Item 1. Business Historical Development of Business This report, in Item 1, Item 7 and elsewhere, includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Center Bancorp, Inc. and its subsidiaries, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which Center Bancorp, Inc. is engaged; (7) changes and trends in the securities markets may adversely impact Center Bancorp, Inc; (8) a delayed or incomplete resolution of regulatory issues could adversely impact our planning; (9) the impact of reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (10) the outcome of regulatory and legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of Center Bancorp, Inc. are included in Item 1A
Item 1A. Risk Factors An investment in our common stock involves risks. Stockholders should carefully consider the risks described below, together with all other information contained in this Annual Report on Form 10-K, before making any purchase or sale decisions regarding our common stock. If any of the following risks actually occur, our business, financial condition or operating results may be harmed. In that case, the trading price of our common stock may decline, and stockholders may lose part or all of their investment in our common stock.
We are required to take certain actions pursuant to our current MOU with the OCC, and lack of compliance could result in additional regulatory actions. As described under “Item 1 - Business - Regulation of Bank Subsidiary,” the Bank is subject to a MOU with the OCC, pursuant to which it has agreed to take various actions to improve the Bank’s capital position and profitability. The OCC has also established higher minimum capital ratios for the Bank than the regulatory minimums. While management is committed to addressing and resolving the issues raised by the OCC and has already initiated corrective actions to comply with various requirements of the MOU, no assurances can be given that the OCC will find the Bank’s compliance plan satisfactory, or that the Bank will not be subject to further supervisory action by the OCC. We may at some point need to raise additional capital to assure compliance with mandated capital ratios and to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to comply with applicable capital requirements and to further expand our operations through internal growth or acquisitions could be materially impaired.
Recent negative developments in the financial services industry and U.S. and global credit markets may continue to adversely impact our operations and results. The general economic downturn continued throughout 2009 and is continuing into 2010. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for our deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:
• we potentially face increased regulation of our industry and compliance with such regulation may increase our costs and limit our ability to pursue business opportunities;
• customer demand for loans secured by real estate could be reduced due to weaker economic conditions, an increase in unemployment, a decrease in real estate values or an increase in interest rates;
• the process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans; the level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process;
• the value of the portfolio of investment securities that we hold may be adversely affected; and
• we may be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits
We are subject to interest rate risk and variations in interest rates may negatively impact our financial performance. We are unable to predict actual fluctuations of market interest rates with complete accuracy. Rate fluctuations are affected by many factors, including:
• inflation;
• recession;
• a rise in unemployment;
• tightening money supply; and
• domestic and international disorder and instability in domestic and foreign financial markets.
Changes in the interest rate environment may reduce profits. We expect that we will continue to realize income from the differential or “spread” between the interest we earn on loans, securities and other interest-earning assets, and the interest we pay on deposits, borrowings and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. Changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, levels of prepayments and cash flows as well as the market value of our securities portfolio and overall profitability.
External factors, many of which we cannot control, may result in liquidity concerns for us. Liquidity risk is the potential that Union Center National Bank may be unable to meet its obligations as they come due, capitalize on growth opportunities as they arise, or pay regular dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.
Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, operating expenses, capital expenditures and dividend payments to shareholders.
Liquidity is derived primarily from deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; net cash provided from operations, and access to other funding sources.
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to market factors or an adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the turmoil faced by banking organizations in the domestic and worldwide credit markets continues. Over the last several years, the financial services industry and the credit markets generally have been materially and adversely affected by significant declines in
asset values and by a lack of liquidity. The liquidity issues have been particularly acute for regional and community banks, as many of the larger financial institutions have significantly curtailed their lending to regional and community banks to reduce their exposure to the risks of other banks. In addition, many of the larger correspondent lenders have reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than do the national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.
The extensive regulation and supervision to which we are subject impose substantial restrictions on our business. Center Bancorp Inc., primarily through its principal subsidiary, Union Center National Bank, and certain non-bank subsidiaries, are subject to extensive regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect our shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Union Center National Bank is also subject to a number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. The United States Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes, especially for the TARP Capital Purchase Program (in which the Parent Corporation is a participant). Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations.
Because of our participation in the U.S. Treasury’s Capital Purchase Program, we are subject to several restrictions, including restrictions on our ability to declare or pay dividends and repurchase our shares, as well as restrictions on our executive compensation. As a result of our participation in the U.S. Treasury’s Capital Purchase Program, our ability to declare or pay dividends on any of our capital stock is subject to restrictions. Specifically, we are unable to declare dividend payments on common, junior preferred or pari passu preferred shares if we are in arrears in the payment of dividends on the Preferred Shares. Further, until the third anniversary of the investment or when all of the Preferred Shares have been redeemed or transferred, we are not permitted to increase the cash dividends on our common stock without the U.S. Treasury’s approval. Additionally, our ability to repurchase our shares of outstanding common stock is restricted. The U.S. Treasury’s consent generally is required for us to make any stock repurchase until the third anniversary of the investment by the U.S. Treasury unless all of the Preferred Shares have been redeemed or transferred. Further, common, junior preferred or pari passu preferred shares may not be repurchased if we are in arrears in the payment of dividends on the Preferred Shares. These restrictions, as well as the dilutive effect of the warrants that we issued to the U.S. Treasury as part of the Capital Purchase Program, may have a negative effect on the market price of our common stock.
Pursuant to the terms by which we participated in the U.S. Treasury’s Capital Purchase Agreement and the terms of the American Recovery and Reinvestment Act of 2009, we and several of our senior employees are subject to substantial limitations on executive compensation and are subject to relatively new corporate governance standards. Such requirements may adversely affect our ability to attract and retain senior officers and employees who are critical to the operation of our business.
The documents that we executed with the U.S. Treasury when it purchased our Preferred Shares allow it to unilaterally change the terms of the Preferred Shares or impose additional requirements on the Corporation if there is a change in law. These changes or additional requirements could restrict our ability to conduct
business, could subject us to additional cost and expense or could change the terms of the Preferred Shares to the detriment of our common shareholders. While it may be possible for us to redeem the Preferred Shares in the event that the U.S. Treasury imposes any changes or additional requirements that we believe are detrimental, there can be no assurances that our federal regulator will approve such redemption or that we will have the ability to implement such redemption, especially in light of regulatory requirements imposed upon financial institutions seeking to redeem TARP securities.
Current levels of volatility in the capital markets are unprecedented and may adversely impact our operations and results. The capital markets have been experiencing unprecedented volatility for more than two years. Such negative developments and disruptions have resulted in uncertainty in the financial market in general with the expectation of a continuing general economic downturn which is continuing in 2010. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our business, financial condition and results of operations or our ability to access capital.
We must effectively manage our credit risk. There are risks inherent in making any loan, including risks inherent in dealing with particular borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific industries, a centralized credit administration department and periodic independent reviews of outstanding loans by our loan review department. However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks.
Our loan portfolio includes commercial real estate loans, which involve risks specific to real estate value. Commercial real estate loans were $405.9 million, or approximately 56.7 percent of our total loan portfolio, as of December 31, 2009. Many of these loans are extended to small and medium-sized businesses. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although many such loans are secured by real estate as a secondary form of collateral, continued adverse developments affecting real estate values in our market area could increase the credit risk associated with our loan portfolio. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties. If the loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.
We may incur impairments to goodwill. We review our goodwill at least annually. Significant negative industry or economic trends, reduced estimates of future cash flows or disruptions to our business, could indicate that goodwill might be impaired. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely on projections of future operating performance. We operate in a competitive environment and projections of future operating results and cash flows may vary significantly from actual results. Additionally, if our analysis results in an impairment to its goodwill, we would be required to record a non-cash charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such change could have a material adverse effect on our results of operations and our stock price.
Union Center National Bank’s ability to pay dividends is subject to regulatory limitations, which, to the extent that our holding company requires such dividends in the future, may affect our holding company’s ability to honor its obligations and pay dividends. As a bank holding company, Center Bancorp, Inc. is a separate legal entity from Union Center National Bank and its subsidiaries and does not have significant operations. We currently depend on Union Center National Bank’s cash and liquidity to pay our operating expenses and dividends to shareholders. We cannot assure you that in the future Union Center National Bank will have the capacity to pay the necessary dividends and that we will not require dividends from Union Center National Bank to satisfy our obligations. Various statutes and regulations limit the availability of dividends from Union Center National Bank. It is possible, depending upon our and Union Center National Bank’s financial condition and other factors, that bank regulators could assert that payment of dividends or other payments by Union Center National Bank are an unsafe or unsound practice. In the event that Union Center National Bank is unable to pay dividends, we may not be able to service our obligations, as they become due, or pay dividends on our capital stock. Consequently, the inability to receive dividends from Union Center National Bank could adversely affect our financial condition, results of operations, cash flows and prospects. Pursuant to the MOU between Union Center National Bank and the OCC, the Bank may not declare dividends without the prior approval of the OCC.
Union Center National Bank’s allowance for loan losses may not be adequate to cover actual losses. Like all financial institutions, Union Center National Bank maintains an allowance for loan losses to provide for loan defaults and non-performance. If Union Center National Bank’s allowance for loan losses is not adequate to cover actual loan losses, future provisions for loan losses could materially and adversely affect our operating results. Union Center National Bank’s allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions of its regulators, changes in the size and composition of the loan portfolio and industry information. Union Center National Bank also considers the impact of economic events, the outcome of which is uncertain. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review Union Center National Bank’s loans and allowance for loan losses. While we believe that Union Center National Bank’s allowance for loan losses in relation to its current loan portfolio is adequate to cover current losses, we cannot assure you that Union Center National Bank will not need to increase its allowance for loan losses or that regulators will not require it to increase this allowance. Either of these occurrences could materially and adversely affect our earnings and profitability.
Union Center National Bank is subject to various lending and other economic risks that could adversely impact our results of operations and financial condition. Changes in economic conditions, particularly a significant worsening of the current economic environment, could hurt Union Center National Bank’s business. Union Center National Bank’s business is directly affected by political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in governmental monetary and fiscal policies, all of which are beyond our control. Deterioration in economic conditions, particularly within New Jersey, could result in the following consequences, any of which could hurt our business materially:
• loan delinquencies may increase;
• problem assets and foreclosures may increase;
• demand for our products and services may decline; and
• collateral for loans made by Union Center National Bank may decline in value, in turn reducing Union Center National Bank’s clients’ borrowing power.
Further deterioration in the real estate market, particularly in New Jersey, could hurt our business. As real estate values in New Jersey decline, our ability to recover on defaulted loans by selling the underlying real estate is reduced, which increases the possibility that we may suffer losses on defaulted loans.
Union Center National Bank may suffer losses in its loan portfolio despite its underwriting practices. Union Center National Bank seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. Although we believe that Union Center National Bank’s underwriting criteria are appropriate for the various kinds of loans that it makes, Union Center National Bank may incur losses on loans that meet its underwriting criteria, and these losses may exceed the amounts set aside as reserves in its allowance for loan losses.
Union Center National Bank faces strong competition from other financial institutions, financial service companies and other organizations offering services similar to the services that Union Center National Bank provides. Many competitors offer the same types of loans and banking services that Union Center National Bank offers or similar types of such services. These competitors include other national banks, savings associations, regional banks and other community banks. Union Center National Bank also faces competition from many other types of financial institutions, including finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In this regard, Union Center National Bank’s competitors include other state and national banks and major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations, offer a broader suite of services and mount extensive promotional and advertising campaigns. Our inability to compete effectively may adversely affect our business.
If we pursue acquisitions, we may heighten the risks to our operations and financial condition. To the extent that we undertake acquisitions or new branch openings, we may experience the effects of higher operating expenses relative to operating income from the new operations, which may have a material adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business. To the extent that we grow through acquisitions and branch openings, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses involve similar risks to those commonly associated with branching, but may also involve additional risks, including:
• potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
• exposure to potential asset quality issues of the acquired bank or related business;
• difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and
• the possible loss of key employees and customers of the banks and businesses we acquire.
Attractive acquisition opportunities may not be available to us in the future. We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators will consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and shareholders’ equity per share of our common stock.
Further increases in FDIC premiums could have a material adverse effect on our future earnings. The FDIC insures deposits at FDIC insured financial institutions, including Union Center National Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at an adequate level. In light of current economic conditions, the FDIC has increased its assessment rates and imposed special assessments. The FDIC may further increase these rates and impose additional special assessments in the future, which could have a material adverse effect on future earnings.
Declines in value may adversely impact our investment portfolio. As of December 31, 2009, we had approximately $298.1 million in available for sale investment securities. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of Union Center National Bank to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.
Concern of customers over deposit insurance may cause a decrease in deposits. With recent increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with their bank is fully insured. Decreases in deposits may adversely affect our funding costs and net income.
We have a continuing need for technological change and we may not have the resources to effectively implement new technology. The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we grow. We cannot provide you with assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. A failure of the security measures we use could have a material adverse effect on our financial condition and results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments None.
Item 2.
Item 2. Properties The Bank’s operations are located at nine sites in Union County, New Jersey, consisting of five sites in Union Township, one in Springfield Township, one in Berkeley Heights, one in Vauxhall and one in Summit, New Jersey. The Bank also has three sites in Morris County, New Jersey, consisting of one site in Madison, one site in Boonton/Mountain Lakes, and one site in Morristown, New Jersey. The principal office is located at 2455 Morris Avenue, Union, New Jersey. The principal office is a two story building constructed in 1993. On October 9, 2004, the Bank opened a 19,555 square foot office facility on Springfield Road in Union, New Jersey, which serves as the Bank’s Operations and Data Center. On February 27, 2008, the Corporation
signed an agreement to lease premises at 105 North Avenue, Cranford, New Jersey to be used to construct a full service branch facility. Subsequently, the Corporation has notified the landlord that it wanted to terminate the commitment and completed the termination in the first quarter of 2009.
The following table sets forth certain information regarding the Bank’s leased locations.
The Bank operates a Drive In/Walk Up located at 2022 Stowe Street, Union, New Jersey, adjacent to a part of the Center Office facility. The Bank has three off-site ATM locations. Two are located at New Jersey Transit stations and one is located at the Boys and Girls Club of Union, 1050 Jeanette Avenue, Union, New Jersey.
On January 12, 2010, the Bank entered into a sale/purchase agreement for its 1180 Springfield Road facility. Under the terms of the agreement the premises will be leased with an option to buy. The agreement is expected to be fully consummated in the second quarter of 2010.
Item 3.
Item 3. Legal Proceedings In December 2009, the Corporation took steps to terminate a participation agreement with another New Jersey bank at December 31, 2009. Under the terms of the agreement, the participation ended on December 31, 2009, and, in the Corporation’s view, the lead bank is required to repurchase the remaining balance. The lead bank questioned our enforcement of the participation agreement. Therefore, the Corporation filed suit in Superior Court of New Jersey Chancery Division in Morris County, New Jersey, for the return of the outstanding principal and has reclassified the outstanding loan into other assets on its balance sheet.
Union Center has instituted a suit against Highlands State Bank (“Highlands”) in the Superior Court of New Jersey (Docket No. MRS-C-189-09). This litigation relates to a participating interest in a construction loan originated by Highlands. This loan was closed, and the participating interest (85%) was acquired, in 2007. Various causes of action are pleaded in this litigation by both parties, including claims for recovery of damages. The primary claim prosecuted by Union Center seeks a judicial determination that the Participation Agreement executed with Highlands was properly terminated in accordance with its terms on December 31, 2009 and that Highlands is obligated to return the unpaid balance of the loan funds advanced by Union Center during its participation in the loan. The primary claim presented by Highlands is that Union Center’s participation in the loan must continue until it is ultimately retired, which will probably result in a substantial loss that it is claimed must be shared by Union Center. This litigation is in its early stages. The initial pleadings have been filed and the discovery phase will now begin.
There are no other significant pending legal proceedings involving the Corporation other than those arising out of routine operations. Management does not anticipate that the ultimate liability, if any, arising out of such litigation will have a material effect on the financial condition or results of operations of the Corporation on a consolidated basis. Such statement constitutes a forward-looking statement under the Private
Securities Litigation Reform Act of 1995. Actual results could differ materially from this statement as a result of various factors, including the uncertainties arising in proving facts within the judicial process.
Item 3A. Executive Officers of the Registrant The following table sets forth the name and age of each executive officer of the Parent Corporation, the period during which each such person has served as an officer of the Parent Corporation or the Bank and each such person’s business experience (including all positions with the Parent Corporation and the Bank) for the past five years:
Item 4.
Item 4. Reserved PART II Item 5.
Item 5. Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities Security Market Information The common stock of the Parent Corporation is traded on the NASDAQ Global Select Market. The Corporation’s symbol is CNBC. As of December 31, 2009, the Corporation had 605 stockholders of record. This does not include beneficial owners for whom CEDE & Company or others act as nominees. On December 31, 2009, the closing low market bid and asked price were $8.92 and $9.07, respectively.
The following table sets forth the high and low bid price, and the dividends declared, on a share of the Corporation’s common stock for the years ended December 31, 2009 and 2008. All amounts are adjusted for prior stock splits and stock dividends.
Share Repurchase Program Historically, repurchases have been made from time to time as, in the opinion of management, market conditions warranted, in the open market or in privately negotiated transactions. Shares repurchased were used for stock dividends and other issuances. As of December 31, 2009, Center Bancorp had 14.6 million shares of common stock outstanding. As of December 31, 2009, the Parent Corporation had purchased 1,386,863 common shares at an average cost per share of $11.44 under stock buyback programs announced in 2006, 2007 and 2008. No repurchases were made during 2009. The repurchased shares were recorded as Treasury Stock, which resulted in a decrease in stockholders’ equity.
Information concerning the stock repurchases for the three months ended December 31, 2009 is set forth below.
As noted elsewhere herein, on January 9, 2009, as part of the U.S. Department of the Treasury’s Troubled Asset Relief Program (“TARP”), the Parent Corporation entered into an agreement with the U.S. Treasury (the “Stock Purchase Agreement”) pursuant to which (i) the Parent Corporation issued and sold, and the U.S. Treasury purchased, 10,000 shares (the “Preferred Shares”) of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share for an aggregate purchase price of $10 million in cash, and (ii) the Parent Corporation issued to the U.S. Treasury a ten-year warrant (the “Warrant”) to purchase up to 173,410 shares of the Parent Corporation’s common stock at an exercise price of $8.65 per share. As a result of the successful completion of the Rights Offering in October 2009, the number of shares underlying the warrant held by the U.S. Treasury was reduced to 86,705 shares or 50 percent of the original 173,410 shares. Until the third anniversary of the issuance of the Preferred Shares, the consent of the U.S. Treasury will be required for any increase in the dividends on the Parent Corporation’s common stock or for any stock repurchases unless the Preferred Shares have been redeemed in their entirety or the U.S. Treasury has transferred the Preferred Shares to third parties. See “Dividends” below for additional restrictions on the payment of dividends.
Dividends Federal laws and regulations contain restrictions on the ability of the Parent Corporation and Union Center National Bank to pay dividends. For information regarding restrictions on dividends, see Part I, Item 1, “Business - Dividend Limitations” and Part II, Item 8, “Financial Statements and Supplementary Data - Dividend Restrictions, Note 17 of the Notes to Consolidated Financial Statements.” Pursuant to the MOU between Union Center National Bank and the OCC, the Bank may not declare dividends without the prior approval of the OCC. In addition, under the terms of the trust preferred securities issued by Center Bancorp, Inc. Statutory Trust II, the Parent Corporation can not pay dividends on its common stock if the Corporation defers payments on the junior subordinated debentures which provide the cash flow for the payments on the trust preferred securities. Further, pursuant to the Stock Purchase Agreement, the Parent Corporation is unable to declare dividend payments on the Parent Corporation’s common stock (and certain preferred stock if the Parent Corporation issues additional series of preferred stock) if the Parent Corporation is in arrears in the payment of dividends on the Preferred Shares issued to the U.S. Treasury. Further, until the third anniversary of the U.S. Treasury’s investment or when all of the Preferred Shares have been redeemed or transferred, the Parent Corporation is not permitted to increase the amount of the quarterly cash dividend above $0.09 per share, which was the amount of the last regular dividend declared by the Parent Corporation prior to October 14, 2008.
Stockholders Return Comparison Set forth below is a line graph presentation comparing the cumulative stockholder return on the Parent Corporation’s common stock, on a dividend reinvested basis, against the cumulative total returns of the Standard & Poor’s Composite and the SNL Mid-Atlantic Bank Index for the period from January 1, 2005 through December 31, 2009.
COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG CENTER BANCORP INC.,
S&P COMPOSITE AND SNL MID-ATLANTIC BANK INDEX
Assumes $100 invested on January 1, 2005
Assumes dividends reinvested
Year ended December 31, 2009 COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE
COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS
Item 6.
Item 6. Selected Financial Data SUMMARY OF SELECTED STATISTICAL INFORMATION AND FINANCIAL DATA
Notes to Selected Financial Data
(1) All common share and per common share amounts have been adjusted for prior stock splits and stock dividends.
(2) Tangible book value per common share, which is a non-GAAP financial measure, is computed by dividing stockholders’ equity less preferred stock, goodwill and other intangible assets by common shares outstanding. The following table provides certain related reconciliations between Generally Accepted Accounting Principles (“GAAP”)measures (stockholders’ equity and book value per common share) and the related non-GAAP financial measures (tangible stockholders’ equity and tangible book value per common share):
All per common share amounts reflect all prior stock splits and dividends.
Return on average tangible stockholders’ equity, which is a non-GAAP financial measure, is computed by dividing net income by average stockholders’ equity less average goodwill and average other intangible assets. The following table reflects a reconciliation between average stockholders’ equity and average tangible stockholders’ equity and a reconciliation between return on stockholders’ equity and return on average tangible stockholders’ equity.
The Corporation believes that in comparing financial institutions, investors desire to analyze tangible stockholders’ equity rather than stockholders’ equity, as they discount the significance of goodwill and other intangible assets.
(3) The Corporation completed the acquisition of Red Oak Bank as of the close of business on May 20, 2005. The acquisition was accounted for as a purchase and the excess cost over the fair value of net assets acquired (“goodwill”) in the transaction was $14.7 million. The Corporation also recorded a core deposit intangible of $702,617 in connection with the acquisition.
Item 7.
Item 7. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Corporation’s results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.
Cautionary Statement Concerning Forward-Looking Statements See Item 1 of this Annual Report on Form 10-K for information regarding forward-looking statements.
Critical Accounting Policies and Estimates The accounting and reporting policies followed by the Corporation conform, in all material respects, to U.S. GAAP. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.
The Corporation’s accounting policies are fundamental to understanding this MD&A. The most significant accounting policies followed by the Corporation are presented in Note 1 of the Notes to Consolidated Financial Statements. The Corporation has identified its policies on the allowance for loan losses, other than temporary impairment of securities, income tax liabilities and goodwill and other identifiable intangible assets to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies can be found in Note 1 of the Notes to Consolidated Financial Statements.
Allowance for Loan Losses and Related Provision The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Corporation’s Consolidated Statements of Condition.
The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.
The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.
Other-Than-Temporary Impairment of Securities Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. FASB ASC 320-10-65 (previously FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Investments”), clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. Previously, this assessment required management to assert it has both the intent and the ability to hold a security for a period of time sufficient to allow for anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. This change does not affect the need to forecast recovery of the value of the security through either cash flows or market price.
In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, FASB ASC 320-10-65 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. Impairment charges on certain investment securities of approximately $4.2 million were recognized in earnings during the year ended December 31, 2009, respectively. Of this amount, $3.4 million related to charges taken on two pooled trust preferred securities owned by the Corporation, $188,000 related to three private label collateralized mortgage obligations, $140,000 on its Lehman bond holding and $113,000 on an equity holding. Additionally, the Corporation recorded a $364,000 charge related to a court order for the liquidation of the Reserve Primary Fund. It is expected that 99 percent of Fund assets will be returned to the Corporation. The Corporation’s approach to determining whether or not other-than-temporary impairment exists for any of these investments was consistent with the accounting guidance in effect at that time. For the year ended December 31, 2009, the Corporation primarily relied upon the guidance in FASB ASC 320-10-65 (previously FAS 115-2 and 124-2), FASB ASC 820-10-65 (previously FASB FAS 157-4) and FASB ASC 310-10-35 (previously FAS 114). Additional information can be found in Note 4 of the Notes to Consolidated Financial Statements.
Impairment charges on certain investment securities of approximately $1.8 million were recognized during the year ended December 31, 2008. As a result of the bankruptcy of Lehman Brothers in September 2008, the Corporation incurred an impairment charge of $1.2 million in its investment securities portfolio during the third quarter of 2008 and an additional $100,000 during the fourth quarter of 2008. These charges were based on the Corporation’s expectation at December 31, 2008 of what the Corporation believed it would receive from the Lehman bankruptcy proceedings as opposed to an attempted sale into an illiquid market. Additionally, the Corporation recorded impairment charges of $461,000 relating to three equity security holdings. This determination was made after certain events during 2008 relating to the financial condition of the issuers caused concern that recovery of the carrying value would not occur in the near term. As such, it was deemed appropriate to mark each applicable security down to fair value. The Corporation’s approach to determining whether or not other-than-temporary impairment exists for any of these investments was consistent with the accounting guidance in effect at that time. For the year ended December 31, 2008, the Corporation primarily relied upon the guidance in FASB ASC 320-10-35 (previously FSP FAS 115-1 and 124-1), FASB ASC 820-10-35 (previously FASB FAS 157-3) and FASB ASC 325-40 (previously EITF 99-20). No impairment charges were recognized during the year ended December 31, 2007.
Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Corporation’s consolidated financial statements or tax returns.
Fluctuations in the actual outcome of these future tax consequences could impact the Corporation’s consolidated financial condition or results of operations. Notes 1 and 11 of the Notes to Consolidated Financial Statements include additional discussion on the accounting for income taxes.
Goodwill The Corporation adopted the provisions of FASB ASC 350-10-05 (previously SFAS No. 142, “Goodwill and Other Intangible Assets”), which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but tested for impairment annually or more frequently if impairment indicators arise for impairment. No impairment charge was deemed necessary for the years ended December 31, 2009 and 2008.
Fair Value of Investment Securities In October 2008, the FASB issued FASB ASC 820-10-35 (previously FASB Staff Position 157-3, “Determining the Fair Value of a Financial Asset When The Market for That Asset Is Not Active”), to clarify the application of the provisions of FASB ASC 820-10-05 in an inactive market and how an entity would determine fair value in an inactive market. FASB ASC 820-10-35 was applied to the Corporation’s December 31, 2008 consolidated financial statements. Changes in the Corporation’s methodology occurred for the quarter ended June 30, 2009 as new accounting guidance was released in April of 2009 with mandatory adoption required in the second quarter. The Corporation relied upon the guidance in FASB ASC 820-10-65 (previously FASB FAS 157-4) when determining fair value for the Corporation’s pooled trust preferred securities and private issue corporate bond. See Note 18 of the Notes to Consolidated Financial Statements, Fair Value Measurements and Fair Value of Financial Instruments, for further discussion.
Introduction The following introduction to Management’s Discussion and Analysis highlights the principal factors that contributed to the Corporation’s earnings performance in 2009.
The year 2009 was a challenging one for the banking industry and for the Corporation. The current global financial crisis and difficult economic climate has created challenges to financial institutions both domestically and abroad. Interest rates in 2009 were reflective of significantly lower short-term interest rates in an effort to stimulate the economy. Competition for deposits in the Corporation’s marketplace remained intense while customers’ preference in seeking safety through full FDIC insured products and more liquidity became paramount in light of the financial crisis. Market conditions remained volatile during 2009, related to global instability in the markets in connection with the sub-prime crises. While we continue to see an improvement in balance sheet strength and core earnings performance, we are still concerned with the credit stability of the broader markets. As a result, the Federal Reserve kept overnight borrowing rates at zero to 25 basis points throughout the course of 2009. Short-term interest rates remained lower than longer term rates resulting in an improved steepening of the yield curve. This resulted in an expansion of the Corporation’s net interest income, which is the Corporation’s primary source of income. The Corporation also took action throughout the year to reduce further exposure to interest rates through a reduction in higher cost funding and non-core balances in the deposit mix and improvement in the earning asset mix. The Corporation’s continued progress in growing and improving its balance sheet earning asset mix has helped to expand its spread and margin. We intend to continue to use a portion of the proceeds of maturing investments to help fund new loan growth.
The Corporation’s net income in 2009 was $4.6 million or $0.30 per fully diluted common share, compared with net income of $5.8 million or $0.45 per fully diluted common share in 2008. A substantial portion of our earnings in 2009 and 2008 was from core operations.
Earnings for 2009 were positively impacted by net interest income and spread expansion through both balance sheet improvements and a lower cost of funds as well as net securities gains as compared to net securities losses in 2008. These improvements were more than offset by higher loan loss provisions as well as substantially higher FDIC insurance, higher other real estate owned expenses and higher pension expense. Other expense for the twelve-months ended December 31, 2009 totaled $23.1 million, an increase of $3.6 million, or 18.4 percent, from the twelve-months ended December 31, 2008 due principally to the above mentioned items.
Higher operating expenses during the twelve month period resulted primarily from increases in salaries and employee benefits, FDIC insurance and OREO expense, offset in part by a decrease in net occupancy expenses, premises and equipment and marketing expenses. The Corporation previously announced a strategic outsourcing agreement with Fiserv to provide core account processing services, which is consistent with the Corporation’s other strategic initiatives to streamline operations, reduce operating overhead and allow the Corporation to focus on core competencies of customer service and product development. This coupled with previously initiated cost reduction plans are intended to improve operating efficiencies, business and technical operations. The core processing transition was consummated during the fourth quarter of 2009. Additionally, the consolidation of the Corporation’s branch office on 392 Springfield Avenue in Summit, New Jersey during the first quarter of 2009 into its new office on 545 Morris Avenue in Summit, New Jersey resulted in improved efficiency and increased customer service.
For the twelve months ended December 31, 2009, total salaries and benefits increased by $1.4 million, or 16.6 percent to $9.9 million. The increase in expense was primarily due to a $755,000 benefit recognized in 2008 relating to the termination of two benefit plans coupled with increased pension expense in 2009 due to both lower asset valuations and the expected rate of return on the Corporation’s defined pension plan, which was frozen back in 2007.
The increased tax rate resulted in part from changes in the Corporation’s business entity structure during 2007 and into 2008 coupled with a higher proportion of taxable income versus tax-exempt income in 2009.
Total non-interest income increased as a percentage of total revenue, which is the sum of interest income and non-interest income, in 2009 largely due to $491,000 in net securities gains as compared to $1.1 million in net securities losses in 2008. For the twelve months ended December 31, 2009, total other income increased $1.3 million as compared with the twelve months ended December 31, 2008, from $2.6 million to $3.9 million. Excluding net securities gains and losses in the respective periods, the Corporation recorded total other income of $3.4 million in the twelve months ended December 31, 2009, compared to $3.8 million in the twelve months ended December 31, 2008, representing a decrease of $335,000 or 8.9 percent. This decrease was primarily attributable to a $180,000 decrease in service charges, commissions and fees as well as lower other income, resulting primarily from lower letters of credit fee income and title insurance income.
Total assets at December 31, 2009 were $1.197 billion, an increase of 17.0 percent from assets of $1.023 billion at December 31, 2008. The increase in assets reflects the growth in our loan and investment securities portfolios as well as a higher level of uninvested excess cash, which reflects inflows in core savings deposits and Certificates of Deposit Account Registry Service (CDARS) Reciprocal deposits, as customers desire for safety and liquidity became paramount in light of the financial crisis. The Corporation has made a concerted effort to reduce non-core balances and, accordingly, its uninvested cash position was reduced by an average of $35 million during the fourth quarter of 2009. Additionally, there has been a concerted effort to reduce higher costing retail deposits.
Loan growth remained strong in 2009, spurred by business development efforts. Overall, the portfolio grew year over year by approximately $70.0 million on average or an 11.2 percent increase from 2008. Strong demand for commercial real estate loans prevailed throughout the year in the Corporation’s market in New Jersey, despite the economic climate at both the state and national levels and market turmoil from the sub-prime markets. The Corporation is encouraged by the strength of loan demand and positive momentum gained this past year in growing that segment of earning assets. However, the Corporation continues to remain concerned with the credit stability of the broader markets due to the weakened economic climate.
Asset quality continues to remain high and credit culture conservative. Even so, the stability of the economy and credit markets remains uncertain and as such, has had an impact on certain credits within our portfolio. The Corporation continued to make provisions to the allowance for loan losses as efforts are made to stabilize credit quality issues. At December 31, 2009, non-performing assets totaled $8.1 million or 0.68 percent of total assets, as compared with $13.9 million, or 1.03 percent, at September 30, 2009 and $4.7 million or 0.46 percent at December 31, 2008. The increase in non-performing loans from December 31, 2008 was primarily attributable to the addition of three large commercial loans and an increase in troubled debt restructurings. In March of 2009, one commercial real estate construction project of industrial warehouses was downgraded to non-accrual status, which was a participation loan with another New Jersey bank. In December of 2009, the Corporation took steps to terminate this participation agreement, as the participation ended on December 31, 2009. The Corporation has filed for the return of the outstanding principal and has reclassified this $5.1 million outstanding loan into other assets on the Corporation’s balance sheet. Other Real Estate Owned (OREO) decreased by $3.9 million due solely to the sale of a residential condominium construction project in Union County, New Jersey during the third quarter of 2009.
At December 31, 2009, the total allowance for loan losses amounted to approximately $8.3 million, or 1.16 percent of total loans. The allowance for loan losses as a percent of total non-performing loans amounted to 102.2 percent at December 31, 2009 as compared with 51.4 percent at September 30, 2009 and 809.1 percent at December 31, 2008. This decrease in the ratio from December 31, 2008 to December 31, 2009 was due to the previously mentioned increase in non-performing loans.
Deposit growth was strong in 2009, reflective of customers’ desire for safety and liquidity and flight to quality in light of the financial crisis. At December 31, 2009, total deposits for the Corporation were $813.7 million. Non-interest-bearing core deposits, a low cost source of funding, continue to be a key funding source. At December 31, 2009, this source of funding amounted to $130.5 million or 12.0 percent of total funding sources and 16.0 percent of total deposits.
Certificates of deposit $100,000 and greater increased to 17.8 percent of total deposits at December 31, 2009 from 15.2 percent one year earlier. With the current turmoil in the financial markets, some of the Corporation’s depositors have become sensitive to obtaining full FDIC insurance for their time deposits. To accommodate its customers, the Corporation began offering Certificates of Deposit Account Registry Service (CDARS) in 2008. As a result of that offering and the temporary increase in insurance coverage by the FDIC to $250,000, the Corporation reported an increase of $44.3 million in certificates of deposit greater than $100,000 at December 31, 2009 as compared to year-end 2008.
Total stockholders’ equity increased 25.5 percent from 2008 to $102.6 million, and represented 8.57 percent of total assets at year-end. Book value per common share (total common stockholders’ equity divided by the number of shares outstanding) increased to $6.38 as compared with $6.29 a year ago, primarily as a result of the $11 million capital raise from the Corporation’s rights offering consummated in October 2009. Tangible book value per common share (which excludes goodwill and other intangibles from common stockholders’ equity) increased to $5.21 from $4.97 a year ago; see Item 6 of this Annual Report on Form 10-K for a reconciliation of tangible book value (which is a non-GAAP financial measure) to book value. Return on average stockholders’ equity for the year ended December 31, 2009 was 4.87 percent compared to 7.03 percent for 2008. This decrease was attributable to lower earnings in 2009 compared with 2008 coupled with higher average equity due primarily to both the capital raise from the rights offering and capital received under the U.S. Treasury Capital Purchase Program. The Tier I Leverage capital ratio increased to 7.80 percent of total assets at December 31, 2009, as compared with 7.71 percent at December 31, 2008.
The Corporation’s capital base includes the $11 million capital raise from the rights offering as well as the $10 million of capital received from the U.S. Treasury under the Capital Purchase Program. It also includes $5.2 million in subordinated debentures at December 31, 2009 and December 31, 2008. This issuance of $5.0 million in floating rate MMCapS(SM) Securities occurred on December 19, 2003. These securities presently are included as a component of Tier I capital for regulatory capital purposes. In accordance with FASB Interpretation No. 46, these securities are classified as subordinated debentures on the Consolidated Statements of Condition.
The Corporation’s risk-based capital ratios at December 31, 2009 were 11.51 percent for Tier I capital and 12.46 percent for total risk-based capital. Total Tier I capital increased to approximately $99.3 million at December 31, 2009 from $78.2 million at December 31, 2008. The increase in Tier I capital primarily reflects the new capital received during 2009.
The Corporation announced an increase in its common stock buyback program on September 28, 2007 and June 26, 2008, under which the Parent Corporation was authorized to purchase up to 2,039,731 shares of Center Bancorp’s outstanding common stock. As of December 31, 2009, the Corporation had repurchased 1,386,863 shares under the program at an average cost of $11.44 per share. Repurchases are now restricted pursuant to the Parent Corporation’s participation in TARP and as such, there were no repurchases during 2009. See Item 5 of this Annual Report on Form 10K.
The following sections discuss the Corporation’s Results of Operations, Asset and Liability Management, Liquidity and Capital Resources.
Results of Operations Net income for the year ended December 31, 2009 was $4,573,000 as compared to $5,842,000 earned in 2008 and $3,856,000 earned in 2007, a decrease of 21.7 percent from 2008 to 2009. Basic and fully diluted earnings per common share was $0.30 per share in 2009 as compared with $0.45 per share in 2008 and $0.28 per share in 2007. All common share and per share information for all periods presented have been retroactively restated for common stock splits and common stock dividends distributed to common stockholders during the periods presented.
For the year ended December 31, 2009, the Corporation’s return on average stockholders’ equity (“ROE”) was 4.87 percent and its return on average assets (“ROA”) was 0.37 percent. The Corporation’s return on average tangible stockholders’ equity (“ROATE”) was 5.96 percent for 2009. The comparable ratios for the year ended December 31, 2008, were ROE of 7.03 percent, ROA of 0.58 percent, and ROATE of 8.86 percent. See the discussion and reconciliation of ROATE, which is a non-GAAP financial measure, under Item 6 of this Annual Report on Form 10-K.
Earnings for 2009 were negatively impacted by an increase in other expense, due primarily to a higher provision for loan losses coupled with increases in FDIC insurance, pension and OREO expense, offset in part by an improvement in net interest income, due primarily to a lower cost of funds, and higher other income, due to net securities gains in 2009 as compared to losses in 2008.
Net Interest Income The following table presents the components of net interest income on a tax-equivalent basis for the past three years.
Note: The tax-equivalent adjustment was computed based on an assumed statutory Federal income tax rate of 34 percent. Adjustments were made for interest earned on tax-advantaged instruments.
Historically, the most significant component of the Corporation’s earnings has been net interest income, which is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. There were several factors that affected net interest income during 2009, including the volume, pricing, mix and maturity of interest-earning assets and interest-bearing liabilities and interest rate fluctuations.
Net interest income is directly affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, which support those assets, as well as changes in the rates earned and paid. Net interest income is presented in this financial review on a tax equivalent basis by adjusting tax-exempt income (primarily interest earned on various obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues, and then in accordance with the Corporation’s consolidated financial statements. Accordingly, the net interest income data presented in this financial review differ from the Corporation’s net interest income components of the Consolidated Financial Statements presented elsewhere in this report.
Net interest income, on a fully tax-equivalent basis, for the year ended December 31, 2009 increased $1.9 million, or 6.8 percent, to $29.0 million, from $27.1 million for 2008. The Corporation’s net interest margin decreased 11 basis points to 2.85 percent from 2.96 percent. From 2007 to 2008, net interest income on a tax equivalent basis increased by $3.8 million and the net interest margin increased by 44 basis points. Our net interest margin has been adversely impacted by the high level of uninvested cash, which accumulated due to the strong deposit growth experienced throughout 2009.
The change in net interest income from 2008 to 2009 was attributable in part to the reduction in short-term interest rates that occurred in 2008 and have remained at historic low levels throughout 2009 coupled with a sustained steepening of the interest rate yield curve. Steps were taken during 2009 to improve the Corporation’s net interest margin by continuing to lower rates in concert with the decline in market benchmark rates. However, in light of the financial crisis, the Corporation experienced significant growth during 2009 in core savings deposits and CDARS Reciprocal deposits, as customers’ desire for safety and liquidity became paramount in light of the investment concerns. During the fourth quarter of 2009, a concerted effort was made to reduce non-core, single service deposits, and accordingly its uninvested cash position, which had an adverse impact on the Corporation’s net interest margin during 2009. However, during the twelve months ended December 31, 2009, the Corporation’s net interest spread improved by 21 basis points as a 52 basis point decrease in the average yield on interest-earning assets was more than offset by a 73 basis point decrease in the average interest rates paid on interest-bearing liabilities.
For the year ended December 31, 2009, average interest-earning assets increased by $102.4 million to $1.018 billion, as compared with the year ended December 31, 2008. The 2009 change in average interest-earning asset volume was primarily due to increased loan and investment volume, which is consistent with the balance sheet strategies of changing and improving the mix of average earning assets. Increased average loan volume in 2009 was funded primarily by deposit growth. Average interest-bearing liabilities increased by $193.9 million, due primarily to increases in core savings deposits and CDARS Reciprocal deposits.
For the year ended December 31, 2008, average interest-earning assets decreased by $8.8 million to $915.8 million, as compared with the year ended December 31, 2007. The 2008 change in average interest-earning asset volume was primarily due to decreased volumes of investment securities and lower short-term investments offset in part by increased loan volume.
The factors underlying the year-to-year changes in net interest income are reflected in the tables presented on pages 36 and 38, each of which have been presented on a tax-equivalent basis (assuming a 34 percent tax rate). The table on page 38 (Average Statements of Condition with Interest and Average Rates) shows the Corporation’s consolidated average balance of assets, liabilities and stockholders’ equity, the amount of income produced from interest-earning assets and the amount of expense incurred from interest-bearing liabilities, and net interest income as a percentage of average interest-earning assets.
Net Interest Margin The following table quantifies the impact on net interest income (on a tax-equivalent basis) resulting from changes in average balances and average rates over the past three years. Any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category.
Analysis of Variance in Net Interest Income Due to Volume and Rates
Interest income on a fully tax-equivalent basis for the year ended December 31, 2009 increased by approximately $398,000 or 0.8 percent as compared with the year ended December 31, 2008. This increase was due primarily to an increase in balances of the Corporation’s loan and investment securities portfolios offset in part by a decline in rates due to the actions taken by the Federal Reserve to lower market interest rates. The Corporation’s loan portfolio increased on average $70.1 million to $692.6 million from $622.5 million in 2008, primarily driven by growth in commercial loans and commercial real estate.
The loan portfolio represented approximately 68.0 percent of the Corporation’s interest-earning assets (on average) during both 2009 and 2008. Average investment securities increased during 2009 by $36.0 million compared to 2008 as the Corporation has continued to reduce its concentration in tax-exempt securities and focused on purchases of lower risk-based mortgage backed securities. The average yield on interest-earning assets decreased from 5.59 percent in 2008 to 5.07 percent in 2009. The volume of Federal Funds sold and securities purchased under agreement to resell decreased by $4.0 million on average as compared with 2008.
The increase in the volume of loans in 2009 primarily reflected increases in commercial and commercial real estate loans. The increase in the average volume on total interest-earning assets created an increase in interest income of $4.9 million, as compared with a decline of $4.5 million attributable to rate decreases in most interest-earning assets.
Interest income (fully tax-equivalent) decreased by $2.7 million from 2007 to 2008 primarily due to a decline in yield offset in part by an increase in loan volume. The decrease in average yield on total interest-earning assets created a $3.0 million reduction to interest income as compared with a contribution of $0.2 million attributable to volume increases, principally loans.
The Federal Open Market Committee (“FOMC”) kept the Federal Funds target rate at zero to 0.25 percent throughout 2009. This action by the FOMC allowed the Corporation to reduce liability costs throughout 2009.
Interest expense for the year ended December 31, 2009 was principally impacted by rate related factors. The rate related changes reflected decreased expense on most interest-bearing deposits and borrowings in 2009 coupled with a decline in average volume of money market deposits and borrowings during 2009. For the year ended December 31, 2009, interest expense decreased $1.5 million or 6.0 percent as compared with 2008. During 2009, the Corporation continued to lower rates in concert with the decline in market benchmark rates. The result was an improvement in the Corporation’s cost of funds and net interest spread. Average interest-bearing liabilities increased $193.9 million, primarily in CDARS Reciprocal deposits, our Max Plus savings product and in borrowings.
For the year ended December 31, 2008, interest expense decreased $6.5 million or 21.3 percent as compared with 2007. Total interest-bearing liabilities increased on average $15.4 million, primarily in money market deposits and in borrowings.
The Corporation’s net interest spread on a tax-equivalent basis (i.e., the average yield on average interest-earning assets, calculated on a tax equivalent basis, minus the average rate paid on interest-bearing liabilities) increased 21 basis points to 2.79 percent in 2009 from 2.58 percent for the year ended December 31, 2008. The increase in 2009 reflected an expansion of spreads between yields earned on loans and investments and rates paid for supporting funds. During 2009, spreads improved due in part to monetary policy maintained by the FOMC keeping the Federal funds rate at zero to 0.25 percent throughout 2009 coupled with a steepening of the yield curve that occurred during 2009.
The net interest spread increased 66 basis points in 2008 as compared with 2007, primarily as a result of an expansion of spreads between yields earned on loans and investments and rates paid for supporting funds. During 2008, spreads improved due in part to the monetary policy promulgated by the FOMC decreasing the target Federal funds rate 400 basis points from 4.25 percent at December 31, 2007 to 0.25 percent at December 31, 2008 coupled with a steepening of the yield curve during 2008.
The cost of total average interest-bearing liabilities decreased to 2.28 percent, a decrease of 73 basis points, for the year ended December 31, 2009, from 3.01 percent for the year ended December 31, 2008, which followed a decrease of 90 basis points from 3.91 percent for the year ended December 31, 2007.
The contribution of non-interest-bearing sources (i.e., the differential between the average rate paid on all sources of funds and the average rate paid on interest-bearing sources) decreased to 26 basis points, a decrease of 11 basis points from 2008 to 2009. Comparing 2008 and 2007, there was a decrease of 18 basis points to 37 basis points on average from 55 basis points on average during the year ended December 31, 2007.
The following table, “Average Statements of Condition with Interest and Average Rates”, presents for the years ended December 31, 2009, 2008 and 2007, the Corporation’s average assets, liabilities and stockholders’ equity. The Corporation’s net interest income, net interest spreads and net interest income as a percentage of interest-earning assets (net interest margin) are also reflected.
AVERAGE STATEMENTS OF CONDITION WITH INTEREST AND AVERAGE RATES
(1) Average balances for available-for-sale securities are based on amortized cost.
(2) Average balances for loans include loans on non-accrual status.
(3) The tax-equivalent adjustment was computed based on a statutory Federal income tax rate of 34 percent.
Investment Portfolio For the year ended December 31, 2009, the average volume of investment securities increased by $36.0 million to approximately $315.1 million or 30.9 percent of average earning assets, from $279.1 million on average, or 30.5 percent of average earning assets, in the comparable period in 2008. At December 31, 2009, the total investment portfolio amounted to $298.1 million, an increase of $55.4 million from December 31, 2008. The increase in the average volume of investment securities continues to maintain pace with the rise in the overall level of earning assets. With the strong deposit growth experienced during 2009 and large buildup of liquidity, the Corporation began to prudently expand the size of its investment portfolio in an effort to deploy excess cash into earning assets. At December 31, 2009, the principal components of the investment portfolio are U.S. Treasury and U.S. Government Agency Obligations, Federal Agency Obligations including mortgage-backed securities, Obligations of U.S. states and political subdivision, corporate bonds and notes, and other debt and equity securities.
The Corporation’s investment portfolio also consists of overnight investments that were made in the Reserve Primary Fund (the “Fund”), a money market fund registered with the Securities and Exchange Commission as an investment company under the Investment Company Act of 1940. On September 22, 2008, the Fund announced that redemptions of shares of the Fund were suspended pursuant to an SEC order so that an orderly liquidation could be effected for the protection of the Fund’s investors. Through December 31, 2009, the Corporation received five distributions from the Fund, totaling approximately 92 percent of its outstanding balance, leaving a remaining outstanding balance in the Fund of $2.943 million. On January 29, 2010, as part of the court ordered liquidation of the Fund, the Corporation received a sixth distribution or $2.446 million, bringing total distributions to date to approximately 99 percent. During the fourth quarter of 2009, the Corporation recorded a $364,000, or approximately 1 percent, other-than-temporary impairment charge to earnings relating to this court ordered liquidation of the Fund. The Corporation’s outstanding carrying balance in the Fund as of January 31, 2010 totaled $133,000.
The volume related factors during the twelve month period ended December 31, 2009 increased investment revenue by $1.1 million, while rate related changes resulted in a decrease in revenue of $1.3 million from December 31, 2008. The tax-equivalent yield on investments decreased by 65 basis points to 4.51 percent from a yield of 5.16 percent during the year ended December 31, 2008. The reductions in the investment portfolio, primarily in the tax-exempt sector, were made to reduce exposure to these particular sectors of the portfolio while continuing to provide cash flow for loan funding and forecasted liability outflows. The yield on the portfolio declined compared to 2008 due primarily to sales as well as the impact that the lower interest rate environment had on higher yielding securities that had either matured, were prepaid, or were called. Improvement in yield has been limited by reinvesting opportunities. Cash flow from the securities was subsequently used primarily to help fund loan growth.
During the first quarter of 2009, the Corporation recorded a $140,000 other-than-temporary impairment charge on its Lehman Brothers bond holding. Through June 30, 2009, other-than-temporary impairment charges taken on this bond amounted to $1,440,000. As part of the Corporation’s tax strategies, management elected to sell the Lehman bond holding during the third quarter of 2009.
The Corporation owns two pooled trust preferred securities (“Pooled TRUPS”), which consists of securities issued by financial institutions and insurance companies and the Corporation holds the mezzanine tranche of such securities. Senior tranches generally are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches, with senior tranches having the greatest protection and mezzanine tranches subordinated to the senior tranches. One of the Pooled TRUPS has incurred its third interruption of cash flow payments to date. Management reviewed the expected cash flow analysis and credit support to determine if it was probable that all principal and interest would be repaid, and recorded a $1.1 million other-than-temporary impairment charge for the three months ended December 31, 2009 and $2.5 million for the twelve months ended December 31, 2009, which represents 78.7 percent of the par amount of $3.1 million. The new cost basis for this security has been written down to $665,000. The other Pooled TRUP incurred its first interruption of cash flow payments in the fourth quarter of 2009. Management determined that an other-than-temporary impairment exists on this security as well and recorded a $1.0 million charge during the fourth quarter of 2009, which represents 32.3 percent of the par amount of $3.0 million. The new cost basis for this security has been written down to $2.0 million.
The Corporation owns three variable rate private label collateralized mortgage obligations (CMOs), which were also evaluated for impairment. Management had applied aggressive default rates to identify if any credit impairment exists, as these bonds were downgraded to below investment grade. These bonds are currently paying with no interruption of cash flow. As such, management determined that an other-than-temporary impairment charge exists and recorded a $188,000 writedown to the bonds, which represents 3.4 percent of the par amount of $5.6 million. The new cost basis for these securities has been written down to $5.4 million.
During 2009, the Corporation recorded $113,000 of other-than-temporary impairment charges relating to one equity holding in bank stocks. Due to the deterioration in that bank’s financial condition and that near term prospects in market value recovery appear remote, management determined that the expectation to recover its cost is not temporary. As such, this equity was written down to fair market value at the time of evaluation, which was December 31, 2009.
Securities available-for-sale are a part of the Corporation’s interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity management and other factors. The Corporation continues to reposition the investment portfolio as part of an overall corporate-wide strategy to produce reasonable and consistent margins where feasible, while attempting to limit risks inherent in the Corporation’s balance sheet.
At December 31, 2009, the net unrealized loss carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to a net unrealized loss of $8.4 million as compared with a net unrealized loss of $6.5 million at December 31, 2008, resulting from changes in market conditions and interest rates at period-end December 31, 2009. As a result of the inactive condition of the markets amidst the financial crisis, the Corporation elected to treat certain securities under a permissible alternate valuation approach at December 31, 2009 and 2008. For additional information regarding the Corporation’s investment portfolio, see Note 4 and Note 18 of the Notes to the Consolidated Financial Statements.
The following table illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for investment securities at December 31, 2009, on a contractual maturity basis.
For information regarding the carrying value of the investment portfolio, see Note 4 and Note 18 of the Notes to the Consolidated Financial Statements.
The securities listed in the table above are either rated investment grade by Moody’s and/or Standard and Poor’s or have shadow credit ratings from a credit agency supporting investment grade and conform to the Corporation’s investment policy guidelines. There were no municipal securities of any single issuer exceeding 10 percent of stockholders’ equity at the end of 2009.
Equity securities included in other debt and equity securities do not have a contractual maturity and are included in the Due after ten years maturity in the table above.
The following table sets forth the carrying value of the Corporation’s investment securities, as of December 31 for each of the last three years.
For other information regarding the Corporation’s investment securities portfolio, see Note 4 and Note 18 of the Notes to the Consolidated Financial Statements.
Loan Portfolio Lending is one of the Corporation’s primary business activities. The Corporation’s loan portfolio consists of both retail and commercial loans, serving the diverse customer base in its market area. The composition of the Corporation’s loan portfolio continues to change due to the local economy. Factors such as the economic climate, interest rates, real estate values and employment all contribute to these changes. Loan growth has been generated through business development efforts via repeat customer business and new borrower requests.
At December 31, 2009, total loans amounted to $715.5 million, an increase of 5.8 percent or $39.3 million as compared to December 31, 2008. The $0.6 million or 1.8 percent increase in interest income on loans for the twelve months ended December 31, 2009 was the result of the increase in volume during 2009, offset in part by a lower interest rate environment as compared with 2008. Even though the Corporation continues to be challenged with heightened competition for lending relationships that exists within its market, strong growth has been achieved through successful lending sales efforts to build on continued customer relationships while striving to maintain asset quality and underwriting standards. The FOMC decreased the target Federal Funds rate seven times during 2008 to zero to 0.25 percent and the target rate has remained at this level throughout 2009.
Total average loan volume increased $70.1 million or 11.2 percent in 2009, while the portfolio yield decreased by 49 basis points compared with 2008. The increased total average loan volume was due primarily to increased repeat customer activity and new lending relationships. The volume related factors during the period contributed increased revenue of $3.9 million, while the rate related changes decreased revenue by $3.2 million. Total average loan volume increased to $692.6 million with a net interest yield of 5.31 percent, compared to $622.5 million with a yield of 5.80 percent for the year ended December 31, 2008. The Corporation seeks to create growth in commercial lending by offering products and competitive pricing and by capitalizing on new and existing relationships in its market area. Products are offered to meet the financial requirements of the Corporation’s clients. It is the objective of the Corporation’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry.
The following table presents information regarding the components of the Corporation’s loan portfolio on the dates indicated.
Included in the loan balances above are net deferred loan costs of $391,000, $572,000 and $579,000 at December 31, 2009, 2008 and 2007, respectively.
Over the past five years, demand for the Bank’s commercial and commercial real estate loan products has increased.
The increase in commercial loans in 2009 was a result of the expansion of the Corporation’s customer base, aggressive business development and marketing programs coupled with positive market trends for the Corporation. While certain sectors of the markets, such as consumer real estate products, lagged as market conditions changed during most of 2008, the Corporation experienced an increase in its lending sales efforts during 2009 as it continued to benefit from the Corporation’s primary core customer base.
Average commercial loans, which include commercial real estate and construction, increased to $476.1 million or by approximately $110.6 million or 30.1 percent in 2009 compared with 2008. The Corporation seeks to create growth in the commercial lending sector by offering competitive products and pricing and by capitalizing on new relationships in its market area. Over the last several years, the expansion of the Bank’s marketplace has aided in this growth. Products are offered to meet the financial requirements of the Corporation’s clients. It is an objective of the Corporation’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry.
The Corporation’s commercial loan portfolio includes, in addition to real estate development, loans to manufacturing, automobile, professional and retail trade sectors, and to specialized borrowers, such as operators of private educational facilities, for example. A large proportion of the Corporation’s commercial loans have interest rates which reprice with changes in short-term market interest rates or mature in one year or less.
Average commercial real estate loans, which amounted to $269.3 million in 2009, increased $58.0 million or 27.5 percent as compared with average commercial real estate loans of $211.3 million in 2008 (which reflected a 54.5 percent increase over 2007). The Corporation’s long-term mortgage portfolio includes both residential and commercial financing. Growth during the past two years largely reflected brisk activity in new lending activity and mortgage financing. The interest rates on a portion of the Corporation’s commercial mortgages adjust to changes in indices such as the 5 and 10-year Treasury Notes, and the Federal Home Loan Bank of New York 5 and 10-year advance rate. Interest rate changes usually occur at each five-year anniversary of the loan.
The average volume of residential mortgage loans, including home equity loans, in 2009 declined $39.8 million or 15.6 percent as compared to 2008. During 2009, residential loan growth was affected by the slowdown in the housing market, brisk refinancing activity into fixed rate loans due principally to the current historic low rate environment and competition among lenders. Fixed rate residential and home equity loans have recently become a popular choice among homeowners, either through refinancing or new loans, as consumers wish to lock in historically low fixed rates.
Average construction loans and other temporary mortgage financing increased from 2008 to 2009 by $1.4 million to $49.4 million. The average volume of such loans decreased by $6.3 million from 2007 to 2008. The change in construction and other temporary mortgage lending in 2009 was generated by a slowdown in market activity of the Corporation’s customers, several of whom engage in residential and commercial development throughout New Jersey. Interest rates on such mortgages are generally tied to key short-term market interest rates. Funds are typically advanced to the builder or developer during various stages of construction and upon completion of the project. It is contemplated that the loans will be repaid by cash flows derived from sales within the project or, where appropriate, conversion to permanent financing.
Loans to individuals include personal loans, student loans, and home improvement loans, as well as financing for automobiles and other vehicles. Such loans averaged $773,000 in 2009, compared with $973,000 in 2008 and $881,000 million in 2007. The decrease in loans to individuals during 2009 was due in part to decreases in volumes of new personal loans (single-pay).
Home equity loans, inclusive of home equity lines, as well as traditional secondary mortgage loans, have become popular with consumers due to their tax advantages over other forms of consumer borrowing. Home equity loans and secondary mortgages averaged $82.2 million in 2009, a decrease of $27.4 million or 25.0 percent compared to an average of $109.6 million in 2008 and $111.4 million in 2007. Interest rates on floating rate home equity lines are generally tied to the prime rate while most other loans to individuals, including fixed rate home equity loans, are medium-term (ranging between one-to-ten years) and carry fixed interest rates. The decrease in home equity loans outstanding during 2009 was due in part to the recent slowdown in the housing market and lower consumer spending. Additionally, floating rate home equity lines and close-end fixed rate home equity loans became less attractive during 2009 as consumers took advantage of historically low interest rates or opted to take advantage of converting these loan balances into fixed rate loan products.
At December 31, 2009, the Corporation had total loan commitments outstanding of $167.5 million, of which approximately 63.7 percent were for commercial loans, commercial real estate loans and construction loans.
The maturities of loans at December 31, 2009 are listed below.
For additional information regarding loans, see Note 5 of the Notes to the Consolidated Financial Statements.
Allowance for Loan Losses and Related Provision The purpose of the allowance for loan losses (“allowance”) is to absorb the impact of probable losses inherent in the loan portfolio. Additions to the allowance are made through provisions charged against current operations and through recoveries made on loans previously charged-off. The allowance for loan losses is maintained at an amount considered adequate by management to provide for potential credit losses based upon a periodic evaluation of the risk characteristics of the loan portfolio. In establishing an appropriate allowance, an assessment of the individual borrowers, a determination of the value of the underlying collateral, a review of historical loss experience and an analysis of the levels and trends of loan categories, delinquencies and problem loans are considered. Such factors as the level and trend of interest rates, current economic conditions and peer group statistics are also reviewed. At year-end 2009, the level of the allowance was $8,275,000 as compared to a level of $6,254,000 at December 31, 2008. The Corporation made loan loss provisions of $3,261,000 in 2009 compared with $1,561,000 in 2008 and $350,000 in 2007. The level of the allowance during the respective annual periods of 2009 and 2008 reflects the change in average volume, credit quality within the loan portfolio, the level of charge-offs, loan volume recorded during the periods and the Corporation’s focus on the changing composition of the commercial and residential real estate loan portfolios.
At December 31, 2009, the allowance for loan losses amounted to 1.16 percent of total loans. In management’s view, the level of the allowance at December 31, 2009 is adequate to cover losses inherent in the loan portfolio. Management’s judgment regarding the adequacy of the allowance constitutes a “Forward Looking Statement” under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from management’s analysis, based principally upon the factors considered by management in establishing the allowance.
Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to increase the allowance based on their analysis of information available to them at the time of their examination. Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey. Future adjustments to the allowance may be necessary due to economic factors impacting New Jersey real estate and further deterioration of the economic climate as
well as operating, regulatory and other conditions beyond the Corporation’s control. The allowance for loan losses as a percentage of total loans amounted to 1.16 percent, 0.92 percent and 0.94 percent at December 31, 2009, 2008 and 2007, respectively.
Net charge-offs were $1,240,000 in 2009, $470,000 in 2008 and $147,000 in 2007. During 2009, the Corporation experienced an increase in charge-offs compared to 2008, principally related to charge-offs taken on four commercial and commercial real estate credits during the fourth quarter of 2009 totaling $1.1 million, coupled with a $900,000 charge-off in connection with a $5.1 million commercial real estate construction project of industrial warehouses, which was placed in non-accrual status during the first quarter of 2009. As previously disclosed, during the fourth quarter of 2009, the Corporation took steps to terminate a participation agreement with another New Jersey bank, as the participation ended on December 31, 2009. The other bank objected to the Corporation’s interpretation of the agreement and subsequent actions. Accordingly, the Corporation filed suit for the return of the outstanding principal and reclassified the outstanding loan into other assets on its balance sheet. As such, a $900,000 recovery was recorded during the fourth quarter of 2009 associated with this termination of the participation agreement.
Five-Year Statistical Allowance for Loan Losses The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs (recoveries) for the past five years.
Implicit in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made, the creditworthiness of the borrower and prevailing economic conditions. The allowance for loan losses has been allocated in the table below according to the estimated amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at December 31, for each of the past five years.
The table below shows, for three types of loans, the amounts of the allowance allocable to such loans and the percentage of such loans to total loans.
Asset Quality The Corporation manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and mix. The Corporation strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values, and to maintain an adequate allowance for loan losses at all times. These practices have protected the Corporation during economic downturns and periods of uncertainty.
It is generally the Corporation’s policy to discontinue interest accruals once a loan is past due as to interest or principal payments for a period of ninety days. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and a satisfactory period of ongoing repayment exists. Accruing loans past due 90 days or more are generally well secured and in the process of collection.
Non-Performing and Past Due Loans and OREO Non-performing loans include non-accrual loans, accruing loans which are contractually past due 90 days or more and troubled debt restructurings. Non-accrual loans represent loans on which interest accruals have been suspended. It is the Corporation’s general policy to consider the charge-off of loans when they become contractually past due ninety days or more as to interest or principal payments or when other internal or external factors indicate that collection of principal or interest is doubtful. Troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate which is lower than the current market rate for new debt with similar risks.
The following table sets forth, as of the dates indicated, the amount of the Corporation’s non-accrual loans, accruing loans past due 90 days or more, troubled debt restructurings and other real estate owned (“OREO”).
The increase in non-accrual loans of $6.6 million in 2009 from 2008 was primarily attributable to the addition of three large commercial credits. In March of 2009, one commercial real estate construction project of industrial warehouses was downgraded to non-accrual status. The loan was a participation loan with another New Jersey bank. In December of 2009, the Corporation took steps to terminate this participation agreement, as the participation ended on December 31, 2009. The Corporation filed suit for the return of the outstanding principal and has reclassified this $5.1 million outstanding loan into other assets on the Corporation’s balance sheet. The $966,000 carried as a troubled debt restructuring represents the total modified amount required to be paid by two different one-to-four family residential developers and four one-to-four family residential mortgage homeowners. The repayment terms are restructured to meet each borrower’s financial circumstances. These loans are secured by real estate located in New Jersey.
The components of accruing loans which are contractually past due 90 days or more as to principal or interest payments are as follows:
Other known “potential problem loans” (as defined by SEC regulations) as of December 31, 2009 have been identified and internally risk rated as assets especially mentioned or substandard. Such loans amounted to $20,048,000, $9,401,000 and $5,776,000 at December 31, 2009, 2008 and 2007, respectively. The increase at December 31, 2009 reflects continued deterioration in the quality of certain loans. The risk rating of assets is a dynamic environment wherein through on-going examination certain assets may be downgraded or upgraded as circumstances warrant. The Corporation’s construction portfolio experienced a decline in potential problem loans from December 31, 2008 to December 31, 2009 as the addition of one new relationship of $3.6 million was offset by the removal of another relationship amounting to $4.7 million. The Corporation’s commercial portfolio experienced an increase in potential problem loans with the addition of six lending relationships while shedding two for a net increase of $12.7 million in this segment. This increase was mitigated somewhat by principal payments made on many of these accounts. All such loans are currently performing. The Corporation has no foreign loans.
During the first quarter of 2010, the Corporation reevaluated several loans which resulted in the downgrade of two lending relationships totaling $4.8 million into risk rating categories associated with “potential problem loans” that had not previously been characterized as such by the Corporation. Further, $725,000 was placed on non-accrual status.
At December 31, 2009, other than the loans set forth above, the Corporation is not aware of any loans which present serious doubts as to the ability of its borrowers to comply with present loan repayment terms and which are expected to fall into one of the categories set forth in the tables or description above.
At December 31, 2009, the Corporation had no OREO, as compared with approximately $3.9 million at December 31, 2008 and approximately $501,000 at December 31, 2007. The decrease in the OREO balance from December 31, 2008 represented a writedown of the carrying value and the subsequent sale of a residential condominium project during the third quarter of 2009.
In general, it is the policy of management to consider the charge-off of loans at the point that they become past due in excess of 90 days, with the exception of loans that are secured by cash, marketable securities or real estate loans, which are well secured and in the process of collection.
With respect to concentrations of credit within the Corporation’s loan portfolio at December 31, 2009, $22.6 million of the commercial loan portfolio or 5.2 percent of $430.3 million, represented outstanding working capital loans to various real estate developers. All but $8.0 million of these loans are secured by mortgages on land and on buildings under construction.
For additional information regarding risk elements in the Corporation’s loan portfolio, see Note 5 of the Notes to Consolidated Financial Statements.
Other Income The following table presents the principal categories of non-interest income for each of the years in the three-year period ended December 31, 2009.
For the year ended December 31, 2009, total other income increased $1.3 million compared to 2008, primarily as a result of net securities gains compared to net securities losses in 2008. Excluding net securities gains and losses in the respective periods, the Corporation recorded other income of $3.4 million in the year ended December 31, 2009, compared to $3.8 million in 2008, a decrease of 8.9 percent. This decrease was primarily attributable to a $180,000 decrease in service charges, commissions and fees as well as lower other income, resulting primarily from lower letters of credit fee income and title insurance income. Additionally, in 2009 and 2008, the Corporation recognized $136,000 and $230,000, respectively, in tax-free proceeds in excess of contract value on the Corporation’s bank-owned life insurance due to the death of insured participants.
During 2009, the Corporation recorded net securities gains of $491,000 compared to net securities losses of $1.1 million in 2008 and net gains of $900,000 recorded in 2007. In 2009, total other-than-temporary impairment charges of $4.2 million were more than offset by net gains on securities sold of $4.7 million. These impairment charges consisted of $3.4 million relating to two pooled trust preferred securities, $364,000 relating to the Corporation’s investment in the Reserve Primary Fund, $188,000 relating to three variable rate private label CMOs, a $140,000 charge relating to the Corporation’s Lehman Brothers bond and a $113,000 writedown relating to one equity holding in bank stocks. In 2008, total other-than-temporary impairment charges of $1.8 million were partially offset by net gains on securities sold of $655,000. During 2008, the Corporation recorded a $1.3 million other-than-temporary impairment charge related to its Lehman Brothers corporate bond and $461,000 of writedowns related to three equity holdings in bank stocks. In 2009, the sales of securities were made in the normal course of business and proceeds were primarily reinvested into the loan
and investment portfolios. In 2008 and 2007, the sales of securities were made in the normal course of business and proceeds were primarily reinvested into the loan portfolio.
Other Expense Total other expense includes salaries and employee benefits, net occupancy expense, premises and equipment expense, professional and consulting expense, stationery and printing expense, marketing and advertising expense, computer expense and other operating expense. Other operating expense includes such expenses as telephone, insurance, audit, bank correspondent fees and the amortization of core deposit intangibles.
The following table presents the principal categories of other expense for each of the years in the three-year period ended December 31, 2009.
Total other expense increased $3.6 million, or 18.4 percent, in 2009 from 2008 as compared with a decrease of $5.1 million, or 20.8 percent, from 2007 to 2008. The level of operating expenses during 2009 increased in three major expense categories, with the largest increases occurring in FDIC insurance, up $1.8 million, OREO expenses, up $1.4 million and salaries and employee benefits, up $1.4 million. Total other expense decreased in 2008 from 2007 across several expense categories, with the largest decrease occurring in salaries and benefit expense.
On October 25, 2007, the Corporation announced that the Boards of Directors of the Corporation and Beacon Trust Company mutually agreed to terminate their Agreement and Plan of Merger dated as of March 15, 2007. Concurrently, the parties agreed to a dismissal of litigation commenced by Beacon Trust Company in October 2007 to compel consummation of the merger. During the fourth quarter of 2007, the Corporation recognized merger-related expenses, reflecting the cost of the transaction from the outset of negotiations, in an amount of approximately $600,000.
Prudent management of operating expenses has and will continue to be a key objective of management in an effort to improve earnings performance. The Corporation’s ratio of other expenses to average assets decreased to 1.88 percent in 2009 compared to 1.94 percent in 2008 and 2.43 percent in 2007.
Salaries and employee benefits increased $1.4 million or 16.6 percent in 2009 compared to 2008 and decreased $2.9 million or 25.6 percent from 2007 to 2008. The increase in 2009 was primarily attributable to a $755,000 benefit recognized in 2008 relating to the termination of two benefit plans. During the third quarter of 2008, the Corporation recognized a $272,000 benefit relating to the lump-sum payment and termination of the directors retirement plan. During the fourth quarter of 2008, the Corporation recognized a $483,000 benefit relating to a lump-sum payment and termination of a benefit equalization plan. These benefits represented the difference between the actuarial present value of the lump-sum payment and the accrued liability previously recorded on the Corporation’s statement of condition. Additionally, pension plan expense increased $514,000 in 2009 from 2008 due to both lower asset valuations and a lower expected rate of return on the Corporation’s defined pension plan, which was frozen back in 2007. On August 9, 2007, the Corporation announced that as
part of its ongoing effort to reduce operating expense, it had frozen its defined benefit pension plan and that it redesigned its 401(k) savings plan, effective September 30, 2007. The changes were consistent with cost reduction strategies and a shift in the focus of future savings of retirement benefits toward the more predictable cost structure of a 401(k) plan and away from the legacy costs of a defined benefit pension plan. The changes included stopping the accrual of future benefits in the Corporation’s defined benefit pension plan, and fully preserving all retirement benefits that employees have earned as of September 30, 2007; and redesigning the Corporation’s 401(k) plan by granting current pension plan participants an annual company-funded matching contribution of as much as 6 percent of their pay, which is an increase from the existing 3 percent match. As a result, the Corporation recorded a one-time pre-tax benefit related to these pension plan changes of approximately $1.2 million in the third quarter of 2007, reflecting the curtailment of the defined benefit plan. For the twelve months ended December 31, 2007, the plan changes resulted in retirement-related expense savings of $1.2 million.
Salaries and employee benefits accounted for 43.0 percent of total non-interest expense in 2009, as compared to 43.7 percent and 46.5 percent in 2008 and 2007, respectively.
In 2009, the Corporation announced a strategic outsourcing agreement with Fiserv to provide core account processing services, which is consistent with the Corporation’s other strategic initiatives to streamline operations, reduce operating overhead and allow the Corporation to focus on core competencies of customer service and product development. The core processing transition was consummated during the fourth quarter of 2009. In 2008, the Corporation announced a series of strategic outsourcing agreements to aid in the realization of its goal to reduce operating overhead and shrink the infrastructure of the Corporation. The cost reduction plans resulted in the reduction of workforce by 12 staff positions, which in turn resulted in a one-time pre-tax charge of $145,000 in the second quarter of 2008 for severance and termination benefits. In March 2007, the Corporation reduced its overall staffing level by approximately 10 percent through attrition, layoffs and voluntary resignations, and took a one-time, pre-tax charge of approximately $140,000 in the first quarter of 2007 and $1.6 million in the third quarter of 2007 related to termination benefits.
Occupancy and premises and equipment expense for the year ended December 31, 2009 decreased $916,000, or 19.4 percent, from 2008. The decrease in occupancy and premises and equipment expense in 2009 was due primarily to lower operating costs (utilities, rent, real estate taxes, general repair and maintenance) of the Corporation’s facilities, due in part to branch closures and consolidations coupled with a $200,000 charge taken during the fourth quarter of 2008 relating to the termination of the Corporation’s lease obligation to build a branch in Cranford, New Jersey. The increase in such expenses of $95,000, or 2.1 percent, in 2008 over 2007 was primarily attributable to the $200,000 lease termination charge.
In May 2009, the FDIC adopted a final special assessment rule that assessed the banking industry 5 basis points on total assets less Tier I capital. The Corporation was required to accrue the charge during the second quarter of 2009, which amounted to approximately $630,000, even though the FDIC collected the fee at the end of the third quarter when the regular quarterly assessments for the second were collected. Additionally, in December 2008, the FDIC adopted a final rule increasing the risk-based assessment rates beginning in the first quarter of 2009. As a result of these changes coupled with the one-time assessment credits recognized in 2008, FDIC insurance expense increased $1.8 million for 2009 compared to 2008.
Professional and consulting expense for 2009 increased $108,000 due to higher legal costs in 2009, principally related to the rights offering capital raise and the TARP Capital Purchase Program. Expenses decreased in 2008 from 2007 primarily due to $960,000 of professional and consulting expenses in 2007 associated with the termination of the Beacon Trust acquisition coupled with the 2007 annual meeting and proxy contest.
Stationery and printing expenses for 2009 decreased $58,000, or 14.6 percent, compared to 2008, due primarily to better cost containment measures relating to stationery and printing materials. The decrease in such expenses of $68,000 or 14.6 percent in 2008 from 2007 reflected improved cost containment in the purchasing of supplies.
Marketing and advertising expenses for the year ended December 31, 2009 decreased $271,000, or 42.5 percent, from the comparable twelve-month period in 2008. The decrease in 2009 compared with 2008
was primarily due to reduced spending in media and advertising. These expenses increased $34,000 or 5.6 percent in 2008 compared with 2007.
Computer expense increased $130,000 during 2009 compared to 2008 and increased $220,000 in 2008 compared to 2007, due primarily to fees paid to the Corporation’s outsourced information technology service provider. This previously announced strategic outsourcing agreement has significantly improved operating efficiencies and reduced overhead, primarily in salaries and benefits.
OREO expense for 2009 increased by $1.4 million over 2008 due primarily to the recognition of a $926,000 writedown coupled with the continued build out costs relating to the residential real estate condominium project in Union County, New Jersey. The Corporation sold the project during the third quarter of 2009.
Other expense decreased in 2009 by approximately $64,000 or 1.9 percent compared to 2008. Other expense decreased in 2008 by $1.1 million, or 24.1 percent, compared to 2007. This decrease in 2008 was primarily due to the charge-off of the Beacon Trust transaction in 2007. Amortization of core deposit intangibles accounted for $82,000 and $95,000 of other expense for the years 2009 and 2008, respectively.
Provision for Income Taxes The Corporation recorded income tax expense of $1.5 million in 2009 compared to $1.6 million in 2008 and a tax benefit of $2.9 million in 2007. The recorded tax benefits in 2007 resulted largely from a change in the Corporation’s business entity structure, which led to the recognition of a $1.3 million tax benefit in 2007 and a $1.4 million tax benefit in 2006. These tax benefits were attributable to a plan of liquidation adopted by the Corporation for its REIT subsidiary, which was completed on November 30, 2007. As a result of the further liquidation of certain other subsidiaries relating to the business entity restructuring, the Corporation began to provide for income tax expense in 2008. The effective tax rates for the Corporation for the years ended December 31, 2009, 2008 and 2007 were 24.5 percent, 21.1 percent and (317.8) percent, respectively. The Corporation adjusts its expected annual tax rate on a quarterly basis based on the current projections of non-deductible expenses, tax-exempt interest income, increase in the cash surrender value of bank owned life insurance and pre-tax net earnings.
Tax-exempt interest income on a fully tax equivalent basis decreased by $2.4 million, or 61.3 percent, from 2008 to 2009, and decreased by $1.7 million, or 29.9 percent, from 2007 to 2008. The Corporation recorded income related to the cash surrender value of bank-owned life insurance as a component of other income in the amount of $1,156,000, $1,203,000 and $893,000 for 2009, 2008 and 2007, respectively.
Recent Accounting Pronouncements Note 2 of the Notes to Consolidated Financial Statements discusses new accounting policies recently issued or proposed but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects financial condition, results of operations, or liquidity, the impacts are discussed in the applicable sections of the financial review and notes to the consolidated financial statements.
On June 29, 2009, the FASB issued FASB ASC 105-10-65 (previously SFAS No. 168, “Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No. 162” (“Codification”)). This Codification is the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009, for most entities. On the effective date, all non-SEC accounting and reporting standards will be superseded. The Corporation adopted the Codification for the quarterly period ended September 30, 2009, as required, and there was not a material impact on the Corporation’s financial statements taken as a whole. In order to ease the transition to the Codification, the Corporation has provided the Codification cross-reference along side the references to the standards issued and adopted prior to the adoption of the Codification.
In April 2009, the FASB issued three amendments to the fair value measurement, disclosure and other-than-temporary impairment standards:
• FASB ASC 820-10-65 (previously SFAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly”).
• FASB ASC 320-10-65 (previously SFAS 115-2 and SFAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”).
• FASB ASC 825-10-65 (previously SFAS 107 and APB 28-1, “Interim Disclosure about Fair Value of Financial Instruments”).
FASB ASC 820-10-05 (previously SFAS No. 157, “Fair Value Measurements”) defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. FASB ASC 820-10-05 provides additional guidance on identifying circumstances when a transaction may not be considered orderly.
FASB ASC 820-10-65 provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with FASB ASC 820-10-05.
FASB ASC 820-10-65 clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of evidence to determine whether the transaction is orderly. It also provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.
FASB ASC 320-10-65 amends other-than-temporary impairment guidance for debt securities and expands disclosure requirements for other-than-temporarily impaired debt and equity securities. FASB ASC 320-10-65 requires companies to record other-than-temporary impairment charges, through earnings, if they have the intent to sell, or will more likely than not be required to sell, an impaired debt security before a recovery of its amortized cost basis. In addition, FASB ASC 320-10-65 requires companies to record other-than-temporary impairment charges through earnings for the amount of credit losses, regardless of the intent or requirement to sell. Credit loss is measured as the difference between the present value of an impaired debt security’s cash flows and its amortized cost basis. Non-credit related write-downs to fair value must be recorded as decreases to accumulated other comprehensive income as long as a company has no intent or requirement to sell an impaired security before a recovery of amortized cost basis. Finally, FASB ASC 320-10-65 requires companies to record all previously recorded non-credit related other-than-temporary impairment charges for debt securities as cumulative effect adjustments to retained earnings as of the beginning of the period of adoption.
FASB ASC 825-10-65 (previously SFAS 107-1 and APB 28-1) requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FASB ASC 825-10-65 also requires those disclosures in summarized financial information at interim reporting periods.
All three FASB ASC’s discussed herein include substantial additional disclosure requirements. The effective date for these new ASC’s is the same: interim and annual reporting periods ended after June 15, 2009. The Corporation adopted these ASC’s at June 30, 2009 and there was not a material impact on its consolidated financial statements.
On May 28, 2009, the FASB issued FASB ASC 855-10-05 (previously SFAS No. 165, “Subsequent Events”). Under FASB ASC 855-10-05, companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued, or available to be issued in the case of non-public entities. FASB ASC 855-10-05 requires entities to recognize in the financial statements
the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. FASB ASC 855-10-05 also requires entities to disclose the date through which subsequent events have been evaluated. FASB ASC 855-10-05 was effective for interim and annual reporting periods ending after June 15, 2009. The Corporation adopted the provisions of FASB ASC 855-10-05 for the quarter ended June 30, 2009. The adoption of this accounting standard had no material impact on the Corporation’s consolidated financial statements.
On June 12, 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (“FAS 166”), and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“FAS 167”), which change the way entities account for securitizations and special-purpose entities.
FAS 166 is a revision to FASB ASC 860-10-05 (previously SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”) and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. FAS 166 also eliminates the concept of a “qualifying special-purpose entity”, changes the requirements for derecognizing financial assets and requires additional disclosures.
FAS 167 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.
Both FAS 166 and FAS 167 will be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The recognition and measurement provisions of FAS 166 shall be applied to transfers that occur on or after the effective date. The Corporation adopted both FAS 166 and FAS 167 on January 1, 2010, as required. The Corporation is currently assessing the impact this adoption may have on the Corporation’s consolidated financial statements.
In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. Under the proposed roadmap, the Company may be required to prepare financial statements in accordance with IFRS as early as 2014. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. The Company is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.
Asset and Liability Management Asset and liability management encompasses an analysis of market risk, the control of interest rate risk (interest sensitivity management) and the ongoing maintenance and planning of liquidity and capital. The composition of the Corporation’s statement of condition is planned and monitored by the Asset and Liability Committee (“ALCO”). In general, management’s objective is to optimize net interest income and minimize market risk and interest rate risk by monitoring these components of the statement of condition.
Short-term interest rate exposure analysis is supplemented with an interest sensitivity gap model. The Corporation utilizes interest sensitivity analysis to measure the responsiveness of net interest income to changes in interest rate levels. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different than that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different than that of an earning asset that it supports. While the Corporation matches only a small portion of specific assets and liabilities, total earning assets and interest-bearing liabilities are grouped to determine the overall interest rate risk within
a number of specific time frames. The difference between interest sensitive assets and interest sensitive liabilities is referred to as the interest sensitivity gap. At any given point in time, the Corporation may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities, or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending in part on management’s judgment as to projected interest rate trends.
The Corporation’s rate sensitivity position in each time frame may be expressed as assets less liabilities, as liabilities less assets, or as the ratio between rate sensitive assets (“RSA”) and rate sensitive liabilities (“RSL”). For example, a short funded position (liabilities repricing before assets) would be expressed as a net negative position, when period gaps are computed by subtracting repricing liabilities from repricing assets. When using the ratio method, a RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1 indicates an asset sensitive position and a ratio less than 1 indicates a liability sensitive position.
A negative gap and/or a rate sensitivity ratio less than 1, tends to expand net interest margins in a falling rate environment and to reduce net interest margins in a rising rate environment. Conversely, when a positive gap occurs, generally margins expand in a rising rate environment and contract in a falling rate environment. From time to time, the Corporation may elect to deliberately mismatch liabilities and assets in a strategic gap position.
At December 31, 2009, the Corporation reflected a positive interest sensitivity gap (or an interest sensitivity ratio of 1:09:1.00) at the cumulative one-year position. Based on management’s perception that interest rates will continue to be volatile, projected increased levels of prepayments on the earning asset portfolio and the current level of interest rates, emphasis has been, and is expected to continue to be, placed on interest-sensitivity matching with the objective of continuing to stabilize the net interest spread and margin during 2010. However, no assurance can be given that this objective will be met.
The following table depicts the Corporation’s interest rate sensitivity position at December 31, 2009:
Estimates of Fair Value The estimation of fair value is significant to a number of the Corporation’s assets, including loans held for sale, and available-for-sale investment securities. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, expected cash flows, credit quality, discount rates, or market interest rates. Fair values for most available for sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. See Note 18 of the Notes to Consolidated Financial Statements for additional discussion.
These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Impact of Inflation and Changing Prices The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the operations; unlike most industrial companies, nearly all of the Corporation’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Liquidity The liquidity position of the Corporation is dependent on successful management of its assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise principally to accommodate possible deposit outflows and to meet customers’ requests for loans. Scheduled principal loan repayments, maturing investments, short-term liquid assets and deposit in-flows, can satisfy such needs. The objective of liquidity management is to enable the Corporation to maintain sufficient liquidity to meet its obligations in a timely and cost-effective manner.
Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. By using a variety of potential funding sources and staggering maturities, the risk of potential funding pressure is reduced. Management also maintains a detailed liquidity contingency plan designed to respond adequately to situations which could lead to liquidity concerns.
Management believes that the Corporation has the funding capacity to meet the liquidity needs arising from potential events. In addition to pledgeable securities, the Corporation also maintains borrowing capacity through the Federal Discount Window and the Federal Home Loan Bank of New York secured with loans and marketable securities.
Liquidity is measured and monitored for the Corporation’s bank subsidiary, Union Center National Bank (the “Bank”). The Corporation reviews its net short-term mismatch. This measures the ability of the Corporation to meet obligations should access to Bank dividends be constrained. At December 31, 2009, the Parent Corporation had $3.2 million in cash and short-term investments compared to $2.2 million at December 31, 2008. Expenses at the Parent Corporation are moderate and management believes that the Parent Corporation has adequate liquidity to fund its obligations.
Certain provisions of long-term debt agreements, primarily subordinated debt, prevent the Corporation from creating liens on, disposing of or issuing voting stock of subsidiaries. As of December 31, 2009, the Corporation was in compliance with all covenants and provisions of these agreements.
Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. By using a variety of potential funding sources and staggering maturities, the risk of potential funding pressure is somewhat reduced. Management also maintains a detailed liquidity contingency plan designed to adequately respond to situations which could lead to liquidity concerns.
Based on anticipated cash flows at December 31, 2009 projected to December 31, 2010, the Corporation believes that the Bank’s liquidity should remain strong, with an approximate projection of $367.1 million in anticipated cash flows over the next twelve months. This projection represents a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from this projection depending upon a number of factors, including the liquidity needs of the Bank’s customers, the availability of sources of liquidity and general economic conditions.
On September 30, 2009, the FDIC proposed a rule that required insured institutions to prepay their estimated quarterly assessments through December 31, 2012 to strengthen the cash position of the Deposit Insurance Fund. The cash prepayment was made on December 30, 2009 and amounted to approximately $5.7 million, which included the 2009 fourth quarter assessment. The prepayment did not have a significant impact on the Corporation’s future cash position or operations.
Deposits Total deposits increased to $813.7 million on December 31, 2009 from $659.5 million at December 31, 2008, an increase of $154.2 million, or 23.4 percent.
Total non-interest-bearing deposits increased from $113.3 million at December 31, 2008 to $130.5 million at December 31, 2009, an increase of $17.2 million or 15.2 percent. Time, savings and interest-bearing transaction accounts increased from $546.2 million on December 31, 2008 to $683.2 million at December 31, 2009, an increase of $137.0 million or 25.1 percent. The increase in deposits was reflective of customers’ desire for safety and liquidity and flight to quality in light of the financial crisis.
Certificates of deposit $100,000 and over increased to 17.8 percent of total deposits at December 31, 2009 from 15.2 percent one year earlier. With the current turmoil in the financial markets, some of the Corporation’s depositors have become sensitive to obtaining full FDIC insurance for their time deposits. To accommodate its customers, the Corporation began offering Certificates of Deposit Account Registry Service (CDARS) in 2008. As a result of this offering and the temporary increase in insurance coverage by the FDIC to $250,000, the Corporation reported an increase of $44.3 million in certificates of deposit greater than $100,000 at December 31, 2009 compared to year-end 2008.
At December 31, 2009, the Corporation had a total of $111.3 million with a weighted average rate of 1.24 percent in CDARS Reciprocal deposits compared to $87.9 million with a weighted average rate of 2.52 percent at December 31, 2008. Based on the Bank’s participation in Promontory Interfinancial Network, LLC., customers who are FDIC insurance sensitive are able to place large dollar deposits with the Corporation and the Corporation uses CDARS to place those funds into certificates of deposit issued by other banks in the Network. This occurs in increments of less than the FDIC insurance limits so that both the principal and interest are eligible for complete FDIC protection. The FDIC currently considers these funds as brokered deposits. All brokered deposits are classified in time deposits. It became apparent during the latter half of 2008 that customers’ preference in seeking safety and more liquidity became paramount in light of the financial crisis, as customers sought full FDIC insured bank products as a safe haven.
The Corporation derives a significant proportion of its liquidity from its core deposit base. For the year ended December 31, 2009, core deposits, comprised of total demand deposits, savings and money market accounts, decreased by $166.4 million or 38.7 percent from December 31, 2008 to $596.7 million. At December 31, 2009, core deposits were 73.3 percent of total deposits compared to 66.6 percent at year-end 2008. Alternatively, the Corporation uses a more stringent calculation for the management of its liquidity positions internally which consists of total demand and savings accounts (excluding money market accounts greater than $100,000) and excludes time deposits as part of core deposits as a percentage of total deposits. This number represented 46.6 percent of total deposits at December 31, 2009 as compared with 53.0 percent at December 31, 2008. The Corporation expects its deposit gathering efforts to remain strong, supported in part by the recent actions by the FDIC in temporarily raising the deposit insurance limits. The Corporation is a participant in the FDIC’s Transaction Account Guarantee Program. Under this program, all non-interest bearing deposit transaction accounts are fully guaranteed by the FDIC, regardless of dollar amount, through June 30, 2010.
The following table depicts the Corporation’s core deposit mix at December 31, 2009 and 2008.
Short-Term Borrowings Short-term borrowings can be used to satisfy daily funding needs. Balances in those accounts fluctuate on a day-to-day basis. The Corporation’s principal short-term funding sources are Federal Funds purchased and securities sold under agreements to repurchase. Short-term borrowings, including Federal Funds purchased and securities sold under agreements to repurchase, amounted to $46.1 million at year-end 2009, an increase of $966,000 or 2.1 percent from year-end 2008.
The following table is a summary of short-term securities sold under repurchase agreements for each of the last three years.
Long-Term Borrowings Long-term borrowings consist of Federal Home Loan Bank of New York (“FHLB”) advances and securities sold under agreements to repurchase that have contractual maturities over one year. Long-term borrowings amounted to $223.1 million at December 31, 2009, a decrease of $153,000 from year-end 2008.
Cash Flows The consolidated statements of cash flows present the changes in cash and cash equivalents from operating, investing and financing activities. During 2009, cash and cash equivalents (which increased overall by $74.1 million) were provided on a net basis by operating activities and financing activities and used on a net basis by investing activities. Cash flows from financing activities, primarily due to a net increase in deposits, were partially offset by an increase in financing activities, primarily resulting from an increase in securities and loans.
During 2008, cash and cash equivalents (which decreased overall by $55.0 million) were used on a net basis by operating activities and investing activities and provided on a net basis by financing activities. Cash flows from investing activities, primarily due to a net decrease in securities, were partially offset by an increase in financing activities, primarily resulting from an increase in borrowings.
During 2007, cash and cash equivalents (which increased overall by $25.7 million) were provided on a net basis by operating and investing activities and used on a net basis by financing activities. Cash flows from investing activities, primarily due to a net decrease in securities, were partially offset by a decrease in financing activities, primarily resulting from a reduction in deposits, as well as funding dividends paid and the purchase of treasury stock.
Contractual Obligations and Other Commitments The following table summarizes contractual obligations at December 31, 2009 and the effect such obligations are expected to have on liquidity and cash flows in future periods.
Stockholders’ Equity Stockholders’ equity amounted to $102.6 million at December 31, 2009, an increase of $20.9 million or 25.5 percent, compared to year-end 2008. At December 31, 2008, stockholders’ equity totaled $81.7 million, a decrease of $3.6 million from December 31, 2007.
On January 12, 2009, the Corporation issued $10 million in nonvoting senior preferred stock to the U.S. Department of Treasury under the Capital Purchase Program. As part of the transaction, the Corporation also issued warrants to the U.S. Treasury to purchase 173,410 shares of common stock of the Corporation at an exercise price of $8.65 per share. As previously announced, the Corporation’s voluntary participation in the Capital Purchase Program amounted to approximately 50 percent of what the Corporation had qualified for under the U.S. Treasury program. The funding was used to support the balance sheet. As a result of the successful completion of the Rights Offering in October 2009, the number of shares underlying the warrant held by the U.S. Treasury was reduced to 86,705 shares or 50 percent of the original 173,410 shares.
In July 2009, the Corporation announced that its Board of Directors had authorized a rights offering of up to approximately $11 million of common stock to its existing stockholders. In October, the Corporation successfully raised total gross proceeds of approximately $11 million in its rights offering and a private placement with its standby purchaser.
Book value per share at year-end 2009 was $6.38 compared to $6.29 at year-end 2008. Tangible book value at year-end 2009 was $5.21 compared to $4.97 at year end 2008; see Item 6 for a reconciliation of this non-GAAP financial measure to book value.
During the year of 2009, the Corporation made no purchases of common stock. At December 31, 2009, there were 652,868 shares available for repurchase under the Corporation’s stock buyback program.
Capital The maintenance of a solid capital foundation continues to be a primary goal for the Corporation. Accordingly, capital plans and dividend policies are monitored on an ongoing basis. The most important objective of the capital planning process is to balance effectively the retention of capital to support future growth and the goal of providing stockholders with an attractive long-term return on their investment.
Risk-Based Capital/Leverage The Tier I leverage capital at December 31, 2009 (defined as tangible stockholders’ equity for common stock and Trust Preferred Capital Securities) amounted to $99.3 million or 7.80 percent of average total assets. At December 31, 2008, the Corporation’s Tier I leverage capital amounted to $78.2 million or 7.71 percent of total assets. Tier I capital excludes the effect of FASB ASC 320-10-05, which amounted to $8.4 million of net unrealized losses, after tax, on securities available-for-sale (reported as a component of accumulated other comprehensive income which is included in stockholders’ equity), and is reduced by goodwill and intangible assets of $17.0 million as of December 31, 2009. For information on goodwill and intangible assets, see Note 1 to the Consolidated Financial Statements.
United States bank regulators have issued guidelines establishing minimum capital standards related to the level of assets and off balance-sheet exposures adjusted for credit risk. Specifically, these guidelines categorize assets and off balance-sheet items into four risk-weightings and require banking institutions to maintain a minimum ratio of capital to risk-weighted assets. At December 31, 2009, the Corporation’s Tier I and total risk-based capital ratios were 11.51 percent and 12.46 percent, respectively. For information on risk-based capital and regulatory guidelines for the Parent Corporation and its bank subsidiary, see Note 13 to the Consolidated Financial Statements.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the bank regulators regarding capital components, risk weightings and other factors. The OCC has established higher minimum capital ratios for the Bank effective as of December 31, 2009: Tier 1 Risk-Based Capital of 10 percent, Total Risk-Based Capital of 12 percent and Tier 1 Leverage Capital of 8 percent. As of December 31, 2009, management believes that each of the Bank and the Parent Corporation meet all capital adequacy requirements to which it is subject, other than the Tier 1 Leverage Capital ratio, which at 7.62 percent was slightly below the 8 percent established by the OCC for the Bank. Under the MOU between the Bank and the OCC, the Bank has agreed to develop a three year capital program, which will include specific plans for the maintenance of adequate capital and the strengthening of the Bank’s capital structure to meet current and future needs.
Subordinated Debentures On December 19, 2003, Center Bancorp Statutory Trust II, a statutory business trust and wholly-owned subsidiary of Center Bancorp, Inc., issued $5.0 million of, MMCapS capital securities to investors due on January 23, 2034. The capital securities presently qualify as Tier I capital. The trust loaned the proceeds of this offering to the Corporation and received in exchange $5.2 million of the Parent Corporation’s subordinated debentures. The subordinated debentures are redeemable in whole or in part, prior to maturity but after January 23, 2009. The floating interest rate on the subordinate debentures is three-month LIBOR plus 2.85 percent and reprices quarterly. The rate at December 31, 2009 was 3.13 percent.
The additional capital raised with respect to the issuance of the floating rate capital pass-through securities was used to bolster the Corporation’s capital and for general corporate purposes, including capital contributions to Union Center National Bank. Additional information regarding the capital treatment of these securities is contained in Note 10 of the Notes to the Consolidated Financial Statements.
Looking Forward One of the Corporation’s primary objectives is to achieve balanced asset and revenue growth, and at the same time expand market presence and diversify its financial products. However, it is recognized that objectives, no matter how focused, are subject to factors beyond the control of the Corporation, which can impede its ability to achieve these goals. The following factors should be considered when evaluating the Corporation’s ability to achieve its objectives:
The financial market place is rapidly changing. Banks are no longer the only place to obtain loans, nor the only place to keep financial assets. The banking industry has lost market share to other financial service providers. The future is predicated on the Corporation’s ability to adapt its products, provide superior customer service and compete in an ever-changing marketplace.
Net interest income, the primary source of earnings, is impacted favorably or unfavorably by changes in interest rates. Although the impact of interest rate fluctuations is mitigated by ALCO strategies, significant changes in interest rates can have a material adverse impact on profitability.
The ability of customers to repay their obligations is often impacted by changes in the regional and local economy. Although the Corporation sets aside loan loss provisions toward the allowance for loan losses when management determines such action to be appropriate, significant unfavorable changes in the economy could impact the assumptions used in the determination of the adequacy of the allowance.
Technological changes will have a material impact on how financial service companies compete for and deliver services. It is recognized that these changes will have a direct impact on how the marketplace is approached and ultimately on profitability. The Corporation has taken steps to improve its traditional delivery channels. However, continued success will likely be measured by the ability to anticipate and react to future technological changes.
This “Looking Forward” description constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the Corporation’s forward-looking statements due to numerous known and unknown risks and uncertainties, including the factors referred to above, in Item 1A of this Annual Report on Form 10K and in other sections of this Annual Report on Form 10K.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk Interest Sensitivity Market Risk The Corporation’s profitability is affected by fluctuations in interest rates. A sudden and substantial increase or decrease in interest rates may adversely affect the Corporation’s earnings to the extent that the interest rates borne by assets and liabilities do not similarly adjust. The Corporation’s primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Corporation’s net interest income and capital, while structuring the Corporation’s asset-liability structure to obtain the maximum yield-cost spread on that structure. The Corporation relies primarily on its asset-liability structure to control interest rate risk. The Corporation continually evaluates interest rate risk management opportunities, including the use of derivative financial instruments. The management of the Corporation believes that hedging instruments currently available are not cost-effective, and, therefore, has focused its efforts on increasing the Corporation’s yield-cost spread through wholesale and retail growth opportunities.
The Corporation monitors the impact of changes in interest rates on its net interest income using several tools. One measure of the Corporation’s exposure to differential changes in interest rates between assets and liabilities is the Corporation’s analysis of its interest rate sensitivity. This test measures the impact on net
interest income and on net portfolio value of an immediate change in interest rates in 100 basis point increments. Net portfolio value is defined as the net present value of assets, liabilities and off-balance sheet contracts.
The primary tool used by management to measure and manage interest rate exposure is a simulation model. Use of the model to perform simulations reflecting changes in interest rates over one and two-year time horizons has enabled management to develop and initiate strategies for managing exposure to interest rate risk. In its simulations, management estimates the impact on net interest income of various changes in interest rates. Projected net interest income sensitivity to movements in interest rates is modeled based on both an immediate rise and fall in interest rates (“rate shock”), as well as gradual changes in interest rates over a twelve-month time period. The model is based on the actual maturity and repricing characteristics of interest-rate sensitive assets and liabilities. The model incorporates assumptions regarding earning asset and deposit growth, prepayments, interest rates and other factors.
Management believes that both individually and taken together, these assumptions are reasonable, but the complexity of the simulation modeling process results in a sophisticated estimate, not an absolutely precise calculation of exposure. For example, estimates of future cash flows must be made for instruments without contractual maturity or payment schedules.
Based on the results of the interest simulation model as of December 31, 2009, and assuming that management does not take action to alter the outcome, the Corporation would expect a decrease of 0.52 and 1.66 percent in net interest income if interest rates increased by 200 and 300 basis points, respectively, from current rates in a gradual and parallel rate ramp over a twelve month period. As market rates declined to historic lows at December 31, 2009, the Corporation did not feel that modeling a down rate scenario was realistic in the current environment.
The declining rates and steepening of the yield curve during 2009 affected net interest margins. Based on management’s perception that interest rates will continue to be volatile, projected increased levels of prepayments on the earning-asset portfolio and the current level of interest rates, emphasis has been, and is expected to continue to be, placed on interest-sensitivity matching with the objective of stabilizing the net interest spread during 2010. However, no assurance can be given that this objective will be met.
Equity Price Risk The Corporation is also exposed to equity price risk inherent in its portfolio of publicly traded equity securities, which had an estimated fair value of $0.3 million at December 31, 2009 and $0.7 million at December 31, 2008. The Corporation monitors its equity investments for impairment on a periodic basis. In the event that the carrying value of the equity investment exceeds its fair value, and the Corporation determines the decline in value to be other than temporary, the Corporation reduces the carrying value to its current fair value. During 2009 and 2008, the Corporation recorded $113,000 and $461,000, respectively, of other-than-temporary impairment charges relating to equity holdings in bank stocks. These equities were written down to fair value.
8. Financial Statements and Supplementary Data All Financial Statements:
The following financial statements are filed as part of this report under Item 8
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures None.
Item 9A.
Item 9A. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports filed or submitted pursuant to the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that information required to be disclosed by the Corporation in its Exchange Act reports is accumulated and communicated to management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of its management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, the Corporation evaluated the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) and 15d-15(e) as of December 31, 2009. Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of such date as described below in Management’s Report on Internal Control Over Financial Reporting (Item 9A(b)).
(b) Management’s Report on Internal Control Over Financial Reporting The Corporation’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) of the Exchange Act. The Corporation’s internal control system is a process designed to provide reasonable assurance to the Corporation’s management, Board of Directors and shareholders regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Corporation; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on our financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As part of the Corporation’s program to comply with Section 404 of the Sarbanes-Oxley Act of 2002, our management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2009 (the “Assessment”). In making this Assessment, management used the control criteria framework of the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission published in its report entitled Internal Control - Integrated Framework. Management’s Assessment included an evaluation of the design of the Corporation’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its Assessment with the Audit Committee.
Based on this Assessment, management determined that, as of December 31, 2009, the Corporation’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
ParenteBeard LLC, the independent registered public accounting firm that audited the Corporation’s consolidated financial statements included in this Annual Report on Form 10-K, has issued an audit report on the Corporation’s internal control over financial reporting as of December 31, 2009. The report, which expresses an opinion on the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2009, is included in this item under the heading “Report of Independent Registered Public Accounting Firm.”
(c) Attestation Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders
Center Bancorp, Inc.
We have audited Center Bancorp, Inc.’s (the “Corporation”) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Center Bancorp, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Center Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of condition of Center Bancorp, Inc. and subsidiaries and the related consolidated statement of income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2009 and our report dated March 16, 2010 expressed an unqualified opinion.
/s/ ParenteBeard LLC
ParenteBeard LLC
Reading, Pennsylvania
March 16, 2010
(d) Changes in Internal Controls Over Financial Reporting There have been no changes in the Company’s internal control over financial reporting identified in the Assessment that occurred during the last fiscal quarter to which this Annual Report on Form 10-K relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information None.
PART III Item 10.
Item 10. Directors and Corporate Governance The Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation’s definitive proxy statement for its 2010 Annual Meeting of Stockholders. Certain information on Executive Officers of the registrant is included in Part I, Item 3A of this report, which is also incorporated herein by reference.
The Corporation maintains a code of ethics applicable to the Corporation’s chief executive officer, senior financial professional personnel (including the Corporation’s chief financial officer, principal accounting officer or controller and persons performing similar transactions), all other executive officers and all directors. The Corporation also maintains a code of conduct applicable to all other employees. Copies of both codes were filed as exhibits to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003. The Corporation will provide copies of such codes to any person without charge, upon request to Anthony C. Weagley, President and Chief Executive Officer, Center Bancorp, Inc., 2455 Morris Avenue, Union, NJ 07083.
Item 11.
Item 11. Executive Compensation The Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management The Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
Stock Compensation Plan Information For information related to stock based compensation, see Note 16 of the Notes to Consolidated Financial Statements. The following table gives information about the Corporation’s common stock that may be issued upon the exercise of options, warrants and rights under the Corporation’s 2009 Equity Incentive Plan, 1999 Incentive Plan, 1993 Employee Stock Option Plan, 1993 Outside Director Stock Option Plan and 2003 Non-Employee Director Stock Option Plan as of December 31, 2009. These plans were the Corporation’s only equity compensation plans in existence as of December 31, 2009.
Item 13.
Item 13. Certain Relationships and Related Transactions The Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accountant Fees and Services The Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
PART IV Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements and Schedules:
The following Financial Statements and Supplementary Data are filed as part of this annual report:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Condition
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(b) Exhibits (numbered in accordance with Item 601 of Regulation S-K) filed herewith incorporated by reference as part of this annual report.
(c) Financial Statement Schedules
All financial statement schedules are omitted because they are either inapplicable or not required, or because the required information is included in the Consolidated Financial Statements or notes thereto.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Center Bancorp, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant, in the capacities described below on March 16, 2010, have signed this report below.
/s/ Alexander A. Bol*
Alexander A. Bol
Chairman of the Board
/s/ Brenda Curtis*
Brenda Curtis
Director
/s/ John J. DeLaney, Jr.*
John J. DeLaney, Jr.
Director
/s/ James J. Kennedy*
James J. Kennedy
Director
/s/ Howard Kent*
Howard Kent
Director
/s/ Elliot I. Kramer*
Elliot I. Kramer
Director
/s/ Nicolas Minoia*
Nicholas Minoia
Director
/s/ Harold Schechter*
Harold Schechter
Director
/s/ Lawrence B. Seidman*
Lawrence B. Seidman
Director
/s/ William A. Thompson*
William A. Thompson
Director
/s/ Raymond Vanaria*
Raymond Vanaria
Director
/s/ Anthony C. Weagley
Anthony C. Weagley
President and Chief Executive Officer and
Acting Chief Financial Officer
*By:
/s/ Anthony C. Weagley
Anthony C. Weagley
Attorney-in-fact