10-Q 1 snbc-10q_20150630.htm 10-Q snbc-10q_20150630.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

or

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 0-20957

 

SUN BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

New Jersey

52-1382541

(State or other jurisdiction of

incorporation or organization

(I.R.S. Employer

Identification No.)

350 Fellowship Road, Suite 101, Mount Laurel, New Jersey 08054

(Address of principal executive offices) (Zip Code)

(856) 691-7700

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

o

Accelerated filer

 x

 

 

 

 

Non-accelerated filer

o

Smaller reporting company

 o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Exchange Act).    Yes  o    No  x

Common Stock, $5.00 Par Value – 18,669,442 Shares Outstanding at August 6, 2015

 

 

 


TABLE OF CONTENTS

 

 

 

Page
Number

PART I – FINANCIAL INFORMATION

 

      Item 1.

Financial Statements

 

 

Unaudited Condensed Consolidated Statements of Financial Condition at June 30, 2015 and December 31, 2014

3

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six months Ended June 30, 2015 and 2014

4

 

Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three and Six months Ended June 30, 2015 and 2014

5

 

Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the Six months Ended June 30, 2015 and 2014

6

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six months Ended June 30, 2015 and 2014

7

 

Notes to Unaudited Condensed Consolidated Financial Statements

8

      Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

43

      Item 3.

Quantitative and Qualitative Disclosures about Market Risk

57

      Item 4.

Controls and Procedures

58

 

PART II – OTHER INFORMATION

59

      Item 1.

Legal Proceedings

59

      Item 1A.

Risk Factors

59

      Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

      Item 3.

Defaults Upon Senior Securities

59

      Item 4.

Mine Safety Disclosures

59

      Item 5.

Other Information

59

      Item 6.

Exhibits

59

Signatures

60

      Exhibits:

 

 

Exhibit 3.1 Amended and Restated Certificate of Incorporation of Sun Bancorp, Inc.

 

 

Exhibit 3.2 Amended and Restated Bylaws of Sun Bancorp, Inc.

 

 

Exhibit 4.1 Common Security Specimen

 

 

Exhibit 31(a) Section 302 Certification of CEO

 

 

Exhibit 31(b) Section 302 Certification of Chief Financial Officer

 

 

Exhibit 32 Section 906 Certifications

 

 

Exhibit 101.INS XBRL Instance Document

 

 

Exhibit 101.SCH XBRL Taxonomy Extension Schema Document

 

 

Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

 

 

Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document

 

 

Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

 

Exhibit 101.DEF XBRL Taxonomy Definition Linkbase Document

 

 

 

2


SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except par value amounts)

 

 

 

June 30,

 

 

December 31,

 

 

 

2015

 

 

2014

 

ASSETS

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

28,544

 

 

$

42,548

 

Interest earning bank balances

 

 

250,319

 

 

 

505,885

 

Cash and cash equivalents

 

 

278,863

 

 

 

548,433

 

Restricted cash

 

 

5,000

 

 

 

13,000

 

Investment securities available for sale (amortized cost of $336,978 and $394,733 at

   June 30, 2015 and December 31, 2014, respectively)

 

 

337,229

 

 

 

394,500

 

Investment securities held to maturity (estimated fair value of $470 and $501 at

   June 30, 2015 and December 31, 2014, respectively)

 

 

462

 

 

 

489

 

Loans receivable (net of allowance for loan losses of $20,331 and $23,246 at

   June 30, 2015 and December 31, 2014, respectively)

 

 

1,558,599

 

 

 

1,486,898

 

Loans held-for-sale, at lower of cost or market

 

 

2,006

 

 

 

4,083

 

Branch assets held-for-sale

 

 

5,604

 

 

 

69,064

 

Restricted equity investments

 

 

15,554

 

 

 

14,961

 

Bank properties and equipment, net

 

 

35,090

 

 

 

40,155

 

Real estate owned, net

 

 

 

 

 

522

 

Accrued interest receivable

 

 

5,233

 

 

 

5,397

 

Goodwill

 

 

38,188

 

 

 

38,188

 

Bank owned life insurance (BOLI)

 

 

80,147

 

 

 

79,132

 

Other assets

 

 

17,048

 

 

 

20,526

 

TOTAL ASSETS

 

$

2,379,023

 

 

$

2,715,348

 

LIABILITIES

 

 

 

 

 

 

 

 

Deposits

 

$

1,876,721

 

 

$

2,091,904

 

Deposits held-for-sale

 

 

34,689

 

 

 

183,395

 

Securities sold under agreements to repurchase - customers

 

 

 

 

 

1,156

 

Advances from the Federal Home Loan Bank of New York (FHLBNY)

 

 

85,698

 

 

 

60,787

 

Obligation under capital lease

 

 

6,880

 

 

 

7,035

 

Debentures

 

 

92,786

 

 

 

92,786

 

Deferred taxes, net

 

 

2,275

 

 

 

1,514

 

Other liabilities

 

 

27,048

 

 

 

31,448

 

Total liabilities

 

 

2,126,097

 

 

 

2,470,025

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Preferred stock, $1 par value, 1,000,000 shares authorized, none issued

 

 

 

 

 

 

Common stock, $5 par value,  40,000,000 shares authorized; 18,901,124 shares issued and

   18,664,268 shares outstanding at June 30, 2015; 18,900,877 shares issued and 18,615,950

   shares outstanding at December 31, 2014.

 

 

94,506

 

 

 

94,504

 

Additional paid in capital

 

 

511,975

 

 

 

514,075

 

Retained earnings

 

 

(342,158

)

 

 

(347,762

)

Accumulated other comprehensive income (loss)

 

 

148

 

 

 

(138

)

Deferred compensation plan trust

 

 

(599

)

 

 

(599

)

Treasury stock at cost, 236,856 shares at June 30, 2015 and 284,927 shares December 31, 2014.

 

 

(10,946

)

 

 

(14,757

)

Total shareholders' equity

 

 

252,926

 

 

 

245,323

 

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 

$

2,379,023

 

 

$

2,715,348

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

3


SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share and per share amounts)

 

 

 

For the Three Months Ended

 

 

For the Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

INTEREST INCOME:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

15,451

 

 

$

21,067

 

 

$

30,549

 

 

$

42,916

 

Interest on taxable investment securities

 

 

1,831

 

 

 

2,193

 

 

 

3,877

 

 

 

4,443

 

Interest on non-taxable investment securities

 

 

309

 

 

 

308

 

 

 

615

 

 

 

617

 

Dividends on restricted equity investments

 

 

202

 

 

 

209

 

 

 

411

 

 

 

441

 

Total interest income

 

 

17,793

 

 

 

23,777

 

 

 

35,452

 

 

 

48,417

 

INTEREST EXPENSE:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

 

1,337

 

 

 

2,188

 

 

 

2,843

 

 

 

4,469

 

Interest on funds borrowed

 

 

536

 

 

 

443

 

 

 

966

 

 

 

879

 

Interest on junior subordinated debt

 

 

545

 

 

 

534

 

 

 

1,077

 

 

 

1,065

 

Total interest expense

 

 

2,418

 

 

 

3,165

 

 

 

4,886

 

 

 

6,413

 

Net interest income

 

 

15,375

 

 

 

20,612

 

 

 

30,566

 

 

 

42,004

 

PROVISION FOR LOAN LOSSES

 

 

(1,218

)

 

 

14,803

 

 

 

(1,218

)

 

 

14,803

 

Net interest income after provision for loan losses

 

 

16,593

 

 

 

5,809

 

 

 

31,784

 

 

 

27,201

 

NON-INTEREST INCOME:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposit service charges and fees

 

 

1,849

 

 

 

2,463

 

 

 

3,853

 

 

 

4,858

 

Interchange fees

 

 

554

 

 

 

629

 

 

 

1,098

 

 

 

1,192

 

Mortgage banking revenue, net

 

 

 

 

 

529

 

 

 

 

 

 

1,164

 

Gain on sale of bank branches

 

 

 

 

 

 

 

 

9,235

 

 

 

 

Gain on sale of loans

 

 

1,226

 

 

 

 

 

 

1,239

 

 

 

 

Investment products income

 

 

488

 

 

 

715

 

 

 

1,077

 

 

 

1,332

 

BOLI income

 

 

503

 

 

 

469

 

 

 

1,015

 

 

 

930

 

Other income (loss)

 

 

261

 

 

 

(828

)

 

 

451

 

 

 

(550

)

Total non-interest income

 

 

4,881

 

 

 

3,977

 

 

 

17,968

 

 

 

8,926

 

NON-INTEREST EXPENSE:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

9,120

 

 

 

16,803

 

 

 

19,710

 

 

 

30,584

 

Occupancy expense

 

 

3,034

 

 

 

3,552

 

 

 

8,001

 

 

 

7,818

 

Equipment expense

 

 

1,500

 

 

 

2,582

 

 

 

5,014

 

 

 

4,331

 

Data processing expense

 

 

1,304

 

 

 

1,281

 

 

 

2,612

 

 

 

2,478

 

Professional fees

 

 

711

 

 

 

2,353

 

 

 

1,547

 

 

 

3,839

 

Insurance expense

 

 

1,094

 

 

 

1,358

 

 

 

2,341

 

 

 

2,825

 

Advertising expense

 

 

223

 

 

 

523

 

 

 

458

 

 

 

1,109

 

Problem loan expense

 

 

38

 

 

 

566

 

 

 

1,026

 

 

 

1,198

 

Other expense

 

 

1,338

 

 

 

4,659

 

 

 

2,871

 

 

 

7,383

 

Total non-interest expense

 

 

18,362

 

 

 

33,677

 

 

 

43,580

 

 

 

61,565

 

INCOME (LOSS) BEFORE INCOME TAXES

 

 

3,112

 

 

 

(23,891

)

 

 

6,172

 

 

 

(25,438

)

INCOME TAX EXPENSE

 

 

284

 

 

 

357

 

 

 

568

 

 

 

716

 

NET INCOME (LOSS) AVAILABLE TO COMMON

   SHAREHOLDERS

 

$

2,828

 

 

$

(24,248

)

 

$

5,604

 

 

$

(26,154

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share (1)

 

$

0.15

 

 

$

(1.39

)

 

$

0.30

 

 

$

(1.50

)

Diluted earnings (loss) per share (1)

 

$

0.15

 

 

$

(1.39

)

 

$

0.30

 

 

$

(1.50

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares - basic (1)

 

 

18,632,526

 

 

 

17,417,829

 

 

 

18,624,585

 

 

 

17,383,192

 

Weighted average shares - diluted (1)

 

 

18,684,597

 

 

 

17,417,829

 

 

 

18,663,721

 

 

 

17,383,192

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

(1)

Prior period share data was retroactively adjusted for the impact of the 1-for-5 reverse stock split on August 11, 2014.

 

 

 

4


SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

 

 

 

For the Three

 

 

 

Months Ended

 

 

 

June 30,

 

 

 

2015

 

 

2014

 

NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS

 

$

2,828

 

 

$

(24,248

)

Other Comprehensive Income (Loss), net of tax

 

 

 

 

 

 

 

 

Unrealized gains on securities:

 

 

 

 

 

 

 

 

Unrealized holding (losses) gains arising during period

 

 

(507

)

 

 

1,593

 

Less: reclassification adjustment for gains  included in net income

 

 

2

 

 

 

30

 

Other comprehensive (loss) income

 

 

(505

)

 

 

1,623

 

COMPREHENSIVE INCOME (LOSS)

 

$

2,323

 

 

$

(22,625

)

 

 

 

For the Six

 

 

 

Months Ended

 

 

 

June 30,

 

 

 

2015

 

 

2014

 

NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS

 

$

5,604

 

 

$

(26,154

)

Other Comprehensive Income (Loss), net of tax

 

 

 

 

 

 

 

 

Unrealized gains on securities:

 

 

 

 

 

 

 

 

Unrealized holding gains arising during period

 

 

284

 

 

 

6,710

 

Less: reclassification adjustment for gains included in net income

 

 

2

 

 

 

30

 

Other comprehensive income

 

 

286

 

 

 

6,740

 

COMPREHENSIVE INCOME (LOSS)

 

$

5,890

 

 

$

(19,414

)

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

5


SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Other

 

 

Deferred

 

 

 

 

 

 

 

 

 

 

 

Preferred

 

 

Common

 

 

Paid-In

 

 

Retained

 

 

Comprehensive

 

 

Compensation

 

 

Treasury

 

 

 

 

 

 

 

Stock

 

 

Stock

 

 

Capital

 

 

Earnings

 

 

Income

 

 

Plan Trust

 

 

Shares

 

 

Total

 

BALANCE, January 1, 2015

 

$

 

 

$

94,504

 

 

$

514,075

 

 

$

(347,762

)

 

$

(138

)

 

$

(599

)

 

$

(14,757

)

 

$

245,323

 

Net income

 

 

 

 

 

 

 

 

 

 

 

5,604

 

 

 

 

 

 

 

 

 

 

 

 

5,604

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

286

 

 

 

 

 

 

 

 

 

286

 

Exercise of stock options

 

 

 

 

 

 

 

 

(53

)

 

 

 

 

 

 

 

 

 

 

 

68

 

 

 

15

 

Issuance of common stock

 

 

 

 

 

2

 

 

 

(2,101

)

 

 

 

 

 

 

 

 

 

 

 

2,644

 

 

 

546

 

Stock-based compensation

 

 

 

 

 

 

 

 

54

 

 

 

 

 

 

 

 

 

 

 

 

1,099

 

 

 

1,152

 

BALANCE, June 30, 2015

 

$

 

 

$

94,506

 

 

$

511,975

 

 

$

(342,158

)

 

$

148

 

 

$

(599

)

 

$

(10,946

)

 

$

252,926

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

6


SUN BANCORP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

 

 

For the Six Months

Ended

June 30,

 

 

 

2015

 

 

2014

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

5,604

 

 

$

(26,154

)

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

(1,218

)

 

 

14,803

 

Increase (decrease) in reserve for unfunded commitments

 

 

34

 

 

 

(24

)

Depreciation, amortization and accretion

 

 

3,712

 

 

 

3,428

 

Impairment of bank properties and equipment and real estate owned

 

 

2,152

 

 

 

511

 

(Gain) loss on sale of real estate owned

 

 

(10

)

 

 

323

 

Net gain on sales and calls of investment securities available-for-sale

 

 

(4

)

 

 

(50

)

Loss (gain) on sale of mortgage loans

 

 

4

 

 

 

(958

)

Gain on bulk sale of jumbo residential mortgage loans, net

 

 

 

 

 

(134

)

Gain on sale of branches

 

 

(9,235

)

 

 

 

Gain on sale of consumer loans

 

 

(1,239

)

 

 

 

Change in fair value of loans held-for-sale

 

 

28

 

 

 

34

 

Increase in fair value of interest rate lock commitments

 

 

 

 

 

(106

)

Derivative credit valuation adjustments

 

 

(64

)

 

 

(113

)

Increase in cash surrender value of BOLI

 

 

(1,015

)

 

 

(930

)

Deferred income taxes

 

 

568

 

 

 

716

 

Stock-based compensation

 

 

914

 

 

 

232

 

Shares contributed to employee benefit plans

 

 

 

 

 

1,578

 

Mortgage loans originated for sale

 

 

 

 

 

(50,288

)

Proceeds from the sale of mortgage loans

 

 

 

 

 

55,931

 

Change in assets and liabilities which provided (used) cash:

 

 

 

 

 

 

 

 

Accrued interest receivable

 

 

164

 

 

 

836

 

Other assets

 

 

(1,342

)

 

 

713

 

Other liabilities

 

 

(814

)

 

 

8,698

 

Net cash provided by operating activities

 

 

(1,761

)

 

 

9,046

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

 

 

 

(22,363

)

Net (purchase) redemption of restricted equity securities

 

 

(593

)

 

 

631

 

Proceeds from maturities, prepayments or calls of investment securities available for sale

 

 

35,495

 

 

 

28,325

 

Proceeds from maturities, prepayments or calls of investment securities held to maturity

 

 

27

 

 

 

44

 

Proceeds from the sale of investment securities available-for-sale

 

 

22,109

 

 

 

18,276

 

Proceeds from sale of commercial real estate loans

 

 

 

 

 

57,147

 

Proceeds from sale of consumer loans

 

 

6,675

 

 

 

 

Proceeds from sale of branch loans

 

 

63,756

 

 

 

 

Proceeds from bulk sale of jumbo residential mortgage loans

 

 

 

 

 

46,729

 

Proceeds from sale of deposits

 

 

10,216

 

 

 

 

Cash transferred to held-for-sale

 

 

(580

)

 

 

(1,507

)

Transfer restricted cash to cash and cash equivalents

 

 

8,000

 

 

 

 

Net (increase) decrease in loans

 

 

(73,529

)

 

 

114,058

 

Purchases of bank properties and equipment

 

 

(141

)

 

 

(769

)

Proceeds from sale of repossessed assets

 

 

 

 

 

80

 

Proceeds from sale of real estate owned

 

 

512

 

 

 

1,155

 

Net cash provided by investing activities

 

 

71,947

 

 

 

241,806

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Net decrease in deposits

 

 

(363,971

)

 

 

(188,143

)

Net (redemptions) issuances of securities sold under agreements to repurchase – customer

 

 

(1,156

)

 

 

192

 

Borrowings (repayments) of advances from FHLBNY

 

 

24,911

 

 

 

(83

)

Repayment of obligations under capital leases

 

 

(155

)

 

 

(140

)

Proceeds from issuance of common stock

 

 

600

 

 

 

-

 

Proceeds from exercise of stock options

 

 

15

 

 

 

 

Net cash used in financing activities

 

 

(339,756

)

 

 

(188,174

)

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

 

(269,570

)

 

 

62,678

 

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

 

 

548,433

 

 

 

267,762

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

278,863

 

 

$

330,440

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

 

Interest paid

 

$

4,953

 

 

$

6,629

 

Income taxes paid

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS

 

 

 

 

 

 

 

 

Trade liability from purchase of investment securities

 

 

 

 

 

9,975

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

7


SUN BANCORP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(All dollar amounts presented in the tables, except share and per share amounts, are in thousands)

 

 

(1) Organization

Sun Bancorp, Inc. (the “Company”) is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is the parent company of Sun National Bank (the “Bank”), a national bank and the Company’s principal wholly owned subsidiary. The Bank’s wholly owned subsidiaries are Prosperis Financial Solutions, 2020 Properties, L.L.C. and 4040 Properties, L.L.C.

The Company’s principal business is to serve as a holding company for the Bank. The Bank is in the business of attracting customer deposits through its Community Banking Centers and investing these funds, together with borrowed funds and cash from operations, in loans, primarily commercial real estate, small business non-real estate loans, as well as mortgage-backed and investment securities. Effective June 23, 2015, the Bank’s subsidiary, Sun Financial Services, L.L.C., was renamed Properis Financial Solutions. The principal business of Prosperis Financial Solutions is to offer mutual funds, securities brokerage, annuities and investment advisory services through the Bank’s Community Banking Centers. The principal business of 2020 Properties, L.L.C. and 4040 Properties, L.L.C. is to acquire and thereafter liquidate certain real estate and other assets in satisfaction of debts previously contracted by the Bank. The Company’s five capital trusts, Sun Capital Trust V, Sun Capital Trust VI, Sun Capital Trust VII, Sun Statutory Trust VII and Sun Capital Trust VIII, collectively, the “Issuing Trusts,” are presented on a deconsolidated basis. The Issuing Trusts, consisting of four Delaware business trusts and one Connecticut business trust, hold junior subordinated debentures issued by the Company.

Through the Bank, the Company provides commercial and consumer banking services. As of June 30, 2015, the Company had 45 locations primarily throughout New Jersey, including 41 branch offices. The Company also had one loan production office located in each of New York and Pennsylvania.

The Company’s outstanding common stock is traded on the NASDAQ Global Select Market under the symbol “SNBC.” The Company is subject to the reporting requirements of the Securities and Exchange Commission (“SEC”). The Company’s primary federal regulator is the Board of Governors of the Federal Reserve System (the “FRB”) and the Bank’s primary federal regulator is the Office of the Comptroller of the Currency (the “OCC”).

The Company declared a 1-for-5 reverse stock split effective August 11, 2014 for shareholders of record as of August 8, 2014. Prior periods reported in this Form 10-Q have been revised to reflect the impact of this transaction.

 

 

(2) Summary of Significant Accounting Policies

Basis of Presentation. The accompanying unaudited condensed consolidated financial statements were prepared in accordance with the instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial condition, results of operations, comprehensive loss, changes in equity and cash flows in conformity with Accounting Principles Generally Accepted in the United States of America (“GAAP”).

All normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the unaudited condensed consolidated financial statements have been included. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 filed with the SEC. The results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 or any other period. The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. The significant estimates include the allowance for loan losses, other-than-temporary impairment (“OTTI”) on investment securities, goodwill, income taxes, stock-based compensation and the fair value of financial instruments. Actual results may differ from these estimates under different assumptions or conditions.

Reclassifications. Certain reclassifications have been made to prior periods in the unaudited condensed consolidated statements of operations to conform to current reporting. On the unaudited condensed consolidated statements of operations, commission expense, which was previously reported in a separate line item, has been included within the combined financial statement caption of salaries and employee benefits. In addition, several items associated with retail service fees which were previously included within other income have been combined with the previous financial statement caption of service charges on deposit accounts into a new financial statement caption of deposit service charges and fees. Interchange fees were reclassified from

 

8


other income into a new financial statement caption. In addition, certain other financial statement captions were reclassified into other income and other expense due to the immaterial nature of the amounts. There was no impact from these reclassifications on the Company’s results of operations or cash flows for the three and six months ended June 30, 2014. The table below reports the impact of these reclassifications to the unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2014:

 

Three Months Ended June 30, 2014

 

As

Reclassified

 

 

As

Reported

 

Non-interest income:

 

 

 

 

 

 

 

 

Deposit service charges and fees

 

$

2,463

 

 

$

 

Service charges on deposit accounts

 

 

 

 

 

2,215

 

Interchange fees

 

 

629

 

 

 

 

Derivative credit valuation adjustment

 

 

 

 

 

(1,162

)

Gain on sale of investment securities

 

 

 

 

 

50

 

Other

 

 

(828

)

 

 

1,161

 

Non-interest expense:

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

16,803

 

 

 

15,992

 

Commission expense

 

 

 

 

 

811

 

Amortization of intangible assets

 

 

 

 

 

283

 

Real estate owned expense, net

 

 

 

 

 

702

 

Equipment expense

 

 

2,582

 

 

 

2,356

 

Office supplies expense

 

 

 

 

 

285

 

Other

 

 

4,659

 

 

 

3,615

 

 

Six Months Ended June 30, 2014

 

As

Reclassified

 

 

As

reported

 

Non-interest income:

 

 

 

 

 

 

 

 

Deposit service charges and fees

 

$

4,858

 

 

$

 

Service charges on deposit accounts

 

 

 

 

 

4,366

 

Interchange fees

 

 

1,192

 

 

 

 

Derivative credit valuation adjustment

 

 

 

 

 

(1,200

)

Gain on sale of investment securities

 

 

 

 

 

50

 

Other

 

 

(550

)

 

 

2,284

 

Non-interest expense:

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

30,584

 

 

 

28,876

 

Commission expense

 

 

 

 

 

1,708

 

Amortization of intangible assets

 

 

 

 

 

567

 

Real estate owned expense, net

 

 

 

 

 

846

 

Equipment expense

 

 

4,331

 

 

 

4,105

 

Office supplies expense

 

 

 

 

 

536

 

Other

 

 

7,383

 

 

 

5,660

 

 

Basis of Consolidation. The unaudited condensed consolidated financial statements include, after all intercompany balances and transactions have been eliminated, the accounts of the Company, the Bank, and the Bank’s wholly-owned subsidiaries, Prosperis Financial Solutions, 2020 Properties, L.L.C., and 4040 Properties, L.L.C. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“FASB ASC”) 810-10, Consolidation, the Issuing Trusts are presented on a deconsolidated basis.

Segment Information. As defined in accordance with FASB ASC 280, Segment Reporting, the Company has one reportable and operating segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.

Investment Securities. The Company’s investment portfolio includes both held-to-maturity and available-for-sale securities. The purchase and sale of the Company’s investment securities are recorded based on trade date accounting. At June 30, 2015 and December 31, 2014, the Company had no unsettled transactions. The following provides further information on the Company’s accounting for debt securities:

 

9


Held-to-Maturity – Investment securities that management has the positive intent and ability to hold until maturity are classified as held-to-maturity and carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts. Premiums are amortized and discounts are accreted using the interest method over the estimated remaining term of the underlying security.

Available-for-Sale – Investment securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity, and changes in the availability and the yield of alternative investments, are classified as available-for-sale. These assets are carried at their estimated fair value. Fair values are based on quoted prices for identical assets in active markets, quoted prices for similar assets in markets that are either actively or not actively traded, or in some cases where there is limited activity or less transparency around inputs, internally developed discounted cash flow models. Unrealized gains and losses are excluded from earnings and are reported net of tax in accumulated other comprehensive income (loss) on the unaudited condensed consolidated statements of financial condition until realized, including those recognized through the non-credit component of an OTTI charge.

In accordance with FASB ASC 325-40, Beneficial Interests in Securitized Financial Assets (FASB ASC 325-40), and FASB ASC 320, Investment – Debt and Equity Securities (FASB ASC 320), the Company evaluates its securities portfolio for OTTI throughout the year. Each investment, which has a fair value less than the book value, is reviewed on a quarterly basis by management. Management considers, at a minimum, whether the following factors exist that, both individually or in combination, could indicate that the decline is other-than-temporary: (a) the Company has the intent to sell the security; (b) it is more likely than not that it will be required to sell the security before recovery; and (c) the Company does not expect to recover the entire amortized cost basis of the security. Among the factors that are considered in determining the Company’s intent is a review of capital adequacy, interest rate risk profile and liquidity at the Company. An impairment charge is recorded against individual securities if the review described above concludes that the decline in value is other-than-temporary. During the three and six months ended June 30, 2015 and 2014, it was determined there were no other-than-temporarily impaired investments. As a result, the Company did not record credit related OTTI charges through earnings during the three and six months ended June 30, 2015 and 2014.

Loans Held-For-Sale. Loans held-for-sale totaled $2.0 million and $4.1 million at June 30, 2015 and December 31, 2014, respectively, and consist of consumer loans which are recorded at the lower of cost or market.

Allowance for Loan Losses. The allowance for loan losses is determined by management based upon past experience, evaluation of estimated loss and impairment in the loan portfolio, current economic conditions and other pertinent factors. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral. While management uses the best information available to make such evaluations, future adjustments to the allowance for loan losses may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations.

The provision for loan losses is based upon historical loan loss experience, a series of qualitative factors and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans under FASB ASC 310, Receivables (“FASB ASC 310”). Values assigned to the qualitative factors and those developed from historic loss experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans that continue to perform. A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in the loan being identified as impaired. For this purpose, delays of less than 90 days are considered to be insignificant. Impairment losses are included in the provision for loan losses. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and qualitative factors. Included in these qualitative factors are:

Levels of past due, classified and non-accrual loans, and troubled debt restructurings (“TDR”);

Nature, volume, and concentration of loans;

Historical loss trends;

Changes in lending policies and procedures, underwriting standards, collections, and for commercial loans, the level of loans being approved with exceptions to policy;

Experience, ability and depth of management and staff;

National and local economic and business conditions, including various market segments;

 

10


Quality of the Company’s loan review system and degree of Board oversight; and

Effect of external factors, including the deterioration of collateral values, on the level of estimated credit losses in the current portfolio.

Commercial loans, including commercial real estate loans, are placed on non-accrual status at the time the loan has been delinquent for 90 days unless the loan is well secured and in the process of collection. Generally, commercial loans and commercial real estate loans are charged-off no later than 180 days after becoming delinquent unless the loan is well secured and in the process of collection, or other extenuating circumstances support collection. Residential real estate loans are typically placed on non-accrual status at the time the loan has been delinquent for 90 days. Other consumer loans are typically charged-off at 180 days delinquent. In all cases, loans must be placed on non-accrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.

Goodwill. Goodwill is the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company tests goodwill for impairment annually as of December 31, unless circumstances indicate that a test is required at an earlier date. The Company elected to not apply the qualitative evaluation option permitted under Accounting Standards Update (“ASU”) 2011-8, Intangibles – Goodwill and Other (Topic 35): Testing Goodwill for Impairment issued in September 2011. Therefore, the Company utilizes the two-step goodwill impairment test outlined in FASB ASC 350, Intangibles – Goodwill and Other (“FASB ASC 350”). Step one, which is used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. A reporting unit is an operating segment, or one level below an operating segment, as defined in FASB ASC 280. The Company has one reportable operating segment, “Community Banking,” and there are no components to this operating segment. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired and step two is therefore unnecessary. If the carrying amount of the reporting unit exceeds its fair value, the second step is performed to measure the amount of the impairment loss, if any. At December 31, 2014, the Company performed its annual goodwill impairment test, and step one of the analysis indicated that the Company’s fair value was greater than its carrying value; therefore, the Company’s goodwill was not impaired at December 31, 2014. Since that time, no event has occurred nor have circumstances changed that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The carrying amount of goodwill totaled $38.2 million at both June 30, 2015 and December 31, 2014.

Bank Owned Life Insurance (“BOLI”). The Company has purchased life insurance policies on certain key employees. These policies are recorded at their cash surrender value, or the amount that can be realized in accordance with FASB ASC 325-30, Investments in Insurance Contracts. At June 30, 2015, the Company had $27.4 million invested in a general account and $52.7 million in a separate account, for a total BOLI cash surrender value of $80.1 million. The BOLI separate account is invested in a mortgage-backed securities fund, which is managed by an independent investment firm. Pricing volatility of these underlying instruments may have an impact on investment income; however, the fluctuations would be partially mitigated by a stable value wrap agreement which is a component of the separate account. Income from these policies and changes in the cash surrender value are recorded in BOLI income of the unaudited condensed consolidated statements of operations.

Income Taxes. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes (“FASB ASC 740”). FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the unaudited condensed consolidated statements of operations. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management’s analysis of tax regulations and interpretations. Significant judgment is applied when addressing the requirements of FASB ASC 740. At June 30, 2015, the Company had a valuation allowance of $131.2 million against its gross deferred tax asset. As the Company remained in a cumulative loss position, the deferred tax valuation allowance is still appropriate at June 30, 2015. The net deferred tax liability of $2.3 million in the unaudited condensed consolidated statements of financial condition at June 30, 2015 primarily represents the tax liability created from the goodwill amortization recorded for tax purposes and not for book purposes.

Accumulated Other Comprehensive Income (Loss). The Company classifies items of accumulated comprehensive income (loss) by their nature and displays the details of other comprehensive income (loss) in the unaudited condensed consolidated statements of comprehensive loss. Amounts categorized as comprehensive income (loss) represent net unrealized gains or losses

 

11


on investment securities available for sale, net of tax and the non-credit portion of any OTTI loss not recorded in earnings. Reclassifications are made to avoid double counting items which are displayed as part of net income (loss) for the period. These reclassifications for the three and six months ended June 30, 2015 and 2014 were as follows:

 

 

 

For the Three Months Ended June 30,

 

 

 

2015

 

 

2014

 

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

Unrealized holding (loss) gain on securities available

   for sale during the period

 

$

(857

)

 

$

350

 

 

$

(507

)

 

$

2,695

 

 

$

(1,102

)

 

$

1,593

 

Reclassification adjustment for net gains included in

   net income

 

 

4

 

 

 

(2

)

 

 

2

 

 

 

50

 

 

 

(20

)

 

 

30

 

Net unrealized (loss) gain on securities available

   for sale

 

$

(853

)

 

$

348

 

 

$

(505

)

 

$

2,745

 

 

$

(1,122

)

 

$

1,623

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2015

 

 

2014

 

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

Unrealized holding gain on securities available for

   sale during the period

 

$

480

 

 

$

(196

)

 

$

284

 

 

$

11,345

 

 

$

(4,635

)

 

$

6,710

 

Reclassification adjustment for net gains included in

   net income

 

 

4

 

 

 

(2

)

 

 

2

 

 

 

50

 

 

 

(20

)

 

 

30

 

Net unrealized gain on securities available for

   sale

 

$

484

 

 

$

(198

)

 

$

286

 

 

$

11,395

 

 

$

(4,655

)

 

$

6,740

 

 

Recent Accounting  Principles.

In February 2015, the FASB issued ASU 2015-02: Consolidation – Amendments to the Consolidation Analysis (Topic 225-20). The amendments in this Update affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The amendments in this Update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In January 2015, the FASB issued ASU 2015-01: Income Statement – Extraordinary and Unusual Items (Subtopic 225-20). The amendments in this Update eliminate from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement – Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In November 2014, the FASB issued ASU 2014-16: Derivatives and Hedging (Topic 815). The amendments in this Update affect hybrid financial instruments issued in the form of a share. An entity (an issuer or an investor) should determine the nature of the host contract by considering all stated and implied substantive terms and features of the hybrid financial instrument, weighing each term and feature on the basis of relevant facts and circumstances. That is, an entity should determine the nature of the host contract by considering the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. The amendments in this Update are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In August 2014, the FASB issued ASU 2014-15: Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments in this Update provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue

 

12


as a going concern and to provide related footnote disclosures. The amendments are intended to reduce diversity in the timing and content of footnote disclosures. The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In June 2014, the FASB issued ASU 2014-12: Stock Compensation – Accounting for Share-Based Payments When the Terms of Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period (Topic 718). The amendments in this Update apply to all entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. The amendments in this Update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. The amendments in ASU 2014-12 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 and may be applied either prospectively to all awards granted or modified after the effective date, or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

In May 2014, the FASB issued ASU 2014-09: Revenue from Contracts with Customers (Topic 606): Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40), Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables, Background Information and Basis for Conclusions. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the considerations to which the entity expects to be entitled in exchange for those goods or services. The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. For a public entity, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial statements.

 

 

(3) Branch Sales

On July 2, 2014 the Company entered into a Purchase and Assumption Agreement (the “Purchase Agreement”) with Sturdy Savings Bank, pursuant to which the Bank agreed to sell certain assets and certain liabilities relating to seven branch offices in and around Cape May County, New Jersey. The Purchase Agreement provided for a purchase price equal to the sum of a deposit premium of 8.765% of the average daily closing balance of deposits for the 31 days prior to the closing date, which included the carrying value of fixed assets, the Company’s carrying value of loans identified and approved by both parties, the aggregate amount of cash on hand and accrued interest on the loans acquired.

The sale was completed on March 6, 2015. The Company sold $149.6 million of deposits, $63.8 million of loans, $4.0 million of fixed assets and $897 thousand of cash. The transaction resulted in a net cash payment of approximately $71.5 million by the Company to Sturdy Savings Bank. After transaction costs, the sale resulted in a net gain of $9.2 million in the six months ended June 30, 2015 recorded in gain on sale of bank branches in the unaudited condensed consolidated statements of operations.

On March 31, 2015, the Company announced that it entered into an agreement with Cape Bancorp, Inc., pursuant to which the Bank agreed to sell the Bank’s Hammonton branch assets and related deposits and loans (the “Hammonton Agreement”). The Hammonton Agreement contains certain customary representations, warranties, indemnities and covenants of the parties, and is subject to termination in certain circumstances. The transaction is expected to be completed during the third quarter of 2015, subject to Cape Bancorp’s receipt of regulatory approvals as well as other customary closing conditions.

 

13


The following summarizes the branch assets and liabilities classified as held-for-sale at June 30, 2015 and December 31, 2014:

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Assets:

 

 

 

 

 

 

 

 

Cash

 

$

580

 

 

$

1,064

 

Loans held-for-sale

 

 

4,649

 

 

 

63,965

 

Properties and equipment

 

 

375

 

 

 

4,035

 

Total branch assets held-for-sale

 

$

5,604

 

 

 

69,064

 

Liabilities:

 

 

 

 

 

 

 

 

Deposits held-for-sale

 

$

34,689

 

 

 

183,395

 

 

 

(4) Stock-Based Compensation

The Company accounts for stock-based compensation issued to employees, and when appropriate, non-employees, in accordance with the fair value recognition provisions of FASB ASC 718, Compensation – Stock Compensation, (“FASB ASC 718”). Under the fair value provisions of FASB ASC 718, stock-based compensation cost is measured at the grant date based on the fair value of the award and it is recognized as expense over the appropriate vesting period using the straight-line method. However, consistent with FASB ASC 718, the amount of stock-based compensation cost recognized at any date must at least equal the portion of the grant date value of the award that is vested at that date and, as a result, it may be necessary to recognize the expense using a ratable method. Although the provisions of FASB ASC 718 should generally be applied to non-employees, FASB ASC 505-50, Equity-Based Payments to Non-Employees, is used in determining the measurement date of the compensation expense for non-employees.

Determining the fair value of stock-based awards at the measurement date requires judgment, including estimating the expected term of the stock options and the expected volatility of the Company’s stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions are used, it could have a material effect on the Company’s unaudited condensed consolidated financial statements.

The Company’s stock-based incentive plans authorize the issuance of shares of common stock pursuant to awards that may be granted in the form of stock options to purchase common stock (“Options”) and awards of shares of common stock (“Stock Awards”). The purpose of the Company’s stock-based incentive plans is to attract and retain personnel for positions of substantial responsibility and to provide additional incentive to certain officers, directors, advisory directors, employees and other persons to promote the success of the Company. Under the Company’s stock-based incentive plans, Options generally expire ten years after the date of grant, unless terminated earlier under the Option’s terms. A committee of non-employee directors has the authority to determine the conditions upon which the Options granted will vest. Options are granted at the then fair market value of the Company’s stock. All or a portion of any Stock Awards earned as compensation by a director may be deferred under the Company’s Directors’ Deferred Fee Plan.

 

In March 2015, the Board of Directors of the Company approved the Sun Bancorp, Inc. 2015 Omnibus Stock Incentive Plan (the “2015 Plan”). The 2015 Plan, which was approved by shareholders in May 2015, became effective in May 2015 and replaced the 2014 Performance Equity Plan, the 2010 Stock-Based Incentive Plan, the 2010 Performance Plan and the 2004 Stock-Based Incentive Plan, as amended. The purpose of the 2015 Plan is to give the Company a competitive advantage in attracting, retaining and motivating officers, employees, directors and consultants and to provide the Company and its subsidiaries and affiliates with a compensation plan providing incentives for future performance of services directly linked to the profitability of the Company’s businesses and increases in Company shareholder value. The 2015 Plan authorizes the issuance of 1,400,000 shares of common stock pursuant to awards that may be granted in the form of Options and Stock Awards. Under the 2015 Plan, Options expire ten years after the date of grant, unless terminated earlier under the option terms. For both Options and Stock Awards, a Committee of non-employee directors has the authority to determine the conditions upon which the options granted will vest. At June 30, 2015, there were no options and 46,712 awards granted under the 2015 Plan.

 

14


Activity in the stock option plans for the six months ended June 30, 2015 and June 30, 2014 was as follows:

Summary of Options Activity

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Number

 

 

Average

 

 

Number

 

 

 

of

 

 

Exercise

 

 

of Options

 

 

 

Options

 

 

Price

 

 

Exercisable

 

Outstanding as of January 1, 2015

 

 

318,901

 

 

$

28.34

 

 

 

161,984

 

Granted

 

 

218,760

 

 

 

18.92

 

 

 

 

Exercised

 

 

(811

)

 

 

15.19

 

 

 

 

Forfeited

 

 

(13,777

)

 

 

17.37

 

 

 

 

Expired

 

 

(6,329

)

 

 

55.34

 

 

 

 

Outstanding as of June 30, 2015

 

 

516,744

 

 

$

24.33

 

 

 

166,271

 

Options vested or expected to vest(1)

 

 

483,676

 

 

$

24.75

 

 

 

 

 

(1)

Includes vested shares and nonvested shares after the application of a forfeiture rate, which is based upon historical data.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Number

 

 

Average

 

 

Number

 

 

 

of

 

 

Exercise

 

 

of Options

 

 

 

Options

 

 

Price

 

 

Exercisable

 

Outstanding as of January 1, 2014

 

 

298,308

 

 

$

36.80

 

 

 

249,853

 

Granted

 

 

43,194

 

 

 

16.75

 

 

 

 

Exercised

 

 

(123

)

 

 

15.50

 

 

 

 

Forfeited

 

 

(14,114

)

 

 

17.00

 

 

 

 

Expired

 

 

(87,888

)

 

 

43.90

 

 

 

 

Outstanding as of June 30, 2014

 

 

239,377

 

 

$

31.75

 

 

 

171,062

 

Options vested or expected to vest(1)

 

 

226,115

 

 

$

32.60

 

 

 

 

 

(1)

Includes vested shares and nonvested shares after the application of a forfeiture rate, which is based upon historical data.

The weighted average remaining contractual term was approximately 7.8 years for Options outstanding and 4.4 years for Options exercisable as of June 30, 2015.

At June 30, 2015, the aggregate intrinsic value was $222 thousand for Options outstanding and $60 thousand for Options exercisable.

During the six months ended June 30, 2015 and 2014, the Company granted 218,760 Options and 43,194 Options, respectively from the Company’s 2010 Stock-Based Incentive Plan. In accordance with FASB ASC 718, the fair value of the Options granted are estimated on the date of grant using the Black-Scholes option pricing model which uses the assumptions in the table below. The expected term of an Option is estimated using historical exercise behavior of employees at a particular level of management who were granted Options with a comparable term. The Options have historically been granted with a 10 year term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected volatility is based on the historical volatility of the Company’s stock price.

Significant weighted average assumptions used to calculate the fair value of the Options for the six months ended June 30, 2015 and 2014 are as follows:

 

 

 

For the Six

 

 

 

Months Ended

 

 

 

June 30,

 

 

 

2015

 

 

2014

 

Weighted average fair value of Options granted

 

$

6.16

 

 

$

7.25

 

Weighted average risk-free rate of return

 

 

1.35

%

 

 

1.16

%

Weighted average expected option life in months

 

 

46

 

 

 

49

 

Weighted average expected volatility

 

 

40

%

 

 

55

%

Expected dividends(1)

 

$

 

 

$

 

 

(1)

To date, the Company has not paid cash dividends on its common stock.

 

15


A summary of the Company’s nonvested Stock Award activity during the six months ended June 30, 2015 and 2014 are presented in the following tables:

Summary of Nonvested Stock Award Activity

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Grant

 

 

 

Number

 

 

Date

 

 

 

of

 

 

Fair

 

 

 

Shares

 

 

Value

 

Nonvested Stock Awards outstanding, January 1, 2015

 

 

248,654

 

 

$

14.22

 

Issued

 

 

46,712

 

 

 

18.87

 

Vested

 

 

(5,080

)

 

 

19.14

 

Forfeited

 

 

(4,300

)

 

 

15.91

 

Nonvested Stock Awards outstanding, June 30, 2015

 

 

285,986

 

 

$

14.87

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Grant

 

 

 

Number

 

 

Date

 

 

 

of

 

 

Fair

 

 

 

Shares

 

 

Value

 

Nonvested Stock Awards outstanding, January 1, 2014

 

 

86,367

 

 

$

15.65

 

Issued

 

 

22,436

 

 

 

17.15

 

Vested

 

 

(4,129

)

 

 

16.95

 

Forfeited

 

 

(9,437

)

 

 

15.30

 

Nonvested Stock Awards outstanding, June 30, 2014

 

 

95,237

 

 

$

15.95

 

 

There were 46,712 shares of nonvested Stock Awards issued during the six months ended June 30, 2015 and 22,436 nonvested Stock Awards issued during the six months ended June 30, 2014. The value of these shares is based upon the closing price of the common stock on the date of grant. Compensation expense is recognized on a straight-line basis over the service period for all of the nonvested Stock Awards issued.

Total compensation expense recognized related to Options and nonvested Stock Awards, including that for non-employee directors, during the three and six months ended June 30, 2015 was $557 thousand and $914 thousand, respectively, as compared to $102 thousand and $232 thousand, respectively, for the three and six months ended June 30, 2014. As of June 30, 2015, there was approximately $1.8 million and $3.4 million of total unrecognized compensation cost related to Options and nonvested Stock Awards, respectively. The cost of the Options and Stock Awards is expected to be recognized over a weighted average period of 3.4 years and 3.0 years, respectively.

 

 

 

16


(5) Investment Securities

The amortized cost of investment securities and the approximate fair value at June 30, 2015 and December 31, 2014 were as follows:

 

 

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Estimated

Fair Value

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

2,500

 

 

$

1

 

$

 

 

 

$

2,501

 

U.S. Government agency securities

 

 

4,974

 

 

 

 

 

 

(139

)

 

 

4,835

 

U.S. Government agency mortgage-backed securities

 

 

227,730

 

 

 

2,150

 

 

 

(1,079

)

 

 

228,801

 

Other mortgage-backed securities

 

 

188

 

 

 

 

 

 

(2

)

 

 

186

 

State and municipal securities

 

 

28,889

 

 

 

1,503

 

 

 

 

 

 

30,392

 

Trust preferred securities

 

 

12,016

 

 

 

144

 

 

 

(2,057

)

 

 

10,103

 

Collateralized loan obligations

 

 

59,935

 

 

 

18

 

 

 

(288

)

 

 

59,665

 

Other securities

 

 

746

 

 

 

 

 

 

 

 

 

746

 

Total available for sale

 

$

336,978

 

 

$

3,816

 

 

$

(3,565

)

 

$

337,229

 

Held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency mortgage-backed securities

 

 

212

 

 

 

8

 

 

 

 

 

 

220

 

Other securities

 

 

250

 

 

 

 

 

 

 

 

 

250

 

Total held to maturity

 

 

462

 

 

 

8

 

 

 

 

 

 

470

 

Total investment securities

 

$

337,440

 

 

$

3,824

 

 

$

(3,565

)

 

$

337,699

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

2,499

 

 

$

4

 

 

$

 

 

$

2,503

 

U.S. Government agency securities

 

 

4,973

 

 

 

 

 

 

(187

)

 

 

4,786

 

U.S. Government agency mortgage-backed securities

 

 

263,215

 

 

 

2,992

 

 

 

(1,051

)

 

 

265,156

 

Other mortgage-backed securities

 

 

265

 

 

 

 

 

 

 

 

 

265

 

State and municipal obligations

 

 

28,981

 

 

 

1,941

 

 

 

 

 

 

30,922

 

Trust preferred securities

 

 

12,014

 

 

 

 

 

 

(2,604

)

 

 

9,410

 

Collateralized loan obligations

 

 

69,931

 

 

 

 

 

 

(1,328

)

 

 

68,603

 

Other securities

 

 

12,855

 

 

 

 

 

 

 

 

 

12,855

 

Total available for sale

 

 

394,733

 

 

 

4,937

 

 

 

(5,170

)

 

 

394,500

 

Held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency mortgage-backed securities

 

 

239

 

 

 

12

 

 

 

 

 

 

251

 

Other securities

 

 

250

 

 

 

 

 

 

 

 

 

250

 

Total held to maturity

 

 

489

 

 

 

12

 

 

 

 

 

 

501

 

Total investment securities

 

$

395,222

 

 

$

4,949

 

 

$

(5,170

)

 

$

395,001

 

 

 

17


The following table provides the gross unrealized losses and fair value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at June 30, 2015 and December 31, 2014:

Gross Unrealized Losses by Investment Category

 

 

 

Less than 12 Months

 

 

12 Months or Longer

 

 

Total

 

 

 

Estimated

Fair Value

 

 

Gross

Unrealized

Losses

 

 

Estimated

Fair Value

 

 

Gross

Unrealized

Losses

 

 

Estimated

Fair Value

 

 

Gross

Unrealized

Losses

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

$

 

 

$

 

 

$

4,835

 

 

$

(139

)

 

$

4,835

 

 

$

(139

)

U.S. Government agency mortgage-backed securities

 

 

22,049

 

 

 

(100

)

 

 

30,269

 

 

 

(979

)

 

 

52,318

 

 

 

(1,079

)

Other mortgage-backed securities

 

 

186

 

 

 

(2

)

 

 

 

 

 

 

 

 

186

 

 

 

(2

)

Trust preferred securities

 

 

 

 

 

 

 

 

6,752

 

 

 

(2,057

)

 

 

6,752

 

 

 

(2,057

)

Collateralized loan obligations

 

 

9,450

 

 

 

(28

)

 

 

37,207

 

 

 

(260

)

 

 

46,657

 

 

 

(288

)

Total

 

 

31,685

 

 

$

(130

)

 

 

79,063

 

 

$

(3,435

)

 

$

110,748

 

 

$

(3,565

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

$

 

 

$

 

 

$

4,786

 

 

$

(187

)

 

$

4,786

 

 

$

(187

)

U.S. Government agency mortgage-backed securities

 

 

7,801

 

 

 

(35

)

 

 

33,453

 

 

 

(1,016

)

 

 

41,254

 

 

 

(1,051

)

Trust preferred securities

 

 

 

 

 

 

 

 

9,410

 

 

 

(2,604

)

 

 

9,410

 

 

 

(2,604

)

Collateralized loan obligations

 

 

23,710

 

 

 

(256

)

 

 

44,894

 

 

 

(1,072

)

 

 

68,604

 

 

 

(1,328

)

Total

 

$

31,511

 

 

$

(291

)

 

$

92,543

 

 

$

(4,879

)

 

$

124,054

 

 

$

(5,170

)

 

The Company determines whether unrealized losses are temporary in accordance with FASB ASC 325-40, Investments – Other, when applicable, and FASB ASC 320-10, Investments – Overall, (“FASB ASC 320-10”). The evaluation is based upon factors such as the creditworthiness of the underlying borrowers, performance of the underlying collateral, if applicable, and the level of credit support in the security structure. Management also evaluates other factors and circumstances that may be indicative of an OTTI condition. These include, but are not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuer.

FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before recovery. If either of these situations applies, the guidance requires the Company to record an OTTI charge to earnings on debt securities for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these situations applies, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the present value of the expected cash flows and the amortized book value is considered a credit loss. When a market price is not readily available, the market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows expected to be collected is recognized in accumulated other comprehensive loss on the consolidated statements of financial condition. Application of this guidance resulted in no OTTI charges during the three and six months ended June 30, 2015 and 2014.

As of June 30, 2015, the Company’s cumulative OTTI balance was $10.2 million. There were no OTTI charges recognized in earnings as a result of credit losses on investments in the three and six months ended June 30, 2015 and 2014.

U.S. Government Agency Securities. At June 30, 2015, the gross unrealized loss in the category of 12 months or longer of $139 thousand consisted of one agency security with an estimated fair value of $4.8 million issued and guaranteed by a U.S. Government sponsored agency. The Company monitors certain factors such as market rates and possible credit deterioration to determine if an OTTI exists. As of June 30, 2015, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security before recovery, which may be maturity, and management expects to recover the entire amortized cost basis of the security.

U.S. Government Agency Mortgage-Backed Securities. At June 30, 2015, the gross unrealized loss in the category of less than 12 months of $100 thousand consisted of five mortgage-backed securities with an estimated fair value of $22.0 million, the gross unrealized loss in the category of 12 months or longer of $979 thousand consisted of six mortgage-backed securities with

 

18


an estimated fair value of $30.3 million issued and guaranteed by a U.S. Government sponsored agency. The Company monitors certain factors such as market rates and possible credit deterioration to determine if an OTTI exists. As of June 30, 2015, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

Collateralized Loan Obligation Securities. At June 30, 2015, the gross unrealized loss in the category of less than 12 months of $28 thousand consisted of one AAA and one AA rated collateralized loan obligation security with an estimated fair value of $9.5 million, the gross unrealized loss in the category of 12 months or longer of $260 thousand consisted of three AAA and three AA-rated collateralized loan obligation securities with an estimated fair value of $37.2 million. The Company monitors key credit metrics such as delinquencies, defaults, cumulative losses and credit support levels to determine if an OTTI exists. As of June 30, 2015, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of these securities.

At June 30, 2015, the Company had 11 collateralized loan obligation securities with an amortized cost of $60.0 million and an estimated fair value of $59.7 million. These securities are subject to the provisions of the Volcker Rule. As a result, the Company will likely be required to divest these investments unless their terms can be modified such that the investments are no longer covered by the Volcker Rule. While there is proposed legislation in Congress regarding a delay to the divestiture requirement for collateralized loan obligations, the outcome of the legislation is unclear at this time. The Company cannot give assurances that the legislation will or will not be enacted. However, based on the Company’s communication with its investment advisors, in the event that the proposed legislation is not enacted, the Company believes these investments can be modified to avoid a required divestiture under the Volcker Rule.

Trust Preferred Securities. At June 30, 2015, the gross unrealized loss in the category of 12 months or longer of $2.1 million consisted of one investment grade rated pooled security with an amortized cost of $8.8 million and an estimated fair value of $6.8 million.

For the pooled security, the Company monitors each issuer in the collateral pool with respect to financial performance using data from the issuer’s most recent regulatory reports as well as information on issuer deferrals and defaults. Also, the security structure is monitored with respect to collateral coverage and current levels of subordination. Expected future cash flows are projected assuming additional defaults and deferrals based on the performance of the collateral pool. The pooled security is in a senior position in the capital structure. The security had a 3.2 times principal coverage. As of the most recent reporting date, interest has been paid in accordance with the terms of the security. The Company reviews projected cash flow analysis for adverse changes in the present value of projected future cash flows that may result in an other-than-temporary credit impairment to be recognized through earnings. The most recent valuations assumed no recovery on any defaulted collateral, no recovery on any deferring collateral and an additional 3.6% of defaults or deferrals’ every three years with no recovery rate. As of June 30, 2015, management concluded that an OTTI did not exist on the aforementioned security based upon its assessment. Management also concluded that it does not intend to sell the security, and that it is not more likely than not it will be required to sell the security, before its recovery, which may be maturity, and management expects to recover the entire amortized cost basis of this security.

At June 30, 2015, the book value of the non-rated single issuer trust preferred security approximates fair value. The financial performance of the non-rated single issuer trust preferred security is monitored on a quarterly basis using data from the issuer’s most recent regulatory reports to assess the probability of cash flow impairment. Expected future cash flows are projected by incorporating the contractual cash flow of the security adjusted, if necessary, for potential changes in the amount or timing of cash flows due to the underlying creditworthiness of the issuer and covenants in the security.

In August 2009, the issuer of the non-rated single issuer trust preferred security elected to defer its normal quarterly dividend payment. As contractually permitted, the issuer may defer dividend payments up to five years with accumulated dividends, and interest on those deferred dividends, payable upon the resumption of its scheduled dividend payments. The issuer is currently operating under an agreement with its regulators. The agreement stipulates that the issuer must receive permission from its regulators prior to resuming its scheduled dividend payments. In September 2014, the deferred dividends of $590 thousand were paid by the issuer. In December 2014, the issuer made its normal dividend payment of $25 thousand. As this security was deemed to be in non-performing status during 2014, these 2014 payments were recorded as a reduction of outstanding principal for this security. In March 2015, the Company received another dividend payment of $25 thousand, which was recognized as interest income. Due to sustained performance, this security was upgraded to performing status in the first quarter of 2015.

During the three and six months ended June 30, 2015, the Company did not record an OTTI credit-related charge related to this deferring single issuer trust preferred security. Based on the Company’s most recent evaluation, and based upon the aforementioned receipt of dividend payments, the Company does not expect the issuer to default on the security based primarily on the issuer’s subsidiary bank reporting that it meets the minimum regulatory requirements to be considered a “well

 

19


capitalized” institution. The cumulative OTTI on this security as of June 30, 2015 was $1.2 million. Based upon the current capital position of the issuer, recent improvements in the financial performance of the issuer and the fact that the book value of the security approximates fair value, the Company concluded that an additional impairment charge was not warranted at June 30, 2015.

On January 14, 2014, the five federal agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities from the investment prohibitions of the Volcker Rule. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if certain qualifications are met. In addition, the agencies released a non-exclusive list of issuers that meet the requirements of the interim final rule. The pooled security was included in the non-exclusive list of issuers that meet the requirements of the interim final rule release by the agencies and therefore will not be required to be sold by the Company. The single issuer security is not subject to the provisions of the Volcker rule.

The amortized cost and estimated fair value of the investment securities, by contractual maturity, at June 30, 2015 and December 31, 2014 are shown below. Actual maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

Available for Sale

 

 

Held to Maturity

 

 

 

Amortized

Cost

 

 

Estimated

Fair Value

 

 

Amortized

Cost

 

 

Estimated

Fair Value

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

3,248

 

 

$

3,248

 

 

$

 

 

$

 

Due after one year through five years

 

 

1,062

 

 

 

1,109

 

 

 

250

 

 

 

250

 

Due after five years through ten years

 

 

53,157

 

 

 

53,495

 

 

 

 

 

 

 

Due after ten years

 

 

51,593

 

 

 

50,390

 

 

 

 

 

 

 

Total investment securities, excluding mortgage-

   backed securities

 

 

109,060

 

 

 

108,242

 

 

 

250

 

 

 

250

 

U.S. Government agency mortgage-backed securities

 

 

227,730

 

 

 

228,801

 

 

 

212

 

 

 

220

 

Other mortgage-backed securities

 

 

188

 

 

 

186

 

 

 

 

 

 

 

Total investment securities

 

$

336,978

 

 

$

337,229

 

 

$

462

 

 

$

470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Due in one year or less

 

$

15,106

 

 

$

15,109

 

 

$

 

 

$

 

Due after one year through five years

 

 

1,181

 

 

 

1,240

 

 

 

250

 

 

 

250

 

Due after five years through ten years

 

 

25,347

 

 

 

25,707

 

 

 

 

 

 

 

Due after ten years

 

 

89,619

 

 

 

87,023

 

 

 

 

 

 

 

Total investment securities, excluding mortgage-

   backed securities

 

 

131,253

 

 

 

129,079

 

 

 

250

 

 

 

250

 

U.S. Government agency mortgage-backed securities

 

 

263,215

 

 

 

265,156

 

 

 

239

 

 

 

251

 

Other mortgage-backed securities

 

 

265

 

 

 

265

 

 

 

 

 

 

 

Total investment securities

 

$

394,733

 

 

$

394,500

 

 

$

489

 

 

$

501

 

 

At June 30, 2015, the Company had $27.9 million, amortized cost, and $29.3 million estimated fair value, of investment securities pledged to secure public deposits. As of June 30, 2015, the Company had $134.9 million, amortized cost, and $135.7 million, estimated fair value, of investment securities pledged as collateral on secured borrowings.

 

 

 

20


(6) Loans

The components of loans as of June 30, 2015 and December 31, 2014 were as follows:

Loan Components

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

264,344

 

 

$

242,494

 

CRE owner occupied

 

 

232,794

 

 

 

278,651

 

CRE non-owner occupied

 

 

601,200

 

 

 

461,631

 

Land and development

 

 

57,351

 

 

 

70,156

 

Consumer:

 

 

 

 

 

 

 

 

Home equity lines of credit

 

 

139,789

 

 

 

156,926

 

Home equity term loans

 

 

14,017

 

 

 

17,239

 

Residential real estate

 

 

265,992

 

 

 

276,993

 

Other

 

 

3,443

 

 

 

6,054

 

Total gross loans held-for-investment

 

 

1,578,930

 

 

 

1,510,144

 

Allowance for loan losses

 

 

(20,331

)

 

 

(23,246

)

Net loans held-for-investment

 

$

1,558,599

 

 

$

1,486,898

 

 

The following table is a comparison of the Company’s non-accrual loans as of the dates indicated:

Loans on Non-Accrual Status

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Commercial:

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

26

 

 

$

155

 

Commercial, held-for-sale

 

 

119

 

 

 

28

 

CRE owner occupied

 

 

892

 

 

 

3,268

 

CRE owner occupied, held-for-sale

 

 

234

 

 

 

32

 

CRE non-owner occupied

 

 

153

 

 

 

 

CRE non-owner, held-for-sale

 

 

 

 

 

229

 

Consumer:

 

 

 

 

 

 

 

 

Home equity lines of credit

 

 

59

 

 

 

1,348

 

Home equity lines of credit, held-for-sale

 

 

 

 

 

1,228

 

Home equity term loans

 

 

101

 

 

 

407

 

Home equity term loans, held-for-sale

 

 

 

 

 

286

 

Residential real estate

 

 

3,919

 

 

 

5,117

 

Residential real estate, held-for-sale

 

 

 

 

 

2,280

 

Other

 

 

6

 

 

 

432

 

Other, held-for-sale

 

 

36

 

 

 

 

Total non-accrual loans

 

$

5,545

 

 

$

14,810

 

Troubled debt restructuring, non-accrual

 

$

702

 

 

$

318

 

 

Many of the Company’s commercial and industrial loans have a real estate component as part of the collateral securing the loan. Additionally, the Company makes commercial real estate loans for the acquisition, refinance, improvement and construction of real property. Loans secured by owner-occupied properties are dependent upon the successful operation of the borrower’s business. If the operating company experiences difficulties in terms of sales volume and/or profitability, the borrower’s ability to repay the loan may be impaired. Loans secured by properties where repayment is dependent upon payment of rent by third-party tenants or the sale of the property may be impacted by loss of tenants, lower lease rates needed to attract new tenants or the inability to sell a completed project in a timely fashion and at a profit.

As of June 30, 2015, the Company had $31.1 million outstanding on six residential construction, commercial construction and land development relationships for which the agreements included interest reserves. As of December 31, 2014, the Company

 

21


had $44.7 million outstanding on nine residential construction, commercial construction and land development relationships for which the agreements included interest reserves. The total amount available in those reserves to fund interest payments was $560 thousand and $1.9 million at June 30, 2015 and December 31, 2014, respectively. There were no relationships with interest reserves which were on non-accrual status at June 30, 2015 and December 31, 2014. Construction projects are monitored throughout their lives by the Company through either internal resources or professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at the time of underwriting in conjunction with the review of the plans and specifications for the project being financed. Advances of the Company’s funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company’s professional inspector who must certify that the work related to the advance is in place and properly complete. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Included in the Company’s loan portfolio are modified commercial loans. Per FASB ASC 310-40, Troubled Debt Restructuring, (“FASB ASC 310-40”), a modification is one in which the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider, such as providing a below market interest rate and/or forgiving principal or previously accrued interest; this modification may stem from an agreement or be imposed by law or a court, and may involve a multiple note structure. Generally, prior to the modification, the loans which are modified as a TDR are already classified as non-performing. These loans may only be returned to performing (i.e. accrual status) after considering the borrower’s sustained repayment performance for a reasonable amount of time, generally six months; this sustained repayment performance may include the period of time just prior to the restructuring.

 

 

(7) Allowance for Loan Losses

Changes in the allowance for loan losses were as follows:

Allowance for Loan Losses and Recorded Investment in Financing Receivables

 

 

 

For the Six Months Ended June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home

 

 

Real

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

Equity(1)

 

 

Estate

 

 

Other(2)

 

 

Total

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

15,834

 

 

$

3,238

 

 

$

3,513

 

 

$

661

 

 

$

23,246

 

Charge-offs

 

 

(1,008

)

 

 

(2,508

)

 

 

(1,932

)

 

 

(93

)

 

 

(5,541

)

Recoveries

 

 

3,539

 

 

 

262

 

 

 

11

 

 

 

32

 

 

 

3,844

 

Net charge-offs

 

 

2,531

 

 

 

(2,246

)

 

 

(1,921

)

 

 

(61

)

 

 

(1,697

)

Provision for loan losses

 

 

(5,182

)

 

 

2,300

 

 

 

2,144

 

 

 

(480

)

 

 

(1,218

)

Ending balance

 

$

13,183

 

 

$

3,292

 

 

$

3,736

 

 

$

120

 

 

$

20,331

 

Ending balance: individually evaluated for impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Ending balance: collectively evaluated for impairment

 

$

13,183

 

 

$

3,292

 

 

$

3,736

 

 

$

120

 

 

$

20,331

 

Financing Receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance

 

$

1,155,689

 

 

$

153,806

 

 

$

265,992

 

 

$

3,443

 

 

$

1,578,930

 

Ending balance: individually evaluated for impairment

 

$

1,167

 

 

$

160

 

 

$

4,461

 

 

$

6

 

 

$

5,794

 

Ending balance: collectively evaluated for impairment

 

$

1,154,522

 

 

$

153,646

 

 

$

261,531

 

 

$

3,437

 

 

$

1,573,136

 

 

(1)

Amount includes both home equity lines of credit and term loans.

(2)

Includes the unallocated portion of the allowance for loan losses.

 

 

22


 

 

For the Six Months Ended June 30, 2014

 

 

 

Commercial

 

 

Home

Equity(1)

 

 

Residential

Real

Estate

 

 

Other(2)

 

 

Total

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

27,828

 

 

$

3,375

 

 

$

2,898

 

 

$

1,436

 

 

$

35,537

 

Charge-offs

 

 

(16,300

)

 

 

(2,319

)

 

 

(1,425

)

 

 

(3,260

)

 

 

(23,304

)

Recoveries

 

 

1,078

 

 

 

144

 

 

 

6

 

 

 

128

 

 

 

1,356

 

Net charge-offs

 

 

(15,222

)

 

 

(2,175

)

 

 

(1,419

)

 

 

(3,132

)

 

 

(21,948

)

Provision for loan losses

 

 

8,410

 

 

 

2,321

 

 

 

1,922

 

 

 

2,150

 

 

 

14,803

 

Ending balance

 

$

21,016

 

 

$

3,521

 

 

$

3,401

 

 

$

454

 

 

$

28,392

 

Ending balance: individually evaluated for impairment

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Ending balance: collectively evaluated for impairment

 

$

21,016

 

 

$

3,521

 

 

$

3,401

 

 

$

454

 

 

$

28,392

 

Financing Receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance

 

$

1,363,900

 

 

$

186,953

 

 

$

298,063

 

 

$

7,200

 

 

$

1,856,116

 

Ending balance: individually evaluated for impairment

 

$

5,447

 

 

$

2,905

 

 

$

5,609

 

 

$

10

 

 

$

13,971

 

Ending balance: collectively evaluated for impairment

 

$

1,358,453

 

 

$

184,048

 

 

$

292,454

 

 

$

7,190

 

 

$

1,842,145

 

 

(1)

Amount includes both home equity lines of credit and term loans.

(2)

Includes the unallocated portion of the allowance for loan losses.

Risk Characteristics

Commercial Loans. Included in this segment is commercial and industrial, commercial real estate owner occupied, commercial real estate non-owner occupied, and land and development. Many of the Company’s commercial and industrial loans have a real estate component as part of the collateral securing the accommodation. Commercial real estate owner occupied loans rely on the cash flow from the successful operation of the borrower’s business to make repayment. If the operating company experiences difficulties in terms of sales volume and/or profitability, the borrower’s ability to repay the loan may be impaired. Commercial real estate non-owner occupied loans rely on the payment of rent by third-party tenants. The borrower’s ability to repay the loan or sell the property may be impacted by loss of tenants, lower lease rates needed to attract new tenants or the inability to sell a completed project in a timely fashion and at a profit. Commercial and industrial loans are primarily secured by assets of the business, such as accounts receivable and inventory. Due to the nature of the collateral securing these loans, the liquidation of these assets may be problematic and costly. Commercial real estate owner occupied and non-owner occupied loans are secured by the underlying properties. The local economy and real estate market affect the appraised value of these properties which may impact the ultimate repayment of these loans. Land and development loans are primarily repaid by the sale of the developed properties or by conversion to a permanent term loan. These loans are dependent upon the completion of the project on time and within budget, which may be impacted by general economic conditions. The Company requires cash collateral in an interest reserve in order to extend credit on construction projects to mitigate the credit risk.

Home Equity Loans. This segment consists of both home equity lines of credit and home equity term loans on single family residences. These loans rely on the personal income of the borrower for repayment which may be impacted by economic conditions, such as unemployment levels, interest rates and the housing market. These loans are primarily secured by second liens on the property, which serves as the secondary source of repayment. The secondary source of repayment may be impaired by the real estate market and local regulations. The Company ceased all home equity lines of credit and all home equity term loan origination activity in the second half of 2014.

Residential Real Estate Loans. Included in this segment are residential mortgages on single family residences. These loans rely on the personal income of the borrower for repayment which may be impacted by economic conditions, such as unemployment levels, interest rates and the housing market. These loans are primarily secured by a lien on the underlying property, which serves as the secondary source of repayment. The secondary source of repayment may be impaired by the real estate market and local regulations. Beginning in the third quarter of 2014, the Company ceased all residential real estate origination activity for both its portfolio and for sale to the secondary market.

Other Loans. Other loans consist of personal credit lines, mobile home loans and consumer installment loans. These loans rely on the borrowers’ personal income for repayment and are either unsecured or secured by personal use assets and mobile homes. These loans may be impacted by economic conditions such as unemployment levels. The liquidation of the assets securing these loans may be difficult and costly.

 

23


The allowance for loan losses was $20.3 million and $23.2 million at June 30, 2015 and December 31, 2014, respectively. The ratio of allowance for loan losses to gross loans held-for-investment was 1.29% at June 30, 2015 and 1.54% at December 31, 2014.

The provision for loan losses charged to expense is based upon historical loan loss and recovery experience, a series of qualitative factors and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans under FASB ASC 310, Receivables (“FASB ASC 310”). Values assigned to the qualitative factors and those developed from historic loss and recovery experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans that continue to perform.

A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in a loan being identified as impaired. For this purpose, delays less than 90 days are considered to be insignificant. Impairment losses are included in the provision for loan losses in the unaudited condensed consolidated statements of operations. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historical loss and recovery experience and qualitative factors. Such loans generally include consumer loans, residential real estate loans and small business loans. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios, management’s abilities and external factors.

The following table presents the Company’s components of impaired loans receivable, segregated by class of loans. Commercial and consumer loans that were collectively evaluated for impairment are not included in the data that follows:

 

 

 

Recorded

Investment

 

 

Unpaid

Principal

Balance

 

 

Related

Allowance

 

 

Average

Recorded

Investment

 

 

Accrued

Interest

Income

Recognized

 

 

Cash

Interest

Income

Recognized

 

For the Six Months Ended June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With no related allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

14

 

 

$

523

 

 

$

 

 

$

16

 

 

$

 

 

$

 

      Commercial & industrial, held-for-sale

 

 

119

 

 

 

152

 

 

 

 

 

 

141

 

 

 

 

 

 

 

CRE owner occupied

 

 

1,002

 

 

 

12,984

 

 

 

 

 

 

1,297

 

 

 

 

 

 

 

      CRE owner occupied, held-for-sale

 

 

333

 

 

 

390

 

 

 

 

 

 

333

 

 

 

 

 

 

 

CRE non-owner occupied

 

 

153

 

 

 

290

 

 

 

 

 

 

158

 

 

 

 

 

 

 

      CRE non-owner occupied, held-for-sale

 

 

148

 

 

 

256

 

 

 

 

 

 

221

 

 

 

 

 

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity lines of credit

 

 

59

 

 

 

60

 

 

 

 

 

 

60

 

 

 

 

 

 

 

Home equity term loans

 

 

101

 

 

 

106

 

 

 

 

 

 

107

 

 

 

 

 

 

 

Residential real estate

 

 

4,461

 

 

 

5,701

 

 

 

 

 

 

4,066

 

 

 

 

 

 

 

      Residential real estate, held-for-sale

 

 

770

 

 

 

1,002

 

 

 

 

 

 

932

 

 

 

 

 

 

 

      Other

 

 

6

 

 

 

11

 

 

 

 

 

 

7

 

 

 

 

 

 

 

      Other, held-for-sale

 

 

36

 

 

 

46

 

 

 

 

 

 

43

 

 

 

 

 

 

 

Total commercial

 

$

1,769

 

 

$

14,595

 

 

$

 

 

$

2,166

 

 

$

 

 

$

 

Total consumer

 

$

5,433

 

 

$

6,926

 

 

$

 

 

$

5,215

 

 

$

 

 

$

 

 

 

24


Impaired Loans

As of December 31, 2014

 

 

 

Recorded

Investment

 

 

Unpaid

Principal

Balance

 

 

Related

Allowance

 

 

Average

Recorded

Investment

 

 

Accrued

Interest

Income

Recognized

 

 

Cash

Interest

Income

Recognized

 

With no related allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

147

 

 

$

149

 

 

$

 

 

$

161

 

 

$

19

 

 

$

 

Commercial & industrial, held-for- sale

 

 

28

 

 

 

50

 

 

 

 

 

 

52

 

 

 

 

 

 

 

CRE owner occupied

 

 

3,297

 

 

 

4,499

 

 

 

 

 

 

3,875

 

 

 

 

 

 

 

CRE owner occupied, held-for-sale

 

 

32

 

 

 

74

 

 

 

 

 

 

136

 

 

 

 

 

 

 

CRE non-owner occupied

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CRE non-owner occupied, held-for- sale

 

 

229

 

 

 

352

 

 

 

 

 

 

53

 

 

 

 

 

 

 

Land and development

 

 

140

 

 

 

223

 

 

 

 

 

 

181

 

 

 

 

 

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

 

4,852

 

 

 

5,587

 

 

 

3

 

 

 

4,513

 

 

 

 

 

 

97

 

Residential real estate, held-for-sale

 

 

3,478

 

 

 

4,984

 

 

 

 

 

 

1,365

 

 

 

 

 

 

 

Home Equity Lines of Credit

 

 

405

 

 

 

456

 

 

 

 

 

 

420

 

 

 

 

 

 

 

Home Equity Lines of Credit, held-for-sale

 

 

619

 

 

 

903

 

 

 

 

 

 

1,282

 

 

 

 

 

 

 

Home Equity Term Loans

 

 

1,347

 

 

 

1,863

 

 

 

 

 

 

1,385

 

 

 

 

 

 

 

Home Equity Term Loans, held-for-sale

 

 

3,266

 

 

 

4,743

 

 

 

 

 

 

3,735

 

 

 

 

 

 

 

Other

 

 

150

 

 

 

348

 

 

 

 

 

 

138

 

 

 

 

 

 

 

With an allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

CRE owner occupied

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total commercial

 

$

3,873

 

 

$

5,348

 

 

$

 

 

$

4,458

 

 

$

19

 

 

$

97

 

Total consumer

 

$

14,118

 

 

$

18,884

 

 

$

3

 

 

$

12,836

 

 

$

 

 

$

 

 

In accordance with FASB ASC 310, those impaired loans for which the collateral is sufficient to support the outstanding principal do not result in a specific allowance for loan losses. Included in impaired loans at June 30, 2015 were five TDRs, for which the collateral is sufficient to support the outstanding principal, one of which was in accruing status. In addition, there were no TDRs at June 30, 2015 that included a commitment to lend additional funds as of June 30, 2015.

There were zero and three new TDR agreements entered into during the three and six months ended June 30, 2015. The following table presents a summary of the Company’s TDR agreements entered into during the six months ended June 30, 2015.

 

 

 

Troubled Debt Restructurings

 

 

 

For the Six Months Ended June 30, 2015

 

 

 

Number

of

Contracts

 

 

Pre-Modification

Outstanding

Recorded

Investment

 

 

Post-

Modification

Outstanding

Recorded

Investment

 

Residential real estate

 

 

3

 

 

$

546

 

 

$

484

 

 

The following table presents information regarding the types of concessions granted on loans that were restructured during the six months ended June 30, 2015:

 

 

 

Troubled Debt Restructurings

 

 

For the Six Months Ended June 30, 2015

 

 

Number

of

Contracts

 

Concession Granted

Residential real estate

 

3

 

Extension of maturity.

 

 

25


During the six months ended June 30, 2015 and 2014, the Company did not have any TDR agreements that had subsequently defaulted that were entered into within the respective preceding twelve months. All TDRs are currently on non-accrual status.

The following table presents the Company’s distribution of risk ratings within the held-for-investment loan portfolio, segregated by class, as of June 30, 2015 and December 31, 2014:

Credit Quality Indicators by Internally Assigned Grade

 

 

 

Commercial

& industrial

 

 

CRE

owner

occupied

 

 

CRE non-

owner

occupied

 

 

Land and

development

 

 

Home

Equity

Lines of

Credit

 

 

Home

Equity

Term

Loans

 

 

Residential

Real

Estate

 

 

Other

 

As of June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

260,545

 

 

$

227,948

 

 

$

601,047

 

 

$

57,351

 

 

$

139,396

 

 

$

13,913

 

 

$

261,241

 

 

$

3,438

 

Special Mention

 

 

3,786

 

 

 

2,328

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Substandard

 

 

13

 

 

 

2,518

 

 

 

153

 

 

 

 

 

 

393

 

 

 

104

 

 

 

4,751

 

 

 

5

 

Doubtful

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

264,344

 

 

$

232,794

 

 

$

601,200

 

 

$

57,351

 

 

$

139,789

 

 

$

14,017

 

 

$

265,992

 

 

$

3,443

 

As of December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

235,985

 

 

$

267,018

 

 

$

451,921

 

 

$

70,018

 

 

$

155,084

 

 

$

16,819

 

 

$

272,044

 

 

$

5,902

 

Special Mention

 

 

6,304

 

 

 

6,669

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Substandard

 

 

205

 

 

 

4,964

 

 

 

9,710

 

 

 

138

 

 

 

1,842

 

 

 

420

 

 

 

4,949

 

 

 

152

 

Doubtful

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

242,494

 

 

$

278,651

 

 

$

461,631

 

 

$

70,156

 

 

$

156,926

 

 

$

17,239

 

 

$

276,993

 

 

$

6,054

 

 

The Company’s primary tool for assessing risk when evaluating a loan in terms of its underwriting, structure, documentation and eventual collectability is a risk rating system where the loan is assigned a numeric value. Behind each numeric category is a defined set of characteristics reflective of the particular level of risk.

The risk rating system is based on a fourteen point grade using a two-digit scale. The upper seven grades are for “pass” categories, the middle grade is for the “criticized” category, while the lower six grades represent “classified” categories which are equivalent to the guidelines utilized by the OCC.

The portfolio manager is responsible for assigning, maintaining, and documenting accurate risk ratings for all commercial loans and commercial real estate loans. The portfolio manager assigns a risk rating at the inception of the loan, reaffirms it annually, and adjusts the rating based on the performance of the loan. As part of the loan review process, a regional credit officer will review risk ratings for accuracy. The portfolio manager’s risk rating will also be reviewed periodically by the loan review department and the Bank’s regulators.

To calculate risk ratings in a consistent fashion, the Company uses a Risk Rating Methodology that assesses quantitative and qualitative components which include elements of its financial condition, abilities of management, position in the market, collateral and guarantor support and the impact of changing conditions. When combined with professional judgment, an overall risk rating is assigned.

 

26


The following table presents the Company’s analysis of past due loans, segregated by class of loans, as of June 30, 2015 and December 31, 2014:

Aging of Receivables

 

 

 

30-59

Days

Past Due

 

 

60-89

Days

Past Due

 

 

90 Days

Past Due

 

 

Total

Past Due

 

 

Current

 

 

Total

Financing

Receivables

 

As of June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

377

 

 

$

 

 

$

16

 

 

$

393

 

 

$

263,951

 

 

$

264,344

 

CRE owner occupied

 

 

 

 

 

940

 

 

 

789

 

 

 

1,729

 

 

 

231,065

 

 

 

232,794

 

CRE non-owner occupied

 

 

277

 

 

 

 

 

 

153

 

 

 

430

 

 

 

600,770

 

 

 

601,200

 

Land and development

 

 

 

 

 

 

 

 

 

 

 

 

 

 

57,351

 

 

 

57,351

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity lines of credit

 

 

867

 

 

 

23

 

 

 

 

 

 

890

 

 

 

138,899

 

 

 

139,789

 

Home equity term loans

 

 

43

 

 

 

9

 

 

 

5

 

 

 

57

 

 

 

13,960

 

 

 

14,017

 

Residential real estate

 

 

3,931

 

 

 

433

 

 

 

2,135

 

 

 

6,499

 

 

 

259,493

 

 

 

265,992

 

Other

 

 

16

 

 

 

1

 

 

 

6

 

 

 

23

 

 

 

3,420

 

 

 

3,443

 

Total

 

$

5,511

 

 

$

1,406

 

 

$

3,104

 

 

$

10,021

 

 

$

1,568,909

 

 

$

1,578,930

 

As of December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial & industrial

 

$

4,212

 

 

$

105

 

 

$

151

 

 

$

4,468

 

 

$

238,026

 

 

$

242,494

 

CRE owner occupied

 

 

1,685

 

 

 

23

 

 

 

1,321

 

 

 

3,029

 

 

 

275,622

 

 

 

278,651

 

CRE non-owner occupied

 

 

2,786

 

 

 

166

 

 

 

 

 

 

2,952

 

 

 

458,679

 

 

 

461,631

 

Land and development

 

 

 

 

 

 

 

 

140

 

 

 

140

 

 

 

70,016

 

 

 

70,156

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity lines of credit

 

 

2,001

 

 

 

903

 

 

 

796

 

 

 

3,700

 

 

 

153,226

 

 

 

156,926

 

Home equity term loans

 

 

254

 

 

 

188

 

 

 

147

 

 

 

589

 

 

 

16,650

 

 

 

17,239

 

Residential real estate

 

 

4,183

 

 

 

670

 

 

 

3,719

 

 

 

8,572

 

 

 

268,421

 

 

 

276,993

 

Other

 

 

45

 

 

 

12

 

 

 

136

 

 

 

193

 

 

 

5,861

 

 

 

6,054

 

Total

 

$

15,166

 

 

$

2,067

 

 

$

6,410

 

 

$

23,643

 

 

$

1,486,501

 

 

$

1,510,144

 

 

 

(8) Derivative Financial Instruments and Hedging Activities

Derivative financial instruments involve, to varying degrees, interest rate, market and credit risk. The Company seeks to minimize counterparty credit risk by establishing credit limits and collateral agreements. The Company utilizes certain derivative financial instruments to enhance its ability to manage interest rate risk that exists as part of its ongoing business operations. In general, the derivative transactions entered into by the Company fall into one of two types: a fair value hedge of a specific fixed-rate loan agreement and an economic hedge of a derivative offering to a Bank customer. The Company does not use derivative financial instruments for trading purposes.

Fair Value Hedges – Interest Rate Swaps. The Company utilizes interest rate swap agreements to hedge interest rate risk. The designated hedged items are subordinated notes related to commercial loans that provide a fixed interest receipt for the Company. The interest rate risk is the uncertainty of future interest rate levels and the impact of changes in rates on the fair value of the loans. The hedging of interest rate risk is intended to reduce the volatility of the fair value of the loans due to changes in the interest rate market.

The Company previously entered into interest rate swaps with a counterparty whereby the Company makes payments based on a fixed interest rate and receives payments from the counterparty based on a floating interest rate, both calculated based on the principal amount of the underlying subordinated note, without the exchange of the underlying principal. The Company no longer enters into these interest rate swap transactions, the last of which occurred in August 2007. The interest rate swaps are designated as fair value hedges under FASB ASC 815, Derivatives and Hedging (“FASB ASC 815”). The critical terms assessed by the Company for each hedge of subordinated notes include the notional amounts of the swap compared to the principal amount of the notes, expiration/maturity dates, benchmark interest rate, prepayment terms and cash payment dates. At June 30, 2015 and December 31, 2014, the total outstanding notional amount of these swaps was $7.6 million and $8.9 million, respectively. For each of these swap agreements, the floating rate is based on the one-month London Interbank Offered Rate

 

27


(“LIBOR”) paid on the first day of the month which matches the interest payment date on each subordinated note. The expiration dates for these swap agreements range from July 1, 2015 to August 1, 2022 and are consistent with the underlying subordinated note maturities and the swaps had a fair value of $0 at inception. At hedge inception and on an ongoing basis, conditions supporting hedge effectiveness are evaluated. The Company believes that all conditions required in FASB ASC 815-20-25-104 have been met, as all terms of the subordinated note and the interest rate swap match. Because the Company’s evaluations have concluded that the critical terms of the subordinated notes and the interest rate swaps meet the criteria outlined in FASB ASC 815-20-25-104, the “short-cut” method of accounting is applied, which assumes there is no ineffectiveness of a hedging arrangement’s ability to hedge risk as changes in the interest rate component of the swaps’ fair value are expected to exactly offset the corresponding changes in the fair value of the underlying subordinated notes, as described above. Because the hedging arrangement is considered perfectly effective, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in a net impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820, Fair Value Measurements and Disclosures (“FASB ASC 820”). The fair value adjustments related to credit quality were not material as of June 30, 2015 and December 31, 2014.

The following tables provide information pertaining to interest rate swaps designated as fair value hedges under FASB ASC 815 at June 30, 2015 and December 31, 2014:

Summary of Interest Rate Swaps Designated As Fair Value Hedges

 

 

 

June 30, 2015

 

 

December 31, 2014

 

Balance Sheet Location

 

Notional

 

 

Fair

Value

 

 

Notional

 

 

Fair

Value

 

Other liabilities

 

$

7,604

 

 

$

(527

)

 

$

8,937

 

 

$

(765

)

 

Summary of Interest Rate Swap Components

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Weighted average pay rate

 

 

7.22

%

 

 

7.24

%

Weighted average receive rate

 

 

2.06

%

 

 

2.09

%

Weighted average maturity in years

 

 

1.65

 

 

 

2.05

 

 

Customer Derivatives – Interest Rate Swaps. The Company enters into interest rate swaps that allow our commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. The Company then enters into a corresponding swap agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps with both the customers and third parties are not designated as hedges under FASB ASC 815 and are marked to market through earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. The Company recognized $63 thousand and $113 thousand in expense resulting from fair value adjustments during the six months ended June 30, 2015 and 2014, respectively, which were included in other income in the unaudited condensed consolidated statements of operations.

 

 

 

June 30, 2015

 

 

December 31, 2014

 

Balance Sheet Location

 

Notional

 

 

Fair

Value

 

 

Notional

 

 

Fair

Value

 

Other assets

 

$

137,425

 

 

$

8,954

 

 

$

174,524

 

 

$

12,294

 

Other liabilities

 

 

(137,425

)

 

 

(9,016

)

 

 

174,524

 

 

 

(12,419

)

 

The Company has an International Swaps and Derivatives Association agreement with a third party that requires a minimum dollar transfer amount upon a margin call. This requirement is dependent on certain specified credit measures. The amount of collateral posted with the third party at June 30, 2015 and December 31, 2014 was $22.4 million and $29.2 million, respectively. The amount of collateral posted with the third party is deemed to be sufficient to collateralize both the fair market value change as well as any additional amounts that may be required as a result of a change in the specified credit measures. The aggregate fair value of all derivative financial instruments in a liability position with credit measure contingencies and entered into with the third party was $9.5 million and $13.2 million at June 30, 2015 and December 31, 2014, respectively.

 

28


 

 

(9) Deposits

Deposits consist of the following major classifications:

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Interest-bearing demand deposits

 

$

758,421

 

 

$

861,914

 

Non-interest-bearing demand deposits

 

 

511,856

 

 

 

548,064

 

Savings deposits

 

 

211,569

 

 

 

224,017

 

Time certificates under $100,000

 

 

203,298

 

 

 

231,111

 

Time certificates $100,000 or more

 

 

126,112

 

 

 

150,977

 

Brokered time deposits

 

 

65,465

 

 

 

75,821

 

Total

 

$

1,876,721

 

 

$

2,091,904

 

 

 

(10) Earnings (loss) Per Share

Basic earnings (loss) earnings per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, during the period. Diluted earnings per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, after consideration of the potential dilutive effect of common stock equivalents, based upon the treasury stock method using an average market price for the period.

Earnings (loss) Per Share Computation

 

 

 

For the Three Months Ended

June 30,

 

 

 

2015

 

 

2014

 

Net income (loss)

 

$

2,828

 

 

$

(24,248

)

Average common shares outstanding

 

 

18,632,526

 

 

 

17,417,829

 

Net effect of dilutive common stock equivalents

 

 

52,071

 

 

 

 

Adjusted average shares outstanding – dilutive

 

 

18,684,597

 

 

 

17,417,829

 

Basic income (loss) per share

 

$

0.15

 

 

$

(1.39

)

Diluted income (loss) per share

 

$

0.15

 

 

$

(1.39

)

 

 

 

For the Six Months Ended

June 30,

 

 

 

2015

 

 

2014

 

Net income (loss)

 

$

5,604

 

 

$

(26,154

)

Average common shares outstanding

 

 

18,624,585

 

 

 

17,383,192

 

Net effect of dilutive common stock equivalents

 

 

39,136

 

 

 

 

Adjusted average shares outstanding – dilutive

 

 

18,663,721

 

 

 

17,383,192

 

Basic income (loss) per share

 

$

0.30

 

 

$

(1.50

)

Diluted income (loss) per share

 

$

0.30

 

 

$

(1.50

)

 

 

(11) Commitments and Contingent Liabilities

Letters of Credit

In the normal course of business, the Company has various commitments and contingent liabilities, such as customers’ letters of credit (including standby letters of credit of $15.2 million and $17.5 million at June 30, 2015 and December 31, 2014, respectively) which are not reflected in the accompanying unaudited condensed consolidated financial statements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

 

29


Reserve for Unfunded Commitments

The Company maintains a reserve for unfunded loan commitments and letters of credit which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition consistent with FASB ASC 825, Financial Instruments. As of June 30, 2015, the Company recorded estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies, and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at June 30, 2015 and December 31, 2014 was $637 thousand and $603 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

Reserve for Residential Mortgage Loans Sold with Recourse

The Company maintains a reserve for residential mortgage loans sold with recourse to third-party purchasers which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition. The Company records estimated losses inherent with residential mortgage loans sold with recourse in accordance with FASB ASC 450, Contingencies. This reserve is determined based upon the probability of future losses which is calculated using historical Company and industry loss data. The reserve for residential mortgage loan recourse as of June 30, 2015 and December 31, 2014 was $731 thousand and $758 thousand, respectively. Management believes this reserve level is sufficient to address potential recourse exposure.

 

 

(12) Fair Value of Financial Instruments

The Company accounts for fair value measurement in accordance with FASB ASC 820, Fair Value Measurements and Disclosure. FASB ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB ASC 820 does not require any new fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. FASB ASC 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). FASB ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and also clarifies the application of fair value measurement in a market that is not active.

FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

30


FASB ASC 820 requires the Company to disclose the fair value for financial assets on both a recurring and non-recurring basis. The assets and liabilities measured at fair value on a recurring basis are as follows:

 

 

 

 

 

 

 

Category Used for Fair Value

Measurement

 

June 30, 2015

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

2,501

 

 

$

2,501

 

 

$

 

 

$

 

U.S. Government agency securities

 

 

4,835

 

 

 

 

 

 

4,835

 

 

 

 

U.S. Government agency mortgage-backed securities

 

 

228,801

 

 

 

 

 

 

228,801

 

 

 

 

Other mortgage-backed securities

 

 

186

 

 

 

 

 

 

186

 

 

 

 

State and municipal securities

 

 

30,392

 

 

 

 

 

 

30,392

 

 

 

 

Trust preferred securities

 

 

10,103

 

 

 

 

 

 

 

 

 

10,103

 

Collateralized loan obligations

 

 

59,665

 

 

 

 

 

 

59,665

 

 

 

 

Other securities

 

 

746

 

 

746

 

 

 

 

 

 

 

Hedged commercial loans

 

 

8,130

 

 

 

 

 

 

8,130

 

 

 

 

Interest rate swaps

 

 

8,954

 

 

 

 

 

 

850

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value interest rate swaps

 

 

527

 

 

 

 

 

 

527

 

 

 

 

Interest rate swaps

 

 

9,016

 

 

 

 

 

 

9,016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

 

2,502

 

 

 

2,502

 

 

 

 

 

 

 

U.S. Government agency securities

 

 

4,786

 

 

 

 

 

 

4,786

 

 

 

 

U.S. Government agency mortgage-backed securities

 

 

265,156

 

 

 

 

 

 

265,156

 

 

 

 

Other mortgage-backed securities

 

 

265

 

 

 

 

 

 

265

 

 

 

 

State and municipal obligations

 

 

30,921

 

 

 

 

 

 

30,921

 

 

 

 

Trust preferred securities

 

 

9,410

 

 

 

 

 

 

 

 

 

9,410

 

Collateralized loan obligations

 

 

68,603

 

 

 

 

 

 

68,603

 

 

 

 

Other securities

 

 

12,855

 

 

 

12,855

 

 

 

 

 

 

 

Hedged commercial loans

 

 

9,726

 

 

 

 

 

 

9,726

 

 

 

 

Interest rate swaps

 

 

12,294

 

 

 

 

 

 

12,294

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value interest rate swaps

 

 

765

 

 

 

 

 

 

765

 

 

 

 

Interest rate swaps

 

 

12,419

 

 

 

 

 

 

12,419

 

 

 

 

 

Level 1 Valuation Techniques and Inputs

U.S. Treasury securities. The Company reports U.S. Treasury securities at fair value utilizing Level 1 inputs. These securities are priced using observable quotations for the indicated security.

Other securities. The other securities category is comprised of money market mutual funds. Given the short maturity structure and the expectation that the investment can be redeemed at par value, the fair value of these investments is assumed to be the book value.

Level 2 Valuation Techniques and Inputs

The majority of the Company’s investment securities are reported at fair value utilizing Level 2 inputs. Prices of these securities are obtained through independent, third-party pricing services. Prices obtained through these sources include market derived quotations and matrix pricing and may include both observable and unobservable inputs. Fair market values take into consideration data such as dealer quotes, new issue pricing, trade prices for similar issues, prepayment estimates, cash flows, market credit spreads and other factors. The Company reviews the output from the third-party providers for reasonableness by the pricing consistency among securities with similar characteristics, where available, and by comparing values with other pricing sources available to the Company.

 

31


In general, the Level 2 valuation process uses the following significant inputs in determining the fair value of the Company’s different classes of investments:

U.S. Government agency securities. These securities are evaluated based on either a nominal spread basis for non-callable securities or on an option adjusted spread (“OAS”) basis for callable securities. The nominal spread and OAS levels are based on observations of identical or comparable securities actively trading in the markets.

U.S. Government agency mortgage-backed securities. The Company’s agency mortgage-backed securities generally fall into one of two categories, fixed-rate agency mortgage-backed pools or adjustable-rate agency mortgage-backed pools.

Fixed-rate agency mortgage-backed pools are valued based on spreads to actively traded To-Be-Announced and seasoned securities, the pricing of which is provided by inter-dealer brokers, broker dealers and other contributing firms active in trading the security class. Further delineation is made by weighted average coupon and weighted average maturity with spreads on individual securities relative to actively traded securities as determined and quality controlled using OAS valuations.

Adjustable-rate agency mortgage-backed pools are valued on a bond equivalent effective margin (“BEEM”) basis obtained from broker-dealers and other contributing firms active in the market. BEEM levels are established for key sectors using characteristics such as month-to-roll, index, periodic and life caps and index margins and convertibility. Individual securities are then evaluated based on how their characteristics map to the sectors established.

Other mortgage-backed securities. The Company’s other mortgage-backed securities consist of whole loan, non-agency collateralized mortgage obligations (“CMOs,” individually, each a “CMO”). These securities are valued based on generic tranches and generic prepayment speed estimates of various types of collateral from contributing firms and broker/dealers in the whole loan CMO market.

State and municipal obligations. These securities are valued using information on identical or similar securities provided by market makers, broker/dealers and buy-side firms, new issue sales and bid-wanted lists. The individual securities are then priced based on mapping the characteristics of the security such as obligation type (general obligation, revenue, etc.), maturity, state discount and premiums, call features, taxability and other considerations.

Collateralized loan obligations. The fair value measurements for collateralized loan obligations are obtained through quotes obtained from broker/dealers based on similar actively traded securities. Those valuations are classified as Level 2.

Hedged commercial loans. The hedged commercial loans are one component of a declared hedging relationship as defined under FASB ASC 815. The interest rate swap component of the declared hedging relationship is carried at its fair value and the carrying value of the commercial loans included a similar change in fair values. The fair value of these loans is estimated through discounted cash flow analysis which utilizes available credit and interest rate market data on performance of similar loans. This is considered a Level 2 input.

Interest rate swaps. The Company’s interest rate swaps, including fair value interest rate swaps and small exposures in interest rate caps and floors, are reported at fair value utilizing models provided by an independent, third-party and observable market data. When entering into an interest rate swap agreement, the Company is exposed to fair value changes due to interest rate movements, and also the potential nonperformance of our contract counterparty. Interest rate swaps are evaluated based on a zero coupon LIBOR curve created from readily observable data on LIBOR, interest rate futures and the interest rate swap markets. The zero coupon curve is used to discount the projected cash flows on each individual interest rate swap. In addition, the Company has developed a methodology to value the nonperformance risk based on internal credit risk metrics and the unique characteristic of derivative instruments, which include notional exposure rather than principal at risk and interest payment netting. The results of this methodology are used to adjust the base fair value of the instrument for the potential counterparty credit risk. Interest rate caps and floors are evaluated using industry standard options pricing models and observed market data on LIBOR and Eurodollar option and cap/floor volatilities.

Level 3 Valuation Techniques and Inputs

Trust preferred securities. The trust preferred securities are evaluated on a quarterly basis based on whether the security is an obligation of a single issuer or part of a securitization pool. For single issuer obligations, the Company uses discounted cash flow models which incorporate the contractual cash flow for each issue adjusted as necessary for any potential changes in amount or timing of cash flows. The cash flow model of a pooled issue incorporates anticipated loss rates and severities of the underlying collateral as well as credit support provided within the securitization. At least quarterly, the Company’s Treasury

 

32


personnel reviews the modeling assumptions which include default assumptions, discount and forward rates. Changes in those assumptions could potentially have a significant impact on the fair value of the trust preferred securities.

The cash flow model for the pooled issue owned by the Company at June 30, 2015 assumes no recovery on defaulted collateral, no recovery on securities in deferral and an additional 3.6% future default rate assumption on the remaining performing collateral every three years with no recovery rate.

For trust preferred securities, projected cash flows are discounted at a rate based on a trading group of similar securities quoted on the New York Stock Exchange or over-the-counter markets which is reviewed for market data points such as credit rating, maturity, price and liquidity. The Company indexes the securities to a comparable maturity interest rate swap to determine the market spread, which is then used as the discount rate in the cash flow models. As of the reporting date, the market spreads were 3.00% for the pooled security and 4.75% for the single issuer that is currently deferring interest payments. An increase or decrease of three percentage points in the discount rate on the pooled issue would result in a decrease of $1.9 million or an increase of $2.9 million in the security fair value, respectively. An increase or decrease of three percentage points in the discount on the single issuer would result in a decrease of $1.0 million or an increase of $1.6 million in the security fair value, respectively.

The following provides details of the Level 3 fair value measurement activity for the three and six months ended June 30, 2015 and 2014:

Fair Value Measurements Using Significant Unobservable Inputs-Level 3

Investment Securities

 

 

 

For the Three

Months Ended

June 30,

 

 

 

2015

 

 

2014

 

Balance, beginning of period

 

$

8,929

 

 

$

8,616

 

Total gains, realized/unrealized:

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

 

 

Included in accumulated other comprehensive income

 

 

1,174

 

 

 

857

 

Purchases

 

 

 

 

 

 

 

Maturities

 

 

 

 

 

 

Prepayments

 

 

 

 

 

 

Calls

 

 

 

 

 

 

Transfers out of Level 3

 

 

 

 

 

 

Balance, end of period

 

$

10,103

 

 

$

9,473

 

 

 

 

For the Six

Months Ended

June 30,

 

 

 

2015

 

 

2014

 

Balance, beginning of period

 

$

9,410

 

 

$

7,967

 

Total gains, realized/unrealized:

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

 

 

Included in accumulated other comprehensive income

 

693

 

 

 

1,506

 

Purchases

 

 

 

 

 

 

 

Maturities

 

 

 

 

 

 

Prepayments

 

 

 

 

 

 

Calls

 

 

 

 

 

 

Transfers out of Level 3

 

 

 

 

 

 

Balance, end of period

 

$

10,103

 

 

$

9,473

 

 

There were no transfers between the three levels for the three and six months ended June 30, 2015 and 2014. The Company evaluates its hierarchy on a quarterly basis to ensure proper classification.

Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of

 

33


impairment). The Company measures impaired loans, loans held-for-sale, bank properties and equipment, bank properties transferred into other real estate owned and SBA servicing assets at fair value on a non-recurring basis. At June 30, 2015 and 2014, these assets were valued in accordance with GAAP and, except for impaired loans, loans held-for-sale, and real estate owned included in the following table, did not require fair value disclosure under the provisions of FASB ASC 820. The related changes in fair value for the six months ended June 30, 2015 and 2014 are as follows:

 

 

 

 

 

 

 

Category Used for Fair

Value Measurement

 

 

Total

Losses

Or

Changes

in Net

Assets /

 

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Liabilities

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

1,364

 

 

$

 

 

$

 

 

$

1,364

 

 

$

(257

)

Bank properties and equipment

 

 

1,729

 

 

 

 

 

 

1,729

 

 

 

 

 

 

(2,082

)

Loans held-for-sale, at lower of cost or market

 

 

1,821

 

 

 

 

 

 

1,821

 

 

 

 

 

 

(677

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

2,962

 

 

$

 

 

$

 

 

$

2,962

 

 

$

(3,961

)

Real estate owned

 

 

294

 

 

 

 

 

 

 

 

 

294

 

 

 

(265

)

Loans held-for-sale, at lower of cost or market

 

 

6,355

 

 

 

 

 

 

6,355

 

 

 

 

 

 

(4,685

)

 

Under FASB ASC 310, the fair value of collateral dependent impaired loans is based on the fair value of the underlying collateral, typically real estate, which is based on valuations. It is the policy of the Company to obtain a current appraisal or evaluation when a loan has been identified as non-performing. The type of appraisal obtained will be commensurate with the size and complexity of the loan. The resulting value will be adjusted for the potential cost of liquidation and decline of values in the market. New appraisals will be obtained on an annual basis until the loan is repaid in full, liquidated, or returns to performing status.

While the loan policy dictates that a loan be assigned to the special assets department when it is placed on non-accrual status, there is a need for loan officers to consistently and accurately determine collateral values when a loan is initially designated as criticized or classified. The most effective means of determining the fair value of real estate collateral at a point in time is by obtaining a current appraisal or evaluation of the property. In anticipation of the receipt of a current appraisal or evaluation, the Company has provided for an alternative and interim means of determining the fair value of the real estate collateral.

The most recent appraisal or reported value of the collateral securing a loan, net of a discount for the estimated cost of liquidation, is the Company’s basis for determining fair value.

The following table summarizes the Company’s appraisal approach based upon loan category.

 

Loan Category Used for Impairment Review

 

Method of Determining the Value

 

 

 

Loans less than $1 million

 

Evaluation report or restricted use appraisal

 

 

 

Loans $1 million or greater

 

 

Existing appraisal 18 months or less

 

Restricted use appraisal

Existing appraisal greater than 18 months

 

Summary form appraisal

 

 

 

Commercial loans secured primarily by residential real estate

 

 

Loans less than $1 million

 

Automated valuation model

Loans $1 million or greater

 

Summary form appraisal

 

 

 

Non-commercial loans secured primarily by residential real estate

 

 

Loans less than $250 thousand

 

Automated valuation model or summary form appraisal

Loans $250 thousand or greater

 

Summary form appraisal

 

 

34


An evaluation report, as defined by the OCC, is a written report prepared by an appraiser that describes the real estate collateral, its condition, current and projected uses and sources of information used in the analysis, and provides an estimate of value in situations when an appraisal is not required.

A restricted use appraisal is defined as a written report prepared under the Uniform Standards of Professional Appraisal Practice (“USPAP”). A restricted use appraisal is for the Company’s use only and should contain a brief statement of information significant to the determination of the value of the collateral under review. This report can be used for ongoing collateral monitoring.

A summary form appraisal is defined as a written report prepared under the USPAP which contains a detailed summary of all information significant to the determination of the collateral valuation. This report is more detailed than a restricted use report and provides sufficient information to enable the user to understand the rationale for the opinions and conclusions in the report.

An automated valuation model is an internal computer program that estimates a property’s market value based on market, economic, and demographic factors.

On a quarterly basis, or more frequently as necessary, the Company will review the circumstances of each collateral dependent loan and real estate owned property. A collateral dependent loan is defined as one that relies solely on the operation or the sale of the collateral for repayment. Adjustments to any specific reserve relating to a collateral shortfall, as compared to the outstanding loan balance, will be made if justified by appraisals, market conditions or current events concerning the loan.

All appraisals received which are utilized to determine valuations for criticized and classified loans or properties placed in real estate owned are provided under an “as is” value. Partially charged off loans are measured for impairment upon receipt of an updated appraisal based on the relationship between the remaining balance of the charged down loan and the discounted appraised value. Such loans will remain on non-accrual status unless performance by the borrower warrants a return to accrual status. Recognition of non-accrual status occurs at the time a loan can no longer support principal and interest payments in accordance with the original terms and conditions of the loan documents. When impairment is determined, a specific reserve reflecting any calculated shortfall between the value of the collateral and the outstanding balance of the loan is recorded. Subsequent adjustments, prior to receipt of a new appraisal, to any related specific reserve will be made if justified by market conditions or current events concerning the loan. If an internal discount-based evaluation is being used, the discount percentage may be adjusted to reflect market changes, changes to the collateral value of similar loans or circumstances of the individual loan itself. The amount of the charge-off is determined by calculating the difference between the current loan balance and the current collateral valuation, plus estimated cost to liquidate.

Impaired loan fair value measurements are based upon unobservable inputs, and therefore, are categorized as a Level 3 measurement. There were no impaired loans with specific reserves at both June 30, 2015 and 2014. There were no charge-offs recorded on impaired loans with a specific reserve during both the six months ended June 30, 2015, and 2014. Impaired loans held-for-investment with an aggregate carrying amount of $1.4 million and $3.0 million at June 30, 2015 and 2014, respectively, did not include specific reserves as the value of the underlying collateral was not below the carrying amount. However, these loans did include charge-offs of $257 thousand, of which $0 related to loans that were fully charged off at June 30, 2015 and $4.0 million, of which $3.7 million related to loans which were fully charged off at June 30, 2014.

Loans held-for-sale, at lower of cost or market with an aggregate carrying amount of $1.8 million at June 30, 2015 included charge-offs of $677 thousand to reduce the balance of the loans to fair value. The fair value of these loans was determined through the use of broker quotes based on market data; therefore, this is a level 2 input.

Once a loan is determined to be uncollectible, the underlying collateral is repossessed and reclassified as other real estate owned. The balance of other real estate owned can also include bank properties transferred from operations. These assets are carried at the lower of cost or fair value of the collateral, less cost to sell. In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of comparable properties included in the appraisal, and known changes in the market and the collateral. During the six months ended June 30, 2015 and 2014, the Company recorded a decrease in fair value on commercial properties of $0 and $197 thousand, respectively, and $0 and $68 thousand on consumer properties, respectively. These adjustments were based upon unobservable inputs, and therefore categorized as Level 3 measurements.

The SBA servicing assets are reviewed for impairment in accordance with FASB ASC 860, Transfers and Servicing. Because loans are sold individually and not pooled, the Company does not stratify groups of loans based on risk characteristics for purposes of measuring impairment. The Company measures the SBA servicing assets by estimating the present value of expected future cash flows for each servicing asset, based on their unique characteristics and market-based prepayment assumptions. This is a Level 3 input. A valuation allowance is recorded for the amount by which the carrying amount of the

 

35


servicing asset exceeds the calculated fair value. The Company had a valuation allowance of $177 thousand on its SBA servicing assets at both June 30, 2015 and December 31, 2014.

In accordance with ASC 825-10-50-10, Fair Value of Financial Instruments, the Company is required to disclose the fair value of its financial instruments. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a distressed sale. Fair value is best determined using observable market prices; however, for many of the Company’s financial instruments, no quoted market prices are readily available. In instances where quoted market prices are not readily available, fair value is determined using cash flow models or other techniques appropriate for the particular instrument. These techniques involve some degree of judgment and, as a result, are not necessarily indicative of the amounts the Company would realize in a current market exchange. Utilizing different assumptions or estimation techniques may have a material effect on the estimated fair value.

Carrying Amounts and Estimated Fair Values of Financial Assets and Liabilities

 

 

 

June 30, 2015

 

 

December 31, 2014

 

 

 

Carrying

Amount

 

 

Estimated

Fair Value

 

 

Carrying

Amount

 

 

Estimated

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

28,544

 

 

$

28,544

 

 

$

42,548

 

 

$

42,548

 

Interest-earning bank balances

 

 

250,319

 

 

 

250,319

 

 

 

505,885

 

 

 

505,885

 

Restricted cash

 

 

5,000

 

 

 

5,000

 

 

 

13,000

 

 

 

13,000

 

Investment securities available for sale

 

 

337,229

 

 

 

337,229

 

 

 

394,500

 

 

 

394,500

 

Investment securities held-to-maturity

 

 

462

 

 

 

470

 

 

 

489

 

 

 

501

 

Loans receivable, net

 

 

1,550,469

 

 

 

1,519,026

 

 

 

1,477,172

 

 

 

1,412,372

 

Loans held-for-sale, at lower of cost or market

 

 

2,006

 

 

 

2,006

 

 

 

4,083

 

 

 

4,083

 

Hedged commercial loans(1)

 

 

8,130

 

 

 

8,130

 

 

 

9,726

 

 

 

9,726

 

Branch assets held-for-sale

 

 

5,604

 

 

 

5,604

 

 

 

69,064

 

 

 

69,064

 

Restricted equity investments

 

 

15,554

 

 

 

15,554

 

 

 

14,961

 

 

 

14,961

 

Interest rate swaps

 

 

8,954

 

 

 

8,954

 

 

 

12,294

 

 

 

12,294

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

 

1,270,277

 

 

 

1,237,570

 

 

 

1,409,978

 

 

 

1,444,488

 

Savings deposits

 

 

211,569

 

 

 

203,484

 

 

 

224,017

 

 

 

232,572

 

Time deposits

 

 

394,875

 

 

 

405,628

 

 

 

457,909

 

 

 

458,233

 

Deposits held-for-sale

 

 

34,689

 

 

 

36,077

 

 

 

183,395

 

 

 

199,469

 

Securities sold under agreements to

   repurchase – customers

 

 

 

 

 

 

 

 

1,156

 

 

 

1,156

 

Advances from FHLBNY

 

 

85,698

 

 

 

85,862

 

 

 

60,787

 

 

 

60,935

 

Junior subordinated debentures

 

 

92,786

 

 

 

69,991

 

 

 

92,786

 

 

 

67,837

 

Fair value interest rate swaps

 

 

527

 

 

 

527

 

 

 

765

 

 

 

765

 

Interest rate swaps

 

 

9,016

 

 

 

9,016

 

 

 

12,419

 

 

 

12,419

 

 

(1)

Includes positive market value adjustment of $527 thousand and $765 thousand at June 30, 2015 and December 31, 2014, respectively, which is equal to the change in value of related interest rate swaps designated as fair value hedges of these hedged loans in accordance with FASB ASC 815.

Cash and cash equivalents. For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value. This is a Level 1 fair value input.

Restricted cash. For restricted cash, the carrying amount is a reasonable estimate of fair value. This is a Level 1 fair value input.

Investment securities. For investment securities, fair values are based on a combination of quoted prices for identical assets in active markets, quoted prices for similar assets in markets that are either actively or not actively traded and price models, discounted cash flow methodologies, or similar techniques that may contain unobservable inputs that are supported by little or no market activity and require significant judgment. The fair value of available-for-sale securities is measured utilizing Level 1, Level 2, and Level 3 inputs. The fair value of held-to-maturity securities is measured utilizing Level 2 inputs.

 

36


Loans receivable, net. The fair value of loans receivable is estimated using discounted cash flow analysis. Projected future cash flows are calculated using loan characteristics, and assumptions of voluntary and involuntary prepayment speeds. For performing loans, Level 2 inputs are utilized as the cash flow analysis is performed using available market data on the performance of similar loans. Projected cash flows are prepared using discount rates believed to represent current market rates. For non-performing loans, the cash flow assumptions are considered Level 3 inputs as market data is not readily available.

Loans held-for-sale, at lower of cost or market. Loans held-for-sale, at lower of cost or market includes consumer loans identified for sale out of the portfolio. These loans are recorded at lower of cost or market. The fair value of these loans is determined through the use of broker quotes based on market data; therefore, this is a level 2 input.

Hedged commercial loans. The hedged commercial loans are one component of a declared hedging relationship as defined under FASB ASC 815. The interest rate swap component of the declared hedging relationship is carried at its fair value and the carrying value of the commercial loans includes a similar change in fair values. The fair value of these loans is measured utilizing Level 2 inputs.

Branch assets held-for-sale. This category includes loans receivable and fixed assets, identified at certain branches for sale. As these assets are under agreement of sale at net book value, the carrying value is deemed to equal fair value. This is a level 2 fair value input.

Restricted equity securities. Ownership in equity securities of the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”), FHLBNY and Atlantic Central Bankers Bank is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value. The fair value is based on Level 2 inputs.

Interest rate swaps and fair value interest rate swaps. The Company’s derivative financial instruments are not exchange-traded and therefore are valued utilizing models with the primary input being readily observable market parameters, specifically the LIBOR swap curve. In addition, the Company incorporates a qualitative fair value adjustment related to credit quality variations between counterparties as required by FASB ASC 820. This is a level 2 input.

Demand deposits, savings deposits and time deposits. The fair value of demand deposits and savings deposits is determined by projecting future cash flows using an estimated economic life based on account characteristics, a Level 2 input. The resulting cash flow is discounted using rates available on alternative funding sources. The fair value of time deposits is estimated using the rate and maturity characteristics of the deposits to estimate their cash flow. This cash flow is discounted at rates for similar term wholesale funding.

Deposits held-for-sale. The fair value is determined by applying the agreed upon deposit premium per a branch sale agreement. This is a level 2 input.

Securities sold under agreements to repurchase – customer. The fair value is estimated to be the amount payable at the reporting date. This is considered a Level 2 input.

Junior subordinated debentures. The fair value was estimated by discounting approximate cash flows of the borrowings by yields estimating the fair value of similar issues. The valuation model considers current market spreads, known and anticipated credit issues of the underlying collateral, term and reinvestment period and market transactions of similar issues, if available. This is a Level 3 input under the fair value hierarchy.

The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2015 and December 31, 2014. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these condensed consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

 

 

(13) Regulatory Matters

The Company is subject to risk-based capital guidelines adopted by the FRB for bank holding companies. The Bank is also subject to similar capital requirements adopted by the OCC. Under the requirements the federal bank regulatory agencies have established quantitative measures to ensure that minimum capital thresholds are maintained. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s consolidated financial statements.

 

37


Prior to January 1, 2015, the OCC’s capital regulations required national banks to meet four minimum capital ratios: a 1.5% Tangible capital ratio, a 4.0% Tier 1 leverage capital ratio, a 4.0% Tier 1 risk-based capital ratio and a 8.0% Total risk-based capital ratio. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) the federal bank regulatory agencies issued the revised capital rules (the “Final Capital Rules”). The Final Capital Rules revised the quantity and quality of required minimum risk-based and leverage capital requirements applicable to the Bank, consistent with the Dodd-Frank Act and the Basel III capital standards. The Final Capital Rules revised the quantity and quality of capital required by (1) establishing a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) raising the minimum capital ratio from 4.0% to 6.0% of risk-weighted assets; (3) maintaining the minimum total capital ratio of 8.0% of risk-weighted assets; and (4) maintaining a minimum Tier 1 leverage capital ratio of 4.0%.

Furthermore, the Final Capital Rules added a requirement for a minimum common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, or the Conservation Buffer, to be applied to the common equity Tier 1 capital ratio, the Tier 1 capital ratio and the total capital ratio. The required minimum Conservation Buffer will be phased in incrementally between 2016 and 2019. If a bank’s or bank holding company’s Conservation Buffer is less than the required minimum and its net income for the four calendar quarters preceding the applicable calendar quarter, net of any capital distributions and associated tax effects not already reflected in net income, or Eligible Retained Income, is negative, it would be prohibited from making capital distributions or certain discretionary cash bonus payments to executive officers. As a result, under the Final Capital Rules, should we fail to maintain the Conservation Buffer we would be subject to limits on, and in the event we have negative Eligible Retained Income for any four consecutive calendar quarters, we would be prohibited in, our ability to obtain capital distributions from the Bank.

The following table provides both the Company’s and the Bank’s risk-based capital ratios as of June 30, 2015 and December 31, 2014.

Regulatory Capital Levels

 

 

 

Actual

 

 

For Capital

Adequacy

Purposes

 

 

To Be Well

Capitalized Under

Prompt Corrective

Action Provision(1)

 

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

June 30, 2015(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

$

324,062

 

 

 

20.81

%

 

$

124,603

 

 

 

8.00

%

 

N/A

 

 

 

 

 

Sun National Bank

 

 

291,925

 

 

 

18.79

 

 

 

124,262

 

 

 

8.00

 

 

$

155,328

 

 

 

10.00

%

Tier 1 common equity capital ratio (to risk-

   weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

214,574

 

 

 

13.78

 

 

 

70,089

 

 

 

4.50

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

17.54

 

 

 

69,897

 

 

 

4.50

 

 

 

100,963

 

 

 

6.50

 

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

268,222

 

 

 

17.22

 

 

 

93,452

 

 

 

6.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

17.54

 

 

 

93,197

 

 

 

6.00

 

 

 

124,262

 

 

 

8.00

 

Leverage capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

268,222

 

 

 

11.26

 

 

 

95,254

 

 

 

4.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

11.46

 

 

 

95,119

 

 

 

4.00

 

 

 

118,899

 

 

 

5.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

$

317,945

 

 

 

19.25

%

 

$

132,147

 

 

 

8.00

%

 

N/A

 

 

 

 

 

Sun National Bank

 

 

286,374

 

 

 

17.37

 

 

 

131,876

 

 

 

8.00

 

 

$

164,844

 

 

 

10.00

%

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

276,349

 

 

 

16.73

 

 

 

66,073

 

 

 

4.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

265,728

 

 

 

16.12

 

 

 

65,938

 

 

 

4.00

 

 

 

98,907

 

 

 

6.00

 

Leverage capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

276,349

 

 

 

10.06

 

 

 

109,894

 

 

 

4.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

265,728

 

 

 

9.68

 

 

 

109,760

 

 

 

4.00

 

 

 

137,200

 

 

 

5.00

 

 

(1)

Not applicable for bank holding companies.

 

38


(2)

The Basel III guidelines and the Dodd-Frank Act established a new minimum Tier 1 common equity risk-based capital ratio and revised the “Prompt Corrective Action” regulations, effective January 1, 2015.

The Bank is also subject to individual minimum capital ratios established by the OCC requiring the Bank to continue to maintain a Tier 1 Leverage Capital ratio at least equal to 8.50% of adjusted total assets, to continue to maintain Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and to maintain a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At June 30, 2015, the Bank met all of the three capital ratios established by the OCC as its Leverage Capital ratio was 11.46%, its Tier 1 Capital ratio was 17.54%, and its Total Capital ratio was 18.79%.

On April 15, 2010, the Bank entered into a written agreement with the OCC (the “OCC Agreement”) which required the Bank to develop and implement a profitability and capital plan which provides for the maintenance of adequate capital to support the Bank’s risk profile. The capital plan contains a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC. During the second quarter of 2010, the Company delivered its profit and capital plans to the OCC. Updated profit and capital plans were subsequently submitted to the OCC as required.

The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. During the second quarter of 2010, the Bank revised and implemented changes to policies and procedures pursuant to the OCC Agreement. The Bank initially agreed that its brokered deposits would not exceed 3.5% of its total liabilities unless approved by the OCC. However, effective October 18, 2012, the OCC approved an increase of this limit to 6.0%. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. As of June 30, 2015, the Bank’s brokered deposits represented 3.1% of its total liabilities.

In addition, the Company is required to seek the prior approval of the Federal Reserve Bank before paying interest, principal or other sums on trust preferred securities or any related subordinated debentures, declaring or paying cash dividends or receiving dividends from the Bank, repurchasing outstanding stock or incurring indebtedness. The Company also was required to submit, and periodically update, a capital plan, a profit plan and cash flow projections, as well as other progress reports to the Federal Reserve Bank.

At June 30, 2015 and December 31, 2014, although the Bank exceeded the regulatory minimum ratios for classification as “well capitalized,” due to the fact that it was subject to the OCC Agreement, it cannot be deemed “well capitalized.”

In August 2014, the Company raised approximately $20 million in equity through a privately negotiated sale of its common stock to several institutions and private investors. The Company issued a total of 1,133,144 shares of common stock in this transaction at a price per share of $17.65.

The Bank is subject to various regulatory restrictions on its ability to pay dividends to the Company. All national banks are limited in the payment of dividends without the approval of the OCC of a total amount not to exceed the net income for that year to date plus the retained income for the preceding two years. Federal law also prohibits national banks from paying dividends that would be greater than the bank’s undivided profits after deducting statutory bad debt in excess of the bank’s allowance for loan losses. Due to our net loss position over the last two years, any proposed dividends from the Bank to the Company will be subject to regulatory approval until such time as net income for the current year combined with the prior two years is sufficient. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), an insured depository institution such as the Bank is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the FDICIA). Payment of dividends by the Bank also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe and unsound banking practice. Further, pursuant to the terms of the OCC Agreement, the Bank may not pay dividends if it is not in compliance with its approved capital plan or if the effect of the dividend would be to cause the Bank to not be in compliance and, in either event, not without prior OCC approval. The Bank did not seek OCC approval to pay a dividend in the first six months of 2015.

FDIC assessment expense of $711 thousand and $944 thousand was recognized during the three months ended June 30, 2015 and 2014, respectively and $1.6 million and $2.0 million was recognized during the six months ended June 30, 2015 and 2014, respectively.

The Company’s capital securities qualify as Tier 1 capital under federal regulatory guidelines. These instruments are subject to a 25% capital limitation under risk-based capital guidelines developed by the FRB. Under FRB rules, restricted core capital elements, which are qualifying trust preferred securities, qualifying cumulative perpetual preferred stock (and related surplus) and certain minority interests in consolidated subsidiaries, are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax

 

39


liability. However, under the Dodd-Frank Act, bank holding companies are prohibited from including in their Tier 1 capital hybrid debt and equity securities, including trust preferred securities, issued on or after May 19, 2010. Any such instruments issued before May 19, 2010 by a bank holding company, such as the Company, with total consolidated assets of less than $15 billion as of December 31, 2009, may continue to be included as Tier 1 capital (subject to the 25% limitation). The portion that exceeds the 25 percent capital limitation qualifies as Tier 2, or supplementary capital of the Company. At June 30, 2015, $53.6 million of a total of $90.0 million in capital securities qualified as Tier 1 with $36.4 million qualifying as Tier 2.

On December 10, 2013, the FRB, the OCC, the FDIC, the Commodity Futures Trading Commission (the “CFTC”) and the SEC issued final rules to implement the Volcker Rule contained in Section 619 of the Dodd-Frank Act. While the Dodd-Frank Act provided that banks and bank holding companies were required to conform their activities and investments by July 21, 2014, in connection with issuing the final Volcker Rule, the FRB extended the conformance period until July 21, 2015. The FRB is permitted, by rule or order, to extend the conformance period for one year at a time, for a total of not more than 3 years. On December 18, 2014, the FRB issued an order that further extends until July 21, 2016 the conformance period under the Volcker Rule. The FRB stated in the order that it intends to exercise its authority again next year and grant the final one-year extension in order to permit banks and bank holding companies until July 21, 2017 to conform to the requirements of the Volcker Rule.

The final Volcker Rule regulations do provide certain exemptions allowing banking entities to continue underwriting, market-making and hedging activities and trading certain government obligations, as well as various exemptions and exclusions from the definition of “covered funds.” The level of required compliance activity depends on the size of the banking entity and the extent of its trading.

On January 14, 2014, the five federal agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities from the investment prohibitions of the Volcker Rule. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if certain qualifications are met. In addition, the agencies released a non-exclusive list of issuers that meet the requirements of the interim final rule. At June 30, 2015, the Company had an investment in one pool of trust preferred securities with an amortized cost of $8.8 million and estimated fair value of $6.8 million. This pool was included in the list of non-exclusive issuers that meet requirements of the interim final rule release by the agencies and therefore was not required to be sold by the Company.

At June 30, 2015, the Company had 11 collateralized loan obligation securities with an amortized cost of $59.9 million and an estimated fair value of $59.7 million. These securities are subject to the provisions of the Volcker Rule. As a result, the Company will likely be required to divest these investments unless their terms can be modified such that the investments are no longer covered by the Volcker Rule. While there is proposed legislation in Congress regarding a delay to the divestiture requirement for collateralized loan obligations, the outcome of the legislation is unclear at this time. The Company cannot give assurances that the legislation will or will not be enacted. However, based on the Company’s communication with its investment advisors, in the event that the proposed legislation is not enacted, the Company believes these investments can be modified to avoid a required divestiture under the Volcker Rule.

Forward-Looking Statements

This Quarterly Report on Form 10-Q of the Company and the documents incorporated by reference herein may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are intended to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. We are including this statement for the purpose of invoking those safe harbor provisions. Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements may include, among other things:

statements and assumptions relating to financial performance;

statements relating to the anticipated effects on results of operations or financial condition from recent or future developments or events;

statements relating to our business and growth strategies and our regulatory capital levels;

statements relating to potential sales of our criticized and classified assets; and

any other statements, projections or assumptions that are not historical facts.

 

40


Actual future results may differ materially from our forward-looking statements, and we qualify all forward-looking statements by various risks and uncertainties we face, some of which are beyond our control, as well as the assumptions underlying the statements, including, among others, the following factors:

the strength of the United States economy in general and the strength of the local economies in which we conduct operations;

market volatility;

the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs;

the overall quality of the composition of our loan and securities portfolios;

the market for criticized and classified assets that we may sell;

legislative and regulatory changes, including the Dodd-Frank Act and impending regulations, changes in banking, securities and tax laws and regulations and their application by our regulators and changes in the scope and cost of FDIC insurance and other coverages;

the effects of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the FRB;

inflation, interest rate, market and monetary fluctuations;

fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;

the effect of and our compliance with the terms of the OCC Agreement and the Federal Reserve Bank requirements as well as compliance with the individual minimum capital ratios established for the Bank by the OCC;

the results of examinations of us by the Federal Reserve Bank and of the Bank by the OCC, including the possibility that the OCC may, among other things, require the Bank to increase its allowance for loan losses or to write-down assets;

our ability to control operating costs and expenses;

our ability to manage delinquency rates;

our ability to retain key members of our senior management team;

the costs of litigation, including settlements and judgments;

the increased competitive pressures among financial services companies;

the timely development of and acceptance of new products and services and the perceived overall value of these products and services by businesses and consumers, including the features, pricing and quality compared to our competitors’ products and services;

technological changes;

acquisitions;

changes in consumer and business spending, borrowing and saving habits and demand for financial services in our market area;

adverse changes in securities markets;

the inability of key third-party providers to perform their obligations to us;

changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Financial Accounting Standards Board;

the potential impact on the Company’s operations and customers resulting from natural or man-made disasters, war, terrorist activities or cyber attacks;

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere herein or in the documents incorporated by reference herein and our other filings with the SEC; and

our success at managing the risks involved in the foregoing.

Some of these and other factors are discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014 under “Item 1A Risk Factors” and “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” as such sections may be amended or supplemented herein or in other filings pursuant to the Exchange Act. The development of any or all of these factors could have an adverse impact on our financial position and results of operations.

 

41


Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference herein or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, unless otherwise required to do so by law or regulation. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed herein or in the documents incorporated by reference herein might not occur, and you should not put undue reliance on any forward-looking statements.

NON-GAAP FINANCIAL MEASURES

This Quarterly Report on Form 10-Q of the Company contains financial information prepared pursuant to methods other than in accordance with GAAP. Management uses these “non-GAAP” measures in their analysis of the Company’s performance. Management believes that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrate the effects of significant gains and charges in the current period. The Company believes that a meaningful analysis of its financial performance requires an understanding of the factors underlying that performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Management uses these measures to evaluate the underlying performance and efficiency of operations. Management believes these measures reflect core trends of the business.

Tax Equivalent Net Interest Income:

This Quarterly Report on Form 10-Q references tax-equivalent interest income. Tax-equivalent interest income is a non-GAAP financial measure. Tax-equivalent interest income assumes a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended June 30, 2015 and 2014 were $167 thousand and $166 thousand, respectively. The fully taxable equivalent adjustments for the six months ended June 30, 2015 and 2014 were $330 thousand and $333 thousand, respectively. Tax-equivalent net interest income is net interest income plus the taxes that would have been paid had tax-exempt securities been taxable. This number attempts to enhance the comparability of the performance of assets that have different tax liabilities. The following table provides a reconciliation of tax equivalent net interest income to GAAP net interest income using a 35% tax rate:

For the Three Months Ended:

 

June 30,

 

2015

 

 

2014

 

Net interest income, as presented

 

$

15,375

 

 

$

20,612

 

Effect of tax-exempt income

 

 

167

 

 

 

166

 

Net interest income, tax equivalent

 

$

15,542

 

 

$

20,778

 

For the Six Months Ended:

 

June 30,

 

2015

 

 

2014

 

Net interest income, as presented

 

$

30,566

 

 

$

42,004

 

Effect of tax-exempt income

 

 

330

 

 

 

333

 

Net interest income, tax equivalent

 

$

30,896

 

 

$

42,337

 

 

Core Deposits:

Core deposits are calculated by excluding time deposits and brokered deposits from total deposits. The following table provides a reconciliation of core deposits to GAAP total deposits at June 30, 2015 and December 31, 2014:

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Total deposits

 

$

1,876,721

 

 

$

2,091,904

 

Less: Time deposits

 

 

329,410

 

 

 

382,088

 

Less: Brokered deposits

 

 

65,465

 

 

 

75,821

 

Core deposits

 

$

1,481,846

 

 

$

1,633,995

 

 

 

 

42


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(All dollar amounts presented in the tables are in thousands)

General Overview

The Company is a bank holding company with headquarters in Mount Laurel, New Jersey. The Bank is the Company’s principal subsidiary. Through the Bank, the Company provides community banking services. At June 30, 2015, the Company had total assets of $2.38 billion, total liabilities of $2.13 billion and total shareholders’ equity of $252.9 million. The Company reported net income available to common shareholders of $2.8 million, or $0.15 per diluted share, and $5.6 million, or $0.30 per diluted share, for the three and six months, respectively, ended June 30, 2015.

In June 2014, the Company adopted a comprehensive strategic restructuring plan to refocus on serving commercial borrowers in the communities in which the Bank operates. Pursuant to the plan, during 2014, the Bank exited Sun Home Loans, its residential mortgage banking origination business and its healthcare and asset-based lending businesses, it sold seven branch locations in the Cape May County area to Sturdy Savings Bank, consolidated three branch locations, significantly reduced classified assets and operating expenses and declared a 1-for-5 reverse stock split. In the first quarter of 2015, the Bank entered into an agreement to sell its Hammonton branch and announced the consolidation of nine additional branches, which resulted in combined restructuring charges of $3.3 million in the six months ending June 30, 2015.  

The Company provides an array of community banking services to consumers, small businesses and mid-sized companies. The Company’s lending services to businesses include term loans and lines of credit and commercial mortgages. The Company is a Preferred Lender with both the SBA and the New Jersey Economic Development Authority. The Company’s commercial deposit services include business checking and money market accounts and cash management solutions such as online banking, electronic bill payment and wire transfer services, lockbox services, remote deposit and controlled disbursement services. The Company’s consumer deposit services include checking accounts, savings accounts, money market accounts, certificates of deposit and individual retirement accounts. The Company’s lending services to consumers consist primarily of lines of credit for overdraft sweeps. In addition, the Company, through its wealth management subsidiary, Prosperis Financial Solutions, offers client access to mutual funds, securities brokerage, annuities and investment advisory services. During 2014 and in prior years, the Company offered residential mortgage loans but completed its exit from this business in the second half of 2014. Additionally, the Company has ceased its offering of home equity term loans, home equity lines of credit and installment loans.

As a result of the implementation of the strategic restructuring plan, the Company’s primary lending focus is centered around commercial relationships, specifically commercial real estate and commercial and industrial originations, as well as both originations and participations in multi-family loans. With the Bank’s branch network rationalized, the organization is focusing on enhancing its brand and building a relationship-based deposit gathering strategy which the Company anticipates will generate additional deposit-related income from service charges, cash management and related commercial banking products and services.

The Company funds its lending activities primarily through retail and brokered deposits, the scheduled maturities of its investment portfolio and other wholesale funding sources. As a financial institution with a primary focus on traditional banking activities, the Company generates the majority of its revenue through net interest income, which is defined as the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon the Company’s ability to prudently manage the balance sheet for growth, combined with how successfully it maintains or increases net interest margin, which is net interest income as a percentage of average interest-earning assets. The Company generates additional revenue through fees earned on the various services and products offered to its customers. Offsetting these revenue sources are provisions for credit losses on loans, operating expenses and income taxes.

On March 6, 2015, the Company completed the sale of seven branch locations to Sturdy Savings Bank. In accordance with the sale, the Company sold $153.3 million of deposits, $63.8 million of loans, $4.0 million of fixed assets and $897 thousand of cash. The transaction resulted in a net cash payment of approximately $71.5 by the Company to Sturdy Savings Bank. After transaction costs, the sale resulted in a net gain of $9.2 million in the six months ended June 30, 2015 recorded in gain on sale of bank branches in the unaudited condensed consolidated statements of operations.

On March 26, 2015, the Company entered into the Hammonton Agreement with Cape Bancorp., Inc., pursuant to which the Bank agreed to sell certain assets and certain liabilities relating to one branch office in Hammonton, New Jersey. The Hammonton Agreement contains certain customary representations, warranties, indemnities and covenants of the parties, and is subject to termination in certain circumstances. The transaction is expected to be completed during the third quarter of 2015, subject to Cape Bancorp’s receipt of regulatory approvals as well as customary closing conditions.

At June 30, 2015, the Company had approximately $4.6 million of loans in branch assets held-for-sale and $34.7 million in deposits held-for-sale on the unaudited condensed consolidated statements of financial condition.

 

43


The economy was sluggish in the first half of 2015. Although interest rates have begun to rise slightly, they remained near historical lows. The unemployment rate in the U.S. declined to 5.3% in June 2015 from 5.5% in March 2015 and from 5.6% in December 2014. While this is the lowest unemployment rate since May 2008, concerns still exist about economic growth as the labor participation rate reached a 37 year low and wage growth has been minimal. Based upon initial estimates, the U.S. gross domestic product for the second quarter of 2015 increased at an annual rate of 2.3% as compared to a revised 0.6% increase in the first quarter of 2015. The increased growth in the second quarter of 2015 was mainly driven by consumer spending which has improved as a result of lower gasoline prices and improvements in the labor market.  Housing, exports and state and local government spending also provided a lift, while the energy sector continued to weigh on growth. At the state level, according to the latest South Jersey Business Survey produced by the Federal Reserve Bank, growth in business activity continued in the second quarter of 2015 and continued growth is expected for the remainder of the year. Additionally, employment growth is expected to continue at a moderate level. In Northern New Jersey, business activity is expected to continue to increase at a modest pace. Overall, New Jersey’s unemployment rate remains one of the highest in the U.S. but has declined to 6.1% as of June 2015 as compared to 6.5% in March 2015.

At its latest meeting in July 2015, the Federal Open Market Committee (the “FOMC”) kept the Federal Funds target rate at zero to 0.25% in an effort to help stimulate economic growth. Although FRB officials are suggesting there will be a rate increase, the timing will be based on the pace of economic recovery. The FOMC reiterated that it will raise interest rates with further labor market improvement and is reasonably confident that inflation will return to 2% over the medium term. Additionally, the FOMC is maintaining its existing policy regarding reinvestment of mortgage backed securities and treasury cash flows to sustain its accommodative posture.

Although moderately improving, the economy is still experiencing uncertainty in certain sectors, and, together with the challenging regulatory environment, will continue to affect the Company and the markets in which it does business and may adversely impact the Company’s results in the future. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the three and six months ended June 30, 2015.

Critical Accounting Policies, Judgments and Estimates

The Company’s significant accounting policies are described in Note 2 to the consolidated financial statements included in the Company’s 2014 Form 10-K and in Note 2 to the unaudited condensed consolidated financial statements included in Item 1 of this report. The discussion and analysis of the financial condition and results of operations are based on the unaudited condensed consolidated financial statements, which are prepared in conformity with GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Management evaluates these estimates and assumptions on an ongoing basis, including those related to the allowance for loan losses, goodwill, intangible assets, income taxes and the fair value of financial instruments. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Allowance for Loan Losses. Through the Bank, the Company originates loans that it intends to hold for the foreseeable future or until maturity or repayment. The Company may not be able to collect all principal and interest due on these loans. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. The determination of the allowance for loan losses requires management to make significant estimates with respect to the amounts and timing of losses and market and economic conditions. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. A provision for loan losses is charged to operations based on management’s evaluation of the estimated losses that have been incurred in the Company’s loan portfolio. It is the policy of management to provide for losses on unidentified loans in its portfolio in addition to classified loans.

Management monitors its allowance for loan losses on a monthly basis and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors warrant. The Company’s allowance for loan losses methodology considers a number of quantitative and qualitative factors. The review and adjustment of the qualitative factors employed in the allowance methodology and the updating of historic loss and recovery experience allow for timely reaction to emerging conditions and trends. In this context, a series of qualitative factors are used in a methodology as a measurement of how current circumstances are affecting the loan portfolio. Included in these qualitative factors are:

Levels of past due, classified and non-accrual loans, troubled debt restructurings and modifications;

Nature and volume of loans;

Historical loss trends;

 

44


Changes in lending policies and procedures, underwriting standards, collections, and for commercial loans, the level of loans being approved with exceptions to policy;

Experience, ability and depth of management and staff;

National and local economic and business conditions, including various market segments;

Quality of the Company’s loan review system and degree of Board oversight; and

Effect of external factors, including the deterioration of collateral values, on the level of estimated credit losses in the current portfolio.

Additionally, for the commercial loan portfolio, historic loss and recovery experience over a three-year horizon, based on a rolling 12-quarter migration analysis, is taken into account for the quantitative factor component. For the non-commercial loan quantitative component, the average historic loss and recovery experience over a 12-quarter time period is utilized for the allowance calculation. In determining the allowance for loan losses, management has established both specific and general pooled allowances. Values assigned to the qualitative factors and those developed from historic loss and recovery experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans and those criticized and classified loans through the use of both a general pooled allowance and a specific allowance. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios and external factors. Estimates are periodically measured against actual loss experience. A specific allowance is calculated on individually identified impaired loans. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss and recovery experience and the qualitative factors described above.

As changes in the Company’s operating environment occur and as recent loss experience fluctuates, the factors for each category of loan based on type and risk rating will change to reflect current circumstances and the quality of the loan portfolio. Given that the components of the allowance are based partially on historical losses, recoveries and on risk rating changes in response to recent events, required reserves may trail the emergence of any unforeseen deterioration in credit quality.

Although the Company maintains its allowance for loan losses at levels considered adequate to provide for the inherent risk of loss in its loan portfolio, if economic conditions differ substantially from the assumptions used in making the evaluations, there can be no assurance that future losses will not exceed estimated amounts or that additional provisions for loan losses will not be required in future periods. Accordingly, the current state of the national economy and local economies of the areas in which the loans are concentrated and their slow recovery from a severe recession could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, the Company’s determination as to the amount of its allowance for loan losses is subject to review by the Bank’s primary regulator, the OCC, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of management after a review of the information available at the time of the OCC examination.

Accounting for Income Taxes. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes. (“FASB ASC 740”). FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities and of its gross deferred tax assets. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the unaudited condensed consolidated statements of operations. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management’s analysis of tax regulations and interpretations. Significant judgment may be involved in applying the requirements of FASB ASC 740.

Management expects that the Company’s adherence to FASB ASC 740 may result in increased volatility in quarterly and annual effective income tax rates, as FASB ASC 740 requires that any change in judgment or change in measurement of a tax position taken in a prior period be recognized as a discrete event in the period in which it occurs. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies.

Financial Condition

Total assets declined to $2.38 billion at June 30, 2015 as compared to $2.72 billion at December 31, 2014, mainly due to a decrease in cash and cash equivalents and investment securities, partially offset by an increase in loans receivable. Cash and cash equivalents decreased $269.6 million to $278.9 million at June 30, 2015 as compared to $548.4 million at December 31, 2014, mainly due to the sale of seven branches to Sturdy Savings Bank during the quarter ending March 31, 2015, as well as new loan funding and a

 

45


reduction in total deposits. Loans receivable, net of allowance for loan losses, increased $71.7 million to $1.56 billion at June 30, 2015 as compared to $1.49 billion at December 31, 2014, primarily due to loan originations of $177.8 million and $98.5 million of multi-family loan participations funded during the six months ending June 30, 2015, partially offset by paydowns.  Investment securities available-for-sale declined $57.3 million to $337.2 million at June 30, 2015, from $394.5 million at December 31, 2014, mainly due to sales of $33.6 million and net paydowns of $23.3 million.  

Total liabilities decreased $343.9 million, or 13.9%, to $2.13 billion at June 30, 2015, compared to $2.47 billion at December 31, 2014. The decrease in total liabilities is primarily attributable to a decrease of $215.2 million in total deposits due to managed run-off  and  a decrease of $148.7 million in deposits held-for-sale. Total deposits decreased due to a managed reduction of higher-costing certificates of deposit as they became due. Deposits held-for-sale declined due to the removal of $183.4 million of deposits held-for-sale in connection with the completed sale of branches to Sturdy Savings Bank, partially offset by the $34.7 million of deposits transferred to deposits held-for-sale associated with the pending Hammonton branch sale during six months ended June 30, 2015. The Company has proactively been reducing its deposit balances, specifically public fund deposits to reduce higher yielding deposit balances in a period of excess liquidity.  Advances from the Federal Home Loan Bank of New York increased $24.9 million to $85.7 million at June 30, 2015 as the Company obtained additional funding.

Shareholders’ equity increased $7.6 million to $252.9 million at June 30, 2015, as compared to $245.3 million at December 31, 2014 primarily due to net income of $5.6 million.

Table 1 provides detail regarding the Company’s non-performing assets and TDRs at June 30, 2015 and December 31, 2014.

Table 1: Summary of Non-performing Assets and TDRs

 

 

 

June 30,

2015

 

 

December 31,

2014

 

Non-performing assets:

 

 

 

 

 

 

 

 

Non-accrual loans held-for-investment

 

$

5,156

 

 

$

10,729

 

Non-accrual loans held-for-sale

 

 

389

 

 

 

4,083

 

Troubled debt restructuring, non-accruing

 

 

702

 

 

 

318

 

Real estate owned, net

 

 

 

 

 

522

 

Total non-performing assets

 

$

6,247

 

 

$

15,652

 

 

The Company’s allowance for loan losses decreased to $20.3 million, or 1.29% of gross loans held-for-investment, at June 30, 2015 from $23.2 million, or 1.54% of gross loans held-for-investment, at December 31, 2014. The decrease in reserve balances is due to net charge-offs of $1.7 million and a reduction in the provision for loan losses of $1.2 million recorded during the six months ended June 30, 2015. The reduction in the provision for loan losses was driven by continued improvement in the Company’s credit metrics and the Company’s aggressive reduction in both existing and potential problem loans. The charge-offs were primarily driven by transfers of mostly problem loans identified to be transferred to held-for-sale, which occurred during the six months ended June 30, 2015. Across the commercial and consumer loan portfolio, the Company continues to closely monitor areas of weakness and take expedient and appropriate action as necessary to ensure adequate reserves are in place to absorb losses inherent in the loan portfolio.

Total non-performing loans held-for-investment decreased $5.2 million to $5.9 million at June 30, 2015 from $11.0 million at December 31, 2014. This decrease was due primarily to the sale of non-performing consumer loans during the three and six months ended June 30, 2015.

Real estate owned, net decreased $522 thousand to zero at June 30, 2015. During the six months ended June 30, 2015, the Company did not transfer any balances from loans into real estate owned. During the same period, one residential property with a total carrying amount of $54 thousand was donated to a charity resulting in a loss of $54 thousand. Additionally, a commercial property with a carrying value of $90 thousand was sold for a gain of $66 thousand.  Finally, a company owned branch with a carrying value of $378 thousand was sold for a loss of $29 thousand.  Net losses on real estate owned liquidations for the six months ended June 30, 2015 were $10 thousand.  At June 30, 2015, the Company did not have any properties in the real estate owned portfolio.

Investment securities available for sale decreased $57.3 million, or 14.5%, from $394.5 million at December 31, 2014 to $337.2 million at June 30, 2015 due primarily to security sales and principal paydowns. Investment securities held to maturity decreased $27 thousand, or 5.5%, from $489 thousand at December 31, 2014 to $462 thousand at June 30, 2015.

Other assets decreased $3.5 million or 16.9%, to $17.0 million at June 30, 2015 from $20.5 million at December 31, 2014. This decrease was primarily the result of paydowns on swap transactions recorded during the three and six months ended June 30, 2015.

 

46


For more information on the Company’s financial derivative instruments, see Note 8 of the notes to unaudited condensed consolidated financial statements.

Total borrowings, excluding debentures held by trusts, increased $23.6 million from $69.0 million at December 31, 2014 to $92.6 million at June 30, 2015, mainly due to $24.9 million in new advances from the Federal Home Loan Bank of New York.

The net deferred tax liability increased $761 thousand from December 31, 2014 to a net deferred tax liability of $2.3 million at June 30, 2015. This increase was due primarily to an increase in tax amortization of goodwill. The Company maintains a valuation allowance of $131.2 million against the remaining portion of the gross deferred tax asset as the Company is a three-year cumulative loss company and it is more likely than not that the full deferred tax asset will not be realized.

Comparison of Operating Results for the Three Months Ended June 30, 2015 and 2014

Overview. The Company’s net income available to shareholders for the three months ended June 30, 2015 was $2.8 million, or $0.15 per diluted share, compared to net loss of $24.2 million, or a loss of $1.39 per diluted share, for the same period in 2014. The Company’s results in the second quarter of 2015 reflect its execution on the restructuring plan announced in July 2014, including substantial improvements in asset quality, expense management and branch rationalization. During the three months ended June 30, 2015, the Company recorded a negative provision for loan losses of $1.2 million, as compared to a provision for loan losses of $14.8 million during the three months ended June 30, 2014. During the three months ended June 30, 2015 and 2014, the Company recorded mortgage banking revenue of zero and $529 thousand, respectively. This decrease was due to the Company’s strategic decision to exit the mortgage banking business in 2014.

Net Interest Income. Net interest income is the most significant component of the Company’s income from operations. Net interest income is the difference between interest earned on total interest-earning assets (primarily loans and investment securities), on a fully taxable equivalent basis, where appropriate, and interest paid on total interest-bearing liabilities (primarily deposits and borrowed funds). Fully taxable equivalent basis represents income on total interest-earning assets that is either tax-exempt or taxed at a reduced rate, adjusted to give effect to the prevailing incremental federal tax rate, and adjusted for nondeductible carrying costs and state income taxes, where applicable. Yield calculations, where appropriate, include these adjustments. Net interest income depends on the volume and interest rate earned on interest-earning assets and the volume and interest rate paid on interest-bearing liabilities.

Net interest income, on a tax-equivalent basis, decreased $5.2 million to $15.5 million for the three months ended June 30, 2015, from $20.8 million for the same period in 2014. The decrease in net interest income is primarily due to a corresponding decline in average commercial loan balances.

Tax equivalent interest income decreased $6.0 million, or 25.0%, from $23.9 million for the three months ended June 30, 2014, to $18.0 million for the three months ended June 30, 2015 primarily due to a decrease in average commercial loans. Average total loans receivable decreased $521.2 million for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014 and the yield on total loans decreased seven basis points during the same time period which resulted in a decrease in interest income on loans of $5.6 million. Interest income from investments decreased $368 thousand which was primarily due to a decrease in average balances of $81.0 million from the three months ended June 30, 2014. Significant pressures on loan yields continued through the second quarter of 2015 due to the competitive lending environment and the Bank’s strategic decision to maintain a very selective approach to new loan relationships.

Interest expense decreased $747 thousand, or 23.6%, for the three months ended June 30, 2015, as compared to the same period in 2014. The decrease was primarily due to a decline in interest-bearing liabilities, primarily reflecting declines in interest-bearing demand deposits and time deposits. The declines in interest-bearing demand deposits and time deposits reflect the branch sale completed in March 2015 as well as a managed reduction in deposit balances. The average interest-bearing deposits decreased $512 million for the three months ended June 30, 2015 to $1.44 billion, from $1.95 billion at June 30, 2014. The Company continued to lower interest rates on its deposit products during the second quarter of 2015 to remain consistent with market rates.

The interest rate spread and net interest margin for the three months ended June 30, 2015 were 2.62% and 2.79%, respectively, compared to 2.89% and 3.03%, respectively, for the same period in 2014. The decline in yield is primarily due to the decrease in the average balance of the commercial loans receivable and a decrease in the average yield earned on commercial loans receivable. The margin decrease is due primarily to the decline in the yield on interest-earning assets of 27 basis points.

Table 2 provides detail regarding the Company’s average daily balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the three months ended June 30, 2015 and 2014. Average balances are derived from daily balances.

 

47


Table 2: Average Balance Sheets

SUN BANCORP, INC. AND SUBSIDIARIES

AVERAGE BALANCE SHEETS (Unaudited)

(Dollars in thousands)

 

 

 

For the Three Months Ended June 30,

 

 

 

2015

 

 

2014

 

 

 

Average

Balance

 

 

Income/

Expense

 

 

Yield/

Cost

 

 

Average

Balance

 

 

Income/

Expense

 

 

Yield/

Cost

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable(1),(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,095,202

 

 

$

11,285

 

 

 

4.12

%

 

$

1,480,491

 

 

$

15,385

 

 

 

4.16

%

Home equity

 

 

161,698

 

 

 

1,685

 

 

 

4.17

 

 

 

185,710

 

 

 

1,777

 

 

 

3.83

 

Residential real estate

 

 

271,585

 

 

 

2,443

 

 

 

3.60

 

 

 

338,028

 

 

 

3,187

 

 

 

3.77

 

Other

 

 

2,122

 

 

 

38

 

 

 

7.35

 

 

 

47,554

 

 

 

718

 

 

 

6.03

 

Total loans receivable

 

 

1,530,607

 

 

 

15,451

 

 

 

4.04

 

 

 

2,051,783

 

 

 

21,067

 

 

 

4.11

 

Investment securities(3)

 

 

370,469

 

 

 

2,300

 

 

 

2.48

 

 

 

451,477

 

 

 

2,723

 

 

 

2.41

 

Interest-earning bank balances

 

 

329,218

 

 

 

208

 

 

 

0.25

 

 

 

243,052

 

 

 

154

 

 

 

0.25

 

Total interest-earning assets

 

 

2,230,294

 

 

 

17,959

 

 

 

3.22

 

 

 

2,746,312

 

 

 

23,944

 

 

 

3.49

 

Non-interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

34,014

 

 

 

 

 

 

 

 

 

 

 

67,196

 

 

 

 

 

 

 

 

 

Bank properties and equipment, net

 

 

36,328

 

 

 

 

 

 

 

 

 

 

 

47,586

 

 

 

 

 

 

 

 

 

Goodwill and intangible assets, net

 

 

38,188

 

 

 

 

 

 

 

 

 

 

 

38,568

 

 

 

 

 

 

 

 

 

Other assets

 

 

80,696

 

 

 

 

 

 

 

 

 

 

 

82,765

 

 

 

 

 

 

 

 

 

Total non-interest-earning assets

 

 

189,226

 

 

 

 

 

 

 

 

 

 

 

236,115

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,419,520

 

 

 

 

 

 

 

 

 

 

$

2,982,427

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposit accounts:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

$

793,954

 

 

$

345

 

 

 

0.17

%

 

$

1,099,385

 

 

 

790

 

 

 

0.29

%

Savings deposits

 

 

222,372

 

 

 

108

 

 

 

0.19

 

 

 

264,386

 

 

 

177

 

 

 

0.27

 

Time deposits

 

 

418,703

 

 

 

884

 

 

 

0.84

 

 

 

582,840

 

 

 

1,223

 

 

 

0.84

 

Total interest-bearing deposit accounts

 

 

1,435,029

 

 

 

1,337

 

 

 

0.37

 

 

 

1,946,611

 

 

 

2,190

 

 

 

0.45

 

Short-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to

   repurchase – customers

 

 

29

 

 

 

 

 

 

 

 

 

598

 

 

 

 

 

 

 

Long-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLBNY advances(4)

 

 

82,416

 

 

 

418

 

 

 

2.03

 

 

 

60,887

 

 

 

315

 

 

 

2.07

 

Obligations under capital lease

 

 

6,916

 

 

 

118

 

 

 

6.82

 

 

 

7,221

 

 

 

127

 

 

 

7.04

 

Junior subordinated debentures

 

 

92,786

 

 

 

545

 

 

 

2.35

 

 

 

92,786

 

 

 

533

 

 

 

2.30

 

Total borrowings

 

 

182,147

 

 

 

1,081

 

 

 

2.37

 

 

 

161,492

 

 

 

975

 

 

 

2.41

 

Total interest-bearing liabilities

 

 

1,617,176

 

 

 

2,418

 

 

 

0.60

 

 

 

2,108,103

 

 

 

3,165

 

 

 

0.60

 

Non-interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest-bearing demand deposits

 

 

521,563

 

 

 

 

 

 

 

 

 

 

 

573,290

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

28,392

 

 

 

 

 

 

 

 

 

 

 

46,918

 

 

 

 

 

 

 

 

 

Total non-interest bearing liabilities

 

 

549,955

 

 

 

 

 

 

 

 

 

 

 

620,208

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

2,167,131

 

 

 

 

 

 

 

 

 

 

 

2,728,311

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

252,391

 

 

 

 

 

 

 

 

 

 

 

254,116

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’

   equity

 

$

2,419,522

 

 

 

 

 

 

 

 

 

 

$

2,982,427

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

15,541

 

 

 

 

 

 

 

 

 

 

$

20,779

 

 

 

 

 

Interest rate spread(5)

 

 

 

 

 

 

 

 

 

 

2.62

%

 

 

 

 

 

 

 

 

 

 

2.89

%

Net interest margin(6)

 

 

 

 

 

 

 

 

 

 

2.79

%

 

 

 

 

 

 

 

 

 

 

3.03

%

Ratio of average interest-earning assets to average

   interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

138

%

 

 

 

 

 

 

 

 

 

 

130

%

 

(1)

Average balances include non-accrual loans, loans held-for-sale, branch assets held-for-sale and deposits held-for-sale.

 

48


(2)

Loan fees are included in interest income and the amount is not material for this analysis.

(3)

Interest earned on non-taxable investment securities is shown on a tax-equivalent basis assuming a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the three months ended June 30, 2015 and 2014 were $167 thousand and $166 thousand, respectively.

(4)

Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase – FHLBNY.

(5)

Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(6)

Net interest margin represents net interest income as a percentage of average interest-earning assets.

Table 3: Rate/Volume(1)

 

 

 

For the Three Months Ended

June 30, 2015 vs. 2014

 

 

 

Increase (Decrease) Due To

 

 

 

Volume

 

 

Rate

 

 

Net

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

(3,954

)

 

$

(146

)

 

$

(4,100

)

Home equity

 

 

(186

)

 

 

94

 

 

 

(92

)

Residential real estate

 

 

(605

)

 

 

(139

)

 

 

(744

)

Other

 

 

(750

)

 

 

70

 

 

 

(680

)

Total loans receivable

 

 

(5,495

)

 

 

(121

)

 

 

(5,616

)

Investment securities

 

 

(458

)

 

 

35

 

 

 

(423

)

Interest-earning deposits with banks

 

 

54

 

 

 

 

 

 

54

 

Total interest-earning assets

 

 

(5,899

)

 

 

(86

)

 

 

(5,985

)

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposit accounts:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

 

(179

)

 

 

(266

)

 

 

(445

)

Savings deposits

 

 

(24

)

 

 

(45

)

 

 

(69

)

Time deposits

 

 

(339

)

 

 

 

 

 

(339

)

Total interest-bearing deposit accounts

 

 

(542

)

 

 

(311

)

 

 

(853

)

Short-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to

   repurchase – customers

 

 

 

 

 

 

 

 

 

Long-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

FHLBNY advances(2)

 

 

109

 

 

 

(6

)

 

 

103

 

Obligations under capital lease

 

 

(5

)

 

 

(4

)

 

 

(9

)

Junior subordinated debentures

 

 

 

 

 

12

 

 

 

12

 

Total borrowings

 

 

104

 

 

 

2

 

 

 

106

 

Total interest-bearing liabilities

 

 

(438

)

 

 

(309

)

 

 

(747

)

Net change in net interest income

 

$

(5,461

)

 

$

223

 

 

$

(5,238

)

 

(1)

For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate) and (ii) changes in rate (changes in rate multiplied by old average volume). The combined effect of changes in both volume and rate has been allocated to volume or rate changes in proportion to the absolute dollar amounts of the change in each.

(2)

Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase – FHLBNY.

Provision for Loan Losses. The Company recorded a negative provision for loan losses of $1.2 million during the three months ended June 30, 2015, as compared to a provision for loan losses of $14.8 million for the three months ended June 30, 2014. The provision reduction was driven by continued improvement in the Company’s credit metrics and the Company’s aggressive reduction in both existing and potential problem loans. Total non-performing loans held-for-investment decreased $8.2 million from $14.1 million at June 30, 2014 to $5.9 million at June 30, 2015. The ratio of allowance for loan losses to gross loans held-for-investment was 1.29% at June 30, 2015, as compared to 1.53% at June 30, 2014.  Net recoveries for the three months ended June 30, 2015 were $633 thousand as compared to net charge offs of $20.2 million during the same period in 2014. See “Financial Condition” above.

The provision recorded is the amount deemed appropriate by management based on the current risk profile of the portfolio to absorb losses existing at the balance sheet date. At least monthly, management performs an analysis to identify the inherent risk of

 

49


loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of concentrations of credit, past loss experience, current economic conditions, amount and composition of the loan portfolio (including loans being specifically monitored by management), estimated fair value of underlying collateral, delinquencies, and other factors. Additionally, management updates the migration analysis and historic loss and recovery experience on a quarterly basis.

Non-Interest Income. Non-interest income increased $902 thousand to $4.9 million for the three months ended June 30, 2015, as compared to $4.0 million for the same period in 2014. This increase was primarily attributable to the $1.2 million gain recognized on the sale of loans during the quarter ending June 30, 2015.  In addition, other income increased by $1.1 million due to negative derivative credit valuation adjustments of $1.2 million recorded in the three months ended June 30, 2014. These increases were partially offset by a decrease in deposits service charges and fees of $614 thousand due to a reduction in branches and a decrease in mortgage banking revenues, net of $529 thousand due to the Bank’s exit from its residential mortgage banking operations.

Non-Interest Expense. Non-interest expense decreased $15.3 million to $18.4 million for the three months ended June 30, 2015 as compared to $33.7 million for the same period in 2014. This decrease was primarily due to decreases in salaries and employee benefits expense of $7.7 million, other expense of $3.3 million, professional fees of $1.6 million, and equipment expense of $1.1 million. The decreases in salaries and employee benefits expense were due to reduced head count as a result of the comprehensive restructuring plan initiated in the quarter ending June 30, 2014.   The decline in other expense was primarily attributed to reduced loan sale related expenses of $1.8 million and lower charges on real estate owned of $737 thousand.  Professional fees declined due to a significant reduction in the Company’s reliance on third-party consultants. The decrease in equipment expense was due to the reduction in branches over the past year.

Income Tax Expense. Income tax expense decreased $73 thousand for the three months ended June 30, 2015 from $357 thousand for the three months ended June 30, 2014. The tax expense in the second quarter of 2015 relates to the tax amortization of the Company’s indefinite-lived intangible assets that is not available to offset existing deferred tax assets which was first recorded in the first quarter of 2013. The income tax expense will decline as individual intangible assets are fully amortized for tax purposes. As the Company remained in a cumulative loss position at June 30, 2015, a full deferred tax valuation allowance is still considered appropriate. The deferred tax asset balance and the related valuation allowance will decrease as the Company generates net income.

 

Comparison of Operating Results for the Six Months Ended June 30, 2015 and 2014

Overview. The Company recognized net income available to shareholders for the six months ended June 30, 2015 of $5.6 million, or $0.30 per common share, compared to a net loss of $26.2 million, or $1.50 per common share, for the same period in 2014.  During the six months ended June 30, 2015 and 2014, the Company recorded a negative loan loss provision of $1.2 million and $14.8 million provision expense, respectively.

Net Interest Income. Net interest income, on a tax-equivalent basis, decreased $11.4 million to $30.9 million for the six months ended June 30, 2015, from $42.3 million for the same period in 2014.

Tax equivalent interest income decreased $13.0 million, or 26.6%, from $48.7 million for the six months ended June 30, 2014, to $35.8 million for the six months ended June 30, 2015. Average total loans receivable decreased $563.4 million for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014 and the yield on total loans decreased 11 basis points during the same time period which resulted in a decrease in interest income on loans of $12.4 million. Interest income from investments decreased $598 thousand which was primarily due to a decrease in average balances of $73.1 million from the six months ended June 30, 2014.

Interest expense decreased $1.5 million, or 23.8%, for the six months ended June 30, 2015, as compared to the same period in 2014. The decrease was primarily due to a decline in interest-bearing liabilities, primarily reflecting declines in interest-bearing demand deposits and time deposits. The declines in interest-bearing demand deposit and time deposits reflect the branch sale completed in March 2015 as well as a managed reduction in deposit balances.

The interest rate spread and net interest margin for the six months ended June 30, 2015 were 2.52% and 2.68%, respectively, compared to 2.90% and 3.04%, respectively, for the same period in 2014.

Table 4 provides detail regarding the Company’s average daily balances with corresponding interest income (on a tax-equivalent basis) and interest expense as well as yield and cost information for the six months ended June 30, 2015 and 2014. Average balances are derived from daily balances.

 

50


Table 4: Average Balance Sheets

SUN BANCORP, INC. AND SUBSIDIARIES

AVERAGE BALANCE SHEETS (Unaudited)

(Dollars in thousands)

 

 

 

For the Six Months Ended June 30,

 

 

 

2015

 

 

2014

 

 

 

Average

Balance

 

 

Income/

Expense

 

 

Yield/

Cost

 

 

Average

Balance

 

 

Income/

Expense

 

 

Yield/

Cost

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable(1),(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,073,526

 

 

$

22,089

 

 

 

4.12

%

 

$

1,520,246

 

 

$

31,735

 

 

 

4.17

%

Home equity

 

 

172,664

 

 

 

3,533

 

 

 

4.09

 

 

 

210,986

 

 

 

4,222

 

 

 

4.00

 

Residential real estate

 

 

277,856

 

 

 

4,842

 

 

 

3.49

 

 

 

334,749

 

 

 

6,145

 

 

 

3.67

 

Other

 

 

2,675

 

 

 

84

 

 

 

6.28

 

 

 

24,100

 

 

 

815

 

 

 

6.76

 

Total loans receivable

 

 

1,526,721

 

 

 

30,548

 

 

 

4.00

 

 

 

2,090,081

 

 

 

42,917

 

 

 

4.11

 

Investment securities(3)

 

 

381,494

 

 

 

4,729

 

 

 

2.48

 

 

 

454,590

 

 

 

5,421

 

 

 

2.39

 

Interest-earning bank balances

 

 

401,702

 

 

 

505

 

 

 

0.25

 

 

 

231,645

 

 

 

292

 

 

 

0.25

 

Total interest-earning assets

 

 

2,309,917

 

 

 

35,782

 

 

 

3.10

 

 

 

2,776,316

 

 

 

48,630

 

 

 

3.50

 

Non-interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

40,331

 

 

 

 

 

 

 

 

 

 

 

67,269

 

 

 

 

 

 

 

 

 

Bank properties and equipment, net

 

 

39,465

 

 

 

 

 

 

 

 

 

 

 

48,093

 

 

 

 

 

 

 

 

 

Goodwill and intangible assets, net

 

 

38,188

 

 

 

 

 

 

 

 

 

 

 

38,709

 

 

 

 

 

 

 

 

 

Other assets

 

 

81,475

 

 

 

 

 

 

 

 

 

 

 

85,302

 

 

 

 

 

 

 

 

 

Total non-interest-earning assets

 

 

199,459

 

 

 

 

 

 

 

 

 

 

 

239,373

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,509,376

 

 

 

 

 

 

 

 

 

 

$

3,015,689

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposit accounts:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

$

844,124

 

 

$

751

 

 

 

0.18

%

 

$

1,124,284

 

 

 

1,597

 

 

 

0.28

%

Savings deposits

 

 

230,865

 

 

 

235

 

 

 

0.20

 

 

 

265,837

 

 

 

357

 

 

 

0.27

 

Time deposits

 

 

443,238

 

 

 

1,857

 

 

 

0.84

 

 

 

595,459

 

 

 

2,515

 

 

 

0.84

 

Total interest-bearing deposit accounts

 

 

1,518,227

 

 

 

2,843

 

 

 

0.37

 

 

 

1,985,580

 

 

 

4,469

 

 

 

0.45

 

Short-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to

   repurchase – customers

 

 

101

 

 

 

 

 

 

 

 

 

502

 

 

 

 

 

 

 

Long-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLBNY advances(4)

 

 

71,647

 

 

 

728

 

 

 

2.03

 

 

 

60,908

 

 

 

628

 

 

 

2.06

 

Obligations under capital lease

 

 

6,955

 

 

 

238

 

 

 

6.84

 

 

 

7,257

 

 

 

250

 

 

 

6.89

 

Junior subordinated debentures

 

 

92,786

 

 

 

1,077

 

 

 

2.32

 

 

 

92,786

 

 

 

1,065

 

 

 

2.30

 

Total borrowings

 

 

171,489

 

 

 

2,043

 

 

 

2.38

 

 

 

161,453

 

 

 

1,943

 

 

 

2.41

 

Total interest-bearing liabilities

 

 

1,689,716

 

 

 

4,886

 

 

 

0.58

 

 

 

2,147,033

 

 

 

6,412

 

 

 

0.60

 

Non-interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest-bearing demand deposits

 

 

540,572

 

 

 

 

 

 

 

 

 

 

 

566,486

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

27,902

 

 

 

 

 

 

 

 

 

 

 

49,631

 

 

 

 

 

 

 

 

 

Total non-interest bearing liabilities

 

 

568,474

 

 

 

 

 

 

 

 

 

 

 

616,117

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

2,258,190

 

 

 

 

 

 

 

 

 

 

 

2,763,150

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

251,187

 

 

 

 

 

 

 

 

 

 

 

252,540

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’

   equity

 

$

2,509,377

 

 

 

 

 

 

 

 

 

 

$

3,015,690

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

30,896

 

 

 

 

 

 

 

 

 

 

$

42,218

 

 

 

 

 

Interest rate spread(5)

 

 

 

 

 

 

 

 

 

 

2.52

%

 

 

 

 

 

 

 

 

 

 

2.90

%

Net interest margin(6)

 

 

 

 

 

 

 

 

 

 

2.68

%

 

 

 

 

 

 

 

 

 

 

3.04

%

Ratio of average interest-earning assets to average

   interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

137

%

 

 

 

 

 

 

 

 

 

 

129

%

 

(1)

Average balances include non-accrual loans, loans held-for-sale, branch assets held-for-sale and deposits held-for-sale.

 

51


(2)

Loan fees are included in interest income and the amount is not material for this analysis.

(3)

Interest earned on non-taxable investment securities is shown on a tax-equivalent basis assuming a 35% marginal federal tax rate for all periods. The fully taxable equivalent adjustments for the six months ended June 30, 2015 and 2014 were $331 thousand and $333 thousand, respectively.

(4)

Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase – FHLBNY.

(5)

Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(6)

Net interest margin represents net interest income as a percentage of average interest-earning assets

 

 

Table 5: Rate/Volume(1)

 

 

 

For the Six Months Ended

June 30, 2015 vs. 2014

 

 

 

Increase (Decrease) Due To

 

 

 

Volume

 

 

Rate

 

 

Net

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

(9,268

)

 

$

(378

)

 

$

(9,646

)

Home equity

 

 

(696

)

 

 

7

 

 

 

(689

)

Residential real estate

 

 

(1,011

)

 

 

(292

)

 

 

(1,303

)

Other

 

 

(677

)

 

 

(54

)

 

 

(731

)

Total loans receivable

 

 

(11,652

)

 

 

(717

)

 

 

(12,369

)

Investment securities

 

 

(724

)

 

 

32

 

 

 

(692

)

Interest-earning deposits with banks

 

 

213

 

 

 

 

 

 

213

 

Total interest-earning assets

 

 

(12,163

)

 

 

(685

)

 

 

(12,848

)

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposit accounts:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

 

(348

)

 

 

(498

)

 

 

(846

)

Savings deposits

 

 

(41

)

 

 

(81

)

 

 

(122

)

Time deposits

 

 

(658

)

 

 

 

 

 

(658

)

Total interest-bearing deposit accounts

 

 

(1,047

)

 

 

(579

)

 

 

(1,626

)

Short-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to

   repurchase – customers

 

 

 

 

 

 

 

 

 

Long-term borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

FHLBNY advances(2)

 

 

101

 

 

 

(1

)

 

 

100

 

Obligations under capital lease

 

 

(10

)

 

 

(2

)

 

 

(12

)

Junior subordinated debentures

 

 

 

 

 

12

 

 

 

12

 

Total borrowings

 

 

91

 

 

 

9

 

 

 

100

 

Total interest-bearing liabilities

 

 

(956

)

 

 

(570

)

 

 

(1,526

)

Net change in net interest income

 

$

(11,207

)

 

$

(115

)

 

$

(11,322

)

 

(1)

For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate) and (ii) changes in rate (changes in rate multiplied by old average volume). The combined effect of changes in both volume and rate has been allocated to volume or rate changes in proportion to the absolute dollar amounts of the change in each.

(2)

Amounts include Advances from FHLBNY and Securities sold under agreements to repurchase – FHLBNY.

Provision for Loan Losses. The Company recorded a negative provision for loan losses of $1.2 million during the six months ended June 30, 2015, as compared to a provision for loan losses of $14.8 million for the same period in 2014. The provision reduction was driven by continued improvement in the Company’s credit metrics and the Company’s aggressive reduction in both existing and potential problem loans. Total non-performing loans held-for-investment decreased $8.2 million from $14.1 million at June 30, 2014 to $5.9 million at June 30, 2015. The ratio of allowance for loan losses to gross loans held-for-investment was 1.29% at June 30, 2015, as compared to 1.53% at June 30, 2014.  Net charge offs for the six months ended June 30, 2015 were $1.7 million as compared to net charge offs of $21.9 million during the same period in 2014. See “Financial Condition” above.

 

52


Non-Interest Income. Non-interest income increased $9.0 million to $18.0 million for the six months ended June 30, 2015, as compared to $9.0 million for the same period in 2014. This increase was primarily attributable to the gain recognized on the sale of certain branches to Sturdy Savings Bank.

Non-Interest Expense. Non-interest expense decreased $18.0 million to $43.6 million for the six months ended June 30, 2015 as compared to $61.6 million for the same period in 2014. This decrease was primarily due to decreases in salaries and employee benefits expense of $10.9 million, other expense of $4.5 million, and professional fees of $2.3 million. The decreases in salaries and employee benefits expense were due to reduced head count as a result of the comprehensive restructuring plan initiated in the quarter ending June 30, 2014.   The decline in other expense was primarily attributed to reduced loan sale related expenses of $2.2 million, lower charges on real estate owned of $811 thousand, lower mortgage recourse provision of $460 thousand, and reduced problem loan costs of $413 thousand.  Professional fees decreased mainly due to reductions in consulting fees of $1.2 million and legal fees of $714 thousand.

Income Tax Expense. Income tax expense decreased $148 thousand for the six months ended June 30, 2015 from $716 thousand for the six months ended June 30, 2014. The tax expense recorded in 2015 relates to the tax amortization of the Company’s indefinite-lived intangible assets that is not available to offset existing deferred tax assets which was first recorded in the first quarter of 2013. The income tax expense will decline as individual intangible assets are fully amortized for tax purposes. As the Company remained in a cumulative loss position at June 30, 2015, a full deferred tax valuation allowance is still considered appropriate. The deferred tax asset balance and the related valuation allowance will decrease as the Company generates net income.

Liquidity and Capital Resources

The liquidity of the Company is the ability to maintain cash flows that are adequate to fund operations and meet its other obligations on a timely and cost-effective basis in various market conditions. The ability of the Company to meet its current financial obligations is a function of balance sheet structure, the ability to liquidate assets and the availability of alternative sources of funds. To meet the needs of the clients and manage the risk of the Company, the Company engages in liquidity planning and management.

The major source of the Company’s funding on a consolidated basis is deposits, which management believes will be sufficient to meet the Company’s daily and long-term operating liquidity needs. The ability of the Company to retain and attract new deposits is dependent upon the variety and effectiveness of its customer account products, customer service and convenience, and rates paid to customers. The Company also obtains funds from the repayment and maturities of loans, loan sales or participations and maturities or calls of investment securities. Additional liquidity can be obtained in a variety of wholesale funding sources as well, including, but not limited to, federal funds purchased, FHLBNY advances, securities sold under agreements to repurchase, and other securities and unsecured borrowings. Through the Bank, the Company also purchases brokered deposits for funding purposes. In a continued effort to balance deposit growth and net interest margin, especially in the current interest rate environment and with competitive local deposit pricing, the Company continually evaluates these other funding sources for funding cost efficiencies. During the second quarter of 2015, the Company continued to lower deposit rates to align itself with the market and continued to manage its excess cash position while undergoing the restructuring.

Core deposits, which exclude all certificates of deposit, decreased by $152.1 million to $1.48 billion, or 79.0% of total deposits, at June 30, 2015, as compared to $1.63 billion, or 78.1% of total deposits, at December 31, 2014. This decrease occurred due to managed deposit reductions. The Company has additional secured borrowing capacity with the Federal Reserve Bank of approximately $116.7 million, of which none was utilized as of June 30, 2015, and the FHLBNY of approximately $172.6 million, of which $85.7 million was utilized as of June 30, 2015. In addition to secured borrowings, the Company also has unsecured borrowing capacity through lines of credit with other financial institutions of $35 million, of which none were utilized as of June 30, 2015. Management continues to monitor the Company’s liquidity and has taken measures to increase its borrowing capacity by providing additional collateral through the pledging of loans. As of June 30, 2015, the Company had a par value of $238.1 million and $160.4 million in loans and securities, respectively, pledged as collateral on secured borrowings.

The Company’s primary uses of funds are loan originations, the funding of the Company’s maturing certificates of deposit, deposit withdrawals, the repayment of borrowings and general operating expenses. Certificates of deposit scheduled to mature during the 12 months ending June 30, 2015 totaled $273.5 million, or approximately 69.3% of total certificates of deposit. The Company continues to operate with a core deposit relationship strategy that values a long-term stable customer relationship. This strategy employs a pricing strategy that rewards customers that establish core accounts and maintain a certain minimum threshold account balance. Based on market conditions and other liquidity considerations, the Company may also avail itself to the secondary borrowings discussed above.

The Company anticipates that deposits, cash and cash equivalents on hand, the cash flow from assets, as well as other sources of funds will provide adequate liquidity for the Company’s future operating, investing and financing needs. At June 30, 2015, the Company had $250.3 million of cash held at the FRB. It is anticipated that these excess funds will be strategically deployed in 2015.

 

53


On April 15, 2010, the Bank entered into the OCC Agreement which required the Bank to develop and implement a profitability and capital plan which provides for the maintenance of adequate capital to support the Bank’s risk profile. The principal components of the capital plan are to generate additional capital through retained earnings from internal growth, access the capital markets for external sources of capital, such as common equity, when necessary or appropriate, redeem existing capital instruments and refinance such instruments at lower rates when conditions permit, and maintain sufficient capital for safe and sound operations. The Company continues to assess its plan for contingency capital needs, and when appropriate, the Company’s Board of Directors may consider various capital raising alternatives. As part of its assessment, the Company performs stress tests on select balance sheet components, deemed to have inherent risk given relevant economic and regulatory conditions, in an effort to gauge potential exposure on its capital position. The capital plan also contains a dividend policy allowing dividends only if the Bank is in compliance with the capital plan, and obtains prior approval from the OCC. In addition, the Company is required to seek the prior approval of the Federal Reserve Bank before paying interest, principal or other sums on trust preferred securities or any related subordinated debentures, declaring or paying cash dividends or taking dividends from the Bank, repurchasing outstanding stock or incurring indebtedness.

The Bank also agreed to: (a) implement a program to protect the Bank’s interest in criticized or classified assets, (b) review and revise the Bank’s loan review program; (c) implement a program for the maintenance of an adequate allowance for loan losses; and (d) revise the Bank’s credit administration policies. The Bank also agreed that its brokered deposits would not exceed 6.0% of its total liabilities unless approved by the OCC. Management does not expect this restriction will limit its access to liquidity as the Bank does not rely on brokered deposits as a major source of funding. At June 30, 2015, the Bank’s brokered deposits represented 3.2% of its total liabilities.

Management is working towards taking all of the necessary actions for the Bank to become fully compliant with all requirements of the OCC Agreement.

The OCC also imposed an individual minimum capital requirement on the Bank. An individual minimum capital requirement requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be “well capitalized.” In accordance with the individual minimum capital requirement, the Bank is required to maintain a Leverage Capital ratio at least equal to 8.50% of adjusted total assets, a Tier 1 Capital ratio at least equal to 9.50% of risk-weighted assets and a Total Capital ratio at least equal to 11.50% of risk-weighted assets. At June 30, 2015, the Bank exceeded all of the three capital ratio requirements established by the OCC as its Leverage Capital ratio was 11.46%, its Tier 1 Capital ratio was 17.54%, and its Total Capital ratio was 18.79%.

Final Capital Rules

Pursuant to the Dodd-Frank Act, the federal bank regulatory agencies issued the Final Capital Rules that subject many national banks and their holding companies, including the Bank and the Company, to consolidated capital requirements. The Final Capital Rules also revised the quantity and quality of required minimum risk-based and leverage capital requirements applicable to the Bank, consistent with the Dodd-Frank Act and the Basel III capital standards. The Final Capital Rules revised the quantity and quality of capital required by (1) establishing a new minimum common equity Tier 1 ratio of 4.5% of risk-weighted assets; (2) raising the minimum capital ratio from 4.0% to 6.0% of risk-weighted assets; (3) maintaining the minimum total capital ratio of 8.0% of risk-weighted assets; and (4) maintaining a minimum Tier 1 leverage capital ratio of 4.0%.

Furthermore, the Final Capital Rules added a requirement for a minimum common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, or the Conservation Buffer, to be phased in incrementally between 2016 and 2019, to be applied to the common equity Tier 1 capital ratio, the Tier 1 capital ratio and the total capital ratio. The rules impose restrictions on capital distributions and certain discretionary cash bonus payments if the minimum Conservation Buffer is not met. The rules also revise the calculation of risk-weighted assets to enhance their risk sensitivity and phase out trust preferred securities and cumulative perpetual preferred stock as Tier 1 capital. The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets became effective for the Company and the Bank on January 1, 2015.

The chart below sets forth the new regulatory capital levels including the Conservation Buffer, during the applicable transition period:

 

 

 

Regulatory Capital Levels

 

 

 

January 1,

2015

 

 

January 1,

2016

 

 

January 1,

2017

 

 

January 1,

2018

 

 

January 1,

2019

 

Tier 1 common equity risk-based capital ratio

 

 

4.5

%

 

 

5.125

%

 

 

5.75

%

 

 

6.375

%

 

 

7.0

%

Tier 1 risk-based capital ratio

 

 

6.0

%

 

 

6.625

%

 

 

7.25

%

 

 

7.875

%

 

 

8.5

%

Total risk-based capital ratio

 

 

8.0

%

 

 

8.625

%

 

 

9.25

%

 

 

9.875

%

 

 

10.5

%

 

At June 30, 2015, the Bank exceeded all regulatory capital requirements and is in compliance with our capital plan. The Bank’s Tier 1 risk-based capital ratio, Tier 1 common equity capital risk-based capital ratio, Tier 1 risk-based capital ratio and leverage capital

 

54


ratio were 18.79%, 17.54%, 17.54% and 11.46%, respectively. The Company’s Tier 1 risk-based capital ratio, Tier 1 common equity capital risk-based capital ratio, Tier 1 risk-based capital ratio and leverage capital ratio were 20.81%, 13.78%, 17.72% and 11.26%, respectively.

The Final Capital Rules also revised the “Prompt Corrective Action” regulations of FDICIA. Prior to January 1, 2015, a bank was considered “well capitalized” if its ratio of total capital to risk-weighted assets was at least 10%, its ratio of Tier 1 (core) capital to risk-weighted assets was at least 6%, its ratio of core capital to total assets was at least 5%, and it was not subject to any order or directive by the OCC to meet a specific capital level. As of June 30, 2015, the Bank was within the required ratios for classification as “well capitalized,” although due to the fact that it was subject to the OCC Agreement, it cannot be deemed “well capitalized.” Under the Final Capital Rules, effective January 1, 2015, to be well capitalized, a national bank must maintain a Total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 risk-based capital ratio of 6.5% or greater and a Tier 1 leverage capital ratio of 5.0% or greater and not be subject to any order or directive by the OCC to meet a specific capital level.

The following table provides both the Company’s and the Bank’s regulatory capital ratios as of June 30, 2015:

Regulatory Capital Levels

 

 

 

Actual

 

 

For Capital

Adequacy

Purposes

 

 

To Be Well

Capitalized Under

Prompt Corrective

Action Provision(1)

 

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

June 30, 2015(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

$

324,062

 

 

 

20.81

%

 

$

124,603

 

 

 

8.00

%

 

N/A

 

 

 

 

 

Sun National Bank

 

 

291,925

 

 

 

18.79

 

 

 

124,262

 

 

 

8.00

 

 

$

155,328

 

 

 

10.00

%

Tier 1 common equity capital ratio (to risk-

   weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

214,574

 

 

 

13.78

 

 

 

70,089

 

 

 

4.50

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

17.54

 

 

 

69,897

 

 

 

4.50

 

 

 

100,963

 

 

 

6.50

 

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

268,222

 

 

 

17.22

 

 

 

93,452

 

 

 

6.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

17.54

 

 

 

93,197

 

 

 

6.00

 

 

 

124,262

 

 

 

8.00

 

Leverage capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sun Bancorp, Inc.

 

 

268,222

 

 

 

11.26

 

 

 

95,254

 

 

 

4.00

 

 

N/A

 

 

 

 

 

Sun National Bank

 

 

272,489

 

 

 

11.46

 

 

 

95,119

 

 

 

4.00

 

 

 

118,899

 

 

 

5.00

 

 

(1)

Not applicable for bank holding companies.

(2)

The Basel III guidelines and the Dodd-Frank Act established a new minimum Tier 1 common equity risk-based capital ratio and revised the “Prompt Corrective Action” regulations, effective January 1, 2015.

The Company’s capital securities qualify as Tier 1 capital under federal regulatory guidelines. These instruments are subject to a 25% capital limitation under risk-based capital guidelines developed by the FRB. Under FRB rules, restricted core capital elements, which are qualifying trust preferred securities, qualifying cumulative perpetual preferred stock (and related surplus) and certain minority interests in consolidated subsidiaries, are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability. However, under the Dodd-Frank Act, bank holding companies are prohibited from including in their Tier 1 capital hybrid debt and equity securities, including trust preferred securities, issued on or after May 19, 2010. Any such instruments issued before May 19, 2010 by a bank holding company, such as the Company, with total consolidated assets of less than $15 billion as of December 31, 2009, may continue to be included as Tier 1 capital (subject to the 25% limitation). The portion that exceeds the 25 percent capital limitation qualifies as Tier 2, or supplementary capital of the Company. At June 30, 2015, $52.6 million of a total of $90.0 million in capital securities qualified as Tier 1 with $37.4 million qualifying as Tier 2.

Dividend Restrictions

The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. All national banks are limited in the payment of dividends without the approval of the OCC of a total amount not to exceed the net income for that year to date plus the retained net income for the preceding two years. Federal law also prohibits national banks from paying dividends

 

55


that would be greater than the bank’s undivided profits after deducting statutory bad debt in excess of the bank’s allowance for loan losses. Due to our net loss position over the last two years, any proposed dividends from the Bank to the Company will be subject to regulatory approval until such time as net income for the current year combined with the prior two years is sufficient. Under FDICIA, an insured depository institution such as the Bank is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the FDICIA). Payment of dividends by the Bank also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe and unsound banking practice. Further, pursuant to the terms of the OCC Agreement, the Bank may not pay dividends if it is not in compliance with its approved capital plan or if the effect of the dividend would be to cause the Bank to not be in compliance and, in either event, not without prior OCC approval. The Bank did not seek OCC approval to pay a dividend in 2014 or the first six months of 2015.

Volcker Rule

On December 10, 2013, the FRB, the OCC, the FDIC, the CFTC and the SEC issued final rules to implement the Volcker Rule contained in Section 619 of the Dodd-Frank Act. While the Dodd-Frank Act provided that banks and bank holding companies were required to conform their activities and investments by July 21, 2014, in connection with issuing the final Volcker Rule, the FRB extended the conformance period until July 21, 2015. The FRB is permitted, by rule or order, to extend the conformance period for one year at a time, for a total of not more than 3 years. On December 18, 2014, the FRB issued an order that further extends until July 21, 2016 the conformance period under the Volcker Rule. The FRB stated in the order that it intends to exercise its authority again next year and grant the final one-year extension in order to permit banks and bank holding companies until July 21, 2017 to conform to the requirements of the Volcker Rule.

On January 14, 2014, the five federal agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities from the investment prohibitions of the Volcker Rule. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if certain qualifications are met. In addition, the agencies released a non-exclusive list of issuers that meet the requirements of the interim final rule. At June 30, 2015, the Company had an investment in one pool of trust preferred securities with an amortized cost of $8.8 million and estimated fair value of $6.8 million. This pool was included in the list of non-exclusive issuers that meet the requirements of the interim final rule released by the agencies and therefore was not required to be sold by the Company.

At June 30, 2015, the Bank had 11 collateralized loan obligation securities with an amortized cost of $59.9 million and an estimated fair value of $59.7 million. These securities are subject to the provisions of the Volcker Rule. As a result, the Company will likely be required to divest these investments unless their terms can be modified such that the investments are no longer covered by the Volcker Rule. While there is proposed legislation in Congress regarding the delay to the divestiture requirement for collateralized loan obligations, the outcome of the legislation is unclear at this time. The Company cannot give assurances that the legislation will or will not be enacted. However, based on the Company’s communications with its investment advisors, in the event that the proposed legislation is not enacted, the Company believes these investments can be modified to avoid a required divestiture under the Volcker Rule.

At June 30, 2015, the Bank had one non-rated single issuer security with an amortized cost of $3.2 million and an estimated fair value of $3.4 million. This security is not subject to the provisions of the Volcker Rule.

See Note 13 of the notes to unaudited condensed consolidated financial statements for additional information regarding regulatory matters.

Disclosures about Commitments

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, the Company would be required to honor the commitment. The Company takes various forms of collateral, such as real estate assets and customer business assets, to secure the commitment. Additionally, all letters of credit are supported by indemnification agreements executed by the customer. The maximum undiscounted exposure related to these commitments at June 30, 2015 was $15.2 million and the portion of the exposure not covered by collateral was approximately $176 thousand. The Company believes that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

The Company maintains a reserve for unfunded loan commitments and letters of credit, which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition, consistent with FASB ASC 825. As of the balance sheet date, the Company records estimated losses inherent with unfunded loan commitments in accordance with FASB ASC 450, Contingencies,

 

56


and estimated future obligations under letters of credit in accordance with FASB ASC 460, Guarantees. The methodology used to determine the adequacy of this reserve is integrated in the Company’s process for establishing the allowance for loan losses and considers the probability of future losses and obligations that may be incurred under these off-balance sheet agreements. The reserve for unfunded loan commitments and letters of credit at June 30, 2015 and December 31, 2014 was $637 thousand and $603 thousand, respectively. Management believes this reserve level is sufficient to absorb estimated probable losses related to these commitments.

The Company maintains a reserve for residential mortgage loans sold with recourse to third-party purchasers which is reported in other liabilities in the unaudited condensed consolidated statements of financial condition. As of June 30, 2015, the Company records estimated losses inherent with residential mortgage loans sold with recourse in accordance with FASB ASC 460, Guarantees. This reserve is determined based upon the probability of future losses which is calculated using historical Company and industry loss data. The reserve for residential mortgage loan recourse as of June 30, 2015 and December 31, 2014 was $731 thousand and $758 thousand, respectively. Management believes this reserve level is sufficient to address potential recourse exposure.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Asset and Liability Management

Interest rate, credit and operational risks are among the most significant market risks impacting the performance of the Company. The Company and the Bank have an Asset Liability Committee (“ALCO”), composed of senior management representatives from a variety of areas within the Company. The Company and the Bank also have an ALCO composed of members of the Company’s Board of Directors. ALCO devises strategies and tactics to maintain the net interest income of the Company within acceptable ranges over a variety of interest rate scenarios. Should the Company’s risk modeling indicate an undesired exposure to changes in interest rates, there are a number of remedial options available including changing the investment portfolio characteristics, and changing loan and deposit pricing strategies. Two of the tools used in monitoring the Company’s sensitivity to interest rate changes are gap analysis and net interest income simulation.

Gap Analysis. Banks are concerned with the extent to which they are able to match maturities or re-pricing characteristics of interest-earning assets and interest-bearing liabilities. Such matching is facilitated by examining the extent to which such assets and liabilities are interest-rate sensitive and by monitoring the bank’s interest rate sensitivity gap. Gap analysis measures the volume of interest-earning assets that will mature or re-price within a specific time period, compared to the interest-bearing liabilities maturing or re-pricing within that same time period. On a monthly basis the Company and the Bank monitor their gap, primarily cumulative through both nine months and one year maturities.

At June 30, 2015, the Company’s gap analysis showed an asset sensitive position with total interest-earning assets maturing or re-pricing within one year exceeding interest-bearing liabilities maturing or re-pricing during the same time period by $316.4 million representing a positive one-year gap ratio of 13.3%. All amounts are categorized by their actual maturity or anticipated call or re-pricing date with the exception of interest-bearing demand deposits and savings deposits. Though the rates on interest-bearing demand and savings deposits generally trend with open market rates, they often do not fully adjust to open market rates and frequently adjust with a time lag. As a result of prior experience during periods of rate volatility and management’s estimate of future rate sensitivities, the Company allocates the interest-bearing demand deposits and savings deposits based on an estimated decay rate for those deposits.

Net Interest Income Simulation. Due to the inherent limitations of gap analysis, the Company also uses simulation models to measure the impact of changing interest rates on its operations. The simulation model attempts to capture the cash flow and re-pricing characteristics of the current assets and liabilities on the Company’s balance sheet. Assumptions regarding such things as prepayments and rate change behaviors are incorporated into the simulation model. Net interest income is simulated over a twelve month horizon under a variety of linear yield curve shifts, subject to certain limits agreed to by ALCO.

Net interest income simulation analysis at June 30, 2015 shows a position that is asset sensitive and will benefit from a rise in interest rates. A large factor causing this asset sensitive position is the high levels of cash on the Company’s balance sheet, which the Company intends to strategically deploy in 2015. After this excess liquidity is deployed, the Company expects that its interest rate risk profile will be more neutral. The net income simulation results are impacted by high cash levels, an expected continuation of deposit pricing competition which may limit deposit pricing flexibility in both increasing and decreasing rate environments, floating-rate loan floors initially limiting loan rate increases and a relatively short liability maturity structure including retail certificates of deposit.

Actual results may differ from the simulated results due to such factors as the timing, magnitude and frequency of interest rate changes, changes in market conditions, management strategies and differences in actual versus forecasted balance sheet composition and activity. Table 7 provides the Company’s estimated earnings sensitivity profile as of June 30, 2015. The Company anticipates that strong deposit pricing competition will continue to limit deposit pricing flexibility in an increasing and a decreasing rate environment.

 

57


Table 7: Sensitivity Profile

 

Instantaneous Change in Interest Rates

(Basis Points)

 

Percentage

Change in

Net

Interest

Income

Year 1

 

+300

 

 

15.1

%

+200

 

 

10.1

%

+100

 

 

5.1

%

-100

 

 

1.1

%

 

Derivative Financial Instruments. The Company utilizes certain derivative financial instruments to enhance its ability to manage interest rate risk that exists as part of its ongoing business operations. In general, the derivative transactions entered into by the Company fall into one of two types: a fair value hedge of a specific fixed-rate loan agreement and an economic hedge of a derivative offering to a Bank customer. Derivative financial instruments involve, to varying degrees, interest rate, market and credit risk. The Company manages these risks as part of its asset and liability management process and through credit policies and procedures. The Company seeks to minimize counterparty credit risk by establishing credit limits and collateral agreements. The Company does not use derivative financial instruments for trading purposes. For more information on the Company’s financial derivative instruments, please see Note 8 of the notes to unaudited condensed consolidated financial statements.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), the Company’s principal executive officer and principal financial officer have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, such disclosure controls and procedures were designed and functioning effectively to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

(b) Changes in internal control over financial reporting. During the quarter under report, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

 

58


PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company and the Bank are periodically involved in various claims and lawsuits, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, and claims involving the making and servicing of real property loans. While the ultimate outcome of these proceedings cannot be predicted with certainty, management, after consultation with counsel representing the Company in these proceedings, does not expect that the resolution of these proceedings will have a material effect on the Company’s financial condition, results of operations or cash flows.

Item 1A. Risk Factors

Management of the Company does not believe there have been any material changes to the Risk Factors previously disclosed under Item 1A of the Company’s Form 10-K for the year ended December 31, 2014 previously filed with the Securities and Exchange Commission.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures.

Not applicable

Item 5. Other Information

Not Applicable

Item 6. Exhibits

 

Exhibit 3.1

Amended and Restated Certificate of Incorporation of Sun Bancorp, Inc. (1)

 

 

Exhibit 3.2

Amended and Restated Bylaws of Sun Bancorp, Inc. (2)

 

 

Exhibit 4.1

Common Security Specimen (3)

 

 

Exhibit 31(a)

Certification of Principal Executive Officer Pursuant to §302 of the Sarbanes-Oxley Act of 2002.

 

 

Exhibit 31(b)

Certification of Principal Financial Officer Pursuant to §302 of the Sarbanes-Oxley Act of 2002.

 

 

Exhibit 32

Certifications of Principal Executive Officer and Principal Financial Officer Pursuant to §906 of the Sarbanes-Oxley Act of 2002.

 

 

Exhibit 101.INS

XBRL Instance Document

 

 

Exhibit 101.SCH

XBRL Taxonomy Extension Schema Document

 

 

Exhibit 101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

Exhibit 101.LAB

XBRL Taxonomy Extension Label Linkbase Document

 

 

Exhibit 101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

Exhibit 101.DEF

XBRL Taxonomy Definition Linkbase Document

(1)

Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q filed on November 6, 2014 (File No. 0-20957).

(2)

Incorporated by reference to the exhibits to the Company’s Current Report on Form 8-K filed on July 7, 2014 (File No. 0-20957).

(3)

Incorporated by reference to the registrant’s Registration Statement on Form S-1 filed with the Commission on February 14, 1997 (File No. 333-21903).

 

59


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.

 

 

 

Sun Bancorp, Inc.

 

 

Registrant

Date: August 7, 2015

 

 

 

 

/s/ Thomas M. O’Brien

 

 

Thomas M. O’Brien

 

 

President and Chief Executive Officer

 

 

(Duly Authorized Representative)

 

 

 

Date: August 7, 2015

 

 

 

 

/s/ Thomas R. Brugger

 

 

Thomas R. Brugger

 

 

Executive Vice President and Chief Financial Officer

 

 

(Duly Authorized Representative)

 

 

 

60