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) difficulties in integrating any businesses that we may acquire, which may increase our expenses and delay the achievement of any benefits that we may expect from such acquisitions; (10) 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 (11) 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 subject to stringent capital requirements which could require us to seek capital at times when capital may be expensive or unavailable to us.
We may at some point be required 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.
Negative developments in the financial services industry and U.S. and global credit markets in recent years may continue to adversely impact our operations and results.
The general economic downturn experienced since 2008 negatively impacted many financial institutions, including the Corporation. Loan portfolio performances 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 increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, were negatively affected by the condition of the financial markets, as was our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. While the United States Congress has taken actions to implement important safeguards, there remains 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 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.
In addition, the possibility that certain European Union (“EU”) member states may default on their debt obligations have negatively impacted economic conditions and global markets. The continued uncertainty over the outcome of international and the EU’s financial support programs and the possibility that other EU member states may experience similar financial troubles could further disrupt global markets. The negative impact on economic conditions and global markets could also have a material adverse effect on our liquidity, financial condition and results of operations.
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, among other things.
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.
The downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity.
Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+ on August 5, 2011. A further downgrade or a downgrade by other rating agencies could have a material adverse impact on financial markets and economic conditions in the United States and worldwide. Any such adverse impact could have a material adverse effect on our liquidity, financial condition and results of operations. Many of our investment securities are issued by U.S. government agencies and U.S. government sponsored entities.
The Federal Reserve’s repeal of the prohibition against payment of interest on demand deposits may increase competition for such deposits and ultimately increase interest expense.
A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on amounts used to fund assets and the interest rates and fees we receive on our interest-earning assets. In July 2011, Regulation Q, which had prohibited the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System, was repealed. As a result, member banks and thrifts are now permitted to offer interest-bearing demand deposit accounts to commercial customers, which could result in increased competition from other financial institutions for these deposits and could result in an increase in our interest expense.
External factors, many of which we cannot control, may result in liquidity concerns for us.
Liquidity risk is the potential that the 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. 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 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. The 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. 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.
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 several years. Such negative developments and disruptions have resulted in uncertainty in the financial markets. 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. If the capital markets are volatile, 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 and construction loans were $537.7 million, or approximately 60.4% of our total loan portfolio, as of December 31, 2012. 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 our 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 to fund 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.
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, and 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, among other things.
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 (such as our recently completed Saddle River Valley Bank transaction) 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 periods of economic difficulties, the FDIC may increase its assessment rates and impose 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, 2012, we had approximately $496.8 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 or 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 the Parent Corporation, 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. The effective use of technology increases efficiency and enables financial institutions to reduce costs, in addition to providing better service to customers. 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 assure you 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.
The Dodd-Frank Act and future regulatory reforms required by such legislation could have a significant impact on our business, financial condition and results of operations.
The Dodd-Frank Act will have a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most are and will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact such requirements will have on our operations is unclear. While it is difficult to predict at this time what specific impact the Dodd-Frank Act will have on us, we expect that at a minimum our operating and compliance costs will increase, and our interest expense could increase.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Bank’s operations are located at ten sites in Union County, New Jersey, consisting of six 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 branch offices in Morris County, New Jersey, consisting of one site in Madison, one site in Boonton/Mountain Lakes, and one site in Morristown, New Jersey. During 2012, the Corporation acquired two bank occupancies from Saddle River Valley Bank and opened a office in Englewood, New Jersey. As a result of its acquisition of assets of Saddle River Valley Bank in 2012, the Bank has three branch offices in Bergen County, New Jersey. The Bank’s principal office is located at 2455 Morris Avenue, Union, New Jersey. The principal office is a two story building constructed in 1993.
The following table sets forth certain information regarding the Bank’s leased locations.
Branch Location
Term
356 Chestnut Street, Union, New Jersey
Term expires in 2028 with renewal options
Career Center Branch located in Union High School, Union, New Jersey
Term expired in October 2008, currently on month to month lease
300 Main Street, Madison, New Jersey
Term expires June 6, 2015 and is subject to renewal at the Bank’s option
2933 Vauxhall Road, Vauxhall, New Jersey
Term expires January 31, 2020 and is subject to renewal at the Bank’s option
545 Morris Avenue, Summit, New Jersey
Term expires February 1, 2024, subject to renewal at the Bank’s option
Ely Place, Boonton, New Jersey
Term expires August 29, 2021, and is subject to renewal at the Bank’s option
171 E. Saddle River Road, Saddle River, New Jersey
Term expires December 31, 2013
Route 202 and Allerman Road Oakland, New Jersey
Term expires November 9, 2027
10 E. Palisade Avenue, Englewood, New Jersey
Term expires July 31, 2022
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.
On October 9, 2004, the Bank opened a 19,555 square foot office facility on Springfield Road in Union, New Jersey, which served as the Bank’s operations and data center until 2010. During the second quarter of 2010, the Corporation entered into a lease of its former operations facility under a direct financing lease. The lease has a 15 year term with no renewal options. According to the terms of the lease, the lessee has an obligation to purchase the property underlying the lease in either year seven, ten or fifteen at predetermined prices for those years as provided in the lease. The structure of the minimum lease payments and the purchase prices as provided in the lease provide an inducement to the lessee to purchase the property in year seven.
Item 3.
Item 3. Legal Proceedings
There are no 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 proceedings 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:
Name and Age
Officer Since
Business Experience
Anthony C. Weagley
Age - 51
1996 the Parent
Corporation
1985 the Bank
President and Chief Executive Officer of the Parent Corporation (April 2008 - Present); President, Chief Executive Officer and Chief Financial Officer of the Parent Corporation (August 2007 - March 2008); President and Chief Executive Officer of the Bank (March 2008 - Present); President, Chief Executive Officer and Chief Financial Officer of the Bank (August 2007 - February 2008); Vice President & Treasurer of the Parent Corporation (1996 - August 2007); Senior Vice President & Cashier of the Bank (1996 - August 2007); Vice President & Cashier of the Bank (1991 - 1996)
Mark S. Cardone
Age - 50
2001 the Parent
Corporation
2001 the Bank
Vice President of the Parent Corporation and Senior Vice President & Branch Administrator of the Bank (2001 - Present)
Joseph D. Gangemi
Age - 32
2008 the Parent
Corporation
2004 the Bank
Vice President and Assistant Portfolio Manager of the Parent Corporation and the Bank (December 31, 2010 - Present): Executive Assistant to the Chief Executive Officer, Investor Relations Officer and Corporate Secretary of the Parent Corporation and the Bank (June 2008 - Present); Executive Assistant to the Chief Executive Officer and Investor Relations Officer of the Bank (January 2008 - June 2008); Executive Assistant to the Chief Executive Officer of the Bank (August 2007 - January 2008); Executive Assistant to the Chief Financial Officer of the Bank (August 2005 - August 2007)
John J. Lukens
Age - 65
2009 the Parent
Corporation
2004 the Bank
Vice President and Senior Credit Administrator of the Parent Corporation and Senior Vice President and Senior Credit Administrator of the Bank (December 2009 - December 2012); Vice President of the Bank (September 2004 - December 2009)
James W. Sorge
Age - 60
2010 the Parent
Corporation
2010 the Bank
Vice President and Compliance Officer of the Parent Corporation and Senior Vice President and Compliance Officer of the Bank (March 2010 - Present); Vice President and Director, PNC Global Investment Servicing (May 2008 - March 2010); Vice President, BSA/AML/OFAC Officer, Yardville National Bank (June 2005 - April 2008)
Name and Age
Officer Since
Business Experience
George J. Theiller
Age - 62
2009 the Parent
Corporation
2005 the Bank
Vice President and Senior Auditor of the Parent Corporation and Senior Vice President and Senior Auditor of the Bank (December 2009 - Present); Vice President and Senior Auditor of the Bank (April 2005 - December 2009)
Vincent N. Tozzi
Age - 62
2011 the Parent
Corporation
2011 the Bank
Vice President, Treasurer and Chief Financial Officer of the Parent Corporation (March 2011 - Present); Senior Vice President and Chief Financial Officer of the Bank (February 2011 - Present); Consultant to the Bank’s Financial Division (December 2010 - February 2011); Partner and Chief Financial Officer, Aztec Environmental Energy Management (January 2008 - Present); Senior Vice President and Chief Financial Officer of The Bank of Princeton (October 2006 - January 2008).
Arthur M. Wein
Age - 62
2009 the Parent
Corporation
2009 the Bank
Vice President and Chief Operating Officer of the Parent Corporation and Senior Vice President and Chief Operating Officer of the Bank (October 2009 - Present); Vice President and Business Development Officer of the Summit Region of the Bank (April 2009 - October 2009); President and Chief Executive Officer of UTZ Technologies, Inc. (manufacturer of thick film hybrid screens) (December 2003 - March 2009)
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
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, 2012, the Corporation had 551 stockholders of record. This does not include beneficial owners for whom CEDE & Company or others act as nominees. On December 31, 2012, the closing sale price was $11.58.
The following table sets forth the high and low closing sales price, and the dividends declared, on a share of the Corporation’s common stock for the years ended December 31, 2012 and 2011. 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. No repurchases were made of the Parent Corporation’s common stock during 2012 or 2011.
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 a 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. On September 15, 2011, the Corporation issued $11.25 million in nonvoting senior preferred stock to the Treasury under the Small Business Lending Fund Program. Simultaneously, the Corporation redeemed from the Treasury, all 10,000 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share, for a redemption price of $10,041,667, including accrued but unpaid dividends up to the date of redemption. On December 7, 2011, the Corporation repurchased the outstanding warrants. In the repurchase, the Corporation paid the U.S. Treasury $245,000 for the warrants.
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 ”, Note 18 of the Notes to Consolidated Financial Statements.” 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. If the Parent Corporation fails to declare and pay dividends on the SBLF Preferred Stock in a given quarter, then during such quarter and for the next three quarters followings such missed dividend payment, the Parent Corporation may not pay dividends on, or repurchase, any common stock or any other securities that are Junior to (or in parity with) the SBLF Preferred Stock, except in very limited circumstances. Also under the terms of the SBLF Preferred Stock, the Parent Corporation may declare and pay dividends on its common stock or any other stock junior to the SBLF Preferred Stock, or repurchase shares of any such stock, only if after payment of such dividends or repurchase of such shares, the Parent Corporation’s Tier 1 Capital would be at least equal to the Tier 1 Dividend Threshold (as defined), excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock.
Stockholders Return Comparison
Set forth on the following page 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, 2008 through December 31, 2012.
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,
Assumes dividends reinvested
Year ended December 31, 2012
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
The following tables set forth selected consolidated financial data as of the dates and for the periods presented. The selected consolidated statement of financial condition data as of December 31, 2012 and 2011 and the selected consolidated summary of income data for the years ended December 31, 2012, 2011 and 2010 have been derived from our audited consolidated financial statements and related notes that we have included elsewhere in this Annual Report. The selected consolidated statement of financial condition data as of December 31, 2010, 2009 and 2008 and the selected consolidated summary of income data for the years ended December 31, 2009 and 2008 have been derived from audited consolidated financial statements that are not presented in this Annual Report.
The selected historical consolidated financial data as of any date and for any period are not necessarily indicative of the results that may be achieved as of any future date or for any future period. You should read the following selected statistical and financial data in conjunction with the more detailed information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes that we have presented elsewhere in this Annual Report.
On August 1, 2012, the Bank assumed all of the deposits and certain other liabilities and acquired certain assets of Saddle River Valley Bank. In this transaction, the Bank assumed $85.2 million in deposits and acquired $89.3 million in loans and securities from Saddle River Valley Bank. See Note 4 of the Notes to the Consolidated Financial Statements. The assumed liabilities and acquired assets are reflected in the table below for the year ended December 31, 2012. The Corporation’s results of operations for 2012 give effect to this acquisition from the date of the acquisition.
SUMMARY OF SELECTED STATISTICAL INFORMATION AND FINANCIAL DATA
Notes to Selected Financial Data
(1)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):
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.
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, 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 that it had 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 through 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 $870,000 were recognized in earnings during the year ended December 31, 2012. Of this amount, $68,000 related to a pooled trust preferred security (or “TRUP”), $484,000 related to a variable rate private label collateralized mortgage obligation (“CMO”) and $318,000 related to principal losses on a variable rate private label CMO. 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, 2012, the Corporation primarily relied upon the guidance in FASB ASC 320-10-65, FASB ASC 820-10-65 and FASB ASC 310-10-35. Additional information can be found in Note 5 of the Notes to Consolidated Financial Statements.
Impairment charges on certain investment securities of approximately $342,000 were recognized during the year ended December 31, 2011. Of this amount, $18,000 related to a variable rate private label collateralized mortgage obligation (“CMO”) and $324,000 in principal losses on a variable rate private label CMO. 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, 2011, the Corporation primarily relied upon the guidance in FASB ASC 320-10-65, FASB ASC 820-10-65 and FASB ASC 325-10-35.
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 (under the caption “Use of Estimates”) and 12 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, 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, 2012 and 2011.
Fair Value of Investment Securities
In October 2008, the FASB issued FASB ASC 820-10-35, 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. 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 when determining fair value for the Corporation’s pooled trust preferred securities and private issue corporate bond. See Note 19 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 2012.
The year 2012 was challenging not only for the banking industry in general but also for the Corporation in particular. The current domestic economic issues, ongoing global financial uncertainty and continued headwinds from new regulatory requirements created challenges to financial institutions both domestically and abroad. Interest rates in 2012 and 2011 were reflective of significantly lower short-term interest rates, as the Federal Reserve maintained its policy stance and continued to expand monetary policy with Quantitative Easing 3, or QE3, to further stimulate the economy and employment. As a result, the Federal Reserve kept overnight borrowing rates at zero to 25 basis points throughout 2012. Short-term interest rates remained lower than longer term rates, resulting in a somewhat improved steepening of the yield curve. Historically, such an improvement in yield curve has benefitted the Corporation’s net interest income, which is the Corporation’s primary source of income.
The Corporation was proactive with its balance sheet strategies throughout 2012 in order to reduce further exposure to interest rates through a reduction in higher cost funding and non-core balances in the deposit mix coupled with an improvement in the earning asset mix. The Corporation’s progress in growing and improving its balance sheet earning asset mix has helped to expand its spread and margin.
The Corporation’s net income in 2012 was $17.5 million or $1.05 per fully diluted common share, compared with net income of $13.9 million or $0.80 per fully diluted common share in 2011. The growth in earnings performance in 2012 (as well as in 2011) was primarily attributable to earnings from core operations. Earnings for 2012 and associated operating performance was characterized by solid revenue growth, strong organic loan generation and a continuation of our stable and favorable asset quality profile. Earnings were positively impacted by growth in net interest income, primarily from an increase in the average balance of earning assets of $216.7 million, which was partially offset by a decline of 40 basis points in yield. The decline in yield on earning assets was somewhat offset by a decline of 20 basis points from a lower cost of funds as compared to 2011, and reductions in loan loss provisions, OREO expense, FDIC insurance, OCC assessments and operating overhead.
For the year ended December 31, 2012, net interest income on a fully taxable equivalent basis amounted to $45.4 million, compared to $40.6 million for the same period in 2011. For 2012, interest income increased by $4.4 million while interest expense decreased by $401,000 from last year. Compared to 2011, for 2012, as noted above average interest earning assets increased $216.7 million while net interest spread and margin decreased on a tax-equivalent basis by 20 basis points and 21 basis points, respectively. For 2012, the Corporation’s net interest margin decreased to 3.32 percent as compared to 3.53 percent for 2011.
Net interest margins reflected improvement in the fourth quarter of 2012, as prior action on reducing the cost of funds coupled with offsetting compression primarily as result of a continued high liquidity pool carried during the periods took root and started to abate further compression. The Corporation still expects an improvement in margin, principally given the continued volume of asset deployment into loans from cash and elimination of temporary factors holding the margin down.
Total non-interest income declined as a percentage of total revenue, which is the sum of interest income and non-interest income, in 2012 largely due to a reduction in net securities gains; $2.0 million in 2012 as compared to $3.6 million in net securities gains in 2011. For the twelve months ended December 31, 2012, total other income decreased $268,000 as compared with the twelve months ended December 31, 2011, from $7.5 million to $7.2 million. Excluding net securities gains and losses and the bargain gain on acquisition of $899,000 in the respective periods, the Corporation recorded total other income of $4.3 million and $3.8 million in the twelve months ended December 31, 2012 and 2011, respectively.
For the twelve months ended December 31, 2012, total other expense increased $1.8 million, or 7.5 percent, compared to the year ended December 31, 2011. Excluding a repurchase agreement termination fee and acquisition cost, the increase was $260,000 and 1.1 percent. Increases primarily included salaries and employee benefits of $1.0 million, $40,000 in occupancy and equipment, $55,000 in marketing and advertising and $107,000 in computer expense. These increases were partially offset by decreases of $558,000 in FDIC insurance expense, $79,000 in professional and consulting fees, $19,000 in stationery and printing expense, $248,000 in OREO expense and $82,000 in all other expenses. The Corporation’ s efficiency ratio for the twelve months ended December 31, 2012 was 46.9 percent as compared to 53.7 percent in 2011.
Our continued performance put the Corporation at a competitive advantage while the competition for deposits in the Corporation’s marketplace remained intense. The Corporation expanded its client base and market share, as customers seek safety through high quality organizations to satisfy liquidity and safety and soundness ,which became paramount in light of the protracted financial crisis. With that competitive advantage, the Corporation continues to move forward with momentum in expanding our presence in key markets. With the acquisition of Saddle River Valley Bank and the opening of our Englewood office, we are working to solidify and expand the service relationship with our new customers. We remain excited by the potential to create incremental shareholder value from our strategic growth. We believe that this type of sequential earnings performance demonstrates the Corporation’s commitment to achieving meaningful growth in earnings performance, an essential component of providing consistent and favorable long-term returns to our shareholders. However, while we continue to see an improvement in balance sheet strength and core earnings performance, we still remain cautious about the credit stability of the broader markets.
Total assets at December 31, 2012 were $1.630 billion, an increase of 13.8 percent from assets of $1.433 billion at December 31, 2011. The increase in assets reflects the growth of $134.7 million in our loan portfolio as the Corporation continued to expand its client base and loan production, deploying cash from increased deposit production into a more efficient earning asset mix. The growth in the earning asset portfolio was funded primarily through deposit growth of $185.5 million, which also resulted in increases in loans net of the allowance for loan losses and loans available for sale of $134.0 million. The Corporation has made a concerted effort to reduce non-core balances and, as mentioned in the preceding sentence, its uninvested cash position decreased by $5.0 million in 2012. Additionally, there has been a concerted effort to reduce higher costing retail deposits.
Loan demand continued to expand in 2012. Overall, the portfolio increased year over year by approximately $134.7 million or 17.8 percent from 2011. Demand for both commercial loans and 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. The Corporation is encouraged by loan demand and positive momentum is expected to continue in growing that segment of earning assets in 2013. However, the Corporation continues to remain concerned with the credit stability of the broader markets due to the weakened economic climate and continues to maintain a conservative credit culture and at the same time, we continue to cautiously maintain our reserves for any potential future loan losses. At December 31, 2012, the Corporation had $244.9 million in overall undisbursed loan commitments, which includes largely unused commercial lines of credit, home equity lines of credit and available usage from active construction facilities. Included in the overall undisbursed commitments are the Corporation's "Approved, Accepted but Unfunded" pipeline, which includes approximately $58.1 million in commercial and commercial real estate loans and $10.9 million in residential mortgages expected to fund over the next 90 days.
Asset quality remains high and a primary focus of the Corporation. 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. Despite that, the Corporation’s asset quality continues to improve and our actions in 2012 related to asset quality have placed us near the top of all publicly traded banks and thrifts in the state of New Jersey. At December 31, 2012, non-performing assets totaled $5.0 million or 0.31 percent of total assets, a decline from $8.5 million or 0.59 percent at December 31, 2011. The decrease in non-performing assets from December 31, 2011 was achieved notwithstanding the addition of several new residential loans (totaling approximately $1.2 million) and commercial loans (totaling approximately $1.0 million) into non-performing status. This was more than offset by decreases from pay-downs of $1.7 million, total charge-offs of $175,000 of existing loans, and the transfer to performing troubled debt restructuring from non-accrual status of $1.3 million.
At December 31, 2012, the total allowance for loan losses amounted to approximately $10.2 million, or 1.15 percent of total loans. The allowance for loan losses as a percent of total non-performing loans amounted to 278.9 percent at December 31, 2012 and 121.5 percent at December 31, 2011. This increase in the ratio from December 31, 2011 to December 31, 2012 was due to the decrease in the level of non-performing assets, along with an increase in the allowance for loan loss from $9.6 million at December 31, 2011.
Deposit grew strongly during 2012, with total deposits of $1.3 billion at December 31, 2012, increasing $185.5 million, or 16.5%, since December 31, 2011. Total Demand, Savings, Money Market, and certificates of deposit less than $100,000 increased $212.7 million or 21.6% from December 31, 2011, underscoring the strength of core growth. These increases were attributable to continued core deposit growth in overall segments of the deposit base, as well as in niche areas, such as municipal government, private schools and universities, together with the Saddle River Valley Bank transaction. Time certificates of deposit of $100,000 or more at December 31, 2012, decreased by $27.2 million or 19.7% from December 31, 2011.
Total stockholders’ equity increased 18.2 percent in 2012 to $160.7 million, and represented 9.86 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 $9.14 as compared with $7.63 a year ago, primarily as a result of earnings of $17.5 million in 2012. Tangible book value per common share (which excludes goodwill and other intangibles from common stockholders’ equity) increased to $8.11 from $6.60 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 tangible stockholders’ equity for the year ended December 31, 2012 was 13.18 percent compared to 12.33 percent for 2011. This increase was attributable to higher earnings in 2012 compared with 2011 partially offset by higher average equity due primarily to benefit from the capital received under the SBLF program. The Tier I Leverage capital ratio decreased to 9.02 percent of total assets at December 31, 2012, as compared with 9.29 percent at December 31, 2011, as an increase in retained earnings was offset by the increased asset base in 2012.
The Corporation’s capital base includes the $11.25 million of capital received from the U.S. Treasury under the Small Business Lending Fund Program in 2011 and simultaneously, using the proceed from the issuance of SBLF preferred stock to redeem the $10 million of capital received from the U.S. Treasury under TARP. It also includes $5.2 million in subordinated debentures at December 31, 2012 and December 31, 2011. 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 ASC 810, these securities are classified as subordinated debentures on the Corporation’s Consolidated Statements of Condition.
The Corporation’s risk-based capital ratios at December 31, 2012 were 11.39 percent for Tier I capital and 12.22 percent for total risk-based capital. Total Tier I capital increased to approximately $143.8 million at December 31, 2012 from $129.4 million at December 31, 2011. The increase in Tier I capital primarily reflects earnings.
At December 31, 2012, the Corporation's capital ratios continued to exceed the minimum Federal requirements for a bank holding company, and Union Center National Bank's capital ratios continued to exceed each of the minimum levels required for classification as a "well capitalized institution" under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA").
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, 2012 was $17,507,000 as compared to $13,926,000 earned in 2011 and $7,004,000 earned in 2010, an increase of 25.7 percent from 2011 to 2012. For 2012, the basic and fully diluted earnings per common share was $1.05 per share as compared with $0.80 per share in 2011 and $0.43 per share in 2010.
For the year ended December 31, 2012, the Corporation’s return on average stockholders’ equity (“ROE”) was 11.69 percent and its return on average assets (“ROA”) was 1.14 percent. The Corporation’s return on average tangible stockholders’ equity (“ROATE”) was 13.18 percent for 2012. The comparable ratios for the year ended December 31, 2011, were ROE of 10.73 percent, ROA of 1.05 percent, and ROATE of 12.33 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 2012 benefitted from increases in net interest income and one time increases to non interest income and from decreases in the provision for loan loss. The increase in non-interest expenses was due to increases in salaries and benefits, occupancy expenses, marketing and advertising expenses and computer expenses, together with costs related to the acquisition of Saddle River Valley Bank and repurchase agreement prepayment and termination fees to terminate certain fixed rate long-term borrowings from Citi Global Market and the FHLB. These increases were partially offset by reductions in FDIC insurance, OREO expenses and professional and consulting expenses.
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 35 percent for 2012 and 34 percent for 2011 and 2010. 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 2012, 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, 2012 increased $4.8 million, or 11.7 percent, to $45.4 million, from $40.6 million for 2011. The Corporation’s net interest margin decreased 21 basis points to 3.32 percent from 3.53 percent. From 2010 to 2011, net interest income on a tax equivalent basis increased by $6.6 million and the net interest margin increased by 23 basis points. During 2012, our net interest margin was positively impacted by increases in the investment portfolio and net loans funded by increases in core deposits, a decrease in high yielding time deposits in excess of $100,000 and reductions in borrowings. These factors were offset, however, by lower rates earned on our loans and investments, resulting in an overall decline in our net interest margin.
The change in net interest income from 2011 to 2012 was attributable in part to the reduction in short-term interest rates that have remained at historic low levels throughout 2012 coupled with a sustained steepening of the interest rate yield curve. In light of the financial crisis, the Corporation experienced growth of $47.9 million in non-interest bearing deposits during 2012 and, $164.8 million in savings, money market and time deposits under $100,000 during 2012 as customers’ desire for safety and liquidity remained paramount in light of their overall investment concerns. During 2012, the Corporation made a concerted effort to reduce non-core, single service deposits, and accordingly its uninvested cash position, had an adverse impact on the Corporation’s net interest margin during 2012. During the twelve months ended December 31, 2012, the Corporation’s net interest spread declined by 20 basis points as a 40 basis point decrease in the average yield on interest-earning assets was not quite offset by a 20 basis point decrease in the average interest rates paid on interest-bearing liabilities.
For the year ended December 31, 2012, average interest-earning assets increased by $216.7 million to $1.4 billion, as compared with the year ended December 31, 2011. The 2012 change in average interest-earning asset volume was primarily due to increased investment volume and increased loan volume. Increased average investment volume in 2012 was funded primarily by the increased deposit growth. Average interest-bearing liabilities increased by $168.3 million, due primarily to an increase in interest bearing deposits of $201.7 million partially offset by decreases in borrowings of $33.4 million.
For the year ended December 31, 2011, average interest-earning assets increased by $121.5 million to $1.15 billion, as compared with the year ended December 31, 2010. The 2011 change in average interest-earning asset volume was primarily due to increased investment volume and to a lesser degree increased loan volume. Increased average investment volume in 2011 was funded primarily by the increased deposit growth. During the third quarter of 2011 certain sweep relationships, in the amount of approximately $37 million, that were previously classified as short term borrowings were discontinued and were moved to interest bearing checking accounts.
The factors underlying the year-to-year changes in net interest income are reflected in the tables presented on pages 37 and 39 , each of which have been presented on a tax-equivalent basis (assuming a 35 percent tax rate for 2012 and 34 percent for 2011 and 2010). The table on page 41 (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, 2012 increased by approximately $4.4 million or 8.3 percent as compared with the year ended December 31, 2011. This increase was due primarily to increases in the 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 maintain historically low market interest rates.
The Corporation’s loan portfolio increased on average $102.6 million to $815.5 million from $712.9 million in 2011, primarily driven by growth in commercial loans and commercial real estate.
The loan portfolio represented approximately 59.6 percent of the Corporation’s interest-earning assets (on average) during 2012 and 61.9 percent for 2011. Average investment securities increased during 2012 by $111.4 million compared to 2011 as the Corporation has continued to increase 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 4.58 percent in 2011 to 4.18 percent in 2012.
The increase in the average volume on total interest-earning assets created an increase in interest income of $9.4 million, as compared with a decrease of $5.0 million attributable to rate decreases in most interest-earning assets.
Interest income (fully tax-equivalent) increased by $4.0 million from 2010 to 2011 primarily due to an increase in balances of the Corporation’s 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 Federal Open Market Committee (“FOMC”) kept the Federal Funds target rate at zero to 0.25 percent throughout 2012. This action by the FOMC allowed the Corporation to reduce liability costs throughout 2012.
Interest expense for the year ended December 31, 2012 was principally impacted by volume related factors. The rate related changes resulted in decreased expense on most interest-bearing deposits and borrowings in 2012. For the year ended December 31, 2012, interest expense decreased $401,000 or 3.3 percent as compared with 2011, principally reflecting a reduction in the volume of borrowings. During 2012, 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 but that was not enough to offset a decrease in the rates earned on interest earning assets resulting in a decrease in the net interest spread. Average interest-bearing liabilities increased $168.3 million; the growth was represented in all deposit categories, except time deposits, as the flight to quality continued as depositors sought the safety of FDIC insurance.
For the year ended December 31, 2011, interest expense decreased $2.6 million or 17.6 percent as compared with 2010. 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) decreased 20 basis points to 3.19 percent in 2012 from 3.39 percent for the year ended December 31, 2011. The decrease in 2012 reflected a decline of spreads between yields earned on loans and investments and rates paid for supporting funds. During 2012, spreads declined due in part to monetary policy maintained by the FOMC keeping the Federal funds rate at zero to 0.25 percent throughout 2012 coupled with a steepening of the yield curve that occurred during 2012.
The net interest spread increased 26 basis points in 2011 as compared with 2010, primarily as a result of an expansion of spreads between yields earned on loans and investments and rates paid for supporting funds. During 2011, spreads improved due in part to monetary policy maintained by the FOMC keeping the Federal funds rate at zero to 0.25 percent throughout 2011 coupled with a steepening of the yield curve that occurred during 2011.
The cost of total average interest-bearing liabilities decreased to 0.99 percent, a decrease of 20 basis points, for the year ended December 31, 2012, from 1.19 percent for the year ended December 31, 2011, which followed a decrease of 42 basis points from 1.61 percent for the year ended December 31, 2010.
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 14 basis points, a decrease of 2 basis points in 2012 from 2011. Comparing 2011 and 2010, there was a decrease of 5 basis points to 16 basis points on average from 21 basis points on average during the year ended December 31, 2010.
The following table, “Average Statements of Condition with Interest and Average Rates”, presents for the years ended December 31, 2012, 2011 and 2010, 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 35 percent for 2012 and 34 percent for 2011 and 2010.
Investment Portfolio
For the year ended December 31, 2012, the average volume of investment securities increased by $111.4 million to approximately $541.3 million or 39.5 percent of average earning assets, from $429.9 million on average, or 37.3 percent of average earning assets, in 2011. At December 31, 2012, the total investment portfolio amounted to $554.9 million, an increase of $68.1 million from December 31, 2011. The increase at year-end and average volume of investment securities reflects the fact that with the strong deposit growth experienced during 2012 and large buildup of liquidity, the Corporation continued to prudently expand the size of its investment portfolio in an effort to deploy excess cash into earning assets. At December 31, 2012, the principal components of the investment portfolio are U.S. Treasury and 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.
During the year ended December 31, 2012, volume related factors increased investment revenue by $4.1 million, while rate related factors decreased investment revenue by $2.3 million. The tax-equivalent yield on investments decreased by 45 basis points to 3.28 percent from a yield of 3.73 percent during the year ended December 31, 2011. The increase in the investment portfolio resulted from the large buildup of liquidity, which caused the Corporation to prudently expand the size of its investment portfolio in an effort to deploy excess cash into earning assets. The yield on the portfolio decreased compared to 2011 due primarily to declines in rates earned on both taxable and tax exempt securities.
During 2011, the Corporation reclassified at fair value approximately $66.8 million in available-for-sale investment securities to the held-to-maturity category. The related after-tax gains of approximately $159,000 (on a pre-tax basis of $245,000) remained in accumulated other comprehensive income and will be amortized over the remaining life of the securities as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount on the transferred securities. No gains or losses were recognized at the time of reclassification. Management considers the held-to-maturity classification of these investment securities to be appropriate as the Corporation has the positive intent and ability to hold these securities to maturity.
The Corporation owns one pooled trust preferred security (“Pooled TRUPS”), which consists of securities issued by financial institutions and insurance companies. The Corporation holds the mezzanine tranche of these 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. During 2012, Pooled TRUP, ALESCO VII, incurred its fourteenth interruption of cash flow payments to date. Management reviewed the expected cash flow analysis and credit support to determine if it was probable to that all principal and interest would be repaid, and recorded an other-than-temporary impairment charge of $68,000 for the twelve months ended December 31, 2012. The new cost basis for this security had been written down to $830,000. The other Pooled TRUPS, ALESCO VI was sold in November 2012 and the Corporation incurred a loss on the sale of $18,000, and had no impairment charge for the twelve months ended December 31, 2012.
The Corporation owns one variable rate private label collateralized mortgage obligation (CMO), which was also evaluated for impairment. Management had applied aggressive default rates to identify if any credit impairment exists, as this bond was downgraded to below investment grade. The Corporation recorded $318,000 in principal losses and a $484,000 other-than-temporary impairment charge on this bond in 2012, subsequently, the bond was sold. The new cost basis for this security had been written down to $2.1 million. The Corporation recorded $324,000 in principal losses on 3 of these bonds and $18,000 other-than-temporary charge in 2011.
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, 2012, the net unrealized gain carried as a component of accumulated other comprehensive income and included in stockholders’ equity, net of tax, amounted to a net unrealized gain of $8.8 million as compared with a net unrealized loss of $2.2 million at December 31, 2011, resulting from changes in market conditions and interest rates at December 31, 2012. 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, 2012 and 2011. For additional information regarding the Corporation’s investment portfolio, see Note 5, Note 15 and Note 19 of the Notes to the Consolidated Financial Statements.
During 2012, securities sold from the Corporation’s available-for-sale portfolio amounted to $130.1 million, as compared with $254.8 million in 2011. The gross realized gains on securities sold amounted to approximately $2,905,000 in 2012 compared to $4,045,000 in 2011, while the gross realized losses, which included impairment charges of $870,000, amounted to approximately $893,000 in 2012 compared to $411,000 in 2011. During 2012, the Corporation recorded an other-than-temporary charge of $68,000 on the Pooled TRUP, ALESCO VII, a $484,000 other-than-temporary charge on a variable rate private label CMO and $318,000 in principal losses on the same variable rate private label CMO. During 2011, the Corporation recorded an $18,000 other-than-temporary charge on a variable rate private label CMO and $324,000 in principal losses on this variable rate private label CMO.
The varying amount of sales from the available-for-sale portfolio over the past few years, and the significant volume of such sales in 2011, reflect the significant volatility present in the market. Given the historic low interest rates prevalent in the market, it is necessary for the Corporation to protect itself from interest rate exposure. Securities that once appeared to be sound investments can, after changes in the market, become securities that the Corporation has the flexibility to sell to avoid losses and mismatches of interest-earning assets and interest-bearing liabilities at a later time.
The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for investment securities at December 31, 2012, on a contractual maturity basis.
For information regarding the carrying value of the investment portfolio, see Note 5 and Note 19 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 December 31, 2012.
Equity securities and other 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 5 and Note 19 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. While the overall economy has been constrained by uncertainty, the Corporation’s growth in loans continued during 2012. Enhanced visibility in its markets coupled with the aggressive business development activities of its sales team has continued to enhance its image and business prospects. However, the Corporation continues to predict economic instability in the near term and therefore expects to move cautiously in the growth process into 2013.
At December 31, 2012, total loans amounted to $889.7 million, an increase of 17.8 percent or $134.7 million as compared to December 31, 2011. The $2.6 million or 7.2 percent increase in interest income on loans for the twelve months ended December 31, 2012 was the result of increased volume as compared with 2011, offset in part by a lower interest rate environment. Even though the Corporation continues to be challenged by the competition for lending relationships that exists within its market, growth in volume has been achieved through successful lending sales efforts to build on continued customer relationships.
Total average loan volume increased $102.6 million or 14.4 percent in 2012, while the portfolio yield decreased by 32 basis points compared with 2011. The increased total average loan volume was due in part to enhanced visibility in the Corporation’s markets coupled with the aggressive business development activities of its sales team and the acquisition of the loan portfolio of Saddle River Valley Bank. The volume related factors during the period contributed increased revenue of $5.3 million, while the rate related changes decreased revenue by $2.7 million. Total average loan volume increased to $815.5 million with a net interest yield of 4.77 percent, compared to $712.9 million with a yield of 5.09 percent for the year ended December 31, 2011. The Corporation seeks to create growth in commercial lending by offering sound 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.
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 2012 was a result of the expansion of the Corporation’s customer base, aggressive business development and marketing programs coupled with its positive image in its market. The Corporation experienced an increased growth in its commercial lending sales efforts during 2011 and 2012 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 $661.7 million for the year ended December 31, 2012 compared to $559.7 million for the year ended December 31, 2011 or by approximately $102.0 million or 18.2 percent in 2012 compared with 2011.
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. A large proportion of the Corporation’s commercial loans have interest rates that reprice with changes in short-term market interest rates or mature in one year or less.
Average commercial real estate loans, which amounted to $394.1 million in 2012, increased $74.4 million or 23.3 percent as compared with average commercial real estate loans of $319.7 million in 2011 (which reflected a 7.8 percent increase over 2010). 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 five and ten-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, increased $6.5 million or 6.8 percent in 2012 as compared to 2011. During 2012, 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 by $10.4 million to $55.5 million in 2012 from $45.1 million in 2011. The average volume of such loans decreased by $8.7 million from 2010 to 2011. 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. Such loans averaged $885,000 in 2012, compared with $363,000 in 2011 and $704,000 in 2010. The decrease in loans to individuals during 2012 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, are popular with consumers due to their tax advantages over other forms of consumer borrowing. Home equity loans and secondary mortgages averaged $52.3 million in 2012, a decrease of $5.9 million or 10.1 percent compared to an average of $58.2 million in 2011 and $70.7 million in 2010. 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 2012 was due in part to the recent slowdown in the housing market and lower consumer spending. Additionally, floating rate home equity lines became less attractive during 2012 as consumers took advantage of historically low interest rates or opted to convert these loan balances into fixed rate loan products.
At December 31, 2012, the Corporation had total loan commitments outstanding of $242.2 million, of which approximately 66.4 percent were for commercial loans, commercial real estate loans and construction loans.
The maturities of loans at December 31, 2012 are listed below.
For additional information regarding loans, see Note 6 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 2012, the level of the allowance was $10,237,000 as compared to a level of $9,602,000 at December 31, 2011. The Corporation made loan loss provisions of $325,000 in 2012 compared with $2,448,000 in 2011 and $5,076,000 in 2010. The level of the allowance during the respective annual periods of 2012 and 2011 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, 2012, the allowance for loan losses amounted to 1.15 percent of total loans. In management’s view, the level of the allowance at December 31, 2012 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 1.15 percent, 1.27 percent and 1.25 percent at December 31, 2012, 2011 and 2010, respectively.
Net recoveries were $310,000 in 2012, compared to net charge-offs of $1,713,000 in 2011 and $4,920,000 in 2010. During 2012, the Corporation experienced a decrease in charge-offs and an increase in recoveries compared to 2011. Charge-offs were lower in most of the portfolio segments in 2012 than in 2011 and recoveries were higher in most of the loan portfolio segments in 2012 than in 2011. The most noticeable change is the dramatic reduction in charge-offs in the commercial real estate, commercial and industrial and construction loan portfolios. Commercial loan charge-offs were 95.1% lower in 2012 compared to 2011. In 2011, over half of the commercial loan charge-offs related to a single non-accrual participation loan that was subsequently placed into OREO during the fourth quarter of 2011 followed by the Corporation’s disposal of its ownership interest prior to December 31, 2011. Under $100 thousand in commercial charge-offs in 2011 were associated with a previously disclosed industrial warehouse construction loan project participated with and led by another New Jersey bank. The Corporation’s entire interest in that project was repurchased by the lead bank during the fourth quarter of 2011.
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 for the past five years.
For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements
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. For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.
Non-Performing and Past Due Loans and OREO
Non-performing loans include non-accrual loans and accruing loans which are contractually past due 90 days or more. 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 to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. The Corporation previously reported performing troubled debt restructured loans as a component of non-performing assets. For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.
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, other real estate owned (“OREO”) and troubled debt restructurings.
At December 31, 2012, non-performing assets totaled $5.0 million, or 0.31% of total assets, as compared with $8.5 million, or 0.59%, at December 31, 2011. The decrease from December 31, 2011 was achieved notwithstanding the addition of several new residential loans (totaling approximately $1.2 million) and commercial loans (totaling approximately $1.0 million) into non-performing status. This was more than offset by decreases from pay-downs of $1.7 million, total charge-offs of $175,000 of existing loans, the transfer of $1.3 million to other real estate owned and the transfer to performing troubled debt restructured from non-accrual status of $3.9 million.
Total non-performing assets decreased $3.4 million from December 31, 2010 to December 31, 2011. The decrease from December 31, 2010 was achieved notwithstanding the addition of several new residential loans (totaling approximately $2.6 million) and commercial loans (totaling approximately $1.4 million) into non-performing status. This was more than offset by decreases from pay-downs of $5.0 million, total charge-offs of $0.7 million of existing loans, and the transfer to performing troubled debt restructured from non-accrual status of $1.7 million.
The components of accruing loans, which are contractually past due 90 days or more as to principal or interest payments, are as follows:
TDR Decrease
Troubled Debt Restructured loans (“TDR’s”) at December 31, 2012 totaled $8.3 million of which $6.8 million were performing pursuant to the terms of their respective modifications. The level of performing TDR’s decreased during 2012 despite the addition of one residential loans totalling $580,000 and one installment loan totalling $137,000. This was offset by payments and payoffs to existing TDR’s totalling $129,000. All but $16,000 of these payments were for commercial loan TDR’s. Another one residential TDR’s totalling $524,000 was returned to its original contractual loan terms. The net decrease for 2012 in performing TDR’s totaled $646,000.
Other known “potential problem loans” (as defined by SEC regulations) as of December 31, 2012 have been identified and internally risk rated as assets especially mentioned or substandard. Such loans, which include non-performing assets and TDR’s included in the table above, amounted to $47,426,000, $48,976,000 and $38,382,000 at December 31, 2012, 2011 and 2010, respectively. The decrease at December 31, 2012 from December 31, 2011 reflects continued improvement 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. During 2012, the Corporation internally risk rated as assets especially mentioned or substandard a total of $16,750,000 new commercial loans of which $8,141,000 were acquired in the Saddle River Valley Bank transaction, $645,000 new residential loans and one installment loan for $137,000. This was partially offset by upgrades to an internal pass risk rating of $9,173,000 in commercial loans and $752,000 of residential loans. Payoffs of commercial and residential loans totaled $6,524,000. Charge-offs and transfers to other real estate owned accounted for $1,400,000. A final mitigant came from continued principal reductions on other potential problem loans. With the exception of non-accrual loans and loans past due 90 days or more and accruing, potential problem loans were performing as of December 31, 2012. The Corporation has no foreign loans.
At December 31, 2012, 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, 2011, the Corporation had no doubtful loans.
With respect to concentrations of credit within the Corporation’s loan portfolio at December 31, 2012, $97.5 million or 53.4% of the commercial loan portfolio represented outstanding working capital loans to various real estate developers. $97.5 million of these loans were not secured by mortgages on land and on buildings under construction.
For additional information regarding risk elements in the Corporation’s loan portfolio, see Note 6 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, 2012.
For the period ended December 31, 2012, total other income decreased $268,000 compared to 2011, primarily as the result of a decrease of $1.6 million in net securities gains in 2012 compared to net securities gains in 2011and a decrease of $121,000 in service charge income partially offset by onetime increases consisting of $899,000 in bargain gain on acquisition (representing the pre-tax net amount recorded between net asset acquired from the Saddle River Valley Bank and the cash consideration paid in the purchase and assumption of Saddle River Valley Bank) and $150,000 gain from the sale of judgments included in other income, as well as $233,000 in gains of loans available for sale, $94,000 in higher annuity commissions and, $78,000 in increases in loan related fees. Excluding net securities gains in the respective periods, the Corporation recorded other income of $5.2 million in the year ended December 31, 2012 and $3.8 million in the year ended December 31, 2011.
During 2012, the Corporation recorded net securities gains of $2.0 million compared to net securities gains of $3.6 million in 2011 and net securities losses of $1.3 million in 2010. In 2012, total other-than-temporary impairment charges of $870,000 were offset by net gains on securities sold of $2.9 million. During 2012, securities sold from the Corporation’s available-for-sale portfolio amounted to approximately $130.1 million compared to approximately $254.8 million in 2011. The gross realized gains on securities sold amounted to approximately $2.9 million in 2012 compared to $4.0 million in 2011, while the gross realized losses amounted to approximately $893,000 in 2012 compared to $411,000 in 2011. The sales of securities were made in the normal course of business and the proceeds were primarily reinvested into the investment portfolio.
During 2012, the Corporation recorded an other-than-temporary impairment charge of $68,000 on a Pooled TRUP, ALESCO VII, and $484,000 on a variable rate private labeled CMO and $318,000 in principal losses on a variable rate private label CMO. For the year ended December 31, 2011, the Corporation recorded an other-than-temporary impairment charge of $18,000 on a variable rate private label CMO and $324,000 in principal losses on a variable rate private label CMO. For the year ended December 31, 2010, these impairment charges consisted of a $3.0 million other-than-temporary impairment charge on its trust preferred securities, $1.8 million on two pooled TRUP, $360,000 on a variable rate private label CMO and $398,000 in principal losses on a variable rate private label CMO.
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, 2012.
Total other expense increased $1.8 million, or 7.48 percent, in 2012 from 2011 as compared with a decrease of $656,000, or 2.72 percent, from 2010 to 2011. The level of operating expenses during 2012 increased primarily as a result of one time charges of $1.0 million in repurchase agreement prepayment and termination fees to break certain fixed rate long term borrowings from Citi Global Markets and the FHLB and $482,000 in costs to acquire certain assets and liabilities of Saddle River Valley Bank, Other expense increases were in salary and benefits which increased by $1.0 million, occupancy expense of $40,000, marketing expenses of $55,000, and computer expenses of $107,000. These increases were offset in part by decreased FDIC Insurance of $558,000, professional and consulting fees of $79,000, stationery and printing expenses of $19,000, OREO expense of $248,000 and other expenses of $82,000. Total other expense decreased in 2011 from 2010 across several expense categories, with the largest decreases occurring in premises and equipment expense, FDIC insurance expense, marketing and advertising expense, a termination fee on a structured securities repurchase agreement and loss on fixed assets.
Prudent management of operating expenses has been 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 1.64 percent in 2012 compared to 1.77 percent in 2011 and 2.03 percent in 2010.
Salaries and employee benefits increased $1,044,000 or 9.06 percent in 2012 compared to 2011 and increased $762,000 or 7.08 percent from 2010 to 2011. The increase in 2012 was primarily attributable to merit increases to existing staff and additions to office and employee staff of $467,000 and $273,000, respectively, pension and 401(k) increase of $133,000, and increased medical insurance expense of $170,000. The increase in 2011 was primarily attributable to merit increases to existing staff and additions to office and employee staff of $439,000 and $125,000, respectively, pension and 401(k) increase of $129,000, and increased medical insurance expense of $40,000.
Salaries and employee benefits accounted for 49.9 percent of total non-interest expense in 2012, as compared to 49.2 percent and 44.7 percent in 2011 and 2010, respectively.
Occupancy and equipment expense for the year ended December 31, 2012 increased by $40,000 or 1.36 percent, over 2011. Occupancy and equipment expense for 2011 decreased by $234,000 or 7.36 percent, compared to 2010. For the year ended December 31, 2012, the Corporation recorded reductions of $56,000 in depreciation expense, $19,000 in insurance, $34,000 in building and equipment maintenance expense and $10,000 in utilities. These decreases were more than offset by increases of $63,000 in real estate taxes and $95,000 in rent expense primarily due to the acquisition of Saddle River Valley Bank branches and the new Englewood branch facility. For the year ended December 31, 2011, the Corporation recorded reductions of $170,000 in depreciation expense, and $62,000 in real estate taxes, largely associated with the Corporation’s former operations facility somewhat offset by an increase of $42,000 in building and equipment maintenance expense.
In 2011 the FDIC adopted a revised assessment schedule based on total assets less Tier 1 Capital and dropped the assessment rate to compensate for increasing the new base. FDIC insurance expense in 2012 was approximately $558,000 less than the 2011 expense. For the year ended December 31, 2011, FDIC insurance expense decreased $414,000 compared to 2010.
Professional and consulting expense for 2012 decreased $79,000 due to reduced compliance and legal loan workout issues. Such expenses increased in 2011 from 2010 primarily due to compliance and legal loan workout issues.
Stationery and printing expenses for 2012 decreased $19,000 or 5.16 percent, compared to 2011, due primarily to reduction of costs related to marketing of new bank products in 2011. The increase in such expenses of $53,000 or 16.5 percent in 2011 from 2010 was due primarily to costs related to marketing of new bank products.
Marketing and advertising expenses for the year ended December 31, 2012 increased $55,000, or 41.98 percent, from the comparable twelve-month period in 2011, primarily due to expense outlays for media for the two Saddle River branches acquired and the opening of the new Englewood branch office. These expenses decreased $137,000 or 51.1 percent in 2011 compared with 2010 primarily due to lower expense outlays for media.
Computer expense increased $107,000 during 2012 compared to 2011 and decreased $54,000 in 2011 compared to 2010, due primarily to fees paid in connection with the maintenance of computer systems for Saddle River Valley Bank for the period between closing the acquisition and conversion of Saddle River Valley Bank’s systems to the Corporation’s systems. The reduction in 2011 was related to fees paid to the Corporation’s outsourced information technology service provider. This strategic outsourcing arrangement has significantly improved operating efficiencies and reduced overhead, primarily in salaries and benefits.
OREO expense for 2012 decreased by $248,000 over 2011 due primarily to a decreased level of OREO properties.
Other expense decreased in 2012 by approximately $82,000 or 2.11 percent compared to 2011 mainly due to decreases in other losses and chargeoffs of $287,000 which represented an expense in 2011 for tax certificates not duplicated in 2012, OCC assessment fees of $95,000 and miscellaneous expenses of 84,000 which were partially offset by increases in postage of $31,000, telephone of $35,000, other insurance of $20,000, donations of $56,000, travel & entertainment of $57,000, lending and consumer reports of $56,000 and fees on our CDAR products of $60,000. Other expense increased in 2011 by $241,000 or 6.6 percent, compared to 2010, mainly due to a $287,000 loss related to tax certificates acquired to protect our interest in property subsequently assigned to Highlands State Bank. Amortization of core deposit intangibles accounted for $47,000 and $57,000 of other expense for the years 2012 and 2011, respectively.
Provision for Income Taxes
The Corporation recorded income tax expense of $7.7 million in 2012 compared to $7.4 million in 2011 and $222,000 in 2010. The increase in 2012 resulted from an increase in pretax earnings offset in part by a reduced rate due to the establishment of a REIT subsidiary to take advantage of favorable tax treatment. The increase in 2011 reflected an increase in pretax earnings as well as the fact that the 2010 provision for income taxes was reduced due to the liquidation of certain subsidiaries as part of a business restructuring. The effective tax rates for the Corporation for the years ended December 31, 2012, 2011 and 2010 were 30.5 percent, 34.7 percent and 3.1 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. For a more detailed description of income taxes see Note 12 of the Notes to Consolidated Financial Statements.
Tax-exempt interest income on a fully tax equivalent basis increased by $2.82 million, or 109.5 percent, from 2011 to 2012, and increased by $2.24 million, or 673.6 percent, from 2010 to 2011. 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 $1,018,000, $1,038,000 and $1,226,000 for 2012, 2011 and 2010, 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.
In December 2012, the FASB issued an exposure draft of a proposed ASU of Topic 825-15, Credit Losses. The amendments of the proposed ASU would require all reporting entities, both public and nonpublic, to calculate impairment of existing financial assets on the basis of the current estimates of contractual cash flows not expected to be collected on the financial assets held at the reporting date. The proposed amendments would remove the existing “probable” threshold for recognizing credit losses and broaden the range of information that must be considered in measuring the allowance for expected credit losses. The estimate of expected credit losses would be based on relevant information about past events, including historical loss experience with similar assets, current conditions and reasonable and supportable forecasts that affect the future collectability of the assets’ remaining contractual cash flows.
As a result of the proposed amendments, financial assets carried at amortized cost less an allowance would reflect the current estimate of the cash flows expected to be collected at the reporting date, and the income statement would reflect credit deterioration (or improvement) that has taken place during the period. For financial assets measured at fair value with changes in fair value recognized through other comprehensive income, the balance sheet would reflect the fair value, but the income statement would reflect credit deterioration (or improvement) that has taken place during the period. An entity, however, may choose to not recognize expected credit losses on financial assets measured at fair value, with changes in fair value recognized through other comprehensive income, if both (1) the fair value of the financial asset is greater than (or equal to) the amortized cost basis and (2) expected credit losses on the financial asset are insignificant. Currently, when credit losses are measured an entity only considers past events and current conditions, the proposed amendments would broaden the information entities are required to consider to include historical loss experience with similar assets and reasonable and supportable forecasts that affect the expected collectability of the assets’ remaining contractual cash flows. It is expected that entities will be able to leverage their current risk monitoring systems in implementing the proposed approach, however, for the inputs used to estimate the expected credit loss approach. An entity would apply the proposed amendments with a cumulative-effect adjustment to the statement of financial position beginning in the first reporting period in which the guidance is effective.
Both users and preparers of financial statements were requested to review and comment upon the exposure draft by April 30, 2013. The exposure draft does not include a proposed effective date of this guidance.
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, 2012, the Corporation reflected a positive interest sensitivity gap (or an interest sensitivity ratio of (1:44 to 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 2013. 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, 2012:
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 19 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 securities available to pledge, 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 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, 2012, the Parent Corporation had $629,000 in cash and short-term investments compared to $2.0 million at December 31, 2011. 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, 2012, 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, 2012 projected to December 31, 2013, the Corporation believes that the Bank’s liquidity should remain strong, with an approximate projection of $196.9 million in anticipated net 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.
Deposits
Total deposits increased to $1.307 billion at December 31, 2012 from $1.121 billion at December 31, 2011, an increase of $185.5 million, or 16.5 percent.
Total non-interest-bearing deposits increased to $215.1 million at December 31, 2012 from $167.2 million at December 31, 2011, an increase of $47.9 million or 28.6 percent. Time, savings and interest-bearing transaction accounts increased to $981.0 million at December 31, 2012 from $816.3 million on December 31, 2011, an increase of $164.8 million or 20.2 percent. These increases were attributable to continued core deposit growth in overall segments of the deposits base and in niche areas, such as municipal government, private schools and universities.
Certificates of deposit $100,000 and over decreased to 8.48 percent of total deposits at December 31, 2012 from 12.3 percent one year earlier. With the turmoil in the financial markets commencing several years ago, some of the Corporation’s depositors have become sensitive to obtaining full FDIC insurance for their time deposits. To accommodate these customers, the Corporation began offering Certificates of Deposit Account Registry Service (CDARS) in 2008. As a result of this offering and the increase in insurance coverage by the FDIC to $250,000, the Corporation reported a decrease of $27.2 million in certificates of deposit greater than $100,000 at December 31, 2012 compared to year-end 2011. See Note 9 of the Notes to the Consolidated Financial Statements for more information.
At December 31, 2012, the Corporation had a total of $14.7 million with a weighted average rate of 0.60 percent in CDARS Reciprocal deposits compared to $58.9 million with a weighted average rate of 0.70 percent at December 31, 2011. 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, 2012, core deposits, comprised of total demand deposits, savings deposits and money market accounts, increased by $209.3 million or 22.6 percent from December 31, 2011 to $1.136 billion at December 31, 2012. At December 31, 2012, core deposits were 86.9 percent of total deposits compared to 83.4 percent at year-end 2011. 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 increased by $184.7 million or 27.6 percent from December 31, 2011 to $852.8 million at December 31, 2012 and represented 65.25 percent of total deposits at December 31, 2012 as compared with 59.6 percent at December 31, 2011. The Corporation expects its deposit gathering efforts to remain strong, supported in part by the FDIC’s raising the deposit insurance limits. The Corporation was a participant in the FDIC’s Transaction Account Guarantee Program. Under this program, all non-interest bearing deposit transaction accounts were fully guaranteed by the FDIC, regardless of dollar amount, through June 30, 2010.
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. One of the provisions of this Act permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.
The following table depicts the Corporation’s more stringent core deposit mix at December 31, 2012 and 2011.
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 $0 at year-end 2012, and 2011. During the third quarter of 2011 certain sweep relationships, in the amount of approximately $37 million, that were previously classified as short term borrowings were discontinued and were moved to interest bearing checking accounts.
The following table is a summary of short-term securities sold under repurchase agreements, including Federal Funds purchased, 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 $146.0 million at December 31, 2012, a decrease of $15.0 million or 9.32 percent, from year-end 2011 as the Corporation decided to terminate a $10.0 million repurchase agreement and to prepay a $5.0 million FHLB NY advance and concentrate its efforts on increasing the core deposit base of the Bank.
Cash Flows
The consolidated statements of cash flows present the changes in cash and cash equivalents from operating, investing and financing activities. During 2012, cash and cash equivalents (which decreased overall by $5.0 million) were provided on a net basis by operating activities and financing activities, and used on a net basis by investing activities. With respect to the cash flows from financing activities, net increases in deposits were partially offset payments on long-term borrowings and the Corporation’s dividend payments.
During 2011, cash and cash equivalents (which increased overall by $73.6 million) were provided on a net basis by operating activities and financing activities, and used on a net basis by investing activities. With respect to the cash flows from financing activities, net increases in deposits and SBLF proceeds were offset by reductions in borrowings and the Corporation’s dividend payments.
During 2010, cash and cash equivalents (which decreased overall by $51.7 million) were provided on a net basis by operating activities and used on a net basis by investing activities and financing activities. With respect to the cash flows from financing activities, a net increase in deposits and proceeds from a stock offering were more than offset by a reduction in borrowings and the Corporation’s dividend payments.
Contractual Obligations and Other Commitments
The following table summarizes contractual obligations at December 31, 2012 and the effect such obligations are expected to have on liquidity and cash flows in future periods.
The Stockholders’ Equity
Stockholders’ equity amounted to $160.7 million at December 31, 2012, an increase of $24.8 million or 18.2 percent, compared to year-end 2011. At December 31, 2011, stockholders’ equity totaled $135.9 million, an increase of $14.9 million or 12.4 percent from December 31, 2010.
On September 15, 2011, the Corporation issued $11.25 million in nonvoting senior preferred stock to the Treasury under the Small Business Lending Fund Program. Under the Securities Purchase Agreement, the Corporation issued to the Treasury a total of 11,250 shares of the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B, having a liquidation value of $1,000 per share. Simultaneously, using the proceeds from the issuance of the SBLF Preferred Stock, the Corporation redeemed from the Treasury, all 10,000 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share, for a redemption price of $10,041,667, including accrued but unpaid dividends up to the date of redemption. The investment in the SBLF program provided the Corporation with approximately $1.25 million additional Tier 1 capital. The capital received under the program has allowed the Corporation to continue to serve its small business clients through the commercial lending program.
On December 7, 2011, the Corporation repurchased the warrants issued on January 12, 2009 to the U.S. Treasury as part of its participation in the U.S. Treasury’s TARP Capital Purchase Program. In the repurchase, the Corporation paid the U.S. Treasury $245,000 for the warrants.
In September 2010, the Corporation sold an aggregate of 1,715,000 shares of its common stock under its previously filed shelf registration statement. The Corporation sold 1,430,000 shares of common stock at a price of $7.00 per share, with underwriting discounts and commissions of $0.39 per share, for gross proceeds from this offering of $10,010,000. The Corporation also sold 285,000 shares of common stock directly to certain of its directors at a price of $7.50 per share, for gross proceeds from this offering of $2,137,500. Net proceeds from both offerings totaled $11,378,000 after underwriting discounts and commissions of $557,000 and offering expenses of approximately $213,000 (which consisted primarily of legal and accounting fees).
Book value per share at year-end 2012 was $9.14 compared to $7.63 at year-end 2011. Tangible book value at year-end 2012 was $8.11 compared to $6.60 at year end 2011; see Item 6 for a reconciliation of this non-GAAP financial measure to book value.
During 2012, the Corporation made no purchases of common stock. At December 31, 2012, 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 Corporation’s Tier I leverage capital (defined as tangible stockholders’ equity for common stock and Trust Preferred Capital Securities) at December 31, 2012 amounted to $143.8 million or 9.02 percent of average total assets. At December 31, 2011, the Corporation’s Tier I leverage capital amounted to $129.4 million or 9.29 percent of average total assets. Tier I capital excludes the effect of FASB ASC 320-10-05, which amounted to $8.8 of net unrealized gains, after tax, on securities available-for-sale at December 31, 2012 (and would be reported as a component of accumulated other comprehensive income which is included in stockholders’ equity), and is reduced by goodwill and intangible assets, which amounted to $16.8 million as of December 31, 2012. 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, 2012, the Corporation’s Tier I and total risk-based capital ratios were 11.39 percent and 12.22 percent, respectively. For information on risk-based capital and regulatory guidelines for the Parent Corporation and its bank subsidiary, see Note 14 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.
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. The floating interest rate on the subordinate debentures is three-month LIBOR plus 2.85 percent and reprices quarterly. The rate at December 31, 2012 was 3.16 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 11 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 Corporation’s 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 or 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, 2012, and assuming that management does not take action to alter the outcome, the Corporation would expect an increase of 0.95 and 1.53 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, 2012, 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 both 2012 and 2011 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 2013. 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 a fair value of $325,000 at December 31, 2012 and $262,000 at December 31, 2011. 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 2012 and 2011, the Corporation did not record any other-than-temporary impairment charges relating to equity holdings in bank stocks. The remaining securities in the other equity portfolio were mutual funds and money market funds.
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, 2012. 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, 2012 (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, 2012, 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, 2012. The report, which expresses an unqualified opinion on the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2012, is included in this item under the heading “Report of Independent Registered Public Accounting Firm.”
(c) Report of Independent Registered Public Accounting Firm
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, 2012, 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 accounting principles generally accepted in the United States of America. 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, 2012, 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 statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2012 and our report dated March 13, 2013, expressed an unqualified opinion.
/s/ ParenteBeard LLC
ParenteBeard LLC
Clark, New Jersey
March 13, 2013
(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 2013 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 2013 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 2013 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, 2012. These plans were the Corporation’s only equity compensation plans in existence as of December 31, 2012.
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 2013 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accounting 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 2013 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:
(b)Exhibits (numbered in accordance with Item 601 of Regulation S-K) filed herewith or incorporated by reference as part of this annual report.
Exhibit
No.
Description
2.1
Bank Purchase and Assumption Agreement, dated February 1, 2012, by and among the Registrant, Saddle River Valley Bancorp and Saddle River Valley Bank is incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K dated February 2, 2012.
3.1
The Registrant’s Restated Certificate of Incorporation.
3.2
The Registrant’s Amended and Restated By-Laws.
10.1
Small Business Lending Fund - Securities Purchase Agreement - Standard Terms attached thereto dated September 15, 2011, between the Registrant and the United States Department of the Treasury is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated September 21, 2011.
10.2*
The Registrant’s 1993 Employee Stock Option Plan is incorporated by reference to Exhibit 10.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993.
10.3*
The Registrant’s 1993 Outside Director Stock Option Plan is incorporated by reference to Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993.
10.5*
The Registrant’s Annual Incentive Plan is incorporated by reference to Exhibit 10.6 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006.
10.6*
Employment Agreement, effective April 4, 2012, by and among the Registrant, Union Center National Bank and Anthony C. Weagley, is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on April 6, 2012.
10.7
Non-Competition Agreement, dated as of December 2, 2010, between the Registrant, and Anthony C. Weagley is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated December 6, 2010.
10.8
Non-Competition Agreement, dated as of December 2, 2010, between the Registrant, and James W. Sorge is incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated December 6, 2010.
10.9*
Center Bancorp, Inc. 2009 Equity Incentive Plan is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated June 1, 2009.
10.10*
Center Bancorp, Inc. 1999 Stock Incentive Plan is incorporated by reference to Exhibit 10.11 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999.
Exhibit
No.
Description
10.11
Registrant’s Placement Agreement dated December 12, 2003 with Sandler O’Neill & Partners, L.P. to issue and sell $5 million aggregate liquidation amount of floating rate MMCapS(SM) Securities is incorporated by reference to Exhibit 10.15 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.12
Indenture dated as of December 19, 2003, between the Registrant and Wilmington Trust Company relating to $5.0 million aggregate principal amount of floating rate debentures is incorporated by reference to Exhibit 10.16 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.13
Amended and restated Declaration of Trust of Center Bancorp Statutory Trust II, dated as of December 19, 2003 is incorporated by reference to Exhibit 10.17 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.14
Guarantee Agreement between Registrant and Wilmington Trust Company dated as of December 19, 2003 is incorporated by reference to Exhibit 10.18 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.15
Registration Rights Agreement, dated September 29, 2004, relating to securities issued in a September 2004 private placement of securities, is incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated October 1, 2004.
10.16*
The Registrant’s Amended and Restated 2003 Non-Employee Director Stock Option Plan, as amended and restated, is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated March 5, 2008.
10.17*
Amended and restated Employment Agreement among the Registrant, its bank subsidiary and Mark S. Cardone, effective as of January 1, 2007, is incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 10-K filed with the SEC on February 26, 2007. See also Exhibit 10.22.
10.18
Registration Rights Agreement, dated June 30, 2005, relating to securities issued in a June 2005 private placement of securities is incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated June 30, 2005.
10.19*
Open Market Share Purchase Incentive Plan is incorporated by reference to exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated January 26, 2006.
10.20*
Amendment to Employment Agreement among the Registrant, its bank subsidiary and Mark Cardone, dated December 3, 2007, is incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 10-K dated December 20, 2007.
10.23
Repurchase Agreement, dated September 15, 2011, between the Registrant and the United States Department of the Treasury, with respect to the repurchase of Preferred Stock issued pursuant to TARP is incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated September 21, 2011.
10.24
Warrant Letter Agreement, dated December 7, 2011, providing for the repurchase of the warrants issued pursuant to TARP is incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated December 12, 2011.
11.1
Statement regarding computation of per share earnings is omitted because the computation can be clearly determined from the material incorporated by reference in this Report.
12.1
Statement of Ratios of Earnings to Fixed Charges.
14.1
Code of Ethics is incorporated by reference to Exhibit 14.1 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
21.1
Subsidiaries of the Registrant.
23.1
Consent of Independent Registered Public Accounting Firm.
24.1
Power of attorney
Exhibit
No.
Description
31.1
Personal certification of the chief executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Personal certification of the chief financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
32.1**
Personal certification of the chief executive officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
32.2**
Personal certification of the chief financial officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
99.3
Code of Conduct is incorporated by reference to Exhibit 99.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.
101***
INS XBRL instance document
101***
SCH XBRL Taxonomy Extension Schema Document
101***
CAL XBRL Taxonomy Extension Calculation Linkbase Document
101***
DEF XBRL Taxonomy Extension Definition Linkbase Document
101***
LAB XBRL Taxonomy Extension Label Linkbase Document
101***
PRE XBRL Taxonomy Extension Presentation Linkbase Document
(c)Financial Statement Schedules
*Management contract on compensatory plan or arrangement.
**Furnished herewith.
***In accordance with Rule 406T of Regulation S-T, the XBRL information in Exhibit 101 to this Annual Report shall not be deemed “filed” for purposed of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject liability under that Section.
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.
CENTER BANCORP, INC.
March 13, 2013 By:
/s/ Anthony C. Weagley
Anthony C. Weagley
President and Chief Executive Officer
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 13, 2013, have signed this report below.
/s/ Alexander A. Bol*
Chairman of the Board
Alexander A. Bol
/s/ Frederick S. Fish *
Director
Frederick S. Fish
/s/ James J. Kennedy*
Director
James J. Kennedy
/s/ Howard Kent*
Director
Howard Kent
/s/ Nicolas Minoia*
Director
Nicholas Minoia
/s/ Harold Schechter*
Director
Harold Schechter
/s/ Lawrence B. Seidman*
Director
Lawrence B. Seidman
/s/ William A. Thompson*
Director
William A. Thompson
/s/ Raymond Vanaria*
Director
Raymond Vanaria
/s/ Anthony C. Weagley
President and Chief Executive Officer
Anthony C. Weagley
/s/ Vincent N. Tozzi*
Vice President, Treasurer and Chief Financial Officer
Vincent N. Tozzi
*By:
/s/ Anthony C. Weagley
Anthony C. Weagley
Attorney-in-fact