Item 1. Business.
The disclosures set forth in this item are qualified by Item 1A.
Item 1A.
Risk Factors.
The following are some important factors that could cause the Company’s actual results to differ materially from those referred to or implied in any forward-looking statement. These are in addition to the risks and uncertainties discussed elsewhere in this Annual Report on Form 10-K and the Company’s other filings with the SEC.
Our dependence on loans secured by real estate subjects us to risks relating to fluctuations in the real estate market and related interest rates, and to legislation that could result in significant additional costs and capital requirements, which could adversely affect our financial condition and results of operations.
Approximately 91.6% of our loan portfolio as of December 31, 2015 was comprised of loans collateralized by real estate, with 98.2% of the real estate located in New Jersey. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market areas could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing the loans and the value of real estate owned by us. As real estate values decline, it is also more likely that we would be required to make provisions for additional loan losses, which could adversely affect our financial condition and results of operations.
As of December 31, 2015, we had $104.2 million, or 15.0%, of our total loans in real estate construction loans. Of this amount, $5.1 million were land loans and $81.6 million were made to finance residential construction. Substantially all of these loans are located in Monmouth, Union and Middlesex Counties, New Jersey. Further, $17.5 million of real estate construction loans were made to finance commercial construction. Construction loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial real estate loans. These risks include:
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the viability of the contractor;
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the value of the project being subject to successful completion;
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the contractor’s ability to complete the project, to meet deadlines and time schedules and to stay within cost estimates; and
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concentrations of such loans with a single contractor and its affiliates.
Real estate construction loans also present risks of default in the event of declines in property values or volatility in the real estate market during the construction phase. If we are forced to foreclose on a project prior to completion, we may not be able to recover the entire unpaid portion of the loan, may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate amount of time. If any of these risks were to occur, it could adversely affect our financial condition, results of operations and cash flows.
The federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate or real estate construction portfolios or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business and result in a requirement of increased capital levels, and such capital may not be available at that time.
Our commercial real estate and commercial loans expose us to increased credit risks, and these risks will increase if we succeed in increasing these types of loans.
We focus our lending efforts on commercial-related loans and intend to grow commercial real estate and commercial loans further as a percentage of our portfolio. As of December 31, 2015, commercial real estate loans and commercial and industrial loans totaled $522.8 million. In general, commercial real estate loans and commercial and industrial loans yield higher returns and often generate a deposit relationship, but also pose greater credit risks than do owner-occupied residential real estate loans. As our various commercial-related loan portfolios increase, the corresponding risks and potential for losses from these loans will also increase.
We make both secured and some unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses or the guarantor(s). Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Further, commercial and industrial loans generally will be serviced primarily from the operation of the business, which may not be successful, and commercial real estate loans generally will be serviced from income on the properties securing the loans.
Our financial condition and results of operations could be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance.
Despite our underwriting criteria, we may experience loan delinquencies and losses. In order to absorb losses associated with non-performing loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as non-performing or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become non-performing assets or that we will be able to limit losses on those loans that are identified.
We may be required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.
We may not be able to successfully integrate any banks or other businesses that we may acquire.
Our strategy has been to carefully evaluate each acquisition opportunity presented to us to determine whether it fits into our strategic growth plan and ensure that it does not involve excessive risk to the Company. Should we decide to pursue any acquisition opportunity, we may not be able to successfully integrate the assets, liabilities, customers, systems and management personnel we acquire into our operations, and we may not be able to realize related revenue synergies and cost savings within our expected time frames. In addition, we will incur substantial legal, investment banking, accounting and other expenses in pursuing any acquisitions. In respect to any completed acquisition, there will be potential goodwill impairment charges and fluctuations in the fair values of assets in the event projected financial results are not achieved within expected time frames.
Negative developments in the financial services industry and the U.S. and global credit markets may adversely impact our operations and results.
Financial institution regulatory agencies have been very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.
The effects of another Superstorm Sandy or similar natural disaster may negatively impact collateral values or loan originations in the areas in which we do business.
On October 29, 2012, Superstorm Sandy made landfall in New Jersey, causing widespread property damage throughout the northeastern United States, including our primary market area in New Jersey. A similar or worse natural disaster than Superstorm Sandy could have a material adverse effect. Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the local economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. The occurrence of a natural disaster could result in one or more of the following: (i) an increase in loan delinquencies; (ii) an increase in problem assets and foreclosures; (iii) a decrease in the demand for our products and services; or (iv) a decrease in the value of the collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.
The Company’s profitability depends significantly on local economic conditions.
The Company’s success depends primarily on the general economic conditions of the primary markets in New Jersey in which it operates and where its loans are concentrated. Unlike nationwide banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in Monmouth, Union and Middlesex Counties, New Jersey. The local economic conditions in these areas have a significant impact on the Company’s commercial and industrial, real estate and construction loans, the ability of its borrowers to repay their loans and the value of the collateral securing these loans. In addition, if the population or income growth in the Company’s market areas is slower than projected, income levels, deposits and housing starts could be adversely affected and could result in a reduction of the Company’s expansion, growth and profitability. If the Company’s market areas experience a downturn or a recession for a prolonged period of time, the Company could experience significant increases in nonperforming loans, which could lead to operating losses, impaired liquidity and eroding capital. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreaks of hostilities or other international or domestic calamities, unemployment, monetary and fiscal policies of the federal government or other factors could impact these local economic conditions and could negatively affect the Company’s financial condition, results of operations and cash flows.
The small to medium-sized businesses that the Company lends to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to the Company that could materially harm the Company’s operating results.
The Company targets its business development and marketing strategy primarily to serve the banking and financial services needs of small to medium-sized businesses. These small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small to medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact the Company’s market areas could cause the Company to incur substantial credit losses that could negatively affect the Company’s results of operations and financial condition.
Changes in interest rates could reduce our income, cash flows and asset values.
Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.
Competition may decrease our growth or profits.
We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service area. Our competitors may have greater resources, higher lending limits or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can.
In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions such as the Bank. As a result, those non-bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our executive management team. The Company’s performance is largely dependent on the talents and efforts of highly skilled individuals. There is intense competition in the financial services industry for qualified employees. In addition, the Company faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. The Company’s business operations could be adversely affected if it were unable to attract new employees and retain and motivate its existing employees.
We may be adversely affected by government regulation.
The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.
The anti-money laundering or AML, and bank secrecy, or BSA, laws have imposed far-reaching and substantial requirements on financial institutions. The enforcement policy with respect to AML/BSA compliance has been vigorously applied throughout the industry, with regulatory action taking various forms. We believe that our policies and procedures with respect to combating money laundering are effective and that our AML/BSA policies and procedures are reasonably designed to comply with current applicable standards. We cannot provide assurance that in the future we will not face a regulatory action, adversely affecting our ability to acquire banks or open new branches.
Additionally, the federal government has passed a variety of other reforms related to banking and the financial industry including, without limitation, the Dodd-Frank Act. See “Item 1. Business - Supervision and Regulation.”
Some provisions of the Dodd-Frank Act became effective immediately upon its enactment. Many provisions, however, required the adoption of rules by various agencies, many of which are very complex, and many of which will be further amended as experience dictates. The provisions of the Dodd-Frank Act may have unintended effects, which will not be clear until actual experience by the industry with the rules is accomplished. The changes resulting from the Dodd-Frank Act could limit our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise materially and adversely affect us. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements could also materially and adversely affect us.
The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is uncertain and could adversely affect us.
Effective January 1, 2015, we became subject to new capital requirements under regulations adopted by the federal banking regulators to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. These new requirements establish the following minimum capital ratios: (1) a common equity Tier 1 (“CET1”) Capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 Capital ratio of 6.0% of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio of 4.0%. In addition, there is a new requirement to maintain a capital conservation buffer, comprised of CET1 Capital, in an amount greater than 2.5% of risk-weighted assets over the minimum capital required by each of the minimum risk-based capital ratios in order to avoid limitations on the organization’s ability to pay dividends, repurchase shares or pay discretionary bonuses. The capital conservation buffer requirement will be phased in, beginning January 1, 2016, requiring during 2016 a buffer amount greater than 0.625% in order to avoid these limitations, and increasing the amount each year until beginning January 1, 2019, when the buffer amount must be greater than 2.5% in order to avoid the limitations.
The new regulations also change what qualifies as capital for purposes of meeting these various capital requirements, as well as the risk weighting of certain assets for purposes of the risk-based capital ratios.
Under the new regulations, in order to be considered well-capitalized for prompt corrective action purposes, the Bank will be required to maintain the following ratios: (1) a CET1 ratio of at least 6.5% of risk-weighted assets; (2) a Tier 1 Capital ratio of at least 8.0% of risk-weighted assets; (3) a total capital ratio of a least 10.0% of risk-weighted assets; and (4) a leverage ratio of at least 5.0%.
Under these new requirements, as of December 31, 2015, the Company and the Bank are well-capitalized and each of them has a capital conservation buffer greater than 2.5%.
The application of these more stringent capital requirements could, among other things, result in lower returns on invested capital, over time require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Any additional changes in our regulation and oversight, in the form of new laws, rules and regulations could make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.
We depend upon the accuracy and completeness of information about customers.
In deciding whether to extend credit to customers, we may rely on information provided to us by our customers, including financial statements and other financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our financial condition and results of operations could be negatively impacted to the extent that we extend credit in reliance on financial statements or other information provided by customers that is false or misleading.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.
We face the risk of cyber-attack to our computer systems.
Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.
We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.
Third parties provide key components of our business infrastructure such as data processing, internet connections, network access, core application processing, statement production and account analysis. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay and expense. If we are unable to efficiently replace ineffective service providers, or if we experience a significant, sustained or repeated, system failure or service denial, it could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition, results of operations and future prospects.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
Failure to implement new technologies in our operations may adversely affect our growth or profits.
The market for financial services, including banking services and consumer finance services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.
A limited market exists for our common stock.
Our common stock commenced trading on the Nasdaq Capital Market on April 4, 2006 and Nasdaq upgraded the listing of the common stock to the Nasdaq Global Market on August 12, 2015. However, trading volumes for our common stock have always been modest. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market. Accordingly, you may have difficulty selling our common stock at prices which you find acceptable or which accurately reflect the value of the Company.
We are subject to liquidity risk.
Liquidity risk is the potential that we will be unable to meet our obligations as they become due, capitalize on growth opportunities as they arise, or pay regular cash 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, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention; principal and interest payments on loans; principal and interest payments on and the 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 a market downturn or 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.
Future offerings of debt or other securities may adversely affect the market price of our stock.
On December 16, 2015, we completed a private placement of $10 million in aggregate principal amount fixed to floating rate subordinated debentures to certain institutional accredited investors. A portion of the proceeds from that private placement was used to repay the remaining $6.0 million of Series C preferred stock that was issued to the United States Treasury in connection with its participation in the Small Business Lending Fund Program. The remaining proceeds from the placement of the debenture will be used for general corporate purposes and to support future growth. In the future, we may attempt to increase our capital resources or, if our or the Bank’s capital ratios fall below the required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated debentures and preferred stock. We currently have a shelf registration statement on file with the Securities and Exchange Commission to allow us to access the capital markets more quickly should the need or desire arise. Upon liquidation, holders of any debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
The Company may lose lower-cost funding sources.
Checking, savings, and money market deposit account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, the Company could lose a relatively low-cost source of funds, increasing its funding costs and reducing the Company’s net interest income and net income.
Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect the Company’s financial results.
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This disintermediation could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
The Company is subject to operational risk.
The Company faces the risk that the design of its controls and procedures, including those to mitigate the risk of fraud by employees or outsiders, may prove to be inadequate or are circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
The Company may also be subject to disruptions of its systems arising from events that are wholly or partially beyond its control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.
Negative publicity could damage our reputation and adversely impact our business and financial results.
Reputation risk, or the risk to our earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with customers and other constituencies, as a financial services company with a high profile in our market area, we are inherently exposed to this risk.
Item 1B.
Item 1B.
Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2.
Properties.
The following table provides certain information with respect to properties used by the Company or the Bank in their operations:
The Company also leases one property in Toms River, New Jersey utilized as a loan production office, with a lease expiration date of July 31, 2016.
Item 3.
Item 3.
Legal Proceedings.
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. The Company may also have various commitments and contingent liabilities which are not reflected in the accompanying consolidated balance sheet. At December 31, 2015, we were not involved in any material legal proceedings.
Item 4.
Item 4.
Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
The common stock of the Company trades on the Nasdaq Global Market under the trading symbol “TRCB.” The following are the high and low sales prices per share.
As of March 14, 2016, there were approximately 494 record holders of the Company’s common stock.
For the year ended December 31, 2015, the Company paid a cash dividend of $0.13 per share.
During the quarter ended December 31, 2015, no shares were repurchased under the Company’s share repurchase program.
All shares repurchased to date have been transacted under the Company’s share repurchase program (the “Repurchase Program”), approved and adopted on December 17, 2015, whereby the Company may repurchase up to $2.0 million of its common stock from January 1, 2016 to December 31, 2016.
The Company maintains a Shareholder Rights Plan pursuant to which each outstanding share of the Company’s common stock also carries with it one right (a “Right”) entitling the holder to purchase from the Company one one-thousandth of a share of Series B Junior Participating Preferred Stock, at a purchase price of $25.00, subject to adjustment (as so adjusted, the “Exercise Price”). Upon the acquisition or attempted acquisition of 10% or more of the Company’s outstanding common stock, and in certain other instances, the Rights have certain benefits designed to protect shareholders from abusive takeover tactics and attempts to acquire control of the Company at an inadequate price. The Rights are not exercisable or transferable unless certain specified events occur and will expire on July 20, 2021.
Item 6.
Item 6.
Selected Financial Data.
Not required.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes and trends relating to the financial condition, results of operations, capital resources, liquidity and interest rate sensitivity of Two River Bancorp as of December 31, 2015 and 2014 and for the years then ended. The following information should be read in conjunction with the audited consolidated financial statements as of and for the years ended December 31, 2015 and 2014, including the related notes thereto.
Critical Accounting Policies and Estimates
The following discussion is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.
Note 1 to our audited consolidated financial statements contains a summary of the Company’s significant accounting policies. Management believes the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Allowance for Loan Losses. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses (“ALLL”) involves a high degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact the results of operations. This critical policy and its application are reviewed quarterly with our audit committee and Board of Directors.
Management is responsible for preparing and evaluating the ALLL on a quarterly basis in accordance with Bank policy, and the Interagency Policy Statement on the ALLL released by the Board of Governors of the Federal Reserve System on December 13, 2006 as well as GAAP. We believe that our allowance for loan losses is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable. The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance account, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management utilizes the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short term change. Various regulatory agencies may require us and our banking subsidiaries to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of our loans are secured by real estate in New Jersey, primarily in Monmouth and Union Counties. Accordingly, the collectability of a substantial portion of the carrying value of our loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the New Jersey and/or our local market areas experience economic shock.
Stock Based Compensation. Stock based compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.
Goodwill Impairment. Although goodwill is not subject to amortization, the Company must test the carrying value for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. Our reporting unit was identified as our community bank operations. If the fair value of the reporting unit exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less than book value, an expense may be required on the Company’s books to write-down the related goodwill to the proper carrying value. Impairment testing during 2015 and 2014 for goodwill and intangibles was completed and the Company did not require any impairment charge during the years ended December 31, 2015 and 2014.
Investment Securities Impairment Valuation. 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. The analysis of other-than-temporary impairment requires the use of various assumptions including, but not limited to, the length of time the investment’s book value has been greater than fair value, the severity of the investment’s decline and the credit deterioration of the issuer. For debt securities, management assesses 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.
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 more likely than not that it will not be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
Other Real Estate Owned. Other Real Estate Owned (“OREO”) and Repossessed Assets include real estate and assets pledged as collateral acquired through foreclosure or by deed in lieu of foreclosure. OREO and repossessed assets are carried at the lower of cost or fair value of the property and underlying collateral, adjusted by management for factors such as economic conditions and other market factors, less estimated costs to sell. When a property or asset is acquired, the excess of the loan balance over fair value, less selling costs, is charged to the allowance for loan losses. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred. OREO and repossessed assets are periodically reviewed to ensure that the fair value of the property and underlying collateral support the carrying value.
Deferred Tax Assets and Liabilities. We recognize deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence, primarily management’s forecast of its ability to generate future earnings, that future realization is more likely than not. If management determines that we may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.
Summary of Financial Results for the Years Ended December 31, 2015 and 2014
Net Income
The Company reported record net income available to common shareholders of $6.3 million for the year ended December 31, 2015, compared to $5.9 million in 2014, an increase of $390,000, or 6.6%. Basic and diluted earnings per common share after preferred stock dividends were $0.80 and $0.78, respectively, for the year ended December 31, 2015 compared to basic and diluted earnings of $0.74 and $0.73, respectively, per common share for the same period in 2014. Our results for 2015 were positively affected by an increase in net interest income primarily due to strong loan and core deposit growth, higher non-interest income and a lower provision for loan losses, partially offset by an increase in non-interest expenses primarily resulting from higher salaries and benefits and occupancy expenses.
Total Assets
Total assets increased by $82.5 million, or 10.6%, to $863.7 million at December 31, 2015 from $781.2 million at December 31, 2014. The increase in total assets was primarily the result of the loan growth funded mainly by core deposit growth during the year.
Total Loans and Deposits
Total loans amounted to $693.1 million at December 31, 2015, which was an increase of $65.5 million, or 10.4%, compared to the December 31, 2014 amount of $627.6 million. The Company continues to provide commercial, residential and consumer lending to our market customers, while maintaining our high credit standards in a challenging market. The allowance for loan losses totaled $8.7 million, or 1.26% of total loans, at December 31, 2015, compared to $8.1 million, or 1.29% of total loans, at December 31, 2014.
Deposits increased to $708.4 million at December 31, 2015 from $642.4 million at December 31, 2014, an increase of $66.0 million, or 10.3%. The increase in deposits is primarily attributable to the growth in our core checking deposits resulting from increased business and consumer activity, along with certificates of deposit.
Shareholders’ Equity and Tangible Book Value per Common Share
Shareholders’ equity amounted to $93.0 million at December 31, 2015 from $93.9 million at December 31, 2014, a decrease of $930,000, or 1.0%, primarily due to the redemption of our remaining $6.0 million of outstanding Series C Preferred Stock and $1.0 million in cash dividends on common stock, partially offset by net income. At year-end 2015, tangible book value per common share (Non-GAAP Financial Measures) increased to $9.44 compared to $8.79 at December 31, 2014.
Results of Operations
Our principal source of revenue is net interest income, the difference between interest income on interest earning assets and interest expense on deposits and borrowings. Interest earning assets consist primarily of loans, investment securities and federal funds sold. Sources to fund interest earning assets consist primarily of deposits and borrowed funds. Our net income is also affected by our provision for loan losses, non-interest income and non-interest expenses. Non-interest income consists primarily of service charges, commissions and fees, while non-interest expenses are comprised of salaries and employee benefits, occupancy costs and other operating expenses.
The following table provides certain performance ratios for the dates and periods indicated.
(1)
The following table provided the reconciliation of non-GAAP Financial Measures for the dates indicated:
This Report contains certain financial information determined by methods other than in accordance with GAAP. These non-GAAP financial measures are “tangible book value per common share,” “return on average tangible assets,” “return on average tangible equity,” and “average tangible equity to average tangible assets.” This non-GAAP disclosure has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Our management uses these non-GAAP measures in its analysis of our performance because it believes these measures are material and will be used as a measure of our performance by investors.
Financial Results for the Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Net Interest Income
For the year ended December 31, 2015, net interest income amounted to $28.2 million, as compared to $26.9 million for the year ended December 31, 2014. This increase of $1.3 million, or 4.8%, was primarily the result of a higher volume of average interest earning assets and higher level of average core checking deposits. These positives were partially offset by the continued compression on our asset yields resulting from the maturity, prepayment or contractual repricing of loans and investment securities in this extended period of low interest rates. The Federal Reserve chose to raise short-term interest rates by 0.25% in December of 2015. Our average earning assets increased by $57.1 million, or 8.0%, to $768.0 million for the year ended December 31, 2015 from $710.9 million for the year ended December 31, 2014, while our net interest spread decreased by 11 basis points to 3.52% for the year ended December 31, 2015 as compared to 3.63% for the same period in 2014. Our net interest margin decreased by 11 basis points to 3.68% for year ended December 31, 2015 as compared to 3.79% for the same period in 2014. These decreases were primarily the result of the maturity, prepayment or contractual repricing of loans and securities in this prolonged low interest rate environment.
For the year ended December 31, 2015, total interest income increased to $32.1 million from $30.4 million for the year ended December 31, 2014. This increase of $1.7 million, or 5.6%, was primarily due to volume-related increases in interest income of $2.5 million, partially offset by interest rate-related decreases in interest income of $824,000, for the year ended December 31, 2015 as compared to the prior year. The average yield on our interest earning assets decreased by 9 basis points to 4.18% for the year ended December 31, 2015 from 4.27% for the prior year.
Interest and fees on loans increased by $1.7 million, or 5.9%, to $30.6 million for the year ended December 31, 2015 compared to $28.9 million for the same period in 2014. Of the $1.7 million increase in interest and fees on loans, $2.5 million was attributable to volume-related increases, which were partially offset by $764,000 of rate-related decreases. The average balance of the loan portfolio for the year ended December 31, 2015 increased by $52.2 million, or 8.6%, to $661.8 million from $609.6 million for the same period in 2014. The average annualized yield on the loan portfolio decreased to 4.63% for the year ended December 31, 2015, from 4.74% for the same period in 2014. The average balance of non-accrual loans was $4.1 million and $6.4 million for the years ended December 31, 2015 and 2014, respectively, which impacted the Company’s loan yield for both periods presented.
Interest income on interest bearing deposits was $74,000 for the year ended December 31, 2015, representing an increase of $4,000, or 5.7%, from $70,000 for the same period in 2014. For the year ended December 31, 2015, interest bearing deposits had an average balance of $28.6 million and an average annualized yield of 0.26% as compared to $27.0 million and the same average annualized yield for the 2014 period.
Interest income on investment securities totaled $1.4 million for the year ended December 31, 2015, unchanged from the $1.4 million for year ended December 31, 2014. For the year ended December 31, 2015, investment securities had an average balance of $77.5 million with an average annualized yield of 1.81%, compared to an average balance of $74.2 million with an average annualized yield of 1.89% for the year ended December 31, 2014.
Total interest expense amounted to $3.9 million for the year ended December 31, 2015, compared to $3.5 million for the corresponding period in 2014, an increase of $411,000, or 11.9%. Of this increase in interest expense, $681,000 was due to volume-related increases resulting from deposit growth, partially offset by $270,000 in rate-related decreases.
The average balance of interest-bearing liabilities increased to $584.6 million for the year ended December 31, 2015, from $536.5 million for the same period last year, an increase of $48.1 million, or 9.0%. The average balance in NOW deposits during 2015 increased $19.7 million from $111.0 million with an average annualized yield of 0.46% for the year ended December 31, 2014, to $130.7 million with an average annualized yield of 0.42% for the same period in 2015. Additionally, during 2015, average demand deposits reached $145.0 million, an increase of $14.5 million, or 11.1%, over the same period last year. Average time deposits increased by $20.0 million, or 24.0%, to $103.3 million with an average annualized yield of 1.32% for the year ended December 31, 2015, from $83.3 million with an average annualized yield of 1.43% for the year ended December 31, 2014. These average balance increases were partially offset by a decrease of $4.5 million, or 1.9%, in average savings deposits from $233.2 million with an average annualized yield of 0.47% for the year ended December 31, 2014, to $228.7 million with an average annualized yield of 0.48% for the year ended December 31, 2015. Average money market deposits increased by $352,000, or 0.5%, to $72.3 million with an average annualized yield of 0.16% for the year ended December 31, 2015, from $72.0 million with the same average annualized yield for the 2014 period. For the year ended December 31, 2015, the average yield on our interest-bearing liabilities was 0.66%, compared to 0.64% for the year ended December 31, 2014.
Our strategies for increasing and retaining core relationship deposits, managing loan originations within our acceptable credit criteria and loan category concentrations, and our branch network growth strategy have combined to meet our liquidity needs. The Company also offers agreements to repurchase securities, commonly known as repurchase agreements, to its customers as an alternative to other insured deposits. Average balances of repurchase agreements for the year ended December 31, 2015 increased to $22.1 million, with an average interest rate of 0.31%, compared to $20.1 million, with an average interest rate of 0.32%, for the same prior-year period.
The Company also utilizes FHLB term borrowings as an additional funding source. Average FHLB term borrowings amounted to $27.1 million and $16.9 million for the years ended December 31, 2015 and 2014, respectively, with an average yield of 2.30% and 2.85%, respectively, for both periods.
In December 2015, the Company completed a private placement of $10 million in aggregate principal amount of fixed to floating rate subordinated debentures to certain institutional accredited investors. The subordinated debentures have a maturity date of December 31, 2025 and bear interest, payable quarterly, at the rate of 6.25% per annum until January 1, 2021 when the rate adjusts. The subordinated debentures have been structured to qualify as Tier 2 capital for regulatory purposes. Subordinated debentures totaled $9.8 million at December 31, 2015, which included $176,000 of remaining unamortized debt issuance costs. The debt issuance costs are being amortized over the expected life of the issue. The effective interest rate of the subordinated debt is 6.67%.
The net cash proceeds of the subordinated debenture offering were used to redeem the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”) issued to the United States Treasury in connection with the Company’s participation in the Small Business Lending Fund program. The balance of such net proceeds will be used for general corporate purposes and to support future growth.
The following table reflects, for the periods presented, the components of our net interest income, setting forth: (1) average assets, liabilities, and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) our net interest spread (i.e., the average yield on interest-earning assets less the average rate on interest-bearing liabilities), and (5) our yield on interest-earning assets. There have been no tax equivalent adjustments made to yields.
(1)
Included in interest income on loans are loan fees.
(2)
Includes non-performing loans.
(3)
The interest rate spread is the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(4)
The interest rate margin is calculated by dividing net interest income by average interest-earning assets.
Analysis of Changes in Net Interest Income
The following table sets forth for the periods indicated the amounts of the total change in net interest income that can be attributed to changes in the volume of interest-earning assets and interest-bearing liabilities and the amount of the change that can be attributed to changes in interest rates.
The change in interest due to both volume and rate has been allocated proportionally to both, based on their relative absolute values.
Provision for Loan Losses
Our provision for loan losses for the year ended December 31, 2015 was $490,000, as compared to $621,000 for the year ended December 31, 2014. The decrease in our provision was primarily due to $154,000 in net loan recoveries recorded during the year ended December 31, 2015, compared to $424,000 in net loan charge-offs in the prior year, coupled with improvements in overall asset quality, all of which have allowed the Company to reduce its loan loss provision. The amount of the reduction was partially offset by increases due to loan growth. The $490,000 provision for 2015 was driven by a number of factors, including the level of charge-offs and recoveries, our assessment of the current state of the economy, allowances related to impaired loans and loan activity. The provision for the comparable 2014 period considered the same factors. The provision for loan losses is determined by an allocation process whereby an estimated allowance is allocated to the specific allowance for impaired loans and the general allowance for pools of loans. The allocation reflects management’s assessment of economic conditions, credit quality and other risk factors inherent in the loan portfolio. The allowance for loan losses totaled $8.7 million, or 1.26% of total loans at December 31, 2015, compared to $8.1 million, or 1.29% of total loans at December 31, 2014.
Non-Interest Income
Non-interest income amounted to $3.5 million for the year ended December 31, 2015, compared to $2.9 million for the year ended December 31, 2014. This increase of $605,000, or 20.6%, was due to a $508,000 increase in residential mortgage banking revenue, a $208,000 gain on the sale of a branch property, a $163,000 increase in gains on the sale of SBA loans and higher other income of $92,000, mainly from our joint venture title agency. These increases were partially offset by decreases of $191,000 in other loan fees resulting from lower prepayment fees, a $109,000 decrease in service fees on deposit accounts, a $51,000 decrease in net gains from the sale of securities and a decrease in bank owned life insurance income of $15,000. In October 2014, we announced the expansion of our residential mortgage lending operations with the hiring of a mortgage banking team with experience in the New Jersey markets of Monmouth, Ocean, Union and Middlesex Counties. We began to report an increase in residential mortgage loan originations in the fourth quarter of 2014, which had continued throughout 2015.
Non-Interest Expenses
The following table provides a summary of non-interest expenses by category for the years ended December 31, 2015 and 2014.
Non-interest expenses for year ended December 31, 2015 increased $1.7 million, or 8.6%, compared to the year ended December 31, 2014. This increase was primarily the result of an increase of $972,000, or 8.4%, in salaries and employee benefits, which was due primarily to the hiring of additional key personnel in its commercial and residential lending groups along with both annual merit increases and commissions paid for higher residential mortgage banking volume generated during the year. Occupancy and equipment expenses increased $476,000 or 13.7% due primarily to the opening of our new Freehold and Cranford, New Jersey branches along with increased expenses associated with computer and technology upgrades. Professional fees increased $137,000, or 16.2%, primarily due to higher recruitment costs and legal expenses. Data processing fees increased $83,000, or 21.2%, due primarily to computer and technology upgrades while, other operating expense increased $84,000, or 6.1%, primarily due to higher costs for business development. Loan workout expenses increased $72,000, or 20.1%, primarily due to increased taxes, appraisals and legal billings relating to impaired loans. Advertising expenses increased $27,000, or 7.2%, due to increased advertising related to the Company’s branding, awareness and products and services. These increases were partially offset by lower FDIC insurance and assessments of $76,000 or 14.9%, while insurance expenses decreased by $40,000, or 13.0%. Additionally, OREO and repossessed asset expenses, impairments and sales, net, declined by $31,000, or 79.5%, from 2014 primarily due to a lower level of OREO assets and, as such, lower associated costs. Amortization of intangible assets, which was the result of The Town Bank acquisition in 2006, amounted to $48,000 during 2015 as compared to $86,000 during 2014.
Income Tax Expense
The Company recorded $3.6 million in income tax expense for the years ended December 31, 2015 and 2014, respectively. The effective tax rate for the year ended December 31, 2015 and 2014 was 36.1% and 37.2%, respectively, due to a lower level of taxable income during the current period due primarily to a higher level of tax-exempt municipal securities.
Financial Condition
December 31, 2015 Compared to December 31, 2014
Assets
At December 31, 2015, total assets were $863.7 million, an increase of $82.5 million, or 10.6%, compared to total assets of $781.2 million at December 31, 2014. At December 31, 2015, total loans were $693.1 million, an increase of $65.5 million, or 10.4%, from the $627.6 million reported at December 31, 2014. Investment securities, including restricted stock, were $80.3 million at December 31, 2015 as compared to $73.7 million at December 31, 2014, an increase of $6.6 million, or 8.9%. At December 31, 2015, cash and cash equivalents totaled $46.7 million compared to $36.1 million at December 31, 2014, an increase of $10.6 million, or 29.4%. Our liquidity position is described below under “Liquidity.” Goodwill totaled $18.1 million at both December 31, 2015 and 2014.
Liabilities
Total liabilities increased $83.4 million, or 12.1%, to $770.7 million at December 31, 2015, from $687.3 million at December 31, 2014. Total deposits increased $66.0 million, or 10.3%, to $708.4 million at December 31, 2015, from $642.4 million at December 31, 2014. Deposits are the Company’s primary source of funds. The deposit increase during 2015 was primarily attributable to the Company’s strategic initiative to continue to remain focused on growing market share through core deposit relationships. The Company anticipates loan demand to increase during 2016 and beyond, and will depend on the expansion and maturation of the branch network as its primary funding source. As a secondary funding source, the Company intends to utilize borrowed funds, including FHLB advances, brokered CDs and deposits obtained through the use of deposit listing services (“Listed Service CDs”), at opportune times during changing rate cycles to help support its growth. The Company continues to experience change in the mix of the deposit products through its branch sales efforts, which are targeted to gain market penetration. In order to fund future loan growth, the Company intends to use the most cost-effective funding mix available within the market area.
Long-term debt increased $10.5 million to $26.5 million at December 31, 2015, from $16.0 million at December 31, 2014, and the Company issued $9.8 million of subordinated debentures during 2015. See “Borrowings” and “Subordinated Debentures” below.
Securities Portfolio
Investment securities, including restricted investments, totaled $80.3 million at December 31, 2015 compared to $73.7 million at December 31, 2014, an increase of $6.6 million, or 8.9%. For 2015 and 2014, investment securities purchases amounted to $46.0 million and $28.5 million, respectively, while repayments, calls and maturities amounted to $15.1 million and $22.1 million, respectively. In 2015, there were investment securities sales totaling $24.3 million resulting in a net gain on sale of $37,000 as compared to sales totaling $9.8 million resulting in a net gain on sale of $88,000 during 2014.
The Company maintains an investment portfolio to fund increased loans and liquidity needs (resulting from decreased deposits or otherwise) and to provide an additional source of interest income. The portfolio is composed of obligations of the U.S. Government agencies and U.S. Government-sponsored entities, municipal securities, a limited amount of corporate debt securities and Community Reinvestment Act (“CRA”) mutual fund. U.S. Government agencies are considered to have the lowest risk due to the “full faith and credit” guarantee by the U.S. Government. All of our mortgage-backed investment securities are collateralized by pools of mortgage obligations that are guaranteed by privately managed, U.S. Government-sponsored enterprises (“GSE”), such as Fannie Mae, Freddie Mac and Government National Mortgage Association. Due to these GSE guarantees, these investment securities are susceptible to less risk of non-performance and default than other corporate securities which are collateralized by private pools of mortgages. At December 31, 2015, the Company maintained $18.2 million of GSE residential mortgage-backed securities in the investment portfolio and $16.2 million of collateralized residential mortgage obligations, all of which are current as to payment of principal and interest and are performing to the terms set forth in their respective prospectuses. Municipal securities are evaluated by a review of the credit ratings of the underlying issuer, any changes in such ratings that have occurred, and adverse conditions relating to the security or its issuer, as well as other factors.
Included within the Company’s investment portfolio are trust preferred securities, which consists of four single issue securities issued by large financial institutions with Moody’s ratings from Baa1 to Ba1. These securities have an amortized cost value of $2.8 million and a fair value of $2.4 million at December 31, 2015. The unrealized loss on these securities is related to general market conditions, the widening of interest rate spreads and downgrades in credit ratings.
Management evaluates all securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluations. As of December 31, 2015, all of these securities are current with their scheduled interest payments. Future deterioration in the cash flow of these investments or the credit quality of the financial institution issuers could result in impairment charges in the future.
The Company accounts for its investment securities as available for sale or held to maturity. Management determines the appropriate classification at the time of purchase. Based on an evaluation of the probability of the occurrence of future events, we determine if we have the ability and intent to hold the investment securities to maturity, in which case we classify them as held to maturity. All other investments are classified as available for sale.
Securities classified as available for sale must be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of taxes. Gains or losses on the sales of securities available for sale are recognized upon realization utilizing the specific identification method. The net effect of unrealized gains or losses, caused by marking our available for sale portfolio to fair value, could cause fluctuations in the level of shareholders’ equity and equity-related financial ratios as changes in market interest rates cause the fair value of fixed-rate securities to fluctuate.
Securities classified as held to maturity are carried at cost, adjusted for amortization of premium and accretion of discount over the terms of the maturity in a manner that approximates the interest method.
The following table sets forth the carrying value of the securities portfolio as of December 31, 2015, 2014 and 2013 (in thousands).
The contractual maturity distribution and weighted average yields, calculated on the basis of the stated yields to maturity, taking into account applicable premiums or discounts, of the securities portfolio at December 31, 2015 is set forth in the following table (excluding restricted stock and mutual fund). Securities available for sale are carried at amortized cost in the table for purposes of calculating the weighted average yield. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. There have been no tax equivalent adjustments made to the yields on tax-exempt securities.
Loan Portfolio
The following table summarizes total loans outstanding by loan category and amount on the dates indicated.
During the second quarter of 2014, certain types of loans were reclassified due to their purpose and overall risk characteristics. Therefore, balances on certain loan and allowance for loan losses as of December 31, 2013, 2012, and 2011 were reclassified to conform to the December 31, 2014 presentation.
Total loans, net of unearned fees, increased by $65.5 million, or 10.4%, to a new high of $693.1 million at December 31, 2015 compared to $627.6 million at December 31, 2014. The increase was due to growth in commercial real estate, residential, construction and commercial and industrial lending. Our local economy seems to reflect some strengthening in certain sectors. As such, we remain optimistic in our growth prospects for lending in 2016, recognizing that we will continue to be challenged due in part to both the competitive landscape and pricing pressures in this low rate environment. However, our loan pipeline remains strong as we continue to stay focused on growing our portfolio. We have taken the approach of opening low cost loan production offices (“LPOs”) in contiguous markets and once a certain level of business is achieved, the intention is to replace some of these LPOs with a full service branch at an appropriate location within that market, if warranted. During the second quarter of 2015, we replaced our Freehold, New Jersey LPO with a full service branch to support that market. During the second quarter of 2014, we replaced our New Brunswick and East Brunswick LPOs with a full service branch in that market, which opened in April 2014. The Bank continues to operate one LPO in the Toms River, New Jersey market with a second one planned in the first quarter of 2016 in the Summit, New Jersey market. Our LPOs are staffed by experienced seasoned loan officers who are knowledgeable within these markets and have begun to produce positive results.
The mix of our loan composition at December 31, 2015 when compared to December 31, 2014 reflects our desire to continue emphasizing commercial and industrial, commercial real estate, construction and residential lending. Within the loan portfolio, commercial real estate loans remained the largest component, constituting 61.0% of our total loans outstanding at December 31, 2015, down slightly from 61.1% from the prior year. These loans increased by $38.9 million, or 10.1%, to $422.7 million at December 31, 2015, compared to $383.8 million at December 31, 2014 due to both increased production as well completed construction projects which, at the time of renewal, were converted to commercial real estate loans. Commercial and industrial loans increased $3.7 million, or 3.8%, to $100.2 million at year-end 2015 compared to $96.5 million at year-end 2014, and comprised 14.5% of our portfolio, down from 15.4% for the prior year. Real estate construction loans increased by $15.1 million, or 16.9%, to $104.2 million at December 31, 2015, and comprised 15.0% of our total loans outstanding, up from 14.2% for the prior year. Residential real estate loans increased $8.7 million, or 28.3%, and comprised 5.7% of our total loan portfolio at December 31, 2015, up from 4.9% for the prior year. Consumer loans decreased by $1.0 million or 3.4%, to $27.1 million at December 31, 2015 compared to $28.1 million at December 31, 2014, and comprised 3.9% of our 2015 loan portfolio compared to 4.5% for 2014.
The following table sets forth the aggregate maturities of commercial and construction related loans, net of unearned discounts and deferred loan fees, in specified categories and the amount of such loans, which have fixed and variable rates as of December 31, 2015.
Asset Quality
One of our key operating objectives has been, and continues to be, to maintain a high level of asset quality. We continually analyze our credit quality through a variety of strategies. We have been proactive in addressing problem and non-performing assets and management believes our allowance for loan losses is adequate to cover known and potential losses. These strategies, as well as our underwriting standards for new loan originations, have resulted in relatively low levels of non-performing loans and charge-offs. Our loan portfolio composition generally consists of loans secured by commercial real estate, land development and construction of real estate projects mainly in the Union, Monmouth and Middlesex County, New Jersey market area. We continue to have lending success and growth in the medical markets through our Private Banking Department. We have experienced signs of improvement in our markets as our loan pipeline remains strong. Efficient and effective asset-management strategies reflect the type and quality of assets being underwritten and originated.
The Company continues to be proactive in identifying troubled credits early, to record charge-offs promptly based on current collateral values, and to maintain an adequate allowance for loan losses at all times. We closely monitor local and regional real estate markets and other risk factors related in our loan portfolio.
The Bank does not originate or purchase loans with payment options, negative amortization loans or sub-prime loans. We evaluate the classification of all our loans and the financial results of some of those loans may be adversely impacted by changes in the prevailing economic conditions, either nationally or in our local market areas, including decreases in real estate values, adverse employment conditions, the monetary and fiscal policies of the federal and state government and other significant external events. For loans involved in a workout situation, a new or updated appraisal or evaluation, as appropriate, is ordered to address current project plans and market conditions that were considered in the development of the workout plan. The consideration includes whether there has been material deterioration in the following factors: the performance of the project; conditions for the geographic market and property type; variances between actual conditions and original appraisal assumptions; changes in project specifications (e.g., changing a planned condominium project to an apartment building); loss of a significant lease or a take-out commitment. A new appraisal may not be necessary in all instances where an internal evaluation is used and appropriately updates the original appraisal assumptions to reflect current market conditions along with providing an estimate of the collateral’s fair market value for impairment analysis testing.
Non-Performing Assets
Non-performing assets include loans that are not accruing interest (non-accrual loans), loans past due 90 days or more and still accruing and other real estate owned, which consists of real estate acquired as the result of a defaulted loan. A loan is placed on non-accrual status when collection of all principal or interest is considered unlikely or when principal or interest is past due for 90 days or more, unless the loan is well-secured and in the process of collection, in which case, the loan will continue to accrue interest. Any unpaid interest previously accrued on those loans is reversed from income. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. A troubled debt restructuring loan (“TDR”) is a loan in which the contractual terms have been modified resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties in order for the Bank to have a greater opportunity of collecting the indebtedness from the borrower. Non-accruing TDRs are included in non-performing loans.
At December 31, 2015 and 2014, the Company had $3.2 million and $6.2 million in non-accrual loans, respectively. Our non-performing loans are primarily secured by real estate. There were no loans past due 90 days or more and still accruing interest at December 31, 2015 and 2014.
The following table summarizes our non-performing assets for each of the five years in the period ended December 31, 2015. Total TDRs are broken out at the bottom portion of the table.
Total non-performing loans decreased by $3.1 million from December 31, 2014 to December 31, 2015. Nine loans comprised the $3.2 million of non-performing loans at December 31, 2015 compared to sixteen loans for the $6.2 million at December 31, 2014. At December 31, 2015, the Company believes it has a manageable level of non-performing loans, many of which are in the final stages of loss mitigation or legal resolution.
At December 31, 2015, non-performing commercial and industrial loans increased by $19,000 from December 31, 2014 due to the addition of one new credit. The $138,000 is comprised of two commercial term loans.
At December 31, 2015, non-performing real estate-construction loans decreased by $407,000 from December 31, 2014, due to the due to the payoff of three construction loans during 2015.
At December 31, 2015, non-performing real estate commercial loans decreased by $2.5 million from December 31, 2014, due primarily to one loan totaling $1.7 million, which was returned to active status during the first quarter, and the payoff of two loans totaling $942,000, partially offset by the addition of one new loan totaling $242,000.
At December 31, 2015, non-performing real estate residential loans increased $102,000, from December 31, 2014 due to the addition of one loan in the amount of $254,000, partially offset by the transfer of a $152,000 loan to OREO.
At December, 2015, non-performing consumer loans decreased by $295,000 from December 31, 2014, due primarily to one loan totaling $215,000, which was returned to active status during the fourth quarter, coupled with the charge-off of one loan totaling $80,000.
OREO represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. These assets are carried at the lower of cost or fair value less estimated selling costs. When a property is acquired, the excess of the loan balance over fair value, less selling costs, is charged to the allowance for loan losses. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred. At December 31, 2015, the Bank had $411,000 of OREO, consisting of two properties, as compared to $1.6 million at December 31, 2014, which consisted of three properties. During the third quarter of 2015, one property totaling $1.1 million was sold for a $104,000 gain while in the second quarter, one property totaling $192,000 was sold for a $3,000 gain. In the fourth quarter, one property was written down by $84,000 based on current appraised value.
All of our OREO are aggressively marketed and are monitored on a regular basis to ensure valuations are in line with current fair market values.
Loans whose terms are modified are classified as TDRs if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a TDR generally involve a temporary reduction in interest rate or a modification of a loan’s amortization schedule. Non-accrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after the modification is in place. Loans classified as TDRs are designated as impaired from a cash flow perspective. Modifications involving troubled borrowers may include a modification of a loan’s amortization schedule, reduction in the stated interest rate and rescheduling of future cash flows.
The Company’s TDR modifications are made on terms typically up to 12 months in order to aggressively monitor and track performance of the credit. The short-term modifications are monitored for continued performance for an additional period of time after the expiration of the concession. Balance reductions and annualized loss rates are also important metrics that are monitored. The main objective of the modification program is to reduce the payment burden for the borrower and improve the net present value of the Company’s expected cash flows.
As of December 31, 2015, TDRs totaled $10.8 million as compared to $20.6 million at December 31, 2014, a decrease of $9.8 million. This decrease was primarily due to the refinance of two commercial real estate loans, totaling $7.0 million, which were underwritten at current market terms and conditions. As such, these loans were removed from TDR status based on recently issued regulatory guidance. The remaining decrease of $2.8 million was largely the result of pay downs and payoffs on other loans throughout the year. Concessions made on TDRs generally involved a temporary reduction in interest rate or a modification of a loan’s amortization schedule. The main objective of the modification is to reduce the payment burden for the borrower and improve the net present value of the Company’s expected cash flows. The $10.8 million is comprised of $2.5 million in real estate commercial loans, $3.9 million in real estate construction loans, $3.9 million in commercial and industrial loans, $383,000 in real estate-residential loans and $209,000 in consumer loans. All but three identified TDRs as of December 31, 2015, are collateral dependent loans while the three others are cash flow dependent. Of the $10.8 million, $3.3 million have specific reserves in our ALLL computation totaling $49,000. The remaining $7.5 million of TDRs are adequately collateralized requiring no specific reserves.
The $2.5 million in real estate commercial loans identified as TDRs are all accruing, with the exception of two non-accrual loans totaling $1.5 million. The first non-accrual loan, totaling $1.4 million, is secured by real estate, and we are in the early stages of commencing foreclosure proceedings. The second non-accrual loans total $57,000. The remaining $1.0 million of performing TDRs are amortizing on various terms. The TDR designation was given primarily due to concessions granted for interest rate, amortization or maturity. These factors were all a result of the weak economy, which resulted in the borrowers having financial and cash flow difficulties.
The $3.9 million in real estate construction loans is primarily comprised of four relationships, one of which totaling $545,000, includes fully improved building lots under contract of sale to one national home builder. The lot sales are structured as tranche takedowns with repayments expected in full by the end of 2015. The remaining three projects with a total of $3.3 million are currently being developed, under contract and/or amortizing.
The $3.9 million in commercial and industrial loans are all performing, with the exception of one non-accrual loan totaling $107,000. This category increased by $3.3 million due to the addition of one relationship consisting of five loans, which totaled $3.3 million, all of which are performing.
The $383,000 in real estate residential loans and $209,000 in consumer loans are all performing.
Potential Problem Loans
Overall credit quality in the portfolio remains strong even though the economic weakness has impacted several potential problem loans. Potential problem loans consist of special mention and substandard loans. At December 31, 2015, the Company had $16.9 million in loans that were risk rated as special mention or substandard, which includes $3.2 million in non-accrual loans that are included in the substandard category. This $16.9 million of special mention and substandard loans represent a decrease of $9.9 million from $26.8 million at December 31, 2014. The change in risk rated loans was attributable to certain loans which were either upgraded due to a variety of changing conditions, including general economic conditions, payoffs and/or conditions applicable to the specific borrower, or due to payoffs and paydowns.
At December 31, 2015, other than the loans set forth above, the Company 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 risk categories set forth in the description herein.
Allowance for Loan Losses
Analysis and Determination of the Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable credit losses in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a monthly basis and such allowances are reported to the Board of Directors on a quarterly basis. Through our prudent risk management practices, we continuously monitor the credit quality of our loan portfolio and maintain an allowance sufficient to absorb current probable and estimable losses inherent in our loan portfolio. We are committed to the timely recognition of problem loans and maintaining an appropriate and adequate allowance.
Our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a specific allowance on impaired loans and (2) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
Specific Allowance Required for Impaired Loans
The first element of the allowance for loan loss analysis involves the estimation of allowance specific to individually evaluated impaired loans including restructured commercial and industrial, commercial and residential real estate, and consumer loans. In this process, a specific allowance may be established for impaired loans based on an analysis of the most probable sources of repayment, including discounted cash flows, liquidation of collateral, or the market value of the loan itself. Restructured consumer loans are also evaluated in this element of the estimate.
General Valuation Allowance on the Remainder of the Loan Portfolio
We establish a general allowance for non-impaired loans to recognize the inherent losses associated with lending activities. This general valuation allowance is determined by segregating the loans by loan category and assigning percentages to each category. The percentages are adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors include changes in existing general economic and business conditions affecting our primary lending areas and the national economy, staff lending experience, recent historical loss experience in particular segments of the portfolio, specific reserve and classified asset trends, delinquency trends and risk rating trends. These loss factors are subject to ongoing evaluation to ensure their relevance in the current economic environment.
Future adjustments to the allowance for loan losses account may be necessary due to economic, operating, regulatory and other conditions beyond our control. Our primary lending emphasis is the origination of loans secured by commercial and residential real estate in the greater central New Jersey area. We are diligently working to address any asset quality concerns, including working with borrowers and increasing our allowance for loan losses when appropriate to ensure that we are well positioned for any losses that we may incur.
The following table summarizes our allowance for loan losses for each of the five years in the period ended December 31, 2015.
Allocation of the Allowance for Loan Losses
The following table sets forth the allocation of the allowance for loan losses by category of loans and the percentage of loans in each category to total loans for each of the five years in the period ended December 31, 2015.
The Company’s allowance for loan losses was $8.7 million at December 31, 2015 and $8.1 million at December 31, 2014. The allowance for loan losses as a percentage of total loans at December 31, 2015 was 1.26%, compared with 1.29% at December 31, 2014. The Company had total provisions to the allowance for loan losses for the year ended December 31, 2015 in the amount of $490,000 as compared to $621,000 for the comparable period in 2014. Net recoveries for the year ended December 31, 2015 were $154,000, compared to $424,000 of net charge offs for the year ended December 31, 2014. Total recoveries were $236,000 for the year ended December 31, 2015, a decrease of $471,000, from the $707,000 in 2014, largely due to two credits, which had been charged off in previous periods. Total charge-offs were $82,000 for the year ended December 31, 2015, a decrease of $1.0 million, from the $1.1 million in 2014. The $82,000 of charge-offs in 2015 were due to two loans, both of which were previously fully reserved. Non-performing loans at December 31, 2015 are either well-collateralized or adequately reserved for in the allowance for loan losses.
In management’s opinion, the level of allowance for loan losses, totaling $8.7 million at December 31, 2015, is appropriate to adequately provide for known and inherent risks in the portfolio. In the current interest rate and credit quality environment, our risk management philosophy has been to stay within our established credit culture. Management will continue to review the need for additions to its allowance for loan losses based upon its ongoing review of the loan portfolio and credit quality trends, the level of delinquencies as well as general market and economic conditions.
Bank-Owned Life Insurance
In November of 2004, the Company invested in $3.5 million of bank-owned life insurance as a source of funding for certain life insurance benefits for officers and for employee benefit expenses related to the Company’s non-qualified Supplemental Executive Retirement Plans (“SERPs”) implemented for certain executive officers in 2004. The SERPs provide for payments upon retirement, death or disability. Since its initial investment in 2004, the Company has purchased an additional $13.1 million of bank-owned life insurance, in order to provide additional life insurance benefits for additional officers upon death or disability and to provide a source of funding for future enhancements of the benefits under the SERP. Expenses related to the SERPs were approximately $261,000 and $249,000 for the years ended December 31, 2015 and 2014, respectively. Bank-owned life insurance involves our purchase of life insurance on a selected group of officers. The Company is the owner and beneficiary of the policies. Increases in the cash surrender values of this investment are recorded in other income in the statement of operations. Income on bank-owned life insurance amounted to $445,000 and $460,000, for the years ended December 31, 2015 and 2014, respectively.
Premises and Equipment
Premises and equipment totaled $5.1 million and $5.7 million at December 31, 2015 and 2014, respectively. This reduction was primarily due to the sale of a branch property in Union County, New Jersey, with its operations consolidated into our South Avenue branch. The resultant reduction in fixed assets, net of accumulated depreciation, amounted to $717,000, and the Company realized a gain of $208,000 from the sale. This fixed asset reduction was partially offset by new capital expenditures, primarily related to the new Cranford and Freehold branches during the first half of 2015.
Goodwill and Intangible Assets
Intangible assets totaled $18.1 million at December 31, 2015 compared to $18.2 million at December 31, 2014. The Company’s intangible assets at December 31, 2015 were comprised of $18.1 million of goodwill and $9,000 of core deposit intangibles, net of accumulated amortization of $2.1 million. The Company performed its annual goodwill impairment analysis as of September 30, 2015. Based on the results of the step one goodwill impairment analysis, the Company concluded that there was no impairment on the current goodwill balance of $18.1 million. The Company’s intangible assets at December 31, 2014 were comprised of $18.1 million of goodwill and $57,000 of core deposit intangibles, net of accumulated amortization of $2.0 million. Accordingly, there was no impairment recorded during 2015 and 2014.
There can be no assurance that future testing will not result in additional material impairment charges due to further developments in the banking industry or our markets or otherwise. Additional goodwill discussion can be referenced in Note 5, “Goodwill and Other Intangible Assets” in the Company’s financial statements.
Deposits
Deposits are the primary source of funds used by the Company in lending and for general corporate purposes. In addition to deposits, the Company may derive funds from principal repayments on loans, the sale of loans and securities designated as available for sale, maturing investment securities and borrowings from financial intermediaries. The level of deposit liabilities may vary significantly and is dependent upon prevailing interest rates, money market conditions, general economic conditions and competition. The Company’s deposits consist of checking, savings and money market accounts along with certificates of deposit (“CDs”) and individual retirement accounts. Deposits are obtained from individuals, partnerships, corporations, unincorporated businesses and non-profit organizations throughout our market area. We attempt to control the flow of deposits primarily by pricing deposit offerings to be competitive with other financial institutions in the market area but not by necessarily offering the highest rate.
Total deposits at December 31, 2015 were $708.4 million, an increase of $66.0 million, or 10.3%, from the $642.4 million at December 31, 2014. Core checking deposits at December 31, 2015, increased $37.1 million, or 14.5%, to $293.0 million when compared to year-end 2014, primarily due to new municipal deposit relationships coupled with seasonality, while savings, money market and time deposits increased $1.9 million, or 0.6%. CDs increased $27.1 million, or 29.8%, to $118.0 million at December 31, 2015. In light of the low interest rate environment and strong loan pipeline, the Company took advantage of extending the maturity of its CD portfolio by utilizing a laddered strategy of both brokered and Listed Service CDs during 2015. The Bank has continued to focus on building non-interest-bearing deposits, as this lowers our costs of funds. Additionally, our savings accounts and other interest-bearing deposit products, excluding high-cost certificates of deposit, provide an efficient and cost-effective source to fund our loan originations.
One of the primary strategies is the accumulation and retention of core deposits. Core deposits consist of all deposits, except CDs in excess of $100,000, brokered CDs and Listed Service CDs. Core deposits at December 31, 2015 amounted to $614.9 million and accounted for 86.8% of total deposits as compared to $571.6 million and 89.0% of total deposits at December 31, 2014. During 2015, we continued to price our retail CDs $100,000 and over at rates that did not exceed our market competition. The balance of CDs $100,000 and over amounted to $56.9 million at December 31, 2015 compared to $43.2 million at December 31, 2014, an increase of $13.7 million, or 31.7%. At December 31, 2015, brokered CDs totaled $37.9 million as compared to $29.0 million at December 31, 2014 with rates ranging from 0.60% to 2.12% and original terms ranging from 12 to 84 months, while Listed Service CDs totaled $33.3 million compared to $10.2 million at December 31, 2014 with rates between 0.96% to 2.10% and original terms ranging from 24 to 60 months.
The Company found this strategy of placing both brokered and Listed Service CDs provides a more cost-effective source of longer-term funding, as the rates paid for these type CDs were very competitive with current fixed rate term advances at the FHLB of New York without any collateral requirements.
The following table reflects the average balances and average rates paid on deposits for the years ended December 31, 2015, 2014 and 2013.
The following table sets forth a summary of the maturities of certificates of deposit $100,000 and over at December 31, 2015 (in thousands).
Borrowings
The Bank has unsecured lines of credit totaling $46.0 million with four correspondent financial institutions. These borrowings are priced on a daily basis. The Bank had no borrowings outstanding on these lines. The Bank also has a remaining borrowing capacity with the Federal Home Loan Bank of New York (“FHLB”) of approximately $55.6 million based on the current loan collateral pledged of $102.3 million at December 31, 2015.
Short-term borrowings consist of Federal funds purchased and short-term borrowings from the FHLB. At December 31, 2015, 2014 and 2013, the Company had no short-term borrowings outstanding.
At December 31, 2015, 2014 and 2013, long-term debt consisted of advances from the FHLB, which amounted to $26.5 million, $16.0 million and $17.5 million, respectively. In light of the low interest rate environment and strong loan pipeline, the Company took advantage of securing laddered advances through the FHLB during the first quarter of 2015. Total FHLB advances had a weighted average interest rate of 2.28%, 2.89% and 2.79% at December 31, 2015, 2014 and 2013, respectively. These advances are contractually scheduled for repayment as follows:
The maximum amount outstanding of FHLB advances at any month-end during 2015 and 2014 was $28.0 million and $17.5 million, respectively. The average interest rates paid on FHLB advances for 2015, 2014 and 2013 were 2.30%, 2.85% and 3.13%, respectively.
Subordinated Debentures
In December 2015, the Company completed a private placement of $10 million in aggregate principal amount of fixed to floating rate subordinated debentures to certain institutional accredited investors. The subordinated debentures have a maturity date of December 31, 2025 and bear interest, payable quarterly, at the rate of 6.25% per annum until January 1, 2021. On that date, the interest rate will be adjusted to float at an annual rate equal to the three-month LIBOR rate plus 464 basis points (4.64%) until maturity. The debentures include a right of prepayment, without penalty, on or after December 14, 2020 and, in certain limited circumstances, before that date. The indebtedness evidenced by the subordinated debentures, including principal and interest, is unsecured and subordinate and junior in right to payment to general and secured creditors of the Company and depositors and other creditors of the Bank. The subordinated debentures have been structured to qualify as Tier 2 capital for regulatory purposes. Subordinated debentures totaled $9.8 million at December 31, 2015, which includes $176,000 of remaining unamortized debt issuance costs. The debt issuance costs are being amortized over the expected life of the issue. The effective interest rate of the subordinated debentures is 6.67%.
Repurchase Agreements
Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected as the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. Securities sold under agreements to repurchase decreased to $19.5 million at December 31, 2015 from $23.3 million at December 31, 2014, a decrease of $3.8 million, or 16.3%.
Repurchase agreements are summarized as follows:
Liquidity
Liquidity defines the Company’s ability to generate funds to support asset growth, meet deposit withdrawals, maintain reserve requirements and otherwise operate on an ongoing basis. An important component of the Company’s asset and liability management structure is the level of liquidity available to meet the needs of our customers and requirements of our creditors. The liquidity needs of the Bank are primarily met by cash on hand, Federal funds sold position, maturing investment securities and short-term borrowings on a temporary basis. The Bank invests the funds not needed to meet its cash requirements in overnight Federal funds sold and an interest bearing account with the Federal Reserve Bank of New York. With adequate deposit inflows coupled with the above-mentioned cash resources, the Bank is maintaining short-term assets which we believe are sufficient to meet its liquidity needs. The Bank’s liquidity can be affected by a variety of factors, including general economic conditions, market disruption, operational problems affecting third parties or us, unfavorable pricing, competition, our credit rating and regulatory restrictions.
At December 31, 2015, the Company had $46.7 million in cash and cash equivalents as compared to $36.1 million at December 31, 2014. Cash and cash equivalent balances consisted of $25.2 million and $17.8 million held at the Federal Reserve Bank of New York at December 31, 2015 and 2014, respectively. At December 31, 2015 and 2014, there were no Federal funds sold. Further information regarding our borrowing capacity with FHLB and unsecured lines is discussed previously under the caption “Borrowings.”
On July 21, 2015, the Company filed a registration statement with the SEC permitting it to issue a combination of securities, in one or more offerings, from time to time, up to $30.0 million. This registration statement was declared effective by the SEC on September 4, 2015. See “Capital” below.
Off-Balance Sheet Arrangements
The Company’s financial statements do not reflect off-balance sheet arrangements that are made in the normal course of business. These off-balance sheet arrangements consist of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. These instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company.
Management believes that any amounts actually drawn upon these commitments can be funded in the normal course of operations. The following table sets forth our off-balance sheet arrangements as of December 31, 2015 and 2014.
Capital
Shareholders’ equity decreased by $930,000, or 1.0%, to $93.0 million at December 31, 2015 compared to $93.9 million at December 31, 2014. This decrease was caused by the redemption of our remaining $6.0 million of Series C preferred stock, $497,000 in common stock repurchases, the payment of $1.0 million in cash dividends on our common stock and the payment of $57,000 in dividends on the Series C preferred stock. These decreases were partially offset by the addition of $6.3 million in net income for 2015, stock-based compensation expense of $186,000 and proceeds from the exercise of stock options of $114,000.
The Company and the Bank are subject to various regulatory and capital requirements administered by the Federal banking agencies. Our federal banking regulators, the Board of Governors of the Federal Reserve System (the “Federal Reserve) (which regulates bank holding companies) and the Federal Deposit Insurance Corporation (the “FDIC”) (which regulates the Bank), have issued guidelines classifying and defining capital. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank is also subject to qualitative judgments by the regulators about components, risk weightings and other factors. See “Item 1. Business - Supervision and Regulation.”
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios, set forth in the following tables of Tier 1 Capital to Average Assets (Leverage Ratio), Common Equity Tier 1 Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Total Capital to Risk Weighted Assets.
As of December 31, 2015, the Company and the Bank met all regulatory requirements for classification as well-capitalized under the applicable regulatory framework. Management believes that there are no conditions or events that have changed the classification.
The capital amounts and ratios of the Company and the Bank at December 31, 2015 and 2014 and the minimum amounts and ratios required for capital adequacy purposes and to be well capitalized under the prompt corrective action provisions are as follows:
*The Prompt Correction Action rules apply to the Bank only. The requirements for “well-capitalized” for the Company come from the bank holding company regulations.
The Bank is subject to certain legal and regulatory limitations on the amount of dividends that it may declare without prior regulatory approval.
Basel III Capital Rules. In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III.
These revisions generally implemented higher minimum capital requirements, added a new common equity Tier 1 Capital requirement, and established criteria that instruments must meet to be considered common equity Tier 1 Capital, additional Tier 1 Capital or Tier 2 Capital. As of January 1, 2015, the new minimum capital to risk-adjusted assets requirements are a common equity Tier 1 Capital ratio of 4.5% (6.5% for the Bank to be considered “well capitalized”) and a Tier 1 Capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% for the Bank to be considered “well capitalized”); the total capital ratio requirement remains at 8.0% under the new rules (10.0% to be considered “well capitalized”).
Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payment to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 Capital above its minimum risk-based capital requirements. This capital conservation buffer requirement phases in over a three-year period beginning January 1, 2016. At January 1, 2019, the capital conservation buffer must be greater than 2.5% of total risk-weighted assets. Additionally, the Company determined, as permitted under Basel III, to opt-out of including accumulated other comprehensive income in regulatory capital.
As of December 31, 2015, the Bank would have had a capital conservation buffer greater than 2.5%.
On July 21, 2015, the Company filed a registration statement with the SEC permitting it to issue a combination of securities, in one or more offerings, from time to time, up to $30.0 million. This registration statement was declared effective by the SEC on September 4, 2015. The purpose of this newly filed registration statement was to replace the availability previously provided by the Company’s registration statement filed in August 2012.
We intend to use any net proceeds from the sale of the securities registered by this Registration Statement for general corporate purposes. General corporate purposes may include, among other purposes, contribution to the capital of the Bank to support its lending and investing activities; the repayment of our debt; the support or funding of acquisitions of other institutions or branches, if opportunities for such transactions become available; and investments in activities that are permitted for bank holding companies. The applicable prospectus supplement will provide details on the use of proceeds of any specific offering.
Interest Rate Risk
Interest rate risk management involves managing the extent to which interest-sensitive assets and interest-sensitive liabilities are matched. Interest rate sensitivity is the relationship between market interest rates and earnings volatility due to the re-pricing characteristics of assets and liabilities. Our net income is affected by changes in the level of market interest rates. In order to maintain consistent earnings performance, we seek to manage, to the extent possible, the re-pricing characteristics of our assets and liabilities.
The management of and authority to assume interest rate risk is the responsibility of the ALCO, which is comprised of senior management and board members. The primary objective of Asset/Liability management is to establish prudent risk management guidelines and to coordinate balance sheet composition with interest rate risk management to sustain a reasonable and stable net interest income throughout various interest rate cycles. We have policies and practices for measuring and reporting interest rate risk exposure, through analysis of the net interest margin, gap position, simulation testing, liquidity ratios and the Economic Value of Portfolio Equity. In addition, we annually review our interest rate risk policy, which includes limits on the impact to earnings from shifts in interest rates.
Gap Analysis
To manage our interest sensitivity position, an asset/liability model called “gap analysis” is used to monitor the difference in the volume of our interest-sensitive assets and liabilities that mature or re-price within given periods. The ratio between assets and liabilities re-pricing in specific time intervals is referred to as an interest rate sensitivity gap. A positive gap (asset-sensitive) indicates that more assets re-price during a given period compared to liabilities, while a negative gap (liability-sensitive) has the opposite effect. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income, while a negative gap would tend to affect net interest income adversely. We employ net interest income simulation modeling to assist in quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest income through varying interest rate changes and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of the interest rate changes on interest-sensitive assets and liabilities in order to determine what impact these rate changes will have upon the net interest spread.
As of December 31, 2015, the Company’s six month cumulative gap was -9.7% of total assets, or a negative $83.4 million, while its one-year cumulative gap was -7.0% of total assets, or $5.7 million, which is within the ALCO policy guideline of + or - 25%.
Simulation Modeling
We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a twelve and twenty-four month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of December 31, 2015. The model assumes changes in interest rates without any proactive change in the composition or size of the balance sheet by management. In the model, the forecasted shape of the yield curve remains static as of December 31, 2015.Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of December 31, 2015. The model utilizes an immediate parallel shift in the market interest rates at December 31, 2015. As of December 31, 2015 and 2014, the results of the simulation model were within guidelines prescribed by the ALCO policy. If model results were to fall outside prescribed ranges, action would be required by ALCO.
The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table above, due to the frequency and timing of changes in interest rates, and changes in spreads between maturity and re-pricing categories. Overall, our net interest income is affected by changes in interest rates and cash flows from our loan and investment portfolios. We actively manage these cash flows in conjunction with our liability mix, duration and interest rates to optimize the net interest income, while structuring the balance sheet in response to actual or potential changes in interest rates.
Additionally, our net interest income is impacted by the level of competition within our market place. Competition can negatively impact the level of interest rates attainable on loans and increase the cost of deposits, which may result in downward pressure on our net interest margin in future periods. Other factors, including, but not limited to, the slope of the yield curve and projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet.
Economic Value of Equity
To measure the impact of longer-term asset and liability mismatches beyond two years, the Company utilizes Economic Value of Portfolio Equity (“EVPE”) models. EVPE considers the entire maturity spectrum of the Bank’s balance sheet, thereby providing a longer term measure of interest rate risk. The underlying economic value of the Bank’s assets, liabilities and off balance sheet instruments are affected by changes in interest rates. These changes occur because the present value of future cash flows and in some cases, the cash flows themselves, are affected by interest rate changes. The combined effects of the changes in these present values reflect the change in the Bank’s underlying economic value.
In addition to providing a longer-term measurement of interest rate risk, the economic value of equity measurement may highlight the impact of current interest rate changes that may not be accounted for in simulation analysis. In addition, a decline in the economic value of equity may indicate below market returns in the future. Because of balance sheet optionality, an EVPE analysis is used to dynamically model the present value of asset and liability cash flows, with rates ranging up or down 200 basis points. Our analysis of EVPE excludes goodwill and includes only tangible equity. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by the ALCO.
At December 31, 2015 and 2014, the Company’s variance in the EVPE as a percentage of change from book value of tangible equity compared to no change in interest rates, and to an instantaneous and sustained parallel shift of + or - 200 basis points, is within the Company’s policy guidelines as presented below.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
Not required.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
Reference is made to Item 15(a)(1) and (2) to page for a list of financial statements and supplementary data required to be filed pursuant to this Item 8. The information required by this Item 8 is provided beginning on page hereof.
Item 9.
Item 9.
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
The Company has established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
The Company’s principal executive officer and its principal financial and accounting officer, with the assistance of other members of the Company’s management, have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report. Based upon such evaluation, the Company’s principal executive officer and principal financial and accounting officer have concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this annual report.
The Company’s principal executive officer and principal financial officer have also concluded that there was no change in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act and for complying with laws and regulations relating to safety and soundness that are designated by the FDIC and the Federal Reserve. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and circumvention or overriding of controls. Accordingly, even effective internal control or compliance with banking laws can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control and compliance with banking laws may vary over time.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting and its compliance with laws and regulations relating to safety and soundness that are designated by the FDIC and the Federal Reserve as of December 31, 2015. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework (2013) (the “2013 Framework”) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on their assessment using those criteria, management concluded that, as of December 31, 2015, the Company’s internal control over financial reporting and its compliance with laws and regulations relating to safety and soundness that are designated by the FDIC and the Federal Reserve was effective.
This annual report does not include an audit report of the Company’s Independent Registered Public Accounting Firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s Independent Registered Public Accounting Firm pursuant to the Dodd-Frank Act.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information required by this item is incorporated by reference from the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders under the captions “Item 1 - ELECTION OF CLASS I DIRECTORS - Information Concerning Nominees and Continuing Directors,” “Executive Officers,” “STOCK OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS - Section 16(a) Beneficial Ownership Reporting Compliance,” “CORPORATE GOVERNANCE - Code of Conduct and Corporate Governance Guidelines” and “- Audit Committee.”
Item 11.
Item 11.
Executive Compensation.
The information required by this item is incorporated by reference from the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders under the captions “EXECUTIVE COMPENSATION,” “DIRECTOR COMPENSATION,” and “CORPORATE GOVERNANCE - Compensation Committee Interlocks and Insider Participation.”
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
Equity Compensation Plan Information
The following table provides information about the Company’s common stock that may be issued upon the exercise of options, warrants and rights under all of the Company’s equity compensation plans as of December 31, 2015. The information in the table has been adjusted for all subsequent stock dividends.
(1)
The Company may issue these shares pursuant to options and restricted stock awards.
Security Ownership of Certain Beneficial Owners and Management.
The additional information required by this item is incorporated by reference from the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders under the caption “STOCK OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS.”
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated by reference from the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders under the captions “CERTAIN TRANSACTIONS WITH MANAGEMENT” and “CORPORATE GOVERNANCE - Director Independence.”
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information regarding principal accounting fees and services and the Company’s pre-approval policies and procedures for audit and non-audit services provided by the Company’s independent registered public accounting firm is incorporated by reference from the Company’s Proxy Statement for its 2016 Annual Meeting of Shareholders under the caption “ITEM 3 - RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - Independent Auditor Fees” and “- Audit Committee Pre-Approved Procedures.”
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
TWO RIVER BANCORP
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Two River Bancorp
Tinton Falls, New Jersey
We have audited the accompanying consolidated balance sheets of Two River Bancorp (the “Company”) as of December 31, 2015 and 2014 and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Two River Bancorp at December 31, 2015 and 2014, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
BDO USA, LLP
Woodbridge, New Jersey
March 25, 2016
Two River Bancorp
Consolidated Balance Sheets
See notes to consolidated financial statements.
Two River Bancorp
Consolidated Statements of Operations
See notes to consolidated financial statements.
Two River Bancorp
Consolidated Statements of Comprehensive Income
See notes to consolidated financial statements.
Two River Bancorp
Consolidated Statements of Shareholders’ Equity
See notes to consolidated financial statements.
Two River Bancorp
Consolidated Statements of Cash Flows
See notes to consolidated financial statements.
Note 1 - Summary of Significant Accounting Policies
A.
Organization and Basis of Presentation
The accompanying consolidated financial statements include the accounts of Two River Bancorp (the “Company”), a bank holding company, and its wholly-owned subsidiary, Two River Community Bank (“the Bank” or “Two River”) and the Bank’s wholly-owned subsidiaries, TRCB Investment Corporation, TRCB Holdings Two LLC, TRCB Holdings Three LLC, TRCB Holdings Seven LLC and TRCB Holdings Eight LLC. All inter-company balances and transactions have been eliminated in the consolidated financial statements.
B.
Nature of Operations
Two River Bancorp is a bank holding company whose principal activity is the ownership of Two River Community Bank. Through its banking subsidiary, the Company provides banking services to small and medium-sized businesses, professionals and individual consumers primarily in the Monmouth, Middlesex and Union Counties, located in Central and Northern New Jersey. The Company competes with other banking and financial institutions in its market communities.
The Company and its bank subsidiary are subject to regulations of certain state and federal agencies and, accordingly, they are periodically examined by those regulatory authorities. As a consequence of the extensive regulation of commercial banking activities, the Company’s and the Bank’s businesses are susceptible to being affected by state and federal legislation and regulations.
C.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The principal material estimates that are particularly susceptible to significant change in the near term related to: the allowance for loan losses, the potential impairment of goodwill, the potential impairment of restricted investments, the valuation of deferred tax assets, valuation of other real estate owned and the determination of other-than-temporary impairment on securities.
D.
Significant Concentrations of Credit Risk
Most of the Company’s activities are with customers located within Monmouth, Middlesex and Union Counties of New Jersey. Note 2 discusses the types of securities that the Company invests in. Note 3 discusses the types of lending that the Company engages in. Although the Company actively manages the diversification of its loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the strength of the local economy. The loan portfolio includes commercial real estate, which is comprised of owner occupied and investment real estate, including general office, medical, manufacturing and retail space. Construction loans, short-term in nature, comprise another portion of the portfolio, along with commercial and industrial loans. The latter includes lines of credit and equipment loans. From time to time, the Company may purchase or sell an interest in a loan from or to another lender (participation loan) in order to manage its portfolio risk. Loans purchased by the Company are typically located in central New Jersey and meet the Company’s own independent underwriting guidelines. The Company does not have any significant concentrations in any one industry or customer.
E.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale and unrealized losses related to factors other than credit on debt securities which have been determined to be other-than-temporarily impaired.
F.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing demand deposits in banks, and Federal funds sold. Interest-bearing deposits are due from the Federal Reserve Bank of New York. Generally, Federal funds are purchased and sold for one-day periods.
Note 1 - Summary of Significant Accounting Policies (Continued)
G.
Securities
Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Securities available for sale are carried at fair value. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains or losses are reported as increases or decreases in other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities available for sale are recorded on the trade date and are determined using the specific identification method.
Securities classified as held to maturity are those securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for the amortization of premium and accretion of discount, computed by the interest method over the terms of the securities.
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Other-than-temporary accounting guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporary impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held to maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future cash flows of the security.
H.
Restricted Investments
Restricted investments, which represents the required investment in the common stock of correspondent banks, is carried at cost and as of December 31, 2015 and 2014, consists of the common stock of the Federal Home Loan Bank of New York (“FHLB”) and Atlantic Community Bankers Bank (“ACBB”). Federal law requires a member institution of the FHLB to hold stock of its district FHLB according to a predetermined formula. The recorded investment in FHLB common stock was $2,020,800 and $1,454,000 at December 31, 2015 and 2014, respectively. The recorded investment in ACBB common stock was $75,000 at December 31, 2015 and 2014, respectively.
Restricted investments also include the Solomon Hess SBA Loan Fund, utilized for the purpose of the Bank satisfying its CRA lending requirements. As this fund operates as a private fund, shares in the Fund are not publicly traded and therefore have no readily determinable market value. An investor can have their interest in the Fund redeemed for the balance of their capital account at any quarter end assuming they give the Fund 60 days’ notice. The investment in this Fund is recorded at cost which was $1,500,000 at December 31, 2015 and 2014, respectively. The Company does not record the investment at fair value on a recurring basis.
Management evaluates the restricted investments for impairment in accordance with U.S. generally accepted accounting principles. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. Management believes no impairment charge is necessary related to restricted investments as of December 31, 2015.
I.
Loans Receivable and Loans Held for Sale
Loans receivable, which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.
Note 1 - Summary of Significant Accounting Policies (Continued)
Generally, loans held for sale are designated at time of origination, generally consist of newly originated fixed rate residential loans and are recorded at the lower of aggregate cost or estimated fair value in the aggregate. The Company did not transfer any impaired loans from held for investment to held for sale in 2015 and 2014. Transfers from held for investment are infrequent and occur at fair value less costs to sell, with any charge-off to allowance for loan losses. Gains are recognized on a settlement-date basis and are determined by the difference between the net sales proceeds and the carrying value of the loans, including any net deferred fees or costs.
The loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following classes: commercial and industrial, real estate-construction and real estate-commercial. Consumer loans consist of the following classes: real estate-residential and consumer.
For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest previously accrued on these loans is reversed from income. Interest received on nonaccrual loans including impaired loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
J.
Allowance for Loan Losses
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet, which at December 31, 2015 and 2014, the Company had no such reserves. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a monthly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan. The specific component relates to loans that are classified as impaired. When a loan is impaired, there are three acceptable methods under ASC 310-10-35 for measuring the impairment:
1.
The loan’s observable market price;
2.
The fair value of the underlying collateral; or
3.
The present value (PV) of expected future cash flows.
Loans that are considered “collateral-dependent” should be evaluated under the “Fair market value of collateral.” Loans that are still expected to be supported by repayment from the borrower should be evaluated under the “Present value of future cash flows.”
For the most part, the Company measures impairment under the “Fair market value of collateral” for any loan that would rely on the value of collateral for recovery in the event of default. The individual impairment analysis for each loan is clearly documented as to the chosen valuation method.
Note 1 - Summary of Significant Accounting Policies (Continued)
The general component covers pools of loans by loan class including commercial and industrial, real estate-construction and real estate-commercial not considered impaired as well as smaller balance homogeneous loans such as real estate-residential and consumer.
These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include:
1.
Changes in lending policy and procedures, including changes in underwriting standards and collection practices not previously considered in estimating credit losses.
2.
Changes in relevant economic and business conditions.
3.
Changes in nature and volume of the loan portfolio and in the terms of loans.
4.
Changes in experience, ability and depth of lending management and staff.
5.
Changes in the volume and severity of past due loans, the volume of non-accrual loans and the volume and severity of adversely classified loans.
6.
Changes in the quality of the loan review system.
7.
Changes in the value of underlying collateral for collateral-dependent loans.
8.
The existence and effect of any concentration of credit and changes in the level of such concentrations.
9.
The effect of other external forces such as competition, legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.
Each factor is assigned a risk value to reflect low, moderate or high risk assessments based on management’s best judgment using current market, macro and other relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation in each factor and accompany the allowance for loan loss calculation.
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The Company engages in a variety of lending activities, including commercial and industrial, real estate-commercial, real estate-construction, real estate-residential and consumer loans. The Company focuses its lending activities on individuals, professionals along with small to medium sized businesses.
The Company originates commercial business loans to professionals, sole proprietorships and small businesses in our market areas. We extend commercial business loans on a secured and unsecured basis. Secured commercial loans are generally collateralized by residential and nonresidential real estate, marketable securities, accounts receivable, inventory, industrial/commercial machinery and equipment and furniture and fixtures. To further enhance our security position, we generally require personal guarantees of the principal owners of the entities to which we extend credit. These loans are made on both lines of credit and fixed-term basis typically ranging from one to five years in duration. When making commercial business loans, we consider the financial statements and/or tax returns of the borrower, the borrower’s payment history along with the principal owners’ payment history, the debt service capabilities of the borrower, the projected cash flows of the business, and the value of the collateral and the financial strength of the guarantor.
Commercial real estate loans are made to local commercial, retail and professional firms and individuals for the acquisition of new property or the refinancing of existing property. These loans are typically related to commercial businesses and secured by the underlying real estate used in these businesses or real property of the principals. Commercial real estate loans typically require a loan to value ratio of not greater than 75%. These loans are generally offered on a fixed or variable rate basis, subject to rate re-adjustments every five years and amortization schedules ranging from 5 to 25 years.
Note 1 - Summary of Significant Accounting Policies (Continued)
Commercial loans are often larger and may involve greater risks than other types of lending. Because payments of such loans are often dependent on the successful operation of the business involved, repayment of such loans may be more sensitive than other types of loans and are subject to adverse conditions in the real estate market or the general economy. We are also involved with off-balance sheet financial instruments, which include collateralized commercial and standby letters of credit. We seek to minimize these risks through our underwriting guidelines and prudent risk management techniques. Any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. Environmental surveys and inspections are obtained when circumstances suggest that the possibility of the presence of hazardous materials. There can be no assurances, however, of success in the efforts to minimize these risks.
The Company is an approved Preferred Lender by the Small Business Administration (“SBA”), which allows the Company delegated authority to approve and close SBA loans up to $5.0 million. The Company maintains prudent credit risk management to monitor and evaluate the value of real estate and other collateral used to secure SBA loans. All SBA loans are originated in compliance with all applicable federal lending regulations, including but not limited to the Equal Credit Opportunity Act. The Bank currently participates in SBA’s 7a and 504 loan programs, which typically provide guarantees up to 75% per loan. The Bank generally sells the guaranteed portion of selected loans to a third party and retains the servicing rights. The servicing asset rights recorded as of December 31, 2015 and 2014 are not material. Our philosophy remains to be prudent and focused on the cash flow of the businesses and financial strength of the guarantors.
The Company originates fixed-rate and adjustable-rate loans to individuals and builders to finance the construction of residential dwellings. We also originate construction loans for commercial development projects, including apartment buildings, restaurants, shopping centers and owner-occupied properties used for businesses. Our construction loans generally provide for the payment of interest only during the construction phase which is typically twelve months for residential properties and twelve to eighteen months for commercial properties. At the end of the construction phase, the loan is either converted to a permanent mortgage loan or paid off. Before making a commitment to fund a construction loan, we require an appraisal and an environmental analysis of the property performed by a bank approved independent licensed appraiser and environmental consultant, an inspection of the property before disbursement of funds during the stages of the construction process, and approval from an identified source for the permanent takeout.
The Company offers a full range of residential real estate and consumer loans. These loans consist of residential mortgages, home equity lines of credit, equity loans, personal loans, automobile loans and overdraft protection. We do not originate subprime or negative amortization loans. Each residential mortgage loan is evidenced by a promissory note secured by a mortgage or deed of trust creating a first lien on one-to-four family residential property. Residential real estate properties underlying residential mortgage loans consist of single-family detached units, individual condominium units, two-to-four family dwellings units and townhouses. Our home equity revolving lines of credit come with a floating interest rate tied to the prime rate. Lines of credit are available to qualified applicants in amounts up to $350,000 for up to 15 years. We also offer fixed rate home equity loans in amounts up to $350,000 for a term of up to 15 years. Credit is based on the income and cash flow of the individual borrowers, real estate collateral supporting the mortgage debt and past credit history.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate in value rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
A loan is considered impaired when it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial, real estate-commercial, real estate-construction, real estate-residential and consumer loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
Note 1 - Summary of Significant Accounting Policies (Continued)
An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
Loans whose terms are modified are classified as troubled debt restructurings (“TDRs”) if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a TDR generally involve a temporary reduction in interest rate or a modification of a loan’s amortization schedule. Non-accrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after the modification is in place. Loans classified as TDRs are designated as impaired.
The Company’s troubled debt restructured modifications are made on terms typically up to 12 months in order to aggressively monitor and track performance. The short-term modifications performances are monitored for continued payment performance for an additional period of time after the expiration of the concession. Balance reductions and annualized loss rates are also important metrics that are monitored. The main objective of the modification programs is to reduce the payment burden for the borrower and improve the net present value of the Company’s expected cash flows.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristics that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectable and are charged to the allowance for loan losses. Loans not classified are rated pass.
In addition, federal and state regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
K.
Transfers of Financial Assets
Transfers of financial assets, including sale of loans and loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Note 1 - Summary of Significant Accounting Policies (Continued)
L.
Other Real Estate Owned and Repossessed Assets
Other Real Estate Owned (“OREO”) and repossessed assets include real estate and assets pledged as collateral acquired through foreclosure or by deed in lieu of foreclosure. OREO and repossessed assets are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred.
M.
Bank-Owned Life Insurance
The Company invests in bank-owned life insurance (“BOLI”) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Company’s wholly-owned trust on a chosen group of officers and directors. The Company is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Income generated from the increase in cash surrender value of the policies is included in non-interest income on the statements of operations.
N.
Bank Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to operations on a straight-line basis over the estimated useful lives of the respective assets. Leasehold improvements are amortized over the shorter of their estimated life or the lease term.
O.
Advertising
The Company expenses advertising costs as incurred.
P.
Income Taxes
Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company and its subsidiary file a consolidated Federal income tax return.
The Company analyzes each tax position taken in its tax returns and those positions not taken and determines the likelihood that the position will be realized. Only tax positions that are “more likely than not” to be realized can be recognized in the Company’s financial statements. For tax positions that do not meet this recognition threshold, the Company will record an unrecognized tax benefit for the difference between the position taken on the tax return and the amount recognized in the financial statements. The Company does not have any material unrecognized tax benefits or accrued interest or penalties at December 31, 2015 or 2014 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months. The Company’s policy is to account for interest as a component of interest expense and penalties as a component of other expenses. The Company and its subsidiaries are subject to U.S. Federal income tax as well as income tax of the State of New Jersey. The Company is no longer subject to examination by taxing authorities for the years before January 1, 2012.
Q.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded in the balance sheet when they are funded.
R.
Earnings per Common Share
Earnings per common share are calculated on the basis of the weighted average number of common shares outstanding during the year. Basic earnings per common share excludes dilution and is calculated by dividing net income available to common shareholders by the weighted average common shares outstanding excluding restricted stock awards outstanding during the period. Diluted earnings per common share takes into account the potential dilution that could occur if certain outstanding securities to issue common stock were exercised and converted into common stock. Potential common shares relate to outstanding stock options, warrants and restricted stock awards, and are determined using the treasury stock method.
Note 1 - Summary of Significant Accounting Policies (Continued)
S.
Stock-Based Compensation
Stock compensation accounting guidance requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service periods, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards.
T.
Reclassification
Certain amounts in the 2014 financial statements have been reclassified to conform to the presentation used in the 2015 financial statements. These reclassifications had no effect on net income.
U.
Goodwill and Other Intangible Assets
The Company’s goodwill was recognized in connection with the acquisition of the Town Bank in April 2006. Accounting principles generally accepted in the United States of America require that goodwill be tested for impairment annually or more frequently if impairment indicators arise utilizing a two-step methodology. Step one requires the Company to determine the fair value of the reporting unit and compare it to the carrying value, including goodwill, of such reporting unit. The reporting unit was determined to be our community banking operations, which is our only operating segment. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to determine the amount of impairment, if any. The second step compares the fair value of the reporting unit to the aggregate fair values of its individual assets, liabilities and identified intangibles.
The Company performed its annual goodwill impairment analysis as of September 30, 2015. Based on the results of the step one goodwill impairment analysis, the Company determined that there was no impairment on the current goodwill balance. See Note 5 for additional details.
V.
Segment Reporting
The Company acts as an independent community financial services provider, and offers traditional banking and related financial services to individual, business and government customers. Through its branch, automated teller machine networks, and internet banking services, the Company offers a full array of commercial and retail financial services, including time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of other financial services. Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail, mortgage banking and consumer banking operations of the Company. Accordingly, all significant operating decisions are based upon analysis of the Bank as one segment or unit.
W.
Subsequent Events
The Company has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2015 for items that should potentially be recognized or disclosed in these financial statements.
X.
Recent Accounting Pronouncements
ASU 2014-04; In January, 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU also requires additional related interim and annual disclosures. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The Company adopted ASU 2014-01 effective January 1, 2015. The adoption did not have a material impact on our financial position or results of operation.
Note 1 - Summary of Significant Accounting Policies (Continued)
ASU 2014-09: In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. The guidance in this ASU for public companies is effective for the annual periods beginning after December 15, 2016, including interim periods therein. In August 2015, the FASB approved a one-year delay of the effective date of this standard. The deferral would require public entities to apply the standard for annual reporting periods beginning after December 15, 2017. Public companies would be permitted to elect to early adopt for annual reporting periods beginning after December 15, 2016. The Company will be evaluating the provisions of ASU 2014-09 and will be closely monitoring developments and additional guidance to determine the potential impact the new standard will have on our financial position or results of operation.
ASU 2014-11: In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this ASU establish two accounting changes. First, repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet, rather than sales. Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with (or in contemplation of) a repurchase agreement with the same counterparty, which also will generally result in secured borrowing accounting for the repurchase agreement. The guidance in this ASU for public companies is effective for the first interim or annual period beginning after December 31, 2014. The Company adopted ASU 2014-11 effective January 1, 2015. The adoption did not have a material impact on our financial position or results of operation.
ASU 2014-12: In June 2014 the FASB issued ASU 2014-12, Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in this ASU requires that a performance target included in a share-based payment award that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Therefore, such performance target should not be reflected in estimating the grant-date fair value of the award. A reporting entity should apply existing guidance in Topic 718 as it relates to the award with performance conditions that affect vesting. The guidance in this ASU are effective for annual periods and interim periods with those annual periods beginning after December 15, 2014. The Company adopted ASU 2014-12 effective January 1, 2015. The adoption did not have a material impact on our financial position or results of operation.
ASU 2015-03: In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. This ASU revises Subtopic 835-30 to require that debt issuance costs be reported in the balance sheet as a direct deduction from the face of the related liability, consistent with the presentation of debt discounts. Prior to the amendments, debt issuance costs were presented as a deferred charge, i.e., an asset, on the balance sheet. Further, the amendments require the amortization of debt issuance costs to be reported as interest expense. Similarly, debt issuance costs and any discount or premium are to be considered in the aggregate when determining the effective interest rate on the debt. The amendments are effective for the Company for fiscal years beginning after December 31, 2015, and interim periods within those fiscal years, and must be applied retrospectively. Early adoption is permitted as of an earlier date for which financial statements have not been previously issued. The Company early-adopted the provisions of this ASU effective with its consolidated financial statements as of and for the period ended December 31, 2015, which was the period in which the Company initially adopted an accounting principle in recognition of a debt issuance cost transaction occurring for the first time. There was no material effect on the Company’s financial position or results of operations. See Note 9 for additional details.
ASU 2016-01: In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income; provides for a practicability exception election for equity investments without readily determinable fair values; simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; eliminates the requirement for nonpublic business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements and clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact that ASU 2016-01 will have on its statement of financial position or financial statement disclosures.
Note 1 - Summary of Significant Accounting Policies (Continued)
ASU 2016-02: In February 2016, the FASB issued ASU No. 2016-02, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessee. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements.
Note 2 - Securities
The amortized cost, gross unrealized gains and losses, and fair values of the Company’s securities are summarized as follows:
December 31, 2015:
December 31, 2014:
Note 2 - Securities (Continued)
The amortized cost and fair value of the Company’s debt securities at December 31, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company had 19 securities sales in 2015 totaling $24,306,000 and recorded gross realized gains and losses of $70,000 and $33,000, respectively, from these sales as compared to thirty-one securities sales in 2014 totaling $9,827,000 and recorded gross realized gains and losses of $105,000 and $17,000 respectively.
Investment securities with a carrying value of $32,596,000 and $31,945,000 at December 31, 2015 and 2014, respectively, were pledged as collateral to secure securities sold under agreements to repurchase and public funds as required or permitted by law.
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at December 31, 2015 and 2014:
Note 2 - Securities (Continued)
The Company had 49 securities in an unrealized loss position at December 31, 2015. In management’s opinion, the unrealized losses in U.S. Government agencies, corporate debt, U.S. Government collateralized residential mortgage obligations, municipal, GSE residential mortgage-backed securities and CRA mutual fund reflect changes in interest rates subsequent to the acquisition of specific securities. The unrealized loss for corporate debt securities also reflects a widening of spreads due to the liquidity and credit concerns in the financial markets. The Company may, if conditions warrant it, elect to sell debt securities at a loss and redeploy the proceeds into other investments in an effort to improve returns, risk profile and overall portfolio diversification. The Company will recognize any losses when the decision is made. At December 31, 2015, the Company does not intend to sell these debt securities prior to recovery and it is more likely than not that the Company will not have to sell these debt securities prior to recovery.
Included in corporate debt securities are four individual trust preferred securities issued by large financial institutions with Moody’s ratings from Baa1 to Ba1. As of December 31, 2015, all of these securities are current with their scheduled interest payments. These single issue securities are from large money center banks. Management concluded that these securities were not other-than-temporarily impaired as of December 31, 2015. These four securities have an amortized cost value of $2.8 million and a fair value of $2.4 million at December 31, 2015.
There was no other-than-temporary impairments recognized during 2015 and 2014.
Note 3 - Loans Receivable and Allowance for Loan Losses
The components of the loan portfolio at December 31, 2015 and 2014 are as follows:
The performance and credit quality of the loan portfolio is monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of December 31, 2015 and 2014:
December 31, 2015:
December 31, 2014:
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
The following table presents non-accrual loans by classes of the loan portfolio at December 31, 2015 and 2014:
The following table summarizes information in regards to impaired loans by loan portfolio class as of December 31, 2015 and 2014:
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of December 31, 2015 and 2014:
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
The following table presents the change in the allowance for loan losses by classes of loans as of December 31, 2015 and 2014:
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
The following table presents the balance in the allowance for loan losses at December 31, 2015 and 2014 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class disaggregated on the basis of the Company’s impairment methodology:
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
The following tables present newly troubled debt restructured loans that occurred during the years ended December 31, 2015 and 2014:
The Company classifies all TDRs as impaired loans. Impaired loans are individually assessed to determine that the loan’s carrying value is not in excess of the estimated fair value of the collateral (less cost to sell), if the loan is collateral dependent, or the present value of the expected future cash flows, if the loan is not collateral dependent. Management performs a detailed evaluation of each impaired loan and generally obtains updated appraisals as part of the evaluation. In addition, management adjusts estimated fair value down to appropriately consider recent market conditions, our willingness to accept a lower sales price to effect a quick sale, and costs to dispose of any supporting collateral.
As of December 31, 2015, TDRs totaled $10.8 million, including $9.3 million that are current and three non-accrual loans totaling $1.5 million. As a result of our impairment evaluation, the Company established an allowance of $49,000 against one loan classified as TDR as of December 31, 2015.
Our troubled debt restructured loans are generally structured with short-term payment plans. The extent of these plans is generally made on terms up to twelve-month payments and all the loans identified as troubled debt restructured as of December 31, 2015, generally involve a temporary reduction in interest rate or a modification of a loan’s amortization schedule.
During the twelve months ended December 31, 2015, twelve TDR loans totaling $3.3 million were paid in full.
Note 3 - Loans Receivable and Allowance for Loan Losses (Continued)
There were no loans receivable modified as TDRs and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the year ended December 31, 2015.
There were two commercial real estate contracts with a recorded investment totaling $281,000 in which the loans receivable were modified as TDRs and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the year ended December 31 2014.
It is the Company’s policy to classify a TDR loan that is either 90 days or greater delinquent or that has been placed in a non-accrual status as a subsequently defaulted TDR loan.
Note 4 - Bank Premises and Equipment
Premises and equipment at December 31, 2015 and 2014 are as follows:
During 2014, the Company constructed a new branch in the Cranford market of Union County. This branch became operational on January 8, 2015.
Note 5 - Goodwill and Other Intangible Assets
The Company’s goodwill was recognized in connection with the acquisition of The Town Bank (“Town Bank”) in April 2006. GAAP requires that goodwill be tested for impairment annually or more frequently if impairment indicators arise utilizing a two-step methodology. Step one requires the Company to determine the fair value of the reporting unit and compare it to the carrying value, including goodwill, of such reporting unit. The reporting unit was determined to be our community banking operations, which is our only operating segment. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to determine the amount of impairment, if any. The second step compares the fair value of the reporting unit to the aggregate fair values of its individual assets, liabilities and identified intangibles.
The Company performed its annual step one goodwill impairment analysis as of September 30, 2015, and uses the fair value of the reporting unit based on the income approach and market approach. The income approach uses a dividend discount analysis. This approach calculates cash flows based on anticipated financial results assuming a change of control transaction. This change of control assumes that an acquirer will achieve an expected base level of earnings, achieve integration cost savings and incur certain transaction costs (including such items as legal and financial advisors fees, contract cancellations, severance and employment obligations, and other transaction costs). The present value of all excess cash flows generated by the Company (above the minimum tangible capital ratio) plus the present value of a terminal sale value is calculated to arrive at the fair value for the income approach.
The market approach is used to calculate the fair value of a company by calculating median earnings and book value pricing multiples for recent actual acquisitions of companies of similar size and performance and then applying these multiples to our community banking reporting unit. No company or transaction in the analysis is identical to our community banking reporting unit and, accordingly, the results of the analysis are only indicative of comparable value. This technique uses historical data to create a current pricing level and is thus a trailing indicator. Results of the market approach need to be understood in this context, especially in periods of rapid price change and market uncertainty. The Company applied the market valuation approach to our then current stock price adjusted by an appropriate control premium and also to a peer group adjusted by an appropriate control premium.
Based on the results of the step one goodwill impairment analysis, the Company determined goodwill impairment did not exist and therefore a step two test was not required. Accordingly, no goodwill impairment was recorded on the goodwill balance of $18,109,000 for the years ended December 31, 2015 and 2014, respectively.
Note 5 - Goodwill and Other Intangible Assets (Continued)
The Company acquired core deposit intangible assets in conjunction with the acquisition of Town Bank. This intangible asset has a carrying value of $9,000, net of accumulated amortization of $2,097,000, as of December 31, 2015 and a carrying value of $57,000, net of accumulated amortization of $2,049,000, as of December 31, 2014. Amortization expense related to intangible assets was $48,000 and $86,000 for the years ended December 31, 2015 and 2014, respectively.
The aggregate estimated amortization expense for the next fiscal year is expected to be $9,000.
Note 6 - Deposits
The components of deposits at December 31, 2015 and 2014 are as follows:
At December 31, 2015, the scheduled maturities of time deposits are as follows (in thousands):
Brokered CDs as of December 31, 2015 and 2014 were $37,859,000 and $29,041,000, respectively. Deposits obtained through the use of deposit listing services that are not brokered deposits as of December 31, 2015 and 2014 were $33,261,000 and $10,176,000, respectively. The aggregate amounts of demand deposit overdrafts that have been reclassified as loan balances are $143,000 and $512,000 as of December 31, 2015 and 2014, respectively.
Note 7 - Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected as the amount of cash received in connection with the transaction. Securities sold under these agreements are retained under the Company’s control at its safekeeping agent. The Company may be required to provide additional collateral based on the fair value of the underlying securities. Information concerning repurchase agreements for the years ended December 31, 2015 and 2014 is as follows:
Note 7 - Securities Sold Under Agreements to Repurchase (Continued)
The Bank enters into Sweep Account Agreements with certain of its deposit account holders for repo sweep arrangements under which funds in excess of a predetermined amount are removed from each such depositor’s account at the end of each banking day, and the Bank’s obligation to restore those funds to the account at the beginning of the following banking day is evidenced by an integrated retail repurchase agreement (a “Repurchase Agreement”) secured by a collateral interest in favor of the depositor in certain government securities held by a third party custodian. The Bank’s obligation to restore the funds under the Repurchase Agreements is accounted for as a collateralized financing arrangement (i.e., secured borrowings), and not as a sale and subsequent repurchase of securities. The obligation to restore the funds to each account is reflected as a liability in the Company's consolidated balance sheets, while the securities underlying the repurchase agreements remain in the respective securities accounts. There is no offsetting or netting of the securities against the Repurchase Agreement obligation.
The following table presents the contractual maturities of the Repurchase Agreements as of December 31, 2015, disaggregated by the class of collateral pledged:
The potential risks associated with the Repurchase Agreements and related pledged collateral, including obligations arising from a decline in the fair value of the pledged collateral, are minimal due to the fact that the Repurchase Agreements pertain to overnight borrowings and therefore not subject to fluctuations in fair market value.
Note 8 - FHLB and Other Borrowings
The Bank utilizes its account relationship with Atlantic Community Bankers Bank to borrow funds through its Federal funds borrowing line in an aggregate amount up to $10.0 million. The Bank also has $36.0 million in unsecured credit facilities with three correspondent banks. These borrowings are priced on a daily basis. The Company had no borrowings outstanding on these lines. The Bank also has a remaining borrowing capacity with the FHLB of approximately $55.6 million based on the current loan collateral pledged of $102.3 million at December 31, 2015.
At December 31, 2015 and 2014, long-term debt consisted of advances from the FHLB, which amounted to $26.5 and $16.0 million, respectively. These advances had a weighted average interest rate of 2.28% and 2.89% at December 31, 2015 and 2014, respectively. These advances are contractually scheduled for repayment as follows:
In September 2015, the FHLB issued a $20.1 million municipal deposit letter of credit in the name of Two River Community Bank naming the NJ Department of Banking and Insurance as beneficiary. The letter of credit will take the place of securities previously pledged to the state for the Bank’s municipal deposits.
Note 9 - Subordinated Debentures
In December 2015, the Company completed a private placement of $10 million in aggregate principal amount of fixed to floating rate subordinated debentures to certain institutional accredited investors. The subordinated debentures have a maturity date of December 31, 2025 and bear interest, payable quarterly, at the rate of 6.25% per annum until January 1, 2021. On that date, the interest rate will be adjusted to float at an annual rate equal to the three-month LIBOR rate plus 464 basis points (4.64%) until maturity. The debentures include a right of prepayment, without penalty, on or after December 14, 2020 and, in certain limited circumstances, before that date. The indebtedness evidenced by the subordinated debentures, including principal and interest, is unsecured and subordinate and junior in right to payment to general and secured creditors of the Company and depositors and all other creditors of the Bank. The subordinated debentures have been structured to qualify as Tier 2 capital for regulatory purposes. Subordinated debentures totaled $9.8 million at December 31, 2015, which includes $176,000 of remaining unamortized debt issuance costs. The debt issuance costs are being amortized over the expected life of the issue. The effective interest rate of the subordinated debentures is 6.67%.
Note 10 - Employee Benefit Plans
Under the 401(k) plan, all employees are eligible to contribute up to 100% of their pay and bonus up to the IRS yearly limit. Annually, the Company matches a percentage of employee contributions. The Company contributed $264,000 and $226,000 for the years ended December 31, 2015 and 2014, respectively. Each year, the Company, may at its discretion, elect to contribute profit sharing amounts into the 401(k) plan. For the year ended December 31, 2015 and 2014, the Company has not contributed any profit sharing amounts.
Note 10 - Employee Benefit Plans (Continued)
The Company has a non-qualified Supplemental Executive Retirement Plan for certain executive officers that provides for payments upon retirement, death or disability. At December 31, 2015 and 2014, other liabilities included approximately $1.4 million and $1.2 million, respectively, accrued under this plan. For the year ended December 31, 2015, expenses related to this plan included in the consolidated statements of operations are recorded in salaries and employee benefits, which amounted to $261,000 as compared to $249,000 for the year ended December 31, 2014.
Note 11 - Income Taxes
The components of income tax expense for the years ended December 31, 2015 and 2014 are as follows:
A reconciliation of the statutory income tax at a rate of 34% to the income tax expense included in the statements of operations is as follows for the years ended December 31, 2015 and 2014:
The components of the net deferred tax asset, included in other assets on the Consolidated Balance Sheets, as of December 31, 2015 and 2014, were as follows:
Note 12 - Earnings Per Common Share
The following sets forth the computation of basic and diluted earnings per common share for the years ended December 31, 2015 and 2014:
Dilutive securities in the table above exclude common stock options with exercise prices that exceed the average market price of the Company’s common stock during the periods presented. Inclusion of these common stock options would be anti-dilutive to the diluted earnings per common share calculation. For 2015, there were no stock options that were anti-dilutive while for 2014, there were 44,000 stock options that had no intrinsic value because their effect was anti-dilutive and, therefore, were not included in the diluted earnings per common share calculation.
Note 13 - Lease Commitments and Total Rental Expense
The Company leases banking facilities under non-cancelable operating lease agreements expiring through 2025. Aggregate rent expense was $1,965,000 and $1,888,000 for the years ended December 31, 2015 and 2014, respectively.
The approximate future minimum rental commitments under operating leases at December 31, 2015 are as follows (in thousands):
Note 14 - Stock-Based Compensation
Prior to the Company’s formation in 2006, its banking subsidiaries had stock option plans, with outstanding stock options, for the benefit of their employees and directors. The plans provided for the granting of both incentive and non-qualified stock options. Options to purchase 9,129 shares of the Company’s common stock outstanding under these plans expired unexercised during 2015, and no further stock options may be granted thereunder.
On March 20, 2007, the Board of Directors adopted the Two River Bancorp 2007 Equity Incentive Plan (the “Plan”), which was approved by the Company’s shareholders at the 2007 annual meeting. This plan provides that the Compensation Committee of the Board of Directors (the “Committee”) may grant to those individuals who are eligible under the terms of the Plan stock options, shares of restricted stock, or such other equity incentive awards as the Committee may determine. As of December 31, 2015, the number of shares of Company common stock remaining and available for future issuance under the Plan is 183,101.
Options awarded under the Plan may be either options that qualify as incentive stock options (“ISOs”) under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), or options that do not, or cease to, qualify as incentive stock options under the Code (“nonqualified stock options” or “NQSOs”). Awards may be granted under the Plan to directors and employees of the Company, and to consultants and other persons who provide substantial services to the Company.
Shares reserved under the Plan will be issued out of authorized and unissued shares, or treasury shares, or partly out of each, as determined by the Board. The exercise price per share purchasable under either an ISO or a NQSO may not be less than the fair market value of a share of stock on the date of grant of the option. The Committee will determine the vesting period and term of each option, provided that no ISO may have a term in excess of ten years after the date of grant.
Restricted stock is stock which is subject to certain transfer restrictions and to a risk of forfeiture. The Committee will determine the period over which any restricted stock which is issued under the Plan will vest, and will impose such restrictions on transferability, risk of forfeiture and other restrictions as the Committee may in its discretion determine. Unless restricted by the Committee, a participant granted restricted stock will have all of the rights of a shareholder, including the right to vote the restricted stock and the right to receive dividends with respect to that stock.
Unless otherwise provided by the Committee in the award document or subject to other applicable restrictions, in the event of a Change in Control (as defined in the Plan) all non-forfeited options and awards carrying a right to exercise that was not previously exercisable and vested will become fully exercisable and vested as of the time of the Change in Control, and all restricted stock and awards subject to risk of forfeiture will become fully vested.
On May 11, 2015, the Committee awarded an officer an ISO to purchase an aggregate of 3,000 shares of Company’s common stock. These options are scheduled to vest 20% per year over five years beginning May 11, 2016. These options were granted with an exercise price of $9.02 per share as determined in accordance with the Plan.
On December 15, 2015, the Company awarded officers ISOs to purchase an aggregate of 32,100 shares of Company common stock. These options are scheduled to vest 20% per year over five years beginning December 15, 2016. These options were granted with an exercise price of $9.66 per share based upon the average trading price of Company’s common stock on the grant date.
Stock-based compensation expense related to the stock option grants was approximately $98,000 and $124,000 for the years ended December 31, 2015 and 2014, respectively, and is included in salaries and employee benefits on the statement of operations.
Total unrecognized compensation cost related to non-vested options under the Plan was $293,000 as of December 31, 2015 and will be recognized over the subsequent weighted average life of 2.6 years.
Note 14 - Stock-Based Compensation (Continued)
The following table presents information regarding the Company’s outstanding options:
The total intrinsic value of stock options exercised was $137,000 and $116,000 during the years ended December 31, 2015 and 2014, respectively. Cash received from such exercises was $113,000 and $113,000, respectively. A tax benefit of $7,000 was recognized during the years ended December 31, 2015 and 2014.
The following summarizes information about stock options outstanding at December 31, 2015:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model.
The following assumptions were used to estimate the fair value of the stock options granted on December 15, 2015:
Note 14 - Stock-Based Compensation (Continued)
The following assumptions were used to estimate the fair value of the stock options granted on May 11, 2015:
The dividend yield assumption is based on the Company’s history and expectations of cash dividends. The expected volatility is based on historical volatility. The risk-free interest rate is based on the U.S. Treasury yield curve for the expected life of the grants which is based on historical exercise experience.
Restricted stock is valued at the market value on the date of grant and expense is evenly attributed to the period in which the restrictions lapse.
On January 15, 2015, the Company awarded an officer an aggregate of 5,000 shares of Company’s common stock. These restricted stock awards are scheduled to vest 20% per year over five years beginning January 15, 2016. On December 15, 2015, the Company awarded an aggregate of 6,100 shares of Company’s common stock. These restricted stock awards are scheduled to vest 20% per year over five years beginning December 15, 2016.
Compensation expense related to the restricted stock was to $88,000 and $43,000 for the years ended December 31, 2015 and 2014, respectively, and is included in salaries and employee benefits on the statement of operations. There was no deferred tax benefit recognized during years ended December 31, 2015 and 2014 related to the restricted stock compensation.
Total unrecognized compensation cost related to restricted stock under the Plan was $179,000 as of December 31, 2015 and will be recognized over the subsequent weighted average life of 3.9 years.
The following table summarizes information about restricted stock for the year ended December 31, 2015:
Note 15 - Transactions with Executive Officers, Directors and Principal Shareholders
Certain directors and executive officers of Two River Bancorp and its affiliates, including their immediate families and companies in which they are principal owners (more than 10%), are indebted to the Bank. In the opinion of management, such loans are consistent with sound banking practices and are within applicable regulatory bank lending limitations and in compliance with applicable rules and regulations of the Securities and Exchange Commission. Two River Bancorp relies on such directors and executive officers for the identification of their associates. These loans at December 31, 2015 were current as to principal and interest payments, and did not involve more than normal risk of collectability. Total extensions of credit to related parties at December 31, 2015 and 2014 were $15.8 million and $16.6 million, respectively. Of these amounts, loans outstanding to related parties at December 31, 2015 and 2014 were $10.2 million and $10.8 million, respectively, with the balance representing unused extensions of credit. During 2015, new loans and advances to such related parties totaled $291,000 and repayments and other reductions aggregated $905,000. Deposits from certain directors, executive officers and their affiliates at December 31, 2015 and 2014 totaled $14.8 million and $14.1 million, respectively, plus an additional $1.7 million and $2.3 million, respectively, in securities sold under agreements to repurchase.
The Bank paid $1,820 and $7,990 for the years ended December 31, 2015 and 2014, respectively, to one director for certain services.
Note 16 - Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the financial statements.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment. The Company had commitments to extend credit, including unused lines of credit, of approximately $166,262,000 and $160,630,000 at December 31, 2015 and 2014, respectively.
Standby letters of credit are conditional commitments issued by the Company to guarantee the financial performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company defines the fair value of these letters of credit as the fees paid by the customer or similar fees collected on similar instruments. The Company amortizes the fees collected over the life of the instrument. The Company generally obtains collateral, such as real estate or liens on customer assets for these types of commitments. The Company’s potential liability would be reduced by any proceeds obtained in liquidation of the collateral held. The Company had commercial and similar letters of credit for customers aggregating $4,315,000 and $4,754,000 at December 31, 2015 and 2014, respectively. The current amounts of the liability related to guarantees under standby letters of credit issued are not material as of December 31, 2015 and 2014.
Note 17 - Regulatory Matters
The Company and the Bank are subject to various regulatory and capital requirements administered by the Federal banking agencies. Our federal banking regulators, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) (which regulates bank holding companies) and the Federal Deposit Insurance Corporation (the “FDIC”) (which regulated the Bank), have issued guidelines classifying and defining capital. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank is also subject to qualitative judgements by the regulators about components, risk weightings and other factors.
Under the New Jersey Banking Act (the “Banking Act”), no dividend may be paid by the Bank on its capital stock unless, following the payment of each such dividend, the capital stock of the Bank will be unimpaired, and the Bank will have a surplus of not less than 50% of its capital stock. Therefore the highest amount of dividends that the Bank could pay to the Company at December 31, 2015 under the Banking Act is $76.9 million, subject to amounts it needs to retain in order to remain “well capitalized” as set forth below.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios, set forth in the following tables of Tier 1 Capital to Average Assets (Leverage Ratio), Common Equity Tier 1 Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets and Total Capital to Risk Weighted Assets. Management believes that, at December 31, 2015, the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2015, the Company and the Bank met all regulatory requirements for classification as well-capitalized under the applicable regulatory framework. Management believes that there are no conditions or events that have changed the classification.
The capital ratios of the Company and the Bank, at December 31, 2015 and 2014, are presented below.
*The Prompt Correction Action rules apply to the Bank only. The requirements for “well-capitalized” for the Company come from the bank holding company regulations.
Note 17 - Regulatory Matters (Continued)
The Bank is subject to certain legal and regulatory limitations on the amount of dividends that it may declare without prior regulatory approval. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including the Company, unless such loans are collateralized by specific obligations.
Basel III Capital Rules. In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III.
These revisions generally implemented higher minimum capital requirements, added a new common equity Tier 1 Capital requirement, and established criteria that instruments must meet to be considered common equity Tier 1 Capital, additional Tier 1 Capital or Tier 2 Capital. As of January 1, 2015, the new minimum capital to risk-adjusted assets requirements are a common equity Tier 1 Capital ratio of 4.5% (6.5% for the Bank to be considered “well capitalized”) and a Tier 1 Capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% for the Bank to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”).
Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payment to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 Capital above its minimum risk-based capital requirements, which amount must be greater than 2.5% of total risk-weighted assets at January 1, 2019. The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. Additionally, the Company determined, as permitted under Basel III, to opt-out of including accumulated other comprehensive income in regulatory capital.
As of December 31, 2015, the Bank would have had a capital conservation buffer greater than 2.5%.
Note 18 - Fair Value of Financial Instruments
Accounting guidance establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
Level 1:
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:
Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2015 and 2014 are as follows:
As of December 31, 2015 and 2014, there were no securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
Note 18 - Fair Value of Financial Instruments (Continued)
The following valuation techniques were used to measure fair value of assets in the tables above:
●
Impaired loans - Impaired loans measured at fair value are those loans in which the Company has measured impairment generally based on the fair value of the loan’s collateral. This method of fair value measurement is used on all of the Company’s impaired loans. Fair value is generally determined based upon either independent third party appraisals of the properties or discounted cash flows based upon the expected proceeds. The appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. At December 31, 2015 and 2014, there were no discounts applied to appraisal values as impaired appraisals were current. At December 31, 2015, liquidation expenses were 5.0% (weighted average of 5.0%), while at December 31, 2014, liquidation expenses ranged from 5.0% to 6.0% (weighted average of 5.3%). These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
●
Other Real Estate Owned (“OREO”) - Real estate properties acquired through, or in lieu of, loan foreclosure are carried at fair value less cost to sell. Fair value is based upon the appraised value of the collateral, adjusted by management for factors such as economic conditions and other market factors. At December 31, 2015, the discount range and liquidation expenses for collateral adjustments to OREO ranged from 0.4% to 6.0% (weighted average of 3.9%), while at December 31, 2014, the discount range and liquidation expenses for collateral adjustments to OREO ranged from 6.0% to 14.5% (weighted average of 12.0%). These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement. At December 31, 2015 and 2014, OREO totaling $411,000 and $1,603,000, respectively, are carried at fair value less estimated selling costs based on current appraisals. At December 31, 2015, there was one residential loan for $153,000 held in OREO while at December 31, 2014, the Company had $1.3 million. During the year ended December 31, 2015, the Company initiated foreclosure proceedings on one residential mortgage loan collateralized by a real estate property in the amount of $542,000.
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2015 and 2014:
Cash and Cash Equivalents (carried at cost):
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Note 18 - Fair Value of Financial Instruments (Continued)
Securities:
The fair value of securities available-for-sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). At December 31, 2015 and 2014, there were no Level 3 securities.
Restricted Investments (carried at cost):
The carrying amount of restricted investment in Federal Home Loan Bank stock, Atlantic Community Bankers Bank stock and Solomon Hess SBA Loan Fund approximates fair value, and considers the limited marketability of such securities.
Loans Held for Sale:
Loans held for sale are carried at the lower of aggregate cost or estimated fair value, less costs to sell. The fair value of these loans are equal to the contractual sales price.
Loans Receivable (carried at cost):
The fair values of loans, excluding collateral dependent impaired loans, are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans, including liquidity. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. The valuation of the loan portfolio reflects discounts that the Company believes are consistent with transactions occurring in the marketplace for both performing and distressed loan types. The carrying value that fair value is compared to is net of the allowance for loan losses and other associated premiums and discounts. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Due to the significant judgment involved in evaluating credit quality risk, loans are classified within Level 3 of the fair value hierarchy.
Accrued Interest Receivable and Payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Deposit Liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date, (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Securities Sold Under Agreements to Repurchase (carried at cost):
The carrying amounts of these short-term borrowings approximate their fair values.
Long-term Debt (carried at cost):
Fair values of FHLB advances are estimated by using a discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Subordinated Debentures (carried at cost):
The fair value of subordinated debentures is estimated by using a discounted cash flow analysis that applies a 4.49% credit spread plus the U.S. Treasury rate (all-in issue spread) to the time remaining until the issue’s call option date.
Off-Balance Sheet Financial Instruments (disclosed at cost):
Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing. The fair values of such fees are not material at December 31, 2015 and 2014.
Note 18 - Fair Value of Financial Instruments (Continued)
The estimated fair values of the Company’s financial instruments at December 31, 2015 and 2014 were as follows:
Note 19 - Shareholders’ Equity
On August 11, 2011, the Company received $12 million under the Small Business Lending Fund (“SBLF”), created as part of the Small Business Jobs Act. The SBLF provided Tier 1 Capital to community banks, and the terms of this capital contained incentives for making small business loans, defined as certain loans of up to $10 million to businesses with up to $50 million in annual revenues. In exchange for the $12 million, the Company issued to the U.S. Department of the Treasury (“Treasury”) 12,000 shares of its Non-Cumulative Perpetual Preferred Stock, Series C, having a $1,000 liquidation preference per share (the “SBLF Preferred Shares”). The SBLF Preferred Shares qualified as Tier 1 Capital. On December 15, 2014, the Company redeemed $6.0 million (6,000 shares) of the outstanding SBLF Preferred Shares, and on December 15, 2015, the remaining $6.0 million (6,000 shares) was redeemed. From July 1, 2013 to their redemption on December 15, 2015, the dividend rate on the SBLF Preferred Shares was 1.00%.
On January 24, 2013, the Board of Directors authorized a share repurchase program to repurchase outstanding shares of the Company’s common stock. A total of 227,612 shares for a total of approximately $1.8 million were repurchased under this program, which expired on December 31, 2014.
On December 18, 2014, the Company announced that its Board of Directors approved a new share repurchase program. Under this new program, the Company repurchased a total of 56,388 shares for a total of approximately $497,000. This program expired on December 31, 2015.
On December 17, 2015, the Company announced that its Board of Directors approved a new Share Repurchase Program. Under this new program, the Company may repurchase up to $2.0 million of its common stock from January 1, 2016 to December 31, 2016.
Note 20 - Condensed Financial Statements of Parent Company
Condensed financial information pertaining to the parent company, Two River Bancorp, is as follows:
Condensed Balance Sheets
Condensed Statements of Operations and Comprehensive Income
Note 20 - Condensed Financial Statements of Parent Company (Continued)
Condensed Statements of Cash Flows
Note 21 - Summary of Quarterly Results (Unaudited)
The following summarizes the consolidated results of operations during 2015 and 2014, on a quarterly basis, for Two River Bancorp. Note that certain balances may not cross-foot due to rounding.
(in thousands, except per share data):
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Capacity
Date
/s/ FRANK J. PATOCK, JR.
Chairman of the Board
March 25, 2016
Frank J. Patock, Jr.
/s/ JAMES M. BOLLERMAN
Vice Chairman of the Board
March 25, 2016
James M. Bollerman
/s/ JOHN J. PERRI, JR., CPA
Vice Chairman of the Board
March 25, 2016
John J. Perri, Jr., CPA
/s/ CHARLES F. BUTRICO, JR.
Director
March 25, 2016
Charles F. Butrico, Jr.
/s/ ROBERT E. GREGORY
Director
March 25, 2016
Robert E. Gregory
/s/ ROBERT B. GROSSMAN, MD
Director
March 25, 2016
Robert B. Grossman, MD
/s/ WILLIAM F. LaMORTE
Director
March 25, 2016
William F. LaMorte
/s/ JOSEPH F.X. O’SULLIVAN
Director
March 25, 2016
Joseph F.X. O’Sullivan
/s/ WILLIAM STATTER
Director
March 25, 2016
William Statter
/s/ ANDREW A. VITALE, CPA
Director
March 25, 2016
Andrew A. Vitale, CPA
/s/ ROBIN ZAGER
Corporate Secretary of the Board
March 25, 2016
Robin Zager
/s/ WILLIAM D. MOSS
President, Chief Executive Officer, Director
March 25, 2016
William D. Moss
/s/ A. RICHARD ABRAHAMIAN
Executive Vice President, Chief Financial Officer
March 25, 2016
A. Richard Abrahamian
(Principal Financial and Accounting Officer)
INDEX TO EXHIBITS
*
Subsidiaries of the Registrant
23.1
*
Consent of BDO USA, LLP Independent Registered Public Accounting Firm
31.1
*
Certification of William D. Moss, President and Chief Executive Officer of the Registrant, pursuant to Securities Exchange Act Rule 13a-14(a)
31.2
*
Certification of A. Richard Abrahamian, Chief Financial Officer of the Registrant, pursuant to Securities Exchange Act Rule 13a-14(a)
*
Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, signed by William D. Moss, President and Chief Executive Officer of the Registrant, and A. Richard Abrahamian, Chief Financial Officer of the Registrant
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
XBRL Taxonomy Extension Definition Linkbase
101.LAB
XBRL Taxonomy Extension Label Linkbase
101.PRE
XBRL Taxonomy Extension Presentation Linkbase
*
Filed herewith.
# Management contract or compensatory plan or arrangement.