|
|
|
|
|
|
9,912,262 |
|
|
|
|
|
|
|
|
|
Other
Assets
|
|
|
21,976,659 |
|
|
|
|
|
|
|
|
|
|
|
17,362,502 |
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$ |
479,139,833 |
|
|
|
|
|
|
|
|
|
|
$ |
419,770,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders’ Equity:
|
|
|
|
|
|
|
Interest-Bearing
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money
Market and NOW Accounts
|
|
|
88,728,412 |
|
|
|
1,661,505 |
|
|
|
2.49 |
% |
|
|
83,618,465 |
|
|
|
1,268,455 |
|
|
|
2.05 |
% |
Savings
Accounts
|
|
|
78,154,933 |
|
|
|
1,465,495 |
|
|
|
2.50 |
% |
|
|
65,739,735 |
|
|
|
1,512,053 |
|
|
|
3.12 |
% |
Certificates
of Deposit
|
|
|
143,165,745 |
|
|
|
4,468,593 |
|
|
|
4.16 |
% |
|
|
120,391,470 |
|
|
|
4,357,012 |
|
|
|
4.84 |
% |
Other
Borrowed Funds
|
|
|
33,553,650 |
|
|
|
1,151,511 |
|
|
|
4.57 |
% |
|
|
28,815,385 |
|
|
|
1,131,093 |
|
|
|
5.25 |
% |
Trust
Preferred Securities
|
|
|
18,000,000 |
|
|
|
799,742 |
|
|
|
5.92 |
% |
|
|
20,051,282 |
|
|
|
1,101,034 |
|
|
|
7.34 |
% |
Total
Interest-Bearing Liabilities
|
|
|
361,602,740 |
|
|
|
9,546,846 |
|
|
|
3.52 |
% |
|
|
316,616,337 |
|
|
|
9,369,647 |
|
|
|
3.96 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Interest Spread
|
|
|
|
|
|
|
|
|
|
|
2.99 |
% |
|
|
|
|
|
|
|
|
|
|
3.80 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand
Deposits
|
|
|
70,568,752 |
|
|
|
|
|
|
|
|
|
|
|
60,993,033 |
|
|
|
|
|
|
|
|
|
Other
Liabilities
|
|
|
5,194,861 |
|
|
|
|
|
|
|
|
|
|
|
4,994,721 |
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
437,366,353 |
|
|
|
|
|
|
|
|
|
|
|
382,604,091 |
|
|
|
|
|
|
|
|
|
Shareholders'
Equity
|
|
|
41,773,481 |
|
|
|
|
|
|
|
|
|
|
|
37,166,409 |
|
|
|
|
|
|
|
|
|
Total
Liabilities and Shareholders' Equity
|
|
$ |
479,139,834 |
|
|
|
|
|
|
|
|
|
|
$ |
419,770,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Interest Margin
|
|
|
|
|
|
$ |
12,405,786 |
|
|
|
3.69 |
% |
|
|
|
|
|
$ |
13,606,506 |
|
|
|
4.60 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
decrease in interest income for the nine months ended September 30, 2008
resulted from a lower average yields earned on the securities and loan
portfolios partially offset by an increase in the loan portfolio average
balance. Average loans increased $61.6 million, or 21.2%, to $351.3
million for the nine months ended September 30, 2008 from $289.7 million for the
nine months ended September 30, 2007, while the yield on the portfolio decreased
171 basis points from 8.66% for the nine months ended September 30, 2007 to
6.95% for the nine months ended September 30, 2008. The lower loan
yield reflected the lower interest rate environment that has continued through
the 2008 period. At September 30, 2008, approximately 64 % of the
Bank’s loans have interest rates which float based on short-term indices such as
LIBOR and the Prime Rate.
Average
securities decreased $12.3 million, or 11.8%, from $104.1 million for the nine
months ended September 30, 2007 to $91.8 million for the nine months ended
September 30, 2008, while the yield on the securities portfolio decreased to
5.10% for the nine months ended September 30, 2008 from 5.31% for the nine
months ended September 30, 2007.
Overall,
the yield on the Company’s total interest-earning assets, on a tax-equivalent
basis, decreased 125 basis points to 6.51% for the nine months ended September
30, 2008 from 7.76% for the nine months ended September 30, 2007.
Interest
Expense
Total
interest expense for the nine months ended September 30, 2008 was $9,546,846, an
increase of $177,198, or 1.9%, compared to $9,369,648 for the nine months ended
September 30, 2007. The average rate paid on interest bearing
liabilities for the nine months ended September 30, 2008 decreased 44 basis
points to 3.52% from 3.96% for the nine months ended September 30, 2007. The
increase in interest expense for the current period resulted primarily from the
increase in average interest-bearing liabilities of $45.0 million or 14.2%,
partially offset by a decline in the average rate paid on these
liabilities.
Net
Interest Income
The
Company’s net interest income for the nine months ended September 30, 2008 was
$12,201,593, a decrease of $1,089,139, or 8.2%, compared to $13,290,732 for the
nine months ended September 30, 2007. The net interest margin (on a
tax-equivalent basis) was 3.69% for the nine months ended September 30, 2008,
compared to 4.60% for the nine months ended September 30, 2007. The
lower yields earned on the Bank’s floating-rate balances in the securities and
loan portfolios has contributed significantly to this margin
compression.
Provision
for Loan Losses
Management
considers a complete review of the following specific factors in determining the
provision for loan losses: historical losses by loan category, non-accrual
loans, problem loans as identified through internal classifications, collateral
values, and the growth and size of the loan portfolio. In addition to
these factors, management takes into consideration current economic conditions
and local real estate market conditions. Using this evaluation
process, the Company’s provision for loan losses was $535,000 for the nine
months ended September 30, 2008 and $100,000 for the nine months ended September
30, 2007. While the risk profile of the loan portfolio was reduced by
a change in its composition via a $25,411,047 reduction in higher risk
construction loans and a $85,153,706 increase in lower risk mortgage warehouse
lines, the total loan portfolio grew by 22.6% from December 31, 2007 to
September 30, 2008 and necessitated the increased provision to account for the
inherent risk in the portfolio as a result of this growth. Also,
management replenished the reserves to compensate for the current period net
charge-offs as well as taking into consideration that real estate market
conditions remained weak. Net charge offs/recoveries amounted to a
net charge-off of $154,471 for the nine months ended September 30, 2008,
compared to a net charge-off of $10,280 for the nine months ended September 30,
2007. See “Allowance for Loan Losses” on page 25.
Non-Interest
Income
Total
non-interest income for the nine months ended September 30, 2008 was $2,567,492,
which is an increase of $629,622, or 32.5%, from total non-interest income of
$1,937,870 for the nine months ended September 30, 2007.
Service
charges on deposit accounts increased to $641,421 for the nine months ended
September 30, 2008 from $493,614 for the nine months ended September 30,
2007. Service charge income increased principally due to a higher
volume of uncollected funds and overdraft fees collected on deposit accounts
during the first nine months of 2008 compared to the first nine months of
2007.
Gain on
sale of loans held for sale represented the largest single source on
non-interest income. Gain on sale of loans held for sale for the nine months
ended September 30, 2008 was $893,945 compared to $604,268 for the nine months
ended September 30, 2007. The lower interest rate environment through
the end of the third quarter of 2008 has resulted in an increased volume of
sales transactions in the mortgage loan and SBA loan markets and resultant gains
from these transactions.
Income
from BOLI assets amounted to $282,546 for the nine months ended September 30,
2008, compared to $274,027 for the nine months ended September 30,
2007. The Company owns $9.8 million in tax-free BOLI assets which
partially offset the cost of employee benefit plans and reduce the Company’s
overall effective tax rate.
The Bank
also generates non-interest income from a variety of fee-based services
contributed to the other income components of non-interest income, amounting to
$749,580 for the nine months ended September 30, 2008, compared to $565,961 for
the nine months ended September 30, 2007.
Non-Interest
Expense
Total
non-interest expense for the nine months ended September 30, 2008 was
$10,959,755, which is an increase of $1,998,823, or 22.3%, compared to total
non-interest expense of $8,960,932 for the nine months ended September 30,
2007.
The
following table presents the major components of non-interest expense for the
nine months ended September 30, 2008 and 2007.
|
|
Nine
months ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Non-interest
Expenses
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
$ |
6,228,445 |
|
|
$ |
5,361,491 |
|
Occupancy
expense
|
|
|
1,324,396 |
|
|
|
1,233,948 |
|
Equipment
expense
|
|
|
458,919 |
|
|
|
355,545 |
|
Marketing
|
|
|
203,359 |
|
|
|
74,167 |
|
Data
processing expenses
|
|
|
660,210 |
|
|
|
626,737 |
|
Regulatory,
professional and other fees
|
|
|
814,606 |
|
|
|
294,392 |
|
Office
expense
|
|
|
469,461 |
|
|
|
437,531 |
|
All
other expenses
|
|
|
800,359 |
|
|
|
577,121 |
|
|
|
$ |
10,959,755 |
|
|
$ |
8,960,932 |
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits increased $866,954, or 16.2%, to $6,228,445 for the nine
months ended September 30, 2008, compared to $5,361,491 for the nine months
ended September 30, 2007. This increase reflects the increase in
staffing levels plus normal employee salary increases.
In
January 2008, the Bank established a Mortgage Warehouse Funding Group, which
introduced a revolving line of credit that is available to licensed mortgage
banking companies. This group is based in a newly leased office space
in Somerset, NJ and consists of five newly hired staff. The Bank’s
action to establish this group and commence operations has contributed to the
2008 increase in most components of non-interest expenses when compared with
2007 expenses for the same period.
Marketing
expenses increased by $129,192, or 174.2%, to $203,359 for the nine months ended
September 30, 2008, compared to $74,167 for the nine months ended September 30,
2007. The increase in marketing expenses was attributable to
marketing campaigns designed to increase low-cost core deposits, further develop
our brand image and continue the Bank’s support of community
activities.
Regulatory,
professional and other fees increased by $520,214, or 176.7%, to $814,606 for
the nine months ended September 30, 2008, compared to $294,392 for the nine
months ended September 30, 2007. During the first nine months of
2008, the Company incurred increased accounting and legal fees as a result of
the restatement of the Company’s financial statements for the first three
quarters and the year ended December 31, 2006 and the first three quarters of
the year ended December 31, 2007, as described in Item 8 of the 2007 Form
10-K. The Bank also incurred additional professional fees for the
first nine months of 2008 in connection with audits performed by independent
consultants in 2008 to assess the effectiveness of controls established over
internal systems as required by the Sarbanes-Oxley Act.
All other
expenses, which are comprised of a variety of operating expenses and fees as
well as expenses associated with lending activities, increased by $223,238, or
38.7%, to $800,359 for the nine months ended September 30, 2008, compared to
$577,121 for the nine months ended September 30, 2007.
The
Company’s efficiency ratio increased to 74.2% for the nine months ended
September 30, 2008, compared to a ratio of 58.8% for the nine months ended
September 30, 2007. The increase in this ratio for the 2008 period is
due to the above-noted increases in non-interest expenses and reduced level of
net interest income.
Income
Taxes
Income
tax expense decreased by $1,106,055 from $1,987,948 for the nine months ended
September 30, 2007 to $971,893 for the nine months ended September 30,
2008. The decrease was primarily due to a lower 2008 level of pretax
income. The decrease in the effective tax rate of 29.7% for the nine
months ended September 30, 2008 as compared to 32.2% for the nine months ended
September 30, 2007 can be attributed to a higher proportion of earnings from
tax-exempt assets, such as obligations of states and political subdivisions
during the 2008 period.
Financial
Condition
September
30, 2008 Compared with December 31, 2007
Total
consolidated assets at September 30, 2008 were $513,561,622, representing an
increase of $84,410,083 from $429,151,539 at December 31,
2007. The asset growth was focused in our loan portfolio, which
increased by $66,651,046. The primary funding for asset growth came
from deposits and borrowings, which increased by $61,244,848 and $21,600,000,
respectively.
Cash
and Cash Equivalents
Cash and
cash equivalents at September 30, 2008
totaled $15,859,628 compared to $7,548,102 at December 31, 2007. Cash and cash
equivalents at September 30, 2008 consisted of cash and due from banks of
$15,848,339 and Federal funds sold/short term investments of $11,289. The
corresponding balances at December 31, 2007 were $7,517,158 and $30,944,
respectively. The increase was due primarily to timing of cash flows
related to the Bank’s business activities.
Investment
Securities
The
Bank’s investment securities represented 20.1% of total assets at September 30,
2008 and 23.0% at December 31, 2007. Total investment securities increased
$4,489,835, or 4.5%, at September 30, 2008 to $103,194,318 from $98,704,483 at
December 31, 2007.
Securities
available for sale are investments that may be sold in response to changing
market and interest rate conditions or for other business
purposes. Securities available for sale consist primarily of U.S.
Government and Federal agency securities as well as mortgage-backed
securities. Activity in this portfolio is undertaken primarily to
manage liquidity and interest rate risk and to take advantage of market
conditions that create more economically attractive returns. At
September 30, 2008, securities available for sale totaled $87,063,748, which is
an increase of $11,871,611 or 15.8%, from securities available for sale totaling
$75,192,137 at December 31, 2007.
At
September 30, 2008, the securities available for sale portfolio had net
unrealized losses of $2,478, compared to net unrealized gains of $30,563 at
December 31, 2007. These unrealized gains and losses are reflected
net of tax in shareholders’ equity as a component of “Accumulated other
comprehensive loss.”
Securities
held to maturity, which are carried at amortized historical cost, are
investments for which there is the positive intent and ability to hold to
maturity. The held to maturity portfolio consists primarily of obligations of
states and political subdivisions. At September 30, 2008, securities held to
maturity were $16,130,570, a decrease of $7,381,776, or 31.4%, from $23,512,346
at December 31, 2007. The fair value of the held to maturity
portfolio at September 30, 2008 was $15,374,652, resulting in an unrealized loss
of $755,918.
During
the nine months ended September 30, 2008, the Bank purchased securities in the
amounts of $33,765,333 for the available for sale portfolio. During
this same period, $29,176,761 in proceeds from maturities and repayments were
received.
Loans
The loan
portfolio, which represents the Bank’s largest asset, is a significant source of
both interest and fee income. Elements of the loan portfolio are subject to
differing levels of credit and interest rate risk. The Company’s primary lending
focus continues to be construction loans, commercial loans, owner-occupied
commercial mortgage loans and tenanted commercial real estate
loans.
The
following table sets forth the classification of loans by major category at
September 30, 2008 and December 31, 2007.
Loan
Portfolio Composition
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
Component
|
|
Amount
|
|
|
%
of
total
|
|
|
Amount
|
|
|
%
of
total
|
|
Construction
loans
|
|
$ |
107,324,873 |
|
|
|
30 |
% |
|
$ |
132,735,920 |
|
|
|
45 |
% |
Residential
real estate loans
|
|
|
10,131,858 |
|
|
|
3 |
% |
|
|
10,088,515 |
|
|
|
3 |
% |
Commercial
and commercial real estate
|
|
|
140,135,082 |
|
|
|
39 |
% |
|
|
135,128,642 |
|
|
|
46 |
% |
Mortgage
warehouse lines
|
|
|
85,153,706 |
|
|
|
24 |
% |
|
|
-0- |
|
|
|
0 |
% |
Loans
to individuals
|
|
|
17,833,277 |
|
|
|
5 |
% |
|
|
16,324,817 |
|
|
|
6 |
% |
Deferred
loan fees and costs
|
|
|
606,277 |
|
|
|
0 |
% |
|
|
302,818 |
|
|
|
0 |
% |
All
other loans
|
|
|
226,691 |
|
|
|
0 |
% |
|
|
180,006 |
|
|
|
0 |
% |
|
|
$ |
361,411,764 |
|
|
|
100 |
% |
|
$ |
294,760,718 |
|
|
|
100 |
% |
The loan
portfolio increased by $66,651,046, or 22.6%, to $361,411,764 at September 30,
2008, compared to $294,760,718 at December 31, 2007. The construction
loan portfolio decreased by $25,411,047, or 19.1%, to $107,324,873 at September
30, 2008 compared to $132,735,920 at December 31, 2007. This current
period decrease is a direct result of the current uncertain New Jersey economic
conditions and management’s actions to allow the higher risk construction loan
portfolio to run off while simultaneously focusing efforts to building the
balance of the lesser risk mortgage warehouse lines. In January 2008,
the Bank’s Mortgage Warehouse Funding Group introduced a revolving line of
credit that is available to licensed mortgage banking companies (the “Warehouse
Line of Credit”) and that has been successful from inception. The
Warehouse Line of Credit is used by the mortgage banker to originate one-to-four
family residential mortgage loans that are pre-sold to the secondary mortgage
market, which includes state and national banks, national mortgage banking
firms, insurance companies and government-sponsored enterprises, including the
Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage
Corporation (“FHLMC”) and others. On average, an advance under the
Warehouse Line of Credit remains outstanding for a period of less than 30 days,
with repayment coming directly from the sale of the loan into the secondary
mortgage market. Interest (the spread between our borrowing cost and
the rate charged to the client) and a transaction fee are collected by the Bank
at the time of repayment. Additionally, customers of the Warehouse
Lines of Credit are required to maintain deposit relationships with the Bank
that, on average, represent 10% to 15% of the loan balances. The Bank
had $85,153,706 outstanding Warehouse Line of Credit advances at September 30,
2008.
The
ability of the Company to enter into larger loan relationships and management’s
philosophy of relationship banking are key factors in the Company’s strategy for
loan growth. The ultimate collectability of the loan portfolio and
recovery of the carrying amount of real estate are subject to changes in the
Company’s market region’s economic environment and real estate
market.
Non-Performing
Assets
Non-performing
assets consist of non-performing loans and other real estate owned.
Non-performing loans are composed of (1) loans on a non-accrual basis, (2) loans
which are contractually past due 90 days or more as to interest and principal
payments but have not been classified as non-accrual, and (3) loans whose terms
have been restructured to provide a reduction or deferral of interest on
principal because of a deterioration in the financial position of the
borrower.
The
Bank’s policy with regard to non-accrual loans is that generally, loans are
placed on a non-accrual status when they are 90 days past due, unless such loans
are well secured and in the process of collection or, regardless of the past due
status of the loan, when management determines that the complete recovery of
principal or interest is in doubt. Consumer
loans are generally charged off after they become 120 days past
due. Subsequent payments on loans in non-accrual status are credited
to income only if collection of principal is not in doubt.
Non-performing
loans increased by $445,157 to $2,482,015 at September 30, 2008 from $2,036,858
at December 31, 2007. The major segments of non-accrual loans consist
of land designated for residential development where the required approvals to
begin construction have been received, commercial loans which are in the process
of collection and residential real estate which is either in foreclosure or
under contract to close after September 30, 2008.
The table
below sets forth non-performing assets and risk elements in the Bank’s
portfolio, by type, for the years indicated. As the table
demonstrates, non-performing loans to total loans (including loans held for
sale) decreased to 0.66% at September 30, 2008 from 0.67% at December 31, 2007
and loan quality is still considered to be strong. This was accomplished through
quality loan underwriting, a proactive approach to loan monitoring and
aggressive workout strategies.
|
|
|
|
|
|
|
Non-Performing
Assets and Loans
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Non-Performing
loans:
|
|
|
|
|
|
|
Loans
90 days or more past due and still accruing
|
|
$ |
0 |
|
|
$ |
0 |
|
Non-accrual
loans
|
|
|
2,482,015 |
|
|
|
2,036,858 |
|
Total
non-performing loans
|
|
|
2,482,015 |
|
|
|
2,036,858 |
|
Other
real estate owned
|
|
|
5,007,263 |
|
|
|
2,960,727 |
|
Total
non-performing assets
|
|
$ |
7,489,278 |
|
|
$ |
4,997,585 |
|
|
|
|
|
|
|
|
|
|
Non-performing
loans to total loans
|
|
|
0.66 |
% |
|
|
0.67 |
% |
Non-performing
assets to total assets
|
|
|
1.46 |
% |
|
|
1.16 |
% |
On an
absolute basis, non-performing assets increased by $2,491,693 to $7,489,278 at
September 30, 2008 from $4,997,585 at December 31, 2007. During the
first nine months of 2008, the Bank has taken possession of five residential
properties totaling $1,389,181 after aggregate loan charge-offs of
$53,946. During the first nine months of 2008, management was
successful in selling three of these real estate owned properties, totaling
approximately $1,049,582, without incurring any losses. The balance
of the increase to “other real estate owned” in the approximate amount of
$1,706,937 is the result of the Company continuing to complete an 18-unit
condominium project for which it has commitments from individual buyers to
purchase as of September 30, 2008. Non-performing assets represented
1.46% of total assets at September 30, 2008 and 1.16% at December 31,
2007.
The Bank
had no loans classified as restructured loans at September 30, 2008 or December
31, 2007.
Management
takes a proactive approach in addressing delinquent loans. The Company’s
President meets weekly with all loan officers to review the status of credits
past-due ten days or more. An action plan is discussed for each of the loans to
determine the steps necessary to induce the borrower to cure the delinquency and
restore the loan to a current status. Also, delinquency notices are system
generated when loans are five days past-due and again at 15 days
past-due.
In most
cases, the Company’s collateral is real estate and when the collateral is
foreclosed upon, the real estate is recorded at fair market value less estimated
selling costs, and subsequently carried at the lower of fair market value less
the estimated selling costs or the initially recorded amount. The amount, if
any, by which the recorded amount of the loan exceeds the fair market value of
the collateral is a loss which is charged to the allowance for loan losses at
the time of foreclosure or repossession. Resolution of a past-due loan can be
delayed if the borrower files a bankruptcy petition because collection action
cannot be continued unless the Company first obtains relief from the automatic
stay provided by the bankruptcy code.
Allowance
for Loan Losses
The
allowance for loan losses is maintained at a level sufficient in the opinion of
management to absorb estimated credit losses in the loan portfolio as of the
date of the financial statements. The allowance for loan losses is a valuation
reserve available for losses incurred or inherent in the loan portfolio and
other extensions of credit. The determination of the adequacy of the allowance
for loan losses is a critical accounting policy of the Company.
The
Company’s primary lending emphasis is the origination of commercial and
commercial real estate loans, including construction loans. Based on the
composition of the loan portfolio, the primary risks inherent in it are
deteriorating credit quality, a decline in the economy, and a decline in New
Jersey real estate market values. Any one or a combination of these events may
adversely affect the loan portfolio and may result in increased delinquencies,
loan losses and increased future provision levels.
All, or
part, of the principal balance of commercial and commercial real estate loans,
and construction loans are charged off to the allowance as soon as it is
determined that the repayment of all, or part, of the principal balance is
unlikely. Consumer loans are generally charged off no later than 120 days past
due on a contractual basis or earlier in the event of bankruptcy, or
if there is an amount deemed uncollectible. Because all identified
losses are immediately charged off, no portion of the allowance for loan losses
is restricted to any individual loan or groups of loans, and the entire
allowance is available to absorb any and all loan losses.
Management
reviews the adequacy of the allowance on at least a quarterly basis to ensure
that the provision for loan losses has been charged against earnings in an
amount necessary to maintain the allowance at a level that is adequate based on
management’s assessment of probable estimated losses. The Company’s methodology
for assessing the adequacy of the allowance for loan losses consists of several
key elements. These elements include a specific reserve for doubtful or high
risk loans, an allocated reserve and an unallocated portion.
The
Company consistently applies the following comprehensive
methodology. During the quarterly review of the allowance for loan
losses, management of the Company considers a variety of factors that
include:
|
·
|
General
economic conditions.
|
|
·
|
Trends
and levels of delinquent loans.
|
|
·
|
Trends
and levels of non-performing loans, including loans over 90 days
delinquent.
|
|
·
|
Trends
in volume and terms of loans.
|
|
·
|
Levels
of allowance for specific classified
loans.
|
The
specific reserve for high risk loans is established for specific commercial
loans, commercial real estate loans and construction loans which have been
identified by management as being high risk or impaired loans. A high
risk or impaired loan is assigned a doubtful risk rating grade because the loan
has not performed according to payment terms and there is reason to believe that
repayment of the loan principal, in whole, or in part, is unlikely. The specific
portion of the allowance is the total amount of potential unconfirmed losses for
such individual doubtful loans. To assist in determining the fair value of loan
collateral, the Company often utilizes independent third party qualified
appraisal firms, which in turn employ their own criteria and assumptions that
may include occupancy rates, rental rates and property expenses, among
others.
The
second category of reserves consists of the allocated portion of the allowance.
The allocated portion of the allowance is determined by taking pools of loans
outstanding that have similar characteristics and applying historical loss
experience for each pool. This estimate represents the potential unconfirmed
losses within the portfolio. Individual loan pools are created for commercial
and commercial real estate loans, construction loans and for various types of
loans to individuals. The historical estimation for each loan pool is
then adjusted to account for current conditions, current loan portfolio
performance, loan policy or management changes, or any other factor which may
cause future losses to deviate from historical levels.
The
Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions which may cause a potential
loan loss but are not specifically identifiable. It is prudent to
maintain an unallocated portion of the allowance because no matter how detailed
an analysis of potential loan losses is performed, these estimates inherently
lack precision. Management must make estimates using assumptions and information
which are often subjective and rapidly changing. At September 30, 2008,
management believed that the allowance for loan losses was
adequate.
The
allowance for loan losses amounted to $3,728,609 at September 30, 2008, which is
an increase of $380,529 from December 31, 2007. As a result of the
uncertain economic conditions in New Jersey that existed during the first nine
months of 2008, management’s plan was to reduce the risk profile of the loan
portfolio by allowing the balance of the higher risk construction loans
component to be reduced while simultaneously building the balance of the lower
risk mortgage warehouse lines components of the portfolio. These
proactive measures resulted in a risk profile change in the loan portfolio at
September 30, 2008 as compared with December 31, 2007. The ratio of
the allowance for loan losses to total loans was 0.99% at September 30, 2008 and
1.10% at December 31, 2007, respectively. Management believes the
quality of the loan portfolio remains strong and that the allowance for loan
losses is adequate in relation to credit risk exposure levels.
The
following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data.
Allowance
for Loan Losses
|
|
Nine
Months
Ended
September
30,
2008
|
|
|
Year
Ended
December
31,
2007
|
|
|
Nine
Months
Ended
September
30,
2007
|
|
Balance,
beginning of period
|
|
$ |
3,348,080 |
|
|
$ |
3,228,360 |
|
|
$ |
3,228,360 |
|
Provision
charged to operating expenses
|
|
|
535,000 |
|
|
|
130,000 |
|
|
|
100,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
charged off:
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
loans
|
|
|
(53,946 |
) |
|
|
- |
|
|
|
- |
|
Residential
real estate loans
|
|
|
(31,865 |
) |
|
|
- |
|
|
|
- |
|
Commercial
and commercial real estate
|
|
|
(71,437 |
) |
|
|
(88,891 |
) |
|
|
(88,891 |
) |
Loans
to individuals
|
|
|
0 |
|
|
|
(1,614 |
) |
|
|
(1,614 |
) |
Lease
financing
|
|
|
0 |
|
|
|
(478 |
) |
|
|
(478 |
) |
All
other loans
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
(157,247 |
) |
|
|
(90,983 |
) |
|
|
(90,983 |
) |
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
loans
|
|
|
0 |
|
|
|
75,000 |
|
|
|
75,000 |
|
Residential
real estate loans
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Commercial
and commercial real estate
|
|
|
2,776 |
|
|
|
- |
|
|
|
- |
|
Loans
to individuals
|
|
|
0 |
|
|
|
5,703 |
|
|
|
5,703 |
|
Lease
financing
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
All
other loans
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
2,776 |
|
|
|
80,703 |
|
|
|
80,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(charge offs) / recoveries
|
|
|
(154,471 |
) |
|
|
(10,280 |
) |
|
|
10,280 |
|
Balance,
end of period
|
|
$ |
3,728,609 |
|
|
$ |
3,348,080 |
|
|
$ |
3,318,080 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
At
period end
|
|
$ |
374,934,016 |
|
|
$ |
305,082,723 |
|
|
$ |
299,834,417 |
|
Average
during the period
|
|
|
351,256,410 |
|
|
|
292,371,351 |
|
|
|
289,702,788 |
|
Net
annualized charge offs to average loans outstanding
|
|
|
(0.06 |
) |
|
|
(0.00 |
%) |
|
|
0.00 |
% |
Allowance
for loan losses to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans at period end
|
|
|
0.99 |
% |
|
|
1.10 |
% |
|
|
1.11 |
% |
Non-performing
loans
|
|
|
150.23 |
% |
|
|
164.37 |
% |
|
|
82.52 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
Deposits,
which include demand deposits (interest bearing and non-interest bearing),
savings deposits and time deposits, are a fundamental and cost-effective source
of funding. The Company offers a variety of products designed to
attract and retain customers, with the Company’s primary focus being on building
and expanding long-term relationships.
The
following table summarizes deposits at September 30, 2008 and December 31,
2007.
|
|
September
30,
2008
|
|
|
December
31,
2007
|
|
Demand
|
|
|
|
|
|
|
Non-interest
bearing
|
|
$ |
70,107,443 |
|
|
$ |
59,055,803 |
|
Interest
bearing
|
|
|
90,375,600 |
|
|
|
86,168,444 |
|
Savings
|
|
|
82,416,751 |
|
|
|
62,094,432 |
|
Time
|
|
|
147,677,422 |
|
|
|
122,013,689 |
|
|
|
$ |
390,577,216 |
|
|
$ |
329,332,368 |
|
|
|
|
|
|
|
|
|
|
It is the
Bank’s strategy to fund loan growth with deposits. To achieve this
goal, deposit products, particularly short term certificates of deposit, were
priced to be attractive to depositors. At September 30, 2008, time
deposits increased by $25,663,733, or 21.0%, to $147,677,422, compared to
$122,013,689 at December 31, 2007. Balances were attracted from both
new customers as well as existing customers.
Non-interest
bearing demand deposits increased by $11,051,640, or 18.7%, to $70,107,443 at
September 30, 2008, compared to $59,055,803 at December 31, 2007, as the Bank
attracted new business customers through the newly introduced mortgage Warehouse
Line of Credit product, which contributed significantly to this current period
increase in balances.
Borrowings
Borrowings
are mainly comprised of Federal Home Loan Bank (“FHLB”) borrowings and overnight
funds purchased by the Bank. These borrowings are primarily used to fund asset
growth not supported by deposit generation. The balance of borrowings at
September 30, 2008 consisted of long-term FHLB borrowings of $30,500,000 and
overnight funds purchased of $26,700,000. The balance of borrowings at December
31, 2007 consisted of long-term FHLB borrowings of $30,500,000 and overnight
funds purchased of $5,100,000. The $21,600,000 increase in borrowings at
September 30, 2008 was the result of an increase in short-term
borrowings. FHLB advances are fully secured by marketable securities,
certain commercial and residential mortgages and home equity loans.
Shareholders’
Equity And Dividends
Shareholders’
equity at September 30, 2008 totaled $43,068,972, which is an increase of
$2,095,655, or 5.1%, from $40,973,317 at December 31, 2007. Book
value per common share rose to $10.78 at September 30, 2008 from $10.47 at
December 31, 2007. The ratio of shareholders’ equity to total assets
was 8.39% at September 30, 2008 and 9.55% at December 31, 2007.
The
increase in shareholders’ equity and book value per common share for the nine
months ended September 30, 2008 resulted primarily from comprehensive income of
$2,197,301, consisting primarily of net income of $2,302,437 and unrealized loss
on an interest rate swap contract, net of tax benefits, of
$158,355. In addition, stockholders’ equity was reduced by an
adjustment of $329,706 resulting from the initial adoption of EITF 06-04,
effective January 1, 2008.
The
Company’s stock is listed for trading on the Nasdaq Global Market System, under
the symbol “FCCY.”
In 2005,
the Board of Directors authorized a common stock repurchase program that allows
for the repurchase of a limited number of the Company’s shares at management’s
discretion on the open market. The Company undertook this repurchase program in
order to increase shareholder value. A table disclosing repurchases of Company
shares made during the quarter ended September 30, 2008 is set forth under Part
II, Item 2 of this report, Unregistered Sales of Equity
Securities and Use of Proceeds.
Actual capital amounts and ratios for
the Company and the Bank as of September 30, 2008 and December 31, 2007 are as
follows:
|
|
Actual
|
|
|
For
Capital
Adequacy
Purposes
|
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provision
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
As
of September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital to Risk Weighted Assets
|
|
$ |
64,104,766 |
|
|
|
15.58 |
% |
|
$ |
32,910,560 |
|
>8%
|
|
$ |
41,138,200 |
|
>10%
|
Tier
1 Capital to Risk Weighted Assets
|
|
|
56,717,940 |
|
|
|
13.79 |
% |
|
|
16,455,280 |
|
>4%
|
|
|
24,682,920 |
|
>6%
|
Tier
1 Capital to Average Assets
|
|
|
56,717,940 |
|
|
|
11.35 |
% |
|
|
19,985,859 |
|
>4%
|
|
|
24,982,324 |
|
>5%
|
Bank
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital to Risk Weighted Assets
|
|
$ |
62,501,918 |
|
|
|
15.19 |
% |
|
$ |
32,910,560 |
|
>8%
|
|
$ |
41,138,200 |
|
>10%
|
Tier
1 Capital to Risk Weighted Assets
|
|
|
58,773,309 |
|
|
|
14.29 |
% |
|
|
16,455,280 |
|
>4%
|
|
|
24,682,920 |
|
>6%
|
Tier
1 Capital to Average Assets
|
|
|
58,773,309 |
|
|
|
11.80 |
% |
|
|
19,927,440 |
|
>4%
|
|
|
24,909,300 |
|
>5%
|
As
of December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital to Risk Weighted Assets
|
|
$ |
62,006,573 |
|
|
|
17.75 |
% |
|
$ |
27,949,600 |
|
>8%
|
|
$ |
34,937,000 |
|
>10%
|
Tier
1 Capital to Risk Weighted Assets
|
|
|
54,437,463 |
|
|
|
15.58 |
% |
|
|
13,974,800 |
|
>4%
|
|
|
20,962,200 |
|
>6%
|
Tier
1 Capital to Average Assets
|
|
|
54,437,463 |
|
|
|
12.66 |
% |
|
|
17,196,222 |
|
>4%
|
|
|
21,495,277 |
|
>5%
|
Bank
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital to Risk Weighted Assets
|
|
$ |
59,961,320 |
|
|
|
17.16 |
% |
|
$ |
27,949,600 |
|
>8%
|
|
$ |
34,937,000 |
|
>10%
|
Tier
1 Capital to Risk Weighted Assets
|
|
|
56,613,240 |
|
|
|
16.20 |
% |
|
|
13,974,800 |
|
>4%
|
|
|
20,962,200 |
|
>6%
|
Tier
1 Capital to Average Assets
|
|
|
56,613,240 |
|
|
|
13.20 |
% |
|
|
17,152,520 |
|
>4%
|
|
|
21,440,650 |
|
>5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
minimum regulatory capital requirements for financial institutions require
institutions to have a Tier 1 capital to average assets ratio of 4.0%, a Tier 1
capital to risk weighted assets ratio of 4.0% and a total capital to risk
weighted assets ratio of 8.0%. To be considered “well capitalized,”
an institution must have a minimum Tier 1 leverage ratio of 5.0%. At
September 30, 2008, the ratios of the Company exceeded the ratios required to be
considered well capitalized. It is management’s goal to monitor and maintain
adequate capital levels to continue to support asset growth and continue its
status as a well capitalized institution.
Recent
Legislation and Other Regulatory Initiatives
On
October 3, 2008, the President of the United States signed the Emergency
Economic Stabilization Act of 2008 (“EESA”) into law. This
legislation, among other things, authorized the Secretary of Treasury
(“Treasury”) to establish a Troubled Asset Relief Program (“TARP”) to purchase
up to $700 billion in troubled assets from qualified financial institutions
(“QFI”). EESA is also being interpreted by the Treasury to allow it
to make direct equity investments in QFIs. Subsequent to the
enactment of EESA, the Treasury announced the TARP Capital Purchase Program
(“CPP”) under which the Treasury will purchase up to $250 billion in senior
perpetual preferred stock of QFIs that elect to participate in the
CPP. The Treasury’s investment in an individual QFI may not exceed
the lesser of 3% of the QFIs risk-weighted assets or $25 billion and may not be
less than 1% of risk-weighted assets. QFIs have until November 14,
2008, to elect to participate in the CPP. The CPP also requires the
issuance of warrants exercisable for a number of shares of common stock with an
aggregate value equal to 15% of the amount of the preferred stock
investment.
EESA also
increases the maximum deposit insurance amount up to $250,000 until December 31,
2009 and removes the statutory limits on the FDIC’s ability to borrow from the
Treasury during this period. The FDIC may not take the temporary
increase in deposit insurance coverage into account when setting
assessments.
As a
condition to selling troubled assets to the TARP and/or participating in the
CPP, the QFI must agree to the Treasury’s standards for executive compensation
and corporate governance. These standards generally apply to the
Chief Executive Officer, Chief Financial Officer, and next three highest
compensated officers of the QFI. In general, these standards require
the QFI to: (1) ensure that incentive compensation for senior executives does
not encourage unnecessary and excessive risk taking; (2) recoup any bonus or
incentive compensation paid to a senior executive based on financial statements
that later prove to be erroneous; (3) prohibit the QFI from making “golden
parachute” payments in connection with certain terminations of employment; and
(4) not deduct, for tax purposes, executive compensation in excess of $500,000
for each senior executive. Participation in the CPP also results in
certain restrictions on the QFIs dividend and stock repurchase
activities. These restrictions remain in place until the Treasury no
longer holds any equity or debt securities of the QFI.
As noted
in the “Shareholders’ Equity and Dividends” section above, the Company exceeds
the minimum regulatory capital standards by substantial
margins. Furthermore, management does not currently believe that the
Company has a significant exposure to troubled assets that would warrant sale of
such assets under the TARP. However, the Company has submitted an
application to participate in the CPP. Based on the Company’s
calculation of risk-weighted assets at September 30, 2008, we would be able to
sell from $4.1 million to $12.3 million of preferred stock to the
Treasury. The Comapny will continue to evaluate this new program and,
if its application is approved, will determine if participation in it would
provide a material benefit to the Company.
Concurrent
with the announcement of the CPP, the FDIC also established the Temporary
Liquidity Guaranty Program (“TLGP”). This program contains two
elements: (i) a debt guarantee program and (ii) an increase in
deposit insurance coverage for certain types of non-interest bearing
accounts. Pursuant to the debt guarantee program, newly issued senior
unsecured debt of banks, thrifts or their holding companies issued on or before
June 30, 2009 would be protected in the event the issuing institution
subsequently fails or its holding company files for
bankruptcy. Financial institutions opting to participate in this
program would be charged an annualized fee equal to 75 basis points multiplied
by the amount of debt being guaranteed. The amount of debt that may
be guaranteed cannot exceed 125% of the institution’s outstanding debt at
September 30, 2008 and due to mature before June 30, 2009. The
guarantee would expire by June 30, 2012 even if the debt itself has not
matured. Pursuant to the temporary unlimited deposit insurance
coverage, a qualifying institution may elect to provide unlimited coverage for
non-interest bearing transaction deposit accounts in excess of the $250,000
limit by paying a 10 basis point surcharge on the covered amounts in excess of
$250,000. All institutions will have this coverage without charge
until December 5, 2008. Institutions may choose whether to continue
the coverage and be charged the surcharge. To opt out of the program,
institutions must notify the FDIC by December 5, 2008. This coverage
would expire on December 31, 2009. The Company does not plan to opt
out of the TLGP.
The
actions described above, together with additional actions announced by the
Treasury and other regulatory agencies continue to develop. It is not
clear at this time what impact, EESA, TARP, other liquidity and funding
initiatives of the Treasury and other bank regulatory agencies that have been
previously announced, and any additional programs that may be initiated in the
future will have on the financial markets and the financial services
industry. The extreme levels of volatility and limited credit
availability currently being experienced could continue to effect the U.S.
banking industry and the broader U.S. and global economies, which will have an
affect on all financial institutions, including the Company. We
cannot predict the full effect that this wide-ranging legislation will have on
the national economy or on financial institutions.
Liquidity
At
September 30, 2008, the amount of liquid assets remained at a level management
deemed adequate to ensure that contractual liabilities, depositors’ withdrawal
requirements, and other operational and customer credit needs could be
satisfied.
Liquidity
measures the ability to satisfy current and future cash flow needs as they
become due. Liquidity management refers to the Company’s ability to support
asset growth while satisfying the borrowing needs and deposit withdrawal
requirements of customers. In addition to maintaining liquid assets, factors
such as capital position, profitability, asset quality and availability of
funding affect a bank’s ability to meet its liquidity needs. On the asset side,
liquid funds are maintained in the form of cash and cash equivalents, Federal
funds sold, investment securities held to maturity maturing within one year,
securities available for sale and loans held for sale. Additional asset-based
liquidity is derived from scheduled loan repayments as well as investment
repayments of principal and interest from mortgage-backed securities. On the
liability side, the primary source of liquidity is the ability to generate core
deposits. Short-term borrowings are used as supplemental funding sources when
growth in the core deposit base does not keep pace with that of earnings
assets.
The Bank
has established a borrowing relationship with the FHLB and a correspondent bank
which further supports and enhances liquidity. At September 30, 2008, the Bank
maintained an Overnight Line of Credit at the FHLB in the amount of $47,534,500
plus a One-Month Overnight Repricing Line of Credit of $47,534,500. Advances
issued under these programs are subject to FHLB stock level and collateral
requirements. Pricing of these advances may fluctuate based on existing market
conditions. The Bank also maintains an unsecured Federal funds line of
$20,000,000 with a correspondent bank.
The
Consolidated Statements of Cash Flows present the changes in cash from
operating, investing and financing activities. At September 30, 2008, the
balance of cash and cash equivalents was $15,859,628.
Net cash
used in operating activities totaled $1,064,964 for the nine months ended
September 30, 2008 compared to net cash provided by operating activities of
$7,526,491 in the nine months ended September 30, 2007. The primary sources of
funds are net income from operations adjusted for provision for loan losses,
depreciation expenses, and net proceeds from sales of loans held for
sale. The primary use of funds was origination of loans held for
sale.
Net cash
used in investing activities totaled $73,604,236 in the nine months ended
September 30, 2008, compared to $19,971,517 used in investing activities in the
nine months ended September 30, 2007. The current period increased amount was
primarily the result of an increase in the loan portfolio and purchase of
securities available for sale.
Net cash
provided by financing activities amounted to $82,980,726 in the nine months
ended September 30, 2008, compared to $11,646,003 provided by financing
activities in the nine months ended September 30, 2007. The current period
amount resulted primarily from an increase in deposits combined with an increase
in borrowings during the nine months period ended September 30,
2008.
The
securities portfolio is also a source of liquidity, providing cash flows from
maturities and periodic repayments of principal. During the nine months ended
September 30, 2008, maturities and prepayments of investment securities totaled
$29,176,761. Another source of liquidity is the loan portfolio, which
provides a flow of payments and maturities.
The
Company anticipates that cash and cash equivalents on hand, the cash flow from
assets as well as other sources of funds will provide adequate liquidity for the
Company’s future operating, investing and financing needs. Management
will continue to monitor the Company’s liquidity and maintain it at a level that
it deems adequate and not excessive.
Interest
Rate Sensitivity Analysis
The
largest component of the Company’s total income is net interest income, and the
majority of the Company’s financial instruments are composed of interest
rate-sensitive assets and liabilities with various terms and maturities.
The
primary objective of management is to maximize net interest income while
minimizing interest rate risk. Interest rate risk is derived from timing
differences in the re-pricing of assets and liabilities, loan prepayments,
deposit withdrawals, and differences in lending and funding rates. Management
actively seeks to monitor and control the mix of interest rate-sensitive assets
and interest rate-sensitive liabilities.
The
Company continually evaluates interest rate risk management opportunities,
including the use of derivative financial instruments. Management believes that
hedging instruments currently available are not cost-effective, and therefore,
has focused its efforts on increasing the Company’s spread by attracting
lower-cost retail deposits.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
Not
required.
Item
4. Controls
and Procedures.
The
Company has established disclosure controls and procedures designed to ensure
that information required to be disclosed in the reports that the Company files
or submits under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in SEC rules and forms and is
accumulated and communicated to management, including the principal executive
officer and principal financial officer, to allow timely decisions regarding
required disclosure.
The
Company’s principal executive officer and principal financial officer, with the
assistance of other members of the Company’s management, have evaluated the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act) as of the end of the period covered by this quarterly
report. Based upon such evaluation, the Company’s principal executive
officer and principal financial officer have concluded that the Company’s
disclosure controls and procedures are effective as of the end of the period
covered by this quarterly report.
The
Company’s principal executive officer and principal financial officer have also
concluded that there was no change in the Company’s internal control over
financial reporting (as such term is defined in Rule 13a-15(f) under the
Exchange Act) that occurred during the quarter ended September 30, 2008 that has
materially affected, or is reasonably likely to materially affect, the Company’s
internal control over financial reporting.
PART
II. OTHER INFORMATION
Item
2. Unregistered Sales of Equity
Securities and Use of Proceeds.
Issuer
Purchases of Equity Securities
In 2005,
the Board of Directors authorized a stock repurchase program under which the
Company may purchase in open market or privately negotiated transactions up to
5% of the number of shares of common stock of the Company that were outstanding
on the date of the approval of the repurchase program (as adjusted for annual
stock dividends). The Company undertook these repurchase programs in an effort
to increase shareholder value. The following table provides common stock
repurchases made by or on behalf of the Company during the three months ended
September 30, 2008.
Issuer
Purchases of Equity Securities (1)
Period
|
Total
Number
of
Shares
Purchased
|
Average
Price
Paid
Per
Share
|
Total
Number of
Shares
Purchased
As
Part of Publicly
Announced
Plan or
Program
|
Maximum
Number
of
Shares That
May
Yet be
Purchased
Under
the
Plan or
Program
|
Beginning
|
Ending
|
|
|
|
|
July
1, 2008
|
July
31, 2008
|
267
|
$11.55
|
267
|
159,229
|
Aug.
1, 2008
|
Aug
31, 2008
|
1,361
|
$11.12
|
1,361
|
157,868
|
Sept.
1, 2008
|
Sept.
30, 2008
|
-
|
-
|
-
|
157,868
|
Total
|
1,628
|
$11.19
|
1,628
|
157,868
|
_________________
(1)
|
The
Company’s common stock repurchase program covers a maximum of 185,787
shares of common stock of the Company, representing 5% of the outstanding
common stock of the Company on July 21, 2005, as adjusted
for the annual stock dividends, including the 6% stock dividend declared
on December 20, 2007 paid on February 6,
2008.
|
Item
6. |
Exhibits. |
|
|
|
|
|
31.1
|
*
|
Certification
of Robert F. Mangano, principal executive officer of the Company, pursuant
to Securities Exchange Act Rule 13a-14(a)
|
|
|
|
|
|
31.2
|
*
|
Certification
of Joseph M. Reardon, principal financial officer of the Company, pursuant
to Securities Exchange Act Rule 13a-14(a)
|
|
|
|
|
|
32
|
*
|
Certifications
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
The Sarbanes-Oxley Act of 2002, signed by Robert F. Mangano, principal
executive officer of the Company, and Joseph M. Reardon, principal
financial officer of the
Company
|
_____________________
* Filed
herewith.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
1ST CONSTITUTION
BANCORP |
|
|
|
|
|
|
|
|
|
Date:
November 14, 2008
|
By:
|
/s/
ROBERT F. MANGANO |
|
|
|
Robert
F. Mangano |
|
|
|
President
and Chief Executive Officer
(Principal
Executive Officer)
|
|
Date:
November 14, 2008
|
By:
|
/s/
JOSEPH M. REARDON |
|
|
|
Joseph
M. Reardon |
|
|
|
Senior
Vice President and Treasurer
(Principal
Financial and Accounting Officer)
|
|
|
|
|
|